Church & Dwight Co., Inc. (CHD) Earnings Call Transcript & Summary

Thank you. If we could all find our seats for our next presentation, make your way in. We're thrilled once again to host the management of Church & Dwight, including CEO, Matt Farrell; and CFO, Rick Dierker. I'd like to take this opportunity right now to thank them for sponsoring the break this year and for their longtime support of CAGNY. Thank you very much, guys. Church & Dwight just completed another great year of their evergreen business model, one that's built around growing large, powerful premium brands, 12 of which now comprise 80% of their sales. They aren't here by accident. Of those 12, only ARM & HAMMER was part of its long heritage dating back to John Dwight's Kitchen in 1846. The rest were acquired just since 2001, a period in which management has delivered strong double-digit returns to shareholders. And their secret is simple. Not easy, but simple. They've used quick decision-making, easy communication and an ability to adapt to outperform virtually all peers, but certainly, their larger peers. Here to tell us more is CEO, Matt Farrell. Matt?

All right. Hey, thank you for that introduction. Let's get going. We have the safe harbor statement. I encourage everybody to read that. And the short story is that 2019 was a terrific year for us. Many of you are long-term shareholders, so you know what our evergreen model is. And evergreen model is healthy right now. The company is becoming more digitally savvy. We have lots of great innovation both past and in the future, and we feel really good about 2020. U.S. growth is going to be steady. We've talked about our international juggernaut in the past. That business has been growing 9% annually for the past 5 years. I'll tell you a little bit more about that. And our animal productivity business is becoming more balanced. Okay. And we've delivered outstanding returns to our shareholders for many, many years, 1, 3, 5, 10 years. And that 8% in 2019 was on top of a 30%-plus number in 2018. All right. Who we are? We have an evergreen business model. Everybody in our company knows this, and well, our long-term shareholders as well. 3% top line, 8% bottom line year-after-year. And if you say, how has that been working out for you? You look at how's the top line been going, at 3% evergreen miles been 3.6% over the past 10 years. And the way we arrive at the 3% is the following algorithm: 2% from the U.S., 6% from international and 5% from Specialty Products. And 12 of our brands -- we have 12 power brands and those 12 power brands make up 80% of our revenues and profits. And you've heard in the opening, we have a very diverse portfolio. Pretty quick balance between household and personal care, and our Specialty Products business makes up 7% of the total. And we operate really well in any economy. We have -- 63% of our products are premium and 37% are value. And we have a long runway ahead of us for international. Even though our international business has been growing 9% annually for the past 5 years, it's still only 17% of the business. So a lot of growth to come from international. We compete against much larger companies. We like to say we operate in the land of giants, but we think we have a competitive advantage in that because of our organizational structure. We move very fast, we adapt very well to changes in the marketplace and we have a long history of growth through acquisitions. If you look from 2004 to 2019, over 15 years, we added $3 billion to the top line. And if you look at the bottom of the slide, you will see all those -- the brands that we've acquired over that time. And we're very fussy about the businesses that we'll acquire. So we only acquire businesses that are #1 or #2 in their categories. I got -- if they have a gross margin that's equal to or higher than our corporate gross margins, which is around 45%. We'd like to be asset-light, so we don't like to acquire businesses that have plants. We like to leverage our existing supply chain footprint. And whatever we buy needs to have a sustainable competitive advantage. And as you heard at the opening, 11 of our 12 brands have been acquired since the turn of the century. And the short story with us, with respect to acquisitions, is we have 12 brands today, 20 tomorrow. Now why are we winning? We're in the right categories, we know how to grow share, we have low exposure to private label, we're growing online and we have products that are on trend. As far as the categories, categories are very important to the health of any company that is in front of you this week. It has a great deal to do with success of the company. So if you look at the weighted average category growth rate for the past few years, you see it's around 3%. And we know how to grow share. So we're one of the few companies that gets up in front of you. And every quarter, we tell you how we are doing with respect to our power brands. Are we growing share or not? So we had a really spectacular year in 2019, with 10 out of our 12 power brands either held or grew share. And we had a good run in laundry over the past few years, and we get lots of questions about that. Since 2016 to 2019, we've added 120 basis points of share. And now, as far as private label goes, low exposure. The weighted average private label share of our categories is 12%. These are the 5 categories that we have the most exposure to. You can see from the lines on those pages, it's pretty stable. And we're growing online. If you go back to 2015, we were in the fourth quartile as far as online sales as a percentage of total sales, 1%. And this past year, we hit over 8%. We think we'll be over 9% in 2020. And we have lots of products that are #1 on Amazon. As far as products being on trend, and trends we focus on today would be convenience and self-care. Let me start with dry shampoo. So we have the #1 dry shampoo in the world. 2/3 of women do not wash their hair every day. And in the U.S., 13% of women over the age 18 use dry shampoo. It means a lot do not use dry shampoo. So there's a lot of runway ahead of us here as far as household penetration. Only 7.5% household penetration in the U.S. for dry shampoo. And just to dimensionalize that, dry shampoo has been in the U.K. for decades. And if you contrast that the U.K. consumption of dry shampoo to the population, in relation to the U.S., the dry shampoo category is going to double to $450 million from where it is today. And we have a new product that we're launching right now. This is a waterless cleansing foam. 3/4 of women have normal to dry hair, so we are trying to attract more women to the category. So we're going to run a spot here for you now. [Presentation]

Okay. Let's move on to another convenience trend. It's waterless hair removal. So we acquired FLAWLESS this past year. It's the #1 women's electric hair remover for face, brow and legs. And the trend there is simply it's less time. U.S. women have just less time to take care of their grooming needs. And if you look at -- again, look at household penetration, it's 2% in the U.S. and it's less than 2% internationally. So we think there's a tremendous amount of growth ahead of us in this category. And we have another new product we're launching right now called FLAWLESS Nu Razor. This is a waterless whole body hair removal, use anywhere anytime, and it's sustainable as well. Okay, self-care, water flossers. So we have the #1 powered flosser recommended by the ADA. And if you use a WATERPIK, it's 2x more effective than brushing and string flossing. So gum health is in vogue right now. In the United States, 44% -- 48% of households have a electric toothbrush, but only 22% have a water flosser. So we use that to contrast, well, how high could water flosser household penetration become in the U.S. And then if you look at internationally, or Europe, only 3% to 5% household penetration. So again, a lot of runway ahead for this particular brand. Next up is Gummy Vitamins. So we have the #1 adult Gummy Vitamin. And this is an easy one. The gummy form is just more appealing than pills and capsules. And if you look at how the category has grown, 3% of vitamins, minerals and supplements were in gummy form in 2012 and today, it's 18%. And we definitely stepped up our innovation over the past year. If you look at 2017 and 2018, we had 7 and 5 new product launches; 2019, 22. We've got 17 more in 2020. And this has really helped our consumption in 2019, and we're off to a strong start in 2020. And finally, hair thinning. So we have the #1 hair fiber and we have the #1 hair-thinning supplement. And a lot of people in this room would know this. 40% of men and women have noticeable hair loss by the age of 40. And TOPPIK, you -- with the hair fibers, you get instant result if you have thinning hair. And I'm going to show you a spot for VIVISCAL, which is the supplement part of the business. [Presentation]

Okay. Moving on to master brand. We have $4.4 billion in sales in Church & Dwight, and over $1 billion is ARM & HAMMER. So this is our billion-dollar brand, which we take very good care of. Last year, we announced a new campaign called More Power To You. You might say, well, how is that working out? It's working out great. If you look at the stat on this page, there's a 3% increase in households that are buying ARM & HAMMER products. And they're actually spending more money as well, 5% more on ARM & HAMMER products in 2019. So this is one campaign that's been a real winner for us. I just want to show you a couple of digital spots with respect to ARM & HAMMER. I'm sure many of you haven't seen this, but just kind of fun spots for how we're showing up online. [Presentation]

