Mead Johnson Nutrition CO (MJN) Management Discusses Q2 2013 Results - Earnings Call Transcript

Jul.25.13 | About: Mead Johnson (MJN)

Mead Johnson Nutrition CO (NYSE:MJN)

Q2 2013 Earnings Call

July 25, 2013 9:30 am ET

Executives

Kathy Ann MacDonald - Vice President of Investor Relations

Peter Kasper Jakobsen - Chief Executive Officer, President and Director

Peter G. Leemputte - Chief Financial Officer and Executive Vice President

Analysts

Diane Geissler - CLSA Limited, Research Division

Kenneth Goldman - JP Morgan Chase & Co, Research Division

Eric R. Katzman - Deutsche Bank AG, Research Division

Jason English - Goldman Sachs Group Inc., Research Division

Matthew C. Grainger - Morgan Stanley, Research Division

Bryan D. Spillane - BofA Merrill Lynch, Research Division

David Driscoll - Citigroup Inc, Research Division

Leigh Ferst - Wellington Shields & Co., LLC, Research Division

John J. Baumgartner - Wells Fargo Securities, LLC, Research Division

Jon Andersen - William Blair & Company L.L.C., Research Division

Robert Moskow - Crédit Suisse AG, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Mead Johnson Nutrition Second Quarter 2013 Earnings Conference Call. My name is Tehitia and I'll be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference call over to Kathy MacDonald, Vice President, Investor Relations. Please proceed, Kathy.

Kathy Ann MacDonald

Thank you, Tehitia. Thank you, and good morning. Welcome to Mead Johnson's second quarter conference call. With me today are Kasper Jakobsen, our Chief Executive Officer; and Pete Leemputte, our Chief Financial Officer.

As we start, let me remind everyone that our comments will include forward-looking statements about our future results, including statements about our financial prospects and projections, new product launches and market conditions, that constitute forward-looking statements for purposes of the Safe Harbor provision under the Private Securities Litigation Reform Act of 1995.

Keep in mind that our actual results may differ materially from expectations as of today due to various factors, including those listed in our annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, in each case, as filed with or furnished to the Securities and Exchange Commission and our earnings release issued this morning, all of which are available upon request or on our website at meadjohnson.com.

In addition, any forward-looking statements represent our estimates only as of today and should not be relied upon as representing our estimates as of any subsequent date. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so even if our estimates change.

Given that you are in the midst of the earnings reporting season, we will be respectful of your time and limit this call, including Q&A, to 45 minutes.

Please note in the consolidated statement of cash flow table, the date should have read in our press release this morning June 30, instead of March 30.

I will now turn the call over to Kasper, who the Board of Directors officially appointed as our President and CEO subsequent to our last quarterly earnings call. Over to you, Kasper.

Peter Kasper Jakobsen

Thank you, Kathy, and good morning to you all. Let me start by highlighting our operating performance in the second quarter, before I turn the call over to Pete, who will provide additional financial analysis. After Pete's comments, I'll then wrap up with some brief more general comments before we take questions.

Addressing now our second quarter performance. We are pleased with our results, which were broadly in line with expectations outlined in last quarter's call. As you likely read in this morning's press release, we delivered sales growth of 4% on a constant-dollar basis. Non-GAAP earnings per share came in at $0.84 per share, up from $0.83 in the second quarter of 2012.

Higher sales and a modest increase in gross margin allowed us to significantly increase investment in demand creation. Advertising and promotional spending approached 16% of sales, a 200 basis points increase from the prior quarter. We are now investing in future growth at levels that are higher than at any time since our IPO in 2009.

Sales growth was 5% from our core operations, excluding the impact of non-core businesses discontinued late in 2012. Price increases in the high inflation markets of Venezuela and Argentina contributed 1 percentage point to total company constant-dollar growth within the quarter. Going forward, we expect continued depreciation of both countries' currencies to offset any benefit of such growth in the second half of 2013.

My following comments will focus mainly on the performance of ongoing core operations. In our last 2 calls, we said we expected to see a better balance between volume and pricing growth in 2013. This was evident in the second quarter, with core volume growth at 3% and growth from price slightly lower at 2%. In the first quarter of 2013, sales growth came entirely from pricing gains.

Turning now to the performance of our 2 operating -- or sorry, reporting segments, and firstly, to the North America/Europe segment. In the second quarter, again excluding the impact of businesses we discontinued in 2012, sales for the North America/Europe segment were in line with prior year. Pricing was up 2%, while volumes declined by the same amount.

There were a number of factors at work during the quarter. Firstly, the category continued to shrink in North America. We estimate by about 1% in volume terms, due to declining consumption. The rate of decline, however, slowed from what was an estimated 3% in 2012. Secondly, as we indicated in our last call, segment comparisons this quarter were tougher than those seen in the first quarter. Encouragingly, sales in the second quarter were 5% above sales in the first quarter of the year. Sequential growth was driven by increased non-WIC market share in the U.S. and continued market share improvement in Canada. These improvements are the result of us having strengthened our product portfolio in both countries over the last year.

We expect full year constant-dollar sales growth from core operations in North America/Europe in the low-single -- to grow in the low-single digits. Our outlook for this segment represents a slight improvement over the view offered 3 months ago.

Before turning to our emerging markets, let me highlight the improvement we've seen year-to-date, with EBIT margins in North America and Europe improving nearly 400 basis points from the first half of 2012 to 21.5% in the last quarter.

Higher gross margins were the main driver of our EBIT improvement. Gross margin benefited from recent price increase in the U.S., as well as from lower commodity costs. Reduced infrastructure costs in Europe also impacted our EBIT margins positively. Strong margins allowed us to maintain advertising and promotion spend at rates within the segment above the company average and slightly above first half 2012 levels. This reflects our continued confidence in the long-term prospects of the North American market as we await the recovery in births.

Turning now to the Asia/Latin America segment. This segment delivered constant-dollar sales growth of 8%, with 6% coming from volume. This was an improvement over 1% volume growth in the first quarter. This improvement came as our operations in China returned to volume growth after 3 consecutive quarters of decline.

As we've mentioned in the past, following an unanticipated buildup of inventory in China in the first half of 2012, we reduced shipments to our distributors in the second half last year to bring inventories back to normal levels by year end. As a result, we'll face an easier comparable in the coming 2 quarters and sales growth for the Asia/Latin America segment should be well into double digits in the second half of this year.

Our market share in China has now been stable for more than 4 months, and we believe we've now put our 2012 challenge firmly behind us. As you would have noticed, there's been significant industry news out of both China and Hong Kong this year.

Let me start with a very brief update on the Hong Kong situation. On a sequential basis, sales in the second quarter were lower than those of the first quarter of 2013, as a result of the Hong Kong export restrictions becoming effective only on March 1. Sales in Hong Kong were particularly strong in the first quarter, ahead of implementation of these restrictions. So this impact was fully anticipated. We're pleased, I note, that sales have stabilized in the second quarter, and on a full year basis, we still expect to show sales growth relative to prior year. We understand the Hong Kong government will review the regulations again in October. Our outlook is, however, not assuming any change to the current restrictions.

Turning now to Mainland China. As mentioned in our recent press release and 8-K filing, we continue to cooperate fully with China's National Development and Reform Commission, the NDRC, in its antitrust review of resale prices. In agreement with the NDRC, we recently agreed to reduce the price of certain products by 7% to 15% and these reductions will become effective mid-July.

As we adjust these prices in China, we'll continue to optimize our sales, marketing and promotional plans. We'll continue to maintain our competitiveness and ensure that we offer good value to Chinese consumers. We pride ourselves on 20 years of manufacturing in China, and we look forward to the next 20 years. We remain committed to playing a positive and responsible role in China's continued development.

I'd now like to spend a moment on other markets in Asia and our markets in Latin America. Both subregions continue to grow. In South Asia, we continued to deliver market share gains in Thailand, Malaysia and Vietnam. We believe we are positioned for strengthening sales growth in the second half of 2013. Excellent and broad-based progress was once again seen across Latin America. In a growing category, we continue to gain market share in many markets, including in Mexico, our largest market. We continue to build infant formula market share in Brazil, and across the Andean region, we continued to see similar strong growth.

You'll notice that Asia and Latin America EBIT margins are down 260 basis points versus the second quarter of prior year. The vast majority of this reduction in segment margin was the result of increased investment in demand generation. As in the case of North America, this is reflective of our overall strategy to invest behind identified growth opportunities. We currently expect Asia/Latin America constant-dollar sales to grow in double digits on a full year basis.

In summary, I'm pleased with our global performance in the first half of 2013. We've successfully defended our leading position in China/Hong Kong. We've seen the Hong Kong situation stabilize as we move through the second quarter. Growth in South Asia and Latin America in aggregate remains in double digits, and we've seen share improvements in North America. We recognize it's difficult to estimate the final impact of the list price reduction in China and what it will mean for full year sales growth for the Asia/Latin America segment. However, lower prices in China may well reduce the need for short-term promotional activity there. And we are seeing stronger-than-expected performance in many of our other emerging markets, as well as in North America and Europe.

On a full year basis, we therefore expect constant-dollar sales from our core operations to grow around 8%. Our exit in late 2012 from certain non-core businesses will reduce 2013 reported constant-dollar sales growth by about 1 percentage point. We reiterate our expectation that non-GAAP EPS will be between $3.22 and $3.30 per share.

And with that, I'll now turn the call over to Pete, who will provide further financial analysis. I will then return to provide some closing remarks before we begin the Q&A. Pete?

Peter G. Leemputte

Thanks, Kasper, and good morning, everyone. I'll start with brief comments on the impact of non-core businesses on sales growth, then move on to discuss foreign exchange, profitability and liquidity, before wrapping up with a summary and our updated guidance.

In the second quarter, we reported constant-dollar sales growth of 5% for our core operations. The impact from the non-core businesses exited late last year reduced our growth rate by 1%, so total sales in the second quarter grew by 4%.

I'm going to keep my comments largely to our non-GAAP results, but I would point out that GAAP earnings were $0.80 per share in the quarter, down $0.01 from $0.81 in the prior year.

As you can see in our press release, legal, settlements and related costs make up the majority of our second quarter specified costs, which are excluded from non-GAAP financials and include a small charge related to the China antitrust review.

Turning to foreign exchange. During the quarter, our sales benefited from a weaker dollar compared to the prior year in our 4 largest markets outside the U.S.: China, Mexico, the Philippines and Thailand. This mitigated the impact to the first quarter devaluation of the Venezuelan bolivar, along with continued weakening of the Argentine peso. As a result, foreign exchange had a negligible impact on sales growth in total during the second quarter.

There are also foreign exchange impacts from balance sheet remeasurement that can influence our financial results. There were no significant balance sheet remeasurement gains or losses this past quarter, while in the second quarter of 2012, there was a net gain of $12 million. This favorably impacted last year's earnings by $0.04 per share.

The dollar has strengthened against most currencies this past month, and as Kasper mentioned, we expect further erosion in the value of the Venezuelan bolivar later this year. We therefore anticipate foreign exchange will reduce second half sales by 2%, a headwind compared to our first half performance.

On a full year basis, foreign exchange is now anticipated to result in sales decline of 1%. During our last conference call, I highlighted that we expected no foreign exchange impact on sales this year. Full year EPS is reduced by about $0.02 a share versus earlier expectations.

In the second quarter, we delivered a gross margin of 63.6%, 40 basis points better than in 2012 and up 130 basis points sequentially versus the first quarter. The improvement is completely attributed to our North American/Europe segment, where we saw the benefit of higher pricing, lower average dairy and other commodity prices and strong productivity gains.

On a year-to-date basis, our gross margin stood at 63%. Last quarter, we noted that dairy prices had jumped significantly due to a drought in New Zealand earlier this year. We've seen the Oceania spot prices retreat somewhat from the peak in April, but global spot prices across the U.S., Europe and Asia Pacific have stabilized at a level significantly higher than the beginning of the year. Given the 7 months lag between what happens in the spot market and our cost of goods sold, we expect to see lower gross margins in the fourth quarter. A greater impact is likely in 2014, although we expect higher pricing and productivity should help mitigate some of the impact.

