Q2 2019 Earnings Call
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Deep flavor.
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Well.
Good morning.
Welcome to the Kellogg Company second quarter 2019 earnings call.
All lines have been placed on mute to prevent any background noise.
After the speakers remarks, there will be a question and answer period. If you would like to ask a question. During this time simply press star and the number one on your telephone keypad.
Please limit yourself to one question during the Q and a session. Thank you.
At this time I will turn the 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 and good morning, everyone. Thank you for joining us today for our review of our second quarter 2019 results and an update of our full year 2019 outlook I am joined this morning by Steve K., Herlin, our chairman and CEO and Amit Banati, our Chief Financial Officer.
Slide number three shows our usual forward looking statements disclaimer as you are 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 today's conference call will be available by phone through Thursday August eight the call will also be available via webcast, which will be archived for at least 90 days.
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 now I will turn it over to Steve.
Thanks, John and good morning, everyone.
In a business turned around there is nothing more important than being able to kindred continuously report back to our shareowners that we're executing our strategy as planned and we are delivering our results as planned and that's exactly what I had the opportunity to do here today.
There is no more compelling evidence of this in in our organic net sales growth, which is shown in slide number five.
Ever since we pivoted in Q4, 2017 from our cost reduction phase and into and invest for growth phase, we have been committed to and demonstrating a gradual improvement in organic net sales growth. This is absolutely critical for long term profit growth.
It is required heavy lifting we had to exit DSD and free up resources, we had to revitalize brands through repositioning and investment we had an innovation pipeline that had to be refilled and we had to shift our portfolio to faster growth categories and markets.
And it's working Q2 was the purest example of this with organic net sales growth of more than 2% and it's not just that this is our best organic growth since 2016 or even since 2012, if you exclude the inflationary benefits of Venezuela in prior years. It's the fact that this growth was broad based with all four regions in growth.
It's the fact that our enhanced capabilities in revenue growth management are yielding improved price realization in a year of notably high cost inflation.
It's the fact that our innovation launches are off to a great start and it's the fact that we are holding or gaining share in more of our categories than before.
And what may be a surprise to many of you. It's the fact that we can post this kind of growth for the total portfolio even in a quarter when our closely watched us cereal business declined meaningfully amidst a pack size harmonization.
This organic net sales growth is the truest sign that we're making strong progress in deploy for growth.
But it's not only sign of progress in Q2.
Slide number six shows some more elements that you should be aware of.
First we've continued to reshape our portfolio just this week, we closed on the divestiture of our cookies fruit snacks pie crusts and ice cream cones businesses.
It's never easy, saying goodbye to colleagues, but these brands our growth going to a more suitable home and Ferrero is truly a world class organization.
For us the closing of this divestiture means we now have a portfolio that is more focused on our most advantaged brands and categories with a better growth profile and higher profit margins.
Meanwhile, we continue to expand in emerging markets, particularly through snacking, not only because of successful acts with acquisitions and partnerships, but also from geographic and product line expansion.
We posted another quarter of good growth in Russia.
We grew double digit again as we expand in West Africa, and the Middle East and we continue to grow strongly in Brazil led by our parents business.
Second we've seen improved end market performance in developed markets as well.
In particular, we are pleased to see the momentum in key snacks brands that we knew we had to revitalize we'll talk more about these later.
Third our improved innovation pipeline is bearing fruit.
As we've told you our net sales from newly launched products in 2019 will be the highest in at least four years.
But more importantly, they are doing well, particularly a new on new food platforms like cheez it snapped.
Fourth we've continued to grow in on the go offerings. Remember this was a key priority for us as we take advantage of this growing occasion, we had another strong quarter of consumption growth in key us snacks categories, and we continue to use single serve to reach affordable price points in emerging markets.
Fifth we have realized price as I mentioned this was important in an environment, where we are facing our highest cost inflation in years.
But it also gives you a read on how much we've improved our capabilities in revenue growth management.
And lastly, we've realigned our business.
I touched on this earlier, but it bears repeating because this isn't easy.
Extracting stranded costs requires a complete rearranging of organization and processes and you should feel good that we are proactively and immediately addressing this.
We also took the opportunity to restructure our European business, both should add to the agility and speed, we have been seeking to enhance.
