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The Clorox Company (NYSE:CLX)

2013 Consumer Analyst Group of New York Conference

February 21, 2013 1:45 pm ET

Executives

Donald R. Knauss - Chairman, Chief Executive Officer and Chairman of Executive Committee

Stephen M. Robb - Chief Financial Officer and Senior Vice President

Steve Austenfeld - Former Vice President of Investor Relations

Analysts

Sally Dessloch - Integrated Finance Limited, LLC

Nik Modi - UBS Investment Bank, Research Division

William Schmitz - Deutsche Bank AG, Research Division

Ali Dibadj - Sanford C. Bernstein & Co., LLC., Research Division

Michael Kelter - Goldman Sachs Group Inc., Research Division

Michael Steib - Crédit Suisse AG, Research Division

Christopher Ferrara - BofA Merrill Lynch, Research Division

Sally Dessloch - Integrated Finance Limited, LLC

I'm pleased to welcome Clorox to this year's CAGNY Conference. With us today are Don Knauss, Chairman and Chief Executive Officer; Steve Robb, Senior Vice President and Chief Financial Officer; and Steve Austenfeld, Vice President of Investor Relations.

When Don joined Clorox in 2006, he launched the company's Centennial Strategy, which has been guiding the company for the past 5 years or so. Clorox celebrates its 100th anniversary this year, and management will unveil its updated strategy at an Analyst Meeting in October.

I'll turn the podium over to Don to talk more about what may be in store. Don, over to you.

Donald R. Knauss

Well, good afternoon, everyone. So if Bill Schmitz is in the audience, in advance to his question, we will be furnishing a volume forecast by ZIP code by hour for the remainder of the month or after lunch, folks. We won't be doing that actually but I had to put the safe Harbor statement up. As you know, some of these things we talk about, obviously, will be projections but what I want to cover with you this afternoon, Steve and I will go through these 3 key messages with you. As Sally said, we launched the Centennial Strategy about 5 years ago, and we answered 4 fundamental questions in that strategy. I want to show you those questions and how we performed against those questions then, obviously, give you a report card on those results. And then I want to talk a little bit about setting up the case for the longer-term, the 2020 strategy that we will unveil, in October. Well, we can give you a bit of a teaser look at that as we go forward.

So these are the 4 questions we asked ourselves. What were the goals and aspirations of the company? Where do we play, basically, our participation strategy question by category, by channel, by country? How we win, what capabilities do we focus on? And then, how do we configure the business in terms of structure and processes of the business.

So on the first one, it was really about maximizing economic profit across categories, channels and countries. And I think using economic profit is what separates Clorox from a number of our peer companies. This is the way we incent people, both on an annual basis, as well as a multiyear basis. The reason we did that is when we looked at all the financial metrics that were out there, this was the best correlation with stock price appreciation of shareholder value over time. And it was the most robust financial metric we could find because it had a P&L component, which was net earnings. It had a balance sheet component, which was the capital deployed to get those earnings. And of course, they had a capital market component, which is the cost of that capital. So we thought that was the best metric or true north that we could use for the company. It obviously, has driven our decision-making, everything from our participation strategy to how we deploy money to build demand. And we'll get into those choices in a minute.

If you look going back to FY '08, we're doing about a 6% compounded growth rate on economic profit, which we think is one of the tougher measures out there to grow in the mid- to high-single digits over time, especially as you bring in acquisitions. Acquisitions and EP are not often friendly together and it's a tough test to master.

On where to play. As many of you know, we acquired Burt's Bees about 5.5 years ago. We divested the auto business a couple of years ago. And we acquired 3 smaller companies in the Healthcare segment, which I'll go through in a little bit in terms of the impact they've had on our business. And you can see by the pie chart that if you go from 7 to 12, we've gotten now almost half of our portfolio growing north of 4%. And in fact, if you look at the last 18 months, we've grown the top line 5%, which is obviously the upper end of our 3% to 5% range. So we feel good that the where-to-play choices have shifted into more tailwind categories and channels and countries.

How to win? This is really about building brands and this is our 3D model. We talked a lot about this with a number of you over the years, Desire, Decided and Delight. These 3 moments of truth we see with consumers, greater desire for the brand, getting them to the point of decide whether it's the brick or a click and then, obviously, deciding in our favor. And then once they get that product into their home, are they delighted with its usage. And today, if you go back to desire, about 5 years -- 5.5 years ago, about 80% of our marketing spend was on traditional media. I'd call it TV, radio, print. Today, it's about 60%. There's a lot more going into digital, obviously, and also into in-store.

On this side, we really shifted our focus from merchandising into one of assortments. About 80% -- 80% to 85% of our business is base business. It turns off the shelf every day, it's not really driven by heavy merchandising events or winning that lobby display during the 4th of July holiday, that's not what drives our business. And then on delight, it was really about shifting to the 60-40 win. So if we give you 2 products to take home and try, plain white wrappers, no branding, would you come back and prefer ours. A pretty good gold standard for that, as you can get 60 consumers out of 100 who'd say that you've got that kind of product preference, you really got something. And about 5.5 years ago, we had about 15% to 20% of our products had that kind of demonstrable win. Today, it's 50%. And I think that's one of the reasons over the last 4 years or so we've held to ticked up little a bit on market share despite a pretty tough economy with premium-priced products.

And if you look at innovation, what's resulted from this is we've had this long-standing goal of 2 to 3 points of growth from new products. We upped that to 3% plus about 1.5 years ago because our categories were starting to decline due to the recession. And of course, you can see that we hit a little bit north of 3% last year and we're on track to deliver another 3% plus this year. And you can see the step up on the right chart and how much of our product superiority has amped up over time.

