Q2 2020 Kellogg Co Earnings Call
Hello.
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Now with Kellogg feeding reading program when you buy a box you can get a free book turning boxes into book over 1 million and counting just bye-bye and you can get a book and turn your favorite food into new favorite stories.
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[laughter] in America, New Kid, who live with hunger Blacksburg, it's time to turn.
In childhood hunger for good Kellogg's is teaming up with no Kid hungry and food network, how things to provide meals to nearly 1 million kids. So they can start their day with a good bracken.
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And you can make a bigger impact look for specially marked packs to learn how you can join the fight turn up or better days presented by Kellogg a brighter future starts with breakfast.
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Hello.
Now with Kellogg feeding reading program when you buy a box you can get a free book turning boxes into book over 1 million and counting just by Abad and you can get a book and turn your favorite food into new favorite stories.
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No.
Lever on really never go.
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Hi.
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Yes in America, New Kids live with hunger Blacksburg, it's time to turn on and I'm childhood hunger for good Kellogg's is teaming up with no Kid hungry and food network housing to provide meals to nearly 1 million Kid. So they can start their day like a good bracken.
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And you can make a bigger impact most for specially marked packs to learn how you can join the fight turn up or better days presented by Kellogg a brighter future breakfast.
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And a little fun.
With rice Krispies.
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I'm glad Hello, and do it Oh fellow graduates and congratulations incurring graduation.
I know the feature we only a wellness airplanes. They can you break.
Great.
Well, leaving ourselves.
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Okay. Thank you for teaching thanks, working down that she was really hard Boeing.
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Turning welcome to the Kellogg company's second quarter 2020 earnings call.
All lines have been placed on mute to prevent any background noise.
After the speaker's remarks, there will be a question and answer session.
If you would like to ask a question. During this time simply please press star and the number one on your telephone keypad.
Please limit yourself to one question during the Q a nice session. Thank you.
Please note this event is being recorded.
At this time I will turn call over to John Renwick, Vice President of Investor Relations and corporate planning for Kellogg Company Mr. Renwick, you may begin your conference call.
Thank you Gary Good morning, and thank you for joining us today for a review of our second quarter results as wells updates regarding our outlook for 2020 I'm joined this morning by Steve Caitlin, our chairman and CEO and Amit Banati, our Chief Financial Officer.
Slide number three shows our forward looking statements disclaimer as you are aware certain statements made today, such as projections for Kellogg company's future performance or 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 to the press.
Isn't station as well as to our public SEC filings.
This is of particular note during the current Kobin 19 pandemic when the length and severity the crisis and resultant economic and business impacts are so difficult to predict.
A replay of todays conference call will be available by phone through Thursday August six the call will also be available via webcast, which will be archived for at least 90 days on the investor page of Kellogg Company Dot com.
As always when referring to our results and 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 and earnings per share and I will turn it over to Steve.
Thanks, John and good morning, everyone. [laughter]. These are certainly unusual and troubling times depend nemec drags on the cases rising again in many states in countries that it just begun to reopen and recent events around racial injustices have only added to an environment that is both uncertain worrisome it goes without saying that these crises.
Touches on some way and our Hearts go out individuals and families that have been directly affected and we certainly hope you and your families and friends are staying safe.
As a company with heart and soul and has been very important for us to maintain ongoing communication with our stakeholders about what we're doing to keep each other safe how we continue to supply our markets with food and how we're giving back to our communities. We've also worked to increase our open dialogue about diversity and inclusion, which we deem to be inherent in our company's value.
Yes. This is included stepped up actions like incremental donations to the NAACP town halls, and testimonials by employees professors and authors and we will continue to do so.
So we are certainly operating in unprecedented times and from our employees on the front lines in our plants and distribution centers and now back in stores to our employees working from their homes. This organization has come together and rally to the occasion like nothing I've ever seen before.
From a business perfect perspective, turning to slide number five we're managing well through the crisis. Our number one priority of course has been keeping our employees and their families safe as best as we can.
We've talked previously about the investments and process changes, we've made and we will remain vigilant to protect our people.
We told you that we feel we have an incredible responsibility in supplying food. During this time I'm happy to report that we've experienced no major supply disruptions and managed to increase our production and keep up or service levels in spite of higher than expected demand in many markets. We continue to aid our communities to volunteer hours and through what is now nearly 15.
Million dollars in cash in food donations do we made since this crisis began these are our priorities during the crisis and we're executing well against them.
Turning to slide number six it was in the usual quarter to say the least in addition to executing against our crisis priorities. We again delivered exceptional results in the second quarter, even amidst a very uncertain environment and new unusual ways of working.
Our net sales came in much higher than expected, we'd assume that at home consumption growth would decelerate meaningfully during the second quarter, but with prolong prices it held up higher and for longer than we had forecast and in some of our categories retailers were able to catch up to demand and rebuild inventory. Meanwhile, declines in away from home channels persisted and our emerging.
