高露潔 (CL) 2017 Q2 法說會逐字稿

Good day, everyone, and welcome to today's Colgate-Palmolive Company Second Quarter 2017 Earnings Conference Call.

This call is being recorded and is being simulcast live at www.colgatepalmolive.com.

Now for opening remarks, I'd like to turn the call over to the Senior Vice President of Investor Relations, John Faucher.

Please go ahead, John.

Thank you.

Good morning, and welcome to our second quarter earnings release conference call.

This is John Faucher, Senior Vice President for Investor Relations.

Joining me this morning are Ian Cook, Chairman, President and CEO; Dennis Hickey, CFO; Victoria Dolan, Chief Transformation Officer and Corporate Controller; and Elaine Paik, Vice President and Treasurer.

Today's conference call will include forward-looking statements.

Actual results could differ materially from these statements.

Please refer to the earnings press release and our most recent filings with the SEC, including our 2016 annual report on Form 10-K and subsequent SEC filings, all available on Colgate's website, for a discussion of the factors that could cause actual results to differ materially from these statements.

This conference call will also include a discussion of non-GAAP financial measures, including those identified in Tables 8 and 9 of the earnings press release.

A full reconciliation with the corresponding GAAP financial measures is included in the earnings press release and is available on Colgate's website.

Good morning.

This is Ian.

I thought before John jumped into his customary division review, I'll just make a couple of opening comments.

Suffice to say, as we said in the press release, this, indeed, was another challenging quarter.

And as I think we all know, the industry continues to face global market volatility, and we have seen a further slowdown in consumer demand in several key markets, most especially the U.S., Southeast Asia and South Pacific.

On the positive side, that pressure was offset somewhat by strong organic growth in Latin America with a good balance between price and volume and a return-to-positive organic sales growth at Hill's.

My purpose in making the introductory comments now is to give you a sense of where we are focused going forward.

And going forward, we are focused, focused intensely, on returning our business to growth over the balance of the year and improving bottom line performance.

And our focus is heightened and will be heightened on 4 fundamentals.

The first is increased advertising spending behind more impactful creative; the second, innovation across our portfolio of businesses, particularly for Personal Care and Oral Care in the growing naturals segment and especially naturals for toothpaste, which has a particular target of local brands in some key geographies in Eurasia and Asia; third, greater investment behind our high-growth e-commerce business; and fourth, aggressively maximizing productivity up and down our income statement.

Those are the 4 fundamentals we are focusing on for the balance of the year.

And I will be back later with more detail on each and turn the call back now to John to go through the discussion of the quarter.

John?

Thanks, Ian.

As Ian said in the press release, the second quarter was another challenging one.

Net sales were down 0.5% in the quarter with 1% pricing growth offset by 1% volume decline and slightly negative foreign exchange.

Organic sales growth was flat year-over-year in the second quarter, below our expectations.

Our categories and markets remained volatile as the macroeconomic picture remains mixed.

We have seen a further slowdown in demand in several markets, including the United States, Southeast Asia and South Pacific.

Looking at the cadence of the quarter, after a weak April, we saw improvement in organic sales through the first half of June.

The back half of June was, however, negatively impacted by retailer destocking in some markets and a reduction in shipments in India in advance of the implementation of the new goods and services tax.

As Ian mentioned in the press release, there were also several encouraging factors in the quarter as compare to the year ago.

We saw strong sales growth in Latin America driven by a balance of volume and pricing, and we saw a return-to-positive organic sales growth at Hill's, following 2 weaker quarters.

We are also encouraged that on balance, foreign exchange headwinds have lessened over the past several quarters, and raw material costs are increasing at a more modest rate.

We believe consumer usage of our products remained broadly stable in the vast majority of markets, which would dictate that category takeaway should normalize going forward.

While we have seen a small decline in purchase frequency in some markets, we are taking steps to adjust price points where necessary due to lower consumption and usage.

While we are pleased with these bright spots, we are attacking the headwinds with a focus you would expect from our company and a strong sense of urgency.

Through pricing and productivity, we achieved gross profit margin expansion in Q2 with 20 basis points of expansion on a GAAP basis and 50 basis points, excluding the impact of our 2012 Restructuring Program.

On a GAAP basis, our operating profit margin was down 230 basis points year-over-year in Q2.

Excluding the impact of our 2012 Restructuring Program, our operating profit margin was down 10 basis points as the improvement in gross profit margin was more than offset by increased advertising investment, prior overhead expenses and other income expense net.

On a GAAP basis, earnings per share of $0.59 was down 12% year-over-year.

Excluding the impact of our 2012 Restructuring Program and the net benefit from a previously disclosed foreign tax matter in the second quarter of 2016, earnings per share was up 3%.

We have returned almost $1.6 billion to shareholders year-to-date through share repurchases and dividends which is a 16% increase versus the first half of 2016.

Now moving to divisions.

We'll start off with North America.

In Q2, we saw improvement versus Q1 in both net sales growth and organic sales growth in North America, but not to the extent that we had expected.

Net sales and organic sales growth in the quarter were down 3.5%.

Category growth rates in the U.S. slowed sequentially versus the first quarter, dipping slightly negative, driven by a notable decline in April.

May and June were better, particularly May.

In the toothpaste category, we strengthened our leadership in the U.S. where our market share lead versus our largest competitor increased again versus Q1 and now stands at more than 1 share point year-to-date.

We continue to gain share in the ultra-premium whitening segment, seeing benefits from our latest launches, Colgate Optic White Beauty Radiant and Tom's of Maine Luminous White.

Outside of Oral Care, our Tom's franchise also continues to gain share in underarm protection, tapping into the continued consumer interest in the natural space.

Tom's has expanded its underarm protection line to now include men's and children's variance as well.

Turning to our hand dish category.

While we saw a sequential improvement in market share in the quarter versus Q1, the business is not yet where it needs to be.

Our restage of the business is progressing slower than anticipated, and it has been impacted by both category weakness and heightened competitive activity.

The rollout of the new SKUs is complete, and we are adjusting our promotional strategy to compete more effectively on shelves.

Now we'll look at Latin America.

Latin America delivered 7% net sales growth and 8% operating profit growth.

Organic sales growth was also 7% as foreign exchange was even with the year-ago period.

Our strong gross profit growth in the quarter funded a significant year-over-year increase in advertising investments.

We are encouraged that our volume performance improved across categories and geographies in the division.

Our net and organic sales growth of 7% was driven by a mix of volume, plus 2.5%; and pricing, plus 4.5%.

While Mexico volumes were down slightly against difficult comparisons, our toothpaste market share in Mexico is up 170 basis points year-to-date versus year-to-date 2016 to 82.1%, our highest share in 6 years.

We saw a sequential improvement in our volume performance in Brazil, Colombia, Argentina and many other markets across the division.

As I mentioned, we are encouraged by the volume growth in Brazil, but the market remains volatile.

We are managing our price points to ensure that we are competitive on shelves.

Our toothpaste market share in Brazil remained at 72% in the quarter, even with Q1.

Our Latin America business will benefit from several new product launches in Q3, including Colgate Triple Action Extra Freshness toothpaste, Colgate Total Mouthwash and in Brazil, Protex Pro-Hidrata bar soap and body wash.

Moving to Europe.

Europe net sales were down 3.5% in the quarter with organic sales down 0.5%, similar to Q1 and a 3% negative impact from foreign exchange.

Our U.K. business continues to perform well with a mix of pricing and volume growth, although this was offset by a significant negative foreign exchange impact, which should abate as we cycle easier foreign exchange comparisons in the second half.

Encouragingly, we saw further improvement in our French business.

Our Oral Care market shares are improving sequentially as we gain distribution, and we would expect this trend to continue into the third and fourth quarters.

Our Personal Care business in France saw strong growth behind the Sanex Zero relaunch.

This relaunch features new graphics and new product lines.

The media investment for the Sanex Zero relaunch includes both TV and digital support that is tested well above advertising testing norms.

Moving forward, along with the Sanex relaunch, we expect to see benefits from the launch of Colgate Max White Expert Complete toothpaste, Colgate Minions license battery-powered toothbrush and the launch of Palmolive Naturals with precious oils.

Next, Asia Pacific.

Net sales in Asia Pacific were down 5% in the quarter, and organic sales were down 3.5%.

As mentioned in the press release, organic sales for this region came in softer than expected primarily due to the reduction in shipments in India in advance of the new goods and services tax, or GST, increased competitive activity in Australia and consumption declines in Thailand.

Volume was down 2% in the quarter driven by declines in India, Australia and Thailand, with Greater China down modestly.

Volume performance in India worsened sequentially in Q2, in advance of the implementation of the new goods and services tax, which took effect on July 1. Due to uncertainty about the new law, the trade in India was cautious, and shipments basically ground to a halt for the last 2 weeks of June.

As I mentioned, our Greater China business posted a modest decline in volumes in Q2, which was a sequential improvement from Q1.

We are driving significant growth in e-commerce, and as a company, we increased our industry-leading toothpaste market share in the quarter in this highly important channel.

In the Philippines, we continue to see solid volume growth performance and market share gains across our Oral Care and Personal Care portfolios.

The Africa/Eurasia division reported net sales growth of 1% in Q2 driven by price increases and foreign exchange, which more than offset weaker volumes.

The volume weakness was driven primarily by the continued impact of our distributor changes in our Sub-Saharan African business.

We showed sequential improvement in volume in our Russian business in the quarter versus Q1 as we raised advertising spending and adjusted price points given some of the recent currency movements.

Benefits from pricing and savings from our funding-the-growth initiatives allowed us to significantly increase our advertising investment in the division.

We continue to invest in brand-building activities, both in terms of increased television and digital advertising as well as programs to build per capita consumption to drive long-term changes in consumer behavior.

Looking at the second half of the year, we expect the Africa/Eurasia division to benefit from the launch of Colgate (inaudible) toothpaste in Russia.

This premium price line uses locally gleaned insights to tap into the rapidly growing premium priced naturals segment in the country.

And we'll finish up with Hill's.

Hill's delivered flat net sales for the second quarter as organic sales growth of 0.5% was offset by slightly negative foreign exchange.

Volumes were down 1.5% with pricing up 2%.

We are encouraged by a notable sequential improvement in volume trends in the United States versus Q1 driven by continued strength in our e-commerce business and greater availability in the pet specialty channel.

We made significant progress in regaining distribution and promotional activity in the pet specialty channel in the quarter, and we continue to expect improved performance as we further align our strategic priorities with our top accounts in this channel.

Our e-commerce growth continues to outpace the category as our e-commerce business in the U.S. doubled year-over-year in the second quarter.

Also, our Prescription Diet business in the U.S. is growing nicely driven by strength in the vet channel.

Hill's continues to benefit from the recent U.S. launch of Hill's Science Diet Youthful Vitality, which is especially formulated for dogs aged 7 years and older to help fight the effects of aging.

It's gaining share in the aging dog segment driven by a strong integrated marketing program that has driven 43 million impressions across all platforms, including some of the most impactful digital advertising we have ever seen on the Hill's brand.

We continue to see significant opportunities to build the Hill's brand in emerging markets where the specialty pet food category remains underdeveloped.

Our emerging markets business volume growth in the quarter was led by Mexico, Brazil, Russia and South Africa.

Now we'll turn to our outlook for 2017.

As stated in our press release, we lowered our guidance of flat EPS on a GAAP basis to down mid-single digits on a GAAP basis.

The change in our GAAP EPS guidance is due to the additional projects I -- is due to additional projects, bringing our protected charges for the Global Growth and Efficiency Program to the higher end of our previously disclosed guidance range.

On a non-GAAP basis, our guidance remains for low single-digit EPS growth.

Based on current spot rates, we expect net sales to be up low single digits for the year with a slight negative impact from foreign exchange.

