Mead Johnson Nutrition Company (NYSE:MJN)
Q2 2016 Earnings Conference Call
July 28, 2016 08:30 AM ET
Kathy MacDonald - VP, IR
Kasper Jakobsen - CEO
Michel Cup - CFO
David Driscoll - Citi
Michael Lavery - CLSA
Bryan Spillane - Bank of America
Amit Sharma - BMO Capital
Ken Goldman - JPMorgan
Matthew Grainger - Morgan Stanley
John Baumgartner - Wells Fargo
Robert Moskow - Credit Suisse
John Anderson - William Blair
Mario Contreras - Deutsche Bank
Pablo Zuanic - SIG
Good day, ladies and gentlemen, and welcome to the Mead Johnson Nutrition second quarter and first half 2016 earnings conference call. My name is Liz and I will be your coordinator 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 process, Kathy.
Thank you, Liz. Good morning and thank you for joining Mead Johnson's second quarter and first half 2016 conference call. With me today are Kasper Jakobsen, our Chief Executive Officer and Michel Cup, our Chief Financial Officer.
Earlier today, we issued our 10-Q earnings release and financial reference slides. If you have the slides in front of you, please turn to slide number 2. A detailed explanation of our forward-looking statements appears in the materials posted on our website in connection with today's conference call.
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, commodity costs, currency fluctuations, pricing, taxes, capital spending, new product launches, other growth initiatives, 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.
Today's comments will include discussion of non-GAAP financial measures. A reconciliation of these measures to comparable GAAP measures appears in this morning's earnings release and financial reference slides, which are available 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.
I will now turn the call over to Kasper.
Thank you, Kathy and good morning to all of you. Thank you for joining us on our earnings call. My comments will focus on our strategy and top line performance and then Michel will follow up with some additional financial information and elaborate on segment profitability and our company's cash flow.
Let me begin by summarizing the company's second quarter performance before I provide additional details on each of our reporting segments. Except where I note otherwise, I'll be referring to non-GAAP results. At the end of last year, we laid out a three-year plan for value creation, with this year being a year of transition. I also identified three key milestones we had used to monitor our profits against this value creation plan. I referenced these plans in our last earnings call, so let me reference them again today.
Of the three milestones we laid out, the first was to return the business to constant dollar sales growth. Today, you’ll hear us reiterate expectations for 2016 sales that anticipates that we will return to growth in the coming quarters. Within the most recently completed quarter, demand in China for new products continued to grow. Actual shipments this quarter, however, were constrained by supply shortage caused by newly introduced additional import processes at Chinese border points. More about this later. Despite these constraints, gross sales before trade support and discounts were in line with prior quarter. Net sales were lower than the quarter before, as trade support for new product introductions increased. Michel will elaborate on this a little bit later.
Our second milestone centered around our commitment to reduce our operating expense base. Year-to-date, we have delivered 47 million in expense reductions. We've already achieved nearly 80% of our annual target of 60 million. We are ahead of schedule, and in this call, we are announcing a revised more ambitious target. We're both accelerating and expanding our cost initiative by increasing our 2016 target to $75 million to $80 million in savings from the previously announced $60 million. We are also raising our three-year cumulative savings goals from $120 million to $180 million.
Our third and final milestone we said would be to invest a portion of our expense savings to fund key growth initiatives. To date, we've invested substantially behind the introduction of a fully imported Enfamil into China and the building of a toddler franchise in North America. This latest quarter, we made strong investments in support of our Enfinitas launch in China and the expansion of distribution reach. Over time, we will demonstrate to you that these investments are central to us delivering on our commitment to shareholder value creation.
Turning now to our second quarter 2016 results. We continue to manage through a challenging global operating environment. The economic growth in many emerging and developing economies of Asia and Latin America has slowed over the past 18 to 24 months. Simultaneously, political uncertainty affects many markets in both Asia and South America. These are facts, and they present near-term headwinds for us. That said, we continue to find opportunity amidst the uncertainty. We continue to invest to put ourselves in the best possible position for when a turn-around in economic growth eventually materializes. And come it will.
For the second quarter, sales for the company was $942 million. Reported net sales were $9 million lower than the prior year quarter. Currency adversely impacted our results by 500 basis points. Consequently, constant dollar sales were 4% below those of the second quarter of 2015. Price was favorable by 1% despite added trade support in China, while volume was 5% unfavorable. Second quarter sales were impacted by significant investments to secure trade support and distribution of Enfinitas in China. Though costly in the near term, these investments will help establish the brand and drive long-term revenue growth. I will return to the topics of Enfinitas a little later.
In China, a requirement for additional product testing prior to importation took effect towards the end of the second quarter, causing delays to the importation process. I want to commend the Chinese government for its actions to enhance food safety standards and importation guidelines to ensure imported products can be safely used by Chinese parents and children. During the quarter, the government implemented new testing standards for imported products within our category. The effect of this change was a temporary delay in the importation of some of our fastest-growing products from our Netherlands facility.
This drove some near-term volatility in our sales results. In the mid to long term, we, however, believe these additional processes will benefit both Chinese children and responsible operators within the industry. Outside of China, the deteriorating circumstances in Venezuela that so tragically impact the people and our colleagues there, have resulted in significantly reduced shipments to the country. When comparing to the second quarter of last year, this adversely impacted the company's sales by 130 basis points in the latest quarter.
Despite a challenging operating environment, I'm pleased with the company's earnings power. Gross margin remains strong. Our strategy to drive growth of higher-value product and product forms is working and helps offset the impact of increased investments above the net sales line. Investments in advertising and promotion represented 17.6% of net sales in the quarter. Our fuel for growth cost reduction initiative drove significant reduction in SG&A. Overall, these costs were down 9% in constant dollars in the second quarter compared to the same quarter of prior year. While we made significant investments in key growth initiatives, our EBIT margin was 24.4% in the quarter and non-GAAP earnings per share for the quarter were $0.88. Michel will expand on our earnings delivery a little later.
I’ll now discuss the performance of each of our reporting segments, beginning with the North America and Europe segment. Net sales in the North America and Europe segment were in line with the second quarter of 2015 on a constant-dollar basis, and improved sequentially from the first quarter. A 1% benefit from price was offset by lower volumes. Additionally, we experienced additional headwind of 1% from foreign exchange. The Center for Disease Control recently issued their report on 2015 US birth and birth rates.
Reported annual birth was 0.3% below the 2014 level. Breast feeding rates, however, appear to have stabilized. Our market share in the US business stabilized in the second quarter, but remained at a level lower than the prior year. In our outlook, we are recognizing it will likely take longer than hoped for to recover market share. Much of our share loss was within the specialty and solutions segment of the infant formula market, but we are confident we understand our challenges and we are addressing them.
There are bright spots within this reporting segment also. Last October, we introduced a new 32-ounce liquids packaging. This product line is now growing double digits and we are gaining share in the high-value liquids category. It is still early days for our premium-priced Enspire product, but reception from retailers has been favorable and we expect to see distribution increase in the coming quarters as we build consumer demand. Our North American toddler business, defined as products targeting children more than one year of age, continues to grow at an annual rate in double digits.
And turning to Canada, I continue to be pleased with our progress. Second quarter sales grew double digits based on strong market share gains in both the infant and children segments. We've executed extremely well over the past year or two and our Canadian team is deservedly receiving much internal recognition.
Our European business remains strong based on a leading position in the growing allergies segment there. We are well positioned to benefit from future increases in diagnosis and have a strong innovation pipeline to support our growth in Europe.
Let me now turn to Latin America. Constant dollar sales for the total region were 3% lower than the prior year's same quarter. Pricing benefits of 9% was insufficient to fully offset foreign exchange impacts of 13%. Excluding the impact of our sharply reduced business in Venezuela, Latin America sales grew 4% in constant dollars over the same quarter of 2015. Mexico and Colombia were the biggest contributors to growth.
In Mexico, we are seeing improved momentum in both our premium pediatric nutrition business and our milk modifier business. We enjoy strong market shares in our milk modifier business and retain a number one position in this category. In infant formulas, we've recently rolled out a product containing milk fat globular membranes, the same key ingredient contained in Enfinitas and Enspire products launched in China and the US. Trends in other parts of Latin America remain broadly unchanged from the prior quarter.
In Brazil, economic challenges continue to hurt demand for discretionary items like our midpriced children's products. The Enfapremium infant formula products are less discretionary and they continue to grow. We continue to benefit from strong sales in our Colombian unit, which maintained strong market shares and in addition, is benefiting from cross-border demand from Venezuela. We're rolling out our new plastics packaging and refill systems across Latin America. And in some markets, we are testing ready-to-drink versions of our children's products. These initiatives will allow us to take advantage of segment growth opportunities and support selective increases in price.
I turn now to the Asia segment. Constant dollar gross sales in Asia were in line with the second quarter of 2015. In support of the Enfinitas launch in China, trade investments, however, were significantly higher when compared to the prior year. Partly as a result of this, price was unfavorable by 2%, as the increased trade investments in China more than offset the impact of price increases in Southeast Asia. Across the region, product mix continued to improve with sales of our premium-price products growing faster than those of our lower-priced variants.
Volume was unfavorable by 5% as we experienced delays to importation in China and dealt with some market share weakness in the Philippines. Despite improving momentum in China, the Asia region has not yet recovered to sales levels seen in the early part of 2015. In the Philippines, we have seen softer market share and sales of our Lactum, our midpriced children's brand. We feel we have identified the root causes behind our share loss and have a remedial plan that will allow us to get back on track.
Our Malaysia business is growing both volume and price. We recently introduced a new formulation and improved packaging that will allow us to recover market share over time. Across Southeast Asia, we are rolling out new product formulations and promoting the benefits of our new plastics packaging. Supported by an approved value equation, we are raising prices behind this innovation.
I will finish my discussion of the Asia segment with China. In my introductory headlines, I described the import delays caused by increased processes at all border points. In mainland China, the government implemented a new requirement that every batch be extensively tested prior to release to Chinese consumers. Previously, a sampling approach had been applied. The increase in the number of tests required caused temporary delays, as testing and verification capacity was stretched. The effect of this was a temporary delay in the importation and shortage of supply of many of our fastest-growing imported line items, as I mentioned earlier. We nevertheless are pleased to see these measures implemented.
Similarly, increased customs monitoring and reduced visitor numbers have adversely impacted our Hong Kong business. It's become more challenging for our Hong Kong business to compete for visiting Chinese tourists that now can access imported products more easily from within the mainland. These challenges confirm our China strategy, pursuing increased flexibility through a broader product portfolio sold through more diverse set of sales channels.
Turning now to mainland China, where our fully imported products continues to gather momentum and we are seeing strong demand from consumers. Through the second quarter, we continued to grow market share of the imported segment. In the baby store channel, we have increased our distribution supported by our most recent new product introductions. We are seeing both our ability to make progress and the substantial runway we have ahead of us.
As of the second quarter, we are no longer underindexing versus the market in the fast-growing baby store channel. Our new Enfinitas product line is off to a solid start. Three months after introductions, we are still building distribution and demand, but we are encouraged by the early signs. In totality, I am satisfied with the progress we've made with our portfolio and channel transformation in China. I also recognize we've got a long way to go and a lot of opportunities ahead of us. It is hard not to be excited about the immense potential of not only our China business but our global business.
Before I hand over to Michel, I want to provide an updated outlook for full year 2016, our year of transition, a year in which we are addressing several structural opportunities within both our brand portfolio, our product lineup, and our cost structure. At the beginning of the year, we knew comparisons in the first half 2016 would be challenging. I'm satisfied that many of our critical initiatives have gone as planned. And we are expecting growth over prior year in the second half of the year. However, we have seen three developments causing us to revisit our estimate for full-year 2016 constant dollar sales growth.
It is taking us longer than expected to recover the market share we lost in the US towards the end of 2015. Secondly, the import-related challenges in China/Hong Kong in the second quarter cost us sales we won't fully recapture until next year. Thirdly, we are supporting our imported portfolio in China with additional trade support. In light of these factors, we now expect constant dollar sales in line with or not more than 2% below the 2015 level. Through the first half of the year, we've identified several opportunities within our cost structure. In doing so, we have found additional opportunities to both reduce costs and increase efficiencies.
In a moment, Michel will outline an expanded ambition and scope for our operating expense initiative, the project we refer to as Fuel for Growth. Despite lower sales, a slightly improved outlook for gross margin, expense optimization and the benefit realized from a lower tax rate in the just completed quarter allow us to reiterate our expectation for non-GAAP earnings per share of between $3.48 and $3.60 for the full year 2016.
I will now hand over to Michel, who will provide additional details on our second quarter and first half financial performance. I will then return with a few summary remarks before we take your questions. Michel, over to you.
Thank you, Kasper, and good morning, everyone. Today I will discuss the company's second quarter and first-half 2016 financial results. I will then briefly highlight EBIT results for each segment, cash flow, and liquidity items, and conclude with a summary of full-year guidance. Unless otherwise noted, my comments will be on the non-GAAP financial results. References to currency impacts or the effects of currency fluctuations generally refer to the impact on the translation of local currency financial statements into US dollars. In addition, my comments about sales refer to net sales, unless I explicitly call out gross sales.
Let me start with sales as shown on slide 3. Kasper addressed the constant-dollar change. I will focus on reported sales and the foreign currency impact. For both the second quarter and first half-year, adverse foreign exchange rates contributed to a 500 basis-points decline compared to the same period of the prior year. Second quarter net sales on a reported dollar basis were 9% below prior-year quarter. Reduced shipments to Venezuela impacted net sales negatively by 1% in the second quarter versus the prior-year quarter.
Slide 4 summarizes the impact of foreign exchange on sales. The US dollar continued to be strong and the effects of translation of local currencies negatively impacted all reporting segments. However, the impact was slightly less significant in the second quarter of 2016 when compared to the trend from the last three quarters. Nearly 2/3 of the second-quarter negative currency impact on sales were from the Chinese renminbi, the Mexican peso and the Argentine peso. The balance of the adverse foreign exchange impact was widespread across the regions.
As a result of the year-to-date foreign exchange impact, our outstanding currency hedges for the remaining of the year, and the current forward rates, we are revising our currency expectations from minus 6% to minus 5% adverse foreign exchange impact on sales for the full year 2016. I will address foreign exchange impact in the EPS guidance section as well.
I'm introducing slide 5 for better transparency of gross sales, which reflect sales to customers before trade investment and other items, which are recorded as gross to net sales adjustments. We reallocated some investments in the second quarter from advertising and promotion to trade investments, in support of the rollout of Enfinitas and built on our momentum of the fully imported premium products which were introduced in the second quarter of last year. Gross sales on a constant dollar basis were flat compared to the prior-year quarter and down 2% for the first half-year of 2016 versus the same period of last year. The significant gross sales improvement in the second quarter have been realized.
Slide 6. The second quarter EBIT of 230 million was 10% above the prior-year quarter on a constant-dollar basis. Foreign exchange adversely impacted EBIT by 6% including currency impacts. EBIT increased 4% on a reported basis in the second quarter. If you would exclude Venezuela, our EBIT on constant-dollar basis improved by 14% versus prior-year quarter. The second-quarter EBIT margin of 24.4% of sales was 290 basis points better than the prior-year quarter.
Despite microeconomic and country-specific challenges which impacted our sales, we made excellent progress to reduce operating expenses as part of our Fuel for Growth program, which allowed continued investments, and at the same time, improved the underlying profitability. Year-to-date EBIT was 474 million, a decline of 1% versus previous year on a constant dollar basis. Foreign exchange, an adverse impact of 8%. Excluding Venezuela, EBIT in the first half-year improved by 3% versus previous-year period on a constant dollar basis, mainly driven by a higher gross margin and our cost savings realized in the first half-year, partly offset by demand generating investments.
I will now move to the factors that impact gross margin on slide 7. Gross margin was 65.1% in the second quarter of 2016, or 66% on a constant-dollar non-GAAP basis. Adverse foreign exchange impacted gross margin by 150 basis points in the second quarter. We were able to deliver a nearly flat gross margin on a reported basis in both second quarter and the first half-year compared to the previous-year periods, despite the significant currency headwind. Sales had a slightly negative impact on gross margin from higher trade investment, especially in China.
Low dairy costs continued to be the largest benefit to gross margin in the second quarter and first half of 2016. Our key dairy components have been secured through supply contracts for the remainder of the year and we expect some further benefits, although the dairy benefits for the remainder of the year will be smaller compared to the first half-year. We continued to deliver productivity savings within cost of goods sold. Year to date, the supply chain team delivered productivity savings of around 3.5% of cost of goods sold, in line with our expectation. With dairy secured for the full year, we expect full-year gross margin to be slightly better than our prior-year guidance of 64%.
Moving to operating expenses, I will start with advertising and promotion investments on slide 8. Advertising and promotion was 17.6% of sales in the second quarter compared to 18.4% in the prior-year quarter. As previously mentioned, in the second quarter we reallocated a portion of investments from A&P to trade investments which are recognized in gross to net sales. Despite the year-over-year savings, the second quarter of both years marked noticeably higher investments. The incremental investments were mainly to support key China initiatives -- last year for the launch of our fully imported products, and in April of this year, the launch of the Enfinitas product line and the continued support of our greater China strategy.
In the second quarter, we purposely delayed some A&P investments due to delays in the importation of some of our China products impacting our sales. As such, we expect the third quarter may continue to be at an elevated level before it normalizes in the fourth quarter.
Slide 9 provides the combined spending of demand-generating investments, both as trade investments classified in gross to net sales, and advertising and promotion. Some of the key trade investment activities include trade support, customer programs, and promotional pricing. For the second quarter, the combined investment increased above the prior-year quarter and was also higher versus the last few quarters. Trade spending is focused closer to our consumer and to ensure our products are present with strong distribution in the key growing channels.
Within the past few quarters, we've increased these investments, especially in China, to be more competitive in the baby store and e-commerce channels. While we increased trade investments, we plan to reduce the A&P as a percentage of sales over the next few years. Last quarter, we committed to provide an update on our review of advertising and promotion expenditures. At Investors Day last year, when I spoke about advertising and promotion, I stated that we should be able to optimize on lower A&P by 50 to 100 basis points over three years. We can now confirm that we expect to be at the top of that range and reduce our A&P by 100 basis points by 2018. We will realize this by prioritizing investment choices that maximize our return on investments of key influence drivers. We will continue to optimize our non-media expenses and leverage our decision supporting tools better. In addition, we will strength our focus on digital marketing versus the traditional media.
Slide 10. We reduced our SG&A costs by 9% on a constant-dollar basis in the second quarter of 2016 versus the previous-year quarter, and by 10% year to date compared to the prior-year period. Like we indicated before, our Fuel for Growth program is focused on cost reduction within our support functions and marketing. Areas of focus were the reduction of key vendor contracts, eliminate discretionary spend, and optimize organizational errors.
As you can see from slide 11, we are significantly ahead of schedule on the original 2016 Fuel for Growth target. Our Fuel for Growth target for this year was 60 million. By midyear, we've delivered 79% of this year's target savings, for 47 million already. Especially in the corporate overhead functions, we were able to reduce our costs by 30 million in the first half-year of 2016 versus the first half-year of 2015. Significant progress has been made by systematically renegotiating contracts with our largest vendors.
Slide 12. Over the last few months, we performed a more extended deep-dive review of our expenses as well as our organizational structure. We concluded, based also on the success of our results to date, to accelerate certain cost savings programs identified earlier and to expand the scope to all operating expenses functions including sales force and distribution. We now expect to deliver $75 million to $80 million of savings in 2016. This is an increase of $15 million to $20 million versus our original 2016 target. Taking into account the savings realized in 2015 of 20 million, cumulative savings by the end of 2016 are expected to be around 95 million to 100 million. In addition to the original program of 120 million, we expect an incremental 60 million of our cost savings opportunities by 2018. The combined Fuel for Growth program will now deliver 180 million savings by 2018. The incremental Fuel for Growth savings will provide additional flexibility to invest in the Company's future growth.
Turning to slide 13 for discussion of EBIT by segment. Let me start with Asia. In the second quarter, Asia delivered a EBIT of 137 million, a decrease of 4% on a constant dollar basis compared to prior-year quarter. Foreign exchange adversely impacted EBIT by additional 8%, largely from the Chinese renminbi, the Thai baht, and the Malaysian ringgit. The Asia EBIT margin at 30%, declined 50 basis point compared to the second quarter of 2015. The main drivers were lower sales and an increase in trade investment in gross to net sales. The lower net sales impact was somewhat offset by a favorable dairy cost and some lower A&P expenses. For the first half-year of 2016, the Asian EBIT margin of 32%, was 350 basis points, lower than the prior year as lower sales and higher demand generation investments were not fully offset by the dairy benefit. A&P as a percentage of sales increased in the first half-year versus the previous period.
Turning to slide 14. Latin America delivered EBIT of 36 million in the second quarter, a decrease of 7% on a constant dollar basis compared to the prior-year quarter. For the segment, foreign exchange adversely impacted EBIT by 12%, largely from the Mexican peso. Excluding our Venezuela business, EBIT, on a constant dollar, increased by 9% in the second quarter versus previous-year quarter; and EBIT, on a constant dollar, increased 16% in the first half-year of 2016 versus the previous-year period. For the balance of the business, lower sales were somewhat offset by lower demand generating expenses. The year-to-date Latin America EBIT margin was 23.6% compared to 25.3% for the same period last year. The lower EBIT margin is mainly a result of a lower gross margin from the deteriorating situation in Brazil and Venezuela, somewhat offset by cost reduction programs.
Slide 15 shows the North America and Europe segment results. For the second quarter, North America and Europe EBIT was 99 million, an increase of 21% on a constant dollar basis. The EBIT margin of 31.1% was 450 basis points better than previous-year quarter. Gross margin remained strong from the benefit of low dairy costs. Within operating expenses, reduction in A&P and SG&A cost savings helped fund selective investments and drove high EBIT margins. The year-to-date EBIT margin was 29.2%, an improvement of 300 basis points versus the previous-year period. Fuel for Growth savings programs and the dairy benefit contributed to the improved EBIT margin.
I will now address the financial results from EBIT to EPS on slide 16. The interest expense of 26 million in the second quarter was similar to the first quarter 2016 expense. When compared to the prior year quarter, the interest expense increase reflects the impact of the November 2015 1.5 billion note issuance. A significant portion of the proceeds from the notes were used to finance the accelerated share repurchase program, or ASR. Since the ASR concluded on June 30, let me briefly provide you a summary of the transaction. During our Investor Day, we announced the new $1.5 billion share repurchase program, of which $1 billion would be in the form of an ASR. 10.7 million shares of stock were received in the fourth quarter of 2015. An additional 2.1 million shares of stock were received in June 30, 2016.
In total, 12.8 million shares of stock were repurchased through the ASR program at an average price of $78.05 per share. Since the IPO, the Company bought back 23.4 million of shares with a total value of $1.8 billion. There are 184.7 million shares outstanding as of June 30 and, in the last 12 months, this had a reduction of 18.5 million shares. The benefit from all share repurchase in 2015 and the full ASR program net of interest expense, delivered almost $0.05 year to date and is in line with our full-year guidance of $0.11 benefit per share in 2016. As part of the $1.5 billion share buyback program announced in 2015, we still have $500 million available for an additional repurchase program. We continue to focus on shareholder value creation. This includes EBIT margin accretion, sales and EPS growth, along with the return of cash to shareholders through both dividends and share repurchases.
Non-GAAP effective tax rate, or ETR, was 18.3% for the second quarter of 2016 compared to 25.6% in the prior-year quarter. In the second quarter of 2016, there was about $0.05 per share benefit as a result of utilizing foreign tax credits on dividends from our foreign operations. We expect the ETR for the balance of the year to normalize. Non-GAAP EPS for the second quarter was $0.88, an increase of 16% on a reported basis and 24% on a constant-dollar basis. Year-to-date non-GAAP EPS was $1.75, a decrease of 5% on a reported basis and an increase of 3% on a constant-dollar basis.
Let me summarize our financial results by address the change to EPS on slide 17. In the second quarter, non-GAAP EPS increased $0.18 to $0.94 per share on a constant dollar basis versus the prior-year quarter. Sales and related gross negatively impact EPS by $0.07. Our Fuel for Growth savings delivered $0.11 benefit. Advertising and promotions were $0.06 lower in the quarter and the share repurchase program delivered a $0.02 benefit net of higher interest expense. Tax and other contribute the $0.06 benefit. Despite the negative impact of foreign currency of $0.06 per share, EPS increased by $0.12 versus second quarter last year on a non-GAAP basis.
Turning to a high-level overview of cash movements. On slide 18, the cash balance of $1.7 billion as of June 30 was similar to the beginning-of-the-year balance. Cash flow from operations was negatively impacted by $94 million as a result of timing of tax payments and other working capital movements. Our CapEx investments were $81 million, mainly in our US and Europe manufacturing facilities. For the full year, our capital spending goal remains about 4% of sales. Dividend payments were $155 million in the first half-year. The negative impact of foreign exchange impact of $32 million was related to the currency devaluation in Venezuela.
To summarize, our forward-looking annual guidance on slide 19. Our sales outlook for 2016 on a constant dollar basis is expected to be 0% to 2% below the prior year. With foreign currency reducing sales growth by about 5%, reported sales are estimated to be 5% to 7% below 2015. We reaffirm our 2016 GAAP EPS guidance of $2.91 to $3.03 and our non-GAAP guidance of $3.48 to $3.60 per share for the following reasons: First, we expect the gross margin improvement from our previous guidance of 64%. Second, our Fuel for Growth savings are well ahead of plan and will only partly be reinvested in our business. Thirdly, we have an ETR benefit of around $0.05 in the second quarter; and fourth, the foreign exchange impact is expected to be approximately $0.35 per share from our previous guidance of $0.40 per share. GAAP EPS guidance is likely to be impacted by potentially significant future market-to-market pension adjustments which cannot be estimated and are classified as specified items. Specified items include charges related to Fuel for Growth on our Venezuela business.
This concludes my discussion on second-quarter and first-half-year 2016 financial results. Thanks again for your time this morning, and I will now hand over the call back to Kasper.
Thank you, Michel. Before we open the lines for questions, let me briefly reiterate our expectation that our relative performance will improve as we move into the second half of 2016. We expect to see the Company return to positive growth in the coming quarters and our guidance reflects that. Our efforts to reshape our product and brand portfolio in China are progressing well. So is our initiative to strengthen our presence in the fast-growing channels there. We're gaining momentum in Mexico, Canada, and Malaysia, while we are addressing our performance shortfalls in the US and the Philippines. We're protecting our ability to invest to maximize our opportunities by improving our gross margins to improve product mix and by lowering our expense base. And finally, we remain as committed as ever to shareholder value creation.
With that, Liz, could I ask you to open the lines to questions, please?
[Operator Instructions] Your first question comes from David Driscoll with Citi. Your line is now open.
Great. Thank you and good morning. Kasper, can you comment on your retail performance in China and distinguish it from all the various shipment issues that I think you were talking about? Can you give us some color on market share and maybe a little bit more on the imported product gains? And then to kind of all this question out, will the third quarter see China shipments pickup because of the problems of shipments within the second quarter because of the customs issues that you talked about? Thank you.
Thanks, David. And it is an excellent question. What I was implying in my prepared remarks, but I'm quite prepared to be more specific is that we are very satisfied with the consumer demand trends that we are observing in China. We feel that we are gaining share with our new products, both in the super high premium segment where we obviously came from a standing start and in the imported product segment where we've now been at it for little while. However, the difficulty of getting product into China in this latest quarter did result with some selective out of stocks situations at retail as well as lower inventories in many of our distributors. To the extent of the latter, we expect that we will gradually recover that over the second half of the year. A little bit hard to say whether we will recover it all in the third quarter because that involves speculating on how the importation process evolves. But we're quite encouraged and we are confident that some of these issues are sort of relatively short-term in nature.
Then just to follow up, would you say, then, that the retail performance and the market share gains are more indicative of the success of the strategy rather than the shipment number you are reporting today?
That is certainly the way we look at it. So I hope I brought that across in my prepared remarks.
Your next question comes from Michael Lavery with CLSA.
I just have two quick ones. One on Enfinitas. I was wondering if you could give some sense of just, I know it's early there still, but for the distribution, is that skewed more toward tier 1 cities or is it broad geographically and how is that progressing? And then just second, in Indonesia, we saw a premium competitor cut prices by about 10%. What are the market dynamics there for you? Are you seeing pricing pressure or share pressure or opportunities in that market?
Let me start with Enfinitas. It really is early to say how that brand is performing, and particularly, as this last month or so was affected by these temporary delays in importation that I've referenced now repeatedly in China. We are aiming for pretty broad distribution, but obviously, with an emphasis on the baby store channel which is the primary outlet for these high-quality premium-priced products in China. In Indonesia, we typically don't mention it very often in our earnings call. That's not because it's not a great market, it's simply because we have a very small business there and our market participation is relatively low. So I suspect there are other people that are far more qualified than I to discuss the market trends in Indonesia.
Thank you, Michael.
Your next question comes from Bryan Spillane with Bank of America.
Just one question related to the increased investment in trade spend. I guess, Kasper, the question is just was that in reaction to some of your competitors promoting more? Was it a reaction, is it really a mix, channel mix issue that you're increasing your sales in the baby store and that just tends to be need more trade promotion? I guess the reason why I ask is just it seems sort of inconsistent that you've got a bottleneck at the border so you're not getting product across yet you're promoting more, which would seem to increase the incidence of out of stock. So if you can just kind of tie those things together, I think that would be helpful. Thanks.
Bryan, thanks for the question. The trade support is not always and in every case tied directly to volume. There are a certain amount of fixed expenses that I incurred in order to support the trade, and particularly, create sufficient presence and awareness in the early stage of a brand launch. So it really reflects that. It is very directly connected to the launch of Enfinitas and it is directly connected to the fact that trade support in the baby store channel tends to be higher than it is, for instance, in the food channel.
Okay. So it seems like you've got, you've made more progress maybe than you would have original -- or it's progressing faster than you thought and so the need for the trade spend has kind of increased sooner than you thought as well. Is that a fair way to put it?
Well, I think a better way to look at it is that we have chosen to rebalance our investment between A&P and trade support to some degree in this latest quarter. We expect that balance will change from quarter to quarter depending on what our activities are and whether they are booked in one line of the sort of brand investments or booked above the net sales line. All right.
Your next question comes from Amit Sharma with BMO Capital.
Kasper, just to continue with what you just said, so if you are going to shift spending between above the line and below the line, how should we reconcile that with what Michel said earlier in the prepared comments about a 100 basis point decline in R&D spending over the next two years? Is that net of higher-priced spending eventually?
Michel, do want to take it? You're probably...
Amit, when I was referring to A&P, clearly we were referring to the A&P line as a percentage of sales. Yes, we stepped up the gross to net investments in the second half-year and, like Kasper said, it was really to support trade and really related also to the rollout of certain new product launches like Enfinitas and to get the distribution right. That gave us a, I would say especially in the second quarter, a temporary step-up and we will continue to see some higher trade investments, but I don't expect a further strong increase in that line.
Just so that I understand it well. So, trade spending slightly up this quarter. We are now looking to sustain an increase in that and then A&P spend savings should accrual or should be available for you to invest or drop to the bottom line?
A&P savings should be reinvested into gross to net or should be dropped to the bottom line. Got it. Thank you.
Thank you, Amit.
Your next question comes from Ken Goldman with JPMorgan.
Forgive the length of my question, here. But from my perspective, the guidance of Fuel for Growth is a bit confusing. And maybe I'm wrong, but I'm just hoping you can clear it up for me. You explicitly said in your slides from the investor day that you're looking for 300 basis point of margin improvement, not savings, but margin improvement. And that implies that your EBIT margin will get to around 27% by 2018, all else equal. And that's an outlook that I think I've confirmed with the Company in recent weeks, but you've also talked, including today, about how you're going to reinvest some of your savings back into the business, which suggests that maybe not all of that $120 million, now $180 million, is going to flow to the bottom line. I'm really just trying to figure out, Michel, how do I reconcile what seems to be some conflicting information out there? I know it's not guidance, but from a rough outlook, is it wrong for us on the outside to think that margins are expected to go up by 300 basis points or more net of reinvestments over the next few years? I think that's a key question for people.
