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 Hero acquisition. As you know, risks and uncertainties involving Church & Dwight's business, including risks relating to the acquisition and integration of Hero and those discussed in the Risk Factors section in our annual report on Form 10-K and other filings with the SEC may affect results referred to in these forward-looking statements. As a result, the company's performance and the impact of Hero acquisition may materially differ from those expressed or indicated by the forward-looking statements.
Church & Dwight will be utilizing both GAAP and non-GAAP financial measures in its discussion of Hero. The company believes the presentation of Hero's non-GAAP financial measures provides useful visual information to investors about the financial performance of Hero 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 of Church & Dwight. Please go ahead.
Good morning, everyone. We have some exciting news today. This morning, we announced that we entered into an agreement to acquire Hero Cosmetics, Inc., the owner of the Mighty Patch brand and other acne treatment products. I'm gonna begin with brief comments on the acquisition, then I'll turn the call over to Rick Dierker, our Chief Financial Officer, and Rick will provide the financial details. We'll open up the call for some Q&A. Now Hero. We're excited about adding Church & Dwight's fifteenth power brand. This acquisition meets the company's long-standing acquisition criteria. Number one or number two in a category, asset light, a growing brand, and expected to be gross margin accretive to the company. Acquisitions have been a key driver of Church & Dwight's historically strong shareholder returns.
We see Hero as a perfect tuck-in acquisition for our specialty hair and skin portfolio, with $150 million of sales projected for 2023. Future growth will be driven by distribution gains as the brand expands into other retailers and expands to a more international footprint. Here are the relevant details for Hero. Hero is the number two brand in the acne category in the U.S. with a 14% share. The patch form subcategory has grown to 18% of the acne category as more consumers transition away from lotions and ointments to a patch solution. We expect 15% net sales growth in 2023. There's a distribution runway for Hero, which currently has only 8% ACV compared to the 99% ACV of the broader acne treatments category.
Currently, Hero products are not sold internationally, so we expect to leverage our international footprint for and distribution, and we expect to close the acquisition in the Q4. Next up is Rick with some financial details.
Thank you, Matt, and good morning, everybody. I'm gonna provide a few comments on the transaction. I'll start with valuation. The purchase price for the acquisition is about $630 million, consisting of about $570 million of cash and $60 million of Church & Dwight restricted stock. Hero's net sales for the trailing twelve months through June 30, 2022, were approximately $115 million. EBITDA was approximately $45 million, with a 40% EBITDA margin. We expect to expand Hero's limited distribution by leveraging our U.S. retailer network and international footprint. We expect to increase distribution as this new form has only achieved 4.4% household penetration compared to 23% for acne lotions and creams.
The acquisition is expected to be dilutive to the company's 2022 adjusted EPS by $0.05, inclusive of transition costs, acquisition-related expenses, interest expense, incremental marketing, and intangible amortization expense. We now expect 2022 adjusted EPS to be $2.97, inclusive of that five-cent dilutive EPS impact. In 2023, Hero's annual net sales are projected to grow approximately 15% to $150 million. Looking forward to 2023, the acquisition is expected to be 3% accretive to cash earnings and neutral to 2023 EPS, inclusive of, again, transition costs, interest expense, and intangible amortization. We start with $60 million in EBITDA, less approximately $55 million due to intangible amortization and interest expense, and then we also have $5 million in transition expenses. That results in flattish EPS.
Adding back the non-cash amortization results in approximately 3% cash accretion. That's how we get there. We expect to end 2022 with a debt-to-EBITDA ratio of 2x and be back below 2x by end of 2023. One last detail to point out is that our adjusted EPS will exclude the impact of the restricted stock being treated as compensation expense for reported purposes. The EPS impact is expected to be about $0.03 in 2022 and $0.11 in 2023. As you read in the release, we are also lowering our Q3 and full-year reported revenue estimates, inclusive of Hero. We're seeing additional softness across our more discretionary brands, including Waterpik and Flawless. We're also seeing our vitamin business decline as it comes off COVID highs.
Consumption is strong across our household business, but orders have slowed as retailers adjust inventory across all their businesses. With that, we'll now open up the call for questions.
Thank you. To ask a question, you will need to press star one one on your telephone. Please stand by while we compile the Q&A roster. Our first question comes from the line of Dara Mohsenian with Morgan Stanley. Your line is now open.
Hey, guys.
Morning, Dara.
First maybe just base business and then a couple of questions on the acquisition. Just in terms of the revision of the top line guidance, how much contribution are you expecting from the acquisition just so we can back into an organic sales number? It seems pretty significant for the three brands, given it's only the three brands where you're expecting a revision. Maybe just a little more detail on what's driving the revision at the brand level. Clearly, earnings is not coming down at all, the acquisition impact. Are you seeing better costs there? Or what's offsetting the top line impact on the EPS line? Thanks.
Yeah, maybe I'll take the second one first. You're right. If you back your way into what's happening, our base earnings is not changing despite you know coming down around $100 million or so. You know, our guidance for the full year goes from 4%-5% reported to 2%-4%. If you take the midpoint of both of those, that's worth about 1.5%. Hero, the stub period that we think Q4 will be is worth about 0.7%. That means the base business is coming down about 2% or $100 million, largely Flawless, Waterpik, vitamins. We said you know some of that is also household.
You know, again, consumption's really strong, it's just the orders are got off to a slower start because retailers are adjusting inventory across all their product lines. EPS doesn't change for really two reasons. One, if you do the math, $100 million on 30% marketing profit contribution, $20 million of that was probably we just tried to put a buffer in place last time we had a call down so that we wouldn't have to affect earnings again. so that's about $20 million-$30 million, and then $10 million is really SG&A as incentive comp and other bill and pay they have.
Great. That's helpful. Just on Hero, can you talk about the big growth opportunities for the brand under your ownership? Obviously, there's probably conversion to the patch side of things. You mentioned internationally, potentially longer term, but just how do you think about the biggest growth drivers for the brand? Second, obviously very high EBITDA margins here. Can you just talk about the competitive environment for the brand and defensibility of that margin structure over time? Thanks.
Yeah, it was a long question, Dara. What was the first part?
Sorry. The first was just the big growth opportunities for the brand from here. Is it more just conversion to patch, or are there other incremental opportunities under your ownership and just trying to understand the forward potential versus the historical delivery recently? Again, just defensibility of those EBITDA margins, given they're so high in terms of competitive intensity in the segment? Thanks.
Yeah. Well, you know, the way to think about it is the opportunity is first and foremost in distribution. Where this brand was born and developed over the last couple of years was at Target and Amazon, and also more recently, Ulta. That's what we said on our opening remarks, that we only have 8% ACV. The goal here would be get this to 80%-90%. That's where the leverage of Church & Dwight comes in. As far as internationally goes, the brand is essentially sold in the U.S. We think the first stop for us would be Canada as far as expansion internationally. As far as competitively goes, I mentioned that it's the number two brand in all of acne with 14% share.
Of course, the number one brand in the acne care is Neutrogena. This brand has significant market share in the patch. It's a 63% market share in patch, and even online, it's in the high 50s. The business has done a fabulous job at developing itself through digital marketing. It's been around for five years. When it first launched, it had one SKU in 2017. It's got over 20 SKUs right now. When you think about the business, 86% of the business is patch. Another 8% is acne aftercare. Then they have another 6%, which is just skincare items. It is concentrated in acne.
We do think that because it's been a first mover, it's got a great following. It's got five times, actually, I think, the number of reviews that the next largest competitor does on Amazon. We do like our chances going forward. Yeah. I would just add one thing, Dara. You know, in addition to the distribution opportunities, it's also the similar story that we had with gummy vitamins, like hard pill to gummy conversion, and this is very similar. Matt said it in his prepared remarks. The category for patch is only 18% of the category, and that's growing rapidly. Yes.
We think that once you have a much broader distribution of the patch, that the transition from ointments and lotions will be accelerated. We think we're in a great spot.
Thanks, guys. Appreciate it.
Okay.
Thank you. Our next question comes from the line of Rupesh Parikh with Oppenheimer. Your line is now open.
Good morning. This is actually Erica Eiler for Rupesh. Thanks for taking our question. I guess I just first wanted to dive a little bit deeper into the category. Could you maybe talk a little bit about, you know, what type of category growth rates you're seeing in the acne treatment category right now? Then you highlighted that 15% top line growth next year. How are you thinking about the longer term growth rates, you know, for the business beyond next year?
Yeah, the way to think about the category. If you went back a few years, say 2018 or 2019, the category measured channels in the U.S. was around $500 million. If you look today, the category is approaching $700 million, and all of that growth is driven by patch. This is a sleepy category prior to patch showing up. That's why we're so confident that this business can continue to grow in the future. That help you?
Yeah, no, that's helpful. Just on repeat rates, so you mentioned, you know, the high level of brand loyalty and repeat purchase. Is there any more granularity you can, you know, provide on the types of repeats, you know, Hero's seeing on that patch product?
I can tell you that, as far as Net Promoter Score, 90% of the consumers will recommend it to a friend. Your other question was you were more specific, though, what you wanted.
The repeat rate.
Oh, the repeat rate.
Yeah.
Well, look, the other stat that might be helpful to you as far as what the purchase cycle is, and for households that are buying patches, what we're seeing is that over a 12-month period, there'll be 3.6 purchases. It's almost one per quarter. Once people buy the brand, they love it and they stick with it.
Okay. That's very helpful. Thank you so much.
Okay.
Thank you. Our next question comes from the line of Kaumil Gajrawala with Credit Suisse. Your line is now open.
Hey, guys. Good morning. Can you first maybe just briefly talk about the structure of the deal? You know, you rarely use equity. Your balance sheet looked like you had enough room, if you wanted to, do this deal all cash. Can you maybe just talk about the motivation of structuring it the way that you did?
Yeah, it's pretty straightforward, Camille. It's really we used a little bit of equity restricted stock just for retention purposes for the three founders. They're gonna be with us. They're gonna be running that business, and we're excited about combining our capabilities with theirs. That's to just ensure alignment to the larger corporation.
Okay, great. On the topic of distribution, and this category, when you think about it being a kind of a conversion category from lotion ointments to patches, how should we think about the speed of this distribution rollout into some of these new accounts? Because it just sound like, you know, the idea of patch in general, maybe is the sort of thing that's not, you know, as top of mind for some of these other retailers that aren't really in the space yet.
Yeah. When retailers see the success of a product, both on Amazon and at a larger retailer like Target, it becomes very appealing to them. As far as the next couple of years go, we don't think there will be any difficulty in getting the large, particularly the larger retailers interested. That's something once we close, we'll be chasing in just three or four weeks.
Okay, great. Thank you.
Okay.
Thank you. Our next question comes from the line of Kevin Grundy with Jefferies. Your line is now open.
Great. Thanks. Good morning, guys. A couple cleanups on the deal and then one coming back to the guidance. One, Rick, perhaps for you, the ACV gap, which I think you said was 8% versus 99% for acne treatments, how quickly can you close that gap? What's kind of been the model for your plan? If current velocity holds, what does that translate to into growth over the next 3 to 5 years? Understanding you gave us the 15% growth for 2023, what's the CAGR look like if you're successful in closing the distribution gap?
Yeah, no, it's a fair question, Kevin. You know, we think there's a lot of room to run. I think today we're really focused on calling, you know, 15% for 2023. If we're closing ACV over the next few years, you could expect some strong growth. We're not gonna call that out today.
Okay. Fair, fair enough. Quick one, cost synergies, which I know typically do not drive a lot of your deals. Any cost synergies modeled for this one?
Actually, no, we don't have cost synergies on this one. You know, will there be? Most likely there will be some, you know, especially around distribution and whatnot and some of the back office stuff. Really, we're focused on enabling, you know, sales distribution footprint in the U.S. and international, and reinvesting in the business. Not really calling anything out specifically.
Got it. If you just indulge me, one last cleanup here on the outlook. How quickly has the environment changed over the past 30 days since you guided? What's the takeaway here in terms of read-through on the consumer change in terms of how retailers are thinking about inventory levels more broadly, you know, maybe just more conservatism on the look back here in terms of how you were guiding? How should we sort of digest the takedown on the top line? I'll pass it on. Thank you.
Yeah. Hey, Kevin. After we announced end of July, and we started watching the trends in the month of August, it became obvious to us that we're gonna need to do a call down on the top line because of just like the drop in demand for flossers and as well as Flawless and the vitamins was steeper than we expected when we projected it out. It's up to you know $100 million. We felt a need to call that.
That number is also, what's contributing to it is retailers who are awash in inventory, not just CPG inventory, but general merchandise, but they got to find a place to put it. We've seen even in categories where we have really strong consumption, like laundry and litter, our shipments are still being curtailed because of retailers reducing their orders. The combination of what's going on with the consumer as well as the retailers pulling back on their orders, which are less than consumption, we thought it was prudent to call out the $100 million change.
Yeah, just as an example, like in some categories we have double digit consumption, right? The orders are flattish. That's just to give you an example.
Very good. Thanks for the color, guys. Good luck.
Okay.
Thank you. Our next question comes from the line of Andrea Teixeira with JP Morgan. Your line is now open.
Thank you. Good morning. I have two questions. One on the Mighty Patch acquisition. Is there any patent protection because indeed they have a strong Amazon review and following, but there are some private label in the category that popped up, so I wonder if there is any ways of protecting that. On the valuation structure of the deal, is there any earn-out protection that I believe served you well for Flawless, at the time, given the expectations were lower than they actually materialized? You mentioned keeping employees, and I understand most of the marketing is digital. It's fair to assume that synergies are limited.
Embedded in all of that, is there any reduction in margin because of course you're going international and of course there's growing pains, but I just wanna figure how you embedded the margin for 2023. If I can squeeze the reduction in guidance you mentioned, Rick, just now that, you know, obviously, consumption is still elevated, but, you know, the orders have been cut. Is there any way for us to figure how much excess inventory you might have in on the trade or how are retailers telling you in terms of duration of that process? Thank you.
Yeah. Maybe I'll take the last one, first.
Andrea, you get the blue ribbon for the multi-part question.
Yes. Thank you.
On the consumption and orders, right, I think what we're trying to clearly say is on some of the discretionary purchases like the Flawless and Waterpik, yeah, some of the retailers were heavy on inventory, as those devices aren't moving as quickly as they had hoped or we had hoped, and that's happened across many different industries, many different areas. That's a piece of it. We think, you know, if those trends, you know, are where they're at, then by year-end we'll be fine. Our inventory also gets worked through by year-end as well.
What Matt was really alluding to was inventory levels at retailers on other, you know, category groups are impacting our orders, you know, even for laundry or for litter or for our household businesses that really have strong consumption. That's a piece of it. Number two, you had asked about valuation, and yep, we did not do an earn-out here. We're aligning interests more with ownership of equity and stock and ensuring that we have the founders around for a period of a few years. Finally, maybe, Matt, you wanna take the IP?
Yeah. You had a question on IP and also a private label. If you looked at the major retailer where Hero was born, there is private label. It's only 4% share. And with respect to IP, the formula and the process are proprietary, so we have the rights to those. And we do believe that the performance of the patch is, based on feedback from consumers, superior to other patches. Feel like we're in a good place in the market.
Thank you. Appreciate all that.
Thank you. Our next question comes from the line of Chris Carey with Wells Fargo. Your line is now open.
Hi, good morning. Can you just, you know, talk to general visibility you have on the base business right now, especially on the personal care side? You know, things have obviously changed pretty quickly, but in Q4 it seems like you're still implying a snapback to this, I guess, mid-single-digit growth range on the top line. You know, what gives you confidence in that recovery? And perhaps put another way, why not embed more conservatism in the outlook if ordering activity specifically is so lumpy?
