Q3 2019 Earnings Call
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Good morning, welcome to the Kellogg company's third quarter 2019, the earnings call.
All lines have been placed on mute to prevent any background noise.
The speakers remarks, there will be a question and answer period.
If you look to ask a question. During this time simple press star and the number one on the telephone keypad.
Please limit yourself to one question going back to a session. Thank you.
The problem I will turn the call over to Mr., John Renwick, Vice President Investor Relations, a corporate planning for Kellogg company.
Mr and work you may begin the conference call Sir.
Thank you Mike Good morning, and thank you for joining us today for a review of our third quarter 2019 results an update of our full year 2019 outlook I'm joined this morning by Steve Caitlin, our chairman and CEO and Amit Banati, our Chief Financial Officer.
Slide number three shows our usual forward looking statements disclaimer as Youre aware certain statements made today such as projections for Kellogg company's 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 this third.
Slide of the presentation as well as to our public SEC filings.
A replay of todays conference call will be available by phone through Tuesday November 5th the call will also be available via webcast, which will be archived for at least 90 days.
As always when retreat, referring to our results in our outlook unless otherwise noted we will be referring to them on a currency neutral basis for net sales and on a currency neutral adjusted basis for operating profit in earnings per share.
Now I'll turn it over to Steve.
Thanks, John Good morning, everyone. We're pleased to report another quarter of good progress with solid organic net sales growth and sequential improvement in profitability. In fact, returning operating profit growth. Excluding our recent divestiture. We continue to do exactly what we said we do in other words, we remained on strategy and it's another.
Quarter in which we delivered the results. We said we would in short we remain on plan, let's start with strategy and slide number five.
Our reshaped portfolio is doing what is intended to do we once again delivered good growth in emerging markets, where we built upscale and diversified our offerings. We once again grew in developed markets snacks. Thanks to revitalize brands effective innovation and on the go pack formats, and we delivered growth in developed markets frozen foods.
Led by innovation and marketing that is driven it driven a particularly exciting acceleration from Morningstar farms Veggie foods. This portfolio should give you confidence in our ability to sustain steady topline growth even as we work to stabilize developed market cereal, particularly in the United States.
As a reminder, our divestiture closed during the quarter, we are addressing stranded costs and the transition services are underway and being well executed we use the proceeds to reduce debt and enhance financial flexibility and we're already feeling the benefit of increased focus behind the rest of our U.S. categories and from a portfolio standpoint.
We are starting to see the divestitures favorable benefit of improved growth profile and better margins overtime.
Beyond our portfolio reshaping deployed for growth also continues to help us improve our competitiveness are focused on winning occasions is reflected in the strong performance of this year's innovations and sustained growth in on the go offerings.
Our focus on building World Class brand is evident everywhere from Pringles global momentum to the share gains of our revitalized U.S. snack brands to Morningstar farms growth Reacceleration.
We have also made progress on improving service and in store execution aided not only by investment in capabilities, but also by the improved visibility and holistic resource management that comes from our efforts earlier this year to flatten our organizational structure and our heart and soul boosters are also generating results as evidenced by our.
A recent rise in the Dow Jones sustainability index ranking released during this quarter.
And the best proof that our strategy is working is in our results in Q3, we again remain solidly on plan for the year. We said, we would return to topline growth this year and we're delivering it slide number six shows that we sustain our acceleration in organic net sales growth.
Again posted organic growth in all four regions and we again recorded positive price realization amidst higher cost inflation.
Globally, we grew organic net sales in snacks frozen and noodles and we grew cereal outside of North America led by emerging markets. Importantly, we again showed growth in consumption and share in key categories and brands around the world as a result, we're confident in our ability to deliver on our full year guide.
Yes.
We said the profit growth would follow as we got past key investments and costs. During Q3, our operating profit excluding the mechanical impact of our divestiture moved into growth for the first time in several quarters, we delivered on promise sequential improvement in gross profit margin and we're seeing savings from the reorganization.
Once we executed earlier this year.
As a result, we're on target for our full year guidance for operating profit as well, even as we contemplate some incremental investments during Q4.
Over the past year, we've often said that the hardest thing to do is to restore topline growth and we're doing that in fact, the heaviest lifting and the biggest most disruptive actions are largely behind US. We can now work on restoring profitability as well as on more targeted areas of investment remember.
Building a foundation for consistent dependable steady growth overtime and Q3 was another quarter of evidence that the foundation is taking shape. So with that let me now turn it over to admit who will take you through our financial results and outlook in more detail on it.
Steve Good morning, everyone.
Q3 and year to date results are summarized on slide number eight.
Keep in mind that the results on this slide our effected by the divestiture of our cookies fruit snacks by cross and ice cream cones businesses, which closed at the end of July .
So during Q3, there were two month of the quarter when we no longer had the sales and profit from those businesses.
Net sales were down year on year because of about four percentage points of this divestiture impact.
But on an organic basis on net sales were up more than 2% for a second consecutive quarter.
Year to date organic net sales growth is well within our full year guidance.
Operating profit declined because of about five percentage points of divestiture impact, suggesting a return to growth excluding it.
This return to growth maybe a little earlier than you were expecting though it did benefit from some favorable timing of soda and investments and costs, which will come in quarter four.
Our year to date currency neutral adjusted operating profit performance is in line with our full year guidance.
Earnings per share declined mainly because of the above mentioned divestiture impact on operating profit.
Weibo, partially offsetting this expected decline was a tax benefit.
To date currency neutral adjusted Ed is inline with our full year guidance.
Our cash flow was also affected by the divestiture.
Remember that transaction proceeds are not included in the cash flow, but the taxes on those proceeds are.
As our any upfront costs and working capital timing differences.
Through the first nine months, our cash flow trains long steel because of divestiture impact and timing.
We're still on track for our full year guidance with taxes on the divestiture proceeds to offset underlying cash flow in quarter Paul.
So our quarter three and nine month results remain clearly inline with our stated 2019 plan.
Let's now go into more detail.
As usual, we did start at the top of the BNS.
With net sales growth and slide number nine.
Organic growth was up 2.4% and again, we grew organically in all four regions.
Among all categories globally snacks led the growth increasing in all four regions.
We also grew in frozen foods, and we continue to expand and noodles.
David was down modestly due to our North America business, but it continued to grow outside of North America led by emerging markets.
Importantly consumption trends remained solid in key markets and categories around the world.
And revenue growth management actions have helped us realized positive pricing, even if modestly impacting volume.
With 1.6% year to date growth and only one quarter left Indio, there, obviously confident about achieving our full year guidance, a 1% to 2% organic growth.
On the slide you can see the negative impact of our divestiture, which closed one month into the quarter and had an impact of negative 4%.
Ill have a little more impact in quarter four its first full quarter autopart results.
Well the folio, we still expect 2% to 3% negative impact on net sales from our divestiture to be offset by the positive acquisition impact of multi pros consolidation, which itself and it was threed early in quarter two.
Lastly, currency translation clipped more than a percentage point of our reported net sales in quarter three.
Why this pressure did moderate sequentially in part because of lapping last year's U.S. dollar appreciation. It has continued to run more negatively than we had expected.
Now, let's turn to our gross profit margin on slide number 10.
As we have communicated previously we expect gross margin to decrease year on year in 2019, but for those declines to moderate as the year goes on.
And once again, we saw mark sequential improvement in quarter, three with a year on year decline in gross margin. The smallest it has been since back in 2017, before we exited DSD and reset our margins accordingly.
The chart shows the drivers of the sequential improvement in our gross margin.
But the mechanical bucket.
The negative mechanical impact of consolidating market Breaux, our distributor business in West Africa as anniversary.
Starting in the third quarter, we began to see the positive mechanical benefit of divesting lower margin businesses during quarter three.
We're also seeing the improvement in the bucket we call growth related.
This buck bucket continues to feel negative pressure from mix, including mix shifts towards emerging market and away from developed markets even.
It also reflects investments and costs into our food and packaging, most notably our push into on the go back formats in North America snacks categories.
Revenue growth management is helping to mitigate some of this impact and over the course of quarter. Three we started to see some offset from supply chain investments.
Specifically, we opened centralized backing centers over the course of quarter three and we are now starting up newly installed backing lines in certain plans to begin repatriating some pullback William.
We also starting up local production of Pringles in Brazil for the first time.
As we get ramped up these actions will provide more and more benefit to gross margin and we expect the overall growth related bucket, we'll continue to improve in quarter four.
The final bucket is what we call ongoing.
As we've discussed previously we not only have higher input cost inflation in this deal.
But we are also comparing against notably favorable hedges last deal, especially in the fall itself.
Net we continue to expect sequential improvement in gross profit margin in quarter four.
Even if not quite as quickly as we would have liked.
On MSG any expense, we continue to realize benefits related to organizational restructuring dating back to early this year.
In quarter three was the final quarter to lap the exceptional infusion of brand building investment that we made during quarter four 2017 through quarter.
Three 2018.
Some of the investment that had been deferred to quarter. Three has now been moved to quarter fall.
The results of our good.
Organic net sales growth moderating growth margin decline and you're on your decreased in as Ginny was a slight growth in operating profit before the impact of divestiture.
We said profit with follow as we got boss unusual investments in cost and it is.
Now, let's move below the operating profit line turning to slide number 11.
We have discussed previously these below the line items placed important headwinds in the first off.
Moderating in the second half.
And you can see this.
Quarter three results.
Interest expense in quarter three was flat for the first time this year.
Member in the first half it was up year on year.
You bet added lots still Barra acquisition in West Africa.
And well entry pension contributions.
Other income was also flat year on year for the first time this deal as favorability in items, such as company owned life insurance offset a narrowing decline in net pension items.
And for the first I'm the CEO in quarter three we saw Youre on your favorability on our effective tax rate.
Not only had we already lapped the sizable discrete benefits of first.
2018 as expected.
We also realized a benefit in this years quarter three related to reversing a tax accrual.
This is a one time benefit that a lot impact waterfall, but it does take down our folio tax rate estimate to around 20%.
Turning to slide number 12 or.
Nothing has changed regarding both divestiture timeline.
As you know the divestiture closed on July 29.
So from a financial perspective, the divestiture will have five months of dilution this sale and seven month of dilution and 2020.
As we now have greater visibility on transition services plans around stranded costs and overall financial impact.
We can now update you on timing of expected operating profit dilution.
Well this year 2019, we will likely track towards the favorable end of the guidance range. We've previously given for impact on operating profit.
Some of this dilution is shifting into 2020 when it may take a little longer to fully extract stranded costs, depending on the land of transition services and when we lap the seasonally largest operating profit of the divested business.
During quarter, three we redeemed deck, incurring onetime premiums and interest expense, but reducing overall debt leverage.
We still anticipate that this cost of redemption, largely offset the savings on interest expense this year.
And again, it's worth mentioning that far more important than how this transaction impacts our 2019 BNS is what it does for overall growth and margin profile going forward.
Not only while these lower growth at lower margin businesses for us.
But we can now focus more attention and resources on our best categories and brands.
And we already starting to experienced this.
So let's move throughout 2019 full year outlook and guidance, which is shown on slide number toting.
We are making no changes to our full year guidance for net sales operating profit and cash flow.
Earnings per share outlook moves to the favorable and Opex guidance range.
Currency neutral net sales are still expected to finished steel in the 1% to 2% range.
In effect the five months of divestiture in the second half offset the full month Multipro acquisition in the first half.
Meanwhile, organic net sales growth is still focused to be 1% to 2% as well.
Year to date.
Panic net sales growth is 1.6% so we have confidence in the guidance range.
Currency neutral adjusted operating profit expectations continue to be in the negative 4% to 5% range as we have communicated since the divestiture.
Thats why we are running through the first nine months.
We mentioned the expected divestiture impact shifting a little into 2020 , but this is mostly offset in 2019 by investment that is shifting into quarter four.
In addition, we may need to leave room for potential Brexit, RIS and or incremental investments.
So we're maintaining our guidance range for operating profit.
Currency neutral adjusted EPS is now expected to be at the favorable end of the previous guidance range of negative 10% to 11% given our quarter three tax benefit and favorability in other income.
And lastly, cash flow is still expected to finish the year at around half a billion dollars.
Reflecting relatively stable base business cash flow, you're on your but with a roughly half a billion negative impact from the divestiture.
Overall, our full year guidance for these metrics has not changed from the beginning of the.
Other than layering on the impact of our subsequent divestiture.
And if anything over the course of deal we've reduced our reliance on waterfall.
Meanwhile, we have paid down debt to enhance our financial flexibility.
So we feel good about our financial position heading into the final quarter of the yield.
I'll now turn it back over to Steve.
Who will review each of our major businesses. Thanks, gentlemen, let's now turn in North America, and slide number 15 for a second straight quarter, we were able to grow organic net sales in this region. In spite of a soft period for cereal. This speaks to the composition of our portfolio and the growth momentum we are seeing in our big snacks and frozen.
It also speaks to the behind the scenes work, we've been doing we've changed our organizational design for better visibility and more holistic resource allocation, we have invested in capabilities such as revenue growth management and digital marketing our innovation launches and pipeline are the best we've had in years our performance in specialty.
Channels remains very solid and we have overhauled key processes for better service and execution.
Meantime, we've been working to cover cost pressures revenue growth management has helped us realized price and we've taken major steps to restore margins on our rapidly expanding on the go pack formats. As a result margin declines in North America have continued to moderate sequentially.
So in a year of incredible change in North America. There is a lot of great work going into its foundation for future growth, let's discuss each major category in a little more detail.
We'll start with snacks, our largest category in North America on slide number 16.
Obviously this is a business most affected by our divestiture Nonetheless, it posted another quarter of strong organic net sales growth supported again by strong consumption.
From a consumption standpoint, the categories in which we compete crackers salty snacks and portable wholesome snacks collectively grew by more than 4% in Q3, and our consumption was up 5% gaining share.
Behind the share gain was continued momentum by our biggest brands driven by effective brand building incremental innovation and growth indication based pack formats.
Pringles continued to grow consumption led by on the go expansion and effective in store activity to go with its new wavy innovation platform.
Cheez it sustain its double digit consumption growth with its successful snapped innovation platform coming on top of double digit growth in the core offerings in portable wholesome snacks rice krispies treats sustain its strong consumption growth with double digit growth in both its core offerings and its new poppers platform.
Pop tarts consumption growth remains very strong bolstered by new bites and nutri grain has rebounded to consumption and share growth with its own bites offerings. So snacks had another very good quarter.
Let's turn now to cereal and slide number 17.
Candidly serial has taken a little longer than anticipated to bounce back after we pulled back investment in the first half to execute our pack size harmonization program.
Our promotional activity as measured by the percentage of units sold on promotion in the scanner data Didnt climb all the way back to year ago levels, yet and we also delayed some advertising activity in part to enable us to activate additional capacity for certain products.
Where we have most returned to normal brand activity isn't a taste fun segment, which underwent it's pack harmonization back in Q1.
This quarter, our Tayfun segment brands collectively grew consumption and share.
Greater consumer activation behind frosted flakes, and its mission Tiger program resulted in share growth for that key brand.
We're seeing a good recovery in honey smacks with new reformulated food and we're supporting better performance for brands like Froot loops, crave and new pop tarts cereal.
It is in a health and wellness and all family segments, which underwent pack harmonization in Q2 that we did not restore activity as quickly as we had planned in quarter three and we're also seeing the impact of eliminating certain underperforming SK use.
In recent weeks, we are encouraged to see positive reaction to new advertising campaigns for both special K and mini Wheats. We've also reaccelerated growth in the bear naked Granola brand and continue to grow corn flakes consumer consumption and share we expect gradual improvement in Q4 and into 22.
NT.
We're not where we need to be yet in North America cereal, but we're on it.
And we'll finish our north American discussion with frozen foods on slide number 18.
We had another good quarter in frozen foods net sales lapse strong year ago growth and felt the impact of phasing out certain SK use more than offsetting these factors was accelerated growth in Morningstar farms Morningstar farms are leading plant based meat alternatives brand accelerated its consumption growth.
Both to 11% and gained more than a full share point.
We are bedded benefiting from some very creative social media exciting new products and distribute distribution growth and major retailers.
So much has been made lately have the emerging ready to Cook were refrigerated meat alternatives segment and there is no question that this segment has terrific momentum and growth prospects. In fact, we're extremely excited about our new launch in Cogs Nieto in Q1 2020 .
But we're also excited about the momentum and prospects in the frozen aisle and not just in burgers, but in all meet alternative types. One of our advantages is that we have a very complete portfolio.
In Q3 for instance, Morningstar farms grew consumption by 20% in poultry alternatives, almost 6% in breakfast meat alternatives and more than 30% in hotdog alternatives. We even grew 2% in frozen Burger alternatives. This segment that has seen the most competition from new referred.
Midyear refrigerated entries and to further emphasize our various offerings. We are rolling out new packaging in December as shown on the slide.
In frozen breakfast, our net sales declined slightly because of tough comps and phasing out certain products. However, in our core frozen waffles pancakes, and French toast businesses, which we refer to internally as from the griddle. Our overall consumption grew nearly 2% year on year.
Eggo despite tough comparisons continue to grow consumption led by innovation in the French toast and pancake segments as well as sustained momentum for its premium second fluffy waffles subline.
Koshi has also accelerated its growth in this category as we pursue a natural and organic occasion.
So we continue to feel very good about our frozen foods business.
Now, let's discuss our international businesses, starting with Europe on slide number 19.
Kellogg Europe has now posted eight straight quarters of organic net sales growth.
The regions momentum continues to be led by Pringles, whose double digit growth benefited from outstanding commercial programs. These ranged from gaming oriented promotions to our Asia inspired rice infused innovation.
Growth is also being driven by increased on the go pack format offerings, and but by continued distribution expansion, most notably in Russia.
Cereal sales continued to stabilize in Q3 across total Europe . The cereal category remains in modest growth and we've returned to share gains over the past few months. This has been led by the UK, where we benefited from effective brand building around brands like crunchy nut and the success of innovations like white chocolate.
Chuck robots, we also continue to grow strongly in Russia aligned to our emerging market strategy.
Wholesome snacks continues to be on a path to stabilization with particularly good performance in the UK. This quarter led by Rice Krispies squares.
Europe's profit decline in the quarter was related to the timing of costs and promotional investments. So is another very solid quarter for Europe .
Let's turn to Latin America, which posted another quarter of net sales growth as shown on slide number 20.
Keep in mind that there was a small divestiture impact on this region as we did offer most of the now divested brands in Puerto Rico.
On an organic basis Kellogg Latin America posted net sales growth of nearly 6% year on year in Q3, despite lapping a double digit gain in the year earlier quarter.
In Mexico, we continued to post good topline growth momentum led by continued consumption growth in cereal and lapping year ago acceleration. Additionally, we grew consumption and share in wholesome snacks and posted double digit consumption growth in pringles.
We also grew in Mercosur, despite continuing to have to work through challenging macroeconomic conditions in Argentina, and cereal and biscuit category softness in Brazil.
We continue to perform well in the marketplace and we continue to realized price.
We also continue to build a future for pringles in Brazil, starting up local production for the first time and ramping up distribution through a new distributor.
This created some extra cost in the quarter, but we'll make it will make us that much more competitive going forward.
Latin Americas operating profit was pressured by the startup costs as well, our as higher input costs and adverse transactional foreign exchange, but also by lapping a notably strong profit growth in the year ago quarter. So despite a challenging environment. We continue to feel good about our business in Latin America.
Finally, our Asia Pacific Middle East in Africa business is shown on slide number 21.
EMEA remained our fastest growing region in Q3 with net sales growth of nearly 8% year on year.
The chart on the slide is intended to show you the relative sizes of our three major category groups.
And as you can see we grew in all three in the quarter just as we have year to date.
In cereal growth was led by Asia in the Middle East North African Turkey sub region.
Noodles and other is concentrated in Africa, where we continue to grow strongly.
Multi pros growth is driven not only by noodles, but also growth in other products. It distributes in West Africa.
In addition, we continue to expand distribution for Kellogg's branded noodles elsewhere in the continent in.
In snacks growth continued as pringles maintained its momentum continuing to show strong consumption and share growth across the region with gains in markets, ranging from Australia, and South Korea to Saudi Arabia and India.
Operating profit in the quarter was aided by the reversal of an accrual related to an excise tax matter that has been settled yet.
Yet even without that we are delivering double digit growth this year.
So EMEA continues to be a very exciting region for us.
Let's wrap up with a brief summary on slide number 23.
We're doing what we said we would do.
We're taking bold decisive actions for the long term health of the business.
We've returned to topline growth and we're now focusing and addressing our profit margins.
We told you that 2018, and 2019 would be an investor grow period for us as we implemented changes and invested behind our brands and capabilities under our deploy for growth strategy.
Through Q3, we clearly remain on strategy.
We have continued to shape our portfolio toward growth closing on an important divestiture and continuing to build emerging market scale.
We have continued to enhance our competitiveness through targeting new occasions, revitalizing world class brands, and improving service and in store execution.
We've continued to build capabilities, notably in revenue growth management innovation digital media and E Commerce, and we've realigned our organization for greater agility.
And yet through all of this change we remain on plan.
Organic net sales growth is on track for full year guidance and our best performance in many years operating profit is on track for full year guidance with margins continuing to gradually come back.
Earnings per share our toward the favorable end of our guidance range and cash flow is on track for full year guidance.
As always I'd really like to thank our employees for their dedication and hard work and bringing about all of this change while still delivering on our financial commitments are people truly our competitive advantage and with that operator, we'll now open it up for questions.
Thank you Sir we'll now begin the question answer session.
Yes. Good question you May proceed Star then one on the Touchtone phone.
Using this speakerphone, please pick up Brad said before presently keys that from the time request and has been adjusted we'd like to drive. Your question. Please press Star then to again as a courtesy. Please ask that you limit yourself to one question during the Q and a session.
At this time, we'll just pause momentarily to assemble roster.
And the first question will come from Jason English.
Goldman Sachs. Please go ahead.
Hey, good morning folks thank you for slot machine.
I guess my first question is on is on cereal is as you mentioned in your slides. This was the year to see some gradual improvement and we havent seen it.
It's we've we've kind of seen erosion is instead.
As you think about the forward can you give us more context in terms of the activation plans you have to improve your market share performance.
And do the reported organic sales are surprisingly softer than what we're seeing in Nielsen on a fairly consistent basis.
Is this the results of maybe you under shipping consumption due to inventory drawdown of the trade or is there weakness in non measured channels that we're not seeing in scan data.
Yes, good morning, Jason Thanks for the question a couple of things.
Clearly and I hope I articulated this well cereal in the United States is job number one in terms of what we have not delivered relative to our performance across the board and so it's obviously a priority we underwent as you know a huge pack harmonization in Q1 in Q2 and even into Q3.
And as I said, we're seeing some return to better performance in our.
Taste and fun for you segment and you can see that in the Nielsen.
A better performance, not where we want to be but modest share gains where we have not yet seen is in the infant.
Special K and for us in many weeks mini wheats in particular, which underwent a later pack harmonization and so theres a couple of reasons for that one reason is the.
Delay of investment around Frost in many ways mini wheats more into the fourth quarter based on coming out of the pack harmonization, a little late and not really having the capacity necessary. So thats one.
And number two is just really making sure that we get the pack harmonization through before we reinvest in the category. So we're not where we want to be but we're getting.
Getting more green shoots showing in if you look at even the latest four weeks look for weeks is not a trend, but the latest Nielsen or IRI data. That's been published shows some of the best performance in the year across the broad cereal portfolio actually actually gaining share through the October 19th report.
So we are seeing some modest improvements more than modest compared to where we had been based on the activities in the marketplace. So we're optimistic that we have the right plan as we go into Q4 and into 2020. The other part of your question around.
Timing shipments and so forth a lot of that has to do with obviously promotional changes and the pack size harmonization and as we always say you know theres always going to be a difference between timing of shipments and consumption, we'd always prefer to be obviously on draw driving consumption and having consumption that.
Ed.
Over time retailers and suppliers are only going to get more efficient. It's in everybody's best interest always improve against inventory, bringing inventory down modestly that works for everybody in terms of working capital in terms of freshness of product in terms of just overall efficiencies in the supply chain. So I don't think we're seeing anything more than that.
We're pleased that consumption is ahead relative to to shipments at this point, but we don't see any overarching theme there.
Okay. That's that's helpful. One more question I'll pass it on I think it was it was Amit who mentioned in prepared remarks that with the topline now back to what you guys. You sustainable growth focus is now shifting on restoring profitability I was hoping you could delve in a little bit more on the drivers of that clearly we've seen gross margin erosion, but from an absolute.
Aspect of your gross margins are still.
Reasonably healthy levels, it's the overhead part of European now that looks looks heavy in context of most your other peers.
Is there is there a structural reason why you think your overhead should be so high or is that an area that in focus as you think about that restoration of profitability.
Yes, Jason I'll start and then turn it over to Ahmed just it's important to note from a gross margin perspective, we are not where we want to be we want to continue to drive that we're very pleased that we're seeing sequential improvement based on the activities that we put in place from an overall overhead standpoint, we've seen good improvements in terms of bringing the overheads down.
When you look at our portfolio relative to others. We don't have a lot. We don't really have any commodity type businesses that don't require brand building. So some of our peers do have those types of commodity.
Businesses in their base, which again, we changed the comparative.
But overall I'd say, we're driving towards better margin performance. We're pleased to see the sequential but we know we still have work to do.
I think you covered it Steve I think the only couple of other points I'd make as we were pleased with the progress that we are making in gross margin both sequentially Europe versus year ago, but also quarter on quarter. So I think if you look at all quarter three absolute gross margin. It's growing 110 basis points was where we were in the previous quarter and obviously, that's going to be a focus area going for.
I would I think the only other thing I'd say on order. It is a scale in emerging markets as we continue to build scale in emerging markets.
That is certainly help us.
From a scale and overhead standpoint in those markets.
Okay. Thank you guys I'll pass on.
Next we have Ken Zaslow of bank of Montreal.
Good morning, everyone.
Good morning America.
What are the comments you said starting through the.
Introductory comments was that you flattening out organizational structure can you talk about what exactly have you done and can you give some anecdotes of how thats actually either change the way you operate or has done something strategically to kind of give it a directional change of how thats actually impacting the outlook.
Yes. Thanks for the question Ken the Big organizational changes, we've made had been in North America and in Europe , and if you think back to the past we had different business units really fully staffed business units focused on snacks focused on morning foods focused on frozen across different categories in what we've done it.
As we've combined into one portfolio, one kellogg portfolio, which allows for a much better resource allocation across you don't have.
Frozen competing with snacks competing with morning foods for investment you have.
Ahead of categories, who is looking across the totality of the portfolio to say where am I getting the best return on investments with Smith, the most strategic areas for us to invest in and driving better decision, making because of that as well as a lighter more nimble organization. You also have a sales organization that is much easier to understand.
From a perspective, so you don't have somebody coming in selling snacks, followed by another person coming in selling morning Foods, you have somebody representing the totality of Kellogg both at the headquarter level and at the store level, which is not only more efficient but also more effective. So it's it's really in that sweet spot of being efficiency and effective.
This together and by and large that's the same.
Focus that we brought to Europe as well so it's about driving better resource allocation better investment decisions faster more nimble decision, making and we're seeing it happening in the marketplace and we're seeing we're seeing that come through and better decision, making faster decision, making some of the best innovation, we brought to bear in the margin.
Place this year I think is a direct.
Output of some of the changes that we've made.
Great. Thank you very much.
Thank you.
Next we have Robert Moskow of credit Suisse.
Hi, Thank you.
One of the things I wanted clarification on in the prepared remarks is I think you said the impact of the divestiture would be less severe in 2019 than you thought, but then it would shift into 2020.
I'm. It can you help us understand like why that timing is happening and and then again.
If it's a little better than you thought.
What are you doing would that upside you said, you're reinvesting it for Brexit and maybe for other reinvestment spending is that correct.
Yes, So let me just start with the divestiture impact right. So I think you know as we've got greater visibility on the transition services.
As we've got no firmed up our plans around stranded costs.
I think we've got just a minimal clarity around the phasing of how this will play out.
So you know it's not a significant shift I think we we had guided to minus four to minus five I think you're now saying that given the visibility that we now have three month into the process.
We think it's probably going to be minus minus four.
And I think it on that 1%, we think would probably shift into into next dealer.
I think another shift into next deal is again really driven by transition services that we expect now to be longer than what we had initially thought so you know thats going to.
Drag into 2020, and then related to that would be when you can extract the stranded costs that goes into the two are obviously link.
And so I think it's really that timing and that clarity on visibility on the timing.
That's that's close the shift between the two iOS.
And I think in terms of.
I think in terms of investments again, given this is not a major shift I think it as we head into quarter four a little bit of shipped in investments from quarter three into quarter. Four is what we're looking at.
And then one follow up.
With SGN a.
Down excluding the divestiture in the quarter because I think you described it as an investment quarter, but it's kind of hard to tease that out with the divestiture.
Yes, so as she had a was down and I think it like I mentioned in my in my prepared comments right. It was a couple of things. One is the benefits that we are getting from the organizational restructuring you know dating back to the started the year.
So that was one driver.
And then the second driver was we were lapping the exception or double digit increase in brand building that we had in quarter three 2000.
80.
Okay. Thank you.
Thanks.
Our next Swift, Ken Goldman of JP Morgan.
Hi, Thank you.
Two for me.
First Steve I think you mentioned, eliminating some underperforming skews in cereal, there's been some I guess industry chatter about the impact of click and collect and delivery on grocery shelf sets and.
That I mean, some retailers have been leaning toward giving facings are bigger facing Susan high velocity items were moving facings from lower velocity items and as sort of accelerated rate I just wanted to know and poke around a little bit is your skew rat does that in any way related to that trend or is this more normal course of businesses at them I don't want to make sure they get deal out of that.
Yes. Thanks for the question, it's not related to that so as the normal course of you know flavors that are underperforming being replaced by new innovations, we haven't seen literally any real change in total points of distribution. So I would say just normal course of business.
Except for obviously that price package harmonization, which was not normal course of business, but in terms of skew ride more normal yes, okay. Perfect. Thank you and then.
I guess my follow up is I know, you're not ready that really talk about 2020.
In any detail, but there were couple of comments made today that I want to make sure I heard correctly, and so sounds a bit sable asked a little bit longer than you thought sounds like stranded costs will still be headwind for next year as expected, but you did caution a little bit about Brexit and maybe some more investments to.
Are you trying to send a signal to investors and hey, there's some really good things happening into next year in terms of sales and margins on the core of level, but there's some other things that maybe Mike.
Hold back at least temporarily some of the growth on the bottom line.
Sort of the messages that we're trying to take away from here or is that am again reading that a little bit too much.
I'd say don't read too much into account I think you know, let's start with Brexit I mean, clearly every day, there's new news in the marketplace and it's hard to determine exactly what if anything will happen. So we've been we've been cautious in terms of that we don't know any better than anybody else exactly what what may or may not happen in.
In terms of investment opportunities, we're saying look we're on strategy. We're on plan, we're very pleased with where we're seeing the the portfolio shape up outside of US cereal. If we had the flexibility can give us a flexibility to make some investments in quarter four.
We will strive to do that to put us in the best Pos possible position to continue to drive the momentum that we have in the topline and so just very much on plan and if we have an opportunity to again continue to invest for the long term then we'll look to do that but I wouldn't I wouldn't read much more than that into it.
Great. Thanks, so much.
Next we have Steve Strycula.
Yes.
Hi, good morning.
Two strategy questions. The first would be on revenue management, Steve as you look across the portfolio. How do you think about which categories in which regions had the most runway here more more companies talking about that being an increasingly important lever to drive price mix, especially as a commodity that kind of flattens out and then I've a follow up.
Yes, Steve Thanks for the question I wouldn't say really that revenue growth management by category has.
More opportunities in one category were another category, we're obviously focused on our big categories and our big geographies and so you think about cereal you thinking about snacks, you thinking about frozen in North America, and driving AARGM activity and progress. There do you think about snacks and cereal in Europe being another big area and focused on develop.
Markets first before we think about emerging markets emerging markets were obviously very very laser focused on our strategy of the affordability pyramid and thinking about making sure. We have locally relevant foods that are affordable for the local populations is the way, we think about kind of broader AARGM strategy, there and and develop.
Markets more sophisticated modern trade approach to it we're pleased with the progress we're making we're striving towards always driving a better balance between volume and price mix. We're pleased with the type of price mix, we've been able to drive this year, particularly relative to the last several years, but we're.
Working towards really driving a better balance and always having a volume component as well as a price mix component that's in the black.
Steve to follow up there how do we think about that particularly North America price mix volume balance.
Transition as we think over the next few quarters and then on the snacking piece you've done a very nice job. There how do we think about as you look for inorganic opportunities to build it out further.
Where is your top priorities as a doubling down on the us market is looking to.
New emerging markets, where you don't have a footprint or actually building out more of a bulk head in some emerging markets where you.
Have like a half position footprint. Thank you.
Yes, so I'd say in terms of the developed markets its balance as I said trying to find the right balance in seeking the right balance between volume and price mix is always important for the long term and so that's that's what we seek to do there in terms of.
Inorganic nothing's really changed from what we've said if we find the opportunity to find a great business in a white space in snacking in better for you in developed markets that could be interesting scale in emerging markets is very interesting for us. We're very pleased with the investments we've made in parity.
In Multipro in do full and so those those are a good kind of template to think about the way, we think about opportunities inorganically for us it beyond that obviously I wouldn't want to single signal anymore.
Alright, thank you.
We have Nik Modi of RBC.
Thanks, Good morning, everyone. Just two quick ones for me.
On that maybe you can just talk about the commodity cost environment from Kellogg point of view I'm talking about you know, obviously, we dropped conditions Australia, leading.
Let's take price increase if anything on the horizon that we should be thinking about and then you are you just thinking about the European.
Thats material and how will they start progressed nicely and move into that entity in Pablo almost positive territory any learnings from that market and you can apply or you think a relevant from U.S. market. Thanks.
So maybe I'll just start with though with your question on commodities, obviously, they're not getting into two anybody guidance on this call, but if you kind of look at where current input prices are on spot rates.
We should be looking at little less inflation.
In the next year compared to 2019 2019 as you know we saw mid single digit inflation year on year.
So compared to that we should probably be seeing.
Lesser inflation as we look at 2020 based on where spot markets, though.
Yeah, and Nick and in terms of Europe , as a bellwether and an area to learn from it clearly is that the European cereal business from a category standpoint is returned to growth and we are growing faster than the category, especially in quarter three in the UK, where we saw some some very nice.
Acceleration led by Crunchy nut and Chaco Pops.
And the learnings there are definitely applicable.
White chocolate Chaco Pops was a huge hit they've also got some commercial programs and innovations that have been very successful that the U.S. team is studying for relevance in the United States Special K actually showing good improvement in.
In Europe and in the United Kingdom really focused on the food food being the hero and some of that learnings being applied as as I said, even if you look at special K in the most recent data available some of the stuff that we brought over from the UK and the learnings into focus on food.
Is giving us reasons for cautious optimism. So I think broadly speaking the fact that Europe is in the type of growth. It is in cereal is an inspiration for us and there is definitely some learning that can be applied to the U.S., but we've got work to do in the us in terms of Sarah we know that were on it.
And when we get that to where we know we can get it I think the rest of the portfolio really shines through.
Thanks, so much.
Thanks, Michael Lavery of Piper Jaffray.
Good morning, Thank you.
Werent wanting me Michael.
Can you give a little bit more color on your implied Fourq you outlook you you've said things have been on plan. So far you are obviously holding guidance, but it looks like that would likely imply a sequential deceleration in organic EBIT growth, maybe down a point or two you mentioned some of the spending shifts can you touch on maybe the magnitude of that.
And you mentioned Brexit as a risk it looks like that could slide to next year. What are your assumptions baked in for Fourq you as it is and maybe the last piece is just as you've talked about some of the centralized packing for the on the Gopac's in Threeq you how much was that ramping and should we expect more of a benefit in fourq.
Can you just help us put all that together.
Yeah, I'll start Michael and it will add as well, obviously, we don't give quarterly guidance and we reaffirmed everything we talked about for full year and so you can you can obviously do the math from there in terms of Brexit areas that we don't know what if anything that will bring and when it will bring we're preparing as best we possibly can.
And.
But there is an array of different.
Potential outcomes, there and we like everybody else are watching in terms of our on the gopac formats, and bringing things in house were making good progress there.
And Thats one of the drivers be tied behind our sequential gross margin expansion. So we'll continue to do that.
And then beyond that I wouldn't signal anything about next year again, it's too early to talk about 2020 guidance and we like where we are in terms of on strategy on plan. We're looking to do the same type of.
Drive the same type of performance in Q4, and we'll be talking about Q4 results in February will give you a better outlook on exactly the way we're thinking about 2020.
I think the only other thing I'd add is just the divestiture impact.
Quarter, three we had two months of impact in quarter four we like the fourth quarter of impact. So you know in quarter three and as we have the divestiture impact was about four percentage points on and as we in about five percentage points on Ob given we've got three month in quarter. Four Oh is it will be around 5% on as we add an open.
It would be around 8% to 9% so I think thats.
The impact of the divestiture will be more pronounced.
As we have three months of that in quarter four.
I think that Steve mentioned earlier, we'd also look.
To see.
If we could make some investments behind us growth opportunities should we should we have the opportunity to do so.
Okay, great. Thank you very much.
Next we have Laurent grandet of Guggenheim.
Yes, good morning, everyone.
Two questions actually the first one is I mean seat on the guidance I mean.
You are stronger margin in the quarter and delivering your beat on EPS. In addition to you lower your tax rate guidance for the year on despite all those positive you'd just hedges modesty your EPS guidance for the year. So could you. Please help us recon side I mean.
As it may prove in your guidance is a bit conservative.
Second question is really more on on the North American frozen food and Morningstar farms specifically.
Lots of interest for some fee on from base Burger or me tell tentative Jerome.
Could you. Please let us know are you are planning to compete against rather new entrants like imposed seaborne or or beyond into category.
Leverage your scale, especially in the out of home consumption.
Yes, Thanks learned I wouldn't I would just be repeating in terms of quarter for guidance. We're pleased about where we are on strategy on plan you look at where our sales is and we want to continue to maintain that type of momentum, which gets us exactly in the 1% to 2% as we guided towards and.
As both Almond and I mentioned, if we have an opportunity to invest in quarter four we'd be looking to do that and so that's that's kind of where we stand in terms of the full year outlook in terms of the frozen business and in particular.
You know our Morningstar farms business, we believe we have a competitive advantage for several reasons number one we've got a very complete portfolio. We've got frozen we're going to introduce refrigerated in the first quarter of 2020, and we even have an ambient offering in our leaf jerky that were.
We're in test right now that we're optimistic about the potential there. So a full on complete portfolio. We have the scale that is kellogg from a manufacturing standpoint from a sales standpoint from an R&D standpoint.
I've been trying our food on a very regular basis that we're going to introduce in the first quarter and I am very.
Pleased with the food and very proud of our.
One of our R&D team that is really created at best in class a refrigerated offering that we're very excited to be launching we've had a number of customers trying that as well and so as I look at the totality of what we bring Morningstar farms. The brand heritage. The tradition, the insights that we have the complete portfolio that we have.
I have the poultry offerings, which continued do extremely well I think we've got a real gem in our portfolio and you'll you'll see more of that come through and I guess I would just end with the fact that even without the refrigerated offering be in them being in the market yet you're seeing a real acceleration as we talked about in our in our vision business Morningstar.
Consumption was up nearly 11% in quarter, three gaining 120 basis points a share. So we're very pleased with the team at what they've accomplished and believe that the best days for that business are clearly in front of us.
Operator, we are at 10 30, so we're going to have to wrap it up but thanks, everyone for your interest and please call. If you have any other questions.
And we thank you Sir to the rest of the management team for your top also this morning again. The conference call is now concluded at this time you may disconnect. Your lines. Thank you again, everyone take care and have a wonderful day.
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