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Church & Dwight Co., Inc. (NYSE:CHD)

Q2 2008 Earnings Call

November 4, 2008 10:00 am ET

Executives

Jim Craigie - Chairman and CEO

Matt Farrelll - CFO

Analysts

Alice Longley - Buckingham Research

Douglas Lane - Jefferies & Company

Bill Chappell - Suntrust

Bill Schmitz - Deutsche Bank Securities

Mili Seoni - JPMorgan

Connie Maneaty - BMO Capital Markets

Joe Altobello - Oppenheimer

Nik Modi - UBS

Jason Gere - Wachovia

Andrew Sawyer - Goldman Sachs

Operator

Good morning ladies and gentlemen, and welcome to the Church & Dwight Third Quarter 2008 Earnings Conference Call.

Before we begin, I have been asked to remind you that on this call the company's management may make forward-looking statements regarding, among other things, the company's financial objectives and forecasts. These statements are subject to risks and uncertainties and other factors that are described in detail in the company's SEC filings.

I would now like to introduce your host for today's call, Mr. Jim Craigie, Chairman and Chief Executive Officer of Church & Dwight. Please go ahead sir.

Jim Craigie

Thank you, Chantal and good morning to everyone. It's always a pleasure to talk to you particularly when we have good results to report. I'll begin this call by providing my perspective on our excellent third quarter, which you've read about in the press release issued this morning.

Let me start off by saying that I'm very proud of my company for both the quality and magnitude of our results particularly in this recessionary worldwide business environment. Our business results reflect an organization that is highly motivated and firing on all cylinders. Our new product pipeline and increased marketing spending is driving strong organic growth despite softening consumer demand.

Our business teams and supply chain organization are working closely together to deliver exceptional growth margin expansion despite the volatility in commodity prices. Everyone is continuing to keep it tight around on overhead costs. This is proven by the fact that we have the same number of employees today as we had four years ago despite of 50% increase in sales during that time.

We are squeezing every dollar out of our working capital to drive a significant increase in cash flow. That increased cash flow and strong balance sheet is also enabling us to smartly invest in our future through accretive bolt-on acquisitions and building new plants to further lower our cost structure and strengthen our competitive advantage.

While we are feeling bullish about our company's business momentum, we are very cognizant of the very tough business environment facing all companies these days. Consumer confidence is at a record low. Consumers are trading down and we believe that consumer spending is going to get worse before it gets better.

However, Church & Dwight had handled this crisis exceptionally well so far in 2008. As demonstrated by our strong organic revenue growth, our gross margin expansion and double-digit earnings per share increase. No other consumer packages company that I can think of is as well suited to handle a recession as Church & Dwight.

We've achieved share gains in 2008 across almost everyone of our core category, including liquid and powdered laundry detergent, laundry additives, cat litter, battery-powered toothbrushes, depilatories, diagnostic kits, and condoms. And we face less of a threat of consumer trading down because over 30% of our domestic portfolio consists of value-oriented products.

Finally, we have a superb plan in place to continue to deliver on our goal of growing gross margin by at least 100 basis points per year. We promised that result for 2008 at a time when oil was less than $100 per barrel. We delivered against that goal in the first nine months of 2008 with a gross margin gain of 130 basis points despite oil rising as high as $140 per barrel. We will continue to deliver against that objective.

You may wonder how Church & Dwight can still do this when most other consumer packages companies are showing gross margin decline. The answer is that Church & Dwight has four key factors driving gross margin. The first two are common to other consumer packages companies that in we have all taken pricing. In Church & Dwight case, we have priced over 50% of our revenue base in 2008.

And I assume the other CPG companies have been cutting their overhead costs wherever possible. On top of these two common industry factors, Church & Dwight has two unique factors. First, the compaction of liquid laundry detergent product which started in September of 2007 and finished its national rollout in June of 2008 has generated significant cost savings that have more than offset the cost increases in this commodity sensitive business.

Second, we had $10 million of manufacturing cost synergies starting last October for the integration of the acquired OGI brands primarily OXICLEAN into our manufacturing facility.

Not only did we have these four factors driving gross margin expansion, but when commodity prices started to rise dramatically in early 2008, we exceeded our assumptions on all four factors through an extraordinary effort by the whole Church & Dwight organization.

In this regard, we took more pricing than originally forecasted. We achieved more cost savings than expected, the liquid laundry detergent conversion went better than expected, and we exceeded the cost savings on the manufacturing synergies on the integration of the OGI acquisition. When you combined this incredible effort on cost savings with the great pipeline of new products, increased marketing spending, site overhead controls, and squeezing working capital, you get the high quality business results achieved by Church & Dwight so far in 2008.

Organic revenue growth of 4% in Q3, and 6% year-to-date. Gross margin expansion of 100 basis points in Q3, and 130 points year-to-date excluding the new plant charges. Earnings per share growth of 6% in Q3 and 10% year-to-date excluding the one-timers and free cash flow increase of 15% in Q3 and 61% year-to-date excluding capital expense for the new plant.

These results are not surprising to us as we expect to continue to deliver solid organic revenue growth of 3 to 4% and gross margin expansion of at least 100 basis points annually. I will provide more detail in my outlook to the year in a few minutes.

I will now turn the call over to Matt Farrell, our Chief Financial Officer, who'll provide you with greater insights on the financial results for the third quarter and year-to-date.

Matt Farrelll

Hey. Thank you, Jim. Good morning everybody. I'm going to start with EPS. Our reported third quarter EPS was $0.69 per share, compared with $0.75 in 2007. The current year quarter included a $0.04 charge for restructuring costs related to the closing of our North Brunswick complex which we'll be closing in the fourth quarter of 2009. It's also noteworthy that last year's third quarter results benefited by approximately $0.04 of earnings from a property sale in Canada and also $0.02 of tax benefits.

So, if you exclude these items, EPS was up about 6% from a year ago and a strong sales performance and gross margin expansion that Jim referred to was the drivers of the third quarter earnings results.

One other thing, in our press release, we noted that we sold our business in Spain for a small net gain. The transaction created a low effective tax rate but it had a little effect on EPS since it was offset by the pre-tax loss on the sale which is included in SG&A. You'll see both of those numbers in the release.

Our revenues now, revenues were up approximately 9% of which about 1% was due to currency and 4% due to the sales of products acquired from the Del acquisition. So .the organic growth for the quarter was 4%. And of the 4% organic growth, the majority is due to price mix as oppose to volume.

So, now let's go through the segments. The domestic business had a strong quarter. Revenues were up about 9.7%, 5% of which was from the Del brands. The organic growth was driven by XTRA liquid laundry, ARM & HAMMER liquid laundry, OXICLEAN powder, ARM & HAMMER Powdered Laundry, Arm & Hammer Dental Care and ARM & HAMMER Super Scoop cat litter and about half of the domestic organic growth came from volume and the balance from price mix.

We successfully raised prices earlier in the year you'll remember for ARM & HAMMER Powdered Laundry Detergent, TROJAN, and baking soda. New product launches also contributed to domestic revenue growth year-over-year.

One other thing, we also announced 10% price increase in mid-October on our liquid laundry detergent businesses, OXICLEAN Powder, SpinBrush, and dental care products. In each case, we are following the earlier pricing moves by competition.

Turning now to international, international posted a 4.3% increase, primarily due to favorable year-over-year foreign exchange rate changes and the impact of Del. Organically, however, the international sales were down slightly due to higher sales in the prior year's third quarter in advance of an announced price increase.

International represents approximately 17% to 18% of our full year consolidated sales and earnings. The strengthening dollar will result in lower reported international sales growth in the future. However, we are fortunate that as a US-centric CPG company, the effect of the strengthening dollar will have a lesser effect on us than others in our peer group.

Now, Specialty Products. The specialty product business had another great quarter, primarily due to price increases for dairy products and specialty chemicals business. Specialty Products enjoyed higher year-over-year prices in Q3 for most of its product but began lapping price surcharges that began in August of 2007. So, the growth rate for Specialty Products for the past four quarters has been bolstered by year ago price increases that we've now lapped. So, the growth rate for this division is expected to return to our perennial 3% to 4% range in the fourth quarter of 2008.

Gross margin, turning now to the margins that are reported, third quarter gross margin was 39.8%. Excluding the $4.3 million charge related to the shutdown of the North Brunswick plant, our gross margin expanded 100 basis points. And remember that the gross margin expansion is net of diesel hedged losses caused by fall in diesel prices as well as significant year-over-year commodity increases. So, very pleased with our gross margin performance in Q3 and also for posting gross margin improvement in each of the first three-quarters of this year.

Looking ahead, we continue to expect a healthy expansion of year-over-year gross margins in the fourth quarter and expect those to exceed 100 basis points.

Marketing, marketing spend was 12.6% of revenues which is a 60 basis point increase over the prior year spend of 12%. Marketing expense was about $10 million higher for the quarter than year ago and included spending behind the newly acquired Del businesses and behind our new ARM & HAMMER Essential Cleaners, ARM & HAMMER liquid and OXICLEAN powder. And this higher spending is one of the drivers of our organic revenue growth and the success of our new products. Our third quarter spend was about $80 million and we expect to spend above this level in fourth quarter.

I'm not going to cover SG&A. SG&A year-over-year was up $14.7 million. The quarter included a $3.5 million charge related to the divestiture of a subsidiary in Spain and last year included a $3.3 million gain on property sale. The balance of the difference, if you adjust for those two items is primarily due to the transition and amortization costs related to the Del acquisition, litigation costs, and also foreign exchange.

Again, looking ahead, for the fourth quarter, we expect fourth quarter SG&A spend to be comparable to Q3 due to higher R&D spending as we continue to invest in new products.

Operating profit, the reported operating margin for the quarter was 13.6% compared to 15.3% last year. If we exclude the plant restructuring charge and the pre-tax loss related to the Spain divestiture, you’ll find that operating margins were 14.8% and if you take a similar approach to 2007 third quarter, we're actually up 10 basis points if we adjust last year for the land sale gain in Q3, 2007.

Other income expense is up $2.2 million for the quarter and reflects lower interest expense as both interest rates and our debt levels are lower than a year ago, but this was more than offset by $3 million of foreign exchange losses that impacted the quarter.

Next is income taxes. As you can see in the release, our effective rate for the quarter is 34.4% compared to last year's 34.7%. It's important to note that the current and the prior year quarters were both impacted by favorable tax benefits. However, in the current quarter the lower effective tax rate had little effect on earnings per share. Remember that the tax benefit from the Spain divestiture is offset by the pretax loss included in SG&A. So, the underlying tax rate for the quarter was actually 37.4%.

We are forecasting an effective rate of approximately 36% for the full year, that's the all-in rate and this also -- this includes not only Spain, all aspects of Spain, but includes the 50 basis points benefit of the reinstatement of the research tax credit which will be recorded in the fourth quarter.

I'll now turn to free cash flow and debt, we generated $65 million of free cash flow in the third quarter. Netted in our free cash flow is $27 million of CapEx which included $19 million of expenditures related to the new facility in New York and Pennsylvania.

We have 175 million of cash on hand and approximately $195 million of available credit through our revolver and asset securitization facilities. We also converted our 100 million convertible debt in the quarter into 3.2 million shares of the company's stock and we completed the 380 million Orajel acquisition on July 7th, which was financed with a $250 million addition to our bank credit facility as well as some cash.

So our total debt to LTM adjusted EBITDA per our bank agreement was approximately 2.0 at quarter end, putting us at the low end of our long-term leverage range of two to three times EBITDA. We expect to generate over $200 million of free cash flow in 2008. And remember that this is after absorbing approximately $43 million of CapEx in the second half of 2008 related to the new plant in York County.

In conclusion, the third quarter results reflect 4% organic sales growth, good gross margin expansion, progress in integrating the Del acquisition, continued reinvestment in marketing as well as strong free cash flow.

Back to you, Jim.

James Craigie

Hey, thanks Matt. I'd like to spend the remaining few minutes of our portion of the call talking about two subjects. First, the strength of our new product pipeline and its impact on our current and future organic revenue growth, and second my earnings guidance for the rest of 2008.

On new product front, we are continuing to see the benefit of a corporate new product team that was created in 2006 to deliver more innovative new products with strong consumer appeal. Last year this group launched over 50 new products which was a record for our company. This year the new product team will launch fewer new products in total but the revenue impact of these new products in the first half of 2008 is over 50% greater. Let me repeat, over 50% greater than the new products launch in the first half of 2007.

The new product launch is affecting 2008 sales include the following. A new sub line of our ARM & HAMMER brand called Essentials which provides consumers with environmentally friendly products at a value price versus category leaders. Our first entry in the Essentials line is a liquid laundry detergent product launched in 2006. This product is in a key driver of our total ARM & HAMMER liquid laundry detergent business which has been growing at over 40% compounded rate over the past five years.

Over the past two years, we have successfully expanded the ARM & HAMMER Essentials sub line into three other categories, fabric softener sheets, cat litter, and underarm deodorant.

In third quarter this year, we expand that line again into a fifth category, household cleaners. This line of cleaners is built on following three simple ideas. First, they include plant based and other biodegradable ingredients that work as well as traditional cleaners.

Second, consumers only have to buy a small refill cartridge after the initial purchase which helps reduce the amount of packaging that ends up in landfalls like 52% and third, the consumers save money with refills up to 25% cheaper than the category leaders.

In order to help you better understand this product line, think of it as similar to Clorox's Green Works new product line in the [bottle] dispensable cleaners, but without the bottle, without the water, which is about 95% of what's in the bottle, and about 40% cheaper than Green Works.

We believe that our line of cleaning products will be very compelling to consumers because it leverages two hot trends. First, providing consumers with environmentally responsible products that work as well as traditional cleaners, and second, providing consumers with a better value.

We are supporting this initiative with significant marketing support in the third and fourth quarters of 2008. Now it's too early to judge the retail success of this new line of cleaners but I'll just say that the early results are in line with our expectations.

Other significant new products impacting 2008 sales include Arm & Hammer laundry detergent with OXICLEAN stain fighters offered in both powder and liquid form. This new co-branded product delivers premium laundry detergent cleaning performance at a value price. It started shipping in the fourth quarter 2007. It is on track to be our most successful new laundry product ever.

All new ARM & HAMMER products are being supported by more appealing and unified packaging, a trademark advertising campaign, and increased levels of marketing spending, almost 50% higher than last year as part of new ARM & HAMMER mega brand marketing campaign that we started in 2006.

Since the start of that campaign, net sales of all ARM & HAMMER brands has grown from 1% in 2004 to over 6% in 2007 and over 9% in the first three quarters of this year. We've also launched innovative new products in our other core categories in the first half of 2008 including the following.

Two new additions to the TROJAN line called Thintensity and Magnum Thin which capitalize in the growing thin segment of the condom category. A new near depilatory product called Shower Power, which enables women for the first time to use depilatory product in the shower with the majority of women remove hair on their legs. This new product has become the number one new product in depilatory category in 2008.

A new SpinBrush toothbrush called Swirl, a value-oriented product which was designed to encourage manual brush users to trade up into the battery-powered toothbrush category. And finally, the FIRST RESPONSE brand has launched a digital pregnancy kit and a daily ovulation kits that are doing extremely well.

Let me switch gears now and talk about the future. While we're pleased with the solid third quarter and year-to-date results, as I often state, we are never satisfied. While the current and future business environment will be extremely challenging, Church & Dwight has a sustainable growth model that will enable us to continue to deliver strong earnings growth.

Our eight power brands being ARM & HAMMER, TROJAN, OXICLEAN, FIRST RESPONSE, SpinBrush, Nair, Xtra, and Oraljel are powerful brands representing over 80% of our total net revenues and profit they are all growing in 2008.

This growth is driven by two key factors. First, our improved competency in new product development has generated strong pipeline of new product innovations at every one of our core categories. Second, we've been steadily increasing our marketing spending behind these brands to continue to build equity and deliver or exceed our 3% to 4% organic revenue growth target.

In addition to our strong portfolio of eight power brands, the next major factor driving our sustainable growth model is our ability to deliver solid gross margin improvement and earnings growth despite an unprecedented level of year-to-date cost increases for raw materials, packaging, and transportation.

We have a well established pipeline and cost saving initiatives in the areas of manufacturing, purchasing, distribution, and trade spending that is being executed to deliver significant cost savings now and initiatives are already underway to deliver significant cost savings as far as out as 2010. In addition, the strength of our core brands has enabled to us raise prices while still delivering or exceeding our organic revenue growth target and record shares on most of our core brands.

In that regard, as Matt stated, we have announced price increases on over 50% of our company's product portfolio so far in 2008. These cost savings and pricing initiatives are being bolstered by manufacturing synergies from the OGI integration, liquid laundry detergent compaction, and volume scale leverage. The net effect of all these initiatives is expected to lead the further steady improvement in our gross margin in Q4, 2008 to deliver our annual average target of at least 100 basis points improvement.

In fact, based on our year-to-date results of 130 basis points improvement through the first three quarters of 2008, excluding new plant charges, we will exceed our 100 basis point full year target in 2008. The improvement in our gross margins has enabled to us increase marketing spending in 2008 to drive a strong organic growth.

Finally, we will continue to keep a very tight lid on overhead costs as demonstrate by our ability to continue to grow our company's sales while keeping our headcount flat.

Now, let me translate into specific guidance for the rest of the year. Our sustainable growth model, which has enabled us to both grow and reinvest at the same time, bodes well for our company and shareholders despite the weakening worldwide economy.

In view of our solid organic revenue growth, gross margin improvement and tight overhead expense control, we feel confident that we can deliver our previously announced EPS forecast of $2.83 to $2.85 for 2008, and that's a 15% to 16% increase over 2007. This excludes the previously announced charges for the new manufacturing plant of approximately $0.08 per share.

Based on that fact that we have delivered $2.20 EPS in the first three quarters 2008, this means that we expect to deliver between $0.53 to $0.55 of EPS in Q4, which is a 37% to 41% increase versus a year ago. These results reflect continued solid organic revenue growth, a significant increase in gross margins, continued strong marketing spending, in fact marketing spend will be a record for us in fourth quarter behind our innovative new products and tight control of SG&A costs.

Now that ends our presentation. I'll now open the call to questions that you may have which Matt and I will do our best to answer. Chantal, please go ahead.

Question-and-Answer-Session

Operator

(Operator Instructions). Your first question comes from the line of Alice Longley of Buckingham Research.

Alice Longley - Buckingham Research

Hi. I'm confused about something. Your guidance includes or excludes the $0.08?

Matt Farrelll

The $2.83 to $2.85?

Alice Longley - Buckingham Research

Yeah.

Matt Farrelll

Yeah, that excludes.

Alice Longley - Buckingham Research

Okay. And was there inventory write-up associated with Orajel in the third quarter?

Matt Farrelll

Yes, it’s customary with any of our acquisitions. We always write-up the inventory to fair value, so that would have impacted the third quarter margins and earnings contributed by Del.

Alice Longley - Buckingham Research

How much was that as a cost in -- cost of goods sold?

Matt Farrelll

We typically don't go to that level of detail, Alice.

Alice Longley - Buckingham Research

Well, I had estimated $0.03, does that sound right?

Matt Farrelll

As I said, we typically don't get into that level of detail on the brands. As you know, our histories, we don't quote sales or earnings by brand.

Alice Longley - Buckingham Research

All right. Raw material costs have come down, does that in your outlook for '09 -- does the benefit of lower raw material costs that you might have expected a couple of months ago, is it offset with any new negative versus what you might have thought a couple months ago?

Matt Farrelll

I think with respect to '09, you see anybody who read the release will see that we have our evergreen targets of 3% to 4% top line growth on a basis point to gross margin expansion of $0.60, $0.70 of up margin.

We are aware of what's going on with respect to commodities. But like so many other companies, commodities for us were peaking in Q3 and in Q4. So, not all of them are actually coming down that quickly. We don't expect the benefits to begin to accrue to us until the late Q1 of 2009.

So that were – so, it's based on our most current information, is why we are confident that we can hit our evergreen targets in '09.

Alice Longley - Buckingham Research

I guess that's it. Thank you.

Operator

Your next question comes from the line of Bill Chappell of Suntrust.

Bill Chappell - Suntrust

To go back to your comments after the second quarter call. I think you originally said that 4Q was going to be a bigger EPS quarter than 3Q, due to the timing of marketing. I mean should we just look at this as shift of marketing from 3Q to 4Q or was there something else going on in the guidance?

Matt Farrelll

No. There are a lot of variables obviously that go into calling what Q3 and Q4 would be for the full year. Yes, you are right. When we came out at the end of Q2, we said that, we expected marketing expenses to be 13% of sales, Bill. We came in at 12.6.

You probably know, we time our marketing to the extent that we hit certain distribution targets for our new product, suppose we have our new Essentials cleaner that's going out as well, more or so in the fourth quarter than third quarter. So, yeah, there's a shift in marketing spend from Q3 to Q4. That's a piece of it.

Bill Chappell - Suntrust

But it still sounds like the quarter came in a little bit ahead of your expectations.

Matt Farrelll

Well, we had a really good quarter. Keep in mind, we had to take a few hits along the way with respect to FX losses as well as the diesel losses. It was a good quarter for us. But given the uncertain environment that we're in right now, obviously, we'd be confident that we can hit the full year number, but we don't think it's prudent to go and start changing full year guidance.

Bill Chappell - Suntrust

Sticking on the marketing theme with the rollout of all the new products, was there trade promotion or couponing that impacted net sales, and was it meaningful?

Matt Farrelll

I mean look every quarter there's a significant amount of promotion and couponing. I will say slotting is something that that we often get questions on. Slotting was slightly higher this year than last year. With respect to couponing, that's not a big factor for us. We're not big in coupons.

Bill Chappell - Suntrust

Okay. Just trying to understand 2Q versus 3Q. If last quarter hit 8% organic growth and 3% volume growth this quarter, 4% organic growth and no volume growth, but you say you are seeing consumers start to trade down. So I am just trying to understand if it is just tougher year-over-year comparisons or is there something else going on?

Matt Farrelll

When you think about the second quarter, Bill, one thing to remember is that we had huge growth on the part of the specialty product business. So, if you went back and say what was your organic growth for specialty product in the first couple quarters of the year, it was both 19% to 20% or higher in Q1 and Q2. Q3 is 14% and Q4, as I said will be back down to earth organically.

So, we have the deceleration of the add? from specialty products going from Q2 to Q3. I would say in that 8% number you quoted for the second quarter, it's about a point and a half for that. So that would say the consumer business worldwide was 6.5% in the second quarter.

And we had lots of things were going out in the first quarter that helped us so we got some new distribution, we had new product launches, and we had some lower slotting year-over-year because we knew it'd be higher in the second half particularly fourth quarter year-over-year. So, if you adjust for those, you still -- you get consumer business more down to in the 4% range.

Bill Chappell - Suntrust

Okay.

Matt Farrelll

And with respect to volume versus price, the domestic business is still rock along pretty well. I guess the domestic business is half volume and half price. It's the other businesses international and SPD that caused us to say that of the 4% organic growth most of it is price. That's because for those other businesses, international, SPD, it's way more skewed toward price than volume.

Bill Chappell - Suntrust

Okay, that makes much more sense. Thanks so much.

Operator

Your next question comes from the line of Doug Lane of Jefferies & Company.

Douglas Lane - Jefferies & Company

Hi. Good morning, everybody.

Jim Craigie

Good morning.

Douglas Lane - Jefferies & Company

Just a follow-up on Bill's question, I mean, you can interpret your outlook for the fourth quarter today to be a little bit more cautious than it was at the second quarter given the third quarter upside plus it sounds like the Orajel contribution is going to be more than you originally thought. Is there almost flipside something in the fourth quarter that is maybe working against you now that was not quite so -- wasn't quite the case the second quarter release?

Matt Farrelll

No I wouldn't interpret the fact that we're at 50 or, pardon me, $0.73 versus $0.69 and not taking up the year as any kind of signal other than what we said before is that we did have far or less marketing spend in Q3 than we expected. So obviously, we expect to spend that in Q4.

Douglas Lane - Jefferies & Company

Okay. That makes sense. With the currencies, I know you don't have a big international presence, but can you just give us a brief on what the key currencies are and without getting into specifics just what do you think the currency impact will be to your sales and EPS next year if we stay where we are at today?

Jim Craigie

Yeah. Sure everybody is listening very closely to my call on currencies for '09. Here's the way to think about. We have four core markets, Canada, UK, France, and Mexico. So obviously anybody that's on the call can compare the spot rates today to the average rates in the first nine months of the year. There would be around 15% change.

But I think we come back to the point that it's hard to call 2009 rates right now. We're fortunate that we're US-centric and so we have far less concern than some of the competitors with respect to what kind of impact that's going to have.

Douglas Lane - Jefferies & Company

Okay. Thank you.

Operator

Your next question comes from the line of Bill Schmitz of Deutsche Bank.

Bill Schmitz - Deutsche Bank Securities

Have you seen distribution gains with some of the value laundry product because of the softening consumer environment?

Jim Craigie

Nothing like that. Bill, not really. Glad you asked. Let me try to give you some facts on two issues. One, I call trading down, and the other private label. Obviously, everybody knows what's going on in the economy. We are seeing consumers trading down and as you know about 30% of our portfolio is a value for us versus competitors particularly laundry detergent, liquid and powder.

We also have value toothpaste business, we also have valued pregnancy kit business and our cleaners business such as in new ARM & HAMMER Essentials line is a value and we are seeing good growth in those businesses, particularly the laundry side of the business is seeing good growth, but also the other ones that are seeing; laundry business is over 10% growth in this quarter and the other businesses are all seeing high single-digit growth.

So, in those businesses ARM & HAMMER laundry detergent half the price of Tide, we are seeing a benefit consumers rating down. There in private label, yes, you are all hearing private label is growing but the honest truth to us is private label for the most part is not a threat to us.

If you were to look at all outlet shares for private label, in the majority of the categories we competed, private label is very small. Just give you some hard core – hard numbers, private label liquid laundry is less than a five share of the total market. Powdered laundry, less than a three share. Stain fighters category as we call OXICLEAN is less than two share. Carpet Deo about two share, toothpaste, private label is less than a 1 share.

Battery-powered toothbrush, private label about a two share and then in condoms, depilatories, underarm deodorant, private labels all less than a 1 share. So, on those businesses, we don't really worry about private label and if you hear private label in those categories is growing double-digits, my answer to that is, big deal, we don't care.

Now private label is a bigger threat in some of the -- couple of categories we are in. Two we worry about most are cat litter and pregnancy kits. Private label is about a 15 share of cat litter and about 30 share of pregnancy kits. But in both those categories, our business is doing exceptionally well. We've had share growth now for nine straight quarters in cat litter and then pregnancy kits, we've gone from number two brand and number one brand over the last two years and in both cases we are having very strong share growth, so the private label threat there is not big to us.

Private label is a player in three other categories that are relatively small to us. That's fabric softener sheets and baking soda and household cleaners but those are businesses where our share is up in fabric softener sheets and up and doing well in cleaners with our new Essentials launch, and baking soda, we're about an 80 share, so we lose a point to private label because of pricing we took, it's not a big threat.

So, the overall, I give you a lot of facts there but the bottom line is we are going to see consumers trading down. For the most part, we are benefiting from that, from our value parts of our portfolio and the private label threat is pretty, I wouldn't say nonexistent but a very small threat to us overall.

Bill Schmitz - Deutsche Bank Securities

Okay, great. And then for '09 guidance, I think you said in line with your long-term shareholder return model so because you have Orajel coming through, does that mean we should look for 12% to 15% next year even with the currency hit?

Matt Farrelll

No. we're gong to get – no we're we are going to give specific guidance in the first week of Feb like we always do, but right now, it's too early to start calling numbers. That's not our practice.

Bill Schmitz - Deutsche Bank Securities

Okay, just because in the press release it says '09 should be in line with long-term plan.

Matt Farrelll

Our long-term perennial goals are the three we stated.

Bill Schmitz - Deutsche Bank Securities

Okay. Got you. All right, that makes sense. And there is there going to be any mix impact to gross margin as you look at some of the categories that are slowing? It’s sort of high margin OXICLEAN. Even on the condom side price has been great, but volume is pretty much flat which actually kind of surprises me because I didn't think that was a very elastic category.

So what happens on the mix side of things, because I think the laundry detergent business is lower gross margin than the fleet average and that should grow faster than some of these newer to higher margin products.

Matt Farrelll

It is true that personal care products have a higher gross margin than households. So to the extent that the mix changes, yeah, that could have an impact on gross margin. But the good news for us is that our household margins, particularly, in laundry have been growing significantly over the past couple years particularly with respect to concentration. So, that should mute any effect that would have on it.

Bill Schmitz - Deutsche Bank Securities

Okay. And then just one more, I am sorry to keep going on this. But if you look at liquid laundry detergent business at 10% price increase and sort of a de facto 10% price increase from compaction. That's sort of like a 20% price increase. Are you seeing a lot of pantry de-loading now and will that catch up at some point? Because I think just probably initial kind of shock value to the list price and then people have to start to buy again later, but right now is there any pantry loading going on?

Jim Craigie

Now Bill, we were watching that. Honestly, we really haven't seen much that I know some competitors have talked about that. But maybe they are more sophisticated, but I don't know. But we have not seen that. Our business continues to do very well.

Bill Schmitz - Deutsche Bank Securities

Okay. Great. Thanks so much.

Operator

Your next question comes from the line of Carla Casella of JPMorgan.

Mili Seoni - JPMorgan

Hi. This is Mili Seoni for Carla Casella. Could you provide an estimate for your cash contributions to the pension plans for next year?

Matt Farrelll

Well, that's something that we'll be looking at in the fourth quarter, like many companies certainly the market has had an impact on the gap between our fair market wherever our assets and our liability. So, we're looking at that right now, but given the amount of cash flow that the company generates, I don't expect that that's going to be a material amount to the company.

Mili Seoni - JPMorgan

That's great. Thank you.

Operator

Your next question comes from the line of Joe Altobello of Oppenheimer.

Joe Altobello - Oppenheimer

Thanks. Good morning, guys.

Jim Craigie

Hi, Joe.

Joe Altobello - Oppenheimer

First question. In terms of the price increases you guys taking in 4Q, did you see any pre-buying ahead of that in the third quarter?

Jim Craigie

No.

Joe Altobello - Oppenheimer

Nothing meaningful?

Jim Craigie

Nothing.

Joe Altobello - Oppenheimer

Okay. Secondly, in terms of the essentials household cleaners’ line, how is that doing relative to expectations in terms of sales and distribution?

Jim Craigie

It is right in line with our expectations. We started shaping that product in Q3. October was really the first big month of trial efforts and strong advertising. And we don't know the results from there yet. But everything we've seen so far is in line with our expectations and we have somewhat conservative expectations for that, but that everything is going well so far.

Joe Altobello - Oppenheimer

Okay. And then, lastly, in terms of the acquisitions you mentioned, Jim, earlier that you are at the low end of your leverage range at this point and I would probably guess you want to integrate Orajel before you do anything sizable, but what's your attitude right now in terms of doing another deal at some point?

Jim Craigie

Joe, we're ready to do a deal anytime. As Matt told that we have a strong cash position. We have strong credit lines out there. I would tell you the market is very active. We're very active in looking. And we would make a deal tomorrow if there was a good one out there.

So I’d say, through the market is,? there are some people out there who don't have the cash that maybe we have. So we're not going to wait till Orajel is integrated later next year to make another deal. I don't have one today, but we're not waiting for that to finish.

Joe Altobello - Oppenheimer

When you say it's active, it sounds like there are a lot of properties for sale, but in terms of valuations have they pulled back?

Matt Farrelll

Not really. Not from what we've seen. I got nothing specific, but I would say there has not been a major change in valuation.

Joe Altobello - Oppenheimer

Okay, great. Thank you.

Operator

Your next question comes from the line of Connie Maneaty of BMO Capital Markets.

Connie Maneaty - BMO Capital Markets

What were the annual sales of the Spanish subsidiary so we can model it?

Matt Farrelll

It's about $9 million.

Connie Maneaty - BMO Capital Markets

So, okay, it's really minor.

Matt Farrelll

Yeah, it's small.

Connie Maneaty - BMO Capital Markets

Did it always operate at a loss?

Matt Farrelll

Well, always is a long time, Connie. It was operating at a small operating loss over the past year and a half.

Connie Maneaty - BMO Capital Markets

Okay. Why do you have an FX loss in the quarter? Where did that come from?

Matt Farrelll

It came from inter-company receivables, payables that we have between certain countries. Those get treated as transaction losses.

Connie Maneaty - BMO Capital Markets

Okay. So that's transaction loss. Okay. And the size of your international business, with all the parts and between the international consumer and the international part of specialty, is that about $600 million in total?

Matt Farrelll

Well, we -- what you would do, is you just take international business and you would add a portion of that for international piece of specialty product.

Connie Maneaty - BMO Capital Markets

So it's something like 20% to 25% of total sales? Would that be about right?

Jim Craigie

No, we say no.

Matt Farrelll

No, no, no. No, it would be nowhere near that big. Remember, 17% for international business. And I think you’ll probably add around $80 million of that to come up with the combined international and SPD.

Connie Maneaty - BMO Capital Markets

Okay, so the specialty international is around 80 million?

Matt Farrelll

Yeah.

Connie Maneaty - BMO Capital Markets

Would you expect there then to be -- if the change in currency, does it affect you more on the top line or more on the bottom line because of transaction impact as well?

Matt Farrelll

Well, on the top line, as I said before, with 17% of the company, all things being equal, if you translate the P&L, so you're going to have an impact, if you have a 15% change, you'd have 50% down top line as well as earnings. Those also with respect to transaction, you could have some of that too to the extent that you are manufacturing this in the US for other entities, but we always have the option of co-packing locally to overcome that.

Connie Maneaty - BMO Capital Markets

So, do you think that you'll be able to overcome the transaction impact? Is that the plan?

Matt Farrelll

We feel confident about '09 as we said in the release with respect to hitting our perennial targets. So, if we say 100 basis points of gross margin expansion that would include the impact of currency as well as commodities.

Connie Maneaty - BMO Capital Markets

So the impact on the top line in the fourth quarter, let's say of the change in the dollar, would that be something on the order of dampening the sales growth by about 2%?

Matt Farrelll

I think it could be that high, Con. You're going to have to make your own guess with respect to where currencies are going to be.

Connie Maneaty - BMO Capital Markets

Okay. But assuming they stay where they are right now.

Matt Farrelll

It could be that high.

Connie Maneaty - BMO Capital Markets

Okay. And that would be, assuming…

Matt Farrelll

That's on reported, remember.

Connie Maneaty - BMO Capital Markets

Sorry?

Matt Farrelll

That's on reported.

Connie Maneaty - BMO Capital Markets

Right.

Matt Farrelll

Right, yeah.

Connie Maneaty - BMO Capital Markets

And assuming they stay where they are then that would be 2% to 2.5% increase for the next three quarters as well?

Matt Farrelll

Did you say increase?

Connie Maneaty - BMO Capital Markets

Dampening, sorry.

Matt Farrelll

I mean look, if Q4 stays where it is right now, it's just math and so it's, yeah, it could be up to 2% and that would obviously impact our reported numbers in the similar fashion in '09.

Connie Maneaty - BMO Capital Markets

Okay. And my final question is on ARM & HAMMER Essentials cleaners, are they -- how are these things shown in the store? Are they being all -- do you have end caps? Do consumers see them as a block of product, so are they scattered through the separate categories?

Matt Farrelll

It varies by store retailer, Connie. In some cases they block together, we definitely had end cap displays and so it varies just like it would for any other brand.

Connie Maneaty - BMO Capital Markets

Is Wal-Mart doing a brown block on these?

Matt Farrelll

I'm not sure what the brown block is but Wal-Mart has done very significant merchandising support for this including displays and trial offers and everything. It's been a very strong supporter of this new product line.

Connie Maneaty - BMO Capital Markets

Okay. That's it for me. Thanks.

Matt Farrelll

Thank you.

Operator

Your next question comes from the line of Nik Modi of UBS.

Nik Modi - UBS

Just two quick questions. Just generally in October, have you seen any noticeable changes in just the consumer dynamics out there?

Jim Craigie

Not yet.

Nik Modi - UBS

Not yet, okay. Second question, assuming diesel stays where it is, I mean should we be looking at any diesel losses in the fourth quarter or are the hedges over?

Matt Farrelll

The change in diesel obviously will be measured from October 1 through December 31st, so yes, to the extent there was a change there that will be a P&L effect.

Nik Modi - UBS

Okay. Great. Thanks so much guys. That's it for me.

Matt Farrelll

Okay.

Operator

Your next question comes from the line of Jason Gere of Wachovia.

Jason Gere - Wachovia

Hey guys.

Matt Farrelll

Hey Jason.

Jason Gere - Wachovia

Hey. Just a question about the innovation pipeline for next year, I mean this year you were saying you did fewer but bigger products and I guess just thinking about the consumer environment and the appetite out there, can you just talk about may be your risk appetite with new products and just some color around that?

Jim Craigie

I think about the same, Jason. We're going to continue on the theme of fewer but bigger new products in the future. So, you will probably see about the same number of new products launched next year as we launched this year. We're obviously will focus continue on our core categories to do that with and so far we feel based on the results this year which I said, our new products this year are delivering 50% more revenue than our product the year before. So, we like that fewer and bigger strategy and that's where we're going to continue into 2009 and 2010.

Jason Gere - Wachovia

Okay. Then just changing topics here, just in terms of the pricing that you are taking this quarter, I might have missed this earlier on the call. I mean can you talk about your outlook? How much of that do you anticipate will stick in this marketplace? Any conversations with retailers, is it too early to kind of talk about, when you might see either a little bit more gross to net spending on the promotion side to kind of just factoring into a softer commodity environment that's going through?

Matt Farrelll

Jason, you hit the nail on the head. It's one thing to take price increases. The other thing is the actions of competitors are unpredictable as is the, what is going to be the reaction of the consumer. So, will we see consumption decline, and will they need to be stimulated by trade promotions. So yes, all of the above are going to have to be factored into what happens in the future, so hard to call right now.

Jason Gere - Wachovia

Okay.

Jim Craigie

I would just say to you. We have announced it, consumers have accepted it, the prices will be reflect at retail over the course of Q4, and we certainly don't intend to do anything to unravel it at this point.

Jason Gere - Wachovia

Okay. And did you quantify I guess on the liquid laundry, how much of your gains might have come from lagging behind, I guess, some of your competitors in terms of taking the pricing?

Matt Farrelll

No, we haven't quantified that.

Jason Gere - Wachovia

Okay. So I won't push. Last question. I guess with the tax credit that just got implemented, how should we think about for next year? How big or how much could that impact your tax rate for 2009?

Matt Farrelll

Well, the impact on 2008, Jason, is 50 basis points.

Jason Gere - Wachovia

Okay. So, it should be similar for next year as well?

Matt Farrelll

Yeah, it doesn't vary too much from year-to-year.

Jason Gere - Wachovia

Okay, great. Thanks a lot, guys.

Jim Craigie

Thank you.

Operator

And your last question comes from the line of Andrew Sawyer of Goldman Sachs.

Andrew Sawyer - Goldman Sachs

Yeah, sure. Hey, guys.

Jim Craigie

Good morning.

Andrew Sawyer - Goldman Sachs

I was just hoping to get two quick ones. One, I was just wondering if you could you help us a little bit with how we should think about the phasing in of compaction benefits in '08 versus '09. I know you completed the rollout in the middle of this year, but you also had some start-up costs. Should we get -- are the savings bigger '09 versus '08 or how can we think about that?

Matt Farrelll

There is actually some benefit in '09. Remember that the whole country was completely converted after the third wave, which started in April and probably completed sometime late June or early July. So on a year-over-year basis, there will be some help in the first half of '09, but not in the second half.

Andrew Sawyer - Goldman Sachs

Were there some start-up costs in the first half of '08 as well?

Matt Farrelll

There's always start-up costs with a changeover like that, but we've never quantified them. So, obviously that will be gone as well, first half '08 versus first half '09.

Andrew Sawyer - Goldman Sachs

A second one, you guys have talked a bit about some of your more discretionary categories whether it's power toothbrush, OXICLEAN and I heard you mentioned you're launching a lower priced option on the power toothbrush. Are there other things like that we're going to see in some of those categories to help sustain consumption if you view the consumer spending continues to get worse?

Jim Craigie

I mean we have had a very strong focus on value part of our portfolio and in categories that we have premium production, like battery powered toothbrushes in that. We have launched more value-oriented new production and you, probably, will see that.

The ARM & HAMMER Essentials cleaners’ line is other great example. We've launched that new line. It’s a great new product and [worth] as well as the leading brands, but it's environmentally based. And when you buy the refills, it's 25% cheaper than the leading brands.

So we think it's a very smart strategy in this environment where the consumers are getting increasingly value-oriented. You'll see that from their panel changes and changing from the traditional retailers out there to the mass merchant channel.

We think that's a wave that's going to happen for a pretty considerable time in the future. And you are going to see probably a good number of our new products that has strong orientation to our value.

Andrew Sawyer - Goldman Sachs

Anything on the OXICLEAN side and I know you talked about laundry additives as a category where you feel like you have some discretionary exposure?

Jim Craigie

Nothing particularly in OXICLEAN additive. That is probably one of the most loyal from of all of our good businesses and we don't have anything in mind to my knowledge in line for a value offering on that business.

Andrew Sawyer - Goldman Sachs

Thank you very much guys.

Jim Craigie

Thank you everyone for taking the time today to talk to us the. Again, we're very proud of our Q3 results. We reaffirm our projection for the rest of the year and we're looking forward to very difficult 2009 business environment to continue to deliver the kind of business results we have in the past. If you have any questions, please give myself or Matt a call later today or whenever we end up. We thank you again. Goodbye.

Operator

Ladies and gentlemen, that concludes the presentation. Thank you for your participation.

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Source: Church & Dwight Co., Inc. Q3 2008 Earnings Call Transcript
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