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Colgate-Palmolive Company (NYSE:CL)

Q2 2009 Earnings Call Transcript

July 30, 2009 11:00 am ET

Executives

Bina Thompson - VP, IR

Ian Cook - Chairman, President and CEO

Analysts

Bill Chappell - Suntrust Robinson Humphrey

Bill Schmitz - Deutsche Bank

Ali Dibadj - Sanford Bernstein

Wendy Nicholson - Citi

Chris Ferrara - Merrill Lynch

Joe Altobello - Oppenheimer

Andrew Sawyer - Goldman Sachs

John Faucher - J.P. Morgan

Lauren Lieberman - Barclays

Jason Gere - RBC Capital Markets

Linda Weiser - Caris

Alec Patterson - RCM

Connie Maneaty - BMO Capital Markets

Nik Modi - UBS

Victoria Collin - Atlantic Equities

Alice Longley - Buckingham Research

Operator

Good day, everyone. And welcome to today’s Colgate-Palmolive Company second quarter 2009 earnings conference call. Today’s call is being recorded and is being simulcast live at www.colgate.com. Just as a reminder, there may be a slight delay before the question-and-answer session begins, due to the Web simulcast.

At this time, for opening remarks, I would like to turn the conference over to the Vice President of Investor Relations, Ms. Bina Thompson. Please go ahead, ma’am.

Bina Thompson

Thank you, Sharla, and good morning. And welcome to our second quarter earnings release conference call. With me this morning are Ian Cook, Chairman, President, and CEO; Steve Patrick, CFO; Dennis Hickey, Corporate Controller; and, Ed Filusch, Treasurer.

This conference call will include forward-looking statements. And these statements are made on the basis of our views and assumptions as of this time, and are not guarantees of future performance. Actual events or results may differ materially from these statements. For information about certain factors that could cause such differences, investors should consult our annual report on Form 10-K filed with the Securities and Exchange Commission and available on our Web site, including the information set forth under the captions, “Risk Factors and Cautionary Statement on Forward-Looking Statements.”

We will discuss organic sales growth, which is sales excluding the impact of foreign exchange, acquisitions, and divestitures. And we will also discuss our results and expectations, excluding charges relating to the 2004 restructuring program, which was completed last year.

A full reconciliation of these measures with their corresponding GAAP measures is included in the press release and the company's financial statements, and is posted on the Investor Relations page of our website at www.colgate.com. We'll be glad to answer any questions you may have including or excluding these items, as you wish.

We are pleased with our strong results in the second quarter. Of particular note is our outstanding progress in gross margin, excellent bottom line performance, and continued healthy organic sales growth. As you know, building gross margin momentum is a critical part of our financial strategy, as is having the appropriate balance between pricing and volume.

As you've seen, we have been able to successfully implement price increases through last year and into the first half of this year. With the easing of raw material costs increases and what appears to be a stabilization of currency movement, we feel pricing is where it should be and would expect to shift the focus back more to volume as we move through the rest of the year. And you will hear, as we go through the divisions, about some specific initiatives we have in place to generate volume growth.

One important driver volume is advertising. As we stated on our previous call, advertising in the second quarter increased from first quarter levels. And we expect that to continue in the third and the fourth quarter as well. And as we also have previously discussed, this will be a combination of media and our increasing focus on effective in-store activities. We plan to fund that advertising through gross margin increases and overhead costs control.

And as you’ve seen, those things are happening and to continue to happen to the balance of the year. Gross margin increases are expected to be at least at second quarter levels in the third and fourth quarter. Now it's important to note that our funding the growth program continues to deliver excellent savings and we expect to see similar benefits in the second half of the year. This gives us further confidence in our ability to increase gross margin.

In short, our financial strategy, which you know very well, is working. Our market shares in key countries around the world are increasing and our pipeline of innovation is as full as it has ever been with value added offerings at every price point.

Now I'd just like to spend a moment on volume. As you saw in our geographic sales analysis attached to the press release, volumes for our Colgate businesses was positive in the quarter. Volume increases for our Colgate businesses should improve through the balance of the year. And more importantly, we expect Hill’s volume to improve substantially and we will review that in more detail when we discuss the Hill’s business.

Not only do we have strong profitability, our balance sheet is strong as well, including our key financial ratios, which are moving in the right direction. The second quarter delivered another quarter of strong cash generation. Our working capital declined year-over-year, and our return-on-capital reached 36.5%, up from 32.7% in the first six months of 2008.

So let's turn to the division starting with North America, and we're delighted to see that the North American business is healthy with good volume growth, organic sales growth and market share growth. In fact, in the US alone, volume increased 3.5% with organic sales growing 4%. Further more in the US, consumption is strong, up almost 5% on a volume basis. Our growth is outpacing category growth, which is reflected in good market share increases. In the quarter, our share were stable or up in 11 of 14 categories.

New products, obviously, are critical to our success. One of our newest innovations, Colgate Wisp, a disposable mini brush, is also a good start with strong market shares as referenced in the press release. Importantly, early trial and repeat numbers are ahead of the norm for the toothbrush category. Early display support was excellent and consumer communication included a wide variety of touch points, including terrific publicity, with the product being featured on the Today Show and other televisions shows.

In the liquid hand soap category, our first quarter launch of Softsoap ensemble continues to contribute to share growth. Our overall liquid hand soap market share in the second quarter, as measured by Nielsen, was up two full points year-over-year.

We have a number of additional new products scheduled for the second half of the year. One is a new line of body wash called Softsoap Nutri Serums. In facial products, Nourishing Rich Serums are known for effectively delivering soft, health looking skin. Nutri Serums is an infused with softening serum pearls, Omega 3 and 6, and vitamin E delivering serum benefits in the body wash.

In the toothpaste category, we will be launching Colgate Total Enamel Strength. As you know, Colgate Total is the number recommended toothpaste by dentists and the hygienists in the US and the only toothpaste approved by the FDA for fighting gingivitis. Since its launch in 1997, with the steady stream of innovations, Colgate Total now has about 15% of the market. This latest variant capitalizes on the significant professional interests in enamel care as well as the threat to tooth enamel posed by acidic fruits and beverages in the modern diet. Colgate Total Enamel Strength is formulated to strengthen tooth enamel and clean gently while providing all the benefits of Colgate Total. Shipment starts next month.

All these activities goes well for continued momentum in North America and looking ahead, volume in North America is expected to increase mid-single-digit to the third quarter and full year with organic sales growing at similar levels. Operating profit is expected to increase double-digit to the third quarter and full year as well of absolutely and as a percent to sales

Turning now then to Europe-South Pacific, Europe remains the most challenging region over a macro economic perspective. With GDP growth rate declining in most of Western Europe and relatively flat in the South Pacific. Despite that, our market shares are holding a new product activity is robust.

In toothpaste, as in the US, we are following a strategy of building a family of variance under the Colgate Total franchise, which continues to drive share following the original Colgate Total and then Colgate Plus Whitening. Earlier this year we launched Colgate Total Advanced Clean. In the second quarter, we launched Colgate Total Advanced Sensitive as a complimentary offering to both Colgate Total Advanced Clean.

In toothbrushes, we launched Colgate Max White, starting late in the first quarter and it is now rolled out across to division with very early results. Activities in-store which showcased the Colgate Max range with both the toothbrush and toothpaste has been particularly successful in driving share.

Our new product pipeline for the second half of the year is even fuller than the first. In fact we expect sales from the new products in the second half to be about double the sales of the new products in the first half. And we expect advertising spending to also increase in support of this launches. This should help deliver improved volume.

So looking ahead at the balance of the year, we expect volume to the third quarter to be up modestly and down slightly for the full year with similar organic sales performance. Operating profit is expected to be flat to third quarter and down modestly for the full year.

Turning then to Latin America, our business in Latin America continues to be strong, maintained double-digit organic sales, increase pricing and excellent profit growth. Although Latin America is not completely immune from the global economic crisis, our strong market position is combined with the portfolio products across all price points have allowed this region to continue to deliver very good results.

And as referenced in the press release, our regional toothpaste market share continues to increase. Interestingly enough, our premium price value added Colgate Total gained two share points here to-date with increases into virtually every market, a testament to the fact that even in the challenging economic times the consumer is willing to pay for superior product performance.

Our toothpaste share in Mexico is at 85.4 year-to-date even with a year ago high levels with the most recently at 85.8. Our year-to-date record toothbrush share in the region of 41.6% widens our lead to over 9 points. In 2006 we were close to parry with our nearest competitor. In Mexico our share increased almost 4 full points over 40% on a year-to-date basis. Enhanced in-store activities with a compelling merchandising helped to achieve these results.

In Columbia, increase focus on the pharmacy channel helped to increase our toothbrush share by 2.3 points to almost 45%. As you know we happened to be making renewed efforts on mouthwash in market outside North America. Across Latin America, we increase our market share almost 4 points versus a year ago with gains in virtually every market.

Other categories where we increased our market share across the region include bar soap, shampoo, dishwashing liquid and liquid cleaners. So looking ahead, we expect the volume in Latin America to grow mid single digit to the third quarter and full year with organic sale continuing to grow double digit for both periods. Operating profit is expected to grow at least high single digit to the third quarter and full year up absolutely and as a percent to sales.

Turning to Greater Asia-Africa, the modest decline in volume in this region was largely due to weakening market conditions in South Africa, Russia, and Ukraine. South Africa was also impacted by our first quarter volume has the price increases implemented in the second quarter. Greater Asia alone increased volume modestly. And importantly the renewed momentum in China we saw in the first quarter continued with volume increasing mid single digit in the second quarter. India also continued to be strong with another quarter of double digit volume growth.

And elsewhere new products played a critical role in driving volume and market share across the region. In toothpaste, our leadership market share increased in eight of 12 markets. Our share in China increased to 31.6 up 110 basis points versus the prior year. In India our share increased 220 basis points to 50.3%. In Russia our share was up 80 basis points to 34.3%. Premium priced products such as Colgate Total and Colgate Max Fresh as well as value priced products such as Colgate White and Colgate Triple Action contributed to this impressive share gains.

We continue to enjoy leadership across the region in manual toothbrushes as well. In India our share was up 40 basis points to 37.6% driven by momentum and the base business as well as new products such as Colgate Extra Clean Gum Care. And in Russia our share was up to another record of 51.8% up to 260 basis points from a year ago. We told you last quarter about our successful launch of Colgate Plax mouthwash in Thailand building on this success we've launched it in other markets including China, Russia, the Philippines, and Malaysia and have built share in all these markets.

We're very encouraged by the resiliency of the consumer in countries such India and China which is reflected in the health of this businesses. In addition, macroeconomic factors in Russia seemed to be improving which goes well for the balance of the year.

Still looking ahead we expect volume in greater Asia Africa to be at modestly to third quarter and full year with organic sales growing high single to double digit. Operating profit is expected to grow double digit to the third quarter and full year up absolutely and to percentage sales.

And finally, Hill’s. Hill’s performance was somewhat good then expected on the top line. But operating profit increased nicely due to the higher pricing and our ongoing cost savings programs related to both gross margin and overhead expenses. As referenced in the press release, the volume decline was due primarily to forward buys in the prior year associated with July 1, 2008 price increases.

Importantly our shares remained relatively stable in the science diet business and are up year-to-date in May for the prescription diet business. This is in part due to the continued “Get A Better Life” weight loss challenge that continued in veterinary clinics until the second quarter. In the feline category Hill’s also continued the urinary health symposium which targets educational and case management communication to practicing veterinarians in key cities.

A number of new products were referenced in our press release. In the third quarter, we will be launching a new line of treats available in seven varieties, to address a wide range of special needs; oral care, mobility, bite, immunity, training, and skin and coat in both biscuit and jerky form.

And in addition, in the second half, we will be implementing more value building in-store activity as well as other pricing focused programs to drive volume. These will be funded by our increasing margin, generated by both price increases already taken, as well as a more benign raw material cost environment, and our ongoing funding the growth programs.

So looking ahead, volume of sales is expected to increase low, single digit in the third quarter and decrease modestly for the full year, with organic sales increasing mid to high single digit for the third quarter and full year. Operating profit is expected to increase mid single digit for the third quarter and full year.

So in summary, a solid quarter, particularly given the challenging macroeconomic times we all face. We’re particularly encouraged by the excellent gross margin increase, strong bottom line, and continued healthy organic sales growth. And as we have said, we’re encouraged by our prospects to the balance of the year both in the developed and emerging markets. Our focused financial strategy, is working well, and with a good line of innovative new products, we expect to continue to deliver good results. My apologies, I have a frog in my throat.

And now, Sharla, I’d like to open it up for questions and I’m going to turn it over to you.

Question-and-Answer Session

Operator

The question and answer session will be conducted electronically for the telephone audience (Operator instructions) We ask that you limit yourselves to one question. And if you would like to ask an additional question, please re-signal and place yourself back in the queue.

We also ask that if you are listening to the conference on the Internet, that you would please turn the volume on your computer before asking your question. (Operator instructions) We’ll have our first question from Bill Chappell with Suntrust.

Bill Chappell - Suntrust

Good morning.

Ian Cook

Good morning, Bill.

Bill Chappell - Suntrust

Could you talk a little bit about the gross margin trends as we look on a go forward basis? The 75 to 125 basis point guidance seems pretty conservative. Is there any reason why margins should go down sequentially over the next two quarters? Or is there something I’m missing?

Ian Cook

Good question, Bill. Let me just put it in a sort of slightly broader strategic context. As you know, and we had been saying for a while, we have been putting a great focus on trying to, A, offset of the dollar impacts of commodity costs and transaction; and then, B, move our gross margin back into positive territory year-on-year as a percentage to sales because that provides the ability to invest in business growth going forward. And obviously, we are delighted with the gross margin increase in the second quarter, slightly ahead of our original expectations.

As we look at that gross margin going forward, our plan right now would see it holding at about the same level as the second quarter, still allowing us to increase advertising support behind a strong pipeline of new products, both of the higher priced end and entry priced end and entry price end over the back half of the year. So for the balance of the year, an expectation that gross margin would be around the same level as the second quarter

Bill Chappell - Suntrust

Great. Thank you.

Ian Cook

Sure.

Operator

We’ll go next to Bill Schmitz with Deutsche Bank.

Bill Schmitz - Deutsche Bank

Good morning.

Ian Cook

Good morning, Bill.

Bill Schmitz - Deutsche Bank

How do we think about pricing going forward? I mean, I know a lot of it is to offset some of the currency transaction hit in developing markets. So you have the dollar softens, will you give that pricing back right away and probably see the volume resume? Or is there a little bit of lag in it? How does it work or how has that worked historically?

Ian Cook

Yes. Again, back to the strategy of recovering gross margin as the fulcrum of the income statement, we have taken the pricing we believe we have needed to take. Pricing, therefore, is at that level that we were targeting. And we have in our plan no new pricing for the balance of the year.

And as I was saying in response to the earlier question, with our innovation stream skewed to the second half, our focus now is on increasing advertising support behind that innovation stream, advertising in the traditional areas, and also as we head been saying for a while, advertising that is in-store, much of which is captured in the gross to net line, not in the traditional A to S line.

So I think what you’re going to see going forward is pricing established, no new pricing, and an increase in marketing support to resume volume growth in the second half.

Bill Schmitz - Deutsche Bank

Okay. So does that mean that the promotionals will probably get an increase? So like you said, maybe half of its advertising and half of its gross to net, which obviously, will sort of impact -- is that on a pricing line for you guys or in volume mix?

Ian Cook

It’s on price, Bill. It’s on price.

Bill Schmitz - Deutsche Bank

Okay. Got you. Okay. Perfect.

Operator

Well go next to Ali Dibadj with Sanford Bernstein.

Ali Dibadj - Sanford Bernstein

Hi. Thanks.

Ian Cook

Hey, Ali.

Ali Dibadj - Sanford Bernstein

How are you? Just want to get underneath a little bit of potentially disconnect. It sounds like you say you’re comfortable with roughly a 10% EPS growth that’s external. However, it sounds like foreign exchange or surely, foreign exchange has gotten better. Russia-China is improving, gross margins were higher this year -- this quarter and you expect that going forward.

So what’s worse? Where were you surprised by? And maybe if I can lead the answer essentially a little bit, its sounds like the price elasticity perhaps, is a little bit worse and so you have to spend more back on advertising and into promotion. Is that the surprise or is there something else?

Ian Cook

I wouldn’t caption it that way, Ali. But let me try and take the thrust of the question. Again, as I said, we started the year with a prudent stance, given the world we were facing then, and we put a focus on gross profit. And by the way, I would add, and as you’ve seen in the release and heard in Bina’s comments, while we have been recovering gross margin, the organic growth has been healthy, and we have seen our market shares, in other words, the general health of our brands improve, and the Colgate business, the traditional Colgate business has held flat volume wise for those two quarters. So that business, a slight readjustment with a step up in traditional A&P behind innovation with in-store marketing activity, that will include a component of price but not a complete change in strategy.

The Hill’s business warrants a separate comment. The Hill’s business as you saw, posted double digit volume decline in the second quarter, which was worse than our expectation. And as a few comments to make there, you know the three price increases that we have taken over a period about 15 months, the year-on-year comparison with the July increase last year.

But coming into the second quarter, things were cracking pretty much as we had expected. We always saw the uptake in that category go down to about a quarter when pricing was taken. And as I commented on the last call, we expected competitors to take price towards the end of the second quarter as they have not followed our first quarter increase so quickly. That didn’t happen. We saw people not taking pricing, and we saw people taking pricing on tops rather than all of their business.

And as the second quarter unfolded, we began to take pricing adjustment on the Hill’s business for the second half because our pricing versus other premium products that historically followed, that was becoming uncompetitive. Interestingly, the category stayed solid and we found ourselves losing to other premium products. It wasn’t that that segment was shifting to other channels.

So on the Hill’s business, what we see is very similar to the Colgate business and innovation stream, an increase in advertising in general. Certainly no pricing planned for the second half, but here, more selectively, pricing adjustment over the back half of the year in order to make sure that we realize our pricing strategy against competitions which we overshot a bit in the second quarter of this year. All of these, I would add, with a gross margin that has increased year-on-year. And even with that increase pricing activity and promotion activity in the back half will continue to be up year-on-year, so a sharper definition on Hill’s, Ali.

Ali Dibadj - Sanford Bernstein

This is very helpful answer. Are you seeing any of the competitive activity in Hill’s in the other businesses at all or not really?

Ian Cook

What it wasn’t competitive reaction, it was more--

Ali Dibadj - Sanford Bernstein

Inaction, I’d say.

Ian Cook

I’m sorry?

Ali Dibadj - Sanford Bernstein

Competitor perhaps, inaction.

Ian Cook

By separating the businesses, I guess the responses we have seen how competitive pricing strategy been maintained on the other businesses. Hill’s was the only call out.

Ali Dibadj - Sanford Bernstein

Thank you.

Operator

We’ll go next to Wendy Nicholson with Citi.

Wendy Nicholson - Citi

Hi. My first question had to do with Russia. I know you said your market shares were still strong, but you called that out as a particularly weak area. Do you think inventory adjustment at retail, or something just something wrong with the consumer?

Ian Cook

Yes. I’d love to categorize it as something wrong with the consumer. But I think Wendy, in answer to the question, you may recall on the last call we had together, we talked about the incredible currency slides in the Eastern European markets, which Russia head experienced before, you will remember at the end of the 90s. But many of the other Eastern European markets (inaudible).

So we found ourselves in a situation where in key Eastern European markets like Ukraine and indeed Russia again, we took significant pricing in the second quarter over 20%, and we felt the customary consumer reaction, which is they de-load entry while that pricing goes through and we fully expect that to come back in the third quarter. I guess the one editorial comment I would make, and I made it on the last full, is that the Eastern European consumer doesn’t adjust quiet as readily to Latin American price increases as the Latin consumer does, given their education over time.

But we don’t see any major dislocation. It certainly not de-stocking beyond some distributor adjustments we have made, which again, I mentioned in the last call. I think it’s more the lead lag between significant pricing increase and the consumer coming back to the market.

Wendy Nicholson - Citi

Okay. And the reason I asked on Russia is, you know P&G has talked a lot about increasing their emphasis in investment in emerging markets and I would assume Russia is one of their key areas of priority. And I know you hate answering that question about P&G, but so far any way, you haven’t seen anything from a competitive perspective, it sounds like your shares are off, and you’ve gotten by with not a lot more spending. So far, you don’t see anything from a destabilizing just a sort of category help or freeze the level of competitive promotion or anything like that?

Ian Cook

Let me just answer in the general rather than the specific. In many of the key emerging markets, I think Brazil, I think China, and I think Russia, to your point, we are in fact and have seen so far this year, some of the principal competitors in fact, pull back spending in our key categories. So our impression weight or share of voices, we call it, has in fact increased.

Wendy Nicholson - Citi

Terrific. Congratulations.

Operator

Next is Chris Ferrara with Merrill Lynch

Chris Ferrara - Merrill Lynch

Hey. Thanks. Ian can you talk a little bit about, I mean this is sort of a tired question, but as retailers try to consolidate shelves and you know, we know its happening, consolidate SKUs. What are you seeing in the US in oral care and specifically tooth paste, and I guess, if anything, as you relate two different things, first of all, you guys and Crest have a lot of different SKUs across toothpaste, right? And there is also a fair amount of tertiary brands that seem like big potentially be at risk.

So are you seeing anything, you seen any progress on shelves there with respect to even weeding out some of your slow-moving SKUs or you ordering some of those tertiary brands that aren’t own by you or Procter?

Ian Cook

Yes, Chris. Good question. And frankly over more essentially to these days, in another new subject we call as SKUs-year-on-year. Every time we go through a planogram research with any key retailer trying to make sure we have the right SKUs, power SKUs we call them, with the right velocity at the shelf. There’s no question over the last year and a half, the intensity on that space has increased. I will tell you that our relative shelf and assortment position in the US toothpaste business continues to be very, very strong.

And, as I say, we often delete SKUs ourselves, as we try and make sure we have the greatest velocity, so not seeing any significant impact in the US. But you’re right, it’s a very -- an area of great attention from retailers these days, but one we are accustomed to discussing and dealing with.

Chris Ferrara - Merrill Lynch

Great. Thank you.

Ian Cook

Sure.

Operator

We’ll go next to Joe Altobello with Oppenheimer.

Joe Altobello - Oppenheimer

Thanks. Good morning. Just two quick questions, first, going back to Hill’s for a second. You’ve obviously taken a lot of pricing there, you mentioned that -- have you guys lost distribution at all, particularly in North America? And by that, I mean have you essentially priced yourself out of certain smaller retailers? You just don’t want to pay that or whose consumers can’t afford that? And then secondly on the marketing side, you mentioned you expect marketing spend, both advertising and gross to net, to increase in the second half. Any particular geographies where that will be focused or primarily in areas where you’ve taken pricing of the past year?

Ian Cook

Good questions, Joe. On the Hill’s business, we have not lost distribution. You will remember that our strategy on Hill’s is, you might say, a limited distribution strategy. Our go to market is very much to provide products that we label pet nutrition not pet food, to provide a clinically proven benefit to the pets of the consumers that buy the product.