So another eventful quarter with continued progress.
The profit will follow particularly as we get past the initial heaviest investments and as we start to surmount, our accelerated cost inflation and challenging cost comparisons.
But we are building for the long term and like we like where we're headed.
With that let me turn it over to our new CFO , Amit Banati, who will take you through our financial results and outlook in more detail on it thanks, Steve and good morning, everyone.
First let me start by saying that it's an honor and privilege to be here today on my first awnings call as CFO .
I look forward to working with you all.
Our Q2 and first half results are summarized on slide number eight.
Context is important here.
Since late last year, we've been telling you how 2019 would play out.
We said that organic net sales growth would improve gradually as the revitalized brand sustained momentum as price realization improves and as modest April adding lotteries and starts to contribute to organic growth.
That is certainly playing out as Steve just discussed.
We said the gross margin would be down year on year growth, especially in the first half owing to Adolfo input cost comparisons on the fact that our on the go back format margins remain our yield on your negative onto the major corrective actions kick in during the second half.
What we told you we'd see gradual sequential improvement in gross margin and Thats exactly what we saw again in quarter two.
We said that the result of these factors would be year on year decreases in operating profit during the first half returning to growth in the second half excluding any divestiture impact.
If anything our operating profit declined less than expected in both Q1 and Q2 affording us the ability to better balance what was already a back weighted plan.
And we noted, particularly difficult year on year comparisons for tax rate during the first half further adding to this first half second half disparity on awnings per share.
Again through the first half we are actually a little ahead of our expectations.
Finally on cash flow, we said that we would likely be flat yield on your before any divestitures or related business realignment charges and outlays.
Through the first half we are ahead of last year on cash flow.
So while Q2 and first half results are clearly in line with our stated plan and they give us increased confidence in our full year outlook.
Let's now go into a little more detail.
I'll start at the top of the BNL with net sales growth and slide number nine.
Steve covered this pretty well already pointing out that this Q2 performance was our best organic growth in sometime.
I would just point out a few other items to consider as you model us.
One.
The organic growth was broad based as already mentioned, we generated organic growth in all four regions.
Among all categories globally snacks led the growth, but we also grew in frozen and in noodles.
Seadrill was down mainly because of our us business, but it continued to grow in emerging markets.
So we feel pretty good about our foundation for growth.
Do we have executed revenue growth management actions across the globe and across categories over the past two to three quarters, including in quarter two.
So there is a near term relationship between the decline in volume and a positive price mix.
We would expect them to balance out a bit as we get into the second half.
Three multi pros consolidation, which we treated like an acquisition from a reporting standpoint, and he was threed on may 2nd during Q2.
So that is now in our organic basis net sales.
Starting in Q3, we will start to see the impact of our divestiture, which depending on seasonality, which reduced reported net sales by roughly four to five percentage points in Q3 and Q4.
And for currency translation has been more negative than we anticipated, though this pressure should moderate a bit in the second off as we start lapping last year's us dollar appreciation.
You wrap it all up and we are up 1.3% year on year on an organic basis through the first off which should give you confidence in our folio forecast for net sales growth of 1% to 2% both on a currency neutral basis and on an organic basis.
Now, let's turn to our gross profit margin on slide number 10.
As we have communicated previously we expect our gross margin to decrease year on year in 2019, but for this decline to moderate as the year goes on.
That's what happened in Q2, but our gross margin decline moderated from Q1's decline.
Let's look at each of the three buckets, we've been using to explain this margin pressure.
The first is mechanical.
About 40 basis points of this decline was simply the mechanical impact of consolidating multi peril for one month in the quarter in April in which we will not yet lapping the consolidation last deal.
As we get into the second half our divestiture provides a small positive benefit.
The next bucket is what we call growth related.
As in recent quarters. This bucket was negative year over year.
Once again most of the growth related impact in quarter, two was related to the mix and cost impact of our shift towards emerging markets and notably toward on the gold pack formats in our North America snacks categories. As you know we have taken some steps to mitigate this impact such as Sq rationalization and revenue growth management, and we did see sequential improvement.
But the bigger vessels, such as centralized backing Santos and repatriating. Some co pack volume don't begin to yield benefits until the second half.
That's why we expect to see less negative impact to this overall growth related bucket in Q3, and maybe even a positive swing by the fourth quarter.
The final bucket is what we call ongoing.
As we've discussed previously we not only have higher input cost inflation indices.
But we also comparing against notably favorable hedges last year, especially in the first half.
This too is a pressure that is expected to moderate slightly each quarter.
Again, none of this is new news and we expect continued sequential improvement in gross margin performance.
Multi pros negative mechanical impact is behind us and will be replaced by modest modestly positive mechanical impact of our recent divestiture.
The revenue growth management actions that commence in quarter four 2018 have been fully implemented.
And actions to restore profit margins on our on the go back formats are well underway.
And input cost inflation gets slightly less negative.
Now lets move below the operating profit line turning to slide number 11.
As we have discussed previously we faced some headwinds on these below the line items in 2019, particularly in the first off.
So thats, what we saw again in quarter two.
Interest expense for example was a modest year on year headwind because the year ago quarter did not have a full three months of borrowings for additional stakes in Nigeria.
Other income is down year on year as we had indicated because of the impact on pension expense, mainly due to a pension asset base that declined sharply with the financial markets last December .
Once again, the biggest year on year headwind was on tax rate.
Our effective tax rate in Q2 and in Q1 was in line with our full year guidance of approximately 21%.
However, because of a sizable discrete benefit in the year earlier quarters. This was a significant drag on EPS.
In both Q1 and Q2.
This becomes less of a headwind in the second half.
So again, none of this is new news and it's coming through as anticipated.
Before we get into our guidance for the year now, let's discuss our recently completed divestiture shown on slide number 12.
With the completion of the transaction, we continue to forecast.
Our net negative impact on our full year 2019 operating profit of about 4% to 5% from the absence of the divested business.
As you know we sold these businesses for $1.3 billion or roughly $1 billion net of taxes.
As previously disclosed we are using the net proceeds to reduce debt.
And we recently announced a tender offer for this purpose.
This reduces our leverage and enhances our financial flexibility.
No the cost of the Dando will largely offset the savings on interest expense this year.
More important than how this drawn a transaction impacts our 2019 PNM is water does for our overall growth and margin profile going forward.
Not only will these lower growth and lower margin businesses for us.
But we can now focus more attention and resources on our best categories and brands.
So let's move to our 2019 full year outlook and guidance, which is shown on slide number 13.
We are making no changes to our full year guidance for net sales operating profit and earnings per share and updating our cash flow guidance for the divestiture impact.
Let's take a look at each.
Currency neutral net sales are still expected to be 1% to 2% just as we guided last quarter.
In effect the five months of divestiture in the second half offsets the four months Multipro acquisition in the first half.
Meanwhile, organic net sales growth is still forecast to be 1% to 2% as well.
Currency neutral adjusted operating profit expectations continue to be in the negative 4% to 5% range as we communicated last quarter.
Because our operating profit finished ahead of our first half outlook, we can now rebalance what had been.
Backwardated plan.
This includes adding back investment to quarter three that was delayed from the first half.
As we brought on additional capacity and worked through organizational changes and the divestiture.
And currency neutral adjusted EPS is still expected to be down 10% to 11%.
With debt redemption costs in Q3.
Largely offsetting interest savings.
So no change to our full year BNL guidance, just increased confidence based on first half performance and clear visibility on the recently closed divestitures impacts.
Slide number 14 looks at our cash flow guidance.
From a cash flow perspective, you may recall that last quarter. We told you. It was too early to call given the uncertainties around the timing of our divestiture the transition services plan and business realignment to address stranded costs.
Now with the benefit of the divestiture transaction, having closed we have increased visibility into cash flow expectations for the full year.
From an accounting standpoint, a 1.3 billion of gross proceeds from the divestiture will show up outside of cash from operating activities bought the taxes paid on those proceeds are in cash from operating activities Thats approximately $260 million.
We'll also have the absence of the divested businesses cash flow for the remainder of the year and we will incur upfront cash costs.
Related to the transaction.
And.
Business realignment and restructuring.
The net of all of this is that cash flow in 2019 temporarily dips to about half a billion dollars.
The key thing to note is that the outlook for cash flow for our base business has not changed meaningfully.
If anything we are tracking towards the higher end of our previous base outlook range tanks for discipline on working capital and prioritization of capital expenditure.
At this point, we'll run through each of our businesses.
Before I turn it back to Steve It make sense for me to go ahead and take you through our performance in EMEA.
Our Asia Pacific Middle East and Africa business is shown on slide number 16.
EMEA had a particularly strong quarter.
In addition to one month of Multipro acquisition benefit the region posted its strongest organic growth in a long time up nearly 9% year on year.
Moderate growth continued growth had a lot to do with this as it became part of our organic growth in may.
This business again posted double digit growth in the quarter.
Even more important for EMEA in the quarter was our snacks growth led once again by sustained momentum and pringles.
This brand gained share collectively across the region and its net sales increased at a strong double digit rate led by growth in the Middle East North Africa, and Turkey sub region.
As well as in more developed markets like Australia, and South Africa.
Cereal sales were up across the region with the exception of Australia, where shipment timing resulted in net sales being off slightly.
But consumption remained in growth in Australia.
Outside of Australia, our cereal net sales growth was broad based with growth in markets, ranging from Japan, and Korea to India and Southeast Asia.
Importantly in a rising cost environment, our price realization in EMEA was strongly positive in the quarter, reflecting good execution of revenue growth management.
So we saw good overall momentum in EMEA in the first half and we expect good growth in the second half as well.
Let me now turn it back to Steve who will walk you through our other regions. Thanks, Romit continuing with our international businesses, Let's discuss Europe shown on slide number 17.
Europe continued to grow in Q2, its seventh consecutive quarter of year on year net sales growth and its growth was fairly broad based across the region, even despite some developed markets with challenging retailer environments.
Growth was led by momentum in Pringles, whose consumption growth remained particularly strong in the UK and France benefitting from our rice fusion innovation and an effective commercial program around electronic gaming.
This growth more than offset modest declines in wholesome snacks in cereal.
Wholesome snacks, you'll recall is a business we set out to transform this year following a declining trend while sales were flat in Q2. They are up year to date and innovation is performing well. So we like where this business is heading particularly around rice krispies squares.
In cereal, we continue we continue to make sequential progress with only a small net sales decline in Q2, and even a return to growth in the key UK market.
Consumption in that cereal market and across the region is stabilizing.
Europe in Q2 also featured another key element of our strategy growth in emerging markets. We recorded another quarter of double digit growth in Russia, and we continue to expand elsewhere in central and eastern Europe , So another solid quarter for Europe .
Latin America posted another quarter of net sales growth as shown on slide number 18.
Growth in the quarter was led by cereal to sales remains strong and was again led by continued momentum in Mexico consumption and share we continue to execute well in this key market.
Our parents tea business continues to perform well despite market softness in Brazil.
We gained share in biscuits and other key categories, and we generated strong price realization.
We couldn't be more pleased with the synergy progress, we're making both on the selling and the supply chain fronts.
Pringles continues to outpace the category in Mexico.
However, we saw continued decline in Argentina related to economic and currency weaknesses, and some temporary softness in Caribbean Central America related to economic conditions and the distributor transition, but the brand remains in very good shape and most of the region.
Profit was pressured a bit in the quarter by input costs transactional foreign exchange and investment in capabilities, but we feel good about how this region is performing particularly on the top line.
So we expect continued growth in Latin America in the second half.
Let's now turn to North America, and slide number 19.
It's not a small thing that we can show you net sales growth in our biggest region. After several quarters in which improvement was masked by DSD price adjustments, a product recall and even shipment versus consumption timing.
We're past all that and what you're seeing in Q2 is the underlying growth showing through.
Some important elements to note about this net sales growth first shipments were right in line with consumption. This suggested last quarter's imbalance was really just one of timing.
Second price realization came through.
Price mix was up nearly 3% year on year in North America, reflecting the full set of revenue growth management actions. We started implementing in late 2018 in order to offset some of the accelerated cost inflation we are experiencing.
Third we grew even though our highly visible cereal business did not.
This is true of net sales and consumption in the quarter and shows just how important are growing snacks and frozen businesses are to our north American portfolio.
And fourth we are generating growth in our specialty channels, we're competing well in key categories channels and customers and there's plenty of opportunity here as we lean into putting our brands in key consumer occasions.
North America's profit remained pressured as expected by higher input costs and continued if moderating drag from on the go pack formats and other mix shifts.
However, north America's Q2 sales performance should give you the clearest sign yet that our strategy is working in this key market just as it is internationally.
We've launched better innovation Weve revitalized key brands and we've executed revenue growth management actions and we've done all of this amidst a major reorganization and divestiture.
Let's discuss each major category in a little more detail.
We'll start with slack with snacks on slide number 20.
Once again, we generated strong growth in our five biggest snacks brands. The brands, we revitalized with increased investments last year and innovation that is shaping up to be our biggest launch year in a long time.
Their use consumption growth is shown on the slide.
Cheez it posted a another quarter of double digit consumption growth.
The brands core SK use our growing and it's on the go offerings are growing a highlight for the brand has been the success of our exciting new platform Cheez. It snapped whose velocities are just as good as the overall brand and showing strong signs of sustained growth.
Pop Tarts is also sustaining its double digit consumption growth in quarter two.
This brand continues to grow its base business paired with a very successful innovation pop tarts bites, whose velocity is even exceeding that of the overall brand.
Rice Krispies treats returned to double digit consumption growth aided by core SK use and new poppers innovation.
Added capacity has been a key enabler as we are no longer supply constrained.
Pringles continued its growth in consumption, even as it laps strong year ago gains growth has been aided by expansion expansion of on the go pack formats, and our new wavy innovation.
And our ex has surged back into strong double digit consumption growth restoring its distribution.
These aren't just any brands collectively they represent over 60% of our us measured channel consumption for snacks, a figure that goes up to nearly 75% when we exclude our now divested cookies and fruit snacks categories. So clearly we have our North America snacks business in very good shape.
Let's now turn to cereal and slide number 21.
As we've discussed previously our pack size harmonization was a strategic priority this year for what it does for making our aisle more easily shoppable for enabling us to cross promote our brands and for revenue growth management, we knew it would create some disruption for us in the first half, though for competitive reasons, we couldn't talk too much about it publicly particularly since it involves involved pulling back on promotional activity.
It did impact consumption during the first half.
On this slide you can see how our promotional activity had to be pulled back in Q1 for our taste Fund segment brands, which were in the first wave of harmonization in Q2 their activity stabilized in their consumption improved led by our key taste fund brands frosted flakes and Froot loops.
At the same time during Q2, you can see how we pulled back on promotion behind our adult and all family brands more recent four week data show that we are already starting to restore normal activity.
The good news is that this is now behind us as we get into the second half we have a return to more normal brand building and in store promotional activity and we like our plans frosted flakes gets a new media campaign as the special K.
Honey smacks, relaunches with new food and new pop Tarts cereal gets expanded distribution and we are Relaunching Koshi go and continuing to support Raisin bran.
So we expect to see the declines in net sales moderate for North America cereal in the second half.
And we'll just we'll finish with frozen foods on slide number 22.
This business posted solid net sales growth in Q2 led by our Veggie foods business Morningstar farms grew consumption in measured channels. Despite lapping a notably strong year ago performance, while also continuing to expand in non measured specialty channels.
In Q2, we accelerated growth on our CIC and breakfast meat portfolio supported by increased media.
This year's innovation, including the first ever Vigen cheeseburger as well as many corn dogs and popcorn chicken offerings demonstrate how we are extending into more consumer occasions.
From Centerplate options to snacking.
We fully understand the opportunities and dynamics emerging in this category and we are very excited about what we have and the innovation pipeline.
Meanwhile, Eggo also grew consumption and net sales in Q2, despite tough comps.
Growth in this strong brand has been aided by recent premium launches in French toast as well as a new high protein offering in waffles called off the grid.
In specialty channels, our new confetti Eggo innovation drove share gains in our K through 12 schools segment.
So we feel good about our frozen business as well and expect to see continued growth in the second half.
So lets some are summarized on slide number 24.
We are on strategy deploy for growth has us thinking differently and investing differently.
We have today a much different portfolio than we did even just a couple of years ago. One that is shaped more toward growth, we have real revitalized our snacks brands and we continue to expand in rapidly growing emerging markets. We're doing what we said we would do.
We're also on plan.
Let me reemphasize the point I made earlier that deploy for growth and the invented the investments behind it were intended to bring us back into organic net sales growth as you can see on this slide it's clearly working we're seeing a return to organic growth in each of our four regions.
And the profit and cash flow will follow.
Our topline is back in growth we have revitalized we have realized price. We are addressing costs that have weighed down our gross profit margin and we expect to see continued sequential improvement in that key metric.
We're now lapping the strong ramp up of investments that started in late 2017 and were so important for revitalizing key brands and enhancing capabilities will have a divestiture impact that will mask. Some of this improvement, but our underlying profit performance will improve and with this improvement will come higher operating cash flow and return on invested capital.
We are also strengthening our balance sheet by using the divestiture proceeds to reduce debt.
In closing I want to be sure to thank and praised our employees. It has been a period of incredibly heavy lifting and their expertise hard work passion and creativity or what is turning around this great company and with that we're happy to take your questions.
We will now begin the question and answer session.
To ask a question you May Press Star then one on your Touchtone phone.
If you are using a speakerphone. Please pick up your handset before pressing the keys to withdraw your question. Please press Star then too.
Please limit yourself to one question during the Q and a.
At this time, we will pause momentarily to assemble our roster.
Our first question comes from Michael Lavery with Piper Jaffray. Please go ahead.
Good morning, Thank you.
Hey, Michael.
Could you just touch on how conservative you think your your full year guidance. Mike You mentioned, obviously that it was your first half was ahead of expectations.
You also touched on some spending shifts how should we think about your are you hearing on the conservative side in the second half and also what if anything are you factoring in for your assumptions on on something like Brexit.
Great. Thank you for the question, Mike I would not characterize our guidance for the back half of the year is conservative I would characterize it as prudent and it was always back weighted if you'll recall. So there is a significant shift in our product profile from the first half to the second half.
What gives us confidence is the return to organic net sales growth across all four regions and the fact that the investments that we put in place.
Our working we did have.
A lot of disruption in the first half that we were anticipating so if you think about what we've achieved despite a divestiture. Despite a major reorganization in both Europe and North America, we are very proud and pleased with the performance of our people, but it gives us the ability to look at the second half and some of the investments that we didn't put in Q2, we are putting into Q3 to sustain the momentum, but we believe it gives us a very good chance to achieve exactly what we said we would would achieve but I wouldn't characterize it as conservative I would say, it's straight down the middle.
Then in terms of Brexit.
Obviously Brexit is.
It's still out there we can't predict any better than anybody else exactly what will happen. There is a new prime minister, who seems very committed to Brexit and we continue to make the type of contingency plans that we've talked to in the past, but nothing new to report on that matter.
Okay. Thank you very much.
The next question comes from Tim Ramey with pivotal Research group. Please go ahead.
Good morning, thanks much.
I know the debt will be going down as a result of the divestiture, but have you modeled what that should do too.
Debt to adjusted EBITDA.
Yes, so I think it off a couple of comments on that one is.
The tender so from a 2019 standpoint.
The tender cost offset the interest savings so from a BNL standpoint, we expect it to be net neutral.
I think from a debt to EBITDA level.
Get us into four range.
Terrific. Thanks, so much.
The next question comes from Ken Goldman with JP Morgan. Please go ahead.
Good morning, It's Tom Palmer on for Ken Thanks for the question.
You had a sizable step up in price mix this quarter versus last quarter. It didnt really seem to translate in full to the gross margin line as much as the magnitude of the step up might have suggested.
Why was this and should we expect a clearer flow through of this pricing to the margin line as we progress through the year.
Yes. Thanks for the question Tom I'll start and then Amit can build on it we are still the things that we've talked about in the past in terms of input costs.
And a strong inflationary environment as well as mix continued to be the issues that we're facing and as Weve talked we're going to see sequential improvement as we go throughout the quarters with the best performance in gross margin being in the fourth quarter and then entering into 2020, and so that hasn't really changed all that much we've had to shift some of our.
Capex investments into capacity.
And away from on the go just as we stay agile and pivot based on strong demand and things like rice, krispies treats and cheez it and so forth to make sure we have the right levels of capacity.
But you will see continue to see sequential improvement in the gross margin as we've discussed as we as we get into the back half of this year and into 2020.