However, given the organic sales weakness in the first half of the year, we now expect organic sales growth will be in the low single digits versus our previous guidance of modestly below our historical long-term range of 4% to 7%.

We still expect solid gross margin expansion, but we are now planning for gross margin to be up in the low end to midpoint of our 75 to 125 basis points long-term guidance range versus at the high end previously.

Lower top line growth and certain higher raw material costs have impacted our year-to-date gross margin performance.

We still expect gross margin expansion to accelerate in the second half of the year given less impact from raw material costs and greater benefits from our funding-the-growth initiatives.

And now I'll turn it back over to Ian.

Thanks, John.

So let me come back to my introductory remarks and say that despite the recent category weaknesses we have seen, we believe a heightened focus on the 4 fundamentals I mentioned, in essence, our focus on brand building and productivity, will allow us to reaccelerate our top and bottom line growth.

So let me talk a bit further about each of them in turn.

The first was, you will remember, increased advertising spend behind more impactful creative.

So we are, as you know from the beginning of this year, committed to more consistent advertising investment sustained across the year with an increase on both a dollar basis and as a percentage of sales.

The year-over-year increase in advertising investment is planned to accelerate in the second half as we lap lower levels of spending in the prior year.

Obviously, part of this advertising will be digital, which is a growing percentage of our working media spend.

And when I talk about quality, we're talking about advertising that is tested to be motivating and persuasive with consumers using testing norms and what it sees is an increase in advertising behind what you might call the equity of the brand or the purpose of the brand advertising behind the base business sustained over time, while we use incremental advertising to launch new products.

That's the most immediate investment effect.

But what I wouldn't want to forget is our increasing investment in building per capita consumption of toothpaste, which, of course, drives sustainable, long-term growth, particularly for Latin America, Asia and Africa.

Our Bright Smiles, Bright Futures program is well on its way to reaching 1.3 billion children and teach them how to brush their teeth by our target year of 2020.

And as you may recall, spending behind this program generates returns that are 3x our return on traditional advertising.

And our analysis has shown that in our top markets outside the United States, 70% of our addressable population brushes their teeth, on average, less than once a day.

The point being, there is significant upside over time in consumption in Oral Care, and so we are investing sustainably to generate that consumption over time.

So advertising for the near term and advertising for the longer term.

Secondly, innovation.

Innovation, of course, across our portfolio for the balance of the year and into 2018, but innovation particularly in the naturals space, which is a growing area of opportunity.

And further than that, specific innovation in the naturals space for toothpaste, which is both an emerging segment and an effective counter, we believe, against local brands in Asia and Eurasia.

Now on the naturals side, beyond Oral Care, John already spoke about progress with Tom's on UAP.

And obviously, we broadened that Tom's range now into other Personal Care categories, like body cleansing and bar soap.

On toothpaste, we have launched the Colgate Naturals toothpaste line in several markets across 3 of our divisions.

And the rollout of that bundle will continue over the balance of the year, particularly across Asia.

Our consumer innovation centers located in those geographies have allowed us to build bundles that are tailored to meet local needs and preferences.

In other words, a counter to the local brands we find in those geographies and are encouraged by the initial results we see.

Now on top of that, as I have mentioned previously, in terms of regional brands, we continue to see benefit from underlying growth on brands like elmex and meridol in toothpaste in Europe; Darlie in China; and Sanex in Europe.

So that's the second, innovation across the portfolio particularly focused on naturals and especially focused on naturals for toothpaste.

The third is working with retailer partners for growth on our business and specifically greater investment behind the high-growth e-commerce space.

So given the changes that we are seeing in the retail landscape, we continue to aggressively adapt our go-to-market execution to service the very different brick-and-mortar retailers growing in our categories today and, of course, e-commerce.

The focused nature of our portfolio and the industry-leading market shares that we have, make us relevant to the shoppers in the -- in those outlets and give us influence in our key categories, and we, of course, are working very closely with our retail partners to help them drive traffic to their stores across all of the different segments of brick-and-mortar retail.

Very importantly, we continue to build our capabilities in e-commerce.

And this, I think, is reflected in our leadership in toothpaste from an e-commerce point of view in our top markets: United States, China and the U.K.

And for Hill's, as consumers increasingly move to online shopping, we have the ability to reach an entirely new group of consumers, and we make sure that our presence is structured to provide the information that pet owners need to make a smart decision about which Hill's product is right for their pets.

Interestingly, year-to-date, Colgate's worldwide e-commerce business growth is up 65%, so an area of aggressive focus for the back half of the year.

And finally, the fourth, aggressively maximizing productivity up and down the income statement.

On the cost front, we are, of course, focused on realizing both short- and long-term productivity in order to drive sustainable margin expansion.

Funding-the-growth that you know well continues, we believe, to be a best-in-class productivity program that we use to work down cost on all lines of the income statement.

In 2017, funding-the-growth is delivering significant savings in areas like ocean freight, direct and indirect procurement, co-packing and fragrance and formula harmonization.

We're also tackling long-term cost structure through our Global Growth and Efficiency Program.

We'll continue to see benefits from our hubbing activity and our move to centralize Colgate Business Services and the back-office services that they, indeed, provide.

And we have said consistently over the last 6 to 9 months that in this last year of our Global Growth and Efficiency Program, we are being particularly focused to capitalize on the opportunity it affords us.

And so in the second quarter of this year, we initiated 2 additional projects as part of that program with the goal to better align our cost structure to longer-term trends: one addresses the structure of our European business; and one addresses our corporate infrastructure, both underway.

And these additional projects take us to the upper end of our previously disclosed cost and savings ranges.

And we continue to say that we remain very focused on identifying as many additional projects in the last year of this program.

So those are the 4 areas of heightened focus: Increased advertising spending behind stronger creative; innovation across the portfolio, particularly in naturals and specially in naturals on toothpaste against local brands; sharp focus with our retail partners and particular emphasis on the high-growth e-commerce marketplace; and continuing to aggressively maximizing productivity up and down our income statement with 2 new programs now public in this quarter just closed.

So those are our areas of focus for the back half of the year.

And now I'd be delighted to open the line to questions.

(Operator Instructions) We'll go first to Dara Mohsenian with Morgan Stanley.

So I'm sure you guys are spending a lot of time analyzing the drivers behind the top line growth slowdown the last few quarters.

My question is how much of the recent top line growth variance in the last few quarters versus your long-term forecast, how much of that do you think is due to the factors that may linger longer-term like consumer brand fragmentation away from leading brands that was sort of implied by your focus on natural and increased competitive environment or any other longer-term factors versus more of the shorter-term factors that you mentioned, and that's in both North America as well as emerging markets?

And the background behind that is, is your long-term 4% to 7% organic sales growth outlook still reasonable?

Why should we have faith in that given the magnitude of disappointment the last few quarters, the fact that it's sustained over a few quarter period and has surprised you guys?

Yes.

Well, a lot in there, Dara.

First, I think as we came into this year and we had the 2 quarters we have had, when we talked about the prior quarter, the first quarter, we clearly said we would be below that range.

And now we are saying, based on the first half performance, that our growth this year will be low single digits.

I would not offer comment at this stage on the 4% to 7% range.

I think that's something that we would come back and revisit once we gain more practical experience of how this year unfolds.

I will say there have been a lot of onetime or at least volatile episodes in the last couple of quarters, particularly late in the second quarter, which have been problematic.

And it would be fair to say that the continuing slow consumer demand is worrisome, but there's nothing that we see in the data that suggests that consumer behavior is changing in any way.

As John said, we have seen pockets of lengthened frequency of purchase, and we are addressing that both strategically with advertising and innovation and also some price point action on the shelf.

The competitive environment is variable.

It can be volatile, and it can be particularly sharp.

And we saw that, for example, in June here in the United States across many categories, heightened competitive activity.

So I think that's going to be a variable.

And our belief, and I think the most important belief here, is that the consumer behavior will see the categories come back.

The only thing we can practically do to address that in the short term is to drive our market shares because then, whatever the category growth is, we will be getting the best return out of the category growth that exists.

And in that regard, I can say that our global year-to-date market shares are better or even with the first quarter shares on all of our priority businesses.

So we are beginning to see our market shares rise.

But I think before one takes a view on longer-term growth rates, one would want to see this year play out and get more information on that consumer behavior, get some practical evidence that, indeed, the consumption patents do return to the norm.

And then when we give guidance for 2018, that would be the time to have the conversation.

We'll go next to Bonnie Herzog, Wells Fargo.

I just have a few questions on the stepped-up innovation that you discussed.

First, could you give us a sense of the growth rates of the natural toothpaste category versus non?

And then, how much cannibalization are you anticipating of your existing business from some of this new innovation?

I guess, I assume this is a premiumization opportunity.

So to some extent, cannibalization could be welcomed.

And then finally, curious why you haven't innovated here earlier.

Were you not sure of the growth of this emerging category would necessarily be sustainable, but now you are?

And I guess, for me, it's sort of begging the question.

Are there other emerging categories that are pressuring your existing business that you might need to move more aggressively in?

Yes.

Well, all good questions.

Suffice to say, the naturals segment is growing faster than the average growth of the category, which is what makes it attractive.

We, of course, have participated in this segment for quite a while, particularly in markets where it's important, Asia or even go back to our now more than decade-ago acquisition of Tom's of Maine here in the United States that continues to grow very, very nicely.

I guess, the point is that the offering we are talking about now is different from the naturals offerings that we have had thus far, much more tailored to brands that now exists that didn't exist when we had our naturals portfolio first in the marketplace competitive with those brands tailored from a flavor point of view, and to the point you made, adding meaningful premium price compared to prior offerings in the marketplace.

So it's more of the tailoring of it than the existence of it because segments, obviously, morph over time.

So I don't think it's a question of missed.

I think it's a question of tailoring the product to the category as it evolves over time.

And the question of cannibalization is a very difficult one to answer in the general.

It varies market by market.

Premiumization tends to reduce the cannibalization, obviously, with lower businesses.

And we will, of course, be supporting our base businesses when we come with this premium innovation.

So we'll be working very hard to keep the cannibalization to a minimum.

But regardless, to the point you made from a cannibalization point of view, this will be accretive from a pricing point of view and, therefore, favorable.

We'll go next to Wendy Nicholson, Citi Research.

A couple of things.

First, just to clarify, when you said your global e-commerce business was up 65% in the quarter, can you break out roughly how much of that was Hill's versus for the core?

And then just remind us off what base that is.

Is global e-commerce still like 2% of your sales?

Or is that number out of date?

And then secondly, just kind of higher level, you talked a little bit in the prepared remarks about maybe taking some, I think, strategic pricing down a little bit in a couple of countries or categories.

And I wanted to sort of go back to something that I had heard Noel talked about recently, which was a little bit more focused on raising prices and revenue management and maybe that Colgate's price points are below where the company would like them to be kind of from a longer-term strategic perspective.

So I get that you're doing things that are right now tactical and strategic to recover some share.

But how important is this concept of revenue management?

How much of it factors into your thinking of your growth algorithm going forward, et cetera, et cetera?

Thanks, Wendy.

Well, the e-commerce growth of 65% is, indeed, for Colgate in totality.

In other words, it is the Hill's business, and it is all of the Colgate businesses.

And frankly, we don't intend to break out the difference between the 2 nor do we intend to break out the percentage of our business that is e-commerce.

Suffice to say, it is still relatively modest but very, very high growth.

And once it reaches a tipping point, we'll certainly bring that information to the marketplace.

The pricing reaction is actually not mutually exclusive.

The -- when we talk about price point adjustment at retail, it is to be competitive on purchase cycles.

And while it applies to all of our categories in promotional pricing, it is less focused on Oral Care, which, of course, is what Noel was talking about.

So they're selective.

They're surgical, and they are less focused on Oral Care, point number one.

Point number two, from an Oral Care point of view, just the prior discussions on the naturals offering, we are also bringing innovation that is materially higher-priced to that business.

And as Noel may have described, in some cases, as we have relaunched literally tiers of our business, T-I-E-R-S of our business in different parts of the world behind that relaunch, we found a way of elevating the value the consumer gets in the pricing of the line to increase the average life -- the average price of our entire portfolio.

So I guess, that's the way to answer it.

And yes, revenue management is extremely important.

The topic that Noel talked about remains highly relevant.

And what John was talking about was surgical activity, less applicable to Oral Care on promotional pricing, not strategic pricing.

And if you just put those 2 concepts together kind of I know you said consumer behavior vis-à-vis the Oral Care category isn't really changing, but clearly, consumer behavior with regards to e-commerce is changing a lot.

So if you say e-commerce plus pricing, in your analysis so far, if I'm buying toothpaste on Amazon as supposed to in Walgreens, does this consumer tend to be more price-sensitive, more brand-loyal?

This is a high-level question.

You guys do such great job of analyzing the business.

I'm wondering if you have any kind of high-level takeaways about how to make sure that your shares are as strong online as they are in bricks-and-mortar.

Yes.

Interestingly, Wendy, it kind of works the other way.

What we observed on e-commerce thus far is that the consumer is actually tends to buy more premium.

And even if they're not buying the premium brands, they tend to buy in multiples.

So in fact, the e-commerce behavior is favorable to us from a consumption point of view.

And if you look at the Hill's business, 50% of the Hill's business in the U.S. on e-commerce is subscription.

So that means, once they buy it onetime, they're signing up to regular delivery of that diet over time, which is, we believe, a good business model for our brand.

We'll go next to Jason English, Goldman Sachs.

This is actually Usha on behalf of Jason.

Gross margin improvement have been impressive in spite of a softer top line growth.

But guidance for the full year was brought down slightly in spite of a good rate -- run rate for savings.

Now is this mainly due to the higher expected reinvestments you plan to make in the second half?

And would those continue into 2018?

Yes.

Well, thanks for the question.

Usha is your name?

I guess, she [broke off].

The gross profit, as John said in his remarks, was behind our expectations for the first half of this year largely because of raw material cost increases, which, in fact, was primarily in the area of fats and oils.

Interestingly, the cost of fats and oils has ebbed since the first half of this year.

So as John also said, we're now moving into a more favorable raw material cost environment and, of course, for this year thus far, and it gets easier against our projections over the balance of the year, there has been less transaction headwind because foreign exchange has not been so negative as it had been in previous years.

So we are looking at what we believe will be a multiple benefit of material costs easing and transaction costs lessening.

And as John also said, we, therefore, expect to see a sequential improvement in gross margin as the year unfolds.

So I think that's the answer to the question.

Our next question is from Steve Powers, UBS.

Ian, a question to follow up on your advertising comments, if I could.

Historically, if we go back, your advertising was spread out pretty evenly quarter-to-quarter as a percentage of sales.

But over the last several years, we've seen, really, a 200 basis point gap open up between first half spending and second half spending.

And I know that directionally, you tend to close that just based on your comments.

But does it get back to 10% of sales in the back half, which would still be 50 basis points slide of what, I think, you spent so far this year?

That would imply 160 basis points of incremental spending in the back half and skewed to Q4, if my math is correct.

I just love to get your sense if that's the right order of magnitude to be considering.

And then if so, what kind of ROI do you expect that's going to have?

And will it contribute to the second half top line improvement that you're expecting?

Or should we now expect the lift to really show through until fiscal '18?

Perhaps that answer lies in how much spending goes to new launches versus the things like Bright Smiles, Bright Futures.

But just some context to how you're thinking about both the magnitude of increased spending and then the expected ROI and when you see it flowing through.

Yes, good question.

And I'm glad you got the scale thing on the table.

You're right, for the last couple of years, and I think we were quite expressive about this when we talked about 2017 faced with sharp foreign exchange negative impacts.

And with having no immediate term place to go, we reduced advertising.

And we said, coming into this year, we did not want to do that.

And -- but even if foreign exchange were going to run sharply negative for whatever global calamity reason, that we would not go back on our advertising investment.

And our intention at the time we said that, and it remains our intention and our plan, is to continue our advertising investment in the second half at approximately the same level, in other words, sustained advertising that we have seen so far across the first half.

And yes, that will suggest a fairly meaningful step-up in advertising investment.

We think the ROI will be good.

This is now talking to the traditional advertising.

Because, as I said earlier, we have a lot of advertising vehicles now developed that have tested extremely well.

So we know the advertising works very, very hard and is persuasive to consumers.

And interestingly, it is good to have this balance between announcing what's new, and shall we say, supporting and reminding of the reason consumers give trust to the brand in the first place.

And so continuous advertising behind, as we call it, the base, is an important part of that decision.

And you're right, obviously, the Bright Smiles, Bright Futures investment is not a short-term investment.

But as again I tried to spell out, we know the ROI on that is terrific.

We know we get good ROI on our media in general.

And therefore, we're very comfortable with the investment decision.

And of course, it is our expectation that this will be part of the reason to return us to growth as we work our way across the year.

And again, Bright Smiles, Bright Future, we hope, will be part of the reason why we will be able to sustain that growth in the toothpaste category out over time.

We'll go next to Jason Gere, KeyBanc Capital Markets.

I guess, obviously, what we're hearing is the first half of the year pricing helped offset, I guess, the weaker volumes.

In the second half, it sounds like volumes will probably offset price to get to that low single digit.

So just wondering if you can just lay out maybe a little bit more some of the macro-micro impacts that you saw in the first half, how that plays during the second half.

So on the micro side, talk about some of the distributor changes in Eurasia, the U.S. liquid.

I think in Europe, there were some packaging changes.

So there were things that were within your control, and I was just wondering how that plays out in the second half.

And on the macro side, I think you were -- besides India, and how that kind of plays out in the second half.

I think you said that there was some destocking in the second half of June, where that is.

And maybe a little bit more color as to how we can think about that going forward.

Broad question, Jason.

Let me try and take it on.

The U.S. dish reset, which I think we have well covered, we now have the products fully in distribution.

They're on the shelf where we want them on the shelf.

We were hit in June, as we've said, by heightened competitive activity, very heightened.

And we are responding to adjust our promotional planning and offerings to jump start progress across the back half of the year.

So yes, in our control and, I think, a plan in place to rebuild growth.

On the decisions that affected customers, I guess, I would focus on the 3 you raised.

You have our decision to move broadly to e-commerce in the United States with our Pet Nutrition business, which we continue to believe is absolutely the right decision, and we're an equal opportunity believer in that space.

In other words, we are just as happy to lean in aggressively with a retailer who has a brick-and-mortar offering and an e-commerce offering as we are with a pure play e-commerce company.

We had a hiccup, shall we say, with a customer in the U.S. That hiccup is now substantially behind us and a return to normal promotional and other consumer engagement activity is recommencing and will, of course, build across the balance of the year.

The European retailer matter, I think, John covered well.

We are seeing our market shares rebound quite nicely and growing sustainably and sequentially.

And we expect to see that continue across the back half of the year.

In Africa/Eurasia, we made those distributor choices that we again believe are the right choices for the business over the long term.

And we will continue to lap those comparisons until the fourth quarter of this year.

So the third quarter will still be burdened by a difficult comparison.

And then of course, the reality is that even though each of them, we believe, was the right decision, they had a compounded effect all at the same time, which was problematic.

But I think faced with the requirement to make the decisions again, we'd make the same decisions.

The GST -- we were just digging out of the demonetization headwind, and then boom, you get the GST, which basically saw the stockists close up shop the last 2 weeks in June.

And we're hopeful, barring another event, that we will see that rebuild across the back half of the year.

So I think, on balance those issues, I think we have identified them before, and I think we are in the process of building them.

The macro environment, looking forward, it really comes down to the categories.

We think the behavior will come back, but we're focused on building our market shares, so that whatever the category growth rate is, we're getting, frankly, more than our fair share of that underlying growth.

So that's the way we're thinking about that, while we get more consumer data in terms of behavior as we work our way through the balance of the year.

We'll go to Faiza Alwy, Deutsche Bank.

Ian, I just had a broader strategic question because, I think, if you look at some of the per capita consumption trends, it seems like the opportunity is really in some of these frontier markets, like in Africa and India, which can be pretty volatile on -- from a macro point of view and maybe geopolitical point of view.

So are you thinking about extending -- using your distribution network globally and extending it into other categories?

So maybe skin care, you have a great brand in Sanex, maybe taking that global or another brand sort of just extending your overall reach into these global markets where you have a great setup.

Yes, I think that's a very relevant and pertinent point.

And yes, of course, it is within our strategic remit.

It's not, and I know you know this, but it's not as simple as simply taking a product and putting it through a proven distribution system.

When you bring products that people may or may not be familiar with in their entirety, i.e.

from a usage point at all, or certainly, from a brand point of view, it requires a considerable degree of investment and patience over multiple years to build a position in the marketplace.

But the answer is, yes, it is clearly one of the assets we believe we have that we can leverage.

The question will simply be timing and pace.

So watch this space.

We'll go next to Kevin Grundy, Jefferies.

First question, Ian, if you won't mind, just a housekeeping one.

In the past, you've been kind enough to supply category growth rates by region, U.S., Europe and EM.

So if we can get an update there.

I think, probably, in aggregate, category growth rates have probably come in about 1 point since 3Q, but an update there would be helpful.

And then the second question more broadly, Ian, would be around M&A.

And you talked a lot about areas of focus for the balance of the year, which we well covered on this call.

So I appreciate that.

That's very clear.

But the question is, I guess, given this sharp deceleration, which we haven't seen in your portfolio in a long, long time, does this give you any pause with respect to M&A, which has not been a big part of the company's portfolio strategy?

Had some nice tuck-in deals, of course, with Sanex and Hill's.

But said differently, in a slower growth environment, does this increase your appetite for M&A?

And if so, would you consider pursuing any businesses outside of the current portfolio?

Yes, the -- well, category growth, frankly, it's reasonably straightforward.

Certainly, for the last quarter, the emerging markets are still mid single digits in some countries, with much more of a presence now in e-commerce.

China would be the obvious example.

And in the developed world, what we have seen is, Europe and United States or North America were essentially flat.

I mean, that's the way the world splits today.

M&A, do we have appetite?

We've always had appetite.

We're just, I would say, very strategic in our appetites.

And when we look at M&A, we look at it from the point of view of strengthening the portfolio of the company, not meeting a sales requirement, and certainly, not jumping into a new business that we don't know too much about.

And mustard would have been a very expensive one to get into, for example.

So I think you could see us buy on the fringes of the businesses we're in.

We have with Sanex, for example, lotions and creams that we are now expanding in Europe.

But if we were to play in M&A, and we are very keen on expanding our portfolio with the right asset, I think you would see it in the broader definitions of the categories we're already in, in Oral Care, in Pet Nutrition and in Personal Care.

And that's the way we think about it.

We're not going to do anything in a undisciplined way just for a tactical response.

We remain keen.

And we'll go next to Andrea Teixeira, JP Morgan.

So can you elaborate more on John's comments on the cadence of the quarter in North America and in Asia?

It seems that June got worse from May and then the destocking was not only in the U.S. and China, which obviously, you mentioned in the last call as well as in Europe.

But I was just hoping to see if there is any other areas where you can kind of recover from where we were in the first half.

And if you can comment if orders are starting to come faster now that we are probably 6 to 8 months behind in terms of -- behind us in terms of the destocking both in the pantry and retail destocking.

And related to that, I mean, in terms of the funding of your funding for growth, you elaborated a lot on the sales perspective.

But is there anything that we can think of the SG&A?

I know you had invested a lot more in overhead over the past 2 months globally.

But if you can elaborate if there is any other source of potential savings on that front that could allow you to continue to invest and foster further growth.

Okay, Andrea.

Well, let me start with the Global Growth and Efficiency Program and the SG&A idea.

I mean, you're right, we remain extremely focused on maximizing our opportunity in this final year of that program.

And I think that is reflected in the 2 actions that we talk about in the second quarter, one of which reflected in the costs in our filing.

Both of them are directly and meaningfully in the SG&A space.

They will play out over time in terms of realizing the benefit, but they will afford a benefit and we continue to focus on finding other areas that we could do light without in any way damaging the firepower we need to be successful on the ground.

So yes, it's a very clear area of focus, and I think it's evidenced in the actions that we took.

It's very difficult to come back to this cadence on the quarter.

Again, as John said, in the U.S., actually, the second quarter, in aggregate, was worse than the first quarter overall, with a combination of a weak April and then a June that traded.

In terms of destocking, we have seen that on a volatile basis.

I guess, the only thing I can repeat is that we are seeing on a year-to-date basis our global market shares in our priority categories better or flat with the first quarter, which gives us a sense that our underlying consumption-driven growth is improving, and we look forward with the 4 areas of focus I mentioned to capitalizing on that fully as we work our way through the back half of the year.

We'll go next to Olivia Tong, Bank of America Merrill Lynch.

I guess, Ian, perhaps, can we talk a little bit about just the aggregate impact of some of these one-offs, like the dish in the U.S, France, GST, et cetera.

Just trying to understand what you think your underlying growth would be, if not for all these things.

Because it's still probably not at the end -- at the low end of your long-term range.

And then also, given these one-offs and recognizing the comp differential in Q3 versus Q4 in the second half, I was wondering if you could give a little bit more color there.

And then just on Naturals, we talked a lot about specifics for naturals in Oral Care, and that was very helpful.

But one category where naturals has also been taking disproportionate share is pet food, and we've talked about that in the past.

But just wondering, can you talk about how you think about that category and the growth potential there and your interest in expanding in naturals in pet as well.

Yes.

The -- well, taking it in reverse order.

In pet, we think about it more in terms of the formulation of our products.

We are unabashedly a brand that provides clinic -- proven clinical benefits to pets, whether it's preventative or whether it's curative with our Prescription Diet business.

And certainly, on the preventative health line, we have reformulated our products to put proteins first and not give people a reason to switch out of our business, and if they value a particular clinical benefit, to not have a barrier to them trying the Hill's product.

And we think that has been quite successful and conceptually moving into a very, very almost Tom's-like naturals is difficult to do.

We have tried a couple of times with Hill's.

And the heritage of the brand doesn't give you the bandwidth to go pure on naturals.

So we've done it by formulation to eliminate barriers.

I don't think at this stage, given the compounding effect of the slowdown in our markets, trying to do the math on what is the one-off and how does it relate to the underlying category growth is going to be particularly helpful because the expectation is that the category growth will come back.

So the reason the way we're thinking about it is to say, over the year, we expect this year now to be low single digits from an organic sales point of view.

And we continue to be very focused on the consumer, on the consumer behavior.

We've taken some actions that John mentioned to try and capture the frequency of purchase in some of our businesses.

And as we learn more, we'll be able to respond more authoritatively is the behavior coming back or is there something else driving what we see in the categories.

And we think it would be premature and probably misleading to get into that at this stage.

We'll go next to Ali Dibadj, Bernstein.

So I have 2 questions.

One question is, when we talk about those initiatives, Ian, that you laid out so eloquently around naturals, local competitors, e-commerce, more ad spend, better productivity or lower SG&A, these are all things you've heard many of us kind of collectively push for and push you on to the path on these conference calls.

I guess, for a while, I mean, I remember 3 years ago about e-commerce were only local competitors.

And all of us were kind of asking these questions.

The ad spend has been an ongoing discussion.

And now you're saying well we got to do something about these things.

So I guess, my first question is, I'm just wondering why it took so long to react.

What was the turning point?

And now it just feels you're behind.

So I guess, why it took so long?

And then the second question -- I lay it aside if it's related or not, I guess.

But there's a lot of buzz out there right now, a lot of discussion, and I think, your stock performance today, given the numbers, would suggest that -- there's a lot of discussion in the investor community that the numbers today are so bad, the numbers last quarter are so bad that they're actually good for shareholders.

And activists will come in, an acquirer will come in and get involved.

What do you think about that view?

Certainly, it's helped your stock out recently.

But what do you think about that view?

And how hard will you work to specifically prevent a bid or an activist in that context?

Yes.

The -- I guess, on the first question, I'm not sure I completely agree.

I think it's fair.

The criticism on the advertising spend and the lack of consistency of advertising, but that we addressed coming into this year's budget.

And I'm just reaffirming that it is playing out the way we expected it to play out.

On e-commerce, we have been very focused on e-commerce for a long time.

We may not have talked about it as eloquently as you find I did this morning, but we have been focused on it.

And I think that's why we have the toothpaste leadership positions in the markets that we talk about and the growth rate and subscription levels on the Hill's business that we talk about, even if we took the pain of making those decisions in the marketplace, which we're now after almost 9 months, nearly 1 year, just working our way out of.

Naturals, again, we have been talking about the naturals for a while.

Yes, it's only coming to marketplace right now.

But when the local brands idea came up, we were saying that, that is our response.

You can chide us on the speed of getting it to marketplace.

And I won't fight that, but in terms of the idea, and that was accounted to the local brands, we feel good about the offering that we're on.

And on the efficiency, I'm not sure you were implying any critique of the productivity.

And I think the action that we have taken in this quarter that we have mentioned was evidence of our focus in that area.

So when we think about going forward, buzz is one thing, and there seems to be increasing buzz in this world about virtually everything, which can become an enormous distraction.

So the only thing I can say, and I won't repeat the remarks I made at Bernstein, but I will say, we are focused on the areas that I have mentioned.

We think these are the right areas to focus on to see a recovery in sales momentum across the back half of the year.

