Reckitt Benckiser Group plc

Joseph Baty - Chief Financial Officer, Principal Accounting Officer and Executive Vice President Tarang Amin - Chief Executive Officer, President and Director Kirsten Chapman - Managing Director and Principal

Lee Giordano - Imperial Capital, LLC Damian Witkowski - Gabelli & Company, Inc. Timothy Ramey - D.A.

Davidson & Co. Michael Gallo - CL King & Associates, Inc.

Thank you, Tom. Thank you all for joining us this morning for the Schiff Nutrition International Fiscal 2011 Fourth Quarter and Year End Results Conference Call.

By now, you should have received a copy of the press release. But if you have not, please contact us at Lippert/Heilshorn & Associates at (415) 433-3777, and we will forward a copy to you immediately.

As a reminder, this call may contain forward-looking statements, the risks of which are the same as those described in the Safe Harbor language in the press release and those detailed in the company's SEC filings. Actual results may differ materially from those described during this call.

With us today from management are Tarang Amin, President and Chief Executive Officer; and Joe Baty, Executive Vice President and Chief Financial Officer. It is now my pleasure to turn the call over to Tarang.

Please go ahead, sir.

Thank you, Kirsten. Welcome to our fiscal 2011 fourth quarter and year end conference call.

We posted solid net sales for the quarter, which grew 5.3% over the prior-year period. Notably, our branded business increased 7.8%.

Before our CFO, Joe Baty, reviews our results in detail, I'll provide an update on our strategy. During our last call on March 22, I'd been President and CEO of Schiff Nutrition for about 2 weeks.

At that time, I was excited about the demographic shifts favoring this industry, our focus on building brands and the great opportunities to lead innovation. Now I've been at Schiff a little over 4 months, and I can tell you I'm even more optimistic than I was in March.

I've seen firsthand the tremendous commitment our employees have to delivering high-quality products, the pride in our leading brands and the potential to unlock significant growth. Our strategy to drive growth is quite simple.

We're focused on 5 key planks: one, build premium brands; two, lead innovation; three, expand the channel and geographic footprint of the company; four, pursue acquisitions; and five, drive world-class operations. Let me give you some specific examples for each strategy to help bring them to life.

First, build premium brands. We have terrific premium brands in Schiff Move Free and Schiff MegaRed.

These brands are often at a significant price premium to the market as they deliver meaningful consumer benefits. Schiff MegaRed is now the number one Omega-3 SKU in food drug and mass stores, according to IRI 52-week data as of May 29, 2011.

Yet, one of the common practices in this industry, which Schiff has also followed, is the prevalence of trade spending such as buy one, get one free, bonus bottles and other discounts. These tactics erode premium brands and incent disloyal consumer behavior.

Therefore, an important action we're taking is to reduce this trade spending and invest resources in consumer advertising. In fiscal year 2012, we expect to substantially increase our advertising levels.

We believe this will drive greater awareness and trial on our new brands. We have confidence to do this, given how responsive our brands are to advertising.

For example, when we air Schiff MegaRed advertising, we see strong sales lift compared to the weeks when we're off air. Consequently, we intend to take our sales and marketing investment as a percent of sales from approximately 16% in fiscal 2011 to between 22% and 24% fiscal 2012.

The other way to build premium brands is to lead innovation and that's our second strategy. We expect to launch more new SKUs in fiscal 2012 than we did the previous 2 years.

This include launches in our joint care business, our Omega-3 business and our Specialty Products. Our experience shows a significant portion of consumers are looking for one small pill.

Therefore, in joint care, we intend to offer one small pill through our new product, Move Free Ultra, which is slated for introduction this fall. Also in Omega-3 space, we're planning some meaningful extensions with the new MegaRed Extra Strength slated for this fall.

We also expect to drive our specialty segment with continued expansion of Schiff Mega-D3, which has seen positive initial movement rates at Wal-Mart. Beyond new items, we're focused on expanding the R&D capability.

We are determined to continue differentiating Schiff Nutrition on the basis of strong science and innovation. To that end, we're forming a Scientific Advisory board to provide guidance and direction on scientific issues and to facilitate connections to new product ideas and technology platforms.

I'm very happy to announce Dr. Richard Carmona, the 17th Surgeon General of the United States, has agreed to chair our Scientific Advisory board.

Dr. Carmona is one of the world's leading experts in public health.

He chose to lead our Advisory Board as he believes in the importance of strong nutrition and the need to ensure sound science in developing products to meet consumer needs. We expect to announce more members in the coming months.

Our third strategy is to expand the channel and geographic footprint of the company. Schiff has excelled, forming long-term relationships and servicing customers such as Wal-Mart, Costco, Sam's, Walgreens and other traditional U.S.

retail, yet there's significant growth potential in other channels, as well as internationally. We also plan to increase our efforts online as consumers are increasingly getting their information and making their decisions online.

We are also exploring what companies to partner with to expand our international presence. Our fourth strategy is to pursue accretive acquisitions that can help build premium brands, lead innovation or expand the channel and geographic footprint of the company.

We believe a great example of this strategy was our June 1 acquisition of the worldwide exclusive rights to use a leading probiotic technology, BC30, in the over-the-counter and dietary supplement space. This addition delivers instant access to the fast-growing probiotic space, which is exhibiting over 20% growth per year through hardier probiotic technology and leading brands in Schiff Sustenex and Schiff Digestive Advantage.

We are in the process of integrating these businesses into our company and fully leveraging their capabilities to grow these brands, including adding consumer investment, expanding distribution. In addition to this transaction, we established another platform for innovation.

We formed a relationship with Ganeden on collaborating on extending the use of probiotic technology in new areas of human health. Finally, we strive to drive world-class operations.

Schiff Nutrition has long demonstrated a terrific track record developing and delivering high-quality products. Our employees take a great pride in its focus on quality and integrity.

We are supplementing this quality orientation by strengthening the management team. In the past quarter, we appointed Jon Fieldman, Senior Vice President, Operations; Jennifer Steeves-Kiss, Senior Vice President, Chief Marketing Officer; and Scott Milsten, Senior Vice President, General Counsel and Corporate Secretary.

We also secured an expanded supply agreement for high-quality Aker BioMarine krill oil, with certain exclusive sale rights for Schiff's leading brand, MegaRed. Finally, we're opening a small office in Emeryville, California to provide space for some of our senior team, as well as to access potential resources in the San Francisco Bay Area, such as online marketing and life sciences R&D.

So as you can tell, we've been busy and I'm tremendously excited about our future. As you'll hear in a minute from Joe, we projected accelerated sales growth in fiscal year 2012 in the high single digits to low double digits.

While we're making significant progress, it will take some time for all these changes to take hold. Going forward, we expect to continue to face headwinds in both joint care category and our private label business.

I hope to see greater progress from higher advertising, brand building and innovation in the back half of fiscal 2012. Now I'll turn the call over to Joe Baty, our EVP and CFO, for a review of the fourth quarter and full fiscal year 2011 results and financials.

Thank you, Tarang. Good morning, everyone and thank you for participating.

First, I will summarize certain industry and business highlights. Then, I will review the financial results for our fourth quarter ended May 31, 2011.

The overall Supplements category grew at approximately 7% in FDMX for the 13 weeks ending May 29, 2011, as measured by IRI. With respect to our focus segments, the joint care subcategory continued to decline, reflecting lack of positive news, potential product switching and fierce pricing and promotion activity.

The overall Omega-3 subcategory continued to exhibit consistent growth. Our Schiff Move Free sales were down quarter-over-quarter but less so than the subcategory.

Tarang referenced certain of our fiscal 2012 initiatives aimed at improving our overall joint category business. Schiff MegaRed maintained its strong sales performance, especially in our big 3 customers.

We continued marketing support, including national TV advertising and plan to invest significant incremental dollars in fiscal 2012. Now a review of our financial results for the 3 months ended May 31, 2011 compared to 2010.

Net sales increased 5.3% to $51.9 million from $49.3 million. The increase reflects 7.8% growth in branded business, which was modestly offset by a smaller than expected decline in our private label business.

Branded sales grew to $37.7 million from $35 million. Private label sales were relatively flat at $14.2 million compared to $14.3 million.

Our gross profit increased to $19.8 million from $19.5 million. However, as previously guided, gross profit as a percentage of net sales decreased to 38.2% from 39.5% due to tighter margins in the private label business.