Let me clarify to avoid any confusion because I want to be consistent with the messages that I gave at Investors Day. At Investors Day, we said we will deliver $120 million of Fuel for Growth savings and we also indicated that we will partly reinvested and partly it will be a roll-through profitability. And in combination with a couple of other initiatives that we announced at Investors Day, we indicated that will deliver a 300 basis point margin improvement from 24% to 27% indeed. So what we announced today is an incremental program of $60 million which should give us $180 million by 2018. From the $60 million, we indicate that we will use that to reinvest in our business to strengthen our future growth. So that will be not part of the growth through profitability, does that answer your question?
I think so. I'm on my cell, so I apologize, but I just want to make sure. Those of us who are modeling, I'm not asking for guidance, but modeling 27% roughly in 2018, I know it's so far out. But are we absolutely insane to do that or is that kind of what the Company is thinking as well, all else equal, if it goes as planned?
I think that in light of what we laid out at Investors Day, that we increased our EBIT margin by 300 basis points to 27%.
I think you are right, Ken, the way you are thinking about it with all of the normal caveats about it being two and a half years into the future. But the majority of the margin increase will come from a combination of the impact of the Fuel for Growth initiatives that we are discussing now, and of course, we would expect over that time horizon, also aligned with what we communicated at the investor day, to see a return to sales growth which will also help the margin accretion exercise.
Thank you, Ken.
Your next question comes from Matthew Grainger with Morgan Stanley.
Kasper, I wanted to just better understand the issue with the testing standards that you mentioned and the anticipated impact, if there is any, that these could have going forward. Do you think that this had a similar impact across your peer set during the quarter or was idiosyncratic to you? And I ask only because we haven't heard any mention of it from two of your larger competitors that have already reported. And related, are there any kind of carry-forward costs associated that would be meaningful in any way?
I normally don't comment on what my competitors say, but I think it depends on how you read the statements they made. I guess we read them a little bit differently from how you may have read them. I do think that it has impacted everybody in pretty much the same manner. So I think other people have referenced the fact that informal exports or imports into China have slowed, et cetera, et cetera. And I think that we probably all have seen the same impact. I do want to reiterate just that we see this as an incredibly favorable development over the midterm and a clear sort of sign of the Chinese government's commitment to ensure the safety of products that are being sold in China and ensure that these products, in every case, conform with Chinese quality standards. You have heard me mention this a number of times before, so I'm frankly, though, I will openly admit that we had hoped that we would report slightly better sales results in the second quarter due to this issue, I'm actually very happy with it from the potential for it to impact our business favorably as we move forward.
Thanks, Kasper. And I'm sure you're well placed to meet whatever requirements that there are but just the costs associated with the requirements, is it material in any way?
No. I should, perhaps, have been more explicit, but actually, the additional testing that is happening is actually done by the Chinese government.
Of course we have invested substantially in ensuring that we can, in every case, meet the Chinese quality standards on products that we sell in China, whether directly or indirectly.
Your next question comes from John Baumgartner with Wells Fargo.
Michel, I wanted to touch on the incremental sales force and distribution savings you mentioned. Can you speak more to the specifics of that in terms of what it entails and maybe what types of risks, if any, that may present to your top line going forward? Just in terms of balancing your end market resources. Thanks.
Maybe I will give one comment then I will let Michel expand on it. John, I think as far as it comes to the sales force reorganizations and reductions in spend, firstly, you should not necessarily infer that greater efficiency in our sales force expenses means a reduction in force. Indeed, in many cases, it is an optimization of discretionary spends that we have in the sales force. That's set in the same line of the P&L. But it is also true to say that outside of the sort of frontline sales force, there are probably opportunities selectively across our global organizations to organize ourselves a bit differently. So I would say that. And I think maybe on the A&P side, I think we're simply recognizing that there are efficiencies available to us as the world is changing that we ought to put more energy into taking advantage of. Michel..?
Two comments to add. The $60 million in additional Fuel for Growth savings that we announced, it is not only related to sales force and distribution, just to make that clear. This is further optimization also of the supporting functions and I would say even a majority will come from the supporting roles. And your point, let's be clear, we always said we will be very careful with sales force optimizations because we don't want to jeopardize our momentum in certain markets that we are having.
Your next question comes from Robert Moskow with Credit Suisse.
I was wondering when you talked about the inspections on the borders, are you talking about all borders? It's not just the Hong Kong border, but it's just any product coming into the country? And also, is there anything that you can do to expedite those inspections? Why can't we think of it more as just kind of like a one-time hit to that incoming product that kind of slows you down temporarily but then is kind of solved maybe a month or two later? It's like a pig going through a snake or something like that.
Robert, I think it's a good question and actually, you can think about it sort of like that. There isn't anything we can really do to expedite it, because, as I said, it applies to the formal importation process into China and the testing is handled by Chinese government agencies outside of the control and involvement of the importing party. So you simply have to wait for your turn, so to speak, and for your individual import batch to be tested and then released through the importation process. It's clear that this was a very large undertaking by these responsible agencies in China and there was some short-term backup. But I'm absolutely confident that they are working day and night to resolve that. And as usual, I have great confidence in the fact that the Chinese government will resolve that and get back to more than normal importation flow as they refine these processes. I do think that part of it is sort of temporary. I think the part that will impact us is that, of course, our financial year inevitably cuts off on December 31 and there are two impacts in the near term from this. Firstly, there are the sales that we lost through supply shortages in the second quarter already.
An element of that, we will probably be able to recapture because we will be able to replenish inventory in our distributors. But as I referenced in response to David's question at the outset of this Q&A session, there were out of stocks that occurred at the retail level, which means that we did lose sales to consumers and those are, if you wanted, permanently lost, so to speak. They are not going to be recovered. The second impact of it is that, if you think about that, it effectively puts our growth plan behind these products two months back because we have been in this constrained supply situation for the last couple of months, which means that, given the rather steep growth curve that we had anticipated for these products we'll be exiting the year, we'll be cutting off the year on December 31 at a point of lower sales than we would have otherwise done given the two months that sort of in adverted commas, lost, or partial loss.
Does this put at all the Enfinitas concept at risk in any way, shape or form? Are customers who have been notified of the product launching, are they upset that it's not available or have they noticed it's not available? Do you have any feedback on that?
I've never had a customer who was entirely happy when you can't supply their orders, but I think we have a great relationship with the vast majority of our customers in China and they understand the situation. As I said, it's not completely unique to our Company and I think we've managed to explain it to them and I feel confident that we still have the support of our customer base.
Your next question comes from John Anderson with William Blair.
I want to put the discrete import testing issue aside for a minute and just, Kasper, if you could comment maybe on some of the border regulatory changes that are happening in China. I'm thinking here about things that may ultimately result in volume migration away from some of the gray market into more responsible producers or registered product hands. Can you talk a little bit of what's happening there, the timing of some of those events and whether you think is a benefit here to meet? Thanks.
Well, I mean, we've been talking about this topic, I guess, the broad topic now for at least a couple of years. I remain very, very optimistic about the way the Chinese government is going about this. It's natural that we would always wish that things could happen faster than they do, but what I see is a very clear determination by the Chinese government to ensure that products that are sold to China for consumption by Chinese children are all safe and in compliance with their standards. And that's a very reasonable goal. There are various initiatives that intersect as they pursue this. This latest one to try to and get a handle on imported products, at least through the formal channels, and making sure that those products comply with Chinese standards I think is a very positive one.
I think there's still a significant amount of product going through sort of informal channels imported into China in small parcels, mainly through what we have previously called consumer-to-consumer e-commerce or what we can perhaps call unofficial exports out of, say, Europe or Australia. I would expect the Chinese government is looking at that, and over time, they will determine a way to ensure that you can't have different quality standards applying to that sales channel than you have to the official sales channels. Overall, I'm very encouraged by what I'm seeing, recognizing that it's challenging us in the short-term but it's a good thing for the long-term development of the China market.
Your next question comes from Mario Contreras with Deutsche Bank.
So I wanted to ask on North America. Earlier in your remarks, you mentioned that share recovery there has been a little bit slower than expected and then later you mentioned that A&P was down in that region. So I guess my first question is, is there any correlation there? And second, and more broadly, what does it take to get share to a more acceptable level? Thank you.
Mario, I think, first of all, let me just start by saying that the market share comments are all relative and they are relative to where we were 12 months ago and there's no doubt that we have lost some market share, probably about 100 basis points or so in market share, versus where we were a year ago, at least the way that we looked at the profitable part of the US market. I'm not sure I'm prepared to comment on what our plans are exactly for recovering that market share, but you can imagine that it's receiving a fair amount of attention, and I did talk about the particular product segments where we had seen our share develop unfavorably. And so it's still, we are spending at the very healthy levels against it and I'm confident that if we felt that it was a question of simply investing more money in order to sell more and therefore gain more share, we would do so. However, I'm not convinced that this is a question of absolute investment levels. I think there have been some execution of issues that we are working through and I am confident in my team in the US that are addressing those issues as we speak.
Okay. Thanks for the color.
Thank you. Operator, we will take one more question.
Your last question comes from Pablo Zuanic with SIG.
Look, just one question on the import and local mix. In previous presentations, you've given the mix. Can't you just give us an update on where you are in China in terms of imports and local? And related to that, this trade promotion question, it would be nice if you can break it by the three product categories. And what I mean by that, the local products, the Enfamil imported range and then Enfinitas launch. Because the way I understand it, you are having to promote your old inventory on the shelves, the local product. So if you can just give some color in that regard it would be helpful. Thanks.
I'm going to try and strike a balance here and make sure that I don't give away more information to my competitors than I would like, Pablo, so please be understanding of that. I don't know that I will go further to identify how we are spending our trade support. On the import versus local business, I think we've been very clear that the imported part of our portfolio is still the fastest growing part of our portfolio and we see us being in a kind of transition phase where, over the midterm at least, we will see our Hong Kong products and our locally produced products probably in decline and we will see us making up for that decline with growth through our imported product portfolio. That assumes that there are no unforeseen changes to the regulatory environment in China that will somehow force that to change.
Right. And if I may, just a very quick follow-up. On the margin question, whether people project 26%, 27%, 28% by 2018, my question is you had guided for a $300 million net gain, but today, you increased the cost savings from $120 million to $180 million, that's about 100 bips on sales. And your A&P efficiencies went from 50 to 100 to 100 now. So that amounts almost another 175 of margin expansion, but you're still sticking to 27% so that my read of that is great. You have more cost savings, but you have recognized that the reinvestment is greater than you had expected. Is that the correct read?
Pablo, before Michel answers, could you put your phone on mute when he answers? We are getting an echo from your phone.
I'm sorry. Okay. Yes.
Pablo, the major part of that incremental $60 million will be reinvested in the business, especially gross to net, especially also for the A&P 100 basis points, the decrease. So it's the gross to net reinvestment and like we said, we also potentially expect over time some further headwinds in gross to margin in line with what I indicated at Investors Day itself. That is the reason why you don't see the fall-through benefit.
Thank you for participating in Mead Johnson's' earnings conference call. I will now turn it back to the operator.
This concludes the presentation. You may now disconnect. Good day.
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