Kellanova - Q1 2021

Transcript

Speaker 0

Good morning. Welcome to the Kellogg Company's First Quarter 2021 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session with the publishing analysts. Please note this event is being recorded.

At this time, I will turn the call over to John Renwick, Vice President of Investor Relations Mr. Renwick, you may begin your conference call.

Speaker 1

Thank you. Good morning and thank you for joining us today for a review of our Q1 2021 results as well as an update regarding our outlook for the full year 2021. I'm joined this morning by Steve Cahillane, our Chairman and CEO and Amit Banati, our Chief Financial Officer. Slide number 3 shows our forward looking statements disclaimer. As you are aware, certain statements made today such as projections for Kellogg Companies' future performance are forward looking statements.

Actual results could be materially different from those projected. For further information concerning factors that could cause these results to differ, Please refer to the 3rd slide of this presentation as well as to our public SEC filings. This is of particular note during the current COVID-nineteen pandemic when the length and severity of the crisis and resultant economic and business impacts are so difficult to predict. A recording of today's webcast and supporting documents will be archived for at least 90 days on the Investor page of kelloggcompany.com. As always, when referring to our results and outlook.

Unless otherwise noted, we will be referring to them on an organic basis for net sales and on a currency neutral adjusted basis for operating profit and earnings per share. And now I'll turn

Speaker 2

it over to Steve. Thanks, John, and good morning, everyone. I hope you and your families are doing well and staying healthy. Here at Kellogg, I'm continuously impressed by the way our organization has remained focused and engaged in executing through what are undeniably challenging circumstances, both at work and at home. Keeping employees safe remains job number 1.

And in quarter 1, we continued to execute safety protocols while following the guidance of local health authorities. Supplying the world with food continued to require agility, including temporary labor and incremental capacity. And of course we continue to actively support our communities. After all the pandemic is not behind us. In fact In some parts of the world, we are seeing it accelerate and our thoughts and prayers go out to all those affected.

Turning to Slide number 6, Our deploy for balanced growth strategy remains as relevant and effective as ever during this pandemic. Its growth boosters continue to do their job. As much as anything else, this pandemic has prompted a shift in eating occasions. Our focus on occasions continued to be evident in the Q1 in our tailored consumer messaging and an innovation geared towards specific occasions. The portfolio that we've shaped toward growth has benefited from balance of convenient meals, snacking that can be done at home, plant based foods and sustained growth in emerging markets.

Our building of world class brands has been evident in our commitment to equity building communication as well as leveraging our data and analytics to devise creative ways to reach new consumers and sustain momentum in the marketplace. And our commitment to perfect service, perfect store tested by the sudden and sharp rise in demand has forced us to get creative around ways to increase throughput even if it meant temporarily holding back on merchandising activity to ensure inventory and incurring incremental logistics costs to get food to our customers. And we continue to grow rapidly in e commerce, leveraging our enhanced capabilities there. Environmental, social and governance is not a new area of focus for Kellogg. It's been embedded in our history and strategy for a long, long time.

Our ESG oriented Better days boosters always a key element of our strategy have become more important to our communities, employees, customers and consumers. At CAGNY, a few months ago, we discussed our Global Better Day's purpose and strategy. And on Slide number 7, you can see that we continue to progress in this area addressing the interconnected issues of health, hunger relief and climate. On nourishing with our foods, we've to innovate and renovate our foods, providing choices across wellness and indulgence. And during the quarter, our Kashi became the 1st organic cereal to be authorized for the women, infants and children program in the United States.

On feeding people in need, we've remained in an elevated level of donations making accelerated progress toward our goal of feeding 375,000,000 families. During the Q1, Pop Tarts joined with the United Way to raise money for School Vegetable Gardens. On Nurturing Our Planet, we announced during the Q1 our commitment to achieve over 50% renewable electricity to address Kellogg Manufacturing globally by the end of 2022 and we celebrated women farmers as part of International Women's Day. And under living our founders' values, we launched in the first quarter our new equity, diversity and inclusion vision and strategy to all employees in all four regions. Aligned with those values, we launched The campaign called A Call for Food Justice in Black Communities in partnership with World Food Program USA tied to some of our biggest brands including Special K, Morningstar Farms, Kashi and Eggo.

Our strategy and execution led to another good quarter as highlighted on Slide number 8. At home demand remained elevated more than offsetting continued softness in away from home channels and on the go occasions. Our biggest brands continued to show strong momentum aided by sustained consumer communication and innovation activity. There why we gain share in most of our key markets and categories around the world. We continue to bring on our planned capacity increases, which will continue to relieve supply tightness and enable us to return to normal levels of merchandising activity as we get through the first half of the year.

Our emerging markets businesses accelerated their growth proving their mettle in what are challenging conditions. From a financial perspective, we continue to seek and deliver balanced financial results, the kind we achieved in 2020, and that's what we did again in the Q1. Strong net sales growth even despite lapping last year's pandemic related surge and we delivered this organic growth across all four regions and all four global category groups for a 5th consecutive quarter. Positive price mix reflecting revenue growth management actions made all the more important by the recent rise in input cost inflation. Gross profit margin improved year on year despite higher costs and faster growth in our emerging markets including our distributor business in West Africa.

Operating profit increased year on year despite lapping last year's strong growth ex divestiture driven by top line momentum and despite a year on year increase in brand investment. Cash flow remains strong and we were able to accelerate share buybacks into the Q1. So a very good start to 2021 with the potential to put us a little ahead of where we thought we'd be through the first half and its extremely difficult comparisons. This enables us to raise the full year guidance we provided for you in February even amidst what is undeniably an uncertain business environment. So with that, let me turn it over to Amit, who will take you through our financial results and outlook in more detail.

Speaker 3

Thanks, Steve. Good morning, everyone. Slide number 10 offers an at a glance summary of our financial results for the Q1. As you can see, they're quite strong, particularly when considering the year ago growth they were lapping. Specifically, last year's Q1 featured 8% organic growth on net sales and operating profit that grew roughly 8%, excluding the impact of the prior year's divestiture.

So we generated very good growth on growth. Net sales grew on a 1 year and a 2 year basis. In developed markets, it was aided by shipment timing and at home demand remaining elevated, partially offset by continued softness in away from home channels. In emerging markets, we generated sales performance that was better than expected. Currency neutral adjusted basis operating profit grew on a 1 year and or 2 year basis, driven by the net sales growth and expansion in gross profit margin and good discipline on overhead, all of which more than offset a year on year increase in brand building.

Clearly, we're seeing good operating leverage from our strong top line growth. Currency neutral adjusted basis, earnings per share grew on a 1 year and a 2 year basis, despite a higher effective tax rate. And in what is typically our lightest quarter for cash flow, it was stronger than anticipated for the quarter. Of course, it's down from last year's unusually high Q1 cash flow, but as you can see, it is ahead of the pre pandemic 2019 level. Let's look at these metrics in a little more detail.

Slide number 11 breaks quarter 1 net sales growth into its components. Volume declined against last year's March surge, but it was up on a 2 year basis. At home demand remained elevated. Emerging markets sustained momentum and we did see favorable timing of shipments in the U. S.

As expected. Price mix was again positive, which is important given the accelerated cost inflation we are seeing. During quarter 1, We saw positive pricing in all four regions, reflecting revenue growth management initiatives, and we also saw an overall mix shift back towards Snacks. Currency translation was a slight positive in the quarter. As we look to the remainder of 2021, We still expect to see a moderating top line.

We face our toughest volume comparison in quarter 2, and we are assuming continued deceleration in at home demand. Slide number 12 offers some perspective on our profit margins, which held up very well in spite of higher costs. Our gross profit margin in quarter 1 improved on a 1 year and a 2 year basis as productivity and price realization were effective at covering accelerated input cost inflation as well as incremental COVID costs against only a partial quarter of those costs in the year earlier quarter. We also more than offset a mix shift towards emerging markets and particularly towards our distributor business in West Africa. The flow through of this higher gross profit margin led to an increase in operating profit margin as well as decreased overhead balanced out a high single digit increase in brand building.

The brand building increase reflects the phasing of our commercial plans relative to last year's modest decrease in quarter 1 at the onset of the pandemic. Even with this year on year increase in brand building, we still grew operating profit at a double digit rate this quarter. As we look to the rest of the year, we obviously face our toughest gross profit margin comparison in quarter 2 due to last year's outsized operating leverage that produced by far the highest gross profit margin of the past couple of years, as you can see on the slide. In the second half, we are working to hold our margin as close as possible to year ago levels in spite of our mix shift towards emerging markets and accelerated cost inflation. Further down the P and L, We faced our toughest comparison on brand building in quarter 2 as well because last year's quarter 2 was when we delayed significant brand investment to the second half.

That second half investment helped create the momentum we are seeing today, but we return to more typical levels of brand investment in this year's second half. Turning to the remainder of the income statement on Slide number 13, we see that our below the line items were relatively neutral to earnings per share in quarter 1. As expected, interest expense decreased year on year on lower debt and this will continue for the remainder of the year with quarter 4 additionally lapping the non recurring $20,000,000 debt redemption expense we recorded last year. Other income was lower year on year and modestly lower than what should be its quarterly run rate for the rest of the year. Our effective tax rate of 22.7% was higher than last year's relatively low level and should still turn out to be around 22.5% for the full year.

Average shares outstanding were flattish year on year with the impact of quarter 1's accelerated buybacks to be more pronounced in the coming quarters, resulting in a full year average shares outstanding that is a little more than 0.5% lower than 2020. Turning to our cash flow on Slide number 14, we had a strong start to the year and maintained good financial flexibility. As expected, our cash flow in quarter 1 was lower than quarter 1 2020's unusually high level, not because of net earnings or working capital, both of which were favorable year on year, but because of year on year swings in accruals and other balance sheet items, as well as lapping last year's delayed capital expenditure. However, as you can see on the chart, quarter 1 2021's cash flow was well above that of quarter 1 2019 in what is always our lightest cash flow quarter of the year. Net debt is lower year on year, even despite our resumption of share buybacks, and we like the state of our balance sheet.

As we look to the rest of the year, cash flow will likely remain below last year's COVID aided levels, but still well above 2019 levels. And between our share buybacks, which we were able to accelerate into the Q1 and an increased dividend, we are meaningfully increasing the cash returned to share owners. I'll conclude with a discussion about full year guidance shown on Slide number 15. As Steve mentioned, our strong quarter one performance gives us the confidence to raise our guidance this early in the year. Specifically, Our guidance for full year organic net sales growth moves up to approximately flat year on year from our previous guidance of about negative 1%.

This would equate to closer to 3% growth on our 2 year compound annual growth rate, effectively eliminating the noise of lapping last year's COVID related surge. Our guidance for currency neutral Adjusted basis operating profit improves to a decline of about 1% to 2% year on year versus our previous guidance of minus 2%. This equates to closer to 4% growth on a 2 year CAGR basis, excluding our since divested businesses from the 2019 base. Our guidance for currency neutral adjusted basis earnings per share Increases to growth of about 1% to 2% year on year versus our previous guidance of up 1%. This equates to something around 5% growth on a 2 year CAGR basis, excluding our since divested businesses from the 2019 base.

