Reckitt Benckiser Group plc

Tarang P. Amin - Chief Executive Officer, President, Director and Member of Executive Committee Joseph W.

Baty - Chief Financial Officer, Principal Accounting Officer and Executive Vice President Rebecca Herrick - Assistant Vice President of San Francisco Office

Timothy S. Ramey - D.A.

Davidson & Co., Research Division Lee J. Giordano - Imperial Capital, LLC, Research Division Damian Witkowski - Gabelli & Company, Inc.

Michael W. Gallo - CL King & Associates, Inc.

Thank you, operator. Thank you all for joining us this morning for the Schiff Nutrition International Fiscal 2012 Second Quarter Results Conference Call.

By now, you should have received a copy of the press release. But if you have not, please contact LHA at (415) 433-3777 and we will forward a copy to you.

As a reminder, this call contains forward-looking statements that are based on management's belief and assumptions, expectations, estimates and projections. These statements are subject to known and unknown risks and uncertainties.

And therefore, actual results may differ materially. Important factors that may cause actual results to differ from those expressed or implied by such forward-looking statements are detailed in today's press release and the company's SEC filings.

In addition, the company's presentation today includes information presented on a non-GAAP basis. The company believes these non-GAAP financial measures provide meaningful supplemental information regarding its operations.

We refer you to the press release the company issued this morning, which is available on the company's website, for a reconciliation of the differences between the non-GAAP presentation and the most directly comparable GAAP measures. With us from management today are Tarang Amin, President and Chief Executive Officer; and Joe Baty, Executive Vice President and Chief Financial Officer.

It's now my pleasure to turn the call over to Tarang. Please go ahead, sir.

Thank you Becky, and good morning, everyone. Fiscal 2012 second quarter net sales grew 16% over the same period last year.

Importantly, branded sales grew 31%, which is consistent with our strategy to build premium brands, lead innovation, expand the channel and geographic footprint of the company, pursue acquisitions and drive world-class operations. We saw growth across key brands with contributions from our recently acquired probiotics business, new products and benefits from a significant increase in advertising.

Based on our first half performance and current expectations, we're adjusting our fiscal 2012 outlook including raising net sales and increasing operating expenses. Here is an update on our 5 key strategies for growth.

Our first strategy is to build premium brands. At the beginning of the fiscal year, we discussed our intent to increase sales and marketing expense to drive awareness and trial of our brands.

During the fiscal second quarter, sales and marketing expense represented 25% of sales, a significant increase versus last year. This increase is consistent with our strategy and includes support for our new item, Schiff Move Free Ultra and MegaRed Extra Strength.

We are still in the very early stages of this initiative, however, the responsiveness to advertising has been encouraging thus far. Our second strategy is to lead innovation.

As mentioned, our new product introductions of Schiff Move Free Ultra, which offers consumers joint relief in one small pill, and MegaRed Extra Strength, which offers 500 milligrams of MSC-certified krill oil, are off to a good start. Much of the 2012 growth plan relies on consumer acceptance of these new products and we remain committed to leading innovation in our categories.

Also during the quarter, we strengthened our innovation team. We appointed Shane Durkee as Senior Vice President of Research and Development.

He has lead teams in innovation, product development and medical science, most recently with Bayer AG in Basel, Switzerland. We also announced 3 key appointments to our Scientific Advisory Board with Doctors Bredesen, Fischbach and Surhan, experts in aging-associated diseases, probiotics and information, respectively.

These appointments compliment Dr. Richard Carmona, the 17th Surgeon-General of the United States, who agreed to chair the Board earlier in the year.

The Scientific Advisory Board provides us with additional science-based expertise from which to build our innovation capabilities and further Schiff Nutrition's reputation as a leader in strong science and innovation. The third strategy is to expand a channeling geographic footprint of the company.

Our primary focus remains on building sales by enhancing our long-standing relationships with the leading retailers such as Wal-Mart, Costco, Sam's and Walgreens. We're also evaluating other channel opportunities domestically, abroad and online.

In fact, in the second quarter, we began selling MegaRed and Move Free online. We are still in the very early phases of building this channel.

Initial consumer experience has been positive. We'll update you as the online and other channel expansion efforts progress.

The fourth strategy is to pursue acquisitions. We are pleased with the performance of our probiotics business since the acquisition on June 1.

The acquisition provides us with leading brands, Schiff Sustenex and Schiff Digestive Advantage, and BC30 technology in the fast-growing probiotics segment. We continue to evaluate acquisition opportunities and we look forward to providing future updates.

The last strategy is to drive world-class operations. We recently made key enhancements to our team such as the new Head of R&D and 3 new Scientific Advisory Board members.

We also recently appointed Brian Swette to the Schiff Nutrition Board of Directors. Brian has more than 30 years of leadership experience in consumer marketing, e-commerce and business operations with companies such as P&G, Pepsi and eBay.

We believe Brian will be a valuable asset to Schiff as we drive our growth strategies forward. World-class operations are dependent on great people and capabilities.

Schiff Nutrition has long had a strong team but takes pride in the quality of our products. We've been selectively enhancing this team with key leadership hires and strengthened capabilities across functions.

We believe that these investments in people and capabilities are necessary to help accelerate the long-term growth of the company. This is one reason why we're increasing our operating expense expectations for the fiscal year.

These operating expenses also reflect an increase in legal fees. We're involved in several cases in which we believe the allegations against us are without merit and we're committed to vigorously protecting our brands and business.

In summary, we're pleased with our financial performance for the first half of fiscal 2012 and encouraged by the initial customer acceptance of our new products and the responsiveness to advertising thus far. We look forward to updating in our future progress.

Now I'll turn the call over to Joe Baty, our EVP and CFO, to review the fiscal 2012 second quarter and year-to-date financials.

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

I'd like to start by sharing some FDMx year-over-year data for the 12 weeks ending in November 2011, as measured by IRI. The overall supplements category grew at approximately 4%.

The joint care kit subcategory declined 12%. Probiotics increased 26%.

And cardiovascular increased 2%. Schiff Nutrition net sales increased 16% to $61 million for the 3 months ended November 30, 2011, compared to $52.6 million from the same period in the prior year.

The increase reflects growth in key brands and includes another quarter of the probiotics acquisition. Branded sales grew 30.8% to $49.7 million from $38 million.

Private label sales were $11.3 million compared to $14.6 million. As previously guided, the decrease was consistent with expectations.

Our overall joint category sales were $22.2 million for the current quarter, compared to $22 million for the prior year period. We are pleased by a second consecutive quarter of overall stability in our joint care business.

We believe the initiatives we're implementing, including incremental advertising support and innovation with new products such as Move Free Ultra, are key contributing factors. Schiff MegaRed continued its strong performance during the quarter.

Our acquired probiotics brands, Schiff's Sustenex and Schiff Digestive Advantage, overall met expectations and sales were consistent with the first quarter results. Our gross profit increased to $26.8 million from $20.2 million in the prior year period.

Gross profit as a percentage of net sales increased to 44% from 38.4%, primarily due to a much higher mix of branded sales. Branded sales were almost 82% of the total for the current quarter compared to 72% for the prior year quarter.

Total operating expenses were $22.6 million as compared to $17.1 million reported in the year ago period. As guided, we increased advertising and marketing support for all key brands in aggregate.

Advertising and consumer marketing expense in the second quarter increased to almost $6 million versus a year ago. We believe this dollar increase may be greater in the third quarter.

Total selling and marketing expenses were 25.4% of net sales, as compared to 17.2%. Other operating expenses totaled $7 million for the 3 months ending November 30, 2011, as compared to $8.1 million for the prior year period.

The current quarter reflects higher legal fees related to litigation, as well as incremental personnel and structure-related cost. The prior year quarter includes costs associated with accelerated vesting of certain long-term incentive awards resulting from the TPG-WHF transaction.

Other operating expenses for the current quarter include $0.4 million in amortization costs associated with the June 1 acquisition of the probiotics business. A portion of related amortization expenses is also included in cost of goods sold.

We believe the allocation of the purchase price is largely finalized, but still subject to true up in the second half of fiscal 2012. For our second quarter ended November 30, 2011, as reported, net income was $2.4 million or $0.08 per diluted share compared, to $1.8 million or $0.06 per diluted share for the second quarter ended November 30, 2010.

Adjusted EBITDA, which is defined as income from operations before depreciation, amortization and stock-based compensation was $6.4 million, compared to $7.1 million. The effective tax rate for the current period was 39.6%, compared to 39.4% last period.

For the 6 months ended November 30, 2011, net sales were $119.3 million, compared to $104 million for the prior year period. Net income was $7.1 million compared to net income of $5.5 million.

Earnings per diluted share were $0.24 for the 6 months ended November 30, 2011, compared to $0.19 for the prior year period. Adjusted EBITDA was $16 million compared to $14.1 million.

On to the balance sheet. And comparing November 30, 2011 to May 31 and August 31, 2011, working capital was $52.5 million as compared to $79.6 million at May 31 and $48.1 million at August 31.

The decline for May 31 was primarily due to the June 1 probiotic business acquisition. The increase from August was primarily due to net earnings from the most recent quarter.

Cash and cash equivalents, including both current and long-term investment securities, were $25 million compared to $46.7 million at 31 and $56 million at August 31. During the second quarter, we paid down $30 million of the $40 million borrowed to fund the probiotics acquisition.

Subject to future M&A activity, we expect to move forward with the revised financing facility by the end of fiscal 2012. Inventories were $43.4 million compared to $34.9 million at May 31 and $38.7 million at August 31.

The increase at November 30 primarily resulted from buildup for certain third quarter branded and private label promotions. Shifting gears to fiscal year 2012 outlook.

Our branded sales are up close to 28% year-to-date and as a result, we are raising our top line growth expectations to 12% to 15% for fiscal 2012 as compared to fiscal 2011. The increase is subject to competitive pricing pressures, including from both branded and private label products and the success of new products such as Schiff Move Free Ultra and Schiff MegaRed Extra Strength, among other factors.

As previously discussed, overall growth expectations are tempered by an expected decline in year-over-year private label sales, which we are down 25% year-to-date. Gross profit percentage is expected to be in the range of 43% to 45%, compared to 38% for fiscal 2011.

The increase from prior guidance primarily reflects an even higher than previously expected mix of branded sales volume in operational efficiencies. Selling and marketing expenses as a percentage of net sales are expected to be in the range of 22.5% to 24.5%.

Other operating expenses, net, including assumptions regarding impact of management incentive awards, are estimated to range from $26 million to $28 million. The increase from prior guidance is primarily attributable to legal fees associated with pending litigation, investment and key personnel and infrastructure in support of our long-term growth initiatives, and increased amortization expense associated with the recent acquisition.

We currently expect a very high single-digit operating margin for fiscal 2012. Again, thank you for participating today.

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

Thanks, Joe. We're focused on continuing to drive our growth strategy and we look forward to discussing progress in the months ahead.

To highlight a few upcoming investor events, we'll be participating in an event run by our investor relations firm in San Francisco on January 11. We also plan to attend the Houlihan Lokey Consumer Conference in New York on February 2.

We hope to see many of you there. Now operator, we can open up the call for questions.

Just wondering if you have a sense of whether you'll get to kind of baseline levels of private label sales this year? Whether we shouldn't expect further erosion next year or -- you'll kind of get to where you want to be this year?

That's a fair question, Tim, and I would say, I believe our -- I believe, as we sit here today, our private label sales will be reasonably consistent going forward. As far as where they end up this year --and just as a reminder, in fiscal '11, private label sales were north of $57 million.

Year-to-date's are down 25%, which is approximately where we think they'll end up in fiscal 2012, down approximately 25%. And then our sense is they may hold somewhere close to that level.

However, depending on the -- how competitive the pricing situation is and other opportunities, it could fluctuate some. But at the end of the day, our focus long-term is clearly on the branded side.

Great. And if you think about the performance in the joint category, which Joe, you went through it really fast.

I know you said it was down, I don't remember the exact percentage. But is that -- I mean if that's one of the areas where BOGOs and trade promotion really was the most aggressive, if I'm not mistaken.

Can you talk a little bit about how that's playing out in the marketplace?

I think if you -- Joe mentioned that the joint category was down 12% for the overall category. You look at our joint business, it was flat for the second consecutive quarter.

And so we believe the strategy we have of launching innovation and putting advertising is a better strategy, and we'll be able to see that play out over the next couple of quarters. I mean I think the category overall continues to be challenged for a number of the reasons that you cite.

But our strategy that we announced a while ago, which we're sticking to, is really using innovation and advertising to help revive it. And we're seeing benefits to our business.

So you're, Tarang, does that mean that the competitive activity and trade spending is continuing?

It is continuing, although it will be interesting to see as we go forward, I think people always take a look at who's actually gaining share and who isn't. And I think you tend to look at those tactics and strategies and say there, is there a better way?

I noticed from conversations with some of our customers that I think the overall industry kind of, a feeling is, perhaps some of the BOGOs are too much and people would like to lessen the reliance on those. And so I think as we look at the back half of our fiscal year that's something we're going to be paying close attention to, but overall, I'm satisfied with the progress we have so far in our strategy.

It's Lee Giordano. I had a question on the probiotics business.

I just wanted to get a sense of how you see that business growing over the long-term? And what you've learned so far as you're integrating those brands into the portfolio?

So we're really excited about our probiotic business. As Joe mentioned, the overall category continues to exhibit strong growth rates.

And I think our biggest learning so far is we're pleased with the integration. Both Schiff Sustenex and Schiff Digestive Advantage, I think, have meaningful advantages and benefits.

And so I think our main focus so far has been kind of bringing them into the fold of Schiff's, start putting them into some of our promotion plans and put advertising on. And so new advertising, I think, goes on air a little bit later this month on both brands.

And so it's something that we're very excited about, particularly given the advantage that the BC30 technology gives us in terms of its benefits relative to competition.

Great. And then a question on Scientific Advisory Board.

Can you talk about how the Board is helping Schiff innovate and generate new product ideas? And secondly, what are the plans for R&D spend going forward?

Okay, I'll take the first half and then turn over to Joe. I'd say our Scientific Advisory Board, the real benefit of it, is I said, is to bring scientific expertise.

I mean, some of the people we have on -- and I think of Dr. Richard Carmona, is one of the world's leading experts in public health, really brings a great lens to us in terms of the health benefits of nutritional supplements and guiding us there.

Dr. Charlie Surhan of Harvard Medical School is one of the world's leading experts in inflammation.

If you take a look at a lot of our lineup, both, kind of, MegaRed as well as Move Free, both heart and joint are fundamentally inflammation-related states; and so having his expertise and collaboration in terms of the science and some of the ideas. And the same goes through with the other experts that we have on board.

And so our plan is to have Shane Durkee, who is our Head of R&D, really kind of tap into the Scientific Advisory Board for scientific ideas and collaboration on innovation and new product ideas, and bring that into the company. And so far, we're pleased with the progress and the ideas we're getting from them.

Good morning, Lee, this is Joe. In response to your second question, our overall research and development cost, historically, have been, including operating and capital expenditures in the $4 million to $5 million range.

We don't anticipate a significant change to that for FY12. Somewhere in that same range maybe, or at the higher end of the range.

Long-term, we'll evaluate that as needed in relation to new product ideas and development efforts and so forth.

A couple of questions. One product area I didn't hear you talk about at all was Mega-D3.

Can you give us an update on trade movement there? How that's doing?

Whether that's something you're thinking - end up in full mass distribution here at some point? Or just some thoughts there?

Sure. I'd say we're still pleased with the results of Schiff Mega-D3.

As you know, it's in the drug class of trade and Wal-Mart. And while the overall vitamin D category in the last 12 weeks softened, we continue to make progress on Mega-D3.

We like the trends we still have on that business. Although, I should mention the last -- Joe may have mentioned, the last quarter, D3 did -- is basically flat in the overall D category.

So that's something we're going to keep an eye on. We still have, as you know, quite a bit of opportunity, both in terms of doors and our ability to continue to grow that business.

Right. Joe, in terms of -- how much were the legal fees in the quarter?

Is that what we should kind of expect on an ongoing basis? I assume that, that's related to the Aker-Neptune lawsuit.

And is that something we should -- until that's resolved, we should kind of expect it to go on in the same range? Or is it something you think will move up a little bit or down a little bit, given, I guess relatively recent?

Good morning, Mike. First off, we don't necessarily get in to that much granularity when it comes to breaking out those fees per se.

Clearly it impacted the quarter and clearly, as we noted in our comments, it's coming into play with the change in guidance regarding our total operating expenses. But that, coupled with a couple of other considerations including the investment in personnel and increased amortization expense led to that overall change.

I mean it's difficult to say when those costs may taper off, as you can imagine, when it comes to litigation. But when all's said and done, we're very committed to aggressively defending our brands and our business.

And overall, we think any allegations against us are without merit.

Right, okay. Then final question.

I've noticed you've got a plant version of MegaRed that you're selling on your website now. I don't recall having really seen it in anywhere in the mass channel.

Is it something you're testing in the mass channel? Is it something that's just more limited in terms of what you think the opportunity for it is?

You'll sell it on your website? Or just help us just to -- whether there's some other SKUs besides Extra Strength in MegaRed that you think have an opportunity for full distribution?

On that specific item that you talked, which is the MegaRed plant, omega. It actually has a pretty broad distribution now.

It's in Wal-Mart, in a fair number of the doors in Wal-Mart and a number of our drug class of trade. And it really meets the needs of those people who want omega-3s in a vegetarian or plant-based form.

And so, that product was introduced around the same time as the MegaRed Extra Strength. And I think we're really pleased overall with our overall MegaRed franchise, including some of these new entries.

In terms of how does it stack up relative to -- I would expect that MegaRed Extra Strength to be a bigger product idea, just given that it builds off the overall MegaRed krill base. And a like a lot of product categories, many consumers are looking for that extra strength version.

And so it's probably a more broadly appealing. But having said that, we've seen in other channels a plant-based product do quite well.

So stepping back, our overall plan is to have a continuous stream of innovation against our brands, particularly our key brands. And you'll see a new number of new items throughout kind of this year and in the future years.

Right, okay, and then. Tarang, final question.

Obviously, big shift in the promotional strategy this year. You're spending a lot more in advertising and marketing, and a lot less in couponing and trade promotion.

As you've done this for a couple of quarters now -- I mean, obviously, the spending on the sales and marketing setup have been a lot higher this quarter. Are you still kind of feeling out what the right levels are?

Is it pretty much continuing to respond, the more you spend the bigger response you're getting? Are you still kind of feeling out certain channels or certain items that are more-responsive, less-responsive?

Just help us get a kind of feel for, I guess, longer-term, where do you envision sales and marketing being? Should we start thinking about it in terms of a whole number?

Is it -- that just you needed more dollars behind the brands and as the revenue grows, maybe even in '13 or '14 or '15, you can start to leverage that? Or are we just going to live in a world where 23% to 25% is kind of where it's going to run longer-term?

Yes, what I'd tell you is so far we're pleased with the strategy. While it's still early days, you look at our year-to-date sales, we're up almost 15% at the quarter.

As we mentioned, 31% branded growth, we think is very much aided by this strategy in terms of kind of a shift from trade into advertising and aided by new products. So you're going to continue to see that as we go forward.

In terms of kind of where do we net out in terms of our overall, is it an absolute or percentage number? I'd say for the balance of this year you are going to continue to see very strong advertising levels and even Q3 is going to be -- the increase will be just as strong, if not stronger.

Because we are really supporting these new items as we go forward. Beyond this fiscal year, I think at some point, you do get the ability to kind of leverage that spend in the absolute.

And my experience, at least having worked, kind of, dozens of brands with a similar strategy is, over time, the stronger the brand becomes, the stronger the innovation becomes, the more efficient you get in terms of the advertising, some of the other expense. And so what I would say is longer-term, we certainly would expect to leverage, kind of, the build that we're doing right now.

Just because the bigger these franchises get, you don't inherently need to invest at that same percentage rate. But for the foreseeable future, certainly for this fiscal year, I think the ranges that we've updated are the right ranges, and I feel good about them based on what we're seeing in the marketplace.

Just wanted to -- in terms of the benefit from the probiotic acquisition in the quarter, dollar-wise, did you disclose how much of the increase was actually from the acquisition?

What we disclosed, Damien, was that the overall probiotic sales for the second quarter were close to what they were in the first quarter. But I'd further that by say, looking at -- look at it this way, using rounded numbers, our quarter-over-quarter branded sales were up about $12 million.

Okay? And give or take, third plus of that was in -- as a result of the probiotics acquisition.

Okay, fair enough. And then if you look at Move Free.

Is your outperformance versus the category, which was down again, I think 12% you said, is it simply just the incremental sales from Ultra Products?

Well, I mean, we clearly had incremental sales from the line extension, Move Free Ultra, in the second quarter, which did offset some erosion if you will in our base business. But overall, I mean we're clearly pleased that as compared to the subcategory decline of, again, 12% in the most recent 12 weeks.

Having overall stability and very modest increase in the second quarter and clearly an increase year-to-date in our joint business, we're very pleased with.

Okay, and does it vary by channel? I mean you have very few, but does it vary a lot by your customer in terms of how it's performing?

Or is it pretty much consistent among Wal-Mart and Costco?

Well again, we don't get into that level of granularity with any of our businesses. But I'd say -- see, you're clearly going to see some volatility on a class to trade basis.

But overall, I would say again, we're pleased with performance year-to-date with our joint business.

And then you talked about beginning online sales. Is it just for your own website?

Or are you -- where else would you be looking?

Yes. So the specific initiative I referenced was our own website sales.

We have had sales through some of the different retail online channels before. I mean if you go on and do a search right now on MegaRed, Amazon.com will pop up, Wal-Mart, Costco and a number of our other customers, regional customers, will pop up.

This is really deepening the relationship we have with consumers. And allowing them also to purchase directly on our own websites.

And I think what you'll see over time is more and more of our brands being -- and being enabled on that capability and our ability then to further that relationship.

And then just circling back to the legal fees. I know you don't want to go onto the details, but is it fair to say if I look at the increase for the full year and a guidance for the operating expenses, and then a lot of it is -- a -- is the legal fees?

Yes.

Is it majority?

Yes. The mature answer's, yes.

Okay, and again in the timing -- I mean, is this – something that could continue beyond this year? Or are we prepping for some sort of a -- are these expenses, sort of prepping for a court data or whatever it may be?

Yes, I mean it's pretty immature for us to respond to that. We're writing guidance as we see it in FY '12 and we'll deal with any impact on FY '13 at a later date.

Okay. And then again, good job with the things that you can control, but if you look at the category, the supplements category in the U.S., it seems like the growth has been slowing a little bit.

Are you seeing anything that in the macro picture that concerns you at all? For the overall supplements category?

No. I mean, I know there was a lot of press in the last quarter on some studies that we thought were flawed.

But overall, I mean, I think we continue to see good consumer fundamentals. I mean, the basic story hasn't changed, right?

The population supplements particularly spike after age 50 the -- it continues to be the largest, fastest-growing demographic group in the U.S. When I take a look at our own subcategories, we've talked about joint for some time, so that category continues to be a bit challenged.

But we're encouraged by our own progress in there, to be over the last couple of quarters. And then some of the other categories like cardiovascular, probiotics, and some of the other areas where we're positioned, we feel pretty good about, not only the growth rates right now, but more importantly, the projected growth rates into the future.

So I wouldn't say there's really fundamental shifts other than the macro trends we talked. We will see a quarter-by-quarter change, here and there, so that's one of the reasons why I don't give quarterly guidance.

But overall, we feel still great about these categories.

Well, thank you, everyone, for participating on the call today. As discussed, we're really encouraged by the progress in our innovation, sales and marketing initiatives.

And we really look forward to keeping you updated, and really hope you have a great day. Thanks, everyone.