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Operator
Good morning, ladies and gentlemen, and welcome to the first quarter 2007 Prestige Brands Holdings earnings conference call.
[OPERATOR INSTRUCTIONS]
I would now like to turn the presentation over to your host for today's call, Mr. Dean Siegal, director of investor relations and communications.
Please proceed, sir.
Dean Siegal - Director, Investor Relations
During this call, statements may be made by management of their beliefs and expectations as to the company's future operating results.
Statements of management's expectations of what might occur with respect to future operating results are what is known as forward-looking statements.
All forward-looking statements involve risks and uncertainties, which in many cases are beyond the control of the company, and may cause actual results to differ materially from management's expectations.
Additional information concerning the factors that might cause actual results to differ from management's expectations is contained in the company's annual and quarterly report that it files with the U.S.
Securities and Exchange Commission.
And now I'd like to introduce Peter Mann, chairman, president and CEO of Prestige Brands.
Peter?
Peter Mann - Chairman, President and CEO
Good morning, everybody.
Thanks for joining us.
I hope that by now most of you have had a chance to see our earnings announcement, which we released last night after the close.
If you haven't, it's available at our website, which is www.prestigebrandsinc.com.
With me today, as always, is Peter Anderson, Prestige's chief financial officer.
The focus of today's call is fairly simple and straightforward.
We're going to review the quarter's results in some detail, provide you some color commentary and then take a brief look forward at what we believe lies ahead for Prestige Brands.
First, though, a few corporate headlines on the quarter.
Total revenues for the quarter were $75.9 million, which represents a 20% increase over the same period last year.
As you know, acquisitions of course played an important role in the sales growth, but if we exclude revenues from the two acquisitions we made last fall, Chore Boy and the Dental Concepts Company, which we did own in the same quarter last year, organic revenue still grew 8%.
Net income for the quarter reached $8.3 million, which translates to $0.17 per fully diluted share and represents a 39% increase over the same quarter last year.
This earnings growth was primarily driven of course by the year-over-year sales increases.
However, our profit margins also improved, driven by a number of factors.
First, gross margins, which, while down slightly from the prior year, were better than we expected.
A&P spending was also down somewhat year-to-year in absolute dollars and this reflects a couple of factors.
First, reduced spending behind our personal care segment, secondly some A&P efficiencies on other brands, but most importantly timing differences that some of the advertising that we ran in the first quarter last year will actually appear later on during this year.
G&A expense was, as we expected, up on a year-to-year basis and included some -- included a one-time expense related to the recent management changes.
Without this one-time expense, G&A would have actually represented a lower percent of revenues than in the year ago period.
All of these operating efficiencies more than offset what was an expected increase in interest expense driven entirely by higher interest rates on the non-fixed portion of our debt.
And finally for the company, free cash flow for the quarter was $21.2 million, or $11.6 million better than net income.
As most of you know, Prestige has consistently delivered higher levels of free cash flow than booked net income, thanks in large part to the company's long-term tax yields.
So that's the overall corporate picture.
Let's get into a little detail now both by segment and then by major brand.
First looking at the key OTC business segment, here revenues increased 19% to $39.6 million.
Importantly, most of our key brands, particularly Compound W, Chloraseptic, Clear Eyes and Murine, all posted gains over last year.
Dental Concepts, our newly acquired line of dental OTC, continued to meet our expectations with double digit increases in consumer consumption of the Doctor's Night Guard.
If Dental Concepts were entirely eliminated from this quarter's results, the OTC segment still grew 9% organically during the quarter.
Profit for this segment, as measured by brand contribution, surged more than revenues, growing 27%.
On a brand-by-brand basis, leading the revenue growth were Clear Eyes and Murine, both of which benefited from the launch of important new items, specifically the new Clear Eyes Triple Action line extension has already achieved good levels of distribution and is selling well in those accounts where it has already reached the shelves.
And our new three-item homoeopathic line under the Murine brand name is also enjoying both good early trade and consumer acceptance.
Advertising for both of these new products will start this quarter and we are hopeful that that advertising activity will further fuel the success of these launches.
Compound W, our wart treatment line, also registered good year-over-year growth in factory revenues, although the year ago period was, as you now, soft.
However, the more encouraging news for Compound W is that consumer consumption for the quarter was positive and was trending upwards.
Chloraseptic, which is coming off of a relatively weak cough/cold season, met our revenue expectations for the quarter and achieved modest factory sales growth over last year.
We are now right in the midst of our 2006/2007 pre-season sell-in and later during the call we're going to be talking to you about a number of new Chloraseptic items which are a part of that effort for this upcoming year.
And finally, while our Little Remedies line factory revenues declined a bit during the quarter as retailers worked through inventories form the cough/cold season, but importantly consumer consumption for Little Remedies, as measured by IRI, remained quite strong, growing nearly 20%.
Turning then to our household product segment, we also saw robust growth in this important part of the company during the quarter with a 32% year-over-year revenue increase.
Of course Chore Boy, which actually exceeded our expectations during the quarter, was incremental to this segment, but again, if we exclude Chore Boy revenues entirely, our existing household business still grew organically 14%.
Profit for the segment was also strong, growing essentially in line with segment revenue.
Pete Anderson is going to provide a lot more detail on all of this later on in the call.
Looking at household on a brand-by-brand basis, Comet turned in another excellent quarter with revenues growing in the mid double digits.
This strong performance for Comet was fueled by three important elements.
First, strong unit consumption growth, secondly, expanded distribution in warehouse clubs added to new placements of the Comet Lavender Powder, and finally, continued distribution and movement improvement are still growing Comet Cream.
As a further reference for you, total Comet consumer consumption for the quarter, as measured by the combination of IRI and other customer point of sale movement, grew almost exactly in line with factory revenues.
And of course Comet, during this quarter, benefited from royalty revenues from our licensing agreement with Procter & Gamble in Eastern Europe.
And you'll hear in a few minutes we are now launching a major improvement to the new Comet Cream, which we expect should further accelerate growth on that key item.
Our third brand in the segment, Spic and Span, also grew, this time growing mid single digits versus last year, and modestly exceeded our expectations for the quarter.
Strong gains at Wal-Mart, expanded distribution on the new citrus fragrance and improved distribution of our Antibacterial Spray all played a role in the brand's growth during the quarter.
In personal care, as you know, personal care is our smallest segment, accounting for only about 8% of the company revenues, and that segment continued to decline during the quarter with all three major brands, Cutex, Denorex and Prell contributing to that softness.
However, the decline was very much in line with our expectations.
The final point I want to cover talking about the quarter is geography.
As many of you know, Prestige currently does very little business outside the U.S. and Canada and so building our international distribution and our international sales base is an important incremental growth opportunity for the company.
And we've made significant efforts over the past year to register our products, to grow in our international distribution and to add totally new geographies.
During the June quarter we began to see some clear signs that those efforts are starting to pay off.
A couple of examples -- sales outside of the U.S. and Canada slightly more than doubled from about 2% of revenues last year to just under 4% of revenues this year.
Of course, this is on a relatively small base but nevertheless is an encouraging sign that our international initiatives are beginning to yield fruit.
I might note as you look at the margins for the company you should remember that our international business model is to sell to our international distributors at a lower price, yielding a lower gross margin, but conversely that international business then carries no A&P expense on the company's books because the distributors are responsible for providing the A&P support.
Internationally we registered sales for the first time in quite a few new geographies.
In many of these instances the volume recorded in the quarter was relatively small and represents initial stocking only.
But we are hopeful that as time progresses we will see steadily larger orders.
And importantly, we saw very nice gains based upon consumption increases in most of our better-established international markets.
So, that's the summary of the quarter's results, both in total and on a segment and on a brand-by-brand basis.
I think in a very real sense the quarter's results are a good reflection of the company's overall continuing strategic focus on priorities, first to drive basic organic growth through new items and line extensions, then to add incremental organic growth on our current lines from expanding our international business, and finally adding new revenues and new earnings from strategically and financially sound acquisitions and to do all of that while continuing to deliver cash flows significantly in excess of book net income.
I'm going to turn the discussion over to Pete Anderson now for a few minutes who'll provide some additional financial detail, both for the company as a whole as well as on a segment-by-segment basis.
Pete Anderson - CFO
Thank you, Peter.
As Peter mentioned earlier, net revenues for the quarter of $75.9 million were 20% higher than the prior year net revenue of 63.5 million.
Operating income of $23.3 million was $5 million, or 27%, greater than last year's operating income of 18.3 million, while net income of 8.3 million was 2.4 million, or 39%, greater than prior year's net income of 5.9 million.
The improvement in operating income was primarily due to the strong sales gains for both the OTC and the household product segments, plus favorable advertising and promotional spending compared to the prior year.
These favorable trends were partially offset by increased cost of sales and increased G&A expenses.
Cost of sales for the quarter of $36.3 million were 7.4 million, or 25%, higher than cost of sales in the prior year.
As a percent of revenue, cost of sales increased from 45.6% in fiscal year 2006 to 47.8% in fiscal year 2007.
This cost of sales increase as a percent of revenues was driven by three factors.
First, as we discussed on last quarter's conference call, packaging and transportation cost increases, which took place largely in the latter half of fiscal year 2006 following Hurricane Katrina, resulted in higher costs than in the first quarter of fiscal '06.
Second, this is a similar trend that we saw last quarter.
This year's sales mix was unfavorable to the prior year's quarter.
Net revenues increased for the household products segment by 32% compared to a 19% revenue increase for the OTC segment and a decline for the personal care segment.
Household products have a higher cost of sales and thus constituted a bigger percentage of the overall sales than in the prior year.
And finally, as Peter just mentioned, international sales doubled over the first quarter of last year.
Basically, the increase in sales all took place in the OTC segment for international and if we excluded that international sales increase, which carries a higher cost of goods, we would have accounted for about 1% increase in that cost of goods.
So basically, had we had domestic sales rather than the international sales, OTC cost of goods would have been 1% lower as a percent of net sales.
Advertising and promotion expense of $7.4 million for the quarter was 1.3 million less than the 8.7 million spent in the prior year.
The decrease in spending in the current year's first quarter was due to a combination of changes in advertising and promotional timing in the OTC segment and a decrease in advertising and promotion spending against the personal care segment.
As we've consistently told you, it is our objective to hold or even slightly increase the importance of A&P as a percentage of sales for our key brands.
The reduction in A&P this quarter is not a change in strategy but it's rather the result of the normal quarter-to-quarter fluctuations that can and will occur during any given year.
Now, I'll briefly review results by segment.
Net revenues for the OTC segment of $39.6 million were 6.2 million or 19% greater than previous year.
Gross margin for this segment was $25.2 million, a 16% increase over last year's first quarter, and gross margin as a percent of revenues was 64%, down from 65% in the prior year's quarter.
Had we not had that international sales increase for the segment, the gross margin would have been approximately the 65% that we saw last year.
Contribution margin of $19.8 million for the segment was 4.3 million or 27% greater than prior year.
This increase was driven by the sales increase, combined with lower advertising and promotional spend in the quarter.
The decrease in advertising and promotion spending was driven by a later start for this year's advertising and promotion campaign for the Clear Eyes brand compared to last year and that was due to the timing of new product introductions this year, which came in a little bit later than last year.
Household products net revenues of $30.1 million in the first quarter were 7.3 million or 32% greater than last year.
Gross margin of $11.9 million was 2.5 million greater than the prior year as a result of the sales increase.
Gross margin as a percent of revenues was 40% in the current fiscal quarter compared to 41% in the prior year's quarter.
Contribution margin for the quarter of $10.3 million was 34% greater than last year, resulting from the gross margin increase discussed above, combined with advertising and promotion spending, which was flat with last year's spending.
And finally, net revenues of $6.2 million for the personal care segment were $1 million or 14% below last year.
Gross margin of $2.5 million was $800,000 less than the prior year, primarily due to the sales shortfall.
Contribution margin was $2.2 million, $300,000 below last year as the gross margin decline was partially offset by a reduction in advertising and promotion expenditures of $500,000.
G&A expense of $6.4 million was 1.5 million higher than the prior year's expense of 4.9 million.
As Peter mentioned earlier, this G&A expense for this year included an accrual for the expense related to the recent management change.
Excluding that charge, the G&A increase was driven by increased compensation expenses related to positions added during the second half of fiscal year 2006.
Our free cash flow for the quarter, which we define as operating cash flow less capital expenditures, was substantially greater than net income.
Driven by our long-term tax shield, a substantial improvement in working capital, our relatively low capital expenditures, free cash flow for the quarter was $21.2 million.
During the June quarter the company paid down the $7 million under our revolver that remained from borrowings used to fund the Chore Boy and Dental Concepts acquisitions in November of 2005.
The full revolver balance of $60 million is currently available.
At June 30th the company's cash on hand was $21.5 million, accounts receivable was 34.3 million, inventory was reduced to 31.4 million, our accounts payable balance was 18.1 million and accrued expenses were 15.3 million.
Total debt at June 30th was $491 million.
And now Peter will speak about upcoming initiatives.
Peter Mann - Chairman, President and CEO
Okay.
Before we take your questions I want to spend a few minutes and look ahead, both for the balance of this fiscal year and a bit beyond.
As we look for the balance of the year, we believe that Prestige has considerable momentum going into the summer months and into the fall.
Our consumer consumption trends are good, our acquisitions are performing almost exactly as we had planned, our factory shipments are very much in line with consumption and, as we'll talk in a second, we have a strong pipeline of initiatives planned for the balance of the year.
So, as we look forward, we have continued confidence in our outlook for the balance of the year.
First, we expect the items that we've introduced over the past few months to continue to gain distribution and then to benefit from increased consumer advertising.
Those include Clear Eyes Triple Action, Murine Homeopathic, Dermoplast Poison Ivy, Little Remedies for Colic, Comet Cream and Comet Lavender Powder; all are expected to have a favorable impact in the months ahead.
As I mentioned a little while ago, our important Chloraseptic brand is now in the midst of its preseason sales effort.
This year we're launching five new items, all designed to broaden the appeal and the usage of this well-known and highly trusted brand.
The lineup of new items includes two new sore throat lozenges, both of which are sugar-free to give consumers further choice in this important segment of our business.
We're adding one additional lozenge item, this one combining proven Chloraseptic sore throat relief with a cough suppressant because many, many consumers suffer from both maladies at the same time.
And rounding out our Strips line, we are introducing two new Chloraseptic Defense Strips.
These items are a great new way to take vitamin C and zinc daily.
There's absolutely nothing like them.
It's still early in the season and it's early in the process, but we are pleased so far with the acceptance and reaction from our retail customers to these new items.
If you go to the stores you'll begin to see Cutex is on the shelf with a totally new and distinctive packaging look, which consumers across the country tell us makes the brand really stand out from what is our biggest competition, private label.
We just re-launched Comet Cream in a brand new upside down inverted bottle, which makes usage easier and gives the whole package a new and more modern look.
And distribution is an important element of our plans for the future as well and we think there's real reason for optimism there.
A couple of examples -- right at the start of the quarter, Spic and Span Antibacterial Spray went into distribution in more than 2,000 Wal-Mart stores and is already selling quite well in those stores.
This item combines a good consumer value with the awareness and the trust that only Spic and Span can bring.
We're steadily adding new distribution for our recent acquisitions, Chore Boy and Dental Concepts, and we are also expanding both the number of warehouse clubs and the size of the product that they sell for Comet.
And we continue to see growth internationally, coming both from established markets as well as new geographies like Central and South America, the Philippines and the Middle East.
Beginning in July, Prestige began to benefit from the second licensing agreement with Procter & Gamble.
You'll recall our announcement a couple of months ago that we had licensed the Comet name to Procter & Gamble for most of Eastern Europe.
This time the new agreement covers both the Comet and Spic and Span trademark for Procter & Gamble's use in the North American institutional markets.
While this is not going to be as large a benefit to us as was and is the Eastern European arrangement, but nevertheless it's expected to deliver incremental revenue with very little incremental expense.
And finally, there is our pipeline of new items which we haven't yet launched to our retail customers.
As you know, it's our policy not to discuss the specifics of new items until they are actually introduced, but Prestige has a history of regularly launching new items under our existing brand names and we expect the balance of this year to be no different.
So, now looking forward a bit more broadly.
As you may know or as you do know, Prestige has a policy of not providing specific guidance either annually or by quarter.
However, going back I want to remind you that at the start of this fiscal year we told you several things.
First, we said that the long-term objective of the company is to grow organic revenues an average of 3 to 4% annually and we said that acquisitions, if they were made, would be incremental to that revenue growth.
We also advised that during fiscal 2007, the year that we've just begun, we expect revenues to grow considerably faster than the 3 to 4% rate, driven in large part by a full year of sales of the Chore Boy and Dental Concepts acquisitions.
Over the long term we have said that earnings will grow somewhat faster than revenue, thanks to the benefits of de-leveraging combined with what we see as some modest operating margin improvement.
But we also said that during the current fiscal year, net income growth would lag revenue growth as a result of cost related margin pressure and increased infrastructure costs that Pete's covered before.
So, as we look ahead, we continue to feel confident in both the short and the long-term outlook.
While the add-on benefits of the current acquisitions will end during the third fiscal quarter, the organic strength of the business is good and there's still a lot of dry powder left in our plan.
Before we close, I can imagine many of you may be wondering, well, how's the search for a new CEO going?
Well, we're still in the early stages but the board has already engaged a search firm who in turn has begun to identify candidates.
We've said that the process could take as long as six months, but the real answer is it's going to take as long as we need to find the right person to fill this important position.
So, in summary, we're pleased with the results of the quarter.
We're optimistic about the plans which will unfold in the months ahead, and we continue to have a high level of confidence in the vision and the strategy for Prestige Brands.
And with that, we'd be happy to take your questions.
Operator
[OPERATOR INSTRUCTIONS]
And our first question comes from the line of Bill Chappell from SunTrust.
Please proceed.
Bill Chappell - Analyst
Good morning.
Peter Mann - Chairman, President and CEO
Morning, Bill.
Bill Chappell - Analyst
I guess first a couple of questions on the personal care business.
What's the outlook for that business now?
It looks like with the advertising budget from this quarter versus a year ago was cut in more -- by more than half.
Is it just leave those businesses alone altogether or does that hurt your chances of selling that down the road if you're not supporting the brands at all?
Peter Mann - Chairman, President and CEO
Bill, the reduction of A&P expense this quarter in the personal care segment is almost entirely related to Cutex, which is a summer seasonal brand.
We've carefully evaluated the impact of Cutex advertising and concluded that our dollars weren't well spent there.
We've moved quite a few of those dollars into trade promotional activity, which actually doesn't show up in the A&P line, it shows up as a reduction of sales.
But we're continuing to support Cutex to the trade.
As I said, we've just launched important new packaging and so we are very much not walking away from that business at all.
And we want to make certain that if we do decide to make a strategic change that we still have a viable, healthy, strong business.
Bill Chappell - Analyst
Okay.
And I guess the second question, you don't give quarterly guidance, is there any way you can give us kind of a gauge of the timing for the new product launches of this year just to better understand the flow of A&P?
Peter Mann - Chairman, President and CEO
The thing that Pete referred to when he was talking about the delay of A&P is really related largely to our eye care business.
Last year we introduced some new items in the [inaudible] March period.
As a result, they were on the shelf during April, May and June and we supported them with increased advertising [inaudible] during that period.
The new items that we're introducing this year, which is primarily Clear Eyes Triple Action and Murine Homeopathic line, we started those launches in March and April.
They're now getting to retail, getting good, broad distribution and advertising for them will start this quarter.
It is very much our plan and our intention that A&P support over the course of the year will be at the same level, excluding personal care, at the same level as it's been historically and perhaps as a percent of sales and perhaps ratchet it up even a slight bit.
Bill Chappell - Analyst
Okay.
And then just a couple of housekeeping.
It looks like inventories certainly the growth was up only a fraction of sales.
Was there anything going on there in terms of just fine-tuning inventory levels?
Pete Anderson - CFO
Bill, we've said over the last couple of quarters that inventory levels definitely were higher than we -- than we wanted and liked.
And that was due in large part to last year's disappointing Compound W sales.
So we've been actively attempting to get the inventory levels back down to where they should be.
We made great strides in the first quarter and certainly are going to continue to look to bring them down somewhat in the upcoming quarters.
Months of supply on hand, our target is 2.4 months.
We were at 2.9 at the end of March and we brought it down to 2.6 at the end of June, so the plan is to continue to get down to that 2.4 months level.
Bill Chappell - Analyst
But it doesn't look like you had any real impact from inventory de-stock at retailers.
Pete Anderson - CFO
Oh, no, no, no, I'm sorry;
I thought you were talking about our inventory.
Peter Mann - Chairman, President and CEO
No...
Bill Chappell - Analyst
I mean, no, I was, but I was also -- it also doesn't look like you had any backup.
Peter Mann - Chairman, President and CEO
No.
Pete Anderson - CFO
No, our shipments are generally very much in line with consumer [consumption].
The only case where that wasn't true during the quarter of note was Little Remedies where our consumption continued to be strong but our -- we worked off some higher levels of retail inventory in Little Remedies in the cough/cold segment of that line.
Bill Chappell - Analyst
Okay.
And finally, can you give us the amount of the charge for the CEO departure?
Peter Mann - Chairman, President and CEO
I...
Bill Chappell - Analyst
That was reflected in G&A?
Pete Anderson - CFO
If you were to look at the contract that's publicly filed when [Frank] came onboard, you could ascertain what the charge is.
Bill Chappell - Analyst
Okay, I'll go back and look at that.
Peter Mann - Chairman, President and CEO
Tax [affected] it was about a penny.
Bill Chappell - Analyst
Thanks so much.
Operator
And our next question comes from the line of Lori Scherwin from Goldman Sachs.
Please proceed.
Lori Scherwin - Analyst
Hi.
Peter Mann - Chairman, President and CEO
Hi.
Pete Anderson - CFO
Good morning.
Lori Scherwin - Analyst
Can you talk a little more about the international?
If I heard you correctly, it sounds like the growth there contributed 2 points to your overall sales growth, but then it also sounded like most of that came from OTC and that surprised me.
I would have thought that most of that would have come from Comet because of the P&G arrangement.
So can you maybe talk about what you're seeing on the Comet side?
But then also on OTC, if that was a big driver, what's really driving that, is that specific brands or countries, and your outlook there.
Peter Mann - Chairman, President and CEO
It's hard to give you a short answer to that because it is -- our international growth is made up of a variety of, if you will, relatively small individual successes.
You are right; the [inaudible] Procter & Gamble yielded a piece of revenue, which you can see is other revenue in the income statement, which wasn't there a year before.
But there is also strong growth in our other OTCs where we basically, excluding our eye care business, essentially in the year ago we had no business and this year we had almost $0.75 million worth of other OTC coming from a variety of markets scattered through the Middle East, Latin America, Africa and the Pacific Rim, and then also our eye care business, which is our most well established business internationally, grew more than 50%, driven in large part by consumption increases in the markets in which we sell them, for example only Australia, New Zealand, Hong Kong and so on.
So it's a number of relatively small individual pieces contributing to make a meaningful overall international growth.
Lori Scherwin - Analyst
And I guess to go from nothing to $750,000, did you change your strategy or how you're operating?
Did you -- ?
Peter Mann - Chairman, President and CEO
No, as we've told you, I think fairly consistently, the part of the problem -- or not problem, but part of the process of selling OTCs internationally is to get the formulas registered with the various local health authorities, like the Food and Drug Administration.
Those registrations are now starting to come on line, which is enabling us to have distributors who can actually buy the product and start to sell it in their countries.
And that's the process that's now starting to yield fruit.
Lori Scherwin - Analyst
So conceivably, if international added 2 points to your sales growth this quarter, that could accelerate as registrations pick up?
Peter Mann - Chairman, President and CEO
We're certainly working hard to make that happen.
It's an unpredictable process that some governments, some registration processes are highly bureaucratic, others are less so, but we think that's certainly our objective is to make that part of our business grow more rapidly than our U.S. part of the business.
Lori Scherwin - Analyst
Okay.
And then on the A&P, in your opening comment you mentioned that there were some efficiencies on some brands and I guess I'm just curious what exactly you were doing there.
There are a lot of companies in this space now talking about this and I'm wondering if you have a new program in place to evaluate this or it just happened by chance that you found it, if you're reallocating the money and if there could be future savings to come?
Peter Mann - Chairman, President and CEO
Again, that's a sum of a lot of small decisions.
We've been very, I think, careful to go through our A&P budgets and to not run programs -- most brands of most companies have many small programs that are almost at the whim of product managers and so on, that ultimately it's very hard to evaluate, to measure any impact.
And so we've tried to prune those back and to place the savings partly into increased profit and partly into higher levels of the support TV and print advertising that we know works.
Lori Scherwin - Analyst
Okay, thank you.
Operator
And our next question comes from the line of Alexis Gold from UBS.
Please proceed.
Alexis Gold - Analyst
Hi.
Good morning.
Peter Mann - Chairman, President and CEO
Morning, Alexis.
Pete Anderson - CFO
Hi.
Alexis Gold - Analyst
You spent a lot of time speaking about the international business.
Can you give us a sense for what your target is in terms of international, just what size in terms of revenue you want that international business to be longer term?
Peter Mann - Chairman, President and CEO
We don't really have a goal, Alexis.
When the company went public a year and a half ago we were doing less than 2% of our revenues outside of North America.
We have a well-developed business in Canada.
And as we looked at companies in our basic industry, we see that they do anywhere from 20 to 50% of their revenues outside of North America and we recognized that that represents a very significant potential for us.
So we're not going to get to 20% of our revenues in the next year or two or three probably, but we're working hard to broaden where we go.
Our model, international model is to do it at low risk, low infrastructure cost, so we use distributors.
It seems to be going reasonably well.
We are getting our products registered.
One of the pleasant surprises is starting to be that the Comet brand, which was really not a place that we thought would be a driver of international growth, has a reasonably high level of awareness in number of international markets that we didn't suspect and so we may see some nice benefit from Comet internationally as well.
Alexis Gold - Analyst
That's helpful.
And just to go back to some of the growth we're seeing in Compound W and Spic and Span, domestically I guess, I think you're up against actually fairly tough comps in Compound W and Spic and Span.
If I remember correctly, they were actually up last year first quarter. [inaudible] been out there for a couple of years.
Can you give us a sense for what's really driving that up?
Is there -- were there any promotion -- I know A&P was down, but were there any specific promotions that you ran during the quarter?
Peter Mann - Chairman, President and CEO
On Compound W?
Alexis Gold - Analyst
Yes, and Spic and Span.
Peter Mann - Chairman, President and CEO
On Spic and Span, that's the simpler answer; first, there was nothing particularly unusual that's driving it.
It is the sum of continued good consumption on the base business, added distribution on new items, increased number of stores that Wal-Mart is stocking Spic and Span in, and you'll start to see in the upcoming quarters the benefit of a major new item, Spic and Span item in Wal-Mart, which is the Spic and Span Antibacterial Spray, which, as I said, went into distribution just at the start of the current quarter and is now starting to generate nice weekly point of sale movement.
So Spic and Span is pretty straightforward story.
Compound W, as you may recall, a year ago we had a very disappointing quarter on Compound W, largely driven by a disappointment in the Compound W Freeze Off item, as the sales of both our cryosurgical wart freezing product, Freeze Off, and others plateaued and actually declined after a strong growth the prior year.
We're now measuring against that more stable base and we saw growth across the Compound W line both in consumption and, in fact, factory revenues.
Alexis Gold - Analyst
Okay.
And I guess just you talked about product mix and the impact on your gross margins.
Can you just talk a little bit about raw materials, distribution costs, the utility costs and how that's impacting your margins?
Peter Mann - Chairman, President and CEO
Sure.
I'll let Pete -- I'll let Pete chime in.
The biggest single place where we are still seeing -- where we're experiencing real cost driving is in household and its in delivery costs, where delivery costs, meaning freight from our warehouse to our customers, where the delivery cost could be as high as 10% of sales at household products and that's where the cost of fuel is impacting us meaningfully.
We are also seeing, as everybody in the world is, gradual increase in the cost of raw materials, gradual increase in the cost of packaging components.
We work very hard to keep those down and under control.
We work -- we do that by finding alternate suppliers, alternate vendors, and we've been generally successful in holding those costs reasonably in check.
We have been taking pricing action on a selective item-by-item, brand-by-brand basis.
We took price increases effective April 1st across items that represent about a third of our OTC line.
And so the gross margin pressures in household are driven mostly by freight.
There is some raw material there.
The gross margin increases in OTC are driven by what Pete described, because of our international selling model, it is inherently a lower gross margin but no A&P support, and then very minor cost upward put pressure on the raw material and packaging there.
Alexis Gold - Analyst
And those price increases that you took, can you quantify those for us, what percentage?
Peter Mann - Chairman, President and CEO
It's averaged 4 to 5% across about a third of our OTC line.
Pete Anderson - CFO
Alexis, if you look at the 8% organic sales growth that we had in the first quarter, about 1% of that was price, 7% was units.
Peter Mann - Chairman, President and CEO
When we -- the price increase that I referred to effective April 1st, it takes a while for that price to actually work its way through all customers.
There is an inherent resistance, obviously, to price increases and it takes a few months for us to be shipping all of our customers at that higher price.
Alexis Gold - Analyst
But your -- all your customers have accepted the price increases?
Those are effective?
Peter Mann - Chairman, President and CEO
I wouldn't want to say all because I'm sure there's an exception or two to it, but most have, yes.
Alexis Gold - Analyst
All right.
Great, thanks very much.
Operator
And our next question comes from the line of Reza Vahabzadeh from Lehman Brothers.
Please proceed.
Reza Vahabzadeh - Analyst
Good morning.
Peter Mann - Chairman, President and CEO
Good morning.
Pete Anderson - CFO
Hi, Reza.
Reza Vahabzadeh - Analyst
You got some free cash flow to be generated in this company this year given your cash taxes being pretty minimal.
What could be the priorities for the deployment of that free cash flow?
Peter Mann - Chairman, President and CEO
The priorities are that if a good acquisition presents itself that we think would be a good strategic addition to the company, we would use the free cash flow to fund that acquisition.
Failing that, the priority would be to pay down debt.
Reza Vahabzadeh - Analyst
Okay.
And then how would you characterize the potential target environment for targets that would be amenable to your criteria?
Peter Mann - Chairman, President and CEO
Acquisition targets?
Reza Vahabzadeh - Analyst
Yes.
Peter Mann - Chairman, President and CEO
Well, there continues to be a good steady stream of potential acquisitions.
We are evaluating a number routinely.
And we've been successful historically in making one or two acquisitions in a 12-month period and there's no fundamental reason to think that that won't happen over the foreseeable future.
But we're also not going to force an acquisition just to make a deal.
Reza Vahabzadeh - Analyst
Would you anticipate these acquisitions to be of the same size as the recent [vintage] of Little Remedies and Chore Boy and so forth?
Peter Mann - Chairman, President and CEO
They could be that size or larger.
Reza Vahabzadeh - Analyst
Okay.
And your maximum leverage tolerance, has that changed much and where is it?
Peter Mann - Chairman, President and CEO
We're now levered somewhere in the 3 or 4 range if you -- that's debt to EBITDA if you take the full year's value of the acquisitions we made in the fall.
And we would be comfortable pushing that up towards 5 to make an acquisition provided that that acquisition had the same cash generating capabilities as the rest of the company.
Reza Vahabzadeh - Analyst
Right.
And you didn't mention share repurchases as a potential use of free cash flow.
Is that still not, I guess, a top two or three priority for you?
Peter Mann - Chairman, President and CEO
Well, we would start to think about it if we were able to, but our loan covenants preclude any share buybacks until our debt to EBITDA ratio is below 3.5.
Reza Vahabzadeh - Analyst
What about the [inaudible]?
Where are you as far as the [RP] basket in the [inaudible]?
Do you recall offhand?
Peter Mann - Chairman, President and CEO
I do not.
Reza Vahabzadeh - Analyst
Okay.
And then if you could comment on A&P spending outlook for the year?
This quarter obviously was down, partly due to timing.
What would be the right level for the whole of the year, taking into account all the timing fluctuations?
Peter Mann - Chairman, President and CEO
We've said that our A&P spending as a percent of net sales should be relatively consistent year to year.
Reza Vahabzadeh - Analyst
Got it.
Thank you much.
Operator
And our next question comes from the line of Joe Altobello from CIBC World Markets.
Please proceed.
Joe Altobello - Analyst
Thanks.
Good morning, guys.
Peter Mann - Chairman, President and CEO
Hi, Joe.
Pete Anderson - CFO
Hi.
Joe Altobello - Analyst
Just want to go back to the pricing question for one second.
Obviously you guys took pricing early in the June quarter.
Are there opportunities to take additional pricing in household products down the line or have you guys done it essentially at this point?
Peter Mann - Chairman, President and CEO
We review pricing carefully every quarter and we look for opportunities to take selective price increase on an item-by-item basis.
And we think there will be opportunities on both sides of the business, on the OTC and on the household side.
As competitive, now this is speculation, Joe, but as competitive pressures mount on brands against which Comet and against which Spic and Span compete, we think our competitors are facing the same issues that we are and so price increases will be likely, we think.
The timing of that is highly unpredictable.
Pete Anderson - CFO
However, there are not additional price increases taking place this quarter that we're in right now.
Joe Altobello - Analyst
Okay.
And it seems like there wasn't much in the way of an impact on volumes from the price increases you took in OTC.
Pete Anderson - CFO
No, we haven't seen any decrease in people ordering or anything.
Joe Altobello - Analyst
Okay.
And then in terms of gross margin, it seems like the first quarter was probably your toughest comp year-over-year in terms of margin.
I would imagine for the rest of the year the margin pressure would be less year-over-year in terms of any gross margin decline.
Is that a fair assessment?
Pete Anderson - CFO
I mean as always, I think the wildcard, Joe, is going to be where does oil go?
I mean, as Peter has said, the unfortunate thing for not only us but for everybody is that the fuel surcharges hit you immediately.
So whereas we may want to take a price increase, we've got to give the trade generally three months to implement.
If oil goes up, the freight surcharge happens a day later.
So you don't know.
Peter Mann - Chairman, President and CEO
And Joe, do keep in mind the thing we talked about on the international business, that that business is now 4% of sales, has a significantly less good gross margin but the brand contribution level, because there's no A&P spending, sort of by definition the brand contribution is at or above the rate of the U.S. business.
Joe Altobello - Analyst
Right, okay.
And then finally in the SG&A line, was there a step-up in the FAS123R expense in the quarter year-over-year?
Pete Anderson - CFO
No, there wasn't.
If you recall, last year was a -- we didn't -- there was a small increase but last year we didn't have anything in the first quarter.
Joe Altobello - Analyst
Right.
Pete Anderson - CFO
This quarter was not big at all.
As we go through the remainder of the year, though, we're going to get into round two, if you will, of restricted stock primarily, and actually -- so you'll see ramping up as we go through the year, not huge, but a gradually increasing amount.
Joe Altobello - Analyst
Under $1 a quarter?
Pete Anderson - CFO
Oh, yes, definitely.
Peter Mann - Chairman, President and CEO
Oh, yes.
Joe Altobello - Analyst
Okay.
Pete Anderson - CFO
Way under.
Joe Altobello - Analyst
[inaudible], all right.
Thanks guys.
Operator
And our next question comes from the line of [Eric Larson] from Piper Jaffray.
Please proceed.
Eric Larson - Analyst
Good morning, everyone.
Peter Mann - Chairman, President and CEO
Hey, Eric.
Pete Anderson - CFO
Hi, Eric.
Eric Larson - Analyst
A quick question going back to Cutex.
Obviously you shifted some of your -- or you claimed you shifted some of your advertising into promotion, would suggest that either your price points may be out of line or that there's pricing pressure on the private label side.
Is that a fair assessment?
Peter Mann - Chairman, President and CEO
It's absolutely true.
That's really not a change in that private label has always been the primary competition for Cutex, Cutex is far and away the leading brand, and we've been trying for years, we have for years advertised Cutex either on TV or in women's service books and we've ultimately concluded that the advertising behind Cutex simply wasn't moving the needle enough.
And so we've put money, the money that we saved in direct to consumer advertising into traded promotional, a little bit into packaging.
In fact, the new package that's appearing is slightly more expensive.
We think it is a sharp upgrade and really makes the brand stand out on the shelf vis a vis private label.
Eric Larson - Analyst
Okay, so that could be a sustainable strategy going forward?
Peter Mann - Chairman, President and CEO
Yes.
I mean Cutex is -- the consumer trends are reasonably good and we think will improve going forward.
Eric Larson - Analyst
Okay.
Then just a question on Compound W. Obviously your comparison was very easy versus a year ago.
Has the size of the category shrunk or how would you view the category at this point?
Peter Mann - Chairman, President and CEO
The size of the category contracted last year and the category is now as we had hoped or expected is now experiencing modest growth.
Eric Larson - Analyst
Okay.
And then maybe a final question for Pete Anderson.
Give us a rough number on what acquisition revenue will be to your full year number for '07?
Pete Anderson - CFO
For Chore Boy and Dental Concepts?
Eric Larson - Analyst
Yes, the combination of the two.
Peter Mann - Chairman, President and CEO
Just under...
Pete Anderson - CFO
30 million.
Peter Mann - Chairman, President and CEO
A little bit under $30 million.
Eric Larson - Analyst
Just under 30 million.
And that would be -- and that contribution ends at the end of Q3?
Peter Mann - Chairman, President and CEO
You mean the year-over-year...
Eric Larson - Analyst
Yes.
Peter Mann - Chairman, President and CEO
...versus -- it phases out during Q3.
Pete Anderson - CFO
Yes, because we purchased them in -- one at the very tail end of October and Dental Concepts in the middle of November, so there was a little bit of -- a little bit of revenue last year in Q3.
Eric Larson - Analyst
Okay, good.
And I just missed this.
What was the percent increase in your price increase in the OTC segment?
You may have stated that already, I missed this.
Pete Anderson - CFO
It was 4 to 5% on items representing about a third of the volume.
Eric Larson - Analyst
In OTC?
Pete Anderson - CFO
In -- a third of the OTC volume, right.
Eric Larson - Analyst
Got you.
Thank you.
Operator
Our next question comes from the line of Chris Ferrara from Merrill Lynch.
Please proceed.
Chris Ferrara - Analyst
Hey, guys.
Peter Mann - Chairman, President and CEO
Hey, Chris.
Pete Anderson - CFO
Hi, Chris.
Chris Ferrara - Analyst
I just wanted to go back and just get a little more detail on the A&P advertising shift and I'm sorry for making you repeat yourself, but can you just explain a little bit more I guess?
I know you're saying the personal care stuff was cut down and it's probably not coming back to the same order of magnitude, but was it just the Clear Eyes and Murine launch that you guys are sort of bucking up for in the back half of the year?
Peter Mann - Chairman, President and CEO
That's the primary driver of it.
The Clear Eyes and -- for the quarter, Clear Eyes and Murine A&P spending this year, I don't have the number right in front of me, Chris, but was down versus last year because we spent heavily behind the earlier launches last year.
Chris Ferrara - Analyst
And you're saying that accounts for a large majority outside of personal care decline of the A&P decline this quarter?
Peter Mann - Chairman, President and CEO
Correct.
Chris Ferrara - Analyst
Got it.
And then I just wanted to ask about shelf space gains and can you just provide a little bit of a review of where you think you're under-indexed in certain brands and obviously you're getting shelf space gain, a lot of them seem to be coming in the club channel.
Are you still -- do you still consider yourselves under-indexed there and what room for improvement is there going forward and is there anything sort of imminent or that you're working on?
Peter Mann - Chairman, President and CEO
There is definitely room for improvement in warehouse clubs, particularly for Comet and Comet Powder and Comet Spray.
We do not have universal distribution in all warehouse clubs on Comet Powder and that represents a meaningful upside because each warehouse club, each door is significant volume for Comet.
Comet Bathroom Spray is a leading bathroom spray, particularly in Wal-Mart, but also in food.
And we have very limited warehouse club distribution on Comet Spray so that represents a significant upside.
Our OTC line is a -- in candor, a harder sell into the warehouse clubs because they carry a much more limited selection and you have to be the number one item.
And if you think about it, multi-packs of Compound W don't make so much sense for warehouse clubs.
But we still nevertheless are pushing away at that.
We have gotten some distribution of Clear Eyes in warehouse clubs and we're working hard on that.
We're also -- other doors that are potential opportunities are dollar stores for our OTC line.
We have good distribution for our household line, but dollar stores for Chloraseptic and Clear Eyes represent opportunities and we have real opportunities in getting more items into the traditional food and drug outlets where right now, for example, most retailers carry Spic and Span [dilutable], but they are not yet carrying the Spic and Span Antibacterial Spray that's selling so well at Wal-Mart.
So that represents an opportunity and that's day-to-day bread and butter stuff for us.
We work hard at that every day.
Chris Ferrara - Analyst
Got it.
And then just finally, since this is the first conference call sort of post this event, can you just give a little color or give your take on what happened with Frank and what the deal was, I guess, sort of with the timing of the departure so quickly after his appointment to CEO?
Peter Mann - Chairman, President and CEO
You know, Chris, that's almost become an old news for us now that the board made the conclusion that it was not a good fit and we moved on.
And that's actually all I want to say on that.
Chris Ferrara - Analyst
Got it.
Thanks.
Operator
And our final question comes from the line of Howard Choe from Standard & Poor's.
Please proceed.
Howard Choe - Analyst
Yes, good morning.
I just had two questions.
Can you tell us whether the operating margin for your international business is below the corporate average?
Peter Mann - Chairman, President and CEO
No, it's at or slightly above.
Howard Choe - Analyst
At or above, okay.
And also, regarding the Chloraseptic Defense Strips, are you the first to market with this type of product?
Peter Mann - Chairman, President and CEO
As far as we know, we're the first to market in the strip form, that's right.
Howard Choe - Analyst
Okay.
And how easy do you think it would be for competitors to copy this sort of product?
Pete Anderson - CFO
Oh, I don't know.
I mean I couldn't tell you that they won't, but it'll take some time for them.
Howard Choe - Analyst
Okay, thank you.
Operator
And at this time I would like to turn the call back over to Mr. Peter Mann for closing remarks.
Please proceed, sir.
Peter Mann - Chairman, President and CEO
Okay, thanks, everybody, for joining us.
We appreciate your involvement in the call, your questions, and we look forward to talking to you again in three months.
Thank you.
Operator
Thank you for your participation in today's conference.
This concludes the presentation.
You may now disconnect.
Have a wonderful day.