And our guidance for cash flow moves up to a range of $1,100,000,000 to $1,200,000,000 versus our previous guidance of approximately $1,100,000,000 We think this guidance is prudent given that it is early in the year and given a business environment that is somewhat uncertain in terms of pandemic impacts and cost inflation. Obviously, we are pleased with our start to the year. We're in strong financial condition. Our brands and regions are performing well, and we are solidly on track for continued balanced financial delivery on a 2 year basis. And with that, Let me turn it back to Steve for a review of our major businesses.

Thanks, Amit. I'll start with

Speaker 2

a quick review of the quarter one results of each of our regions, and then I'll go a little deeper into some of our key brands and categories. The region's net sales and operating profit growth rates in quarter 1 are shown on slide number 17. You can see that our growth was broad based particularly on the more meaningful 2 year growth rates. In North America, our organic net sales grew on top of last year's high growth with elevated at home consumption and strong momentum in key brands as well as favorable timing of shipments between quarters partially offset by continued softness in away from home channels. Operating profit also increased year on year despite tough underlying comparisons.

The 2 year trends only further confirm that this business got off to a good start to the year. Our business in Europe had another good quarter. Its solid 1 year organic net sales growth was on top of last year's strong growth and it was led by accelerated growth in Pringles. Resulting operating leverage produced strong operating profit growth. In Latin America, our strong organic net sales growth was driven by Pringles and Cereal and the result in operating leverage boosted operating profit as well.

Macro conditions in this region are challenging, So this was a terrific way to start the year. And in EMEA, our strong organic net sales growth was led by Multipro, the distributor portion of our business in West Africa and across the region by Pringles, Cereal and Noodles, leading to outstanding growth in operating profit as well. Now let's go a little deeper in some of our categories, markets and channels. We'll start with our global category groups as shown on slide number 18. As you can see from the chart, we grew all 4 category groups on both a 1 year and 2 year basis during quarter 1 despite lapping last year's COVID related surge and despite continued softness in away from home channels.

Our largest global category snacks to sustain growth in the Q1 on both a 1 year and 2 year basis with growth in all four regions. And that's despite the on the go nature of many of its foods and pack formats. This is a testament to the strength of our snacks brands as well as to our ability to adapt messaging and pack formats to current at home occasions. In cereal, we also recorded growth on both a 1 year and 2 year basis. We saw notable strength in Europe with share gains led by power brands like Tresor and Crunchy Nut.

We posted broad based growth in Latin America with share gains in key markets led by cornflakes. We also recorded strong growth and share performance in EMEA where our master brand approach is working well in Asia and innovation activity is contributing across the region. As expected, we had a slow start in the U. S. As we limited merchandising activity on supply constrained brands, but this should improve in the second half as new capacity comes online.

Frozen Foods also grew net sales on both a 1 year and 2 year basis. This predominantly North America business sustained momentum in both Eggo and especially Morningstar Farms and I'll come back to each of them in a moment. And our noodles and other business, which is predominantly in Africa, continue to generate rapid growth, both on a 1 year and 2 year basis as well. With annual net sales approaching $1,000,000,000 this is going to be a growth contributor for some time. So both on a region basis and a category basis, Our reshaped portfolio clearly offers growth and diversification.

And within each of these regions and categories are world class brands that continue to grow. Let's take a look at a few of these important brands. We'll start with our largest global brand Pringles whose consumption trends for its biggest market in each of our 4 regions are shown on slide number 19. This is more than a $2,000,000,000 global brand that has demonstrated exceptional momentum for some time in all four regions. During quarter 1, this momentum continued with Pringle sustaining growth on on top of very strong year ago growth.

This was driven by effective brand building including the incremental consumer communication we did in late 2020 plus important consumer activations in the Q1 such as our Super Bowl campaign in the U. S. And our gaming oriented commercial activations in Europe. The growth was also augmented by innovation launches including our more intense flavors under the scorchin' and sizzlin' sub lines in the U. S.

In U. K. Respectively as well as uniquely local flavors in Asian markets. All of these innovations are off to great starts. It's also aided by increased local production in emerging markets, notably in Brazil, where this relatively new local capacity is enabling exceptional growth.

Pringles is truly a world class brand performing extremely well. Here's another really incredible brand Cheez It shown on slide number 20. Its U. S. Consumption and share growth has been exceptional over the last several years and it has continued in the Q1.

The base product line continues to perform well helped by effective advertising and sports related activations as as well as new flavors and a reformulation of the Grooves sub line. Meanwhile, the Snapped sub line is providing incremental growth enough that we had to add capacity in 2020 and only its 2nd year since launch. And Cheez It is no longer solely a U. S. Brand.

We expanded into Canada last year and during the Q1 it continued to grow rapidly. And in the Q1 we brought Cheez It to Brazil where it's off to a very good start. This is more than $1,000,000,000 plus retail sales brand that continues to outpace its category in the U. S. And when we have begun to expand internationally.

And before we move on from our Snacks discussion, I want to point out 2 other power brands in our snacks portfolio shown on Slide number 21. Since the outbreak of the pandemic, the portable wholesome snacks category has been declining due to fewer on the go occasions. We've continued to gain share of this category largely because of to brands that have been able to grow their at home consumption. Pop Tarts continued to post growth on a 2 year basis in quarter 1 lapping last year's extremely large growth and sustaining multi year growth momentum. Rice Krispies Treats consumption and share growth has been impressive over the last several years and this momentum has continued in quarter 1 aided by the launch of new homestyle treats.

