The Procter & Gamble Company (PG) F4Q 2013 Earnings Conference Call August 1, 2013 8:30 AM ET
A.G. Lafley - Chairman of the Board, President and Chief Executive Officer
Jon Moeller - Chief Financial Officer
Teri List-Stoll - Senior Vice President and Treasurer
John Faucher – JPMorgan
Bill Schmitz – Deutsche Bank Securities
Lauren Lieberman – Barclays
Dara Mohsenian – Morgan Stanley
Wendy Nicholson – Citi
Jason English - Goldman Sachs
Ali Dibadj - Bernstein
Joe Altobello - Oppenheimer
Connie Maneaty – BMO Capital Markets
Javier Escalante - Consumer Edge Research
Olivia Tong – Bank of America - Merrill Lynch
Michael Stieb – Credit Suisse
Good morning and 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. Adjusted free cash flow represents operating cash flow less capital expenditures and adjusted for after tax impact of major divestitures. Adjusted free cash flow productivity is the ratio of adjusted free cash flow to net earnings, excluding divestiture gains. 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.
Thanks, and good morning everyone. I am joined this morning by A.G. Lafley and Teri List-Stoll. I will start our discussion with a review of our fourth quarter and fiscal 2013 results. A.G. will discuss our key strategies and focus areas going forward and I will then wrap up with guidance for fiscal 2014.
Fourth quarter organic sales results were at the high end of our forecast range with core earnings per share slightly ahead of plan. Organic sales were up 4%. Importantly, this sales growth was underpinned by strong organic volume growth of 5% and was achieved during a period in which underlying market growth rates were decelerating. Pricing was neutral to organic sales growth and mix reduced sales growth by 1 point. Foreign exchange lowered sales growth by 2 points resulting in all-in sales growth of 2%.
P&G global value share was around 20% for the March to May period, roughly in line with the prior year. Market share improved sequentially throughout the quarter. In May, the last period for which we currently have global share data, volume share increased 0.4 points versus prior year with growth in all regions except Central and Eastern Europe, Middle East and Africa. On a mixed adjusted basis, May global value share was up 0.2 points. In the U.S where we have data through June, mix adjusted value share was up 0.3 points. We held or grew global market share in businesses representing nearly 60% of sales in the March to May period. In the U.S, we held or grew value share in businesses representing over 70% of sales.
Moving to the bottom line, core earnings per share were $0.79, $0.02 above the high end of our guidance range due to cost savings and a $0.01 help in tax. Core earnings per share was down 4% versus the prior year as the benefits from top of range organic sales growth and strong cost savings were more than offset by mix, higher marketing spending and a $0.06 per share or roughly 7 percentage points earnings per share growth headwind from foreign exchange rate. All-in earnings per share were $0.64. This includes a $0.02 non-core impact from restructuring costs, a $0.04 non-core impact from legal items in Europe and a $0.10 non-core, non-cash impact of a further impairment of intangible assets related to the Brown business, reflecting the 20% devaluation of the currency in Japan where Brown earns the majority of its profits.
Core operating profit margin declined 130 basis points as core gross margin was down 90 basis points and core SG&A cost increased 40 basis points. Operating margin was about 50 basis points less than we had originally anticipated due largely to foreign exchange. The core effective tax rate for the quarter was 22.3%, in line with last year. We generated 2.8 billion of free cash flow in the quarter, repurchased $1 billion in stock and returned $1.7 billion of cash to shareholders in dividends.
Turning to the fiscal year, we met our commitments on each key measure. Organic sales growth was 3%, in the mid-point of our initial guidance range of 2% to 4%. We grew core earnings per share of 5% above our initial minus 1% to plus 4% guidance range. We absorbed the unexpected impact of the Venezuela Bolívar devaluation and significant overall dollar strengthening, while increasing marketing investments as the year progressed. We continued to make good progress on our productivity plans. Through June we reduced non-manufacturing enrollment by 7,000 roles. This is 1,300 role reductions ahead of our initial enrollment reduction target for June 30, 2013. We delivered over $1.2 billion in cost of goods sold savings and approved manufacturing productivity by 7% versus the target of 5%.
Our progress on working capital and capital spending productivity enabled us to deliver 98% adjusted free cash flow productivity, ahead of our 90% target. We returned $12.5 billion to shareholders, 110% of net earnings through a combination of $6.5 billion in dividends and $6 billion in share repurchase. In April we raised the dividend by 7%. We’re beginning to restore growth in the core U.S. Market that represents over a third of P&G sales and an even greater percentage of profit. U.S. Fourth quarter organic sales grew at 7% on a volume growth of 5%.
We maintained good developing market momentum. Organic sales growth in our top 10 developing markets was up 8% in the fiscal year. We grew profit meaningfully ahead of sales in developing market while increasing investments in these markets year-on-year. We stabilized global market share and ended the year with modest market share growth. We are moving in the right direction, but there is more work to do.
To talk us through that, I’ll turn the call over to A.G.
Thanks, Jon. We’ve spent a lot of time doing a deep dive over the past two months, making sure we fully understand our reality, ensuring we see things as they are, not as we want them to be. We’ve gotten grounded in the realities of our consumers and markets. I’ve personally dialoged with customer, partners and suppliers. We've listened to a range of outside advisors, critics, as well as fans. We’ve taken a hard look at business strategies, reviewed budgets and business plans and dug deeply into innovation programs and productivity initiatives. We know we are not winning, like we know we can, and we are committed to make the changes we know we need to make to improve P&G's performance significantly. First, we will establish value creation. First and foremost for consumers, but also importantly for share owners as our clear priority. Operating TSR will be our primary business performance measure. Operating TSR is an integrated measure of value creation at the business unit level, requiring sales growth, progress on growth and operating margins and strong cash flow productivity.
We focused on business unit value creation because we are determined to have more P&G business units deliver more operating TSR more consistently. We will we guided by disciplined strategies and operating plans. We will focus strategically on core businesses, our leading, most profitable categories in brands and leading most profitable market channels and customers. Delivering consistently strong results in our core business is the largest contributor to shareholder value creation, an important contributor to growth and an important enabler of investments in developing markets and innovation.
Many of our strongest business units and total company positions are in the U.S. we need to ensure P&G's home market stays strong and growing. We will focus developing market investments on the categories and countries with the largest size of the prize and the highest likelihood of winning. Developing markets driven by demographics and household income growth will continue to be a significant growth driver for the company. We will continue to focus the company's portfolio, allocating resources to businesses where we can create disproportionate value and continuing to exit those where we cannot.
Second, we will strengthen and accelerate productivity and cost savings. Productivity and innovation are the primary drivers of growth in value creation. Productivity is particularly important in a slower growth world and in an environment of increased volatility in foreign exchange, commodity and interest rate markets. And the more productivity means more opportunities to invest in core business in developing markets, expansion and in innovation. Here is what we are doing specifically with P&G's productivity initiative. We will deliver the productivity program we promised, on or ahead of schedule. But that is not an end-point for productivity improvement. It's just the next milestone along our productivity journey. We know we can do more.
We are already mobilized to address the next round of productivity initiatives. We are working these significant opportunities in parallel, not sequentially. They cover a full range of cost and cash opportunities. Projects are being led by business unit and function leaders. They are being worked on short cycles. Some are yielding savings as we speak, others will take years to fully implement. We have opportunities to further localize supply chains in developing markets reducing cost and improving customer service.
In developed markets we are taking a blank sheet of paper look at supply chains, designing from the consumer and customer back. We are studying options that would reduce the number of facilities, build scale across categories and reduce cost and inventory, all while improving customer responsiveness and service. This will require investment but will generate very attractive returns. That’s a huge opportunity. We will redesign and strengthen our go-to-market operations in North America and Europe to be more effective and efficient.
In Europe, we will look to scale operations across larger and fewer country clusters. We will evaluate organization design options to improve effectiveness and efficiency in developing markets. We will further reduce the size of support staff and move from fully dedicated functional support organizations to a more productive hybrid of dedicated and (inaudible) work resources and shared services. We will improve marketing ROI, driven by an optimized mix of advertizing media, greater clarity of communication and messaging and greater efficiency in non-advertising marketing spending.
The key point to understand today is that we are committed to making productivity a core strength for P&G, like branding or innovation and with innovation, a second big driver of operating TSR and value creation. It has to for P&G to deliver leading value creation and growth. Productivity will become systemic, not episodic. We will continuously improve our effectiveness and efficiency. We'll measure productivity. We'll recognize it and we'll reward it. Third, we will improve our operating discipline. We simply have to execute better, more consistently and more reliably every day, everywhere to win with consumers and win with customers. Execution is the only strategy they ever see. Winning with consumers and winning with customers day-in and day-out is what it takes to generate leadership returns in our industry and that's what we've committed to do.
Fourth, we will reallocate some of our savings to make strategic investments in a very focused way in innovation and go-to-market capabilities. These are two of the company's core strengths and two important sources of competitive advantage. They are critical to winning the first and second moments of truth with consumers. We will build on the past year, but we will be more focused. We’ll commercialize brand and product innovations with excellence. We’ll prioritize productivity initiatives, significantly simplifying and streamlining how we work together and we will bring a sense of urgency to realizing hard savings. We'll focus on best in class execution and we'll continue to invest selectively where needed to win.
I’m confident that P&G has what it takes to win with consumers, with customers and for all of our shareholders. We have a strong brand portfolio with 25 category leading billion dollar brands and 15 more between $0.5 billion and $1 billion in annual sales. We have leading brand equities in most of our categories. We have consumer preferred products in a majority of our brand product lines. We have a well-balanced geographic portfolio. We have the leading CPG business from the U.S, the largest and fastest growing developed market and we have the leading household and personal care business in developing market. Both are significant sources of value creation opportunities. We have an innovation portfolio and pipeline that will only get stronger. We have an exciting portfolio of productivity initiatives we're working hard.
We have outstanding people. The productivity and organization design changes we are making are freeing up P&G-ers to fully leverage their creativity and initiative, their skills and capabilities. They are passionate about the consumers they serve and about their businesses. They are committed to win. They are our most important asset, a critical source of strength and ultimately competitive advantage for this company. We've taken a hard look at what we need to do, how we need to change to perform better. More business units have to deliver more consistently. We're committed to do what it takes to get P&G back to balance, consistency, reliability and sustainability in the creation of value for consumers and customers and value for shareholders and employees. It takes time to work out of a tough patch. We take encouragement from the progress we've made in the year just closed, but we are focused on the future and we are determined to deliver industry leading value creation.
Thanks A.G. As we said we would at the Deutsche Bank conference in June A.G, Terry, John and I have spent some time reviewing our guidance framework. We've talked to shareholders and analysts as we've done this work and we’ve looked at a number of benchmarking studies. The preponderance of feedbacks we've received supports the decision we’ve made to focus our guidance on the fiscal year, which we’ll update quarterly. This approach is the norm in our industry. We believe it provides a better match between our guidance timeframe, the long-term view we take while managing the business and the investment time horizon of many of our shareholders.
We've also reviewed long-term guidance targets. We continue to believe that the right organic sales growth target is one that is modestly above the rate of market growth. At current market growth rates we see high single digit bottom-line growth as a right objective. We believe these targets will allow the company to strike the right balance between long-term investments in growth, flexibility to respond to macro and competitive challenges, and delivery of consistent, dependable results in our value creation goals. With that let me move to guidance for the fiscal year.
Fiscal 2014 presents several challenges and opportunities, headwinds include weaker underlying market growth, a much stronger dollar, higher commodity costs and a highly competitive operating environment. Opportunities include positive market share momentum, a number of promising innovations and savings from productivity improvements. We're currently forecasting organic sales growth of 3% to 4% which is better than last year at 3% and compares to expected market growth rates of about 3% to 4%. Foreign exchange is expected to be a sales growth headwind of about 2 points which leads to all-in sales growth in the range of 1% to 2% for fiscal 2014.
