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WD-40 Company (WDFC)

Q2 2008 Earnings Call

April 9, 2008 5:00 pm ET

Executives

Maria Mitchell – VP Corporate & IR

Garry Ridge – President & CEO

Michael Irwin –Executive VP & CFO

Analysts

Jeff Zekauskas – J.P. Morgan

Alan Robinson – RBC

Cheryl Cortez – Susquehanna Financial Group

Robert Felice – Gabelli & Co.

Frank Magdlen – Robins Group

Operator

Good day and welcome to this WD-40 Company second quarter 2008 earnings release conference call. (Operator instructions) At this time I would like to turn the conference over to the Vice President of Corporate and Investor Relations for WD-40 Company, Ms. Maria Mitchell, please go ahead ma’am.

Maria Mitchell

Good afternoon and thank you for joining us for our second quarter earnings call for fiscal 2008. Today we are pleased to have Garry Ridge, President and CEO and Mike Irwin, Executive Vice President and CFO. This conference call contains forward-looking statements concerning WD-40 Company’s outlook for sales, earnings, dividends and other financial results. These statements are based on an assessment of a variety of factors, contingencies and uncertainties considered relevant by WD-40 Company. Forward-looking statements involve risks and uncertainties which may cause actual results to differ materially from forward looking statements, including the impact from cost of goods, the impact from new product innovations, the timing of advertising and sales promotion activities and the uncertainty in economic conditions both in the United States and internationally.

The company’s expectations, beliefs and projections are expressed in good faith and believed by the company to have a reasonable basis but there can be no assurance that the company’s expectations, beliefs or projections will be achieved or accomplished. The risks and uncertainties are detailed from time to time in reports filed by WD-40 Company with the SEC including Forms 8K, 10Q, 10K and readers are urged to carefully review these and other documents and to stay up to date with our most recent company developments provided in the investor relations section of our website at WD40.com. Our third quarter fiscal 2008 earnings conference call is scheduled to take place on Wednesday, July 2, 2008 at 2:00 pm. At this time I’d like to turn the call over to Garry Ridge.

Garry Ridge

Good day, thanks Maria and thank you for joining us today on our conference call. The company’s diversification strategy across borders and trade channels continues to benefit global sales and profits. In the second quarter, 66% of WD-40 brand sales and 57% of our total sales were outside the United States, proving we are truly a global company. Our international segments grew over 22% in total versus the second quarter last year, essentially offsetting the challenges we are seeing in the US market. Today we reported net sales of $78.9 million for the second quarter of fiscal 2008, a decrease of $400,000 or half of a percent versus last year.

Year to date net sales are $158.1 million, an increase of 4.5% over the same period last year. Net income for the second quarter was $8.7 million, down 3.1% compared to the second quarter last year. Year to date net income is $14.9 million, up 1.8% from the same period last year. Earnings per share for the quarter were $0.51 compared to $0.52 last year and year to date earnings per share are $0.87, up from $0.85 last year. Taking a look at our performance by product segment, in the lubricants segment, sales in Q2 were $59.3 million, up 4.5% over the same quarter last year and year to date are $116.6 million, tracking at 10.4% above the year to date last year.

Hand cleaners came in at $1.2 million, they were off 700 basis points, year to date they are $2.9 million, off 300 basis points and household products were $18.4 million, down 13.7% in the same quarter for last year and $38.6 million year to date, off 9.7%. Lubricant sales were up globally in the second quarter, with both driven by the European and Asian Pacific trading blocks. Our core lubricant business continues to be a growth opportunity with great geographic expansion and the addition of WD-40 smart straw. As previously announced, we converted many of our can sizes exclusively to the smart straw format in the United States in just recently which was in late March of this year.

Household products were down 14% globally in Q2 versus the second quarter last year, driven by declines in the US market. US household product sales were down 20% in the second quarter and down 14% year to date, the result of several factors including lost distribution, timing of promotions and customer purchasing patterns. I am pleased however to see sales growth in our household products in Asia Pacific and Europe business segments which grew 42% and 6% respectively in Q2 versus the second quarter last year.

The increases were driven by growth of the 1001 brand in Europe and No Vac sales in Australia. Heavy duty hand cleaners continued to be a small stable and profitable line of our business at our company. Hand cleaners represented 2% of global sales this quarter and sales in Q2 were essentially equal to the same period last year. We switched to our regions, in the Americas trading block, sales for Q2 were $41.9 million, up 14.4% and year to date are $85.4 million, off 9.2%.

Last year the Americas region accounted for 62% of global company sales while still the company’s largest segment, the Americas region shifted to 53% of total sales in the current quarter. This shift is due to the growing Asia Pacific and European markets as well as the challenges and weakening market to conditions in the US. Breaking the Americas block into smaller regions, in the US, sales were down 20% and are down 13.6% year to date.

US sales were down 20% in Q2 versus the second quarter last year driven by declines in both the WD-40 brand and household products. The decrease in the WD-40 sales was the result of the timing of promotional activities as well as key customers reducing inventory levels and in store promotional activity in advance of the smart straw conversion and also in response of the slowing US economy. The decline in household products was driven by decreased or lost distribution, the carpet and toilet bowl cleaning segments continued to sustain the declining shelf space and category shifts, while hard surface cleaners continue to be a highly competitive category.

In addition to these pressures, the US lost the distribution in Q2 with some customers because of out of stocks that were related to the Q1 manufacturing disruption. The company is working to offset these declines in household products through innovation that capitalize on category trends as well as new packaging and promotional offerings. And as a result, in the carpet care segment, we are introducing an environmentally friendly stain remover. The company is introducing a non aerosol green and pet focused spot shot products that are non-toxic and bio-degradable.

The pet product is already in distribution and the other items will be in distribution during Q3. In Latin America, our Latin American business which is primarily based in lubricants, WD-40 and 3-in-1 brand were up 22% in the quarter, and primarily due to increased distribution and development of the business in countries such as Argentina, Brazil, Chile and Mexico. Year to date Latin America was up 23%. In Canada, we sell lubricants, hand cleaners and household products, Canada sales were up 22% in Q2 due to increased promotional activity in the WD-40 brand versus the prior fiscal year and second quarter.

We now will go across the pond to Europe. Our European business includes lubricants and household products and sales in Q2 were $29.8 million, up 22.2% for the quarter. Year to date they’re running at $58.2 million, up 25.8% year to date. The European region generated sales increases versus last year in all of its operating segments. Changes in foreign currency exchange rates compared to Q2 last fiscal year positively impacted current sales in the region by approximately $600,000 or 2%.

In our European direct markets, where we have sales forces, those being UK, Spain, Italy, France, Germany Portugal, Austria, Denmark and the Netherlands, sales were up 17.7% in the quarter and year to date are running at an increase of 20.6%. Specifically, by country in the quarter, the UK is up 9%, we’re up 28% in France, 25% in Germany, Switzerland, Austria, Denmark and the Netherlands, 23% in Spain and Portugal and 21% in Italy. Sales from these countries accounted for 69% of the total European sales in the current fiscal quarter, down from 72% in Q2 of the last fiscal year.

Our investment in our direct operations in Europe continues to be validated by the consistent growth of our business. We in the distributor markets of Europe, we sell through independent local distributors in Eastern and Northern Europe and in the Middle East and Africa. All of the European distributor markets combined grew 34% over the second quarter last year. The distributor market grew to account to about 31% of our total European segment in Q2, up from 28% in the same period last year.

Turning to the Asia Pacific block, Asia Pacific sales are approximately 9% of our total company sales compared to 8% of the total sales in the second quarter of last year. Sales in that area were $7.3 million in the quarter, up 20.9% and year to date are running at $14.5 million, up 32.3%. Asia Pacific benefited from increased lubricant sales in both Asia and Australia as well as increased No Vac and Solvol sales in the Australian market. Changes in foreign currency, exchange rates compared to the same period last year positively impacted current sales by approximately $400,000 or 6%.

Breaking the region into two, looking at Asia alone, the Asian sales were up 17.4% for the quarter and up 30.5% year to date. This region represents long time growth potential for the company. While the company has historically sold to Asia through third party marketing distributors to help accelerate the growth in the region, the company began direct operations in China in 2007. We are pleased that our sales in China grew by 68% in Q2 over the second quarter of last year.

The balance of the Asia distributor markets grew 5.3% for the second quarter of last year. Sales across the region were up including India, Indonesia, Japan and Hong Kong. The increased sales were the result of both increased promotional activity as well as continued growth in awareness, penetration and usage of the WD-40 brand. Strong sales in China and Asia distributor markets led Asia total sales to a 17% increase. In Australia, sales were up 28% in Q2 and are running at a 35.5% year to date, primarily due to the sales growth of lubricants and No Vac.

Sales of WD-40 are benefited from account specific promotional activity with key accounts as well as the continued broad distribution across many trade channels. The No Vac product continued to gain market share in the Australian growing industry of aerosol rug and room deodorizers. That’s it for the sales update, now over to Mike Irwin who will continue to review the financials.

Michael Irwin

Thanks Garry. In addition to the information presented on this call we suggest that you review our 10K that will be filed today. As Garry’s covered the sales in detail we’ll continue with the rest of the financials. In regards to our second quarter results, gross profit was 48.3% of sales in the quarter compared to 49.2% of sales in Q2 last year. The 0.9% decrease in gross margin percentage was primarily attributable to increases in costs of products stemming from escalating component and raw material costs including aerosol cans and petroleum based products.

To combat the rising costs, the company has implemented price increases on certain products worldwide. These price increases added approximately 0.9% to the gross margin percentage in the second quarter of fiscal 2008 compared to Q2 of 2007. In addition to price increases, shifts in product mix in Europe helped to mitigate the rise in cost during the second quarter compared to the same period last year. Another factor in the decreasing gross margin percentage was the increase in advertising and promotional discounts which negatively impacted gross margin by 0.3%.

Certain A&P costs such as coupons, slotting and customer rebates are treated as a reduction in sales. The timings of these promotional activities as well as shifts in product mix may influence fluctuations in gross margin percentage from period to period. Selling, general and administrative expenses for the second quarter increased 3.1% to $20.3 million. The increase in SG&A stems in part from higher employee related costs of $0.4 million for salary increases, benefits and additional staffing to support China operations as well as $0.2 million for stock options expense.

Higher research and development costs of $0.3 million due to the timing of new product development activity, higher costs for professional services of $0.2 million primarily as the result of increased legal costs and $0.3 million of the SG&A expense increase was due to changes in foreign exchange rates. These increases were partially offset by $0.8 million decrease in freight costs and other miscellaneous expenses, such as commissions and investor relations costs. The higher costs though lowered our operating leverage as SG&A expense increased to 25.8% of sales in the second quarter compared to 24.9% in the same period last year. Advertising sales promotion expenses decreased to $4.2 million in the second quarter from $5.1 million in Q2 last year. And as a percent of sales, decreased to 5.4% from 6.4% in Q2 last year.

In the prior fiscal year second quarter the company invested in consumer broadcast advertising and print media in the US to support advertising of the Spot Shot brand which wasn’t repeated. The costs of certain promotional activities are required to be recorded as a reduction in sales while others remain in advertising and sales promotion expenses. In the second quarter, total promotional costs recorded as reductions in sales, was actually two sales were $3.9 million in fiscal 2008 versus $3.4 million in fiscal 2007, therefore the company’s total investment in advertising and sales promotion activity totaled $8.1 million in Q2 versus $8.5 million last year.

Operating income for the quarter was $13.4 million compared to $14.1 million in Q2 last year. Net interest expense for the quarter was $0.4 million, down from $0.6 million in Q2 last year, reflecting the continued reduction in debt as we made our annual $10.7 million principle payment in October 2007. Other income was $229,000 in Q2 compared to other expense of $94,000 in the prior year’s second quarter. The increase of $323,000 was due to foreign currency exchange gains in the current fiscal second quarter compared to foreign currency exchange losses in the prior year’s second quarter.

The provision for income taxes was 34.6%, for the current quarter, an increase from 33.2% in Q2 last year. The increase in rate is primarily due to onetime tax benefits in Q2 last year, including favorable rulings on foreign tax matters, the renewed Federal research and experimentation credit and the tax benefit of municipal bond interest. The increase in tax rate in the current year quarter was partially offset by decreases in foreign tax rates and increased benefits related to qualified production activities.

Net income in the quarter was $8.7 million, down 3.1% from Q2 last year and on a diluted per share basis, earnings were $0.51 compared to $0.52 in Q2 last year. Diluted shares outstanding have decreased to 17 million shares compared to 17.2 million for the prior year quarter. Now moving on to the first half results, gross profit was 47.8% of sales compared to 48.6% for the same half last year. The 0.8% decrease in the gross margin percentage was primarily attributable to increases in costs of products stemming from higher component and raw material costs. To combat these costs again, the company has implemented price increases.

These price increases added approximately 0.8% points to the gross margin percentage in the first half of 2008 compared to the same period in 2007. In addition to price increases, the shifts in product mix period versus period in Europe helped to mitigate the cost. The company continues to address the rising costs through innovation and cost containment strategies. Another factor in the decrease in gross margin percentage was the increase in A&P or advertising promotional and other discounts which negatively impacted the first half gross margin by 0.2%.

Moving on to selling, general and administrative expenses for the first six months, increased 7.2% to $41.6 million and the increase in SG&A stems in part from higher employee related costs of $0.9 million for salary increases, benefits and additional staffing to support China as well as $0.3 million for stock options expense, higher costs for professional services of $0.4 million, primarily as a result of increased legal cost and higher miscellaneous expenses of $0.3 million which included increased R&D costs and increased meeting and investor relations costs.

The $0.9 million of the SG&A expense increase was due to changes in foreign exchange rates. The higher costs lowered our operating leverage as SG&A expense increased to 26.3% of sales in the first half compared 25.6% in the same period last year. Advertising and promotion expenses increased slightly to $10.9 million in the first six months from $10.7 million in the first half last year. And as a percent of sales, A&P expense decreased to 6.9% of sales from 7.1% in the half year.

Excluding the impact of foreign exchange rates, advertising promotion expenses were essentially flat. Investment in global advertising promotion expense for 2008 is expected to be in the range of 6.5-8.5% of sales for the year. Operating income for the first six months was $22.9 million compared to $23.7 million in the same period last year. Net interest expense for the year to date period was $0.8 million compared to $1.3 million during the first six months of 2007.

And again we have made our annual principle payment in October with another one due in October 2008. Other income was $541,000 during the first six months compared to other expense of $185,000 in the prior fiscal year period. The increase of $726,000 was due to foreign exchange gains in the current fiscal year period compared to foreign currency exchange losses in the prior year period. The provision for income taxes was 34.1% for the first six months of fiscal 2008, nearly flat to the 34.2% rate we experienced in the first half last year.

The slight decrease in tax rate was primarily due to increased benefits related to qualified production activities and a decrease in foreign tax rates which were partially offset by onetime benefits in the prior fiscal year from favorable rulings on foreign tax matters. Net income in the first six months was $14.9 million, up 1.8% from the first half of the prior year and on a dilutive per share basis, EPS was $0.87 compared to $0.85 last year. Diluted shares outstanding decreased to $17 million for the first half compared to $17.3 million for the half last year.

And regarding the dividend, on March 25th the Board of Directors declared a regular quarterly dividend of $0.25 a share, equal to the previous year’s dividend and that’s payable on April 30th, 2008 to shareholders of record on April 16th. Based on today’s closing price of $33.16, the annualized dividend yield will be 3%. Moving on to the balance sheet at February 29th, 2008, cash and equivalents were $23.4 million, down from $61.1 million at the end of the fiscal year. Year to date cash uses included $10.7 million for the principle payment on debt, $8.5 million for dividend payments and $17.7 million for share repurchases.

Accounts receivable increased to $52.9 million, up $5.7 million from the end of last year as a result of the timing of sales. Inventory increased to approximately $17 million, up by $3.8 million versus the end of year level. The increase in inventory was due to the buildup of inventory for new product introductions in the US, as well as the acquisition of inventory from VML which is the contract manufacturer and warehouse distributor for the company. Certain finished goods were owned in warehouse by VML under the company’s historical contract to manufacture model as the company transitions to direct management of these finished goods of acquired inventory from VML to supply its distribution centers.

The purchase of VML manufactured goods will continue going forward. A word about auction rate securities. Periodically the company has invested in an interest bearing short term investments consisting of investment grade auction rate securities. Although these investments have states maturities 13 months to 30 years, they’re designed to provide liquidity through an auction process that resets interest rates at pre-determined periods ranging from 7 to 35 days. This reset mechanisms is intended to allow existing investors to continue to own their respective interest in the auction rate security or to gain immediate liquidity by selling their interest at par.

Our practice had been to liquidate short term investments near the end of each fiscal quarter. However at the end of the second quarter we had $6.1 million of auction rate securities with underlying tax exempt municipal bonds with stated maturities of 26 to 27 years. These bonds are insured and have triple A ratings. The underlying issuer of these bonds have credit rates of at least double A minus. As a result of the recent liquidity issues experienced in the global credit and capital markets, in February and March of 2008, auctions for auction rate securities held by the company failed.

The auction rate securities continue to pay interest in accordance with the terms of the underlying security, however liquidity will be limited until there is a successful auction or until such time as other markets for these investments develop. We do not believe that the lack of liquidity related to auction rate securities will have an impact on our ability to fund operations. Current liabilities were $48.5 million, down from $53.9 million at August 31st, 2007. Accounts payable and accrued liabilities decreased by $4.7 million due to the timing of payments. Accrued payroll and related expenses were down $3 million, primarily due to decreased bonus accrual.

And on March 27th 2007, the Board of Directors approved a share buyback plan and under the plan which was in effect for up to 12 months the company was authorized to acquire $35 million of the company’s outstanding shares. During the fourth quarter of fiscal 2007 and the first six months of fiscal 2008, the company completed the repurchase program by acquiring 1,028,800 shares at a total cost of $35 million. That’s the financial update; again more information is available on the 10Q to be filed today. Thanks very much and we’ll turn it to Garry Ridge.

Garry Ridge

Thanks Mike. While we are poised to weather the deteriorating economic conditions in the US with our growing international operations, we are revising our fiscal year guidance to reflect the challenges in the US market and global pressure on cost of goods. Here’s a recap of our revised guidance for fiscal 2008. We now expect sales to grow by between 4% to 8% to $320 million to $332 million driven by continued geographic expansion, market penetration and new products.

We expect our advertising and promotional investments to range between 6.5% to 8.5% of sales and we expect net income of between $30.3 million and $31.9 million which would achieve an earnings per share of between $1.80 to $1.90 assuming shares outstanding of 16.8 million. Our guidance does not include any acquisition. We will continue to focus on growing sales and improving gross margins from both innovation activities and cost reduction initiatives. We’ll also continue to look for the right acquisition of well known niche brands that can be entirely integrated into our business. To sum up, we really have the tale of two businesses right now.

We’ve got the challenges in the US market offset by continued growth in nearly every other market around the world. The US market challenges are as we see them as follows, continued pressure in household products by direct competition and competition of shelf space as we’ve seen for several years. WD-40 sales affected thus far as major customers scale back purchases and promotional activity in anticipation of the conversion to WD-40 smart straw which was done and executed on time in March and early April.

With both of these factors amplified by customer response to the ailing US economy. Cost of goods remains a concern to us. Today oil hit $112 a barrel. But we’re not sitting still, we’re introducing a non-toxic bio-degradable carpet stain removers from the spot shot brand and we also expect the US smart straw conversion to help our sales and gross margin dollars as the unit price is approximately 30% higher than the comparable size of the WD-40 can. In addition, we’re taking price increases in several countries around the world. Outside the US, we continue to sustain growth rates.

Our European business has grown sales at a compounded annual growth rate of 19.9% from 2002 through to 2007 and is up 25.8% through the first half of fiscal year 08. Our Asia Pacific sales are up 32.3% through the first six months of fiscal year 08. At the core we sell simple staple maintenance products, we’re in the squeak, smell and dirt business and as far as I can tell, the needs continue to happen regardless of the economic climate. Thanks for joining us today and that’s the way it was for Q2 2008. We’d be pleased to take any questions.

Question-and-Answer Session

Operator

Thank you. And we’ll go to Jeff Zekauskas at J.P. Morgan.

Jeff Zekauskas – J.P. Morgan

Good afternoon, this is Ben Richardson sitting in for Jeff Zekauskas. Looking at your gross margin we saw a decline year over year of about 90 basis points. And can you talk a little about what you’re experiencing, whether it’s in aerosols, cans or in on the petroleum end.

Michael Irwin

Well I mean a couple things to keep in mind; I just want to put this in perspective. In the case of just using a can of WD-40 as an example, the majority of the cost of the WD-40 can finished product is not related to the cost of petroleum because the biggest chunk of it is related to packaging. But as Garry mentioned earlier, oil hitting $112 barrel today, we’ve seen higher costs of the component ingredients that go into those products, higher petroleum costs also affect us in the plastic parts like the straws and the spray nozzles and that sort of thing and affect us in plastic bottles in which we sell many of our household cleaning products.

We’ve seen a continued rise in the cost of aerosol cans which I think have gone up by more than 75% over the past five years. That too is a major factor to us. And so we’ve been in this cycle of spiraling upward of costs across many of our cost lines on our underlying cost of goods. So it is a concern to us. We don’t sit around and feel like we’re waiting on costs to go down and so what we’ve done is we’ve taken a three pronged approach to helping improve our gross margin which is a strong priority to us. Number one we’ve taken price increases where we can and where it makes sense.

We are a company though that believes that our job is to deliver above expectation performance at extremely good value to end users and so we’re mindful of what our challenge is and so we try to maintain efficiency in our operation. But we have taken price increases and we’ve taken price increases I believe for every single one of the past four fiscal years including the current one and that’s a consideration. Number two, we want to use innovation as a way to improve our gross margin as Garry mentioned.

We have been in the implementation phase of the transition of WD-40 in the regular spray nozzle cans to the smart straw which is a way of delivering added value to end users and it just so happens that that added value also comes in the way of a higher price. So much like the toothbrushes which are of higher value today but also more expensive, WD-40 is following that step in the US. And so we’re using innovation for things like that to help address the margin. And then the third area is that we continue to look at our supply chain and ways to help improve our efficiency, improve our gross margin while at the same time delivering better service to our customers.

Jeff Zekauskas – J.P. Morgan

Alright. And is it possible for you to quantify all of the, you know the gross margin you expect to recover through the introduction of smart straw in the US?

Michael Irwin

No it’s not and we don’t give forecast on gross margin anyway.

Jeff Zekauskas – J.P. Morgan

Okay, alright. In that case I’ll get back in the queue.

Operator

Thank you, next we’ll go to Alan Robinson at RBC.

Alan Robinson – RBC

Hi, good afternoon. You mentioned price increases during the quarter, improved gross margins by I think 90 basis points. To what extent was that impacted by smart straw or is that really a third quarter issue?

Michael Irwin

Smart straw is a third quarter issue as Garry mentioned the implementation really was a March April timeframe so it had nothing to do with the second quarter. What happens though is that I think it was last year during the second or third quarter last year we implemented price increases so on a year to year basis that’s really where the majority of the difference of the benefit of pricing came from.

Alan Robinson – RBC

Okay and in terms of the smart straw could you remind us of where this is being rolled out and what your plans are for additional roll outs? You mentioned you completed the domestic roll out in March and April, what’s left now?

Garry Ridge

The initial stage, firstly, smart straw is sold as a single SKU in a number of markets around the world. We chose to convert the majority of sizes in the US to smart straw and that happened at the end of March, early April. We’ll be now executing and monitoring that swap over. This was an absolutely enormous endeavor. You know it’s not often that you restage nearly a complete line of product and our folks just did a superb job of doing that. We’ll be watching the roll out. As we build capacity for the smart straw unit itself and then reflect on the final outcomes in the US, we’ll be deciding whether we totally convert other markets over time. But that will be a little bit of a test and see.

Alan Robinson – RBC

And do you have any significant inventory in the form of the old canned version at the moment that might be at the risk of a revaluation?

Garry Ridge

No, we don’t have, WD-40 is not an unsalable product, there was some residue inventory that we will be using as some clear outs but no we have nothing to be concerned of. WD-40 has no use by date and we’re able to manage that pretty effectively.

Alan Robinson – RBC

Okay good and then you mentioned a lost distribution channel in terms of the household products is this something that you’re working to reclaim or is this something that’s not economical for you to reclaim?

Garry Ridge

We didn’t lose any specific distribution channel, maybe it was in my communication but we have continued to lose certain pieces of distribution in certain channels and gained some distribution in other channels over time. We did have an issue with some supply; some of the product, but this being ebbs and flows so there was nothing that was hugely impactful. But it’s just a trend that we continue to see in that really competitive trade channel.

Alan Robinson – RBC

Okay and then just a sort of 30,000 foot question really, you know if you look at your household products segment you’ve seen very good historical growth in Europe, you know perhaps above the growth of the market there and by the same token you’ve seen pretty big declines in the American market. So you know what gives you a competitive advantage in Europe as far as you see and how confident are you that you’ll remain insulated from the competitive pressures you’ve seen build up in the US market over the past two years in terms of your European strength?

Garry Ridge

Well Europe is a very clear story. We were able to take the innovation of Carpet Fresh which was a product that was developed here in the United States, we matched that with 1001 brand and we were first in the market with a completely game changing innovation in the room and rug deodorizer category. We did the same thing in Australia, so what we did is transplant an innovation into markets where the innovation had not been executed upon.

We continued to gain market share in the category of room and rug deodorizers in both Australia and the UK. Without significant entry by a competitor, my belief is probably because it’s not big enough for them to get too excited about it. But you know we have to listen for the alarm bells, but at this stage we’ve now built businesses in Australia and in the UK in the room and rug de-odor category with an aerosol product that is significant and basically unchallenged.

Alan Robinson – RBC

Interesting. And last question, regarding the share repurchases that you’ve completed, any plans to ask the Board for a further authorization?

Michael Irwin

The Board reviews our capital structure on a quarterly basis and at this stage we have no additional authorization. But just to reflect back on share repurchase, this was one share repurchase authorization that we completed but we did another one several years ago and so we’ve repurchased about $50 million in shares over the past three or four years. So roughly 10% of the shares outstanding over that time period.

Alan Robinson – RBC

Alright and your best guess for diluted share count for the second half of the year is what about 16.7 or something like that?

Garry Ridge

In the guidance that we gave, we estimated 16.8.

Alan Robinson – RBC

I’ve got you, okay, alright thank you.

Operator

Thank you we’ll take our next question from Cheryl Cortez at Susquehanna Financial.

Cheryl Cortez – Susquehanna Financial Group

Hello. I just wanted to, most of my questions have been answered just now but I wanted to get additional color on any innovation products that you’re focusing on for the future.

Garry Ridge

We haven’t, as we’ve always said, we’ve got a number of things in our pipeline that we’ll be releasing them over time but for obvious competitive and other reasons we don’t really tip our hat on what they are. But certainly as you would have seen, our research and development, our team [inaudible] costs were up in the second quarter so we continued to invest in that activity and are really rigorous about the process and are optimistic that some new product will come out. The new green product in the spot shot category is an example of that and in fact we failed to mention that we are the first green positioned carpet stain remover to be released in the United States. We have a leading edge on that so we’re kind of happy about that.

Cheryl Cortez – Susquehanna Financial Group

Okay. Last year you mentioned placement in major stores was shrunk because of the holiday season. Is some of the, did you see that activity again this year or was it more an economic factor that made [overlay].

Garry Ridge

Yeah I think you were referring to spot shot in the holiday season of the year before last actually. But there are certain retailers who rotate product in and out to make way for what I call Barbie Dolls and barbeque sets that sell better in the holiday period. That’s a ways off yet, we’re not aware of any of that at this time but I guess that review session will come up in the next 90 days or so.

Cheryl Cortez – Susquehanna Financial Group

Okay, well thank you very much.

Operator

Thank you, next we’ll go to Robert Felice at Gabelli & Co.

Robert Felice – Gabelli & Co.

Hi, just a couple of quick questions. I guess first Garry I was hoping you could characterize to what extent you think the weakness you experienced domestically is a function of customer de-stocking and to that end is just a timing issue versus a more fundamental or systemic slowdown. And it would seem to me that the bulk of WD-40’s products are load ticket items and to that end should be somewhat resilient to an overall slowdown.

Garry Ridge

You know what I can tell you is that firstly as far as the economic behavior of our customers, it’s erratic. What I can tell you is that the conversion to smart straw was probably the biggest thing we’ve done in our 50 year history where we basically swapped out a complete line of product. The evidence would have been that we would have maybe expected a buy in of the old product against that because there’s about a 30% lift in price. We didn’t see that, in fact there was excitement about the new product. So we, the amount of promotion that we would have normally had around the WD-40 brand and the inventory at store level of the old product did decline in the second quarter.

Which we are now looking to see the other side of that in quarters three and four, we would hope that with the new innovation of smart straw, with the higher retail price, with the enhanced margin for the retailers, the higher dollar ring, that we’re going to get some enthusiastic promotion for the WD-40 smart straw brand through to the end of the year. I’ve been saying since day one of this year that it’s going to be a pretty sort of roller coaster ride for the WD-40 brand in the US throughout the year.

There are a number or risks, firstly the risk that we would get the conversion done and as I’ve said I’m extremely proud of our team who executed rigorously to get that conversion done and basically seamlessly, although I’ll tell you there was a lot of work in the background. So we got through that risk and now it’s a matter of us getting the most amount of WD-40 in front of where the most people who use the most are. And that’s what it’s about. In the household products area, you know we’re seeing a lot of activity going on there as with some economic pressure but I can’t read that, that’s too volatile for us to read.

What we need to be concentrating on is innovation like our new spot shot green product and some other product enhancements that we have that we’ll be rolling out in the second quarter and really you know. I have a saying, no doom no gloom just boom. We can convince ourselves, have everybody else convince us that things are worse than they are, I wish we’d declare a recession so we could get out of it, but we’ve just got to do the best we can, get the best promotions we can and fill our consumer needs.

Robert Felice – Gabelli & Co.

So it sounds like if I’m reading into it correctly I mean the economic environment really perhaps just noise in the background and the biggest dynamic is really this gap that you had in between that came about as a result from the switch to the old product to the new product in which customers really de-stocking, so there’s just kind of empty period.

Garry Ridge

I don’t know whether it’s noise in the background, what I can tell you is that certainly the behavior of our customer in relation to the WD-40 brand during the conversion period caused us to have less activity at retail for the WD-40 brand than we would have normally had in that period.

Robert Felice – Gabelli & Co.

Okay. And then switching gears for a second to the smart straws I was hoping you could kind of help me understand the economics behind it. I know that the pricing on the smart straw will be about $1.00 higher per can at the retail level but I’m trying to get my hands around how much higher the gross margins will be on that product so I can get a sense for the overall incremental contribution a full conversion could have.

Garry Ridge

That’s a really, really interesting question Rob you know we could freeze the input costs to our product right now, I could hope you’d do that, but because we can’t freeze the input costs to our product, i.e. cans, petroleum, freight and everything associated to that, we are also interested to see how it turns out. What we do know is that we’ve raised our wholesale price 30%; we believe that as we get our production volumes up through smart straw, we’ll gain some production efficiencies.

I would expect over time that the margin will enhance because initially any swap to a new production process, the initial period, the volumes are a little off what maximum productivity would be. So I’m with you, what we do know is that we see this as a positive move and hopefully it’ll give us some sort of breather from the absolutely crashing effects that the increase in raw materials have had on us over the past five years.

Robert Felice – Gabelli & Co.

And do you see this as a dynamic that could potentially lift your gross margins for the company north of you know say 49-50% over the long term?

Garry Ridge

I’ve said that one of our stated goals was to get our gross margin back over 50%. This and many other things that we work on everyday are just brutally focused on doing that.

Robert Felice – Gabelli & Co.

Okay and then I guess last question you know I know your advertising and sales expenses are quite variable, volatile from period to period but if I look back over the last three years or so your A&S expense has kind of been at the low end of your 6.5-8.5% range. And I’m just wondering should we kind of think about that lower end of that range as more of a normalized level on a percentage of sales basis on any given year perhaps certain dynamics could occur to push it up but that 6.5% level is more the normalized level?

Garry Ridge

No you shouldn’t. That’s why we give a range between 6.5-8.5% and the reason being is there are activities we have planned that are circling around some of the new things we’re doing in spot shot and we anticipate executing on them but then again timing may change that for a particular reason. So the best we can do is give you that range and have you trust us that we’ll execute the best way we can when the time is right and it’s in the best interest of our brands and reaching our consumers.

Robert Felice – Gabelli & Co.

Alright well thanks for taking my questions.

Operator

Next we’ll move to Frank Magdlen at the Robins Group.

Frank Magdlen – Robins Group

Good afternoon Garry. On the roll out of the stain remover, is that through all channels or your normal channels where spot shot is currently found?

Garry Ridge

Yes it’s two staged, the first stage is the pet product and you’ll already find that in distribution, it’s in Petco and rolling out at other trade channels and you’ll see the other SKU or two SKUs start to go into retail distribution in May and June. And it will be going across all trade channels.

Frank Magdlen – Robins Group

All trade channels. And first quarter you had some stock outs and I know that cost you a little bit in distribution possibly but did you have any problem in the second quarter?

Garry Ridge

We’ve had some continued disruption, not as severe, but certainly it hasn’t been helped by some of this staging of product that we’ve been doing like swapping out or bringing in the new spot shot green product and some other things we’ve been doing but it wasn’t as severe but there was some, still some disruption.

Frank Magdlen – Robins Group

All right, one last question on the green product you said it was the first in the US which begs the question is there a competitor available and on another continent or country?

Garry Ridge

No we think we’ve got to the finish line first on this one.

Frank Magdlen – Robins Group

So first worldwide.

Garry Ridge

We think. Well for the best of our knowledge.

Frank Magdlen – Robins Group

Okay that’s fine, that’s good, thank you very much.

Operator

At this time there are no further questions I’d like to turn it over to our presenters for final or closing remarks.

Garry Ridge

Okay that’s it from us and we’ll see you in about nine days or so. Thanks, good afternoon.

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Source: WD-40 Company F2Q08 (Qtr End 02/29/08) Earnings Call Transcript
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