Reckitt Benckiser's (RBGLY) CEO Rakesh Kapoor on Q2 2016 Results - Earnings Call Transcript

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Reckitt Benckiser Group plc (OTCPK:RBGLY) Q2 2016 Earnings Conference Call July 29, 2016 3:30 AM ET


Richard Joyce - Head of Corporate Communications

Rakesh Kapoor - CEO

Adrian Hennah - CFO


Eileen Khoo - Morgan Stanley

Iain Simpson - SocGen

James Targett - Berenberg

Toby McCullagh - Morgan Stanley

Charles Pick - Numis Securities

Guillaume Delmas - Bank of America Merrill Lynch

Richard Joyce

Good morning and welcome to RB’s half year 2016 results. Today we’re just going to walk through our half year presentation, which is being webcast, and followed by the usual Q&A.

So without any further ado, I will hand over to our CEO, Rakesh Kapoor.

Rakesh Kapoor

Good morning and welcome to our half one results webinar. Let me just start with the usual cautionary note concerning forward-looking statements, which I hope you will read in great detail. And really start the half one results with key messages for you today, which, hopefully and reassuringly, are what you’ve seen and heard from me before. Which is our focus on the right brands and the right markets continues. And as a result of our growth, continues to be very much health and hygiene led. Secondly, our earnings model, the core driver of our financial strategy, continues to deliver and is creating value for all shareholders. Thirdly, in this uncertain, post-Brexit world, I’m pleased to say that we are on track with our full year targets and I will come back to the specifics around our targets at the end of this presentation.

So let’s now turn to my first message on how our strategic choices are proving to drive growth for RB. This slide may look familiar to you as I showed this at our Investor Day a few years ago. Growth rates by category will fluctuate from quarter to quarter, and even from one year to the next, depending on external factors such as cold and flu season, or weaknesses in macro conditions. But over the medium term, we still maintain the same outlook for category growth rates we talked about a few years ago. Therefore our focus on moving the center of gravity of our business towards the faster-growing categories and structurally more attractive health and hygiene brands remains the right strategy, and will continue to be one of our key priorities going forward.

Health and hygiene brands now represent 75% of our Group portfolio and their contribution to Group growth is significantly higher. So if these category growth rates are what we benchmark ourselves against every year, how have we done in half one? Let’s start with health. We had a strong half year with 8% like-for-like growth, well exceeding both medium term and current category growth rates. Growth has been a bit lumpy between quarters and the primary reason for this is the underperformance of one of our Q1 Scholl innovations, our Wet and Dry Velvet Express pedi, which we sold into a number of markets earlier this year.

When you combine this softness in consumer offtake and subsequent stocking corrections at retailers, with an extremely high comp in 2015, there has been a marked impact to our Scholl growth rates in the second quarter. Given the size to which we have grown this Scholl brand over the last few years, this had a marked impact on our consumer health performance in the quarter. Am I disappointed that one of our big innovations hasn’t done well? I am. But I’m also reminding myself that if we want to see very big innovations in RB, we should be prepared to fail sometimes. Of the five big innovations on Scholl alone, one hasn’t worked.

That said, the remainder of our healthcare brands did well in the quarter. And as you will see later, we're innovating more than ever before, not just in Scholl but across our power brands and this makes me confident in our ability to outperform category growth rates over the long term. Now let's turn to hygiene which has been also lumpy between quarters but in the opposite order. I've said openly that we have not performed well enough in hygiene for several quarters because we've not been growing or rather we have been growing at the lower end of the medium-term category's growth rates. Now one summer does not make a swallow, but we have been working very hard on our key power brands within hygiene and some of the recent innovations such as Dettol Gold are working well.

So overall, let me restate our ambition. We want to outperform the category growth rates in health and in hygiene our ambition is to deliver growth at the higher end of the range. We will not do this every quarter but that will not change our strategic ambition.

Let's now turn to the benefits we are seeing of driving our health and hygiene business faster. You've heard me saying this before, P&L starts at gross margin. Now 240 basis points is an extraordinary result and Adrian will talk you through the moving parts in more detail. Yes, the input cost environment has been very benign and it will not be so benign for much longer. But our focus on mix, on Project Fuel, on appropriate pricing and more recently on supply-related project Supercharge initiatives, has created significant room within our P&L, allowing us to both invest for growth and improving our returns to shareholders.

We've got off to a fast start in our investment for growth. Whilst you will see we invested in additional £39 million behind BEI in the first half, this is actually not telling you the full story, as we continue to achieve and reinvest Supercharge efficiency savings within our media planning, working media investment and copy production lines. Fixed cost remains relatively stable; we are now seeing more of a positive impact from Supercharge in our gross margin line as we start achieving supply-related efficiencies following the significant fixed cost savings we achieved last year.

So to summarize our financial performance, net revenue growth for the first half was 5%, a strong start to the year. Our earnings model enabled us to convert this top-line growth into significant adjusted net income growth, 12% at constant rates. Our cash conversion remains excellent, and we are announcing a 16% increase in our interim dividend, slightly above our adjusted net income growth rates, due to a slightly more favorable FX on translation impact for a change and a minor benefit from our share buyback program.

I will come back to you at the end of this presentation to talk about 2016 targets, but before I hand over to Adrian, I just want to talk about the HS issue in Korea. Whilst we have made great strides as a business over the past 15 years, we have also made mistakes. You will no doubt be aware of one of our Oxy RB products in Korea, which has caused death and lung injury to people, which I profoundly regret. Let me give you some background. The product was sold, was used in sanitizing humidifiers. This product was only sold in Korea and in no other market. We acquired the company selling this product in 2001. We and a number of other suppliers sold the product until 2011. As soon as we were alerted to the potential link between the product and respiratory disease we began withdrawing it immediately and voluntarily from the market from August 2011. Since the issue came to light five years ago, we have settled many cases brought against us through a court approved mediation process; however, putting victims through a due process has not reached all people impacted by this issue. It’s taken far too long and is not fair to the victims.

We have therefore apologized to all victims, their families, all stakeholders and the Korean society. We’ve also come forward with a proposal for both a compensation plan for users who were almost certain or high possibility to have been impacted by a product, and a humanitarian fund to be set up for additional relief and assistance for those who believe they have suffered as a result of this humidifier cleaner issue. I’m personally very sorry and very much regret that Oxy RB’s product caused harm to people in Korea. We’re taking lessons from this and making further improvements to our safety organization, systems and processes to ensure that something like this can never happen again. Consumer safety remains our number one property.

I will now hand over to Adrian, our CFO, to give you some more details on the half one financials and the ramifications of the HS issue.

Adrian Hennah

Thank you, Rakesh, and good morning, ladies and gentlemen. Turning to the next slide and the income statement. As you’ve seen, revenue for quarter two was GBP2.266 billion, a like-for-like growth of 4%. The Korea HS issue, which we will return to in a later slide, reduced growth by 1 percentage point. Total growth at actual rates in quarter two was 6%, reflecting a 3% translational ForEx tailwind and the disposal of the Russian Medcom hospital business. Revenue for half one was GBP4.569 billion, a like-for-like growth of 5%. We have set out an analysis of the impact of currency movements and disposals in the appendices to this presentation and in the release. If the exchange rates at the June 30th, were to remain at that level until the end of 2016 we would expect reported revenue growth to be increased by 7 percentage points in the full year numbers.

Gross margin in half one increased by 240 basis points, the seventh consecutive half of material gross margin improvement. Adjusted operating profit before exceptional costs in the half was GBP1.081 billion, an 11% constant currency increase on last year. The profit margin was 23.7%, 180 basis points higher than half one last year. We will return to the drivers of these margin movements in a later slide. Exceptional items in the half were a charge of GBP319 million, GBP300 million relates to the humidifier sanitizer, or HS issue, in Korea. The balance of GBP19 million arose under the existing restructuring and integration programs communicated to investors.

We have, as usual, set out in the appendix the guidance we have given for exceptional items and our progress against that guidance. The HS provision is clearly new and we will return to it in a moment. We are on track with the other guidance given. Moving to the next slide and moving further down the income statement. Net finance costs in half one were GBP11 million, slightly lower than last year. The tax rate in adjusted net income, i.e., excluding exceptional items, for half one was 23%, in line with our expectation for the full year and in line with guidance. As you will know, the previous Chancellor here in the UK proposed a further future reduction in the UK corporate tax rates to 17%. If enacted this reduction would have only a small impact on our ongoing tax rate. It would have, as with the reductions enacted last year, a larger one-off impact on our reported tax charge in the current year as we have significant deferred tax liability in the UK. The impact would be a 1% on the reported 2016 tax rate. The higher tax rate on net income, i.e., not adjusted net income but full net income includes a preliminary assessment of the tax deductibility of the HS exceptional item.

Adjusted net income was £822 million in half one, a 12% increase at constant exchange rates, and 14% at actual rates. The Board has approved an interim dividend of 58.2p per share in line with our policy of paying out about 50% of basic adjusted earnings per share. This is a 16% increase on the interim dividend in 2015. Our 2016 share buyback program continues to target £800 million of buybacks in the year, subject to the Group not undertaking a material acquisition. The program has been proceeding to schedule. On 30th of June we had bought back £400 million of shares this year; to the end of last week we had bought back an additional £50 million.

Turning then to the next slide, an analysis of revenue growth rates by business segment by quarter. Firstly on price and volume changes across the geographies we operate in. The 4% net revenue growth for the Group as a whole in quarter two was around one quarter volume and three quarters price and mix. As noted already, the HS issue reduced revenue by 1%. This was almost all volume. With respect to ENA sales, we delivered growth of 2% in quarter two. This was slightly lower than recent quarters. Sales growth in the United States of 3% benefited from strong growth across most of the portfolio, but was held back by a decline in Amope sales, as a result of both a strong comparative, which included launch docking and also weaker consumer offtake, as you've heard from Rakesh.

Sales in Russia were weak despite good market share performance, the result of a weak market, with continued weak volume and lower pricing benefit. Sales growth in the rest of Europe was lower than in recent quarters, due to some softening in the markets and due to similar dynamics to the USA on Scholl. In developing markets we delivered an 8% like-for-like growth rate in quarter two. Growth outside Korea was in double digits. We saw continued strong growth in India and a continued strong performance in China and in Turkey. We saw a weakening in of the Middle East, especially Saudi market. We saw a mixed performance in Africa. West Africa and Nigeria in particular, continue to be a weak economic environment and South Africa continued at a modest level. We saw encouraging performance in North Africa. We saw continuing challenging market conditions in Latin America, especially Brazil; but our sales continue to be helped by consumers seeking protection from the Zika virus. In Southeast Asia we saw improved performance in Thailand and Indonesia.

In food, growth at 5% was encouraging. Growth in ketchup in the USA and growth outside the USA, continue to more than compensate for the pressure on mustard in the United States. We've included as an appendix a reconciliation of the reported to the like-for-like numbers shown in this slide.

Turning then to the next slide, and analysis of revenue growth rates by our principal product categories. Firstly, health. We delivered a growth rate of 5% in quarter two, lower than in prior quarters, but in line with signals we have consistently given that we did not expect the growth rates of the last couple of years to be sustained in full. Performance across most brands continued in line with a strong, consistent trend. As noted in the geographic analysis, we saw a decline in Scholl Amope revenue, lapping a strong prior year, and with weakness in consumer offtake of the quarter one innovation, amplified by retailer destocking.

Mucinex growth was strong, with further discontinuity in the supply of private-label competitor product. But we continue to expect increased private-label competition over coming quarters. As Rakesh has emphasized, we see no change in our medium-term expectation for health growth: a 4% to 6% market growth, which we expect to consistently outperform, but of course, not every quarter. In hygiene we delivered 7% growth, higher than in recent quarters. We saw good growth across much of the hygiene portfolio. As with health, we do not see this change in the quarter’s growth rate as signaling a change in the expected growth trend.

We see hygiene as a 3% to 5% growth market. We aspire to deliver at the top end of this range, and need to do this consistently. In home we delivered a 1% decline in revenue in quarter two. The HS issue impacts disproportionately the home, and also the portfolio growth. Vanish in particular is a large part of the Korea portfolio. Portfolio brands were down 8% in quarter two. Within this, the food business grew at 5%. As noted, laundry and fabric softeners are a large part of the Korea portfolio.

Turning then to the next slide, and analysis of margins. We delivered another strong operating margin improvement in half one: an increase of 180 basis points. This was more than we expected to achieve. As always with margin improvement, it is important to understand how it was achieved; and in particular, was it done in a healthy way, and is it sustainable? This chart shows that more than all of the improvement came from gross margin at 240 basis points. We reinvested 40 basis points in brand equity; and non-BEI SG&A expenditure increased by 20 basis points.

Firstly on gross margin. The improvement in half one comes on top of 460 basis points of improvement through 2013, 2014 and 2015. It continues to be driven by a number of factors. Mix improvement contributed less than in previous halves, as a result of the lower health growth relative to the rest of the portfolio, and the higher DvM growth. Input price tailwinds continue to be an important driver. The spot prices for a number of inputs increased during half one over the prior year. However, the first half has benefited from the lagging effect of forward buying and the inventory cycle. This lagging protection will largely end during half two, and we expect to see some headwind going into 2017.

Our own efficiency programs continue to be important. We saw benefits both from the ongoing Project Fuel, and also from Project Supercharge. As discussed with prior earnings releases, the early Project Supercharge benefits were mainly in SG&A spend; and we are now seeing the longer lead-time cost of sales benefits being delivered. Price also contributed modestly to gross margin in half one. In the long-term we expect the benefit of price increases to be broadly offset by transactional ForEx losses: in other words, that prices will remain broadly constant in real terms, offsetting consumer price inflation, but not, clearly, a source of real growth. During half one we saw price increases slightly ahead of transactional ForEx losses, reversing the position of the last two years.

Secondly, we increased our investment in brand equity by 40 basis points, to 14.8% of revenue in half one; an increase of £39 million in absolute BEI at constant rates.

Thirdly, our non-BEI SG&A expenditure increased by 20 basis points to 21.5% of revenue. Where, you might be asking are the benefits of the Supercharge program? Well, the program is fully on track; so the top end of the £100 million to £150 million benefit range and all visible in the P&L. We saw a very fast start in 2015. We're seeing more cost of sales benefit now, as we expected. We did see Supercharge benefit in SG&A in half one and we also saw increased spend in a number of areas; ongoing investment in the business.

Specifically on Project Supercharge, how much of the £150 million targeted benefit have we achieved to date? We're not going to give an exact number. We had achieved about £100 million by the end of last year. We have seen a good contribution, especially in cost of sales, in half one. We expect the balance to be achieved over the remaining 18 months of the program. Cost of sales will continue as a major part. The Korea HS issue also acted as a small drag on margin in half one and will act as a slightly larger one in half two. We lost sales and with it gross margin, but retain most of the unit's infrastructure

Turning then to the next slide. This shows an analysis of operating margin before exceptional items, by business segment, for half one. Within ENA we saw continued strong margin progress, 130 basis points increase. Commodity tailwinds were an important contributor and also our Fuel and Supercharge projects. Pricing in Russia also contributed. In DvM we achieved a very strong 320 basis points increase in the half one margin. Within gross margin, price was an important contributor, as one would expect, given the higher price inflation in a number of the markets served, partially offset by transactional currency headwinds. Commodity price benefits and our own supply efficiency efforts were again important.

In food, half one margin was 210 basis points lower than the very strong half one last year. This was mainly the result of higher BEI in the United States and the cost of expanding distribution outside the U.S.

Turning to the next slide and a summary of the Group's net working capital position.

You can see that the strong overall position continues. We continue to look for and find, improvement opportunities to counteract the structural headwinds in receivables and in inventory levels, as we increase the size of our consumer health business. We have achieved improvements in payables during half one. The level of payables, however, can be more variable, and we're at a level at the end of the half that we do not expect to be maintained. We continue to target sustainable net working capital of around a negative 8% to 9%.

Turning to the next slide, the cash flow statement. As you can see, the Group had another good half of cash generation. Free cash flow generated in half one was £939 million. This was 114% of adjusted net income. The Group had net debt of £1.6 billion at the end of the half year. This was essentially flat with the end of 2015. H1 saw good cash-generation, and also the £625 million payment of the final dividend and £400 million share buybacks.

Turning now to the next slide. You've heard Rakesh express his regrets, the regrets of all of us in RB, for the suffering citizens in Korea as a result of a product we sold. And you've heard him refer to the steps we are taking to do the right thing now, acknowledging that we should have taken these steps earlier. We thought it would be helpful to summarize the issue in slightly more detail in this presentation, in order that investors can have a fuller understanding.

Turning to the next slide, then and some history, a little bit more history than you heard from Rakesh earlier. In March 2001, RB purchased a Korean company called Oxy, effectively creating a Group presence in South Korea. Oxy sold a range of household products. A sanitizer disinfectant product for humidifiers was a small product in its portfolio. Oxy had changed the active ingredient to PHMG in, we believe, 2000. This product was one of a number of humidifier sanitizer, or HS, products, in the market in South Korea. In all the years from acquisition until the withdrawal of the product in 2011, our HS product accounted for less than 0.5% of RB Korea sales, and the Group did not sell the product outside Korea.

Toward the end of the decade, the Korean Government noted an increase in incidents of severe respiratory disease being treated at a number of hospitals; and asked the Korean Center for Disease Control, or KCDC, to investigate the causes. In August 2011, the KCDC announced the results of an epidemiology study, indicating that certain HS products containing PHMG may be the cause of lung and respiratory injuries, and deaths. At this time, Oxy RB had the largest share of the market for HS products. Following the KCDC announcement, Oxy RB immediately began to withdraw its product from the market.

In November 2012, the KCDC Investigation Committee was formed, to review all reported cases of death or injury from the exposure to HS products; and to categorize the cases on the basis of the evidence linking their lung condition with HS product use. This classification has been undertaken in a series of rounds, the first two of which are complete. The third and fourth rounds are planned, but not yet complete.

Turning, then, to the next slide, and an overview of those KCDC assessments. KCDC is categorizing cases as either category I or II, where it assesses the link between the use of HS and the injury as almost certain or of a high possibility. Where KCDC assesses the link as low possibility, or almost no possibility, they use categories III and IV. And where there is insufficient evidence, they use category V. In addition to categorizing cases according to the likelihood of a link between an individual’s injury and the use of an HS product, the KCDC has also made findings based on environmental survey as to which manufacturer’s HS product was used. The status of the four rounds of applications established to date is set out in the half one release and also in this slide.

The KCDC has stated its intent to finish reviewing round three applicants by the end of 2016; round four is still open and we are not aware of any stated timetables for this round. Turning then to the next slide, in parallel with this work since 2012 by KCDC, other aspects of this issue have also developed. In 2014 RB Oxy was found liable and fined for the civil offence of mislabeling. During the period 2012 to quarter one of this year, RB Oxy settled 80% of the cases brought against it by victims and their families, a total of 64 cases through a process of court approved mediation.

We understand that other suppliers of HS were, and some still are, following this approach. It became clear during half one that the approach being taken by all the parties to this tragedy, including the manufacturers, retailers, and parts of government, was not adequate. RB determined that we needed to apologize more clearly and forcefully and to demonstrate our sincerity by bringing forward a compensation plan which would make it unnecessary for victims to go through a court process. We acknowledge that we could and should have brought this plan forward earlier.

We have through quarter two been consulting on the terms and form of this compensation plan. Our latest proposals are available on the website of RB Oxy. We plan to make this compensation plan formally available to victims in Korea next week. The plan addresses all category I and II Oxy HS users in rounds one and two. We have also committed to contribute to a humanitarian fund to be made available as part of a wider industry and government effort to provide assistance to those who have suffered as a result of the HS issue.

In addition, the Korean authority is undertaking a series of criminal prosecutions of various parties allegedly involved in this issue. Oxy RB has been charged with false labeling of its HS product. The prosecutor has also charged five current and former employees of Oxy RB in connection with Oxy's HS product. We understand that a total of 18 people from 10 different organizations have been charged in connection with the HS issue.

Turning then to the next slide. What is the financial impact of the HS issue on the financials of the Group? Firstly, on trading, our Korean business accounted for 1.5% of Group net revenue in 2015 and in quarter one of this year. The business has recently seen its product range delisted from many retailers' shelves. This has had a significant impact on the trading performance of our Korean business since April of this year. The Group's net revenue has been reduced by 1% in quarter two. We do not expect the adverse trading issues we are seeing in Korea to materially change in the near term.

Secondly, with regard to exceptional costs. As we saw a couple of slides ago, the KCDC has reviewed 530 cases of respiratory disease potentially linked to the Oxy HS product of which it found a link in respect to 181. It is reviewing a further 752 and has stated a target of reviewing these by the end of the year and it has a round four, open for other sufferers from respiratory illness to apply for review. We have provided exceptional costs totally £300 million in half one in respect of compensation to victims in rounds one to three and in respect of all associated costs on the business. These include about £40 million of impairments on intangibles relating to the acquisition of the Oxy business.

Thirdly, with regard to contingent liabilities. We are not in a position to provide for costs relating to potential round four cases, as we have no reliable basis on which to calculate them. We do not know how many cases will come forward; we do not know how many will be assessed as being linked to HS products in general and RB Oxy's product in particular. We do note, however, that the product was withdrawn from the market almost five years ago. You'll find a little more detail on these matters in the press release included in notes five and 13 to the financial statements. We do hope that this information gives you as clear a picture as is possible on this tragic issue and it demonstrates our determination to do the right thing, to do what we can for victims in Korea.

With that, I will hand back to Rakesh.

Rakesh Kapoor

Thank you, Adrian. Before I summarize how we see the remainder of the year, let me give you a short overview of our innovation pipeline for half two beginning with health. Achy and heavy legs is an issue faced by half the women globally, but 80% do not treat them because they don't know how to. Now we have a solution in the form of Scholl Light Legs compression tights. The light compression improves foot and leg blood circulation which helps energize legs and feet. Its action avoids fluid accumulation in the feet and legs leaving legs feeling lighter, firmer, and more taut. Legs look and feel great all day.

Moving onto another Scholl Amope innovation. I’m very pleased that we are extending the Amope brand in North America into insoles, following a successful launch in Europe in Q1 2016. Women love shoes, and high heels in particular, despite their discomfort. That’s why women suffer from four times as many foot problems as men. Regular insoles are too thick; they don't fit women’s shoes; they are just not interesting to wear. Amope GelActiv insoles provides superior and all-day comfort for tired and achy feet, with an ultra-slim design and non-slip technology.

Moving to MegaRed. We are launching our strongest Omega-3 supplement. Its advanced four-in-one formula is our strongest Omega-3 supplement formula to support four vital health areas: heart, joint, brain and eyes. As it says, it’s two times more concentrated versus standard fish oil. Moving to Nurofen. Body pain involving either muscles, joints, or back, tends to be more chronic in nature and particularly amongst middle-aged or aging populations. When it comes to body pain, consumers don’t want a painkiller which wears off quickly, indeed preferring a solution that gives them the confidence of relief for longer. But chronic pain sufferers also want a range of solutions; some prefer pills, others prefer patches, or some gels. That’s why we’ve launched a range that delivers all these three product variants, delivering long-lasting relief for up to eight hours with just one single dose.

Moving to Mucinex. We’ve learned that people want sensory relief when it comes to their cold and cough medication. So quite simply, what we’re doing is launching a range of Mucinex Clear & Cool liquids with max strength formula. It’s for different kind of conditions ranging from cold, flu, and sore throat, congestion relief, or even nighttime and sinus, which provide the liquid cools to throat and nasal passage to provide an instant cooling sensation and relief. And clearly launching in the USA in 2016 with all these four variants.

Moving to Optrex. Night is medically the optimal time to treat your dry eyes. As you don’t blink, the retention time in the eye is significantly increased and makes treatment much more effective. That’s why we’re launching the Optrex night repair gel drops; the unique gel drops formula works for repairing the eye’s natural lipid layer, and restores optimum moisture levels throughout the night. It’s launching in a number of markets in 2016: UK, Australia, Italy. And then also rolling out as the formulas get registered in a number of parts of Europe in early 2017.

Let’s close health with Durex. We're launching a range of Durex Intense orgasm gel, and condom. Now the Durex Intense is about protection and pleasure both. Durex Intense gel will give a sensual wave of warming, cooling and tingling, and actually working perfectly with the Durex Intense condom, which has been specially designed with ribs and dots to provide this fantastic combination of both gel and condom products for both protection and pleasure, the dynamic duo of great sex.

Moving from sex to hygiene, let's talk about Veet. We're launching actually quite an interesting Veet sensitive precision beauty styler. This is the first electric trimmer from Veet, specifically tailored for sensitive body parts such as bikini, face, and under arms. Don't you think it's only for women, you can also use it for men. Its cutting blades don't touch the skin so no fear of cuts. It's safe, it's painless and it's precise. You can achieve precise shaping and styling as it comes with dedicated trimming heads and combs as you can probably see in the pack. There are a number of different types of combs for all sorts of body parts.

Moving from Veet to Dettol and we are launching something which I am quite excited about, because Dettol protection is something that people need not just when they're at home, but also when they're not in the security of their homes. This is an on-the-go protection product and what's different about this is not that the sanitizer has not been there before, it has been; but what is really quite interesting is just the design and the range. What we have done is basically we specially designed this bottle, which allows it to be attached to a backpack, a purse, even a key chain and very convenient protection wherever you are, whenever you want it. Actually comes not just in one but eight different variants, I haven't put all the variants on the page, eight different variants so there is something for everyone. We are seeing some very early signs of this being very, very interesting in the market we have launched it. This is going to be rapidly rolled out.

Moving from this to Harpic. We are extending, for those of us who have seen toilets in developing markets, we know that toilets in developing markets, particularly where there are squat toilets, tends to be a continuum between a toilet and a bathroom. We have a very successful Harpic business in developing markets. So what we are doing in extending Harpic into bathroom cleaning in markets where toilets and bathroom are that one continuum. Of course Harpic provides a noticeably better performance versus what people use which is largely a pot pourri of [indiscernible] or detergents and so on and so forth. This is materially better in terms of product performance and comes from Harpic so it provides a complete cleaning solution for toilets which includes bathrooms. We are quite interested and excited about this.

Moving from hygiene quickly to home. Let's start with Air Wick, a brand where we've truly upped the innovation engine over the past 18 months or so. This is Air Wick Pure Essentials. You will recall that we have launched a range of aerosols with the Pure sub-brand; the Pure sub-brand very successfully, actually, done very, very well in all the markets where we launched that Pure range of aerosols. This Pure range addresses really the key aerosol performance gap, which is when you spray, the spray really does not last that long; the fragrance experience does not really last in an aerosol. What is different about this range is that it comes, not just with essential oils, it delivers a superior experience, a fragrance experience, that is formulated so that not a single drop of water is added. And the fragrance is fresher and it’s purer and lasts longer.

Moving from Airwick Pure Essentials to Vanish. Now as people, we know that dried-in stains are the torture test for stain removals. If it works on those, it will work on everything. This is our best Vanish ever, with the ultimate performance claim of 30-second stain removal, even on a seven-day dried in stain. And that comes under the Vanish Gold platform and we are going to roll it out across Vanish markets. With this quick snapshot of our half two innovation pipeline, I’d like to move to 2016 targets before we take Q&A.

So in February 2016, we had outlined our revenue targets to be between 4% to 5%. And while we were indeed tracking on the upper end of this range, the impact of the HS issue in Q2, and expected for the remainder of the year, means that we now expect revenues to come in at the lower end of this range. In terms of op margin, we’ve already, we originally said to you that you should expect 2016 delivery to be in line with our medium-term guidance of moderate margin expansion, plus the year-2 benefit of Supercharge. Now given the excellent first half of 180 basis points is in the bag, a second half of moderate margin expansion means that we are on track to come in higher than the targets we had set originally in February.

With that, both Adrian and I would be happy to take your questions.

Question-and-Answer Session

A - Richard Joyce

Thanks, Rakesh and Adrian. So first is from Eileen Khoo from Morgan Stanley. Go ahead, Eileen.

Eileen Khoo

The first one is actually on Project Supercharge or what you’ve called the Treasure Hunt in the past. Are you finding more treasure that would suggest upside to that top end of GBP100 million to GBP150 million that you’ve previously guided to? And then the second question is on hygiene. Obviously, looking at the quarter trend, is that representative of the full picture? As you said, 7% is very strong indeed and I wonder if you could just comment on how much of this is due to better execution, outperformance versus the market, as opposed to perhaps special factors? Maybe the impact of Zika or uptick in key EMs, et cetera; that would be very helpful.

Rakesh Kapoor

Let me just take both these, actually. This is a mindset of the company and then there is a project called Supercharge. The Project Supercharge targeted a range of GBP100 million to GBP150 million, and we said, having achieved a fantastic fast start in one year itself, where we called out GBP100 million, we said we are going to come in at the top end of the range. And we stick by that top end of the range for Supercharge. The other part of the mindset is this ongoing mindset of looking for opportunity to take cost out, whether this is in product cost or in other areas of the cost. And that is what I call the squeeze, the incredible squeezing of the lemon which will go on.

So I think you should expect that this whole mindset of looking at costs which don’t really create value will be a mindset which will run through the company, whether we have a Supercharge project or not. But the Supercharge project is well ahead of where we originally felt it to be at this stage of the game, and we still believe that we will come in at the top end of the program. On hygiene, first of all, we have been very open that this kind of growth rate that we have been delivering in hygiene was not something we were very proud of, because it was mostly at the bottom end of the 3% to 5% range and we said that our target is to be at the top of that 3% to 5% range. Now in half one, we are at the top of the 3% to 5% range and in quarter two we are materially better than that. Is it Zika related? I would not say so. I think the growth rate on hygiene has been fairly broad-based across brands, whether that is to do with Finish or Harpic. Of course, there is Mortein too. But it's a very broad-based and Dettol Lysol we should not ignore that.

So we had a pretty good quarter on hygiene but also I would just be very cautious about saying well actually, there is a new trend on hygiene, as much as I would, say, caution on a new trend on health. I think this is a quarter. We have to move on from just one quarter and getting too narrow about that, to looking at the broader picture. Our broader picture, our broader ambition, our broader focus has not changed at all. And if you actually take a step back and look at the half year as a whole, and 8%, 5%, 1% being the picture that is a good picture for half. Hygiene is much better in the quarter. Will it look like that in the future? Well, we want to do it consistently and we are not there yet.

So we're working very hard. We are upping the innovation across the board and we are going to keep investing like we have in the first half. But you know what? We have to deliver it consistently to know that we are at a stage where we are achieving hygiene at the top end of the 3% to 5%. So that's how I would say it.

Richard Joyce

Thank you, Eileen. Next question is from Iain Simpson at SocGen. Go ahead Iain.

Iain Simpson

[indiscernible] you've flagged that 37% of sales was truly exceptional and we'd see a bit of normalization, but just looking at it more generally, payables is always much, much higher than at your peers. I just wondered if there were any factors you'd point to as to why your suppliers seem to be happy to get paid rather more in arrears than with other comparable companies. Thank you.

Adrian Hennah

Iain, I'm not sure we heard the very start of your question but I think it focused on our net working capital in general and particularly why payables for us was so good, is consistently so good. Well the answer is, we regard, in our relationships with our vendors and suppliers, we regard payables as one of the very important terms of trade. Price is important, quality is important, and so are terms. And we have, over a long period of time, made that a very central point for the way we interact with our suppliers and built up a pattern that is indeed one that is very good. So there's no magic sauce beyond that, other than being systematic, pay attention to it, putting lots of energy into it and having it as part, of course of the overall net working capital target which is reflected in the incentive programs of people throughout the Company. There is nothing beyond that, as we often see. And it's not a structural question it's a cultural question as to why we are better.

I would, however, also point out, as I did in my text, that the actual number when you look at the period-end payables is a bit artificially high. Payables does wobble up and down with stuff and so the number you're actually seeing as period-end is artificially high. We don't expect to sustain that through time and through intervening month period-ends.

Rakesh Kapoor

And as the CFO said before and we've reiterated before, our net working capital target is in the 8% to 9% negative range and we are sticking to that.

Iain Simpson

Thank you very much. Just one more if I may. You very kindly gave guidance for the FX impact on revenue for this year at current spot rates. I wondered if you could just make any comment as to the FX benefit to revenue that you'd see next year. Obviously, FX can move around a lot over the next five months, but at current spot rates, what sort of benefit would you be thinking for 2017?

Adrian Hennah

Roughly, roughly half that, Iain.

Iain Simpson

Thank you.

Richard Joyce

Okay. Thanks, Iain. Next question is from James Targett, Berenberg. Go ahead sir.

James Targett

Good morning, everyone. Just one question from me. Just looking at the ENA business outside of North America, you mentioned a slight slowing of the market growth in Europe. Could you just give any color on are there particular countries which are driving that and any particular categories as well? Thank you.

Rakesh Kapoor

Right, okay. I think there are a couple parts of ENA. First of all, we talked about Russia. And Russia, we always have said that despite our own outperformance in Russia, which I think we are doing very well in Russia from a market outperformance point of view, the market has been very choppy. So I think there is a Russia factor. If you remember last year, there was a massive aspect of inflation, but also, that inflation did not really, at that point in time, turn into a very significant volume slowdown at least in the first four or five months of the year because people were probably buying up, thinking the prices are going to hit and there was a lot of volume buying before actual inflation hit. But there was pricing going on, consumers were still buying, trying to beat prices. But I think we are now seeing a softer environment, both on inflation, but also a material slowdown in volume in market.

So that’s one aspect of what is happening. And then actually, on the rest of ENA, I would say that there could be two factors. One is probably well explained; that last year, we had a fantastic flu season; this year is probably a more normal one, so like for like indicates a slower, of course, market overall. And maybe a smaller, a softer consumer environment, but I would not read too much into it. So I don’t think we should make a big deal about a slowdown in ENA. I think there is a factor which we easily understand, which is the impact of flu. A brilliant season last year versus a more average one this year so far. And then, of course, this Russia impact, which is always expected to be a bit choppy. But beyond that, I would not say much more.

James Targett

Okay, thank you.


[Operator Instructions].

Richard Joyce

Next on the line is Toby McCullagh. Toby welcome back to circulation. You’re going to ask your questions.

Toby McCullagh

I’ve got a couple of questions if I may. The first is in health, I guess in Nurofen in particular, in the Australian case re the misleading advertising. Other than the fine, can you just remind us what the remedial action you had to take on shelves? And what impact, if any, this had on sales growth or market shares after whatever changes it was that you had to make? Would it be reasonable, can we extend this into the more recent UK situation? And are there any other examples of similar?

And I guess is this pattern influencing at all your approach to innovation or advertising of those new innovations? Then just as a second question, on the portfolio business, the non-food portfolio brands look to be down about 20% like-for-like, which quick math suggests is about 80 basis points of sales on the quarter. What is there specifically there and what’s left within that business? And is that a rate that we should expect to see going forwards, or have you largely stopped focusing on the businesses which are no longer of a core focus? Thanks a lot.

Rakesh Kapoor

Okay. Let me just try and deal with, actually, both and I'm sure Adrian will come in and help me out when I'm not making it sound good. So on Nurofen, actually, it is an Australian issue, started in Australia, but not just in Australia, there was also something in New Zealand. Let me just say that we've paid a AUD1.7 million fine which is what the courts asked us to do. We accepted that our packaging needed to be modified. We immediately modified the pack and that's what we have done. Just to clarify, the court also ruled that we did not intentionally mislead, so I think I just want to make sure that everyone understands the court rule; that we did not intentionally mislead and if there was a suggestion of it could have misled, we have taken appropriate action, withdrawn the product, collected the labels.

Actually, we sticker at that point in time, we always sticker the labels to make sure that this idea that this product could also work on other kinds of pain was made very, very clear to all consumers. So that is where it is. This issue does not affect the UK, because in the UK, we actually have that disclaimer, which is even if you have a specific product for, let's say, migraine or period pain, we also make it clear to people that it's also effective for other kinds of pain.

Now we always said that we want to actually provide these kinds of ranges so that consumers find it easier to navigate, easier to shop, easier to identify the product with the need for their own particular cases. In many cases, we have them slightly differently formulated, i.e., one could be a caplet versus a tablet and so on, so forth, different doses, 200 milligrams versus 400 milligrams, but sometimes it's not always exactly the same. And I think we have accepted that we needed to be clearer as the case has been in Nurofen.

Has the impact of Nurofen in Australia been material to either Australia or to anywhere else? No, and I think I would not see this as a, I don't want to undermine what is happening. But I think the reporting on this issue is unusually disproportionate to the issue itself. So I just want to go set that point right. I think we want to be responsible in our innovation. We want to say things which are valid and legal and responsible and don't mislead in all our innovation. And we want to take attention.

Now this particular product, as an example, on the Nurofen in Australia, you don't launch innovation in markets without telling anyone. So there was a PG association which actually approves all this stuff. It was PG approved thing. Well, somebody took exception and rightly so, and we acknowledged that we needed to do something. But all these things go through an approval process. And I don't want anyone to believe that, somehow, these creams get through without the proper diligence, both from a scientific and regulatory point of view or also from a pain approval point of view. So that's on Nurofen.

On portfolio, as we've called out, South Korea has had a material impact on portfolio and to an extent on home. Because the South Korean portfolio was materially weighted towards home and portfolio. We had a laundry detergent business, we had a fabric softener business and as you know, we captured those businesses in portfolio. So when you do the math, you can figure out that actually the biggest impact amongst all category groups of Korea, was in portfolio, followed by home.

Toby McCullagh

Great, that's very helpful. Thanks a lot.

Richard Joyce

Next on the line is Charles Pick from Numis Securities. Go ahead Charles.

Charles Pick

Good morning, gentlemen. Thanks very much. I have three questions. Firstly, regarding the warning on input costs. Are you able to give any guidance as to what the headwind factor might be on the margin in 2017? Secondly, regarding the HS situation. It looks as though the potential cash consequence is £260 million. Is that correct basically? And finally, regarding the Scholl Wet and Dry product, what is the future of that? Are you intending to relaunch it in different format? And why specifically has it been something of a failure? And actually, also, if possible, can you quantify the sale shortfall from that, vis-a-vis your budgeted aim?

Rakesh Kapoor

So let me get hand over the difficult questions to Adrian and take the easier one, the third one. So let Adrian take the first two difficult ones.

Adrian Hennah

Thank you. In terms of quantifying the input cost tailwinds and then headwinds. No, Charles, it won’t surprise you to know we’re not going to give you a precise number for that. Safe to say that it has been a material contributor over recent times to the tailwind and we do not expect that to go through the second half. And we do expect it to be adverse by the time we get into 2017. But a magnitude of that, not going to give specific guidance. In terms of the HS provision. Yes, the GBP260 million, I guess, you’ve got by looking at the GBP 300 million provision, and we pulled out GBP40 million, or so, of that as being non-cash. So, yes, GBP260 million roughly, roughly will be the cash impact of that provision, that’s right.

