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The Clorox Company (NYSE:CLX)

Q2 2010 Earnings Call

February 4, 2010 1:30 pm ET

Executives

Don Knauss – CEO

Larry Peiros – EVP & COO Clorox North America

Dan Heinrich – CFO

Steve Austenfeld – VP IR

Analysts

Doug Lane – Jefferies & Co.

Ali Dibadj - Sanford Bernstein

Andrew Sawyer - Goldman Sachs

William Schmitz - Deutsche Bank Securities

John Faucher - JPMorgan

Connie Maneaty - BMO Capital Markets

Lauren Lieberman - Barclays Capital

Chris Ferrera - Bank of America-Merrill Lynch

Nik Modi - UBS

Karen Lamark – Federated Investors

Operator

Good day ladies and gentlemen, and welcome to The Clorox Company second quarter fiscal year 2010 earnings release conference call 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. Mr. Austenfeld, you may begin your conference.

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 of 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 website, www.thecloroxcompany.com.

On today’s call, Larry will start with comments on business unit performance as well as a perspective on the current category and share results. Dan will then follow with a review of our quarter’s financial performance as well as comment on our updated fiscal year 2010 outlook, as communicated in our press release this morning. Finally, Don will close with his perspective on key initiatives driving overall company performance. After that, we will open it up for your questions.

Let me remind you that on today’s we will refer to certain non-GAAP financial measures including but not limited to free cash flow, EBIT margin, and debt-to-EBITDA. 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 webcast prepared remarks, or supplemental information available in the financial results area of our website 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 press 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 10-K 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 over to Larry.

Larry Peiros

Thanks Steve and good morning to all of you on the call. As you saw in our press release we had another good quarter in what remains a very challenging environment. We delivered our strongest sales and buying growth in the last five quarters.

Brand support was up significantly behind higher levels of advertising, and increased trade spending to address competitive price gaps. Our earnings per share were up 26% as a result of our fourth consecutive quarter of gross margin expansion.

As you know I’m going to focus my comments on top line performance, highlighting sales and market share trends. Dan will follow with a review of our financial results. Starting with the US, consumer takeaway in our categories remained relatively stable.

Versus year ago, consumption in US tracked channels was down about 1% in Q2, a similar trend to what we’ve seen over the last several quarters. We grew our [health] share in three of eight categories and our overall US share was down a bit.

Private label share was up only slightly and private label growth was less of a factor than it has been in the last several quarters. More perspective tracked channels account for only about a third of our US business volume and as a result the tracked channel data is not the best indicator of our overall performance.

Our US volumes were 6% with shipments in untracked channels significantly outpacing tracked channels. On an all outlet basis we grew our market share nearly a full share point during the past calendar year.

In our international businesses, market share results are positive and we generally have seen stronger category sales growth primarily due to pricing. International volume was up about 1% driven by shipments of disinfecting products in Latin America.

Sales were up 21% due to price increases and favorable foreign exchange. Overall our categories in international markets are healthy. We grew share in a number of markets most notably dilutable cleaners and bleach in Latin America. Overall dollar share in Latin America increased 1.4 share points.

Our total company volume was up 5% for the quarter, gains were broad based with volume growth in three of four segments. Key drivers included higher shipments of disinfecting products due to the H1N1 flu pandemic, strong shipments of Brita water filtration products, and solid results in a number of other major brands.

In addition our institutional disinfecting products business while small, grew at very strong double-digit rates as healthcare institutions continue to increase purchases of our products to kill germs to reduce the spread of infection.

Sales for the quarter were up 5% in line with volume. Favorable foreign exchange rates contributed 1.7 points of sales growth offsetting higher levels of trade spending. As usual we saw differences in performance across the portfolio.

In our largest category home care, we grew share and maintained our number one over share position. Volume and sales were up due to strong growth in Clorox disinfecting products as well as strength in Pine-Sol, Liquid Plumber, and Formula 409.

Clorox Disinfecting Wipes had another very strong quarter driven by the H1N1 pandemic. [inaudible] was up more than 25% with exceptionally strong consumption early in the quarter. Disinfecting wipes consumption growth was more than 40% in October, but flattened out by December as concerns about H1N1 diminished.

We had an outstanding quarter in Brita with very robust volume and sales growth. This brand continues to benefit from the sustainability mega trend that consumers focus on value given the significant savings Brita provides versus bottled water. Our Filter for Good website remains one of our most successful internet marketing programs.

In food we continue to gain in the salad dressing category growing volume, sales and share. Despite its premium price Hidden Valley is winning with highly effective marketing and a great tasting product. In fact in Q2 we were the number one salad dressing brand in tracked channels for the first time in history.

We are now extending the brand into flavors other than Ranch. In December we launched Hidden Valley Farmhouse Originals in four flavors, from Creamy Parmesan to Garden Tomato and Bacon.

We saw improved results in our GLAD business in Q2. Volume was down only about 2% versus much larger volume decline during the previous four quarters. Trash bag shipments were up with volume growth on base trash bags and a return to volume growth in our premium ForceFlex and OdorShield products.

GLAD sales remained soft however primarily due to price rollbacks in our trash bags which brought retail prices more in line with current resin cost. The intense promotional activity we saw in the trash bag category during the last several quarters has moderated and retail pricing is becoming more rational.

We are also benefiting from the GLAD product improvement we began shipping in August. The ForceFlex trash bag that grips the top of the trash can and stays in place. As a result our trash share showed steady improvement during the quarter and our December share was up slightly.

Turning to laundry, we grew sales but our results were mixed across the two key brands. [Barks] bleach volume grew and share was down only slightly. In Clorox 2 however sales and share declined as a result of the intense competitive dynamics.

We are vigorously defending this business through marketing investment and we’re working to address price gaps. Last month we began shipping a new line extension of Clorox 2 in single dose packs that provide consumers greater ease of use.

On Burt’s Bees, volume grew in the mid single-digits. While Burt’s continues to be negatively impacted by economic conditions, we remain confident about the long-term prospects of this business. Our new natural acting solutions line continues to perform very well and last month we introduced a full range of Burt’s Bees natural toothpaste that are clinically proven to improve oral health.

Burt’s consumption growth remains in line with the natural personal care category and natural personal care continues to outpace mainstream personal care products. We expect consumption to further strengthen and along with international expansion fuel future volume growth.

Wrapping up we feel good about our Q2 and first half results especially given the economic environment. We believe we will continue to grow volume in the second half. Given that concerns about H1N1 flu appear to be waning we are anticipating a bit of a trough in our disinfecting products during the second half.

Net, net however we are confident that we can affectively manage our businesses to deliver on our plans and maintain the investment needed to keep our brands healthy for the long-term. With that I’ll turn it over to Dan.

Dan Heinrich

Thank you Larry, I’d like to provide some perspective on our second quarter and first half financial performance and discuss our updated financial outlook for the fiscal year. As I look at our Q2 and first half performance there are three key messages that you should take away from our results.

First we’re very pleased to see good progress in expanding our margins and we’re a bit above our estimates at this point in the fiscal year. While we’re not fully back to historical gross margins we strongly rebounded from a recent low quarterly gross margin in the year ago second quarter as commodity prices peaked.

Our Q2 gross margin increased almost 400 basis points and benefited from lower commodity costs, strong cost savings, and continuing benefit of price increases partially offset by increased trade spending and other costs.

Our EBIT margins increased about 130 basis points versus the year ago quarter. Our EBIT margin expansion during the second quarter was not quite as large as our gross margin expansion due primarily to the impact of Venezuela which I’ll talk about in a minute.

Second, we increased our investments in the long-term health of our brands. In times when consumers are looking for increased value in the brands they trust, and retailers are reducing assortment on the shelf, having strong leading brands is a key to success. Our success in these conditions is due in large measure to the strength and value of our brands to consumers.

We’re dedicated to making sure that they remain strong for new product innovation, increase marketing and sales efforts to create demand, and enhancing the value of our products to consumers.

Our advertising investment was up 19% in the second quarter and up 12% for the first half of the fiscal year. We have increased the level of our research and development and our in store support is also up for both the quarter and the first half of the year.

We also invested to close price gaps at the shelf versus competition to maintain or increase our products’ value to consumers. Third, while were not happy with the financial impacts we suffered in Venezuela, we’re effectively managing the situation and we’ve worked to contain the impact.

As we reported in this morning’s press release, we incurred a $19 million pre-tax loss due to currencies in Venezuela. There were two components to the Venezuela currency related pre-tax loss. First we incurred a $7 million pre-tax foreign currency transaction loss or about $0.03 per diluted share as we converted local currency to US dollars through the parallel currency exchange market to pay for certain inventory purchases in Venezuela during the quarter.

Second, we incurred a $12 million pre-tax loss or about $0.06 diluted EPS resulting from the remeasurement of certain assets and liabilities in Venezuela as we decided to begin converting Venezuela results at the parallel currency exchange rate effective December 31, 2009.

Our previous financial outlook for the second quarter anticipated a $0.03 diluted EPS loss from currency conversions but did not include the $0.06 diluted EPS impact from the remeasurement loss. For the past two years its been increasingly difficult to convert Venezuela currency to US dollars through the official currency exchange rate.

A substantial portion of our currency conversions to US dollars to pay for raw materials and finished goods inventory, is currently being done through the parallel currency exchange market. The Venezuela government devalued its currency in early January and introduced a two tier official currency exchange rate system.

We anticipate having little access to the official currency exchange rates. We’ve concluded that substantially all of our future Venezuela currency conversions will likely occur through the parallel currency exchange market making that the appropriate currency rate to convert our Venezuela results to US dollars.

As a result of this decision we’ll translate our Venezuela second half financial results at the parallel currency exchange rate. We anticipate that this action will reduce reported second half total company sales by just under two percentage points and reduce second half pre-tax earnings by approximately $20 million.

The anticipated profit impact which we had substantially accounted for in our prior outlook is included in our updated financial outlook which I’ll cover in a moment. While conditions in Venezuela remain highly unstable we’re taking the appropriate actions to enhance the safety of our personnel, protect our facilities, ensure supply, and limit the financial impact.

Let me turn to earnings per share, for the second quarter we delivered $0.77 in diluted EPS, a 26% increase from the year ago quarter which saw the biggest impact from increased commodities cost. Our Q2 diluted EPS results include the $0.09 impact from Venezuela as I just discussed.

The current quarter also reflects an effective tax rate of about 33% versus the 34% effective rate in the year ago quarter. The lower tax rate in the current quarter was primarily due to more favorable foreign taxes. For the full fiscal year we continue to anticipate that our tax rate will be in the 34% to 35% range although likely near the lower end of that range.

Our strong net earnings and improved working capital during the second quarter generated a 55% increase in cash flow from operations versus the year ago quarter. For the first half of the fiscal year cash flow from operations increased 29% from the year ago period.

We’re using that cash flow to support dividends and pay down debt. At December 31, 2009 our debt to EBITDA ratio was 2.45:1 which is now inside our targeted leverage range. Our balance sheet is very healthy and our cash flow generation gives us significant flexibility and investment funding capacity.

Let me now turn to our full year financial outlook which we updated in today’s press release. For the full fiscal year we continue to anticipate sales growth in the range of 1% to 2% although likely to be in the lower end of this range due to the impact of accounting for our Venezuela business at the parallel currency exchange rate.

This sales growth range includes the benefit of our strong first half results, and continued volume growth anticipated in the second half with these positive impacts offset by three factors; increased trade promotion spending and response to competitive activity, an anticipated third quarter slowdown in disinfecting product sales as previously discussed, and a second half negative impact of just under two percentage points related to Venezuela.

We continue to believe that foreign currencies excluding Venezuela will be about neutral to sales for the full year but slightly accretive in the second half. We now anticipate that gross margin will improve in the range of 150 to 175 basis points which reflects our strong first half margin performance, the benefit from continued cost reduction initiatives, and updated assumptions for commodity costs.

As you may recall at the start of the fiscal year we were anticipating a $90 to $110 million net pre-tax benefit from favorable commodity costs. We continue to believe commodity costs will be favorable for the full fiscal year. However due to recent increases in energy, resin, and wood input costs, we now anticipate the cost favorability for the year will more likely be in the range of $50 to $60 million, most of which we’ve realized in the first half of the fiscal year.

This outlook continues to assume modest gross margin declines in the second half of the year as we’re lapping extraordinary strong margin improvement in the year ago period as commodity prices collapsed. In addition we’ve increased the level of trade promotion spending in our plan which we expect will decline over time as the commodity cost reinflation we’re beginning to see moderates to the level of competitive promotional spending.

There will also be a small negative impact on gross margin due to Venezuela because the contribution from this higher margin business will be reduced as a result of the devaluation. Based on these assumptions and our strong first half performance, we now anticipate fiscal year 2010 earnings per diluted share in the range of $4.10 to $4.25.

This diluted EPS outlook includes the anticipated additional $0.09 negative impact in the second half of the fiscal year from Venezuela. Our increased diluted EPS outlook for fiscal 2010 is on top of 17% diluted EPS growth last fiscal year.

So to sum up, our brands continue to be strong. Our first half performance has been better than our expectations and we continue to deliver strong cost savings across all elements of the P&L. Despite some second half volatility we’re likely to see, we’re optimistic for the full year and are increasing our outlook for diluted EPS and margins.

While we anticipate the economic and competitive environments will remain challenging we feel good about our plans for the remainder of the fiscal year. Let me now turn it over to Don.

Don Knauss

Thanks Dan, and hello everyone. As Dan and Larry discussed we had a great second quarter and first half, I’m obviously very pleased with how the organization is responding to this environment to address competitive challenges while certainly I believe remaining vigilant about the long-term health of the business.

So as we wrap up the call I’d like to provide my perspective on the business results and outlook and I think there are four key takeaways I’d like you to consider.

First, we’re very committed to keeping our brands healthy and driving profitable volume and share growth. We’re supporting our brands aggressively as evidenced by this quarter’s increase in advertising. Additionally we continue to invest in trade spending to keep our on shelf pricing competitive.

Now on an all outlet basis, as Larry noted, we grew our overall share nearly a full share point in calendar year 2009. I think its really important to note that tracked channels, now only account for about a third of our volume so I think forming conclusions about our brand strength based only on tracked channel data can really be misleading.

We’re committed to a meaningful innovation, have a number of new products shipping right now such as the Hidden Valley Ranch dressings that Larry noted, Burt’s Bees toothpaste and Clorox 2 single dose packs.

And although the GLAD business is not performing as we would like, I think based on what Larry told you, you can see the trends are improving and we’re cautiously optimistic this trajectory is going to continue as we move through the second half of the year.

Second thing, we’re pleased that second quarter sales grew in pace with our volume growth. I think even with our significant investment in trade promotion spending, and I think that says a lot about the strength of our brands and our business mix.

Third, private label is slowing. And we believe the retail marketplace is returning to a more balanced approach to growing categories and generating traffic. In tracked channels where private label is the most developed, we’ve seen private label share growth rate drop as those categories have gone from 6.6% growth over the last 52 weeks and these are in Clorox categories, to less than 1% in the past 13 weeks and in fact to a decline of 1% in the past four weeks.

So with respect to our business I believe frankly there’s been too much focus by the investment community on private label. Private label has a meaningful presence across only about a third of our categories where we compete. And truly only in the last year that we’ve challenged primarily in bags and wraps which represent only 15% of sales and trends on that business as we noted are improving.

To grow categories effectively and efficiently I believe all our retail partners understand they need to offer both opening price points and differentiated national brands that invest in innovation and consumer communication to drive traffic. I think the point is, both have a role to play.

And fourth, as we’ve discussed on prior calls one element of our strategy is making targeted smaller acquisitions to drive growth. Our $23 million purchase of Calltech Industries is an example of that kind of tuck in acquisition.

This is an expansion of our away from home business. It increases our ability to serve the healthcare industry where the use of disinfecting products is growing rapidly in response to the increased attention on killing germs to help prevent hospital acquired infections.

For those of you who are not familiar, Caltech Dispatch, their number one brand is the number one brand of disinfectant bleach in the healthcare industry and their cleaners and wipes are also used in nearly 1000 hospitals.

