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

Good morning, ladies and gentlemen, and welcome to the Church & Dwight conference call. Before we begin, I have been asked to remind you that on this call, the company's management may make forward-looking statements regarding, among other things, Church & Dwight's financial objectives, the completion of the acquisition, the financing of the acquisition and forecasts and the impact of the TheraBreath acquisition. As you know, risks and uncertainties involved in Church & Dwight's business, including risks relating to the acquisition and integration of TheraBreath and those discussed in the Risk Factor section in our annual report on Form 10-K and other filings with the SEC, may affect the matters referred to in these forward-looking statements. As a result, the company's performance and the impact of TheraBreath acquisition may materially differ from those expressed or indicated by such forward-looking statements. Church & Dwight will be utilizing both GAAP and non-GAAP financial measures in its discussion of TheraBreath. The company believes the presentation of TheraBreath's non-GAAP financial measures provides useful additional information to investors about the financial performance of TheraBreath and trends in its operations. These non-GAAP financial measures are presented solely for informational and comparative purposes and should not be used as a replacement for corresponding GAAP measures. I would now like to introduce your host for today's call, Mr. Matt Farrell, Chief Executive Officer, Church & Dwight. Please go ahead.

Good morning, everyone. We have some exciting news today. This morning, we announced that we've entered into an agreement to acquire TheraBreath. I'll begin with my thoughts on the acquisition. And then I'll turn the call over to Rick Dierker, our CFO. Rick will provide the financial details, and then we'll open the call for some Q&A. So now TheraBreath. We see TheraBreath as a perfect tuck-in acquisition for our Oral Care business with $100 million of sales projected for '22, high gross margins and the ability to deliver annual sales growth that exceeds our 3% Evergreen model thereafter. TheraBreath competes in the broad mouthwash category, which is a $1.6 billion category. The alcohol-free subcategory has been a steady grower, averaging about 4.5% annual growth the last few years. And TheraBreath's double-digit growth has outpaced the category over the past few years, and the brand's growth has largely been driven by incremental retailer distribution. As many of you know, acquisitions have been a key driver of Church & Dwight's consistently strong shareholder returns. This acquisition meets the company's long-standing acquisition criteria, which are #1 or #2 brand, asset-light, has to grow at or above our 3% Evergreen target and is expected to be gross margin-accretive to the company. So here are the relevant details for TheraBreath. TheraBreath is the #2 brand in the nonalcohol mouthwash category in the U.S. with a 14% share. We expect 15% net sales growth in 2022, which follows double-digit growth for each of the past 3 years. Strong consumption and steady retail distribution gains remain tailwinds for this business. ACV today stands at 68%, and we believe we can continue to drive additional distribution by leveraging Church & Dwight's capabilities, which exceed those of the former owner. Currently, less than 10% of sales are international, so we expect to leverage our international footprint for added distribution. The product is currently co-packed, which makes it asset light, and the gross margin is in excess of our corporate gross margin. We're very excited about adding the Company's 14th power brand, which we expect to fully integrate by mid-'22, while retaining the expertise critical to the TheraBreath business. Next up is Rick.

Thank you, Matt, and good morning, everybody. I'm going to provide a few comments on the transaction, in particular, valuation, synergies and leverage. I'll start with valuation. The purchase price for this acquisition is about $580 million, as you read in the release, and we expect a discounted cash tax benefit of $85 million making an effective price of $495 million. TheraBreath's annual net sales are projected to be $100 million in 2022, and EBITDA is expected to be $36 million, excluding $7 million of transition costs. This represents a synergized EBITDA multiple of 13.7x. In terms of synergies, we expect to leverage our in-house manufacturing footprint, our distribution network, operating discipline and support functions to generate anticipated annual cost savings of approximately $6 million by 2023, made up of SG&A and supply chain savings. We will manufacture a portion of the volume in-house at our oral care facilities. For 2021, our outlook, the acquisition is expected to impact Q4 2021 earnings per share by $0.03, largely due to a onetime transition and transaction costs and some incremental marketing. Turning to 2022, we will give our 2022 outlook in February, but specifically on this acquisition, TheraBreath is expected to be approximately 2% accretive to cash earnings and neutral to 2022 EPS and accretive in 2023. Neutral to EPS in 2022 is due to intangible amortization and interest expense as well as onetime transition expenses and incrementally higher marketing spend. Finally, in terms of leverage, we expect to end the year with debt-to-EBITDA of 2.2x and less than 2x by the end of 2022. And with that, we'll now open the call to questions.

[Operator Instructions] Our first question is from Kevin Grundy with Jefferies. We have Andrea Teixeira with JPMorgan.

Congrats. I was just hoping if you can elaborate a little bit more, Rick, on the cost of financing. And I guess one for you, Matt. You said you expect to produce part of the -- to make it part of your -- of the products. So can you update us on how much you think you can produce? And what is the impact on the gross margin as we go forward?

Yes, Andrea. So on the first one, we're in the middle of it right now, but we probably anticipate the cost of financing to be anywhere between 2.5% to 3%. And then in terms of in-house synergies, right, we said $6 million of synergies by 2023. About half of that is COGS synergies, and half of that is SG&A., and the predominant reason of COGS is because of in-house manufacturing.

And as far as the percentage we're bringing in-house, that really hasn't been nailed down yet. We have some flexibility there. But we have facilities in Canada in Montreal, where we can make the product.

And then in 2022 -- that's helpful -- you expect to expand even more internationally or the 10% will be over the next few years? And then as you go, you're going to be mostly expanding your ACV in the U.S.? And then a final point also on the DTC, I understand that they also sell online. Is that something you want to expand even further? Is that below your -- I believe you reached mid-teens in the last earnings call. You talked about it. What is your goal for TheraBreath?

We said 15% growth in '22, and we would expect at least high single digits to double-digit growth in '23. And as far as where the opportunities are, with the 68% ACV, that means we do have opportunities in certain classes of trade to expand that. And those Andrea, would be food class trade dollar and club. And as far as international goes, the product actually is in many major markets like Europe or North America, even Asia, but at a very small scale. So that also is an immediate opportunity for us to expand. And online is 20% today of the business. So it's well developed there. We can expect that will grow in proportion to the rest of the business.

Super helpful. And the 20% is mostly their own? Or there's -- what is the balance between...

No, that will include Amazon and also their own therabreath.com.

Yes, and retailer.com as well.

Yes.

And we have Kevin Grundy with Jefferies back online.

You guys hear me okay?

Yes.

Sorry about that before. Rick, first one for you. Maybe just talk a little bit about cost synergies, areas of cost synergies, visibility on those timing. I think you indicated it'll take a couple of years to reach the $6 million run rate. And then maybe any potential areas of upside you think may present itself?

Yes. No, I think we partially answered that with Andrea. But in total, we said $6 million by 2023. About half of that is supply-chain-related. And when you think about supply-chain-related synergies, it's really a portion of the volume, right? We have great co-packer partners, and we're going to keep those guys, but we're going to also bring a part of the volume in-house. So a piece of the COGS synergies are in-house manufacturing. A piece of it is going to be distribution, right? We serve almost 100% of the same customers and retailers. So from a distribution network perspective, that's also synergy. So those are some detail. And of course, we buy a lot of bottles as well from a procurement perspective. So that kind of gives you some color. We're going to get about $4 million of the $6 million by 2022. So actually pretty rapidly.

Okay. That's helpful, right. And then maybe just talk about the price point of the product. What sort of gets you guys most excited when you think about the total addressable market awareness at this point, trial conversion rates things like that? Maybe just comment also on the product mix. You highlighted it seems to be predominantly on the mouth rinse side. But when I look at the product offerings on the website, it does seem like there's other products in oral care that are also part of the portfolio. Maybe just touch on that as well.