What we're expecting for the Q4 is, and you recall that our fill rates were so low early in the year, and they have come back, which is what we expected to happen in the second half. We don't think we're gonna be hampered by that as much in the Q4 as we had been in other quarters. That's a real plus. The other two things are we put both two-thirds of our advertising is back-end loaded, as well as a lot of our trade promotion as well, which is even more skewed towards the Q4 versus the Q3. Those are the reasons why we expect Q4 to be sequentially better than Q3.
You know, as far as visibility goes, you know, we're doing the best we can with respect to looking at the trends for flossers, vitamins and Waterpik. You know, based on the information we have today, this is our best estimate.
Yeah. The good news is a lot of our categories are doing really well. We presented Barclays today, and Barry will walk through some of those categories. Laundry is doing exceedingly well. Litter is doing exceedingly well. TheraBreath's doing really well. Batiste is doing really well. You know, we just hit an all-time high share in laundry. A lot of things going right, it's just we had to adjust these two or three pieces of the business.
We know also that you know we got discretionary categories that are impacting us right now. Obviously eventually those will recover. If you think about what we've done over the last couple of years, we bought Zicam in 2020. We bought TheraBreath, fast-growing brand, in 2021. We bought another fast-growing brand, Hero, now in 2022. We have 15 power brands that make up 85% of our revenues and profits. As we add number 16 and number 17 power brand, the discretionary portion of our portfolio obviously will be diminished and future recessions you know down the road will be less impacted.
Yeah, I think the nuance, for example, like on Waterpik, we had 20% growth in 2021, after double-digit growth for a while. That's coming down. VMS, we had 50% growth in 2020. We're coming back down to normalcy, on some of the vitamin business as consumer behavior, you know, kind of adapts post-COVID.
Thanks. Just a quick follow-up on that response and then my second question. The follow-up is on fill rates. Were fill rates still a challenge in Q3, but you just have a lot more visibility on Q4 fill rates being better? Just confirming that.
Yeah, no. We see, actually, we're in the 1990s in Q3. We think we expect to be in the mid-1990s by Q4. We see, again, we continue to see good visibility into achieving that. We're on track.
Okay. The second question, just, you know, more strategically. You know, some of the recent deals, as you noted, have created some demand volatility. You know, there's also been quite a bit of strength followed by normalization. You know, how did you frame that risk when you contemplated and ultimately went through on this Hero deal? And the thought process around the sustainability of demand through perhaps different economic cycles. And then if I could just squeeze in one. What’s the non-tracked versus tracked exposure for your personal care business today? So thanks for all that.
Yeah. Well, the acquisitions you referenced are actually not recent. Waterpik was acquired in 2017. That's five years ago. Five years ago, actually, this month in August. You know, that business grew high single digits every year after we acquired them, 2018, 2019, 2020, 2021. That's a great business. Sure, we got a little pullback here, got a reset this year. Long term, the importance of gum health will continue to grow, and we think we got a lot of opportunity both U.S. and internationally. Like I said, those are not recent acquisitions. We've had three others since then, in Zicam, TheraBreath, and now, and Hero.
We do think we really have our balance back going forward, but no regrets with respect to Waterpik.
You'd ask about personal care, tracked versus untracked. Are you talking about the entire personal care category, or are you talking about Hero?
The entire personal care category would be helpful, and if you have any comments on, you know, the specific brands. Ultimately, what I'm trying to get to is, you know, being mindful of any disconnects between, you know, what we're seeing in the Nielsen data versus what we should be expecting, is happening in non-tracked channels. Thank you.
Yeah. In general, I would say when you look at IRI or Nielsen, it's around 75%-80%, reflective of what's going on. That's true in personal care as well. The only nuance there is Waterpik. Only about 25% of their sales shows up in tracked channels.
Okay. Thank you both.
Thank you. Our next question comes from the line of Steve Powers with Deutsche Bank. Your line is now open.
Hey, can you guys hear me?
Yeah. Hey, Steve.
