高樂氏 (CLX) 2004 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Clorox Company fiscal year 2004 second quarter earnings release conference call. At this time all participants are in listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. If anyone should require assistance during the conference please press the star button followed by zero on your touch-tone telephone. As a reminder this call is being recorded. I would now like to introduce your host for today's conference, Mr. Steve Austenfeld, Director of Investor Relations for The Clorox Company. Mr. Austenfeld, you may begin your conference.

Thank you. Welcome everyone and thank you for joining Clorox's second quarter conference call. I'm Steve Austenfeld, Clorox's Director of Investor Relations. With me on the call today are Gerald Johnston, Clorox's Chief Executive Officer, and Dan Heinrich, Chief Financial Officer. Were broadcasting this call over the Internet and a replay of the call will be available for seven days at clorox.com.

On today's call Jerry will start by providing some observations about the quarter, then Dan will discuss the key financial drivers and results and provide our financial outlook. Finally, Gerry will wrap up and open it up for your questions.

Before we begin I need to remind you that the material we're providing during this call contains forward-looking information. Our actual results may differ materially from what we're projecting. Information about factors that could cause actual results to differ materially from our expectations can be found in our filings with the SEC, including our 10-K filing for the fiscal year ended June 30th, 2003.

I'd also like to point out that we have filed our 10-Q for the period ended December 31, 2003, and it is available through our website at clorox.com. With that, I'll turn it over to Gerry who will briefly recap our second quarter results.

Hello. Thanks, Steve. As you saw in the press release we had a very good quarter. Earnings grew 28% to $.51 a diluted share.

Our earnings results did benefit from comparison to the base period in which we took a charge for our Argentina business that was only partially offset by some beneficial items. But when you factor those out, Clorox delivered very healthy double-digit EPS growth for the quarter. On the top line sales came in up 2% and volume in higher up 4% in line with expectation. If you exclude the impact of divestitures sales were up 3%, volume was up 6% versus the prior year.

In fact this quarter's volume growth was the highest since March 2002. As we discussed with you on the past couple of conference calls, the first half of fiscal 2004 including Q2 presented some tough earnings comparisons for us. We continued to spend to support new products and we faced high raw material costs.

We also faced tough comparisons on the top line due to the impact of prior year divestitures as well as lower trade promotion spending in the year-ago period which was related to closing out legacy programs as the company converted to new systems. We're quite pleased to have met our first-half commitments, especially given these challenges.

Importantly, with positive momentum going into the third quarter and with the base period effects of divestitures and coupon and trade spending adjustments behind us we're looking forward to delivering strong double-digit year-over-year EPS growth in the second half as Dan's going to discuss when he gives our outlook.

Now, before I highlight the quarter against the company's key priorities I'd like to address two topics mentioned in this morning's press release and in our 10-Q. First, as originally noted in our June 30th 10-K the IRS is conducting a routine audit of our 1997 through 2000 tax returns. They are also auditing tax returns of the investment fund in which the company is a limited partner.

Let me take a minute to remind you of the purpose behind our investment in this fund, which we made in 1998. A significant portion of Clorox's international operations are located in emerging markets, primarily Latin America and Asia, and that exposes us to risks from currency fluctuations. This fund, which invests in developed markets currencies, provided us with a cost-effective method of partially mitigating our exposures.

Now, prior to investing in the fund we conducted appropriate due diligence to ensure it was a transaction that would help us manage our risks in emerging markets. As a limited partner the company doesn't manage the fund or control the investment decisions of the fund. Based on their audit the IRS recently informed us that they are proposing adjustments that we reattribute taxable income generated by the fund to Clorox. The amount of potential tax from these adjustments is about $200 million.

Now, we don't typically talk about the details of an audit or areas of disagreement with the IRS until we are farther along with the process since we generally don't believe it's in our best interest, or that of shareholders, to do so while we're attempting to resolve the issues. But given the size of the proposed adjustments we decided to proactively provide this information to you now rather than wait until the matter is resolved, which could take up to two years. The application of the tax code changes over time, and obviously requires judgment.

It's not uncommon that difference of opinion arise out of audits that often take considerable time to resolve. In this matter we strongly disagree with the IRS position and intend to vigorously defend our position. Nonetheless as a normal course of business we establish and periodically adjust accruals for tax contingencies even if our tax return positions are fully supported.

As a matter of company policy we do not disclose amounts accrued for any specific matters. However, we clearly believe that our tax contingencies accruals are adequate in this matter. Now, it is difficult to predict exactly when and how any tax dispute may ultimately be resolved. If the matter is partially or fully resolved in favor of the IRS, Clorox would be required to make a cash payment for that amount.

However, it would not be expected to have a material impact on our tax rate or our earnings. On the other hand if the dispute is resolved in the favor of Clorox or if any payment required were less than the amount we have accrued, it would simply lower our effective tax rate in that period. Now as we move forward we'll just update this matter in our 10-Q and 10-K filings.

The second area I want to address is Henkel. As you know in December Henkel announced plans to acquire Dial. In conjunction with that announcement they indicated they might sell all or some of their stake in Clorox to fund the transaction. As noted in our press release we're holding off for now on further share repurchases under our board-approved program until Henkel makes their intentions clear.

Now, in the meantime we are appropriately considering all of our options in light of their pending decision. I firmly believe that should Henkel decide to divest any or all of their stake in Clorox that it would be conducted in an orderly and methodical fashion.

Now I'm going to briefly highlight the quarter against the company's four key priorities. That is, driving growth, cutting costs everywhere, getting more customer-focused, and outexecuting the competition.

First, drive growth. We feel very good about the record number of new products we launched in our first quarter and the positive momentum that carried into in Q2. As expected our top line strengthened in the second quarter and in line with guidance we expect greater year-over-year sales growth in the second half of fiscal year '04.

Demand for Glad Press 'n Seal wrap remains strong. We have added capacity as planned and we're confident in our ability to meet demand as we are now completely distribution to all of our customers in this third quarter.

Response to the new laundry and homecare products also remain strong. Notably Clorox Bleach Pen, Clorox Bathroom Cleaners with Teflon, Clorox Disinfecting Wipes for the Kitchen and some lavender fragrance products we introduced for the Hispanic market in the U.S.

As we have discussed, innovation and brand-building are the cornerstones of our drive growth strategy. On January 27, a Boston-based PR firm released results from a nationwide survey of consumers. First the most successful product launches of 2003 employed a mix of marketing strategy.

I'm pleased to report in the studies ranking of 2003's most memorable new products, Clorox Bleach Pen came in 8th out of all new products launched with 42% of Americans indicating awareness of the product. In addition, CNBC also recognized both the Bleach Pen and Glad Press 'n Seal as two of the top ten new products.

Now turning to our second priority, we are continuing to see positive momentum against our priority to cut costs everywhere. Cost savings of about $100 million remain on track for the year. As indicated last quarter cost savings are helping to offset some of the impact of higher trade spending and raw material costs.

Third, we're continuing to make progress in our efforts to get more customer focused. As I've said before this is all about building our retail customers businesses with our brands, and the impact is showing up in our top-line results.

For example, our sales team partnered with some other suppliers at key retailers this fall to successfully execute game day football tailgating programs nationwide. The featured big displays of Kingsford Charcoal as well as Hidden Valley and KC Masterpiece food products. Other companies also participated.

It really is a win-win proposition that creates significant scale for the customer and delivers incremental volume for Clorox. As a result in the second quarter our food business delivered its 6th consecutive quarter of record year-over-year volume growth and Kingsford delivered its 11th consecutive quarterly record.

Finally, the processing system improvement we're driving with project Delta are a significant factor in our ability to outexecute the competition. This is our fourth priority. In November we went live on the first of three waves of our phase II systems implementation. Now as a reminder, phase II focuses on supply chain and logistics processes, including manufacturing procurement and inventory related account payables processes.

The five manufacturing facilities involved in the first wave did an exceptional job of preparing for the implementation, and it shows. The plants were up and running from the start and the processes are working well. We're now in the process of preparing for the wave 2 to go live later in the third quarter and we're on track to complete all three waves of phase II during the fourth quarter.

At closing this section out, the Clorox organization remains focused on executing our key priorities and driving results on the top and bottom line. Net-net we feel good about the business and the quarter. We have the toughest part of the year behind us, and we're pleased to have met our first-half expectations. We also feel very good about the outlook for the rest of the year. With that, I'm going to turn it over to Dan Heinrich for more details.

Thank you, Jerry. As Jerry mentioned we're very pleased to have met our first-half commitments especially when you consider the unfavorable comparison due to the coupon and trade promotion adjustments in the base period, the continued high level of trade promotion spending to support new products, higher commodity costs and the drag of prior year divestitures.

On the top line sales came in up 2% or up 3% excluding divestitures. As expected sales growth lagged volume growth primarily due to the base period trade spending comparison we've already discussed, increased spending to support new product launches, and some unfavorable product mix as we ship more larger sizes to support merchandising activity at key retailers. These factors were only partially offset by favorable foreign exchange rates and price increases on Glad trash bags and other items.

Volume came in at 4% or 6% when you exclude the impact of divestitures in the base period, and as Jerry mentioned this quarter's volume growth was the highest since March 2002. With each segment contributing. Let me review some of the highlights. The household products North America segment recorded 5% volume growth driven by a 14% increase in our laundry business.

Clorox Bleach Pen certainly added its share of incremental volume. As we entered the cold and flu season we also enjoyed strong growth on Clorox disinfecting wipes, with high quality merchandising support from customers seeking to meet consumer demand for germ prevention through disinfecting. Consistent with the partial shift in marketing spending we implemented in 2003, trade spending behind Clorox liquid beach again drove healthy volume gains for this brand.

The Glad business which delivered another strong quarter with 9% volume growth also boosted top-line results in this segment behind the impact of from our Press 'n Seal launch and record second quarter shipments of trash bags. Partially offsetting these gains was a decline in shipments of Brita product due to category softness in the pour through segment.

In the specialty product segment we had record Q2 shipments of cat litter and 11th consecutive record quarter of charcoal shipments and a 6th consecutive record quarter of food shipments which drove a 7% volume gain excluding divestitures. These positive trends were partially offset by the auto business which posted a decline behind ongoing category softness.

Volume for the household products Latin America other segment was up 5% excluding divestitures. This is for the second quarter in a row. We continue to gain momentum behind the more stable political and economic environments in South America and distribution gains in market expansion in Asia Pacific.

As I look back on a quarter, I believe our volume results reflect the commitment of Clorox people to focus on and deliver on our key priorities. Here's just a few examples. We clearly realized benefits from our focus on innovation to drive growth.

In addition to the successful launches of Press 'n Seal and Bleach Pen we were the market leader in bathroom cleaners for the third consecutive quarter behind our new Teflon products. In fact, we grew our share in this segment despite aggressive competitive responses. Our efforts to execute with excellence continue to accelerate.

In addition to the tailgating promotions that were executed, new distribution gains contributed to the cat litter and food records we set. We also executed extended season support to help deliver charcoal's latest quarter, and it's been continued great execution that's helping to drive the health of the Glad trash bags business including this quarter's record shipments.

Our strategy to get more customer focused, which is all about building our retail customers businesses with our brand, also delivered strong results. By way of example in Q2 we secured secondary displays for Clorox Bleach Pen at a number of retailers including the checkout stands in more than 900 major stores.

I'll now turn to the P&L. As we said before we're managing our business for consistency on an annual basis not necessarily on a quarterly basis. At the same time we've been striving to improve predictability by quarter. While we still have some work to do in this area we'll continue to provide additional insight into quarterly trends and into our direction going forward.

Now let me start a P&L discussion by providing some perspective on second quarter gross margin and advertising results. As noted in our press release gross margin came in at 43.5% which was down 300 basis points versus the prior year. Now this is in comparison to a 340-basis-point improvement in the year-ago quarter. However, while we expected a decline it was somewhat more than we had guided.

As I did last quarter I'll provide details about some of the key items driving year-over-year performance. On the plus side we picked up near 200 basis points from cost savings initiatives. The benefits from cost savings were more than offset by several items. First, the impact of increased trade promotion spending this quarter and the year ago trade promotion adjustment reduced gross margins by about 150 basis points. Going forward we expect trade spending trends to have much less of an impact on gross margin.

Second, high raw material prices contributed about 150 basis points to the decline. This is primarily driven by resin and chloralkalide prices. As we had projected, the gross margin impact from commodities was slightly better in Q2 than we experienced in Q1. We expect continued improvement in future quarters as we face easier comparisons against the increasing price levels of a year ago.

Third, other manufacturing costs reduce gross margin by about 125 basis points. This was primarily driven by third-party manufacturing costs for some of our Match Light charcoal which I described on last quarter's call. As we've discussed this business has been on a tremendous growth curve. Outsourcing allows us to support the growth as we take steps to expand capacity.

As I'll explain in a moment we expect this cost to also decrease significantly in future quarters. Finally, increased logistics cost contributed about 75 basis points to the decline, primarily driven by increased freight cost related to Match Light outsourcing and some start-up costs related to our direct plant shipments program. A portion of the increase cost will continue in future quarters as I'll explain in a moment.

In combination all of these factors explain our year-over-year gross margin decline but we did come in 50 basis points below our latest gross margin guidance, and it really stemmed from two areas. The first was increased transportation and warehousing costs as we decided during the quarter to accelerate purchases of the outsourced Match Light charcoal earlier than we had previously planned.

This brings our finished goods inventory up to more normal levels and helps ensure we're in a strong position to support customers as we move into grilling season. You may recall that last year we came into Q3 with unusually low charcoal inventory levels. Taking this product now will lessen our outsourcing requirements in the second half of the fiscal year particularly in the third quarter.

The second area is the results of higher than anticipated customer demand for the cat litter direct plant shipment program we launched in October. You may remember that the direct plant shipment program is one of the many projects under our cut costs everywhere strategy. The higher demand created some start-up inefficiencies but we believe the issues are short term in nature and we expect the program to smooth out over the next couple of quarters but both of these cost areas came in higher than we projected when we provided our latest guidance.

Turning to advertising, as expected it came down with the 36% increase of a year ago as we adjusted the mix of our investments in brand building and marking to support new product launches in our bleach business. In addition, we shifted some advertising activity to Q3, specifically the promotion and related costs for some new media.

This quarter's rate at 9.3% of sales remains at the upper end of our peer group and we're comfortable with our overall level of investment. R&D came in about as expected with an 11% year-over-year increase as we continued our increased investments in game changer innovation and also in the Glad joint venture.

Going forward we expect to continue adjusting our investment mix to best drive growth. While second quarter advertising as a percent of sales was slightly lower than full year directional and continued guidance of 10% overall spending behind growth investments, that is advertising, R&D and trade promotion combined was again up double digits versus the prior year.

Selling and admin expenses decreased slightly verse the prior year quarter primarily due to the timing of some administrative costs and some shifts to the second half of the year. Our tax rate is lower than it was a year ago due to the effects of the Argentina asset impairment charge in the base period.

I'll now turn to the balance sheet. While we maintained a negative working capital position this quarter inventories did grow, primarily due to the normalization of charcoal inventories. Looking at cash flow, we generated cash provided by operations of $188 million, or about 20% of sales. That's down slightly compared to $199 million generated in the year-ago quarter which was a second quarter record for Clorox.

Free cash flow which we define as cash provided by operations less capital expenditures was $144 million. This quarter we again used our free cash flow to fund $73 million in share repurchases and to fund increase stock dividends.

Finally, capital expenditures were 4.6% of sales for the quarter. For the full year we still expect capital expenditures to fall between 5% and 6%, excuse me, 4% and 5% of sales.

Now I'll move on to our guidance. As Jerry noted we expect the second half to deliver stronger year-over-year sales in earnings growth than we saw in the first half of fiscal 2004.

In the second half of fiscal '04 we'll have less difficult prior years comparisons as we put behind us the impact from divestitures and coupon and trade spending adjustments, as we face easier year-over-year commodities and trade spending comparisons, as we reduce spending on project Delta with the completion of phase II, and as our increased investments in R&D begin to match that of the year-ago period.

Consistent with our long-term growth goal we continue to expect to our top-line projections for the full year, that is sales growth of 3 to 5%. Net customers sales growth will be stronger in Q3 than -- excuse me, in Q4 than in Q3.

This is due to the ongoing impact of first-half new product launches including full distribution in all channels for Glad Press 'n Seal, which will be completed by the end of Q3, and due to new products that we'll begin shipping in the third quarter. These product include a new Tilex product, three new Clorox Bleach Pens and three new flavors of bottled Hidden Valley Dressings.

Consistent with long-term earnings goal we continue to expect to deliver double-digit EPS growth for full year. Specifically, we now expect earnings in the range of $2.48 to $2.53 per diluted share which is within the range previously communicated.

As Jerry mentioned, we're holding back on share repurchases for the time being. This has the effect of reducing our EPS guidance by a penny per share for each of the third and fourth quarters and has been fully reflected in full year guidance. We continue to expect our gross margin trend, that is the year-over-year variance, to improve sequentially in the next two quarters and to turn positive by the fourth quarter.

Specifically on a year-over-year basis we expect gross margins to decline in the range of 50 to 150 basis points in the third quarter and to increase 100 to 200 basis points in the fourth quarter. Again, this sequential improvement will be driven by the comparisons I discussed a moment ago. We'll also continue to benefit from the 150-basis-points, on average, in cost savings that we delivered in the first half of the year.

That said, we now expect our gross margin decline on a full-year basis to be about 100 to 200 basis points. That's a slightly steeper decline than we communicated to you on our last call. The reasons for change include the impact of start-up costs for the direct-plan shipments that I discussed earlier and some continuing unfavorable product mix.

Regarding R&D and selling and administer we expect these two items to grow in line with our slightly slower than sales and come in about flat as a percent of sales on a full-year basis. Consistent with the guidance we gave you last time, on a full-year basis we expect advertising costs to come in at about the 10% level of sales, including the third quarter.

Our total investments behind the growth levers is advertising, growth, R&D are expected to increase versus the high levels of a year ago. All other items on the P&L are projected to be about the same as previous guidance and we have no changes for previous guidance on the balance sheet.

With that we expect earnings per diluted share of $.55 to $.57 in the third quarter and $.82 to $.85 in the fourth quarter. Now I'll turn the call back over to Jerry.

Thanks. Before I open it up to questions I'd like to emphasize four things that I hope you take away from the call.

First, as we've discussed for several months now, the first half of fiscal '04 provided our greatest challenges due to the prior year comparisons. Heavy investments to support new products, prior year divestitures and a number of other things we've discussed with you.

Having just completed the first half and having met our first-half expectations, we feel very good about the business and our prospect. Importantly, as the guidance indicates, we expect strong double-digit year-over-year EPS growth in the second half.

Second, we remain committed to delivering and improving our annual consistency and improving quarterly predictability. While we still have some work to do here, we're going to continue to provide insights into trends and our expectations going forward.

Third, we've got some strong positive momentum. The business is healthy, we significantly stepped up our innovation output and particular in the game changers area we have very strong cash flow generation, we're on track to complete the project Delta systems implementation, and while we still have work to do to institutionalize new processes we're that much closer to seeing the real benefits of that investment.

Finally we're making solid progress on our long-term strategy work. And in late summer early fall we're going to be prepared to discuss our longer term goals and strategic agenda going forward. In short, I have a lot of confidence about our business.

I feel very good about the balance of this year and I have every expectation we'll carry positive momentum into fiscal 2005. With that I am going to open it up up to questions.

Thank you. Ladies and gentlemen, if you have a question please press the one on your touch-tone telephone. Again, if you have a question please press the one on your touch-tone telephone. One moment, please, for our first question . Our first question comes from Amy Chasen of Goldman Sachs.

Hi.

Hi.

First question is about volume. The real number this quarter was 6%, which is great, and I'm just wondering if there's anything one-time in that, because it looks like for the third quarter you guys are saying volume up low to mid-single digit and I'm surprised it's not going to be stronger than that given that the divestitures are no longer having a negative impact.

Well, Amy, I think that we're still going to project on those numbers. I don't think there's any big one-time thing other than we had some pretty substantial new product in the first quarter that continued to impact the second quarter. But in terms of looking at third and fourth quarter we feel pretty positive about the direction of those things and hopefully we're conservative.

Okay. Can you give us specific -- a more specific number for the third quarter?

You know, at this point, Amy, it's really too early to say. As we said, low to mid single digits in volume with sales being in the 3 to 5% range, so potentially being a little bit faster than volume. I think it's important to note that's a change from the first half of the year where sales has actually trailed volume for a number of the things we've talked about, particularly our higher levels of trade spending. In the back half of the year both quarters we expect sales to actually grow faster than volume.

Can you just tell us, if you look at the composition of the profit growth in the quarter by division, it looks like all of the recovery was in Latin America and margins were down in both household and specialty. Can you just talk about that and, you know, whether you feel confident that Latin America can continue to drive that improvement or whether we'll see that shift in the second half?

I do think we'll continue to see improvement in the second half in international, but for all of the reasons we've been talking about, whether it's the cost implications of raw materials in packaging, whether it's the one-time events because of release of these trade spending kinds of things, whether it's the new product expenses associated, those are all related to the U.S. division businesses, and they all moderate, and we come on to much different kinds of comps as you move into the second half of the year.

Okay. So then we should expect that the North American profitability will improve in the second half?

Yes.

Okay. Great. One last question on Henkel. Can you give us, you know, maybe some color on how you're thinking about this? Obviously you don't yet know, or maybe you do, but we don't yet though what Henkel's decision is going to be in terms of how much of Clorox they may or may not sell. If they were to decide to sell a significant chunk would you be willing to participate and buy some of that back directly from them, and along those lines can you talk about your comfort level in terms of levering up to do that?

I think that we're not going to get into the details of exactly how far we go. As you know we've got a very strong balance sheet and we are exploring all of the various alternatives that you could conceivably look at as it relates to buying back shares. At this point we're just not prepared to go into the details of exactly what that might be, particularly pending them still not telling us or Ecolab exactly what their specific plans are, but I think we've got a very healthy environment from a balance sheet standpoint which we've got some flexibility.

Great. Thanks a lot.

Our next question comes from Connie Maneaty of Prudential Equity Group.

Good morning. Lets see, I have a couple questions. I noticed in market share data which is admittedly incomplete but, anyway in your food storage bag segment, it seems as though retail sales of Glad food storage bags are declining around 15%, and yet the category is down considerably less than that. So I'm looking at this two ways. Either there's a whole lot of competitive activity, or are you clearing the shelves to introduce a new product? And if it's not either of those, what is it?

You know, I do think that the segment is very weak, and that our business in that particular segment is facing considerable competitive activity that's going on. I don't think you should be thinking that we're clearing the shelves for some activity that we've got planned.

Okay.

Connie, just to build on that for a moment we typically think of the bags and wraps business as being three primary segments. One being containers, another being trash, and another being food storage bags. The food storage bags, as Jerry indicated, is probably the softest segment of the three for Clorox's business, alternatively if you look at the containers business we still have a very strong leadership position there, and on the trash segment that has been a business that has been extremely strong over the last two to three-quarters and we continue to feel very good about. So you really pointed out the one area that's soft for us, but the rest of the business is quite healthy, and I think you can see that in the Glad volume results that have been 5% or higher for five or six quarters now.

Okay. On the gross margin, I'm feeling kind of sick here, why should there be a negative gross margin impact from the direct shipments you're making in cat litter, and are there any other categories where you're doing this?

Ultimately that's going to improve the margins in that area. This was strictly an issue of some surprising start-up costs related to that program.

Connie, we had our ramp-up program for direct plant shipments envisioned a certain pace of adding customers to the program. In fact, the demand for that program was much higher than we anticipated, so we had some start-up inefficiencies in getting all those customers onto the program more quickly than we had originally planned.

What categories are you doing these direct plant shipments in?

We've always done direct plant in our bleach and charcoal businesses and recently we created a program for direct plant shipments for the Glad business and for the cat litter business.

Great. If I could just ask one other question.

Sure.

That's about the gap that sometimes occurs between volume growth and sales growth. I understand that in the next six months sales will be stronger than volume, but should we anticipate that every time you come out with a major new product that your sales growth will lag units by, you know, three or four points?

Probably not in that dimension. Remember, there were so many other pieces of noise sitting inside of that, that had to do with a prior year's release of trade spending program, those old programs, and a number of other activities that go on there. Any one particular launch would have just on that item have an impact in that direction, but it's usually mitigated by other kinds of activities that we have going on. So I would not expect that to be the case in the future, even when we have a major launch.

Okay. That's helpful. Thank you.

Uh-huh.

Thank you. Our next question comes from Joe Altobello of CIBC World Markets. Your question, please.

Thanks. Good morning. Just a couple quick questions. On the IRS audit it sounds like that's isolated to the year '97 to 2000. Is there a chance that could extend into other years?

The audits underway today are for 1997 to 2000, and the IRS has recently begun 2001 and 2002. The issues associated to the IRS matter we disclosed actually does extend into some of those additional years so it does affect the outcome of this matter will impact those other years that are currently under audit.

So the $200 million number you gave out this morning does that include the '01-'02 audit as well?

That estimate does represent the total amount of what we believe the potential issue to be with respect to the investment fund, yes.

Second, if I could ask another question, you guys announced this morning obviously you're suspending your share buyback program. Is that purely voluntary or was there some regulatory issue that required to you announce that?

Purely voluntary.

Great. Thanks.

Our next question comes from Andrew Shore of Deutsche Bank. Your question, please.

Gerry, two questions. First, if the first quarter was your most prodigious new product cycle you said in your history, wouldn't the second quarter actually be a very heavy on-air period normally?

Yeah, but you have to look in the context of the entire advertising budget that we have. For instance, our Glad advertising in the second quarter was up substantially. The real changes in the advertising came in the laundry home-care business which were down, and a good portion of that had to do with the shift that we talked about, I think about this time last year, when we said we were making a pretty fundamental shift in how we allocated the total amount of money we spend on marketing and trade spending and media on the bleach business. So that was the biggest impact if you're just looking at it in the absolute.

Okay. A follow-up is, if did you 6% core volume that's pretty good but are you also tempering expectations for volume to low to mid-single third quarter because you're going to be pulling back on trade promotions? What happens to your volume when you stop spending this much on trade?

I think our trade spending promotion spending shouldn't look very different than what you've seen recently. In other words, we made these adjustments over this past year, now we're finally lapping the changes. Other than any time you have any new product, of which there will be some in the third quarter.

Finally, what was the percent of your profits in the quarter that came by losing less in trade promotions? Like I think, Gerry, you talked about the possibility of a $60 million profit swing this year. Where are you on that?

Could you repeat that question, Andrew? I'm not sure I understood exactly where you're going with it.

I think when you talked about your proprietary sophisticated software planning for marketing mix and all that you mentioned that there was a $60 million swing.

Andrew, we started to track a measure called cost per incremental case. I think that's what you're referring to. As the key measure to understand are we getting better efficiency and greater lifts for our trade promotion spending. I think last year we communicated that our initial results on this when we started this was about an 8% reduction in cost per incremental case which is good. For the first quarter it was down 1%, which again is good, but the rates slowed a bit as we add lot of new spending behind the new products. In this quarter it's a bit difficult to measure because in the prior year period we were closing out the old trade promotion programs, but what we have been able to measure on this same cost per incremental case measure is that over the last two years, we have a 15% reduction in our cost per incremental case. And so all the trends right now would indicate for that portion of the $60 million savings that we expected we will achieve it in fiscal year '04.

Thanks. That was helpful.

Our next question comes from Andrew Mcquilling from UBS Warburg. Your question, please.

Thank you very much. Just again, and I'm sorry to harp on the gap between sales and volumes, can you talk about how big an impact the increase in bleach trade spend was in the quarter and will this continue? Obviously the volumes -- and what were base laundry volumes up in the quarter?

Let me give you a little picture of the base volume then I'm going to have Steve answer the original question. But back in the second quarter of fiscal '03 we saw some trends that we didn't like with regard to we had made some big investments from a marketing spending and absolute spending standpoint on bleach business in the area of advertising and we shifted away from trade spending and we started to see our volume get soft. In fact, in Q2 our volume was down 4%, and then it took a little while, we announced the new program in Q3, or late Q2 I guess it was, and our volume was down 2% in the third quarter, it was then up 1% in the fourth quarter, up 2% in the first quarter of this fiscal year and up double digits in this last quarter on laundry and bleach. So we feel like the range of things that we're doing in terms of making these adjustments are the ones that are working right for our business. I don't know if you want to answer.

Andrew, you were asking about the gap between volume and sales, is that correct?

I guess the thing is, incremental bleach volume were obviously very profitable.

Correct.

How long do you think the strong bleach volume continues and what's been the competitive reaction?

The strong bleach volume, Gerry noted double-digit increases this quarter, a result of not only stronger results on the base business, both Clorox and Clorox 2, primarily behind the shift towards trade spending as Gerry discussed but we're clearly also benefitting from Clorox Bleach Pen this quarter. The near-term results, particularly as we're still in this first year window of the launch of Bleach Pen, laundry would continue to show very strong results. I don't know that I would necessarily say double-digit volume growth but stronger than our normal traditional growth rate.

Maybe another one on the tax rate 34.7 in the quarter. You've mentioned -- and can you say what your expectation are for fiscal '04? And if I think I understood your discussion you're accruing for potential tax liability in the tax rates that you're currently running, is that right?

Our overall expectation of effective tax rate for this fiscal year is about 35%. The slightly lower tax rate in the second quarter brings our full-year effective tax rate to the 35% level. And our -- inside our effective tax rate any accruals that we do for tax contingencies or other matters would be reflected inside those rates.

But the rate isn't going up for fiscal '04. How about fiscal '05? They thoughts?

It's a little early to tell what our rate will be in '05. I think we're at the 35% level today. My gets is this is purely a guess, we'll be somewhere around that level in '05 but we need to finish our planning and make final calculation on that rate.

If I could, maybe one last one. When Henkel took its original stake in Clorox obviously they were acting as a passive investor. Is there anything in the wording of your agreement that talks about a change in situation where Henkel becomes a potential competitor?

There's nothing in the language that would deal with them as a potential competitor that. Would strictly be a business discussion for them or us to consider.

Terrific. Thank you very much.

Our next question comes from Wendy Nicholson of Salomon Smith Barney. Your question, please.

Hi. My first question goes back to this bleach issue, and I guess the question being, this terrific volume growth that you saw, did it in fact, was it additive to your margins or was the promotion level so high that it contributed to the margin decline in the household product segment?

Only as it relates to the comp year-over-year and it's impact on the gross margin decline would it be impacted that way. And so I think that it's very much a positive in terms of incrementality, particularly once you've lapped the previous year.

But this isn't a business you've ever done a lot of advertising on right, so is the bleach business an area where you actually swapped TV ads or print ad for promotion?

No, I think that we do a lot of advertising and have always done a lot of advertising on liquid bleach. We made a choice during fiscal '03 to see what the impact of that would be if we really ramped up the advertising, and it didn't deliver the same thing, so we shifted some of the incremental money from an advertising standpoint that we had done then back to trade promotion, and we're getting the benefits of it right now.

Because I guess I look at that category and say it's been a declining growth category, at least according to Nielsen, for a very long time. Your shares have been very, very strong, and I'm wondering, kind of the does it pay for itself to spend so much money. I mean 14% volume growth is great, but did you overshoot your goal, sort of, in terms of did you give product away effectively you didn't have to?

No I don't think so. I think that is the right level of spending is because it's strictly a shift from an operating margin standpoint it doesn't negatively affect you at all.

Wouldn't it negatively affect the third quarter? If I bought two bottles of bleach because they were so much cheaper, it's not like I'm going to use it up any faster, so the maybe the third quarter is going to see pressure?

I don't think so, we feel very good about what the third quarter looks like and fourth quarter looks like on the bleach business.

To be clear, Wendy this change in strategy has been in place for about three-quarters now so any sort of advance buying like you're describing, if that were to even to occur, it would have occurred quite some time ago.

My second question is on the resin pricing environment. A couple of other companies in the group tha also have significant resin exposure have had to lower their number with an outlook, I think resin pricing was up I think $.05 in January, another $.05 in February so far. Have you just hedged out or got capture collars in place that protect you, if you will, so that you feel comfortable with that big gross margin expansion in the fourth quarter that we don't have to worry about if resins remain this level that's going to eat into the gross margin?

Resin prices are high. As it relate to our buying approach we do have stabilized buying, stabilized purchase ling in place for resin that ex extends out for next couple of quarters. Our primary issue on resin pricing has to do with the comps to the previous period. If you recall last year our resin prices were ramping up and in the second half, on a comparative basis we'll start to compare back against resin prices in the year-ago period that are much higher, and, therefore, it will ease the competitive issue--or the comparative issue that we have. We do have stabilized buying in place for resin.

Terrific. Thank you.

Thank you. Our next question comes from Linda Bolton-Weiser of Oppenheimer.

Thank you. I'm curious about maybe you could be a little more specific about how much of a downgrade in your debt ratings would you be will be to accept if you were to choose to leverage up further?

I think that we just aren't comfortable yet exposing ourselves to specifically what we might do. I think that we obviously, our view is going to be we're going to be able to run our business, we're going to be able to make the right kind of investments as we move forward, we're going to want a strong balance sheet, an appropriate credit rating but I don't want to expand on how far we'd go or what would we do until we get farther down the road in knowing what Henkel would like to do.

Okay. Because I guess my thought is that, you know, I mean, you've had sort of a year here where you haven't really had that much of operating income growth excluding charges, and, you've had some ups and downs in your business and you seem to have some cyclicality to your business because of the resin exposure. I'm sort of wondering is it wise from a risk perspective to even leverage up more than what you're already leveraged given the nature of your business?

I think today we do have a very strong balance sheet so clearly I think the company can handle more leverage if it choose to do so. But we would take any leverage on prudently and I think we need to wait and have further discussions and dialogue with Henkel to understand what they want to do with their stake before we get any farther with it.

I think to be clear, Linda, you pointed out properly this our operating income growth in calendar year '03 was not as strong as in past years, but this, as we've described, is very much a transition year, and as we get into the second half of the fiscal year which started in January we expect to see very strong operating results, and by all means that hasn't impacted our cash flow generation. We still expect to be able to generate upwards of $550 to $600 million of free cash flow.

I feel very good about what I describe as the stability of our core business, even with the noise that goes on in a number of these areas, that we've gone through what I knew was going to be a very difficult calendar year and a difficult first half of this year from a comps standpoint, I feel very good, though, about the stability of our business and all along we've done the right kinds of things with regard to cash generation, through all these different restructuring and variety of things that have happened.

Okay. Thank you very much.

Uh-huh.

Thank you. Our next question comes from Ann Gillin of Lehman Brothers. Your question, please.

Thanks. Just two questions. Dan, on cash flow, if you can stand another one, when you were initially looking at the program to buy back shares, was the $200 million potential IRS settlement in the projections, or is this new that we should also factor in even as you learn what Henkel's going to do with their shares?

I think the decisions we made around share repurchases are based on the long-term cash flow generation capability of the company, and we really look at the capital structure on a long-term basis, look at the level of cash flows which have been quite strong and we make our decisions based on that view. So it's not based necessarily on short-range issues that may come into play.

Okay. And then, Gerry, just a separate question. I know one of the things that you wanted to bring to Clorox was more consistency.

Right.

And I always focus on the revenue line as you said that. Now I feel like I have to focus on the A & P line, too. And obviously they go hand in hand, but it just seems like, you know, kind of we're back to a situation where every quarter we're getting kind of a back and forth between those two, and when will that start to mitigate?

I think that fiscal year '03 really was the year in which we looked at the advertising line and we made some choices to invest heavily in order to ramp up volume. I think some of the outcomes of that weren't what we were looking at, and as we've made adjustments now, for instance, even in the second quarter our advertising spending went down to about 9.3% of sales versus somewhere in the range of 10% that we were projecting, but the vast majority of that was simply a delay in some production of some some new advertising. That was moved to the third quarter, and it simply a move of that particular cost from one quarter to the next. As it relates to this sort of 10% being the ballpark for where I think we are and where we should be, I feel pretty confident about that being about the right number for total year in that sort of as we're moving forward here, so I don't think there needs to be a lot, even though it may vary a little bit from quarter to quarter, particularly as it relates to this consistency on an annual basis. And I think we're spending, you know, if you look at all of our peers, everybody in the peer group that I would consider, not only household and personal care but food companies and the absolute levels of spending on the advertising line, we're going to be right up there near the top at a 10% level of spending.

Okay. And then just how should we think about promo going forward? In terms of when we can see it being a smoother contribution every quarter.

By promo, let's make sure --.

Net to sales.

Trade promotion spending?

Yes.

I think that that, you know, it changes generally driven by the kind of new product activity that we have. We don't have big swings in that -- the biggest swing that we've seen is this shift we made on the bleach business predominantly. We have minor shifts there normally so I think that the trend is sort of a normalized one and now as we go into calendar year '04 other than any impact that you'd have from heavy new product activity at any one point in time.

Ann, just to build off that, clearly the first half of the year's been a bit abnormal in the trade promotion line because of those year-ago, adjustments, and that's the primary reason why our sales have lagged volume growth but it's also the primary reason why when we look at the back half of the year that trade spending begins to normalize that we would expect trade spending to normalize.

That's helpful.

Our next question comes from Connie Maneaty of Prudential Securities.

I was wondering, I guess Venezuela devalued yesterday. Is there any impact on your Latin-American business from that?

We had considered that all along, the likely devaluation in Venezuela, in fact probably even more than what actually happened, so it has no effect on our going forward activity and, in fact, there could be further devaluation and we would be fine.

Also, on Match Light, could you discuss why you had to go to Match Light outsourcing and why this issue, you know, continues? I mean, what kind of production capacity did you have and why wasn't it enough, or what was going on back then?

I think over the past year and a half to two years the demand in the charcoal business has clearly exceed our expectations, and at some point in time we had to make some decisions around do you build your own production capacity for that or do you go outside, and because what you want to make certain if you make a big capital investment in any of that that's long term in nature. As we moved along here, the demand has continued to be very high in our charcoal business and we're now making the appropriate choices as we move forward to make sure we mitigate the extra costs we have out of this capacity restraint that we've had and with the right kind of capital decisions as we move forward but we're fine in terms of moving forward. We're going to have another year or so of challenges just from a short-term standpoint on the gross margin line on related to Match Light.

And could you just tell us, then, since this seems to have a beginning and end what the impact on the gross margin just from Match Light outsourcing has been?

Steve, I'm not sure, have we released that?

Yeah, referencing back to Dan's commentary, both for the first quarter and the second quarter, the outsourcing piece was the primary reason why we had about 125 -- I'm sorry, about 120-basis-point decline in gross margin in Q1, and it was about the same in Q2. So that will lessen as we move into the back half of the year. In fact, we wouldn't expect it to be anywhere near that magnitude going forward.

Importantly, as you know, this is such a seasonal business, by the time you get to the fourth quarter, just the total tonnage relationship to the high volume we do in total just won't have much of an effect.

So that if you decide to build your own Match Light facility we should see this kind of impact in Q1 and Q2 of the next fiscal year but then it goes away once and for all?

Well it's a scale that we'd be going down over time because it's not just a matter of building one Match Light facility it's a matter of increasing capacity through our entire structure and that can be done with bits and pieces all the way as you go along here.

Okay. So gradually, so even if next year you have to outsource we will presume that you've already built in some capacity, some extra capacity, so the impact at the start of fiscal '05 would be less than at the start of fiscal '04?

That's exactly right.

Okay. Great. Thanks.

Uh-huh.

Our next question comes from Art Cecil of T. Rowe Price. Your question, please.

Hi, Art.

Where do you all typically show your share of the profits from the investment fund?

That investment is included in other assets in our balance sheet and the result from that, from our investment in the fund, come through other income and expense, nonoperating item.

Other income and expense. So in '03 that category was a net income item of $8 million, year before it was $4 million. I'm kind of curious as to how in the world they end up with a $200 number. I'm just wondering what kind of pretax profits that you've reported could lead to that kind of -- even by IRS mentality.

Let me see if I can explain that. Obviously we're very early in the discussion with the IRS. We've just recently got the findings, have not had a chance to respond to those findings. Normally we wouldn't be talking about it this early in the process but given the size of the amount we felt it prudent to start talk about it which we've done.

Is their number, $200 million?

This is their assessments and essentially the way I would explain it, and again,s I don't want to get too far ahead of ours because we haven't had discussions with the IRS and I don't want to impact the discussion that we will have but essentially when we invested in the investment fund in 1998, a number of assets position in the fund had tax bases that were much higher than the book bases, and as those positions were either matured or liquidated over the years the tax benefits associated with that higher tax basis flowed through which we participated in. The IRS, and I don't want to go into too much detail what their assertions are, the IRS is trying to reattribute certain income items from the investment fund to us to offset some of the deductions that we've had the benefit of.

Just looks to me like the magnitude of the $200 million can't bear any resemblance to the pretax numbers that you've shown as your share through the other income line. You know, for reporting purposes.

That's correct. The results that we've reflected from the investment fund through other income and expense have been fairly nominal over the years.

So there's a big difference in terms of what you're reporting for tax purposes.

That's correct.

Is this a currency hedging fund operation that you're involved in here to help offset the Latin-American risk?

Business purpose of entering into the investment was exactly that, to try to find a cost-effective method for mitigating some of the currency risks that we had against our foreign direct investments.

And you're still fully participating in this fund?

We are still active in the fund, another the absolute size of the fund has come down over the years.

In the release you talk about looking at trade promotion spending plus R&D plus advertising in the second quarter was up double digits. And given that R&D and advertising were not up very much it looks like the trade promotion piece of it had to be up in the 35% area year-over-year. And I guess whether that calculation -- if that calculation is right is a function of the year-ago base being so low because of what you talked about earlier. But is that about right that the year-over-year trade promotion which we don't see was up, you know, over 30%?

Art, we can't quote you a specific number but it was quite strong and it was not only because of the low year-ago base period but it was also due to the support behind the new products we launched in the first quarter which again was a record, and the strategic shift on Clorox liquid bleach that we discussed. So you had three things there that drove a very strong increase.

You've given us enough data points to come close to figuring out what trade promo did and it seems to me it had to be way up over 30% year over year, and I'm just wondering how that comports with improving trade efficiency spending which you've talked about has been going on at your company for awhile. Seems to me that kind of increase doesn't say much about trade efficiency.

Actually, it works hand in hand. Let's just use Clorox liquid bleach as an example. One of the reasons that we made the shift from advertising to trade promotion is because our analytical models told that you say was a more efficient use of those funds and was going to generate higher volume than if we had continued to invest in advertising, and by making that shift we actually saw higher efficiency and higher lift.

But I do think it's important to note that we have sort of, as you had noted this funny base number.

Yes.

So that the absolute percentage increase, while looking large, isn't really as relevant a number when you take out the impact of the new product spending and the one-time adjustment that we had there.

Okay. And your volumes in the quarter being up 6% on a continuing basis met your budget?

Yes.

Okay. Thank you very much.

You're welcome, Art.

Thank you. Our next question comes from Lauren Lieberman of Credit Suisse First Boston.

Thanks. I was just hoping you could talk us through actually the guidance for the rest of the year that you're expecting third quarter to be a little bit lighter, I think the more consensus was, then putting a little bit more into the fourth quarter. What shifted? Does it have to do with traction on new product? My sense now at this point in the call is there isn't any real change in your sense of the timing for delivering more straightforward earnings but just wanted to get some more color on the back half of the year.

I'm going to turn this over to Dan in a second but probably the two biggest things that changed the third quarter was some movement of some of the production on our advertising into the third quarter which will increase advertising spending by that much. Along with the fact that we're not doing share repurchases and the impact that has in both the third and the fourth quarter. So you get an impact just from those two things that amounts to about $.03. Dan?

Yeah, I think that's right. I think we had some shifts of spending that will impact us in the third quarter. We also have some continuing costs associated with our direct plant shipment start up that will continue to affect us as well in the third quarter.

Okay. And then also, sticking with direct plant, what's the timing for that becoming a positive for gross margins?

I think it will become a positive relatively quickly. It's a program that we expect will deliver some pretty substantial savings over time. This is really a start up inefficiency issue. So once we get the customers up and running on the program it starts to pay out right away but we did have some higher start up costs in getting these customers set up.

If it's still going to be an issue in Q3 then it's really Q4/Q1 that it starts to become positive.

It has some lingering issues in Q3, shouldn't be a huge impact in Q4 and should improve in Q1, Q2 next year.

But our guidance on gross margins on Q3 and Q4 already include that thinking.

Okay. And then just, I guess, finally, on the trade promotion close-outs, that we're comparing against, can you give us any insight to what was the actual impact on the top line, was it more in household, more on specialty, also any impact on profitability?

I think the impact of the close-out of the trade promotion programs a year ago on a gross basis was about $13 to $14 million. That translates to about $.03 to $.04 a share. That would have been probably spread across principally across the specialty and the laundry home-care product division.

Okay. Oh, and there's also a property sale that was mentioned in the press release that was in last year's numbers.

A year ago in the second quarter we had, actually an eminent domain action in one of our plants in Florida which generated about $4 to $5 million in profit associated with that, that is not repeating.

That was also in North America household?

Yes.

I'm all set thank you.

Thank you. Our next question is a follow-up from Amy Chasen of Goldman Sachs. Your question, please.

My question's already been asked. Thank you.

Again, ladies and gentlemen, if you have a question please press the one key on your touch-tone telephone. Our next question comes from Wendy Nicholson of Salomon Smith Barney.

I just wanted to follow up on something you said at the very end of your remarks, Jerry, about kind of the game changer in the portfolio. Would you classify at this point kind of the Bleach Pen and Press 'n Seal as being the two game changers of fiscal '04? Because it doesn't sound like what's coming in the fourth quarter kind of classifies.

We haven't disclosed at all what plans are involved or the timing for the future game changers in terms other than we clearly will have one or more in fiscal '05, but we haven't disclosed anything else about the balance of the quarters this year. I would not disclose, although it may end up being in that range, that the Bleach Pen was intended to be a game changer. It's just doing much better than the original anticipation was. The Press 'n Seal, because I've given sort of the definition around game changer as being adding a point of top line growth to our business that's highly incremental for the business. We continue to have a body of game changers that look good for these out years, for the balance of this year, for '05, '06, '07 etc., so we're feel good about the level of innovation and the kind of things that come out of that.

So if you don't have those two, we had the ready mop in fiscal '03, none in '04, maybe we get one in '05, I mean is that -- that's kind of how you're thinking about all you need to get to your long-term sales growth target of 3 to 5%, so it's less game changer driven, if you will, and more kind of, I don't know, brand extensions and line extension and things like that?

I think it's a combination of all those things. Press 'n Seal was a game changer in terms of the household segment that. Would be included in that grouping that we've talked about, and that's an '04 initiative

And that's added a point to your total top line growth?

That's what we would be saying, that a game changer, to be qualified to be one has to add a minimum of a point of top line growth to the company.

Okay.

Wendy, I was going to say, our 3 to 5% from a target standpoint is split between an objective, rough objective of 2 to 3% from our base business and 1 to 2% coming from innovation. So that 1 to 2% coming from innovation, again, at least half of that would come from a game changer year.

I think you said you're going to update us late summer, early fall. Is it new initiatives, is it new long term growth targets, what should we look forward to then?

I think the intent at this point in time, and we're finalizing the exact date, but it's likely to be in late September that we have a meeting but it is to essentially update the goals that we have that go out to 2008, that would give you the growth targets along with some other financial targets that we're going to be setting as a part of that exercise, and importantly as a part of that what's the strategic agenda that allows us to get there.

Fair enough.

Un, I think that at this point I'll go on and wrap up. I think the questions are dying down. I feel we add very good quarter. I think we've got, in particular, glad to get the first half of the year behind us, and we feel very good about this next half of the year that's coming up. So thanks a lot for dialing in and we'll talk to you soon.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect.