The Clorox Company - Q2 2024

Transcript

Operator (participant)

Good day, ladies and gentlemen, and welcome to The Clorox Company second quarter fiscal year 2024 earnings release conference call. At this time, all participants are in a listen-only mode. At the conclusion of our prepared remarks, we will conduct a question-and-answer session. If you would like to ask a question, you may press star one on your touchtone pad at any time. If anyone should require assistance during the conference, please press the star zero on your touchtone pad at any time. As a reminder, this call is being recorded. I would now like to introduce your host for today's conference call, Ms. Lisah Burhan, Vice President of Investor Relations for The Clorox Company. Ms. Burhan, you may begin your conference.

Lisah Burhan (VP of Investor Relations)

Thank you, Jen. Good afternoon, and thank you for joining us. On the call with me today are Linda Rendle, our Chair and CEO, and Kevin Jacobsen, our CFO. I hope everyone has had a chance to review our earnings release and prepared remarks, both of which are available on our website. In just a moment, Linda will share a few opening comments, and then we'll take your questions. During this call, we may make forward-looking statements, including about our fiscal 2024 outlook. These statements are based on management's current expectations, but may differ from actual results or outcomes. In addition, we may refer to certain non-GAAP financial measures.

Please refer to the Forward-Looking Statement section, which identifies various factors that could affect such forward-looking statements, which has been filed with the SEC. In addition, please refer to the Non-GAAP Financial Information section of our earnings release and the supplemental financial schedules in the Investor Relations section of our website for reconciliation of non-GAAP financial measures to the most directly comparable GAAP measures. Now, I'll turn it over to Linda.

Linda Rendle (Chair and CEO)

Hello, everyone, and thank you for joining us today. We delivered financial results above our expectations in the second quarter, thanks to very strong progress on a recovery from the August cyberattack, continued advancement of our strategies to drive top-line growth and rebuild margin, as well as the swift and effective management of currency headwinds in Argentina. We are rebuilding retailer inventories ahead of schedule, enabling us to return to merchandising and restore distribution. As a result, we made great strides rebuilding market shares. Importantly, throughout our out-of-stock period and recovery, we've maintained our strong brand superiority results as measured by our consumer value metric. This speaks to the power of our advantage portfolio, the superior value of our brands, and their role in consumers' daily lives.

While there's still more work to do, we're on the right path to return our business to the trajectory it was on before the cyberattack. Looking ahead, we expect the operating environment to remain challenging as consumers remain under pressure and their value-seeking behaviors continue. Nevertheless, we remain committed to growing the top line and rebuilding margins and expect volume to play a stronger role in our top-line performance as we lap pricing. We're well-positioned to make further progress in rebuilding distribution and market shares, as well as drive volume and household penetration growth over time through strong demand creation plans. Given the progress we made in the second quarter, we are also updating our full year 2024 outlook. We have a strong, diverse portfolio of trusted brands.

We play in essential categories, and we're making the right investments guided by our Ignite strategy to create long-term value for stakeholders. I'm confident that we're taking the appropriate actions to build a stronger, more resilient company that is positioned to win in the marketplace and deliver consistent, profitable growth over time. With that, Kevin and I will take your questions.

Operator (participant)

Thank you, Ms. Rendle. Ladies and gentlemen, if you have a question, please press star one on your touchtone telephone. Our first question today will come from Andrea Teixeira with JPMorgan Chase.

Andrea Teixeira (Managing Director and Senior Equity Research Analyst)

Thank you. Good afternoon there. Linda and Kevin, I just wanted to go back, obviously, an amazing performance you caught up with, I think with the second quarter fiscal, you caught up with, kind of, according to my math, a -2%, pretty much first half against first half of the prior year. And then what are you implying, given the Argentine periods of depreciation, is underlying better, as you put it in prepared remarks, and you commented on this just now, but then you have a greater FX headwind?

But when you go and look through everything and according to the new guidance, the +200 basis points improvement in gross margin, it implies that your gross margin in the back end declines vis-a-vis what you had in the back end of last year. So I was just trying to reconcile because your, your numbers kind of imply profitability going the other way. I understand the translational, the transactional effects, but it seems a bit high. If you can kind of walk us through why would that happen, given the beats, the magnitudes of the beats?

Kevin Jacobsen (EVP and CFO)

Yeah, Andrea, and maybe let me take a stab at answering some of those questions, and let me know if we've missed anything. But as it relates, maybe I'll just start with Argentina, might be a good place to start, because you've heard from many of our peers, that's an incredibly difficult environment right now. I think if you just step back and think about our business in Argentina, we've been in there for a very long time. We have very capable leaders managing very strong brands.

While there are some negative impacts in Argentina flowing through our outlook we provided today, both on the top line in terms of higher FX, as well as higher inflation and FX exposure and margin, what you should know is, based on the actions we've taken in Argentina, including incremental pricing, we think we fully covered the negative impacts of Argentina within this outlook, with the one exception of the remeasurement loss, and I'm happy to talk about that. But setting that remeasurement loss aside, we think we fully contained the Argentina impact in this P&L.... As it relates to the back half, I, you were asking about gross margin, and, and as you saw, we delivered about 41.5% gross margin in the front half.

And if you look at the back half based on outlook, it suggests we'll be fairly similar, 41.5% as well. And so we're looking at sequentially fairly consistent trends. If I think about what's changing from the front half to the back half, there's a few items I'd point out. In terms of increased headwinds, we continue to expect higher trade spending in the back half of the year as we get to a more normalized environment. We also now have lapped all our U.S. pricing. We lapped the last round of pricing in December, so you'll see less benefit from pricing in the U.S. And then we're expecting more inflation and more FX headwinds coming out of Argentina.

We are offsetting that with incremental pricing we're executing in Argentina, so you'll see international price mix benefits in the back half of the year to a greater degree than the front half of the year, as well as we're projecting improving volume trends. And so collectively, that's offsetting those headwinds, and we're getting to a margin fairly consistent front half versus back half, and that puts us in a position to improve margins about 200 basis points on a full year basis.

Now, I think maybe the last question you talked about versus prior year, I think you have to be a little careful looking at the comps. If you look at our gross margins in the back half of last year, I think they were up almost 600 basis points, and so we're relatively flat, but on a very strong performance in the prior year. Let me stop there, and Andrea, let me know if that answers your question.

