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Hansen Natural Corporation (HANS)

Q2 2007 Earnings Call

August 8, 2007, 2:30 PM ET

Executives

Rodney C. Sacks - Chairman and CEO

Analysts

Dara Mohsenian - JP Morgan

Andrew Sawyer - Goldman Sachs

Gregory Badishkanian - Citigroup

Mark Astrachan - Stifel Nicolaus

Joseph George - Thomas Weisel Partners

Presentation

Operator

Good day everyone and welcome to today's Hansen Natural Corporation Second Quarter 2007 Conference Call. Today's call is being recorded. At this time for opening remarks I would like to turn the call over to Mr. Rodney Sacks. Please go ahead sir.

Rodney C. Sacks - Chairman and Chief Executive Officer

Good morning ladies and gentlemen, thank you for attending this call. To start, I just would like to report for the record that certain factors made in this call may constitute forward-looking statements in the meaning of Section 27A of the Securities Act of 19333 as amended and Section 21E of Securities Exchange Act of 1934 as amended. Regarding the expectations of management with respect to revenues and profitability we cautioned that these statements are qualified by the terms or important factors many of which are outside the control of the company that could cause actual results and events to differ materially from the statements herein. Thank you.

We do also wish to report that we assure no obligation to update any forward-looking statements. Again, just perhaps run very briefly through the announcements, gross sales for the second quarter increased 54.1% to $280.6 million from $192.1 million a year earlier. Net sales increased 56.9% to $244.8 million from a $156 million a year ago. Operating income for the second quarter increased 34.3% to $61.4 million from $45.8 million a year ago, net income for the second quarter increased 35.9% to $38.3 million or $0.39 per diluted share from $28.2 million or $0.28 per diluted share last year.

Net operating income was after taking into account certain non-recurring expense items which I will describe and after that if you exclude those items, operating income increased by 61.7% to $74 million from $45.8 million a year ago and net income for the same quarter on the same basis increase 62.7% to $45.9 million or $0.47 per diluted share from $28.2 million or $0.28 per diluted share last year. The items concerned are all explained in the announcement. Firstly, in connection with the transition of certain of our distribution arrangements to the Anheuser-Busch system, we incurred termination cost of $8.4 million and $14.7 million during the three and six months periods respectively to certain of our prior distributors. These positive expense is included in operating expenses for the three and six months. These are one of the major cost we referred to is non-recurring for obvious reasons and also for, I want to draw to your attention that we have received income in the form of... principally in the form of cash which is equal to or exceeds the amounts we have expensed but because of accounting rules net income is only being brought to account after 20 years. So, you really do have a mismatching. So, they are non-recurring at the moment in order to believe, show a clear picture of our trading, we think it is appropriate for those items to be excluded and then for the numbers to be looked at and I will give you some of the numbers as we go through on net basis.

In addition the amount... or just what we received from the Anheuser-Busch distributors were non-refundable patents and commitments amounting to $6.5 million and $19.8 million in the three and six months, that aren't always met exactly because you may get the payment and then your termination may take place in a different period.

The revenue recognized on net basis was a $0.5 million in the quarter and $0.9 million in the six months end of June. The other costs that we believe should be excluded in trying to assess and sort of analyze the numbers and that is the cost that we incurred by the company in connection with the review of our stock option grants and granting practices and relates to litigation. Professional service fee was $4.2 million in the quarter and $10.9 million for the six months. These fees have also been expensed in the respective periods and we believe that they are also non-recurring and out of the ordinary quarter therefore should be excluded in order to properly assess and review our results.

If we do that, what you get is the position that your net income as a percentage of sales was 18.1% last year in the quarter and is reflected in the result at 15.7% but if you adjust for these amounts the effect, the net income as a percentage was 18.7% which is just slightly ahead of last year which shows that we are still able to continue to bring some good numbers to the bottom line.

On a six months basis, last year the net income as a percentage was 17.9%, it's reflected in this year's... sorry, in this quarter's financial statements at 14.2%, but if you again use the figures and exclude these figures, these costs, the non-recurring cost the figure comes in at 18% which is just above last year. So we think those are important numbers that should be taken into account.

To run through again just on the six months figures which I haven't given you, gross sales increased 47.1% to $470 million from $320 million a year earlier. Net sales for the first half were up 48.9% to $410 million from $275 million a year ago. Operating income for the six months advanced 15.8% to $93.3 million from $80.6 million a year ago, net income for the first half increased 18.7% to $58.5 million or $0.59 per diluted share from $49.3 million or $0.50 per diluted share last year.

Operating income excluding the non-recurring expense items that I have discussed earlier increased 47.6% to $118.9 million from $18.6 million a year ago, the net income for the first half on the same basis increased 15% to $73.9 million or $0.75 per diluted share from $49.3 million or $0.50 per diluted share last year.

Gross profit as percentage of net sales for the three months ended June increased to 52.4% from 51.9% for the comparable 2006 quarter. This was we think a great achievement. It was largely fuelled by the increase as a percentage of our sales of our DSD product. They went up from roughly about an 85% mix compared to our warehouse products to about a 90% mix. That obviously helped and although we did have items within the DSD section where we had a slight decrease in margin, the juice products 24 ounce and also the addition of Java Monster which is a lower margin product. So those additional products are at lower margins but yet they are still at higher margins than the warehouse division. So when you look, as a result of the mix during the quarter we actually ended up with an ability to actually increase our gross margin.

Going forward it is going to be obviously difficult to continue to increase the percentage of our sales above the 90% level, above the warehouse division, but we think it will happen but its going to be at a more gradual basis. And so we still have the issue that obviously as we continue to expand Java Monster in 24 ounce and they continue to be a greater part of DSD business there will be a slight compression on our margin because of the low margin that those products have. But again at this point they are still the minority of the DSD sales, majority of the DSD sales are Regular Monster, and Lo-Carb Monster in 16 ounce which comprises a bulk of the DSD business and of the Monster business.

Going through a couple of other items that I wanted to take you through. On the balance sheet side, in current assets, let me go through perhaps on cash and cash equivalents. I mean, two short term investments as really one item, increase from $136,796,000 at the end of December '06 to $198,095,000 at the end of June. This obviously we have demanded in investing this cash and we are earning about 5% on it. It is generally invested in high grade securities with less than 1 year's duration.

Accounts receivables increased from $54,624,000 to $111,928,000. The days outstanding on accounts receivable went down from the first quarter from 35.4 to 33.9 but slightly up in the forth quarter which was up on the fourth quarter which is 27.1 days. The increase was largely driven by one of the large customers outstanding the doctor, the kept Rigvets [ph] group which as I'll expand on the number of quarter about how they have to consolidate within the group and it takes time to get the payment in from them. It's just a effect of lock and we try and with them but we did have a shorten period in December and they were out a little in June at they were about 41 days whereas as of December there were at a lower daily level.

In addition with the increase in sale, the percentage of sales, that are represented by DSD products that is all on 30 day terms as opposed to when you give a 2% 10 day term and so the greater mix is through distributors which has resulted also obviously continues to set result in a slot pushing out of all of our receivables. With respect to the increase, one of the comments I just want to make is that net sales in June were very much higher than the net sales in December and for that reason you are also obviously picking up the receivables that come with the increased sales. We are going into a period, I think you must realize going in to December, end of the year, you are probably on a downward trend in your sales because you are higher shelter in the summer months and sort of lowest through the winter, say you sort of sending letters you go into December was when you are going in to June you are selling more, you are accelerating into some of your selling's and despite of all past all that retail going through in the market. And so that was higher.

In the case of inventory, inventory increased from $77 million at the end of December to $87.5 million, so there is a... the launch is pretty nominal increase. Days in inventory actually came down quite substantially from 98 to 68. So, we were actually managing our inventory. One of the reasons as you know we've obviously now explained and discussing in more detail later in the job amongst us. Obviously we had some raw materials here but we have had constraints on our production capacity which difficult strength on sales and basically we were able to manage our inventory a bit better but obviously that's because we shipped, we are shipping out very quickly.

On the asset side, intangible assets increased form $22,600,000 to $24,800,000 largely due to increased legal cost incurred in protecting the Monster market protecting our trademark generally. On the liabilities, accounts payable moved up quite substantially from $34.36 million to $91.8 million. This increase was largely in line with increases in inventories and general operating expenses. Our payables... our cost of goods in June again was very much substantially higher than our cost of goods in December where we were paring back production because of obviously anticipating going into the end of the year and going into January. Whereas in June we are giving up production and we are buying good volume for materials and obviously we are buying products as well, finished products.

So, that really basically accounts for that increase. We are continuing to take advantage of world class discounts that we get often and substantially all of our expenses are being paid within their payment terms. We believe that hello this is a large increase, we believe its perfectly within the normal range of our trading in the way that we are operating the business and going into June. Deferred revenue has increased from $20 million to $39 million that's due to the receipts coming in from the distributors which more than compensate the company only for the distribution termination payments we've paid to the existing distributors, but again because of the non-matching issue that shows up on our balance sheet now as a deferred revenue item that will be taken to the account over 20 years.

Working capital has increased from $212 million to $294 million and I think that all I'd like to say on the balance sheet that should give everyone a reason with good explanation of the balance sheet items. Going forward sales going into July sales are up in July 43.6% in the company. Sales of Monster are up well over 50% one of the issues the sales would have might appear first launched to be a little lower than we have achieved as a increase in sales in the third quarter, that's there are number of reasons for that. It was a short month in deliveries, secondly we had a buy and obviously in we took out our pricing about 24 ounce product and the water buying that's just simply one of the effect of loss and is normal which obviously did boost sales a little bit in June and then it took away from detector from sales in July, we believe that will soon normalize as we go forward.

And then finally we did have some shortages in Monster Java sales of Monster Java which are again the Lutheran [ph] explains will go through this now are doing very nicely but we just weren't able to get out product so some the sales that we had that taken orders had were deferred over into August. We are quite happy with the sales increase. We still think that the brand is continuing to post strongly and is ahead of the category and it really is very exciting that we have been able to maintain this momentum and we continue to do so going forward.

Talk a little bit about the market, market share measuring the markets, basically in our measurement we have increased our market share over last year and it was a slight sort of dip in towards the end of last year when Red Bull introduced a 12 ounce can which obviously gave them a boost as there was a lot of introductory trial, Rockstar over the course of the year came out with a number of juice products and as you are aware from our loss but we only came out with that in earlier about March this year and then we launched Java Monster at the end of... very end of April.

So we should have had sort of full back in March obviously our dollars were still continuing to grow nicely. We should have recouped that and we have in fact increased our market share now not only beyond the position in December but in fact prior than the position was at its peak in the middle of last year. So we are continuing to make in roads into the category and on our numbers by the way we measure it, we are up to about 24% share. Now but that is a measurement of our internal measurement of the category it is not all measure channels it doesn't measure Wal-Mart it doesn't measure Clapps and a number of other on premise location. So I want to make that clear in making that statement that is just our own internal measurement that we use.

In the same period Red Bull has basically lost some market share mostly above what they were in the middle of last year because they have the extra 12 ounce can but basically that also move from where they were in December they have got basically a 10 pre-boost by introducing the 12 ounce but it has come off somewhat. Rockstar is at a little bit on loss but it also down on niche from where they were in December. So that made some in roads and some margin share gains up to the end of the year but that is given in the lot of that back now and their offers well.

Full Throttle is also seeing to be off a little despite the fact that they have introduced a third and we now hear that are going to have a fourth version of the Full Throttle brand. On the other side of competitive side Pepsi products there are so be no clear and so be adrenaline rush or both of the product substantially in market share, those brands seem to be weakening quite substantially. The end brand seems to be putting some attention to that plant, put their effort behind that brand so that brand and that line extended into a 16 ounce and 24 ounce can size. Its given them a little bit of an increasing market share but its still relatively small, its still actually trailing or about shortly below Full throttle and so we just believe that that's really just kind of a lot of there Mountain Dew consumers because it is a Mountain Dew brand and so we think that it is walk through respectable brand that beginning that's going to be a major threat going down in the future in the category. The Cadbury itself is still continuing to be very healthy, we are seeing obviously slight decrease in the changes but really that just has to be accepted I mean where we are trying to go from much bigger category now it is continuing to grow at substantially bigger numbers. The category is up in 13, in the convenience channel which is the major channel, in the 13 weeks ended June 30th, its up 42.4%. Monster as a brand in that period is up about 52% in that channel. So we are continuing to gain market share which is really gratifying for the brand. The [indiscernible] which I mentioned earlier are largely complete, we sort of put a break on some of the professional arrangement during summer so that we could get ourselves focused on selling and rather not... focusing on product transition, brands and dealing with a number of issues that are with that. We will probably continue to do a little bit of transitions after the summer, but by and large we are generally done in our minds at the moment with the transition. We think that is working for us, we are getting good solid distribution, we are working with professional distributors, and so we are all generally very happy.

On the on-premise opportunity that is getting going. We are starting to open accounts in on-premise. We are starting to employ people who are going to be focused purely on the on-premise working together with the aiming people, they are employing people. It's probably taking a little more time than we would have liked and we might have anticipated but it is a big channel, it has to be right. It's not going to be opened in the day. There are many existing agreements with competing brands and competing beverages that encompass energy drinks even though they may not be selling them. At least in many cases we got to look at those contracts and see whether we have an opportunity to supply this, to spark the contract or wait for the contact to expire. And these happen when they renew all the time. But that's -- so it is a longer process to do it on a as large a scale as we are hoping to do it and we are moving ahead with it.

On the expansion front with international our sales in Canada where we transitioned to the Pepsi system are doing very well. The brand is doing very, very nicely there. It's growing so that was a positive transition. We are working well with the Pepsi system. It is a challenge to work with a well established system who have their own product and it is very different to working with an independent distributor. And so there are challenges that you got to overcome and resistance for change internally but it is working very well and we are very happy with the arrangements and we think that, there was well. So we think all was well as we continue to make product inroads [ph] and we are gaining quite a bit of market share in Canada.

We are also supporting the Canada market now, we are doing promotions in Canada, we supported the Canadian Motocross series and there were number of events BMX Downhill Racing series and whistler [ph]. So, we are doing quite a bit to obviously support the brand now in Canada. The expansion into Mexico, that has been very, very well received. The brand is well received in the... area we had by far the largest share of market there. In the rest of Mexico we have distributed to the Capri Group that is continuing to do well for us, we are the number two brand and we all are obviously very happy with that expansion. As I have indicated we are starting to take steps towards expanding into other areas internationally. We are slotting to re-interviewing distributors and the personnel. We want to get the right mix. We have got lot on our plate with the introduction of job over the other products. So we don't want to rush that.

I understand that and what investors might want to know, would like to see results moving more quickly into Europe but the fact of the matter is that we can't rush in and make a mistake and not do it right. We are looking at sponsorship opportunities there, we are involved in some motor sports that translate very well into Europe. We have got that motor sport share and we are looking to extend their end agreements and to go into Europe and other places. So that is happening and hopefully probably I will be able to report more on that and some progress as we go into the... when we report on the next quarter. By and large we are really very happy with our results.

Finally just to go through a couple of small numbers. As you will notice from the gross and the net we have continued to improve our efficiency in the spin that we have to achieve ourselves. Last year we out rose to net which was after our marked development funds, chain CMA fees, and allowances, etc were 16.7%, in this quarter it will be down to 14.6%. Distribution cost generally we've managed to achieve quite a lot of efficiency, we are down from 6.9% in the comparable quarter last year to 5.4% this quarter. We have opened up a number of additional production and distribution facilities and that has obviously helped those items as we go forward.