Markets did not slow down as much as we had expected given kobin disruptions and recessionary conditions. We also generated higher than expected operating profit the higher than projected volume ranch, where we'll utilize plants driving strong operating leverage this more than offset significant incremental kobin related costs in the quarter mainly.
Around safety employee benefits temporary labor and logistics. The net of this was an unusually large increases in gross profit.
Our operating profit also received a temporary boost from the deferral of various investments, we again shifted brand building investment in the second half, particularly investment in activities that we tied to canceled or delayed sporting events movie releases and innovation launches. We also shifted some overhead in capital investment to the second half as a result, we've seen.
And even larger shift of the years operating profit into the first half it's important to recognize that we also executed well and there are clear signs that our underlying business is in good shape. For instance, we continue to increase household penetration aided by our ability to get food into the market and to adjust our brand communication there is trial.
Repeat and reappraisal, they can benefit us long after the crisis finally passes.
There are signs of execution include our improved category share performance, including some brands that we had been revitalizing through fresh brand messaging and our supply chain is operating well gradually improving our service levels emit unusually challenging circumstances. All of these contributed to an outsized financial delivery in Q2.
So let's discuss what this means for full year turning to slide number seven.
We recognized that many companies have refrain from giving guidance in its uncertain environment and we can understand why there are a number of variables that are extremely uncertain right. Now. So today, we're going to offer you are planning stands for the second half and how we're approaching some of these variables and we're raising our full year guidance to reflect our over delivery.
In the first half.
From a net sales standpoint, our increased full year outlook reflects the strong growth we delivered in the first half as well as a slightly improve topline outlook for the second half, we won't get more aggressive than that because too many variables are simply too uncertain.
From a profit in earnings standpoint, we do know that or second half profit will be weighted down by investment. Most of this increase second half investment is simply shifted from the first and second quarters. The result of focusing on supply and postponing promotional activity tied to canceled event specifically in the second half we plan to return to full commercial.
Programming and to completely invest our full year brand building budget.
Again, there are many unique assumptions that we have to make in formulating and outlook right now the length in severity of the cobot crisis and related economic recession is not notable but on that will walk you through our key planning assumptions in a moment.
Suffice it to say, we feel very good about having a front weighted profit delivery this year and a strengthened commercial plan for the second half so with that let me turn it over to arm. It will take you through our financial results and outlook in more detail.
Thank you, Steve and good morning, everyone.
Let's start with slide number nine I know reminder of a financial approach during the crisis.
Employee safety is the top priority and we will continue to invest in this area in safety supplies temperature checks, an incremental cleaning protocols as well as information technology to facilitate working remotely.
To supply the market, but food we've continued to focus production on priorities skews utilize temporary label win where necessary and reward our frontline logos with bonuses and benefits. We've also invested in logistics to get food, while customers as quickly as possible.
We've continued to Entcho financial flexibility, which is particularly important in this environment of economic recession and wallet died financial markets.
Our cash flow has been very strong, enabling us to carry higher than usual cash balances and shows strong liquidity and reduce debt leverage.
We remain committed to investing in the future as Steve mentioned, the crisis led us to defer some commercial activity and investments to the second off and we plan to execute not only those shifted investments, but also incremental investments that can be funded by our strong first half earnings and cash flow.
So this is the context in which we view our financial results and outlook.
Slide number Dan summarizes our results for the second quarter and first off as Steve mentioned these strong results reflect good execution in an unprecedented environment.
That really what do big factors that exceeded our expectations for the quarter.
At home consumption in developed markets did decelerate through the quarter, but not nearly as quickly as we had anticipated back in April, particularly as we improved our share performance in key markets and Guy degrees.
And second I emerging markets did slow amidst lockdowns, an economic slowdowns, but we manage through them well and they did not slow by as much as we had expected.
I'm a margin perspective, the better than expected volume and very strong supply chain execution resulted in greater operating leverage than expected more than offsetting higher incremental corporate costs, which obama amounted to more than 20 million in quarter two.
Sizable increase from quarter one.
We also found ourselves having to delay mold brand investment into the second half than previously anticipated.
Acting with agility to shift plans due to both sporting events and supply constraints.
These were the key underlying drivers into Florida.
On a double that of course was the mechanical impact of last year's divestiture.
The absence of those businesses results negatively impacted organic net sales by approximately 6% in quarter, two and about 8% year to date.
It's negative impact on adjusted basis operating profit was more than 8% in quarter, two and 10% year to date.
We lap the divestiture. This week, so we'd have only one month impact in quarter three.
Below operating profit, we continue to pry rise debt reduction, making no share buybacks in the quarter and reducing our interest expense on lower net Derek.
Other income benefited from changes to sodas pension funds in the quarter. So this was offset by higher than projected effective tax rate.
There is out of all of these is an earnings per share and cash flow that again came in ahead of pace.
Taking into a little more do you didn't let's look at net sales growth and slide number 11.
Organic basis net sales growth was 9% you're on your in the quarter slightly higher then I'll first quarter growth.
This organic growth was again driven by volume, reflecting the pandemic related demand, which I'd up higher and for longer than expected.
Our price mix was modestly negative in the quarter wait to category and country mix.
Once again organic net sales growth was across all four regions and across all four global Guy degree groups snacks. So you do frozen foods a noodles another.
The divestiture impact in quarter two reflects the absence of those businesses in quarter three will have only one month of impact translating into approximately negative 2% of net sales.
Currency will that was in quarter two owing to the dollar strengthening against key currencies back in March.
Now, let's turn to profit margins on slide number 12.
As we've discussed previously our goal. This year was you finished twentytwenty at a stable level you're on your on gross profit margin.
Obviously, the surge in at home demand and the result, and operating leverage has moved this plan from being a gradual improvement across the yield to being a front weighted plan.
During quarter, two we saw a substantial you're on your increase in gross margin, reflecting not only operating leverage from higher volume, but also a moderation of what had been up meaningfully negative margin mix trend towards emerging markets.
In the pandemic affected second quarter emerging markets actually grew less than developed markets in a moment I'll discuss why we view this large quarter to gain that's temporary but this run rated performance does offer increased confidence in our full year outlook for gross profit margin at the operating profit margin.
The improvement was also substantial in quarter, two and also mostly timing related I.
As we've discussed previously a good portion of our brand building investment had to be shifted to the second half, particularly investment that will start to external events or innovation launches that have been postpone.
Yeah, repo, putting that investment into brand activities in the second half.
Let's discuss cash flow and capital structure on slide number toting a.
Cash flow continue to be strong in quarter, two up significantly on you.
This brings our year to date cash flow the more than $750 million, our strongest both outperformance in euros, even despite the absence of businesses, we divested last July.
This is timing awnings upfront of wagered this deal with significant investment delayed due the second half.
And as we did not want to disrupt our supply chain during the first off.
Capital expenditure is weighted to the second half as well.
However, this strong yield on your performance also reflects continued strong working capital management and reduce cash outlays related to restructurings.
The next chart on the slide shows on net debt position.
Combination of last year's divestiture proceeds and strong year to date cash flow have enabled us to pay down debt you're on your and carry higher than usual cash balances around the world in fact at quarter end, our cash position was again or a billion dollars a bond offering and may was very successful.
Indicating confidence in our balance sheet and cash flow and resulting in low interest rates.
Our liquidity is excellent in addition to our high cash balances, we did gain access to commercial paper and we have two and a half billion dollars of unused backup facilities, we're taking a proactive approach to financial flexibility in an uncertain operating environment and we feel good about our liquidity and balance sheet.
Going into the second half.
Let's now discuss our rest of your outlook, starting with slide number 14.
Obviously this is the time of tremendous uncertainty and Marianne variables can you a wide range of outcomes.
We want to give you visibility into the assumptions around which we are planning for the second off specifically related to the pandemic and investment plans.
We plan for net sales growth to slow in the second half.
We assume that at all demand in developed market.
Continue to decelerate week to week two quarter three.
Outlook still considered the likelihood of prolonged softness in our away from home channels, including channels like travel and lodging that may take longer to stabilize unreliable and we assume that emerging markets businesses will continue to feel the impact of covered just.
And economic recession in the second off.
Next we view much of our outside Q2 improvement in gross profit margin to be temporary.
As we enter the second half we lapped the divestiture, so that particularly if you're on your benefit obviously goes away.
We also assume that we'll have less operating leverage in the second off as volumes slows and be lab Dom plant related changeovers as we resumed production of paused skews.
We sustain much of the direct go it costs, particularly around safety and cleaning and we will have less productivity savings this year due to delays in capital investments during the crisis.
The result is youre on your pressure on gross margin in the second half.
And finally, we will execute a substantial year on year, increasing investment in brands and capabilities. There is principally the advertising and promotion investment that shifted out of the first half and into the second half and on top of that there is also some incremental investment.
In addition, there is incremental oil and capital that reflects our desire to invest behind capabilities.
Simply board, we're taking the profit upside we realized in the first off and putting it to go to use investments for future growth in categories that just got more exciting.
So this is how we're viewing the crisis from a financial perspective in the second off.
Again as I'm sure you can appreciate it's hard to say how the crisis will play out well. These are the assumptions we are planning around at this time.
Now, let's put it all together and look at our full year guidance shown on slide number 15.
As Steve mentioned, we're raising our guidance for the yield.
Based on our second half planning assumptions, we now expect to finish twentytwenty with organic net sales growth of around 5%.
This implies a modest improvement to our previous growth forecast, but the second off and a substantial increase to our full year guidance.
We now expect currency neutral adjusted operating profit declined by only about 1%, which is about three percentage points better than our previous guidance and still includes roughly six percentage points of negative impact from our divestiture.
This improved profit picture reflects a sizable growth in the first off partially offset by shifted an incremental investments coming into the second off.
This increase in investment will weigh down operating profit in quarter three in particular.
