The Clorox Company
Q2 2012 Earnings Call Transcript

Published: 3 Feb 2012

[Operator:]

Good day, ladies and gentlemen, and welcome to The Clorox Company Second Quarter Fiscal Year 2012 Earnings Release Conference Call. [Operator Instructions] As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Mr. Steve Austenfeld, Vice President of Investor Relations for The Clorox Company. Mr. Austenfeld, you may begin your conference.

[Steve Austenfeld:]

Thank you. Welcome, everyone, for joining Clorox's second quarter conference call. On the call with me today are Don Knauss, Clorox's Chairman and CEO; Larry Peiros, Executive Vice President and Chief Operating Officer; and Steve Robb, our Chief Financial Officer. We're broadcasting this call over the Internet, and a replay of the call will be available for 7 days at our website, thecloroxcompany.com. Let me remind you that on today's call, we will refer to certain non-GAAP financial measures, including but not limited to free cash flow, EBIT margin and debt-to-EBITDA. Management believes that providing insights on these measures enables investors to better understand and analyze our ongoing results of operations. Reconciliation with the most directly comparable financial measures determined in accordance with GAAP can be found in today’s press release, this webcast's prepared remarks or supplemental information available in the Financial Results area of our website as well as in our filings with the SEC. In particular, it may be helpful to refer to tables located at the end of today’s earnings release. Please recognize that today’s discussion contains forward-looking statements. Actual results or outcomes could differ materially from management's expectations and plans. Please review our most recent 10-K filing with the SEC and our other SEC filings for a description of important factors that could cause results or outcomes to differ materially from management's expectations and plans. The company undertakes no obligation to publicly update or revise any forward-looking statements. Today, Larry will start with a discussion of our volume and sales results. Steve will follow with a review of our financial performance in the quarter and our updated outlook for fiscal year '12, as noted in this morning's press release. And finally, Don will wrap up with his perspective on the acquisitions we announced about a month ago. With that, let me turn it over to Larry.

[Lawrence S. Peiros:]

Thanks, Steve, and welcome to everybody on the call. I'm happy to report that we had another good quarter. As anticipated, volume was up about 0.5 point despite the impact of price increases across most of our portfolio. Sales were up a very solid 4% as the benefit from price increases was either in line with or even slightly better than our expectations. This is our fourth consecutive quarter of sales growth during a challenging economic environment, with 8 out of 11 SBUs delivering year-over-year growth, driven both by pricing and product innovation. In fact, we're on track to deliver a record level of incremental sales from innovation in fiscal '12. Overall, we feel great about the quarter and the progress we are making in this tough economy. As usual, I'm going to focus my comments on market share, volume and sales and provide perspective on what drove our top line results. Steve will then provide the financial detail. Starting with our U.S. business, our market share in track channels, which account for about 1/3 of our business, was equal to year ago in the second quarter. On an all-outlet retail basis, we also helped share over the past 52 weeks with an absolute market share that remains near record levels. These share results are particularly encouraging given the large number of recent pricing actions. Turning to our U.S. categories. We are starting to see improving sales trends as pricing kicks in and the economy recovers. Category consumption on an all-outlet basis was about flat for the past 52 weeks versus a decline of over 2% just a year ago. In international, our share results were mixed with solid growth in Latin America and declines in Canada, Australia and New Zealand due to competitive pressures. Categories in the international markets continue to be healthier overall than in the U.S. In our Cleaning segment, which includes our Home Care, Laundry and Away From Home businesses, volume was flat, and sales grew 5%. All 3 businesses in this segment saw solid sales growth in the quarter, driven by the impact of pricing actions at our Home Care and Laundry businesses and very strong volume results in our Away From Home business. Home Care grew sales and market share behind higher shipments of Clorox Clean-Up, as well as innovation like our Clorox Bleach Foamer spray, Clorox Toilet Bowl cleaning gel and Liquid-Plumr Double Impact. In addition, we are seeing our Home Care business benefit from our focus on multicultural consumers as key brands grew significant share within the Hispanic market. On Laundry, we also grew sales and share. Our Laundry, and it is all-outlet market share, was up of 2.4 points on a 52-week basis. Finally, our Away From Home business delivered strong double-digit volume and sales growth behind new products and expanded distribution in healthcare channels. These results do not include the impact of the recent acquisitions of Aplicare and HealthLink, which closed on December 31 and will contribute to second half results. In our Household segment, which includes Bags and Wraps, Charcoal and Cat Litter, volume grew 1% and sales grew 4%. Glad delivered double-digit sales growth, although volume declined due to the impact of price increases taken last year. Cat Litter volume was up behind new Fresh Step Extreme and new Scoop Away Extra Strength. Sales were down, however, due to higher trade merchandising in support of these new products. Finally, Charcoal sales were down in what is always a light volume, off-season quarter for that business. In our Lifestyle segment, which includes food products, Water Filtration and Natural Personal Care, volume grew 2% and sales grew 6%. All 3 business units in this segment also grew sales. Our Burt's Bees business had a solid quarter, driven by a lot of innovation, including the launch of our new natural personal care brand called güd from Burt's Bees. Güd targets a younger consumer with a line of highly fragrant face and body products that are 97% natural. These products started appearing at retailer shelves in the latter part of the quarter. Very good [ph] sales and volume behind the continuous success for the new Brita on-the-go water bottle. Finally, our food business grew sales as a result of new salad dressing flavors as well as the benefit of pricing taken last August. In our international segment, volume was down 1%, and sales were flat. Our largest geography, Latin America, saw modest volume declines as a result of double-digit losses in Venezuela and some declines in our non-strategic export business. The Venezuelan government has announced the impending price law, but specifics are yet to be released. This has led to a decline in shipments as retailers are delaying orders and consumers are holding back on spending. For perspective, Venezuela represents about 2% of total company sales. Overall, we're very pleased with another quarter of very solid results. Although the pricing actions we implemented early in the year will continue to impact volume results for another few quarters, they are playing out as expected, resulting in our overall performance being in line with expectations and consistent with our price elasticity model. Based on our solid sales performance year-to-date and the future benefit of the recently-announced acquisitions, we are raising our sales outlook to 2% to 4% for the fiscal year. We expect to be in that range for the remainder of the year, despite the tougher comparisons we will take from the second half. With that, I'll turn it over to Steve.

