The Clorox Co. F2Q09 (Qtr End 12/31/08) Earnings Call Transcript

Feb. 4.09 | About: The Clorox (CLX)

The Clorox Co. (NYSE:CLX)

F2Q09 Earnings Call

February 4, 2009 1:30 pm ET

Executives

Steve Austenfeld – VP Investor Relations

Donald Knauss – Chairman, CEO

Larry Peiros – Executive VP, COO

Dan Heinrich, Chief Financial Officer

Analysts

Christopher Ferrara – Bank of America, Merrill Lynch

[Ollie Debaugh – Sanford Bernstein]

Nik Modi – UBS

Joseph Altobello – Oppenheimer

Lauren Lieberman – Barclays Capital

Connie Maneaty – BMO Capital

Alice Longley – Buckingham Research

Alec Patterson – RCM

Douglas Lein – Jefferies

[Cindy Nicholson – Citi Investment Research]

Andrew Sawyer – Goldman Sachs

Linda Bolton Weiser – Caris

Operator

Welcome to the Clorox Co. second quarter fiscal year 2009 earnings release conference call. (Operator Instructions) I would now like to introduce your host for today's conference call, Mr. Steve Austenfeld, Vice President of Investor Relations for the Clorox Company.

Steve Austenfeld

Welcome everyone and thank you for joining Clorox's second quarter conference call. On the call with me today are Don Knauss, Clorox's Chairman and CEO, Larry Peiros, Executive Vice President and Chief Operating Officer, Clorox North America and Dan Heinrich, our Chief Financial Officer.

We're broadcasting this call over the internet and a replay of the call will be available for seven days at our web site cloroxcompany.com. On today's call Don will start with his perspective on both our current quarter results and changes to our operating model as noted in our press release this morning.

Larry will then follow with specific comments on business unit performance include perspective on the current consumer and retail environment. Dan will close with a review of the quarter's financial performance as well as additional details supporting our updated FY09 outlook as communicated in our press release this morning.

Included in Dan's comments will also be details on commodity costs and the impact of foreign currencies before we then open up the call for your questions.

Let me remind you that on today's call we will refer to certain non-GAAP financial measures including but not limited to cash flow, EBIT margin, debt to EBITDA and economic profit. Management believes that providing insights on these measures enables investors to better understand and analyze our ongoing results of operations.

Reconciliation with the most directly comparable financial measures determined in accordance with GAAP can be found in today's press release, this web casts prepared remarks or supplemental information available in the financial results area of our web site as well as in our filings with the SEC. In particular, it may be helpful to refer to tables located at the end of today's earnings release.

Lastly, please recognize that today's discussion contains forward-looking statements. Actual results could differ materially from management's expectations. Please review our most recent 10K filing with the SEC and our other SEC filings for a description of important factors that could cause results to differ materially from management's expectations.

With that, let me turn it over to Don.

Donald Knauss

Welcome everyone. As we reported in our press release this morning, Clorox delivered solid results in the midst of what we could all call a very dynamic and difficult environment out there and our performance was in many ways we believe, consistent with the outlook we provided to you on our last call.

Specifically, we anticipated and were impacted by foreign currency devaluations and increased commodity costs for the quarter. Also as anticipated, the global economic slowdown continued to pressure consumers around the world.

Now during Q2, retailers responded to this dynamic environment by tightly managing their inventories, particularly in November as they made adjustments prior to the holiday season. We certainly saw differences between our shipment volume and consumer consumption at several major accounts.

While tight inventory management is certainly to be expected in times like these, the inventory actions taken in November were particularly steep, and while our business recovered in December, and we continued to see positive trends in January, the impact of mid quarter destocking at retail negatively impacted our overall top line results for the second quarter.

While we believe modest retailer inventory reductions will continue in a few categories through Q3, we certainly don't expect that impact to be nearly as severe as Q2. Overall, I believe we delivered solid second quarter results given this environment.

As always, we remain focused on the long term and leveraging our strengths. Let me just remind you for a second about some of the strengths of Clorox and our portfolio. First, we do have premium value added brands that we certainly believe consumers trust.

Second, we have a very strong 3-D demand creation in brand building set up capabilities. Third, we continue to support innovation which I think is incredibly important during times like these and with a strong set of initiatives in the third quarter focused on sustained consumer megatrends we've been talking about for the last two years. This certainly includes our Green Works line extensions into liquid dish soap and biodegradable wipes which were just launched last month.

Fourth, our ability to drive strong cost savings to help offset the cost pressures we see and provide resources to invest back in the business.

For those reasons, despite the current market, we certainly are cautiously optimistic about our business going forward. Given that context, let me address two specific topics with all of you; pricing and share.

As you know, we've implemented more than 40 price increases over the past three years. Given the dramatic and unprecedented run up in commodity cost increases on our business, that was certainly the right thing to do and it has I would say played out largely as we anticipated.

Importantly, I think we continue to expect that the majority of these price increases will stick. In fact, of those 40 plus increases, we've rolled back just one, and that's the December action we took on Glad trash bags. While we have seen impacts to our share results in certain categories, generally these impacts were anticipated in our models.

At the same time in a few categories we've seen a bit more trade down in share, and Larry's going to talk to that in just a few minutes.

So despite this tough environment, I feel good about the second quarter results and the fundamental health of our business, and I certainly believe we're well positioned for the second half of this fiscal year.

Now before I turn it over to Larry, I thought I'd give you some additional perspective and that is to spend a few minutes talking about the context for the incremental charges we announced in today's press release.

Consistent with our centennial strategy which was work we began almost two years, we have been refining the company's operating model and that is how we're structured. Our core processes, our systems and our management routines. This operating model is certainly designed to enable better and faster execution of our strategy choices to build brands and gain market share profitably.

In the coming weeks and months we begin a critically important phase in our operating model which includes reducing the cost of services to support our business so we could put more effort and resources towards things that really drive shareholder value.

During the past year we significantly slowed hiring across the board primarily to divest the cost pressures we faced, but also to help us leverage attrition and minimize as much of the impact of people as possible from implementing our operating model changes.

That said, as you saw in today's press release, we do anticipate reducing head count by about 170 people over the next 18 months. That's about 2% of our global work force. We anticipate that further positions will be reduced through attrition as we continue to tightly manage hiring.

I think as you can all imagine, this is a difficult decision because of the impact on Clorox employees, but making these changes to implement our operating model is essential and allows us to more effectively and efficiently drive our centennial strategy and accelerate growth for the future years.

Dan will discuss and give you some more detail. We anticipate realizing net fading in fiscal year 2010 some of the charges we're taking to implement these changes. With that, let me turn it over to Larry. He'll give you some additional perspective on the business.

Larry Peiros

Let me start with a view of our categories and consumer demand. Overall our categories remain relatively stable despite the economic downturn. Although considered take away U.S. channels declined about 1% versus the year ago quarter, our sales growth in the untracked customer base, retailers like Wal Mart, Cosco and Dollar General, they're significantly outpacing sales in a tract universe.

While the categories are not immune to economic pressures, we are generally far less impacted than many other businesses. We did see some mixed results in our market shares. In the A categories we measure in the U.S. we grew share in five, and lost share in three. Our total share across all the categories was down slightly.

Share declines were generally attributable to pricing actions and some limited growth in private label shares given the economic environment. We're never happy about share declines and this continues to be a performance area that is at the top of our priority list.

As is typically the case, results vary across categories and the stories are different at a more granular level. In our largest category, Home Care, we grew share and track channels versus a year ago quarter and retained our number one share position. Home Care sales growth was driven by Green Works natural cleaners and price increases on many of our cleaning brands.

Green Works continues to perform well, supporting our focus on sustainability and consumer mega trends. We have not seen a meaningful slowdown in consumption growth in our Green cleaning products despite the challenging environment.

The Natural Cleaning category grew more than 80% in Q2 and we still offer consumers a strong value proposition. Green Works remains the category leader and has driven the bulk of the category growth.

Brita is another brand that continues to benefit from the sustainability mega trend. This business is also increasingly compelling from a consumer value perspective with filtered water a far less expensive alternative to bottled water. Brita Filtration in track sales grew in Q2 although shipments declined due to retailer inventory reductions.

[Oracle] Trash remains one of our fastest growing categories. In food, we continue to win with Hidden Valley in the salad dressing category. Hidden Valley dressing group volume and share in Q2 despite a significant price premium to the competition, we have a great case in product consumer's love and a very strong marketing program.

Turning to Burt's Bees, while consumption remained solid in Q2, we did see some slowing in sales growth due to retail inventory reductions and weaker holiday sales stemming from the weak economy. We anticipate some further inventory reduction at the back half of the fiscal year, but based on our solid consumption data, we remain very excited about the fundamentals of the business and the long term prospects.

The Natural Personal Care category remains profitable and continues to grow faster than traditional personal care and most of our other categories. Burt's Bees remains the share leader in the Natural Personal Care category by a significant margin.

In our international business, currency declined versus the U.S. dollar in many of our markets. Category growth also slowed due to weakening global economic conditions. The global economy is likely to impact this business through the next few quarters with the potential for some categories to show declines. We continue to hold leadership position in many of our international categories and are well positioned to weather the storm.

Next, I'd like to address concerns about our exposure to private label, particularly in categories where we've taken pricing, mainly trash bags, bleach and charcoal which represent about 30% of our global revenues.

Glad was our most dynamic business in Q2. Effective December 1, we rolled back the 10% price increase we had taken on Glad trash bags in October. This quick shift in direction was based on an equally quick change in the resin market. We will be monitoring this category closely and will take appropriate action to maintain the right value equation on shelf.

This is the one category we are most likely to have pricing driven by commodities. We still believe that we can restore margins on this business over time to trade up the force flex and aggressive cost savings.

In our Laundry business, Clorox was soft in Q2 partly as a result of our last price increase. However our volume declines were in line with what our pricing models predicted and we met our Q2 sales forecast.

Private label bleach has generally followed our pricing actions. Since our last price increase our price gap versus private label has actually decreased by 1% point in track channels. We did see some shift to private label during the quarter. However, our biggest focus is on driving category growth given our very strong share position.

We are investing heavily behind new marketing initiatives highlighting the benefits of bleach versus detergent alone as well as cost effective non laundry uses. We're very pleased with the early results.

Finally, turning to Charcoal, our only competitors are private label. With Kingsford we grew share in Q2 and remains the share leader by a significant margin. Kingsford is a good example of a business where commodity costs are not tracking with the declines in oil and other commodities. With higher input costs, we increased prices effective January 2009.

Company wide as Don said, we continue to find our pricing models are very predictive. That said, we have modified our fiscal 2009 pricing plans based on the dramatic declines in cost of some raw materials. All businesses have been impacted the same, and since commodity costs are continuation to increase as I mentioned with Charcoal.

In addition, many of our pipelines are still in catch up mode as reflected in our gross margin decline over the last several years. I hope this illustrates for you that sometimes too broad a brush is used to paint the picture of our portfolio. Really, each of our businesses are subject to different demands; some have increasing prices, some not, some seeing declining costs, some higher costs, some we've lost a little share and others where we're gaining share. On balance thought, the portfolio is well positioned to compete in this economy.

Before I wrap up, I'd like to take a moment to talk about advertising spending. When adjusted for the impact of declining foreign currencies, we were about flat versus a year ago quarter on a dollar spend basis. Our end spending reflects an ongoing effort to shift more from ad production development into port costs and direct media to drive efficiency and increase our ROI.

Fiscal year to date we had decreased non working advertising and a greater proportion of our advertising spend is now being spent on working media. We believe our annual target percentage range for advertising support is still appropriate. Despite the challenging economy, we remain committed to building our brands and will adjust spending levels by business where appropriate.

In the back half we also expect to benefit from lower media prices as a result of the weak economy.

Looking forward, we'll likely to see modestly reduced consumer demand and trade down due to the challenging consumer environment. However, we do not believe our categories will be dramatically impacted.

We also believe in this environment strong leading brands such as ours wind up winning retail customers and consumers. Given the challenges involved in the market place we will remain agile and quickly responds to opportunities to build our brands while also building our bottom line.

With that, I'll turn it over to Dan.

Daniel Heinrich

In our press release and on our web site this morning we provided details regarding our Q2 financial performance. That information includes reconciliations of sales, gross margin and EPS performance versus the year ago period.

Don and Larry have provided some additional commentary related to our volume and sales performance and what we're seeing in the businesses, with retailers and the consumer. I'd like to provide some further perspective on our financial performance for the quarter and our updated financial outlook for fiscal year 2009.

In all respects, this was truly an unprecedented quarter. We saw deteriorating global financial and consumer markets, faced steep declines in foreign currency values and extremely volatile interest rates.

The holiday shopping season was one of the weakest on record and the significant pull back by retailers on inventory levels was quite stark. Retailers are under severe pressure. Vendors and suppliers are under significant financial stress and a global recession is well under way.

No one could have possibly foreseen the depth and breadth of the conditions we experienced over the last quarter. As a company of strong leading brands, we're easily positioned to weather this downturn, but we're not immune to the economic and consumer pressures.

We've seen higher interest costs, declines in the value of pension assets, higher bad debt reserves and some incremental costs to replace bankrupt suppliers. On the good news side we've seen sharply lower commodity and diesel costs which will benefit us going forward.

All things considered, we feel pretty good about our second quarter financial performance. While we didn't forecast the extent of the retailer inventory pull back, our quarterly financial results were reasonably in line with our forecast.

Let me add some perspective on our sales growth. The native impact on volume from price increases was pretty consistent with what our price elasticity models projected. The top line benefit from pricing came in about as expected. Foreign currency substantially weakened during the quarter but the impact on sales was close to what we had assumed in our outlook.

We forecasted lower category growth in our international markets and saw that slowing during the quarter, but international sales growth was still 11% before the impact of currencies.

The one area that didn't come in as anticipated was the greater impact from retailer inventory adjustments during the quarter. When you adjust for the impact of foreign currencies, acquisitions and exiting the private label food bag business, we saw total company sales growth of 3.2% versus 3.5% in the year ago quarter. Given current market conditions, we consider this a pretty solid sales growth quarter.

Our gross margin performance for the quarter was generally in line with our forecast. During the last two quarters, we've experienced the most significant commodity and diesel cost increases in the company's history. On last quarter's earnings call we projected about $60 million of commodity and diesel cost increases in Q2.

During the second quarter we incurred about $57 million of commodity and diesel cost increases compared with $60 million in the first quarter of this fiscal year and $20 million in the year ago period.

We've now cycled through the peak of the commodity cost increases over the last three and a half years and are anticipating substantially lower commodity costs in the second half of the fiscal year and into fiscal 2010.

Our margins also benefited from $24 of cost savings and cost of goods sold, and another $6 million in cost savings in other parts of the P&L. The positive impact of pricing on gross margin was consistent with our projections. With all of these factors we were able to hold our gross margin at about 40% of sales compared with 40.6% in the first quarter and 40.4% in the year ago quarter.

We've been able to weather through these significant cost increases and essentially hold gross margins flat over the last two quarters and versus the year ago period. We now anticipate expansion of margins in the second half of the fiscal year as we begin to rebuild our margins back towards historical levels.

Other aspects of our second quarter performance were also in line with our expectations. Effective tax rate was higher in the current quarter due to the impact of favorable tax settlements in the year ago period. Our selling and administrative expenses after adjusting for the impact of acquisitions were down versus the year ago quarter as we tightly controlled spending in this environment including a hiring freeze and other actions.

Selling and admin expenses also reflect lower incentive compensation accruals. Our annual incentive compensation program is based on two equally weighted targets; sales growth and economic growth. Due to the impact of declining foreign currencies on our top line growth projections, we anticipate lower incentive compensation accruals for the fiscal year which is reflected in our Q2 results and financial outlook for the full fiscal year.

Importantly, we're continuing to strongly support our brands. Despite the cost pressures, we're maintaining our healthy levels of brand building support and are absolutely committed to doing so.

Our cash flow from operations for the quarter was $98 million compared with $148 million in the year ago quarter. Operating cash flow was down primarily due to the timing of tax and interest payments.

We continue to use cash on hand and free cash flow to pay down debt during the quarter and at December 31, our debt to EBITDA ratio was 3.1 to 1.

We updated our fiscal year 2009 outlook in today's press release. We're maintaining our diluted EPS outlook for the fiscal year, but lowering our sales growth outlook range. We now project sales growth in the fiscal year in the range of 3% to 5%. This reflects the full year impact of retailer inventory reductions, the effect of the weakening environment on consumers and our updated yield of foreign currencies and international sales growth. The 3% to 5% sales growth range is consistent with our long range sales growth target.

Our second half and full year gross margins will benefit from significant price declines in some of our key commodities, especially resin. We now anticipate full year commodity and diesel costs increases of about $140 million to $150 million versus our previous outlook of about $150 million to $170 million.

Since we've already incurred about $117 million of commodity and diesel cost increases during the first half of the fiscal year, the remaining impact from cost increases in the back half will be substantially lower. Additionally, we now anticipate slightly higher cost savings of $105 million to $110 million.

With lower commodity cost increases, higher cost savings, lower incentive compensation accruals and the benefit from price increases, the vast majority of which are anticipated to stick, we now anticipate about 50 to 100 basis points of gross margin expansion for the full fiscal year.

Despite our lower top line in projections, we're maintaining our diluted EPS outlook range at $3.60 to $3.75. We're maintaining our range even though we now plan to take higher restructuring charges this fiscal year.

Previously we were planning to take about $20 million to $25 million of restructuring charges in the current fiscal year primarily related to our manufacturing consolidation. We're now anticipating about $35 million to $37 million of total restructuring charges for the total fiscal year.

This range includes about $15 million to $17 million of incremental charges primarily for severance costs resulting from the operating model changes Don discussed earlier. We estimate operating model savings of about $3 million to $4 million in fiscal year 2009 which will be incremental to the $105 million to $110 million in savings we're already projecting.

We anticipate about $8 million to $10 million of incremental operating model related charges in fiscal year 2010. We normally plan for about $20 million to $30 million in annual charges for restructuring actions. For fiscal year 2010 we anticipate the $20 million to $30 million annual restructuring budget will absorb the additional operating model charges.

We estimate additional operating model savings of about $25 million to $30 million in fiscal 2010. The fiscal 2010 operating model savings will be incremental to the preliminary $80 million to $90 million in cost savings we're projecting for fiscal year 2010.

As Don said, we've leveraged attrition to minimize the impact of these changes on Clorox people. Affecting even one person during times like these makes a decision like this extremely difficult, but we must ensure that the company remains competitive during these extreme economic conditions. The changes will give us a more balanced and nimble operating model while enhancing our competitiveness.

Due to the incremental restructuring charges and revised pension funding estimates, we now anticipate that free cash flow for fiscal year 2009 will be in the range of 9% to 10% of sales. While current pension funding rules do not require us to make a cash contribution to the pension plan this fiscal year, we're planning a voluntary cash contribution of about $20 million to $25 million in our fiscal fourth quarter.

We're also trimming our fiscal 2009 capital spending down to about $185 million continuing our hiring freeze and trimming other areas of spending. We will continue to use free cash flow to support [audio break] and pay down debt and project that the company will at or below 3.1 to 1 debt to EBITDA by the end of the current fiscal year.

Before we open up for your questions, I'd like to provide you with some preliminary thoughts as your think about our fiscal year 2010 which will begin in July. We'll provide our initial financial outlook for 2010 on our third quarter earnings call in May.

On the positive side, the company is expected to benefit from substantially lower commodity and diesel costs. We anticipate the cost savings will remain strong and the company will benefit from increment cost savings due to the operating model changes being announced today. Incremental restructuring charges should return to our normal budgeting range of $20 million to $30 million including the additional charges from the operating model.

We anticipate the vast majority of the recent price increases will stick, providing some continuing pricing benefits into fiscal 2010. The near term impact from pricing volume should subside with a return to volume growth in fiscal 2010.

We have now fully anniversaried the Burt's Bees acquisition and the volume, sales and profits from this business will be in our base growth. As we continue to pay down debt, our interest expense should decline further.

Four areas will partially moderate the positive earnings momentum from the above. Based on today's currency exchange rates, the company will continue to be impacted by lower foreign currencies until we anniversary the current low levels in the first half of fiscal year 2010.

We anticipate further slowing in category growth rates in our international markets. While fiscal year 2009 results will reflect lower incentive compensation accruals, we would anticipate a return to more normal levels of annual levels of compensation in fiscal year '10.

We're also likely to see higher pension expense next fiscal year. Due to declining pension asset values over the last several quarters, we're preliminarily estimating a $15 million to $20 million increase in 2010 pension expense. We also anticipate funding an additional $25 million to $35 million into the pension fund next fiscal year.

While the current turmoil in the global markets makes forecasting a challenge, we are cautiously optimistic about fiscal 2010, and again we'll provide our initial fiscal 2010 financial outlook in May.

In closing I'd like to leave you with three key messages. First, this past quarter was a pretty wild ride, but under the circumstances, we're pleased with our results. Second, we're lowering our sales growth outlook for the fiscal year but believe we've taken the appropriate actions to achieve our existing EPS outlook.

Finally, we're taking the right actions to maintain the strength of our brands and drive our centennial strategies, strengthen our balance sheet, maintain the financial health of the business and emerge from this downturn even stronger.

We'll now open it up for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Christopher Ferrara – Bank of America, Merrill Lynch.

Christopher Ferrara – Bank of America, Merrill Lynch

I wanted to ask about the top line guidance. You're saying 3% to 5% for next year for this current year. You only lowered it by about a point. It seems like inventory destocking is close to that amount anyway. You're saying international, some categories in international could actually swing negative. So I guess why are you still going to be able to do a plus 3% to 5% this year? Why wouldn't that guidance prove to be too high as you get through a tougher economic environment?

Daniel Heinrich

The top line outlook that we have factors in our current view on all of those impacts, the slowing in international, the impact of currencies and certainly the inventory reductions that we've seen in the first half of the year and probably some additional we'll see although fairly modest in the third quarter.

So based on what we've delivered in the first half of the year and our outlook for the back half, we feel reasonably good with the 3% to 5% outlook.

Lawrence Peiros

The only thing I'd add is, we look at the first half of the year, we're a little bit north of 7% sales growth already in the bank, and then when you look at how we've paced innovation out, the innovations comes in two ways in the first quarter of the fiscal and in the third quarter of the fiscal.

So we've got our new wave of innovation hitting the marketplace as well so we feel pretty good about what's coming down the pike.

Christopher Ferrara – Bank of America, Merrill Lynch

On SG&A, how much of the change in incentive comp was, how big a piece of the SG&A improvement was that and is that sort of a one time adjustment to an accrual or is that something that we'd expect to be ongoing over time?

Daniel Heinrich

If you're talking specific to second quarter SG&A, we had two primary drivers in the change in SG&A. First of all, we still had incremental SG&A coming in from Burt's Bees and that was probably $6 million to $7 million in the quarter. And then the incentive compensation adjustment that we talked about is about $7 million for the quarter.

So we'll have lower incentive accruals in the back half of the year and as a reminder we pay those out generally in the September/October time frame. So these represent accrual adjustments in the quarter and then we'll pay out in the September/October time frame.

Christopher Ferrara – Bank of America, Merrill Lynch

On the bleach business, can you talk about which volume declines were in the quarter if you didn't already? If you did I missed it. Can you also elaborate on what you're seeing that gets you excited about the new campaign? I guess it rolled out in September so presumably you've seen some data look a little bit better. Is that right on a category basis?

Lawrence Peiros

Volume was soft as was share. Overall we this as more of a category issue than a competitive issue although private label has picked up a bit of share in the category. We feel very good about our two new advertising messages we have out there. One is this idea that detergent alone is not enough and that you need the power of a Clorox bleach. That would be Clorox liquid bleach or Clorox 2.

And the second one which is more recent is this kind of versatility message which is using bleach for non-laundry usage. As you know bleach is a terrific product, a very good value and does lots of great things from killing germs to removing stains in sinks and toilet bowls. So I think it's the absolute appropriate message for this kind of economy.

The versatility advertising has been on the air a short time but we're seeing some very positive results. We saw very positive results in the testing of the ad, and we're starting to see some very positive results in the marketplace as well. So we're optimistic that we'll begin to turn the bleach business in the second half.

Clorox 2 shipments are doing well. We still have a share issue, although Clorox 2 has a lot of volume in the universe, but we did see a double digit gain in share on the Clorox 2 business behind our 2X conversion.

Operator

Your next call comes from [Ollie Debaugh – Sanford Bernstein]

[Ollie Debaugh – Sanford Bernstein]

I wanted to talk a little bit in terms of volumes. Surely North America looks like including Green Works it's probably down about 5%, excluding Green Works probably down about 6% or so. How much of that if you could just aggregate it is destocking, is the price elasticity that you mentioned or is just the general consumer malaise?

Donald Knauss

Obviously it's hard to dissect this precisely, but I'll talk to destocking. What we done is we've looked at the sales growth as projected by IRI in the 40% with a track and compared that to our shipments in those same channels. And there is a significant difference and quite frankly most of it fell in November where we kind of hit a wall.

So our best is that overall we saw about a point of growth lost in the quarter as a result of inventory destocking total company.

[Ollie Debaugh – Sanford Bernstein]

So then the rest is just some combination of price elasticity and consumer trading down or what have you?

Donald Knauss

Yes.

[Ollie Debaugh – Sanford Bernstein]

As you look at that piece, the volume piece and then you skip over to pricing a little bit, clearly this was the biggest benefit that you have on your top line. Your gross margin was 250 basis points or more than it had been before. That's all in an environment where many of the commodities, again I want to be mindful of your comment, don't paint everything with one brush, but many of your commodities are rolling over. Clearly resins are certainly by-products but not yet, but what would it have to take for you to start too have to give back in other categories. What would have to take in terms of commodity costs for the retailers to start saying, "You know what, let's start giving a little bit back to our consumer here."

Donald Knauss

It's obviously been impossible for us to predict commodities, particularly resin, but generally speaking the cost structure of most of our product line is such that the raw materials as used as they are in the Glad business. So Glad's unusual in both the fact that commodities are such a large part of the cost structure and it's so volatile. Typically we don't see that as much in other categories.

Having said that, we're living in a very unpredictable world and never say never. I would tell you that in many cases we're catching up to margin declines we've experienced over the last several years. We're very open and transparent with our customers about the cost of commodities and the impact on our various businesses.

Obviously we have questions. We have a very data driven story around each of our categories and what's going on and as I said, and as you noted, categories do behave differently. We do see some commodity pressure in some select categories while many of the other are going the other way.

So we feel pretty good at this point that we think our current pricing will hold up. As we did say, we took Glad down because of resin, there was a sharp decline in resin, and that's a category we'll continue to watch. There were some planned price increases in the second half that we have cancelled. Those were price increases that never went out there in the marketplace, just in our forecast plans, but we pulled back on those.

And we're generally feeling pretty comfortable. So I would say we got to see a pretty dramatic change in commodities outside of Glad and probably a fairly monstrous change for us to change our pricing practices at this point.

Lawrence Peiros

The only thing I'd add to that is regardless of where commodities are, the other thing we're doing given the environment and the focus around price value obviously with consumers as well as our retail partners is, we have a good understanding from our models what our price gaps from an absolute price point, on price gap standpoint need to be versus our competitors, whether they're private label or other branded competitors.

I think we're really looking hard at those gaps and absolute price points as we go into the second half of the year and orienting our merchandising program around that price value equation. So despite where or regardless of where commodities go, we're being very mindful of that equation.

[Ollie Debaugh – Sanford Bernstein]

Give us a sense, what percentage of Glad costs for example are resins versus clarified bleach?

Donald Knauss

I don't think we want to share that specific information.

[Ollie Debaugh – Sanford Bernstein]

[inaudible] 2X versus the other. Just to give us a sense. You did mention it's a much bigger piece of the Glad business than the bleach business for example.

Lawrence Peiros

If you think about the make up of the products, Glad is essentially cost [audio break] Bleach you've obviously got the bottle but you've got all the costs associated with Clorox as well which are pretty substantial. So without being too specific, the resin component of Glad is going to be a bit higher.

[Ollie Debaugh – Sanford Bernstein]

That's what I'm heading towards because on the resins we know prices have come down, a big piece of Glad if you take down the pricing. Caustic, soda ash, prices are still up year on year. If those were to come down trying to get a sense of those prices may have to come down as well because absolutely commodities are not reacting the same way across the different businesses but wouldn't that have to happen as well?

Lawrence Peiros

I would just remind everybody that we did not price anywhere near the peak of any these commodities including and especially resin. So we're really thrilled that we're seeing these prices come down and candidly we're hoping they'll continue to come down. But the reality is that even though we've seen some pretty substantial drops in these, you're still not down at the level in many of categories where we've priced to.

Certainly we could have a hypothesis that if you see further major declines in resin and other commodities that we would need to look at our pricing structure but we feel pretty good about where we are today. We have lost a lot of margin over the last two to three years, and again, as we monitor price gaps, as we monitor competitors and as we monitor what the consumer is doing, all of those factors are going to go into our pricing equation. And that's how we manage it.

You have to manage the total picture. But as it stands right now, we anticipate most of our pricing is going to stick and we'll see where commodities go and these other factors go over time.

Daniel Heinrich

In the short term we'll manage that much more effectively with temporary fund increases and price roll backs on list.

Operator

Your next question comes from Nik Modi – UBS.

Nik Modi – UBS

Have you noticed any dislocation within the competitive environment given the current macro economic environment, the credit environment, meaning some of your smaller competitors, are you seeing any of those folks struggling? The second question is on the private label side. Do you envision from your key private label competitors dropping pricing as they probably buy more on the spot market in some of your categories. And the third question is just some perspective on the buy back program. Just curious how you're thinking about that.

Donald Knauss

Unfortunately we don't know of any competitors that have gone out of business. I will say that as retailers are pressured on the cost side and the balance sheet side and look at inventories they continue to focus on assortment and we're quite frankly happy to partner with them on assortment because generally that means that the number one, number two brands stay on the shelf and some of the smaller brands drop off the shelf. But thus far we haven't seen anybody go out of business.

In terms of private label, we have not seen any private label reduction on the part of our competitive set outside of Glad as yet. In bleach, private label folks have followed us basically our pricing, we've actually seen a tick up in the course of the Q2 quarter. We haven't seen any activity in charcoal and don't expect any.

Daniel Heinrich

On your question on buy backs, as you know we've been using our free cash flows to support the dividend and to pay down debt, and the focus remains at least for the balance of calendar year 2009 to use our free cash flow again for dividends and paying down debt. So we're not currently buying back any stock. [audio break]

Operator

Your next question comes from Joseph Altobello – Oppenheimer.

Joseph Altobello – Oppenheimer

The turn of the inventory destock, was that concentrated in any particular category or channel, whether it's grocery or mass for example. Second, in terms of the overall of competitive spend, obviously the ad spend was down, but what does that look like above the line in terms of the sales line and the overall level of competitive spend versus a year ago. And third, a more modeling question for Dan and the restructuring costs in the back half of this year is that more 3Q or 4Q weighted?

Donald Knauss

I think I talked about we kind of hit a wall in November in terms of shipments and it was across every single category, and I would say based on what we know and some of it's anecdotal, the destocking took place pretty much across the board. So in that some of our strategic customers were heavily engaged in destocking programs but I think we definitely saw it in grocery channels and smaller customers.

So it's clearly pretty broad and it was very deep in November and we kind of bounced back to normal shipment levels in both December as well as January.

Daniel Heinrich

In terms of demand, billing spending, no significant changes in the totals. On a dollar basis, we're about flat on advertising spend and fairly consistent on trade and promotion so no significant changes or deltas there. On restructuring, let me give you a sense of that Q3, Q4, the existing manufacturing restructuring that has been under way for awhile, we'll probably see about $5 million to $6 million of those costs coming through cost of goods sold in Q3 and another $5 million to $6 million coming through cost of goods sold in Q4.

Of the $15 million to $17 million incremental charges associated with the operating model, probably see $13 million to $14 million of those in Q3 and call it $4 million to $5 million or so in Q4. But Q3 will mostly be on the restructuring line. Q4 will be probably in cost of goods sold with some in admin. But roughly that should give you the parameters on how it's going to calendarize.

Operator

Your next question comes from Lauren Lieberman – Barclays Capital.

Lauren Lieberman – Barclays Capital

A question on international, because your comments on both expecting the categories to slow and you did in fact see in, and I know I can't remember which one of you actually mentioned that yes, the business was up this quarter, but you did see the slowing. So can you help us understand was it an end of the quarter slowing, which markets, which categories and how to think about it as you are for the rest of the year?

Lawrence Peiros

Generally the categories in our international markets have remained pretty healthy although the level of growth has slowed versus what we've seen historically. I'm not talking dollar sales which is obviously a little different versus volume, seen a bit more slowdown in volume because the sales are reflective of pricing that has taken place in a lot of the markets.

So going forward we do think that categories may slowdown as a result of the global depression and that there's some potential to see some category declines in some of our countries.

Lauren Lieberman – Barclays Capital

Is it best to think about it then that the pricing that you've taken which I'm assuming is to offset some of the cost, that the pricing sticks so really as we think about it to focus more on seeing the slowdown by volume?

Lawrence Peiros

Yes, I think this is more of an economically driven slowdown than a pricing kind of issue. Obviously you have the FX thing so, which I have pretty strong double digit sales growth if you looked at local currencies, but when it gets translated back, it's about flat.

Donald Knauss

I would just say to add to that that the trend in the quarter was not unlike the U.S. where we saw November very slow and then December sales were much stronger than November again. So as Larry said, in local currencies we felt pretty good about it but the pattern wasn't very different from the U.S. in terms of November down and December back more solid.

Lauren Lieberman – Barclays Capital

A question on Burt's Bees. You said still growth but slower rate of growth, and I wanted to know in your forecast are you assuming the growth potentially goes negative in that business. I mean it would be consistent with what we're seeing with other personal care competitors and given the breadth of the distribution build out you had, I would think that should be part of the thought process.

Lawrence Peiros

We're definitely not seeing negative growth for Burt's. The consumption in the quarter was very, very strong so we're continuing on a very strong growth trajectory in Natural Personal Care. Our sales are not as strong as our consumption and that was clearly due to some inventory destocking, particularly in the drug channel. But we feel very positive about the consumption trends and this is still a very good value because consumers are concerned about not just the environment but putting petrochemicals on their bodies.

Donald Knauss

And this is a business that over the last couple, three years has enjoyed very strong north of 20% kind of growth rates. We certainly had very good growth rates since we've acquired the company. Still positive growth in the quarter and as we look at the back half of the full year, we're probably talking mid to high single digit sales growth and certainly as we look out in to fiscal 2010, we're certainly seeing a nice return to their sales growth trends.

The other thing to keep in mind is we did have a lot, if you think about Q3, we did have a lot of pipeline sales a year ago as we launched into particularly Wal Mart, so we will anniversary in the back half some of that pipeline fill.

Donald Knauss

The other thing I'd add to that is, when we talked to all of you over a year a go about this business, we talked a lot about the Natural Personal Care category which we said was in the $6 billion range. And we talked about roughly 8% to 10% growth in that Natural Personal Care category.

When you narrow the scope of that category into the segment that Burt's competes in, we're still seeing as Dan noted, growth in those segments consumption wise in the high teens to low 20's. So we certainly don't see negative growth going forward.

Lauren Lieberman – Barclays Capital

And just a reminder, have you brought Burt's Bees, have you done much with it internationally yet to broaden that? I'm not including Canada or is that part of the plan for the second half?

Donald Knauss

Absolutely. Part of the distribution build is in fact in our international businesses and we continue to add countries there. We're in Taiwan, we're in Australia and there's selected other countries that we'll be launching into in the second half of this year and into fiscal 2010. So adding those distribution points and those countries is certainly part of the game plan for Burt's.

Operator

Your next question comes from Connie Maneaty – BMO Capital.

Connie Maneaty – BMO Capital

It seems to me that there was a reversal of something for Burt's Bees in the gross profit line because the gross margin ex charges 39.4% is lower than the gross margin with charges of 40%. What was going on there?

Daniel Heinrich

I'm not aware of much going on with Burt's. The only change in Burt's is, we had a step up in the inventory level in the year ago quarter which was about a $5 million write up in inventory. As you know, when you acquire a company you have to write up the inventory to fair value, so when you sell those units they come across with very little margins.

So we didn't repeat that obviously, so we had some benefit in margin this quarter versus year ago because we didn't have the step up, and I think there's another $14 million or $15 million of that stepped up that was in the year ago third quarter that will benefit our upcoming Q3. Is that what you're referring to?

Connie Maneaty – BMO Capital

Maybe we've made a mistake on our modeling, but it seems as though the gross margin excluding charges ought to be higher than the gross margin with charges and it's coming out the other way. Is there something else going on?

Daniel Heinrich

If it's specific to Burt's, as far as I know their gross margin is pretty much consistent with where it's been excluding the step up in inventory. We'll follow up with Steve afterwards and see if we can work it out.

Operator

Your next question comes from Alice Longley – Buckingham Research.

Alice Longley – Buckingham Research

I really just have a clarification. When you said Burt's Bees in the second half would be at mid to high single digits, is that the shipments or sales at retail?

Lawrence Peiros

Those are dollar sales.

Alice Longley – Buckingham Research

And that's just the U.S. That's not including shipments overseas?

Lawrence Peiros

That would be total for Burt's.

Alice Longley – Buckingham Research

So in the U.S. your shipments are growing low single digits in the second half?

Donald Knauss

No, I wouldn't say that because U.S. is still about 88% to 90%. That's the majority of our sales. And again, just to be clear, that's our sales not retail dollars.

Alice Longley – Buckingham Research

And retail dollars you think are growing faster than that, right?

Donald Knauss

Absolutely.

Alice Longley – Buckingham Research

A question on your categories at retail just doing the math, putting together tracked and untracked channels, you said there was a six point differential. It looks to me like your categories were up about 2.5% at retail all in in the quarter rather than down that 1% you said for the tracked channels. Is that true? And also, how much of that would be pricing so we can just sort of back out how much your categories were up or down in volume in the quarter at retail.

Donald Knauss

On track is on track. We don't really have a good category read. My best guess is that categories are flattish in terms of retail dollar sales. My best guess is they are two or three points in pricing captured in most of the categories. That would be pricing by us and pricing by others. I don't have that complete picture for the quarter.

Alice Longley – Buckingham Research

So the point is I guess in terms of consumer purchasing for your categories down 2% to 3%.

Donald Knauss

There is definitely some volume loss obviously attributable to the economy, probably attributable in some categories to pricing. But dollar sales I would call about flat for categories across all outlets.

Operator

Your next question comes from Alec Patterson – RCM.

Alec Patterson – RCM

On the foreign exchange, can you give a breakdown of the impact on North America versus international?

Daniel Heinrich

I don't know if I have that. What I can tell you is Canada would be in the North American results and then the rest of it obviously would be in the international categories. Steve, do you have those numbers?

Foreign currency hurt us by just under 300 basis points on the sales line. We said earlier on our comments there was about an 11 point drop in international and about a 100 basis point drag from North America.

Alec Patterson – RCM

The total debt levels were down a bit. I think cash was also down a bit. Interest expense was up. Most of the other companies I've seen have benefited from a lower interest rate environment. Is there something going on there I'm missing on why your interest expense ticked up.

Daniel Heinrich

No, there wasn't a large change in our debt balances over the quarter. What we did have as you recall back in the September through November time frame with the disruption in the CP markets there were in LIBOR some spikes in interest rates. That impact for us for a period of time almost doubled our CP rates for call it an eight to ten week period from a high 2.5% to 3% to at its peak over 6%.

So we did suffer some higher interest costs and that's probably in the $3 million to $4 million range for us, but we're back to historical issuance levels today and we are using as much of our cash on hand obviously to pay down debt.

Alec Patterson – RCM

So going forward it's more of a $40 million run rate per quarter or something like that?

Daniel Heinrich

We'll see. Again as our debt to EBITDA goes down our interest is going to go down as well.

Alec Patterson – RCM

There's been a lot of talk about the destocking going on by the consumer and the retailer for their balance sheets etc., and not much mention about what vendors such as yourselves may be doing in that regard. I'm just wondering if there's a comment along the lines of what you're doing to so to speak destock and how that's working out with your vendors.

Daniel Heinrich

Our inventory levels on a unit basis are fairly consistent. We run pretty short cycles on our inventory. You take bleach which is relatively short, and our categories are ten days to two weeks. So the inventory turns on them are pretty quick. I think on a unit basis, we're not materially different.

We obviously work in each business unit to manage our working capital. Most of the pressure on working capital has been the dollar cost per input not inventory level. So we manage it fairly tightly and we haven't seen any need where we really need to pull back on that.

Operator

Your next question comes from Douglas Lein – Jefferies.

Douglas Lein – Jefferies

You mentioned a couple times the gap between measured and non measured channels. Can you give us sort of a trend there? Has that been widening or staying the same or narrowing over the last six to twelve months? And secondly, can you give us an update now that we've anniversaried the Burt's Bees acquisition on what your attitude is towards M&A these days.

Donald Knauss

Let me handle the tracked versus untracked. If you went back two or three years ago you would have seen pretty healthy double digit differences between 10 and 15 points in each quarter where the track channels were growing much less than the untracked channels. It has narrowed over the last year or so more in the mid single digit range typically in any given quarter, sometimes as near as a couple of points.

Lawrence Peiros

On the M&A front, our focus near term is on the pay down of our debt so while we always look at things, no real appetite right now to do anything near term. We'll continue to look. If we do anything, it would be on a very small basis at least for the next year to 18 months.

Douglas Lein – Jefferies

So it sounds like that approach is more internal than external. At what sort of internal leverage ratios or what ever you want to use as a metric, would you then be more interested and more aggressive in looking at acquisitions?

Daniel Heinrich

We've said we're trying to target to be in the 2.5 to 3 times debt to EBITDA. We'll obviously be below the three by the end of June, but we'd like to live inside that 2.5 to 3 even with acquisitions. So whatever we would do, we would try to fit inside that type of leverage structure so that obviously would limit the size of what we would look at or what we would do.

Operator

Your next question comes from [Cindy Nicholson – Citi Investment Research]

[Cindy Nicholson – Citi Investment Research]

On Burt's Bees, can you comment particularly, I know distribution expansion has been a huge part of the story so far, but what inning are you in as you think about the U.S. market place? Are you in the seventh inning, eighth inning in terms of total distribution of what you hope to get for that business?

Donald Knauss

I'd say we're probably in the sixth to seventh inning, and as we look at the growth on this business including international growth, we still think about 50% of our growth over the next couple of years can come from expanding distribution, probably about 30% from new innovation and then about 20% from continued growth in the base business.

[Cindy Nicholson – Citi Investment Research]

And apart from the destocking that you've seen just given the economic environment, has the pace of the expansion or the interest on the part of retailers about accepting more or the product at all changed at all? In other words, has the timing of new distribution been pushed out at all?

Lawrence Peiros

I met with a number of retailers at FMI mid winter just a couple of weeks ago and I would say the appetite for this category is as strong as ever, not only because of the growth rate in the category, particularly the segment that Burt's in, but also the margin structure of the business. This is a 50 margin to retailers so they really like this category and like the growth prospect. So I didn't hear any of that when I talked with them recently.

[Cindy Nicholson – Citi Investment Research]

On the private label manufacturing that you've been doing on the Glad business, does the fact that private label has actually been gaining market share change your view at all in terms of your exiting the private label business or say "Oh gosh, let's slow that down and continue to absorb some overhead capacity by doing more private label'? And then the second one, can you just comment on Latin America how much pricing you've taken to offset the devaluation? Has there been a lag? Are you actively raising prices?

Donald Knauss

The answer on the private label business is pretty easy. The answer is no. It's not a business that we think we can do well in and we're very happy with the choice that we made some time back to get out of the business. There was some volume in Q2 but essentially as of January 1, we're out of the business.

Obviously the indexing of the volume in the base, but we'll be out of the business essentially effective the start of this calendar year.

Daniel Heinrich

On the international pricing, we have been increasing our prices. We have been consistently over time to help offset the commodity cost pressure that we've seen and we are looking at what we can do on pricing to help moderate some of the devaluation. But that's going to be a local market call on how much we can do in each market.

[Cindy Nicholson – Citi Investment Research]

And you haven't taken that yet?

Daniel Heinrich

Our pricing impact I believe in the second quarter international was about 9% so we have been consistently taking a lot of pricing. And going forward we will take a look at devaluation.

Operator

Your next question comes from Andrew Sawyer – Goldman Sachs.

Andrew Sawyer – Goldman Sachs

There was a comment in your prepared remarks about moving back to more normalized margin levels and I know if you look back four or five years prior to the commodity spike, you had gross margins into the mid 40's. Can you give us some context about whether that's an achievable over multi-year in your horizon and what it might take to get back to that type of a level?

Daniel Heinrich

We certainly think those mid 40's levels may be a bit higher or certainly achievable over the next couple of year particularly with the projections of everything, where commodity costs are going to go, the fact that we think a lot of the pricing we've taken will in fact stick. Plus the changes in the mix of our business when you look at the profitability of a Burt's Bees, you look at Green Works, our Brita business is doing really well.

So the business mix certainly would indicate that we would add some margin there. So certainly mid 40's and we'd certainly be working to be even higher than that.

Andrew Sawyer – Goldman Sachs

Obviously people are worried about the potential for price give backs that would keep you from getting there. Is there anything else on the horizon that would potentially hamper your ability to drive that kind of improvement?

Daniel Heinrich

I think the other big question is how send the commodity side, so I'm feeling great about the direction of commodities right now, but obviously hard pressed to predict the future.

Lawrence Peiros

Just to build on Dan's point, the innovation that we've got in the mix of our business continues to help us point in that direction to the mid 40's or even higher. We feel pretty good as we look out at the innovation pipeline over the next 18 to 36 months, that's where we're oriented to those higher margin items.

Andrew Sawyer – Goldman Sachs

On the gross margin build, you had a 90 basis point other item. Is that some give back on the pricing on promotions?

Daniel Heinrich

No, it's just a lot of little small things, 10, 15 basis points here and there. It's just sort of the collective all other that's in there. There's a little of, I think for the quarter we had a little bit of negative business mix, probably the biggest component that sits in there, but other than that it's just a lot of little small details.

Operator

Your next question comes from Linda Bolton Weiser – Caris.

Linda Bolton Weiser – Caris

You mentioned that your innovation is going to pick up in the second half. Did you mention the timing of launches without being specific, but is it more heavily weighted for the fourth quarter or third quarter? Can you comment on that?

Donald Knauss

We particularly have a window in the first quarter and the third quarter. I think we've already talked about the launches in the third quarter. The biggest ones will be the pre wash biodegradable wipes. We also have a new designer canister on our Clorox disinfecting wipes. We have a new premium charcoal product call Kingsford competition brickets. We have a new scent on our Glad Odor Shield product, a lemon scent which is terrific. We have a flavor on Hidden Valley Garden Vegetable and a few other items across our lines.

Linda Bolton Weiser – Caris

Can you make a comment in terms of how your inventory ended the quarter at retail? Was it still up or was it actually down at retail do you think?

Lawrence Peiros

Again, hard for us to get a very specific answer, but I thing our judgment is based on our shipment flow. We took pretty much a significant one time hit in November and essentially that was more of a one time hit. I'm sure there are ongoing activities in inventory but we didn't see a big impact in our shipment and we were kind of normalized shipment volume in December as well as January. At this point in time we feel pretty good that this is more of a one time adjustment.

Daniel Heinrich

It feels like it was taken down in the November time and our volume has been consistent so we assume that those inventory levels whatever they were adjusted to in November have been fairly static.

Linda Bolton Weiser – Caris

A question on the color safe bleach category. We saw a product at Wal Mart, and maybe it's a one off type thing but a Vivid Ultra that was on the shelf. It looked like [Recca] was the marketer of it that looked like it was about half the price of yours. Is that just an anomaly or your mistake? Can you just comment on that competition?

Lawrence Peiros

It's been around for 30 years. I don't know what the market share is. It's an indication of how much we worry. It's a pretty small player. I can't tell you what the price point is at this point in time. I don't know if that was a mispricing situation or not, but it's a relatively small player in that color safe bleach category.

We have a large share in that category. We feel good about our share position and the focus in bleach land is more around how do we drive category growth and how do we convince people they need to add a bleach to their detergent less around share issues at this point.

Operator

At this time we have no further questions.

Donald Knauss

Thank you everyone for your interest in our business and we'll look forward to giving you an update as Dan talked about in April we'll give you our initial outlook for FY2010, but thanks for your interest in our company. We look forward to talking to you in a few months.

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