No I think you've covered it I think you know the mechanical in fact as I mentioned in my prepared remarks will don't favorable.
As we get into the back half so that drag goes away and then I think it on some of the actions we will have better comps was a year ago and then some of the actions on the on the go formats, such as the Repacking centers et cetera would come into play in the second half. So I think the combination of all of that will result in an improving trend in gross margins.
As we go through the year.
Okay, and just to follow up on on that and thank you for the color a quarter ago. You said you expected to exit the year with year over year gross margin growth.
Is that still the case.
Yes, I think that that would still be our expectation I think we remain on track with all major initiatives.
Okay. Thank you.
The next question comes from Chris Growe with Stifel. Please go ahead.
Hi, good morning.
And Chris I, just hi, I just had a question for you as you look at the the serial promotional activity for your business, obviously will go up and down and down during most of the first half.
Okay Im just curious what your expectations for the category and as the category to improve or do you expect your improvement to come from say market share gains you get back like a normal operating environment for your business.
Yes. Thanks for the question, Chris You know clearly we did an awful lot in the price package harmonization efforts in the first half of this year.
A very consequential redo of our price package architecture and as I mentioned in my prepared remarks, we couldn't really talk too much about this and tip. Our hand in terms of you're not going to go public and say, we're going to stop promoting the category is currently running at about minus 1%.
I think thats, a reasonable forecast, we have been losing share as we've gone through this price package harmonization because of our significant.
Pull back on promotions as we went through it we are not in the shared donation business. So we would expect to be back exactly where we would like to be which is at a minimum growing with the category or staying right at the category at a minimum but what I would tell you is just to kind of reemphasize. Despite the challenges and headwinds in us cereal. The fact that North America was able to post a solid 1% growth. Despite this.
We're very proud of the team and what they've gone through and what they did to deliver that type of result, and I think it really again shows the strength of the snacks portfolio the frozen portfolio, the specialty portfolio and the different balance that we're achieving in North America and indeed around the world.
Thank you for that I just had one other question you talked about pushing some investment into the second half of the year, we had modeled some in the first quarter. They are kind of got pushed to the second quarter sounds like some of that's getting pushed to the third quarter. Now is do you have any frame of reference for how big that might be and I guess really where that focus as we also also of interest.
Not really a frame of reference, but I think the focus would be on Q3.
Because it's about.
What we've heard from the first half of this year into the second half we've got really good momentum.
In the topline we definitely plan on sustaining that so from a brand building standpoint.
We'll be looking at the third quarter is a good opportunity to take some of that shift from the first half of the year.
Okay. Thank you.
The next question comes from Robert Moskow with Credit Suisse. Please go ahead.
Hi, Thanks, I had a question about.
The transition services.
Guidance here and how it continues into 2020.
It does that mean that you are getting.
TSH income in 2020 and that will continue.
Or does that phase out eventually in 2020 and and create more dilution in 2020 I'm trying to.
I know we have dilution this year I'm, just trying to figure out how much to expect and next year and how it relates to that transition services.
Yes, so as I mentioned in my prepared remarks, we forecasted a negative four to five portfolio will be impact operating profit impact as a result of not having the divested brand profits for five months.
This impact may seem a little high but remember this was a very well integrated business.
And much of the indirect expense stays with us during the initial transition period before we can start reducing that dried up we are not going to give guidance on 2020 .
They will be an impact.
Nick in 2020, but we're working through that as we finalize the TSA agreements.
Now.
Okay. One quick follow up promotional spending on cereal you say you want to.
Put it back to normal will that put any pressure on your margins in the second half.
No I wouldnt expect that that puts pressure on our margins. There is a lot of noise in the first half because again it was such a consequential redo of our price package architecture, but you can you can think about us getting back to normal competitive.
Levels, and obviously for competitive reasons, we're not going to get into great detail around exactly what we're going to do.
Okay. Thank you.
Give me. The next question comes from Jason English with Goldman Sachs. Please go ahead.
Hey, good morning folks.
Real quick housekeeping I missed I missed your answer to how much income you're generating on T. assays per Rob's question.
Yes. So I think you just like we said for this youre right, though overall impact would be four to five.
On operating profit dilution of four to five.
And that includes what are the benefits, we're getting from the TSA This year.
Which are very small.
