The Procter & Gamble Company (PG) F2Q 2014 Earnings Conference Call October 25, 2013 8:30 AM ET
Jon Moeller - CFO
John Chevalier - IR
Chris Ferrara - Wells Fargo
John Faucher - JPMorgan
Dara Mohsenian - Morgan Stanley
Wendy Nicholson - Citigroup
Bill Schmitz - Deutsche Bank
Lauren Lieberman - Barclays
Olivia Tong - Bank of America
Nik Modi - RBC Capital Markets
Ali Dibadj - Bernstein
Jason English - Goldman Sachs
Connie Maneaty - BMO Capital Markets
Javier Escalante - Consumer Edge Research
Joe Altobello - Oppenheimer
Bill Chappell - SunTrust Robinson Humphrey
Alice Longley - Buckingham Research
Mark Astrachan - Stifel Nicolaus
Caroline Levy - CLSA
Leigh Ferst - Wellington Shields
[Operator instructions.] Welcome to Procter & Gamble's quarter-end conference call. Today's discussion will include a number of forward-looking statements. If you will refer to P&G's most recent 10-K, 10-Q, and 8-K reports, you will see a discussion of factors that could cause the company's actual results to differ materially from these projections.
As required by Regulation G, P&G needs to make you aware that during the call, the company will make a number of references to non-GAAP and other financial measures. Management believes these measures provide investors valuable information on the underlying growth trends of the business.
“Organic” refers to reported results excluding the impacts of acquisitions and divestitures and foreign exchange, where applicable. Free cash flow represents operating cash flow less capital expenditures. Free cash flow productivity is the ratio of adjusted free cash flow to net earnings.
Any measure described as “core” refers to the equivalent GAAP measure, adjusted for certain items. P&G has posted on its website, www.pg.com, a full reconciliation of non-GAAP and other financial measures.
Now, I will turn the call over to P&G’s Chief Financial Officer Jon Moeller.
Good morning. Our October-December results came in pretty much as we had expected, keeping us on track to deliver our fiscal objectives. All-in sales were up modestly versus the prior year, including a 3-point headwind from foreign exchange. Organic sales grew at 3%. Organic sales were in line or ahead of year ago in each reporting segment.
Coupled with 4% growth in the first quarter, this leaves us on track to deliver 3% to 4% organic sales growth for the fiscal year. Sales growth was driven by organic volume growth of 3%. Organic volume was ahead of a year ago in each of our reporting segments. Pricing added 1 point to sales growth and mix reduced sales growth by 1 point.
Consistent with the reported market growth and market share data you’ve seen, October and November were relatively soft months for our categories and for P&G. December, on the other hand, was a relatively strong month for us. December organic volume growth was over 5%, with each sector growing at or above 4%. Organic sales were up mid-single digits.
December quarter all-in GAAP earnings per share were $1.18, core earnings per share were $1.21, which leaves us on track with our plans to deliver 5% to 7% core earnings per share growth for the fiscal year. Earnings for all segments were ahead of a year ago, except for baby, feminine, and family care, due to foreign exchange.
Foreign exchange was an $0.11 per share headwind for the company in the quarter. The year ago period also included a $0.07 per share gain from the sale of our bleach business in Italy. Combined, these two items constitute a 15% core earnings per share growth headwind for the quarter.
Core operating margin was about equal to last year, down 10 basis points. Organic sales growth leverage and 230 basis points of cost of goods overhead and marketing savings were offset by foreign exchange and negative mix. Core gross margin was down 90%. Cost savings of 130 basis points and volume leverage were offset by geographic and category mix of 130 basis points, foreign exchange of 90 basis points, higher commodity costs, and higher manufacturing startup costs.
Core SG&A improved 80 basis points, driven by 100 basis points of marketing and overhead productivity savings. These benefits were partially offset by foreign exchange imps and targeted innovation and go-to-market investments.
The effective tax rate on core earnings was 21.5%. This included a positive 1 point impact from the release of a tax reserve following a favorable outcome in Asia. This reserve reversal accounted for roughly $0.02 of earnings per share benefit on the quarter.
The net impact from all of the items below operating income, tax, interest expense, interest income, non-operating income, and supply chain, was a slight headwind to core earnings per share growth for the quarter. We generated $2.4 billion in free cash flow and remain on track to deliver free cash flow productivity of about 90% for the fiscal year.
As planned, we returned $1.7 billion of cash to shareholders in dividends, and we repurchased $1.5 billion in stock, bringing year to date share repurchase to $4 billion. Net, the second quarter came in pretty much as we were expecting, on both the top and bottom lines, leaving us on track to deliver our sales and earnings forecast for the fiscal year.
As we move forward, value creation for consumers and share owners remains our top priority. Operating TSR is our primary business performance measure. Operating TSR is an integrated measure of value creation at the business unit level, requiring sales growth, progress on gross and operating margin, and strong cash flow productivity.
Operating TSR drives focus on core brands and businesses, our leading, most profitable categories, and leading, most profitable markets. We’ll begin to make more operating TSR progress as we move into calendar 2014.
Our strongest brands and business units and total company positions are in the United States. We need to continue to ensure our home market stays strong, and is growing. The actions we’ve taken over the past two years to restore consumer value, expand our vertical product portfolios and horizontal regimens, and lead innovation have enabled us to restore value creating share growth in many parts of the business.
We still have more work to do in a few categories, and the competitive environment is intense, which leads to choppy results on a quarter to quarter basis, but we’re making good progress. We have a stronger brand and product innovation program ahead of us in the U.S. this quarter.
We continue to grow and expand our business in developing markets, with a focus on the categories and countries with the largest sizes of prize and the highest likelihood of winning. This is where the world’s baby’s will be born, and where more new households will be formed. Developing markets will continue to be a significant growth driver for our company this year and for years to come. In October/December, organic sales grew 8% in developing markets.
We’ll continue to focus the company’s portfolio, allocating resources to businesses where we can create value. We’ll continue to exit businesses where we determine that potential buyers with different capability sets can create more value than ourselves.
Consistent with our focus on operating TSR, we’re continuing to push forward with our productivity and cost savings efforts. We’ve made solid progress over the last fiscal year and a half. We have strong productivity plans for fiscal 2014, and we’re working to accelerate some fiscal 2015 savings into 2014.
Versus a target run rate of $1.2 billion, we’re now forecasting more than $1.6 billion of cost of good productivity savings this fiscal year, across materials, logistics, and manufacturing expense. This is up $200 million since our last update. Versus a going-in target of 5%, we expect to improve manufacturing productivity by at least 6% this year. We’re up more than 8% fiscal year to date.
We’ve now exceeded our 2014 fiscal year non-manufacturing enrollment reduction goals, only 6 months into the year, and have begun work to accelerate role reductions planned for fiscal 2015 into 2014. Our strict objective is to get substantially to our end of 2015 objectives by the end of 2014. This would put us close to, or within, the 16-22% reduction goal we’ve established, 1 to 2 years ahead of target
And we won’t stop there. We continue to identify opportunities to simplify and streamline our organization design. We continue to drive marketing productivity and effectiveness through an optimized media mix, with more digital, mobile, and social presence, improved message clarity, and greater non-advertising marketing efficiencies.
We expect absolute marketing spending to come in slightly above prior year levels, but marketing as a percentage of sales to decline. Importantly, the overall effectiveness and impact of our marketing spending will be well ahead of the prior year.
We see several more years of effectiveness improvement ahead, driven by new, more efficient digital and social mobile media and big opportunities to continue to improve the efficiency, precision, and effectiveness of our communication.
We remain committed to making productivity a core strength and a sustainable competitive advantage. We’re equally committed to being the product and commercial innovation leader in our industry.
We’re currently bringing significant innovation to market in fabric care, including upgrades on all of our Tide Plus value-added liquid detergents; new extra-large tub sizes on Tide Pods; Gain Flings, a triple-chamber, single-load laundry pack providing Gain consumers with enhanced scent, better freshness, and more cleaning power, all with the convenience of a single-load form; scent upgrades on Downy Unstoppables and Gain Fireworks in Wash Scent Beads; Tide Oxy, a multipurpose stain remover that can be used in the laundry or around the house; and Tide Simply Clean and Fresh laundry detergent, specifically designed with the right level of cleaning and freshness for mid-price-tier consumers.
We’ve received strong retailer support for these innovations, overdelivering our distribution, shelving, and initial merchandising objectives for the launch. The Arial unit [dose] innovation in Western Europe is tracking well above expectations. We’re continuing the expansion, launching in Italy, Iberia, and the Balkans earlier this month. Consumption trends on Tide Pods have remained strong, growing in the low teens fiscal year to date versus the prior year.
We’re also launching a very strong oral care innovation bundle next month, including Crest 3D White Brilliance, delivering our most advanced whitening and freshness benefits in one toothpaste; Crest 3D White Luxe, which removes up to 90% of tooth stains in five days, and with our new White Lock technology, locks out future stains and microfine lines in the teeth; Crest 3D White Luxe White Strips, with new Flexfit Film, an innovation created with technology from our baby care business, that stretches and molds for a custom fit for more whitening coverage; our new Crest Sensor Relief Innovation, which delivers improved sensitivity relief, combined with Scope freshness; and Crest B, a new line for experiential consumers, including flavors like B Dynamic, Lime Spearmint Zest, B Inspired, Vanilla Mint Spark, and B Adventurous Mint Chocolate Trek.
In North America, our recent baby care absorbency, comfort, and design innovations are driving diaper market share growth. U.S. diaper share is up 1.5 points versus prior year, with particular strength on the Pampers, Swaddlers, and Luvs product lines, retaking market share and leadership for the first time in many years.
We continue to strengthen our share position in the U.S. batter business behind the Quantum innovation and recent distribution increases. P&G batter value share is up 2.5 points for the past three months, to over 40%.
In December, we started shipping Pantene in North America, with improved product performance and packaging. The shampoo and conditioner formulas contain a new Pro-V antioxidant complex, delivering clinically proven healthier hair with every wash.
We’re also leveraging Pantene’s Shine Strong advertising that has received global acclaim for tackling gender labels and encouraging women to show their strength and shine. The advertisement has generated nearly 1 billion consumer impressions globally.
We’re expanding Old Spice into the rapidly growing North American male hair care segment behind a full array of shampoos, conditioners, and styling products, with Old Spice’s most popular scent collections. This started shipping last week. Old Spice Body Spray is growing strongly behind the new Smellcome to Manhood commercial campaign. To date, the campaign has generated over 700 million consumer impressions, the vast majority of which have been free, through social media and mass media coverage.
Duracell’s Trust Your Power advertisement has also gained high awareness online. It features Derek Coleman, the only legally deaf player in the NFL, and the barriers he’s overcome by trusting his inner power. The U.S. advertisement has driven over 1.7 billion consumer impressions in just two weeks, since it was launched on January 10.
We recently launched our new commercial campaign for the Winter Olympics. The commercial program includes a balanced combination of single brand and multibrand executions. Our research shows stronger purchase intent is generated when individual brand executions are closely coupled with the multibrand execution. The Olympics ad campaign had generated nearly 1.6 billion consumer impressions so far, and like Old Spice and Duracell, most of these are earned or free impressions generated through traditional and social media.
These product and commercial innovations should contribute to strong top line momentum in the back half which, combined with productivity savings, should enable us to deliver our fiscal year objectives. Next, we’re improving execution and operating discipline. We simply have to execute better, more consistently and more reliably. We need everyone playing their position and playing it well.
Consistent with the customer service improvements we discussed last quarter, we were recently named the top rated manufacturer in China, our second largest market, as rated by our retail partners and both the Advantage Group and Kantar Retail surveys. These surveys reflect the quality of our customer business development organization, promotion plans, and customer service reliability.
Last, we’re making strategic investments in innovation and go-to-market capabilities. Targeted R&D investments are enabling us to strengthen our near and midterm innovation pipeline. Targeted go-to-market investments will enable us to strengthen sales coverage in our fastest-growing markets and fastest-growing channels.
We believe that the focus that we’re bringing to these four areas: operating TSR, productivity, innovation, operational excellence, along with targeted reinvestment, will enable us to continue to improve results, even as we work to address several remaining opportunities. We remain on track to deliver our 2014 guidance, top line, bottom line, and cash.
We’re maintaining our organic sales growth range of 3% to 4%. Achieving organic sales growth in the upper half of our target range should result in modest overall market share growth. Foreign exchange is expected to be a sales growth headwind of 2 points, which leads to all-in sales growth in the range of 1% to 2% for the fiscal year.
We’re maintaining our forecast for bottom line core earnings per share growth of 5% to 7%, despite stronger headwinds from foreign exchange and softer market growth rates. We aim to make up the difference through productivity advances, which will primarily benefit the fourth quarter.
The fiscal year headwind from foreign exchange has continued to increase. We now expect foreign exchange to be a 7-point headwind to core earnings per share growth. As a result, our guidance now translates to constant currency core earnings per share growth in the range of 12% to 14%.
We now expect the tax rate on core earnings to be a point or so below prior year levels. On an all-in GAAP basis, we expect earnings per share to grow approximately 7% to 9%. This range reflects somewhat lower noncore restructuring costs in fiscal 2014 versus the prior year.
The second half earnings growth increase that’s implied within our guidance is driven by foreign exchange and cost structure improvement. Foreign exchange was a significant headwind in the first half but will moderate in the second half at recent spot rates. We’ll also annualize the operating impacts from last year’s Venezuelan bolivar devaluation.
Manufacturing startup costs will annualize in the second half of fiscal 2014. Productivity savings and devaluation related price increases will build sequentially. As you prepare your estimates for Q3 and Q4, please keep in mind a couple of items.
We won’t annualize the Venezuela impact until mid-February in Q3. We’ll had a full quarter of laundry and oral care innovation impacts in Q4. Productivity savings that are being advanced to offset stronger FX impacts and lower market growth will primarily benefit the fourth quarter. Also, pricing that we’ll be taking to offset recent devaluations in some markets will take effect only in Q4.
We expect another year of about 90% free cash flow productivity. Our plans assume capital spending in the range of 4% to 5% of sales and share repurchase in the range of $5 billion to $7 billion.
In addition to the assumptions included in our guidance, we want to continue to be very transparent about some key items that are not included. The guidance we’re reconfirming today is based on last week’s FX spot rates. Further currency weakness is not anticipated within our guidance range.
We continue to monitor unrest in Egypt, which is a large business for us and a base of export for the balance of Africa, as well as unrest in economic instability in the Ukraine, though the situation has recently improved. Venezuelan price controls, access to dollars for imported products, and devaluation present risk, as do import restrictions, price controls, and devaluation on Argentina.
Finally, our guidance assumes no further degradation in market growth rates. Our first half results were in line with what we expected, putting us on track to deliver our goals for the fiscal year and make progress towards our long term growth objectives. We continue to operate in a volatile environment, with uncertainty in foreign exchange, some deceleration in market growth rates, and a rapidly developing policy environment.
Against this backdrop, we’ve maintained top line growth and improved constant currency operating earnings growth. We have an even stronger innovation program in the back half of the year and savings from productivity improvements that will build. We’re making targeted investments in our core businesses, most promising developing markets, and biggest innovation opportunities, and are aggressively driving productivity and cost savings.
Above all, we remain focused on value creation for consumers and for our share owners. That concludes our prepared remarks. As a reminder, business segment information is provided in our press release and will be available on slides, which we posted on our website, www.pg.com following the call.
Our next significant investor event ahead of A.G. Lafley is the Cagney conference on February 20. We hope to see many of you there. I’d be happy now to take your questions.
Earnings Call Part 2: