Good morning, ladies and gentlemen, and welcome to the Church & Dwight Third Quarter 2022 Earnings Conference Call. Before we begin, I have been asked to remind you that on today's 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 filings. 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.

Okay. Thank you, operator. Good morning, everyone. Thanks for joining us today. We've got lots to talk about. I'm going to begin with a review of Q3 results. Then I'll turn the call over to Rick Dierker, our CFO. And when Rick is done, we'll open the call for questions. First off, I'll say, we revised our full year revenue outlook in early September, and we're tracking to hit 3%, which was the midpoint of our 2% to 4% range at that time. In Q3, reported revenue was up 0.4%, and that exceeded our expectation of minus 1%. As you read in the release, while the majority of our brands are performing well, we have 3 businesses that are coloring our results this year. And those are WATERPIK, our vitamin business, and FLAWLESS. And those businesses accounted for a 6% sales headwind in Q3. Adjusted EPS was $0.76. Now this was $0.11 higher than our EPS outlook, driven by higher international sales, lower SG&A and timing of marketing spend. The U.S. portfolio grew consumption in 11 of 17 categories. The trade down to value laundry detergent continued as ARM & HAMMER liquid detergent achieved an all-time high market share of 14.3%. The ARM & HAMMER clumping litter, BATISTE dry shampoo, and THERABREATH mouthwash also achieved all-time high market shares. TROJAN condoms returned to share growth and OXICLEAN stain fighters and ARM & HAMMER baking soda delivered double-digit consumption growth. The strong performance of these businesses is offsetting the impact of the discretionary businesses and vitamins on reported sales. In Q3, our most discretionary brands, WATERPIK and FLAWLESS, which account for approximately 10% of our global sales were impacted by lower customer spending. Similarly, the gummy vitamin category, in which our VITAFUSION brand competes, was impacted by a decline in consumption as fewer households purchased vitamins and supplements and we were also lapping the COVID Delta variant in the prior year quarter. In Q3, online sales as a percentage of total sales was 15%, and we continue to expect online sales for the full year to be above 15%. Now I'm going to comment on each business. First up is the U.S. U.S. consumer, which had a 1.7% organic sales decline. Looking at market share, 7 of our 14 power brands held or gained share. Looking ahead, we expect even further improvement in our market share positions in Q4 as we expect our highest fill rates of the year and our highest quarterly promotional and marketing spend. I want to look at a few of the important categories in the U.S., and I want to start with laundry. The trade down to value detergent which began in Q2 continued in Q3. During Q3, the liquid laundry category grew 3.1%. Now if we break that down, value laundry detergent grew 9%, premium declined 3%. ARM & HAMMER unit dose also benefited from the trade down. Our ARM & HAMMER pods grew consumption by 25% in the quarter compared to unit dose category growth of 4.5%. With more consumers migrating to ARM & HAMMER, the long-term benefit to the ARM & HAMMER brand is similar to the last recession. In litter, the category grew 11%, while ARM & HAMMER litter grew 14%, so we gained share in the quarter. Both our black box, which is premium, and our yellow box, which is value, had double-digit consumption growth in Q3. In stain fighters, OXICLEAN gained share as consumption was up 10%, while the category grew 7%. The dry shampoo category was up 18% in Q3, driven by BATISTE consumption, which was up 37%, and we now enjoy a 46% market share in dry shampoo. The condom category was up 3.5% in Q3, while TROJAN consumption was up 4.5%. So again, we gained 60 basis points of market share, thanks to our new TROJAN BARESKIN RAW condom and the success of more targeted marketing. Our most recent acquisitions are performing well. THERABREATH, which we acquired in December of 2021, had a great quarter with a 46% consumption growth. THERABREATH grew share of 4.3 points to 17.8% of the alcohol-free mouthwash category. THERABREATH is the #2 non-alcohol mouthwash and the clear #4 brand in total mouthwash. THERABREATH is expected to be a long-term grower for Church & Dwight in the future. ZICAM also delivered strong results this quarter. You may recall, we acquired ZICAM in December of 2020. ZICAM is the #1 brand in the cold shortening segment with a 76% share in Q3. Now looking ahead to Q4, the regular flu season in the U.S. is projected to be far more severe than recent years. And as a reminder, approximately 40% of ZICAM consumption happens in Q4. We closed on our latest acquisition, Hero, in mid-October. Now while we did not own Hero in Q3, the brand performed extremely well, growing consumption 56% and gaining 3.6 share points to achieve a 14% market share in the total acne treatments category. There's a great deal of excitement here about this business as we look ahead to 2023 and longer term. All right. Next up is International. Our international business delivered organic growth of 3.2% in Q3, primarily driven by the international subsidiaries, which posted strong growth in the quarter. On the other hand, our Global Markets Group has been impacted by weakening demand in China due to lockdowns, and we expect this to continue in Q4. Finally, Specialty Products. Our Specialty Products business delivered 1% organic growth in the quarter. But keep in mind that the 1% organic growth is on top of an 18.5% organic growth in Q3 2021. Now I want to spend a couple of minutes discussing our 2 discretionary brands, WATERPIK and FLAWLESS, which have longer purchase cycles. And after that, I'll talk about the vitamin business. First, WATERPIK. So WATERPIK is the #1 brand in water flossers. We continue to see lower dollar consumption for water flossers in the U.S. However, WATERPIK unit volumes are actually positive both in Q3 and year-to-date as consumers trade down to lower-priced cordless models. If we look back at 2021 and 2020, the consumer was healthier and a good portion of our growth came from our super premium products like Sonic-Fusion. In 2022, the decline in our flosser sales is driven by trade down and inventory reductions by retailers. Shipments for the full year 2022 are expected to decline approximately 20% as retailers reset their inventories and product mix. We continue to invest in demand-driving activities for WATERPIK, such as Lunch & Learns with dentists and hygienists to drive household penetration of flossers. And in 2023, next year, we expect to return to pre-pandemic levels for Lunch & Learns. Now remember, WATERPIK is the Kleenex of water flossers and 9 out of 10 dentists recommend the product by its brand name. This is extremely important as 60% of consumer purchases are driven by a recommendation from a dental professional. It's fair to say that gum health is not going away and still only 16% of the U.S. population flosses every day. Now looking back, WATERPIK averaged high single-digit top-line growth from 2017 when we acquired the business through 2021. So we're taking a big step back in 2022, but we're confident that the long-term growth prospects for WATERPIK are sound. Now the other discretionary brand we have is FLAWLESS, which is the #1 brand in women's health hair removal. We're experiencing lower consumption in this category which resulted in higher inventories at retail. Our share has been further hurt by the delay in launching new products caused by the China lockdowns at our supplier. After the conclusion of a 30-month earn-out period, which ended in 2021, our marketing team took over the front end of the business and has been narrowing the product assortment to the winners. So if you're familiar with the brand, that's Face, Brow, Mani, and Pedi. And we're also shifting the focus from older consumers to digital targeting of younger consumers in the beauty space. Now we believe these changes will have a positive impact on the long-term prospects for the business. Now finally, over in VMS, we have the #1 adult gummy vitamin. Category consumption is being impacted as temporary consumers who were interested in prevention during COVID times have exited the category. Beyond category dynamics, the VITAFUSION brand has also lost some share due to our lower fill rates, particularly earlier in the year. It's clear that fewer households are purchasing vitamins and supplements post-COVID, and the category is being impacted by the recession. So here are some stats. For the last 3 quarters, the category growth rate has been plus 10% in Q1, plus 5% in Q2, and most recently minus 8% in Q3. Now the minus 8% compares to a plus 33% increase in the category in Q3 2021. And there is some good news here. In the first few weeks of October, the rate of category decline has moderated to minus 4%. And longer term, the transition from pills and capsules to gummy vitamins gives us confidence in the long-term appeal of the gummy category. And I'll conclude with a few takeaways that I'd like to leave you with. The majority of our business is strong. We believe the 3 brands that are coloring our numbers have good, long-term prospects. Case fill is now over 90% and improving. We've ramped up our marketing and trade promotion investment in the second half, especially in Q4, and we have confidence in our Q4 outlook. Now I'm going to turn it over to Rick to give you more details on Q3.

Thank you, Matt, and good morning, everybody. We'll start with EPS. Third quarter EPS was $0.76, down 5% to prior year. The $0.76 was better than our $0.65 outlook primarily due to higher sales, lower SG&A expense, and timing of marketing spend. Reported revenue was up 0.4%, including a 1% drag from currency. Revenue was higher than our outlook of minus 1%. Organic sales declined 0.7% as volume was down 8.5%, partially offset by positive pricing of 7.8%. Matt reviewed the top line for the segments, so I will go right to gross margin for the company. Our third quarter gross margin was 41.7%, a 250 basis point decrease from a year ago. Let me walk you through the Q3 bridge. Gross margin was impacted by 580 basis points of higher manufacturing costs, primarily related to commodity inflation, distribution, and labor. These costs were offset by a positive 190 basis point impact, largely from pricing; positive 20 basis points from acquisitions and a positive 120 basis points from productivity. Moving to marketing. Marketing was down $20 million year-over-year, although this was a significant increase of $40 million sequentially from our first half 2022 levels of 8% of sales, as our fill rates have improved. Fill rates in Q3 were 91%, and we expect further improvement in Q4. Marketing expense as a percentage of net sales was 10.7% in the quarter. We expect continued increase in marketing spend in Q4 to approximately 13% of net sales. For SG&A, Q3 adjusted SG&A decreased 30 basis points year-over-year. Other expense all-in was $19.4 million, a $7.3 million increase resulting from higher average outstanding debt levels and higher interest rates. And for income tax, our effective rate for the quarter was 20.2% compared to 20.4% a year ago. And now to cash. For the first 9 months of 2022, cash from operating activities decreased $119.5 million to $534 million due primarily to higher inventory levels from WATERPIK, FLAWLESS, and vitamins. We expect inventory levels to come down over the next 12 months. And as of September 30, cash on hand was $438 million. Looking ahead to Q4, we expect reported sales growth of approximately 2%, organic sales decline of approximately 1% and gross margin contraction. Adjusted EPS is expected to be $0.58 to $0.62 per share, a 3% to 9% decrease from last year's adjusted Q4 EPS. This decline is primarily due to significantly higher quarterly tax rate of 25% versus an unusually low tax rate in the prior year of 3.7%, which was largely due to a high number of stock option exercises a year ago. Turning to the full year, we expect the full year outlook for reported sales growth to be approximately 3%, the midpoint of our previously 2% to 4% range. We expect organic sales growth to be approximately 1%. The strong consumption across most of our businesses in 2022 has offset the slowdown in discretionary brands, as Matt talked about. We now expect full-year adjusted EPS to be $2.93 to $2.97, a decline of 2% to 3% compared to 2021. The range is influenced by the extent of margin mix within the portfolio. We continue to expect the full-year tax rate to be 23%. And we now expect cash from operations for the full year to be approximately $800 million. And our full-year CapEx plan is now approximately $170 million as we continue to expand manufacturing capacity in anticipation of future growth in laundry and litter. In closing, we continue to perform in a volatile environment. We expect further market share gains in Q4 as we invest in our brands and our supply chain fill levels continue to improve. And with that, Matt and I would be happy to take any questions.