Moving to the bottom line, our current forecast is for core earnings per share growth of 5% to 7%. Equal to prior year growth at the low-end of the range and within our long-term annual growth target range at the high-end. This core earnings per share guidance includes a 6 point impact from foreign exchange. We expect the effective tax rate on core earnings to be in line with prior year levels. Our plans include another year of strong productivity improvement. We have line of sight to $1.4 billion in cost of goods sold savings in fiscal 2014, including manufacturing and productivity improvements of around 6%. As I said earlier, we exceeded our overhead enrollment reduction targets by 1,300 roles as of the end of June, giving us a nice head start on the 2% to 4% reduction we were planning for fiscal 2014. We will deliver this and accelerate fiscal '15 reductions in to fiscal '14.
We expect marketing spending to increase in absolute dollars but decrease modestly as a percentage of sales as we continue to drive higher ROI. On an all-in GAAP adjusted basis, we expect earnings per share to grow approximately 7% to 9%. This range reflects somewhat lower non-core restructuring cost in fiscal year 2014 versus the prior year. We continue to operate in a volatile environment with uncertainty in the foreign exchange and commodity markets, decelerated market growth rates and a rapidly developing policy environment. Our guidance is based on mid-July foreign exchange spot rates, further strengthening of the dollar or significant devaluations, for example in Venezuela, are not built into our forecast.
As we described last quarter, one particular risk not included in our all-in earnings guidance is the potential impact from the revaluation of Venezuelan bolivars, earmarked for foreign currency transactions through the new (inaudible) auction rate market. At this time there is no official information available on details or plan frequency of the new auction process or the underlying rates. So far we've measured all our Venezuela exposures at the official exchange rates of 6.3 bolivars to the U.S. dollar. If it becomes clear as the auction rate market forms, that it will operate in a liquid and transparent matter at a different rate, we may need to adjust our balance sheet which will result in additional non-core impact on earnings. We'll keep you updated on this as we learn more.
Major changes in market growth rates or significantly adverse policy changes are also not assumed within our guidance range. Absent these or other unanticipated events, we believe our core earnings per share guidance range is realistic and balanced. It reflects the headwinds we're facing, the investments we'll be making, and the strong cost savings progress we are committed to deliver. If you think about earnings progress throughout the year, there are several headwinds that will impact first half earnings growth that will dissipate or disappear in the second half. For example, foreign exchange will be a significant headwind in the first half but should moderate in the second half.
We'll continue to have relatively high spending and manufacturing startup costs, but this will largely annualize in the second half of fiscal 2014. We will annualize the operating impacts of the Venezuelan bolivar devaluation in the second half. Stepped up marketing support levels will also annualize and productivity savings will build throughout the year. Last, the first half comparison includes the onetime gain from the Western European bleach business in the base period. With all of these factors considered, core earnings per share growth will likely be down modestly in Q1 with slight improvement in Q2. Second half earnings will be much stronger. We expect to deliver another year of about 90% free cash flow productivity. Our plans assume capital spending in the range of 4% to 5% of sale and share repurchase in the range of $5 billion to $7 billion, continuing to deliver on our commitment of cash return to shareholders.
In closing, our primary objective for fiscal 2014 is to continue to build on the momentum we’ve created, making this year another stepping stone back to our long-term growth objectives. Our plans are even more focused and even more balanced. We will make choiceful investments in our core business, most promising developing markets and biggest innovation opportunities and we will aggressively drive productivity and cost savings. Above all we'll remain focused on value creation for consumers, for customers and for our shareholders.
That concludes our prepared remarks. As a remainder, business segment information is provided in our press release and will be available on slides which will be posted on our website www.pg.com following the call. A.G, Terry and I would now be happy to take your questions.
Earnings Call Part 2: