Mondelez International - Q1 2023

Transcript

Operator (participant)

Standby. Your program is about to begin. If you need assistance during your conference today, please press star zero. Good day and welcome to the Mondelēz International First Quarter 2023 Earnings Conference Call. Today's call is scheduled to last about one hour, including remarks by Mondelēz management and a question and answer session. In order to ask a question, please press the star key followed by the number one on your touch-tone phone at any time during the call. I'd now like to turn the call over to Mr. Shep Dunlap, Vice President, Investor Relations for Mondelēz. Please go ahead, sir.

Shep Dunlap (VP of Investor Relations)

Good afternoon and thank you for joining us. With me today are Dirk Van de Put, our Chairman and CEO, and Luca Zaramella, our CFO. Earlier today, we sent out our press release and presentation slides, which are available on our website. During this call, we'll make forward-looking statements about the company's performance. These statements are based on how we see things today. Actual results may differ materially due to risks and uncertainties. Please refer to the cautionary statements and risk factors contained in our 10-K, Q, and 8-K filings for more details on our forward-looking statements. As we discuss our results today, unless noted as reported, we'll be referencing our non-GAAP financial measures, which adjust for certain items included in our GAAP results. In addition, we provide our year-over-year growth on a constant currency basis, unless otherwise noted.

You can find the comparable GAAP measures and GAAP to non-GAAP reconciliations within our Q1 2023 earnings release and at the back of the slide presentation. Today, Dirk will provide a business and strategy update, followed by a review of our financial results and outlook by Luca. We will close with Q&A. I'll now turn the call over to Dirk.

Dirk Van de Put (Chairman and CEO)

Thanks, Shep, and thanks to everyone for joining the call today. I will start on slide four. I'm pleased to share that we are off to a record start in 2023 with very strong double-digit top-line growth in the first quarter, driven by effective pricing and ongoing volume growth. We continue to execute on our long-term strategy, and we see robust momentum across geographies and categories. We delivered strong performance in both emerging and developed markets, and we successfully implemented circa 80% of our price increases in Europe. Our robust profit dollar growth was driven by volume leverage, cost discipline, and pricing to offset cost inflation. Our strategic decision to focus our portfolio on the attractive categories of chocolate, biscuits, and baked snacks continues to bear fruit, with consumers gravitating to those categories.

We continue to invest in our brands, in our capabilities, and our portfolio reshaping initiatives to accelerate and compound growth on both the top and bottom lines. We are confident that the strength of our brands, our proven strategy, our continued investments, and especially our talented people, position us well to deliver another strong year. Based on the strength of these Q1 results and our latest view across businesses, we are raising our revenue and adjusted earnings outlook to 10%+ for the year. Turning to slide five, you can see that the first quarter showed continued momentum across our entire business. volume/mix for the quarter was more than 3 percentage points on pace with recent performance, demonstrating the continued strength and resiliency of our beloved brands and categories, even in an inflationary environment. We delivered organic net revenue growth of $1.5 billion versus prior year.

At 19.4% growth, we delivered our best quarter ever, significantly ahead of our already strong 12% in full year 2022. We also delivered adjusted gross profit dollar growth of a half billion dollars. Again, we're well ahead of last year's pace with 18.2% growth. We're proud of our team's continued focus and agility, which enable us to continue investing to drive further growth acceleration with an A&C increase of 19% for the quarter. These results translated into strong adjusted OI growth of close to $300 million, up nearly 21%, and again, well ahead of last year's pace. We remain confident that our virtuous cycle of strong gross profit dollar growth, fueling local first commercial execution, increasing investment in our iconic brands, empowered by winning culture, will continue to consistently deliver attractive growth.

On slide 6, a few examples of our brand strategy in action. We continue to invest in our core categories of chocolate, biscuits, and baked snacks with strong creative assets, digital personalization at scale, new product launches, and great in-store execution. All this continues to strengthen our already strong brand loyalty. It is clear that we're playing in the right categories with attractive growth in volume and dollars, combined with solid profitability characteristics. There is also significant headroom in both penetration and per capita consumption in developed and developing markets. We continue to expand the breadth and reach of our chocolate leadership in the attractive and growing Latin America region. For example, we recently launched our chocolate brand, Milka, into Colombia. Additionally, we launched two Milka ice cream products in Argentina in association with Froneri.

We're excited about these opportunities to explore a new segment and reach more consumers while expanding one of our most iconic brands into a new consumption occasion. We hit another milestone in biscuit category as Chips Ahoy!, a $1 billion brand, celebrates its 60th birthday. Our fifth-largest brand globally, Chips Ahoy!, has delivered almost double-digit revenue growth annually since 2018, yielding positive results from our increased A&C spend during that time period. The brand's current key markets are the United States and China, where the business is on a $200 million run rate. Chips Ahoy! also has a sizable presence in Canada, Latin America, and Southeast Asia. We have exciting plans to further expand this franchise as we grow our leadership in both core biscuits and new chocolate bakery innovations around the world.

Oreo continues to show, sorry, strong momentum across markets as consumers continue to demonstrate that this iconic brand is truly the world's favorite cookie. Give & Go is a success story in our baked snacks line. It grew strong double digits in Q1, driven by solid pricing execution, expansion into adjacencies such as mini donuts, and strong category demand. These are just a few examples of our team's ongoing focus on delivering our growth and acceleration strategy as we continue to reinvest in and drive our very powerful brands. Let's take a look at our chocolate strategy on slide seven. Tablets remain the centerpiece of our chocolate franchise. Mondelez accounts for more than 1/3 of this segment, more than three times the size of the number two player, and we continue to lead this segment year after year.

2023 is off to a very strong start, aided by the recent launch of our renovated Milka formulation, the creamiest, most tender Milka ever, combined with some strong local jewels. Our tablets business is up nearly half a point in market share, with particularly strong growth in Australia, Canada, Germany, and Brazil. We're also performing well in the incremental segments of seasonal and gifting chocolate products. We delivered a record sell-in for the Easter season across markets, with Milka celebrating its first ever Easter in Chile. Our Cadbury team executed another successful virtual Easter egg hunt, reaching more than 300,000 people in the United Kingdom, Ireland, and South Africa, making our seasonal products even more iconic. We also are growing in the premium chocolate space.

For example, Toblerone volume is up more than 15% in Q1, fueled by its relaunch with updated on-trend positioning. We are further strengthening the Toblerone portfolio with additional offerings, including praline and personalized gifting. Switching to slide eight. Solid execution against our integration playbook is delivering a strong start to the year for our recently acquired businesses. We are pleased that CLIF, in Q1, posted double-digit revenue growth and grew profitability by more than 1,000 basis points. We're making strong operational improvements, focusing on enhancing service levels and improving supply chain efficiencies, and we successfully implemented two rounds of pricing. Additionally, we recently announced the consolidation of creative and advertising agencies under a single partner, which will accelerate productivity in our media spend while continuing to strengthen brand equity and loyalty.

Similarly, our Ricolino business continues to demonstrate strong momentum in the fast-growing and strategically important Mexican market, and we are making solid progress on integration. Along with our financial performance, I'm pleased to share that we continue to make significant progress in our sustainability strategy. We firmly believe that helping to drive positive change at scale is an integral part of value creation with positive returns for all of our stakeholders. As you can see on slide nine, this quarter, we announced the next chapter of Harmony, our European wheat sustainability program. With regenerative agriculture at its heart, this next chapter aims to mitigate climate change and reverse biodiversity losses while investing in research seeking to demonstrate that more sustainable wheat is also better quality wheat.

Created as the first program of its kind in 2008 with just a handful of farmers, the Harmony program now collaborates with more than 1,300 farmers across seven European countries. Our enhanced program will support these farmers in implementing a stronger charter of more sustainable farming practices, such as further diversifying crop rotation, protecting pollinators and other wildlife, and reducing pesticide use. Our goal is to grow 100% of the wheat volume needed for our European biscuits production under our expanded Harmony regenerative charter by 2030. This is just one example of the way that we are fully integrating our sustainability agenda within our day-to-day business operations and growth strategy. I'm proud of Team Mondelez continued progress in helping to make positive impact on critical environmental and social issues while creating value for shareholders and other stakeholders.

With that, I'll turn it over to Luca to share additional insights on our financials.

Luca Zaramella (EVP and CFO)

Thank you, Dirk, and good afternoon. Q1 was a great start to the year. Broad-based volume, pricing, profit dollar growth, brand investment, earnings, and free cash flow all indicate that our strategy is sound, and our focus on execution in paying off. Our model is working well, while meaningful opportunities still exist to further drive our long-term ambitions. For the quarter, revenue growth was +19.4%, with more than 3 points from volume/mix. Emerging markets grew more than 25%, with strong performance across the overwhelming majority of countries. 4.5 points of this growth were attributable to volume/mix. Developed markets grew 15.8% in Q1, with across-the-board strength and more than 2 points of growth coming from volume/mix. To note, the customer disruption in Europe was more benign than we anticipated. Turning to portfolio performance on slide 12.

Chocolate, biscuits, gum, and candy all posted robust double-digit increases in Q1. Biscuits grew +16.9%, with positive volume/mix despite substantial price increases. Oreo, Ritz, Chips Ahoy!, Give & Go, and Club Social were among brands that delivered double-digit growth. Albeit not contributing to organic growth, CLIF posted good growth versus last year too. Chocolate grew more than 18%, with significant growth across both developed and emerging markets. Volume was positive despite some customer disruptions in Europe, albeit lower than anticipated. Cadbury Dairy Milk, Milka, Lacta, and Toblerone all delivered robust growth, and we had a record Easter selling that, based on preliminary data, also resulted in record high sell-out. Gum and candy grew 35%, with robust growth across all of our key markets. Now let's review market share performance on slide 13.

