Operator: Good day, everyone, and welcome to the Mead Johnson Nutrition Fourth Quarter 2009 Earnings Release Conference Call. This call is being recorded.
Now, I would like to turn the conference over to Kathryn Chieger, Vice President of Investor Relations. Please go ahead, ma’am.
Kathryn Chieger - IR: Thank you and good morning. Welcome to Mead Johnson’s fourth quarter conference call. With me today are Steve Golsby, our CEO; and Pete Leemputte, our CFO.
Before we get started, let me remind everyone that our comments will include forward-looking statements about our future results, including statements about our financial prospects and projections, new product launches and market conditions that constitute forward-looking statements for purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995.
Keep in mind that our actual results may differ materially from expectations as of today due to various factors, including those listed in our Annual Report on Form 10-K for 2008, quarterly reports on Form 10-Q, current reports on Form 8-K, and registration statements, in each case as filed with or furnished to the Securities and Exchange Commission and our earnings release issued this morning, all of which are available upon request or on our website, at meadjohnson.com.
In addition, any forward-looking statement represent our estimates only as of today and should not be relied upon as representing our estimates as of any subsequent date. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so even if our estimates change.
Given that we are in the midst of the earnings reporting season, we will be respectful of your time and keep our call to 45 minutes.
Now, I will turn the call over to Steve.
Stephen W. Golsby - President and CEO: Thank you, Kathryn, and good morning, everyone. We have just completed a memorable and successful year, both for our shareholders and for our employees around the world. Mead Johnson became a publicly traded company with our IPO in February and we have been pleased by the market’s positive reception to our stock. Full independence was completed in December when Mead Johnson shares held by Bristol-Myers Squibb became part of the public float through an exchange offer and all our shares are now trading on the New York Stock Exchange.
With a market capitalization exceeding $9 billion, Mead Johnson recently became one of the newest members of the Standard & Poor’s 500. We also accessed the debt markets for the first time with a $1.5 billion notes offering successfully completed in November, taking advantage of the lower interest rate environment and resulting in significant interest expense savings.
While these transactions were highly visible, there were many other accomplishments for Mead Johnson in 2009. We reported record non-GAAP earnings. Gross margins were at the highest level in five years, driven not only by lower commodity costs, but also by record productivity.
Our focus on the balance sheet reaped rewards. Higher earnings along with reductions in working capital led to solid free cash flow, which we used to invest for growth, as well as to pay down debt. R&D investments are bearing fruit. Over 30 new products came to market last year. And finally, global expansion into high growth emerging markets gathered pace. Today 66% of our sales are outside of the United States, up from 61% in 2008.
While we were accomplishing these strong results and producing excellent returns for our shareholders, I also want to acknowledge all the work that was going on behind the scenes to build standalone capabilities and to make progress towards separation from the BMS IT systems and shared service functions.
Turning to our financial results, we ended the year on a strong note with fourth quarter non-GAAP earnings of $0.48 per share, bringing earnings for the full year to $2.23 per share. Consistent with our previously stated intentions, we invested in growth and infrastructure development at record levels in the fourth quarter. Operating expenses were up by $0.07 per share relative to the third quarter, helping to build stronger growth momentum as we enter 2010.
We are very confident in our strategies and in our outlook for 2010, but we recognize that we continue to operate in a challenging economic environment with many uncertainties. A current example of such uncertainty would be our exposure to currency devaluation in Venezuela, where we have built a sizable and profitable growth business. Nevertheless, we are issuing initial guidance for the year. We are currently estimating non-GAAP EPS in the range of $2.30 to $2.40 per share in 2010 on revenue growth of at least 7%, double the rate of 2009.
I’ll let Pete provide you with further details, so I’ll now turn to an overview of our segment performance.
We report our results in two geographic segments. The growth driver for Mead Johnson continues to be the Asia Latin America segment, which represents 60% of total sales. Sales for the segment were up 13% in the quarter, excluding the benefit of foreign exchange. Once again, China led the way with a 25% increase in sales in the quarter. This was an especially excellent performance given the difficult comparison with the prior year when the melamine incident opportunistically benefited Mead Johnson and the other multinational manufacturers. Based on the latest Nielsen data, we are growing at twice the rate of the overall market and we are the only multinational whose share today is higher than at the peak of the melamine incident.
The China sales growth was about two thirds from share gains in cities in which we are well established and the balance from cities we have entered in 2009. We are now fully resourced in 139 cities, more than double the number we were in as we entered the year. Our focus in 2010 will be on further strengthening our position in our traditional markets, as well as consolidating and building share in those new cities.
