Good day, ladies and gentlemen, and welcome to The Clorox Company Second Quarter Fiscal Year 2022 Earnings Release Conference Call. 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.

Thanks, Michelle. Good afternoon, and thank you for joining us. On the call with me today are Linda Rendle, our 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 addition, we've posted a transcript of the pre-recorded remarks. 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 about our fiscal year 2022 outlook and the potential impact of the COVID-19 pandemic on our business. 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 statements section, which identify various factors that could affect such forward-looking statements and the non-GAAP financial information section, including the tables that reconcile non-GAAP financial measures to the most directly comparable GAAP measures, both of which are located at the end of today's earnings release, which has also been filed with the SEC. Now I'll turn it over to Linda.

Hello, everyone. Thank you for joining us. I hope you and your families are well. Hopefully, you found our prepared remarks helpful. We faced significant cost headwinds in a volatile operating environment in Q2, but despite these challenging conditions, we executed well on those factors under our control. This includes taking strategic pricing actions and driving cost savings, while restoring supply, serving our customers and advancing our consumer-centric innovation pipeline. Demand remains robust across our portfolio, and our brand superiority results are better than during the height of the pandemic. We have a portfolio of strong, trusted brands exposed to demand-driven tailwinds, and we will continue to invest in them, which we expect will fuel long-term growth for our business. While we anticipate this highly dynamic and challenging environment to persist over the near term and adjusted our fiscal 2022 outlook as a result, we are confident that we're taking the appropriate actions to navigate this period, deliver profitable growth over time and build a stronger, more resilient company. With that, Kevin and I will open the line for questions.

Thank you, Ms. Rendle. Our first question comes from the line of Dara Mohsenian with Morgan Stanley.

So a couple of questions on gross margins. Just given the magnitude of declines now expected this year, can you discuss conceptually how long do you think it takes to try to recover these cost pressures from a pricing standpoint? Originally, it sounds like you're hoping to make a lot of progress next year, at least based on the exit rate in Q4. But you run the arithmetic now and it would require a mid-teens corporate price increase, even if you assume no demand elasticity just to recover this year's gross margin compression. So clearly, not realistic to take that much pricing in one year. So just any thoughts on how long it might take to try to recover the gross margin pressure? Is it a multiyear endeavor? And how do you think about pricing offset relative to potential impact on share? And then second, just any thoughts around if there's an ability maybe to more aggressively consider your SG&A structure and more aggressively consider ways to lower your fixed cost base just in light of what now appears to be a structurally different cost level in terms of commodities and other cost factors?

Dara, this is Kevin. I appreciate the question. Let me start with the expectations for gross margin. And I'm sure, as you can appreciate, I won't provide a specific outlook beyond this year. But I can give you some perspective in terms of what we're seeing. And if you look at the work we're doing, we believe we're taking the right actions primarily through our pricing efforts and our cost savings program that we continue to be in a position that we can recover costs and rebuild margins over time. Now I do think that's going to take some time given the level of inflation we're dealing with. And I think you're hearing from us and a lot of peers. This is a unique environment with an extreme level of cost inflation. But we do think we've got the right plans in place to be able to rebuild margins. Now for us, that continued recovery is something we expect to see start this year. We think by the fourth quarter, we're in a position to begin the process of rebuilding margins, and we fully expect that to continue next year. If I look at our history, this is the fourth inflationary cycle we've gone through in the last 10 years. If you look at the three previous times we've done this, we've been able to fully price and drive our cost savings program to offset the cost inflation and rebuild margins. Historically, it has taken us about 12 to 18 months to do that. I would tell you though in this case, because of the extreme level of inflation we're dealing with, I expect it to take longer. So we'll have to see exactly how that plays out. And what will also influence the timing, to a certain extent, is how the inflationary market plays out. That could either extend the timeline or accelerate if we encounter any tailwinds or further headwinds on cost inflation. But I do think it's going to take several years for us to rebuild margin. And what's important for us is while we are committed to rebuilding margins, at the same time, we want to make sure we continue to invest in the business to maintain top line momentum. We have very good momentum on the top line. As you know, we're expecting 3% to 5% growth moving forward. We want to continue to invest to maintain that momentum. So we believe the way to maximize the value of this company is to invest to maintain that momentum. And then at the appropriate pace, we rebuild margins, which we're committed to doing. Regarding fixed costs and choices we can make, as you know, we have significantly extended our supply chain through this pandemic, both to increase supply availability and to meet elevated demand. That is an opportunity for us, and as demand continues to moderate, we're going to be able to go after those fixed costs in our supply chain and take those out. That's another reason that gives us confidence that we're going to be able to rebuild margins.

Great. And then any opportunities from an SG&A standpoint you're looking at, given the higher commodity levels here, in terms of leverage you can perhaps pull on to have greater cost savings and offset some of this gross margin pressure as you look out?

Yes, we're going to continue to drive our admin productivity program. We've been doing that for years, and we'll continue to rely on that to help offset cost inflation. We're on track to have another very good year from a cost savings perspective, and you'll see both benefits to the cost of goods, but we also drive admin productivity, and you'll see us continue to do that moving forward. But that will certainly be a key component of our work as we go.

Your next question comes from the line of Andrea Teixeira with JPMorgan.

I hope everyone is doing well. Are there any take-or-pay third-party contracts that will come up for renewal and possibly go online this year? Or is that something being considered for 2023? Kevin, you mentioned supply chain considerations earlier in response to Dara's question. Do you still want to maintain a cushion of supply even now that capacity and demand have normalized? Regarding inflation, as a follow-up, we've heard many peers say that the broad-based nature of inflation, especially in logistics and transportation, could account for more than half of the pressure. While other commodity revenues seem to have peaked and improved, is this a trend you are observing more broadly? Should we expect it to take the 12 to 18 months you've mentioned?

Yes, Andrea, thanks for the question. As it relates to take-or-pay agreements and as we've talked about this in the past, because of the tremendous increase in demand for our products, we quickly started expanding our supplier base, including the use of third-party manufacturers to get more product out to meet demand. That came at a higher cost, but we thought that was a smart choice to make because we did not want to overinvest in our capacity. As demand moderated, we expect that we'd start stepping out of those agreements. I would expect that to start this fiscal year. In the back half of the year, we'll start stepping out in some of these agreements. The pace will really be driven by consumer demand. As we watch demand play out, we will pull back on the capacity we've built up over time to match that demand moderation. Everything we're looking at suggests we'll start this year. I think how you'll see that play out in our performance is you'll start to see our inventory levels come down. Because we've increased the number of manufacturing nodes we have in the network, that just means we're holding higher inventory levels across various locations. I think by the end of the year, you'll start to see our inventory levels come down. And then in fiscal year '23, you'll start seeing the real benefit of bringing that production back in-house, utilizing our facilities rather than these third-party manufacturers. Regarding inflation, we are seeing inflation broadly across all inputs within the supply chain. We're calling out commodities and transportation because, by far, that's the biggest amount of inflation we're dealing with. For us, commodity is still about two-thirds of the inflation, about one-third transportation, and resin is obviously the biggest component of the commodity inflation. On transportation for us, we see higher rates broadly across the transportation market. The challenges we're seeing include our use of spot carriers. With elevated demand for trucks and a continuing driver shortage, it's forcing us to move to the spot market at a greater pace than we've done historically with premiums running 50% to 75% higher than our primary carriers. Over time, assuming demand for goods moderates, we should be able to move away from those spot carriers back to our primary carriers, significantly reducing our transportation costs. While there will be inflation in the market, using spot carriers incurs a significant upcharge for us. That ability to move back should provide nice savings over time as we expect to see demand settle out.

Your next question comes from the line of Chris Carey with Wells Fargo Securities.

I am trying to gain a clearer understanding. I hear your outlook for gross margins for the full year. I'm trying to understand the factors for the second half. Looking at this quarter, productivity seems to be a bit below expectations, pricing is expected to increase, raw materials likely did not deteriorate significantly compared to what you anticipated this quarter, while manufacturing and logistics have definitely worsened, along with worse sequential operating deleverage. To feel confident about how negative gross margins might be in the second half, we need to assume that productivity stays subdued, raw materials remain unfavorable as you mentioned, and there's considerable operating deleverage. Is this a fair way to think about that transition? Additionally, the normalization of the mix is a significant aspect of this year's narrative. As pricing increases, you're going to adjust prices on 85% of the portfolio now? How does this play into the situation? I understand there is pressure on gross margins, but we need to assume that certain factors will remain quite challenging, and I want to ensure I'm approaching this correctly.

Sure, thanks, Chris, for the question. Let me talk a little bit about how we see gross margin progressing through the year. We expected last quarter, and we continue to expect now, that Q2 is going to be our most challenging quarter in terms of margin pressure. You saw margins down about 33%. We expect sequential improvement as we move throughout the balance of the year. By Q4, we anticipate starting to rebuild margins, and that trend should continue into fiscal year '23. To your question about the drivers for the back half of the year that will drive that sequential improvement, the first is pricing. Pricing will continue to build in terms of the value it generates for us. In Q1, it was fairly limited, benefiting margins about 50 basis points. This last quarter was about 100 basis points, and by Q3, it should approach 200 basis points. By the fourth quarter, the benefit should exceed 200 basis points. You'll see the value from our pricing actions building through the back half of the year. In addition, our cost savings program is on track for another good year, with a back half weighting in benefits. And so in the front half of the year, we generated about 80 to 90 basis points of benefit, and we expect that to be north of 100 basis points in the back half of the year. The other point is the cost inflation we're dealing with was most challenging in Q2 in a year-over-year context. As we get to the back half of the year, while we're still in an inflationary environment, the year-over-year change is smaller as we saw significant increases in commodities starting at the beginning of calendar year '21 with the ice storm in Texas. By Q3 and Q4, the increases in both commodities and transportation will have a lower hit to margin as we progress through the quarters. Lastly, to your comment about mix, we've discussed this for the last few quarters. We had a temporary benefit during the pandemic by significantly reducing our product offerings to increase supply. As we reintroduce our full line of products, including multipacks, that has a mix effect. We expect a four-quarter unwinding of that temporary benefit, passing through Q3, and by Q4, we should not see a mix drag on margins. Regarding the deleveraging, volumes were down in the first half of this year leading to some deleveraging that impacted margins. In the back half of the year, we anticipate flat or slightly increased volumes, which will help mitigate that margin drag. These are the elements contributing to the expected rebuilding of margins as we progress through Q4.

If I could just ask one more question. You mentioned a rise in commodity and transportation expenses to 500 million dollars compared to the prior 350 million. While the incremental pricing will provide some relief, earnings are still declining more significantly. Is it due to other factors and the difficulty in tracking costs beyond those two items you highlighted? I'm just trying to understand the complete picture quantitatively.

Yes, I'd say on the 350 million to 500 million, just a couple of thoughts. As we've discussed, that's the increase we're seeing in commodities and transportation. While that's not the entire inflation we're facing, it forms a significant part. We're seeing inflation across the portfolio. As we've moved from planning to price 70% of our portfolio to now pricing 85% with multiple rounds of pricing for several brands, there is often a lag associated with that. Therefore, we'll incur that extra cost this year, projecting an increase to 500 million dollars. The pricing benefit will be modest as those pricing actions take effect in the back half, setting ourselves up for more benefit as we move into fiscal year '23.

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

A couple of questions, I guess. Shifting to sales rather than margin. It looks like it's coming in a little bit better than expected. Can you maybe unpack that a bit? Is it a little more pricing is coming through than you had planned? Maybe the elasticity is lower than you thought? Or is it just that demand isn't really moderating at the rate that you might have expected?

Kaumil, happy to get started on that one. We did see a strong quarter from a top line perspective, and really that continues to be the strength of our brands with our consumers. It's broad-based across our categories where they continue to turn to our cleaning and disinfecting brands, and our household essentials. If you look across our two-year stacks across all our segments, we're in strong double digits from a Q2 perspective. Looking at share, we're up in the majority of our business units. Our consumer value measure, which assesses the amount of our portfolio deemed superior by consumers, is at an all-time high of 75%. All of our investments in advertising, sales promotion, innovation, and executing against distribution as we restored supply are paying off, and demand remains robust. Moving forward, we anticipate long-term tailwinds that will continue from a portfolio perspective, giving us confidence in achieving our 3% to 5% growth goal that we have mentioned, expecting to return to that in the fourth quarter. I'd note that some of our household essentials businesses were up even after a strong Q2 a year ago. If you examine our Brita business and Glad in the food category, all off a strong quarter a year ago, the fundamentals along with innovation indicate that consumers continue to turn to trusted brands.

Okay. Great. To clarify, Kevin, you mentioned that it takes 12 to 18 months to offset cost inflation, but given the depth of this situation, it may take several years. Are you suggesting that it will take several years to return to the mid-40s range on gross margins, or did you mean something different?

Yes, Kaumil, I’ll be cautious about providing an outlook beyond this year. As Linda and I have said, we are committed to rebuilding margins and returning to those mid-40s ranges we achieved before the pandemic. However, I believe it will take longer than what we've been able to do in terms of timing to recover, as the inflation we're experiencing now is three to five times any previous cycle. I expect that timeline will be extended. We need to see how inflation plays out over the next few quarters for better visibility. I think as we prepare for fiscal year '23, we will be in a better position to provide a perspective on the timing.

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

Great. I wanted to just talk a little bit about working through inventory because last quarter, I think we had talked about cash flow being weak and inventory and finished goods in particular were up, which led to a realization around the external supply and estimating what was going to happen in terms of consumer demand. Inventories grew again sequentially. You talked about volumes. You're hoping to get to up volumes by the end of the year. I want to talk about how you're thinking about working through inventory if there's particular categories where the overcapacity is more or less severe because, to Linda's point, there are businesses that are growing year-over-year in volume. And the degree to which some of these external supply contracts, it's easy to exit versus being contracted for certain amounts of supply for a given amount of time?

Yes, Lauren, thanks for the question. Let me discuss inventory and where we're at and where I see that going in the next few quarters. We ended the second quarter with about 65 days of inventory across our enterprise. Typically, we carry about 55 days pre-pandemic. We have built inventories for two primary reasons. First, we are taking up inventory levels across our portfolio to help manage through ongoing supply chain disruption. This ensures if we encounter disruptions in transportation or supplier issues, we can still meet demand. In the near term, we think it's smart to invest some working capital into inventory. As the supply disruptions resolve, we should be able to reduce that inventory. The second reason is our extended supply chain with additional third-party manufacturers. We have increased the number of third-party manufacturers we work with as demand has moderated, and we will begin stepping out of those agreements in the back half of the year. As demand moderates, we expect our inventory levels to decrease because we've increased the number of manufacturing nodes in the network. We expect the consolidation of manufacturing to start reducing inventory levels by the year's end, as we feel confident in our supply chain and the timing of shipments. We plan to continue this progress in fiscal year '23.

Okay. That's great. And if I can sneak in one more. Linda, you commented on market share improvement, where your on-shelf availability has improved. That's certainly true in categories year-over-year, but there are also categories where shares, at least as far as we can see in Nielsen, are down versus where you were in 2018, 2019. So I'm curious, to be more constructive and you kind of look further out, what's the bogey? How do you think about your share goals? What's the right gauge of success in reclaiming share positions? Year-over-year progress is important, but if you look back a bit further, shares are still soft in certain categories on a multiyear basis?

Lauren, yes, thank you. Overall, I'd say in regards to market share, we're feeling good about returning to pre-pandemic share levels in aggregate and growing in the majority of our businesses. We've made strong share growth in recent weeks, even stronger than the first half of the year. However, we absolutely need to continue progressing. Our goal is to grow market share, and I've been clear about that; we want to win in our categories. This doesn't mean we'll always win in every category at all times. There will be ups and downs based on competitive spending and innovation. But overall, we’re focused on growing market share in our categories and winning with our brands. I’d like to highlight Glad as a great example—we're growing Glad Trash's share after being flat to slightly down for quite a while. Our innovation is working, pricing is effective, and we’ll continue to make progress across the portfolio.

Your next question comes from the line of Kevin Grundy with Jefferies.

Two questions for me. Kevin, I'm sorry, I'm going to beat a dead horse here, but I'm going to come back to gross margin but tackle it a bit differently. I guess, like others on the call, I'm wrestling with some of the commentary around recovery as clear as our crystal ball may be today. However, I wanted to ask more about the structural aspects. When we discussed in November, you sounded good about an 18- to 24-month recovery. What has drastically changed over the past three months to make you more cautious on the cadence of that recovery? If I consider the quarter, and I think this was an earlier comment, the commodity piece is dire, but perhaps not drastically more dire than we had modeled. The manufacturing logistics have worsened, and operating deleverage was likely worse sequentially. Taking those pieces together, what has transformed in your mind? What has changed within the company that makes you increasingly cautious on the pace of recovery and ability to price and offset it with productivity?

Thanks, Kevin. A couple of thoughts about pricing overall. I'm confident in our pricing abilities. We've executed pricing on 50% of our portfolio quite successfully through the second quarter. We still have work to do over the remaining year to get to 85%, and many conversations with retailers have already taken place. So I'm optimistic about the team's efforts and our pricing abilities. What we're currently facing is inflation, which has intensified. Sitting here today, we now believe there's 500 million dollars of cost inflation. Three months ago, we assessed it to be 350 million. Additional inflation denotes more challenges for pricing, cost savings, and the overall timeframe to work through it. It's prudent to recognize that we may extend the timeline, given the continuous inflationary environment we are dealing with. As I mentioned before, maintaining a balanced approach is vital. We are seeing top-line momentum and will continue investing to sustain that. We are committed to rebuilding margins at a careful pace that enables us to do both. Hence, planning for a couple of years for recovery seems reasonable, and we will possess clearer visibility across the next few quarters.

Okay. And just a quick follow-up for Linda. Can you comment on expectations or potential risks around trade-down in your categories, given this level of pricing and the few categories where you have a higher private label exposure? And then I'll pass it on.