One of the items I talked about last time was sponsorships that has increased as percentage versus last year. We think it is coming down as a percentage overall and will continue to level off over the year. But that is an increased item and merchandise display is again, we really are... the bad news is it is costing us more to put out merchandise but the good news is they are actually going up in stores and not being thrown away. So we think it is an effective and good use of our cash to get these displays up in stores that is important point to sell for us at the point of purchase and so that amount we have continued to spend quite a lot. As a percentage it is pretty much the same as what we spent in the same period last year but it is a big amount and that's why I do refer to it.

Costs have gone up slightly on our selling side 8.7 to 10.6 but then also a large portion of that increase in really is the commissions and royalties, principally commissions and amount that were payable to Anheuser-Busch as part of the Anheuser-Busch arrangements. In addition we could take that amount with the addition of the increase in sponsorships that pretty much accounts for that increase in selling expenses I think that pretty much of covers the individual items. I would like to go through it, I would like to open the call now to interested investors and be happy to take your calls.

Question And Answer

Operator

Thank you sir. [Operator Instructions]. And we will go first to Dara Mohsenian of JP Morgan.

Dara Mohsenian - JP Morgan

Hi guys.

Rodney C. Sacks - Chairman and Chief Executive Officer

Hi, Dara.

Dara Mohsenian - JP Morgan

Can you give us an update on your plans with 16 ounce energy pricing, do you have any plans to raise pricing at some point this year?

Rodney C. Sacks - Chairman and Chief Executive Officer

We do have plans. What we are doing is we are going to... we are pretty close to raising costing partially in one of the channels as we have which is the channel through the club stalls and that's going to be more imminent and then we will probably look towards the end of the year for costing on 16 ounce for the remainder of the market.

Dara Mohsenian - JP Morgan

Okay, and do you think is that more in the mid single-digit range or some of the 24 ounce more in the high single range, can you give us some sense?

Rodney C. Sacks - Chairman and Chief Executive Officer

I really can't at this time because the party structures are little bit different, and so I can't give you a figure at this point.

Dara Mohsenian - JP Morgan

Okay and how has the 24 ounce price increase gone so far in terms of push back from distributors?

Rodney C. Sacks - Chairman and Chief Executive Officer

That is... we think that has been acceptable. Everybody is... obviously nobody is keen to see an increase but I think our distributors have understood what we are up against on that and that we have the lower margins and we believe that in fact the consumers are prepared to pay but we don't think there is a resistance level from consumers because they are getting value on that package compared to the 16 ounce which has pretty much set the yard stick for it. So that hasn't been a major problem for us.

Dara Mohsenian - JP Morgan

Okay, thanks.

Rodney C. Sacks - Chairman and Chief Executive Officer

Thank you

Operator

And we will go next to Andrew Sawyer with Goldman Sachs.

Andrew Sawyer - Goldman Sachs

Hi guys, I was wondering if you could help square something up for me. I think one thing I have struggled with as far as the numbers is your sell in versus your sell through and one thing that has kind of deviated this quarter is that the numbers they get from scanner data whether it is sea stores or food stores they didn't track as well versus what you reported, so I was wondering if you can maybe elaborate on what you are seeing in unmeasured channels and maybe some learnings you have got from the budnet system that you now have some access to?

Rodney C. Sacks - Chairman and Chief Executive Officer

It really is a difficult exercise and we simply can't pinpoint it but what we have always seen basically there is a difference and it just is no different this quarter. One of the large sectors for us where we are doing a lot of business is in Trupp stores, Wal-Mart stores, unmeasured channels and so our products in those channels have continued to improve and it is doing very nicely and so that is really I would think the major reason for the discrepancy and in we are doing some on premise business and that is also not mentioned. We do a lot real small independent business independents don't also show up the any if these, even if you look at the Neilson for convenience that's really, it is convenience shine at the certain amount and its an extrapolation, so you will also were taking account that meal set is an extrapolation its some times does doesn't reflect exactly it gives you a direction and an idea but you can't use it as a absolute bible I mean the fact of the factor our sales are we've got. There is obviously a lead time but it is not a large lead time because our customers don't hold many weeks of stock of inventory.

Andrew Sawyer - Goldman Sachs

Right and I guess kind of separate follow on question I was wondering if you can talk a little bit about Java Monster and what kind of repeat purchases you are seeing and any update on, where you are and gaining for capacity for that products and are you seeing the bump up against this during the quarter?

Rodney C. Sacks - Chairman and Chief Executive Officer

What has happened is obviously when you start up with new products, we try and be conservative and you... we sort of been though what it was it was a completely different product. We didn't know how it would be received. We obviously on the other side, we knew that we had a more professional distribution system out there and we put it out into the market and it has got a really good taking for and ready was well received not only by the buyers but very quickly by distributors by salesman and they've embraced it and they put themselves behind this and we got a lot of listings. What other issues we had with the existing listings is that what whole the buyers have accepted the product pretty much across the country and I am going to put it in a systematic in the coffee section in the interim stage the quick fix for as at a salesman level is to go in, it's a harder things to go and put it in the cut it into the coffee shop and take away slices from other competitors and products.

In the meantime we have got often two and three shelves of Monster very close to the coffee door but not in it and the easy fix is... the easy way out for the sales guys is to just take three phasing away from the regular Monster product and stick in that submit in the two shelves. And so we probably have a little more cannibalization than we think we should have had and we think we will be able to manage it better going forward when the schematic starts to get approved and we actually are able to transfer the phasing from the energy section into the coffee section.

On the actual sales it did roll up very nicely and we really started to get immediate pull. Again I think that we don't have statistics other than the fact from our distributors, our distributors put into account it pulled through very quickly there were sales they came back and ordered and we are seeing a lot of repeat orders from the same distributors and sales have been very strong. So once we got that sense we obviously started to look at ramping up production, but pretty quickly we bumped up against the production limit, the company that is manufacturing for us arranged to put on extra shifts and additional production and our production has doubled in August now it is doubled what it was in July.

Now going in September we're probably going to almost double it again they've had to completely train an entire shift of personnel and to go to a third shit and pretty we will get between I think about 70% more production going forward than we got in August which was in turn was more than double what we've had in July, So we've been able to ramp up but its taken a couple of months off the event to get everything in place and lined up with equipments and everything else to gear it up for this production.

We are also looking to making some plans to look for additional productions at basically at a fully aided company that might have a limited amount of production but we are not sure of whether that production will affect the taste of all of the brand. At the moment, the production we have now got geared up for us in September is very much high it was literally four times the production that we had in July and June. So we believe that we can sell the product the production. We haven't even begun to scrub the surface. We haven't started to introduce full pack of it. There are number of mass markets that we haven't gone to because you just can't go to them and run out there is no purpose.

Grocery stores that hasn't gone into, we are making presentations and obviously that takes longer to get into the stores to get their sets done whereas in the convenience channel we are all waiting for schematic changes I indicated earlier at least there is an opportunity to get onto the shelves in the mean time its pretty much that doesn't exist in the case of grocery, you really do have to get your shelf reset. And as of it on the mass side, club side all of that we really done nothing because there was just no purpose in going out and selling out and finding we didn't have production. So the ramp up of these brands has default quicker and fall higher then the ramp up of any of our other product introductions. Now we do understand that this is three product versus often one line extension at a time, but be that as it may that was to an established product and with the ramp up has been just been great. There is a high cost of production and we just from a prudent point of view we just didn't want to go up and run up massive quantities in the hope that it would take and then you serve. One of the issues we had with that there is a shorter shelf life good Java Monster then there is with our regular Monster products because largely because of the fact that its got interrupt.

It's a retail process and its got a move solid and premise [ph] and we really don't know what the shelf is that's an unknown entity for us. But the indication is all to start it's going to be... it is much shorter than regular Monster and even then we are not sure until we've actually had the product for the length of time whether time is going to affect the tasting anyway. So, we are obviously cautious about just launching into it with a lot of fan feel [ph] and then further we got we stuck with the lot of inventory. So, is ramping up the product is really doing nicely. We are planning some extensions to the products, some line extensions already. Going forward for the... which we hope to launch within the next quarter. There is a long testing procedure in getting government clearances with a retail product, we are going through that now and but we will be launching that additional product as soon as in the near future. We are also planning to launch an additional product in the 32 ounce can for Monster and probably willing to have an additional flavor as well. So, those all plans also going forward. So, we are pretty excited about the new product particularly the Java Monster line overall. And by overall continued growth and in the energy category.

Andrew Sawyer - Goldman Sachs

Oh!. Thank you very much Rodney.

Rodney C. Sacks - Chairman and Chief Executive Officer

Pleasure.

Operator

We will take our next question from Greg Badishkanian of Citigroup.

Gregory Badishkanian - Citigroup

Great. Thank you. Hey Rodney just a few quick questions for you. Did you just mention a 32 ounce is that sort of a like a single serve or is that going to be something that can be stored in a refrigerator after may be checking or serving of two of it?

Rodney C. Sacks - Chairman and Chief Executive Officer

Well. You can store in the refrigerator but that at the moment there isn't an ability to have that in a cap can.

Gregory Badishkanian - Citigroup

Right.

Rodney C. Sacks - Chairman and Chief Executive Officer

And so its not re-sealable water it really can be stored if probably its going to be something that will be consumed relatively quickly it may not be one serve but it maybe over a couple of hours whatever. But it is what it is bigger is better we think demand for us.

Gregory Badishkanian - Citigroup

Yes, its interesting to see that the consumers of that product.

Rodney C. Sacks - Chairman and Chief Executive Officer

We also think that's a good product that we are trying to look at on an offer on premise.

Gregory Badishkanian - Citigroup

Right and just sort moving over to on premise big opportunity for you can you it may be more terms of like how you see that revolving over the next year too?

