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Executives

Tarang P. Amin - Chief Executive Officer, President and Director

Joseph W. Baty - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Rebecca Herrick - Assistant Vice President of San Francisco Office

Analysts

Damian Witkowski - Gabelli & Company, Inc.

Michael W. Gallo - CL King & Associates, Inc.

Schiff Nutrition International, (WNI) Q1 2012 Earnings Call September 13, 2011 4:30 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the Fiscal 2012 First Quarter Schiff Nutrition International Earnings Conference Call. My name is Melanie, and I'll be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Ms. Becky Herrick. Please proceed.

Rebecca Herrick

Thank you, Melanie, and thank you all for joining us this afternoon for the Schiff Nutrition International Fiscal 2012 First Quarter Results Conference Call. By now, you should have received a copy of the press release. But if you have not, please contact LHA at (415) 433-3777 and we will forward a copy to you.

As a reminder, this call contains forward-looking statements that are based on management's belief and assumptions, expectations, estimates and projections. These statements are subject to known and unknown risks and uncertainties. And therefore, actual results may differ materially. Important factors that may cause actual results to differ from those expressed or implied by such forward-looking statements are detailed in today's press release and the company's SEC filings.

In addition, the company's presentation today includes information presented on a non-GAAP basis. The company believes these non-GAAP financial measures provide meaningful supplemental information regarding its operations. We refer you to the press release the company issued this afternoon, which is available on the company's website for a reconciliation of the differences between the non-GAAP presentation and the most directly comparable GAAP measures.

With us from management today are Tarang Amin, President and Chief Executive Officer; and Joe Baty, Executive Vice President and Chief Financial Officer. It is now my pleasure to turn the call over to Tarang. Please go ahead, sir.

Tarang P. Amin

Thank you, Becky, and welcome, everyone, to our fiscal 2012 first quarter conference call. Our results for the first quarter were strong, with revenue and EPS growth greater than expected. Our top line grew 13% over first quarter last year driven by several factors. Branded business grew 25% from fiscal 2011 first quarter and reflected growth across all of our key brands, and the contribution from the recently acquired probiotics brands. Our branded business is also aided by 2 new items: Move Free Ultra and MegaRed Extra Strength, which were accepted by certain customers earlier than expected.

This growth was partially offset by an anticipated 29% decline in our private label business. The combination of strong branded growth and private label decline benefited our gross profit margin, which grew to 44.9% from 39.5% last year, contributing to diluted EPS of $0.16 versus $0.13 last year. Again, this growth was higher than expected in part, due to some of our new items shipping in August versus September.

Let me update you on our strategy and progress. We are focused on 5 key strategies to drive growth: The first strategy is to build premium brands. Schiff Move Free and Schiff MegaRed continue to be leaders in their respective categories. Last quarter, we discussed our intention to build these premium brands by increasing the sales and marketing expense as a percent of sales, from 16% in fiscal 2011 to between 22% and 24% in fiscal 2012. During the first quarter, we started executing on this initiative and increased sales and marketing to 20% as a percent of sales. So far, we're pleased with the responsiveness as all of our key brands grew this quarter when compared to the prior year period. Of course, it's still early, and we have an opportunity to make adjustments as needed. But it's good to see initial positive consumer response to higher advertising.

Our second strategy is to lead innovation. Last quarter, we spoke about our innovations of Schiff Move Free Ultra, which offers consumers joint relief in one small pill; and MegaRed Extra Strength, which offers 500 milligrams of MSC certified krill oil. The initial retailer response to these innovations has been positive, and the products were accepted into distribution at a couple of our key customers even earlier than anticipated. Again, it's still early and much of fiscal 2012 plan relies on the consumer acceptance of these items. But we remain committed to leading innovation in our categories.

In addition, we believe expanding our R&D capability will further Schiff's reputation as the leader in strong science and innovation. Last quarter, we announced Dr. Richard Carmona, the 17th Surgeon General of the United States, agreed to chair our Scientific Advisory Board. We continue to build this SAB to provide guidance and direction on scientific issues and to facilitate connections for new product ideas and technology platforms.