So this increases our penetration in hospitals from 600 to almost 1600 hospitals. The company is based in Midland, Michigan and has a 30 year history devoted solely to disinfectant for healthcare customers. To date, the use of disinfecting bleach has been a relatively small portion of this market but now is growing more rapidly because bleach has been proven effective at eliminating some of the toughest pathogens including [c dip spores] which can cause a wide variety of symptoms including life threatening intestinal disease and which is a key disinfecting challenge for hospitals.

And as Dan noted with our debt to EBITDA level within our targeted leverage range the Caltech acquisition I think is a really good example of using our strong cash flow to expand our portfolio of leading brands where there is some strong tailwinds to drive growth.

So in summary, we had a great first half. Our folks are managing the business in this environment while looking out for the long-term health of the company. I think we’re executing our 3D demand creation model that we’ve talked a lot about as well as anyone, is evidenced by our share gain.

We’re raised our outlook for the second consecutive quarter and we anticipate continued volume growth in the second half driven by our focus on our core businesses and brands, which we believe are really enjoying some tailwind trends out there around health and wellness, sustainability, and affordability.

So we’re very pleased at our fiscal 2010 results are anticipated to be better than previously projected and with that we are ready for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Doug Lane – Jefferies & Co.

Doug Lane – Jefferies & Co.

You have a lot of new product activity happening around now, can you quantify how much of that 5% volume growth might have been some sell in of your new products.

Larry Peiros

Overall in the year we typically target two our three points from new product incremental, sales from new products. I don’t think there was extensive activity in the second quarter. So I don’t think that accounted for a big portion of that 5% growth.

Doug Lane – Jefferies & Co.

And secondly can you talk about two our three categories that are perhaps most competitive. I imagine Clorox 2 would be one of them but maybe if you could go beyond that to the next one or two, what you’re seeing on the competitive front.

Larry Peiros

So Clorox 2 category definitely tops the list as you said, the trash category has been competitive but as we pointed out, I think things are getting a little bit more rational at this point and some of the intense trade promotion has dissipated a bit. So I think we’re feeling better about that category. Cat litter has also been a bit of a competitive category with quite a bit of trade spending going on.

Again I would say its getting a bit more rational at this point, but those are the top ones probably that I would mention.

Doug Lane – Jefferies & Co.

And can you comment on trading conditions in Mexico.

Dan Heinrich

Really nothing to report. We would view it in our categories anyhow as relatively normal competitive activity.

Larry Peiros

Is there something you’re considering there.

Doug Lane – Jefferies & Co.

Yes, the political unrest overall in Mexico coupled with the recession that they’re in, just some people have just found it to be an increasingly difficult market and I wondered if you’re starting to see similar patterns there.

Don Knauss

The only thing I would add on Mexico, Mexico for us is one of our smaller Latin American markets when you contrast it to Argentina, Chile, Venezuela certainly. We haven’t seen any material change in our business in Mexico. With the advent of H1N1 in Mexico when it started we saw really strong pickup in our sales because most of our business in Mexico, a lot of our business in Mexico, is in the disinfecting space. So for us it hasn’t had a material impact.

Operator

Your next question comes from the line of Ali Dibadj - Sanford Bernstein

Ali Dibadj - Sanford Bernstein

Wanted to see if you could please talk a little bit more about the sustainability of volume growth particularly in the areas where you had really good volume so in cleaning and lifestyle, you mentioned a little bit of a slowdown given the H1N1, I wanted to get an understanding if you can quantify that a little bit and similarly on Brita I guess in lifestyle.

Larry Peiros

Brita in particular has been on fire for quite a long times so we’ve seen basically strong double-digit gains I think going on for two years now, behind this phenomenon around people being concerned about bottled water waste, coupled with the fact that in a tough economic times the value of Brita is immense versus buying individual bottled water.

So we haven’t seen that dissipating whatsoever, in fact we had an exceptionally strong quarter in Q2 and would expect that to continue. And obviously we’re also spending behind that so we’ve taken advantage of the additional volume to invest more behind the brand, particularly in the internet space and social media space.

We’re getting a lot of good PR value out of that so, we are forecasting continued strong growth on the Brita business. H1N1 there was a phenomenon and it really started Q4 of last year where we saw a fairly dramatic pickup on brands like wipes, but brands not just in the homecare US business but also in the international business and our away from home business.

We are seeing obviously H1N1 concerns dissipate. Now that could change and we have no control over that, but based on what we’re seeing in the market today and the slowdown we saw in consumption in the second quarter we expect a bit of a trough particularly in Q3 on our disinfecting products and then as we go into Q4, we’ll start indexing off of that higher base.

So obviously there’s a bit of a boom for us in the first half and will dissipate in the second half but we still have an immensely successful wipes and generally disinfecting business so we feel great about that.

Don Knauss

I think the only thing I’d add to Larry’s comments on your question around categories its interesting when you look at the all outlet data and you look at cat litter for example, we’re seeing over the last 52 weeks strong single-digit growth in that category. We’re seeing the same thing, low single-digit growth in food, but solid growth there. And I think this gets to the fact that people are staying home more.

We’ve seen the same kind of phenomenon with mid single-digit growth in charcoal. So I would think as long as the economy remains challenged which we don’t see that changing in the next 12 to 18 months for sure, but if this trend towards people staying home more bodes pretty well for some of our categories.

Ali Dibadj - Sanford Bernstein

And just to recap a little bit so lifestyles still roughly double-digit is what we should think about and cleaning still positive growth but low single-digits is how we should think about it, is that fair.

Don Knauss

Well I think in cleaning, I think the real spike up in the category in cleaning is obviously been around the stain fighting category, color safe bleach category where we’ve seen low teen growth in the category. We’ll see that spending is probably going to continue to play out for the balance of this fiscal anyway, but I think its going to, as Larry said, its going to continue to kind of drop down as we get past that spending.

Larry Peiros

And the different pieces of those segments are performing differently but I think overall we would expect kind of single-digit growth in cleaning and closer to double-digit or above in lifestyle based on current trends and forecasts.

Ali Dibadj - Sanford Bernstein

And I guess, part of the reason I asked that question I’m just trying to understand a little bit about the price elasticity you’re seeing. So is it that the price sensitivity is just as you would have expected, clearly in North America market pricing including no trade spend or promotion, down in cleaning, down in household, down in lifestyle, internationally the only place that’s growing, we’ll put international aside for a moment, are you seeing the elasticity you would have expected or is it less than you have expected if you pull out the H1N1 and perhaps some of the Brita broader themes here.

Larry Peiros

I don't think the elasticity has changed very dramatically. I think you know of our history, we’ve taken 40 plus price increases, did a lot of price modeling and those models were exceptionally predictive. I think what’s going on today is we got competitors that are either launching new products or in most cases just infusing more trade spending and being more competitive.

So I think we’re playing little mini battles on the trade spending kind of pricing front versus seeing some fundamental change in consumer dynamics around the elasticity.

Ali Dibadj - Sanford Bernstein

Because the scary thing is, could potentially be going forward if that pedal to the metal from competitors and yourselves don’t, doesn’t release a little bit and you have to put in more pricing to get these volumes but commodity starts to peak up as you look forward between the back half of this calendar year, so the expectations it sounds like is that people are going to let go a little bit of being aggressive on pricing as commodity peaks up are not willing to take the hit folks used to take a year, year and a half ago, on the gross margins. Is that how we should think about it.

Larry Peiros

I think the likelihood is commodities go up again, we’ll probably see reductions in trade spending first and then ultimately if those are substantial changes in commodities, we’ll probably see pricing actions.

Operator

Your next question comes from the line of Andrew Sawyer - Goldman Sachs

Andrew Sawyer - Goldman Sachs

I was hoping to get a little more color around your thoughts on uses of cash, as leverage levels get down, I know you had alluded a bit to some tuck in deals but I guess the magnitude of the one you did is obviously relatively small, how are you balancing buyback versus deals and what kind of opportunities are you seeing in the deal pipeline.

Dan Heinrich

On use of cash obviously we’ve been using our free cash flow to pay down debt. That was our goal to get back inside this 2 to 2.5 times debt to EBITDA. We are really pleased to get back inside that leverage range in the second quarter. So I think we have flexibility going forward. Our historical profile has been to buyback shares to offset dilution. I think you can assume that we will begin that again more likely probably in fourth quarter then third quarter.

But we’ll reassume that posture. And as we’ve always done we’ll look at what our investment needs are and if we don’t have the use of the cash in the business we’ll certainly look at share repurchases to return that cash to shareholders. In terms of the deals I think the Caltech acquisition is a great example of little tuck ins that we’ll do but again its not meaningful to cash flow. We can do a fair bit of those.

And in terms of deal flow and other things we’re looking at there’s just nothing on the horizon right now that I would speak to and so I think our posture in the second half of the year will be looking to resume at a minimum share repurchases to offset dilution and continue to support the dividend.

Andrew Sawyer - Goldman Sachs

And then I think you alluded a little bit to an expectation that the promotional environment will back off going forward just as commodity declines, start to moderate, have you seen any early inklings of that in some of the categories where that’s been more of an issue.

Larry Peiros

I think we talked specifically to the trash bag category and that’s where we’re definitely seeing things moderate as resin prices tick up a bit.

Andrew Sawyer - Goldman Sachs

And then just on the trash bag, any quick comment on [inaudible] taking over the private label supply contract at Wal-Mart, does that mean anything to you or is that just something we shouldn’t worry about.

Larry Peiros

I don’t think that really has much of an impact on us, obviously there’s a role for private label in the trash category as well as branded products and we like private label’s competitor so it shouldn’t have any effect on our ability to build our brand at Wal-Mart or elsewhere.

Operator

Your next question comes from the line of William Schmitz - Deutsche Bank Securities

William Schmitz - Deutsche Bank Securities

First question has to do with kind of what happened during the downturn, because a big part of the business is sort of health and wellness and convenience and my guess is that that stuff probably slowed a little bit. I think this is the first call we haven’t really talked about Green Works. As I think about volume growth going forward is there assumptions that that stuff probably comes back because I know its more discretionary but its also more value added, so is there anything in the plan along those lines.

Larry Peiros

So Green Works and obviously Burt’s have definitely taken a hit from current economic situation. We still absolutely believe in those two businesses and we think over the long-term they’ll obviously return to more substantial health. Green Works has taken probably more of a hit of late. The categories have definitely softened. We have taken some pricing moves across the Green Works line to reduce our premiums versus traditional products.

A lot of that is based on cost savings that we’ve been able to develop on some of those key products. And going forward we will continue to be a very, we’ll take a very targeted approach to talk to the consumers that are more open to those messages. So I would say certainly we have taken a hit on those brands, or reduced growth in those brands today.

But we still see those as opportunities over the long-term.

Dan Heinrich

Particularly as we look at Burt’s we saw some nice growth in the second quarter, as we go into the second half in particular Burt’s will begin to index and lower numbers in the year ago period. So the positives there is we’ve seen that category return to the mid to higher single-digit growth rates so the overall category is returning to growth again.

That growth rate is well above conventional personal care so it looks like the category is returning to health, consumers are coming into that category and I think the combination of that category expansion as well as Burt’s efforts to expand internationally along with some of the new products that they’re launching I think we feel pretty good about Burt’s performance in the second half of the year.

William Schmitz - Deutsche Bank Securities

So I think [inaudible] talked about pricing, and I don’t think there was any mention from you, you talk about promotional environment being intense, but they were pretty quick to point out and I think it was probably for your benefit, that they were taking pricing, [inaudible] into the year so I’m just wondering if you could react to that.

Larry Peiros

My best guess is you will see reduction in trade spending before you’ll see any pricing moves. We’re not announcing any pricing moves. We’re not anticipating any pricing moves. But I can’t predict the cost of resin unfortunately so things can change over time. But right now it would probably be more of move on the trade spending side versus the price side.

Dan Heinrich

And we look at the resin markets right now, there was a forced in price increase in resin that went in in January and stuck. There’s another probably $0.14 of announced price increase in the market. Pretty unclear whether any of those stick. But if you kind of look at where oil and everything is trading right now, oil has been in the $75 to $80 trading range.

My guess is if it doesn’t move materially outside of that range for an extended period of time, I’m not sure that would lead to support for pricing actions.

Operator

Your next question comes from the line of John Faucher - JPMorgan

John Faucher - JPMorgan

In terms of looking at your earnings guidance it seems as though you’re looking for a nice increase in ad spend in the back half of the year, most likely to support the new product activity is the order of magnitude in that increase as a percentage of sales similar to what we saw in the first half or I guess probably maybe a little bit less, can you give us a little bit of color there.

Dan Heinrich

Again our target is 9 to 10, we had a strong increase obviously in the second quarter and that was planned all the way along. As we look at the second half of the year, we’re still likely to be in the middle to the higher end of that range and I think that’s a pretty good increase. I forget exactly what we had in the year ago period, but it should be, I think you should plan for in the higher end of the 9 to 10% range in the second half.

John Faucher - JPMorgan

For the second half or for the year. I guess probably actually its going to end up being both.

Dan Heinrich

It will end up being both given what we did in the first half of the year.

Operator

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

Connie Maneaty - BMO Capital Markets

Can you talk about Green Works and the pricing actions you’ve taken, was it a reduction of list price or increased trade promotion to narrow the price gap and secondly what is the status of Green Works detergent right now.

Larry Peiros

Actually the biggest pricing move has been on the detergent product and I think we’ve already talked about that its been below expectations although it has stabilized. And that’s the product where we were able to reduce the cost of the formula without reducing the performance of the formula so we essentially translated that into a fairly substantial price decline.

That’s currently being executed in the from of trade spending but will ultimately be a permanent rollback. So more of a truckload rollback. So that’s the place where we’re readjusting the pricing on Green Works most dramatically. We anticipated we were going out with it something like a 20 to 25% premium while we launch and given all the activity in detergents, that turned out to be a much more substantial premium so we’re looking at a premium that’s probably going to be pretty close to zero versus the premium products at least on an everyday basis.

So unpromoted value versus the leading brand would probably be about parody.

Connie Maneaty - BMO Capital Markets

And are you getting placements for Green Works detergent.

Larry Peiros

So we do have distribution and obviously we’re looking for additional distribution opportunities with these new pricing moves. I wouldn’t say we’ve seen any dramatic movement of late.

Don Knauss

The other thing I would add on Green Works is basically think of Green Works as three different businesses, you’ve got the homecare the original five SKUs we launched and then the light duty liquid dishwashing soap, and then detergent.

I think the pricing on the homecare items and light duty liquid are in this 10 to 20% premium. When we initially launched detergent it got into the 30 to 505 premium depending on the retailer so what we’re really doing now is adjusting back to the original strategy we had for pricing on the first homecare launch and then the light duty liquid launch.

The good news for us in this brand or in this franchise is that the latest repeat data we have on our homecare line is its stabilizing in fact its been growing but its in the low 40’s for repeat so it has the best repeat of anything we’ve seen in the natural space.

And repeat is building on detergent as well, so the issue is trial. And we think getting these price points down closer to conventional leading brands is the key to the trial.

Operator

Your next question comes from the line of Lauren Lieberman - Barclays Capital

Lauren Lieberman - Barclays Capital

I just have a quick question on the level of volume growth in the household business particularly around GLAD, so it sounds like trash is obviously getting better, is there in fact a drag from food bags having fewer facings going forward and if so, does that sort of impact the volume numbers for a couple of quarters that would maybe keep a little bit of a lid on volume growth in that division to the rest of the year.

Larry Peiros

We definitely have seen, we are seeing weak trends in our food bag business. For quite some time, it’s the only good news there, its gotten quite a bit smaller. That doesn’t have as much impact on the overall business but we don’t foresee that changing in the near-term.

Lauren Lieberman - Barclays Capital

And was it particular to this quarter and then thinking about the next two, is that a drag we should be thinking about because it just sort of looks like in this quarter with the big step up in promotion in the household business with volume stabilized which is good but we didn’t get growth yet. As I look over the next two quarters is there still a drag in there from food bags having fewer facings or is it so small I shouldn’t even think about it.

Larry Peiros

There is a drag.

Lauren Lieberman - Barclays Capital

Okay so trash has started to improve and is growing and is expected to grow the rest of the year and then a little bit of an overhang, but really the biggest overhang in that division at this point is the food bag business because everything else is really stabilizing and starting to grow.

Larry Peiros

Correct.

Lauren Lieberman - Barclays Capital

And then in cleaning do you have any sense yet, you talked about a trough that means you actually expect shipments for disinfecting products to decline in Q3—

Larry Peiros

Correct.

Lauren Lieberman - Barclays Capital

And then you think though its probably like a one quarter thing because its really just a matter of an adjustment and things can kind of stabilize by the end of the year.

Larry Peiros

We don’t have an incredibly accurate estimate but obviously retailers built inventory as they saw the demand increase. We also think consumers built their pantry inventory as a result of the H1N1 concerns. So based on the slowdown we’re seeing in consumption even in Q2 we anticipate there’ll be a bit of trough in Q3 and again, we talk about wipes a lot but this accrues to really all of our disinfecting products US and international.

In Q4 we actually start indexing it against the front end of the H1N1 pandemic so we had a fairly high base period in Q4 of a year ago and so we’ll start indexing off of that so we may look less robust in terms of growth just because of the base period.

Don Knauss

I think the interesting thing for that particular sub segment of that division, cleaning division, wipes in particular is going to be this is the product line that we’ve talked about this for a long time that has about 355 household penetration as a category. With the advent of H1N1 obviously we saw huge swings up in consumption. What’s going to be interesting in the second half of the year is to watch what happens to household penetration if we retain some of those users going forward.

Lauren Lieberman - Barclays Capital

And then on the acquisition because its obviously you said small but its great news because you’ve been looking to do something in this area for awhile. Are these businesses, does it tend to be regional like these guys are based in Michigan, so it sort of services a certain geographic region and it’s a little bit of a consolidation play that way.

Don Knauss

Its not really a regional business, as I said their Dispatch brand which is the number one brand in bleach based products for the healthcare industry. Its not really a regional business, its pretty widely distributed. I think to your point the interesting thing for us in this is our reach into 600 of the 6000 hospitals that are out there, and their 1000 hospitals is almost totally unduplicated reach.

That was one of the big attractive features of Caltech and their sales organization for us is they virtually have these relationships in a totally different footprint of hospitals than we do.

Operator

Your next question comes from the line of Chris Ferrera - Bank of America-Merrill Lynch

Chris Ferrera - Bank of America-Merrill Lynch

So you mentioned private label swelling, I just want to get an understanding of the nature of that. I guess (a) can you talk about what categories in particular you’re seeing it, if its disproportionately large in any of them and then also is that really just the lapping of big moves or is it related to anything specific that you or maybe other brands have been doing. Just trying to get a sense of whether it’s a lap or whether its some kind of change.

Larry Peiros

Its probably a combination of factors, obviously but there has been a slowdown considerably and I think private label’s in our collectively categories, tracked channels US were up about 1%. So quite a bit different than the trends we’ve been seeing which are high single-digits or even double-digits in some past quarters.

Three categories that we talk about a lot that have a fairly high level of private label presence would be [hyper choleric] beach where our share in the last quarter was about flat. The GLAD trash category where again our share is about flat. Charcoal there was a bit of a pick up in private label in the quarter although obviously OND is not a big quarter for charcoal.

So we are seeing a pretty dramatic difference in terms of private label performance in the last quarter versus what we saw in the last say four to six or four to eight quarters.

Don Knauss

And just for perspective if you take bleach as Larry noted in one of the three categories where we really interface with private label, I talked about the last 13 weeks private label in all of our categories combined being up about 1% they’re down 26% in measured channels in bleach. So there’s a huge swing down in bleach as we certainly got more focused on that category by managing our price gaps.

So you can see that there’s some real dramatic swings down in certain categories where we’re the primary brand.

Chris Ferrera - Bank of America-Merrill Lynch

So in your view this is not just a lapping, in bleach specifically, its not a lapping it’s a response to some of the competitive actions you’ve taken to mitigate their growth.

Don Knauss

Its interesting because that almost 26% decline in the last four weeks, its 25% decline in the last year so as we continue to advertise in that space and we also not only with our detergent alone, there’s not enough campaign but also the alternative uses of bleach and we’re managing our price gaps down and we have some innovation, I think its clearly paying off in that category.

We see other categories like in wash stain removers as well where’s there real pressure on private label because of all the branded spending that’s going on in those categories. On the other hand we’re seeing some responsiveness, some robustness in private label in the charcoal category although that’s starting to wane as well.

But I think where you see the branded people really spending and innovating you’re seeing private label react as it has done historically.

Chris Ferrera - Bank of America-Merrill Lynch

On a totally other note, have you seen in the natural cleaning lines, have you seen retailers to any extent lose their nerve. I understand consumption trends are down in things like Green Works but what about the space allocated to these higher priced cleaning products. Has that remained constant through this.

Larry Peiros

No there definitely has been some distribution losses going along with the category slowdown. So I think there’s a lot of customers, retailers that are still very committed to this space but obviously they’re responding to the opportunities. Quite frankly there are also a lot of [inaudible] products introduced that created a lot of extra SKUs in the category that didn’t deserve to be on the shelf.

So there’s been some winnowing down of those as well.

Chris Ferrera - Bank of America-Merrill Lynch

And then finally I guess one last one, the hard conversion to, I thought that you were going to see some impact this quarter from it, and I don’t know if I missed it and you talked about it, but could you see pressure from increased promo related to hard conversions that are happening and what’s the scheduling of the product pipeline relative to what it was say three months ago or six months ago.

Larry Peiros

I don’t think we’ve seen anything dramatically different on the conversions, probably charcoal is the biggest conversion for us where we’re going to a [heartened] version on a new product that actually weighs less than the previous product which is why it’s a hard conversion.

We’ve also got some changes in packaging on our cat litter business and I think those are all going as anticipated, nothing out of the ordinary on those conversions.

Chris Ferrera - Bank of America-Merrill Lynch

But there was a drag this quarter related to extra promo to move product from older products, stuff like that.

Dan Heinrich

We already had in our plans to move that product and as Larry said particularly in charcoal we’re on track with that plan.

Operator

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

Nik Modi - UBS

Just on the planograms as they’re all getting set right now at retailers, can you give us any perspective on how you feel about your shelf allocation and if you’ve seen any more incremental wins on that front. And then we’ve seen, I guess for the past few quarters a couple of incremental headwinds to the P&L whether it be Venezuela or some of the input cost inflation, your guidance has been held or raised and I’m just curious of where you’re finding that flexibility or where the upside is to allow you continue to raise your targets.

Larry Peiros

On the assortment front we feel good about some testing that we have in place and generally speaking as you know, generally to our advantage to reduce the numbers of SKUs in any category because we tend to be the leader in the category. So we tend to be the winner. And while we still see that as an opportunity I think we would tell you that to date we haven’t seen dramatic movement.

If you did some simple arithmetic on [inaudible] or Nielson data on the number of items in a store or in our categories, you wouldn’t see dramatic movement so we’re seeing some puts and takes. Some things that are benefiting us and we have some tests in the marketplace that we feel good about but I wouldn’t say we’ve seen the dramatic movement that we might have thought we would have seen.

Dan Heinrich

And in terms of our margins, we feel really good about our progress in the first half of the year. We’re a little bit ahead of our own expectations and its really kind of across the board, cost savings, continued cost savings, some of the other actions we’ve taken so we feel good about where we are.

We will be comping some pretty high margin increases in the year ago period because as you recall that’s when commodity prices collapsed. In our model it tends to be somewhat flexible. We try to drive a high level of cost savings. And we’re certainly on track. We’re on track for $115 to $120 million of cost savings this year the bulk of which will be in cost of goods sold, but we have other cost savings in other parts of our operating model.

Efficiency of our ad spending, our ROIs on that are improving. And we try to drive efficiency throughout the P&L and we’re awfully disciplined on the SG&A side as well. So as these things pop up, Venezuela was unfortunate but I think we’re managing through it effectively and our outlook also had a range of possible outcomes so we had some flex already sitting in the outlook range that we had.

But we’re able to respond to a certain extent to help absorb and drive performance and we’re not quite back to our historical margins but we’re certainly working to get there. Let me just comment on commodity reinflation, so most of the favorability we had expected to see in commodities did occur in the first half of the fiscal.

So as we look out into the second half of the fiscal year while we are seeing some commodity reinflation its pretty modest. Even though we’ll be comping against some big improvement numbers in the year ago the actual inflation we’re seeing is relatively modest. So as we look out, our margin expansion model is predicated on doing $80 to $90 million of cost savings a year and hopefully commodity inflation is in the $40 to $50 million range a year.

And if we can stay inside those parameters, we would anticipate continued margin expansion.

Nik Modi - UBS

And just to clarify, trade spending is two to three points in your P&L correct. Is that what you’re budgeting for the year.

Dan Heinrich

You mean the net increase.

Nik Modi - UBS

Yes.

Dan Heinrich

Yes, you can call it in that range and that’s baked into our second half and that will impact our margins. As we’ve said though as commodities continue to increase we are seeing that start to impact the trade promotional environment and particularly as we look forward, assuming we even just stay in the range that we’re at today, we would expect some of that trade spending to subside and we should be able to bleed that expense out of our P&L.

Operator

Your final question comes from the line of Karen Lamark – Federated Investors

Karen Lamark – Federated Investors

With Caltech you expanded your distribution effective with the store rate or the customer base, but what penetration opportunities might you have in particular with your own products. I’m just sort of curious if you can leverage your own portfolio more aggressively.

Don Knauss

Let me give you an example, I think with bleach based products just for some background, about a billion dollars is being spent by the healthcare industry on hard surface disinfecting primarily in hospitals but other acute care facilities as well like nursing homes.

Of that billion dollars only $30 million is bleach based. As the advent of hospital [inaudible] infections has really taken off where basically one out of ten people acquires an infection in a hospital bleach is the only thing certified by the EPA to kill [c dip] for example which is one of the leading causes of those infections.

So what we’re seeing from healthcare professionals is a much bigger interest now in bleach based products so we think the combination of our germicidal wipes and other products that are Clorox branded along with Dispatch from Caltech, we’ve got an opportunity to really develop protocols.

For example in New York Presbyterian one of the more significant hospital chains in the country, we’re selling hundreds of thousands of dollars worth of bleach based disinfecting products and we’re trying to take that best practice and model that across the country now. It doesn’t take much arithmetic to figure out if a small percentage of the 6000 hospitals are on the same protocol as New York Presbyterian which is having big success, managing these infections, it opens up a significant growth opportunity and we could do something good for the consumers out there.

So we’ll continue to look at those best practice cases like New York Presbyterian and try to drive that with this expanded sales force now across the country.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Don Knauss

Thanks everyone for joining us today. As I think you all know that we had a terrific second quarter and first half of the year and we look forward to discussing our third quarter with you in the next few months so, thanks again and we’ll look forward to speaking to you on the next call. Take care.

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Source: The Clorox Company F2Q10 (Qtr End 12/31/09) Earnings Call Transcript
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