And then how to configure. We really went into a strategic business unit structure where we pushed the P&L ownership and the ownership of economic profit down the strategic business units in the company and actually aligned our annual incentives and our multiyear incentives to that metric. Some of the things, obviously, we've done the last 1.5 years, have been 2 of the big investments around configuration of the SAP investment we put into Latin America. We now have all 12 of those countries up and running with no real glitches there at all. We're in a sustained mode now on SAP. And of course, the picture on the right is the new R&D facilities out in Pleasanton, which has been -- come out to the October Analyst Meeting. We're going to hold that meeting there because that's where all the labs and the pilot plant are and see the capability enhancements we have out there.

And if you look at is it paying off, is that -- are those answers to those questions, those 4 fundamental questions, have they resulted in progress? Well, if you look at the CAGR over business sales growth, and this is, obviously, as reported, includes any impact of FX, 2.5% CAGR kind of obviously a little bit south of the low end of our range. But if you look at, obviously, during the recession when everybody was hit hard and categories were declining, everybody saw that dip. If you look at the last 18 months, you can see FY '12, we grew at 5%. The first 6 months of FY '13, we've grown at 5.5%, so we feel like the last 18 months, we've really got this thing to the upper end of the range. If you look at earnings per share, 11% compounded growth rate since '08. So again, the aspiration here was always to be in the top third of our peers set, the top tertile and I'll show you how we've done. But that, clearly, with dividend payout of around 3 -- had been about 3.5% before the stock has run up so much in the last 2 months, we're now about a 3.2% yield. But if you add our yield to that EPS, we're comfortably in this 13% to 14% TSR range.

And then you look at our return on invested capital, which is really another way of looking at economic profit percentage basis. We feel we're almost best-in-class on return on invested capital at 24%. You can see the peer companies listed on the bottom of the chart. And then if you look at TSRs, so the combination of stock price appreciation and the dividend increases, we've more than doubled the dividend in the last 6 years. You can see this is taking the last 4 complete fiscal years. So '09, '10, '11, '12, 59% total shareholder return comparing that to the 47% from the peer set and the 16% from the S&P. Interesting, if we -- when you look at this and expand it through February 8 of this year, so if you look at it on a 55 months, the last 55 months, we're at 82% TSR, the peers stood at 65% and the S&P to 31%. So we think we've done of fairly good job for our investors over a fairly long period of time.

So beyond Centennial, can we stay with this aspiration of being in the top tertile of TSR? We think we can certainly do that by maintaining this 3% to 5% top line growth rate. And then a change from what we had in Centennial, this is a more aggressive margin expansion target of growing to 25 to 50 basis points of EBIT margin. We had 25 in the Centennial Strategy. So we think with the more benign commodity environment out there, with some of these major investments behind us in terms of SAP, our R&D facilities, we think there's a good opportunity to get some increased margin expansion going forward, along with getting to the middle or upper end of the top line growth range. So this is an algorithm we showed at the May Analyst Meeting. This will be the foundation of 2020 going forward, but the core of the business, obviously, is U.S. Retail, 75% of the company. You can see we're expecting 2% to 3% growth out of that segment of the business. We think that's a realistic target, the categories over the last 52 weeks are growing about 1.5%, so they're toggling between 1% and 1.5% typically. So this implies a modest share gain and that would contribute 1.5 to 2.5 points of growth for the total company.

Professional Products, which is now up to 5% of the company sales, we think that segment grows 10% to 15%. Obviously, Healthcare is an anchor here. I'm going to give you a little bit of a profile on to what's going on with the Healthcare business in a minute, that adds another 0.5 point. You can see International. We believe we can grow 5% to 7%. I'd say that's more like 6% to 8% outside of North America, Canada drags that down a little bit. Canada is much more flattish than the emerging markets. That comfortably gets us in the 3% to 5% range. Then you can see the margin improvement, so that's the way we look at the business.

To drive that top line to the middle and the upper end of that range, which we've done the last 18 months, the Centennial Strategy focused on 4 megatrends going on around the world, and how we worked on making our brands relevant against those trends, and those were health and wellness, multicultural, affordability and sustainability. And then you can see we've developed 5 platforms to bring those alive at retail. Under health and wellness there are 2. Obviously, stop the spread infection is right in our sweet spot. But also family togetherness is a part of wellness. We use our food brands to anchor that. U.S.-Hispanic opportunities has been a large opportunity for us. Our brands given that 2/3 of our International business is Latin America, our brands have a lot of equity with the Hispanic consumer in this country, given especially that half the Hispanics in this country are of Mexican origin and we've got some fairly large brands down in Mexico. So those habits travel, obviously, with people. The value focus during the recession was key and, of course, the green focus on sustainability. And of course, we used that 3D model to bring alive those platforms.

Now I want to talk about 2 of these platforms, give you a little bit more of a peek under the tent, what's going on in these platforms. Let's start with the green side of this because as the economy improves, we're seeing more robustness in this category. But I want to focus on Burt's Bees and gud. Now obviously, we acquired Burt's in the fall of '07.

We have really -- over the last couple of years, we have really focused very hard on lip, face and body. It's been a -- I think that kind of focus, particularly on lip, which is about 40% of the brand, has really done well to us. We're getting into a lot more color, colored lip balms, lip wands, it is really driving the growth, which I'll show you in a second. And of course, gud gave us an opportunity to get into shampoos and conditioners, where we couldn't keep the 99% natural formulation approach that we have with the Burt's brand. We couldn't get the fragrances. Now we have the most natural shampoos in the space. They are about 95% natural and they're doing quite well as well. So that's been the focus and the payoff has been basically a little bit north of 10% growth on Burt's over the last 3 years. That includes the FY '13 outlook, so you can see the numbers in '11, '12 and obviously, what we're forecasting for '13.

The other interesting piece of this is, obviously, the international growth is well north of 20% as we drive Burt's. When we acquired it, we were in 5 countries. Today, we're in over 30. Now many of those countries are small flags that we planted but we're starting to really build it. I think there's a lot of potential upside especially internationally with Burt's.

Going back to the first trend, which is -- probably impacts the most brands in our portfolio, is stop the spread of infection. And this is a global platform. So I want to show you how we look at this across all 3 of these different business segments because that is anchored in all 3 of the businesses. And so on retail, it's about the bleach compaction initiative undertook last year and then driving disinfecting solutions during cold and flu, which we had, obviously, a pretty aggressive flu season this year and I'll show you some of the results. Professional, it's obviously about going after the acute care facilities. Now not only hospitals but we're into doctors and dentist offices with the 2 recent acquisitions we made. And then leverage continuing to leverage M&A with bolt-on acquisitions in that space. And then international, we've also, obviously, focused hard on disinfecting and cleaning solutions. So let's show you a little bit of an update on what's going on with bleach compaction.

We're close to the fourth region ruling now. We've got 2/3 of 3 quarters of the country rolled out. The West Coast, the fourth region starts next month, so another -- basically, another week. So we'll be done with this by the time we get through May because it will be converted on all the shelves. And in terms of the progress, I think the early -- we would describe the early results as very encouraging. The bleach category is up 7% in sales. And I would say to you that our shipments through the first half of the fiscal year, shipment volume is consistent with that level of growth. And the category growth rate in the regions that have compacted versus those that haven't, which is primarily the West Coast, we're seeing about 10 points difference in terms of growth rate.

And then we also believe that our Bleachable Moments campaign is working. This is the new advertising we showed you last year, really skewed much more young -- in fact, in the 6 years I've been with the company, we've never seen this number at the bottom which is we have 100,000 households IRI panels that we track. And for the first time last year, we saw new users up 6%. We hadn't seen that a long time as we hadn't advertised to people under 35 and that's what this new campaign really is about. And then we also saw -- are seeing some higher usage tip up. We're seeing the purchase cycle shortening, which obviously, means more purchases during the course of the year. So all in all, the early results are very encouraging. The other interesting thing about this is we've lost no shelf space during this conversion. We get about 23% more units on the shelf during this pack out. And private label is obviously converted along with us.

This is worth, over time, about 300 to 500 basis points of margin improvement to the company. And obviously, the retailer is happier too because it helps eliminate a lot of out-of-stock issues on the weekends with more unit pack out. If you look at basically giving your home a flu shot, and this became very relevant during the recent flu problems that we had, this is something we are coordinating not only with disinfecting wipes but with Clorox Clean-Up and Clorox Bleach. So you've seen, if you've been out of retail over the last 6 or 8 weeks, you obviously had seen cold merchandising between a number of our brands. And when you look at the results, the top numbers are the Wipes category. So if you look at the last 52 weeks, and this is data ending January 20, so it's the most recent data we have, the category is up 7% for last year but interesting, in the last 4 to 5 weeks, obviously, up 13% but you could see our results in terms of share growth up to almost a 55 share over the last 52 weeks, almost up 2 share points. Last 4 weeks, we hit over 55 share, up 2 points. So you can obviously infer that we're growing faster than those category rates, so we feel pretty good about that equity on disinfecting wipes.

If you look at professional, and this is something many of you probably don't have a lot of visibility into but it's a very interesting business. What you see on the left side of this slide is all the bad things we want to kill in particularly the hospitals starting with spores like CIDP, which are very difficult to kill. And as you go down this triangle, basically things get easier to kill. But what we try to do is develop a one-stop shop, if you will, for acute care facilities. So we have Clorox germicidal wipes, which are bleached based on the far left and you see in the middle, we have a whole new hydrogen peroxide line, which doesn't give you some of the odor issues that you're working around bleach all day, give you -- has essentially the same kill rates, except on CIDP. And then you can see the broader spectrum on the right. So essentially, you can get with Clorox a one-stop shop for all your disinfecting needs to kill these bacteria and viruses that cause hospital-acquired infections, which is a massive problem, not only in this country but around the world. And here, we have -- think about this, we have 3x as many people dying in this country from hospital-acquired infections than dying in car wrecks. So it's a big problem, about 100,000 people a year.

And when you look at what's going on with these new acquisitions that we've added in, we think with the product lineup we now have, we're the most trusted infection control partners you can have in an acute care facility. We now have 15 of the 16 top ranked hospitals using our products in their protocols for stopping infection and that's a ranking by U.S. News & World Report.

We've got over 400 new facilities in the U.S. have adopted Clorox bleach-based wipes and sprays and we continue to build on that. If you look at expanding beyond bleach and we've done this with a partnership with hydrogen peroxide, we have over 300 new facilities across the U.S. adopting hydrogen peroxide. And we have a number of other facilities looking at this and evaluating the product line. And if you look at the 3 acquisitions, Caltech, which gave us a #1 spray bleach for hospitals and dispatch. If you look at HealthLink, which gave us the #1 antibacterial soap and lotion and hand sanitizers for doctors' and dentists' offices. Then Aplicare gave us an into entry skin antiseptics, cleaning the skin, disinfecting the skin before surgery. That's added significant capability to us. The other interesting thing is now we've gotten 3 points of added growth to our Healthcare business just by putting Clorox products now through the HealthLink sales organization that's going into doctors' offices. So for example, now, HealthLink, that sales organization, which has been integrated in, is now selling Clorox germicidal wipes to doctors and dentists, which hasn't occurred, obviously, in the past.

And then if you look at International, what is going on there. The lower left of the screen is a campaign we did in Peru on driving bleach consumption to really drive up category usage. On the low end of the curve, usage curve in a number of developing countries, Peru has, as you would expect of a lot of development countries, a number of sanitation and hygiene issues, particularly in the villages and in the smaller towns and in the cities. This in fact -- that poster says, save your home, help save your country, basically is a loose translation. The bottles on the bottom of that is our chloro gel, a thicker bleach used for cleaning counters, et cetera, that those products -- those particular bottles are from Chile and we're rolling that out around the world. So this is a big issue around the developing world as it is, obviously, in this country.

If you look at Peru, this is the bleach compounded growth rate in Peru. Bleach is now a little bit over half the business in Peru. To put it in perspective, and I think this is pretty much a good example of our international strategy, which is to more focus on midsized countries just like we focused on midsize categories, try to stay out of the BRIC, so to speak, and focus on to countries like Peru. Our business in Peru in the last 5 years has quadrupled to well north of $40 million now. And in fact, if you look at -- through the first 6 months of FY '13, our bleach business improved, it's up 21% on top of what it's been doing. So we feel very good about the midsized country approach as we roll out and stop the spread of infection.

I thought I'd dive a little deeper into international, since it's been one of the key discussion points as we head to our 2020 strategy. Obviously, it's about 1/4 of the company sales, 2/3 of it is in emerging market. As you can see, Latin America, obviously is the biggest chunk. We are in over 100 countries. We have a couple of JVs in the Middle East, where we don't consolidate that numbers. In Saudi Arabia, we have a 95 share of bleach. In Egypt, we also have a fairly significant fast-growing business but we have 49% ownership of Egypt. And as I said, when we look at the CAGRs over the last few years, about 6% has been on the top line CAGR.

Challenges in the short term. I think, this is a common refrain you've heard from a lot of folks but obviously the headwind, the devaluation we just went through in Venezuela, the high inflation in -- particularly in markets like Venezuela and Argentina and then the price controls and restrictions. However, we still, like everyone else, I think, that at this conference, we still are bullish that long term, we obviously have to be there and play in these emerging markets. Category growth, still stronger than the U.S.. In fact, if you look at current dollars in our core markets internationally, categories, they're still growing about 4% more than double what they're growing in the U.S. We've got strong shares, particularly in bleach at a little over 40 share. And a well-developed bleach habit. I mean if you go into Latin America, for example, the bleach usage there is about -- it's the reverse of the U.S., where 70% of it's used in cleaning and 30% in Laundry versus the U.S., where it's 70%, laundry, 30% cleaning. And you use more bleach when you use it as a cleaning agent. It's obviously aligned with the trends and the conditions will improve over time as we see the emerging middle class coming in these countries. We all want to participate in that. So the fact -- growing the top line is certainly faster than the U.S.. As I said, we're focused on our existing geographies. For example, in Latin America, those 12 countries we put the SAP system into where we've got some good scale, that's where we're going to focus. And they're typically midsized which tends to avoid a lot of the larger players who just don't see the scale opportunity in some of those countries like Peru, for example.

One of the other big challenges is fixing margins. With price control and high inflation, a number of our peer companies and ourselves have obviously seen margin contraction and it's a big focus for us. So the SAP investment was a big opportunity for us to get at fixing gross margins and I'll show you where we see some real opportunities to do that and then improving the mix through getting up on the usage curve as people trade up.

So from SAP, and as I said, we're in 12 countries. Now we're up and running, so we're starting to anniversary that investment as we head into the back half of '13 and then, obviously, into FY'14. Here are some of the big 3 bucket areas where you can expect us to get real benefit for our shareholders out of this. Enhancing the top line, certainly there are trade fund efficiency, we just didn't have good visibility into how the trade was deployed across countries by brand. Now we have that visibility. Improving margins, product portfolio optimization. Obviously a lot of SKUs, some of whom don't pull their weight, we now have much better visibility in those SKUs. Having profitability by SKU will give us a real opportunity to prune those SKUs and get working capital out that way as well. Easier identification of cost savings opportunities as we can now look at Latin America holistically.

Lower working capital, already in the first couple of months of this. We've already gotten $7 million out of working capital in 3 countries: Mexico, Chile and Costa Rica, just by getting receivables down and getting people to pay us on time. So the higher cash flow obviously will result from that. So we see some real ability to drive the top line, to improve the margins overall and then obviously to get cash flow up as we see get SAP really ingrained in our system in Latin America.

And with that, let me turn it over to Steve.

Stephen M. Robb

Well, thanks, Don, and good afternoon, everyone. So Don talk a little bit about the Centennial Strategy. The choices we've made, and I think you can see that it's working. What I'd like to do now is talk about our long-term investment case. But before I do that, let me just take a minute and reconnect back to our fiscal '13 year-to-date results, as well as the outlook for fiscal '13 as well.

So starting with the year-to-date results. This represents our 6 months results for the period ended December 31. And I think you can see we've got some pretty strong numbers, 5% top line sales growth, that's at the high end of the 3% to 5% outlook that we established for ourself. And really it demonstrates that the innovation, pricing and the benefit of the acquisitions, all of that's working for us and we certainly had a very strong start to the year.

Now the next one, I particularly feel very good about and that's our margins. About a year ago, we laid out a plan to rebuild our margins back to where we thought they ought to be. And for the last 2 quarters, we've actually seen consistent steady improvement in both our gross margins, as well as our EBIT margin. And in fact, for the first 6 months, we're almost up a full point in both EBIT and gross margins. And as we'll talk in a few minutes, we think we've got plans in place to keep those margins building well into the future.

And then finally, not surprising, when you've got good growth and margin expansion, good things happen on the earnings per share line and we've got double-digit earnings per share growth of 10% in the first half. So we're off to a good start.

Now just to comment on margins. If you go back to fiscal '08 and you look at our margins, we had an EBIT margin of about 15%. And we were pretty successful in building those margins up into the high teens, call it about 18%. Now more recently, we've seen some downward pressure in margin, particularly in fiscal '12 with a runup in commodity costs. But as we've laid out the plans to rebuild the margins, I think you're seeing those come back. And importantly, as we look into the commodity environment for fiscal '13 and beyond, we think it's much more benign than what we've seen over the last couple of years, which is a reason to believe that the cost savings and pricing actions we're taking should enable us to continue to build these margins back.

Now our fiscal '13 outlook. If you listened to our last call a few weeks ago, you know we raised the outlook. We came into the year with growth outlook of 2% to 4% sales growth. And we raised that to 3% to 5%. And again, it recognized the strength of the first half result that we're seeing, as well as the benefit from the innovation programs. We're continuing to focus on delivering consistent, steady EBIT margin expansion of 25 to 50 bps, and we're well on our way to doing that.

And then finally earnings per share. We brought the lower end of this range up by about $0.05, so the range is $4.25 to $4.35. And importantly, we've been communicating for some time about the growing risks in Venezuela and that's not just price control, it's also currency devaluation and currency controls. So this outlook includes $0.05 to $0.10 of diluted earnings per share for the devaluation, which has obviously taken place. And the message we would leave you with is for this fiscal year, we believe that we've got the exposure of Venezuela covered in this outlook.

So with that, let me turn to our long-term investment case. Starting with sales growth. We think we'll be able to deliver consistent, solid 3% to 5% sales growth over the next few years. And actually, over the last 6 quarters, we've been at the high end of this, we've been at closer to 5%. We're going to focus on steady margin improvement of 25 to 50 bps of EBIT margin and then finally, free cash flow. Every year, we target to deliver about 10% to 12% free cash flow as a percentage of sales. And we think if we can deliver solid growth and margin expansion, we'll continue to throw off a lot of cash and I'll talk about some of the uses of that cash in a minute.

Let's look at 3% to 5%. What's the reason to believe? Well, first, if you look at our categories that we compete in, we believe that they will likely give us a very light tailwind, call it 1% to 2% growth. And in fact, as Don mentioned a few minutes ago, our categories are up about 1.5 points over the last 52 weeks. So we think 1 to 2 points of growth in the category, which is about the rate of population growth, makes sense to us and is certainly consistent with what we've been seeing more recently. In addition to that, we feel very good about our 3-year pipeline of innovation. A little over a year ago, we raised our innovation goal from 2 points of growth to 3 points. And in fact, in fiscal '12, we delivered 3.3 points of sales growth from innovation. We're very much on track this year to deliver another 3 points and we're feeling very good about our ability to deliver 3 points year in and year out for the foreseeable future.

And then price and mix. This is actually been a bit of help to over the last year or so. We've actually picked up about a point. We think over the long term, this might be flat, could be up a little bit or down a little bit. But on balance, when you look at that, 3% to 5% seems very reasonable for our company given the categories we compete in.

Now turning to margin. Again, we are absolutely committed to rebuild these margins back to where they should be given the portfolio of brands that we have. And we think again, 25 to 50 basis points is a very realistic goal. And there's 4 reasons why we think that we're going to be successful in rebuilding these margins. Number one, the commodity environment. It's been pretty intense over the last couple of years. But for fiscal '13, we expect it's going to be about flat. And as long as we're in this slow bumpy recovery, we think commodity costs are likely to go up but probably at a slower rate than what we've seen over the last couple of years. And if in fact that's the case, it means more of our pricing and cost savings will flow through to the bottom line and help us rebuild those margins.

We've also taken a lot of pricing, which this stock in the marketplace. Our cost savings program remains very healthy. And finally, SG&A. We remain very disciplined to how we managed SG&A within the company over the last couple of years. This year, for fiscal '13, we think SG&A as a percentage of sales will be about 15% and probably a bit less than that. But if you look at us over the long term, our SG&A costs were actually 14% or less and that's where we're going to bring the number back to. As we anniversary the investments that Don talked about in SAP being put in Latin America, as well as rebuilding our R&D facilities in Pleasanton and as we continue to tightly control these expenses, we think there's at least a margin point just in the SG&A line over the next few years. And that's one of the things that will help us get those margins built back.

So let me talk about each of these quickly. Starting with commodities, this shows you the impact that commodity price increases have had on our business over the last couple of years. And if you look at it over the last 2 years, fiscal '11 and fiscal '12, we had almost 4 full points of commodity cost pressures pushing down on the gross margins. That's the bad news. The good news is the pricing, the cost savings enabled us to offset most of this. But certainly, our margins were squeezed a bit. Now as you look forward, as I said a few minutes ago, we think commodity costs will be about flat this year and certainly, what we've seen for the first 6 months of the fiscal and what we would anticipate for the back half. And as we look into the future, while we do expect costs to go up, probably not at the level we've seen over the last few years.

Pricing has been another success for us. We have 90% of our portfolio as brands that are #1 and #2 in the categories we compete. So when you take those strong brand equities and you combine it with innovation, it translates into pricing power. It may be the best evidence of that is how many price increases we've taken on our U.S. business over the last 5, 6 years. We've taken 66 price increases. And some of these increases were mid- and high-single digits, so these were meaningful increases in a tough economy. 64 of those increases are still in the market today and that's pricing power.

In addition to that, our market shares during this same time period has been flat, in some cases, up. So the message I would leave you with on pricing, if commodity costs go up, we'll take more pricing and we think we've got the pricing power to do it. If, however, commodity costs stay more benign, which is our outlook, then we'll take less pricing but pricing will move up and down based on what we see with inflation and commodities. And I think the track record speaks for itself in this area.

Turning to cost savings. The one thing that is different about Clorox and probably one of the hallmarks of our company is how we approach cost savings. We don't have a big restructuring program. What we do have is a dedicated teams that have been in place for many years that focus on identifying and pursuing cost savings across the world. And they focus on developing a 3-year pipeline of ideas using the latest technology and insights. And they look at every single line of the P&L for potential savings. And when you do that, we've got, in our company, over $4 billion of potential opportunity to save money. And what we challenge this team to do is find at least 2 points of productivity each and every year from cost savings. And we've been at this for more than a decade. We've been very successful and this year, we're certainly on track to deliver another 150 basis points for margin expansion from these cost savings programs and we feel very good about the 3-year pipeline that we have.

Now the one thing that we're not afraid to do is invest to get the cost savings. In most years, we'll set aside about $20 million to $30 million for restructuring and other related costs. But in the last 2 years, fiscal '12 and the outlook for fiscal '13, the number is a bit higher. It's closer to $50 million to $55 million and the reason for that is because we're again, rebuilding these facilities in Pleasanton and investing in systems in Latin America. But as we anniversary those investments at the end of this fiscal year and both projects are on time, on budget, we would expect we'll go back to more of a normalized level of $20 million to $30 million.

Turning to free cash flow. Maybe the best indicator of the health of a company is your ability to convert sales and earnings into cash. If you look at our track record here, it's very good. For most of the last 5 to 10 years, we've had about 10% free cash flow as a percentage of sales. Now in the last 2 years, it has dipped down a bit below that target range because when margins were squeezed a bit and we also are making these infrastructure investments. But as we anniversary the infrastructure expense investments, we think our capital spending will go back to the rate of depreciation. So it's going to come down quite a bit. And we also think the efforts to rebuild margins, which are working, will also help us bring that free cash flow up. So we're feeling good about that. And our outlook for fiscal '13 is for free cash flow as a percentage of sales to be about 9% to 10%. Although as I said on the earnings call just a week ago, I think it's likely to be at the high end of the range based on the performance we've seen in the first half of this fiscal year.

Now with cash flow comes opportunities to do things and this is the use of cash that we continue to prioritize. We'll continue to support the growth of our business, and that's including all of the innovation programs, which will be self-funded. We're going to look for bolt-on acquisitions and we remain very interested in the Healthcare space, this idea of stopping the spread of infection that Don talked about.

The dividend has been increasing for over 30 years and we would anticipate continuing to support the growth of the dividend in line with earnings growth over the long term. And then finally, we're going to maintain the right leverage ratios. And for us, we think debt-to-EBITDA in the range of 2% to 2.5% makes sense. Our ratio at the end of our second quarter was 2.3%. And we think by the end of the fiscal year, we should be well within this range.

Now after doing those 3 things, we've got cash left over, which has been our history. Because we threw off a lot of cash, we'll look for ways to return that back to our shareholders. And historically, that's come in the form of share repurchases.

In fact, if you go back over the last 7 years, we've actually repurchased 40% of our outstanding shares, so I think we've got a very long track record of taking excess cash that we don't need and getting that back to investors in a timely way. And as Don says, will continue to support our dividend. Our dividend yield as of June 30 of last year, was about 3.3%. I think, today, it's about 3.2%. So we certainly have a healthy yield, particularly when you compare that against the 10-year treasure, which is running a little less than 2% right now. So we feel good about this and we'll continue to make sure we have a good yield and a good payout on the dividend.

So with that, I guess, the messages I would leave you with are few: Number one is we've got a strategy, Centennial, and it's working. We on the management team, we've been at this strategy for quite a few years and I think we're executing well and you see that in the numbers. And then finally, we think we have a long-term business case for this company that make sense for the realistic set of goals.

So with that, I'll pause and we'll just open it up for any questions that you may have.

Question-and-Answer Session

Unknown Analyst

It's a question about the Healthcare business. I know you've done the 3 acquisitions but with the amount of cash you generate and the opportunity that's in front of you, why not accelerate that? I mean, if there's so much out there to consolidate, why not move faster, gobble this up and kind of make it happen in a big way.

Donald R. Knauss

Well, I think we're trying to move as fast as we can, Laura. We've got a pretty robust pipeline of candidates teed up. You never know -- quite know how these things will fall when they fall. The last 2 happened in the same month. So now that we've got Aplicare and HealthLink fully integrated, I think you'll see continued activity from us. And I would say that, that activity will be in the tradition of bolt-ons. And most of these companies are in the $20 million to $40 million in revenue size so that's what you can expect from us. So we're certainly working aggressively to make it more happen in that regard. We think that the Healthcare business is a $300 million business over the next 5 years or so. It's a $125 million today, so we think half that growth is probably coming from acquisitions. So we're with you, we're trying to get more aggressive with it.

Stephen M. Robb

I would just add into that. We do want to be -- maintain financial discipline in this. So as Don says, we've got a lot of candidates that we're looking at. And if we can find good properties that are attractively priced where we think there's enough head space for shareholder return, we need to obviously move on those but they also have to be attractively priced. We've certainly seen that recently but being financially disciplined in M&A is something that we're going to continue to focus on as well.

Donald R. Knauss

John?

Unknown Analyst

If I could just clarify something, Don, you mentioned when you talked back compaction of the 300 to 500 basis point benefit you said to the company. And I just want to make sure is that you're saying total company gross margin benefit of 300 to 500 basis points?

Donald R. Knauss

Yes. That's the 300 to 500, John, on a going basis. Once we get through, obviously, the rollout and the investment behind the rollout, that's the gross margin benefit to the liquid bleach business.

Unknown Analyst

Okay. Yes, that's what I assumed. And then secondly, you talked about the 10% differential in shipments between sort of non-compaction areas and compaction areas. Obviously, you're benefiting from some shelf space. What's the takeaway differential on those markets? Are you seeing -- how much of that is actually continuing or how much is just simply pipeline sell?

Donald R. Knauss

Yes. I would say right now, it's a little early to tell, John, because of the purchase cycle. Obviously, we think the bulk of it right now is the shelf fill because you're getting, as you said, more units on the shelf with the same revenue per bottle, so you got more revenue there. So I think we could give you a better answer when we get to the May earnings call. By then, we'll have a little bit more under our belt. Nik?

Nik Modi - UBS Investment Bank, Research Division

Don, I think it's fair to characterize Clorox as best-in-class when it comes to execution, especially at retail. And so I just -- I wanted to get your thoughts on white space within retail, outside of the Healthcare, Away From Home. Why not get more aggressive? I mean, you guys, obviously, have the capabilities to interact with retail and programs and merchandising, et cetera. Why not get more -- accelerate the white space opportunities that are probably out there?

Donald R. Knauss

Yes. Nik, I think you'll see that happening as we get into what we're calling more adjacencies. I'll give you an example, we're just rolling out right now Hidden Valley Ranch sandwich spreads. So we're getting -- broadening beyond salad dressing into sandwich spreads. Brita, when you leave here in the bag what you'll get from us, there's a hard-sided Brita On-The-Go bottle. You're going to see from us continued expansion on the innovation front into adjacent spaces. So that will continue to happen. We're also going to look at inorganic adjacencies that we might want to get after as well. Bill?

William Schmitz - Deutsche Bank AG, Research Division

Is there a change in the retail's behavior as it relates to pricing because I know there's been a series of price increases over the last 2 or 3 years, both of it sort of commodity pass-throughs, especially in your category. So as kind of commodities moderate, is it going to be harder to kind of keep these price points, you think?

Donald R. Knauss

I think, well, right now, Bill, I think you'll see from us basically one -- right now, we've got one pricing action on the books in the calendar year '13. That's a 5% price increase on spray cleaners, which is going in March, which is hooked to the new innovation on spray cleaners we have as tubeless bottle. I think we've been very careful about going to retailers with anything other than the cost justified price increase. So I think if commodities remain benign, then you won't see much pricing from us. We'll continue to focus on cost evasion, taking cost out and enhancing the customer experience. But I think any manufacturer that tries to go in with price increases now that are not commodity justified, are going to have a tough time with retailers.

William Schmitz - Deutsche Bank AG, Research Division

Because the reason I asked is that -- you sort of like -- you guys have done a lot of hard work to sort of offset the commodity beyond the pricing in terms of cost savings, whatnot. So do you think the retailers are looking at your gross margin, saying gosh, Chlorex did 100 basis points of gross margin expansion. This year, they're going to have to get some of that back even though it wasn't related to the commodities at all which has you guys being more efficient.

Stephen M. Robb

So let me just build on Don's comments. So first of all, on the pricing front, I would say keep in mind that we do have a large business still in International, it's a little less than 0.25%. So that business will continue to take pricing because as you can imagine, you've got inflationary pressures. As far as the gross margin outlook, we still think there's headspace with margin accretive innovation that we can bring out acquisitions over the long term that we think can help us build gross margin. And there's a lot of room still on the cost savings. So if the commodity environment is benign and we get this 150 basis points plus, and we've been on the plus end of this for quite some time, we think it's a reason to believe both gross margin and EBIT have got some headspace to continue to grow.

Donald R. Knauss

Ali?

Ali Dibadj - Sanford C. Bernstein & Co., LLC., Research Division

Two questions. One is to go back to the compaction question. And as you're kind of modeling this out, you don't have the answers today, but as you're modeling this out, for the launch -- do you think of -- what you're seeing, you're seeing clearly sales up. But again, that's just because same units but more in the unit. And if you see that the kind of return purchases are faster, it's clearly overdosing, which are all good things. But what's the longevity of that? So as soon as you lap your first, I think, Southeast rollout, what's the longevity of that growth going forward in that category?

Donald R. Knauss

I think one of the keys to that, Ali, is that one number I put up were the new users, younger, under 35 is up 6%. If we can keep that trend going where we're getting more users into the category again, I think that's the key to this, obviously, the sustainability of that growth rate. The other interesting thing was compaction has been we've seen a big surge in our king-size sales, much more than we thought we would see. So what's interesting about that is I think there's some consumer confusion that people are grabbing a king, which used to be the old kind of 96-ounce bottle, but they're paying $4 for it. So it doesn't seem to be a lot of sticker shock, so we're seeing more trade up, we're seeing more new users, younger users into the category and I think that's what really should bode well for us. We've also seen some share erosion as we talked about on the call over the last 6 to 9 months but that's fairly consistent with what happened over a decade ago when we moved on compaction from 128 to 96. It took a while for our consumers to get used to the fact that there are same number uses in that bottle. We weren't ripping them off or the private label was not ripping them off. So I think if all those bode well for over the next 6 months, we'll be able to give you a better answer.

Ali Dibadj - Sanford C. Bernstein & Co., LLC., Research Division

Okay. And the other question is around this innovation piece and it's under the umbrella, I guess, of -- you're expecting 3% growth from innovation and 1% -- no, actually more of less flat from price mix that's certainly higher. So under this question of do you or do you not have price power, how should we feel about that difference, right? How should we feel about that ratio? In other words, you're not taking pricing unless commodities go up. Your innovation may not even allow you to take as much pricing as you'd like. So do you really have pricing power in the end or are you really more -- do you need commodity to go up to really push your pricing up?

Donald R. Knauss

Well, I think that the only thing I would say about the pricing power, Steve, put the chart up, I can only go back to the past and reflect on the last 5 years and we have taken those 60-odd price increases, most of those, the vast majority are still in the market. And we have held or gained a little bit of share. So I would -- and while the vast majority of those price increases were anchored in a commodity increase, some were anchored in innovation or just improving the mix, I don't know, Steve, if you want to add anything either, Steve, but I think that would seem to demonstrate to us that those brands who are retaining their #1 or #2 status have some kind of pricing power. There's certainly a value offering to the consumer.

Stephen M. Robb

I would just build on that pricing power, we've absolutely seen it in the numbers. I mean, I think the proof is in the pudding, Ali. At the end of the day, when market shares are flat to up, we've taken 66% increases on the U.S. business covering 70% of the portfolio and the pricing is stuck and it's offset tremendous commodity pressures. And looking forward, I would just remind everybody that as we think of our pricing actions, it's not just about commodities. To Don's point, it includes new products, it includes wage inflation, it includes Healthcare inflation, which has been significant for a lot of companies. So there's a lot of elements to inflation. And as much as I'd like to think that inflation is going to be neutral for the next few years, we don't expect that. So we will take pricing over time to protect and build the margins. But again, the track record has been very successful here. And we'll continue to try to marry it up with innovation when we can.

Donald R. Knauss

Michael?

Michael Kelter - Goldman Sachs Group Inc., Research Division

Thanks for the incremental color on some of the international sales drivers. I want to talk about profitability for your International business. You've lost almost 900 basis points of margin over the last 5 years. With SAP now in place, how much of that recovery can we or should we expect and what may be the pacing of that?

Donald R. Knauss

So our margins in International -- profitability of our International businesses, obviously, had been challenged over the last 12-plus months. 2 real drivers for that. Number one are the investments we're making in SAP and those systems, some of which we're going to be lapping as we start to go into next fiscal year. So that's certainly going to help. The other thing has been the price controls in Venezuela and to a the lesser extent, but still importantly, in Argentina as well. So we've had a margin squeeze where inflationary pressures have been pushing on us while at the same point, it's been very difficult to get pricing through. We think the benefits, as Don talked earlier, in terms of looking at our SKUs, getting a better line of sight to how we spend money, where we spend it with SAP is going to allow us to fine-tune those businesses and begin improving margins, but it's going to take time. We fully expect that at least for this calendar year, our International business will be challenged from a margin profitability standpoint because we think the situation in Venezuela and Argentina will turnaround but it's not going to turn around over the next few months. We think we've got at least another year or more ahead. So you should see improvement over time but it's going to take a couple of years. Nonetheless, we have plans in place to rebuild the margins over the next couple of years.

Donald R. Knauss

Michael?

Michael Steib - Crédit Suisse AG, Research Division

My question relates to the 25 to 50 basis points margin improvement target that you have communicated. I was wondering what role mix, both category and geographic mix will play and then what assumption is underlying that?

Donald R. Knauss

Mix has been a bit of a drag on the margins actually. And if you go back over the very long term, it's probably been maybe half a point, maybe a bit less in terms of the drag on margin. I wouldn't expect mix will be positive. I think there's good things going on in mix when you hear about Brita growing quickly or Burt's Bees, those are obviously very beneficial to the mix and margins. But in general, this notion that consumers are trading up to larger more value-oriented sizes, we expect that will continue. But nonetheless, we know how to absorb that to the combination of cost savings, pricing and other things that we can do. So we don't see that as a showstopper for us to be able to get these margins growing at the 25 to 50 bp level. Chris?

Christopher Ferrara - BofA Merrill Lynch, Research Division

So with SG&A being targeted to get down to 13% of sales, which is pretty close to our best-in-class can you, I guess, talk about the margin opportunity? I mean, are we really -- we're playing for COGS at this point beyond that 13% or do you actually see more room beyond 13% of sales as you move out?

Donald R. Knauss

So I like your vision of 13%, I think I said 14%. But that's a good stretch goal to go to 13%. Again, over the next couple of years, as we anniversary the infrastructure investment, we think there's probably a full point of EBIT margin sitting in that SG&A line. It's not going to happen in 1 year. It's going to take time to get it but we think we can get it to 14% or less and that will help us. In addition to that, we think there's opportunity, obviously, in cost of goods sold. This idea of looking at the buy, make, ship whether it's materials we use, how we design or product even how we ship the product and load the trucks, we think there's good cost savings across all of those areas that should enable us to have good gross margin expansion over time as well. So it will be a combination is the answer.

Christopher Ferrara - BofA Merrill Lynch, Research Division

What about trade spending specifically? I mean, with the more benign commodities environment, how do you think about the opportunity to improve efficiency and trade? I know you've made strides there in the past but where do think you are in that progression?

Steve Austenfeld

Go ahead. You start it and I'll finish.

Donald R. Knauss

So we've actually put some very good tools in place over the last 24 months to get a better look at trade to make sure that when you a merchandising event in on shelf, that you know how it performed. And for example, if you're doing feature and display and you combine those, you get a better lift. And so, we think we've gotten better in terms of the ROIs on our trade spending. We clearly think there's more room there and that's an area we'll look at for continued efficiencies and cost savings over the long term. But at this point, I would say, it will be kind of slow and steady with some opportunity there.

Steve Austenfeld

No. I don't think it's unrealistic, Chris, for us to think about a 50 basis points reduction in trade spending this year. We see a trend where we're getting more efficient with the tools that Steve mentioned. So that certainly helps on a margin front as well. Anybody else?

Sally Dessloch - Integrated Finance Limited, LLC

We probably do have time for one more question, if there are any. Otherwise, we can convene to the breakout room. No? Okay. Thank you, Don and Steve, for a great presentation.

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