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Church & Dwight Company (NYSE:CHD)

Q1 2012 Earnings Call

May 4, 2012 11:00 am ET

Executives

Jim Craigie - Chairman & CEO

Matt Farell - EVP & CFO

Analysts

Alice Longley - Buckingham Research

Marc Riddick - Williams Capital

Leigh Ferst - Wellington Shields

Operator

Good morning, ladies and gentlemen and welcome to the Church & Dwight first quarter 2012 earnings conference call.

Before we begin, I have been asked to remind you on this call the company’s management may make forward-looking statements regarding, among other things, the company’s financial objectives and forecasts. These statements are subject to risks and uncertainties and other factors that are described in detail in the company’s SEC filings.

I would now like to introduce your host for today’s call, Mr. Jim Craigie, Chairman and Chief Executive Officer of Church & Dwight. Please go ahead, sir.

Jim Craigie

It's always a pleasure to talk to you particularly when we have outstanding results to report. I will start of this call by providing you with my perspective on our first quarter business results which you read about in our press release this morning. I will then turn the call over to Matt Farrell, our Chief financial Officer. Matt will provide you with his perspective on the financial details for the quarter.

When Matt is finished I will return to provide some detailed information on the performance of our key brands and to discuss our earnings guidance for the year. We will then open the call to field questions from you. Let me start off by saying that I'm very happy with the first quarter business results. We told you in February that we exited 2011 with strong momentum as reflected in our 7% organic revenue growth in the fourth quarter. We continue that momentum in the first quarter of 2012 by delivering 8% organic revenue growth, our highest quarter since the fourth quarter of 2008.

This outstanding organic revenue growth was driven by a 10% growth in our domestic business and 7% growth in our international business. The 10% organic growth in our domestic business was driven largely by 14% growth in our household business. Behind strong growth in our value-based fabric care business and innovative product news in our cat litter business. Our sales results are down slightly for our premium priced personal care brands due largely to the weak or declining category trends.

However we gained market share on key power brands such as Trojan which achieved the second-highest quarterly share ever and first response which gained a full share point. These share gains should pay big dividends when the economic improves because we expect this category to return to historical growth rates. We also told you in February that we expected a lower gross margin in the first quarter of last year due to the continuing year-over-year domestic makes.

However we are making progress on this front as the gross margin for the first quarter of 2012 was 50 basis points above the fourth quarter of 2011. The first quarter results also reflect that we tighten our belts on overhead costs, as SG&A as a percent of sales improved by 40 basis points. Don't be concerned about the lower marketing spending in Q1 and it is simply a function of timing. It was only a $1 million or roughly 2% below year-ago dollar spend. Also our organic growth was so exceptional from the first quarter at the spending levels that we decided to delay some marketing spending to later quarters where we are going to use more effectively behind new products.

Most importantly we delivered a 13.8% increase in earnings per share which represents a strong start toward our annual EPS target of 9% to 10%. Now please don't start foaming at the mouth and raising our annual EPS target as Matt will surely explain why our 9% 10% annual EPS target is still appropriate. Those of you know me know that I have been a long-term pessimist about the business environment. I believe we will continue to face strong headwinds in 2012 including high commodity costs and weak consumer spending which will perpetuate competitive price for us.

All consumer packages companies are fighting the same headwinds, but we believe that no other CPG company is as well-suited as Church & Dwight to deliver exceptional performance in a tough environment. I will explain my rationale for that statement in a few minutes after Matt provides you with greater insights from the financial results for the first quarter.

Matt Farrell

Thank you, Jim and good morning everybody. I will cover the EPS. First-quarter EPS was $0.66 per share compared with $0.58 in 2011. So EPS was up approximately 14% from a year ago. Reported revenues were up 7.5% to $691 million. Organic sales was 8.4% which excludes the impact of an acquisition and foreign exchange rate changes which together had a negative impact of 50 basis points. Organic sales includes 2011 sales in December resulting from customer orders made in anticipation of our January 2012 US systems upgrade.

That particular adjustment accounted for a 1.4% of the 8.4% organic. The company believes such December sales would have occurred in the first quarter of 2012 where it not for the timing shift. Of the 8.4% organic growth approximately 10.5% is due to volume with 2.1% negative product mix and pricing and mostly product mix. Given our strong start, we now expect to deliver organic sales at the high end of our 3% to 4% annual target for the year.

Now let's review the segments. The consumer domestic business' organic sales increased by 10.1% primarily due to higher sales of ARM & HAMMER liquid laundry detergent. Other products that contributed to volume growth were XTRA liquid laundry detergent, ARM & HAMMER cat litter and the introduction of ARM & HAMMER CRYSTAL BURST powerpack laundry detergent. These increases were partially offset by lower sales of ARM & HAMMER SpinBrush, Trojan condoms and ORAJEL oral analgesic products.

Volume contributed approximately 3.4% of sales partially offset by the 3.3% negative effect of product mix and price and again mostly product mix. Organic sales includes an estimated 1.7% benefit from the timing shift that I discussed earlier with respect to customer orders from December that were pulled forward into January in anticipation of the US systems upgrade.

Now International. International had 7% organic growth in Q1 due to higher sales in Canada, France, Australia and exports. This increase is driven by volume growth of 8.7% partially offset by 1.5% of product mix and price. For our specialty products division, organic sales were lower by 2.5% with volume down 8.1% and price up 5.6%. The price is driven generally in the animal nutrition business where we are recovering raw material costs. The organic decrease is primarily due to softness in our end markets especially in the dairy markets.

Looking ahead to the balance of the year we now expect to be at the high-end of our 3% to 4% organic growth rate. We expect organic sales to be higher in the first half of 2012 as compared to the second half of 2012 as a result of easier comparisons in the first half. We continue to expect our value products particularly in the laundry category to continue to benefit from the weak economy and deliver strong organic growth.

Now I'm going to cover gross margin. I reported first-quarter gross margin was 43.8% which is a 110 basis point contraction from a year ago. You may call that in February we expected Q1 gross margin to be a replay of Q4 2011 gross margin when gross margin was down year over year a 120 basis points. The decrease in gross margin is primarily due to unfavorable product mix as net sales of lower margin consumer domestic household products rose 14.4% and net sales of higher margins consumer domestic personal care products were 2.6% lower.

The other contributor to the contraction is a start-up of the new California plant which is on track to be fully operational in July. What is also noteworthy is that higher commodity costs in the quarter were offset by the effective cost reduction programs.

Gross margin improved by 50 basis points compared to the fourth quarter of 2011. Looking ahead first and second quarter, we expect second-quarter gross margin to be comparable for the first quarter due to a continuation of the product mix story. Because of the trend in product mix we expect full-year gross margin expansion to be at the lower end of our 25 to 50 basis point range for 2012.

Our anticipated gross margin improvement is primarily a result of our cost savings programs outpacing commodity increases and product mix. So despite gross margin contraction in the first half we are confident in our ability to hit the lower end of annual 25 to 50 basis point target as a result of the following reasons. One is the absence of first half slotting. So slotting was very front-end loaded this year and larger year over year in the first half versus the first half of last year.

Second is higher mix of personal care in the second half including some of our exciting new personal care products. And then finally cost savings programs are outpacing our cost increases and just some color on those cost savings programs. First one obviously would be the Victorville start up which as I said is going to be fully operational in July. The second is bringing unit dose laundry manufacturing in-house. You may recall that we said in the past to the first half of the year we would be manufacturing the parts out-house versus in-house.

And the third is the benefits of our Simply Saline projects at two of our PC plants, personal care plants, one in the UK and one in the US that we are having lots of success with and those savings will be coming on in the second half of the this year. Then finally approximately two-thirds of our most voluble cost inputs are hedged for the second half of 2012, which gives us greater confidence with respect to our input costs.

Now I am going to cover marketing. Marketing spend for the first quarter was $68 million or 9.8% of revenues, which is 100 basis points below the prior year spend rate and slightly lower on the dollar spend. In spite of the slightly lower dollar spend, we grew dollar share in five of our eight power brands. This is due to the great execution by our sales and marketing teams. Looking ahead, we expect to increase spending for the balance of the year and now project full year marketing spends to be approximately 13% of sales.

SG&A year-over-year was up $4 million from the quarter. SG&A as a percentage of sales was 13.3%, down 40 basis points from a year ago. The higher SG&A costs in the quarter reflect higher legal costs and costs associated with our information systems upgrades.

For the full year, we expect a reduction of approximately 30 basis points to 13.1% of sales. This is a reflection of our continuous vigilance-to-control costs. With respect to operating profit, the reported operating margin for the quarter was 2.7% and that margin was 30 basis points higher than the prior year 20.4%.

Now, equity in earnings from affiliates. Income from affiliates increased slightly due to the higher income from our joint ventures. On a full year basis, we expect a decrease about 3 million in part due to the start up of our Natronx joint venture. Other income was virtually unchanged in the quarter. We do not anticipate any material changes for the full year as compared to 2011 and income taxes. Our effective rate for the quarter was 33.1% compared to last year 36.5%.

The tax rate includes a 220 basis point benefit due to the settlement of an IRS audit. This of course translates into $0.02 of EPS help, but it’s purely timing. We anticipated this settlement to have in sometime in 2012 and we continue to expect the full year effective rate to be approximately 35%. So, no change since February.

Now cash flow. We generated a $114 million of net cash from operations in the quarter which was $34 million higher than last year. We also spend $15 million in CapEx, a large percentage of which was for our California manufacturing distribution facility. If we net those two numbers together we come to approximately $99 million of free cash flow. So, a very strong quarter.

And during the first quarter we purchased approximately 1.9 million shares at the total cost of $19 million. We continue to buy in April and purchased to $110 million or another 2.2 million shares and at this point we do not anticipate any further purchases for the balance of the year.

At quarter end, we had over $230 million of cash on hand and approximately $500 million available credits to our revolver and a commitment to increase that feature should we choose to for an additional $500 million. And I told that to LTM adjusted EBITDA for our bank agreement was approximately 0.5 times. So, clearly an unlevered company.

In conclusion, the first quarter highlights include 8.4% organic sales growth, driven by 10% volume growth, an increase in share of five of our eight power brands and a healthy 20.7% operating margin. We expect second quarter earnings per share of approximately $0.54 per share compared to $0.57 per share last year. Remember last year’s second quarter included a $0.04 per share tax benefit as a result of New Jersey’s corporate tax reform. If you look at that full year we are expecting a balanced year for EPS when comparing the first half EPS to second half EPS or maintaining our annual earning per share goal of 241 to 243 for the year, which is an increases 14% to 15% over last year’s reported $2.12 and 9% to 10% higher if we exclude the fourth quarter 2011 deferred tax charge. Back to you, Jim.

Jim Craigie

Thanks, Matt. I’ll finish off our call by adding a little color to the outstanding first quarter business result that Matt just took you through and my outlook on the year. Our great first quarter business is also directly linked to seven factors that support my earlier statement that we believe that no other consumer packages company is as well suited as Church & Dwight to deliver exceptional performance in a tough business environment.

First, we have the most unique product portfolio in the CPG industry. It consists both premium and value brands which put us in position of pride in any type of economy, as exemplified by our consistently strong EPS growth over the past 10 years. In particular, our value brands representing about 40% of our revenue based, have experience strong growth in this recessionary economy as consumers are making smart choices by switching to and staying with our high quality but lower price brands. A great example of this is the fact that our value based ARM & HAMMER Laundry Detergent business was up double-digit in sales growth in the first quarter and outpaced all the liquid and powdered detergent brands.

We (inaudible) this strong sales and share growth to continue in 2012. So ARM & HAMMER brand becomes a number two liquid laundry detergent brand in America. The second factor which is the key driver of Church & Dwight success is that we have a proven record of our driving our power brand. We have 80 brands but eight of these brands are our power brand that’s showing 80% of our sales and profits.

From 2008 to 2011, we grew market share on these eight power brands in almost 80 % of the quarters. In the first quarter of this year, we grew market share of five our eight power brands. Two key factors for those excellent share results. First, we have effectively reinvested some of the increased profits from a strong growth of our value brands to selectively increase marketing support our eight power brands by a total of a 130 basis points between 2007 and 2011. While our marketing spending was slightly lower in dollar versus year ago in the first quarter of 2012, please keep in mind that we traditionally spend the bulk of our advertising dollars in the second to the fourth quarters to support the launch of our new products. And we do intend to do spend more marketing dollars in the remaining three quarters of 2012 to support continuous share growth on our power brands.

The other factor driving the growth of our power brands is the robust pipeline of new products. Over the past four years, new products delivered about 50% of the company’s organic revenue growth. We plan to ship innovative new products in every key category this year. This fourth delivery of organic growth target is 3% to 4%. We expect these new products to be as successful as new products we introduced over the past four years.

A sample of this new products include a new sensitive skin product on our ARM & HAMMER Liquid Laundry Detergent line has significantly enhanced the brands appeal to the 52% consumer households who have sensitive skin issues. This will help to drive continued growth in ARM & HAMMER Liquid Laundry Detergent business, which has achieved 12 consecutive quarter of growth and continues to grow faster than all other liquid laundry detergents brands.

Another great new product being launched in 2012 is ARM & HAMMER Ultra Last Cat Litter. Every granule of this new Cat Litter is coated with baking soda to deliver long lasting odor control. Ultra Last is off to a great start and follows it’s hugely successful launch of ARM & HAMMER Double Duty Cat Litter line in 2010.

As a result of the steady stream of great new product introductions the ARM & HAMMER Cat Litter brand achieved its all time high quarterly share in the first quarter and has now achieved 33 consecutive quarters of net sales growth, 12 consecutive quarters of share gain and is now the clear number two brand in pumping cat litter business and is closing in on number one. That's pretty impressive for our category which we entered only 14 years ago. It also shows a strong consumer [POP] ARM & HAMMER brand which now accounts for over $1 billion in total sales.

On the personal care side of our business we have several exciting new products in 2012. First is our new toothpaste for sensitive teeth which combines two of our power brands, ARM & HAMMER and ORAJEL to provide maximum pain relief in a lower bracing formula that is gentle on enamel.

Another new product in the oral care category is TOOTH TUNES which provide manual toothbrushes for young children and uses proprietary technology to place two minutes of music from a broad range of artists. This product will begin shipping in the second half of 2012. For those of you with young children, I guarantee that if they use a TOOTH TUNES toothbrush you will have to yell at your kids to stop brushing instead of yelling at them to brush. TOOTH TUNES represents our first entry in the $800 million manual toothbrush category.

We are also pursuing two other high margin wide space categories to help drive the company's future growth. First is a Vibrator category which is over $500 million in size with no major brand and players. We first entered this category in 2005 with electronics TROJAN brand and this year we are launching full size vibrators in the new channels.

Second we have entered the dish washing additives category which is over $100 million in size via the OXICLEAN brand. The government mandated removal of phosphates from dish washing detergents and is thus created a need for a Booster product to deal with a notable increase in ceramic glasses and dishes. Our new OXICLEAN dish washing Booster product Booster Clean for our dishwashing detergents that once again deliver crystal clear dishware.

There are many other new products that we are launching in 2012, but in the interest of time I will move out with my review of the factors driving switching to our continued success and discuss our updated earnings guidance on the year.

Let me quickly run through five of the key factors of our success. Number three is we have a proven history of ferociously defending our brands as evidenced by our successful defense of the OXICLEAN brand when a large competitive entered the category two years ago.

The fourth factor behind our continued success is the strong growth in our international business; while our international business represents only 20% of our total revenues, it has delivered high single digit sales growth and double digit operating profit growth over the past five years.

This strong growth continued in the first quarter as Matt mentioned earlier.

Factor number five is our long history of success in expanding growth margins through cost optimization programs, supply chain restructuring, acquisition synergies and launching higher margin new products.

We expanded gross margin by 1,550 basis points in the past 10 years. We did not improve our gross margins in 2010 and 2011; we were successful in holding on to 380 of the 430 basis points gain we achieved in 2009 despite major headwinds from commodity costs.

As Matt told you earlier, our gross margin declined 110 basis points from the first quarter, but that was in line with our expectations and 50 basis points above the prior quarter. We have initiatives in place to achieve our gross margin target of 25 to 50 basis points improvement in 2012 although the strong household mix may drive it to the lower end of that range. And we are picking longer term actions to drive continued gross margin growth in future years.

For example, as Matt told you in late May, we began production of new manufacturing facility is Southern California. This plant will enable us to look forward to continuing strong volume growth of both our Liquid Laundry and Cat Litter businesses, and position these businesses to be among the industry leaders in low-cost production and distribution.

Factor number six is our ability to tightly manage our overhead costs. Church & Dwight currently has the highest revenue per employee of any major Consumer Packages Company. As mentioned earlier, our overhead costs were down 40 basis points from the first quarter versus year ago which reflects how aggressively we manage our overhead costs to stay best-in-class in our industry.

Finally, factor number seven is our strong record on free cash flow conversion. We’ve almost quadrupled our free cash flow over the past 10 years. Over the past five years, our free cash flow conversion as a percent of net income was 128%, which was best-in-class in our industry.

As Matt told you a few minutes ago, we continue to improve in the first quarter as our free cash flow was 36% above year ago. This cash flow and our strong balance sheet have enabled us to smartly invest in our future through both investments in our supply chain including construction of more efficient new plants and acquisitions of higher margin and faster growing leading brands.

All these factors give me great confidence of our ability to deliver our aggressive 2012 business targets despite a very tough business environment facing all companies these days.

In my biased opinion, no other Consumer Packages Company is well suited as Church & Dwight to thrive in any type of business environment. We were delivering exceptional earnings per share growth before the recession; we are delivering exceptional earning per share growth during the recession and we are taking actions to ensure that we continue to deliver exceptional earning per share growth going forward regardless of the future economic environment.

Let me switch gears now and simply talk about our outlook for the rest of 2012. As stated in the press release, as a result of the fact that our first quarter results were strong, we remain confident that we can deliver our previously announced earnings per share estimate of $2.41 to $2.43, which is an increase of 9% to 10% over 2011 adjusted earning per share. We strongly believe that we can deliver this aggressive EPS targets just like continued expected headwinds on higher commodity costs and weaker consumer demand.

Our confidence delivering these aggressive targets is based on two key factors. First, we strongly believe that we can deliver the market share gains in our power brands to deliver our target of 3% to 4% organic growth. These share gains are expected to result from our innovative new products, significant distribution gains across the majority of our power brands and consistent marketing support. All three of these factors have contributed to continued organic growth. But the growth will not be as strong in the second half of 2012 because it will be up against stronger getting sales in the second half of 2011.

Second we strongly believe we can deliver gross margin expansion of 25 to basis points despite being down 110 basis points in Q1, although that mix may drive us to the lower end of the range. Our gross margin expansion is expected to result from the factors that Matt mentioned earlier. And keep in mind that we’ll be clomping over gross margins in the back half of 2011 that were lower than the front half.

Three, other points that I would like to make before I turn the call over to questions. First, achieving our 2012 EPS target is not depended upon making an acquisition. We aggressively pursued a lot of acquisition opportunities over the past year. We have not been able to find a major acquisition at the right price that meets our acquisition criteria.

Second, I want to assure you that we are fully aware of the threat posed by competitive marketing initiatives and new products being launched by our competitors in the second half of 2012. As I told you earlier, Church & Dwight’s greatest strength is in the building and ferociously defend our brand. We have compared the new list against any future competitive threat.

Third, although we had a great first quarter with 13.8% EPS growth, please do not expect or forecast higher earnings for the year than our forecast of 9% to 10% growth. Our $0.97 EPS growth target is already higher than almost all other CPG competitors. If things go better than we expect with regards to 2012, we will reinvest back into higher marketing spending in the second half to ensure that we exit 2012 with strong momentum, just like we exited 2011.

In conclusion 2012 is shaping up to be another very challenging year due to the weak consumer demand and high commodity prices. Well when things get ugly or stay ugly you should place your bets on the company with the product portfolio that can thrive in any environment and the management team that has the track record of knowing how to successfully leverage their portfolio to deliver strong earnings per share growth.

Now that ends our presentation. I'll open the call to questions that you may have which Matt and I'll do our best to answer. Operator, please go ahead.

Question-and-Answer Session

Operator

(Operator). And your first question comes from Bill [Tapel].

Unidentified Analyst

This is [Sarah] on for Bill. I just have a couple of questions about with the laundry pod. I'm wondering if you can give us some color on the pods business and how you saw initial sellthrough, how the growth progressed through the quarter and what you see growth trajectory looking like in the next couple of quarters? And then was your -- were you able to gain incremental shop space at your key retailers or was it more replacement shop space, just kind of give us some color around that?

Jim Craigie

It's really too early to really give a good forecast in the pods. We were out early, our distribution was almost entirely incremental. It's off to an okay – a good start, a very good start, but it's really too early. It's just the latest four week share that is coming in. It's really early for everybody. Marketing support in a big way it is just beginning to start and the same is true for our competitors.

So it's really too early to say how big the pods category will be and how everybody is doing. We are very happy with our start. Again the distribution was terrific, it was incremental and the initial takeaway by consumers is looking good, but again it's just too early I use that as a projection vehicle.

Unidentified Analyst

And then if I could, just one follow-up to that question. Given how early it is in the market, can you talk about your competence level with the capacity that you have and being able to support the business coming inhouse?

Jim Craigie

Yeah we feel very confident. You know like I said the product is coming inhouse by the end of Q2 and we will have plenty of capacity to meet demand to that product.

Operator

Thank you. Your next question comes from Bill (inaudible).

Unidentified Analyst

It is (inaudible) on for Bill. Another laundry question, can you guys just tell us how much total of the US laundry volume was up in the quarter because I mean if I look at the scanner data it looks like it probably came in a whole lot better than the data would suggest even considering the prebuys. So any help there will be appreciated?

Jim Craigie

Yeah Nick the laundry category exhibited a little bit more growth in the first quarter than some in the past, but it's not good. But nothing to shock folks with, we are more impressed by the fact that we had very strong share gains as we've had for the last couple of years. We continue to outpace the category as consumers trade down to our great value brands, but it was a good quarter, but I wouldn't say these trend so far, so let's see what happens over the rest of 2012.

Unidentified Analyst

Then if you don’t mind, could you just comment a little further on the acquisition environment? I mean if there has been any meaningful changes since we last spoke?

Jim Craigie

I would just tell you that we don't discuss any specific details on M&A. I would tell you the environment is very active and we are very involved, but we have very specific acquisition criteria of looking only for leading brands and margin accretive brands and asset light brands. So far there's been nothing that was acquired by somebody that we regret and we're actively looking for acquisitions that fit that bill but that's about as far as I can go.

Operator

Thank you. Your next question comes from Tim (inaudible).

Unidentified Analyst

Just a couple here. I guess to add on to that acquisition question, Jim do you think the environment will accelerate as we push towards the year end? Again we've seen this movie before and it didn't quite, the rules changed right near the end, but with the tax situation as it sits now and if they are for private companies, do you think there's a motivation there to get things done, number one?

Then you touched on it, but if you could give a little bit more color about your large competitor's commentary to rollback prices in certain categories and how that may impact you?

Jim Craigie

I've been wrong before about the acquisition environment. I think like you're insinuating that the lot of factors are going on with organic growth being tough for a lot of companies. Tax law changes in the future potentially that it would accelerate it. I would tell you that there is more activity out there as far as opportunities for deals, but it has materialized in deals quite honestly.

So I don't know. I would tell you I think sellers still are a little bit lofty on what they think they can get for their businesses and so it's kind of, you would think and I think you're right. I thought I was right in the past thing. I thought activity would pick up and it hasn't happened, but you never know, so stay tuned.

On our competitor rolling back prices I would say that only affects us in one category being powdered laundry detergents. We did take pricing in that category and we intend to maintain that price increase.

Unidentified Analyst

Okay and then one other maybe a little off-to-the-side question here. Again your powder brands are doing well, you guys continued the great track record of execution. Any thoughts at this point about further SKU rationalization in those pieces that generate only about 20% of sales that maybe a lesser piece of margin?

Unidentified Analyst

Yes absolutely Tim. It's an understatement to say you have no idea of the pressure inside this company to deliver our gross margin targets and that is leading to intense detail on every business, SKUs, small brands. You have no idea we even own out there that are small. We're looking under every rock in this company to find anything that delivers a low margin and either we can discontinue the SKU or even discontinue some tiny brands out of our 80 brands and like you don't know some of them, most people don't know some of them. So we're doing everything possible to drive our gross margin targets this year and into the future and that's resulting in intense scrutiny on every SKU in our portfolio.

Operator

Thank you. Your next question comes from Jason (inaudible).

Unidentified Analyst

So I guess the first question I wanted to talk about is the personal care side and I know you have confidence in the second half, but obviously the business has been a little bit soft. So when we think about the guidance that you're providing, the gross margin obviously needs to see the negative mix turn a little bit more neutral with personal care coming back. But at the same point I guess I'm just trying to see what type of contingency plan do you have if personal care doesn't get better and household still continues to deliver?

I don't have any doubt about the EPS, but I'm wondering about the composition of your earnings growth next year or for this year, if the gross margin comes in lower because of personal care. So may be lead off of that as the first question?

Jim Craigie

So Jason we're feeling pretty good about personal care in the back half there. First of all we're lapping some pretty weak category trends in the back half of last year. And secondly, we have a whole slew of new products launching in the back half the year. So as I mentioned things like the TOOTH TUNES and that.

So we are feeling pretty confident and you know us, we always had contingency plans to make our numbers and it wouldn’t be a worst thing in the world of our household business continue to -- it was raging growth and maybe the mix for the gross margin little bit, we make our EPS with, that’s what we get paid to do. It’s a lots on the levers and we will deliver that EPS and things change out there and we will adjust to it, but back to your further point is, we feel pretty damn good about the personal care business in the back half for the reasons I told you.

Unidentified Analyst

And then, just I guess kind of housekeeping related, what’s your expectation for the specialty business, because I mean the organic sales I think it was a little bit weaker this quarter than we saw last year, so you are expecting negative organic sales, so hence the high end of the three to four is really going to be more consumer than maybe specialty helped that last year?

Jim Craigie

Yeah that’s fair Jason. We got off to a very soft January and February, March and April ticked up, but it’s a bit of hole for us to fill that on a full year basis for the specialty business. So yeah as far as on a full year basis the driver is going to be in the consumer business almost (inaudible). Don’t forget that the specialty business has a lower gross margins, so to the extent that it’s a little week that actually again houses make our corporate gross margin targets.

Unidentified Analyst

And then I guess just a last question, thinking about some of you brands that obviously if you have a strong following in the US like TROJAN or First Response, but not really getting that global expansion. I know, I am just wondering how do you guys talk internally with the Board just about how to get the real growth opportunities that are out there outside of really North America whether it’s Canada, Mexico, the US but certainly it still seems to be a huge opportunity for many of your categories and your brands and I was just wondering how you guys think about that over the next few years?

Jim Craigie

Jason we do think about a lot. We don't really talk to you guys a lot, but I mean I can tell you First Response hit record shares in Canada and Australia this latest quarter. TROJAN hit a record share up in Canada and had a very strong quarter down in Mexico. So we are looking as best as possible to take our US brands outside of the US and grow, but we use good reasons. In some cases they have lag, in some cases they don't.

We've been driving share growth on ARM & HAMMER toothpaste over in the UK, we are still doing that again maybe our fault we don't talk about enough, but we are looking to as much as possible globalize some of our key brands, but we do it smartly. We got to look at the market overseas, where the competitors are and what kind of equity we believe we can have and where we've done it, we've taken first response into Australia and so it’s a leading share brand and we've driven up in Canada and other countries. So maybe we should talk about it more in the future, but we are looking for that.

And then we look for strong brands in overseas market. You don't know the fact we have two or three local brands up in Canada that are market leaders like [Gravel] and that is up there I think, up (inaudible) from that. So maybe in fairness we should talk about more of that in the future so you’ll understand what we are doing better.

Unidentified Analyst

And actually I am just going to throw one last one, you talked about the new channels with the vibration category, you picked my interest, so I was wondering if you could talk a little bit more about that?

Jim Craigie

Well, those are channels that you largely visit to the adult store channels out there and that’s actually the largest seller of adult products right now. So we have joined that channel, it’s a little more difficult than other channels because there's a few change and then there's a lot of mom and pops and so it’s a little slower distribution build, but right now it’s the largest seller of vibration type products and we are making a full force effort through our distributors in that to get into that channel with that product.

Operator

Your next question comes from Alice Longley [Buckingham Research]

Alice Longley - Buckingham Research

I hope I didn't miss this; I think you said second quarter sales would be strong, did you specify where organic sales growth should be then? And then could you say something about this recall of Spinbrush and how much that might affect sales?

Matt Farrell

No, we did not call second quarter top-line. We just said we expected another strong quarter.

Alice Longley - Buckingham Research

What does that mean, stronger than three to four?

Jim Craigie

We've said on the year, we think we’ll now finish it at the high end of our 3% to 4% range.

Alice Longley - Buckingham Research

And are you going to beat that in the second quarter and then be below that in the second half, that's my question?

Jim Craigie

Don't forget the pacing of our last year; organic growth last year from Q1 to Q4 went 1%, 3%, 5%, 7%. So this year we are starting up against weaker comps last year, but we end up again stronger comps in the back half, so we’ve kind of guide everybody that think the opposite way this year, organic growth will start very strong and then as we lap big numbers in the back half it will get lower.

Saying the opposite is true for gross margin. Our stronger gross margins occurred in the front half of last year and the ones in the back half are weaker. so that's why we are telling you we think we will have gross margin outside in the back half of the year to get to our targeted 25 to 50 basis points. So that now were because the product mix we are seeing maybe toward the lower end of that target. So that's about as clear as we've been on those two factors.

Matt Farrell

Alice, the only line item call on the second quarter was we said that the gross margin in the second quarter will be comparable to the first quarter, so we have strong sales. But we don't, we are not calling the individual items on the P&L, just the EPS we said was around $0.54.

Alice Longley - Buckingham Research

The last comps I think last year it sounds really tough in the second half because it was 7% in the fourth quarter but that was partly a calendar issue and your calendar is pretty similar this year, right?

Matt Farrell

No, calendar issue.

Alice Longley - Buckingham Research

Okay. So I guess my question, would your sales be up in the second half, will your organic sales be up in the second half?

Jim Craigie

Sure, yes.

Alice Longley - Buckingham Research

And then what about that recall?

Matt Farrell

The recall, as we said in the release that we’ve recalled selected lots of Spinbrush, Rechargeable SONIC toothbrushes distributed between the day seven when they were released and we said that they are also it was a material item both to the second quarter and to the full year and the only context that I can give you is the annual sales of this particular Rechargeable SONIC toothbrush is less than $2 million.

Alice Longley - Buckingham Research

And then on the personal care category you highlighted that the decline was the categories, and you gained share was TROJAN and First Response; so how much of your category is declining in personal care?

Jim Craigie

Very weak, we’ve had some categories like battery toothbrush is down about 3% toothache was down about 2% and then the condoms and diagnostics categories were up less than 1% that we consider to be weak. So, overall weakness, that’s pretty common to all the industry as they are higher margin and more discretionary category, so those category traditionally grow in the 3% to 5% range. So we think that growth will come back when the economy comes back; in the mean time, like I said we are happy just pounding away at growing our shares in those categories.

Alice Longley - Buckingham Research

Well, its sound from the numbers you just gave us, your category is sort of flat down one or something and you were down more than that so its sound if actually lost share?

Jim Craigie

That’s not what I said. I told you TROJAN gained half a share point; First Response gained full share point in those category. So we’re gaining share in some key categories that are just relatively weak or slightly down.

Operator

And your next question comes from Joe [Altobello].

Unidentified Analyst

Just a couple of quick ones. I guess first on, in terms of the overall market growth you know Jim you've been pretty downbeat for a while and obviously been correct here. Have things gotten worse incrementally thus far in 2012 and secondly on that point have you seen any impact in your categories. Are they good or bad for you in terms of higher gas prices?

Jim Craigie

No, Joe it has kind of plateaued. It's kind of in a stall rate now out there in the categories which I honestly think we will continue for a little while ahead. You know again who knows what the election will do with the economy in that or what will happen around the world, but I call it kind of a plateau. I really haven’t seen the gas thing, it's hard to translate through. I would say consumer package get a little more insulated from that, but other more discretionary things like going up to restaurants or buying items that you don’t really need. You have to eat, you have to brush your teeth and you have to wash your cloth and things like that.

So I would think. I don’t think it's being as much an impact as it has been on going out the outer restaurants and things like that.

Unidentified Analyst

Okay. so to make the link between the growth in household and high gas prices, that’s not a driver?

Jim Craigie

I wouldn’t, I don’t think this as much. I mean there is a lot you know there is a lot of things going on out there. I don’t think it’s a bigger driver as in other businesses.

Unidentified Analyst

And then just secondly in terms of the marketing expense, is there a mix impact on marketing given the fact that your household businesses are growing so much faster?

Jim Craigie

No, not really Joe we pretty much planned flat dollar spending in the first quarter and then our volume exploded on is more in the household side. So again on a basis points or a percent of that revenue it doesn’t look pretty, but it was pretty much in line with what we expected to spend and I told you we always plan to spend more money in the second through the fourth quarter because that's when our new product is launched and it is always more effective to launch and spend money against new product news and against the old product line.

So, that was just numbers games going on with marketing spending more than anything else. So we are very happy that we have lots of dry powder left to the back three quarters.

Operator

Thank you next question is from Connie (inaudible).

Unidentified Analyst

I have a question. Earlier in the year you had some caution about the liquid laundry detergent category as unit dosing started to become part of it. So, I was wondering if you could describe what dynamics you think would be healthy for the category if unit dosing is successful?

Jim Craigie

The first quarter of that category in the food, drug and mass channels is only up a little less than 2%. We are kind of looking back at what happened in laundry additives a couple of years ago when a major competitor entered the category. And when that happened, some big product news, a lot of spending went on. And the category had very strong growth rates for the first four quarters and then it fell back and went negative for the last four or five quarters.

Again, you never know this is a huge category. It is like a $6 billion category versus that $1 billion category for laundry additive. So, I would think in this case with every competitor out there launching the pod, every competitor spending some kind of decent money to support those pods that I would expect to see some pretty strong category numbers maybe up in the mid high single digits on liquid laundry detergent for maybe three or four quarters and then the key thing will be repeat, how do customers react to it. It is going to be the highest price per wash for the laundry detergent out there which was pretty tough in a recessionary type economy, but the consumers will try it. There will be a lot of incentives to try it and the key thing will be when it goes back to its normal high prices and there's less incentives what the repeat purchases will be and again that will happen about a year after the products are launched.

Unidentified Analyst

So are the pods considered a part of liquid laundry because they are different forms, some of them are just powder and some are part liquid, part powder, how is that categories done, once investment spending is over, is it profit accretive in the category?

Jim Craigie

We are honestly tracking it as a separate category, but we look at it in combination with the liquid laundry detergent category. And the accretion, every company has got their own numbers as far as this product which is pretty expensive to make versus other stuff, but it is going to be sold at a higher price for wash load. So I can only speak for ourselves. At long term, this will be accretive and we will just have to see how much we sell and how well it does.

Operator

Your next question is from Caroline [Levy].

Unidentified Analyst

A couple of questions. I don't know if you addressed this but I understand Maureen has left, who should we be calling with questions?

Matt Farrell

I am the lucky one. This is Matt Farrell.

Unidentified Analyst

Okay, Matt good, so I am assuming it will take a while for you to replace. So you have not planned at this point?

Matt Farrell

Yeah big shoes to fill.

Unidentified Analyst

Secondly, my question is sort of around how much of the demand growth you've seen in laundry is coming from consumers being stretched. So that geographically, do you see a difference where your market shares are significantly higher and you're growing faster in the toughest economies in the US?

