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Executives

Kirsten Chapman – IR, Lippert/Heilshorn & Associates

Bruce Wood – President and CEO

Joe Baty – EVP and CFO

Analysts

Michael Gallo – C.L. King

Ian Corydon – B. Riley & Company

Damian Witkowski – Gabelli & Company

Steven Gregory – Mandalay Research

Schiff Nutrition International, Inc. (WNI) F1Q2011 Earnings Call Transcript September 14, 2010 11:00 AM ET

Operator

Good day, ladies and gentleman, and welcome to the Schiff Nutrition International fiscal 2011 first quarter conference call. My name is Michael, and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of today's conference. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today's conference, Ms. Kirsten Chapman. You may proceed.

Kirsten Chapman

Thank you, Michael. Thank you all for joining us this morning for the Schiff Nutrition International fiscal 2011 first quarter results conference call. By now, you should have received a fax or email of the press release. But if you have not, please contact us at Lippert/Heilshorn & Associates at 415-433-3777, and we will forward a copy to you immediately.

As a reminder, this call may contain forward-looking statements. The risks of which are the same as those described in the Safe Harbor language in the press release and those details in the company's SEC filings. Actual results may differ materially from those described during the call.

With us from management today are Bruce Wood, president and chief executive officer; and, Joe Baty, executive vice president and chief financial officer. It's my pleasure to now introduce Bruce. Please go ahead.

Bruce Wood

Thank you, Kirsten. And good morning, and welcome to the first quarter call. We were encouraged with our strong brand of sales performance, which drove an overall 5.9% net sales increase on a quarter-over-quarter basis and more than offset the decline in our private label business.

With respect to the key profit measures, we maintained a solid 39.5% gross profit margin. And although our operating margin declined on a period-over-period basis, this was strictly a function of a significant increase in consumer advertising and other marketing support in the quarter. The increased marketing support was primarily directed at our Schiff MegaRed Krill Oil product, which continues to perform strongly having achieved virtually full national mass market retail distribution in the fourth quarter of fiscal '10.

In the first quarter, Schiff MegaRed benefited from national TV print and online advertising, FSI couponing, in-store sampling, PR support, and customer-specific promotions. In the first quarter, the overall mass market supplements category, as measured by IRI, maintained a mid to high single-digit growth rate. The fish oil segment continued to grow strongly, a positive factor for Schiff MegaRed.

At the same time, the joint care segment remains growth challenged and continues to be very pricing promotion driven. Within this environment, we continue to support our Move Free flagship brand and other Schiff-branded joint care products. Move Free first quarter marketing programs included print and online advertising, FSI coupon support, grassroots PR efforts, and customer-specific promotions. We also completed certain (inaudible) class specific adjustments and promotion and pricing tactics in order to improve our overall competitiveness on the value dimension.

Our joint care business overall registered a modest net sales decrease on a quarter-over-quarter basis as we face overall joint care segment weakness, coupled with some specific retailer inventory reductions. We believe we have the plans in place to maintain our joint care competitive position in the coming quarters.

On the new product front, our new Schiff Mega-D3 product reached the shelves of certain retailers in the first quarter, and customer specific promotions and an FSI coupon supporting the product were initiated. The marketing program behind Mega-D3 ramps up in our second quarter when we commence national TV advertising, in fact, starting next week. We expect to have more information on Mega-D3 sales performance on our second quarter call.

With respect to our private label business, the first quarter sales declined versus the prior year period, in part reflects our transition out of some business lost and into new business won. As noted in our last call, we have held our own, competitively speaking. But we do expect the private label business to continue to be volatile in the balance of the year. And we expect to experience continued margin pressure as competition remains intense. That said, we're confident in our ability to compete effectively in private label based on our reputation for high quality, excellent customer service, strong customer relationships, and our solid financial condition.

We're optimistic about our future prospects overall. And our commitment to delivering shareholder value is reflected in today's announcement of a $0.70 per share special dividend payable to shareholders of record as of close of business September 23rd, with proceeds to be distributed on October 26th. We are confident that the company will continue to generate positive operating cash flows in the future and that our post dividend cash position will provide the financial flexibility to fund growth initiatives, invest in our facilities, and explore acquisition opportunities.

Let me now turn the call over to Joe for his comments.

Joe Baty

Thank you, Bruce, and good morning to everyone. Earlier today, we announced our financial results for our fiscal 2011 first quarter. Fiscal 2011 first quarter net sales overall increased 5.9% to $51.4 million from fiscal 2010 first quarter net sales of $48.6 million. Net sales increased due to an 11.8% increase in first quarter-over-first quarter branded sales, primarily resulting from increased MegaRed business, including the benefit of expanded distribution during fiscal 2010. Aggregate branded sales amounted to $40.1 million and $35.8 million, respectively. Private label sales were $11.3 million for the current quarter, compared to $12.8 million for the prior year quarter.