One more for you. This is in personal care. You can run this one, too. [Presentation]

Okay. All right. Next one I'll tell you about is a new product we're launching right now called ARM & HAMMER CLEAN & SIMPLE. And the trend here is that consumers are really focused on what's in the products. And they're thinking about what am I my putting into my body, what's on me and what's around me. So we came up with a laundry detergent that only has 6 ingredients plus water. You might say, well, "Okay, so what?" Well, the so what is that the most laundry detergents have 15 to 30 ingredients. And this is a label. You'll see a list. There's 15 things crossed out there that we were able to formulate the product without them. And there's really no other detergent on the market today that has what we call no compromise, powerful clean with a very simple ingredient list. And you might say, so what about efficacy? Well, the CLEAN & SIMPLE is just as powerful as our best laundry detergent with this ARM & HAMMER with OxiClean. And if you look at the back label, you will also see that we've got the Safer Choice designation from the EPA, which is a very high bar to meet. Some other things you will see on there as well is that it's made with 100% certified renewable energy. And I'll also tell you a little bit later on that we've been planting lots of trees in the Mississippi River Valley over the past few years. All right. It's a very good story, but how did you come up with this? So there's a picture on the slide of Archie Gupta. So Archie works in R&D in Princeton. So Archie was shopping with her daughter and sort of picked up an energy bar, you see on the slide there RX. And Archie, being a chemist, said, "I think I can do this." So she went to the head of R&D, Carlos Linares and said, "Hey, how about you give you some funding. I'm trying to figure out if I can replicate what RX did with laundry detergent?" And he said, "Yes, go for it." And she did. So it's such a great story. And I want to show you a spot for CLEAN & SIMPLE. [Presentation]

Okay. And now the international story. It's a great story. If you go back to what we said our algorithm was, if we're trying to grow 3% annually, 2% from the U.S., 6% international and 5% for Specialty Products. The business has spent $0.5 billion in 2014, now it's $0.75 billion in 2019. So we really accelerated the growth in -- starting in 2015. Steve Cugine took over of the business then, added lots of really talented people around the division. And it shows up in the numbers. And here are the numbers. You can see them live from 2015 to 2019. We got a target of 6%, but we're doing a lot better than that. And so where is it coming from? Take a look at this around the world: Canada, Europe, Mexico, Australia. But the biggest business right now is the Global Markets Group. And that's the business that exports our product to 130 countries around the world. And the Global Markets figure, you could see the CAGR there, it's been 19% since 2014. And on the right-hand side of the slide, it'll give you a sense for which brands are the ones that are driving the growth. And it's not just the Global Markets Group that's growing. You see sort of 2019 numbers, our subsidiaries in countries grew 5% in 2019. We have been making lots of investments over the past few years. So in China, we hooked up with a company called Shanghai Jahwa, which is a public consumer products company. In Southeast Asia, we have an arrangement with DKSH, which is a master distributor. We also opened an office in Singapore. We have a new legal entity in Germany. And in Central America, we opened an office in Panama. So lots of investments, not only in country but also in technology and also in training and providing support for our distributors. So to just kind of wrap up. We have -- there's a lot of runway ahead for our existing brands. So the brands most recently that we acquired, WATERPIK and FLAWLESS, you can see just from the household penetration we looked at earlier, there are lots of runway ahead internationally. Global Markets Group, again, double-digit growth. We expect that business to double again in the next 5 years. And we continue to make investments in markets. One last thing, our operating margin expansion -- operating margin is going to expand in the future. You see that 10.8% operating margin is very low in comparison to the company. That's because we have been making investments over the past few years. We're going to start getting leverage on that starting in 2020 and beyond. Okay. Animal productivity story is next. We expect to have 5%. That's our long-term algorithm for that business. That has not been working out for us more recently, and I'll tell you why. Here, it's been a cyclical business. So if you look 2011 to 2014 to '17 and '20, so there's a top every 3 years. And we said, well, what is driving that? It's because the biggest business within Specialty Products is in animal productivity business. So you get the same chart on the top of the page. And on the bottom of the page, you see milk prices. So you see there's 4 circles down there. So as milk prices improve, the dairy economy comes back, and then it affects the results. But seeing that over time, we said, we have to expand into other species. And the reason for that is because of world population growth. There would be 2 billion more people on the planet by 2050. So we said, we're going to have to get into cattle, swine and poultry. The question was how? Antibiotics are out of favor. In fact, there's been a 40% decrease in the use of antibiotics since 2015. We had been in nutritional supplements. But what we've done over the past couple of years, we've got ourselves into prebiotics and probiotics for cattle, swine and poultry to get us -- move us out from simply being dependent upon dairy. So today, 2019, 27% of our sales are nondairy in the animal productivity business. So we got a ways to go here, but this is going to help balance this out over time and give us other avenues for growth. And here's a fun fact. Lots of people will say, "Hey, why do you want to be in dairy? Isn't milk consumption declining in the U.S.?" Absolutely. So you can see the chart on the page is the blue line is fluid milk consumption, but the yellow line is the cheese consumption. And you need a lot of milk to make cheese. It will take 10 pounds of milk to make 1 pound of cheese. So there is an offset there, which means that the dairy industry still is healthy going forward. So our -- all of our products within Specialty Products are branded, ARM & HAMMER. We're definitely on trend. We're moving into other species, and we think the global growth is going to be the underpinning for us in the future. And here's how we run the company. So you know we have brands consumers love, so we're very focused on 12 of those brands. We are a friend of the environment, I'm going to tell a little bit more about in a second. And we have highly productive people. I think that revenue per employee is an underappreciated statistic among investors. Leverage assets, we would like to be asset-light. You can see that also in our acquisition criteria. And if you do those 4 well, you get really good returns. But -- because we're able to leverage assets, we get -- leverage acquisitions, we get really superior returns. You know the brands that consumers love. These are the 12 displayed there. As far as friend of the environment, that's important because 83% of consumers will say that they are mainstream or extreme green. Now we've been a friend of environment for a long time. If you go back to the 19th century, 1888, we were putting bird trading cards in our baking soda boxes. And then in the early 1900s, we were using recycled paperboard in our cartons. First corporate sponsor -- the only corporate sponsor, frankly, of the first Earth Day. And then more recently, we started to focus on renewable energy in 2016. And in 2018, 100% of global electricity supplied by renewable sources. And also, 3 years ago, we started planting trees. In this past year, we planted 5 million trees through Arbor Day. And our goals are to reduce water consumption by 25% by 2022. We're going to recycle a whole lot more. And we want to be carbon neutral by 2025. What that means is that we offset 100% of all the CO2 that we put into the atmosphere. And we're getting the recognition for that as well. If you read those across the page, you don't apply for these organizations, but we have been recognized for the good things that we've been doing. And here's the statistic with respect to people. So we have -- our revenue per employee is about over $900,000. So on our way to $1 million. And this would give you an idea of how our company is organized in comparison to our competitors. And [ our incent ] is very simple. We have only -- we have 4 targets: net revenue, gross margin, cash from operations and EPS, 25% each. And when you have gross margin and when you have cash from operations in your incentive comp, it promotes financial literacy within the company. So our employees know what gross margin is and cash from operations. And gross margin is in every -- we have an all-employee bonus. This is one of the components. So it does promote financial literacy and alignment. And finally, there's lots of ways to get the gross margin, and we're working all of those levers. So we have a good to great program, which is what we call our continuous improvement program. Supply chain optimization, we're continually investing in our plants. When we launch new products, the new products are meant to have a higher gross margin than the products that they're replacing. And finally, we have acquisition synergies. When we buy a business, very often, we're able to expand the gross margins over time. Now Rick is going to come up and say a little bit about the financials.

All right. Thank you, Matt. Good morning. We're going to go through 3 things: 2019, how we finished; 2020 outlook; and then we'll talk about capital allocation briefly. But first, the evergreen model. Matt alluded to it. 3% on the top line, 8% on the bottom line. And the detail of the evergreen model is really gross margin expansion, SG&A leverage, and that gets to operating margin expansion and 8% EPS growth. So for this full year, we were at 4.4%, 4% domestically, 9% internationally and went backwards a little bit due to dairy pricing in SPD. But gross margin, we returned to growth in a big way, 110 basis points. And if you strip out the acquisition impact, we were up 60 basis points. Marketing was up as we invested in our brands. That was higher than our outlook. So we were able to reinvest in our business. And then SG&A was up largely because of acquisition-related costs, like amortization and transition services agreement. EPS was better than our outlook at 9%, better than our evergreen model as well. And then cash was stellar, $865 million; free cash flow conversion of 128%, and we'll get into cash in a minute. So 2020, range of 7% to 9% EPS growth, with organic sales of 3.5%. And the way to think about that is 3:7:3 for the divisions, and I will talk about how much momentum we had as we exited 2019. Really, that number is about 4.5%, but I'll do a walk-down in the next slide. Gross margin is up 10%, but if we kind of make it a comparable margin year-over-year, we're up 50 basis points. And then marketing is up 10 as we invest behind our new products. Operating margin is up as well. And EPS is, again, 7% to 9%, which is right in line with our evergreen model. Cash is very strong. So here is how to think about the organic outlook. We -- our run rate in the back half of '19 was around 4.5%. And as Matt said, our categories are strong, growing 3%. We continue to take share gains, 10 out of 12 power brands. And so our run rate is around 4.5%. It gives us the leeway to make decisions, and we're going to get out of private label vitamins over the next 2 years, and that's a drag on organic sales. And then we're also lowering promotions on OxiClean laundry. So those 2 things add up to 100 basis points, and that's why we're at 3.5%, which is still top tier. As far as EPS, 8% is our evergreen model. We have 2% from our recent FLAWLESS acquisition, so accretion. And then tariffs is a negative drag of 1%. That's the 4 -- Tier 4 list that went into effect largely for FLAWLESS and SPINBRUSH. And then market investments. As we increase our marketing spend by 10 basis points, the drag on EPS is around 1% and that's how we get to 8% for the year. So we have a long track record and history on focusing on gross margin. We believe gross margin drives a lot of value, at the end of the day a lot of cash. And Matt told you that gross margin is one of the 4 metrics that's in our incentive compensation system, which is very unique in the industry. Organic sales growth. Again, Matt showed this slide, 3.5% over the 10 years, right? But what's unique about it is over the last 10 years organic growth is made up of 2 things: volume-driven growth and then price/mix. And for a long time, our volume-driven growth has been between 4% and 4.5% on average. And then price/mix brings it back down to around 3.5% over the last 10 years. In 2019, we had a bit of an inflection point as we took a lot of the price increases, and so price/mix was actually the leader. In 2020, of the 3.5% organic growth, we think about 50-50 will be between volume and price/mix. So very balanced. Marketing spend, we're one of the top 20 advertisers within CPG. We spend hundreds of millions of dollars of margin, and we -- and it's working, right? Our share gains are strong. SG&A on a reported basis is up a little bit, that's largely due to acquisition costs, like amortization. When you strip that out, we're flat, which we're very proud of. And then EPS growth, we've been at high single digits -- or double-digit growth when we had tax reform. But high single digits for the last couple of years, and we expect no different this year. Now free cash flow conversion. This is really what makes Church & Dwight different. We're 124% in 2018, the peer group on average is 85%. Most peers target 90%. This is a new slide this year. It's a track record, right? It's not 1 year, it's not 2 years, it's every year. Over the last 5 years, we've averaged about 126% free cash flow conversion, and our peer group is around 90% to 95%. And we do that in a couple of different ways. Number one is we have strong cash earnings, right, gross margin expansion. We have high sales growth, so it leads to cash -- earnings growth. The other way is the balance sheet. So we have strong working capital management. We've gone from 52 days cash conversion cycle down to 18 days. And if you strip out the last 2 acquisitions we've done, WATERPIK and FLAWLESS, that have Chinese supply chains, we've really made great progress all the way down to 7 days. And when we buy businesses, it resets our baseline to 18 days. And we have plenty of room to run, and we continue to do that. We have a strong balance sheet. We ended the year about 1.9x levered. We're going to end 2020 about 1.5x levered. So that means we have a lot of dry powder, about $2.8 billion with flexibility. And I'll talk about that with the capital allocation slide, which is right here. So number one is TSR-accretive M&A. And as Jon Feeney said in the introduction, right, we only had 1 power brand in the year 2000, right? For most of our history, we had 1 brand, ARM & HAMMER. But since 2001, we've acquired 11 of our 12 power brands through acquisition. And we expect that to be no different in the future. Number two is debt reduction. Of course, as we continue to delever down to 1.5x by the end of 2020, that will move down the list. And the other 3 and 4 will move back up. New product development. Number four, CapEx for organic growth and our productivity program. And then number five would be dividends and buyback. So we're not a capital-intensive company. We've been less than 2% of sales for a very long time, and 2020 is no different. And then as the dividend increases, 119 consecutive years of dividends. I heard P&G earlier say that only 10 companies in existence have been around and paying a dividend longer than 120 years, so we're ready crack that as well. So 5.5% dividend increase. High annual dividend growth rate versus peers. This is a great slide. Over the last 3 years, we've averaged 8% dividend growth, which is almost double that of the peer set. And with that, we'll turn it back over for questions. Thank you.

Okay. Bill, you're up.

Just talking about Tide -- I mean, not Tide -- about ARM & HAMMER -- CLEAN & SIMPLE.

Up late last night, Bill?

Still doing work. Back to my question. Obviously, at your Analyst Day a week ago and today, you're very, very excited about the launch. So can you kind of give us a gauge of how this compares to prior launches, either in laundry or elsewhere in terms of what you expect out of it? And also, I know it's early stages, but kind of what competitive response, getting back to Tide simply, that you've seen or you might see over the next few months?

Yes. So competitive response to CLEAN & SIMPLE is going to take a while because, as I said, most laundry detergents have 15 to 30 ingredients. So you have to reformulate in order to get a product on the market. So it's really the only mainstream brand that's out there. And it's not being positioned as a niche. It's positioned as mainstream. As far as how big it could be, we think it could be as big as any launch we've had historically. So if you want to put a number on that, from a gross sales standpoint, it'd be at least $50 million. But gross sales and net sales are different numbers, as you know. So there's a lot of promotion that happens in the first year to attract the consumer to the new product. But we feel great about it, and we think it's a breakthrough. It differentiates the product. Yes, Joe?

Thanks, Matt. First, what went wrong with OxiClean, the laundry detergent that you're pulling back on promotion? And secondly, on FLAWLESS, maybe a little bit of an update there in terms of the opportunities you see in that business now roughly 6 to 9 months post-acquisition?

Yes. What's your first one, OxiClean?

Yes.

So actually, we launched into OxiClean Liquid Laundry a number of years ago. And shortly after we launched, Henkel showed up with Persil in the category. So it was unexpected. And we had been promoting quite a bit in order to attract the consumer to this premium laundry detergent, OxiClean. And I think we had trained the consumer to think of it not as a premium laundry detergent because we were promoting so much but more of a mid-tier detergent. So we decided to pull back on that to make it more profitable. We're not sad about launching into premium laundry detergent with OxiClean over time because as I mentioned that, more recently, that our share of the stain fighter category was 42%. So that's the other category at the end. That's our -- really bread and butter for OxiClean, and today, it's 56%. So all of the advertising promotion around OxiClean Liquid Laundry has haloed the entire brand. So net-net, it's been a win for us. And your other questions is with respect to FLAWLESS?