The Clorox Company (CLX) Annual Deutsche Bank Global Consumer Conference (Transcript)

The Clorox Company (NYSE:CLX) Annual Deutsche Bank Global Consumer Conference Call June 6, 2023 4:30 AM ET

Company Participants

Linda Rendle – Chief Executive Officer

Kevin Jacobsen – Chief Financial Officer

Conference Call Participants

Steve Powers – Deutsche Bank

Steve Powers

Alright, everybody. Thanks and welcome back. I am Steve Powers, I am the U.S. consumer packaged goods analyst at Deutsche Bank and I am thrilled to once again welcome the Clorox Company to our conference. As you all know, Clorox has a leading portfolio of trusted brands such as Clorox, Glad, Fresh Step, Hidden Valley, Burt’s Bees. And with us today to talk about their story is CEO, Linda Rendle as well as CFO, Kevin Jacobsen. So again, thanks, and welcome back. It’s great to have you here.

Linda Rendle

We are glad to be here. Thanks for having us, Steve.

Question-and-Answer Session

Q – Steve Powers

Let’s start just on general terms to kind of give everybody a grounding. And maybe Linda, you can talk, there has been tremendous number of ups and downs and twists and turns over the past couple of years, but you’ve fared very well of late. Your most recent results were strong and being able to raise guidance intra-year. Maybe, Linda, you can just ground us on how you are feeling about current trends, progress you are making, both kind of operationally as well against the larger IGNITE strategy that you have outlined? And then, Kevin, maybe just you can ground everybody in current fiscal year guidance?

Linda Rendle

Sounds good. Thanks everyone for your interest. Happy to be here today. It has certainly been a period of ups and downs for all of us over the last few years given everything that’s going on. But we a really happy with our progress that we have made particularly in accelerating top line momentum, which we set out to do in our IGNITE strategy. And if you look at kind of CAGRs in any period, we have been at the top end of that range. But of course, we have a lot of work to rebuild profitability given the significant amount of inflation that our company has experienced over the last few years. And we are really happy with the progress we made over the last few quarters, given the level of pricing and cost savings that we have been able to activate. And of course, the job is not done. So we have to make additional continued progress on the margin front, continuing to rebuild that. We remain committed to building it back to pre-pandemic levels and really importantly, doing that while we maintain that top line momentum. So continuing to invest in our business and ensuring that we have the right level of advertising and sales promotion, we are investing in innovation and of course investing in our digital transformation as well as our operating model change.

If we step back and look at our IGNITE strategy, which we were really happy about when we hit the pandemic that we had made that set of choices in 2019. They have played out really well and we have made good progress. And just maybe I’ll quickly tick through them. So I know we don’t have a ton of time for me to sit here and give you a 40-minute dissertation on our IGNITE strategy. But we really wanted to ensure that we were accelerating what we are already good at Clorox and then able to accelerate our financial performance. The first choice we have made was to fuel growth and goodness gracious do we need that now, our ability to remove waste out of our system and drive cost savings. And we thought we could do that in an expanded way. And we are actually doing that even more expansive ways now and figuring out how we can remove cost, take pricing to ensure that we build back margins to where they need to be to invest in our business. We wanted to innovate experiences and primarily, we wanted to do that through ensuring we have the right shopping experiences for consumers through partnering with category growth ideas with retailers and creating bigger, stickier innovation platforms that led to more value from innovation and we have done that. So, if you look at the last 3 years, we have delivered significant incremental growth from innovation and we are going to continue to be focused on that moving forward.

And then I will skip to the fourth choice, come back to the third one. On Evolve portfolio, we continue to see great opportunities on our core to strengthen our business, and we have leaned into that through investments, and we have stronger brands today than we did when we set out on that strategy. So if you look at our superior rating from a brand perspective, about 70% of our portfolio is deemed superior by consumers. Pre-pandemic, we were in the mid-50s range. So our brands are stronger than they’ve ever been as a result of the actions we’ve taken.

And then the final choice we called Reimagine Work. And back then, we envisioned partly what we are doing today, but really, we’re expressing this in a very different way. The world has changed. The operating environment is like nothing we’ve ever seen before, and we need to be faster, we need to be digitally enabled and we need to be leaner. I mean we put in place a $500 million investment in digital transformation, which we are in the first 2 years of implementing. We have a few years left as well as an operating model change really putting the business units at the center of what we do to ensure that we’re consumer obsessed faster and leaner. And that is all going well in helping contribute to results and expect us to continue to make progress over the coming couple of years.

Steve Powers

Great. Kevin, just run us through current guidance, please.

Kevin Jacobsen

Yes, I’d be happy to. And then you think about our financial goals this year and for you folks who follow, as you know, last year was a very difficult year for the company, particularly driven by the level of supply chain inflation we’ve been dealing with. For perspective, a typical year of inflation for Clorox is about $75 million roughly. Last year, we experienced about $800 million worth of supply chain inflation. As a result of that, we saw our margins compressed last year about 800 basis points, and we saw profitability contract as well. We’re really on a journey now as we move forward. We’re committed to rebuilding gross margins back to those pre-pandemic levels. And doing that, as Linda said, well, we continue to invest in the business and continue to maintain that top line growth rate. And that’s really what we’re doing this year. And so from a financial outlook perspective, we’re targeting 3% to 4% organic sales growth this year. We’ve executed now 4 rounds of pricing, including our most recent round in December and it’s all going very well for us. We’re working to rebuild gross margins. We think this year we will rebuild about 250 to 300 basis points.

So getting back, making progress on that 800 basis points we lost a lot more work to do as we move forward, but a good progress this year. And then earnings per share on an adjusted basis, we’re targeting 6% to 10% growth, so making progress. The other one to highlight is free cash flow, which is an important metric for us about the cash we’re generating, we can reinvest in the business. We target 11% to 13% typically. Last year, as a result of our reduced profitability, we generated about 8% free cash flow as a percent of sales. This year, I expect we’ll get that back up into the high single digits, low double digits as we work back at 11% to 13% over time, so a good year this year, but plenty of work to do as we move forward.

Steve Powers

So as you think about – you’re coming up at the end of fiscal ‘23, few weeks away. As you think about momentum in the business and the progress you’re making against some of those financial objectives, I know it’s too early to be overly specific about ‘24. But what are some thoughts, some framework that you maybe can provide investors as to how you’re thinking about approaching questions of what appropriate fiscal ‘24 targets should be.

Linda Rendle

I’ll start and Kevin, please build. And we want to maintain that focus on maintaining top line momentum while rebuilding margins and getting that balance right. And we think we have the right actions in place and we will continue to execute against those actions in fiscal year ‘24. We’re looking very carefully at our categories. They have held up very well in pricing. We’ve maintained share during that period of time of taking four big price increases across the majority of our portfolio and we are looking at that. We want to make sure we keep our categories healthy and starting to implement additional actions as we took the vast majority of the truckload pricing that we had anticipated. We would want that to be less now and we moved to things like net revenue management, price pack architecture to continue to rebuild margins, continuing to lean into our cost savings program. And what we’re watching is what we can’t control. And we are ready with plans to pivot against that. So the expectations for what we see in inflation and that we need to continue to expect to be inflation in our Q4, and we would expect that to continue into ‘24.

And then from a consumer perspective, they are holding up very well now, but it’s going to get tougher from our estimation for them. Who knows what’s going to happen? Will the world, the U.S. see a recession, how deep will that be? And certainly, as they continue to have weaker balance sheets, less liquidity, what will the impact be or very recession-resilient categories, and we tend to fare well during these times but it’s something we’re watching very carefully as we head into fiscal year ‘24. So that’s the framework of we want to maintain, we’re ensuring that balance. We want to maintain our superiority with consumers, continue to invest in our brands. But we’re going to have to be agile as we adjust to this environment.

Kevin Jacobsen

The only other thing I’d add beyond, as Linda said, continue to drive the top line growth rate, continue to rebuild margins, is continue to prioritize our strategic investments. And so we have two critical initiatives. The digital transformation Linda talked about. Next year will be year 3 of our 5-year investment cycle. It’s also our streamlined operating model. So this is an operating model we started implementing at the start of this year. We expect that to be a 2-year program that will deliver about $75 million to $100 million in value. We’re very much on track to complete that at the end of fiscal year ‘24. So you should expect to see that program continue to advance next year as well.

Steve Powers

Okay, great. There is a lot of conversation already in this conference around pricing power. It shifted – the conversation shifted from who can take price, how much price can be taken to who is going to be able to hold price? So the concern of investors very palpably has shifted to risk of price rollbacks, promotional investments, et cetera. As you think about where you sit from a pricing perspective, you have taken 4 rounds of pricing. Are you looking to take more price? Are you looking the total line on price? Are you open to the possibility that you may have to invest in price as we go forward? How do you think about those – that scenario – those range of scenarios as we go forward?

Linda Rendle

I would start with pricing has gone well. And elasticities are generally in line or better than we had expected based off of historical elasticities. So that’s good. But again, we’ll be watching what the consumer does. The way that we’re thinking about pricing is we’re going to shift more to net revenue management levers and less truckload pricing. However, if the environment plays out differently and there’s significantly more inflation than we would expect, then we might have to lean more into truckload pricing in order to accomplish that or push out margin if we felt like we couldn’t take additional pricing, but we’re focused on the following: One, maintaining the pricing we’ve already taken in market. And if you look historically, we’ve only rolled back 1 price increase in 20 years.

And again, this is an environment like we haven’t seen before, but the history would be that we can take pricing and we can maintain it in the market. We’re focused on ensuring our price gaps are right, so in the places where Charcoal is a good example. Competitors didn’t fully follow in private label. We are making adjustments to our plan to try to maintain that truckload pricing but ensure our price gaps are right in the short term and hoping that we will adjust over time. And then we are ramping up that activity in those other areas like getting price pack architecture that takes longer because you have to reach full supply chains at times, et cetera, to get the right packaging or the right footprint available, we will use more of that as a lever. So hold on to pricing. We will take more if we need to, given the environment and switch to new mechanisms to take pricing over time and support growth is how we are thinking about it. When we look at the consumer, the good news is our categories are very resilient during times like this. We’re in essential categories that people use in their everyday lives. And so we think that will fare well. And our brands have never been stronger and we are going to continue to invest in them. So that’s the mindset we are in is maintain what we have, take additional action as required, continue to invest in our brands. And if worst times come, then we think our brands are well positioned to deal with it.

Steve Powers

And on that – is there any update on the specific situation you mentioned in Charcoal in terms of, basically, you had taken price, a competitor had not followed as was expected. And so you have taken some intervention to kind of control those price gaps. Where are we in that process? What’s been the response so far in the market? And where do you think – where you – is that dynamic limited to that category because of the specific competitive situation or is that a canary in the coal mine that’s going to spread to other categories?

Linda Rendle

We think it’s isolated to this category, and it’s very specific. Charcoal, we primarily compete with private label and private label did not fully follow the price increase. And so we’ve taken actions as a response to that. So that happened in Q3, which happens to be one of our smaller quarters. We are in Q4 right now, which is our largest quarter for Charcoal. We have two major U.S. holidays with Memorial Day on July 4 that are celebrated and about 50% of our Kingsford business is done in Q4. We believe we’ve taken the actions required to make the adjustments we needed to the plan to make sure we have the right price gaps, but also so that we have the right plans with retailers. Obviously, we won’t talk about the quarter in the middle of the quarter. We’ll talk about that in August. But the team did take immediate actions after what we learned in Q3 and we are hopeful that they will do what we expected them do in Q4.

Steve Powers

Another – I mean, this year was a year of trying to realize those price increases to start to rebuild that gross margin kind of openly at the expense of volume and household penetration. As we go forward, how do you – how do the priority shift? Where are we in the pendulum of focusing on price versus focusing on volume rebuild and a household recovery rebuild? And when do you think – I mean essentially, when do you think you can get the portfolio back to those high watermarks on household penetration volume?

Linda Rendle

Well, first, maybe a comment that’s just a helpful framing. If you look at what we expect to end this year at, our volume will still be larger than it was pre-pandemic. So even with all that significant pricing and the volume declines that we’ve seen in the last few quarters, we’re still a bigger business from a volume perspective. And certainly, though, price/mix has played a very big role over the last year as we’ve taken all of those actions and to your point, at the trade-off of volume, which we made openly. That’s what elasticity is, and it’s been better than we expected it to be, same thing for household penetration. So typically, when you take a price increase, the first people you tend to lose are your light users. Not usually the people who use your category day in and day out or your brand day in, day out, but the people who come in and out of the category. And that’s been the case for household penetration. We continue to see heavy buyers buying more, which is a very good sign. The people that we’re seeing drop out are light users, which we think is very manageable and in line with our expectations. And over time, we will begin to build that back. That’s the reason why we’re not slowing down on investments in advertising and innovation and of course, in our digital transformation to support that.

So what you’ll start to begin seeing is we’re beginning to lap those price increases. So price/mix will be a smaller contributor. Volume loss will be smaller as well. And then we will begin to rebuild volumes. Here’s what I’d say, though, exactly that time line given we’re still looking at what ‘24 will look like and what we expect inflation to look like, what we expect the consumer to look like. I won’t give a specific time line exactly when that will shift, but we will start to see volume play a bigger role next year, and then we would expect to continue to grow that beyond that. And if you look at our categories, volumes typically grow very low single digits in our categories.

We would expect to return to that and then have growing share would be a helpful contributor to volume as well. And then we know how to get light users back in the category. We’ve done it for a number of years. Certainly during the pandemic, we leaned in and invested and we brought a lot of new users to the category, some of which we converted to medium and heavy users and then some others that have dropped out now, but we will continue to use innovation and merchandising to bring those people in and convert them over time.

Steve Powers

Okay. Another question, I know you get a lot, but it’s top of mind is how that – how some of these dynamics net out into gross margin progress, right? So you’ve made significant gross margin progress back above 40% last quarter, which is a significant improvement from – I think you bottomed around 33%. So significant improvement off the bottom, but not yet back to where you started. So how do you frame your aspirations on that front? Clearly, there are a range of scenarios, a lot of things you don’t control. But is there some kind of framework or paradigm that we can think about as you think about it, to say, okay, I want to be in this corridor as we go forward over time. Like what’s the time line? What’s the process you think about that margin rebuild and what would make you – I guess, what’s the limitation on what unsatisfaction?

Kevin Jacobsen

Sure. I think it starts with our goals, we’ve been very clear. Our goal is to rebuild margins back to those pre-pandemic levels. We lost about 800 basis points as a result of cost inflation. We’re making progress this year, building it back. But our goal is to build all the way back to about a 44% gross margin. Now what’s important for us is to make sure we’re striking the right balance between maintaining investments and growing the top line while rebuilding margins. That’s ultimately how we will maximize the value of the company. And so for us, Steve, we’ve tried to take a view of this is something we want to do at the right pace that allows us to continue to invest in the top line. As a result of that, we expect to make more progress in our fiscal year ‘24, which starts next month. I do believe this is a multiyear journey though, for us to get back to pre-pandemic levels, and we think that’s the right pace. And so what you’d see is good progress next year. We’re in a way to that 44% gross margin, but that will carry beyond fiscal year ‘24 for us.

Steve Powers

And of the different variables that you do control where we talked about pricing, revenue growth management, but there is cost savings, there is optimization of supply and utilization. How much of the path forward on margin is in your control versus is dependent on the macro backdrop or the competitive environment as we go forward?

Kevin Jacobsen

Yes, it’s a great question. I think if you think about what we can control, and this is a good year, we’re driving pricing, we’re driving cost savings. And something we haven’t talked about, we’re driving what we call supply chain optimization. We built up tens of millions of dollars of cost in our supply chain as we’re managing through the pandemic and the supply chain disruptions. We now have the opportunity to go back and pull that money out. And so those are the levers we’re driving this year. Usually expect as we move into fiscal year ‘24, we will keep driving those levers. I think pricing will not be as material as it is this year, but you’ll continue to see very strong cost savings, more supply chain optimization. I think, Steve, on those areas we don’t control, which is primarily the cost environment as well as how the consumer holds up, I think that will either accelerate or delay our time to margin recovery. And so we’re going to focus on things we can control. And I’d say, we feel very good about our progress this year and what we can continue to do as we move into fiscal year ‘24 and beyond. But what we don’t control is cost environment. And so I think, as I said, that will either delay or accelerate our time to that margin recovery. And we’re just going to see how that plays out over time.

Steve Powers

Okay. So investors are – look at your business – sometimes overly simplistically, in my view and probably maybe your view as the spreadsheet math is pretty compelling, right? If you start from where we are now, your guidance has – the top end of your guidance you’re at $4.50, an EPS for this year. If you carry your kind of top line algorithm forward, you rebuild that gross margin, and you achieved your other objective of holding SG&A to 13%. You start to get earnings power of $7, $8 looking out in time. I guess a key variable in that is that 13% – is that path 13% SG&A., is that – how much in your view is that a function of top line leverage versus actual cost cutting in SG&A? Where are the opportunities to drive actual cost reduction?

Kevin Jacobsen

Sure. Leverage will be a piece of it. But really, what’s going to drive our admin spending. And if you take up a one-time cost, we typically up around 14% admin as a percent of sales. Our intention is to get that down to 13%. The primary drivers are really twofold. The first is our operating model changes we’re making. We expect to save about $75 million to $100 million over this 2-year period. that progress, that initiative is well on track, and we should complete that work next fiscal year. That will be an important component. But the other element is our digital transformation. We are investing $500 million in fundamentally changing the technology capabilities of this company. There is tremendous productivity, opportunities behind that. If you think that as an example, our ERP, it’s almost 20 years old. And you think about the advancements in productivity on technology and new ERPs. Now that’s going to take some time. As I said, we’re just completing the second year of our 5-year investment cycle. So it’s going to be a longer time frame when you’ll start to see the benefits from admin productivity from that initiative. So I think in the near-term, you’ll see the benefit of our operating model. Longer-term, you’ll see the benefits from our digital transformation. Collectively, that will put us on a path to get down to 13% over time. But that’s something we will take some time to get to that.

Steve Powers

Okay. Can we maybe focus in on that digital transformation program because it’s gotten a lot of discussion over several years and mostly just around the cost of it and whether investors should include it or exclude it because it’s cash charges, cash investments, so it is material, but it’s also onetime. It’s a one-time transformation. I think maybe what’s lost in that is just the magnitude of that transformation. So can we focus more on that part of it? Just I mean, how do we – how can investors conceptualize how different Clorox will be once that transformation is behind us. What will you be able to do that you weren’t able to do a couple of years ago? And just sort of how pivotal will that be to building capabilities?

Linda Rendle

I’d love to focus on that part of the digital transformation Thank you, Steve. And you characterized it exactly right. There is not one person at Clorox who will work the same 2 to 3 years from now as they do today. Not one. We fundamentally are enabling the company through technology and through process change through technology transformation. This means that our supply chain, the way that we market, the way that we innovate, the way that we do, we close the books, you name it, we are reinventing it. And this is as a result of we have a 20-year old ERP. So we have to put the foundation in place and then we have to put the capabilities around that to enable the team. How do we have this during the pandemic? It would have really helped. One, drive more top line sales; and two, help us from a margin perspective. We are operating in many cases, very manually today on things on Excel spreadsheets. We were managing inventory when we had 27% sales growth and things fluctuating. We were having teams manually call. We’re putting all of the technology in place to ensure that we have the right data and importantly, the right insights, where that be on the cost side, on the growth side in order for us to manage our business. And then we’re doing what it takes from an operating model perspective to make sure we use that the right way.

So we want our team to be more consumer-obsessed. We want them to know consumers better than anyone else does in our categories, and this will unlock that even further for us, more real-time insights, ability to react more quickly, ability to do things that we hadn’t done before, like fully integrated business planning with AI models and machine learning. And we’ve started to pilot those things, and we’re seeing what we’ve signed up for because this project has a great return. We’re starting to see those things come to fruition as we begin to put them in place. So it is – it’s fundamentally the Clorox Company will operate differently than we did pre-pandemic, and even as we are now with all the right backbone and capabilities to ensure we can compete at the speed that’s required and against the aggressive operational goals that we put in place to rebuild margin and maintain growth. So thank you for asking it that way.

Steve Powers

And is – so I mean – it’s grown on me over time and appreciate just how fundamental this was. I mean the spreadsheet inventory management example, I think, is pretty clear. So when it’s over, you’ll be light years ahead of where you were. How do you ensure that, that will also be at least competitive with, if not ahead of your competition, because a lot of these things are obviously moving target?

Linda Rendle

So we need to maintain it. And so what you’ll hear from us is just a continued commitment to and knowing that this is a core way that will create value and the way that we spend our normal tech – because we spend normal technology money that we would spend that in the best way to keep those systems updated. For example, we are looking at AI and Gen AI and what that offers and we’re thinking about how would we do that moving forward and how do we build that in and ensure that we stay current so that we don’t fall behind again? But that’s our mentality. Now obviously, technology is changing fast. Who knows what’s going to be here 5 to 10 years from now. But our commitment is to ensure that we’re keeping pace so that we don’t fall behind again.

Steve Powers

Okay. And is that – does that what kind of – if there is a way to frame this, but what kind of run rate – I mean, the $500 million you’ve been clear is $500 million, and then it falls away and then the run rate expenses keep you up to date. Do those run rate expenses mimic the run-rate expenses above before or are they structurally higher because you don’t want to fall behind?

Kevin Jacobsen

We will have to see exactly how that plays out. Our expectation is it will generally be in-line. We were spending quite a bit of money. In fact, you can say fairly and efficiently because we’re trying to maintain very old systems. There is going to be a lot more efficiency on how we spend that money going forward. And so right now, you should generally assume the money we’re spending historically for maintenance will be what we will spend going forward after we get past this $500 million investment over 5 years.

Steve Powers

Your long-term target is 3% to 5% growth as part of the updated IGNITE strategy. I guess – we’ve asked – so I’ve talked about this before, but remind us why those are the right targets. And then how do you envision your various segments contributing to them over that.

Linda Rendle

So those targets do represent an acceleration versus past performance from a top line perspective. And what we called out is we thought we had the opportunity to capitalize on consumer megatrends in order to drive extra growth. And we wanted to lean into innovation and brand building to do that. We can create bigger innovation platforms that we can invest in for multiple years, and we’ve given examples of those in various conferences, and I’m happy to talk through any examples today as well. that allow us to continue to create more. So we want to at least grow at the rate of the category and we want to grow share over the long run in order for us to get to those targets by investing behind our brands. We saw opportunities before the pandemic, and the pandemic has given additional opportunities. For example, our cat litter business, which was a nice contributor prior to the pandemic. But given the rapid rate of cat adoptions, much to see I know you don’t love that. I’m allergic to cat, too, although I appreciate them for what they are, very nice little business. They are cute and fluffy and I make cat videos, but that lot of people adopted cats during the pandemic. And so that category is a stronger contributor for us and something we can take advantage of through innovation and brand building more than we thought we could in IGNITE. People are continuing to clean more than they did. So, not at the height of what people are doing during COVID, which I think is a relief for everybody. But people care more about it. And so we can take – create additional opportunities through innovation to get that extra point of growth that we are talking about. I would say, from a business standpoint, we expect all of our businesses to grow and all of them to contribute to margin growth. But of course, that is dependent on their role in the portfolio at what time and where we can lean in, in a particular year if we have a great innovation and that will always change year-to-year depending on the opportunities. But we feel good about the portfolio we have, the exposure to growth that we have and our ability to leverage that through innovation and brand building. And so we remain committed to the 3% to 5%. It certainly hasn’t been a linear path as we have had normalization, etcetera. But we performed at the top end of that range. If you look at the last few years in average and we continue to hold ourselves to that standard moving forward.

Steve Powers

What about your opportunities overseas, have they had evolved as part of upgraded growth? Have they further evolved since, or you remain committed to the same opportunities you had seen a few years ago?

Linda Rendle

We wanted to accelerate the performance of international and have it be a bigger contributor to the company’s growth and it has done just that. And that was true pre-pandemic. And then during the pandemic because we have such a large portion of our business in the Cleaning segment, we saw opportunities to bring new innovation to market like wipes in markets around the world, and we continue to do that. That’s a long-term growth opportunity. It took us 20 years to grow that category to the degree it is in the U.S., and we would expect something like that around the world in the markets where it’s relevant. But we also had opportunities pre-pandemic like cat litter and Burt’s Bees natural personal care and those continue to contribute well also. So, for international, we remain on track. It will be – we expect it to be a stronger contributor than it was pre-IGNITE, and we continue to make the right investments there to do that. For example, localized supply chains, which we did during the pandemic and to ensure that we have the right production capacity where we needed it.

Steve Powers

Yes. I mean speaking of supply chain, let’s maybe just help check on the current state of the supply chain, where capacity utilization is, where service levels are, your overall satisfaction with the supply chain and its redundancy and it’s – and your ability to drive productivity off the back of the current state.

Kevin Jacobsen

Yes. I would say we are making very good progress in the supply chain. If you think about where we were just a year, 18 months ago, fill rates were down significantly from historical levels. We were building up cost to increase resiliency and responsiveness given the supply chain disruptions. We took inventory levels up by hundreds of millions of dollars to make sure we could respond given supply chain disruptions. We signed up hundreds of additional suppliers to make sure we had redundancy. We have seen significant improvements in the supply chain broadly. As a result of that, we are able to go back and attack all those costs. We now have five straight quarters, Steve, where we have been able to bring inventory levels down as we are getting more reliability in our supply chain. Last quarter, we had a case fill rate. The best case fill rate we have had since the pandemic began. So, we are seeing more consistency in our supply chain. And it also allows us to go after all those suppliers we signed up. We are now able to go back and start optimizing those relationships to get costs down. So, that work is well underway. We certainly have more work to do, but I would say it’s absolutely going in the right direction, we are making progress for sure.

Steve Powers

Okay. I mean supply chain modernization resiliency was we kind of layered in as part of the IGNITE strategy as an enabler of growth. I guess two others that are interesting to me right now are our innovation and R&D, specifically bigger, stickier innovation was the objective of IGNITE as well as improvements in digital and data analytics. And you talked about some of the transformation, but I am thinking more of the – the backbone is one thing, but then actually layering on the functionality and capability on top of that. How much progress do you feel you have made on both being able to drive consistently that bigger stickier innovation on the one hand, and on the other hand, driving competitive, if not advantaged, consumer insights and data analytic capabilities.

Linda Rendle

Maybe the framing that we look at it, we look at the stuff that we have always done, an investment that we need to do better because there is modern capabilities, and that would be in the area of advertising and innovation, Steve. We have always focused on those two things, but we can do them more effectively and efficiently. And obviously, we use technology to do that. Kind of more one-time investments, supply chain stuff that we spoke about, making sure that we have for example, cat litter, we can’t fully supply. It’s one of the only businesses right now that is constrained. We are building a new facility, once we get that up and running, and that was a specific investment to get us to the place we needed to. And then the third layer, which is more of a new investment, which is in this digital infrastructure that we talked about in capabilities. I would say on the first bucket, the stuff that we do, we continue to optimize, we are making good progress. Innovation, we are getting bigger platform ideas. We are seeing it stickier in market. We are getting more of a net impact, and our advertising dollars were driving significant efficiency. I know we have talked about this before out of that. So, we feel really good about the kind of continuing to evolve our capabilities and things that we regularly do. I think on the supply chain, Kevin just noted, making good progress there. But on the digital transformation, I think we want to make sure we are clear. The vast majority of the value from that program happens in the back half and next strategy period because we are still putting those capabilities in place. We only put the first instance of our ERP in, in Canada in the fall – coming up in the fall, and then we will a year later follow with the U.S. and then we will go around the world. So, just having that foundation in place and then all of the capabilities that go around, some are being put in place now and they are either in test word in one business unit that we are beginning to expand to other business units or still just in the design phase. So, it’s important work. It’s helping inform the work that we do today to rebuild margins, but the vast majority of that value happens later, and we are in early innings.

Steve Powers

Okay. Are you behind of your own objectives? Are you behind competition or…?

Linda Rendle

From a technology perspective?

Steve Powers

Yes.

Linda Rendle

Yes.

Steve Powers

Okay. And when do you think in this 5-year journey, you catch up? And ultimately, can you get ahead?

Linda Rendle

So, maybe what is the goal, should we be ahead, we should be leading top third in places where it really matters because we don’t want to overinvest in capabilities that don’t differentiate us. So, for example, in marketing, we want to make sure that we are in that more leading-edge pack because it’s something that is a core to how we create value for our brands from a superiority perspective. In other things, we just want to make sure that we have the right technology, and of course, hopefully, we will execute better than others do and that we would be at the right average. We are not – we won’t be there until we finish this implementation. And we would expect to be in line with our peers and then in distinct capabilities that we think are unique to how we create value, we would want to be more on the – in the top third. I don’t think it would ever be appropriate for us to have big scale capabilities that are leading the number one. That’s not given the size of the company we had, I don’t think it’s necessarily what we can do is learn a little bit from what others do and then implement and execute with excellence.

Steve Powers

Yes. I guess I was thinking about it. So, I think behind – are you also behind your direct competition? Is there a distinction between your peers and your direct competition? Because a lot of your categories, you are competing – you are kind of – you are the big player in relatively smaller niche categories. You are competing often times with private label or with private competition. So, is there a distinction between being behind against the broader peer set and being brought behind against your competition?

Linda Rendle

We compete against multinationals in many of our categories. And we do have private label, too. So, against private label, we play a very different game than they do. We are about innovation and using technology. And so certainly we are ahead to some degree and that they are going to follow. But if you look only really three of our businesses are exposed to significant private label, the rest are more average or lower. But we compete against big multinationals in home care, and in litter, and in the Burt’s and natural personal care and so – and then those were behind, but still have leading brands are able to outperform and out-execute in order to continue to have leading share brands.

Steve Powers

A couple of minutes left. So, maybe we close a few questions on cash and capital allocation. So, on free cash flow, you have historically targeted 11% to 13% of sales. Like many companies, you have been a little bit behind that target in recent years because of CapEx, because of inventory demands as supply chain issues were elevated. What’s the path back to that range as a sustainable run rate?

Kevin Jacobsen

Sure. So, I think the path back is everything we have been talking about today, as Steve said, our goal is 11% to 13% free cash flow as a percent of sales. We ended last year a little below 8%. And this year, I expect will be high-single digits, low-double digits. We are making good progress. The path back is exactly what we talked about. It’s rebuilding gross margins, rebuilding profitability, optimizing working capital as we execute those initiatives, that’s the path we are starting this year, and you should see that continue as we move forward, Steve. But very much tied to our operating plan improvements will lead to more cash we will generate over time.

Steve Powers

Okay. And after – as you get that cash back after organic reinvestment in this environment, your appetite or priorities changed on how you deploy that capital in terms of cash returned to shareholders, deleveraging, debt pay down or optimization as well as obviously M&A?

Kevin Jacobsen

Yes. The priorities have not changed. As Steve said, job one for us is to invest in our base business. So, that’s what we will continue to do, and we have been doing throughout the entire pandemic. After we get past investing in the base business, we will continue to actively support the dividend. We are one of, I think 68 companies a dividend aristocrat, given our long-term commitment to the dividend. You should expect that going forward. Now, we have seen more modest increase in the dividend because of our reduced profitability. You see over time, typically, we want to grow the dividend more in line with profit growth, but it will be more muted until we get back to that more normalized level of profit. Third priority is we will focus on our leverage. We target debt-to-EBITDA of 2x to 2.5x. Historically, we have operated at the very low end of that range. More recently, we have seen our leverage ratio tick up. Our debt levels have not changed, but because of reduced profitability. And so we ended last year about 3x. This year, we will start bringing that down to 2.7x, 2.8x. And then Steve, I would expect next year as we continue to rebuild profitability getting leverage back into that historical range of 2x to 2.5x. And then we will look at returning excess cash to shareholders. We suspended that program last year because of the reduced cash flow we are generating. When you get back into that 11% to 13%, that gives us more flexibility. Typically, that’s plenty of money to invest in the business, support the dividend and then look about how best to deploy that, either we look at M&A or we do share buybacks, I think that’s something we will look at over time, but we are not there yet.

Steve Powers

Okay. And on M&A, I mean they have been successful over time additions to the portfolio that Burt’s Bees comes to mind. But I think a lot of investors also think about mixed success in currently in BMS and previously that efforts to kind of penetrate the professional healthcare channels make success. Does the kind of the long-term history or the more recent history of Clorox on from an M&A perspective impact – influence you at all? Does it change maybe where you focus, how you focus? Does it change your overall appetite to go spend money inorganically versus invest in the organic opportunities you have talked about?

Linda Rendle

I think what hasn’t changed is always – we absolutely have to get the core right and that’s absolutely consistent, and I think no, we have learned a lot. I mean that’s the most important part in the successes and the ones that they haven’t gone as well, BMS being one of them, what we would do moving forward. So, we are always looking at our portfolio with our Board. We are always looking at opportunities where we can apply our capabilities. And we are looking for a good return. And of course, it’s been an interesting market over the last several years, ups and downs in that. And we have been really focused on getting our core to steady state, getting our supply chain up to where it needs to be, being able to fully supply, doing our digital transformation. But we are very open to acquisitions in the future, where we can apply our capabilities. But again, we would look to make a good investment that we thought would be a strong return for our shareholders.

Steve Powers

Great. I will give you the last word. We covered a lot of ground. Is there one, two, three things you would like investors in the room are listening to take away?

Linda Rendle

First, thank you for your attendance. We really appreciate your interest in the company. We think we are taking all of the actions necessary to do what we are setting out to do, which is to maintain that top line momentum and rebuild margins over time. We have made good progress. We have more work to do, and we are focused on the things that we can control in order to do that. Looking forward, I don’t know exactly what the environment is going to hold. But what we do know is that our brands are very well positioned. They are at the highest value superior rating that they have ever been at. We continue to invest in them and invest in our capabilities across the company to be well positioned to handle whatever comes our way and deliver profitable consistent growth over time. Thank you.

Steve Powers

Great. Linda, thank you. Kevin, thank you. Thank you, all.