Gross profit as a percentage of net sales was 39.5% for both the fiscal 2011 and fiscal 2010 first quarters. The current quarter percentage primarily reflects the benefit of the higher mix of branded sales offsetting tighter margins on private label sales. The branded-private label mix may change in subsequent quarters. The overall impact of raw material costing was modest on a first quarter-over-first quarter basis.

Total operating expenses were $14.4 million or 28.1% in net sales for our fiscal 2011 first quarter, compared to $12.1 million or 25% in net sales for our fiscal 2010 first quarter. As a percentage in net sales, selling and marketing expenses increased to approximately 18.1% for the fiscal 2011 first quarter from 13.7% for the prior quarter, primarily due to an increase in advertising costs. Fiscal 2010 first quarter advertising costs were lower than initially expected last year due to the temporary delay in certain MegaRed promotions. The modest $0.3 million first quarter-over-first quarter reduction and other operating expenses primarily reflect the decreased research and development costs.

Reported operating income was $5.9 million for the fiscal 2011 first quarter, compared to operating income of $7 million for the fiscal 2010 first quarter. The reduction reflects the quarter-over-quarter increase in advertising costs. Effective tax rate for the fiscal 2011 first quarter was 36.6%, compared to 37.8% for the fiscal 2010 first quarter. As reported, diluted net income per share was $0.13 for our fiscal 2011 first quarter, compared to net income per share of $0.15 for our fiscal 2010 first quarter.

In regards to the balance sheet, excluding long term incentive plan obligations, working capital increased to $84.3 million at August 31st, 2010 from $79.4 million at May 31st, 2010. The change in working capital includes a $2 million reduction in cash and short term investments. The reduction resulted primarily from a $7.3 million increase in inventories partially offset by an increase in current liabilities. The increase in inventories reflects overall greater quantities and/or cost of raw materials and finished goods due to sales growth, change in private label production mix, raw material buy-forward strategies, and both branded and private label promotional timing considerations.

Stock-based compensation expense amounted to $0.3 million and $0.4 million, respectively, for the fiscal 2011 and 2010 first quarters. Depreciation expense was $0.8 million and $0.7 million, respectively. Fiscal 2011 capital expenditure initiatives currently approximate $5 million.

The special dividend aggregating $20.9 million will be funded from cash and cash equivalents. Approximately $20.1 million of the distribution will occur next month. The remainder will be distributed subject to vesting of underlying stock awards, and in certain cases, upon actual receipt of the deferred shares.

In connection with dividends paid on outstanding shares, we believe a significant portion of the distribution will qualify as dividend income to the recipient. The remainder will be treated as return of capital. The impact of future income tax rate was a key factor in the timing and magnitude of the special dividend.

Regarding fiscal 2011, we currently forecast net sales to increase in the low single-digit percentage range, primarily driven by overall branded growth. The modest increase is subject to the impact of ongoing competitive private label and branded pricing pressures; potential incremental private label bidding activity; and, the effectiveness of our branded market initiatives; including promotions, advertising, product differentiation efforts, and other considerations.

We forecast gross margin to be in the 36.5% to 38.5% range subject to branded private label sales mix, including incremental private label bidding activity among other factors.

While first quarter-over-first quarter private label sales were down, we believe results will be relatively flat for fiscal 2011 as compared to fiscal 2010. We believe selling and marketing costs will approximate 15.5% to 17.5% in net sales. And other operating expenses will approximate $21 million to $22 million subject to incremental impact of certain long term performance-based management incentive plans.

We are currently forecasting a high single digit, low double digit operating margin for fiscal 2011. Actual results for fiscal 2011 may vary, and our subject to among other considerations, competitive conditions and the factors noted herein and in our public filings. Our forecast will change as fiscal 2011 continues to play out.

Again, thank you for your participation. And now, we will turn the time back to our president, Bruce Wood.

Bruce Wood

Thanks, Joe. To summarize then, while we expect fiscal '11 to be challenging, we are confident about our prospects and expect to continue to strengthen our competitive and financial position in future quarters. And on that note, Joe and I are now ready for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Michael Gallo of C.L. King. You may proceed.

Michael Gallo – C.L. King

Hi, good morning. Congratulations on the good results.

Bruce Wood

Thanks, Michael.

Michael Gallo – C.L. King

Just have a question on the inventory billed in the quarter, it looks like it was up about $7 million sequentially. DSI is up about 10 days. Could you explain that in a little more detail given your guidance for sales growth is I think on low single digits in the fiscal year? Thank you.

Joe Baty

Good morning, Michael. Well, the reasons are multiple. Not the least of which is we do have in place a raw material buy-forward strategy that can cause some volatility in our inventory levels, just depending on to what extent we're buying forward, and obviously, the cost of the raw materials we're buying forward on.

In addition, the – as a result of some of the private label bidding activity, on a net-net basis, what we lost versus what we won, we saw some shift in the mix of private label business that we have now versus what we had before. And part of what we lost was on a per unit basis carried a lower cost attached to it versus some of the business that we won that has a higher cost attached to it. So that's clearly impacted our level of inventories.

In addition, in regards to MegaRed and the results we've been seeing or carrying incremental inventories in support of that business, and then just playing the business forward in trying to prepare for promotional considerations, whether they're branded or private label. Those considerations have also caused our inventories to ramp up a bit. So it's due to a number of factors. Sales growth is part of that, but there are a number of other considerations as well.

Michael Gallo – C.L. King

Something you expect to be ongoing or is this a one-time step-up, particularly on the private label Schiff. Would you expect that to flatten at least in terms of the growth and be more in line with the sales growth?

Joe Baty

Well, just broadly speaking, when it comes to the inventories, on a quarter-to-quarter basis, sequentially, and so forth, there can always be some volatility, whether they're up on down, just generally again, due to the other considerations, the raw material buy-forward strategies in place and so forth. And we hesitate in trying to provide guidance on inventories on a quarter-to-quarter basis. I would say generally, we would expect some further increase here in the near term in inventories. But I would believe that in the back half of fiscal '11, based on our forecast and so forth, we would see in the mix of business that we have, we would expect some decline in inventories in the back half of the year.

Michael Gallo – C.L. King

Okay. Thank you.

Operator

Your next question comes from the line of Ian Corydon of B. Riley & Company. You may proceed.

Ian Corydon – B. Riley & Company

Good morning.

Bruce Wood

Good morning.

Joe Baty

Good morning, Ian.

Ian Corydon – B. Riley & Company

Good morning. It looks like Mega D-3 is in most of the national drug account. Is that accurate? And is there any additional distribution coming on line in the second quarter?

Bruce Wood

That's accurate, Ian. And there'll other accounts that it'll flow into smaller accounts, in say, the national drug change, though, just to be clear.

Ian Corydon – B. Riley & Company

Okay. I guess this is answered by the inventory buy-forward. But can you maybe talk a little bit about what the outlook is for raw material costs?

Joe Baty

Well, as I noted in my comments, in at least our first quarter of '11 versus first quarter of '10 basis, the overall impact for raw material costing was manageable, modest. We did sense that certain raw materials are subject to some increases, on the flip side, in our senses that some other ones will see some reductions. So as of today, the overall impact from raw material puts and takes we believe we will be somewhat negative in for FY'11, but modestly so.

Ian Corydon – B. Riley & Company

Okay. That helps. And then, my last question was on the capital expenditures. Have you made any decisions on some of the larger CapEx decisions you have talked about recently?

Joe Baty

Fair question. And we have not made a final decision on that. We continue to evaluate. It primarily has to do with making sense of buy versus build strategy and/or whether in some regard it just – it makes sense to continue to outsource certain production.

Ian Corydon – B. Riley & Company

Got it. Thank you.

Operator

(Operator Instructions) Your next question comes from the line of Dan Witkowski of Gabelli & Company. You may proceed.

Damian Witkowski – Gabelli & Company

Hi, good morning. It's Damian. Joe, I missed in your prepared remarks you said that the reason for your dividend payout and how large it is. What was the reason that you actually had in your prepared remarks for it?

Joe Baty

Good morning, Damian. The comment I made in the remarks was – clearly the uncertainly over the potential, if you will, for income tax rates in calendar '11 to be greater than they are in calendar '10. Potentially significantly so was a factor in the wait-in on the decision for the timing and the magnitude of the special dividend. That was noted in my prepared remarks.

Damian Witkowski – Gabelli & Company

Okay, okay. Thanks, Joe. Does this mean – does this take you out of – we've been talking about possible M&A, of you buying something. Does this mean that you're not seeing anything that's interesting out there right now?

Joe Baty

No. We continue to see a number of deals that are out there that are for sale now. For us, it clearly needs to make sense and needs to be valued right, and so forth. But the dividend, in our view, doesn't necessarily change your – or take on our interest on acquisition activity going forward. We continue to have a healthy cash balance. And we continue to expect to generate positive cash flows. And we still have an $80 million unfunded credit facility. So we will continue to look at opportunities as they avail themselves. But clearly, they've got to be priced right and make sense for the company.

Damian Witkowski – Gabelli & Company

Okay. And then, SG&A increased I think $2.7 billion this year – this quarter, I'm sorry. Can you break down a little bit further in terms of where the increases are coming from?

Joe Baty

I believe the key increase, which is really in the selling and marketing line, the other operating expenses was actually down a few hundred thousand, which was just due to the timing of certain research and development costs. So the significant increase clearly was in selling and marketing. And that's primarily in advertising both behind our MegaRed product and our Move Free product.

And if you recall, Damian, the prior year quarter, we – for the first quarter of FY'10, we actually delayed some advertising in support of MegaRed due to some supply issues we had for MegaRed at the time. So it appears to be a much bigger increase than it may – than it would have been if we had not delayed some of that advertising in the prior quarter.

Damian Witkowski – Gabelli & Company

And Joe, out of curiosity, your incremental marketing dollars are going TV, radio, Internet, print, where?

Joe Baty

All of the above, primarily TV.

Bruce Wood

Including TV. Yes.

Damian Witkowski – Gabelli & Company

Sorry, all, but TV? Is that what you said?

Bruce Wood

All of the above, including TV.

Damian Witkowski – Gabelli & Company

Okay, including TV, okay. And then, I know it's been a short time, but any changes that you're maybe seeing on the competitive front with the MBTY announced acquisition?

Bruce Wood

Good morning, Damian. This is Bruce.

Damian Witkowski – Gabelli & Company

Good morning, Bruce.

Bruce Wood

It's pretty much business as usual, I would say, with respect to MBTY as far as being a very aggressive competitor, so really, no change that we've been able to observe in terms of competitive intensity or otherwise.

Damian Witkowski – Gabelli & Company

Okay. And again, your own thoughts in terms of a competitor probably going to be more highly levered, does that make them a more rational competitor or not necessarily?

Bruce Wood

Well, I think that's to be seen, really. The MBTY has always been a very aggressive, price-oriented competitor. They say that clearly in all of their calls in terms of delivering value to the consumer. And they pretty much deliver on that. As you said, with more depth that may impose some more discipline. But really, at this stage, we're not planning for any – see change in competitive behavior there.

Damian Witkowski – Gabelli & Company

Okay. Fair enough. Thank you, Bruce. Thank you, Joe.

Bruce Wood

Thank you, Damian.

Joe Baty

Thank you.

Operator

Your next question comes from the line of Steven Gregory of Mandalay Research. You may proceed.

Steven Gregory – Mandalay Research

Yes. Thank you. Bruce, good job this quarter, and a couple other questions for you. Over the last two months, actually about two months ago on the Wall Street Journal, there was an article written that companies are moving for more of the risk type of the business to more of the clique type of business, and looking to drive a lot of their business online, especially in 2011. Can you provide some color for us on the call? What is your vision for what your e-business, e-commerce business will look like in the next couple of years? And how do you plan to get there?

Bruce Wood

Well, at this stage, our model for the e-business is strictly educational. And we find the Internet is a very fertile environment to educate our consumers on the merits of the product. But we don't sell products through the Internet. And that's a deliberate strategic decision. I mean, we're widely available, not only in bricks and mortar of major retailers, but also on all the major e-sites. So in a sense, we are leaving that ground to our customer base. And I think you can understand that that would – if we were to think otherwise, we might start conflicting or competing with our customer base, which is not something that we believe is wise.

So we're committed to really the retail bricks and mortar and retail e-tailer [ph] environment. And having said that, though, we have a very robust array of Web sites supporting our individual brands; educating the consumer; providing all kinds of data on the benefits, safety, and efficacy of our products. And we know that the consumer is looking for that kind of information in a very active way. So we're keeping up in that regard.

Operator

(Operator Instructions) Your next question comes from the line of Steven Nisson [ph] of Mirage Capital [ph]. You may proceed. Steve Nisson, your line is open.

Bruce Wood

Hello, Steven?

Operator

And you have no more questions at this time.

Bruce Wood

Well, good luck to Steven. It sounds like his car alarm went off. In any event, thank you for your interest today in Schiff. And we look forward to reviewing our second quarter results with you in late December. And for some of you, I just wanted to add that Joe and I will actually be presenting at the C.L. King Best Ideas Conference in New York on Thursday, so we look forward to catching up with many of you there, if you are so disposed. Thank you, and good day.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a good day.

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