The Clorox Company
Q1 2008 Earnings Call Transcript

Published: 1 Nov 2007

Operator:

Good day, ladies and gentlemen and welcome to the CloroxCompany fiscal year 2008 first quarter earnings release conference call.(Operator Instructions) I would now like to introduce your host for today’sconference call, Mr. Steve Austenfeld, Vice President of Investor Relations forthe Clorox Company. Mr. Austenfeld, you may begin your conference.
Steve Austenfeld:

Great, thanks. Welcome, everyone and thank you for joiningClorox’s first quarter conference call. On the call with me today are Don Knauss, Clorox’s Chairman and CEO; LarryPeiros, Executive Vice President and Chief Operating Officer of Clorox NorthAmerica; and Dan Heinrich, our Chief Financial Officer. We are broadcasting this call over the Internet and a replayof the call will be available for seven days at our website,www.thecloroxcompany.com. On today’s call, Larry will start with comments on the firstquarter operating results, providing key business highlights as well asperspective on the current commodities cost environment. Dan will follow up with a review of thequarter’s financial performance as well as detail supporting our updated fiscalyear ‘08 outlook as communicated in our press release this morning. Don will then conclude our discussion of ourfirst fiscal quarter with his perspective on a recent performance and futureexpectations. Following that, we will be joined by other members ofmanagement who will share additional information and perspective on theacquisition of Burt’s Bees, as was announced in our press release earliertoday. We will then open it up for yourquestions. Let me remind you that on today’s call we will refer tocertain non-GAAP financial measures, including but not limited to
Lawrence S. Peiros:

Good morning and Happy Halloween. As you saw in our press release, we are offto a great start this fiscal year. Strong first quarter results across our businesses were driven byhealthy top line growth and positive business mix. Sales were up 7%, with sales up 5% in North America and sales up 18% in international markets. In North America, volume grew 5%, with strong shipments ofthe home care products, Hidden Valley salad dressings, Brita water filtrationproducts, cat litter and double-digit gains in Canada behind strong basebusiness growth and the recently bleach acquisition. On the international side of the business, volume grew 11%,behind strong category growth in laundry and home care in Latin America, as well as the bleach acquisition. Our Australian business returned a positive,high single-digit volume growth behind increased shipments of trash bags andthe new Chux Spray and Wet Wipes in the utensils category. Dan will review the financial results in more detail in afew minutes. Before that, I’ll providesome overall perspective in three areas
Daniel J. Heinrich:

Thank you, Larry. With that, let me walk you through our first quarter financialresults. For the quarter, we delivered $0.76 in earnings per diluted share,reflecting strong top line performance, including the benefit of increasedsales from higher margin businesses and also reflecting slightly lower Q1restructuring costs than previously anticipated, due to the timing of therelated initiatives. On the top line, sales grew 7%, including 1 point fromfavorable foreign exchange and about 2 points from the recently acquired bleachbusinesses, while volume grew 6% versus the year-ago quarter, including about 1point from the bleach acquisition. Despite increased year-over-year investments in tradepromotion spending to support brands facing competitive pressure, sales growthoutpaced volume growth due to the benefits of favorable business mix, priceincreases and favorable foreign exchange. Given the competitiveenvironment, increased year-over-year trade promotion spending is expected tocontinue into the second quarter and beyond. As expected, first-quarter gross margin declined, coming inat 42.6%, compared with 42.9% in the year-ago quarter. Let me break down the 30 basis pointdecline. Gross margin benefited fromabout 180 basis points from cost savings and 50 basis points from priceincreases. These positive factors weremore than offset by 140 basis points from higher expenses for manufacturing andlogistics, which includes diesel costs and some restructuring charges; and 120basis points from commodity cost increases, primarily from resin, but as wellas agricultural commodities such as soybean oil and corn starch. First quarter charges were $27 million for consolidation ofour manufacturing networks and other charges the company decided to take inlight of our Centennial Strategy. As areminder, we continue to anticipate fiscal year 2008 total pre-tax charges tobe in the range of $49 million to $58 million, of which $35 million to $39million are non-cash. We anticipate thebalance of this year’s charges of $22 million to $31 million to be spreadfairly evenly across the quarters with about half hitting cost of sales whichwill have a dilutive affect on gross margin. As previously communicated, in the first quarter we executedan accelerated share repurchase agreement or ASR. As a result of the ASR, first quarterinterest expense increased due to the debt we incurred to finance thetransaction. Final settlement of the ASRprogram is scheduled for no later than January 24, 2008. The final number of shares the company is repurchasing underthe terms of the agreement and the timing of the final settlement will dependon prevailing market conditions, the final discount of volume weighted shareprice over the term of the ASR program and other customary adjustments. Turning to cash flow, we had a terrific quarter. For the quarter, cash flow from operationswas $163 million compared with $133 million in the year ago quarter. Free cash flow increased 34% to $137 millionor 11% of sales compared with $102 million or 9% of sales in the year agoquarter. We define free cash flow ascash provided by operations less capital expenditures. Q1 capital expenditureswere $26 million compared with $31 million in the year ago quarter. Our cash flow increases were primarily driven by higher earnings,excluding $25 million of non-cash charges. As you know, we focus on the company’s cash flow generation abilitywhich has been our hallmark. We believeit’s an excellent indicator of the long-term performance of the company. But as a reminder, $0.01 of EPS equals butabout $1.5 million after tax. So ofvariance of a few cents EPS in the quarter does not have a material impact oncash flow generation in that quarter. Turning to our financial outlook for the year, we continueto expect organic sales growth in the range of 3% to 5%. Including the benefit of the recent bleachacquisitions and before the impact of Burt’s Bees, we anticipate total salesgrowth in the range of 4% to 5%. It’spossible we could be in the higher end of the range based on the potential ofthe Green Works launch, our efforts to revitalize grocery and some otherpositive trends we’re seeing in the business. Gross margin for the year is now expected to declinecompared with fiscal 2007. This reflectsour current outlook for additional downside from commodities costs,particularly in the second quarter. Previously, we had assumed greater declinesin resin costs over the balance of the year. Given current trends, we still anticipate declines in the second halfbut less than previously anticipated. Our belief in moderating resin prices is based on capacitycoming online in the Middle East. In light of our increased commodity costoutlook, we’re doing a number of things to help offset this impact includingevaluating trade spending levels, marketing investments and administrativespending. Additionally, we’re taking our cost savings target from $80 millionthe $90 million up to about $100 million for the full year. Of course we’re always looking to do more onthe cost savings front. In addition tothe charcoal price increase Larry mentioned, we’re also considering whereadditional price increases may be necessary, particularly with Glad. Previously we anticipated our tax rate to be 35% to 36% forthe fiscal year. We now anticipate ourfull year tax rate to be in the range of 34% to 35% based on our outlook forthe timing of settlement of certain tax matters. Due to all the factors I just discussed, our updatedearnings outlook before the impact from Burt’s Bees is for fiscal year 2008diluted EPS in the range of $3.33 to $3.50 which still includes $0.21 to $0.25 EPS impact from the charges we’vediscussed. This increased EPS outlookprimarily reflects the benefits of the accelerated share repurchase. For the year, we now anticipate weighted average dilutedshares outstanding to be about 142 million, subject to adjustment once the ASRtransaction is settled. So we had a very strong quarter. While we’re also facing a higher thananticipated commodity cost environment throughout the year, we feel good aboutthe organization’s ability to deliver on our plans for the fiscal year. Now with that, I’ll turn it back over to Don.
Donald R. Knauss:

Thanks, Dan. Goodmorning, everybody. Certainly as Larryand Dan noted, we had a great first quarter. I’m particularly pleased with the strong results across the business andalso that our brands responded well behind our investments to address thecompetitive conditions we’ve talked to you all about over the last six months. Also that strong cost savings and the ongoingbenefit of price increases helped mitigate what we all know to be a fairlyintense commodity cost environment out there. Now at the same time, I think it’s still important to bearin mind that we focus on annual targets and long-term goals, and as we noted frequentlythere are going to be quarters that come in higher or lower than anticipated aswe saw this quarter and last. What’simportant is how our business performs over time and whether we stay on trackto hit our annual targets and the long-term goals, despite variances in thequarters. Based on our current performance and the outlook for the year , I’lltalk a little bit about the innovation pipeline for the second half, we feelgood about where we are right now. I’d like to take a couple of minutes to update you on our CentennialStrategy and comment on our economic profit outlook for 2008. While it’s stillvery early, I’m certainly pleased to note we’re beginning to gain tractionagainst several of our strategic choices. Let me give you a couple of examples. As you’ll recall, one of our strategies is to expand our business in andbeyond the core, and we’re making considerable progress against this strategy. As Larry already mentioned, the transition of our recentbleach acquisition is going extremely well, and we continue to anticipate thisbusiness will add a little less than a point of growth to the top line. Many of you have heard me talk about Green Works, and weplan for that later in this year. We’re alsolaunching in Canadaand Puerto Rico with more markets to follow. With GreenWorks, Clorox is the first major CPG player to enter the natural cleaningcategory. As I’ve talked frequently,unlike other natural cleaners on the market, Green Works cleans as well asconventional cleaners, and it’s going to be the first natural cleaner withnational distribution and significant brand-building investments. We believe we really hit the sweet spot herebecause Green Works capitalizes on the convergence of two of the mega-trendswe’ve been talking about that we’re seeing taking off with consumers, healthand wellness and sustainability. We’reoptimistic about the brand’s prospects as it performed very well in test markets,and customer reaction and interest across channels has been very enthusiastic. On a similar note, as Larry mentioned, we believe the sametrend may have contributed to some positive Q1 results for Brita waterfiltration systems as consumers certainly seem to be adopting more sustainablelifestyles. Just for a brief second, looking to the second half of theyear, we’ve got a number of new product launches planned. I would just say we feel very good about oursecond half innovation pipeline, leading of with Green Works. Another one of our strategies is to win by building consumerlifetime loyalty through what we call the three Ds
Beth Springer:

Thanks, Don. We aresimply delighted to announce this acquisition. As Don said, it is very strongly aligned with our Centennial Strategy, akey element of which is to grow the company in and beyond our core by focusingon higher growth and higher margin categories. Our goal with this transaction is to make a platform acquisition byacquiring a company with sufficient scalability. With Burt’s, we are entering into a rapidlygrowing market that has gained momentum behind the consumer mega-trends ofhealth and wellness and sustainability. Let me take a moment now to outline in a little more detailhow Burt’s Bees aligns with our strategy and our acquisition criteria. First, it’s in a high-growth category that isconsistent with the consumer mega-trends we’ve talked about. In line with our strategy, we’ve beenactively seeking potential acquisitions aligned with these trends, and we were veryexcited when we found this brand and this opportunity. Burt’s Bees is anchoredin the sustainability and health and wellness mega-trends, and we believe thisbusiness will continue to benefit from those tailwinds for years to come asmore consumers adopt these lifestyles. Second, we believe Burt’s Bees has the ability to become aneven stronger brand. Currently, it isthe leading natural care player with strong shares in most of itscategories. Among many consumers whopurchase natural brands, it is already viewed as the most natural personal carebrand and the leading natural brand in the US. And as Don mentioned, growth rates in themarkets outside of the US are as high or higher as they are here. Third, national personal care is an economically attractivecategory and Burt’s Bees margin structure is at the upper end of the range ofconsumer products. It will be highlyaccretive to Clorox. Finally, the brand aligns strongly with our strategy todrive demand creation and build lifetime loyalty by focusing on the three Ds ofdesire decide and delight. As areminder, desire is about increasing consumer awareness and trial. Decide is about winning at the point ofpurchase. We believe our deepcapabilities in desire and decide complement Burt’s Bees strong capabilitiesand innovation to delight consumers with natural products they truly love. As mentioned in our press release, the business will remainin North Carolina and John Replogle will stay on as President and CEO of Burt’sBees reporting to me. I could not bemore pleased with John’s decision and truly look forward to working with theother employees and Burt’s Bees affiliates. Our plan is to operate Burt’s Bees as a semi-independentunit leveraging its highly effective strategy and plan, its excellent tradepractices and organizational capabilities and Burt’s is a wonderful robustculture and esprit de corps that we want to build on and protect by minimizingthe disruption to the business and the culture. At the same time, we are confident there are opportunitiesto accelerate the company’s profitable growth and we will focus on creatingthese revenue synergies. Specifically,we’ll leverage our considerable capabilities in the food, drug and massmerchant channels, our expertise in niche brand management, as well as ourcapabilities in advertising and sales promotion to ensure we maximize thepotential of this business. Our strategic rationale in this acquisition was alwayspredicated on the recent strong growth and our belief that the convergence ofthe two trends of health and wellness and sustainability will sustain growth inthis category and for this brand for years to come. That said, we believe the acquisition hasadditional value to be unlocked as our national platform expands and takeshape. Burt’s Bees will also an enablerfor international expansion and our broader strategy to pursue health andwellness and sustainability at Clorox. We’re truly looking forward to working with John andeveryone at Burt’s Bees to develop the right principles and protocols wereworking together and to identify and pursue all the synergies as well asimplement appropriate controls. With that I’m going to ask John Replogle to say a few wordsbut before I do I want to let you know that John and I spent the morning heretoday in the Burt’s Bees headquarters in North Carolina,as Don said. We’ve had the pleasure nowof meeting with probably about 100 of the employees and we’re pleased to saythat their response to our message about the merger is positive. With that I’m going to ask John to share some of hisperspective about the acquisition.
John Replogle:

Good morning everyone and thank you, Beth. I’m absolutely delighted to be staying on andto be part of this historic next phase, which presents a great growthopportunity, not only for Clorox but also for Burt’s Bees. Both companies are built on strong leadingbrands with a history of delighting consumers and we have very similar corevalues and missions. At Burt’s Bees, ourmission is to make peoples lives better every day naturally, which is a perfectcomplement to Clorox’s mission to make everyday life better every day. Clorox brings tremendous brand building, customer facing andproduct supply capabilities to Burt’s Bees that can help us take our businessto the next level. The combination ofour two companies creates great opportunities for more innovation and evenstronger growth platforms built on health and wellness and sustainability. I’mreally looking forward to what the future has in store for Burt’s Bees and forClorox as we begin to work together. Now I’d like to turnthe call over to Dan Heinrich.
Daniel J. Heinrich:

Thank you, John. AsBeth said, we’re delighted with this acquisition and we believe Burt’s Beesstrategic fit and alignment with our acquisition criteria creates strong salesand margin growth opportunities for Clorox. I’d now like to walk you throughthe details of the transaction and our financial outlook. As you saw in a press release we’ve entered into anagreement to acquire Burt’s for $925 million net of an additional $25 millionpayment for anticipated tax benefits. Weanticipate the transaction will close by the end of the calendar year and it’ssubject to regulatory approval. Our valuation of the business is primarily based onexpansion within the US and the countries in which Burt’s is currently marketedwith anticipated ramp up and marketing spending as the brand transitions to amore complete mass distribution model. The business is enjoying very strong distribution gains and we believewe can add value and expand these trends over time through our strong customercapabilities. As Beth noted, we see significant potential for buildingdistribution. While not included in our base valuation for the business,expanding the brand into product adjacencies and seeking more aggressiveinternational expansion offers significant upside potential beyond ourvaluation. Burt’s Bees has very attractive returns and we believe itwill create value for us. It helpsaccelerate our top line growth. It helpsbuild our gross margins and EBITDA margins. It’s anticipated to be EPS accretive in fiscal year 2009. We’re optimistic we can exceed theassumptions in our base business plan for Burt’s Bees. We intend to fund the all-cash transaction through cash andshort term borrowings, which will initially take our debt to EBITDA ratio to3.5
Donald R. Knauss:

With this transaction, Burt’s Bees allows us to expand evenfurther into the natural sustainable business platform in an area where webelieve there is certainly tremendous opportunity to build this into a bigshare brand and we believe the business is the compelling fit for usstrategically and as I said, this is consistent with the mega-trends that I andothers have been talking about since I got here last October. We think it’s a great strategic fit and that ourcomplementary strengths, our core value and the parallel missions that we havethat John referenced provide us a really strong foundation for success. So with that I’d ask the operator to open the lines up foryour questions.
Operator:

Your first question comes from Chris Ferrara - MerrillLynch.
Chris Ferrara -Merrill Lynch:

I just wanted to ask on the Burt’s acquisition, first of allI want to talk about margins and the growth rates. You’re saying low to mid-teens sales growthover the next few years and presumably a ramp up in advertising. So what does that mean for that business’EBIT growth going forward? And also on the competitive environment, I mean,would you have expected deterioration in margins anyway as the category getsmore difficult over time?
Donald R. Knauss:

I think you’re looking at a brand that has had over a 25%compounded growth rate the last three years. We think our valuation, which puts it into the-low teens growth rateobviously growing off a larger base is fairly conservative. We certainly think, as Dan said, that we canexceed the assumptions that went into our valuation, particularly when you lookat the distribution opportunities that are out there. For example, our focus on grocery, which is starting to payoff. We think there is significantopportunity in grocery where Burt’s Bees does less than $20 million of revenue. If you look at the mass opportunity, you look at thecontinued drug opportunity and convenience stores where there’s very littlepresence at all, we think we can exceed that valuation. When you look at the pricing power of the brand, we thinkthe margins are extremely healthy and will stay that way, but I will let Johnjump in and Beth as well.
Beth Springer:

Don, we absolutely agree. We see lots of growth potential in the business. We have no expectation of margin erosion andin fact, see opportunities as we begin to turn our sights after growthsynergies to cost synergies potentially to boost those. So we are confident that we can deliver thenumbers we’ve committed to you, Don.
Daniel J. Heinrich:

Chris, on our valuation model in this business it doesassume over the coming years as we go increasing with this business to masschannels that there are certain increases in trade spending and certainly wehave a ramp up in the model on the marketing support for the brand but as Donand Beth has said we still expect the margins on this business to remain verystrong.
Chris Ferrara -Merrill Lynch:

Do you think 30% plus is sustainable over the next couple ofyears from an EBITDA margin perspective given the ramp up in spending?
Daniel J. Heinrich:

I think when we model this thing out we believe for the nextseveral years that those kind of margins are certainly achievable and as Donmentioned, the growth trajectory of this business, the pricing power of thisbrand, are pretty strong and we believe that will help us sustain margins evenas we move more increasingly in this business into the mass channels.
Donald R. Knauss:

I think, Chris, the other thing that builds on that is,especially on the purchasing leverage that we can bring to Burt’s Bees with ourscale. So I think there are some costsynergies here that we really haven’t talked about but certainly they’re thereto help protect that margin.
John Replogle:

I’ll add to Don’s point on scale is organizationally we area business that has really just hit organizational scale. So as we continue togrow the top line we should enjoy some scale benefits.
Chris Ferrara -Merrill Lynch:

Don, what’s your view of the EP impact of doing this deal?
Donald R. Knauss:

Well I think as we model this thing out, Chris, we think itcan be EP positive in five to seven years. It is a little longer than we would have hoped but I guess what reallyexcites us about this and what we think is unique about this is that as wescour the universe to find brands that fit with the criteria we articulated inthe Centennial Strategy, consistent with mega-trends, big share brands,economically attractive categories, fragmented categories, et cetera. As we looked at those I mean we couldn’t findanything that got us nearly as excited as Burt’s Bees. When you look at the brand strength, the fact it’s beengrowing over 25% a year, the fact that we think the trends, the convergence ofsustainability are trends that are going to sustain the category of growthrates into the future for years to come. The fact that you do have a fragmented category where thetop five players don’t have a 20 share combined plays to our strength. And thenyou look at the fact that these margins are very accretive to our margin structureand we do think we can sustain them. Lastly, we think there’s a significantimpact on EPS fairly short term. Whenyou add up all those things we are saying we’ll take a little bit longer timeto build EP.
Daniel J. Heinrich:

Chris, the other thing I would say is if you look at theimpact of Burt’s in the Clorox in terms of our annual goals and economic profitgrowth, for ’08 our annual goal is to increase economic profit at least in thedouble-digit level annually. As we’venoted before in the base Clorox business, we are not likely to achieve that infiscal ‘08 primarily due to the restructuring costs that we’re taking in ourmanufacturing network. Certainly when you overlay the Burt’s acquisition, primarilydue to the transaction the one-time cost associated with the transaction in’08, that we’re likely to see some dilution on economic profit for Clorox. But in ‘09 as Don said it becomes accretivefor EPS and for EP for the total company we’re anticipating growth in EP and weanticipate right now in fiscal 10 and beyond that we’ll be returning to annualdouble-digit increases in economic profit. So it does have a bit of a near term impact in fiscal ‘08and fiscal ‘09 but by fiscal ’10, we should be back on the trajectory to annualdouble-digit growth and economic profit.
Chris Ferrara -Merrill Lynch:

Just on a totally different note, your long-term view thatresin is going down over time, I was wondering if you could just talk aboutthat relative to -- I understand capacity is the reason you think that’s goingto happen, but with hydrocarbon costs where they are and I guess the generalview that hydrocarbon costs again are the biggest driver of resin; I mean, if crude stays at $90, do you stillget the type of resin declines in the long term that you think you’re going tosee?
Daniel J. Heinrich:

Well, certainly oil prices have been pretty stubborn atthese very high levels and we still anticipate that the long-term thesis in themarket is the right one. We are going to be seeing the resin capacity in theworld market increase probably by 30% to 40% over the coming years as thatMiddle East supply comes on line. And as a reminder the input, the raw materialinput is natural gas in the Middle East versus oil in Asia. Again, thesovereigns there will be fixing those input costs at reasonably low levelscompared to the U.S. And we think just the sheer supply/demand curve with thatsupply coming on line with lower input costs will naturally start to driveresin down, and again we are anticipating that. Obviously we had anticipatedthe inflection point to be a little bit sooner than it has been, but we stillbelieve in our longer term thesis that that will bring resin down over time. We still believe in that thesis. Certainly we are encouragedbecause we are in discussions with suppliers in the Middle East and we have anidea of what they are thinking of in terms of pricing.
Operator:

We’ll go next to John Faucher of J.P. Morgan.
John Faucher:

Good morning, everyone. You talked a little bit about thebroad strength of the business, and can you maybe walk us through on some ofthe businesses whether or not announced price actions have had any impact onthe underlying volume? Are you generally seeing the strength in top line acrossthe businesses reflected in the take away?
Lawrence S. Peiros:

We have seen very good broad-based growth in the business.We are not seeing a lot of impact from pricing. We took charcoal pricing up ayear ago. We saw fairly minimal impact. That business is still very healthy andgrowing and we expect it to be healthy and growing despite another priceincrease this year. We are obviously doing lots of things on the marketing sideto offset the impact of pricing, because there is some impact. But overall,it’s a very healthy business. I would say most of the other businesses have not beendramatically impacted by pricing. Most of our pricing actions have been prettymuch anniversaried at this point. We did have some concern about raising priceson Hidden Valley, given that we haven’t taken pricing on that brand in a longperiod of time. We were happy to learn it appears that our competitive set isfollowing our pricing actions, so we should be relatively unchanged from aprice point versus competition. We are seeing growth on lots of fronts. We have beenspending pretty aggressively on Wipes, given the competitive situation. We’vereturned to double-digit growth. We saw some incredible performance on ourBrita business. We are attributing that in part to the fact that this concernaround bottled water waste is gaining momentum with consumers. But just a lot of places where we are seeing just very goodgrowth. I should also mention that Bleach acquisition we talked about that,terrific results versus our expectations in both Canada and Latin America. Alsothe potential over the longer term to broaden that to a very successful healthand wellness platform like we have on Clorox in the U.S.in those areas of the world.
Don Knauss:

Let me just add, as Larry ticked off the brands andcategories, let me talk about channels for a second. I do think just a littlecolor commentary on the grocery initiative. As you know, we brought 15 peopleon board, we are bringing another 15 on board, and the focus on AMPS, or assortment,merchandising, pricing and shelving, is starting to pay off. The trend in thefirst three months of this fiscal year, our grocery business was up about 3%versus a 97 index for the previous 12 months, so that’s a significant tailwindbehind the growth in the business overall. We feel very good about that, so weare gaining traction there even quicker than we though we might. And then lastly in countries, as you look at the countries,a strong growth across Latin America, Canada extremely strong growth, andreally gratifying, we’re seeing Australia return to single high digit growthrates as we sort through customer issues there. So really across the board strong growth by category, bychannel, by country.
John Faucher:

So it sounds like you don’t think there is much in the wayof loading involved in terms of in advance of some of these price increases?
Lawrence S. Peiros:

No, there’s really only two price increases that we talkedabout, Charcoal, Hidden Valley, and -- no. I mean, we basically have policiesin place that don’t really allow for a lot of loading, but it really hasn’tbeen a big issue in the past in our pricing and we don’t expect that it’s acurrent issue.
John Faucher:

Okay. Thank you.
Don Knauss:

Plus on the charcoal, John, we are going into theoff-season, so they are not going to load it up.
Operator:

We’ll go next to April Scee of Banc of America Securities.
April Scee:

Thanks. When we look at margins versus our expectations, itlooks like part of the beat was driven by less advertising and research anddevelopment. When you talk about your pipeline, it sounds like that could bepartially driven by timing, but could you just talk a little bit more aboutwhat we should expect from advertising and research and development as we gothrough the year and what’s in your pipeline in particular that gives youconfidence?
Daniel J. Heinrich:

April, let me start with R&D. Typically, we’re around 2%of sales, slightly above that. A touch lower on R&D this quarter and that’sstrictly due to timing of some of the initiatives and some of the spending thatwe have there, so a little over 2% is still a good number for R&D. On advertising, as we said in the past, we tend to averageright around 10%. What you do see in the advertising line though is there havebeen some shifts, as we’ve been responding to competitor activity, we haveshifted some of our spending into trade merchandising to deal with some ofthese competitive issues, so you see that reflected in that metric. Having said that, we are still strongly supporting ourbrands and growing our brands. We have spending, as Larry mentioned, torevitalize the acquired bleach businesses, so that’s supporting there. And thenwe also have some spending that we are doing behind C2 to address some of thecompetitive activity there. We still believe we are strongly supporting our brands butyou do see some shift from our advertising into trade spending. And for thefull year, we would anticipate we are going to be in the 9% to 10% range ofsales.
Lawrence S. Peiros:

Let me just build on that. Again, demand building, if I lookacross both our advertising investment, trade investment is up prettysignificantly versus a year ago. A lot of that is because of the competitiveactivity. I also want to point out that a lot of our trade spending these daysgoes to what we would call brand building within stores, so activity withinstores that is well beyond price and trying to deliver a message around buildingour brand equities within store. I think you’ve heard a lot about that withinthe industry, and so some of this trade spending, technically classified astrade spending is really advertising in a different form.
Don Knauss:

April, just let me tick off some of the second half pipelinefor you in terms of new products and why we feel strongly about it. We’ve gottwo new Clorox Bleach items coming out, Cold Water and Anti-Allergen. We’ve gota line of highly fragranced cat litters under the Fresh Expressions brand name,so it’s off of Fresh Step. We’ve got refrigerated Hidden Valley salad dressingcoming out in original and buttermilk flavors into the refrigerated case sothat gets the brand into another section of the store. We’ve got a 409 formula coming out for natural stonecleaning, as obviously houses now have granite fixtures in their kitchens andcountertops, so we are going after that. We’ve also got an Armor All on the goauto-glass exterior detailing and cleaning line coming out, and of course, thebig news is Green Works, which starts off with early shipments in lateDecember, and then it really starts heavily in January.
April Scee:

Okay, just another quick question on trash; you mentionedthat you were looking at the possibility of price increases there. What seemslike it should be a lay-up, given what’s happening with polyethylene prices, sois there anything that would stop you from taking this price increase? Also,could you just talk a little bit more about the dynamics that you’ve seen intrash recently, particularly versus [inaudible]?
Don Knauss:

I think I would say stepping back, there are multiple leverswe might apply on the Glad business with respect to the current situation onresin. We could choose, for example, to change our trade promotion spendinglevel versus our pricing. Some would translate to pricing but some of whichgoes well beyond pricing. We could choose to diminish our advertisinginvestment. I can’t say for certainty that we will look at pricing, butobviously given the current resin situation and our outlook for resin, that’ssomething that we will poke at pretty hard. In terms of the business, we’d describe the business in Q3as basically overall flat. The good news is we continue to see very good growthon our ForceFlex trash business. ForceFlex is gaining at a high single digitrate, and we are still seeing share growth in the trash segment versus Heftyand private label.
April Scee:

Thank you.
Operator:

We’ll go to Lauren Lieberman of Lehman Brothers.
Lauren Lieberman -Lehman Brothers:

Thanks. Good morning. I’m a little confused about tradepromotion, because it seems that clearly you had promotion and in-storemerchandising step up in investment to some degree, but if we are not seeing itat all on the revenue or in the gross margin breakout that you gave. The secondhalf of ’07, trade promotion was around 100 basis points drag to margin. So ifyou can explain to me what the difference is, that would be great.
Daniel J. Heinrich:

Lauren, I think what you basically see, we do have asignificant ramp or a sizable ramp-up in trade promotion spending. It’s beenoffset though do to the business mix that we’ve had. Some of these trends inour higher margin businesses and the contributions that we are seeing, that’sbeen some tailwind to us in terms of margin and that business mix is offsettingsome of the drag from the trade promotion spending.
Lauren Lieberman -Lehman Brothers:

And is that channel or product mix, or is it a combinationof both maybe?
Daniel J. Heinrich:

It’s really both. It’s mix of businesses, you know, foods,Brita, certainly we’ve seen benefit there. And it’s also channel, as Don andLarry referenced, particularly the grocery channel, the improved trends we areseeing there are contributing.
Lawrence S. Peiros:

It was also noted in our press release, currency gave usabout a point of benefit in the quarter and we are also getting some benefitfrom pricing, primarily the charcoal price increase we took earlier in theyear. So those two things as well are masking that stuff up in trade promotionspending, which has really continued since the last half of last fiscal year.
Lauren Lieberman -Lehman Brothers:

Okay, but the pricing is a separate line item, right? Imean, the pricing is given at whatever that -- 50 or 55 basis points, so maybeit’s the FX. Okay, but as we look forward, as the mix shifts, theoretically,and I would think Hidden Valley maybe is a little bit slower next quarter, Britamaybe maintains its momentum, I mean -- do you expect trade promotion toreemerge as being a little bit of a drag to margin? Even just given -- you saidyou are going to be shifting some of your spend from traditional advertisinginto the store.
Daniel J. Heinrich:

I will say that we will -- we see the competitive activitycontinuing. We are going to continue to support our brands through the trademerchandising efforts that we have. Also in second half, we have the launch ofthese new products that Don mentioned, particularly Green Works, and we will bespending to support those launches. So in the second half, you will probablysee a slight up-tick in total trade spending in response not only tocompetitive activity but also the launches we are planning.
Lauren Lieberman -Lehman Brothers:

Okay, all right. That’s great. Thank you.
Operator:

We’ll go next to Ali Dibadj with Sanford Bernstein.
Ali Dibadj:

Just a couple of questions; one is, sticking to Burt’s Beesfor a little bit, I am kind of surprised, given the very strong emphasis thatwe’ve been hearing for a while now on EP, that you did kind of feel like thesuccession was warranted to wait for EP to become positive five to seven yearsand still [be a deal]. Particularly at 5%-plus of sales and [through the]valuation, which was pretty high compared to even most recently [inaudible] atroughly 2, 2.4. All this in the context of it sounds like you didn’t have todo anything to the portfolio, although you were looking, and EP was a veryimportant driver of some of your decisions. And I understand the benefits goingforward. I’m just trying to get a sense of has anything shifted on how youthink about EP, or give me just a little bit more detail on why you think is[so great].
Don Knauss:

I think, Ali, that as I said when I ticked off those fivereasons for why we took a little bit more forgiveness on EP in a four tofive-year timeframe versus a five to seven-year timeframe, as Dan noted, webelieve we are going to return to double-digit EP growth as we get out about 18months from now, so we don’t think this is certainly dilutive or inconsistentwith our focus on EP. But I do think when you look at this brand, it is a uniqueopportunity and as I said the day I got here, it was about making this companylarger, not smaller. It was about accelerating the top line and the bottom linegrowth, and really doubling the value of this company over a five to six-yeartimeframe, not just doubling EP which we thought was the best proxy to doublingthe value of the company. But I think when you look at the brand strength of Burt’sBees and the fact that this strong double-digit growth in this brand iscompelling, I do think -- I really do believe these trends around health andwellness and sustainability are not trends. I think they area cultural shift and I think it is only goingto build as people are educated about the benefits of natural personal careversus the other personal care. I think the fact that this category is fragmented where fiveplayers don’t even add up to 20 share, really speaks to the whole strategicpremise of the Clorox company over the last 30 years, which is build brands inmid-size or smaller categories. And then, when you look at the margin accretion of this, withover a 30 EBITDA and the EPS accretion, that can be fairly significant in afairly short amount of time. I’d say that’s a pretty good reason, if you addall those up, to say we’ll give ourselves another year or two on EP to makethis thing positive. Having said all of that, we think there is significantpotential to go beyond our valuation and move that up a year or so, but thoseare the reasons that were compelling to us.
Ali Dibadj:

One question just about [inaudible] five points that you aretaking off there, regarding just the fragmentation of the market. Do you havein your model -- do you think about the fact that many people are going towardsthis organic natural product space and no big player has made a major, major --but that could change?
Don Knauss:

Yeah, well, I think -- and I’ll let John speak to, but letme just kick it off by saying we believe there are and as we did our duediligence here, that there are strong barriers to entry for competitors whowant to get into this category. The typical product development approach ofmainstream personal care has really been shown to be ineffective at gettinginto this category. The instability of natural materials makes for a reallysteep learning curve in reproducing natural formulations and makes frankly,backward engineering really difficult to impossible. We think Burt’s Bees has a one to two-year lead on potentialnew entrants, so we feel very good about that. John, I don’t know if you want to add some additional colorcommentary.
John Replogle:

Sure, Don. Ali, I think absolutely we will see other playersmove into the category. It is inevitable as the consumer moves there and goesmainstream. By our modeling, consumer penetration in natural today is somewherein the 12% range. We expect that to double over the coming years, so as thisnatural market really goes mainstream, more and more of the mainstream playerswill look to enter this market. But we have a distinct advantage, really, in a couple ofways. One is we have leadership. We’ve been in the market for 20 years. We havea leadership position. Secondly, we have the most authentic brand. We areadored by consumers and trusted and we’ve built that reputation and that brandover the last 20 years. And third, as Don mentioned, natural formulations -- we havean outstanding formulation development team, processes within our manufacturer,manufacturing system that allow us to make the highest quality naturalformulations, and those are very difficult to replicate. So we’ve got advantage and differentiation that I think issustainable on at least three fronts.
Ali Dibadj:

That’s quite helpful. In terms of just the differentiationon the barriers to entry, how is that different than pushing in with GreenWorks?
Don Knauss:

I’m sorry, go ahead. Could you ask that again, Ali?
Ali Dibadj:

Sure. You mention a lot of differentiation, a lot ofbarriers to entry to enter into the organic and natural categories,particularly that relate to personal care. Is that a completely differentdynamic in terms of entering Green Works into the natural household careproducts?
Don Knauss:

I think Green Works is just another example of us internallymoving into the same space. We do see the same convergence of these two, healthand wellness and sustainability, applying to Green Works as well. I think the sophistication of our R&D development, ourunderstanding of chemistry, our ability to develop biopolymer technology thatuses coconut and lemon juice basically as surfactants to create cleaners thatcan be as effective as conventional cleaners is something that the smallerplayers in this space just can’t replicate. Now, can the multinationals who are in these spacesreplicate it? Perhaps certainly they could over time. We do think we’ve got asix to 12-month head start. We also think the brand, Green Works, is asignificant advantage going forward. I think when you look at our R&D capabilities in thisspace and the fact that we’ve got I think probably at least a six if not12-month head start will really play to our advantage. I think also as otherpeople get into the category, I think it will just continue to drive thecategory up. We are also looking at follow-on products into adjacentspaces that we already compete in, Ali, that we think we can get out therefairly quickly. What you should expect from us on Green Works is every four tosix months, you will see new product and package news coming out on that brandto keep it fresh, so we are just going to keep pushing ahead quickly intoadjacent spaces to stay ahead of the game.
Lawrence S. Peiros:

The only bit I’ll add on that is Green Works is a new brandname but it does carry a Clorox endorsement and we did an awful lot of workwith consumers and the credibility of Clorox is an important factor in makingsure the consumers understand these product do actually work, whereas othergreen type cleaners have let them down over the years. So it is an importantcomponent of our [inaudible] and a barrier to others.
Ali Dibadj:

Okay, thanks a lot, guys.
Operator:

We’ll go next to Amy Chasen with Goldman Sachs.
Amy Chasen:

A couple of things; first of all, can you -- you mentionedin passing cost synergies on Burt’s Bees but you didn’t give anything specificin terms of either dollars or where they would come from. Can you talk aboutthat?
Don Knauss:

Let me ask Beth and John to respond to that first and thenwe’ll come back to Dan and myself.
Beth Springer:

Amy, we are going to be focusing initially on revenuesynergies, as we discussed earlier. We do think there are cost synergies. Ithink the initial focus will be in procurement. There will be some rawmaterials, a lot of transportation services and the like, and at this point, wedon’t have an estimate of cost synergies that we are sharing.
Amy Chasen:

Okay, so I guess my follow-up would be if we use a mid-teenssales number and the type of margins that you are talking about, at about 5.5%,6% financing costs, we are not coming up with any kind of significant accretionin FY09, so maybe we’re doing something wrong but if you can walk us throughthat math, that would be very helpful.
Steve Austenfeld:

Amy, obviously there are still a lot of assumptions in thesenumbers that we are going to have to fine-tune as we get closer to fiscal ’09.I think the message today is that you could roll out the one-time costsassociated with the transactions, it’s understandably going to be dilutive infiscal year ’08. We talked about that on a GAAP reported basis of being in therange of $0.10 to $0.15 as we see it today. The message for ’09 though is that we see it beingaccretive. How accretive I think still remains to be seen but the message is itis a very quick -- relatively quick period and we believe it is at leastneutral to accretive by ’09 and then moving into solidly accretive by fiscal’10.
Amy Chasen:

Okay, so by -- I’m sorry. I thought you said solidlyaccretive by FY09.
Don Knauss:

If you look through the charges, it is. If you do it on aGAAP basis, it is slightly accretive.
Amy Chasen:

No, I’m excluding the charges. So when you say solidlyaccretive, that means neutral to slightly accretive or does that mean meaningfullyaccretive? I’m sorry, I don’t mean to be getting into the semantics but ournumbers are just showing 1% to 2% accretion in FY09, which to me is not solidlyaccretive. But I don’t know if I’m doing something wrong or if our definitionsare just different.
Steve Austenfeld:

For fiscal ’09 on an as-reported basis, I would describe itas neutral to accretive, slightly accretive, recognizing we still have to do alot of the fine-tuning around final purchase adjustments, updating assumptionsand so forth. Excluding one-time costs, some of which will be subject tothose purchase adjustments, we would see it as being solidly accretive.
Amy Chasen:

Okay, so my numbers are wrong. Can you tell me where I mightbe wrong?
Steve Austenfeld:

It might be easier to cover this after the call on a one-offbasis, just because even for ourselves, actually, we are dealing withassumptions at this point on a business [inaudible] portfolio.
Amy Chasen:

Okay, that’s fine. I’ll call you after the call. Just on atotally separate note, on your annual guidance, you obviously beat the firstquarter in a very meaningful way. You are getting some ASR benefit, you aregetting some benefit from the tax rate as well, and yet -- well, you didinclude the ASR benefit in your raised guidance but you did not include thehigher tax benefit, which suggests that your underlying core fundamentals aregoing to be weaker than you originally anticipated. Can you just talk aboutthat?
Daniel J. Heinrich:

I don’t think our fundamentals are changed. Essentially, theway we view our outlook for the full year is certainly we had a very goodquarter in the first quarter and that gives us a bit of a leg up. We will get alittle benefit of the ASR, which is in our outlook. The tax rate will be alittle bit better than we had anticipated, but the offsetting factor, thewaiting factor again is our updated outlook on commodities cost and the updatedoutlook that we have on that is that we are likely to see between $30 million to$40 million of additional commodity cost pressure over the balance of thisyear. We are a little bit better in the first quarter, but we aregoing to need all of those factors to help overcome the commodity cost impactthere. Certainly taking cost savings up from our range of 80 to 90 to 100 willhelp. As I mentioned, we are going to be looking at admin spending, tradespending, Larry discussed that. So there’s a number of things we are going toneed to do to overcome that pressure and until we get farther along, that’s whybasically what we’ve done with the outlook is update it for the impact of theASR.
Amy Chasen:

Okay. Sorry, just last thing; is it safe to assume that themost difficult quarter for you out of the next three will be the secondquarter?
Daniel J. Heinrich:

That is certainly our view at this point, is Q2 we shouldsee the peak, particularly of commodities cost.
Operator:

We’ll go next to Bill Schmitz of Deutsche Bank.
William Schmitz -Deutsche Bank:

Can you guys talk a little bit about the battlefieldcategories? You know, Clorox 2, Wipes, and then of course, Glad versus Heftyand what’s going on there and what the defense is, especially against [P&G]on the [inaudible] categories?
Don Knauss:

Let me start with Glad. I think I mentioned previously thatwe feel good about our results on glad. We continue to gain share. We continueto see very strong growth on ForceFlex, which you’ll recall is a very goodbrand for us from an EP perspective, so we are in very good shape on Glad. We feel very good about the results on Wipes. We’ve regainedour momentum. We are up double digits in the quarter, so we did have avariation in the previous two quarters where we had a very significant growthand then a bit of a decline. But over calendar year-to-date results, we arestill up strong double digits on that business. In the last month, given the impact of some of our activity,increase in spending, we actually saw share growth on that business, despitethe fact that Mr. Clean is on shelf and starting to gain some share. Theirshare is a 5% to 6% range, so it is obviously well, well below our share. The other threat in Wipes has been and continues to beaggressive spending by Lysol. But again, our results on our Wipes are very, verygood and healthy. We are growing strong double digits. We continue to have avery strong share in that category. Clorox 2, we talked about previously. I think we are moredisappointed there. We didn’t expect a lot in the first quarter. We expect morehealthy results in the back half as we introduce some innovation on thatbusiness, so we are still down a bit, both in terms of volume and share onClorox 2, and we are looking to improve that business in the second half of thefiscal.
William Schmitz:

Okay, and then, are you guys done on the acquisition frontfor the time being?
Steve Austenfeld:

I’m sorry, Bill, the question being are we on the --
William Schmitz -Deutsche Bank:

Are you done on the acquisition front now that did two [BOs]in fairly quick succession?
Don Knauss:

I think we’ve got some time to digest what we’ve got here,Bill. I don’t think that we are out in the market right now looking actively.There may be some things that are modest tuck-in acquisitions, but I don’t thinkwe are active, obviously given with the events of the day.
Daniel J. Heinrich:

I would certainly say we are certainly going to focus onintegration of this business, of helping John and the team there drive theirbusiness plans. That’s certainly going to be a focus of the group, particularlyover the next couple of quarters. We are obviously targeting to get back to a3.0 or lower on our debt leverage, and we are committed to doing that. Our debtratings are very important to us and so we’ll be focusing free cash flow onthat debt paydown. The good news is we generate, as you know, a lot of cashflow and within about three quarters, we are projecting that we will be at orbelow the 3.0 debt-to-EBITDA level. So while we’ll continue to look at otheracquisitions, obviously we are going to balance any of those points of viewwith making sure that we get our leverage ratio down to where we would like itto be.
Don Knauss:

Our primary commitment right now, as Dan said, Bill, is tointegrate the Burt’s Bees business, as Beth alluded, as John as well. We’regoing to run this as a semi-independent company because we don’t want tocertainly do anything that would negatively impact the culture of Burt’s Bees. Having said that, the other thing is that we are verycommitted to getting back to the 3.0 to 1 debt-to-EBITDA ratio within 12months, and that’s what we are going to make happen.
William Schmitz -Deutsche Bank:

Okay, and then this is a random one for you, because Ialways have one for you every quarter, but is this [bee] shortage impacting thecost structure at Burt’s Bees? I don’t know if you follow this at all, butapparently the --
Don Knauss:

Yeah, we’ve been aware of that. John, I’d ask you torespond. Did you hear Bill’s question?
John Replogle:

I’m sorry. I couldn’t hear Bill.
Don Knauss:

Bill’s question was around the bee shortage in the United States, the dying off of certain bee hives.
John Replogle:

Terrific, Bill. It’s an issue that obviously we are quitefamiliar with. It’s called colony collapse disorder here in the U.S., and it issomething we are obviously very concerned about. However, Bill, we source ourbeeswax from Africa and so we do not expect a commercial impact on ourbusiness. But we are taking a very active stance right now on that, trying toeducate consumers and build awareness. And in fact, tomorrow is the release of our first publicservice announcement. We’ll be doing a national PSA on colony collapsedisorders in theaters around the country to build awareness about it and whatconsumers can do to help understand and remedy the issue.
William Schmitz -Deutsche Bank:

Is that going to be conjunction with The Bee Movie?
John Replogle:

It’s not in conjunction with The Bee Movie. We just happento be breaking tomorrow in theaters around the country.
William Schmitz -Deutsche Bank:

Thank you.
Operator:

We’ll go next to Kathleen Reed of Sanford Financial.
Kathleen Reed:

Good morning. Can you talk a little bit about on the Burt’sBees business, is this a very different business than your existing core focuson household products? Is there a lot more SKUs or is it a lot smaller thanwhat I typically think? And what specific personal care categories does Burt’sBees compete in? I know some of them, but is it hair care, deodorant? If youcould just go through.
Don Knauss:

Why don’t I ask Beth and John to comment first, Kathleen,and then we’ll come back.
Beth Springer:

Kathleen, there are definitely some differences from thebusinesses we are in today. If you will allow me, I am going to start byfocusing on some of the things that are most common, then we’ll talk about thedifferences and I’ll ask John to dimensionalize a little bit more about SKUsand where we participate. Fundamentally, we are talking to many of the same consumers.We are talking about building great brands. We have significant channeloverlap, particularly as we look to the future where we grow distribution. I’d say the greatest points of difference, if you will, inhow we add value, these are personal care products, all natural formulations.That’s why we would not have entered the space organically. We wanted toacquire a leading player like a Burt’s. You will find that we have more SKUs and the brand isalready fairly broad in its participation in personal care. I am going to askJohn to elaborate on that.
John Replogle:

Kathleen, our business is really focused in two areas; one,we have a core care business. We are also then in cleansing categories. And ourcore strength is in care. We play in lip care and skin care and baby care, andthose are leadership positions we have in each of those. And we are quicklygrowing our share in our position in the cleansing areas of hair care or haircleansing and body wash and personal cleansing, and we see those as very goodgrowth opportunities for the business going forward and we’ll look to continueto grow into white space areas where we don’t play today, really in the oralcare and deodorant space.
Kathleen Reed:

Also the current distribution of Burt’s Bees is it primarilyin specialty organic stores? Or can youjust walk through where it is now? Isthere a risk that you will alienate your core consumer if you move a lot ofdistribution out of specialty stores into mass or is that not the problembecause more consumers are adopting the trend and so they shop in mass anyway?
John Replogle:

It’s a great question and I’ll go back to a dynamic I talkedabout earlier which is really the increasing penetration or household penetrationin consumer adoption of natural personal care. It has doubled in the last three years in terms of householdpenetration. We expect it to doubleagain in the next call it three to five years. So this is really becoming a mainstream consumer choice and so we arejust moving with the consumer. What wecontinue to do is make the best, most efficacious high quality products that wecan and they continue to be available in those channels where we started andgrew the business; where if you will, the core natural consumer tends toshop. But we are increasingly reaching more and more new consumersand moving into those channels where that consumer shops on regular basis.
Donald R. Knauss:

The only thing I would add to what John and Beth have saidKathleen, is if you look at some of the larger customer footprints that Burt’sBees has done over the last 18 months, some of those large customers are ourlarge customers as well; I mean Target, Walgreen’s, the chain drug channel ingeneral, grocery. Clearly there is opportunity to accelerate it in grocery buta lot of these customers are the same types of customers that we call on everyday. The specialty and gift and the natural side is actually anadd to us so I think it will give us some increased capability and exposure forour other brands. For example, GreenWorks. So we think there is a nicesynergy at play here between both customer-facing organizations.
Steve Austenfeld:

Kathleen just one other thing, for you and the otherlisteners, I would encourage you to go to our website. We have presentation deck, probably 15 pagesor so of really good reference information related to Burt’s Bees business, thestrategic fit for Clorox and in addition, Burt’s Bees has a fantastic websitethat provides a lot of great information that part of the business.
Kathleen Reed:

Also on your full year revenue guidance, raising it 1percentage point, I think there was a lot of discussion or some confusion onyour last conference call with the 3 to 5. Did that include the bleach acquisition? Did it not include the bleach acquisition? Now it’s up 4 to 6; is that with 1% on the bleach business? Is the raise then due to stronger organicvolumes in a certain area?
Donald R. Knauss:

Kathleen, there is certainly a higher confidence given thefirst quarter performance across a number of categories and brands that theorganic side of this business, the fundamentals of it, we think arehealthy. The 4% to 5% uptick doesinclude the roughly 1 point, slightly less than 1 point in volume from thebleach acquisition. Obviously anythingthat Burt’s Bees would be additive to that so that would take that 4% to 5%range more like into the 6% to 7% range with Burt’s Bees.
Kathleen Reed:

With the Burt’s Bees business closing at the end of thecalendar year and the $0.10 to $0.15 dilution then for fiscal ‘08, is thatspread pretty evenly for the last two quarters and are you going to break thatall out in the restructuring line or will it be embedded?
Daniel J. Heinrich:

Kathleen, we still have some work to do exactly the timingand sequencing of when this closes and which quarters all these thingshit. So the $0.10 to $0.15 that we havewill be probably on our next call will be able to provide more information asto how that is going to sequence. A lotof the one-time charges are things like the write-up in inventory that you arerequired to do. Then there are someother transaction costs and then some compensation programs we are putting in.The inventory will hit very fairly quickly. Some of the compensation programs will be over time. So probably on ournext call we’ll be able to give better information as to the exact impact andthe timing.
Kathleen Reed:

It will be broken out separately or you still don’t know?
Daniel J. Heinrich:

Well the inventory adjustments certainly would go throughthe COGS line but we will be able to call that out when it occurs and provideadditional detail on that. Some of the othertransaction costs and compensation programs go likely through the SG&A linebut there is likely to be some impacts on several lines of the P&L. Afterwe have done our work and know exactly when it is going to close we will beable to provide more information.
Operator:

Your next question comes from Nik Modi - UBS.
Nik Modi:

Don or John or Beth, can you provide a little bit of contenton the ACB penetration for the Burt’s Bees business? Where are the brandindexes today relative to your business?
Donald R. Knauss:

Let me start now and ask Beth and John to comment. Burt’s Bees distribution today is about 54%of the ACB of food, drug and mass Nik, and of course we have 100% ACB coveragethere. And in that 54%, well over halfof it is the drug channel where they’re extremely well developed relative tofood and mass. Given that Target, notWal-Mart, is the presence in mass. So in terms of store count, Clorox is in 4 to 5 times asmany stories as Burt’s Bees is right now and clearly that is where we see someof the upside. So John or Beth, if youwant to add to that?
Beth Springer:

We absolutely see upside and roughly half the stores thatwe’re in today Burt’s is not in and belongs in. Beyond just getting the distribution, we are very excited about theopportunity to continue to build on what you know us to say as AMPS,particularly the assortment and the shelving. Burt’s has done a great job there, has innovated with their hives andhas more opportunity. So we thinkcombining their capabilities with ours, a big upside there. I do want to reiterate also the excellent presence in thenatural channel which is above and beyond the roughly 50% number that Donquoted and of course a lot of specialty distribution like bookstores where youprobably were first introduced to the lip balm.
Nik Modi:

Just on the drug store it seems that is where Clorox has theleast amount of penetration in the traditional channels. Is there any opportunity to use Burt’s ACB inthe drug stores to kind of push some of your other products?
Lawrence S. Peiros:

Well we think there could certainly be an opportunity around Green Works. For example, we think of drug stores as aconvenience store for women and when we look at brands like Green Works, wethink it has real application there and gives us a real entry and a brand thatis really relevant for that channel. SoI think there could be some synergies there for sure.
Nik Modi:

[Kick] Corporation was as we all know bought by privateequity I think eight months ago or so. Have you noticed any changes in the marketplace on the pricingside? Do you think it makes sense to maybe put Glad through a SKUrationalization program to really trim down the commodity based business andfocus more on ForceFlex?
Donald R. Knauss:

With respect to [Kick], I haven’t seen any change in pricingso if you looked at Clorox liquid pricing versus your guiding to the samerelationships between Clorox and private label whether it be the trackedchannels or the untracked channels or Wal-Mart. So no change there, no change in behavior from [Kick].
Nik Modi:

What about SKU rationalization?
Donald R. Knauss:

The SKU rationalization, I would say very specifically thatwe are very focused particularly in trash on building the higher EP items. So in the trash business that would includeboth ForceFlex as well as our odor control products, both of which have much,much higher EP than base trash. So youwill see that our advertising for example is very much focused on ForceFlex andthe added-value products and most of our trade promotion programs are focusedon that as well.
Operator:

Your next question comes from Connie Maneaty - BMO CapitalMarkets.
Connie Maneaty:

As I was looking at the additional cost you are going to payfor raw materials over the next three quarters, assuming no offsets, is it agood calculation that the gross margin may decline about 50 basis points yearover year?
Donald R. Knauss:

I’m sorry, could you ask the question again Connie?
Connie Maneaty:

I was taking the $30 million to $40 million in increased rawmaterial costs and just calculating that could force the gross margin todecline about 50 or 60 basis points year-over-year, assuming that you don’thave any offsets. Is that a reasonableassumption?
Daniel J. Heinrich:

Connie, the commodity component for the last couple of yearsas you know has been so volatile, we have really tried to shy away from beingtoo specific on gross margin change. Ithink what we are clearly indicating today is that we are going to look at anumber of things to try and offset the commodity pressure not only that we haveseen but we think is still in front of us, particularly this next quarter, thesecond quarter. We are looking at moreefficiencies around trade, SG&A spending and potentially pricing aswell. One of the other things that Dan noted is we have taken ourcost savings target up from $80 million, $90 million to about $100 million forthis year. So assuming we can achievethat, that will certainly help. But with that said, the commodity pressures right now arepretty significant and that’s going to cause certainly some material grossmargin dilution versus what our earlier expectations were for the year, whichis why we’re now signaling that we do see gross margin to decline.
Daniel J. Heinrich:

Connie, the other factor which makes it a little difficultto know exactly what the net impact will ultimately be is, we’ve talked in thepast about we are qualifying a broader spectrum of resins into the mix and thatwe hope will help offset some of this. Certainly, we are continuing ourdiscussions with many suppliers and that could impact it as well. Again, the 30 to 40 is sort of kind of an estimate out thereright now that we are working against, but we are working against variousfactors that ultimately may bring that down.
Connie Maneaty:

With the flow of new products in the second half of theyear, I imagine that advertising will really ramp-up then as well? Does it make sense that most of the earningsgrowth for the balance of the year will take place late over the next ninemonths?
Donald R. Knauss:

With respect to thesecond half advertising revenue, I don’t think you will see an appreciable rampup in advertising in the second half. Yes we do have new products in the second half but we had new productsin the year-ago period as well. We weredoing other things in terms of advertising so I wouldn’t expect much of changefrom this overall range of 9% to 10% on the advertising line. As we’ve talked previously, you’ll probablycontinue to see some ramp up on trade spending side.
Daniel J. Heinrich:

In terms of earnings flow, we have a tough comp from Q3 yearago that we will be up against in the third quarter where a lot of our productlaunches are going to be. So we wouldexpect to see a greater earnings accretion in the fourth quarter than the thirdversus year ago, simply because of the comp we are up against and the launch.
Connie Maneaty:

That makes plenty of sense. Over to Burt’s Bees, I only know the company or the brand because of thelip balm so I’m going to ask to an uninformed question. Is it the biggest product and what percentageof sales does it represent?
Donald R. Knauss:

John why don’t you jump in?
Beth Springer:

John and I are both looking at each other and Connie, John’sgoing to test me to see how much I have learned. Lip balm is currently, the lipline I should say, lip care is a little bit less than 40% of revenue. It is the original lip balm, some extensionof it and the lip shimmers. There isanother 30% of business in face and body care and the remaining 30% is split across several categoriesincluding baby, outdoor, some gifts and kits. So the business is really diverse. It has certainly moved beyond the original lip balm. Is that about right John?
John Replogle:

You have done well.
Beth Springer:

All right.
Connie Maneaty:

What part of the product line is growing the fastest?
John Replogle:

Well we have been innovating quite rapidly over the last fewyears. We see tremendous growth in thecleansing area, in personal cleansing and hair care, so we’ve seen some verynice growth in that area. We have awonderful face care portfolio that is growing and we’ve got some terrificinnovation coming in Q1 of next year, which should drive our business a goodbit. Of course our core remains very, very strong; our lipbusiness continues to grow in double-digits and we expect it to continue to doso as we both innovate there, but expand our distribution. Our lip business, especially our lip balm, is an expandableconsumable and we find that if you put it within arm’s reach, you can reallydrive sales growth. So it continues tobe a real engine for us as well.
Donald R. Knauss:

The only thing I would add, Connie, you know, when we lookedat this business as well, one of the things that really excited us about it isthe innovation that John and the team have brought to the baby care section andthat’s a relatively underdeveloped part of the Burt’s Bees portfolio and thecategory, but we think that’s going to continue to build significantly overtime.
Connie Maneaty:

If I could just ask one final question, since it’s going tobe in theaters tomorrow, what can consumers do about colony collapse disorder?
John Replogle:

Well thanks for asking. First and foremost is we need to build awareness for the issue. It is pretty dramatic; 30% of the food thatwe eat relies on a pollinator, namely a honeybee, to produce that food. First of all, really we don’t have an answer. We need to find a solution. Burt’s Bees is investing in research to helpfind an answer or find the cause of colony collapse disorder. I think the more consumers are aware, engagedand really provoking a debate for an understanding here makes adifference. We can support local farmers and organically grown food andwe can plant seeds that will create the natural habitat and environment for thebees to flourish. So those are a coupleof things. Consumers can also visit our website tomorrow, www.burtsbees.com andthey’ll learn more about it. We’ll havea special page there on colony collapse; they can learn more and what they cando. We’ll also send consumers a seedpacket that they can plant to create that environment for the bees to flourish.
Operator:

Your next question comes from Joe Altobello - CIBC WorldMarkets.
Joe Altobello:

First, on the Burt’s Bees deal; was that negotiated or wasit an auction?
Beth Springer:

Dan, how would you say we should describe it? I know how I would describe it, but being alittle bit less of a technician in this area, I’m going to actually defer itback to Dan.
Daniel J. Heinrich:

It was a competitive bidding environment that we wereengaged in on the business.
Joe Altobello:

Rough number of other bidders?
Daniel J. Heinrich:

We don’t have those details, necessarily.
Joe Altobello:

Secondly, if you look at your EBIT on a company-wide basis,year-over-year it was up about $30 million, but the segment EBIT was flat. Was there a significant reduction incorporate spend this quarter versus last year?
Daniel J. Heinrich:

Well, EBIT is impacted by our charges.
Joe Altobello:

Over the line, though?
Daniel J. Heinrich:

Not the way we report out EBIT.
Donald R. Knauss:

No in fact, if you do this on a pro forma basis, our EBITwas up over almost 15% year-over-year, if you exclude the charges.
Steve Austenfeld:

Joe, there’s a schedule on our website that reconciles EBITfrom our pre-tax earnings and to your point, it is about flat, but thatincludes $27 million of one-time costs for restructuring this quarter. So if you add that back, you actually getsome pretty healthy EBIT.
Donald R. Knauss:

It’s about 15% when you exclude the charges.
Joe Altobello:

I thought I did that, but I’ll just follow up with Steveafter the call.
Operator:

Your next question comes from Jason Gere - Wachovia.
Jason Gere:

I wanted to talk about the international piece. I know it’s 11% volume growth, but 18% fromthe acquired business. So it seemed likeyou had some pricing in there and I was just wondering about 3% organic volumegrowth and how you looked at that internally?
Daniel J. Heinrich:

On the international side, I’m trying to remember all thedetails. The total increase in sales forinternational was 18%. I think about 4points of that were foreign exchange and I believe 8 points were the bleachacquisition so that’s about 12. So, thecore organic piece of that is probably about 6 to 7 and then pricing as acomponent of that. You know generally,our pricing practices international are to follow inflation, but call it maybe2 points, probably, on the international piece. But again, I don’t know that that’s the right number; Steve can alwayscheck me on that.
Jason Gere:

How did that measure to what you were planning internally interms of the 6%?
Steve Austenfeld:

I think the 6% organic volume growth was pretty close towhat our target was. I think we had a little bit of upside on currencies as Ithink everyone did, obviously the weak dollar helped the top line from thatperspective. The bleach acquisitioncontinues to exceed our expectations. Intotal company numbers, it isn’t that material, but in the internationalsegment, it was probably a couple points ahead of what we might haveanticipated in the end of the quarter.
Daniel J. Heinrich:

You know, we’re really pleased again with international;it’s continuing a long string of quarters of nice growth for us and as Stevesaid, probably the two areas that were better, certainly we’re in currency andwe’re pleased that the bleach acquisition is ahead of expectations
Jason Gere:

Over the last couple of days we’ve heard the mantra beingthe health of the consumer and if you look at the consumption in food, drug andmass, two things
Donald R. Knauss:

I guess the best indicator for us is share growth andcategory consumption. Overall categoryconsumption is about flat, which is actually a little bit healthier than whatwe’ve seen in previous quarters. So wefeel good about that. Our total Cloroxshare is up slightly, which is also an improvement in trends, so we feel verygood about that. Three of the eightcategories that we look at in track channels are growing; three are flat andtwo are down which again, is better than the trends have been. So feeling very good about our share performance, certainlyrelative to the last year or so and feeling like the categories are in goodshape.
Jason Gere:

Just in terms of trade spending, maybe looking ahead, justthe overall magnitude versus maybe what we saw in the fourth quarter and thenjust for this quarter as well?
Donald R. Knauss:

You’ll see the trade spending increases continuing; it’shard for us to predict when we may pull back on that lever it really depends onwhat’s going on, both in terms of our results as well as what the competitorsare doing. But we do see it continuingat this point.
Daniel J. Heinrich:

You will see an uptick in the third quarter behind the newproduct launches.
Jason Gere:

With the new Hidden Valley products that are refrigerated,in terms of distributing that, do you have to go through a DSD system or it’skind of different than what your core businesses are.
Donald R. Knauss:

Yes; we’re using a partner. Refrigerator Warehouse System.
Operator:

Your next question comes from Linda Bolton Weiser -Oppenheimer.
Linda Bolton Weiser -Oppenheimer:

I was kind of interested in the comments you were makingabout Brita and I was wondering if your projections for the future economicprofit growth of that business is changing, because you had highlighted that asone of the three businesses with the lowest projected economic profit growthback at your analyst meeting. So I’mwondering if you’re changing on that and is your thinking changing on any otherof the categories you talked about?
Donald R. Knauss:

Well I think in New Yorkwe talked about three and as you know, that was one of them. Brita has always,from an economic profit standpoint, always had extremely attractivemargins. The issue is we couldn’t growthe business the last five to seven years. I think we’re certainly changing our outlook in terms of the Britabusiness and the tailwind that appears to be behind it right now. That’s why we’re stepping up marketingspending behind that brand. The partnership with Nalgene we think will continue to gothrough the second half. So, if Britacan continue on this trend, which we currently think it can given thesustainability focus of consumers, it’s a terrific brand to have on a growthtrajectory because the EP margin is one of the best in the company.
Linda Bolton Weiser -Oppenheimer:

So it sounds like you’re thinking of changing a bit?
Donald R. Knauss:

Well, we are certainly thinking the growth trajectory ofthat business has a lot more to it than we did nine months ago to a year ago.
Daniel J. Heinrich:

Linda, it’s in early days, so we’re certainly encouraged bythe trends we’re seeing and we’re hoping that those trends will continue andwe’re certainly investing behind those trends with Nalgene and other activitiesthat we’re doing. So we are encouragedand we’re looking forward to see if we can drive that higher level of growth.
Donald R. Knauss:

I think just as a finishing comment on it, I think it’samazing what’s happened in the last four or five months in terms of consumerawareness around the bottle waste issue and the fact that we’re throwing 38billion bottles in landfills every year is starting to really gain somemomentum out there, not only with consumers, but I’m hearing it fromretailers. I’ve been out with a numberof retailers the last 90 days and some of those retailers are now giving moreand more section space in bottled water sections to Brita. Traditionally, we’ve been stuck over in the small applianceaisle or somewhere else buried in the store; you get over in the water sectionand you get a lot more consideration from consumers.
Steve Austenfeld:

I’ve got to build on this. We’re seeing an incredible wave behind the sustainability issue onmultiple fronts. It appears to bedriving our Brita business in a big way; it definitely is helping the receptionon our Green Works introduction and obviously it will play into the Burt’sacquisition. It doesn’t seem like any ofit is going to stop anytime soon; it feels like something that’s going to buildand build and build. But it’s reallyhelping us on multiple fronts right now.
Linda Bolton Weiser -Oppenheimer:

one question on the Burt’s Bees
Donald R. Knauss:

I don’t think we want to comment on exactly where we wouldgo for competitive reasons. So, I guessI would have to punt on that question.
Linda Bolton Weiser -Oppenheimer:

Is it possible you could consider extending the brand intocleaners, or is there no applicability there?
Donald R. Knauss:

I think we’re going to stay true to the core of thatbusiness, which is natural personal care. We see so much upside there over the years to come, I think we’re goingto focus there and with Green Works, we have a significant platform, we think,already to take into the natural cleaning space.
Lawrence S. Peiros:

I do think there is some synergy between these businessesthat share those kind of sustainability and health promotion platform. There’s probably some learning we can get onnatural ingredients that could potentially help our Green Works product, forexample
Beth Springer:

Just to build on that in our conversations with the Burt’steam over the last several months, and particularly today, first we affirmedthat we share a common consumer for Green Works and Burt’s and our gaps andbreadth of insight is going to grow there. Second, we’re very interested in learning more about the naturalchannel, where products like Green Works would get extra cachet and Burt’s hasclearly established several relationships there. Third, we think, particularly in sustainable packaging andjust general waste reduction, Burt’s has done some innovative thinking thatthey can bring to us and in turn, we’ve done some innovative thinking we canbring to them.
Steve Austenfeld:

I want to thank everyone for their questions today. If there is anyone who we were not able toget to in the interest of time, please feel free to either contact myself orLee May. With that, let me turn it to Don to wrap up.
Donald R. Knauss:

I will just summarize by saying we’re feeling very goodabout the performance of our core business; we obviously had a really solidquarter. We’re feeling good about asolid start to the second quarter as well and as you look to the second half ofthe year and our innovation pipeline, we feel very good about that. On Burt’s Bees, we think, look, we’ve got a great brand anda great team with John leading it to take that business to the next level;extremely high growth in that natural personal care category, which iscertainly accretive to our growth rates. The margin structure of the business we feel terrific about; we thinkthat’s sustainable and as Larry just talked about, we think we have a newbusiness platform here where we can actually learn from each other around thewhole natural sustainability spaces and leverage both of these companies’capabilities. So we feel like we are off to a new day here. So thanks, everyone, for your participationand we’ll talk to you at the end of next quarter.

The Clorox Company Q1 2008 Earnings Call Transcript

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The Clorox Company
Q1 2008 Earnings Call Transcript