Sure, Kevin. Generally, we don’t have very high private label exposure in our categories—it's concentrated in a few areas where we maintain a strong share position over many years. The facts regarding our brand strength remain relevant. As I noted earlier, our superiority rating by consumers is at an all-time high of 75%. Consumers are continuing to favor trusted brands during this time. Throughout the pandemic, we've invested in these brands through effective advertising, sales promotions, and a strong innovation program, which has proven successful. I'm optimistic about Brita, which has experienced strong double-digit growth as customers focus on health, wellness and sustainability. When considering our pricing actions, we are aware of potential consumer behavior shifts due to inflation. We are committed to ongoing monitoring, but based on historical performance during economic stress periods, our household essentials categories generally perform well. We believe we will successfully pass through price increases and maintain our top-line momentum.

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

A couple of quick questions. The gross margin contribution from price, a little north of 200 basis points in the fourth quarter. Is that going to reflect full price or will there be additional price increases as we proceed into fiscal '23?

Jason, regarding pricing, I won't comment on pricing for fiscal year '23. Let me simply discuss our plans for this year. As we've mentioned, we have implemented pricing on 50% of our portfolio, and we have more to do. Some pricing will take effect in this quarter, Q3, and additionally, we have more pricing actions coming in Q4. Thus, while we expect north of 200 basis points in the fourth quarter, it will not reflect the full value as some of those pricing actions impact will not be fully realized in Q4. As we approach fiscal year '23, you can expect that we will continue to assess the cost environment and will be open to further pricing adjustments, depending on recovery. But for now, we want to see how inflation unfolds this fiscal year.

Understood. And Linda, pre-COVID, several business lines suffered from market share losses, whether from branded competitors or private labels. It's uplifting to observe the recovery and growth you are now experiencing. However, this growth is occurring on a more subdued price rate than seen in most of your other categories. In other words, it’s emerging with narrowed price gaps. What share level do you believe you’re gaining from that? Is part of what’s transpired here a bit of a permanent rebase in your pricing strategy and thus a permanent alteration to margin structure?

Jason, I think what's true in the data and what will be evident in the coming months is there's going to be variability in pricing gaps, etc. However, we haven't observed a material alteration in our aggregate price gaps across categories. There are some variations due to the timing of pricing implementations. That said, the strength of our brand is chiefly attributed to effective execution. We observe increases in distribution and improved merchandising, even though they remain below pre-COVID levels, alongside our solid innovation initiatives. Therefore, while economic conditions play a role, our share growth is mainly driven by specific factors under our control rather than being retaliated by price gaps. This situation is expected to unfold over the next several months, but we don’t foresee price gaps significantly impeding our performance—it should revert to pre-pandemic levels.

Our next question is from the line of Peter Grom of UBS.

My main query is about whether you've built enough flexibility into your guidance to instill investor reassurance that we’re at the final negative revisions' boundary? Additionally, on the margin commentary—phasing is important. You mentioned improvement in Q3 and sequential improvement in Q4. Can you shed light on the directional improvement expected in Q3 since being down 1,200 basis points is considerable?

Thanks, Peter. Regarding our guidance, I believe we have a balanced outlook and am confident in our controllables, including pricing actions, cost savings, and innovation efforts. However, given the current volatile environment, I recognize that it’s prudent to have wider ranges in our outlook this year. I think we have provided a reasonable outlook given the level of volatility in areas we do not control. For Q3 margins, we expect to land in the mid-30s range, building on Q2 results. Previously, we anticipated finishing in the low 40s, but with the increased inflation levels we now expect, we anticipate finishing in the high 30s range. We plan to build upon that moving into fiscal year '23.

Our next question comes from the line of Linda Bolton-Weiser with D.A. Davidson.

I have a question that's not on gross margin. Have you experienced issues with the EPA labeling in your Brita business? I know Helen of Troy had to halt shipments due to needing to redo some labeling as per EPA regulation changes. Are you having or expect to have similar issues?

Linda, no, we do not have that issue. I’d like to take this opportunity to highlight what's happening in Brita, as it's an exciting story. Brita has performed exceptionally during the pandemic as consumers turned to filtered water to meet their demands. This stems from two aspects: growing health and wellness awareness and sustainability considerations. Brita has achieved robust double-digit growth, with a five-point share increase in the last quarter. Our household penetration is at its highest in eight years, fueling optimism for the future of this business, complemented by a strong innovation pipeline that we will continue to accelerate. We are not facing any EPA-related challenges holding us back.

This concludes the question-and-answer session. Ms. Rendle, I will now turn the program back to you.

Great. Thank you. Thanks, everyone. We look forward to speaking to you again on our next call in May. Until then, please stay well.

And this does conclude today's conference call. You may now disconnect.