Mead Johnson Nutrition's (MJN) CEO Kasper Jakobsen on Q2 2014 Results - Earnings Call Transcript

Jul.22.14 | About: Mead Johnson (MJN)

Mead Johnson Nutrition Company (NYSE:MJN)

Q2 2014 Earnings Conference Call

July 22, 2014, 9:00 AM ET


Kathy MacDonald - VP, IR

Kasper Jakobsen - CEO

Pete Leemputte - CFO


Bryan Spillane - Bank of America

Robert Moskow - Credit Suisse

Jason English - Goldman Sachs

Eric Katzman - Deutsche Bank

Matthew Grainger - Morgan Stanley

David Driscoll - Citi Research

Ken Goldman - JPMorgan

John Baumgartner - Wells Fargo

Amit Sharma - BMO Capital Markets

Diane Geissler - CLSA


Good day, ladies and gentlemen, and welcome to the Mead Johnson Nutrition Second Quarter and First Half 2014 Earnings Conference Call. My name is Danielle and I will be your coordinator for today. At this time all participants are in a listen-only mode. Following the prepared remarks there will be a question-and-answer session. (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 MacDonald

Thank you, Danielle, and good morning. Welcome to Mead Johnson's second-quarter 2014 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 Provisions 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

Today's comments will include discussion of non-GAAP financial measures. A reconciliation of these measures to comparable GAAP measures appears in our morning's earnings release posted on the Investor section of our website.

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 dates. 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.

I would now like to turn the call over to Kasper.

Kasper Jakobsen

Thank you, Kathy, and good morning to all of you. Thank you for joining us on this call. I’ll highlight the overall operating performance for the second quarter of 2014 before discussing each of our segments and our updated earnings guidance. Pete will then follow and provide a few additional details on our financial performance, and finally I’ll wrap up with some comments before we take questions.

Turning now to the second quarter, the quarter unfolded largely as we expected with strong revenue growth and EPS growth impacted by foreign exchange, higher commodity costs and significantly higher advertising and promotion spending associated with key marketing initiatives.

As you likely read in this morning’s press release, sales grew by 10% on a constant dollar basis. Pricing gains in the high inflation environments of Argentina and Venezuela contributed 1 percentage point of growth within the quarter.

We saw double-digit growth for the company in total within Asia and as a whole and within China/Hong Kong. Encouragingly, we again saw growth in our North America/Europe segment, driven by stronger pricing, market share gains in North America infant formula and continued growth in our children’s business.

Overall, volume growth was strong at 5%. Pricing and productivity helped partially offset the impact of higher dairy costs. Innovation is a fundamental driver of growth for us and within the second quarter, we invested in marketing initiatives that included the launch of our low glycemic index children’s reformulation in several additional markets in Asia. This introduction was highlighted with new packaging graphics.

We also continued to invest to generate awareness and trial for our children’s products in the U.S. Important clinical research was published in the May edition of Pediatrics, the official journal of the American Academy of Pediatrics. The study, which was completed in China, compared an Enfagrow formulation containing DHA, our blend of prebiotics and beta-glucan, to cow’s milk and demonstrated, as expected, that our Enfagrow formulation resulted in fewer episodes of acute respiratory infections.

As we had expected, our non-GAAP gross margin of 61.8% was down by 180 basis points versus the first quarter. The impact of higher dairy costs became evident through the quarter. Pete will provide further details in a moment.

Advertising and promotional spending of $175 million in the quarter was at a record level. Spending once again approached 16% of sales and was up 170 basis points sequentially from the first quarter. Significant variation in the level of demand creation spend reflects timing of marketing initiatives and is entirely consistent with patterns we have seen in prior years.

Despite lower gross margin and increased investment in growth, non-GAAP earnings per share increased slightly from prior year’s quarter to $0.88 per share. This was in line with our expectation.

Let me now comment on the performance of each of our reporting segments, starting with Asia. In the second quarter, revenue in our Asia business grew 11% on a constant dollar basis over prior-year quarter; 6% came from volume gains and 5% from improved pricing.

We’re pleased that our China/Hong Kong business continued to grow double digits in constant dollars and it remains an important driver of the segment’s growth. I know many of you are very focused on developments in China and the ongoing changes in the regulatory environment there. I’m pleased to report that in the first half of this year our manufacturing licenses were renewed for both our local plant in Guangzhou and key base of supply sites outside of China.

I want to be clear that we support the government’s initiative to strengthen supervision over quality and safety of pediatric nutrition and we are fully committed to meet future requirements as they occur. I also want to mention that we will begin production at our Singapore facility in the third quarter. We achieved our originally planned timeline and the construction project came in slightly below budget.

In the balance of Asia, we again saw solid sales growth. Volume growth accelerated in markets where we had recently invested in innovation of brand renewal. We are pleased with the recent market share gains, especially in Thailand and Malaysia.

Across the region, price increases and gains in productivity have been critical to mitigating some of the impact of rising dairy costs. Gross margin was pressured by start-up expenses in our Singapore plant, as well as the impact of these rising dairy costs. Notwithstanding these challenges, we continue to raise our investment in demand generation. Within the quarter, the region’s EBIT increased to $196 million from $192 million, thanks to higher sales and despite the lower gross margin.

I turn now to Latin America. Constant dollar sales grew 14% in the second quarter; 6% from volume and 8% from pricing. Venezuela and Argentina accounted for most of the price gains. Volume growth was broad based and stood at 9% outside of these two markets.

Foreign exchange adversely impacted dollar-denominated growth in the region by 13%. Constant dollar revenue growth in the quarter at 14% was somewhat lower than the 21% growth we saw in the first quarter. Several factors contributed to our lower growth rate in the quarter.

As stated in our earnings call in April, we decided to manage our Venezuela financial exposure conservatively by ensuring shipments to reflect both fewer in-market consumption and the availability of U.S. dollars to pay for matching product imports. Reported sales in Venezuela consequently fell noticeably versus the prior year’s quarter due to lower volume and a much weakened bolivar.

In Peru, our volume growth was negatively affected by the temporary and disruptive promotional strategy of a certain retailer, while in Mexico, our largest market in Latin America, we saw solid performance and sequential improvement versus the first quarter. In Brazil, we continued to grow market share of infant formula despite a challenging economic environment that has somewhat impacted growth in our children’s business there.

In the second quarter EBIT Latin America grew by 12% in dollar terms over prior year’s quarter, despite slightly lower gross margins and an unfavorable foreign exchange environment in Venezuela and Argentina.

Let me now turn to the North America/Europe segment. Revenue in our North America/Europe segment grew 4% and we achieved market leadership in U.S. infant formula for the first time in several years. This reflects our general progress as we, over several years now and across two generations of leadership, have continued to invest in innovation and marketing despite a challenging market condition.

Exemplifying this, we also continued to invest in our toddler milk initiative and we continued to make progress in the second quarter. In our last conference call, we mentioned that there were a few timing factors that boosted first quarter sales growth, namely lower weak accruals and U.S. retailer inventory adjustments. These factors reversed as expected in the latest quarter.

Wrapping up my remarks on this segment, North America/Europe EBIT was down 9% in the second quarter, due to phasing of demand creation investments and the timing impact of weak accruals. Looking at year-to-date EBIT to eliminate any noise from timing, you’ll note that our North America EBIT margin of 21.7% is similar to that of the first half of 2013.

Let me now summarize our 2014 full-year outlook for the total company. This morning we revised our guidance for revenue growth and we now expect constant dollar revenue growth of not less than 9% for the full year, up from the approximately 8% on which our prior guidance was based. The improved outlook for sales growth comes mainly from North America. Based on strong year-to-date results, we are raising our North America/Europe constant dollar sales guidance and now anticipate growth in the mid-single digits for the full year.

For Asia, let me note that quarterly sales comparisons will get tougher in the third quarter. Competitors in China experienced supply disruptions in the third quarter of 2013 and a benefit accrued to us as a result. We remain confident, however, in our long-term growth prospects in China.

While there will be puts and takes amongst markets, our full-year outlook for Asia remains unchanged at this time with constant dollar sales growth expected at rate similar to prior year. In addition, in Latin America, we expect to deliver strong double-digit constant dollar growth for the full year although reported dollar sales growth will be significantly offset by weaker currencies.

Talking now again about our global outlook. Based on current exchange rates, we now expect currency headwinds to reduce reported dollar sales by 5% for the full year. On a full-year basis, we expect advertising and promotion to run about 15% of sales, in line with the 14.8% seen in the first half of the year.

Reflective of these regional trends, we revised our expectations for non-GAAP earnings per share to between $3.65 and $3.72 per share, compared to the $3.60 to $3.72 per share in our last conference call. This reflects increased confidence in our revenue outlook while recognizing a challenging currency environment.

I’ll now turn the call over to Pete who will provide a little more texture on our financials. Following Pete’s section, I’ll return with some wrap up comments before we open the lines to questions. Pete, over to you.

Pete Leemputte

Thanks, Kasper, and good morning, everyone. Kasper already addressed sales growth, so I’ll start my remark on foreign exchange, then provide some additional detail on earnings with a focus on trends moving into the second half and wrap up with comments on our balance sheet and cash flow.

You recall that in the first quarter we moved to mark-to-market accounting for our pension plans. We saw an unfavorable mark-to-market adjustment in the net value of our pension liability in the second quarter. This is treated as a specified item and excluded from our non-GAAP earnings.

In addition, please note that the mark-to-market pension change shows up in our corporate/other financial data and does not affect earnings or margins for our geographic segments. Several expense categories, including cost of goods sold, are impacted by the pension adjustment. As a result, we have provided the bridge from our GAAP to non-GAAP earnings by expense category for our specified items. The rest of my comments will be focused entirely on our non-GAAP numbers.

As Kasper detailed, constant dollar sales grew by 10% in the second quarter. Foreign exchange reduced sales growth by 5%, resulting in reported sales growth of 5%. Relative to the prior year quarter, the most significant weakening of local currencies continued to be seen in Latin America. In Venezuela, you may recall, we adopted the higher SICAD I exchange rate for use in our financials at the end of February. Our second quarter sales, therefore, reflected a full impact of the devaluation.

Pressure on the Argentine peso was also seen. Asia was not immune to the strengthening dollar with foreign exchange reducing reported sales by 3%, the toughest quarterly comparison we’ve faced since our IPO. The Chinese renminbi and the Indonesian rupiah both weakened on average during the second quarter versus our earlier expectations. On a full-year basis, we now expect that foreign exchange will reduce sales for the company by about 5% as compared to 4% in our prior guidance.

We currently expect that currency impact will reduce earnings by about $0.03 versus our earlier guidance based on current exchange rates. Finally, let me point out that there is some risk of a further devaluation in Venezuela late in the year. The government has multiple exchange rates in use from 6.3 bolivars all the way up to 50 bolivars to the dollar. Reports have started to circulate that the government might seek to converge to a rate above the June month-end SICAD I rate of 10.6.

Turning to profits, in the second quarter, non-GAAP gross margin was 61.8%, down 180 basis points from 63.6% in the first quarter of 2014. This was expected and largely reflected the impact of higher commodity costs with a smaller negative effect coming from the timing and the level of weak accruals, as well as the stronger U.S. dollar.

Please note that the higher commodity prices reflected in the cost of goods sold for the second quarter relative to the first quarter included not only higher dairy costs but also increased costs for packaging cocoa and some other commodities as well. Higher pricing and productivity initiatives were partial offsets.

On a full-year basis, we expect gross margins to come in slightly above 62%. Gross margins in the second half will therefore be at or slightly below the 61.8% reported in the second quarter. We expect that gross margins will bottom out in the third quarter at a level slightly below 61.8% before recovering a bit in the fourth quarter. The dip in gross margins in the third quarter is largely from higher start-up costs for the Singapore spray dryer.

The facility will begin commercial production in August. We continue to expect that the full-year impact on earnings in 2014 is about $0.10 per share. We had $0.02 in each of the first and second quarters related to pre-production start-up costs. The residual $0.06 will be spread about equally across the remaining two quarters and is primarily related to the impact of low capacity utilization.

The strong dairy headwinds, which were evident in the second quarter, affected all three segments with the most pronounced impact being in Asia. Higher dairy costs will continue through the second half of the year, but there will be a slight moderation in dairy costs as reflected in our cost of goods sold during the fourth quarter based on trends in spot prices seen early in the year.

In the last month or two, we have seen steeper declines in spot dairy prices. If this is sustained, it creates a bit of a gross margin tailwind as we move into next year. At this early day, however, it would be premature to count on that trend continuing throughout 2015. In addition, the cost of innovation and additional demand creation investments to fuel growth could partially offset any benefit that might materialize.

As a percentage of sales, our operating expenses were generally in line with the prior-year quarter. Sequentially, the $20 million increase in dollar spending in the second quarter as compared to the first quarter was expected. Advertising and promotion spending which stood at a record level of $175 million in the quarter accounts for almost all of the increase.

Please note that on a full-year basis, we continue to anticipate operating expenses slightly below 38.5% of sales. That spending rate is above the 37.8% in the first half. As a result, spending, measured on a percentage of sales basis, would be higher than the full-year average in the second half.

Based on the gross margin and operating expense assumptions I just detailed, EBIT margins should approach 24% for the full year, consistent with our performance in all years from 2010 onwards. That’s excellent performance in light of the dairy headwinds and stronger U.S. dollar we faced in 2014, both of which are driving lower margins.

Turning to taxes, our non-GAAP effective tax rate, or ETR, was 23.8% in the second quarter and 24.8% on a year-to-date basis. On a full-year basis, we expect that our ETR will be near 24%.

Moving on to a discussion of our balance sheet and cash flow, you’ll note we had a busy quarter on the financing front. Our cash balance stood at just under $1.6 billion at the end of June, up from $1.1 billion in March. That’s the result of $500 million in new 30-year debt due in 2044 that we issued in the second quarter.

We issued the new bonds as part of our refinancing plan for $500 million in bonds that are due in November of this year. Given the rising interest rate environment seen in the second half of last year, we had entered into a plain vanilla interest rate swap early in the fourth quarter of 2013 to lock in rates.

Since interest rates continued to rise during the remainder of 2013, the hedge had a net positive value of about $20 million at year-end. With a relatively steep drop in interest rates seen in 2014 on weakening economic news here in the U.S. and abroad, the value of that hedge fell to a net liability position of $45 million by the time we unwound the swap in connection with the new debt offering.

That $45 million was a one-time cash outflow in the second quarter, but for accounting purposes, it is amortized over the 30-year life of the new bonds. There was very strong demand for our bonds and, as a result, we were able to secure very long-term financing at an attractive all-in rate of 4.9%, including the amortization of the interest rate hedge.

I should mention that the credit spreads we paid over treasuries were quite attractive and reflected the earlier credit upgrade we received from S&P to BBB+. We have called the November 2014 bonds and will retire those in mid-August, about 2.5 months before their final maturity. This action will bring our cash balance down by about $500 million.

Interest expense in the second quarter stood at a bit over $15 million, up $3 million from the first quarter as we carried both the 2044 and 2014 notes for half the quarter. You should expect to see interest expense grow to about $18 million in the third quarter as we will have an early call premium on the 2014 notes.

Please note that there is no real economic penalty for the early retirement. Under the terms of these existing bonds, this premium in effect reflects the net present value of those 2.5 months of interests, basically an acceleration of the future interest recognition.

Fourth quarter interest expense will be about $14 million and will reflect a full and clean quarter under our new debt structure. For the full-year 2014, interest expense is expected to be about $60 million. This is slightly higher than prior guidance as we moved a bit earlier with the new bond issuance given favorable trends in the market.

I also want to point out that we amended our revolving credit agreement during the second quarter, extending its term from 2016 to 2019, increasing the commitment level to $750 million and reducing both annual fees and the spreads paid on any drawdown. Free cash flow, defined as operating cash flow less capital expenditures, was about $210 million after consuming $95 million in cash for capital spending in the first half of 2014.

Working capital increased to support the growth of the business and particularly inventory as we prepare to bring our Singapore spray dryer online. One final point on cash flow, capital spending for the full-year is expected to remain unchanged at $180 million. Depreciation and amortization expense should be about $90 million.

To summarize, our 2014 non-GAAP earnings are expected to be in the range of $3.65 to $3.72 per share on at least 9% constant dollar sales growth. Foreign exchange will reduce sales growth by about 5%, assuming currencies remain at their current level, bringing reported sales growth to at least 4%.

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

Kasper Jakobsen

Thank you, Pete. Let me just provide some summary comments before we open the lines for questions. In summary, we’re pleased with our continued momentum in our earnings trajectory. We knew from the beginning of the year, our gross margins would come under pressure from rising dairy costs and certain once-off expenses. I’m pleased with the work done throughout our organization to substantially mitigate impact on earnings through productivity and improved pricing.

But I’m equally proud that we again this quarter demonstrated our commitment to invest aggressively in our future. Investment in demand creation and innovation grow substantially in the quarter, helping increase our confidence in a stronger outlook for annual revenue growth.

Finally, I want to remind you all that we are still only halfway through the year, much can still happen, but the change to our revenue and earnings guidance reflects our increasing confidence in the outlook for the year.

I’ll now hand the call back to Danielle, our operator, who will open the lines for questions.

Question-And-Answer Session


Thank you. (Operator Instructions) and our first question does come from Bryan Spillane from Bank of America. Please go ahead.

Bryan Spillane - Bank of America

I have a question just related to China/Hong Kong, I guess over the last few weeks, we feel that if you increase or from context there, just suggesting that maybe the market had slowed somewhat sequentially in May and then again potentially in June and that may be there been a little bit of heightened price competition there. So can you just kind of talk about just situationally how the market has evolved over the course of the quarter and if there’s anything that’s really meaningfully changed in terms of the market environment there? Thank you.

Kasper Jakobsen

Bryan, thanks for the question. And I think the first thing I would say is and I think I mentioned it before to you all on this call that it is very, very hard to read the China market at the moment because there is an enormous amount of channel fragmentation taking place in China. So getting an accurate read on what’s happening in the total market and to underlying consumption is very tough indeed, so we tend to focus on our own business and what we are seeing and though we recognize that we have opportunities to improve our presence in certain channels, as we’ve talked before, we remain satisfied with the plans we have and with the outlook for the full year.


Thank you. And your next question comes from Robert Moskow from Credit Suisse. Please go ahead.

Robert Moskow - Credit Suisse

A quick question on Venezuela and then, maybe a follow-up on China. When you entered the year, Pete and Kasper, I think you had a pretty conservative view as to what Venezuela could do especially considering the tough comps on volume and certainly those tough comps came in today. But I was wondering, are you shipping more volume in than you expected? And you’re not getting as much price as you may need, but are you getting more pricing than you thought, to what extent is that helping your guidance or maybe not at all?

And then just a follow-up on China, I mean I think it’s very hard for us sitting here to read the China market, are you having difficulty reading the China market? Is that what’s implied by your statement? And because of all these channel shifts and how is that influencing your ability to do business?

Pete Leemputte

Bob, this is Pete. With regard to Venezuela, I think I had mentioned in our last call that we were expecting $0.04 to $0.05 per share in contribution in EPS from Venezuela in total this year. That really hasn’t changed any significantly at this point in time. Volume has really kind of uncovered -- unfolded as we expected in the second quarter. Pricing, no big changes either.

The only thing I would point out is that our plans there were, as Kasper said, we’re operating the business conservatively, but we want to get cash for our product. And the good news is that we’re seeing better payments from the government in the quarter than maybe what we had expected earlier. If that continues, that might allow us to increase volumes at some future point, but we don’t anticipate at this point in time, that’s the case.

Kasper Jakobsen

Let me go back over to the China situation. Certainly it is, as I said earlier, it’s very challenging to read the China market, because there is so much fragmentation of channels, some of which are measured, some of which are not measured and a lot of them trade with each other. So there is the risk of double accounting when one looks at that.

So what we tend to do is, we tend to focus on the numbers we have the greatest metrics, we have the greatest amount of confidence in, which are the uptake numbers that we can read ourselves as reflected in distributor sales and retailer sales. And we remain confident and satisfied with the trend we are seeing in those metrics.


Thank you and your next question comes from Jason English from Goldman Sachs. Please go ahead.

Jason English - Goldman Sachs

Picking up where Rob left off, based on the metrics you kind of rate in China, what is your beat on market growth rate right now for the category? And then, my other question relates to the innovation, the low glycemic product, Can you elaborate a little bit more on some of the markets you’ve rolled that out to, exactly when you rolled it out to? And also, does this enable you to roll it out at a slightly higher price point to hopefully cover a little more of that inflationary pressure that you’re feeling today?

Kasper Jakobsen

We haven’t really changed our view of China significantly. As you remember, I think if we go back about a year, you’re highlighting to us the fact that we thought the market was growing significantly slower than some of our competitors thought. And I guess, as a consequence of that perhaps, we’ve not really changed our outlook for the market very significantly.

We still believe that we’ll be looking at sort of a mid-single digit volume growth, amplified by some growth in pricing. At the moment, that growth in pricing is arguably more driven by segment shifts than is driven by price increases, but we expect that price increases will return to the China market at some time in the not-so-distant future.

With regards to your question regarding where we rolled out our Enfagrow reformulation, to-date we’ve rolled it out in Thailand, Vietnam and Singapore.

Kathy MacDonald

Great. Operator, can we go on to the next call?


Thank you. Our next question comes from Eric Katzman from Deutsche Bank, please go ahead.

Eric Katzman - Deutsche Bank

I guess I realize Kasper your comments about we’re only halfway through 2014, so we don’t want to get too ahead of ourselves. But just I guess, Pete, to the extent that you’ve got a number of one-time, let’s say, items this year, maybe I guess depending on how you measure it, $0.06 to $0.10 on the Singapore facility, you had a couple of pennies from the Venezuela devaluation, balance sheet re-measurement, just called out some additional costs on the bond call option or call premium and you mentioned some possible tailwind from dairy costs.

So when you’re at our conference in Paris, you couldn’t have emphasized more the desire to spend back into the business, but it just seems that with some of these items, 2014 versus ’15, there is a lot that is swinging, let’s say, unusually positive at this point. Maybe, Kasper or Pete, you could kind of frame a little bit as to how we think about it?

Pete Leemputte

I think the biggest potential upside that could exist is dairy. And if you listened to what I mentioned, we have seen a drop in dairy prices. The biggest drops really have been seen in the New Zealand market, roughly 20% and keep in mind that accounts for less than 40% of our total dairy purchases, it’s been much smaller elsewhere. That’s where we’ve seen it, but it’s only July and while we’ll enter the first quarter with lower dairy, we think it’s premature to sit there and count on that for the full year at this point.

So you could do your own math around what that could be, but I think your points on interest expense is a good one, the run rate will be something closer to $50 million a year versus the $60 million that we had -- that we’ll have this year. And another point I would make here, when we’ve talked about this in the past has been the Singapore start-up costs are $0.10 this year, that’s not going away in its entirety next year.

We still will have lower plant utilization in 2015 than our target. It should improve as you move through the year, but we expect that we’re only going to eliminate maybe half of that $0.10 in next year. Other than that, we’re not giving guidance for 2015 at this point and as we get closer to the end of the year, we’ll probably be in a better position to address that.

Kasper Jakobsen

Eric, I just want to add to that, as I did in the conference in Paris that we still believe that our ability to create long-term shareholder value is intimately linked to our ability to sustain attractive revenue growth over time, and therefore, we will continue to prioritize investment in meaningful demand generating activity where we can. And to the extent that we have any tailwinds when we get to next year, we will be looking for opportunities to use at least a sizeable proportion of that to underpin the future growth prospects.

Eric Katzman - Deutsche Bank

And Kasper, based on last year’s analyst meeting, I think you kind of emphasized the company’s capability in R&D and clinical-backed studies et cetera, do you see that 2015 is a greater year for new product introductions and could that be one driver of higher A&P spending?

Kasper Jakobsen

Well, I mean, I think we always have the ability to either bring forward certain projects or perhaps more easily expand the number of countries in which we introduce certain initiatives. So that’s a process, a planning process, that we generally finalize through the remainder of this year and we’ll obviously do that in the context of our cost structure.

And I don’t know that I want to – made any comment beyond what I’ve said before that are sort of our long-term commitment is that we will grow earnings at or above the rate of revenue growth and I don’t know that I want to expand beyond that.


Thank you. Our next question comes from Matthew Grainger from Morgan Stanley. Please go ahead.

Matthew Grainger - Morgan Stanley

I just wanted to follow-up on the margin expansion in Latin America during the quarter. Presumably, some of this just the allocation of demand generation spend and it’s skewed towards North America and toward Asia. I think I was just surprised, Pete, the margins up this sharply when you are continuing to invest in the region and you’re pricing through quite a bit of inflation. Is this just the case or we should get used to some volatility in quarterly margins and not overthink it or are there specific factors you point out and can you give us any guidance on how you’re thinking about Latin America margins for the balance of the year?

Pete Leemputte

Your point, Matt, about not – you expect to see volatility in quarterly margins, particularly in this market, is spot on. The only thing I would add is we have always said that the timing of when we’re going to invest can vary year-to-year and quarter-to-quarter. That’s certainly the case this year.

The only thing I would point out and we had expectations on a full-year basis that we would get paid a certain level of cash by the government for the product – our access to dollars at that favorable rate of 6.3 bolivars to the U.S. dollar, we went -- the way we handle our accounting is, we are using the SICAD I rate of roughly 11 to translate our local currency results into U.S. dollars.

Then, when we do get access to U.S. dollar that 6.3 rate for product imports, we recognized a gain on that, and that’s very, very, very lumpy. And we did get some dollars, I think as I mentioned earlier, for product imports in the quarter, so that went a farther way through to help – it benefited EBIT margins in the quarter.

Matthew Grainger - Morgan Stanley

Okay. And for the full year, do you -- is it fair to say, I guess, you would expect similar to the -- total company segment operating margins to be similar to last year or any particular skew there?

Pete Leemputte

I would count on something probably close to what we had in 2013. I should say that the 23.8% EBIT margin we had in the second quarter was very close to 24% we saw for the full year in ‘13 and it’s going to be a matter of growth versus foreign exchange that’s going to drive the bottom line margin for the full year, but something consistent with last year, 23% to 24% range is probably legit.


Thank you. And your next question comes from David Driscoll from Citi Research please go ahead.

David Driscoll - Citi Research

Two questions. First one is for Kasper, second one is for Pete. Kasper, the six-month numbers for the North American segment, I mean they look pretty terrific, revenues up 7% on a constant currency basis. I understand pretty clearly that the second quarter was impacted by the timing issues, the shift between 1Q and 2Q. But I’d really like you to just spend a few minutes and talk about the detail on what’s driving the performance between infant and then the new launch in child?

And then really, can you just expand on the opportunity here, I mean this is a revenue performance we haven’t seen in a long time from this segment and I don’t -- I maybe want to just hear from you how optimistic we should be?

Kasper Jakobsen

Well, I mean clearly we are attributing the improved revenue guidance to the performance of the North America segment, David, so like you I’m encouraged by what we’re seeing and we do believe that we are perhaps seeing some improvement or beginning to see some small improvement in the underlying environment that we’re operating in.

But I think really most of the improved performance in the first half of the year has come from better execution of our plan, which -- I’m obviously pleased with that. So, I don’t know what I can expand on – I don’t know, Pete, you want to add anything on that?

Pete Leemputte

Yeah. I think it’s a combination of things, it’s increased share on infant formula, it’s the success. Remember we put a lot of money in the fourth quarter of last year into Enfagrow, we saw great growth particularly in the fourth quarter. So we’re lapping against some easier comparisons there. If we said mid-single digit annual guidance, we’re probably, for the segment, we’re running about 6% to 7% rate, the comparisons are going to get tough particularly in the fourth quarter of this year.

But it’s really a combination of all those. To some extent, we also gained the WIC contract in Florida that we started shipping in on that I think in the month of February. So that helps a bit too. And when you’re filling the distribution channel to some extent, that isn’t necessarily going to continue, so that’s why we’re seeing mid-single digits versus what we’ve seen in the first half.

David Driscoll - Citi Research

Pete, could I just sneak one more in. Just wanted to ask you for your updated thoughts on share repurchase and the balance sheet quality, we’ve been talking for a bunch of quarters here and I think you had some hope that M&A might be a part of the puzzle here in 2014, what’s your latest thoughts here on M&A opportunities and/or share repurchase?

Pete Leemputte

I think it’s very difficult to sit back and predict when and if any deals come through. We try to be out there buying in the marketplace, we did buy some shares. It’s a bit of a challenge too, we tend to do it through 10b-5 plans and we saw very good run-up in the stock price of the company over the last three quarters and that ended up limiting how much we bought, but re-evaluate that on a regular basis and I think we’re committed to return cash to shareholders through share repurchases over time, but we want to make sure that we have -- we save some of our capital, if you will, and debt capacity for deals.


Thank you. And our next question comes from Ken Goldman from JPMorgan. Please go ahead.

Ken Goldman - JPMorgan

A quick clarification. And my question, just wanted to confirm, Pete, I think you said mid-single digits for North America/Europe. I think prior guidance was low to mid-single digits, if I’m not incorrect, can you just confirm that was an actual change or --?

Pete Leemputte

That is a change, and you are absolutely right.

Ken Goldman - JPMorgan

Okay. And then, going back to dairy, how comfortable are you later this year and into next year in some of your more competitive geographies that you’ll be, I guess, able to hold on to a lot of your pricing when these lower costs start to flow through, right. It hasn’t really been an issue in the past, so I’m not overly concerned. I just – it’s a more competitive environment in some areas than we’ve seen in the past, some of your peers are getting more eager than usual to regain share. So I just wanted to kind of pick your brain on that a little bit?

Pete Leemputte

Historically, we have been able to maintain pricing in a lower commodity price environment. There are some very competitive markets right now too and people have been mentioning China to some extent. I would say the biggest thing for us with regard to pricing has been and will always be innovation and the one thing, I think I mentioned in my remarks too, is that innovation has costs and when we bring new product to market, you could see a higher cost base as a result of that. I think what dairy gives us is the ability to use some other offsets so that we don’t necessarily have to price to a higher level over the medium term.

Kasper Jakobsen

I just add to that I think in all the time that I’ve been working in and around this industry, I’ve never really seen anybody gain from lowering prices or via -- even in medium-term periods. And certainly, our strategy generally [splinters] [ph] on investing in innovation and increasing the investment in demand generation. I think those are the things that help grow the markets and therefore, really increase the opportunity for everybody and certainly that’s the way that we intend to continue competing going forward.


Thank you. And our next question comes from John Baumgartner from Wells Fargo. Please go ahead.

John Baumgartner - Wells Fargo

Pete, just in terms of Avex’s recent agreement with Fonterra, we’ve seen that, plus a few of the local China manufacturers having made some investments in land in Australia to really go after regional milk safety. So with that in mind, how does Mead approach the situation? Is this something that you’d consider in terms of investment, do you feel [forced] [ph] to respond in a competitive perspective, just why don’t if you can maybe through your supply position relative to your competitors, how the local China demands are evolving?

Kasper Jakobsen

It’s Kasper and I think I’ll take that question. There are a lot of different supply chain models being utilized in industry and I’m quite sure that several different variations of supply chain models can be made to work. Obviously, the dairy cooperatives tend to be much more vertically integrated than a company like ourselves.

We believe that we have the capabilities needed to adapt to any regulatory changes that might force any evolution on our supply chain. Obviously, we are doing a lot of studies, as you might imagine, and a lot of scenario planning to contemplate how we would respond to regulatory changes particularly in China.

And really our key focus is really to ensure that whatever supply chain construction we put in place is best able to ensure that we deliver the kind of quality and safety of products that we’ve been able to do over many years now.


Thank you. And our next question comes from Amit Sharma from BMO Capital Markets. Please go ahead.

Amit Sharma - BMO Capital Markets

Pete, a quick question for you and then, for Kasper. Can you extend your dairy coverage in this environment? Traditionally, you said seven to nine months, are you able to extend that given the favorable environment that we face are certain?

Pete Leemputte

It’s pretty difficult to do that just because hedging markets really are not very well developed at this point in time. They might be better developed five years from now, but it’s a challenge now.

Amit Sharma - BMO Capital Markets

And then, Kasper, you talked about recently about opening up the specialty and solutions market in China, can you just talk about the potential size of this segment, growth profile and what is the competitive dynamic at this point?

Kasper Jakobsen

The way we look at that market is that it’s small in its initial stage largely because diagnostic skills in China are pretty underdeveloped not surprisingly because you haven’t really had products that allowed you to treat these various metabolic disorders. Given the size of the population and the inevitable evolution of the China healthcare system, we obviously believe that it’s an important segment for the longer-term profile and growth of the company, but it’s more of a longer-term initiative than it is a near-term growth initiative.

Kathy MacDonald

Operator, we have time for one more call.


Thank you. And our last question comes from Diane Geissler from CLSA. Your line is now open. Please go ahead.

Diane Geissler - CLSA

I have a two-part question, so I think you indicated that you did see pricing in your Asia segment, China is a big piece of that, so I’m assuming that you took pricing in China in the second quarter, but if you could comment? And then I had a question about the pediatric journal article that you mentioned in terms of that study being performed in China.

I’m assuming that that means you can make the lower respiratory infection claim on the China label now versus cow’s milk. And I just -- I’m wondering how long between the time the innovation is tested between that time and the time you could see product in the market? And is that something that could be the basis of a super-premium line or would you look to move that innovation into the core line that you currently have offered in China? Thank you.

Kasper Jakobsen

Diane, thanks for the question. As you know, we try not to comment on sort of forward-looking plans and initiatives. So let me just talk more generally about the study. The study would indeed allow some promotional activity behind our Enfagrow formulation in China, however, I want to distinguish between that and the on-label claims which would, I think, be very difficult.

Typically, in most countries across the world, if you want to make claims of this nature on-label, you generally have to register products in a completely different category, which is not beneficial, it generally attracts different duty structure et cetera, et cetera and we don’t intend to do that. So I think we would envisage deploying these claims as part of our general promotional strategy but unlikely that you’re going to see them in exactly this [from unlabelled] [ph].

Pete Leemputte

The only thing I would add is that with regard to pricing too, we didn’t say that we got pricing in China in the quarter. Most of the pricing for Asia came out of -- the Asia segment came out of South Asia.

Kathy MacDonald

Operator, this will now close our second quarter earnings call.


Thank you for your participation in today’s conference. This concludes the presentation, you may all disconnect. Good day.

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Mead Johnson Nutrition (NYSE:MJN): Q2 EPS of $0.88 misses by $0.01. Revenue of $1.11B (+4.7% Y/Y) beats by $10M.