Jim Craigie

Caroline it is a very good question. Quite honestly, we haven't seen anything like that. I think you would see the economic pain is pretty spread across the country, but it is an interesting one, we really haven't looked into that kind of intense detail as to whether some higher markets maybe like a New York city compares to a very rural market, but, good question. I'll ask my troops to take a look at it, but I don't think there is anything that different, quite honestly across the markets right now.

Unidentified Analyst

I am just trying to understand if the economy ever improves and whether you can hold on to your share or not?

Jim Craigie

We will, we have lots of research data that show that consumers who have traded down and now have repeatedly tried our products over the last several years since this recession kind of kicked in 2008 are sticky with the brand even whether or not they get their jobs back or make more money in that. They have found that we truly produced a great laundry detergent and they can save you know a lot of money by buying us versus the higher priced brands.

Unidentified Analyst

Right and then if you were to suddenly see your volumes drop off a lot as a result of Procter discounting, would you take action? I mean are there certain levels that you are you will defend?

Jim Craigie

We always maintain careful price gaps versus all of our competitors and do take action when things like that happen. So yeah we do, we have a lot of scientific studies that tell us what price gaps we have to maintain and again across every brand against every competitor and we do I think we have quite a good reputation for knowing it. We take action very quickly when we see things that either close those gaps and we have to respond by lowering prices or some times increase the gaps so we take advantage of it by raising our prices.

Unidentified Analyst

Right, I notice I think you said you are not going to buy any motions back this year. Is that right?

Matt Farrell

Not after April, we brought back in

Unidentified Analyst

Don’t you have ample cash flow, I mean, because I think you know is this typical that you just do your certain amount or do you need further authorization?

Matt Farrell

Yeah, we actually hadn’t brought back shares for over ten years until late in 2011 and this is a company that generates significant amount of free cash flow and we were building lot of excess cash. So obviously through the outlook, our dividend and buyback, and in February we raised our dividend again in 2011, we had doubled it, and in 2012 February we took it up again. So we are now at a 40% pay out and then the buyback of shares that we started in late 2011, we continued in March. So we said in February we would buy at least as much as we brought last year at a minimum and likely increase it and you are correct in that we generate lot of cash and in the first quarter we generated almost a $100 million of free cash flow and then at the quarter with 230 million of cash. We have an authorization of about $300 million. So we are going to start bumping up against that. So we would need another authorization of a similar size to continue what we have been doing for the last two months.

Unidentified Analyst

It is just the way you say that sounded pretty (inaudible) that you are not going to do more. Is that open for discussion?

Matt Farrell

Not for this year.

Unidentified Analyst

This year.

Matt Farrell

Yes, that’s correct.

Unidentified Analyst

Okay. And then do you think marketing expense in the second quarter will be up a little bit, actual dollars?

Matt Farrell

Yeah, we expect marketing to increase in the second quarter from. You’re talking about from the first quarter or year-over-year?

Unidentified Analyst

Year-over-year.

Matt Farrell

Year-over-year it will be up.

Unidentified Analyst

But the real increase, the more dramatic increase will be in the back half. Is that what you are expecting?

Matt Farrell

Well, we are expecting it to increase the rest of the year actually because on a full year basis, we are expecting 13% on starting at that 10.8% and reason why we, the first quarter is typically low-ish because we don’t have full distribution on our new products. So it is common for us to have higher marketing spending in Q2, Q3 and Q4 and then Q1.

Unidentified Analyst

Right. And if gross margin doesn’t do everything you hope it will, would you adapt to marketing expense that you will make your targeted EPS growth?

Matt Farrell

Marketing isn’t the only area we look at and we look across the board and make the leverage. So we are not going our goal really in the year is to increase and get that 15% and if there is upside, which I think there is more chance of now. Than down side we would spend that more on marketing to exit the year. It will add to a great momentum

Operator

Thank you. Your next question comes from [Erin Lash].

Unidentified Analyst

Thank you for taking my question. I wanted to follow-up on the acquisition environment and specifically what areas you would be looking to either build out your portfolio or build out your geographic reach on growth and acquisition?

Jim Craigie

We are pretty agnostic on that. We have consistently said over time, we look for our criteria again. Number one and number two share brands, margin accretive brands, growth accretive brands that we think we can grow steadily, and asset like brands. And I think our history has shown that we’ll look at almost any category and any geography doing that. Keep in mind, I mean, today we make products and almost every type of product, liquids, powders, rolls on sticks, rubbers, sprays and everything. So that holds the door to look at a lot of other categories because we can bring those products into our plans and save a lot of money from the current orders. No, we’re pretty agnostic and we did, our most recent acquisition was the BATISTE hair spray brand over the UK. We’ve never been in hair spray. It’s UK, which is one of our smaller markets but we got into that business. We happen to make aerosols in our UK plant. So we brought, we are bringing that product in house to help us save money, drive our gross margins north and just one of the fastest growing hair spray brands in the UK market. And it’s also a fantastic start. So that just shows you nobody would ever have thought we would have gone in the hair spray business. We've found a great opportunity, higher margin; high growth, asset life, great gross margins and we bought that business.

Unidentified Analyst

And just follow-up and I apologize if I missed this but what is your expectation, have you provided an expectation for commodity costs for the year?

Matt Farrell

We haven't, other than to save it, we don't expect them to, we don't expect that to be down year-over-year, commodity costs are higher for us year-over-year. We did say that we are hedged. So we are not as concerned about movements in the second half for the remainder of the year actually.

Operator

Thank you. Your next question comes from [Thomas Wilkin].

Unidentified Analyst

Going back to the 40% payout ratio for dividends, that's the highest payout ratio in the last 11 years and percentage wise a big increase in the dividend. Does this reflect a change in philosophy at the board level; we are seeing this at other companies. I wonder whether you would comment whether there's more emphasis now on dividends versus buybacks.

Matt Farrell

Yeah, historically the company for many years had a payout ratio of somewhere between 10% and 15% and as the company has become a lot, lot bigger over time with more and more power brands and generated significantly more free cash flow on an annual basis. The company has realized that we generate a lot of excess cash. So we slowly have being bringing it up. So we went from 15% to 30% payout a year ago and then we took it up to 40% payout this February. The philosophy frankly is that the company's strategy were (inaudible) company. So we always want to have plenty of capacity to acquire and add to our power brands and over the period of time we have now, we were BBB rated. That was far, different story several years ago. So the company's access to the capital markets is significantly greater than it was historically. So therefore we have the excess cash, the excess of the capital markets convinces us. So we don't need to hang on to that cash and that we can take the dividend up and pay money back to our shareholders, and then take some shares out and at least cover share creep on annual basis, and then some if we have additional cash.

Unidentified Analyst

But do you think the board has preference now for dividends versus buybacks.

Matt Farrell

No, no. Once you declare a dividend its apparent, right? So we are going to be, we have been paying dividends for, I don't know, how many; 100 years? So, we continue to pay, we are going to continue to pay dividend.

Unidentified Analyst

Let me word my question in other way. Percentage wise, using your free cash flow for dividends or buybacks, the allocation for dividends is increasing now. Right?

Matt Farrell

As far as the dividends go, we can only comment on what we've declared as dividends today and we cannot project in future what our, if there are going to be future increases. That's something that the board and management evaluates on an annual basis; as far as we can go on that topic.

Operator

Your next question is from Marc Riddick [Williams Capital].

Marc Riddick - Williams Capital

I was wondering about the comment you mentioned on the trading down process for your brands and sort of consistent with that it seem as though retailers are not – and sort of pulled back from embracing or at least aggressively pursuing private label in store brand compared to maybe where they were a couple of years to go.

And if that’s the case and you consider that my view it doesn’t have to be yours, but if that’s the case I was wondering then provide you a different view or impact how you are looking at marketing for the remainder of the year or maybe sort of addressing maybe target areas that you might look at?

Jim Craigie

Well Marc, it’s a good insight. In our 13 categories, private label only have a meaningful presence, so what I mean by that more than say 10 share points in about three of those categories. And the history of private label has been that only in categories we it has a meaningful presence does it really cause some harm during economic tough times. So first of all I said, we face private label only in a very few of our categories.

And retail, always have a tough time on growing; you would see overall private labels been creeping due to the economic, but again its very small piece of majority of categories. Now most of the people buying our products Marc have just as you’ve seen the fact that you know they’ve tried them, they were facing some tighter to pocket books, they have always heard about our great brands and they tried them and they found out how terrific they are.

The growth rates we’re seeing, I think (inaudible) and it’s just fantastic and proving that people didn’t just try it once and run back to other brand, they tried it, realized how good it was, they repeated it and called that sheer requirements; how many of your annual purchases you make from a particular brand and we are seeing our share requirements to grow steadily.

Brands like ARM & HAMMER, people find out how great they are, people forget too we have several forms of that brand, we have ARM & HAMMER with OXICLEAN. We have ARM & HAMMER laundry detergents for sensitive skin so we have all the variety that the premium brands have, but we offer a bit more of a value prices. So people who need them for whatever purpose again more powerful cleaners with like OXICLEAN and or sensitive skin we have those varieties and the people can say quite a bit of money, I mean on a 150 ounce jug of laundry detergent you will save $9 by buying ARM & HAMMER versus the premium brand and that's quite a bit of money in today's pocket book.

Marc Riddick - Williams Capital

And I agree with those sentiments, but from the standpoint of, would you say that do you still think you have to communicate that to the retailers, because from the standpoint of understanding the consumer behavior, I get that there's trade down and then the trade across or whatever it maybe, the consumers get it, they are happy with it, and their behavior becomes sticky, do you find yourself continuing to how to educate the retailers that this is the case and then from that standpoint future shelf space gains maybe possible?

Jim Craigie

Well, tough question; I mean retailers are very under support for private label. Some are very focused on growing their private label and had very minimal private label. For those who have minimal private label they are all about big brands. They love our brands and push them. For those that have private label businesses, we do what we constantly do to educate them about the power of having our brands as part of their portfolio.

And again the growth rate, they just can't deny how fast our brands are growing and as they are behind our brands like ARM & HAMMER laundry detergent, they are losing out the marketplace right now and that led to a lot of distribution gains for us and a lot of share growth over the past several years.

Operator

Your next question comes from Leigh Ferst [Wellington Shields]

Leigh Ferst - Wellington Shields

I have a question about how you are discussing your gross margin progression and I realized you probably analyze this from a lot of different point of view. But you are talking about on a sequential quarterly basis more than your year-over-year; and I was wondering if you could tell us the reason why you’re set up to do with the commodity environment or something else?

Jim Craigie

Now the way to think about it is this. In the first half of the year, we have the mix issue obviously hurting us and when we’re saying that that’s going to get a little bit better in the second half and one of the reasons for that what I said was that we have a little more balance in personal care in the second half from compared to household versus the first half.

I remember we have some new products something like TOOTH TUNES in the second half that are going to help us. We also are slotting that’s very front end loaded this is year. So slotting is another drag on gross margin and there is an absence of that in the second half.

The third thing which would be price, so we have taken price selectively on some brands in the first quarter. And those would for example, (inaudible) and natural, just the natural layer and also baking soda. But that’s really being offset by the slotting. So as you move to the year and we get to the second half we get the benefit of that, so that’s a plus in the second half.

The other thing is that we have to develop our plant, that with startup cost in the first half, we don’t have those startup cost in the second half. We are manufacturing the unit those, or pods outsider third party in the first half. We are not making it in our house in the second half.

And then we have a number of programs with two of our personal care plants, one in Folkestone, UK and then in the Lakewood, New Jersey where we expect to get the benefits of the completion of certain projects starting in the third quarter.

So there are a number of things that benefit the second half that are not in the first half. So that's the way to think about why on a year-over-year basis, we think we are going to be showing positive gains in the second half versus the first half.

Operator

Thank you. There are no further questions in the queue. Please go ahead with your closing remarks.

Jim Craigie

Okay, everybody. Again, this is Jim Craigie; I want to thank you all for taking the time to listen to our first quarter results. Again, we are very thrilled with those results. We've given you our outlook on the year which I think is consistent with what you expect from us overtime. So with that, if you have any questions, follow-up, call in Matt and I wish you all a great day. Thank you.

Operator

Thank you. This concludes today’s Q1 2012 earnings call. You may now disconnect.

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