Rakesh Kapoor

And moving to your third question on Scholl Wet and Dry. What are we going to do about that? Let’s just, before I answer the question on the last 90 days of Scholl, I’d rather answer, take a step back and tell you my perspective on the last 900 days of Scholl. We bought this brand, as you know, from SSL, and late 2010 we talked about in our Investor Day that we were still grappling with how to actually build Scholl as a good brand. And that we were not truly outperforming growth rates was our expectation at that time. But over the last 900 days, I think a combination of factors has truly transformed Scholl from what it was, which was a very fragmented, itsy-bitsy brand, into something which is coherent, which is strong. Which is, for the very first time, telling people and consumers that you should look after your feet as much as you look after your hair.

Now in this 900 days, basically we have done that, through creating many, many things. First, we’ve created new growth platforms, let me call it new legs or feet of growth. We’ve created an insole platform; we’ve created a compression hosiery platform; we’ve created a hard-skin remover platform; we’ve created a nail-care platform. And beyond that, we’ve created a range. If you go to an average pharmacy, and we are not there yet, we have lots to do. But you go to an average pharmacy, you probably see a nicer foot-care zone where people can understand how to take care of their feet much better.

And I have to say that in the last 900 days, we might have launched probably five big innovations. Five really big innovations, of which one has not worked. And do I feel bad about the fact that we haven’t made one work? We want everything to be perfect. But it also is, at least philosophically, a reminder that if you want to stretch your legs, if you want to stretch your innovation ambition, you should be prepared to see, once in a while, something not working.

And it is probably a symbol of our ability to stretch and go for big things. What are we going to do about this? As much as our ambition talks about, and will actually keep thinking about innovation, in fact, I presented two of them this morning, we are all over how to actually get the current issue of Wet and Dry. We launched Wet and Dry with the assumption that some women want their dry-skin product to work, even with their wet feet.

And perhaps it's not resonated as well as we would have expected. But we are all over it; we're trying to refocus the business back on what works on this, what drives penetration, what brings new users. And while it cannot be an immediate correction, I have no doubt that we will find a way of bringing our Scholl business back to the same ambitious growth trajectory that we have set over the last 900 years.

Charles Pick

Thank you very much for that. Yes

Richard Joyce

Okay, thanks. So that's all the questions we have at the moment, so [multiple speakers]. Sorry, go on.

Charles Pick

A couple more actually. The brand equity investment, is that expected to fall in the second half? And also on the HS issues, there've been varying numbers appearing in the press for the number of deaths. What is your understanding of the true figure?

Rakesh Kapoor

Let me take the first and then maybe Adrian can give you a quick second answer. On the first, we do not set targets by quarter on BEI. We look at our brand investment needs; we look at our innovations; we look at how we want drive growth in our performance. And in the first half, our brand equity is at 14.8% to net revenue; it's never been higher. So we have been funding brand equity over the last, since we have identified this to be a big thing that we want to make sure. So our passion for brand equity and how we want to make sure that we keep funding our investment for growth does not go away.

I'm not going to tell you by quarter, by half, how that might lie because that also is weighted. If you look at half one last year, half two, there was a difference. And half-to-half differences happen based on the patterns of investment. Our commitment to brand equity still is very much intact.

Adrian Hennah

And in terms of the number of deaths, Charles, yes in rounds one and two, which are the rounds that have been reviewed by the KCDC so far, there were 73 deaths attributable to our product.

Rakesh Kapoor

May I just add one point, which is not to absolve ourselves of the responsibility because we fully accept it and we are working extraordinarily hard to do all the steps. People have used multiple products. You remember there were multiple products available in the market and therefore, there are multi-user issues. Now, estimates might be varying but they're in the same ballpark, 60% of all issues were multiple user issues. So I just wanted to put that maybe additional context for you.

Adrian Hennah

Good point. 73 deaths attributed, in part, to our product.

Rakesh Kapoor

In part to our product because there were multiple users. A bit like what you would find in any home; people using different products for the same kind of product.

Richard Joyce

So we have one more late question from the analyst of Bank of America Merrill Lynch. So go ahead Guillaume Delmas.

Guillaume Delmas

Good morning, gentlemen. I want to go back to the HS situation in Korea and particularly to what extent has it impacted the RVs, employee morale and, I guess, your momentum internally which has been quite strong in the last 18 months with Supercharge. And also linked to that, to what extent, at least in the short term, it could curtail your M&A ambitions, given the uncertainty about the fees and compensations you might be subject to?

Rakesh Kapoor

I think the first thing is, if you ask me and I'm an employee of the Company, I'm an owner of the Company, I'm the CEO of the Company and I don't feel good about what we have done. I would imagine that none of us are proud of what has happened because, of course, at this point in time we are thinking about the people who've been affected by it. It has been a 15-year issue. It has come to a big head right now.

And I think what will make us proud from now on is whether we put our credo, which we have put for this whole issue, in front of us and do everything possible in our control to find a resolution; a fair, appropriate, speedy, transparent resolution to this. If we work as hard as we’ve been working and we continue to do the right thing, I think when we look back, of course we learn many lessons and of course we will never be very proud of what we did before this problem, or at the time that the problem happened, but fairly look back and say, we did the right thing.

So I think that’s the phase we are in. We’re not proud of what has happened over 15 years. We are working incredibly hard to set it right, to do the right thing, put that credo that I talked about just now, in front of us, and find the best resolution for people. Now, you ask me whether this is going to impact our ability to do M&A. I don’t think so at all. In fact, our M&A ambition, our M&A thinking, is still based on the same strategic choices and the same strategic criteria, and the same financial discipline that I’ve spoken about many times. And I think the charge that we’re talking about, related to Korea, will not come in the way of inhibiting our ability to do the right M&A, which is the most important thing.

Guillaume Delmas


Richard Joyce

Okay, thank you, Guillaume. That’s it for the questions.

Rakesh Kapoor

Thank you very much for joining on the call, and good day to you all.

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