Hey. A couple questions on Hero and then also some overarching ones. On Hero, is there a percentage you can call out of what is DTC, and is that material in your calculations going forward? Number one. Number two, I think you mentioned 20+ SKUs. I think their website says 30+ products. Obviously, SKUs are heavily to patch. As you think about the distribution runway here, you know, I'm assuming SKUs to patch. How are you thinking about the seemingly long tail of products, and is there, you know, an initiative to maybe narrow that down as you go forward?
Well, I'm gonna leave that to the sales guys with respect to which of the 20+, as you say, 30+. I mean, 30 is. I'm still right, Steve. It's 30, a bigger number. You're gonna make a liar out of me saying over 20. Look, as far as on shelf, obviously the strongest products that turn the fastest are gonna be ones, well, initially, what we'll be fighting for at distribution gains. The tail maybe over time we would add in. They'll be the core products that we'll be pushing initially.
Okay. DTC, is that material?
It's 4% of sales.
Okay.
It is small.
Okay, great. On the broader, you know, step down in revenue outlook, not just over the last 30 days, but going back, you know, last two or three months, is there a way to parse out how much of your, the reduction in your outlook has been because of inventory destocking versus actual demand degradation? You know, number one, I guess. Number two is when you strip away the more discretionary categories, you look at things like laundry and litter in your call out today about inventory destocking. Is there a way to frame, you know, how full versus thin inventories are?
Does that destocking in these more everyday categories continue over the balance of the year, or is it sort of, are we most of the way through it? How are you thinking about that?
Well, it's not enough just to look at where our inventories stand, because remember, we're affected by all the space in the DCs for the retailers. Even if we'd said, "Hey, we think we're not too far off with some retailers with respect to inventory," it doesn't matter. You know, they're trying to reduce the amount of space allocated, so they have places to put general merchandise. That's a real hard one to get your arms around.
Yeah, I would just say that over time, you can only go so long when consumption is strong and orders are flattish, or slightly positive on some key brands that are growing really well. That will come back in balance as these inventory issues get worked through. Not really as concerned about that. You know, if you take a big step back, and you talk about in general, the call downs that we've had, I would probably say, you know, earlier in the year, it was fill related, right? We've kinda gotten past that. These days, it's more, number one would be probably discretionary items like Flawless and Waterpiks. Number two would be vitamin demand coming back down to earth, after some really high COVID years and just category dynamics.
Three would be kind of the orders of the rest of portfolio lagging consumption.
Okay, fair enough. Thank you.
Thank you. Our last question comes from the line of Olivia Tong with Raymond James. Your line is now open.
Great, thank you. Just first following up on Steve's question is just around if you could give a little bit more granularity around what you think is consumer slowdown versus inventory adjusting by retailers. I realize that's a little bit difficult of a question, given your previous answer. Do you have a sense, you know, with, in your discussions with retailers of what, you know, their end goal is relative to historical levels and where you think your inventory levels at retail are now versus historical levels? Then just follow up, really quick question. Are you manufacturing the patch yourself or still sticking with external? Thank you.
Okay. The last one's easy. This is an asset-light business, which, as you know, Olivia, that is our part of our acquisition criteria. It's made by a third-party co-packer.
Just to give you a ballpark, in terms of, you know, consumer demand versus inventory at retailers, I would probably say, again, this is probably weighted towards discretionary items and vitamins, but two-thirds of it is that and one-third of it is retailer inventory and orders. I would probably say, you know, it's a mixed bag, but overall, all of our household fast-moving personal care items, I would say we're in balance or a little thin at retail on inventory, probably below norms, but then on some of the device stuff like Waterpik, we're probably a little heavy. And that's gonna get balanced out by year-end. That's kinda how I'd frame it.
Thank you.
Thank you. I would now like to hand the conference back over to Matt Farrell for closing remarks.
Okay. Well, thanks for joining us today on short notice. We're at the Barclays conference today, so if you can tune into the webcast, we're gonna provide more details on what we're seeing as far as category insights and more detail on Hero. Thanks for joining us today, and the next time we'll talk will be the end of October with our Q3 results. Thanks, everybody.
This concludes today's call. Thank you for participating. You may now disconnect.