Our outlook for currency neutral adjusted earnings per share also improves meaningfully to a yard on your decline of only about 1%.
Despite a negative impact of about 5% from the divestiture.
This is raised EPS guidance is driven by the increased outlook for operating profit.
Below operating profit.
The income line benefits from quarter to favorable pension changes, but this should be roughly offset by an increase tax rate owing to some unfavorable tax items recognized in quarter, two which will put us closer to our 22.5% rate for you.
Cash flow is now forgot about a billion dollars the high end of our previous guidance range.
This improvement reflects our rates earnings outlook, partially offset by increased capital expenditure as we invest for the future.
As I said this is our planning stance, yes, there could be upside if at home consumption remains more elevated than we have assumed however that could also be downside if emerging markets feed greater pressure from recessionary impacts or if we sell for on anticipated supply chain.
Disruptions related to the pandemic.
We think this is an appropriate planning stance and we're pleased to be able to raise guidance, while also investing more for the future.
And with that let me turn it back to Steve for a review of each of our major businesses. Thanks, gentlemen, I'll now to our normal walk through the region's even keeping in mind the uniqueness of the current environment and therefore, the timing related benefits to sales and operating profit we saw good underlying execution and performance in all of our regions and all four.
The global category groups, let's begin with North America, and slide number 17, we've had a strong quarter in first half of 2020 as a pandemic is lifted demand for at home consumption. The result was organic net sales growth of 11% in quarter, two which turned out to be even higher than our 6% growth in quarter. One this ella.
They did consumption was most pronounced in meal oriented categories, which for us is cereal frozen breakfast and frozen veggie foods reversing what happened in quarter, one shipment growth in quarter, two to retail channels exceeded consumption growth mainly in cereal, suggesting replenishment of retailers inventory. We were also rebuilding our own inventory.
Worry during quarter, two helping us to improve our service levels and adding to an unusually large margin benefit from operating leverage in the quarter. This too has a timing element to it not surprisingly our away from home business declined sharply in quarter, two though we managed it well we've mitigated sales declines in the schools channel by shift.
I think toward emergency feeding programs and our declines and convenience stores have begun to moderate that said our sales into restaurants remain down sharply and we're seeing our sharp declines in vending and travel lodging with the latter likely to remain soft for some time in Canada, we recorded double digit organic net sales growth led by elevated consumption growth.
In cereal and frozen breakfast and veggie foods as well as our expansion of Cheez. It importantly, we gained share in four of our six main categories. There North America's profit growth was notably strong in quarter two and this reflects the unusually high operating leverage and a shift of investment to the second half.
Let's take a look at each of our three major category groupings in North America, starting with our largest snacks on slide number 18. This is the business affected by the divestiture, but on an organic basis. It had another good quarter with net sales increasing 6% year on year.
Our crackers consumption in the U.S. increased by almost 9% in quarter, two gaining share of the category.
Is it continued to grow at a double digit rate and we also saw share gains by our club and cars brands, reflecting their orientation toward at home occasions, as a company men crackers and salty snacks Pringles grew consumption by almost 12% modestly trailing the category because the declines in immediate consumption pack formats.
The brands core four flavors collectively grew in line with the category.
In portable wholesome snacks, we've gained share behind double digit growth in pop tarts and continued growth in rice Krispies treats these brands are more than offsetting softness in the overall category, which has been declining because of the on the go nature of so many of its products for US. This has included Rx bar as we move to the second half we expect to see.
Moderating at home consumption growth against tougher year ago comparisons, but with the resumption of commercial programming and investment.
Now, let's turn to North America, cereal and slide number 19.
The us in Canadian cereal categories continued to see elevated levels of consumption during quarter, two and in both markets our quarter to net sales got further lift from replenishing retailer inventories.
In the United States, our cereal consumption was up almost 16% year on year outpacing. The category importantly, we are gaining share not only behind taste fund brands like Froot loops, but also behind health and wellness oriented brands that we set out to revitalize this year through refreshed messaging and media.
Special K gained share in quarter, two as it mini wheats and Raisin bran.
We're also excited about the consumer trial and rediscovery, we are seeing from new and lapsed users in cereal.
Household penetration continued to rise sequentially and year over year in quarter, two and we are tailoring, our messaging and media to reaching out to these consumers, we're not only growing consumption faster than the category, but we're also increasing household penetration faster than the category as we entered the second half we returned to normal merchandise.
Activity not only versus the first half when investment was delayed but also against last year. When we were only just coming out of the pack size harmonization during the year ago third quarter. We're certainly encouraged by the momentum we're building in our cereal business.
Now, let's turn to our North America frozen foods business and slide number 20.
These categories saw very elevated at home demand continue in quarter, two driving very strong net sales growth in what we call. The frozen from the griddle category, our Eggo brand posted consumption growth of about 26% during the quarter gaining substantial share while our Kashi brand grew about.
19%, we outpaced each of the categories three product segments.
Those pancakes and French toast aided by strong innovation and renovation, we have done over the past year.
In frozen Veggie foods, our Morningstar farms brand grew consumption by more than 31% in the quarter failing to keep up with the category only because we ran up against our capacity in the quarter.
Both of these categories are seeing increased household penetration so even as at home demand inevitably decelerates, we see an opportunity to increase our communication to take advantage of the increased household penetration.
Indeed in the second half we will be investing in this communication as well as in the launch of incognito, you'll recall that this is the refrigerated subline of our Morningstar farms brand, whose launch was deferred to the second half because of retailer resets getting delayed because of the crisis. So another big quarter for Kellogg North America and.
Even though much of its first half profit growth will reverse in quarter three in quarter four when we see growth rates moderate and our investments get executed there's no doubt that our business in North America will emerge from 2020 much stronger.
Now, let's discuss our international businesses, starting with Europe on Slide number 21, Europe had another solid quarter, specifically, we realized elevated cereal consumption growth across all of our key markets in Europe as shown on this slide and equally importantly, we've gained share in each of our top five cereal markets.
Namely, the UK, France, Germany, Italy, and Spain, our crave brand known as resort in some markets is up 25% year to date and has become the number one cereal brand in Europe.
Special K the number three cereal brand in Europe has kept up with the category. So far this year attributed to our packaging and messaging overhaul.
Cocoa Pops another brand in Europe to top five also outpaced the category.
So between at home demand rising during the pandemic and strong execution and share gains by our team our cereal net sales grew at a double digit rate in quarter two.
Our net sales in snacks, however declined in the quarter as expected you'll recall that with the cancellation of the Euro Cup Soccer tournament, we had to cancel a 360 degree marketing program that was a strong plan to growth Pringles on top of two years of exceptional summer programs.
Due to the agility and creativity of our brand team, we were able to move to a combination of smaller programs, which successfully held Europe's pringles sales flat year on year.
Our only soft spot in the quarter was portable wholesome snacks who's on the go orientation has pulled down the entire category and our share remained relatively stable.
As we focused on supplying the market with food, we defer more of Kellogg Europe's overall brand investment to the second half, which effectively shifted profit into the first half and out of the second half. We're very pleased with how we are executing in Europe.
Let's turn to Latin America, and slide number 22.
Amidst a growing koby crisis in an uncertain economic environment, our Latin American business is performing well net sales in the quarter grew 14% on an organic basis during quarter, two which was much more than we had expected for two reasons first at home demand growth actually accelerated in this region as the cobot out.
Break worsen.
This was especially the case for meal oriented categories in the modern trade channels.
Yes. This had a major effect on cereal and we saw double digit consumption growth in key cereal markets across the region during quarter two.
And second retailers proceeded with their summer promotions as normal in June, whereas we had anticipated some execution delays given kobin limitations.
The result was higher than expected cereal net sales, which more than offset impacts of recessionary economic environment and general softness in snacking categories, particularly in high frequency stores or mom and Pops and on the go channels.
Our snacking categories have not seen a lift in demand, particularly in on the go oriented categories like wholesome snacks, and particularly in markets like Brazil were high frequency stores predominate.
The good news is that Pringles continued to grow consumption and gained share in key markets like Mexico and Brazil.
KOVA cases on the rise in an economy that is clearly soft we remain cautious in our outlook for Latin America's second half, particularly with new labeling restrictions in Mexico.
But there is no question that our team is managing well through a difficult environment.
And finally, we'll discuss EMEA shown on slide number 23, EMEA also it exceeded expectations in the second quarter cereal sales remained strong sustaining a mid single digit growth rate as at home consumption remained elevated in the more developed markets of the region. We also performed well within these.
Cereal markets in Australia, and South Africa for instance, our strong double digit consumption growth rates were enough to gain multiple points of share in those growing cereal categories.
The biggest positive surprise in the quarter was multipro the distributor portion of our rapidly growing business in West Africa.
Coated lockdowns and a softening economy did indeed slow growth from Multipro, but certainly not as much as we anticipated.
Where we did see softness as expected was in snacks in the middle East and other emerging markets like India related to covert disruption and slowing economies. Nevertheless, despite challenging macro environment, we still managed to deliver good topline growth in this region in quarter, two and our profit growth was augmented further by.
Delays in brand investment to the second half.
We see quarter twos topline growth remaining at a decelerated pace in the second half given the macro environment, but we like how we are managing through the crisis overall in EMEA.
So allow me to summarize we slide number 25.
The company continues to execute well amidst the crisis. It hasn't been easy is required encourage and flexibility in the part of our employees and is required to considerable incremental costs in the form of safety and cleaning temporary labor additional freight and bonuses for deserving frontline employees and it's working we're keeping.
Our employees safe, we're supplying food to customers and consumers, we're giving back to the community and we're enhancing our financial flexibility. Meanwhile, we're very grateful for our partnerships with our suppliers and our retail customers. During these challenging times. It is this execution that has enabled us to deliver eve and.
Sales and we had anticipated in both quarter one in quarter, two and both in market in our financial results. This has important implications we are able to raise our financial forecast for the year delivering more net sales more operating profit more earnings per share and more cash flow and then we had plans and.
At the same time, we're also able to reinvest back in the business. During the second half. This means investing to revitalize more of that brands in our portfolio and reaching out to new and lapsed users web. This rediscovered our foods during the crisis that means we can invest more in capabilities that will give us a leg up in the marketplace.
Such as data and analytics digital in E Commerce and packaging.
And in the end. It means we can finished 2020 with both better than expected financial performance and come out a stronger company. It means we can improve our financial flexibility in a time of great uncertainty and it only solidifies our path toward balanced and consistent growth in sales profit and cash flow overtime beef.
Before we close I want to extend a heartfelt. Thank you to our employees their bravery dedication and hard work or exemplary and their engagement. During this time at prices has been inspiring it just reaffirms that kellogg as a truly special culture and with that we'll open it up for your questions.
We will now begin the question and answer session.
To ask a question you May press Star then one on your telephone keypad.
If you are using a speakerphone please pick up your handset before pressing the keys.
To withdraw your question. Please press Star then to.
At this time, we will pause momentarily to assemble our roster.
Our first question comes from Chris Growe, It with Stifel. Please go ahead.
Okay.
Hi, good morning.
Good morning, Chris Hi, I had two questions for you. The first one just be would be theres. Some.
A lot of shifts and moving occurring.
This quarter, especially behind marketing.
As we are trying to get a sense of the fixed cost leverage no doubt, that's a benefit to margins and helped drive profit growth.
Can you give a better sense of you know of how that levers to cold maybe.
How how much marketing shifting to the second half of the year.
Yes, I don't know Theres, a we give kind of a gross margin.
Discussion in terms of the various cost that occurred in the quarter as well. So just sort of look at at the leverage and that profit growth that occurred kind of absent the unique items.
Yes, Thanks, Chris I'll start and I think it will build on it first obviously, we had monumental changes in the first half you think about at the very beginning the March madness, obviously being canceled and be a on and on everything just.
Got canceled so that led us to making big shifts in marketing and investment, which we plan on as we said in the prepared remarks to fully invest in the second half order of magnitude, we're talking about maybe as much as $60 million six zero in shift from the first half into the second half much of that advertising and promotion.
And a lot of it will be weighted towards quarter three.
Which were obviously in right now you want to talk about maybe look on operating leverage so Chris just on on gross margin. Obviously, we had a very strong gross margin performance in the quarter I think if I were to kind of break down the drivers of that are the divestiture was about 60 basis points, which was just mechanical as it flow through.
We did have incremental costs related to covert of around 22 million. So that was about a 50 basis points headwind during the quarter.
Input costs were roughly neutral.
So largely the balance of the gross margin was driven really by by two things one of the operating leverage coming through and also have positive margin mix.
So as the growth was more pronounced.
On moved away from snacks towards Arctic noodles.
That created a positive margin mix for us in the quarter I think it as we looked at the second off a we'd expect the margin mix to be neutral.
And then obviously of its lower while you're on growth the operating leverage.
I would be lower into second half.
Overall.
We remain confident of our guidance on a stable gross profit margin for you.
Thank you for that just in relation to that leverage point you made the increase in in inventories that occurred both your own and and at retail did that how much of the that.
Contribute to the gross margin.
Well I think it was.
I think in terms of the inventory specifically, we did see replenishment of inventory traded off trade inventory, but from an overall standpoint right I think another leverage was driven by the increased production in the quarter.
Okay. Thank you for your time today.
Thanks, Chris.
Your next question is from Jason English with Goldman Sachs. Please go ahead.
Hey, good morning folks.
Pages the Atlantic.
Thank you for slot me.
Impressive results this quarter congratulations to you hear organization.
The North America cereal business was especially impressive.
But as we look at consumption. It looks like demand is waning. Despite the breakfast occasion being one of those flows to recover and the away from home market.
I was hoping you could sort of applied why you think we're seeing the cereal business state or at least consumption levels they faster than most other at home categories.
Yes. Thanks for the question, Jason you know, what I'd say about cereal consumption, it's moved around it's been pretty choppy.
And if you look at the latest syndicated data it actually looks like it's coming back now and so it's been Choppier and I think some of that might be stocking up we do see trips down and baskets up so people load up their pantry, but they are going through it and so I think we're just going to have that continue to take a wait and see approach because all of our.
Our.
Panel research also suggests that consumption remains very strong and very robust and we like our performance in that.
And we're investing quite substantially in the back half of the year in a back to school program you can see the mission Tiger, which has been on an air which has been very successful in.
Really gaining steam so it's one to watch obviously, but we're pretty confident that the at home consumption is going to remain elevated and we're assuming a deceleration obviously from the from the height of it as people become more mobile and things do return back to normal, but we're still seeing good overall.
Consumption, although choppy.
That's helpful context, thank you.