Rodney C. Sacks - Chairman and Chief Executive Officer

We really... it really is speculate we just don't know, we know what's out there. We know the accounts we know the opportunity but we just really store in the planning and execution stages, it is taking time as I indicated earlier its probably a little longer than we would have liked but the gain we have a very substantial partner in it and there are large corporation and things just don't happen overnight in any large corporation unfortunately. But you know it is going at a good price and we are very confident that we are going to be able to make real in road in that section but it is going to take time and everything takes time, even the transition to the AIB system. I think everybody wonder sort of instant gratification. And it just doesn't happen like that we would level to happen and you can see that why it should happen but just because you go into a, say a territory where you have very low distribution you get low recognition for your brand now you get a distributor he does his job, he puts it on the shop, he get you with the facings. It doesn't happen that within a week later you find out the store and the sales have doubled. You have got to get the consumer, he is got to get used to seeing it, he goes it and it sees no now its more visible. This is going to take him time before he puts it and before he tries. This all takes time and so I know that there has been the analysis on the pre-bud transition and the post bud transition, these things do take time. In some markets we have disappointments but by and large we are very happy with the improvement, the policy of our distribution and ourselves have improved pretty much in most of the bud markets, and that we been into. And it is going to happen. We think it is just a long haul, it is building yourselves in a single-can but it is happening and we are continuing to increase our market share for big base as you are aware. And so, I think that is the proof in reporting on that. It is happening for us and it will continue to we think improve as we go forward and the same thing applies to the on-premise. We think it is going to take time but it is going to happen and it is going to happen well for us. We are seeing some results coming already but it is obviously, we have got much higher expectations than what we are seeing at the levels we are seeing now.

Gregory Badishkanian - Citigroup

Good and just on the competitive environment, what type of price increase have you seen from other competitors, from Red Bull and what you expect to see from the major competitors?

Rodney C. Sacks - Chairman and Chief Executive Officer

We really haven't seen any product increases. It just depends on the period you are getting. There is no product increase at the frontline. What you are seeing is just the right people of the marking. In some cases they are promoting more aggressively and other cases less aggressively. So we are not seeing any product increases yet. So, I think that we may see some through but we haven't seen anything fall out from the main competitors.

Gregory Badishkanian - Citigroup

Would you expect to see a price increase and would you need to see that to maybe increase prices on a more broader scale at the end of the year like you were talking about?

Rodney C. Sacks - Chairman and Chief Executive Officer

I don't think so. I think that obviously it just makes easier for everybody to like it if any of our competitors do increase, but ultimately we feel that by the end of the year we probably will increase. Again, we haven't made a final decision but we think we'll increase and we think the competitors will probably follow. If they don't, we don't think it will affect the sales. We think we have enough of a market and as long as we have been doing something revolutionary we think that the increase will be palatable both to the retailers and to consumers particularly bearing in mind the value relationship we see with our main competitor which is Red Bull.

Gregory Badishkanian - Citigroup

Great, thank you. Great job in the quarter.

Rodney C. Sacks - Chairman and Chief Executive Officer

Thanks very much.

Operator

And we'll take our next question from Mark Astrachan of Stifel Nicolaus.

Mark Astrachan - Stifel Nicolaus

Hey, good afternoon guys, couple of questions for you. First, wondering how deviated measure if you take away from your distributor in terms of sales from the distributor to retail and if its relatively easy to comment on how that has been trending over the last couple of quarters.

Rodney C. Sacks - Chairman and Chief Executive Officer

I am going to... I will dodge it. I don't know data from distributors to retail.

Mark Astrachan - Stifel Nicolaus

Okay, I guess I am just trying to get a sense for general sort of demand here at retail versus what it is in terms of how you are shipping the product?

Rodney C. Sacks - Chairman and Chief Executive Officer

I will just assume... distributors don't keep inventory and probably one of our problems is they buy on too short notice, that's probably the biggest problem. What resale is going through, it is going to the retail stores and going to the consumers but your best bet at facing that is to use the Nielsen's because that reflects sales at a store level to consumers. I mean that's the only real yardstick, I mean we use that as much as anybody else really.

Mark Astrachan - Stifel Nicolaus

Okay, that's fair enough. Shifting gears a little bit to what you would talk about for July trends, could you talk a little bit about what the comparisons were versus 2006 and I guess in particular if you could talk a little bit about how the month by month volume trends were in the third quarter last year, a July, August, December sort of thing in terms of what we are looking at from a comparison standpoint?

Rodney C. Sacks - Chairman and Chief Executive Officer

I don't have the numbers for August and September, may be I will be able to get them and comment later in the call. On... prior year we had a pretty good July. Obviously, we are just treading up on additional numbers, prior was the first... one of the first months I think that we had exceeded $50 million in our Monster sales on a gross basis. So, it was a pretty good month. But we just really hope for a pretty good year. I will try and get the figures on a monthly basis so I can answer your question and I will come back to that, I don't have an ability to really answer you on that at this point, Mark.

Mark Astrachan - Stifel Nicolaus

Alright, and then in terms of breaking out the DSD versus warehouse segments, can you typically give a little bit more color there in terms of revenue, in terms of contribution, and maybe even volumes, if you could give that it would be helpful?