On a full year basis, we expect 2013 gross margins of about 62.5%. Operating expenses for the quarter came in at just under 41% of net sales for the quarter compared to 38% in 2002 (sic)

[2012]. There were 2 key factors at work. The increased advertising and promotion spend that Kasper mentioned was the most significant factor. In addition, the balance sheet remeasurement gain in the second quarter of 2012 reduced the spending level seen last year.

On a full year basis, we expect that total operating expenses will be near 39.5% of sales, the same level as seen in the first half of 2013. That is up from 38.7% in 2012. Higher demand-generation investments, coupled with the higher pension and -- pension settlement and bonus accruals are the key drivers.

Please note that full year advertising and promotion spending is also expected to run near the 14.9% level seen in the first half of the year. Note that with gross margins of about 62.5% and operating expenses of 39.5% of sales, EBIT margins would be around 23% for the full year, close to the levels seen in 2012.

Turning to taxes, our non-GAAP effective tax rate, or ETR, for the first half of 2013 is 24.9%, a 180-basis-point improvement from the 26.7% seen in the second quarter of 2012. The decision to hold more of our international earnings outside the U.S. is the main driver.

We anticipate making further progress in reducing our global tax rate and now expect the full year ETR to be in the range of 24.5% to 25% for 2013. Net income for the quarter of $171 million was basically in line with the prior year. Non-GAAP EPS grew $0.01 to $0.84 per share on a slightly lower share base. The benefit of top line growth, a higher gross margin and a lower effective tax rate, were reinvested back into the business, with $0.10 per share in increased demand generation and Research and Development spending.

Moving to our balance sheet and liquidity. Liquidity was quite strong with $283 million in free cash flow in the first half of the year. That's excellent performance given we consumed $117 million in cash for capital spending. Strong working capital performance was a key factor, particularly accounts payable management.

For the full year, we continue to project CapEx at $260 million. Spending for the Singapore spray dryer is expected to consume more than half of our capital budget for the year. Depreciation and amortization expense is expected to be around $88 million in 2013.

During the second quarter, total debt dropped by $69 million, largely as we reduced borrowings under our short-term revolver, bringing the year-to-date short-term debt reduction to $134 million. Also, we paid off the final tranche of our borrowing for the Argentine acquisition during the month of July, a bit earlier than expected, following the receipt of antitrust approval from local regulators. We now expect interest expense to run in the low $50 million range for the year.

We repurchased 250,000 shares of stock in the second quarter, which brings our year-to-date buyback to 550,000 shares. The share buyback, coupled with dividends, returned $173 million in cash to shareholders in the first half, or over 60% of our free cash flow.

Before I turn the call back to Kasper, let me summarize our current outlook for the year. We expect constant-dollar sales growth will be about 8% for the core business in 2013. Reported sales will grow at 6% after taking the impact of both foreign exchange and non-core operations into account. The 7% to 15% price reduction that Kasper highlighted in China will reduce annual sales by about $55 million to $65 million. In 2013, we will see a half year impact, with a sales risk in the low $30 million range before any offsets.

Please note that this pricing impact is included in our non-GAAP guidance. We anticipate 3 positive factors that will mitigate the impact in the second half. First, we're seeing higher growth relative to earlier expectations in the developed markets of the U.S. and Canada from share gains, and the emerging markets outside of China and Hong Kong account for over 40% of total sales. Growth in these markets has also exceeded our prior estimates.

Second, we believe that our lower prices in China may result in a somewhat reduced level of promotional activity. And finally, Hong Kong has stabilized at a level higher than we anticipated last quarter. Our non-GAAP EPS guidance remains unchanged at $3.22 to $3.30 per share.

As detailed in our press release, we would expect that GAAP EPS will range from $3.16 to $3.24 per share, excluding any incremental impact from the China antitrust review. Note that incremental legal, settlements and related costs, if any, would be treated as a specified cost excluded from our non-GAAP earnings.

At this point, we cannot predict what the final resolution from the investigation will be, but we would note it could be material to the operating results of the company in the quarter in which it occurs. Most important, we do not believe it is material to the business or financial condition of the company.

With regard to the timing of any charge, discussions with the NDRC continue on a regular basis, with the next meeting scheduled in the near future. Although it's difficult to predict when this matter will be resolved, we obviously hope for a prompt resolution.

With that, I now turn the call back to Kasper.

Peter Kasper Jakobsen

Thank you, Pete. Before we begin the Q&A, I'd like to just make a few more general comments. We remain committed to our articulated strategy, which has us focusing on pediatric nutrition. We retain this focus because we see great long-term potential for growth within the space. At a recent meeting of our global business leaders, I shared the following thoughts. I shared a commitment to leveraging our smaller size and singular focus for competitive advantage.

Our singular focus should allow us to understand our consumers and their needs better than any other company. And our smaller size should allow us to connect better across organizational layers and communicate better across functional and geographic borders. This will permit us to speed up decision-making and will ultimately allow us to act with greater agility in the marketplace.

From time to time, we'll see challenges in the marketplace, but we've proven over time that we can overcome these. This is the nature of our dynamic business in a dynamic environment and of our exposure to emerging markets. It's also what creates an attractive growth profile and I'm excited about the large number of opportunities we have in front of us. Our growth and our margins give us the opportunity to invest in these growth opportunities. And with that, I'll now turn the call back to Kathy.

Kathy Ann MacDonald

Thank you, Kasper. As stated in both this morning's earnings release and our prepared remarks, Mead Johnson Nutrition is involved in an ongoing antitrust review by China's NDRC. Since this is an active investigation, we may not be able to answer all questions you raise. We ask for your understanding. Also, we want to allow time to address questions about other regions of our diverse global business. Thank you, and operator, please open the lines for questions.

Question-and-Answer Session

Operator

[Operator Instructions] That question comes from the line of Diane Geissler from CLSA.

Diane Geissler - CLSA Limited, Research Division

First a comment and then a question. I think it's completely bogus that you're limiting your call to 45 minutes, when there are so many questions around China, you should just be taking questions until the last dog dies. Especially when you spend 30 minutes with your prepared comments. That's my comment there. The question I have is really, Pete, I wanted to just understand the $30 million that you indicated from the pricing action is included in your non-GAAP numbers, but you haven't assessed the potential bottom-line impact? Is that...

Peter G. Leemputte

No.

Diane Geissler - CLSA Limited, Research Division

Is that an accurate read of your commentary?

Peter G. Leemputte

The impact of the price rollback is definitely included in our non-GAAP guidance. It's included in the fact that we anticipate core constant-dollar sales growth of 8% and it's included in our $3.22 to $3.30 non-GAAP EPS. We were just making the distinction, Diane, that there may be legal, settlement and related costs that are not included in that. We would specify just that piece of it and only that piece then would then also roll through into the GAAP.

Diane Geissler - CLSA Limited, Research Division

Okay. And when do you think you'll have a better idea about consumer behavior in that category? I appreciate your pricing -- your price action went into place about 10 days ago. When do you feel that you'll have a better read about what's going on at the shelf, and then just in terms of volume drivers?

Peter Kasper Jakobsen

Diane, thanks for the follow-up question. I don't think that we anticipate that there would be a major shift in consumer behavior. It's obviously an evolving situation, but as we understand it right now, it would appear that pricing relativities within the segment in which we compete are being broadly maintained and we obviously feel that we have provided for that in our financial outlook. So it's not our expectation that there will be a major shift in the -- in consumer behavior as a result of these actions.

Operator

Your next question comes from the line of Ken Goldman from JPMorgan.

Kenneth Goldman - JP Morgan Chase & Co, Research Division

And I second Diane's comments about the 45-minute call. I appreciate the top line offset you're getting against the China situation, but I'm still a bit curious about your gross margin guidance, right, which you seem to be maintaining today. I might have expected the shift from higher margin markets like China to lower margin ones like everywhere else, that, that will hurt your margin a bit. And I also might have expected, what seems to be a shift from pricing to volume, to hurt your margins a bit, too. So can you talk about what you're seeing that would allow you to maintain your gross margin guidance?

Peter G. Leemputte

Sure, it's an excellent question, Ken. $30 million in lower sales and margins as a result of the price rollback in China would reduce our gross margin by 1/4 of 1%. Remember, we have a base of $4 billion in sales. And keep in mind that the impact is mitigated somewhat if we see lower promotional spend in light of our list price reduction. And I'd also point out that we're seeing higher growth in the U.S., Canada and Hong Kong, all of which carry gross margins which are well above the company average. So net-net, they tend to balance themselves out.

Operator

Your next question comes from the line of Eric Katzman from Deutsche Bank.

Eric R. Katzman - Deutsche Bank AG, Research Division

I guess, Kasper, I'd like -- if you could comment on the longer-term plans for the China rollout of new cities and kind of whether you are still committed to that, given the changes in the marketplace there, as well as the reason for the lower prices demanded by the government. I remember your predecessor, Steve, had talked about other products in the market that seemed to be charging significant amounts for what you viewed as not that much efficacy. So is that one of the major reasons you see as to why the government is moving forward? So I guess there's 2 questions in there.

Peter Kasper Jakobsen

Let me deal with the second part of your question first. I can only reiterate what we've said on previous calls, that we have -- believe that it was unwise for anybody to launch products without significant scientific differentiation at prices that were significantly higher than any other part of the world into the Chinese market. And we have said that we did not intend to do so unless we felt that we could provide a true scientific substantiation for those prices. I don't want to speculate as to what has prompted the Chinese government to conduct this probe, that would clearly be speculation. And as it's an ongoing investigation, it wouldn't be wise for me to enter into that space. I do want to make the point that we've been in China for a very long time, and we look forward to being there for many, many, many more years, and we're very committed to being responsible corporate citizens in China. We employ a lot of people there. We've manufactured there for 20 years and it's an important part of our overall success as a company. As a -- with that backdrop, we don't see ourselves making any changes to our strategy in China that involves city expansion over time. And indeed, we are returning to growing the number of cities in which we have a full marketing presence later this year. So all of that, maybe just to wrap that all up by saying that we understand that this is sort of a period of uncertainty and there are some adjustments happening in the Chinese market, but we still continue to see this as being a tremendous growth opportunity for the company and we'll continue to make investments in China.

Operator

Your next question comes from the line of Jason English from Goldman Sachs.

Jason English - Goldman Sachs Group Inc., Research Division

I'll try to keep this brief given the unfortunately short conference call today. The broad -- stepping -- staying on China, stepping away from the NDRC, there's a broader regulatory overhaul of the dairy industry and infant formula market underway there. Can you elaborate on exactly how that's unfolding and what you expect the outcome to be and maybe the timeline of that?

Peter Kasper Jakobsen

We don't have specific insights beyond what you probably have access through the media, Jason. We understand that the new administration in China has mapped out a new vision for particularly the local industry. We understand that it involves a vision of consolidation, the creation of fewer but stronger local operating companies. And that's about as far as I think we can comment. And there's nothing different from what you probably have read in the media.

Operator

Your next question comes from the line of Matthew Grainger from Morgan Stanley.

Matthew C. Grainger - Morgan Stanley, Research Division

I apologize, I have to ask one more question about China. The -- just, with respect, Kasper, to your comments on relative price gaps among the premium brands in the market, I believe some of your premium foreign competitors have announced a combination of list price reductions and a commitment to maintain their existing promotional discounts. I mean, if you are seeing some degree of flexibility in moderating promotional spend, does that lead to any concern within the company about potential widening of price gaps between your brands and some of your stronger competitors?

Peter Kasper Jakobsen

We'll continue to monitor the competitive environment very closely in China, but we believe that included in the financial projections that we reflected in this earnings call, we have enough flexibility to make sure that we maintain the sort of competitive pricing relativities at a level we feel comfortable with.

Operator

Your next question comes from the line of Bryan Spillane from Bank of America.

Bryan D. Spillane - BofA Merrill Lynch, Research Division

I just wanted to ask a follow-up to Matt's question. So just to understand, first on promotions, when you're talking about promotions, is it just simply a discounted price in the store? Or is it other sort of incentives that you would offer at point-of-sale? So I'm just trying to understand the nature of what the type of promotions are. And then second, just for some clarity, the guidance you've provided and the estimate you provided in terms of the effect that the price cut has on your sales on an annual basis, that is net of a reduction of promotions? Or that assumes that the level of promotional activity is exactly the same? And then maybe if I could, just again for clarity, I guess, I was -- I'm a little confused in thinking that there was an expectation or the design of the negotiation between yourselves and the regulators was to sort of get a shelf price that was "acceptable". But if there's some variation in the promotion, it just seems to me then, whatever, the shelf price could actually move around a little bit. So if you could help with some clarity on those topics, that will be helpful.

Peter G. Leemputte

Let me address the second question in there with regard to what's in our guidance. We said there is that $30 million or so impact on reduced sales this year from the price rollback and it's offset by 3 factors: Stronger growth in our other markets outside of China; the fact that in light of the price rollback, we anticipate there could be fewer promotions that we might offer in the marketplace; and then the third is that Hong Kong came in better than we expected. And all of those are included in our guidance and we're not going to get more specific on what we're going to do there. We're still in an active investigation with the government.

Peter Kasper Jakobsen

I think just in general, maybe I can just add that promotional activity, sort of by definition, is short term in nature, and uneven in the sense that it occurs at different times in different accounts and in different regions. And hence, you can't look at it as a simple sort of impact on an average base price. That's not the way that the Chinese regulatory body looks at it. It's not the way that we look at it, either. So I -- I don't think you need to be overly concerned with either eroding competitiveness, or for that matter, the fact that there would be no benefit seen on pricing in China.

Operator

Your next question comes from the line of David Driscoll from Citi Research.

David Driscoll - Citigroup Inc, Research Division

I wanted to ask, Hong Kong, the fundamental question is, who's buying the product? And then maybe a little bit more detail is, it was my understanding that you had about $350 million of annual sales in Hong Kong and that the -- more than half of it, maybe well more than half of it, was in fact, privately exported to the Mainland. The private -- the restrictions that the Hong Kong government then put into place, kind of at face value, say that this can't happen. So then I think there's a nice logical impression on my part that, that would reduce sales. I think it's pretty tremendous that you're able to say that sales actually grew year-over-year in the quarter. And so I, can I just say simply, who's buying the product?

[Technical Difficulty]

Operator

[Operator Instructions] All right. So Ms. MacDonald, are we going to go ahead and continue taking the questions?

Kathy Ann MacDonald

Yes, so we're going to -- for all of those on the phone, we will definitely extend this to make sure that we make up for the time. I think is the next one -- who is next on the line?

Operator

We actually had David Driscoll that was on the line. So I guess that he needs to finish his question. His line is now open.

David Driscoll - Citigroup Inc, Research Division

So my question was on Hong Kong. Just to -- I think you heard it, but just a quick recap, the question is kind of who's buying the product. It was my understanding that the bulk of this got exported, privately speaking, from Hong Kong to the Mainland and I wondered if you could just give me some understanding as to how the situation is working, because it's a very impressive result that sales are actually increasing year-on-year.

Peter Kasper Jakobsen

Yes, David, we believe that the bulk of our products sold in Hong Kong is still being exported or being brought across the border into Mainland China. You will remember that this is not a ban on doing so, it's simply a restriction on how much any individual person can carry at any one time. We have said that the sales in Hong Kong were down from the very high levels we saw pre-restriction in January and February. However, what we have seen in the subsequent 3, 4 months is that sales have now stabilized and appear to be relatively stable at a level that would, on average, through the year, allow us to report growth for the full year.

Operator

Your next question comes from the line of Leigh Ferst from Wellington Shields.

Leigh Ferst - Wellington Shields & Co., LLC, Research Division

Could you give us some color on the strength in Latin America beyond Mexico, maybe in the Southern Cone and some other areas?

Peter Kasper Jakobsen

Sorry, Leigh, I didn't catch the question on Latin America, what was your specific question?

Leigh Ferst - Wellington Shields & Co., LLC, Research Division

Could you give us some more color on the strength in Latin America beyond Mexico?

Peter Kasper Jakobsen

Yes, I mean, we've talked about it in previous calls also and we remain very encouraged by the progress we are making in building an infant formula business in Brazil. So I guess I would call that out as a highlight. You know that we have previously referred to the establishment of the infant formula business in Brazil as a seed market. Another highlight is tremendous strength in our Andean region and that really goes right across the countries that make up that portion of the world. We are seeing strength in Colombia, Peru, Ecuador and in Venezuela at this time. We've been in these markets for a very long time and we hold very strong market share positions in all of these markets. And that's really benefiting us now.

Leigh Ferst - Wellington Shields & Co., LLC, Research Division

And are you able to grow share in those markets?

Peter Kasper Jakobsen

In the -- I mean, it varies from country to country, but what we have done and what we have seen is a very strong share growth in Colombia, in Ecuador and in Venezuela as of late. I think Peru is perhaps a bit more stable, but we have a very high share there already.

Operator

Your next question comes from the line of John Baumgartner from Wells Fargo.

John J. Baumgartner - Wells Fargo Securities, LLC, Research Division

Kasper, if we could speak to South Asia a bit and what your expectations are there for driving the sales acceleration in the back half? And maybe what you perceive as the largest risk to your outlook there?

Peter Kasper Jakobsen

I think we feel good about the share momentum that I referenced in the prepared remarks, with share growth in Thailand, Malaysia and Vietnam. We also, I guess, seeing encouraging prospects in the Philippines for a stronger second half performance than we had in the first half performance of the year. So that's sort of what underpins the assumption of associated growth in that region. If I was to highlight any risks, I guess, the strengthening dollar poses an FX risk for us across many of these emerging markets. Pete referenced the headwind that we assume from foreign exchange in the second half of the year. But beyond that, I think that region is diversified enough that we feel pretty good about the outlook.

Operator

Your next question comes from the line of Jon Andersen from William Blair.

Jon Andersen - William Blair & Company L.L.C., Research Division

Just shifting gears to the U.S. Are you seeing higher births in the U.S. now? And is that a reason for your expectation for higher growth in developed markets this year?

Peter Kasper Jakobsen

No, we're not seeing higher births in the U.S., but what we are seeing is that births appear to be in line with prior year, which is a marked improvement over the last several years, where we have continued to report declines in births. We are still seeing some shrinkage in consumption on a per capita basis, but we are hopeful that, that will eventually turn around as well. So I would characterize the birth trend more as a stabilization as opposed to a reversal.

Operator

Your last question comes from the line of Robert Moskow from Credit Suisse.

Robert Moskow - Crédit Suisse AG, Research Division

Operating margins in North America/Europe used to be in the low 30s and they're now kind of in the low 20s. And I wanted to know, to what extent have volume declines in the U.S. contributed to lower operating margin? I know there's been a lot of other factors at play. And I found it actually a little curious, Kasper, that you said that you're actually increasing the advertising or marketing investment in the U.S. right now. What is your strategy there for the U.S. given that you probably have a 3% headwind from increased incidence of breast-feeding on an ongoing basis?

Peter G. Leemputte

Rob, this is Pete. First, with regard to your margin question, from the time when we saw those 30% EBIT margins immediately prior to our IPO, today, we've seen a decline in volumes in this industry that's quite significant and deleverage in our manufacturing plant definitely has had an impact on our gross margin. You've seen us talk about price increases the last couple of years, but the whole industry, I think, has been more hesitant to take pricing over the, maybe a 5-year period here in general, because of the births situation. And the other thing I would point out is that we have made a decision consciously to continue to invest in this business for when the recovery comes. And I'll turn it over to Kasper to talk about that.

Peter Kasper Jakobsen

Pete, I think you've captured it well. I think, Rob, just really to repeat what I said in the prepared remarks, we think that the North American market is still enormously important to us, and on a longer time horizon, offers a growth opportunity as well. Therefore, we have made a very serious commitment to maintaining our strong competitive position in that market. And we are proving that we are willing to invest in order to do so.

Kathy Ann MacDonald

Operator, we're now ready to end the call.

Operator

Ladies and gentlemen, that will conclude Mead Johnson Nutrition's Second Quarter Conference Call. You may now disconnect. Have a great day.

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Mead Johnson Nutrition (MJN): Q2 EPS of $0.84 beats by $0.01. Revenue of $1.05B beats by $0.01B. (PR)