Total operating expenses were up $14.9 million as compared to $15.6 million reported in the year-ago period. Selling and marketing costs reflected the decrease, primarily due to the timing of certain advertising and promotional programs.

Other operating expenses include $1.2 million in costs associated with the June 1 acquisition of the probiotics business. For our fourth quarter ended May 31, 2011, as reported, net income was $3.1 million or $0.10 per diluted share compared to $2.4 million or $0.08 per diluted share for the fourth quarter ended May 31, 2010.

Stock-based compensation expense was $0.4 million and $1 million for the respective quarters. Depreciation expense was $1 million and $0.8 million, respectively.

The effective tax rate for the current period was 36.2% compared to 35.5% last period. Now I will review results for fiscal 2011.

Schiff Nutrition's net sales were $213.6 million, which reflects a 4.3% increase from $204.9 million for fiscal 2010. The growth primarily demonstrates improved branded business.

Branded revenues grew 4.8% to $156.1 million from $149 million in 2010. This overall growth reflects the positive impact of Schiff MegaRed, which reached full distribution around midyear fiscal 2010 and which offset a year-over-year decline in our joint business.

Private label sales were $57.5 million as compared to $55.9 million. For fiscal 2011, as reported, net income was $12.6 million as compared to fiscal 2010 net income of $18.4 million.

As reported, earnings per diluted share were $0.43 as compared to $0.64. As previously noted, we incurred $1.9 million in pretax CEO-transition-related expenses, $1.2 million in pretax acquisition-related costs and an increase in long-term stock compensation costs in fiscal 2011.

Stock-based compensation expense was $4 million and $2.2 million for the respective fiscal years. Depreciation expense was $3.6 million and $3.1 million, respectively.

Now on to the balance sheet and comparing May 31, 2011, to May 31, 2010. Working capital was $79.6 million as compared to $79.4 million.

Cash and cash equivalents, including both current and long-term investment securities, were $46.7 million compared to $52.2 million. As previously disclosed, the special dividend aggregating $20.2 million was paid during the second quarter.

Inventories were constant at $34.9 million and $35.1 million, respectively. On June 1, 2011, we consummated the acquisition of our probiotics business.

We utilized our credit facility to fund the $40 million purchase price. Our current pretax cost of borrowing is approximately 3%.

A number of factors, including ongoing net cash flows and any incremental M&A activity, will determine the timing of repayment. Shifting gears to fiscal year 2012 outlook.

We currently forecast net sales percentage growth of high single digit to low double digit. This is, of course, subject to competitive pricing pressures, including from both branded and private label products; success of new products, such as Schiff Move Free Ultra, Schiff MegaRed Extra Strength and the recently acquired probiotics brands: Schiff Sustenex and Schiff Digestive Advantage, as well as incremental private label bidding activity among other factors.

We believe the sales increase will be due to overall branded growth, as we currently expect a significant decline in private label sales. Gross profit percentage is expected to be in the range of 41% to 44% compared to 38% for fiscal 2011.

The increase primarily reflects higher mix of branded sales volume driven by the probiotics acquisition and launch of new products, together with a reduction in private label business, volume and pricing. In reference to Tarang's comments and the expected increase in advertising costs, selling and marketing expenses as a percentage of net sales are expected to be in the range of 22% to 24%.

Other operating expenses, net, including preliminary assumptions regarding allocation of recent acquisition purchase price and impact of long-term incentive awards are estimated to a range from $22 million to $24 million. We currently anticipate a very high single-digit operating margin for fiscal 2012.

We continue to evaluate capital expenditure initiatives but currently anticipate investing approximately $3 million in fiscal 2012. Actual results for fiscal 2012 may vary and are subject to, among other considerations, competitive conditions and the risks noted herein and in our public filings.

Our forecast is likely to change as fiscal 2012 plays out. Again, thank you for your participation.

Now I will turn the time back to our President and CEO, Tarang Amin.

Thanks, Joe. Our employees' commitment to delivering high-quality products has helped Schiff build our leading brands: Schiff MegaRed and Schiff Move Free.

Next, we intend to accelerate growth through increased advertising support behind these premium brands, launching more new items and participating in faster-growing subcategories, such as our recent entry into the probiotics space with leading brands Schiff Sustenex and Schiff Digestive Advantage. We're very excited about our progress and we look forward to updating you on future calls.