Rodney C. Sacks - Chairman and Chief Executive Officer

Sure, DSD in the three months ended June 30th, DSD net sales was $220,428,000 and warehouse was $24,335,000 compared to $131,976,000 and $24,061,000 in the warehouse. Contribution margin from the two was $74,982,000 from DSD $934,000 from warehouse, and the three months royalty was $51 million from DSD and $1,678,000 from warehouse. In the six months DSD net sales was $363,722,000 versus $238,067,000 the prior year. Warehouse was $46,893,000 versus $44,916,000. Contribution margins were adjusted for the six months and a $122,317,000 versus $99,035,000 last year and warehouse contribution margin was $1,687,000 versus $3.497 million. Contribution margin from the warehouse division was as you see was essentially flat, just a couple of points up, and the contribution margin however, was substantially lower. That was due to... pretty much due to... margins and increased cost particularly across PET, Roll It [ph] apple juice which was a big component of the warehouse division. Apple juice cost have gone up and so that was probably the major, pretty much one of the major cost if not the major cost. We also had cost increases in sweeteners and obviously in cans and PET bottles. And those costs in that division clearly had a far greater impact on the bottom line than they have in the DSD division. So as a percentage geography there was a big swing down which we are obviously unhappy but we are also taking steps to try and deal with that and mitigate against it. We are also in the process, we are about to launch a new... completely new line of premium sparkling drinks that are sweetened with cane sugar. And so we are sort of looking at different ways of increasing products that will help better margins. In that division the kids juices, the junior juice, and kids effect juices [ph] are continuing to do very nicely and as of the main issue we face in that area was we are continuing to supply on a big contract, but we've had some cost increases when we didn't... initially when we entered into that contract we fixed the pricing for apple juice for 3 year. We hadn't fixed the fourth year which was an option which we decided to let to take and there has been an increase in apple juice pricing and that has helped margins quite a bit in that area.

Mark Astrachan - Stifel Nicolaus

Great, and the final question is, in terms of the growth in your DSD business, could you talk a bit about how the growth was in the region where the Anheuser-Busch distributors are selling the product versus what it was in I guess more of the legacy market?

Rodney C. Sacks - Chairman and Chief Executive Officer

We have seen growth, but I don't have that analysis. We just have not done it. Because there have been a number of factors, in some markets we obviously expect growth because we are in markets where we had low distribution but what we are seeing in those markets is very much improved distribution levels, there is no doubt about that. In areas that we were mature we are continuing to see improvements but whether those improvements would have been achieved by the distributors, we can go through a number of analysis, we just don't believe there is enough of a direction to have given us a feel. Have we improved our market share in Florida which was the first market, yes we have. Have we improved our distribution levels, absolutely. So, I think, you will ask me would I have done better with the existing distributor, I don't believe so. I believe in Florida we are doing substantially better with the AB system than we would have done where we were. In New York for example which is a major market, which is a great opportunity for us. We have a very small market share although, we are the number two brand in New York area. In that area we are very much behind Red Bull they have got a very commanding lead there. But we believe that's a great opportunity for us as what we are seeing are substantially improvements to the AIB distributor system there. We are actually taking steps to actually put some focus and more effort behind in New York market because we believe that is a growth opportunity for us. As opposed to some of the more mature markets. We are still having some issues in the Northern market we are not making the progress we would have liked. That we've made a lot of progress in Nevada which is a... we are getting some good on premise distribution there as well. That's another area that we have done well and so, its on the market by market basis. But overall we are pretty happy with the distribution system but I just don't have any analysis that would give me or that me to give you any real direction other than to say in general we there clearly has been progress but I just want major to our existing areas.

Mark Astrachan - Stifel Nicolaus

Great. Thank you guys.

Rodney C. Sacks - Chairman and Chief Executive Officer

Thanks.

Operator

And we will take our next question from Joseph George of Thomas Weisel Partners.

Joseph George - Thomas Weisel Partners

Good afternoon guys. Couple of quick questions. One is on the international front right now you have a presence in Canada and Mexico. At what stage will you have a level of comfort on your domestic front which will actually help you get aggressive on the international front?

Rodney C. Sacks - Chairman and Chief Executive Officer

I think we have at a level where we are comfortable going internationally. The question is where do we have more opportunity and how are dividing our attention. We all obviously happy with the domestic front. We still see good growth opportunities. We have increased our distribution levels probably closer to 90%, 85% now from 80% let me just get the CNG and I'll give you that figure for last year across the CNG channel we are up to 86% distribution which is 15% up on last year this time. So we are continuing to see opportunities here. We have opportunities in the club stall channels and the mass merchandiser channels which we just touching with we have listings you all modern types that I cant believed we actually are in the small percentage potential stalls in that we have the listings.

We have product line extensions for the brand which is excepted here which is obviously the money we are spending is being spent across the brand. So we see good opportunity in extending our line shelf and then we sold the... obviously what we did was we sold the growth opportunity for Java Monster net we don't have our planning since the end of last year and I think that is being borne out because we are seeing really good volumes on Java monster and we are very up on the brand. We are very positive we think that's going to make quite a big in road into that whole coffee section which is really been dominated by Starbucks and which is quite a big... we just think we could ever big chunk of that. So Walls International is good and international is important.

International is not going to happen overnight I mean Red Bull has been well established in Europe for well in excess of 10 years. I have got the majority share in that market are not going surrender that laughing they are going to defend it to they have got the share that known to consumers. So we are going to have to build in which means we are going to have to do it account by account block by block and build the brand. So those markets are great long term opportunities. The shorter term opportunities still for us is probably greater still in the U.S. because of where we think we can go with the brand.