And in order to do that in an educated way, we provide those products to neighborhood and pet stores, vets themselves, and the retailers who provide education in this space, given their nature like the Pet Superstores. So that’s our area of focus and those retail channels are quite loyal and supportive of the Hill’s business. As I was saying earlier to Ali in response to the question about Hill’s pricing, what actually happened was that premium pricing -- that segment, we saw what the pricing we took in the first quarter, a gap beginning to appear against other premium competitors who did not follow the pricing we took in the first quarter.

And so, as a matter of operations, we’ve had to adjust. And we have adjusted here in the US and in key markets around the world in order to make sure we are on pricing strategy, and that is what we are seeking to return to. So it’s a global initiative, and it is selective, where we find ourselves out-priced, no loss in distribution. And as I mentioned in response to the earlier question, all with gross margin up year-on-year and projected to be up year-on-year for the full year as well.

Joe Altobello - Oppenheimer

Okay. And in terms of the marketing spend from a geographic perspective?

Ian Cook

Selective, globally. It’s a global initiative against select premium global competitors to make sure that we are achieving our pricing strategy on the business. So, global.

Joe Altobello - Oppenheimer

Okay. And then one last, if I could sneak it in. Back to Hill’s, obviously one month has passed now since the end of the quarter. Are you seeing any pick-up or improvements sequentially in volumes?

Ian Cook

Very good question. In fact, the answer is yes, specifically on the Hill’s business. In fact, across the entire Colgate business, the volume pace so far in the quarter, sees us with a fastest start in the first month of the quarter, for two quarters. So faster than the first quarter and faster than the second quarter. And that absolutely applies to the Hill’s business. So off to a good start.

Joe Altobello - Oppenheimer

That’s great. Thank you.

Operator

We’ll go next to Andrew Sawyer with Goldman Sachs.

Andrew Sawyer - Goldman Sachs

Yes, sure. Thanks, guys. I was wondering if you could talk a little bit more on the A&P side, and perhaps maybe give some context around your share of voice. In the US it looks like at least in the measured media channels, we can that your share of voice is still up slightly. I was wondering if you could talk to where your share voice levels are in some of your other large markets outside of the United States?

Ian Cook

Yes. I think obviously for competitive reasons Andrew, I would prefer not to get into a market-by-market dialogue because we’re very specific about where we put our emphasis. To repeat comments made before, there are various issues at play here. You’ve got the real reduction in cost of media. Which as I’ve said before, we are seeing around the world between 5% and 25%. That’s giving us increased impressions for less money.

We are seeing competitors pulling back in some key markets, which is providing opportunity. And we, particularly at this time, are finding ways, like the “Seeing is Believing” campaign with Hill’s, of communicating directly communicating with consumers at retail. And that spend, a large part of it comes out of the gross to net line and you don’t see in the traditional A&P.

I think the ultimate distillation of it is the kind of market share movements that you are seeing on our toothpaste business, many of which we described in the release or being commented on.

Andrew Sawyer - Goldman Sachs

And just a quick follow-up, if I could. I know entering the year, Latin America, you had to talk about launching a portfolio that skewed pretty heavily to premium priced products. And Bina, in her prepared remarks mentioned that you’re seeing market share gains from Total. Have you seen a trading up phenomenon in some of the other categories, whether it’s liquid soap, toothbrushes, et cetera? And what’s that meant for -- as far the mix contribution to your unit volume figures in the Latin American region?

Ian Cook

The mix is a factor of gross margin growth for us and the dollar weighted volume growth. We are continuing to see the consumer paying for value. I wouldn’t overstress that point. We have consistently said that we have a broad portfolio of products, and variance, and sizes to reach all different retail environment priced accordingly. And we innovate across that portfolio. The consumer chooses to continue to buy, at an increasing rate, the premium end of the portfolio because of the perceived benefit.

Andrew Sawyer - Goldman Sachs

Thanks a lot.

Operator

We’ll go next to John Faucher with J.P. Morgan.

John Faucher - J.P. Morgan

Yes. Good morning. It seems that the concern on getting play back from investors today is the ramp down in advertising. And yes, it’s going to shift a little bit more favorably in the back half of the year. But you combine that with disappointing volumes. So are you seeing any correlation whatsoever in terms of the pullback in ad spending and a disappointment in volumes? And to get more specific on that, can you talk about the pullback on the ad spending on Hill’s, relative to what you are seeing across the rest of the portfolio?

Ian Cook

Yes. First, the answer is no. The answer is absolutely and categorically no, John. I think the strongest correlation we’re seeing, and it traces specifically to Hill’s, is in pricing, period. Advertising, you know, a percent to sales ratio is an interesting ratio and the conventional wisdom is that it should always go up. But as I have said before with the rate reductions we’re getting -- we’re seeing, the competitive pullback we’re seeing, and our own choice to shift into the in-store activity, I don’t see that as a concern.

We are increasing our advertising in the second half. We did say we we’re going to be prudent coming into the year until we recovered gross margins. So I think we’re poised quite well now to step up the A&P behind an innovation stream so that there is news and we have corrected the pricing imbalance on Hill’s.

Hill’s, specifically on advertising, actually year-on-year on a ratio basis will be up. But again, one has to be careful because the Hill’s model is so different in terms of that vets’ recommendation driving the purchase of the product. And that recommendation continues to be at all-time high, leadership level. And that’s what we focus on with Hill’s because it’s their belief in the clinical behind the nutritional efficacy of the product that creates the consumer conversion.

John Faucher - J.P. Morgan

Okay. And then geographically-- thanks for that. Geographically, again it seems that the correlation between the volume disappointment is probably more related to pricing than advertising. But if you could provide a little more color on that?

Ian Cook

Well, again the Colgate business held flat overall from a volume point of view with the pricing that we have taken in order to offset transaction and commodity and recover gross margin. No new pricing across the balance of the year, and the pullouts were Hill’s, which we’ve discussed. And as I mentioned in the Greater Asia region, the significant pricing we had to take in South Africa, Russia and Ukraine, which affected the quarter, but which we expect to bounce back in the second half of the year.

John Faucher - J.P. Morgan

Got it. But again, no atypical variances from an advertising standpoint in those markets, relative to what you were seeing globally?

Ian Cook

And all projected to continue up on the balance of the year.

John Faucher - J.P. Morgan

Okay. Thanks.

Ian Cook

Thanks, John.

Operator

We’ll go next to Lauren Lieberman with Barclays.

Lauren Lieberman - Barclays

Thanks. Since no one else has asked, could you give us the breakdown of gross margin in the quarter?

Ian Cook

Oh. Yes. Yes. Yes.

Lauren Lieberman - Barclays

Thank you.

Ian Cook

The prior year gross profit second quarter was $56.8 million. The pricing contribution, very similar to the first quarter this year, was 3.1%, $310 million. Nothing from restructuring, as you would expect, funding the gross came back very nicely in the second quarter at $1.8 million. The material prices were negative at 2.9. And that, as you can see, if you track it back, is an easing. And net, that delivers the 200 basis points increase year-on-year to the 58A.

Lauren Lieberman - Barclays

Okay. Great. I just wanted to follow-up --I know someone asked this earlier, but I just wasn’t quite clear on the answer. I know there’s no new pricing coming. But as currency eases -- or is it just that we are not yet confident that where currency is based, where it will stick. So you don’t want to move back quickly on pricing.

I would have thought there’d be a little bit of pullback on pricing where you’ve taken it to cover translation and transaction, rather than letting it ride. I mean, is the decision to let it stick because you’re comfortable in where volumes are in those markets?

Ian Cook

The pricing we have taken on the Colgate business, we’re comfortable with where it is and expect it to stick because in the main, competitors have followed and the investment goes behind more traditional marketing techniques, which includes promotion to be sure, but not a rollback of pricing. But of course sequentially, quarter-on-quarter, the benefit impact of pricing will ease as you are taking new pricing and you’re lapping year-on-year.

Lauren Lieberman - Barclays

Okay. And then just the other thing with North America because I know at least in specific regions, Nielsen data is useful. And certainly what you guys have been saying, Wisp is doing fantastically well and I would think is actually -- given its market share of the toothbrush category, it’s certainly big enough to be mattering in the quarterly results. So how does the rest of the oral care business volume-wise look in the US right now?

Ian Cook

One second.

Lauren Lieberman - Barclays

Sure.

Ian Cook

The oral care business -- I don’t have the US number here, I have a North American number, which, for the quarter, would show organic growth about between 2% and 3%. That’s the North American number.

Lauren Lieberman - Barclays

Okay. And that includes Wisp, of course, right?

Ian Cook

That includes Wisp, yes.

Lauren Lieberman - Barclays

Right. So volume ex-Wisp is probably down?

Ian Cook

No, no. Wisp is not that significant, Lauren.

Lauren Lieberman - Barclays Capital

Okay.

Ian Cook

So that’s it. It’s exciting, it’s encouraging. We still have to wait for the repeats to play out over the back half of the year. It’s accretive from a gross margin point of view. But it’s not -- it's not a -- it's not that significant a factor.

Lauren Lieberman - Barclays Capital

Okay, great. Thank you.

Ian Cook

Thanks.

Operator

We'll go next to Jason Gere with RBC Capital Markets.

Jason Gere - RBC Capital Markets

Good morning.

Ian Cook

Good morning, Jason.

Jason Gere - RBC Capital Markets

Hi. And adding on to Lawrence’s question, could you just talk about maybe the oral care category in North America. Going to or seeing different channels in different geographies, a bit surprised about the magnitude of promotions out there on the super premium category. I can understand more about the basic lines, but this is what we’ve been seeing in the last few weeks.

So I’m wondering, is this retail driven, to just move inventory, or is there some sort of shift going on and kind of talking about where the volumes are that they put out last quarter?

Ian Cook

I don’t know what channel you’re looking at, I guess the headlines in the US were outdated, doesn’t show anything of a significant change compared to this traditional promotional activity. It does show the category posting good value growth, low single digits, healthy in this environment. It shows a channel shift more to mass. The club stores and the dollar stores, they are the ones outpacing, which I think is data well known to people.

And quite pleasingly, for our US business, we have seen the consumption of our aggregate categories outpace category consumption on a volume basis for each of the months of this year, and that accelerating actually in the second quarter. So we’re quite pleased with our performance and we don’t see anything untoward or unusual, thus far, in category activity. And our share is up very nicely.

Jason Gere - RBC Capital Markets

Okay. And then, I’m not sure if you clarified this, in terms of those categories, I think you said your share was flatter up in 11 of the 14. Did you call up the three that were down? And is this where we’re going to see a bit more instant merchandising? Is there innovation behind those three?

Ian Cook

Well, there’s innovation behind all of them. If there is corrective action required, it will be taken. We’re getting into too much US data, frankly, but balls would be one, which is a declining category in favor of body washes. And body wash would be a second, but I’m not sure I’d call point one significant. And the serums launched being mentioned is coming, and a modest decline on underarm, with activity coming as well.

So we were just being thorough in terms of what was down, but we’re not talking about meaningful declines and we have innovation streams behind those three segments to rebound in the second half.

Jason Gere - RBC Capital Markets

Okay, great. And just a last question, I’m just wondering, this has been the year that we occurred most HPC coming talking about sales productivity. I was just wondering if you could give us an update of some of the measures that you’ve taken. Which regions that maybe you’re seeing the most effectiveness from a sales productivity standpoint?

Ian Cook

Well, I guess we would caption our productivity program in the sales area excluding the fixed cost would be governed by Covey business planning, which is that SAP driven technique we’d been deploying for the last four years, which focuses on increasing our return on investment, in terms of each of our sales activities, and sharing those learnings around the world.

And I know we have spoken on several meetings about the kinds of techniques. We said this year that we were goaling [ph] a pre-tax savings of around $150 million and thus far, this year we’re on track to deliver that and we will have CBP SAP driven in place on about 3/4 of our trade spending subsidy -- 3/4 of our global trade spending by the end of this year. So we’re seeing improvement.

Jason Gere - RBC Capital Markets

Great. Thank you very much.

Ian Cook

Thanks, Jason.

Operator

We’ll go next to Linda Weiser with Caris.

Linda Weiser - Caris

Hi. Thanks. First, I was just curious on the materials cost. I was projecting them to be down in the third quarter. Is that the case or will it not be until the fourth quarter?

Ian Cook

We’re seeing some materials cost off already, year-to-date. I guess the way I would answer that is to say that the primary benefit would be in the fourth quarter.

Linda Weiser - Caris

Okay. And just a longer term question on innovation. I know when you started your multi-year restructuring a few years ago, you put some investment or partnership with some medical institutions or something that focused on oral care. Are there any big time innovation you’re expecting to come from that? Because it has been a while since we’ve seen major innovation.

Ian Cook

Well, we felt like Wisp, but who’s looking? I guess, Linda, you’re right in your recollection. We stepped up the resources we had and there are shorter term innovation groups, the so-called Centers of Innovation, focusing on products that we could bring to the market three-year window.

And then we established three years ago, two years ago, in fact, some long term innovation centers, which are focused on three and five-year plus innovation. And we have several of these external partnerships that you mentioned. The one you’re probably remembering is the full site institute up in Boston that we have talked about before. These are much longer term innovation streams and we have, indeed, some interesting leads. More than that, I would not say.

Linda Weiser - Caris

Okay. Thanks a lot.

Operator

We’ll go next to Alec Patterson with RCM.

Alec Patterson - RCM

Good morning.

Ian Cook

Hi, Alec.

Alec Patterson - RCM

Hi. I just wanted to get a better handle on the materials trend, the gross margin trend from two angles. One, you did break down packaging raw material impact by region, and I guess it was surprising to see where it was a benefit in North America, Asia, and Africa, but not called out in Europe and Latin America, but overall, it was still quite negative. So should one draw the conclusion that it was predominantly a Hill’s factor, in terms of the negative raw material impact?

Ian Cook

What page are you looking at, Alec?

Alec Patterson - RCM

You just said that, I believe the 290 basis point impact to gross margins from raw materials and in the release you cite lower raw impact material cost in Asia, Africa, and North America, with no comment whatsoever on Latin America and Europe. So I’m just trying to zero in on the cause of the raw material hit.

Ian Cook

Well, you’ve got the foreign exchange piece, I guess, in the Latin countries. But remember, that is a -- what I was calling out was the roll forward of the gross profits. So last year, for example in the second quarter, material prices negatively affected the gross profit by 430 basis points. This year, the impact was 290, so a lessening of the impact on the gross margin. If we -- I don’t have the data in front of me to break down that by division. So we’ll have to talk about that offline, Alec.

Alec Patterson - RCM

Okay, well, maybe just a different attack then on the Hill’s business. The price gap, you talked about having widened and became a competitive issue, and you’re looking to close those price gaps. Do you have a sense for whether your position, in terms of your raw material cost in that business, tend to be more locked-in, more supply contract constraining, such that it’s more of a lag for your business to benefit from a lower raw material environment than, say, maybe a private label manufacturer of some of your other competition.

Ian Cook

No, I wouldn’t say that. And the over-arching comment balancing the pricing action that we have already started to take on the Hill’s business and what we see in terms of the material cost environment, again on that Hill’s business, sees the gross margin up year-on-year for the full year and the balance of the year.

Alec Patterson - RCM

Okay. All right, thanks.

Ian Cook

Okay, sure.

Operator

We’ll go next to Connie Maneaty of BMO Capital Markets.

Connie Maneaty - BMO Capital Markets

Hi, just two questions. What is the order of magnitude of price roll-backs by Hill’s?

Ian Cook

We’re not rolling back pricing, Connie. We’re adjusting promotionally and it varies.

Connie Maneaty - BMO Capital Markets

Okay. But to the consumer, it would seem more affordable?

Ian Cook

The pricing will -- yes, is the answer. The pricing will be more in line with our other premium competitors, yes.

Connie Maneaty - BMO Capital Markets

Okay.

Ian Cook

Because they did not follow in the main -- the pricing we took in the first quarter, which have not been the case with the last two price increases.

Connie Maneaty - BMO Capital Markets

Okay. And then secondly, one final question on advertising. I understand that the dollar spend would go down because rate has come down and there will be more in-store activity. But I was kind of puzzled by the comment about competitive activity. So I was wondering what difference does it make what competitors are doing. Why wouldn’t you have stepped up advertising in the quarter to fully take advantage of the spending gross margin and really solidify the shares?

Ian Cook

The timing doesn’t work quite sometimes as precisely as that, Connie. We had said we wanted to be prudent. We had said we wanted to recoup gross margin. We exceeded our expectations on gross margin in the second quarter.

It is very relevant, I think, in terms of what competitors are doing on market-to-market basis. And some of these emerging markets, the GRP weight, the actual number of spots we are running are extraordinarily high in terms of reaching the consumer. You’re talking about four, five, six spots a day, which is a very elevated level.

So if a competitor is not spending, it may be much wiser to adjust your advertising spend, still dominate share of voice, but in a more economic fashion on top of the market cost reduction. And the proof of the pudding in the end is what happens to market share. And again, what we have seen is our market share in key markets continuing to increase. So that’s the balance you’re revisiting all the time, Connie.

Connie Maneaty - BMO Capital Markets

Okay. That’s very helpful. Thanks.

Operator

We’ll go next to Nik Modi with UBS.

Nik Modi - UBS

Yes, I’ll make this quick. Good morning --

Ian Cook

Hi, Nik.

Nik Modi - UBS

Just a couple of questions, Ian, if you could just go around quickly and globe trot, and tell us your perspective on the consumer just given we’re six months into the year or seven months, are you seeing any stabilization out there or do you continue to think it’ll get worse?

And the second question is on the emerging markets, as you took pricing late in the first quarter, did you see your local competitors follow, as you had expected? Thanks.

Ian Cook

Yes, globe trotting, I guess like everyone else, the consumer is looking for green tubes. But they are seeing -- continuing to see value in our categories and they are continuing to -- they’re continuing with the behaviors. So once they buy in to a health and wellness behavior, they don’t drift out. They continue to put a disproportionate loyalty to a brand because a branded good provides a level of confidence and trust, pleasingly as you’ve seen in the shares. They continue to provide a loyalty to our brands.

Now, we continue to see them shift in terms of channel. We continue to see them look for value. But we haven’t seen any disconnect from language I have used before, in terms of the consumer's behavior in the world today. So we continue to feel quite comfortable. We’re seeing the categories growing and they’re growing in the kind of sequencing you would expect, faster in the emerging, slower in the developed. So I guess that would be the summary there.

And your second question, Nick, again, sorry?

Nik Modi - UBS

It’s on the emerging markets. How do competitors and local competitors follow the price increase?

Ian Cook

It depends. In the main, everyone is faced with the same cost increases, particularly in those emerging markets, if the materials are dollar denominated. So in the main, we see both private label and local brands come with the pricing. It may be later. It oftentimes is later. But ultimately, the same economic reality hits and they have to accommodate and adjust for it.

Nik Modi - UBS

Excellent. Thank you very much.

Ian Cook

Sure.

Operator

And we’ll go next to Victoria Collin with Atlantic Equities.

Victoria Collin - Atlantic Equities

Hi, Ian. Hi, Bina.

Ian Cook

Victoria.

Victoria Collin - Atlantic Equities

Hi. I just wanted to ask Ian a little bit more, and I’ll be brief about Europe and the South Pacific volumes. You’re guiding too modestly up in these three. And I was just wondering what strategies you’re undertaking to get that swing in the volume into positive territory, given that you’re still facing a relatively tough comp? And the same question will probably apply to the greater Asia-Africa region as well.

Ian Cook

It’s separate answers, I would say. Europe-South Pacific is largely -- same as most places; no new pricing, increased advertising, and increased innovation stream. In fact, in the second half in Europe, our innovation stream in terms of sales impact is twice what it was in the first half of the year. So that’s really the answer for Europe and South Pacific.

Asia is a little different. I mean, the same general principles apply. The big drag this quarter, as I mentioned, was the pricing we had to take in South Africa, Ukraine, and Russia, over 20% to offset the significant currency devaluation. And as I have said before, consumer tends to work down (inaudible) for a quarter before coming back to the category. So the same applies; no new pricing, increased advertising, increased innovation stream, but also, the rebound of the consumer after some significant pricing in some major markets.

Victoria Collin - Atlantic Equities

Okay. Great. Thank you. If I could just sneak in a tiny, follow-up question. Are you seeing much in demand for trading down on more value orientated products in Europe? And would that support the volumes that people leave a little bit away from the more premium priced items?

Ian Cook

We are seeing in some categories in Europe, contraction. We are seeing private label at a higher level in Europe than we see in other parts of the world. But in the end, the consumer is looking for value.

And as a branded-goods manufacturer, if you deliver that value, the same principle applies that the consumer will choose the value. And value isn’t necessarily a just price. And as I’ve said before, the kinds of businesses we’re in, particularly the oral care and personal care tend to have a greater emotional loyalty than some of the other more functional businesses because of who you use them on and which parts of your body you put them on.

But yes, private label is definitely more developed in Europe than other parts of the world. Victoria?

Victoria Collin - Atlantic Equities

That’s very helpful. Thanks. And if I may just ask where the private label was growing or where you’ve seen it increase slightly?

Ian Cook

Usually, where we have seen it increase is in the functional categories; categories like bleach, categories like detergents, categories like household cleaners, and to a degree, garbage disposal bags. These are the categories we have seen the greatest increases in private label.

Victoria Collin - Atlantic Equities

Thanks very much.

Ian Cook

Okay.

Operator

We’ll have our final question from Alice Longley with Buckingham Research.

Alice Longley - Buckingham Research

Hi. Good morning -- good afternoon. Your volume in Latin America was up 2%. In what countries was it more than that and what less than that, please?

Ian Cook

I’m not sure we’re going to go through a run through of countries, Alice. But it was led this time by Brazil and Venezuela.

Alice Longley - Buckingham Research

Okay. That’s great. My second one was you said the dog food category was just fine. You’re stable. Was volume for dog food and specialty channels flat in the quarter, roughly?

Ian Cook

One second. First of all, I challenge your definition. We view it as pet nutrition. But that said -- and when we talk about the category, we talk about the -- what I would call the specialty category, as you say, which would be the PETCOs, the PetSmart, the Neighborhood Pet, and the vet outlets. And overall, the specialty channel, as you asked, was indeed positive, is positive year-to-date, and was positive for the months in the second quarter that we have data.

Alice Longley - Buckingham Research

In value terms or unit terms?

Ian Cook

In unit terms, volume terms.

Alice Longley - Buckingham Research

Okay. Perfect. My last--

Ian Cook

Balance.

Alice Longley - Buckingham Research

Perfect. And then my last question is, if you had to guess how much ad rates are running down, what would that be?

Ian Cook

Yes. The answer Alice, would be, “It depends.” Without docking it, we advertise in 80 countries. And the ad rates are down anywhere from 5% to 25%, depending on the country.

Alice Longley - Buckingham Research

Thank you very much.

Ian Cook

Okay. Well, thanks very much for joining us. Thank you very much for all of your questions and interest in the company. And special thanks to all the Colgate people around the world who make all of this happen. Talk to you next time.

Operator

That concludes today’s conference. Thank you for your participation.

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Source: Colgate-Palmolive Company Q2 2009 Earnings Call Transcript
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