Andrea Teixeira (Managing Director and Senior Equity Research Analyst)

Yeah, that did, Kevin. Thank you. And I think one of the, kind of like a fine point on that commentary, when you say, and the prepared remarks, I think Linda had mentioned you're confident to regain shelf space, and you're looking, obviously, regained service levels. It sounds to, and even in our meeting recently in New York, you kind of alluded to initially that guidance, and I think we all in this call appreciated there was a lot of moving pieces and you were conservative.

It seems like you're embedding some potential risk at that point of not being able to recover the service levels. Now you did recover, so I'm more in the side of, like, thinking of the strength of what you achieved in six months. So, I'm thinking, more, why not expecting that momentum to continue now that you potentially could recover some of the shelf space losses that you had, especially now coming up on the spring reset?

Linda Rendle (Chair and CEO)

Sure. I'll take that, and maybe I'll just start with your first important point, which was our expectations in Q2 and what drove the significant overdelivery. If you recall, you got it exactly right. You know, at the point where we provided an outlook for Q2, we were at a point where we had just turned back to automated order processing, and we knew there would be a transition time going from manual to automated, and that that would take us a bit of time to ramp up.

We were also heading into key holiday time for retailers, which is a challenging time to ensure that we get the ability to have appointments and ensure that we could deliver what we needed to in order to deliver what we ended up doing for the quarter, which was every single day shipping significantly above an average day that we would normally ship. We, I think, were appropriately cautious, given all of those potential headwinds on what we could accomplish. Again, the goal was to restore inventories by the end, the majority by the end of Q2, knowing some of that would flow into Q3 and Q4. What happened in Q2, we were able to get all of that ramp up, and we really leaned into our operating model.

We designated a general manager who was in charge of solely getting inventories rebuilt in retailers, and she had a multifunctional team around her to do that. We were able to quickly ramp up from manual to automated and ship nearly every single day, significantly above an average shipping day pre-cyber event. Our retailers were extraordinary. We were able to get in, we were able to get appointments. The results of that, if you look at distribution, we were down over 30% of our TDPs. If you look at average weekly TDPs, down over 30% at the height of our out-of-stocks. We've gotten back to mid-single digits. Some businesses slightly better than that, some slightly worse, and I can cover that. Market shares at the height of this, we were down over 5 points.

If you look at the four or five weeks ending December, we were down a point. Look at the latest four or five weeks ending January 21, down 0.7. So all that flowed in the right direction, which gives us confidence. But that speaks to what with the work we have remaining, and we talked about this last quarter. We spoke about the fact that a lot of this was under our control, and we were gonna maximize that, and I felt good about what we did in Q2. But we are also dealing with the fact that in order to fully restore distribution, we need to have retailer resets, and those happen mainly in the spring, and they vary through the back half of our year. And we intend to finish the job then.

And in addition to that, we have to fully restore merchandising. So as we get our business up to the service levels we expect, and to be clear, our service levels are still depressed. They're significantly better, but we need to fully restore those. We'll return to merchandising in the back half in full as well. And with that, we feel good about our plans. We feel like we have the right investment levels. Our brands have maintained their superior value, as I said in my opening comments, so feel good about it. But I just want to be clear, we didn't—you know, the job's not done in Q2. Tremendous progress, but we have more work to do in the back half.

Andrea Teixeira (Managing Director and Senior Equity Research Analyst)

Thank you. I'll pass it on.

Operator (participant)

Our next question will come from Peter Grom with UBS.

Peter Grom (Executive Director and Senior Equity Research Analyst)

Thanks, operator, and good afternoon, everyone. So I wanted to ask on the organic revenue growth trajectory, can you maybe just help us understand how you are thinking about volume versus price in the back half of the year? Linda, you mentioned you expect volume to be a stronger contributor to your performance. Does that assume a return to growth or just kind of less of a drag... versus what we've seen prior to the disruption? And then just on the pricing as well, particularly as you've now lapped the U.S. pricing, but are, you know, taking an incremental pricing related to Argentina. Thanks.

Kevin Jacobsen (EVP and CFO)

Sure. Hi, Peter. As it relates to organic sales growth and transitioning from the front half to the back half, we think about what the changes are. As it relates to volume, we expect to see improving volume trends in the back half of the year. That's a combination of both continued recovery from the cyber event, as well as now that we've lapped pricing, we'd expect to see improving volume. If you look at the front half, our volume was down high single digits, and so we would certainly expect to see those improving volume trends as we go forward. And then in addition to price mix, we've now, as I said, lapped our U.S. pricing in December, the last of the four rounds we took. And so U.S. will be contributing much less, in fact, very little impact of favorable price mix.

We have now leaned into Argentina. In November and December, we took double-digit price increases both months, and so you will still continue to see positive price mix in the back half of the year, in spite of increased trade spending. So I'd say, overall, improving volume trends from the front half of the year, price mix being a little lower than the front half because we've lapped U.S. pricing, but still fairly strong for us. That's how we get to an expectation that we'll be growing for the full year, low single digits, and that'd mean the back half would be a bit stronger than where we landed in the front half in terms of organic sales growth.

Peter Grom (Executive Director and Senior Equity Research Analyst)

Got it. That's really helpful. And then I guess just, Kevin, on the 42% exit rate, and I may be reading too much into this, but are you simply just trying to provide some color on the second half phasing, or are you trying to signal how we should be thinking about the gross margin recapture opportunity looking out to fiscal 2025?

Kevin Jacobsen (EVP and CFO)

Yes, it's more about phasing in the back half. Just wanna make sure we're highlighting to folks. For that, all that pricing in Argentina to take effect, it'll probably be the fourth quarter, but before it's fully in market. So I'd expect our fourth quarter gross margin to be a bit stronger than third quarter. But having said that, you know, Peter, Linda and I remain committed to rebuilding gross margins back to the level we had before the, what I describe as the, you know, the super cycle of inflation.

Good progress last year. We intend to make more progress this year, but the work's not done, and I fully expect going into 2025, we'll continue to expand margins. But importantly, we'll do that while we continue to invest to grow the top line and continue to advance our strategic initiatives. We continue to focus on all three, but as it relates to margin, I expect to make solid progress this year, and I expect that to continue as we go into 2025.

Peter Grom (Executive Director and Senior Equity Research Analyst)

Thanks so much. I'll pass it on.

Kevin Jacobsen (EVP and CFO)

Thanks, Peter.

Operator (participant)

We'll move next to Anna Lizzul with Bank of America.

Anna Lizzul (VP and Equity Research Analyst)

Hi, good afternoon. Thanks very much for the question. I wanted to ask on the outlook in the prepared remarks, you mentioned expecting a modest slowdown in category growth rates in the back half of the fiscal year. Are there any particular categories where you expect an outsized impact versus categories that you think are more resilient?

Linda Rendle (Chair and CEO)

Sure. You know, this assumption on a modest slowdown in categories is one consistent with what we provided as an original outlook to fiscal year 2024, as we saw the consumer come under more pressure. And we originally had the assumption of a mild recession, which we are no longer assuming, but still assuming the consumer is gonna be under more pressure, given all the factors in the macroeconomy. And so that's consistent with that.

And if you look at our categories, given they're all mostly household essential categories, we would expect, you know, no large difference in those categories. We might see little nuances here and there, but on average, we'd expect all of them to be slightly slower, and that's consistent with what we've seen in the past in times like this. I wouldn't call out anything in particular that would be a wide variance to that assumption.

Anna Lizzul (VP and Equity Research Analyst)

Thanks for that. And just to follow up on the organic sales question earlier, on the lifestyle segment in fiscal Q2, we saw a negative price mix. Can you just tell us what is driving that, and should we expect to see negative price mix in the back half of the year on this? Thanks.

Kevin Jacobsen (EVP and CFO)

Sure. As it relates to lifestyle, that was in our, our Burt's Bees business. We do quite a bit of holiday gift packing and merchandising in the second quarter on that business, and so you have increased promotional activity. And so that was specific to the second quarter. And you may see that occasionally based on merchandising plans as we go forward.

Anna Lizzul (VP and Equity Research Analyst)

Great. Thank you.

Operator (participant)

Our next question will come from Dara Mohsenian with Morgan Stanley.

Dara Mohsenian (Managing Director and Senior Equity Research Analyst)

Hey, guys. Just maybe looking beyond fiscal 24, I think the salient question today is probably the earnings outlook as we look out to fiscal 2025. I know obviously you won't comment on that directly, but maybe just looking at a couple line items. First, Linda, from a top-line standpoint, obviously, a lot of moving parts, are you pretty comfortable now that longer-term retailer relationships have not been impacted from the systems issue?

Do you have a line of sight to eventually regaining full distribution? You know, to Andrea's question, understanding the job's not done, but do you think you have that line of sight? And also maybe just an update on the competitive environment near term. Are there any pricing or promotional concerns that have cropped up from competitors recently, given some of the volatility that might linger as we look out over the next year or two, and how you think about that?

Linda Rendle (Chair and CEO)

Sure. Thanks for the question, Dara. So obviously, as you said, we won't provide any perspective on fiscal year 2025, but the things that you outline are important as we think about closing out this year and then, of course, the future of our continued commitment to grow top line while rebuilding margins. And you know, what we see from a top-line perspective is very strong brands, and I think I'd highlight again what I called out around brand superiority. Even in the out-of-stock issue that we experienced in cyber, we maintained our brand superiority ratings, which is significantly higher than it was pre-pandemic. So our brands continue to remain strong. And we feel great about the investments we have in the back half, both increasing our advertising and sales promotion levels, and we're gonna spend about 11% this year.

We continue to expect that, and we do expect trade promotion to increase, as Kevin highlighted earlier. And innovation plans, you know, we've also spoken about the fact that during the cyber incident, we walled those resources off, and so our innovation plans remain on track, and we expect innovation across every major brand at Clorox, and we'll continue to invest in those plans. So I feel great about the brand health going into this. From a category perspective, as we said, we expect to see some moderation in category growth. We tend to fare well in times when the consumer is stretched because we offer value superiority, and in fact, we're seeing in many cases, people still trading into premium segments of our business.

We're seeing that in wipes, we're seeing that in premium litter, we're seeing that in our food business and across many others. So I feel really good about where we stand with the consumer, even as they are more challenged. And, you know, we're not seeing excessive trading to private label. We did see some during our out-of-stock period, but we're seeing that rebound as we get back on shelf. And then retailers, you know, just take another moment to thank them, and I can't thank them enough. They've been tremendous partners, and I say with confidence, our relationships are stronger coming out of this unfortunate incident than they were heading in, and they were strong heading in.

Super grateful for their partnership and what they've done, and we're both back focused on category growth and focused on finishing the job on distribution. I have full confidence, given the plans that we have, that we will restore distribution. It will just be how fast we can do it and on what timing. Again, some of those things are out of our control, but we have the right plans, we have the right relationships and strong brands to get it done.

Dara Mohsenian (Managing Director and Senior Equity Research Analyst)

Okay, can you just comment on the promotional environment? If I can slip in one more, Kevin, on the margin front, you talked about leaving the year at 42%. That's still well below peak levels of 45%-46%, if you go back historically. You mentioned in response to Peter's question that there'll be progress in fiscal 2025. Just help us understand potentially the slope of that gross margin recovery over time, the key drivers, and how you think about long-term potential relative to that peak historical level. Thanks.

Linda Rendle (Chair and CEO)

Sure. On the merchandising and competitive front, we continue to see merchandising levels below what we saw pre-pandemic, and we expect in the back half for those to continue to ramp up. But what I'd say is, you know, some of that was depressed given the fact that we were out of stock and not had as much merchandising. But we're not seeing anything in any material way where we're seeing, you know, deep discount price merchandising, where we're seeing a fundamental change, but we would expect that, that level to rise consistent with a more pressured consumer. And I would say there are little pockets here and there in categories.

We're seeing some competition in litter, where there's a bit more aggressive merchandising and price promoting going on, but nothing outside of what we have assumed in our outlook from our categories and competition. Again, we continue to expect merchandising to increase both ours and competition in the back half, but we don't expect that to go to levels beyond what we saw pre-pandemic. We'll see how that plays out.

Kevin Jacobsen (EVP and CFO)

And then, Dara, on gross margin, yeah, as I said, I'm getting to about 42 as our exit in Q4. I expect we'll make more progress in fiscal year 2025, and I'm sure you can appreciate I'll refrain from being too specific. We haven't finished our plans yet for 2025, but here's what I expect: we will continue to drive cost savings, and as you know, we target 175 basis points of EBIT margin expansion each year. You know, the last couple of years, we've been doing north of 200, so we'll continue to drive cost savings. If you assume we're gonna move into a more normalized cost environment, potentially even some cost deflation, you can see how that 200 basis points can quickly start advancing our gross margins. It's not being absorbed by cost inflation.

So that'll be what we expect going forward. We'll have to see where the cost environment is when we get there. Pricing will play a smaller role as we've now lapped US pricing. We're still doing some pricing international, but that'll play a smaller role. But as we mentioned, we continue to expect improving volume trends, which will certainly contribute to margin expansion as well. So as I said, we're gonna make progress. It's hard to call, you know, when we think we'll get back to that initial margin. We talked about 44%. It's hard to call exactly when we'll get there because it's not fully in our control. Some of that's gonna be driven on how the cost environment plays out. If we see deflation, it could move more quickly, and if it still continues to inflate, it may take a little bit longer.

Then I think once we get back into a more normalized environment, typically our cost savings is more than enough to offset a normal level of cost inflation, and we get to take a little bit to the bottom line, and that's how you get that 25-50 bps of EBIT margin expansion each year ongoing. So I think job one is to get back to that 44%. We remain committed to doing that. I think over time, you get back to a more modest improvement, year-after-year in a more normalized cost environment.

Dara Mohsenian (Managing Director and Senior Equity Research Analyst)

Thank you.

Operator (participant)

Your next question will come from Filippo Falorni with Citi.

Filippo Falorni (Director and U.S. Beverages, Household Products, and Personal Care Analyst)

Hey, good afternoon, guys. So Linda, I wanted to go back to your comment of there's still some job to be done in terms of recovering shelf space. Maybe zooming in on a few categories. If I look at the track channel data, there's three big categories where your total distribution points are still below pre-cyberattack levels, particularly trash bags, bleach, and cat litter. Maybe you could give us a color, like, what your plans are to get the shelf space back?

Linda Rendle (Chair and CEO)

Sure, Filippo. You know, just in aggregate, so that we're completely clear, we are still have fewer distribution points than we did pre-cyber, but we are close to restoring at an aggregate enterprise level. As I mentioned earlier, we were down well over 30% in average weekly distribution points at the low point of our out-of-stocks, and now we're mid-single digits on average. But you're right to call out that in particular, trash and cat litter were actually more on track to what we originally expected in Q2, and we were able to, in the rest of the categories, accelerate the distribution point recovery. But trash and cat litter were more on the schedule that we had expected them to be in Q2, and there's really two things driving it.

The first on cat litter is the ongoing catch-up that we're playing as the category has grown so fast to catch up from a supply perspective to demand. We continue to expect to make progress on that this year, but that's part of the reason why cat litter is slightly behind. And then trash, you know, that's a complex category, and we prioritized a certain set of items to ensure that those were on shelf fast. And with that, we have to bring back the full distribution, particularly, I'll call it large sizes, is one that we have not fully restored yet. We have plans to do that in these upcoming resets. Those are important items in the category, and retailers realize that, and we feel we have the right plans in place to get them back.

But those are two categories that will look more like we had thought at the beginning of Q2. But just like the rest of the categories, we believe we have the right plans. We will make progress in Q3 and Q4, and we're not seeing anything abnormal from a consumer perspective that gives us any concern of our ability to do that.

Filippo Falorni (Director and U.S. Beverages, Household Products, and Personal Care Analyst)

Great. That, that's super helpful. And then, Kevin, two quick follow-ups on the gross margin. First, on the commodity line, it was neutral this quarter. You talked about maybe a more favorable environment. Are you expecting some deflation in the second half, meaning a benefit? And then on the manufacturing and logistics, maybe you can walk us through the drivers of that line as well.

Kevin Jacobsen (EVP and CFO)

Sure, Filippo. And as it relates to... Maybe I'll start with all three and just talk about inflation. As you know, we came into the year expecting about $200 million worth of cost inflation, some of that in commodities, but more of that in manufacturing and logistics, primarily driven by wage inflation. What I would tell you is we're seeing a little bit of improvement in commodities, a little bit better than we anticipated. And keep in mind, we forecast not based on spot rates, but based on forward curves. And so I'd say we're still generally in that $200 million range, but a little bit better news we're seeing on commodities. Now, having said that, that's before we factor in Argentina, and sort of the new reality in Argentina.

But, if I exclude that for a moment, I'd say generally playing out as we expected, about $200 million of inflation, mostly in manufacturing and logistics. You don't see it as much when you look at our web attachments in the front half of the year. We had a number of charges last year that we're lapping. We should had more favorability in manufacturing and logistics, but that was offset by inflation in the front half, and you get to a pretty neutral outcome is what you're seeing for the front half. And now, when you add in Argentina, you know, we're forecasting now almost 300% inflation in that economy. So we are seeing more cost inflation broadly across the supply chain, including commodities.

And so I expect to have unfavorable commodity inflation in the back half of the year, a little bit of the U.S., but more so being driven from Argentina. But what's important to note, and I mentioned this earlier, in Argentina, if you step back from all the noise and where it shows up in the P&L, we believe we have a plan to fully cover the negative impact to our P&L through the increased pricing we're taking.

Filippo Falorni (Director and U.S. Beverages, Household Products, and Personal Care Analyst)

Got it. Super helpful, guys. Pass it on.

Kevin Jacobsen (EVP and CFO)

Thank you.

Operator (participant)

We'll move next to Chris Carey with Wells Fargo.

Chris Carey (Managing Director and Head of Consumer Staples Research)

Hi, everybody. So just a couple, you know, questions, and then, you know, kind of a broader question. Number one, are you, or did you experience any negative impact from a delayed cold/flu season that we should anticipate some benefit, you know, going into the March quarter? And then just, you know, follow up there on Argentina. You know, we've seen some companies cap the level of pricing so as not to, I guess, take all of the inflationary pricing, but we just need different methodologies. Is it fair to assume that you would strive to offset all of the inflation in Argentina if it gets worse, just so we know how to kinda, you know, try to track this going forward? I have a follow-up.

Linda Rendle (Chair and CEO)

Sure. Yeah, Chris, I'll start with the cold and flu. And just so we're all level set, cold and flu is actually, this year, very similar to previous cold and flu seasons that we've saw before. So definitely different than last year, so started later than last year, but more like an average cold and flu season, which we typically see in January and February.

So I would say normalized is, is the assumption that we have. So too early to say what the impacts will be. We'll obviously talk that when we, when we talk Q3, but we're looking at an average cold and flu season. And to your point, that means as we lap it, the lap looks different because we experienced cold and flu earlier last year, and we'll be experiencing a more normalized, so mostly a Q3 impact for cold and flu.

That's been contemplated in our outlook, and we have, like we normally do, normalized assumptions around cold and flu, and we'll see how that plays out. But to date, it looks like a very normal cold and flu season. From an Argentina perspective, that would certainly be our perspective, and as Kevin highlighted, you know, we intend right now, with the plans that we have and what we're seeing in Argentina, to fully offset the impact through pricing. You know, we'll see what happens as we move forward. That would continue to be our posture. And the reasons and proof points we believe we can do it, our market shares continue to be very strong. Our brands are very strong. We'll watch that closely, but based on what we're seeing today, we expect to fully offset the currency headwinds with pricing.

Kevin Jacobsen (EVP and CFO)

Yeah. Hey, Chris, the one item I'd add as it relates to Argentina is on remeasurement. It's worth noting the things you're modeling. In Argentina, you have to remeasure the monetary assets every quarter... and the more devaluation you have, the larger charge you take to your P&L. In Q2, we took a $0.10 charge to the P&L. We have in our outlook the assumption we're gonna take about a $0.20 charge in total. We took $0.04 in Q1, so most of the charge we're taking, which is roughly $30 million, we've taken in the front half, but we do expect there'll be some more remeasurement impacts to the P&L in the back half of the year, but it's fairly modest given what we've already taken to date.

Chris Carey (Managing Director and Head of Consumer Staples Research)

Okay. And then just one additional clarification on some prior questioning. So just to be clear, you're mostly caught up on inventory levels, but not entirely caught up, and so we're still seeing negative trends on a year-over-year basis from a sales standpoint in the Nielsen data, for example. You should continue to outpace your consumption data for, you know, maybe at least another quarter. Is that a fair analysis? Then you would expect some acceleration in consumption going into your fiscal Q4? Just any way you could frame that for us would be helpful. Thanks.

Linda Rendle (Chair and CEO)

What I would say is, you've got it right, and that you're hearing us correctly, that we've restored the vast majority of inventory. We still have work to do to close all the way back to the distribution points that we were at pre-cyber. And so, as I said, we're still down about low single digits, up from down over 30 points. And then market share is the same thing I highlighted. We have work left to do as we do two things: restore those distribution points and return to merchandising in full, and those two things will have an impact, and an output on share. And, and I'd also say the underlying thing behind this all is, too, we, we have to do that work on the fundamentals, and we will.

We also have to ensure, you know, consumers bought other items during this time when we were out of stock, and so we're also doing the discipline work by brand to ensure that we get them back to the Clorox brands they know and love, through our marketing efforts, through the efforts that we're talking with shoppers, you know, at the point of decide. And all that's going on track, but that's the work that we also have to do, not only just restoring distribution and merchandising, but also ensuring that we're getting that next purchase from people who may have tried something different during our out-of-stock period.

Chris Carey (Managing Director and Head of Consumer Staples Research)

Okay. Thanks so much.

Linda Rendle (Chair and CEO)

Thanks, Chris.

Operator (participant)

Our next question will come from Kaumil Gajrawala with Jefferies.

Kaumil Gajrawala (Managing Director of Equity Research)

Hey, everybody. This is a good segue from Chris's question on winning back some of the consumers that you lost. I guess you're holding advertising flat as a percentage of sales, but your outlook for revenues are higher. So from a dollar perspective, I suppose that's an increase. Is it an increase, or is it about what internally you had expected to spend over the course of the year?

Kevin Jacobsen (EVP and CFO)

Yeah, Kaumil, we're expecting increased spending. So as you know, we, we typically spend about 10% of sales. This year, we're targeting 11%, and in fact, in the back half, it'll be closer to 12%. So we're leaning in, investing to continue to drive value superiority at an elevated rate. So year-over-year, it will be higher based on the, the elevated rate of spending we, we intend to spend.

Kaumil Gajrawala (Managing Director of Equity Research)

Got it. That's useful. Thanks. And then, maybe a little more information on something you've alluded to a few times on, on consumer pressure. Is it something you're already seeing or something you're planning for the back half? And maybe if you could sort of marry that comments with some of what, you guys have talked about as it relates to promo activity.

Linda Rendle (Chair and CEO)

Yeah, you know, the consumer has been fairly resilient, and we've continued to say that, and we saw that in the front half of the year. It is a little difficult in our categories to get a completely clean read, just to be fair, given that we were out of stock, and so there's a lot of dynamics going on. But as we come back in stock, we're seeing largely what we expected from the consumer in the front half, which is a lot of resiliency. We continue to see value-seeking behaviors, so we're seeing trading up to large sizes. We're seeing trading into opening price points. Not seeing what we would expect, anything different on trading into private label than we would have expected.

Again, certainly more people tried private label when we were out of stock, but we're seeing that reverse as we get back on shelf. We continue to see a squeeze of other brands, so the leading brand and private label tend to be the two that are doing well in categories that have multiple brands. All of those behaviors continued in the front half. What we expect in the back half is the consumer to continue to be under more pressure. That being said, our categories are fairly resilient because we're household essentials, so we're expecting a moderation, but this is not a reversal of the trends we've seen. We're seeing the, the shift from price mix being the driver of growth to volume, and that is certainly playing out.

If you look at sequential volume improvement trends over this course of time, and if you kind of back out the effects of being out of stock from cyber, you're seeing consistently volume improving. At the end of December, volumes were down very low single digits, for example, from a consumption perspective, if you look at the MULO universe, and we would expect to see that continue in the back half. So what we just see is consumer under more pressure, value-seeking behaviors continue, a slight moderation in our categories.

We'd assumed all of that in our outlook will continue to moderate, but to date, the consumer has been resilient, and we think those things will play in to the other assumptions we have, like more merchandising in the back half, and, you know, competitors focused on ensuring that they're offering a great value to consumers as their wallets are stretched. But it's very, very consistent with what we had expected at the beginning of this year. We don't see any change in behavior from consumer outside of those assumptions we had six months ago.

Kaumil Gajrawala (Managing Director of Equity Research)

Okay, great. Thank you. Well done.

Linda Rendle (Chair and CEO)

Thanks.

Operator (participant)

We'll move next to Steve Powers with Deutsche Bank.

Steve Powers (Managing Director and Senior Equity Research Analyst)

Hey, thanks, and congrats from me, and really to you and to the whole company on the pretty remarkable recovery these past several months. One quick follow-up and then a question. The follow-up, just on the categories that Filippo had mentioned, you talked about still some work to do to fully you know fully catch up and recover. Is the expectation that as you exit fiscal 2024, that you have fully recovered there? Or is there more work that you expect we should expect carries over into the back half of calendar 2024 and fiscal 2025?

Linda Rendle (Chair and CEO)

Hi, Steve. Thank you for your, for your nice comments. We, we really appreciate them. On those categories, and I would say just in general, we intend to make as much progress as we possibly can in Q3 and Q4. Will there be some lingering effects that could be outside of our control if there's a retailer reset or a change? Perhaps. But we are focused on getting as much of that back in Q3 and Q4 as we can. What I wouldn't say is, you know, I, I wouldn't commit to any number at this point right now, except we expect to make continued progress over the course of the next six months.

I think for trash and litter, litter has been a challenge for a while, given that we've caught up to supply, so that is the one that we're laser focused on, and has more to do with bringing a new plant up to speed than it has to do with recovering from the cyber incident itself. So that'll be one that we'll be watching closely and trying to make as much progress on. But we are going to make as much progress as possible, and we expect significantly more in Q3 and Q4.

Steve Powers (Managing Director and Senior Equity Research Analyst)

Okay, very good. And the question I had, you know, if we step back from the last, you know, you know, since August, you know, we go back to before the summer, we were talking about, you know, a lot of things, but one of those—one of those topics was sort of the ongoing digital transformation in the company, the operating model changes that you guys have been working on, sort of long-term strategic arc of, of, business transformation. Has anything, you know, over this, over this period since August, you know, set you back on that trajectory? Or have you been able to keep pace so that we, you know, so that the progress that was anticipated, at the start of the summer is still sort of broadly on track?

Linda Rendle (Chair and CEO)

Thanks, Steve. And, you know, just as a preview, we'll spend a lot more time at this at CAGNY and have a chance to talk about our overall transformation and, in particular, the operating model and digital transformation. So I look forward to talking to you all about that then. But right now, you know, what I can say is we are absolutely deeply committed to the strategic priorities, including those two areas of transformation for the company. They're critically important for our success. They're about investing in the long-term health of our business and being ready to take on the challenges of the future. And so the commitment is absolutely there. What I'd say is, on the operating model, we were able to proceed even through the cyber event in executing that. We remain on track to that plan.

As you can imagine, from a technology side, during a cyber event, you know, we've had some delays on our ERP. We'll talk to you more about the timeline of that when we finalize it, but we're still committed to the transformation and all of the elements of that. But of course, our team was focused on getting safe and secure, and ensuring that we moved from manual to automated processes, as the number one priority, and we are now returning to that digital transformation, and we'll have more of an update in the coming months.

Steve Powers (Managing Director and Senior Equity Research Analyst)

Okay, excellent. I'll see you in a couple of weeks.

Linda Rendle (Chair and CEO)

Thanks, Steve.

Operator (participant)

We'll move next to Javier Escalante with Evercore ISI.

Javier Escalante (Senior Research Analyst)

Hi, good evening, everyone. I have a... I'm gonna kick a dead horse here, but I do have a problem with the, with, adding up into the second half forecast, particularly for the gross margin. So if you can help us with two items, specifically. One is Forex. How big Argentina can possibly be to—if you can help us understand and dimension that impact first on sales and gross margin as to, as to basically be flat in the second half? So that, point number one.

The other has to do with the job to be done and the two categories that, that you are investing or you are still talk—about to invest, trash bags and pet. They are very competitive. You have competitors that have a value stand. So to what extent is not an issue of distribution, but an issue of retailers, changing the assortment or value, and then you needed to basically buy up space, features and things like that, that is gonna create a negative offset to gross margin? Thank you.

Kevin Jacobsen (EVP and CFO)

Hey, Javier, let me start with your question on FX and how it's impacting sales and gross margin. And, you know, when we entered this year, we were anticipating about 2 points of FX headwinds on the top line, mostly coming out of Argentina. The Argentina economy has declined more than we had anticipated, and as you may have seen in our prepared remarks, we're now anticipating about 5 points of FX headwinds on the top line. That is solely a function of revising our expectations for Argentina. We now have in our outlook and expectation that the currency will devalue about 75%, and that's gonna be back half loaded.

If you look at the front half, we had about 3 points of FX headwinds, and that puts you into the mid- to high single-digit FX headwinds in the back half, and again, a function of Argentina. And then that also plays through in gross margins. We expect a greater negative hit to gross margins as it relates to the FX impact. So if you look at last year, FX was about, you know, less than 100 basis point hit. This year, it'll be well north of that, closer to 150 basis points or so. And again, it'll be more pronounced in the back half of the year.

Important to note, though, maybe just to finish that up, and I'll let Linda address the other question. As I mentioned earlier, in spite of those negative impacts, based on the actions we have already taken and will take, primarily as it relates to pricing, we believe we can offset both the top-line FX impact as well as the FX impact to gross margin. And as a result, you can see we're raising our sales expectation and expect to grow margins in spite of a pretty difficult environment we're dealing with there.

Linda Rendle (Chair and CEO)

Javier, on the piece that you mentioned on those two particular categories, trash and litter, that we spoke about, you know, it's exactly what we said it is. From a supply perspective, you know, those are two businesses that are a bit more challenged. We feel very confident in the health of our brands there. And as I spoke about from a superiority perspective, you know, consumers define value not as the lowest price, but of course, what is the overall best offering from them, which price is an element of. We feel great about the superior value of both of those brands and what they offer. We continue to see our innovation do very well in both of those categories, and we highlighted both of those in CAGNY.

Some of the innovations we have, Glad with Clorox, and other launches that we have in Glad that are similar, and of course, our Outstretch cat litter, which has done very well and has held up even through out-of-stocks. We continue to see people trade in to premium cat litters. So we feel confident about our plans.

Again, we have the right investment levels, and yet we're focused on providing exactly what you said, which is the right value to consumers, and retailers see that, and we play an important role in their category growth. And I have confidence that we will retain or regain distribution, get back to the proper level of merchandising in these categories, and that we'll get our shares back to where they need to be. Just in these two categories, it's a little bit extended versus some of our other categories. But I have every confidence in these two that we'll get back just like we are on the other ones.

Javier Escalante (Senior Research Analyst)

Thank you very much.

Linda Rendle (Chair and CEO)

Thanks, Javier.

Operator (participant)

We'll hear next from Callum Elliott with Bernstein Research.

Callum Elliott (Senior Analyst)

Great. Thank you for the question. I just wanted to build on Steve's question and hopefully not to preempt your CAGNY presentation too much, but alongside the digital transformation, you guys had other long-term initiatives before the hack that were also targeting the top line. I think it feels like quite a long time ago now that you raised the long-term top line target to 3%-5%, driven by this push into international and professional. But hoping you can update or update us on those strategic initiatives and where we stand now that we're hopefully starting to put the hack in the rearview mirror. Thank you.

Linda Rendle (Chair and CEO)

Thank you. We certainly want to get back to where we ended fiscal year 2023. You know, we were very proud of the performance and what we had done, and of course, remain deeply committed to what we talked about, which is expanding top line over the long term, 3%-5%, and expanding EBIT margins 25-50 basis points. We want to get back to that, exactly as you said. Our transformation is a critical component of that, in ensuring that we have the right capabilities and processes, and that people at Clorox are more consumer obsessed, and we're working faster, in a leaner fashion to get there, and we'll talk about that. As we spoke about, actually, at CAGNY, I think it's two years ago now, you know, what we expected from a growth perspective continues to remain.

We continue to see opportunities in international. We continue to expect to see returning to growth in our professional business as that more normalizes. But we spoke about all the other things that we had seen trend-wise. We saw more cat adoptions, and so, you know, natural category tailwinds for litter. We saw people have an increased interest in disinfecting, which still remains, and we still see that, and we're seeing it as we look at the data today. People still have a heightened need to have their spaces cleaned and disinfected. People generally are taking care of their health and wellness more, so things like Brita have natural tailwinds, and water consumption. Our vitamins, minerals, and supplements business, the same thing, continues to have natural tailwinds.

So we'll speak about all of that at CAGNY, but we remain committed to that 3%-5% top line over the long term, and to do that in a more profitable and consistent way. And we have all the right levers and are pulling all of the right transformation buckets in order to do that, and I feel we're on the right path to get back to where we were coming out of fiscal year 2023.

Callum Elliott (Senior Analyst)

Thanks, Linda.

Linda Rendle (Chair and CEO)

Thank you.

Operator (participant)

We'll move next to Lauren Lieberman with Barclays Capital.

Lauren Lieberman (Managing Director and Senior Equity Research Analyst)

Great. Thanks. Hi, everybody. So I was just looking back, and I remember that last quarter when you were talking about the outlook and the recovery plan and, and expectations, that you said you expected customer inventory levels to be rebuilt by the end of fiscal 2Q. But tying to that was a conversation of mid-single-digit sales growth, right?

So now retail inventories are in fact rebuilt. It's amazing, to say the least, but it was with, you know, sales growth that was way higher than mid-single digit. So can you just tie those two things together for me? Because I think the, just the visibility and the forecasting, I think, is an open question. And if you go back even pre-cyber, the pattern of exceeding your own outlook was incredible. But you do have to also ask the question of, like, what happens if it goes the other way, if this is a question of visibility?

Linda Rendle (Chair and CEO)

Hi, Lauren. Let me try to paint a picture for what happened in Q2, so we're all on exactly the same page. You are right to say that we expected to build the vast majority of inventories by the end of Q2. What happened is, we did that faster, so what you get is less of a consumption loss impact in the quarter. So instead of doing that, call it the last two weeks of December, we did that earlier and earlier by categories, so you have less out-of-stocks, which significantly increased our top line... and that's really the difference that you see in the quarter.

And of course, that has positive impacts in terms of the merchandising we can do and all of the fundamentals at, from a retailer perspective that we wanna return to, and gave us great confidence in the back half. You know, not only did we take our outlook up because we over-delivered in Q2, but we see a stronger back half as a result of that. So that's really the difference, is we had less lost consumption because inventories returned faster in the quarter than we had expected.

Lauren Lieberman (Managing Director and Senior Equity Research Analyst)

Okay. Okay, that's fantastic. And then just also on Burt's, I feel like when, you know, we all saw you in December, at the time, you were talking about the challenge of Burt's and restoring that business, just because the, you know, natural complexity of the SKUs and the lineup in that business, and that holiday merchandising might actually be a spot where you'd, you know, fall short. When I look at the trends in lifestyle, right, clearly, Burt's had a great quarter. So there, too, kind of same story? Or I'm just... I'm a little confused on that one because it felt like that was a business that was gonna be tough to be able to, you know, get that merchandising in, and the holiday is a pretty, you know, it's an important seasonal time for that brand, is my understanding.

Linda Rendle (Chair and CEO)

Yeah, Lauren, you remember correctly from December. We highlighted one of the places that we were focused on. Actually, two places. We talked about cold and flu, if you recall, and our push to get as much of that distribution restored to ensure that we could protect cold and flu, which we feel we did. And then second, exactly right, is Burt's Bees and the importance of the holiday period. We were able to do most of that.

I would say for holiday, we didn't get all of it out, but we got the vast majority of holiday out, which was good. And that certainly did support a stronger performance on Burt's than we had anticipated. But that was a big challenge. But I would say, you know, unfortunately, we didn't get it all out. That certainly, you know, has an impact, but the good news, it was more positive than we even expected back in December for it to be.

Lauren Lieberman (Managing Director and Senior Equity Research Analyst)

Okay. Okay, perfect. And then the final thing, sorry, in this vein, but I'm just trying to put the pieces back together, if you will. On logistics, that was one area, Kevin, where you had talked also last quarter about that logistics costs would be elevated this quarter because, as you mentioned, Linda, you're shipping well above normal every day, right? And that you're gonna end up using a lot more, you know, carriers and freight and so on, beyond what you'd normally be contracted for, and that there would be elevated costs with that.

Again, like, I know there's many pieces of that gross margin build, but logistics was one that really jumped out for us, as being pretty different. So I'm just not-- That's another area of question of kind of what played out differently there. Was it retailer fines? I think you mentioned that in the prepared remarks, but that seemed like a pretty significant difference versus something that should have carried elevated costs within the quarter itself.

