Church & Dwight - Earnings Call - Q3 2020

Transcript

Operator (participant)

Good morning, ladies and gentlemen, and welcome to the Church & Dwight third quarter 2020 earnings 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, 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 filing. 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.

Matt Farrell (CEO)

Okay. Good morning, everyone. Thanks for joining us today. I'll begin with a review of the Q3 results, and I'll turn the call over to Rick, our CFO. When Rick is done, we'll open up the call for questions. The pandemic has given us an opportunity to display our agility as a company. We increased our communications with retailers. We changed our marketing messages. We shifted investments to categories that are most important to consumers. We have set new production records for Vitafusion, Arm & Hammer Laundry, and Arm & Hammer Baking Soda. We have moved people to focus on the online class of trade. We have been proactive in seizing the opportunities presented by the crisis and are increasing manufacturing capacity in our plants and externally with new co-packers. I want to thank all of our employees for their hard work. Their efforts are paying off.

The agility and resilience of the Church & Dwight team is showing up in our results. Our priorities continue to be employee safety, meeting the needs of consumers and retailers, helping the communities where we live, and ensuring the strength of our brands. Our plant warehouse and laboratory employees have done an exceptional job keeping safe, which has contributed to our ability to operate our supply chain. Our office employees continue to work remotely and are doing a super job running the company. Now let's talk about the results. Q3 was another exceptional quarter. Reported sales growth was 13.9%, and Adjusted EPS was $0.70. Revenue, earnings, and operating cash flow were all significantly higher in Q3 than last year, driven by the significant increase in demand for many of our products. Organic sales grew 9.9%, driven by higher consumption.

Regarding e-commerce, we were already strong pre-COVID and well-positioned online. In Q3, our online sales increased by 77% as all retailer.coms have grown. One example would be gummy vitamins. In 2019, 8% of our full-year sales were online. This year, we expect full-year to be about 14% online. Recall we began the year targeting 9% online sales as a percentage of global consumer sales. In Q1, it was 10% online. Q2, 13%. Q3, also 13%. We expect the full year to be actually close to 13% as well. We continue to conduct research on the purchasing habits of U.S. consumers. There's no surprises here, actually. There is continued consumer concern that stores will run out of stock and websites will face delivery issues.

Consumers report that they are consolidating shopping trips and continue to stockpile to ensure that they have enough product for a couple of weeks at a time. If we look at year-to-date shipment and consumption patterns, our brands remain generally in balance in the 15 categories in which we compete. With respect to our brands, we had broad-based consumption growth in Q3. We saw double-digit consumption growth in Vitafusion and L'il Critters Gummy Vitamins, Arm & Hammer Baking Soda, OxiClean, Flawless, Orajel, Nair, First Response pregnancy kits, and cleaners. In household, our laundry business consumption was up 4%, and ARM & HAMMER Cat Litter was up 8%. Water flossers is another bright spot as consumption turned slightly positive in Q3. Although our lunch and learn activity continues to be significantly curtailed, we intend to continue to address this with incremental advertising.

In addition to Vitafusion and Little Critters, water flossers is another brand we expect to benefit from the heightened consumer focus on health and wellness. Batiste dry shampoo remains impacted by social distancing, with consumption down 10%, but improved sequentially compared to Q2 when consumption was down 22%. Trojan consumption was down 6% in Q3, but also improved sequentially when we were down 15% in Q2. There is no doubt that consumers have made health and wellness a priority. Vitafusion and Little Critters Gummy Vitamins saw the greatest consumption growth of any of our categories in Q3, up 49%. The category consumption was even higher. Our expectation is that consumer demand for gummy vitamins will remain high. We have new third-party capacity coming online in late Q4 to take advantage of this trend. Consumers are focusing on health and wellness, but also cleaning, home cooking, and new grooming routines.

At a recent investor conference, you may have heard me cite consumer research that suggests it takes 66 days to form a new habit. Only time will tell if all of these new behaviors will translate into permanently higher levels of consumption. If they do endure over time, we believe we are well-positioned. Now, a few words about private label. As you know, our exposure to private label is limited to five categories. Private label shares have remained generally unchanged for the first, second, and third quarters of this year. Now, international. Our international business came through with double-digit organic growth in the quarter, driven by strong growth in our GMG business, that's our global markets group, and Canada. In October, our GMG business is off to another strong start, and we continue to see strong POS recovery in Canada and Europe.

After three consecutive quarters of growth, our specialty products business contracted 3.4% in Q3, primarily due to the poultry segment. Now, turning to new products. Innovative new products will continue to attract consumers even in this economy. In 2020, we launched many new products, which are described in our press release. Vitafusion Gummy Vitamins launched a number of new products. To capitalize on increased consumer interest in immunity, we launched Power Zinc and Elderberry Gummies. We have launched Arm & Hammer Clean & Simple, which has only six ingredients plus water compared to 15-30 ingredients for typical liquid detergents. In the second half, we launched Arm & Hammer AbsorbX Clumping Cat Litter, a new litter which is 55% lighter than our regular litter. Now, let's turn to the outlook. We're having an exceptional year.

We now expect full-year Adjusted EPS growth of 13-14%, which is far above our evergreen target of 8% annual EPS growth. Given our strong performance, we have raised our full-year outlook for sales growth to be approximately 11% and organic sales growth to be approximately 9%. As mentioned many times in the past, we take the long view in managing Church & Dwight in order to sustain our evergreen model. In the second half, we took the opportunity to increase our marketing spend behind our new products, and we made incremental investments in the company. As we wind up the year, we are putting together our 2021 plan. It's safe to say that we have a high degree of confidence that we will meet our evergreen model in 2021. In February, we'll provide our detailed outlook for next year.

Now, in conclusion, I would like to remind everyone of the many reasons to have confidence in Church & Dwight. The great thing about our company is we are positioned to do well in both good and bad economic times. The categories in which we play are largely essential to consumers. We have a few categories that stand to benefit from the current environment. We have a balance of value and premium products. Our power brands are number one or number two in their categories. We have low exposure to private label. We are coming off some of the best growth quarters we have ever had. With a strong balance sheet, we continue to be open to acquiring TSR accretive businesses. We believe our company is stronger and more agile than ever.

Finally, we have the resources, the common sense, and the ambition to ensure that our brands perform well in the future. Next up is Rick to give you details on the third quarter.

Rick Dierker (CFO)

Thank you, Matt. Good morning, everybody. We'll start with EPS. Third quarter Adjusted EPS, which excludes an acquisition-related earn-out adjustment, grew 6.1% to $0.70 compared to $0.66 in 2019. As we discussed in previous calls, the quarterly earn-out adjustment will continue until the conclusion of the earn-out period. Stronger-than-expected sales performance allowed the company to spend incrementally on marketing. Reported revenue was up 13.9%, reflecting a continued increase in consumer demand for our products. Organic sales was up 9.9%, driven by a volume increase of 10.2%, partially offset by 0.3% of unfavorable product mix and pricing, primarily driven by new product support. Volume growth was driven by higher consumption. Now, let's review the segments. First, consumer domestic. Organic sales increased by 10.7%, largely due to higher volume.

Overall growth was led by Vitafusion and Little Critters Gummy Vitamins, Waterpik, oral care products, Arm & Hammer Liquid Laundry Detergent, and OxiClean stain fighters. We commonly get asked to bridge the Nielsen reporting to our organic results. This quarter, tracked consumption was 7.7% for our brands compared to an organic sales increase of 10.7%. In this environment, one might assume that is restocking retailer inventory. That is not the case. We had 400 basis points of help from strong growth in untracked channels, primarily online, and 100 basis points dragged from couponing to support new products. The good news is, as you heard from Matt, consumption and shipments are in balance, both low double digits. Consumer international delivered 11.6% organic growth due to higher volume offset by lower price and product mix. This was a great recovery for our international business from a flat Q2.

Growth was primarily driven by the global markets group in Canada. For our SPD business, organic sales decreased 3.4% due to lower volume offset by higher pricing. The lower volume was primarily driven by the non-dairy, animal, and food production and sodium bicarbonate business. Turning now to gross margin. Our third quarter gross margin was 45.5%, a 110 basis point decrease from a year ago. Gross margin was impacted by a 110 basis point drag from tariffs and a 90 basis point impact from acquisition accounting. In addition, to round out the Q3 gross margin bridge is a plus 100 basis points from price volume mix, plus 160 basis points from productivity programs, offset by a drag of 80 basis points of higher manufacturing costs, inflation, and higher distribution costs, as well as a drag of 90 basis points for COVID costs. Moving now to marketing.

Marketing was up $45.7 million year over year as we invested behind our brands. Marketing expense as a percentage of net sales increased 230 basis points to 13.8%. For SG&A, Q3 adjusted SG&A decreased 30 basis points year over year, primarily due to leverage from strong sales growth. Other expense all in was $12.3 million, a $3.9 million decline due to lower interest expense from lower interest rates. For income tax, our effective rate for the quarter was 17.3% compared to 21.6% in 2019, a decrease of 430 basis points primarily driven by higher tax benefits related to stock option exercises. Now, turning to cash. For the first nine months of 2020, cash from operating activities increased 29% to $798 million due to significantly higher cash earnings and an improvement in working capital. As of September 30th, cash on hand was $549 million.

Our full-year CapEx plan continues to be approximately $100 million as we began to expand manufacturing and distribution capacity, primarily focused on laundry, litter, and vitamins. As I mentioned back at the Barclays Conference in September, we do expect a step up in CapEx over the next couple of years to approximately 3.5% of sales for these capacity-related investments. In addition, as you read in the release, due to the strong cash position, the company may resume stock repurchases in the future. For Q4, we expect reported sales growth of approximately 9%, organic sales growth of approximately 8%. As Matt mentioned, we have strong consumption across many of our categories. Turning to gross margin, we previously called a 150 basis point contraction in the second half. Now, we're saying down 190 basis points. The change is primarily due to non-recurring supply chain costs.

We also expect significant expense, and we have called flat for the year in terms of a percent of sales, which implies a step up in Q4. We also anticipate a lower tax rate. As a result, we expect Q4 Adjusted EPS to be $0.50-$0.52 per share, excluding the acquisition earn-out adjustment, as we exit 2020 with momentum. For the full-year outlook, we now expect approximately 11% year 2020 sales growth, which is above our previously 9-10% range. We're also raising our full-year organic sales growth to approximately 9%, up from our previous 7-8% outlook. We raised our cash from operations outlook to $975 million, which is up 13% versus a year ago.

Turning to gross margin, we expect gross margin to be down 20 basis points for the year, primarily due to the impact of acquisition accounting, COVID costs, incremental manufacturing and distribution capacity investments, and the higher tariffs on Waterpik. As to tariffs, remember back in 2018, we got caught up in tier two tariffs for which we were granted an exemption in 2019. That exemption expired and was not extended as of Q3 2020. We continue to work on mitigating that impact. Another word or two on gross margin. Previously, I had said the first half of the year was plus 150 basis points on gross margin, and the second half was down 150 basis points on gross margin. Our outlook as of last quarter was flat for the year.

Last quarter, you heard me walk through investments we were making in the second half of 2020. Examples here included a new third-party logistics provider, outside storage to handle surge inventories, preliminary engineering on capacity, VMS outsourcing costs, as well as other investments around automation, consumer research, and analytics. What changed? Now, we're calling down 190 basis points for the back half, or down 20 basis points for the year, and that implies down 250 basis points for the quarter. We have some supply chain non-recurring costs. Here are a few examples. First, because of our outsized growth, I mentioned last quarter, we're adding a new 3PL distribution center. In the quarter, we again had stronger sales and, as such, had duplicative outside storage locations and the new 3PL distribution center that was not operational. For a period of time, we had duplicative costs.

We're also in the process of going through make-versus-buy decisions, and that will trigger a couple of asset write-offs, likely in Q4. We have lean training across the plant. Finally, due to the great results this year, higher incentive comp costs that flow through COGS. Our full-year tax rate expectations are 19%, and we also raised our Adjusted EPS growth to 13-14%. Now that we're through the outlook, I also want to spend a minute on Flawless. As you saw in the release, we had an earn-out benefit of approximately $50 million in the quarter in reported earnings. We exclude any of the earn-out movements in Adjusted EPS. Some color on that swing. As a backdrop, we bought that business for $475 million upfront and a $425 million earn-out tied to year-end 2021 sales.

That sales target represented an excess of 15% CAGR for three years off of a baseline of $180 million of trailing sales. That revised three-year CAGR for this business is closer to 8%. As such, the earn-out liability comes down and earnings go up. We're still positive on this business, and the strong consumption growth these past six months is a great indicator for the future. As you heard from Matt, the company is well-positioned as we enter 2021. Matt and I would be happy to take any questions.

Operator (participant)

Thank you. As a reminder, ladies and gentlemen, to ask a question, you will need to press star one on your telephone. To withdraw your question, just press the pound or hash key. Our first question comes from Olivia Tong with Bank of America. Please go ahead.

Matt Farrell (CEO)

Hi, Olivia. You there?

Olivia Tong (Analyst)

Hi. Can you hear me?

Matt Farrell (CEO)

Yeah. I hear you now.

Olivia Tong (Analyst)

Okay. Great. Good morning. First, I want to talk a little bit about some of the expenditures. First, on marketing, can you just talk a little bit about the key buckets of spending and whether is it more about frequency, depth of brands being advertised, more mediums, and the e-commerce investment that you're making as well? Thanks.

Matt Farrell (CEO)

Yeah. Olivia, about 70% of our advertising right now is digital. And that's been moving up year after year. It was accelerated more this year because of consumers moving online. As far as where to invest, we have a couple of big launches right now. We have Arm & Hammer Clean & Simple, as I described in the opening comments and also in the script. It's a new platform for us. It's got six ingredients plus water compared to many ingredients for the typical laundry detergent. We think that's going to be a platform we can build on in the future. We've been spending behind it. The second is Arm & Hammer Clump & Seal AbsorbX. It's a new cat litter. We haven't had a strong cat litter in the category. There's been a lot of growth there over the years.

We came up with a brand new cat litter that has a different substrate. It's 55% lighter than our existing cat litter. We're getting behind that in the second half. The third would be Flawless. Flawless is obviously a new brand that we acquired last year. It's an at-home solution. A lot of people are turning to devices instead of going to salons and spas that are generally closed and have lower volume. I've been putting my money behind Flawless as well. Again, the other money would be going to just brand building, which we've typically done in the past when we have the ability to spend.

Rick Dierker (CFO)

Yeah. I would just add, Olivia, to that, right? The brand building comment is maybe a quarter ago, we did have some out of stocks as such, but five of our brands were growing share as of last quarter, seven this quarter. We think it's going to be even stronger than that as we exit the year.

Olivia Tong (Analyst)

Can I just follow up too on this strength in organic sales? Obviously, very strong. I am a bit surprised in how little leverage you seem to be getting off of that in the SG&A because it does seem that SG&A are growing maybe not 10%, but close to it on the top line. They are seeing a lot better margin flow through. Can you just talk a little bit about the SG&A? Thank you.

Rick Dierker (CFO)

Yeah. Sure. No, you're right. We're getting phenomenal growth on the top line. SG&A, we're not getting the leverage maybe that you might think because we're also making investments. When we talked about investments last quarter, that transpired across the P&L. We're talking about marketing investments, step up. We're talking about supply chain investments, and we're talking about SG&A investments. As we look at analytics, or we look at IT, or cybersecurity, or things that we can do to just bulletproof the company for many years to come, SG&A is one factor.

Matt Farrell (CEO)

Yeah. Hey, Olivia, you know we run Church & Dwight's a very lean shop. There's no shortage of good things in which we can invest across the company. As Rick said, we got automation projects, not just in the plants, but in the office environment, new product initiatives where we do a lot of test and learns, IT projects, R&D. These are all SG&A items. Olivia, you still there?

Operator (participant)

Just to answer your question. Thank you.

Matt Farrell (CEO)

Okay.

Operator (participant)

Our next question is from Kevin Grundy with Jefferies. Please go ahead.

Kevin Grundy (Analyst)

Great. Thanks. Good morning, guys. And congrats on the strong quarter. Matt, question for you just on longer-term guidance. I mean, this is clearly an exceptional year for the company. I mean, probably the strongest in the company's history from a top-line perspective. And you're planning on 9% organic growth this year. You're clearly investing in capacity. So there is recognition here that demand is going to be sustainably higher in some of your key categories, expanding relationships with co-manufacturers, etc. I don't expect you to guide for next year at this point. You'll do that in February. Should investors expect the company to revisit the longer-term algorithm as well? I mean, clearly, it would seem like 3% is not the appropriate number, nor do I think that's what's discounted in stock or in sell-side numbers.

Maybe you could just comment on that, and then I have a follow-up for Rick on margins.

Matt Farrell (CEO)

It is safe to say we'll hit our number for next year, but we typically don't give the details or the numbers right now, as you know. We have a lot of tailwinds going into next year, the biggest being in health and wellness, but also cleaning, at-home grooming, and at-home cooking. All of those things are tailwinds for us. We also expect an improvement in consumer mobility next year. That is going to help the PC brands have an up year for those brands that are down this year.

Rick Dierker (CFO)

Yeah. I want to make sure you heard that, Kevin. I know we have 12 pages of material that we read through during the call, but Matt did say that we have a high degree of confidence in hitting our evergreen model next year.

Kevin Grundy (Analyst)

Got it. Very clear. Rick, quick one for you, and then I'll pass along. A couple of areas that are getting increasing attention from investors would be the normalization or return of trade spending, as well as higher freight costs. With respect to promotion, we're starting to see that a little bit in the Nielsen data. You guys appear to be spending behind laundry and litter in households. Can you just talk a little bit about your intentions, what you're seeing competitively? Rick, with respect to freight costs as well, maybe talk a little bit about that and maybe even broadly expectations from a planning perspective. I'll pass it on. Thank you.

Matt Farrell (CEO)

Yeah. In thinking about the promotional environment, you have to go to household. Household is laundry and litter.

If you go back to Q2, Kevin, and you look at sold-on deal for laundry and litter, if you look year over year, Q2 2020, Q2 2019, litter was down like 800 basis points sold-on deal, and laundry was down 1,700 basis points. The numbers were in Q2, laundry was sold-on deal 19% and litter 12%. If you go to Q3 and you look at laundry and litter sold-on deal, you're going to see litter at 15% and laundry at 30%. They have stepped up a bit in laundry and litter, but if you still look at year over year, there's still a huge gap. I believe 2019 Q3 sold-on deal for laundry was 38%. It's 30% in Q3. It's still an 800-point gap. If you look at litter, it's also similar. Last year, Q3, 23% sold-on deal. This year, 15% sold-on deal.

An 800-point gap, both in laundry and in litter. As the in-stock levels have improved, promotional activity has slowly returned to normal, but it's still well below normal.

Rick Dierker (CFO)

Yeah. I would just add to what the gross margin impact of that is, right? The first half of the year, if you look at price volume mix, because this is where that would show up, price volume mix for us was, on average for the first half, a good guy of 180 basis points, 170 basis points or so. Remember, we pulled back a ton on trade and couponing because we just did not want to exacerbate out-of-stocks. In the second half of the year, that number was closer to a positive 80 basis points as promotional levels have started to return to normal, and we are supporting our new products. While still positive, just a deceleration as a contributor, maybe on margin. Your second question was distribution. Absolutely right. Distribution market is extremely tight.

I shared with our board yesterday as an example that before these last few months, only about 5% of all spot loads would not be picked up or rejected. I said another way, and now that is up to about 25% of all spot loads in the industry are being rejected. For us, the good thing is we do have a large significant part that is dedicated lanes, right? We have some customers that pick up, and so it is more on their supply or distribution network. I would just tell you it is tight. Costs are increasing. Brokerage costs are increasing. At the end of the day, we have done a really good job managing that. It is not as impactful for us because of our dedicated lanes.

Kevin Grundy (Analyst)

Thanks for the call, guys. Good luck.

Matt Farrell (CEO)

Okay. Thanks, Kevin.

Operator (participant)

Thank you. Our next question is from Andrea Teixeira with J.P. Morgan.

Andrea Teixeira (Analyst)

Hi. Yes. Hi. Good morning. Thank you. Just following up on the commentary on the gross margin that you just gave now, is it fair to assume that given the tariffs that were, I believe, started more in the back half of the year, right, that you had been hit by some of the tariffs, the Chinese tariffs in flow, especially in the water flossing? Is that fair to assume that you're going to have lingering gross margin pressures at least through the first half of the year, especially as you mentioned now, some of the puts and takes, or we should be seeing some mitigating or pricing as you go into 2021?

Rick Dierker (CFO)

Yeah. No, it's a fair question, Andrea. Of course, if the tariffs come in the back half, then there'll be more pressure in the first half of next year. I would just point you back to Matt's comment is we kind of tried to give kind of an outlook and said that in 2021, we believe that we're going to hit the evergreen model. That does mean margin expansion as an example because it's our job to mitigate things like that, whether it's where we manufacture from, how we can increase productivity. Our supply chain has done a fantastic job. We hit an all-time high this year in terms of productivity, our good-to-great program. That trend, we think, is just going to continue.

Matt Farrell (CEO)

Yeah. The other thing, Andrew, to keep in mind is we always tend to focus on what can hurt you. You say, yeah, there's going to be some pressure because of tariffs initially. You got to remember COVID is also going the other way, right? That will not be as high, those COVID costs in 2021 versus 2020. There are always offsets.

Rick Dierker (CFO)

Yeah. Let me give you an example because you might say, what happens if COVID spikes back up in 2021? A big part of incremental COVID costs for us early on was just trying to ship as much product as we could to customers. We were shipping out less than full trucks, right? Now that we have built inventory, now that we are building capacity, we have more flexibility to make sure that we do not run into that same issue again.

Andrea Teixeira (Analyst)

On the distribution centers, which obviously it's the right thing to do, you're trying to get in third parties and all of that. You're also investing a lot more money on your own capacity. When would you think on that end you're going to be having the capacity coming through from a production standpoint and also the distribution? When do you think you're going to hit those targets and alleviate those pressures that you said you called out as non-recurring?

Rick Dierker (CFO)

Yeah. The great news is we just did our first shipments from the new 3PL this past week. We believe we'll be up and running almost full board in Q1 of next year, which is fantastic. That is distribution. That is a meaningful difference in terms of our shipping capacity overall for the network. For manufacturing, right, if you do something in-house, it always takes about 18 months. The good news is we said for vitamins specifically as an example that we're going to go outside. That is going to be outside for some small quantities already in Q4 and then ramped up really quickly in the beginning of 2021.

Andrea Teixeira (Analyst)

Okay. Great. Thank you so much, pass it on.

Operator (participant)

Thank you. Our next question is from Rupesh Parikh with Oppenheimer. Your line is open.

Rupesh Parikh (Analyst)

Good morning. Thanks for taking my question. Also, congrats on a nice quarter. I guess I want to start.

Hey, Matt.

Hey, Matt. I guess just starting out the M&A, curious what you're seeing right now on the M&A front. Does anything change in terms of what you guys are looking at from an M&A perspective, just given the pandemic and maybe some of the new opportunities you see going forward?

Matt Farrell (CEO)

We have had the same criteria for many years, as you know, Rupesh. I do not expect that to change. At one point, we thought that there may be more properties come to market in the back half of the year as the election was looming. I guess that is still possible between next week and the end of the year. We did do a deal once upon a time that started in mid-November, and we closed it by the end of December. We know that is possible. I would say with respect to our criteria, it has not changed.

Rupesh Parikh (Analyst)

Okay. Great. You guys also mentioned that you may resume share buybacks. Is it fair to assume that you may prioritize share buybacks over debt paydown near-term?

Rick Dierker (CFO)

I mean, you got to keep in mind, Rupesh, that our debt-to-EBITDA levels are still net debt-to-EBITDA is 1.1 times by the end of the year. So in my mind, we can do both, no problem.

Rupesh Parikh (Analyst)

Okay. Great. Maybe just one last question. There's been some questions just around thinking about gross margins going forward. Clearly, you also have headwinds this year. You also have tailwinds from a lower promotional environment. How do you think about the base level of gross margins as we look to next year? Is it flat? I guess it's a modestly, I guess, a 20 basis point decline in gross margins. Is that the right way to think about the new base level, or could there be more, I don't know, more headwinds this year that are artificially depressing that base level of gross margins?

Rick Dierker (CFO)

I mean, you heard Matt, and we talked about the COVID costs as an example that we think are extraordinarily high this year that will not be as high next year. Again, in January or February, when we go through our outlook, we will go through it in detail. Today, we just want to leave you guys with that we are confident in achieving our evergreen model. That means gross margin expansion.

Rupesh Parikh (Analyst)

Okay. Great. Thank you.

Matt Farrell (CEO)

All right. Thanks, Rupesh.

Operator (participant)

Thank you. Our next question is from Lauren Lieberman with Barclays.

Lauren Lieberman (Analyst)

Great. Thanks. Good morning. I wanted to talk a little bit about the vitamin business. I know you guys have expressed a high degree of confidence in both it being taking vitamins and health and wellness concerns being a sticky habit. I think, assuming that you can lap the performance this year with growth in 2021 has to be a key part of the outlook because as I look at it, at least using the Nielsen, not knowing I do not have the full look of all channel, vitamins is growing, is contributing maybe 50% of the top-line growth in consumer domestic right now. I mean, historically, VMS has been a fairly cyclical business overall for the industry.

Can you just maybe talk a little bit about why you think this time is different, why you think that taking vitamins is going to be something that really persists as people's degree of belief that immunity comes from vitamins? I just think that'd be a really helpful perspective because it feels pretty critical to the outlook. Thanks.

Matt Farrell (CEO)

Yeah. I think you're a little bit high on your 50% estimate.

Lauren Lieberman (Analyst)

Okay. It's just using Nielsen. That's why I tried to clarify.

Matt Farrell (CEO)

Yeah. You're a bit over the line there. I think you have to remember that when we bought this business, gummies were 3% of VMS. And obviously, that's grown over time. I think a lot of people have discovered gummy vitamins as a result of the pandemic. You have a lot more consumers oriented towards gummy vitamins than they were in the past. That's number one. Number two is we're not growing as fast as the category. In Q2 and Q3, the category on average grew 55%. We grew 40%. We grew 35% in Q2. This is consumption, Lauren, and 49% in Q3. Consumers are looking for a product. We're the number one brand, and we're sold out. We're capacity constrained. We're going to take the governor off the business as soon as we get this third-party capacity online.

We expect to get our fair share, which we're missing out on right now. Like I said in my remarks, it does take a while for a new habit to stick. I don't expect the current levels to return back to 2019 levels. If anybody's thinking that's a possibility, I would dispel that worry.

Rick Dierker (CFO)

Yeah. And just to give you some color, Lauren, on we usually do not do this, but since you asked the question directly, we will do it. VMS, and this is out of the 9.9% organic, was about a third. So a third of the growth out of the company's growth. Laundry was about 10%. Waterpik was about 20%. OxiClean was about 10%. Litter was about 10%. Kaboom and Baking Soda was 10%. It was pretty broad-based in my mind this quarter.

Lauren Lieberman (Analyst)

Okay. Great. That's super helpful color. Then just on the top line.

Matt Farrell (CEO)

Yeah. Lauren, the other thing too, I think that with respect to health and wellness, you got to also keep in mind Waterpik water flossers. They took a big hit in the second quarter as far as sales being down year over year. That business is not going to grow year over year in 2020 versus 2019. This is a perennial grower. This is a business that's been growing 10% a year since we bought it. You got to kind of reset this year for Waterpik. There is so much growth ahead of us both in the U.S. and internationally. That is just going to get restarted next year. Long-term, that is another one that is going to benefit from this focus on health and wellness.

Lauren Lieberman (Analyst)

Okay. That's great. On the CapEx, and I know you're still going to round it, and maybe I've kind of missed the specifics, but the usual run rate is about 2% of sales. I think you're going up to 3-4% over the next couple of years. It sounds though like for vitamins, it's more going to be with third parties. I just wanted to understand a lot of where this extra CapEx is going because I think laundry was added this year. Just some more color. For how long do you think that higher rate of CapEx continues?

Rick Dierker (CFO)

Yeah. No, I said in my remarks it's approximately 3.5%. I said it for the first time at your conference. I think I did say 3-4% then. It's about 3.5% for about two years. It's laundry, litter, and vitamins. Laundry, we just are experiencing three or four years of growth in one year in many of our categories. Laundry is no exception. I think we talked publicly last quarter about how it's sometimes better to be lucky than good. We had a line come on in late March, early April. That's already fully utilized. I mean, really, a brand new line fully utilized within four to six months, right? We have great plans for laundry. That business is doing extremely well. We know that we have to add capacity there.

Litter, I think you heard from Matt. I think in the quarter, as an example, it was up 8% on consumption. We have some great new products. Again, we need to lay the groundwork for litter. For vitamins, you're right. We said initially you're going to go outside, but you have to go outside if you need volume within months. Over the long term, of course, that's one of those businesses that we want to have in-house because we have expertise in gummy manufacturing.

Lauren Lieberman (Analyst)

Okay. That's great. Thanks for all the time. I appreciate it.

Matt Farrell (CEO)

Okay.

Operator (participant)

Thank you. Our next question is from Kaumil Gajrawala with Credit Suisse.

Kaumil Gajrawala (Analyst)

Good afternoon. Would you mind giving us a little more on ad spend, your plans on increasing ad spend, maybe percentage of sales into 4Q, and also maybe some context of how much of the ad spend you're maybe pulling forward from 2021 into the back half of this year given the strength of your P&L year to date?

Matt Farrell (CEO)

Yeah. I would not necessarily think of it as a pull forward. Remember, Rick said on a full-year basis, we are going to be comparable to 2019. It is just that in Q2, we pulled way back because we had lots of in-stock. So we were spending at a 10% level. We are in the 13s. I mean, 10% is percentage of sale in Q2. Q3 was obviously higher, 13 and change. Fourth quarter will be around 14.5%. We have a lot of spending coming in the fourth quarter. Again, it is behind these big new product launches. We just happen to have two big ones coinciding at the same time. We are concentrating our effort in the second half.

Rick Dierker (CFO)

Yeah. The only thing I'd add to that is last quarter, when I was asked for the full-year outlook on marketing, somebody said, "Hey, 11.5-12% is that the sweet spot?" And I said, "Yeah, it is." If you did the math based on our gross margin outlook and everything else, it would have put you at maybe the lower end of that range. Now we're saying we're closer to 11.8% for the full year, which implies kind of a step up from where we thought even three months ago.

Kaumil Gajrawala (Analyst)

Okay. Got it. If I could, I know we talked about gross margins a lot, just to try to understand a little bit better from some of the information you gave us, some of the gross margin pressure sounds like it will continue into the first half of next year. Some of it, such as duplicative storage and such, sound like they are more temporary. Can you give us maybe a read on how much of the pressure is temporary, how much might be permanent as it relates to some of the things you're putting in place?

Rick Dierker (CFO)

Yeah. No, it's a fair question. I would say we kind of talked, I would just go through a couple of different lines. We talked about COVID, right? Those costs should be rolling back in terms of some of the inefficiencies on how we shipped, especially early on in the front half. The Waterpik tariffs, that'll be probably a headwind in the first half. The Flawless accounting, the good news is we're out of that, the acquisition accounting. We've lapped all that noise, and there's going to be no impact next year from acquisition accounting, which has been a 40 basis point drag this year. That's fairly significant. Commodities for us have actually, we've discussed this the last few calls. Resins and ethylene for us have been up the last few quarters. Nothing really new there. That will likely be a bit of a headwind.

Our productivity program, which I just said was kind of hit an all-time record this year, is going to be a tailwind, and we'll offset that. I am not going to get into the quarterly cadence. I would just tell you that at this point in time, we're confident of gross margin expansion for next year. A lot of those investments you heard me walk through for Q4 specifically are discrete one-time non-recurring items.

Kaumil Gajrawala (Analyst)

Okay. Got it. Thank you.

Operator (participant)

Thank you. Our next question is from Joe Altobello with Raymond James.

Joe Altobello (Analyst)

Thanks. Hey, guys. Good morning. First question, you guys have been very clear that you're extremely confident in hitting your evergreen targets next year. I know, Matt, you've talked about a lot of permanent changes going on in consumer habits, which are clearly net-net beneficial to you. I guess what do you guys need to see to maybe rethink those evergreen targets, at least on the top line, heading into 2021 and beyond?

Matt Farrell (CEO)

Yeah. Joe, you got to give us a few months. I mean, we typically come out in February with these numbers. We just want to give everybody assurance that the evergreen model's intact for next year. As far as how high is high, we have to—we'll come out with that in February.

Joe Altobello (Analyst)

You said 66 days. I figured we're beyond that period, just kidding. Secondly, on Flawless, in terms of revised outlook, 8% is obviously still a good number, but it's not 15. How much of that delta is COVID-related, and how much of that is coming from other factors?

Rick Dierker (CFO)

Yeah. I mean, we're not going to get into that. I mean, just know that, right, especially retailers were closed for a period of time, right? That jumping-off point, the baseline, was depressed. If you look at consumption right now, and you guys see this, consumption for that business is just really strong. It has been strong for the last six months. It is a good indicator.

Joe Altobello (Analyst)

Okay. And just one last one, if I could. In terms of online sales, you mentioned it was up, I think, 77% this quarter. I think it was up 75% last quarter. Do you think that takes a step back next year, or do you think this is a new plateau and we continue to increase penetration off of that 13% base going forward?

Matt Farrell (CEO)

Yeah. Look, one of the things that we found is that there are many consumers that rarely used or ordered online and now have discovered it. More and more people are discovering it. I think as we get into the winter months, and it sounds like this COVID thing's not going away, there could be a resurgence. More and more people get used to it. I do think you may have one more quarter, Q1, where you'll have a big growth year over year, just because Q1 of 2020 did not spike as much as Q2 and Q3. I do think this march is going to continue, Joe, over time. We went back to 2015. We had 1% of our sales online, just 1%. This year, it'll be 13%. Last year was 9 or 8, 8 going to 13.

We had a big pop this year, 500 basis points. We fully expect that this is going to be a significant part of our sales, online sales, in the future. We'll be well over 20 in a few years.

Joe Altobello (Analyst)

Got it. Okay. Thank you, guys.

Operator (participant)

Thank you. Our next question is from Bill Chappell with Truist Securities. Please go ahead.

Bill Chappell (Analyst)

Thanks. Good morning.

Matt Farrell (CEO)

Hey, Bill.

Bill Chappell (Analyst)

I guess first question on Flawless, just any color around the timing of, I guess, the change of the payout. Is it just COVID-related and they could not get to the three-year numbers in part because of that and the weak start? Or is there something else on the outlook that you were seeing that you need to make a change now?

Rick Dierker (CFO)

No. Joe just asked a similar question, Bill. I would say that our original earn-out methodology was an extremely aggressive growth number, right? It was 15% plus. It was in excess of 15%. As we go through and time gets closer to that end of 2021, we have to right-size those expectations. Yep, it's been a little bit choppy because of the current economic environment. Like I said to Joe, we've had some really good consumption. We feel confident on that business. An 8% plus CAGR, we'd sign up for that business every day of the week.

Matt Farrell (CEO)

Sorry, Bill. You may not be as, yeah, it may not be as big an earn-out as might initially have been contemplated. The prospects for the business are bright. We think the math is going to work out. This is going to be a real good acquisition for us.