China was not alone among Asian markets in delivering excellent growth. Double-digit growth was also reported in Thailand, Malaysia, Vietnam and Indonesia. Further, we are making progress planting seeds in India for future growth, where we have been investing for just over a year and now have a market presence in 17 leading cities.
As we have discussed in the past, the Philippines has experienced a market contraction. We are seeing signs, however, that the market is stabilizing. While Mead Johnson’s sales were down in the quarter versus the fourth quarter a year ago, the rate of decline was significantly below the prior two quarters and sales were actually up on a sequential basis. Remember, sales were also affected by the typhoons that hit early in the quarter. A pickup in overseas remittances along with the national election scheduled for May point to a steady recovery in 2010.
Latin America also continues to post impressive growth. In addition to strength in Mexico, our third largest market, we have established leading positions in the premium infant formula and children’s nutrition categories in Venezuela, Peru, Colombia and Ecuador.
We are also investing in Brazil. As you will recall, following the IPO our ability to operate in Brazil had been constrained due to certain regulatory requirements around the transfer of permits between BMS and Mead Johnson. The bulk of the permits are now in our hands and we are very excited about the opportunities in this country where we have a strong presence in the children’s category under the Sustagen brand.
According to ERC, the children’s category is expected to grow at a 12% compound rate over the next five years and we are targeting to expand both our category and geographic footprint. Overall, as we look at Nielsen data for the last three months, in our top 11 international markets, we grew share in 8 of them and surpassed the aggregate growth of all our competitors.
Turning now to our North America Europe segment, constant dollars sales were down 13% compared with the fourth quarter in 2008. Two significant factors affected this result. Firstly, the planned reduction of distributor inventories held by BMS in Europe, which accounted for 5 percentage points of the decline. Our underlying business in Europe continued to grow steadily, with particular strength in our core Enfamil PREMIUM and Nutramigen brands. We now have leadership in place in Russia and will be investing for accelerated growth in 2010.
Secondly, we suffered from the market contraction in the U.S. due to fewer births. According to Nielsen retail data, the infant formula market was down 5% for the full year 2009, but in the fourth quarter that decline increased to 7%. While this market contraction has had a significant effect on our results, I remain confident that families have only postponed their plans to have children and that the birth rate will pick up as the economy improves.
We also had good news in the quarter in the U.S. business, notably from the market share data. While still down a couple of points versus the prior year, we picked up a point of share in the fourth quarter on a sequential basis. Given that there have been no significant changes in WIC contracts, this points to non-WIC share growth. Among non-WIC babies three months old, our share gains have been even more impressive. This is a key leading indicator of future share strength as these babies enter their heavy formula consumption period.
We continue to invest heavily in demand generation activities to capitalize on the success of our recent innovations, notably Enfamil PREMIUM. Rates of trial and repeat purchase are tracking ahead of our estimates, and we are seeing meaningful increases in key brand attribute ratings that underpin the Enfamil equity. We are also very pleased with the performance of our packaging innovation, Value Box, which has been in test markets since last fall.
For those of you who attended our Investor Day event in November, you heard us talk about the four pillars of our U.S. growth strategy; increased pace of innovation, higher investments behind consumer messaging of our value proposition, leadership resources to drive execution of our medical and retail sales strategies and building a strong toddler brand in a growing segment. We are seeing tangible progress against each of these strategy pillars and firmly believe we will continue to see improvements in operating performance in 2010.
With that, Pete will now highlight some of the key fourth quarter numbers and our outlook for the year.
Peter G. Leemputte - SVP and CFO: Thanks, Steve, and good morning, everyone. Turning to our GAAP results, we reported earnings of $0.31 per share in the fourth quarter of 2009, up from the $0.27 we delivered last year. The 2009 fourth quarter results include a total of $54 million in pre-tax spending or $0.17 per share for costs associated with the December split-off from Bristol-Myers Squibb, the launch of our SAP implementation project and legal expenses and judgments for lawsuits against one of our subsidiaries, all in line with our prior disclosures.
Because of these factors, along with changes in our capital structure, I will focus my comments on our non-GAAP numbers. We delivered fourth quarter non-GAAP earnings of $0.48 per share, up 33% from 2008. Earnings were down slightly from the $0.53 we reported in the third quarter as a result of $0.07 per share in higher spending for advertising and promotion, sales force additions in high-growth markets and increased research and development expenses, all designed to build demand as we move into 2010. So we are very pleased with these results. The only new information relative to our prior guidance was a $0.02 unfavorable impact from slightly higher advertising and promotion spending and a 50 basis point increase in our full year 2009 tax rate as we finalized our global earnings mix for the year.
Since Steve already provided color on our segment sales, let me walk down the income statement with a few more details on the quarter and our outlook for 2010. Reported sales of $714 million were up 2.5% from the prior year. This reflects the positive impact of 4% pricing and about 1.5% from a slightly weaker dollar. Consolidated volumes declined by just over 3%.
Excluding the impact of foreign exchange, sales were up by 1% from the 2008 quarter, while constant dollar EBIT grew by almost 10%. On a full year basis, our 2009 sales grew at 3.4% excluding the impact of foreign exchange. As we enter 2010, we expect to double growth to at least 7% on a constant dollar basis.
We anticipate continued strong double-digit sales growth in Asia and Latin America. The key improvement will be in the North America Europe segment. In Europe we will not be facing the distributor inventory drawdown that Steve highlighted. So that’s a definite plus. In the U.S., sales will be influenced by overall industry trends as well as continued market share gains by Enfamil PREMIUM.
The most recent birth data provided by the CDC was from April 2009, which showed a 3% decline year-to-date, and we assume that births continued to trend down slightly through the remainder of the year. Remember that pregnancies planned after the financial crisis began in earnest would not be reflected in birth rates until mid 2009.
For planning purposes, we are assuming relatively flat births for the U.S. in 2010 with slightly unfavorable comparisons in the first half before moderating and beginning to turn up toward the end of the year. And please keep in mind, any benefit of a stabilizing birth rate won’t be reflected in our financial results until those babies age into heavier consumption months.
Our own internal research supports continued share recovery as the youngest infants move into their heavier consumption months. We are very confident and are reporting higher average share in 2010. In any case, we expect that for the full year North America Europe segment sales will be at least flat on a constant dollar basis, a big improvement from the 10% decline in 2009.
Gross margins in the fourth quarter and the full year came in at 65.5%, right on the forecast, and the highest gross margins seen over the last five years. The 320 basis point increase versus the fourth quarter of 2008 is largely the result of lower dairy costs, higher pricing, strong manufacturing performance and our productivity initiatives. Overall, we expect to see a noticeable drop in gross margins in 2010, perhaps by as much as 200 basis points to the mid 63% range. Note that this is still historically high and above the 62.6% realized in 2008.
Let me touch on four key factors driving the decline. First, as we discussed at our November Investor Meeting here in Chicago, dairy costs climbed significantly in the second half of 2009 and have only stabilized of late. As a result, we expect to see the impact flowing through our cost of goods sold starting later in the first quarter. We have also seen higher sugar and cocoa prices, which largely impact our milk modifier business in Mexico.
Second, it will prove difficult to offset commodity costs with higher pricing. Dairy prices are still well below the peak level seen in 2007 and 2008. Therefore, taking price will be more difficult in the current environment. We expect price increases for the year will fall below the 5% level seen in 2009, which included the carryover impact of price increases taken in the second half of 2008 in response to commodity cost pressures. Higher raw material and packaging costs, net of price increases, should account for up to half of the gross margin decline.
Third, we expect to see an unfavorable impact on gross margins from foreign exchange, accounting for about a quarter of the potential decline. The dollar has weakened slightly and that may contribute to sales growth in 2010. But the weakening has been much more pronounced in currencies where we have manufacturing operations, notably the Mexican peso, the Philippines peso, the Australian dollar and the euro. And remember, we source much of our China volume from our Dutch plant. I’ll have more comments on foreign exchange impacts in a minute.
Fourth, we will continue to experience unfavorable geographic mix shifts with higher growth in Asia and Latin America as compared to the mature markets in the North America Europe segment. Asia and Latin America carried lower gross margins due to a greater mix of children’s nutrition products, whereas higher margin infant formula accounts for the majority of our sales in North America and Europe. The impact should be mitigated somewhat in 2010 with the stabilization of these mature markets, but can still account for another quarter of expected gross margin declines.
I also want to note that we will deliver productivity improvements this year, but these will be offset somewhat by inflation on labor and other conversion costs, along with slightly lower plant utilization as we bring on more third-party manufacturing capacity, particularly in Asia to support China growth. In addition, we will have to absorb some fixed costs previously covered by the Bristol-Myers Squibb, our former parent, as they vacate some Mead Johnson facilities here in the U.S.
Turning to operating expenses, I spoke on our last call about increased advertising and promotion spending in the fourth quarter, and indeed that did occur. A&P as a percent of sales came in at 16.7% for the quarter and 14.2% for the year. Spending was up in both segments, but the impact on a percentage of sales basis is much more pronounced in North America and Europe due to the sales decline.
Total operating expenses came in at 42.1% for the quarter and 38.6% for the year. Looking forward, we intend to continue investing in growth, advertising and promotion along with our sales force and R&D spending near 2009 levels measured on a percentage of sales basis.
General and administrative expenses will reflect a temporary increase of about $25 million in shared service expense for IT, back office accounting and indirect procurement functions, as we carry costs from both BMS and IBM, our newly selected partner. In total, operating expenses as a percent of sales should be in the 38.5% to 39% range.
Turning to the balance sheet, we ended December with $561 million of cash, down slightly from $597 million in September. Let me remind you that we refinanced $1.75 billion of debt owed to Bristol-Myers Squibb in early November. The very successful refinancing involved our first set offering of $1.5 billion in new bonds, a drawdown of $200 million on our revolver and the remainder came from cash on hand.
By the end of December, we had paid off $80 million in the revolver and had a little more than $1.6 billion in gross debt outstanding. So the cash balance at year-end is particularly impressive due to the de-leveraging completed in the quarter.
Debt net of cash stood at about $1 billion at year-end, down from the $1.5 billion immediately following the IPO. I also want to note that we paid off the remaining $120 million balance on our revolver this month. The debt reduction coupled with the lower interest rate on the new bonds is expected to lead to about $30 million in lower interest expense during 2010 as compared with 2009. That’s a savings of $0.09 or $0.10 per share.
Capital spending for the year totaled $122 million, a bit higher than we indicated last quarter, primarily due to increased spending for innovation and growth projects as well as for our SAP programs. Depreciation and amortization expense came in at $59 million. In 2010, we are budgeting about $140 million for capital expenditures, with the increase largely for the SAP installation. D&A is estimated about $65 million.
Let me conclude by pulling together our outlook for earnings in 2010. We anticipate that constant dollar sales growth should be at least 7%, more than double the 3.4% we reported for 2009. We expect that this growth will be more heavily weighted toward volume than price for the reasons I mentioned earlier. EBIT margins are expected to drop by 200 to 250 basis points, with most of the decline coming from gross margins.
I also want to add a little more color on foreign currency impacts. If current exchange rates prevail for the full year, the slightly weaker dollar will add about 1 percentage point to our reported sales growth. But as I mentioned earlier, the unfavorable impact on our costs from a greater weakening of the dollar in several key currencies actually eliminates any benefit on earnings.
In addition, the devaluation of the Venezuelan bolivar two weeks ago will also impact our financial results. As you may know, the Venezuelan government put in place a new dual exchange rate. The first rate covers essential imported products, like the majority of our infant formula and early age growing-up milks, at a preferred rate of 2.6 bolivars per dollar, representing a 20% devaluation. The second rate of 4.3 bolivars or 100% devaluation applies to all other products and may also be applicable to dividends. Because of the uncertainty around effective exchange rates for actual dividends out of Venezuela, the impact can only be estimated at this time, but we believe it will be around $0.05 per share spread through the year.
In addition, we face another $0.02 to $0.03 from translation losses on our balance sheet that will be recognized in the first quarter. Nevertheless, we still have a profitable, albeit smaller business in dollar terms on the top line. Note that the Venezuela currency impact will be included in our non-GAAP financial results for 2010.
A portion of the EBIT margin drop will be offset below the other line with $0.09 to $0.10 benefit in interest expense. Our effective tax rate is affected by geographic mix, and it’s hard to be precise this early in the year, but we are anticipating that it should run in the 30% to 31% range. Average shares outstanding should be slightly above 205 million.
Rolling it all up, we estimate non-GAAP earnings in the range of $2.30 to $2.40. We are taking into consideration that it’s early in the year and there is limited visibility around the uncontrollables, including birth rates, commodity costs and the impact of foreign exchange, most notably Venezuela, on our results. On a GAAP basis we expect to see earnings from $2.07 to $2.17 per share. The $0.23 differential from our non-GAAP guidance reflects cost primarily associated with the separation from BMS’s IT systems.
With that, let me turn the call back over to Steve.
Stephen W. Golsby - President and CEO: Thank you, Pete. In summary, Mead Johnson performed strongly in 2009 in what was a very difficult environment. We will continue to face challenges in 2010 with continued economic uncertainty, higher commodity costs, lower price inflation and fierce competition. However, I am confident that the business is stronger than ever and I am truly excited by our opportunities for sustained growth. Our prospects have never been more promising. Our attractive growth industry, portfolio of leading brands and products, strong presence in emerging markets, robust innovation pipeline, commitment to quality and productivity, diverse and experienced leadership and compelling financial performance, all lead to excellent prospects for continued shareholder value creation.
Let me conclude my remarks by thanking my Mead Johnson colleagues for their dedication and contributions and turn the call back to the operator who will open the line for questions.