Yes. The way to think about it, Kevin, is that 85% of the sales are mouthwash, and the remainder would be things like toothpaste or toothbrush or gum or lozenges, those types of things. So what we're really going to be driving is the mouthwash. Now the mouthwash itself is a premium price. So you want to do some comparisons. The retail is at about $7.67 on average. For a comparably priced major brand, it would be $3.50 to $4. It is clearly a premium mouthwash. And retailers really like the presence of a successful premium brand in the category. And that's been proven out by the amount of distribution gains that the brand has gotten over the past 3 years. So we're really optimistic that, that 68% ACV is going to grow rapidly in the next 18 months.

The only thing I would add to that, Kevin, is also our international growth, right? We think there's a lot of upside. And as an example, when we bought the WATERPIK business back in 2017, we've more than doubled that business in 4 years.

Okay. One last one, just where do you think the ACV can go? I mean I recall the company has done deals in the past where the ACV has been lower so I guess the thinking perhaps there's been more of a distribution opportunity domestically, at least in scan channels. Maybe just comment on that where you're kind of catching this one in terms of the product development and where you think the ACV can go relative to your other personal care brands like TROJAN and ORAJEL, et cetera.

Yes. I think the benchmark would be, if you would just look at some of the major brands cycles like Crest, they're between 90% and 95% ACV. That would be -- I don't think we'll ever get -- but I do think we'll be getting into the 80s, Kevin, in the not-too-distant future.

Our next question is from Rupesh Parikh with Oppenheimer.

I guess, first, in terms of the 15% sales growth that you guys are expecting next year, if you can remind us what are some of the key drivers there. And then for this brand, like are there any COVID impacts, positives or negatives, that have impacted the brand?

Yes, we didn't really see a big drop for this brand in 2020. So that's not a worry for us, Rupesh. What was your other question?

Yes. So the 15% sales growth next year, just give us some color the drivers.

Well, I mean, the biggest one is going to be distribution. The second would be larger sizes, which the brand doesn't have right now, and that would be incremental shelf space. And then, of course, international, which we already described, where we have a foothold in a lot of different markets, but it really hasn't been developed well. So I would say those are the 3 things I would point to.

Yes. And just strong consumption overall, right? This is a problem solution brand. If you just look at consumption without even ACV increase is really strong, same-store growth.

Yes. And one of the things we plan to do next year is to dial up the advertising, more than they had spent in the past to drive the top line. So that's in the plans as well for '22.

Okay. Great. And then maybe just one follow-up question. What does the competition look like in the category, both in the U.S. and internationally, right now?

Yes. Well, if you look at alcohol free, I said that TheraBreath is the #2 brand at 14% share. The #1 in the category is Crest at 34% for alcohol-free. Listerine would be 12 and ACT would be 11%. So that gives you an idea. It is a fragmented category, but this brand has come on strong in the last 3 years.

Our next question is from Steve Powers with Deutsche Bank.

First, just back on international. Are there certain markets where you see more immediate prioritization relative to how you framed a relatively broad footprint today?

Yes. I think that because of the strength of our Global Markets Group, I think that Asia would be probably #1 from a region standpoint, where we're going to go.

Okay. Okay. And then I guess, just the brand, as I look into it, has a long history. I think it was founded in '94.

Yes.

So maybe just a little bit more context around why the recent success, just what's driven it? What kind of drove an inflection more recently? And then somewhat related, I guess, just your perspective on the importance of Dr. Katz who founded the brand, whose name features pretty prominently on the packaging. Is his involvement in the brand important? And if so, do you have a relationship there contracted as part of the deal?

Yes. No, we have a good relationship with Dr. Katz. And certainly, it was his efforts over the past -- over 20 years that drove the brand, and he stuck with it for a long time and finally caught fire last 3 or 4 years. I do think that the breakthrough is probably because their packaging really pops. Over time, just the accumulation of the marketing and the advertising has created a greater awareness with respect to the brand. So -- and we do have a relationship with Dr. Katz going forward. So we think we're well positioned to drive it in '22.