We are focused on the SG&A line in our income statement to get us more productive from a reasonably advantaged base going forward, so we have no blinders in terms of a need to focus on our cost structure, and we will continue to do that.

And if we have more to say in that space, we will say that in a way that we think is consistent with driving growth sustainably over time.

And with or without buzz, we are steadfastly focused on that.

So I'm sorry, I can't sound more energetic.

It seems to fail me.

But I think you can rest assured -- well, you don't have to rest assured.

I guess, I'm saying that we very much are focused on growth and on cost structure.

Our next question is from Jonathan Feeney, Consumer Edge.

Just -- thank you for your comments earlier about the focus on innovation to address the local brands, particularly in Asia and Eurasia.

I know it's other places, but you called out that specifically.

And I'm trying to understand maybe why is it now versus any of the times in the past 10 or 20 years, where you've had really nice businesses in these places that local brands are gaining traction.

And does it have to do with a change that is relevant to other markets?

Is it technology driven?

And specifically, does it have anything at all to do with -- I know in some markets in Asia, e-commerce has developed somewhat rapidly.

Does the pressure that puts on retailers and retail distribution have anything to do with the increased traction some of these local brand forms are having with consumers?

Yes, I think -- I don't think it's driven by e-commerce.

I think it's driven by, shall we say, business entrepreneurs who are local.

I think, pleasingly for us, it's driven by ideas that tend to be premium, which are ideas we're happy to compete with rather than, perhaps, in the early years, ideas that were more pricing driven.

In some cases, it's driven by affinity.

So the Yunnan Baiyao brand in China was already a well-established wound healing brand in the country.

You take it into the toothpaste category and say, you stop bleeding gums, well-known brand in the toothpaste category, and they didn't do much advertising in the early years, and the business started to grow.

Patanjali in India takes a very naturalist view of his business.

So these are concepts in the local market.

They tend to be premium-price oriented.

And it means that you have to respond with a very specifically constructed offering that attacks the benefit the consumers are looking for.

Hence, the naturals reaction.

So I think it's more a function of entrepreneurs' concepts, affinity with the local market, which is why we have innovation centers and technology centers in China to be close to the consumer on the ground in that country.

And in the end, the winner over time in these clashes are going to be the companies that best understand the consumer and serve them offerings that they want over time.

And of course, that's what we are resourced and focused on doing.

We'll go next to Iain Simpson, SG.

A couple of questions, if I may.

Firstly, just drilling down into advertising, it's sort of a big picture stuff, I guess.

Your volumes are down 1.5% in the first half, and that really does seem to imply some fairly significant global share loss.

Yet, your advertising is only up 10 bps year-on-year, and you're talking about marketing being about a sort of level in the second half as well.

Is that enough?

I mean, up until 2014, your advertising was 10.5%, 11% of sales pretty much every year.

In recent years, it's been more like 9%, 9.5%, and we've seen your top line slow pretty meaningfully.

So structurally, where do you think advertising needs to get to medium term?

And secondly, visibility on FX is pretty limited.

But if you do get a big transactional FX tailwind, be it in second half '17 or in 2018, what will you do with that?

How much will you let through to the bottom line?

Or will you reinvest?

And what are the sort of key factors you'll look at (inaudible) be in a position to make that decision?

Well, let me start by saying, you start with a great name.

So that's a good place to start.

Our point on advertising was not to do with the advertising in the first half.

Our point on advertising and the numbers you referred to in the recent historical past was to do with adjustments downward that we made in advertising in response to, unfortunately, foreign exchange very sharply going the other way that your second question was suggesting.

And when we came into this year, what we said was, that isn't what we were going to do.

Advertising north of 10% is a good level of advertising.

And so what we said coming into this year is that we wanted to sustain our advertising across the full year, which means the comparison over the last couple of years is driven by a lower second half in those prior years and what will be a sustained level over the back half of the year, which means the advertising will be meaningfully up versus the prior year.

So it's sustainability rather than a lack of in terms of investment.

And hey, foreign exchange, you look at the last 5 years.

I think the pundits have been wrong coming into basically every single year.

And if foreign exchange does turn positive, we will have a quick round of applause, and then we will bring it back to the business.

Our general historical rule of thumb has been to reinvest some and to bring some to the bottom line.

What we would actually do this time around would be a subject of internal debate, but that rule of thumb has been our historical action.

We'll go next to Lauren Lieberman, Barclays.

Okay.

First is, I have to ask about gross margin bridge, or else we won't have it.

So that's one.

And secondly, just maybe let's talk about Latin America for a second, where things turned very much for the better.

And I think about 6 to 9 months ago now, I got to spend some time with Thanos, and he talked about sort of a broader innovation pipeline in Latin America, where you were going to be bringing more news to lower-priced tiers in your portfolio, so giving the consumer more room for kind of trade up at a lower level.

And I was just wondering the degree what -- has some of that news flow started to hit the market?

Because it was a pretty significant change in that volume, really dollar-weighted volumetrics.

If you can talk a little bit about what's starting to work in Brazil that we started -- particularly in Brazil that we started (inaudible) this turn.

Yes, the gross profit roll forward.

So prior year gross profit was 60.2%.

As you know, we picked up 40 bps from pricing between the restructuring, which is de minimis and funding-the-growth, positive 170 bps.

Material, negative 180 bps, which was primarily the fats and oils, as I said.

All other, 20 bps.

And that takes you to the 60.7%, which is up 50 basis points year-on-year.

So that's the gross margin roll forward.

I would say, in Latin America, it is a focus on the fundamentals.

It is innovation.

I wouldn't go so far as to say the lower-end innovation is making the difference.

And I would say, markets like Brazil, I'm afraid, remain variable.

So we're very pleased with that bounce back, but we'll be watching very closely in terms of sustainability through the third quarter.

But the fundamentals are the same fundamentals for Latin America across the back half of the year.

Okay, I understand that is the last call.

So thank you for being with us, and we look forward to talking to you again in October.

That does conclude today's conference.

Thank you for your participation.