The third strategy is to expand the channel and geographic footprint of the company. We have long-standing relationships with our key customers including Wal-Mart, Costco, Sam's, Walgreens and other U.S. leading retailers. We recently shipped Move Free Ultra to Walgreens from CVS. We plan to leverage our strength in this channel while evaluating potential partnerships that build our presence in other channels in the U.S., abroad and online.

The fourth strategy is to pursue acquisitions. We continue to evaluate acquisitions that could help us build premium brands, lead innovation or expand the channel and geographic footprint of the company. On June 1, we acquired probiotics brands, Schiff Sustenex and Schiff Digestive Advantage, backed by the BC30 technology. The integration is now complete. The transaction enabled us to penetrate into a category with a growth rate of 20%, according to IRI. In the first quarter, we turned on advertising support and are pursuing further distribution opportunities.

The last strategy is to drive world-class operations. Our employees are one of our strongest assets, so they take great pride in delivering high-quality products. Their engagement and dedication remains high and contributes greatly to all our efforts.

As recently announced, we appointed Rick Wolford to the board -- to our Board of Directors. Rick is the former Chairman, President and Chief Executive Officer of Del Monte Foods and brings significant experience, having helped grow Del Monte revenues to around $4 billion. I'm excited to benefit from Rick's insights in the guidance of our board.

While I feel good about our progress in the first quarter, I want to remind you that our fiscal year results still depend on, among other things, the consumer acceptance of our innovations and their responsiveness to higher advertising. It'll take some time before we have better visibility on these efforts.

Now I'll turn the call over to Joe Baty, our EVP and CFO, to review the fiscal 2012 first quarter financials.

Joseph W. Baty

Thank you, Tarang. Good afternoon to everyone and thank you for participating.

The overall Supplements category grew at approximately 9% in FDMx for the 12 weeks ending August 21, 2011, as measured by IRI. With respect to our focused segments, the Joint Care subcategory continued to decline, albeit at a lower rate. The overall Omega-3, Probiotics and Vitamin D subcategories continued to exhibit growth.

Schiff Nutrition net sales increased 13.3% to $58.2 million for the 3 months ended August 31, 2011, compared to $51.4 million for the same period in 2010. The increase reflects growth in all key brands and includes a full quarter of the recently acquired Probiotics business. Branded sales grew to $50.1 million from $40.1 million. Private label sales were $8.1 million compared to $11.3 million. The decrease was consistent with our expectation.

Our overall Joint category sales increased to $26.2 million from $24.3 million. As noted, first quarter results benefited from initial shipments of Move Free Ultra. We believe our Joint Care business is beginning to experience some stability, as we continue to implement initiatives to provide incremental advertising support and be more innovative with new products. Schiff MegaRed generated double-digit growth and solid sales performance, especially with our big 3 customers.

Our recently acquired probiotics brands, Schiff Sustenex and Schiff Digestive Advantage, represented almost half of the branded sales increase. These results are consistent with our initial expectations.

Our gross profit increased to $26.2 million from $20.3 million in the prior year period. Gross profit as a percentage of net sales increased to 44.9% from 39.5%, primarily due to the much higher mix of branded sales.

Total operating expenses were $18.4 million as compared to $14.4 million reported in the year-ago period. As guided, selling and marketing costs were up as we increased advertising support for certain key brands. Other operating expenses include $0.3 million in amortization costs associated with the June 1 acquisition and incremental legal, research and development and personnel-related expenses. The allocation of the purchase price remains preliminary and is subject to true-up over the course of fiscal 2012.

For our first quarter ended August 31, 2011, as reported, net income was $4.7 million or $0.16 per diluted share, compared to $3.7 million or $0.13 per diluted share for the first quarter ended August 31, 2010. Adjusted EBITDA, which is defined as income from operations before depreciation, amortization and stock-based compensation, was $9.5 million for the fiscal 2012 first quarter compared to adjusted EBITDA of $7 million for the same period of fiscal 2011. The effective tax rate for the current period was 36.5% compared to 36.6% last period.

On to the balance sheet and comparing August 31, 2011 to May 31, 2011. Working capital was $48.1 million as compared to $79.6 million. As previously disclosed, we financed the $40 million purchase price for the probiotics business utilizing our revolving credit facility. Subject to future M&A activity, we expect to move forward with a revised financing facility by the end of fiscal 2012. Cash and cash equivalents, including both current and long-term investment securities, were $56 million compared to $46.7 million. Inventories were at $38.7 million and $34.9 million, respectively. The increase primarily resulted from the recent acquisition.

Shifting gears to fiscal year 2012 outlook. We are pleased with our fiscal 2012 first quarter financial results. At this time, we continue to have similar expectations for fiscal 2012 as we evaluate consumer acceptance of our new products and the effect of increased advertising support on our financial results. As such, our detailed financial guidance follows:

We continue to forecast net sales percentage growth of high single-digit to low double-digit, subject to competitive pricing pressures including from both branded and private label products; success of new products such as Schiff Move Free Ultra, Schiff MegaRed Extra Strength; and the recently acquired probiotics brands, Schiff Sustenex and Schiff Digestive Advantage; as well as incremental private label bidding activity, among other factors. We believe the sales increase will be due to overall branded growth, as we continue to expect a significant decline in private label sales.

Gross profit percentage is expected to be in the range of 42% to 44%, compared to 38% for fiscal 2011. The increase primarily reflects a higher mix of branded sales volume driven by the probiotics acquisition and launch of new products, together with a significant reduction in private label business. However, as forecast, we expect private label business in subsequent quarters of fiscal 2012 will represent a greater percent of total sales than experienced in the first quarter.

As previously guided, selling and marketing expenses as a percentage of net sales are expected to be in the range of 22% to 24%. We expect advertising support to ramp up further in fiscal 2012 as new products gain incremental distribution. Other operating expenses net, including assumptions regarding allocation of the recent probiotics acquisition purchase price and impact of management incentive awards, are estimated to range from $23 million to $25 million. We currently anticipate a very high single-digit operating margin for fiscal 2012.

We continue to evaluate capital expenditure initiatives and currently anticipate investing approximately $3.5 million in fiscal 2012. First quarter capital expenditures were $1.1 million.

Actual results for fiscal 2012 may vary and are subject to, among other considerations, competitive conditions and the risk noted herein and in our public filings. Our forecast is likely to change as fiscal 2012 plays out.

Again, thank you for participating today. And now, I will turn the time back to our President and CEO, Tarang Amin.

Tarang P. Amin

Thanks, Joe. We believe we're making good progress against our strategy, and we're particularly pleased with the growth of our branded business. We look forward to updating you in the future. Also tomorrow, we'll be presenting at the CL King 9th Annual Best Ideas Conference in New York. We hope to see many of you there. Now Melanie, we can open up the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Michael Gallo with CL King.

Michael W. Gallo - CL King & Associates, Inc.

Just a couple of questions. I wanted to dive in a little bit on Joint Care. You mentioned seeing signs of stabilization. I was wondering if you're seeing that with regards to price as well. Obviously, the pricing seems like it's been worse than units in the last couple of quarters. And then also is it the launch of the new products that gives you that optimism? Or were you seeing sort of general signs of stabilization even before that hit?

Joseph W. Baty

Okay. Well, first in regards to the overall stability. Certainly, we believe that our new product launches are hopefully starting to provide some stability. And as I noted in my comments, hopefully our innovation there is going to assist in that effort. I would point out that according to IRI data, even though the overall category continued to decline, our Joint business declined at a much softer rate. So we see that as well. On the pricing front, I wouldn't go as far as to say that we see some clear changes on -- in that regard. I mean, it's still a very highly competitive space, subject to a lot of promotional activity and still fairly price sensitive. So that's why we're convinced for us to be successful and to rectify that situation going forward, we've got to be innovative. We've got to come out with some new products and differentiate ourselves from the standard GC combos.

Michael W. Gallo - CL King & Associates, Inc.

Great. And then any initial commentary on the sell-through of the Mega-D3 product, which I guess has been in -- I think about 3,000 Wal-Mart doors for a little more than a quarter?

Joseph W. Baty

The results there, yes, the initial results at Wal-Mart are positive. We continue to see some increase overall in the weekly movement, and so we're excited by that. But it's still early to say how that ultimately is going to play out. And Wal-Mart hasn't been in the distribution for that long of a period. But based on the initial results, safe to say that we're pleased by how it's trending.

Operator

Our next question comes from the line of Damian Witkowski with Gabelli.

Damian Witkowski - Gabelli & Company, Inc.

In your gross margin guidance, the 42% to 44% range, which I think is tightened up from 41% to 44%, what's the biggest risk going forward? Is it the price you're going to realize? Or is it the raw material cost? Remind us if you've locked in the prices for the year or if those are still open.

Joseph W. Baty

That's a good question, Damian. Biggest risks, overall, raw material cost, at least as we sit here today, our sense is that they're relatively stable. I mean, there certainly situations where they've popped a bit. There's other situations where there's been some softening. So overall, we're reasonably confident on the raw material, the input cost side. As far as maybe potentially bigger risks, it's going to go back to previous comments, how successful we are with some of those new products, because they are branded products and there's a much higher gross profit margin associated with those. And then on the other side, how does the private label business ultimately play out. And what ultimately becomes the breakdown or the mix between branded and private label, at least as far as looking at gross profit in and of itself.

Damian Witkowski - Gabelli & Company, Inc.

Okay. And then so you raised the range now and -- but you kept your guidance for operating income at the very high single-digit range for the full year. And I realize we just have one good quarter behind us now. But is the plan to then if it comes in higher than expected, to sort of reinvest in marketing perhaps? Or is it that you're -- it's still just one quarter and it's too early to take that guidance up?

Joseph W. Baty

Well, we clearly, I mean, it is just one quarter. And as we noted in the comments, 2 key things. First off, we've got to be able to see some reaction from the consumer. A little more of -- we've got to allow a quarter or so to see what the consumer reaction is to those new products. So that's key is to -- and that will ultimately factor into our thoughts for the rest of the fiscal year and so forth. Second of all, as we've noted and talked about, we're clearly expecting to ramp up selling and marketing costs in fiscal '12 as compared to fiscal 2011. You saw some evidence of that even in the first quarter, where it was a little over 20%, say, versus 18% in the prior year quarter. But the guidance overall is still for that to be 22% to 24%. And given that, we need to have a chance to see how that plays out, see what the reaction is and see how effective it is in building our brands.

Operator

[Operator Instructions] And we have a follow-up question from the line of Damian Witkowski.

Damian Witkowski - Gabelli & Company, Inc.

Let me just follow up real quick. The incremental marketing dollars that you spent in the first quarter, which category -- I mean, which products in particular did you spend it on? Is it just MegaRed and the D3? Or is it sort of across the board? And I'm just curious as to, you sort of highlighted a good initial reaction from the incremental spend, I'm just wondering what's sort of working well, which media's working the best for now at least. Any color there will be appreciated.

Tarang P. Amin

Yes, Damian, we typically don't talk about the individual brands in terms of what we're advertising. What I'd tell you is, the increase was across the board, in terms of our key brands. We had advertising on air in the first quarter on Move Free, MegaRed. Also importantly, the new probiotic brands, the Schiff Sustenex and Digestive Advantage, as well as Mega-D3. So we actually had it across a number of different brands. And I think that was part of why we saw growth across all of our key brands this quarter. I think it's encouraging, but back to kind of reinforce one of Joe's points, it was about 20% selling and marketing as a percent of sales. Our intention is to continue to ramp it up, particularly as the new items hit within distribution. And so a little bit of what we're going to see is what is the response to those items, as well as that increased level of advertising.

Operator

[Operator Instructions] Our next question comes from the line of Steve DeNichilo with ACK Asset.

Stephen R. DeNichilo

Can you talk about -- so your gross margin guidance 42% to 44%, but you're at 45% this quarter. Is it that we're going to have additional private label sales coming off that's going to lower your margins?

Joseph W. Baty

Yes, Steve, it's a good question, and it's currently forecast. And as I noted in my comments, as compared to the overall mix in this first quarter, we believe the mix of private label sales in subsequent quarters for the rest of the year overall will be higher than it was. And that will land [ph] to that overall gross profit percentage.

Stephen R. DeNichilo

You mean private label sales will be down?

Joseph W. Baty

Private label sales as a percent of the overall mix will be up.

Stephen R. DeNichilo

Got it, okay, okay. And then from a sales and marketing standpoint, are you looking at it as absolute dollars or as a percent of sales, meaning that if the top line comes in stronger, will you continue to spend?

Tarang P. Amin

That will be a combination. Part of what we said is, we're going to evaluate what the effectiveness is. And so right now, I'd say our plan is an absolute dollar plan that translates as a percent. A lot of it will depend, in terms of what we're seeing. This last quarter, we saw really good responsiveness. If we continue to see that, we can potentially take it up. But again, we'll have to evaluate that as we go on.

Stephen R. DeNichilo

Okay. So then you targeted 22% to 24% as a percent of sales, just top line was stronger than you thought?

Joseph W. Baty

Yes.

Tarang P. Amin

That's right.

Joseph W. Baty

But also, please keep in mind, as we noted in the comments, that we're just getting initial distribution of some of these new products. And so as that distribution continues, then we'll certainly ramp up the advertising.

Stephen R. DeNichilo

Right, okay. And then is there are any color, and I'm sorry if you covered this, but just when I think about organic growth x acquisitions, where did that come in, in the quarter?

Joseph W. Baty

Well, what I noted in the comments again, just looking at overall branded sales on a Q1-over-Q1 basis, they were up $10 million, okay? And a little under half of that was -- resulted from the acquisition.

Operator

[Operator Instructions] Our next question comes from the line of Michael Gallo.

Michael W. Gallo - CL King & Associates, Inc.

Just a follow-up and maybe I missed it earlier. But did you give the revenue for the Move Free brand in the quarter, Joe?

Joseph W. Baty

We didn't, Mike. Obviously, Move Free is clearly a significant part of the overall joint category sales that we disclosed of $26 million. But we believe going forward, we're just going to provide information on the overall joint category. And as I noted, Move Free is clearly a very big piece of that.

Michael W. Gallo - CL King & Associates, Inc.

Right. The $26 million, can you just give us what that was Q4 and Q1 for like-for-like?

Joseph W. Baty

Q4 for FY '11, looking at it, just total joint category sales was just under $20 million. And did you say first quarter of '11?

Michael W. Gallo - CL King & Associates, Inc.

Yes.

Joseph W. Baty

Because that was -- okay, that was in my comments, but that was $24.3 million.

Michael W. Gallo - CL King & Associates, Inc.

Okay, so you actually saw an increase in overall joint care. Was Move Free up? Or was it just the private label up? Or is that not commentary?

Joseph W. Baty

No, those figures that I'm noting are just branded. That's just our branded joint care category business. Q1 of FY '12 just over $26 million compared to a little over $24 million in the year-ago quarter. That includes Move Free and our other branded glucosamine business.

Michael W. Gallo - CL King & Associates, Inc.

All right, okay. So it's fair for me to assume that Move Free, then, likely was up on both a sequential and year-over-year basis?

Joseph W. Baty

Yes, that's fair for you to assume keeping in mind the it was aided by the initial shipment into a couple of accounts of Move Free Ultra.

Operator

And ladies and gentlemen, I show no further questions at this time. I'd like to turn the call back over to Tarang Amin for closing remarks. Please proceed.

Tarang P. Amin

Great. Well, thank you everyone. As we said, it was a strong quarter, and we feel good about our progress. But there's a lot of years still ahead of us. I hope to see some of you tomorrow in New York when we're there at the CL King Conference. And appreciate your time and look forward to speaking to you again next quarter.

Joseph W. Baty

Thank you.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. That does conclude the presentation. You may disconnect. Have a wonderful day.

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