We held or gained share in 60% of our revenue base, which includes 10 points of headwinds coming from EU customer disruption. The U.S. continues to make service level improvements, ending Q1 with good on-shelf availability and case fill rates, resulting in share being flat to last year. Given stabilization of the supply chain, we feel confident that share will continue to improve during the year in the U.S. Turning to page 14. We delivered strong double-digit i-dollar growth, driven by a gross profit increase of more than $540 million. These results enable us to continue to significantly fund our business for future growth, while also providing strong earnings and cash flow. Moving to regional results on slide 15. We delivered double-digit revenue growth and posted volume mix increases in all regions.

This growth, fueled by pricing and volume leverage, drove robust OI dollar growth across all regions. Europe grew plus 18.9%, with high single-digit OI growth. We have made progress in landing expected pricing increases with circa 80% of our customers, and we lowered disruption than we anticipated. We are still planning for some disruption in Q2, which has been factored into our revised outlook, as the remaining 20% of our customer base is not done yet. Consumers' confidence has stabilized in much of the region, with many key countries trending back to spring 2022 levels. Elasticities of biscuits and chocolate are overall less negative than we anticipated, including in the U.K., where the impact of HFSS is less material than what we had forecasted.

Overall, rather than cutting back significantly on size of their basket, consumers are shopping around to find attractive deals and trading up and down in terms of pack sizes based on their specific needs and consumer occasions. They remain loyal to branded products, particularly in chocolate. Our focus is now on landing the remaining part of the price increases. North America grew +17.3%, with OI dollar growth of more than 40%, driven by higher pricing, solid volume/mix, and strength from our ventures, particularly CLIF. We are reassured by the quality of the P&L in the region and by the fact that volume is holding up well, while we still have opportunity of returning market share to steady growth. EMEA grew +13.8%, with strong volume/mix of nearly 6%, OI dollars increased +15.6%.

India continues to be a key driver of success in the region. We also have ambitious plans in China that will benefit from a broader reopening after COVID. Latin America grew +39% with OI $ growth of more than 47%. We are very pleased with the performance in the region, with clear progress made over the last couple of years in terms of execution and ability to drive key brands like Oreo to new heights. Ricolino is off to a strong start. We have not yet realized the benefit of the full integration that will happen toward the end of the year. Next to EPS on slide 16. EPS grew +17.3% in constant currency or nearly +10% at reported dollars, driven primarily by strong operating gains. Turning to slide 17.

We generated free cash flow of $900 million in Q1, returning $900 million to shareholders through dividends and share repurchases. A few words on our recent KDP sell down on page 19. This investment has been highly successful, demonstrating our discipline and flexible approach to managing our investments and assets over time. Including dividends received and the market value of our remaining stake, this investment has generated a return of approximately 3.3x our initial investment over a seven-year period. We received approximately $1 billion in net proceeds from the most recent sale, and our remaining stake is now 3.2%. From an accounting perspective, we will no longer account for this under the equity method, but rather recognizing dividends as the only income as of the dividend record date.

We will adjust out mark-to-market quarterly remeasurements of the stake in line with the gains that we have been obtained after each sell-down. These adjustments will be recorded in a new P&L line item, which will be below interest expenses. In terms of net EPS impact for 2023, purely on the basis of the different accounting treatment, we expect a headwind of approximately $0.03. I want to reiterate that this is merely accounting driven and not changing the essence of the investment itself. The gain on this sale, which is approximately half a billion dollars, will run through the same account that we have used for past share sales. Albeit a subsequent event to the quarter, you might have noticed that we sold down also some stock for JDE Peet's.

The transaction was equivalent to approximately EUR 400 million through an equal combination of an outright sale and options at an all-in net discount of 2%-3% versus the JDE stock price at the time of the transaction. Options have a maturity which is about 6 months. Both transactions put us in a good spot in terms of our leverage and debt profile, together with the expected proceeds of developed market gum, pretty much balance the outflows related to the acquisition of CLIF and Ricolino. Turning to our outlook on page 20. Given the strength of our Q1 results and the overall operating environment across our business, we are raising our full-year outlook for revenue growth and EPS. We now expect top line growth of 10%+ versus our original outlook of 5%-7%.

EPS growth is expected to be 10%+ versus our previous outlook of high single-digit growth. In terms of the assumptions, inflation is still expected to increase double-digit for 2023, driven by elevated cost in packaging, energy, ingredients and labor, while lapping favorable hedges in 2022. In terms of interest expenses, we now expect $400 million for the year, given recent coffee transactions. We now expect $0.09 of EPS of headwinds related to Forex impact for the year versus $0.04 in our previous outlook. The outlook revision reflects our increased confidence in another exceptionally strong year, given the resilience of consumer consumption in our categories, more benign elasticities than we planned, and share dynamics in H2, as well as lower actual disruption and better environment in Europe.

Having said that, we might have some more disruption for the remaining pricing, which will potentially affect Q2. Continued strength in our emerging markets is what supports our improved guidance. This current outlook does not consider a material deterioration of geopolitical environment surrounding some areas of our business. With that, let's open the line for questions.

Operator (participant)

Thank you. At this time, if you would like to ask a question, please press the star one on your touch-tone phone. You may remove yourself from the queue at any time by pressing star two. Once again, that is star one to ask a question. We will pause for a moment to allow questions to queue. We'll take our first question from Andrew Lazar with Barclays.

Andrew Lazar (Managing Director)

Thanks. good afternoon, everybody.

Dirk Van de Put (Chairman and CEO)

Hi, Andrew.

Luca Zaramella (EVP and CFO)

Hi, Andrew.

Andrew Lazar (Managing Director)

I guess first off, Dirk, I was hoping you could double click a little bit on the emerging markets performance, which was obviously, you know, dramatically better than I think most had certainly modeled and were expecting. Organic sales were up 25%. I guess I'm just looking for some color on some key drivers and maybe more importantly, sort of on the sustainability of the performance and how we should think about that as the year progresses.

Dirk Van de Put (Chairman and CEO)

Okay. Yeah. Definitely a very strong performance this quarter, but I would say already for several quarters that we have strength in our emerging markets. Emerging markets for us are about 40% of our business. As you said, 25% growth in Q1. I think it's important also to see that there has been very strong or solid volume growth around 4.5%. It's not just pricing. If I go a little bit through the markets, India keeps on growing at a very accelerated pace, strong double digit, no real signs of a slowdown. Our outlook for 2023 remains optimistic. We have to invest in capacity increases, which we are doing.

As you know, it's a combination of the strength of our Cadbury and Oreo franchises, who are receiving heavy support with strong innovations and as well a distribution expansion where we still have a runway for several years to go. In China, we also have strong momentum. There we also see good share gains. We have in the past quarters been establishing Chips Ahoy! as a second biscuit brand after Oreo. Business, as you know, is mainly biscuits and gum. I think with the post-COVID period now in China, we see the confidence of the consumer going up, and we're expecting a strong year in China also.

Same thing as in India, heavy support in our brands, good innovations, building extra capacity, and still big upside on increasing our distribution. In Mexico, we now with the acquisition of Ricolino, have significantly increased our distribution power. There, we will see the distribution of the Mondelēz brands increasing significantly in the coming months. We also have double-digit growth in the quarter, and the whole acquisition and integration of Ricolino is on track. Maybe adding Brazil. Brazil is also double-digit growth. We continue to see strong demand, and we are expanding our distribution also in Brazil. I would say, overall, the key markets in our emerging markets group are doing well.

Particularly in Latin America, I would add to that the whole economic environment is pretty strong. Important to note is that they have delivered and are delivering reported dollar growth in top and bottom line, and that the cash flow that we are generating is also very strong. The return on our investment in emerging markets is very good. I would say that we believe that we have a sustainable growth engine that will continue for the foreseeable future. The reasons for that we have stepped up in execution in a major way. We now, for several years in a row, have continued heavy reinvestment in our business.

We have these distribution opportunities that I've been mentioning. We keep on going deeper and deeper into distribution, setting up routes and presence, which are having a very good return, and we keep on doing it year after year. As I said, macroeconomics in Latin America are helping. Then also the gum business, which during the pandemic suffered, is one of the drivers of our growth in Latin America. At this stage, consumer confidence is relatively strong. We have high loyalty in our brands. Private label in emerging markets remains a relatively small challenge. We continue to be very optimistic for 23 and beyond. We feel that we have plenty of opportunity. We have a lot of headroom for accelerated growth, I would say.

Our the penetration of our categories is very low. The distribution runway in places like China, India, but even in places like Brazil and Mexico are high. Our brands like Oreo, for instance, is really exploding in Latin America, but Cadbury in India, Milka that we are now launching throughout Latin America. We see all this combined gives us the confidence that we'll keep on doing well in our emerging markets.

Andrew Lazar (Managing Director)

Really helpful. Appreciate that rundown. Just super briefly, Luca, just from a guidance standpoint, you know, it does not seem as though your expectations for the remainder of the year have necessarily changed that much and that the upward guidance revision primarily is based on the better than forecast 1Q results. I guess my question is maybe how should investors think about the sort of the plus in the revised 10% plus constant currency EPS growth outlook? Like, the sort of the puts and takes or things to consider there. Thank you.

Luca Zaramella (EVP and CFO)

Yeah. Thank you, Andrew. Clearly as we move through the year, we will be lapping materially higher quarter than Q1 last year, which is the only one quarter we had with high single digits. I think we moved obviously sequentially to higher revenue growth throughout the year. The reality is, there might be a scenario there where we exceed the 10% floor that we have guided you to in terms of both revenue and EPS.

I think while I feel quite good on the underlying trends of the business, particularly in emerging markets, the strong momentum is there. Obviously, we still have headroom to accelerate to a certain extent. I think I'm very pleased, obviously, with the U.S. and North America, which is on an upward trend, excellent pricing execution, supply chain improving. I think the watch out is a little bit on the European side. Happy with the improved profit in Q1, which is the result of the 80% of the pricing kicking in, but profitability in Europe is still not where it should be. The remaining 20% of the pricing that is being implemented is important.

Unknowns are in relation to this further pricing that is needed, a potentially related disruption and some macro volatility. Obviously, as anywhere else in the business, we continue to invest, and that coupled with additional pricing that will kick in should result in top to bottom line. Look, I think it is very early for us to guide you to something that is materially better than what we are saying at this point. If everything plays out, we might have further opportunities. I think the other one I want to hit briefly on it is the assumptions that we're making around commodities. We still see double-digit inflation rates into 2023, with obviously energy, sugar, ingredient causing most of the pressure.

A good part of this inflationary pressure, as I reminded this audience a few times, it is due to the favorable coverage we had in 2022. In general, overall costs are not coming down materially. The most recent spikes in terms of cocoa and sugar prices are offsetting some of the other benefits that we see. I think you might have in the back of your mind percentage margins too. I said it a few times, we continue to be obsessed with dollar growth and cash, and there might be some pressure in percentage terms, particularly in the next couple of quarters. Sequentially, we will be much better throughout the year. We plan to end clearly the year on a gross margin percentage positivity.

Reality is we prefer driving a strategy that has been proven to be compelling for everyone, and that is about dollar growth.

Andrew Lazar (Managing Director)

Great. Thank you so much for that.

Luca Zaramella (EVP and CFO)

Thank you, Andrew.

Operator (participant)

We'll take our next question from Ken Goldman with JPMorgan.

Ken Goldman (Managing Director and Senior Equity Research Analyst)

Hey, thank you. I wanted to ask, you know, most companies that we cover, or at least that I cover now, pricing is exceeding their COGS inflation. For you, it's still not a full offset. I think you mentioned that it was only a partial offset to the inflation. I'm just curious, is there a point this year when you do get pricing ahead of inflation? Is there any way to kind of forecast that? I just wanna kind of get a sense of how we think about some of those potential tailwinds ahead from that perspective.

Luca Zaramella (EVP and CFO)

I think all in all, we are quite pleased with the level of pricing that we have at this point in time. If you look at the three major pricing actions we have taken in places like the U.S., I mean, that is something that you see in the P&L with the segment profit growth that we have explained here, which is 40%. Obviously, in that number, there is synergies coming out of the ventures. In general, we are happy with the level of pricing. The same in emerging markets overall. You look at Latin America, you realize how disciplined we have been with pricing.

The model in EMEA is slightly different in the sense that volume leverage is absolutely critical in some of these places. Maybe we have been a little bit less aggressive on pricing than we could have been. All in all, the P&L is working very well. I think they quoted that, A&C year-over-year is up almost 20%. That gives you the understanding of how much we are investing in the business and also thinking ahead out of a potential inflationary period. Where pricing is not necessarily where it should be at this point in time, it is Europe. We told you 80% is being, has been implemented already with a little disruption compared to what we had anticipated. There is still 20% to go.

I think once you get that 20%, the picture will look quite a bit different. In fact, Europe is the biggest segment we have. I don't want to give the impression that we were shy on pricing, quite the opposite. We have done what was necessary, but obviously, in our case, we want to keep volume leverage. I think looking at the 3%+ volume/mix is something that is remarkable in Q1, and that leverage into the P&L and the profit dollar growth that we are showing, I think it is a winning formula, at least for us.

Ken Goldman (Managing Director and Senior Equity Research Analyst)

Great. I'll pass it on. Thank you.

Luca Zaramella (EVP and CFO)

Thank you.

Operator (participant)

We'll take our next question from Bryan Spillane with Bank of America.

Bryan Spillane (Managing Director and Equity Research)

All right. Thanks, operator. Good afternoon, everyone. Luca, two quick ones for you. One's a clarification. Just the, you know, with the KDP, you know, accounting change, is the earnings base that we're using for 2022 to calculate the, you know, the EPS growth for 2023, is that $2.89, so $0.06 below previous? Is it $0.03? I think on one of the slides it said the net effect was $0.03. I just want to make sure we're using the right 2022 base as a starting point, and I have a follow-up.

Luca Zaramella (EVP and CFO)

Look, the simple answer to that question is we had to take out all the income that was related to KDP last year, and it was around about, I think, post-taxes, $90 million, give or take. We are replacing that with dividends. The net effect between a dividend payout, which is around about 48% or 50%, depending on the base, and the fact that we stripped out earnings last year in the tune of the $90 million I told you, is causing the headwind of $0.03. As we restated the base, the impact was $0.06, but the year-on-year impact is due to accounting, is really $0.03. Is that clear?

Bryan Spillane (Managing Director and Equity Research)

Okay. Okay. Yeah. I guess it's clear. The base is $2.89, but as we're adding back, you're re-capturing $0.03 of that $0.06 headwind back in 2023, right? But our starting point is $2.89 to start the calculations off of for the forward guide.

Luca Zaramella (EVP and CFO)

That's correct.

Bryan Spillane (Managing Director and Equity Research)

Okay. Okay. Just had a follow-up, and I think it's a follow to Ken's question just now. And just thinking about pricing and percentage margins, in the quarter, I think it was an $81 million hit to operating income from currencies, which was, like, $0.06 of the $0.09 for the year. I'm assuming it's a little bit of a bigger hit at the gross profit line. We were thinking somewhere between 90 to 100 basis points, maybe a gross margin. I guess as we're kind of thinking about margin progression, percentage margins and gross profit dollars, seems like this is the worst of it, right?

Unless things change in this quarter in terms of the FX piece and, like, one tailwind we should see, assuming other things hold, is just that drag from foreign exchange should become a lot less severe as we move through, especially the second half. Just wanna make sure we're thinking about that correctly.

Luca Zaramella (EVP and CFO)

I can tell you that, sequentially, the gross margin percentage, albeit I don't like talking about it, should improve throughout the year. Reality is today, if I look at, gross margin and gross profit dollar growth throughout North America, Latin America, and as I said, a good portion of EMEA, I'm very happy with the numbers I'm seeing. Europe is still impacted by the fact that there is 20% of pricing to go. As we implement that, the situation should sequentially improve.

Bryan Spillane (Managing Director and Equity Research)

Okay, the FX drag should, again, assuming things don't change from here, the FX drag should become a less of a, much less of an impact than it has been.

Luca Zaramella (EVP and CFO)

Absolutely, it should.

Bryan Spillane (Managing Director and Equity Research)

Okay. All right, cool. Thanks.

Luca Zaramella (EVP and CFO)

You're welcome.

Dirk Van de Put (Chairman and CEO)

Thank you.

Operator (participant)

We'll take our next question from David Palmer with Evercore ISI.

David Palmer (Senior Managing Director)

Thank you. strong results in so many areas, I'd be interested to hear if you had to choose, you know, two or three that really drove your increase versus in guidance or upside versus your internal expectations, whether those are current trends or maybe just sources of visibility. I would imagine what's going on in Europe with retailer and consumer response to pricing is high on the list, I'd be interested to hear what also makes that sort of top three.

Dirk Van de Put (Chairman and CEO)

Yeah. The top three for me would be, yes, for sure, Europe, where we were expecting a bigger client disruption, and that did not occur in Q1. As Luca said, we're only 80% done with the price increases, and we still have some negotiations going on. We could still see a part of that client disruption in Q2, but that has been included in our outlook for the year. That's certainly significantly better than we had anticipated.

The second one that I would mention is the U.S., whereby you see a very solid top line, but the bottom line is probably the strongest increase, driven by, first of all, an improvement in our supply chain, but then also a very strong recovery of CLIF Bar's profitability since the acquisition. We expect that that positive trend for North America will continue. The third one is probably the ongoing strength in emerging markets. I already went there, but if I compare our emerging markets growth of 25%, that stands for me well above any of our colleagues, and that has been going on for several quarters now.

Those would be my top three, I would say, of what's carrying the quarter for us and probably is gonna carry the year for us.

David Palmer (Senior Managing Director)

Thank you. That's helpful. I'm wondering to what degree this year and what you're seeing going on, maybe internally, not just some of the macros, informs how you view your company and the long-term growth rate of your company. To some degree, we've had COVID obscure what might have been happening in terms of all the changes that have happened. Of course, you've made plenty of acquisitions that are adding to your long-term growth rate. Does this make you feel more optimistic that the long-term growth rate is heading in the right direction and higher?

Dirk Van de Put (Chairman and CEO)

Well, I think the recipe that we have is a strong recipe. We event a little bit, for instance, in emerging markets through the different growth vectors that we have. The fundamental principle is to make sure that we are well-positioned from a pricing perspective, that we continue to invest heavily in our brands, that we drive distribution in-store presence. We work RGM. We seem to have a recipe and a way of working that is really starting to click. It certainly gives us confidence that we've got something going here that is very strong. What that exactly means going forward, because we are in a very particular period where last year and this year, we had to implement significantly price increases.

I guess to our delight, the consumer has not reacted by buying less product. They keep on buying the same or more product. As we get through those price increases, growth will come down. We will have to see what happens with input costs going forward. It's difficult to say, but I can certainly say that we are in durable categories that are doing particularly well in these circumstances, that we are performing well within those categories. We feel very good about our long-term algorithm. I think we have to wait a little bit to see where things will pan out as we get through these price increases, that will be the moment to restate our long-term growth algorithm.

So far, I would say very strong and we feel that we are in line or above our long-term or growth algorithm for sure.

David Palmer (Senior Managing Director)

Fair enough. Thank you.

Operator (participant)

We'll take our next question from Alexia Howard with Bernstein.

Alexia Howard (Research Analyst of US Foods)

Good evening, everyone.

Dirk Van de Put (Chairman and CEO)

Hi, Alexia.

Luca Zaramella (EVP and CFO)

Hi, Alexia.

Alexia Howard (Research Analyst of US Foods)

Hi there. Two quick questions. First of all, where are we on the cost synergy recouping for the recent deals that you've done? It seems as though that was quite a strong benefit to profit growth recently, but I'm just wondering how much more there is.

Luca Zaramella (EVP and CFO)

Let's start with CLIF. We have announced a new organization. CLIF started from a relatively high level of SG&A. We have protected and increased A&C, an area in which we have been able to obtain round about $10 million of synergy a year, given better rates that we have. There is already cost opportunities coming into the P&L in the area of selling and administration. The new organization is already in place. The next step is really to go and get synergies in the area of COGS. There is still quite a bit of an opportunity. Just for a reference point, as we acquired this business, the EBIT margin was not great.

I think today in Q1, particularly given the pricing we have taken, which is the other area where we brought quite a bit of discipline, the margin is just shy of 20%. It's quite a good outcome at this point in time. There is still more to come. We are thinking potentially about leveraging DSD and doing other things. Obviously, the biggest opportunity we see is establishing this brand internationally. That hasn't started yet as a work stream. On Ricolino, we just got the business. We have TSAs in place still with Bimbo. As we implement SAP, and as we move towards the end of the year, that's the moment where we will start getting SG&A costs and COGS synergies.

Reality is the biggest opportunity here is to sell Oreo through the system and revenue synergy can be very, very material. There is still more to come on both platforms. I would say in general, in the other ventures, there is still work to be done and so potential synergies coming out there, too.

Alexia Howard (Research Analyst of US Foods)

Great. Just as a quick follow-up, can you just quantify how much the retailer inventory rebuild, benefited North America this quarter? Is there any more to come on that? I'll pass it on.

Luca Zaramella (EVP and CFO)

I think there was a slight positivity due to that. Reality is we have been promoting less than optimal. Now that inventory is available, there is opportunity for us to do selective promotions and boost our brands now that pricing is implemented. It hasn't been material, I would say. Obviously in a context where you see this growth rate, it is minimal. We still have opportunities to really replenish stock more. Now that we have potentially a little bit of more promotions coming, I think we are in a good position.

Alexia Howard (Research Analyst of US Foods)

Great. Thank you. I'll pass it on.

Operator (participant)

We'll take our next question from Jason English with Goldman Sachs.

Jason English (Managing Director and Equity Research)

Hey, good afternoon, folks. Thanks for letting me in.

Luca Zaramella (EVP and CFO)

Hi, Jason.

Jason English (Managing Director and Equity Research)

Hey there. A couple of quick questions, both also sticking on North America for a moment. Great news on the margin progression on CLIF. Congrats on that. That's impressive in such a short duration. We had been assuming that it was gonna be a margin mix drag to both gross margins overall and the segment. With a 1,000 basis points improvement that you've seen so far, is it still margin dilutive, or are you now closer to parity with the segment?

Luca Zaramella (EVP and CFO)

It is, it is still margin dilutive on the overall segment. Again, as we think about potential opportunities in the year to come, this is another platform that we are going to integrate into SAP in the second part of the year. I'm sure the margins will get better. Pricing has been announced for the last round, but it hasn't kicked in yet. There is now that we have stock more opportunities to really activate that point of sales must-stock list, as we call them, i.e., the right assortment by store is an area of opportunity that we have. I'm confident that the margins will look quite close to the U.S. business going forward.

Jason English (Managing Director and Equity Research)

That's good to hear. Sticking on North America, it seems like supply chain has been this overhang that we've been talking about in North America for year upon year upon year, and maybe I'm exaggerating just because it feels that long. It's great that you're over the hump and you're seeing improvement. Nice to see the sales side of that. How about on the margin side? Clearly, this has been costly to the business. How much of a margin drag have supply chain issues been? How much of a tailwind can that be as you look to sort of rebuild that?

Dirk Van de Put (Chairman and CEO)

Well, I would say the, there's this, a mix going on with the price increases that we have implemented together with some of the extra costs we had to incur during the pandemic to get the right service and so on. You see, in the recuperation phase, we also promoted less than we were planning because our inventories were low. It's quite a complex picture to exactly pinpoint how much was due to the disruption since we had to go through all these additional effects. Certainly it's the case that the headwinds have moderated quite significantly, you know, about the labor markets, the logistic situation. Our external manufacturers network has improved significantly.

A lot of the cost headwinds that we were facing have now eased. That still doesn't mean that the costs have come back, there's been significant inflation. I would say the resulting effects from our supply chain improvement is that our inventory levels are back to the expected level. Service level are reaching 90%. Our own shelf availability is 96%. We still have some issues in our confectionery brands where the demand is higher than anticipated, and also CLIF Bar, the service levels have fully recuperated. At this stage, I would say that the cost effects and the top line effects have largely eased, and we can now start to function normally with higher promotional levels and cost levels that are better.

It's very difficult for us to estimate exactly what it was. Going forward, things we're doing is, we are increasing our capacity. We have changed our way of working and our relationship with our external manufacturers. The inventories are rebuilt. We have simplified our portfolio. We've increased our warehousing capacity on top of our manufacturing capacity. We have implemented labor strategies for retention and an improvement in temporary labor. I think, apart from easing the cost, we've also put in place long-term solutions for our supply chain situation. Difficult to give you the exact number, but hopefully you can feel that we are in a much better spot as it relates to our supply chain in North America.

Jason English (Managing Director and Equity Research)

Yeah, for sure. Thank you very much. I'll pass it on.

Dirk Van de Put (Chairman and CEO)

Yeah. Thank you.

Operator (participant)

We'll take our next question from John Baumgartner with Mizuho.

John Baumgartner (Managing Director and Equity Research of Food and Healthy Living)

Good afternoon. Thanks for the question.

Luca Zaramella (EVP and CFO)

Hi, good afternoon.

John Baumgartner (Managing Director and Equity Research of Food and Healthy Living)

Good afternoon. I wanted to ask, Luca, I wanted to ask about profitability in EMEA. You're heading into reinvestment mode there. You also mentioned the pricing disparities in an earlier question. I'm curious, at this point, how are you thinking about the point at which vol mix growth relative to reinvestment, and I guess what I also think is pretty strong potential for accretive product mix over time, you know, when that begins to yield leverage and tip the region back to margin expansion? Or is the mid-teens margin just the structural ceiling for EMEA? Thank you.

Luca Zaramella (EVP and CFO)

I don't think there is a structural ceiling in EMEA. EMEA is quite good in terms of profitability overall. I think when you look very closely to EMEA, there are a set of countries that are, I call them cash machines. The India or the China of the regions run on profit margins that are north of the average of the company. We invest in both businesses around about 15% of A&C as a percentage of revenue, which is materially higher than the average of the company.

We have cash conversion cycles whereby by growing these companies, not only we get the volume leverage that runs through a very sizable installed machine, both from a manufacturing standpoint, supply chain and sales, but also on negative cash conversion cycle, the cash throughput is impressive. There are countries where we have a little bit less material scale, the likes of Southeast Asia. There are certain countries in Southeast Asia where the business is still developing, where categories like chocolate are not well established yet, we are investing to make these categories much bigger for us. There, I think it is a matter of time because the scale and the volume we are adding will get to a point where the P&L will make perfect sense.

As you might imagine that in these countries, we are investing both in terms of price point and support ahead of material expansion that I think it will come. Obviously you have countries like Australia that are again, more mature markets where volume grows. We're happy with Australia overall, but it doesn't grow high single digit or double digit as in other places. There, the evolution of profitability is steady. As you think about EMEA, very happy with the sizable markets that are doing very well, and that emerging market, very happy with Australia. The rest is the untapped opportunity we are looking at, and we have the obligation to invest for future growth and margins, I think it will come.

Dirk Van de Put (Chairman and CEO)

Thanks, Luca. Very helpful.

Luca Zaramella (EVP and CFO)

Thank you, John.

Operator (participant)

We'll take our last question from Michael Lavery with Piper Sandler.

Michael Lavery (Senior Equity Research Analyst and Managing Director)

Thank you. Good afternoon.

Luca Zaramella (EVP and CFO)

Hi.

Dirk Van de Put (Chairman and CEO)

Hi, Michael.

Michael Lavery (Senior Equity Research Analyst and Managing Director)

Just wanted to understand. I love, like on slide five, how clear it is that your A&C spending is almost identical to your sales growth. Clearly, your spending as a percent of sales is holding about constant. You get really some operating leverage there, just given the amount of pricing that's driving the top line growth. On a per unit basis, you're really coming out ahead. How do you think about managing that going forward? Is it sort of a luxury you wanna maintain? Could some of that maybe get adjusted to fall to the bottom line? Just help us understand how brand spending might evolve given how that dynamic sets it up.

Luca Zaramella (EVP and CFO)

Clearly, the 20% might be something that is on the high side. I can tell you one thing, one of the biggest differentiators of this company over the last three years, it has been level of investment, it has been quality of marketing, it has been brand support. We, in the end, sell brands, and it is important that we keep line of sight to that. I don't think you're gonna see a consistently a 20% A&C increase. At this point in time where we are moving price point, where we are trying to retain and increase our consumer pools, it is important that we use this as an important accelerator of growth for years to come, and that's what it is at this point in time.

When this inflationary cycle is done and things will get more normal, I think what is a big differentiator is the level of volume and the scale businesses are still gonna have or not have. In our case, if you look consistently over the last few quarters, we have been growing volume, and there is a correlation between the level of investments we are making, both in terms of marketing and distribution. I don't think we are gonna see consistently 20%, but reality is that is still a big opportunity for us to get our brands to where they belong, which is higher sales, hopefully quarter after quarter.

Michael Lavery (Senior Equity Research Analyst and Managing Director)

That's great color. Thank you so much.

Luca Zaramella (EVP and CFO)

Thank you.

Dirk Van de Put (Chairman and CEO)

Thank you. With that, we've come to the end of the call. Obviously, a strong quarter. We're looking forward at this stage to a strong year. Thank you for your attendance and any other questions, please refer to Shep and the IR team, which we can follow up with. Thank you.

Luca Zaramella (EVP and CFO)

Thank you, everyone.

Operator (participant)

That concludes today's teleconference. Thank you for your participation. You may now disconnect.