Again, big brands sustaining momentum. Let's turn to cereal markets and brands on slide number 22. Behind our 1 year and 2 year growth in global cereal net sales in the 1st quarter our strong performances by key brands in key markets. The chart shows our largest international markets of each region with consumption growth on a 2 year basis to avoid distortion from lapping last year's surge in March and share performance on a 1 year basis to show how we're competing. In Europe, we've outpaced the category with share gains in key markets like the U.

K. Which was propelled by power brands like Crunchy Nut and All Bran. And in other European markets, we saw particular strength in global brands like Tresor, our largest cereal brand in Europe and Extra, a key wellness oriented brand internationally for us. In Canada, where the category got more immediate lift than we did in the year ago quarter, we outpaced in this year's Q1 on the strength of brands like Global Brand, All Brand and Local Jewel Vector. We recorded strong growth and share performance in EMEA led by our largest cereal market in that region Australia.

The outperformance was led by global brands like our Australian version of Raisin Bran as well as local jewels like our wellness oriented Just Right. We saw broad based cereal growth in Latin America where we continued to gain share in key markets like Mexico, Brazil, Puerto Rico and Central America. In Mexico, you can see the strong share performance was driven by big brands like Corn Flakes and Choco Crispies and across the region our growth was aided by strong innovation. In short, we're seeing the impact of strong brands and strong execution in all of these markets. Let's discuss U.

S. Cereal for a moment shown on Slide number 23. As expected, we experienced a slow start in this market as we limited merchandising activity on supply constrained brands. In scanner data, you can see this in our larger than category decline in percent of volume sold on promotion. We will be caught up on supply and capacity around mid year as we've mentioned previously.

But in the Q1, those supply constrained brands Frosted Flakes And Froot Loops, 2 of the stronger brands in the category accounted for all and more of our share decrease in the Q1. Excluding them, our consumption kept pace with the category. So our underlying business remains in good shape. We're very pleased with our innovation, which not only outpaced the categories innovation in the Q1, but is showing very strong velocities already. This includes additions to the jumbo snacks line we successfully launched last year, as well as Mini Wheats, Cinnamon Roll, Little Debbie, Special K Blueberries and Keto Friendly Kashi Go offerings.

So we get back up to adequate supply and capacity and return to a normal commercial calendar, particularly in the second half, we expect our U. S. Cereal performance to improve and perform like our other big developed markets. Slide 24 calls out another big brand that is sustaining growth on a 2 year basis. Eggo's reliable growth in consumption over the past few years accelerated to nearly 17% in 2020 gaining nearly 2 points of share but leaving us very tight on capacity.

In quarter 1, Eggo sustained strong 2 year growth of +5 percent despite capacity limiting its upside. This is one of the brands for which we are freeing up capacity over the course of this year. And when you add in Kashi, our overall from the griddle consumption outpaced the category on that 2 year CAGR basis. As to pace the category on that 2 year CAGR basis. Eggo is in really good shape with more capacity coming on.

With effective advertising and promising innovation on the way, this is a nearly $1,000,000,000 retail sales brand with an outlook for sustained growth. And even better growth is being generated by our leading plant based brand MorningStar Farms shown on Slide 25. Our overall Morningstar Farms brand franchise is over $400,000,000 in retail sales and is poised to sustain strong growth for years to come. This brand's consumption growth in the Q1 even on a 1 year basis added to its multi year growth trend. And with incremental capacity in place, This brand gains share as well.

There is no question that consumers are becoming more aware and interested in plant based foods. Morningstar Farms has increased its household penetration in the last year to a level that remains well above any of our competitors and yet it's still only 8%, suggesting significant room to expand. Morningstar Farms is also unique in the breadth of its offerings. This is evident in our share gains across a spectrum of segments in quarter 1 ranging from breakfast meats to breakfast handhelds, to sausage, to poultry. Our new vegetizers line has created a whole other occasion for plant based foods and now we are reaching an expanded consumer base.

Our recently launched Incognito by Morningstar Farms sub brand is aimed at incremental flexitarian consumers. It continues to expand retail distribution both in the refrigerated and frozen aisles and it continues to add foodservice customers. It's early days, but incognito is great food and is showing a lot of promise. Just this week, the National Restaurant Association awarded 2021 FABBI Awards for the year's most delicious, unique and exciting food for restaurant operators and consumers. Among those awarded were 3 incognito products, Homestyle Chicken Tenders, Italian sausage and original bratwurst as well as an iconic veg forward offering MorningStar Farms Chipotle Black Bean Burger.

Simply put, Morningstar Farms is the largest brand with the highest penetration, the broadest portfolio and the most occasions in this plant based category. So we are realizing good underlying momentum across our major category groups and led by world class brands. Let's now shift our discussion to geographic markets, specifically our emerging markets highlighted on Slide number 26. Emerging markets accounted for more than 20% of our net sales last year among the highest percentages in our peer group. This is important because these markets represent outstanding long term growth prospects for packaged food owing to their population growth and expanding middle classes.

In 2020, despite COVID related shutdowns of retailers in schools, economic disruption from depressed oil prices and even bouts of political and social unrest, our geographically diverse emerging markets businesses actually accelerated their net sales growth. This is a credit to our product portfolios, our brand strength, our local supply chains and experienced management teams in these markets. And in the Q1 of this year, despite lapping in the unusually strong year ago quarter, we sustained this momentum, even accelerating again. In Africa, our Multipro distributor business grew more than 20% year on year in quarter 1 even as it lapsed strong high teens growth in the year earlier quarter and we also continue to grow our Kellogg's branded noodles business. In Asia, we sustained double digit growth in Pringles and Cereal.

In Russia, we recorded double digit organic growth in Cereal and in Snacks. And Latin America's strong quarter 1 growth was broad based and led by cereal in Mexico and Pringles in Brazil. And let's finish up with a couple of channels to call out on slide number 27. In the Q1, we sustained tremendous growth momentum in e commerce. The investments we had made in this channel, everything from reorganizing around it, bringing in external talent and developing capabilities paid off in a big way in 2020 when our e commerce sales doubled year on year.

And in the Q1, our growth was about 75% even as it lapped the year ago's quarter's acceleration. This is a shopper behavior that is likely to stick. Now roughly 7% of our total company sales, we know that our brands and categories play well in this channel and we are building this business for the long term. Of course, on the other end of the spectrum during the pandemic are away from home channels, which did decline sharply amid shutdowns and restrictions. The slide shows that our U.

S. Away from home business continued to moderate its declines as measured on an average 2 year basis to better gauge the trend. Important to know is that we have not been sitting still waiting for consumer mobility to resume and away from home outlets to reopen. We have been actively securing future business, signing up new accounts for brands ranging from RX to Morningstar Farms and IncaMido. These actions today will pay off well into the future.

Let's wrap up with a brief summary on Slide number 29. Quarter 1, 2021 was yet another quarter of good performance and investment in the future. We have sustained strong momentum in most of our biggest world class brands, never having let up in innovation or communication with consumers. We are unlocking capacity so we can resume full commercial activity in some of the foods and brands that had reached capacity limitations after good growth in recent years and acceleration since the pandemic. This added capacity will continue to come on stream during the year, continuing to improve service levels and returned to full merchandising activity with our retail partners.

Our emerging markets have not only managed through challenging macro environments over the past year, they've actually accelerated their growth and we continue to build scale in these long term growth markets. We're leveraging capabilities that we've been enhancing over the past few years from data and analytics to e commerce to innovation. These capabilities have only become even more important since the pandemic. Our cash flow and balance sheet are strong and we have increased cash return to share owners while maintaining financial flexibility. Our results for quarter 1 were particularly strong, but more importantly, they reflected high quality balanced financial delivery.

We sustained net sales growth, expanded gross profit margin, remained disciplined on overhead and invested behind our brands and still delivered growth in operating profit and earnings per share leading to strong cash flow, all of which adds up to an early increase in our full year outlook. As always, I want to salute our 31,000 employees whose dedication and creativity have made this performance possible despite the most challenging of business conditions. And with that, we'd be happy to take any questions you might have.

Speaker 0

With publishing analysts. As a courtesy to your colleagues, please limit yourself to one question. Our first question comes from David Palmer with Evercore ISI. Please go ahead.

Speaker 4

Thanks. A question about the 'twenty one guidance and the implications of that. You had a 3% 2 year CAGR that's implied by that. And obviously, this has been an unusual year in 2021. Even if we look past 20.

There's still some COVID related factors. You mentioned supply chain. If you think about I think you would take a 3% organic growth rate most years, but could you maybe talk about that 3% CAGR? What has Sort of been a tailwind, what has been headwinds and how do we think about that as you're really executing this turnaround plan like how you're basically setting up for 'twenty two and beyond. Thanks.

Speaker 2

Yes. Thanks, David. I'll start and Amit can build. But what I'd say is, it's important to look at those 2 year CAGRs. As you point out, that's what we've been talking about because 2020 was such an unusual year, Right.

But what's underlying our confidence in that CAGR is the brand performances that we talked about as we went through the prepared remarks. Our snacks business, our frozen business, our veg business, our international businesses, our emerging markets business all performing very strong. And if you think about our new guidance for 2021, essentially just from a top line basis, we're saying flat. So What we thought potentially what many companies thought of 2020 when they were COVID beneficiaries would be a high watermark is in fact We're going to lap that. And so that's because of the strength of our brands, the execution in the marketplace and the plans that we put in place.

So Amit, you and I?

Speaker 3

Yes. I think it reflects the strength of our portfolio and you're seeing that come through. I think from a pure guidance standpoint, We are expecting that elevated demand will moderate a little bit from quarter 1. So I think that's what's built into the guidance. We're expecting growth in emerging markets to sustain, maybe not at the double digit rates that we saw in quarter 1, But certainly, we continue to expect growth in the emerging markets.

Speaker 5

Thanks. I'll pass it on.

Speaker 0

The next question is from Ken Goldman with JPMorgan. Please go ahead.

Speaker 6

Good morning. It's Tom Palmer on for Ken. I wanted to ask on the inflation picture. So during the prepared remarks, You made mention of rising cost inflation. Could you provide a bit more detail on the inflation you're seeing right now?

And then what you expect to see as the year plays out and just the timing of your hedges rolling off. And then, your comfort in terms of offsetting it,

Speaker 5

I guess really the major tool

Speaker 6

I'm curious about color on is how you think about list pricing and instituting that this year? Thank you.

Speaker 2

Yes. Thanks, Tom. So what I'd say is we've talked about the inflationary environment, which is real. We've also talked about the hedging and I'll let Amit build on that that we've gotten in place for the first half of the year as well as the back half of the year. On the pricing front and just a cost pressure front, what I'd say is we have a host of tools at our disposal.

So we think about the suite of offerings. We want to always start with disposal. So we think about the suite of offerings. We want to always start with productivity and drive productivity as hard as we possibly can. And then we're going to look to revenue growth management and the tools that we have in revenue growth management, whether they be price package architecture, whether they be Pricing, which would include list pricing, all of those are at our disposal.

But at the end of the day, we have to earn that price in the marketplace through investing in our brands, through innovating, through putting the types of performances that we've been able to put to our brands, which puts us in a good position to have the confidence to slightly raise our guidance even despite increased cost pressures that are quite real. Amit, you have?

Speaker 3

Yes. I think cost inflation, no question, it's accelerated. I think we're now looking at it being in the high end of the mid single digit rate for 2021. We're seeing it across our cost basket from exchange traded commodities to diesel and energy, ocean freight. We've seen a spike in ocean freight as well.

I think all of that has been incorporated into the guidance that we provided today. From a hedging perspective, We're about 76% hedged on the exchange traded commodities. Obviously, there are other cost pressures outside those as well. But I think we reflected that in our guidance. And you would have seen that in our quarter one results, We had strong pricing and mix come through.

And as Steve mentioned, it's across the whole range of levers, including list price increases, including trade optimization and price pack architecture, so in the whole suite of revenue growth management tools.

Speaker 6

Okay. Thank you. And just to clarify, where would you have been in the Q1 in terms of that inflationary environment?

Speaker 3

I think similar levels, though obviously it's accelerating through the year. And then obviously in quarter 1, we were in more hedged than in the later part of the year as you would expect. Thank you.

Speaker 0

The next question is from Steve Powers with Deutsche Bank. Please go ahead.

Speaker 5

Yes. Hey, guys. Thanks. Maybe just to round out that conversation a little bit more. When the I think you said on the last Quarter that you were targeting 'twenty one gross margins ahead of 'nineteen levels.

Is that I guess, first off, is that still realistic Or has that been ratcheted down a bit in your thinking? And then given that relatively extensive coverage from a hedge position, It would appear just given the cost curves that we're seeing in the spot market that it implies some residual inflation carrying over into 2022. I I don't know if there's a way you can kind of frame the extent of that carry over to 'twenty two, but I'm really curious about given that, if I'm right about that outlook. Does that impact your plans around the timing of pricing or other discretionary spending at all as 'twenty one progresses? Thank you.

Speaker 3

Yes. So I think our goal is still to expand our gross profit margin on a 2 year basis. So I think that's still our goal. And in that context, from a 'twenty one standpoint, obviously, we were ahead in quarter 1. Quarter 2 is going to be our biggest lap as we lapped last year's outsized operating leverage.

And then for the balance of 2021, our goal would be to be as close to flat as possible. So that's kind of the way we're thinking about gross profit margin. Too early to talk about 2022 right now, but certainly, As Steve mentioned, from a revenue growth management standpoint, we're looking at a whole range of tools to offset the inflation that we see.

Speaker 5

Okay. Thank you very much.

Speaker 0

The next question is from Jason English with Goldman Sachs. Please go ahead.

Speaker 5

Hey folks, thanks for slotting me in. One quick housekeeping question and then a more robust question. First housekeeping, I thought I heard you say that developed markets benefited from shipment timing in the quarter. Am I right? Did I pick that up?

Can you clarify and provide any sort of quantification.

Speaker 2

Yes. So we definitely did benefit somewhat from shipment timing. And if you think about go back Quarter 1 2020 where U. S. Consumption growth exceeded shipments fairly markedly because of the surge.

You almost have the mirror reflection in quarter 1 2021 where the reverse was true where U. S. Net sales growth exceeded consumption. And as we've said many times in the past, consumption is a good guide. It evens out over time.

And some of this was clearly borrowed from or taken from quarter 4, which we talked about when we did our quarter 4 call. But that's essentially where that ends up. Amit, do you want to? Yes.

Speaker 3

I think just to build on what Steve said, Jason, In addition to last year's factors and timing versus last year, as we had mentioned in our last call, some of this came from Quarter 4, most of it, I'd say the timing came from quarter 4. There's been a little bit as it relates to quarter 2. So there was some shipment ahead of activities, but most of it came from quarter 4.

Speaker 5

Okay. And then on those activities,

Speaker 4

Steve, we certainly heard you

Speaker 5

talk a lot about bringing merchandising activity back to try to get the market share going the right way. How do we think about that in context of the price equation? I mean, for the pricing we saw this quarter was phenomenally robust, particularly in EMs, but also in DMs. As we think about the glide path forward net of this more merchandise activity. Can you hold the serve at like the levels we're looking at?

Or Should we expect sort of a migration to net neutral by the time we get to the back half of the year, at least within DMs? Thank you.

Speaker 2

Yes. No, thanks, Jason. I'd say, obviously, we can't comment on forward looking pricing and promotions and so forth. But what we are seeing, what we'd expect is for ourselves and others starts to become more normalized. I would just expect that you'll see a more normal return to levels.

I wouldn't see anything really above that. I wouldn't see the macro conditions that would drive that. And so yes, I think we can hold serve. And we're off to a good start. It's clear the areas where we want to work on, where we need to work on, and it's clear where we have really good momentum, and we want to continue to push against that as well.

Speaker 7

Thanks a

Speaker 5

lot guys. I'll pass it on.

Speaker 0

The next question is from Michael Lavery with Piper Sandler. Please go ahead.

Speaker 8

Thank you. Good morning.

Speaker 2

Good morning, Mike. Good morning.

Speaker 8

Can you give a sense of how your conversations with retailers are going with respective pricing and maybe specifically are they more sensitive to list pricing and more receptive to other approaches or is it similar across the board? Just kind of love to get a temperature check on where they are and how much kind of wiggle room you have from here out?

Speaker 2

Yes. Thanks, Michael. So obviously I'm not going to comment on any specific customers, but We have a mantra here that we talk about all the time and that's it. We have to earn the pricing that we get in the marketplace. Clearly, there There is an inflationary environment that's real.

Clearly, that's across broad swaths of the economy. And clearly, there's been a lot of reporting on that. But we approach it with the humility that says we've got to invest in our brands, we've got to bring innovation, we've got to do everything that we can to continue to earn our place in the marketplace. But I'd also say we did raise guidance and we're talking about holding as close to possible to our gross margin. So that to flex the types of confidence that we have that we'll be able to get through this by managing our price, mix, innovation with our customers.

Speaker 8

How much can you balance the EBIT margin targets with the brand spending and inflation pressures? Is there Some interplay there or do you want to protect the brand spend specifically to allow pricing?

Speaker 2

Well, We've said in the past we like the brand building that we've got in place. We like the levels that we have in place. In the back half of last year. We were very purposeful in saying what we pulled from the second quarter, we're putting in the back half of the year because brands need investment and we kept to our overall budget from last year although is back half weighted and that clearly gave us momentum as we entered 2021 whether it be The Pringles example in the U. S.

And in Europe, but we like our levels of brand building spending. We think they're important. They clearly give us the opportunity to 5 our brands and as I said earn what we get in the marketplace. And so I think we're well balanced. I think we're confident.

Again, we raised our guidance based on that and it's still very early in the year, so there's a lot of uncertainty at play. But we like the way it's shaped up. We like the way it started and we like our plan going forward from a brand building perspective and a profit delivery perspective.

Speaker 8

Okay, great. Thanks so much.

Speaker 0

The next question is from Chris Growe with Stifel. Please go ahead.

Speaker 8

Hi, good morning.

Speaker 1

Good morning. Hey, Chris.

Speaker 0

Hi. Just a bit of

Speaker 9

a follow on to that last answer and to Michael's question. I guess just to get a sense of The Q1 profit performance and EPS performance being so much stronger than expected. I guess I want to understand were there any unique factors? We talked about some maybe some over shipment in relation to consumption. But just to understand kind of how that kind of took hold during the quarter and then the degree to which inflation I guess is obviously picking up through the year.

Was that is that picking up more than you expected such that there's maybe more of a limitation earnings growth in the remaining quarters. It just seems that this degree of outperformance in the Q1 that it would have led to a stronger performance for the year overall unless there's some other unique factors I'm not just not incorporating

Speaker 2

Yes. Thanks, Chris. I'll start and Amit can build as well. We did raise guidance. And I think I hear your question, why not more?

But we're being prudent. Obviously, we're still in a pandemic where others are really not Even giving guidance beyond the next quarter, we're trying to be as helpful and as transparent as possible. We still have COVID. Obviously, we have Lots of challenges in emerging markets based on COVID and other things, but we're off to a good start. And we're confident and we feel like we can to manage all the things that you mentioned, the inflationary environment, the potential disruptions, but we want to be prudent and we want to be able to deliver what we say we're going

Speaker 3

to deliver. And just to build on that, maybe a couple of additional points just on the shape of the year. So I think quarter 2 is when we've got the biggest lap, Right. So if you look at it from a gross margin standpoint, that was the quarter where we saw the operational the outsized operational leverage come through. So, we're going to lap that in quarter 2.

Quarter 2 was also when we delayed our brand building into the rest of the year. And just if you recall, quarter 2 operating profit last year in 2020 was up 24%. So I I think that will just give you a sense of the lap ahead of us and just the shape of the year. I think like I said, from a gross margin standpoint, In the second half, we target to get as close to flat as possible, recognizing that inflation continues to rise and recognizing that we are probably about 76% hedged. And the SG and A comp should moderate in the second half.

Speaker 9

Okay, that's great. Thank you for the color on that.

Speaker 0

The next question is from Brian Spillane with Bank of America. Please go ahead.

Speaker 7

Hey, good morning, everyone.

Speaker 5

Good morning, Brian.

Speaker 7

So two quick ones for me. First is just a follow-up on some of the inflation and commodity questions. I mean, could We've heard from some other companies there's been with some commodities like soybean oil for instance where there's where availability It's actually a question. So can you just, I guess, give us some insight in terms of your confidence And the availability or your ability to source the raw materials you need?

Speaker 3

Yes. I think from a sourcing Standpoint, we feel very confident in terms of our diverse supplier base. So, while obviously, with ocean freight and containers and the Suez crisis. There's been pressure in the system, but I think from a supply and a security of supply standpoint, we are confident about that.

Speaker 7

Okay. And then Steve, it's been a few years now since the ploy for balanced growth. And I know there's been some disruption with COVID over the last year or 13 months or so. But I guess, just stepping back, can you just give us a little bit of insight in terms of like where you think you're maybe ahead of What your expectations would have been? Kind of what's in line?

And then maybe just where you still think there's some work to do?

Speaker 2

Yes. Thanks, Brian. So I'd say we're really where we want to be, right? We're always constructively discontent. We want to do better.

We demand of ourselves to do better. But when you think about things like shaping a growth portfolio that came through and it delivered. The divestiture is behind us. It was a Smart thing to do. It was the right thing to do.

But you see our emerging markets, you see our snacks brands, you see our Many of our portfolio brands really executing well for us. When we think about perfect service and perfect store, built perfectly for the type of Pressure that we had to face last year and ongoing and facing this year. We talk about building world class brands and we put some investment surges into our brands unapologetically in the past. And because of those things before the pandemic, I'd remind you that we exited the year before the pandemic with 2.7% organic sales growth, right? And we were getting to balance.

And then the surge happened and COVID happened. And here we are, we've had this unbelievable sampling opportunity, this reappraisal opportunity, which we've Aimed to make the most of. But when you look at the 2 year stacks and you look at our portfolio and you look at our performance, we're delivering Top line growth, we are back to growth, reliably and for a lot of quarters now, and we're delivering balanced growth as well. And it's through the strength of our brands and the strength of the execution of our strategy. So we remain Eager to do better.

We remain hungry, but I think there's no question that Deploy for Growth has delivered and we are back to a balanced growth performance. I

Speaker 5

think the

Speaker 3

only thing I'd add is that we delivered balanced delivery last year. I think Our goal is to grow our gross margin on a 2 year basis and our cash flow conversions. Last year was an exceptional year, But even if you set that aside, our goal is to increase our cash flow conversion. And Our new guidance on cash flow would indicate around a 75% to 80% conversion.

Speaker 0

Our next question is from Robert Moskow with Credit Suisse. Please go ahead.

Speaker 4

Hi. The 5% pricing or price mix in the quarter is a lot higher than what I had modeled and I think others had to. I think the perception was that the pricing from a list basis and maybe revenue growth management too would come later in the year as your hedges roll over. Does this mean that You can accelerate pricing even above 5% as the year goes on? Or is there something unusual about the 5% maybe related to the timing of promotional programs that would indicate that that's your peak.

Speaker 3

Yes. I think most of the price mix came from pricing in the quarter. And like I mentioned, That was the whole range of tools across all the regions. I think in some of our EMs, we took for significant pricing to cover for our commodity. And remember, in some of these markets, we've also had transactional ForEx impacts through the back half of twenty twenty into 2021.

So, you've seen pricing to like that come through in the pricing. I think we also benefited from mix with Snacks Growth coming back from a certainly from a mix standpoint, that's a positive. So that's That's kind of what drove the quarter 1 results.

Speaker 4

Okay. So as Snacks comes back, that boosts your price mix. But what does it do to your gross margin and operating margin? Is that dilutive to both or just one of those?

Speaker 3

[SPEAKER SIVASANKARAN SOMASUNDARAM:] Yes. We don't get into the by category profitability, but I would say that, Yes, I mean, it's kind of at the mix level, at the margin level, it kind of is neutralish. At the price level, it's accretive.

Speaker 4

Okay. All right. Thank you.

Speaker 0

The next question is from Andrew Lazar with Barclays. Please go ahead.

Speaker 5

Thanks. Good morning, everybody.

Speaker 7

Good morning. Good morning, Andrew.

Speaker 5

Just a quick one, Steve, on the capacity additions that you talked about. I'm curious if you can maybe dimensionalize a little bit, how much of that capacity broadly speaking Would be sort of internal versus, let's say, leveraging external third party sources. And really the reason I ask is just because to the extent that more of the capacity is internal, That has the implications for obviously your level of conviction around stickiness of demand or elevated levels of demand going forward, let's say versus pre pandemic versus if you were doing more of this externally? Thanks so much.

Speaker 2

Yes. Thanks, Andrew. So I'd say most of what we talked about is internal capacity, Right. Many times we look to external capacity when we're starting out. So if you look at like a Cheez It Snap line, we might start with the first line being external, But we got lots of conviction that second line was internal.

And so when we talk about serial capacity, when we talk about EGO capacity, we're talking about internal capacity building and expansion. And so you can take from that that there is real conviction. But what I would say is we're not building based on any kind of pandemic It's going to go away. We're building on what we really need, right? And so like others, we operate Our capacity pretty tightly, right?

And historically, when you're in a category categories that are growing low single digits, you'd expect that. The surge created a whole different set of circumstances. But as I said, 2020 is not really going to be our high watermark, Right. And so we're going to lap those things in 2021, and we're going to need the capacity to do that in things like certain elements of our ready to Cereal, in Eggo, in some of our Cheez It lines, but we're in pretty good shape. And so it's all embedded in our guidance, and We feel like we got a good plan.

Speaker 4

Thank you.

Speaker 1

I think operator we have time for one more question.

Speaker 0

And that question comes from Rob Dickerson with Jefferies. Please go ahead.

Speaker 5

Great. Thanks so much. Maybe two quick questions and one just quick follow-up from Andrews on capacity. As that comes on, it sounds like increasingly later this year than into next this year. Is that just one of the drivers very simplistically as to why you might feel a little bit better on the gross margin side?

I mean, I'd assume, right, as that comes on, 3rd

Speaker 2

Not really, Rob. A couple of years ago when we were doing a lot of On the Go, we were attacking the On the Go occasions and we did a lot of 3rd party, but we also had a lot of manual work being done. That was the case. But now we're more in a normalized environment where we're building capacity based on increasing demand. So not really.

Speaker 5

Okay, great. Cool. And then just other quickly just on the EM pricing piece. I know you said, Right. There's some transactional impact, obviously, and then obviously and then also on the cost inflation side.

It was very high, right, EMEA, impressive. Is that like was there pricing in there that you would say could also have It's been opportunistic given what you're seeing across all of those countries within that segment, such that You weren't pricing that much historically, but maybe there was, like you said, some of that brand building could have been targeted to some of the areas within EMEA. And therefore, You kind of stepped in and took maybe a little bit more pricing that FX or cost inflation may have Excuse me, mail suggested. Thanks. That's it.

Speaker 3

No, I think it's I think just looking The cost situation, commodities, ForEx, and obviously, we've seen inflation in both. So I think trying to preserve your margins while also balancing out volume growth and share, I think, and triangulating between those drivers.

Speaker 5

Sorry, Debra. That's all I have. Thank you, everyone.

Speaker 1

Thank you. All right. Well, that concludes it. Thanks very much everyone for your interest. And if you have follow-up questions, please do not hesitate to call us.

Speaker 0

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.