Kevin Jacobsen (EVP and CFO)

Yeah, Lauren, you remembered exactly correct. When you think about the gross margin for the second quarter came in higher than we expected, both a combination of stronger top line, but exactly what you just highlighted, we did not incur the upcharges we anticipated. If you remember, when we were talking last quarter, we said our priority, job one, is to get product back on shelf as quickly as we can, and we were fully prepared to incur additional logistics, manufacturing upcharge to get that done. And that take the form of, you know, running the plants more overtime, you know, less than full truckloads, out-of-route shipments. We said that was all available, and we expected to do some of that to get product there quickly.

A credit to our team, and as Linda mentioned, a credit to our retail partners here, as we move more quickly, getting product to retailers, we did that in a very efficient manner. We did not have to incur the upcharges. We were mostly using our carriers. We were mostly being able to do that in full trucks. And because we got that done even faster than we expected, it didn't bleed onto the full quarter. And so it's really about us executing more effectively than we anticipated going into the quarter. But we went in expecting we would have to spend more, and we prepared to do that as we were prioritizing getting product on shelf. It just resulted in the fact that we didn't have to.

Linda Rendle (Chair and CEO)

Yeah, just maybe make another comment on our operating model, Lauren, and there were some good questions on our transformation and are we continuing it. And I think one of the things I'm really proud of is, one, we learned a lot in COVID that we applied to this situation. Unfortunately, we were hoping we'd never have to apply it again, but we were ready to go. The second thing is this is, an output of our operating model, getting laser-focused on what matters, putting a business leader in charge who sees end-to-end, who is able to make the calls and trade-offs, and she and her team were able to do just that, to be able to restore inventories and do all those things Kevin spoke about, not requiring a lot of overtime.

Our decision to take our inventories up in Q1 was an important one, and we knew that we would work those down, but we made that choice early to ensure that we could do as much as we could in Q2. But I would just plug our operating model. That's a real output of what we've been driving and that change to be, you know, more, more business unit focused, more, more, focused on the consumer and customer, and, and fast.

Lauren Lieberman (Managing Director and Senior Equity Research Analyst)

Okay. All right, great. Thanks. I really appreciate it.

Linda Rendle (Chair and CEO)

Thanks, Lauren.

Operator (participant)

Our next question comes from Olivia Tong with Raymond James.

Olivia Tong (Managing Director and Senior Equity Research Analyst)

Great, thanks, and, great work on the, on the improvement. In terms of the macro backdrop, you talked about how, for second half, you're now no longer expecting, the recession that you had before. But could you just talk about, what your expectations are? Is it for the current environment to stay the way, the second half to be similar to what we saw in the first half, or that there is still a step down, just not as, not as much as you had before?

Linda Rendle (Chair and CEO)

Hey, Olivia. You know, on the macroeconomic and consumer front, that's exactly right. We are no longer expecting a mild recession. And of course, when we released our outlook six months ago, we said that's an assumption, and if it changes, then we'll adjust. But really what we meant by mild recession and the impact it would have for us is a more stretched consumer, and we continue to see an environment that leads us to believe that consumers will be more stressed. And if you start to look at categories around us, that certainly has been playing out. We feel the impact will be moderate to our categories, given the fact that we play in household essentials.

But we are seeing consumers, you know, more use of credit, we're seeing them shift their behaviors, and showing things that they value and don't value. Discretionary goods have been down for a while, and we see the cumulative impacts of that, you know, as they've gotten down to a place now where their savings are down to pre-pandemic levels, they no longer have that extra disposable cash, even though employment remains high. We think that all adds up to a more pressured consumer, and we think the impact of that will be a moderate impact on our categories, as consumers, you know, are more conscious about how they spend their dollars. That's really the assumption. Again, the consumer has been resilient to date. We've continued to see that, but we are seeing them in our categories; they are value-seeking.

And as I mentioned earlier, they're trading up to larger sizes. They're using opening price points. They're stretching their dollar. They might be trading into an item they feel like is more multipurpose. And at the same time, we're seeing them, given the superior value of our products, they're trading into premium because they are not willing to trade off efficacy. They are not willing to trade off convenience. So we're seeing all of those things play out, but we just think the consumer will continue to be under more pressure, not in the form of, we believe, a mild recession anymore, but just all of the other macroeconomic factors that are out there.

Olivia Tong (Managing Director and Senior Equity Research Analyst)

Got it. That's very helpful. And then relative to your expectations going into the year, obviously putting aside the, the cyberattack, do you think you'll end the year in line with your start-of-year targets on promotion and merchandising levels? Because I'm trying to understand... You know, obviously, there's a lot of puts and takes, of, of where your expectations stand now versus in August before the cyberattack happened. But, you know, you had said in the past that perhaps we'd have to do a little bit more promotion, a little bit more merchandising, just to, to make sure that, you know, you know, given what's happened. Just wondering, you know, today, what you're thinking in terms of, of the level of promotion merchandising relative to where you started the year.

Linda Rendle (Chair and CEO)

Yeah, on that assumption, certainly we saw a dip in Q2, given the out-of-stock situation, and we had to prioritize ensuring that we got supply up before we could merchandise. But now that we're returning distribution and market shares, we would expect promotion to pick up, and we expect for the back half the same assumption that we had at the beginning of the year, which is higher than it had been and returning closer to pre-pandemic levels.

We don't think that merchandising will exceed pre-pandemic levels, but begin to return to that level as people are focused on a more stressed consumer and continuing to offer the right value, and of course, doing things like releasing innovation, ensuring we introduce consumers to new items and great innovation. So that's what our expectation continues to be. We'll see merchandising increase than what it was last year, getting closer to pre-pandemic levels, and we expect that to happen over the course of Q3 and Q4.

Olivia Tong (Managing Director and Senior Equity Research Analyst)

Got it. Thank you so much.

Linda Rendle (Chair and CEO)

Thanks, Olivia.

Operator (participant)

This concludes the question and answer session. Ms. Rendle, I'd now like to turn the program back to you.

Linda Rendle (Chair and CEO)

Thank you, everyone. As we covered today, we made strong progress on our priorities in the second quarter. While there's still more work to do to fully recover in the market from the cyber incident, we're focused on executing with excellence and delivering on our strategies to drive top line growth and rebuild margin. Guided by our IGNITE strategy, we're confident we have the right plans in place to deliver long-term shareholder value creation. And as I mentioned earlier in the call, we look forward to sharing more with you in our upcoming presentation at the CAGNY Conference in February. Until then, please stay well, everyone.

Operator (participant)

This concludes today's conference call. Thank you for attending.