Our next question is from Jason English with Goldman Sachs.

Just a couple of quick questions. First, on the guidance revision for the fourth quarter. Can you unpack it a bit? Because I know in the press release, you cited a number of factors. I'm sure interest expense is going to be one. This is yet synergized, but you seem to also be including in there some transaction expenses that I think most will look at as one-timers. So could you parse out the onetime expenses that will probably exclude versus the ones that are maybe ongoing?

Yes. I mean we tried to give a good sense of there's 3 things that are going to impact the $0.03 drag in 2021. It's transition costs like IT integration, like severance, as an example, partially. Transaction costs are like our banker fees, for example, or legal fees. And then finally, there will be incremental marketing spend as well. So I would probably say about 1/3 of that is really around transaction costs, Jason.

Got it. And the other 2/3 is like the interest in the higher marketing?

And some of the transition costs, yes.

Okay. Okay. So at least more than half it's one time, it sounds like. And sorry, unrelated housekeeping item, but as I look to include this in my model, it caused me to go back and scrub my cash flow statement, and I have earmarked in the fourth quarter this year, a reasonably chunky earn-out related to FLAWLESS that I think what I've earmarked is probably too high. Can you give us an update on the expected cash flow related to earn-out in the fourth quarter?

Yes. I think we mentioned a little bit in the last release. We had made a final earnout adjustment in the Q3 quarter-end release, and we expect there to be no further earn-out adjustments to be necessary and no cash flow impact.

Got it. So I need to 0 that out is what it sounds like, correct?

Correct.

Our next question is from Olivia Cheang with Raymond James.

Wondering how the addition of TheraBreath allows maybe your ability to expand beyond sort of build an entire oral care regimen if it can help growth in other brands within the oral care portfolio. And then also your ability to expand TheraBreath, excuse me, beyond the core that it has right now you mentioned 85-15 in terms of the split. Do you think that 15% gets bigger over time? Or do you think it's more around the 85%?

Yes. Initially, the efforts are all around the 85%. I think sometimes companies get in trouble when they fragment their efforts. So the mouthwash part of the business is where we're going to put all of our efforts. As far as the co-branding, yes, that's always an opportunity for anybody that acquires a brand, but we wouldn't tip our hand now with respect to where we think we might be able to use that brand in other categories.

Got it. And then in terms of the distribution expansion that you have in '22, how much of that is already locked in, relationships already there before you entered? Or is it almost all things where you expect to utilize your relationships in order to get shelf space for the brand?

Look, I'd say the -- we have a great deal of confidence in hitting that 15% next year. Yes, some of it may already be in place. Some is not, but the indications on the part of the retailers are positive. So yes, we feel good about 15%.

And our next question is from Kaumil Gajrawala with Credit Suisse.

If I can follow up on some of your commentary on competition. Can you maybe talk a little bit about we've obviously seen a bump on what was the growth rate very recently for TheraBreath. Has the competition seen a similar growth rate in the alcohol-free space? Or is this unique to this brand?

Well, I'd say the #1, Crest, has done well in alcohol-free, but the other brands have not performed as well, at least in the most recent 52 weeks. So I'd say it's not entirely unique to TheraBreath. I did mention that the category has grown on average for the last 3 years, 4.5%. And TheraBreath has grown double digit in each of those 3 years. And I think one of the reasons why is that it is a different product in that it targets bad breadth germs, and it has an ingredient that creates oxygenation in your mouth, which inhibits bacteria growth. So it's kind of a different mechanism than other nonalcohol or even alcohol-related products on the market. So I think the point of differentiation is really helping.

I see. Interesting. Is that a proprietary formula? Or is there -- are those ingredients that are readily available that someone else can try to replicate?

Yes. No, there's no IP related to the products. So there's no patents, but there is know-how with respect to the manufacturing process. And as far as the ingredient goes, there's nothing unique about it other than it is -- it's 1 of only 2 brands that use it in the entire category, whether it's alcohol-free or alcohol-based.