Bill Chappell (Analyst)

Gotcha.In the same vein of Joe's questioning, how do you figure out on contract manufacturing versus internal expansion for some of the categories like vitamins or other at-home type categories that are spiking now, which maybe they continue to grow in 2022 at this rate, but certainly, it would seem like it would come back to earth. I mean, are there areas where you're thinking, "Look, contract manufacturing makes sense for the next couple of years until we know more"? Or are you changing your CapEx budget for next year at this point? We need to step it up even faster.

Rick Dierker (CFO)

No, that's a good question, Bill. It's a fair question. I'd tell you that for those businesses, those are the keystones of the company, right? Those are the growth drivers. And we've had capacity plans in place.

We have an outlook on three, four, five-year capacity and volume forecasts. It is not like it is a new demand. It is just fast-forwarding some of those plans that were already in place.

Bill Chappell (Analyst)

Okay. Did you change your CapEx budget for next year over the past few months?

Rick Dierker (CFO)

We did. Yes. I announced at Barclays, and I re-emphasized it today, that for the next two years, we're going to approximate 3.5% of sales as we invest in capacity for laundry, litter, and vitamins, and distribution capacity as well.

Bill Chappell (Analyst)

Okay. Great.

Rick Dierker (CFO)

Thank you.

Operator (participant)

Thank you. Our next question is from Mark Astrachan with Stifel. Please go ahead.

Mark Astrachan (Analyst)

Thanks. Good morning, everybody. I wanted to ask on promotional activity, just out of curiosity, who's pushing increasing promotions or point of sale or any sort of step up there? Is it being done because, as you've talked about, you've got some upside to numbers, want to reinvest? I know not all of that goes into the promotional activity and some of it's in marketing. Is it the CPG companies? Is it the retailers? Is it both? How do you think about that looking out to 2021, obviously, with a lot of uncertainty, but would seem greater than this year, at least in absolute. Anything there could be helpful.

Matt Farrell (CEO)

Yeah. I mean, my comments earlier were that if you looked at Q2 versus Q3, that sold-on deal has increased sequentially, but it's still down significantly year over year. The shorthand is both laundry and litter sold-on deal is 800 basis points lower in Q3 2020 compared to Q3 2019. Yeah. The reason for that's recovered a bit is because of in-stock levels. As far as you're trying to figure out what's going to happen in 2021, look, it's possible that it could stay where it is right now for a period of time as opposed to keep creeping up because, obviously, all the competitors are benefiting from the lower sold-on deal year over year, and it doesn't seem to be affecting consumption. I think we'll update everybody with our thinking about 2021 sold-on deal or promotion when we get to February.

A little bit too soon to speculate on that.

Mark Astrachan (Analyst)

Got it. Okay. And then just quickly back to Flawless. Maybe building on the other questions, I guess, why now in terms of changing the payout and the CAGR, especially given your commentary last quarter about seeing increasing at-home consumption given salon closings, spa closings, and such? Maybe bigger picture, does this at all change your thinking about which categories you focus on from an M&A standpoint, meaning more kind of the legacy HPC business versus some of the hardware businesses that you've acquired in recent times?

Rick Dierker (CFO)

Yeah. Maybe I'll take the first part, and then Matt can talk about M&A. The reason we do it now is the accounting guidance says we need to look at it every quarter. Last quarter, and really the last two quarters, it's tough to go through the haze of the macro environment when there's a COVID impact or when retailers are closed. We were waiting for, just as time goes by, you get a little bit more credence on what's actually happening from a consumer trend. While consumption's positive, it was just going to have to start at a lower baseline because of some of the retailers being closed and some of the consumption and demand trends. I guess my answer would be we look at it every quarter.

We didn't make a big adjustment last quarter because we didn't have the visibility into the baseline like we do now.

Matt Farrell (CEO)

Yeah. As far as the category itself, we've made a lot of investments in categories we thought there could be a tailwind. If you go back and we say we bought gummy vitamins in 2012 because we thought there would be a transition from capsules to gummies over time. That's proved to be true. Obviously, we benefited from what's happened this past year. We bought Waterpik. It was obviously a device. We believed that gum health was going to become more important to consumers over time. I think that's proven to be true. We think there's a lot of opportunity there going forward. When it comes to Flawless, Flawless is hair removal or using a device. We thought historically there'd been a stigma attached with women using devices to remove facial hair, both face and brows.

We thought that was going to pass over time. We think that the COVID has, because spas and salons being closed, has helped the business because people have discovered the at-home solution. As far as how that's going to work out, that's going to work out well for both the seller and the buyer, Church & Dwight, as far as the multiple end, ultimately, that we will have paid for it. Our criteria hasn't changed. All of those investments meet the same criteria. To be a number one brand, you got to be able to grow. You got to be a high gross margin, asset light, and need to have a competitive advantage.

Mark Astrachan (Analyst)

Thank you.

Matt Farrell (CEO)

Okay.

Operator (participant)

Thank you. I'm not showing any further questions in the queue. I would like to turn the call back to Mr. Farrell for his final remarks.

Matt Farrell (CEO)

Yeah. Hey, thanks everybody for joining us today. We are looking forward to February when we tell you about our 2021 plans. Thank you.

Operator (participant)

Thank you, ladies and gentlemen, for participating in today's conference. You may now disconnect. Have a wonderful day.