Now Tom, we can open up the call for questions.

A couple of questions. I look at the marketing increase.

Historically, when you've increased marketing, particularly around national with MegaRed or Move Free, as you mentioned, you've gotten a significant benefit sales growth but when I strip apart the guidance of high single-digit to low double-digit growth in sales, when I look at the trends that you have in MegaRed, when I look at the overall category, which continues to grow and when I look at some of the drivers in place, it wouldn't imply from the guidance that you've built in any real significant benefits from what is an incremental call it $20 million of advertising spend, so is there some conservatism around it or is it timing driven or is it just not having the history of that kind of ratcheting up in spending. Because I presume, that if you're not going to get a benefit or return on that advertising spending then obviously you wouldn't spend it, so just help us put some framing around that.

First off, when you factor into your model that while our sales were $213-plus million in fiscal 2011. Moving forward in FY '12, we do expect a significant decline in private label sales.

And by significant, I mean 25% or so, so I mean it is significant. So then when you lay that on top and then factor in both (a) the acquisition of the probiotics business, which may pretty close cover that decline then you've got the new product growth and in order to achieve the high single-digit, low double-digit sales growth, it's primarily coming from new products.

It's primarily coming from Schiff Move Free Ultra, the Schiff MegaRed Extra Strength, the expanded distribution of Mega-D3 and so forth. So all in all, while I hope you're right that we are conservative and that we actually beat those expectations, with the dependence on a fairly high mix of new product launches in fiscal '12, that is where the guidance is as of today and regarding the advertising spend behind that, you also have to factor that in our view the probiotics brands recently acquired were somewhat starved of advertising support pre-acquisition and given that they're in a category growing at 20% a year, we certainly want to invest some dollars there but we haven't had -- owned the business for too long yet so it's too -- it's premature to say what the benefit will be.

Now to some degree, as we put the money behind it and we don't see the results, we'll obviously have the opportunity to ratchet back on the advertising. And as we said earlier, as the year plays out our forecasts will clearly change.

Second question, more of a housekeeping question, just 2-part question for Joe. How much have you embedded into the assumptions for purchase accounting amortization, it sounded like that's something built into the other line?

Yes, we tentatively built in less than $1 million in amortization expense for fiscal 2012, Mike. But we don't have the final report, valuation report.

So until we do, it is an assumption and it could change depending on that final allocation as far as what ends up as amortize-able versus what ends up as goodwill.

Okay. And then just final question, I was wondering if you will be able to recognize any meaningful tax benefits from the acquisition given some of the bonus depreciation with regard to the Economic Stimulus Bill?

Well, clearly, the acquisition itself was an acquisition of assets. And as such, for tax purposes, we're recognizing the full purchase price as amortization expense over the next 15 years and that's really what you're dealing with there, with intangible assets on this situation.

So it's an asset purchase. We'll clearly be able to deduct it for tax purposes but it will result over 15 years.

All right. Okay.

I was just wondering if there was any bonus amounts that you can take. I know in some cases, companies have been able to recognize that on capital asset purchases this year but ...

Yes, it's a good -- it's a fair question but in this particular situation, the bulk of the purchase price is intangible assets versus hard tangible assets.

Just a couple more questions on revenue. If you're backing off BOGO and trade spending, that should have a positive impact on revenues in and of itself, even though there'll be an offset in the advertising and merchandising line below it.

Is that a fair assumption and can you quantify that at all?

Yes, Tim, it is a fair assumption that rather than some of that price discounting type activity being offset against gross sales to your question it will now be shifted to advertising and come across as selling and marketing costs. But that was built into the overall guidance that we've given at this point and we'll see how the year plays out, and how effective those advertising programs are.

Can you quantify at all what the change in trade spending might mean to revenues?

Well, we prefer not to break that out. We don't like to get into the detail to that level, but it's clearly a component of the overall sales growth expectations and factors into the improvement from a gross margin standpoint as well.

Okay. And then relative to the acquired probiotics business, is it a fair assumption to be kind of thinking a $20 million-ish kind of sales contribution in fiscal '12?

I'd say you're in the ballpark, yes.

Okay. And then Joe, just back to your comments on tax amortization and deductibility.

Can you give us any sense of what you expect the rate to do in '12? You're, I think, all in 36% for '11.

Should we take that down by a point or 2 or hold it steady??

Good question, again, I would -- no, I would peg the overall effective tax rate for fiscal 2012 consistent with FY '11 somewhere -- and historically the last few years, it's been somewhere between 36% and 38% and that's where we currently peg it for FY12.

I had a question on the private label business, just wondering longer term, where you see the mix of branded versus private label and what is the long-term strategy for that part of the business?

Well, first off, just as far as the percentage breakdown: for FY '11, 73%, 27%. 73% of our sales dollars were branded, 27% for private label.

Again, as you can deduct from the guidance we provided, we expect a significant decline in private label sales in FY '12 such that, that overall mix is going to change. We expect it to change.

Such that rather than 73%, 27% or 75%, 25%, it clearly could go, north of 80%, south of 20%, as FY '12 plays out and long term. As far as where we end up 2 or 3 years out, it's difficult to say at this point but I would say, the focus is clearly to build premium brands, as Tarang noted in his comments.

And the only other thing I would add to that is we're actively managing both sides of the business so even on the Private Label business we'll continue to bid on Private Label business that makes sense where we can make money. What we're going to step away from is the stuff that's crazy and where no one can make money.

So that's reflected in the guidance and the plan we have in FY '12 and we'll see how that plays out over time.

Great. And just to follow up on the probiotics acquisition.

Maybe you could add some color about the strategy longer term for growing that business and the synergies you see between your existing operations and the new probiotics business?

We're very excited about the business, first of all, because of, as Joe said, the inherent growth rates in that category. What we're probably most excited about is the technology itself, BC30 is got great studies behind it.

It's one of the hardiest strains of probiotics out there, being able to survive both the gastric system as well as the manufacturing process. And the brands we got, we've got leading brands in Schiff's Sustenex and Schiff Digestive Advantage.

So our main plan forward is consistent with what we're doing across the board, which is actually increasing the advertising levels and investment behind these brands and continuing to drive our consumer, kind of both marketing as well as increasing distribution levels. So I think it's consistent with what we're doing across MegaRed, Move Free and some of other businesses and I think you can continue to see us kind of put some effort against it.

As Joe said, these brands are a little starved for support and so we're hoping that putting a little bit support behind it and putting some of our capabilities can help really unleash some greater growth. In addition, this acquisition gives us the opportunity to collaborate with Ganeden on future areas of -- basically probiotic technology for future areas of human health, which I think we're also excited about in terms of our innovation program.

And just lastly, how should we think about timing of the advertising spend throughout the year? Will the increases be pretty consistent or will they be more or less in certain quarters?

Let's say, overall, that given some of these new product launches are more towards the fall and latter part of the calendar year, which gets into late second quarter, third quarter of our fiscal year. You should think in terms of, at least overall, that the level of spending in the back half would be a little north of what it would be in the first half.

Beyond that, we prefer not to try to get too much guidance on a quarterly basis.

It's Damian Witkowski with Gabelli & Company. I want to go back to the strategy shift on trade spend to actually advertising and a couple of questions on that.

First, is it for all of your private label brands or is it that you're going to put more behind joint care and perhaps the new probiotic business as well as MegaRed? And then secondly, just looking at the decline in private label, and I assume that probiotics, it was $20 million in sales, I believe, before you purchased the company.

So I assume there should be some growth in that so the probiotic business should, in theory at least, more than offset the decline and in the private label business and I would think a much higher gross margin as well so if you could tell me if I'm wrong or right about that one.

First off, if I cut you short on the second question, please let me know. As far as the trade shift itself, I mean that's a shift in the support behind the branded business.

Okay, and then historically, as Tarang mentioned, and we've been guilty of it as well, there's been a lot of price discounting activity, buy one, get one free activity and so forth and that's been more on the branded side. So across the board, more so maybe for the joint business but also for MegaRed and our other Schiff-branded businesses, we'd like to shift some of that type of spending into hard advertising dollars and we believe there will be payoff as far as better growth and long-term stability with our consumers.

Now your second question, could you repeat...

Joe, can I just go back -- so on this one, you're talking about joint care mostly or...

This is Tarang. What I'll tell you is the advertising increases are across pretty much most of our portfolio, so you'll see activity on joint care certainly Sustenex and Digestive Advantage, as we talked earlier.

And MegaRed we actually also talked in terms of really continuing to kind of drive its success, so this isn't focused in any just one area, it's a more fundamental shift in terms of how we go to market.

Once you make that move, I mean, is there a point where you say -- where you can see whether it's working or not? I mean, I assume if you cut trade spending there could be a backlash at retail at least for a short period of time.

We'll be able to measure the results pretty quickly, right? And so certainly track that but as we sit here today we believe it makes a lot of sense and it's a fundamental shift, as Tarang Amin mentioned, but if something goes awry, seriously awry, then we can adjust for that.

And the good news here is, this is one of the places where we've talked in the past, the concentration of our retailer based actually does help us a lot here with our key customers being Costco, Wal-Mart, Sam's, some of our top customers. They're looking for manufacturers to step up and put more against the consumer from an advertising standpoint, and stop some of the heavy high-low discounting.

We think, in our particular case, that actually has a great advantage.

You have a second question. Could you please repeat that?

Actually, I'll skip that one, not as important. But I just wanted to go into your thoughts on your balance sheet.

And obviously, acquisitions is part of the strategy going forward. So, a, are you looking -- what areas would you be looking to add?

And more importantly, do you feel like you have enough availability on your borrowing base and such to do the acquisitions you might be thinking of?

Well, clearly, incremental acquired EBITDA will assist in incremental -- supporting incremental borrowing needs, right? As we sit here today, we clearly have availability on the facility and just given our trailing EBITDA, we have availability to actually lever up a little bit further.

But as we move and continue to look at other potential acquisitions, again, the key will be combined pro forma EBITDA between what we have and what the target brings to the table to support with the required financing.

And again, the acquisition is most likely be not getting yourself more vertically integrated in terms of manufacturing necessarily but probably more buying brands that you could market and put through your system.

I think the key thing is, we'll be looking at opportunities we first and foremost believe clearly drive shareholder value.

And then what's the reasoning behind not using the cash you have on hand versus borrowing, I mean, you have $45 million of cash on hand, I think, and you borrowed $40 million to do the deal?

Yes. Fair question.

And first off, as I noted in my comments, our pretax cost of borrowing on that is actually a little under 3% so then when you tax effect that, I mean it's really fairly inexpensive money. But beyond that, we wanted to see -- get a little bit of a market reaction and plus we continue to consider other potential M&A activity.

So as it plays forward, we'll debate as to how quickly and when we pay it back and/or we'll leave it outstanding because the possibility of another acquisition or so, sometime in the future.

Thanks for the follow-up. A couple of things.

You mentioned the strategy of expanding channel and geographic reach but I didn't hear much specifics about that relative to '12. Is there anything that you can talk about that would relate to that strategy?

What I'd tell you is, I can't tell you the specifics right now because I don't like to give away our channel strategy but what I can tell you is it's well-known and documented of where we currently have great retail relationships. We're highly concentrated in a few customers.

So when I take a look, it's always going to be lead by where the consumer goes and there's just a lot of white space when I look at different channel opportunities as well as geographic opportunities for us and we've been mapping some of those out but were not prepared yet to talk the specifics.

Okay, and can you update us on what the combined mix of Costco, Wal-Mart, Sam's was for fiscal 2011 in terms of percentage of revenues? I don't think I've seen that number yet.

We do historically disclose that in our public filings. But again, you are going to be -- it's been 70-plus-percent of the overall total and it didn't change dramatically in FY '11.

Okay. And Joe, was any of that $47.7 million in cash restricted or is there any reason why you wouldn't have used that other than just keeping dry powder as you suggested?

No, there's no restrictions, Tim. I mean you certainly have some of the -- especially the long-term piece, maybe tied up in certain investments that don't mature for another 6, 8, 12 months kind of thing, but for the most part, it's all very liquid.

There's no restrictions in place. Again, the reason why we opted to borrow versus utilize the cash is for the reasons previously noted.

It's just very cheap borrowing and we wanted to see -- get some reaction and we're just continuing to be interested in other possible M&A activity.

Well, I want to thank everyone for participating. As I said, we're really excited about the future and really excited to put this plan into place and look forward to updating you on future quarters.

Thank you, everyone.

Thank you.