Okay. Got it. And then just maybe final question on breaking down the growth a little bit more. You mentioned they're double digit with a significant increase in distribution. Can you maybe talk about how velocities have been trending during that period of distribution gains?

Yes, they've been doing well. I mean it's when you get distribution gains in '19 and the product turns, you get more distribution in '20, more in '21. So it's been feeding on itself over the last few years. That's one of the reasons why we have confidence we're going to expand distribution next year. So success begets success.

Our next question is from Bill Chappell with Truist Securities.

Just a couple of follow-ups Help me understand kind of the distribution today. I mean 68% ACV seems fairly high or I guess the $86 million in revenue seems fairly low for 68% ACV. So is it -- right now you only have kind of 1 or 2 SKUs, and you think you can double or triple that per store? And with that in mind, I mean, I would imagine the company knows what the planogram resets look like for the spring, and that's kind of baked into your 15% outlook. Is that a fair statement?

Well, you don't know everything for the spring, Bill. And as far as ACV goes, we do expect greater facings as well going forward. So you might be included in ACV, maybe a couple of facings, but if you -- this is what the company likes to call a rainbow of color on shelf. So to the extent we can get more facings it's going to increase the sales even in places where we already have distribution.

So you do or not sure if you'll get into the dollar club or grocery more exposure in the spring, that's too early to tell?

Bill, we're -- you're getting into the weeds here, I think. We've obviously -- only the company has spoken to the retailers, we have not. The -- because this isn't going to close until the end of the month. However, we are aware of the conversations that the brand has had with various retailers, and that's what gives us confidence for next year.

Yes. And I think it's also over the long term, we expect to get this brand up in the 80s for ACV is kind of what the comment I made.

Got you. No, I just -- I would think it's more to TDPs, but we can take that off-line. Second, can you just maybe talk a little bit about the -- on the revenue for next year, do you plan to get out of the non mouthwash products and just focus on mouthwash? Or will that -- is that still baked into next year's numbers?

No, that's still baked in, Bill. So we're not abandoning those, but we do think that the big opportunity is on the mouthwash side. That's why we made my earlier comment.

Sure. And then finally, just a little background on kind of -- and you might have said this before, on the transaction. I mean, how long you've known them? Was this an auction? I imagine that this type of growth in this category, there are a lot of interested parties.

Yes. Yes. No, it was an auction process. And it began, I would say, over the summer and concluded in the wee hours of the morning on Thanksgiving day.

And our last question is from Chris Carey with Wells Fargo Securities.

Can you just confirm whether or not this is going to be included in the incentive compensation for gross margins for next year?

Yes, Chris, I mean, what we'll do is we'll sort of plan like we always do. And that plan will include sales, gross profit, gross margin, cash. Whatever we get from this acquisition would roll into 2022 when we give our full year outlook and provide our full year plan in February.

Okay. Got it. And just the growth outlook, clearly, the brand is seeing inflation as well. It's got very good margins and synergies. Are you going to need to take a level of pricing that you're seeing in the rest of the portfolio? Or is it too early to say?

Yes. It's too early, Chris, to address that question.

Okay. And then one final one. Just there's a bit of certainly a pharmacy kind of in the dental line where it would appear anyways. Is the professional channel a place where this brand is today? Is that an opportunity? You mentioned that it's got good ACV, it's 68%. It's clearly not relevant, but the distribution of the [indiscernible] organization that's going to be additive. So anyways, the question is really about, yes, retail, but is professional channel an opportunity? Or is it already there today?

Yes. And potentially, remember, we have the WATERPIK brand, so we call on all the high-volume dental offices in the United States. So that's a potential avenue for us, but that's not something where that's foundational to our plans for '22 or '23.

That concludes the Q&A session. I would now like to turn it back to Mr. Matt Farrell.

All right. Hey, everybody. Thanks for joining us today. It's a big day for us of acquiring our 14th power brand, and we'll talk to everybody with our -- when we have our fourth quarter results at the end of January. So thanks for joining us today.

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