[Stephen M. Robb:]

Thanks, Larry. Well, hello, everyone. As Larry said, we're very pleased with the quarter. I'm going to provide more depth on our second quarter results and our updated financial outlook for fiscal '12. As Larry noted, sales were up 4% in the quarter, which reflected about 5 points of pricing benefit, offset by 1 point of mix and a slight decline due to foreign currency. Second quarter gross margin decreased 20 basis points to 41.5% of sales compared with 41.7% in the year-ago quarter. As expected, higher commodity costs and inflationary pressures in manufacturing and logistics continue to challenge margins. Mix was also a bit more unfavorable in the year-ago quarter. On a few key items, our volume continues to shift towards larger sizes, where margins are slightly lower. Volume in the quarter also shifted to a mix of countries where profitability was lower, with declining sales in Venezuela having the biggest impact. These factors were partially offset by the benefit of price increases as well as $25 million of cost savings, with $20 million of the savings reflected in gross margin. Second quarter, selling and administrative expense, on a dollar basis was up 2 percentage points versus the year-ago quarter. It's slightly lower than anticipated. This was due in part to a shift in timing of spending for the implementation of our international systems upgrade and new R&D facilities that we discussed before. Year-to-date, free cash flow from continuing operations was $86 million versus $81 million in the same period a year ago. For the full fiscal year, we continue to anticipate free cash flow of about 10% of sales, within our targeted range of 10% to 12%. As a reminder, we define free cash flow as cash provided by operations less capital expenditures. In Q2, we repurchased 2.3 million shares of our common stock for approximately $149 million, using the remaining proceeds from the sale of the Auto Care businesses. With these purchases, we have now used all of the net proceeds from the sale to repurchase a total of 10 million shares for $679 million since February of 2011. We ended the quarter with a debt-to-EBITDA ratio of 2.6

[Donald R. Knauss:]

Okay. Thanks, Steve, and hello, everyone. I'm certainly pleased with our results in the second quarter, which I think, as most of you know, built on our strong first quarter. We've had broad innovation across the portfolio, as Larry mentioned, and really strong retail execution. And I think that's really helped contribute to the delivery of our fourth consecutive quarter of sales growth. In addition, as Larry noted, volume was up about 0.5 point for the quarter, which speaks, I think, to the strength of our brand, given the level of price increases we've taken over the past 6 months. I think, as most of you know, in the most recent quarter alone, price increases total about 5 points across the portfolio. And our consistent delivery of incremental growth from new products has really helped, which is trending above 3% for this fiscal year, which really has helped maintain our recent share gains, as the macro trends and our categories continue to improve. Now as Larry noted, we've taken up our sales outlook for the year due to those strong first half results and our acquisitions of HealthLink and Aplicare. Just a little bit more color for you on those acquisitions. These acquisitions certainly complement and expand the breadth and depth of our healthcare portfolio and our Away From Home business, which has been focused on infection control. Both these businesses had strong revenue growth over the last 3 years, averaging about 8% to 10% revenue growth at the CAGR. So building on the Caltech acquisition of January 2010, this is really another step in our strategy to use our strong cash flow to help reshape our portfolio and really take advantage of some of these significant tailwinds that are out there to drive growth. And as to tailwinds, infection control is about a $2.5 billion market. It's rapidly expanding in the U.S. due to the increased attention on healthcare-associated infections along with the trend for just the aging of America. And we believe we can continue to grow our business organically and with strategic tuck-in acquisitions. Now Aplicare expands our portfolio into different forms of products for helping prevent skin infection from needles or surgery. And these products are sold to hospitals and other companies that create kits for use by healthcare facilities. Now Aplicare's expertise also includes really understanding how to develop FDA-regulated products, and that really helps our entry into this new channel of distribution for the manufacture of surgical kits where we did not previously sell our products. Now HealthLink provide -- products and their sales force provide entry into the small clinical sites such as individual physician and doctors' offices across the country, where our existing products can also find new outlet for increased distribution products like our germicidal wipes. So combined, we anticipate Aplicare and HealthLink will add more than 1 point of total company sales growth, annually, on an ongoing basis. So again, I feel very good about the first half of the year. We certainly all continue to face the challenges in the environment. We've got a fragile consumer out there, but I believe we've got solid plans in place and continue to feel confident about the remainder of fiscal year 2012. So with that, why don't we go ahead and open it up for your questions?

[Operator:]

[Operator Instructions] Our first question comes from Chris Ferrara of Bank of America. We'll take our next question from Bill Schmitz from Deutsche Bank.

[William Schmitz:]

Are there signs that bleach is turning the corner? Because the scanned channel growth looked great. A lot of it was pricing-driven, but are you optimistic about that business?

[Donald R. Knauss:]

So we have some plans that we're pretty excited about on bleach. You may have seen our new campaign around Bleachable Moments, and essentially, we're trying to attract the lighter user and new users to the category. And we're convinced that some of this new messaging will appeal to that. We also have some interesting innovation in place. Hitting shelves pretty much as we speak is as a gel of bleach in a bottle that's easy to use on an HE machine. I think as many people know, it's pretty hard to manipulate even some of our smaller bottles, to get it into that little container in HE machines. So this is a bottle that has a directed spout, with a little thicker formula, that allows customers to get it into HE machines. And we know we've an issue with dosing over the last several years. That has impacted volume, particularly with HE machines. So this is a way that we are addressing the dosing issue as well as giving a more convenient form to consumers.

[Lawrence S. Peiros:]

Yes, we're feeling more optimistic than I think we have in some time. But the category still is definitely not one of our healthiest.

[Donald R. Knauss:]

Just to put a point on it, Bill, as you noted, when you look at FDKT data, the track channel data, certainly the data ending in January, we saw a 52-week trend of down almost 4.5 points and in the last 13 weeks, up 1.3, as you said, a lot of that driven by pricing. But as Larry noted, we certainly feel better about it now than we have in a while.

[William Schmitz:]

Okay, great. And then can you just tell me how the acquisitions were dilutive, only because money is virtually free now? So was there something funky going on with the amortization? Or how should we kind of look at that? I know you said about $0.04 for the year.

[Stephen M. Robb:]

Yes, Bill, we're projecting about $0.04 for this year, probably slightly less in fiscal '13. But we fully expect that these acquisitions combined will be EPS-neutral to accretive as we get into fiscal '14. Here's how we would have you think about that

[William Schmitz:]

Okay. And just one last one, and a little bit broader. I mean, as an organization, was there any sort of soul-searching sort of after the whole Icahn episode? I mean, has anything sort of changed broadly? Did you learn anything from the process?

[Donald R. Knauss:]

Well, I think, Bill, what we learned is that we had pretty good credibility with our long-term investors. And I think the belief in the investment thesis behind the company is the fact that our brands are -- brand shares are near all-time highs. The margins of the structure -- or the margins of the business, we see continuing to improve as we get into FY '13 and these commodities tend to mitigate some. So I think what we learned is that the investment thesis behind the company still is a robust one, and our investors certainly agreed with that. So I think that was the primary learning we got out of it. And I think the organization did a pretty good job of staying focused on building the business while this was going on.

[Operator:]

We'll go to our next question from Chris Ferrara from Bank of America.

[Christopher Ferrara:]

So pricing. It looks like, I mean, obviously, just going off your schedule, I guess, most of the pricing you guys took or the most recent was back in August. Is there -- are we at kind of the top of -- I guess, is this quarter a full realization of all the price you guys have taken? And do you think that process is generally over for now?

[Stephen M. Robb:]

Yes. Actually, the pricing is behind us. We will continue to see the volume impact, as anticipated. But at this point, I don't really have any serious concern that we have to roll something back or increase trade spending or anything like that. I mean, it's kind of a done deal for the most part.

[Christopher Ferrara:]

And have elasticities pretty much been in line with what you guys thought? Because your volume has held up rather well, I guess, relative to the amount of pricing you're taking. I think you kind of have -- you got best-in-class at least this quarter pricing with relatively little volume friction. So I mean, is that in line with what you thought? Or is it coming better?

[Donald R. Knauss:]

It's exceptionally close. I mean, every -- we've taken more pricing than we care to over the last 5 years, and we always go back and kind of look at -- we look at the models, see how predictive they are, and they are amazingly accurate. Obviously, you can't control for the all variables that might occur in the marketplace, but we're very happy with the accuracy of those models.

[Stephen M. Robb:]

I think the only thing I'd add, Chris, is that one of the other learnings we've gotten out of this is we much more tied this pricing to innovation. And as Larry noted in his remarks up front, our innovation pipeline this year, and it looks good through -- as you go through FY '13, it's trending at 3% or north thereof. So I think linking really good innovation to a lot of the pricing helped as well.

[Operator:]

We'll go next to Jason Gere of RBC.

[Jason Gere:]

I guess, just thinking about the updated guidance. We're expecting another year of operating margins to decline. So it's, I guess, a couple of years since 2009 that we've actually seen improvement. So internally, how do you guys talk about that? Because your margins probably would -- if you go to your guidance, looks like about 16.5%. You're kind of in the 19% range. And if we think about this year, obviously, with weak margins to hit your numbers, you need to see the strong sales. So just, I guess, a little bit more color why your confident that the organic sales can accelerate beyond what you've done in the last couple of years.

[Stephen M. Robb:]

Let me just turn to margins. Certainly, the margins have been challenged over the last year, the gross margins, because we face the commodity pressures. It's $140 million to $150 million in commodity pressures and another $40 million to $50 million of other inflationary pressures from manufacturing and logistics. What I would say is the pricing, as Larry noted, is working. The cost savings program continues to deliver very strong -- we delivered over $25 million in cost savings in the second quarter. And that's actually helped us in the second quarter. Margins were about flat, when you bring those 2 things together. And certainly, as we look at second half of the fiscal year, we expect gross margins also to be flat. And I think we're cautiously optimistic as we look at the future, if commodities begin to mitigate, and so they don't realize quite as quickly as they have more recently, then there's reason to believe that we'll get back to the typical margin expansion that we've seen in the past.

[Donald R. Knauss:]

Yes, and I think just to add, Jason, on the top line, as I said just a second ago, I think the innovation pipeline, we have focused very hard on that over the last 18 months, given that as categories flattened, we didn't get the normal 1 to 2 points of category growth tailwind behind us. We knew it was more incumbent on us to drive that growth. And what we've come up with, I think, is a pipeline that gives us a solid 3%-plus on the top line, looking forward. If we get any kind of resurgence, that we're starting to see now in the categories, we feel very good about the top line. And of course, I think the health of the top line is really going to drive our ability to get these margins back to where we want, their historical highs. We do see, as Steve said, the first 3 quarters of FY '13, we're going to have some very high commodity cost in there that we're cycling through from FY '12. So we'll have some easier comps on margin as we get into FY '13. So all in all, we feel pretty good about our ability to start expanding these margins again.

[Jason Gere:]

Okay. And what is it about innovation that -- I mean, normally, I think you guys contribute 2% of sales. You're saying it's closer to 3%. What is it this time around that -- can you maybe talk about the consumer and maybe the affinity back towards premium categories, if that's one of the drivers? But what are you seeing this time around that, I guess, gives you that confidence?

[Donald R. Knauss:]

Go ahead, Larry.

[Lawrence S. Peiros:]

Last year, we achieved 2.8% of incremental sales from innovation, and as Don said, this year, we're trending above 3%. And I would say, number one, it starts with a lot of focus, so we've been talking innovation internally for several years now. We've put more resources behind it, put more focus behind it. And the innovation is -- comes in all shapes and forms. It's not just new product innovation. It certainly is not just premium items, but a lot of this is base innovation that drives incremental sales of -- one recent example would be on our base trash bag, we have a trash bag that actually has less resin in it, but it is stronger and better-appreciated by consumers. And obviously, we also have examples of going to new spaces, like the Brita on-the-go water bottle. So it's a variety of innovation. The good news is, it's broad-scale innovation across almost every business unit. So this is not the case where we have one big game-changer kind of innovation that's driving the numbers, but it's virtually on every part of the portfolio.

[Stephen M. Robb:]

I think to Larry's point, the innovation is much more broad-scale across every major brand. I think the other thing that's changed -- about 2.5 years ago, we put all of our Insights people, and we had 3 different groups of Insights people

[Jason Gere:]

Okay. And then just one question, if I may, and I'll hop off. I mean, just some comments maybe around the promotional environment and maybe within that context, the price gaps. After all the pricing and the price gaps versus your branded peers, private label. But in general, just with the promotional environment, are you seeing some of the spending abating? Is it more rational? Which categories do you still worry a little bit about?

[Donald R. Knauss:]

I would say it's stabilized. So we're not seeing increases, our spending is essentially flat versus last year at this time. I would say things have calmed down a bit, and there may be a couple of categories where we're seeing a little bit more than others, but nothing dramatic in the current quarter.

[Stephen M. Robb:]

To give you one example, if you look at bleach, which is our most challenged category, the price gaps and the IRI data, the track channel data, a year ago, we had about a 29% premium versus private label. Today we have a 32% premium. So there hasn't been a material change. I think we've done a pretty good job of watching these price gaps on core businesses and keeping them fairly tight.

[Operator:]

We'll take our next question from Connie Maneaty from BMO Capital Markets.

[Constance Marie Maneaty:]

I have a question. I'm not sure I understand the dynamics in the gross margins, how the second half should be flat but the third quarter down and the fourth quarter up. I mean, does the third quarter need to decline something on the order of 100 basis points? And why would that be?

[Stephen M. Robb:]

A couple of things. So first of all, the third quarter is expected to be down slightly versus the year ago. It's a reflection of mix, a little bit of currency drag. And keep in mind, we're still anniversary-ing quite a bit of commodity cost increases. When you get to the fourth quarter, with the commodity cost comparisons, we're just a whole lot easier. And that combined with pricing, the cost savings starts to look a lot better, as Don mentioned in his earlier comments. And at this point, we believe that it should be about flat when you look at the entire year and the second half in terms of margins.

[Constance Marie Maneaty:]

Okay. And then, also, there were some comments about rising costs in manufacturing and logistics. Is this wage-related or something else?

[Stephen M. Robb:]

The -- we've talked pretty consistently about inflationary pressures in, obviously, the manufacturing we just experienced. Certainly, there is some wage inflation and health care inflation included in that number. There's also just transportation cost increases. In the depth of the recession, you have quite a few carriers that dropped out of the market. We just experienced more pressure on the logistics side over the last year. And so it's a reflection of all those factors that caused that number to be in this 40 to 50 range.

[Donald R. Knauss:]

Yes, Connie, and just a little bit more color on the wage inflation in manufacturing. A lot of that is more internationally-driven, where you've got markets like Argentina where you've got double-digit inflation, and salaries had to be kept up with the double-digit inflation rate, so a lot of it's international more so than domestic.

[Operator:]

We'll go next to Lauren Lieberman from Barclays Capital.

[Lauren R. Lieberman:]

Wanted to follow up on Trash Bags. So I must have made a mistake. I thought the base trash upgrade was launching in the December quarter, but you guys actually talked about volume being down. So is it a Q1 launch? And should we expect volume -- are you expecting volume to accelerate in that business even though the pricing is still there?

[Donald R. Knauss:]

We've taken a lot of pricing, so I think that our base trash improvement is definitely helping. But we are seeing volume losses as a result of pricing. So just trying to -- if you net out the 2, we're definitely seeing a positive impact on the innovation, but we have taken a lot of pricing. So we took a May price increase, a November price increase. We're up close to 20% on Trash Bags.

[Lauren R. Lieberman:]

Okay. How much was the November increase?

[Lawrence S. Peiros:]

9.5.

[Lauren R. Lieberman:]

9.5, okay. And then just I know it's -- 4 weeks doesn't make a trend, but the latest, and again, it's track channel, but it looked like there was a real surge in volume in Hefty trash in the last 4 weeks without any real change in promotional activity. So are you still seeing -- I mean, base trash, do you still like it's getting the traction you've expected, and is pricing in the category, overall, kind of symbiotic and everyone's playing along at this point?

[Lawrence S. Peiros:]

I would say everybody is -- Lauren, I wouldn't use the word playing along. But I would say, essentially, we've been followed by both private label and Hefty in the category on our pricing actions, so there's nothing out of kilter. Broadly, there are always some individual retailers that behave differently. But generally speaking, this is going kind of as expected and as we want it to go.

[Lauren R. Lieberman:]

Okay, great. And then, just real quickly on the Away From Home sales, what's the relative profitability? I know you talked about the acquisition still being slightly dilutive next year, but if they're adding a full point to top line growth going forward, that's really significant. So what at point can we think about that even just being operating-profit-margin-neutral? Is that second half of fiscal '13? Or is that more fiscal '14?

[Donald R. Knauss:]

It will take us about 18 months to fully integrate this business, to implement the cost savings programs and the other investments that we're making. But I think when we get to fiscal '14, the businesses are expected to be EPS-neutral to accretive. And at that point, we would also expect them to be operating-margin-accretive to the company as well. So this is just the typical time that it takes into integrate a business and, again, do the things we do so well in terms of taking cost savings out of businesses.

[Lawrence S. Peiros:]

The other thing I'd say, Lauren, is that the healthcare side of our Away From Home business, those margins are quite a bit accretive to the company average. So when we look at that business given the high growth rates on the top line, we feel very good about the margin structure and its ability contribute not only to the top line, but, obviously, the bottom line.

[Operator:]

We'll go next to Tim Conder from Wells Fargo.

[Timothy A. Conder:]

To follow on, can you talk a little bit about -- since Lauren hit the Trash Bags, talk a little bit about what you're seeing in Litter? You gave a few comments on that. And then any additional pricing at this point contemplated for the second half of the fiscal year as you see the world at this point? And then thirdly, strategically, your views, just maybe articulate out on the Brita business, given the divestiture of PUR by P&G.

[Donald R. Knauss:]

So in Canada, we saw good volume gains. We were hurt on the sales side because of certain trade spending behind new products. But we're seeing our brands being healthier than they have been in the recent past. So we're feeling good about our position in that category. It is a lower-margin category for us, and there's some commodity pressure there. We haven't taken pricing on Cat Litter, and that's really one that we would look at over time.

[Stephen M. Robb:]

Just a point I'd add on Litter, Tim, when we look at the all-outlet data, so obviously, this combines all the channels, not just a fraction of it, that's probably been one of our strongest-performing share items in the last 52 weeks. We're up over a share point in Litter. So we feel really good about the price value we're offering in there [ph].

[Timothy A. Conder:]

Okay, okay. And then, gentlemen, pricing, looking into the back half of the year, as you see the world at this point.

[Lawrence S. Peiros:]

So I would say that we've taken the bulk of our pricing, a vast majority of our pricing already in the fiscal year. There is some limited pricing going on in the second half, but I think we'd rather not be specific about that pricing until it's been announced in the marketplace.

[Donald R. Knauss:]

I would say that, just to build on Larry's comment, that any pricing that we take in the second half would obviously be cause us to find [ph] a lot of that would be internationally-focused where we're seeing inflation.

[Timothy A. Conder:]

Okay, okay. And then lastly, on the Brita business?

[Lawrence S. Peiros:]

So obviously, we're very pleased that we have done very well despite Procter's presence in that category, a lot of effort in spending on their part. We don't know as much, obviously, about the new ownership, but we're certainly going to take them seriously. They have some good brands and good customer presence, and so we plan on being as aggressive as possible in that category as we have been in the past.

[Operator:]

We'll go to John Faucher from JPMorgan.

[John A. Faucher:]

I'm going to follow up on Bill's question, because I'm really not sort of understanding the math on the dilution here on this deal. Because given the cost of debt, if these businesses are margin-accretive, it seems to me you'd have to be paying sort of like a high-single-digit multiple of sales to not have this be accretive, unless there's just an amazing amount of spending here. And I guess if that's the case, can you give us a better handle in terms of what the spending is, what the key investment criteria are, et cetera, just so I can try to get a better handle on these numbers?

[Stephen M. Robb:]

Sure. Let me see if I can give you some additional color. So today, these businesses were small family-held businesses. So these businesses today are not margin-accretive to the company. We absolutely believe that when we bring our scale and our capabilities and cost savings to it that they will be accretive to our operating margins in fiscal '14. But today, they're slightly dilutive to the company margins. And so maybe that's part of what you're struggling with. The other thing, again, is we are setting aside money early in this first 18 to 24 months to make those investments, particularly the cost savings investments, to get the margins where we believe that they ought to be and that they can be.

[Donald R. Knauss:]

And I think, John, just to put it in order of magnitude, we are talking about $78 million here. That's what we're talking about. So as Steve said, we really think there are some pretty significant profit opportunities going down the road. And there are some integration costs, and there are some retention costs as well.

[Operator:]

We'll go next to Nik Modi from UBS.

[Nik Modi:]

Just a couple of quick questions. Can you provide any context on nat gas and exposure to the P&L? Because I recall, I guess, many years ago that it was one of the most critical cost drivers, and nat gas prices have imploded year-to-date. So just if you can give me some context there. And then the second question is, Don, a year ago, you had discussed the impact of one of your largest customers was having on your business, just given the slow traffic growth. I'm just wondering if you're seeing the business there improve, at least over the last few months. Any context on that would be helpful.

[Donald R. Knauss:]

Okay. Let me start off now with the natural gas. Probably what you're remembering is natural-- first off, natural gas is trading at historical lows. Obviously, there's a lot of supply out there in the market, and so, clearly, it's trading very cheaply. Natural gas is one of the feedstocks for resin, which, as you know, we buy a lot of resin. And normally, you would expect that natural gas trading at this levels, then resin prices would be significantly lower than they are. But as a reminder, natural gas is just one of many inputs that goes into it. There's supply demand, overseas demand for resin. And so on balance, despite the fact that natural gas is at historical lows, we continue to see resin prices firming up and staying fairly elevated on a year-over-year basis.

[Lawrence S. Peiros:]

Your question on our largest customer, we are definitely seeing improved performance at that customer. They're doing lots of good things across many of our categories. We're helping them change some of their assortment across most of our categories. And so we're feeling much better about that business. That business is much healthier today than it was a year ago.

[Nik Modi:]

And Larry, is the -- a question was asked earlier about the volumes held up in spite of some pretty big pricing. Could reinvestment at that retailer, by that retailer drive some of the variance between kind of the volumes that you printed versus what everyone was expecting?

[Lawrence S. Peiros:]

So I think you're getting at pass-through repricing. We have seen probably less pass-through at Walmart because they have decreased their margin across some of our categories to be more aggressive in the marketplace, and that's one of their steady goals. That happened particularly in bleach, where they've taken less of a price increase on bleach than they have on some our other products. So they are being more aggressive on the marketplace. And actually, we are benefiting, and they're benefiting.

[Donald R. Knauss:]

And I think, Nik, just to add a point to that. I think what we would describe as the heartbeat categories, kind of in the center of the store, home care, laundry. Certainly, when you have the #1 brands and #2 brands in that space, it certainly benefits. So we're seeing it there. But brands like Glad, they've reflected all of the pricing. So it's kind of a mixed bag, but in general, as Larry said, we're seeing very much improved trends there.

[Operator:]

We'll go next to Ali Dibadj from Bernstein.

[Ali Dibadj:]

A couple of things. One is you mentioned a few times about margin, negative margin mix from gross margin, operating margins. You mentioned product and country and other. Can you talk a little bit more about that? So Venezuela, in particular, had an effect to that issue. Channel, if any, margin degradation, trade down. Just to give us a sense of what we're really looking at and how we should think about that issue going forward.

[Lawrence S. Peiros:]

Let me start just giving you a quick update on Venezuela. I think as you're already aware, a couple of months back, the government expanded price controls in Venezuela. Those have yet to take full effect. Now what we've been saying since that time is that retailers, and consumers, to a lesser extent, are really holding back on the purchases of inventory under the hope and expectation that future prices might be lower, and that's certainly having an impact on our Venezuela business, which, albeit, small, it's only about 2% of sales, it's a very profitable and a very good business for us. And that's the negative country mix that we're really experiencing in the second half of this fiscal year and projecting. In terms of product and size mix, we just continue to see a trend where consumers are very value-conscious, and they're trending to buy more of the larger sizes, which are slightly dilutive from a margin standpoint.

[Stephen M. Robb:]

Relative to the others.

[Lawrence S. Peiros:]

Relative to the other products and SKUs that we've got in the portfolio.

[Ali Dibadj:]

So Venezuela is 2% of sales. What -- I mean, is it that big from a profitability perspective? I mean, it is double, so 4% of profitability? I mean, how should we think about it? Because you've been calling out 1 country as a country mix issues meaningful enough that you may have implications for the rest of the sector?

[Lawrence S. Peiros:]

So first of all, this is an example of the country mix we're seeing. And then, second to answer your question, it's about 2% of sales. It's about the same in terms of profitability. The profit and the sales are fairly close.

[Stephen M. Robb:]

I think the key point of all of this is Venezuela was down strong double-digits in volume, as Larry noted in his earlier comments, and I think that's really driving it maybe to a greater extent than you might otherwise imagine.

[Donald R. Knauss:]

I think that, really, that double-digit decline in volume -- I mean, the sales were up in the mid-single-digits, the volume, off significantly, as Steve noted. I think people are just locked down on buying any inventory. The price control clarification is supposed to come in the middle of this month, so we'll see what it does. But I think it's impacting a number of categories.

[Ali Dibadj:]

Okay. One of the things that's different from last quarter is last quarter, we talked a lot about consumers trading down some of the rougher patches of elasticity. And this quarter, we're not talking about it as much. Can you talk about why and how much of that is the consumer versus the lack of pass-through pricing versus of some other effects, competitive, et cetera?

[Donald R. Knauss:]

I don't remember talking about such a difficult time last quarter, to be honest. So I think we have always said and we have seen that taking pricing, particularly in this economy, does affect your volume. And there is a pretty big swing between our sales number and our volume numbers because of the reaction we're getting from consumers. But it's all as anticipated, as expected, as modeled. But nevertheless, losing unit volume is not a positive thing from our standpoint or, quite frankly, our customers' standpoint. So that's the rub in taking pricing. Again, totally as expected. In fact, a little bit better than expected. But you do take a volume hit, particularly in a difficult economy, when you take pricing up.

[Lawrence S. Peiros:]

I do think, Ali, there is a difference in the macroeconomic environment out there versus last quarter. In the sense that if you look at the jobs report today, with unemployment now at 8.3%, I mean, one of the things we know in this country is we used to think our business correlated with GDP. We know it now, it correlates a lot more with the employment rate -- or unemployment rate. So I think there certainly is some positive momentum out there in the macro economy, I think, that benefits us. And I think it's also the innovation we've got out there. It's certainly helped mitigate the effect of some of that pricing.

[Ali Dibadj:]

Okay. Just my last question around innovation. So it's obviously a very good innovation quarter. Can you talk a little bit about sustainability? But if you get down to that 3.5% sales growth that we're talking about, the organic sales growth, how much of that is consumer takeaway? Is the consumer takeaway 3.5%? Or is there a significant amount of inventory load that's going on because of the good innovations that you have?

[Donald R. Knauss:]

I don't think there's an inventory issue at all. I don't think there's one way that the inventory changed.

[Ali Dibadj:]

Well, when you're sending in new inventory, you're filling up shelves that may not have been there, e.g., with güd, for example, from Burt's. So it's insignificant in the 3.5% number?

[Donald R. Knauss:]

Yes, I think it's insignificant, Ali, in the sense that as you look at some of the significant innovations, they've been out there for 3, 6, 9 months. Take the case of Febreze, OdorShield, think Brita on-the-go, which has been out there for months. So a lot of the stuff that manifested itself in the October, November, December quarter was out the previous quarter or the previous even 6 months before that. So I think it's very little impact with inventory.

[Operator:]

We'll go next Javier Escalante from Consumer Edge Research.

[Javier Escalante:]

I have a question on gross margin but not in the shorter term but rather over the longer term, particularly so we can think about the future. For the past 5 years, I think you have said that you had increased prices about, I don't know, 40-something times, and that the success ratio is about 96%. So would you -- did you need rollbacks? And there have been periods in which commodities have come down. Why shouldn't we expect, then, if you're keeping all this pricing, to see gross margin inching up a bit over the long run, as we have seen with Colgate over the past 3, 4 years? Why is it that your gross margin gyrates so much if you're keeping all this pricing? Does it have to do with the channel shift? What is the driver that is offsetting all this pricing power that you guys certainly have?

[Donald R. Knauss:]

I think, Javier, if you look the last 5 years, we've only had 1 year of those 5 where, actually, commodities were a tailwind, and that was a slight tailwind 2 years ago of about $20 million. So when you look at the commodity market movement over that period of time, it's well north of $500 million. And when you look at the pricing we've taken, until this year, we always lagged in pricing. We've only recouped about 65% to 70% of that commodity increase over that 5-year horizon. I would say, I think, this year is a good example of us getting faster on the price increasing and also getting more bullish on the innovation to try and tie that pricing to innovation. So I think on the last year, we're almost at a historical high, again, in gross margin. But I think that's the central point, is that over a 5-year horizon we did not recoup all of that commodity increase, but now we're at the point where we're taking pricing faster. We're taking it to reflect the true nature of the cost increases, and we're also tying it to innovation that has higher and more accretive margins to us overall. So you should start to see, over the long term, that margin march up.

[Javier Escalante:]

And finally on the -- I mean, I think you have alluded to this in many ways, but I don't think that -- at least to my -- in my view, you have answered these unequivocally. Certainly, your larger peers, Kimberly, Colgate, Procter, they also have innovation, and they had a terrible fourth quarter in the U.S., with volumes down as much as 5% for Procter. Things like Kleenex, down 4%. And you guys held up really well. So if you can help us understand how you dodged the bullet, right? You have more exposure to Walmart. Walmart has been very open in saying that they are trying actively to trade consumers down. So if you can help us understand how you maneuver all this that you wind up to be so much better than your larger peers.

[Donald R. Knauss:]

Obviously, it's hard for us to understand what's going on with our competitive set in detail. But I would say we're doing the basics very well. We've been focused on the 3 Ds [ph]

[Lawrence S. Peiros:]

Let me add a color point to it, Javier, maybe this will help you as well. When you look at the 3 segments of the U.S. business, the Household segment, the Cleaning segment and then the Lifestyle segment, so Household, up 4%; Cleaning, up 5%; and then, Lifestyle, up 6%. I think what that says is very good balance across those 3 segments from an innovation standpoint. Every one of those business units had strong innovation across a number of SKUs in their portfolio. The second thing I think we're doing very well is retail execution. I think if you look at our top 25 customers, I would say our execution at retail is as good as anybody's. And it's fine to have great ideas like Brita on-the-go, but if you can't execute it at retail, it doesn't much matter. And I think if you look at the ACV coverage of our innovation, we're getting to shelf quickly. I think the retailers are excited by the innovations. So I think it's the broadscale-ness of our innovation across all the business units and our ability to really double down on superior retail execution that's helping.

[Operator:]

We'll go next to Leigh Ferst of Wellington Shields.

[Leigh Ferst:]

You mentioned that the aging of the U.S. population is a positive for your healthcare business. Could you comment on how it affects your other businesses?

[Lawrence S. Peiros:]

I would say, yes, it's probably a little bit more of a negative trend in general. I'm trying to think off the top of my head. I mean, obviously, cleaning tech categories with smaller households, we clean less, we've see that trend for some time. Other categories might be relatively unaffected or maybe even boosted, like our food business, like Hidden Valley, may be a positive in some ways. So I would say it's a huge improvement and probably a bit of a drag across the rest of our categories. Obviously, it is positive on healthcare-type categories, and it's certainly positive when it comes to disinfecting products that can turn [ph] around germs.

[Donald R. Knauss:]

If I could just add to Larry's point. I don't think it's a material effect on a lot of our categories. I do think, obviously, in health care, it is a fairly substantial impact, given the increment [ph] of hospital space. And also, the other side of the acute care equation is nursing homes. We talk a lot about hospital-acquired infections, but it's also a major issue in nursing homes, and as the population ages, obviously, that's going to be significant market that expands. This whole infection control market for us -- we think it's at least a $2.5 billion category. We can't find anybody with more than a 5 to 7 share of that business. So we think it is extremely fragmented, wide open for somebody that really understands how to build brands. And I think these 2 recent acquisitions really bode well to increasing our product exposure as well as the channel exposure we get now with the new products as well as the existing ones.

[Operator:]

At this time, we have no further questions.

[Donald R. Knauss:]

All right. Well, if there are no further questions, we certainly look forward to updating everyone in May, when we do our fiscal '13 outlook. Thanks, everyone, for being on the call today. We appreciate it. Take care.

[Operator:]

That does conclude today's conference. We thank you for your participation.