Our first question comes from Dara Mohsenian of Morgan Stanley.

First, just a detailed question. Can you just be a bit more explicit on what changed in the earnings guidance for this year post the early September update? I know there's year-over-year tax rate pressure in Q4, but I think that was known. So just curious on what's changed. And then second, just on the vitamin side. You guys have articulated that the business is suffering from tough comps versus COVID variants last year, that makes sense. As you think about the business longer term, some of the people that were brought in during COVID, who maybe aren't as loyal to the category, is there sort of risk that this weakness lingers and perhaps they're more susceptible to pullback in consumer spending and won't be as loyal to the category from these sort of on-the-fence users who were brought in during COVID? So just any thoughts on vitamins as you look out more to next year.

Yes. Dara, it's Rick. I'll take the margin mix, and Matt will take the vitamin question. So really, the change in the outlook is pretty straightforward. We didn't change the revenue outlook. We're still the midpoint, the 3% number. The mix to get there has been a little bit different though. The businesses like FLAWLESS and WATERPIK and vitamins have come down, and the rest of the household portfolio has gone up. And so that's created a mix pressure. Matt also talked about how there's a trade down for WATERPIK going from the higher-priced units to the lower-priced units, that's also caused a mix issue on a profit basis and that's impacted earnings.

Yes. With respect to vitamins, as you heard in my opening remarks, we've lost some share due to fill rates. So we had lost some consumers to brands earlier in the year. So we've got to win them back. And there's definitely fewer households purchasing. Your question is, can we call the bottom? And do we know that all the consumers who are leaving the category have left? Obviously, that's not knowable. I will say that the coming flu season actually should bolster the VMS category, just beyond COVID because we haven't had a weaker flu season for a few years. But given it's been many quarters now since the end of COVID, we do think things are starting to bottom out. As I mentioned, since we saw that in the fourth quarter that, at least early in the fourth quarter, the decline year-over-year is reduced to 4% where it was 8% in the previous quarter. So it's possible that we could be hitting an inflection point where the category may flatten out and then start to grow.

Our next question comes from the line of Chris Carey of Wells Fargo.

I'm trying to determine how much of WATERPIK, FLAWLESS, Vitamin pressure impacted your consumer domestic versus your international segment. You've previously given some perspective on the geographic mix of these businesses. I wonder if you can update us on the U.S. versus non-U.S. exposure today or how things look today for those businesses. And then just connected to that, do you have a sense of what your organic sales growth would have been in your consumer domestic and international businesses, assuming that these frequencies were neutral growth? Obviously, you gave the 6% headwind, which is quite helpful. I'm wondering how that looks out between your reporting regions.

Yes. I would like to mention that WATERPIK operates globally, which means it has business both internationally and in the U.S., with the U.S. accounting for the majority of our sales. Additionally, FLAWLESS is even more focused on the U.S. market. While I don't have exact figures, I believe it is reasonable to say that the 6% growth is likely divided fairly evenly between WATERPIK’s U.S. and international markets, although FLAWLESS is more heavily weighted toward the U.S.

Yes. And I would only add to that, that we tried to give you a little bit more visibility and granularity into it. But if we were flat for the quarter on net sales, we said those 3 businesses were about a 6% headwind. And as Matt said, our divisions are usually 80-20 split, but WATERPIK is probably more 50-50. But I don't think we'll get any more granularity, but we had a 6% headwind in the quarter.

Yes. And Chris, the reason we called that out in the release on the call this morning is because we want to put a ring fence around where our problems are. We got 80% of the business that's really clicking. And we have 3 businesses; we like them on a long-term basis, but certainly hurt us in an environment where you have a weakening consumer, weakening economy.

That's really helpful. If I could just follow up quickly and then get back in the queue. Just as it pertains to when the headwinds came together for these businesses, and as such, when you could potentially start lapping those headwinds, is it reasonable to just look at your personal care business and what the growth started to come off? And then can you just confirm whether you're seeing any sequential worsening or you expect stabilization and this is really just about getting beyond tough comps.

Yes. I'm sure a lot of people have questions about 2023, but what we can say about that 10% of the business WATERPIK and FLAWLESS is that the next couple of quarters, we do expect to be choppy, meaning Q1 and Q2 of next year, just looking at year-over-year comps, et cetera. But we think after that, things are going to even out.

Yes. And then on the Vitamin side, we think that, as Matt said in his prepared remarks, that we're starting to see the minus 8% to minus 4% just because of the Delta variant year-over-year. And we're seeing that start to inflect in a good pattern, so that's about the color we'd give you.

Our next question comes from the line of Kaumil Gajrawala of Credit Suisse.

Can you discuss how you are balancing advertising spending with capital expenditures on the vitamin side, considering the uncertainty in demand? It seems there are issues with both supply and demand, along with additional capital expenditures and advertising efforts. How are you managing these different factors?

I'll start with capital expenditures and then Matt can address the consumer aspect. Regarding capital expenditures, we previously indicated that for 2023, we were planning around $300 million, which included investments in laundries, litter, and vitamins. We have decided to pause the vitamin investments. Therefore, the revised estimate for 2023 will likely be between $250 million and $270 million. We will provide a final figure when we present our complete outlook for 2023. That covers the capital expenditures.

Yes. You asked about marketing. Looking back over the last few quarters, we had 8% marketing as a percentage of sales in the first two quarters. This was a prudent decision due to lower fill rates. In the third quarter, that increased to 10.7%, and we anticipate it will reach 13% in the fourth quarter. For the full year, we expect to average around 10%. However, we plan to increase this next year as fill rates normalize, leading to a return to a more typical marketing spend.

And on Vitamins, I would just add, I think it's really key to understand when we're talking about the category, right? And yes, the category was down 8% in 2022, but it was up 33% in 2021. And that's what Matt had in his comments. So on a stacked basis, it's up 25%. So it's not like the category is cratering; I think it's just coming back in line with a super high growth relative to the pre-COVID levels.

Yes. In fact, if you look at the stack rate for Q2, it'd be similar to Q3.

Okay. Great. And then on laundry, was any of the strength linked to your ability to supply versus the competition? We've obviously heard of some shortages at some of your competitors. I'm just wondering, is it indeed trading down? Or is it perhaps that you have better supply at the moment than some others?

No, I don't think supply is a significant factor here. I believe this situation is entirely influenced by the economy and consumer behavior. We have witnessed similar trends in the past during the great recession. We're noticing this in liquid laundry detergent and in pods. Additionally, while the Scent Boosters category remained flat, we experienced a 3% to 4% increase. This trend is consistent across all areas of laundry, showing weaknesses reflected in many subcategories. It's a real issue and it will persist.

Our next question comes from the line of Stephen Powers of Deutsche Bank.

I noticed that in the third quarter, there was definitely a decline in demand for FLAWLESS, WATERPIK, and Vitamins, along with ongoing supply issues across the business. Additionally, retailer destocking affected the entire portfolio. As we look ahead, when do you anticipate being able to ship based on consumption, whether in the core consumables or in the areas that have been the most challenging?

Yes, that answer is a bit more complicated. Our fill rates in the third quarter were 91%. We expect them to be closer to 93% or 94% in the fourth quarter. Historically, full numbers were 98%, so we're quite close to that. There are a few key areas, particularly raw materials, that are still holding us back in some important categories. In certain instances, it's also about addressing capacity for international distribution. As we approach the end of this year, I believe we will be shipping to consumption in most categories.

Yes. Regarding inventory in the channel, the primary focus is on WATERPIK and FLAWLESS. We anticipate that the next 6 to 8 months will be more challenging for those two brands. However, we are not concerned about ship to consumption for the rest of the business.

Okay. Could you provide an update on whether you've accounted for any additional cost coverage into '23 at this point? If so, how much? Also, as a general observation, do you believe Evergreen is a viable option for next year or is that too ambitious?

We have expectations for the fourth quarter. You're inquiring about 2023, which has both upsides and downsides. Most of our business is performing well. While there will be inflation next year, it's still early regarding requests for proposals for procurement and related aspects. We're noticing some improvements, but we won't have clarity on how those proposals will pan out for another 90 days. I mentioned we anticipate a few uneven quarters from WATERPIK and FLAWLESS. On the other hand, our laundry segment is performing exceptionally well right now, and value is proving successful, which we expect to persist over the next year. Conversely, everyone is facing higher interest rates and foreign exchange issues, which are a drawback. Additionally, if we plan to increase our marketing spending in 2023, there might be some other factors to consider. Rick, do you have anything else to add?

I agree with Matt that we're increasing marketing due to higher fill rates, which normalizes our incentive compensation. However, we expect a positive impact on our gross margin. There are many factors at play, and we're not prepared to make predictions for 2023 just yet; we'll have more clarity in three months. We're seeing some positive signs in the RFPs, and certain commodities are starting to show improvement, but we won't delve into specifics at this time.

Yes, it's just way too early to call it, Steve.

Okay. And then, Rick, has there been any forward buying and coverage as it relates to commodities for next year? Or are you still in a floating position?

That's a good question. So usually, just for context, right, we are usually about 60% to 70% hedged by now. I said last call, we were approximately 0% hedged. I would tell you today, we're about 25%. We did do some diesel before the run-up as an example. But mostly, we're still not back to historical levels on hedging because we believe those costs will continue to come down.

Yes. So all those factors, Steve, they're all material one way or the other. So the question is how big are each of them once we get to the end of January when we call 2023.

Our next question comes from Nik Modi of RBC.

Just a couple of brand category-level questions. Just on laundry, looking at some of the numerator data, it looks like household penetration is down. And I was just curious on your thoughts around that, what do you think is happening there? And then XTRA in this kind of environment would typically do better than what I'm seeing at least in the scan data. So I just was hoping you could just comment on that. And then I had a question on FLAWLESS.

Yes. Regarding households and the decrease in wash loads, that hasn't been a significant topic of conversation here, so I can't elaborate further. For XTRA, we've focused on ARM & HAMMER over the last 18 to 24 months due to fill rate challenges, which are now resolved. We are optimistic that in 2023, XTRA, being our value detergent, could perform well. We observed similar trends during the great recession, so I believe we can expect a positive outcome. You also mentioned another question about FLAWLESS, Nik.

Yes, FLAWLESS, just this kind of euthanizing the brand from the older consumer to the younger consumer. I'm curious 20 years of covering this space, when any time a company does that, there tends to be a lot of disruption in terms of alienating the older consumer base, right, as you try to make the brand younger. I'm just curious if you guys have looked into that or worried about that, have seen that. And could that kind of prolong the recovery of that brand?

No. I would say that the size of the prize is so great with the younger consumers that we don't think that, that shift is going to be so dramatic and so noticeable that it's going to alienate the older consumer. So I would say no, that's not a worry.

Okay. Great. And then just one more question, Matt, sorry. Colgate earlier today talked about some inventory destocking in some of their categories at brick-and-mortar retail. I'm just curious if you've seen any of that happening in the categories you operate in.

Nik, it's Rick. I'll take it. Early in the quarter, we talked about that. We gave a bit of guidance in September. And we said part of the reason was actually because of inventory destocking at retail and it wasn't just one category; it was multiple categories. And so that was implicitly already in our minus 1 outlook. And so we saw that early in the quarter. But after we got through that, we didn't really see it any further.

Our next question comes from the line of Kevin Grundy of Jefferies.

Question for both on the promotional environment and just sort of your expectations there near term. And then as we sort of look out to next year with fill rates normalizing, gross margins still under quite a bit of pressure, a lot of commodity inflation in the P&L, that should start to subside. We're seeing some of that, and pricing is starting to catch up. And then, of course, I'm asking about the promotional environment and trade support within the context of some of the earlier discussion around trade down in laundry. There seems to be some differences in opinion, I guess, between some of your commentary and one of your key competitors as to what's driving the share loss. But that's all kind of a big wind up. What's your expectation for trade support? And are you anticipating seeing perhaps considerably more with Procter in a better supply position?

Yes. I can't comment on competitors, so you can appreciate that. But if I look at, take laundry detergent and cat litter, so on the household side of the house, and those are the most promotional areas. So the category sold-on deal for liquid laundry was 32% in Q3. And we were at 26%. And obviously, we have competitors that are higher than that. But that 32% was actually down year-over-year. So I still think that the category spend, the promotional environment, is still lower than it has been historically. And then it's probably worthwhile talking about litter as well. The sold-on deal in litter was 10% in Q3. And that's also historically low as well. Now we were at 13% in Q3, but the 10% and the 13% are still lower than historical levels, which are typically in the high teens level. So it's all ahead of us right now, but I wouldn't say that the environment has been super promotional in Q3, and that could change in Q4 and Q1.

I understand. I have a quick follow-up regarding mergers and acquisitions. Since your balance sheet is in good shape and you are able to pursue transactions, could you share your thoughts on the current pipeline? Additionally, considering the volatility in the market, even though most of your portfolio is performing well, there are some areas that are not. With this volatility and the attention required from management for the integration of Hero, does that create any hesitation in pursuing another deal, despite having a strong balance sheet? It would be helpful to hear your views on this before I move on.

Yes. Well, it's important to remember, when we acquire businesses, go back to THERABREATH, for example. We didn't take a whole lot of employees from THERABREATH. And we already have an oral care business, right? So oral care business handles toothbrushes, toothpaste. It's ORAJEL. So we're already in the category dealing with the same buyers. So that was really a tuck-in. And then when you think about Hero, keep in mind, for Hero, we're hanging on to the 3 founders that are sticking with us for the next few years, and we want to retain all the employees. So we got an intact, high-performing team to run that business. So we don't feel like we're in a position where we can't look at another business. And as you said, the balance sheet is pretty strong. And as far as the pipeline goes, we are always looking at new deals and have even looked at one since the Hero deal closed. So it's not to say we're going to transact, but we're always looking for strong brands and good categories.

And Kevin, it's always a measure of how much complexity the organization can handle at one time, and that has to do with when and how much we're integrating. And the THERABREATH deal, as Matt said, was an easy tuck-in. We're fully integrated from a systems perspective already. Hero, we're going to integrate from a systems perspective by the middle of the year. So that's a pretty quick process.

Our next question comes from the line of Rupesh Parikh of Oppenheimer & Co.

So on the inventory front, inventories were up 22%. Do you guys see any risk of obsolescence or markdowns with higher inventory levels?

Yes. Rupesh, it's Rick. Yes, it's a fair question. I'd say 2 things. One, we expect inventories to get back in line over the next 12 months, as I said in my prepared remarks, right? We've adjusted production levels for some of those long-lead devices we sourced out of China as an example, like WATERPIK and FLAWLESS. It just takes months to run through that inventory as consumption slowed a bit. But we have taken some inventory reserves, both in Q2 and Q3, whenever we have long-dated products like that. So we feel like we've already recognized some of that.

Okay. Great. And then, Rick, on the gross margin, I know you guys called out the mix shift that's a new headwind in Q4. But maybe if you can just walk through some of the puts and takes as you look out for the balance of the year?

Yes, I went over the bridge in my prepared remarks. I’d like to keep it at a high level. Previously, in Q4, we mentioned that we anticipated a positive inflection for gross margin. We've been stating this throughout the year, but now we are witnessing some contraction. We believe this contraction will be slight, and we expect a significant improvement sequentially. In Q3, we saw a decline of 250, but we do not expect a decline anywhere near that in Q4. We have some tailwinds contributing to this outlook, partly due to commodity comparisons and the fact that Q4 last year had a lower baseline. However, there are several factors to consider.

Our next question comes from the line of Jason English of Goldman Sachs.

I want to revisit the earlier question about examining the effect of the three challenged businesses on the U.S. operations. It appears there’s an approximately $80 million impact. Assuming that 80% of this affects the U.S., which might actually be on the higher side considering the WATERPIK technical difficulty, this would mean about a 14% decline in your U.S. personal care segment. It seems organic sales in that area are down roughly 16%. Even if we exclude the impact, it seems your organic sales would still show a decline in personal care, despite the strong growth you're experiencing with BATISTE and the recovering growth with TROJAN. Could you elaborate on this and clarify what other factors are currently affecting the performance of the personal care business?

Yes. We haven't done the calculations yet. You made a preliminary estimation, but we're not ready to provide details on how we will adjust the information we released by division for the international and U.S. business.

Yes, I would just add that our order fill was 91% for the quarter. It varies by segment; around 94% for household products and in the mid-80s for personal care. The main decline in personal care is attributed to three brands: FLAWLESS, WATERPIK, and Vitamins. We still have several key issues in personal care that we are working to resolve. For instance, BATISTE is experiencing significant growth, but we are unable to keep up with the demand. Consumption has increased dramatically, and we are facing can shortages, similar to what's happening in the beer industry regarding aluminum cans. We are working to increase our supply as quickly as possible to meet this high demand. Additionally, VMS is struggling, not only due to a decline in the category but also because our fill rate is lower than desired because of a key ingredient issue with a specific SKU. There is some pressure in personal care due to these fill rates, but we expect to have this resolved as we move past Q4.

Okay. You mentioned reallocating some investment as you approach next year and a return to standard marketing practices. What does standard marketing entail? Also, is incentive compensation expected to be a challenge as we move into next year? Can you provide any insights on how this year's incentive compensation is performing compared to a typical level?

Yes. I would say incentive compensation will be a challenge next year. We're estimating a payout of about 30% as a reference point. That will be a challenge as we aim to return to a 1.0 payout level. Your first question was on—remind me, Jason.

Marketing, marketing. Matt mentioned that you would expect to return to more normal marketing. My question was what does that mean?

Yes, yes. And I think we'll go through that in February. We'll be very clear on what it is and what it means. I think you should expect that it's a stairstep over time back to what we think has been our sweet spot in marketing from a historical perspective.

Our next question comes from the line of Andrea Teixeira of JPMorgan.

My question is about VMS. I understand this segment represents about 10% of sales. Along with the WATERPIK and FLAWLESS issues you discussed, it seems like the main issue has been consumption, especially since you’re comparing to a very strong performance from last year. Can you tell me how much the VMS business has declined this quarter and year-to-date? Additionally, are you concerned about excess inventory with retailers? I know it's a fast-moving item, but I was curious if this potential destocking issue is reflected in your guidance for the fourth quarter, particularly regarding that SKU that is not being served.

Yes, thanks, Andrea. There are two core issues with the vitamin portfolio. The first is the overall category, which is the most significant concern. We noted earlier that in the third quarter of 2021, we experienced 33% growth, so we are coming down from that peak more than anticipated. This trend has continued over the past 13 weeks, but we expect it to improve slightly as we progress. The second issue is fill levels, which Matt has mentioned as well. We anticipate that as we close out the year, our fill levels for vitamins will enhance, positively impacting our market share. These are the two main factors. I won’t provide further details beyond this regarding the magnitude, but roughly 10% of the business consists of the discretionary portfolio and another 10% relates to the vitamins. The crucial takeaway is that the category issue is primarily what we're facing, rather than just the fill level concern.

Yes. If you do the math, 80% of the rest of the business is growing 4%, 4.5%, which is fantastic.

Our next question comes from the line of Anna Lizzul of Bank of America.

I just wanted to follow up a little bit on the topic of promotions. We've been hearing from some of your peers that promotions are essentially not really going to return to the same depth as they were pre-COVID. So just wondering if you're comfortable here with your frequency and depth of promotions where you are now versus pre-COVID?

Yes. I mean, where we are right now, we're winning. So some of the numbers I quoted, the category in liquid laundry is 32%, we're at 26%. And we're gaining share. So you're right, it would appear that there's no need for a heat-up, but I can't predict what competitors will do in the next 6 months.

Our next question comes from the line of Olivia Tong of Raymond James.

My question is on pricing and promotion. You obviously saw a 1 point sequential acceleration in price/mix in Q3, but obviously, some pressures on the higher price portion of your portfolio while pricing on the everyday consumables. So can you give a little bit of color on what impact mix had versus price? And then perhaps a little bit on domestic household versus personal care.

I don't have the specifics regarding domestic household versus personal care at the moment, but I can provide insight into the price/volume mix over time. In the first quarter, we experienced a 7.8% growth in price/mix, which then adjusted to 6.2% in the second quarter, primarily due to issues with the WATERPIK mix. Moving from the second to the third quarter, we saw a rebound back to 7.8%. This improvement was largely attributed to the new laundry and litter pricing introduced in the second quarter, which had a full quarter impact in the third quarter, outweighing any negative effects from WATERPIK or similar factors. This outlines the sequence of events related to the drivers of price mix.

Got it. And then on Vitamins. I'm curious your view on what you think vitamin consumption trends will be longer term. Obviously recognize that flu could be a factor near-term. Still variants of COVID here and there. But where do you think consumption ultimately ends? I mean, does it get back to where it was? Does it stay above pre-COVID levels, or does it end up getting back to where it was pre-COVID in your view? What are you planning for?

Look, we were planning on expanding our capacity, right? We've got to put a pause on that. But we do think so long term, we're going to need that capacity. The transition from pills and capsules to the gummies is a pretty important factor. So if you look at the percentage today, it's 27% of the total VMS category is gummies. And we expect that's going to continue in the future. And a lot of people discovered the category as a result of COVID. Yes, certainly, some people have exited, but not all. So consequently, we think the future is still bright for the business, but we're going to have a kind of a rough ride here, at least for the next couple of quarters.

Our next question comes from the line of Lauren Lieberman of Barclays.

I have a few questions. First, regarding gross margin progression, Rick mentioned it is likely to be a positive factor overall next year. However, looking at this quarter and the expectations for the fourth quarter, you indicated there will be ongoing challenges, particularly in the first half of the year in some discretionary businesses. It seems that gross margin progression might not see improvement until the latter half of 2023. Is that accurate, considering the mix dynamics you mentioned regarding discretionary areas?

Yes. I'm not ready to give quarterly or first half, second half guidance on 2023 yet. I would just say that we're kind of getting ahead of ourselves talking about 2023 at all, and so we were just trying to give broad brush strokes. And I would tell you the answer as of right now, our visibility is gross margin expands next year. And we'll get into all the details, all the bridges that you guys want to in February.

I wanted to revisit the topic of fill rates, which I've been considering several times this year and over the past year. Fill rates have been improving, as you mentioned, and that's definitely a positive development. I understand that in certain categories, the ability to supply justifies increased marketing efforts. However, you've also indicated that out-of-stocks are not a concern. Therefore, I'm still trying to grasp why improving fill rates should significantly boost sales growth moving forward, especially if out-of-stocks haven't been an issue. I'm not suggesting that it wasn't necessary to address this, as it was, but I need clarification on the sales growth benefits stemming from improved fill rates in that context.

Yes. I believe I have some comments as well. Overall, a fill rate of 98% for 2023 suggests that we will be able to meet consumption demands throughout the year. This means we won't have to reduce promotions in certain areas, which has been a challenge this year. Despite our desire to do so, we have not been able to, and while I won't go into specific examples, that situation does exist. This is something I keep in mind when discussing fill rates.

Yes. And when we say out-of-stocks are a lot better and less of an issue, it's because we finally cracked the low 90s. But we still leave money on the table. The out-of-stocks being at 90% is not something we're proud of. And by the way, we still get it with retailer funds because of our inability to fill. So that's another drag that we have on our gross profit. So we definitely do, in certain categories, have certain SKUs that are problems for us that are creating a drag on our organic sales, Lauren.

Okay. And final thing was just the SG&A in the quarter. It was down a bunch, not terribly different than last quarter. But just curious on the levels of SG&A spending, if there's like an incentive comp reset we should be thinking about, but presumably that would come next year. But any color on the SG&A piece would be great, too.

Yes, I think that's kind of alluded to at last quarter, that we expected SG&A favorability. And fortunately, it is because of incentive comp. When you have some of these recessionary pressures on discretionary items, it's dragging the whole company below some of the key metrics. And so I just answered Jason and said that our payout was tracking around 30%. And so that's a benefit in the quarter per se and for the year, not the one that we would want and that we'll have to get refunded next year.

If you recall, Lauren, we have 4 targets annually, right? Sales, gross margin, EPS, and cash. And the last 2, we got a 0 on. So that's what's affecting our incentive comp, as you well know, where our EPS is and our cash flow.

Our next question comes from the line of Bill Chappell of Truist.

A couple of just clarifications, I guess, on Jason's and Lauren's questions. So I assume you accrued for variable comp in the first 2 quarters. Was there a reversal that gives a bigger benefit in the third quarter? Or will it in the fourth quarter? Or is that not the way you look at it normally?

Yes, you always have to accrue kind of on a year-to-date basis, and we were tracking more favorably in Q1 and Q2. And then as some of these pressures like on inventory, for example, on these discretionary categories impacted cash flow, then we have to adjust the accrual, and you get like some of the catch-up, year-to-date catch-up in the Q3 accrual, as an example. So yes, that's true.

Yes, it's been coming down all year long though.

Okay. So there wasn't an outsized benefit this quarter from the reversal or accrual.

There was a benefit in Q2 and a benefit in Q3.

And a bigger benefit in Q3 as projections for instance, comps have come down.

Okay. So we need to wrap up. Thank you all for your questions. Matt or Rick, do you have any closing remarks?

Okay. Thanks, everybody, for joining us today, and we do look forward to talking to everybody about 2023. So thanks for joining us.

Thank you. Ladies and gentlemen, that concludes today's conference. Thank you all for participating. You may now disconnect. Have a great day.