In light of that why do you expect margin mix to not be a tailwind in the back half year, what's going to change to make that to make that go net neutral or or or exceed the benefits.
Yes, So I think I think just into the second.
Mix was favorable in the in the quarter like I said.
As as as we saw lower of oil.
Growth move from snacks towards Arctic a notice I think it all as we look at the second half, we expect that to moderate as we get back to more normal.
Consumption levels. So that's that's the assumption thats the planning assumption underlying gross margin for the second home.
Got it. Thank you so much all that so.
The next question is from Brian Splaine with Bank of America. Please go ahead.
Hey, good morning, everyone.
Hey, Brian.
Just two questions related to the second half first.
I guess, you're thinking about or you're planning for for an increase in marketing.
Expenses the backup in the especially in the third quarter can you just talked about held back to school is shaping up and what changes you may be making too.
Your sort of back to school promotions and merchandising and then maybe just related or second would be just on pringles in Europe, I know that theres a change in merchandising there because you've done a lot.
The soccer in recent years. So can you update it there in terms of what your change plants or I guess for Pringles in Europe in the third quarter.
Sure. Thanks for the question, Brian first with respect to the back to school program and how we're thinking about the second half I'd start by actually giving you. Some that we didn't say it but our actual advertising spend in the first half was still up year over year, but obviously in store merchandising and promotions and consumer promotion.
Is affected by covered in the first half as we think about the back half we were very purposeful in back to school for example in thinking about what the environment might be will kids, the actually going back to brick and mortar will they be doing a hybrid will they be staying at home. So we believe our program works in any environment and it's tied to.
It is tied to literature in books and getting books indicates hands tied to the purchase of our cereals and so we think it's we think it's very good we think it's very strong and we think it's very versatile depending on what the environment may end up being and so the team has worked very hard on it and I think we've got a solid solid program we.
With respect to Pringles.
Pringles, obviously in the first half we had to lap that the cancellation of the Euro Cup, which was huge and we put a lot of.
Effort into building that program to lab, what had been two years of exceptional performance in pringles over the course of the summertime and now as we think about Q3 in Q4, we're taking the same type of approach how do we put together programs around gaming how do we put together programs that drive more in store execution we.
Our salesforce back in stores. So we have a lot more merchandising happening and the fact that we were able to get to flat on pringles in the first half of the year lapping exceptional two year performances.
Without the Euro Cup I think is a testament to the versatility in the agility of the team and we expect that to continue in the second half, but it'll be continue to be a challenge.
Operator.
The next question is from Rob Dickerson with Jefferies. Please go ahead.
Great. Thank you so much.
Just a quick question on your comment that you.
Okay maybe.
Kind of consumption, that's a demand food at home how are we define it in Q4's starts to normalize.
Obviously you have.
Right.
Place.
But.
Maybe if you could provide a little bit more color as to what you, though in this case, what normalized room exactly.
And then and then I guess number to just kind of how you think broadly about.
Through to at home consumption versus what you were seeing kind of on the go just given you do have part of your portfolio in all undergo an food service right or the fastest does it feel at home consumption comes down a bit maybe on the go improves a little bit maybe foodservice recoveries slow, but still crudes, so just kind of.
Holistically what is normalization in how are the moving parts in fact that thanks.
Yes, Thanks, Rob. It's obviously an important question and you know, it's an unknowable right and we all have are.
Hunches about what might happen, but it's an unknowable what happens with this virus we expected.
Right now, we're still seeing at home consumption, obviously elevated but as we as we think about planning and giving guidance for the rest of the year. The best that we felt we could do is take a planning stansted says it will decelerate and in quarter four it will get back to a more normalized world. So that you can understand.
And you can make your own judgments about do you think that's conservative do you think thats straight down the middle of the fairway, it's in unknowable, but it is our planning stance.
Same thing for traveling lodging and away from home, we expected that we'll continue to face pressure traveling lodging, probably more so than convenience, which we're seeing come back we are seeing mobility.
Grow.
But it's choppy. Obviously, then you have the virus wreaking havoc in many states in the southern part of the United States in that goes backwards and so from a planning stance. That's why we tried to be as transparent as possible and tell you exactly what we're thinking and then you can draw your conclusions as to exactly how you think.
That may change, particularly in quarter four and beyond.
Okay fair enough.
That is quickly just in terms of the back half investments.
So you're not.
Food company that speaking to back half investments.
Again kind of broadly speaking you though.
Yes.
Sure.
Our field that.
So a lot of companies have kind of your experience increased household penetration left.
Got it as we get through the back half generally right. The kind of brand investment will be up across all channels within food and then maybe as we even think in 2021 those levels to remain high because everybody is essentially trying to acute that penetration sticky as possible. That's it. Thanks.
Yes, Rob I think I think Thats right. If you think about just the environment that we're in this elevated demand has made these categories more attractive than they've been in many many years, obviously that a lot of that is driven by coated but it does drive reappraisal. It does drive increased penetration our penetration is up.
And our usage is up and so these are big opportunities for us to continue to connect.
Our brands with consumers in an environment of elevated demand, making as much of that stick as possible and so our whole goal with this investment in the second half.
Is again to fully spend what we plan to spend but to come out of this a much stronger company and we're very confident that we're going to be able to do that because we've got good brand plans, we're investing inorganic growth opportunities that are more attractive than they have been in many many years and so it's a crisis, obviously, but it's an.
Opportunity for us to strengthen or bands brands to make better connections with consumers to build retailer programs that work for the retailers that worked for us that work for consumers and drive stickiness and drive brand loyalty and therefore come out of this crisis and into next year in a much stronger position than when we entered it.
All right.
So much.
The next question is from David Driscoll with DD Research. Please go ahead.
Great. Thank you good morning.
Hey, David.
I wanted to ask a little bit about this a this advertising in brand building shift into the second half Steve what.
What are you, saying to the risks to the question or concern from investors.
That being a sizable amount of brand building will be less efficient in just six months versus had it been able to spend been able to be spent over a full 12 months do you worry about the effectiveness of of all of the spending that you're moving into the second half and if not.
Got you know why maybe give us a little bit of of inside color here on on why this spending is going to be highly effective and maybe on which brands is there. Some things that we all should be looking for to understand the good worked at your team is doing.
Okay, great. Thanks, Dave Good question, and we're very confident that we're going to have terrific ROI is on our brand spend and the return on investment calculations will be very important as we plan out and we'll guide exactly where we're spending but it's also for the long term to build a long term equities and continue to improve.
Awareness trial, and overall brand health of our brands. The other thing I would tell you is and this is continuing with people far less mobile and staying at home our ability to connect with them.
Continues to be very strong maybe not as strong as.
April and May when the Lockdowns were very severe but people are less mobile there at home and we know how to connect with them and that's what it's going to be about so its digital its social its traditional all guided by ROI is and with very attractive categories, you look across our portfolio.
You know cereal doing very well frozen breakfast frozen veggie doing very well incognito, we've consolidated that launch into the back half of the year that will be fully supported and so there's a lot of really exciting things that we're spending our money against.
And that we're very excited about but we'll be guided by the right ROI is and the long term.
The long term nature of building equities for our brands.
Last one follow up for me is you mentioned that you have this expectation that everything moderates and that's your planning expectation is there is there any concern that if you're wrong. If there's upside to this will you have the capacity will you have the inventories to service elevated demand. So if you.
If you will get a guy Im just worried that if you tell the manufacturing teamed only plan for a certain scenario of moderation. If it comes out better maybe you don't actually have the inventories to meet retailer demand.
Yes, so I'd start by saying what our supply chain is done in the first half of this year has been extraordinary and it starts with a commitment to keeping people safe to making sure that we've got the right procedures and processes in place and none of that has changed our plans continue to run at a very high level.
Even now so we will do our best to stay agile.
To forecast as best as we possibly can and to make sure that we can we can execute against any potential upside and so that's our planning stance.
Certainly we're working on how can we make it better.
We're working on rebuilding inventories are service levels, which are still not where they were pre coded there are certainly much better and continue to improve.
But the supply chain continues to really show exemplary performance and their ability to be agile and meet unexpected demand has proven itself and if necessary I think we've got a lot of confidence that that there'll be able to meet whatever unforeseen future is in front of us.
Thank you very much time.
I think we have time for one more question.
Excuse me on that question comes from Alexia Howard with Bernstein. Please go ahead.
Good morning, everyone.
An example accident hi, now so just a couple of questions from me.
As you think about.
Uses of cash given the fixed free cash flow that you've got.
Where are you likely to add to channel backload possible that you'd like target acquisition or will it be returned to shareholders.
My first question and then secondly, I'm actually relates to pricing.
In your press release, the pricing in North America out in Europe, particularly with down.
Thanks, So down largely I think one.
With that down actually look profoundly one for potential.
And yet when we look and thanks to the pricing on shelf Im just wondering if you can just speak to what the dynamics all that okay ill pass it on.
Alright, So I think just from a cash standpoint, I think innovate looking to invest the cash as Steve talked in brand building increase Capex I think debt reduction continues to be a priority. So we're very focused on that as we've said throughout the course of this.
Oh, so that'll continue to have.
Remains a priority in the second off as well, we're making good progress on that as you saw in the prepared remarks.
I think from a price mix standpoint pricing was actually positive in the quarter.
I think what Youre seeing is the mix.
It goes back to the category mix.
We've seen growth move away from.
US from snacks towards Arctic and noodles and on all on the price on the price mix line, that's negative but on the gross margin line, that's actually a positive so really that's what's driving the price mix.
Great thank very much.
This concludes our question and answer session I'd like to turn the conference back over to John Red with for any closing remarks.
Well. Thank you we are at the 10 30 point here. If you did not get to ask question I apologize, but I'm around all day and.
But you all have a good day.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.