Ultimately yes we recognize we need to and we also go international and we are doing it but we don't want to just rush in there and throw a lot of money against it on the basis that we just expected to work in, if we doesn't work then we are all sorry later we are just not the approach. We think we will spend the against it, we are all prepared to go into in the serious way but we think it has to be done sensibly. So we are on that track we are on the international track but we just had the opportunity, we focused on you have senior management Tom was focused on making a successive Java Monster. The one thing we didn't want is to simply try out a brand and then run around looking for other opportunities. To launch a bran like that and make an impact against the Starbucks brand and make an impact generally in the market it takes a lot of attention and time and that's our belief and so that's what we've be done and we think we've really made a real impression into that... in that market. So we are very happy and we will be expanding but it is going to come with time and it is going to come, it needs patience before it starts dropping a very... lot of money to the bottom line. Mexico and Canada were very much easier because a lot of our marketing shelves pulls over to those countries. A lot of the every thing that we do out here is more... its been official way without having do things whereas when you go to other international countries you really do have to establish things from the very bottom.

Joseph George - Thomas Weisel Partners

Got it. The next thing I wanted to know was about your cost structure on the G&A front its held back quite well as a percentage of sales. Going forward especially in the context of on premise and the new product launches, what kind of investments have you made in the second quarter or what kind of additional investments in G&A will you expect going forward?

Rodney C. Sacks - Chairman and Chief Executive Officer

I think that investments on the general business let me just back up off the on premise from our general business we think that the investments going forward will be pretty much in line with what we have done in the past, we might get some efficiencies on some big items like as we increase sales because our budgets are down for the year on. Marketing are promotional spins, some of our promotional spins are not dependent on volumes that is said for the year, some of the affiliates and the sports endorsements and promotions. Some of the shelf program fees we pay which are big numbers to the chain tools that is offset for the year.

Some of the variables that go up or things like, merchandising equipments, coolers, merchandising aids, rack something's, then some of the NBA is on the per case basis where you do promotions. So those will go up and we think that they will go up a little more slowly but we also think that against that we will have a slight reduction in the gross margin through actual margin in certain of the products from the product mix dropping as the transition into more the DSD products flows because we are already bumping up against the 19 to 10 percentage level and against that we are obviously are trying to increase our share of 24 ounce is still continue to get traction, the juice products are continuing to get tractions and Java Monster an all of those are at a lower percentage than our traditional products in the Monster category. So those will put a little bit of pressure down so that even though we had thus gross profit which was early nicely up. This quarter over the last year and even over the last quarter we didn't that it will beat it's probably more likely to go down to the more normal level that we have seen in the past.

Joseph George - Thomas Weisel Partners

Got it thank you

Rodney C. Sacks - Chairman and Chief Executive Officer

Sure.

Operator

And with the time constraints that will conclude our question-and answer session. Mr. Sacks I will turn the call back over to for additional remarks

Rodney C. Sacks - Chairman and Chief Executive Officer

Alright thank you. Once again I want to thank everybody for their support. We are also very gratified to have received the letter which we announced yesterday that had been an end to the enquiry that had been out there. So we will believe out down our heads now and go forward and concentrate fully on the business and we think that you know obviously there is some litigation that still, the litigation that follows from that we don't believe the case is of merit but obviously takes time and definitely cost to continue to fight them.

We will do what we need to do on that front. However we do believe that the level of lieu cost obviously will now go down quite substantially because we limit to the cost relating to those... to that litigation and so we believe that item will go down. Similarly the amount of cost that will be incurred in distributor terminations will also go down dramatically, there are a couple of loose ins there, there are a couple distributors who haven't accepted settlements and there is a little bit of litigation going on and so subject to that we don't think that will be very material and those cost should also come down going forward and that is what we thought was important to obviously give you guys a sought of pro forma vision of the results without those costs.

The results for July again, we think that they shouldn't be too much reading into it we always do caution that one month doesn't make a summer. Its one month there were a number of factors we couldn't get some products out as I indicated earlier. We also had a shorter month and there were a number of factors. So we are very happy with the brand going forward as it happens last year just looking at some numbers.

So hold one minute as we look the numbers before we go for the first quarter asked the earlier question. Thanks. Hello. Just one of the things I have got some numbers for August in last year. there was quite a substantial increase in August over the July which we had a similar trend the June number last year was higher than the July number. Generally the South of build up to June and then had a drop of last year in July a little bit and then was quite a good increase in August and then continue to just slight drop back in September and then it started the level of but those were at much higher levels than earlier. So what we are doing is we are trading off labels now that are very much higher last year than the second quarter. So, they want that very sort of similar trend. Where June is higher July dropped often in August was substantially high. So just to give you that color and answer to that earlier question.

Okay. Thanks very much. We are happy with the results we are excited to go forward. We think we got great new product line. We got some new products coming and we are very excited about the second half of the year and for the category generally which is continuing to show really-really strong and solid results for us. Thank you once again for your support and hopefully we will be happy to able to report to you probably the results to you guys at the end of the third quarter. Thank you.

Operator

And we conclude today's conference call. Thank you for your participation. You may disconnect at this time.

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