Okay. So there are negligible.
After the two assays are negligible alright, yes.
And it's going back to another question in terms of the cadence of investment.
I know last year was framed as an investment year. This year was framed again, it's an investment year to get the top line working congrats on getting the topline working by the way, it's great to see the sequential improvement and building momentum there.
I just it's unclear to me, where the investments are with SGN a coming in.
Substantially lower than last year and.
They have the same thing last year, we add SDMA coming in light.
What's driving the SGN a efficiency what's happening with your your your brand marketing expense.
And where is this investment going into.
Yes, Thanks, Jason I'd say a couple of things first we are lapping a significant step up that started in the back half of 2017 and as I've said in the past we feel pretty good about where we are from a brand building investment as a percentage of sales and will remain agile and we'll do the things necessary to put the right level of pressure behind the brands, but remember we're lapping a significant double digit increase from two years ago.
And so that's that's got something to do with the SG and officials. We've also got a reorganization that is coming through we've got overall.
Really good zero overhead growth.
Practices and good strict.
We've had good disciplines around overall cost and so that's driving good SGN efficiency and as I said some of it is deferred into the third quarter as well, but if the question is do you have enough brand building and you know.
How do you like where you're at I think we can point to our organic sales growth in all four regions and say that doesn't happen by accident. Obviously it happened because we put the right capabilities in place we put good pressure against good commercial ideas in place you're seeing that type of.
Results flow through on Cheez it on pop tarts on Pringles on Rx far in so we will continue we'll continue in that vein.
Okay. Thank you.
The next question comes from Laurent Grandet with Guggenheim. Please go ahead.
Yes, hi, good morning, everyone and welcome I mean.
Well just to pursue before on the last question. So you add that to the new from rocks I mean, the momentum building for brands like Pringles choosy than some others.
What are the key drivers of that momentum in your view I mean is it execution more marketing I mean.
So I mean did you get in penetration or repeat purchase like to understand better tools to better assess the sustainability of that momentum. Please. Thank you.
Yeah, Lauren Thanks for the question I would say, it's all of the marketing mix coming together in a really meaningful way.
Underpinned by excellent execution. So if you take a couple of examples of that Pringles.
In Europe , we are lapping the World Cup from two years ago. It would take a very good commercial idea to make that come to life and they came out with rice fusion as an innovation and gaming as a commercial idea and executed incredibly well and lapped.
Growth on growth and I'm talking about lapping strong double digit growth cheez. It in the United States you have snapped as a terrific innovation backed with very good commercial ideas coming through and you know and it's the right brand building that supporting those brands as well as innovation and then the on the go offerings, which we always said we are very under indexed in so it's targeting new channels and new occasions with the right commercial ideas the right innovation.
All bolstered by strong execution and so we've done that in a lot of our portfolio.
Showing through in all four regions, we recognize we still have work to do.
The number one item under construction is us cereal, but we're taking a meaningful and purposeful approach to that through the price package architecture.
And approaching it the same way that Weve approached all those other very big brands that I just mentioned.
Thank you I'll pass it on.
The next question is from Rob Dickerson with Deutsche Bank. Please go ahead.
Great. Thank you so just.
Quick question on a trajectory of the North America organic sales growth a into the back half I guess you know obviously, while we appreciate.
The result in Q2 was was great right year over year.
I think we do need to note that the year ago compare was obviously materially all but easier in Q2 relative to Q3.
As we I mean, sorry, Q2 relative to Q1.
So as we get into Q3, right. If you have a little bit more brand support maybe a little bit more innovations being pushed kind of back on track in cereal. So to speak like is that should we all be thinking that you know that this kind of 1% or low single digit positive growth trajectory should continue into the back half in North America or.
Should we also be taking under consideration just kind of what the compares are relative to Q2 and that's it.
Yeah no. Thanks for the question no we're not going to give any guidance on the regions and I would just reemphasize that we have a lot of confidence in a 1% to 2% reaffirming that top line guidance.
We feel very good about the north American business, what's happening in snacks, what's happening in frozen the R. Tech we're past the big disruptions in the first half and so we know we feel confident that the north American team is delivering and feel very confident that they will continue to deliver.
All right great. Thanks, Steve.
Thanks, Rob.
The next question is from Bryan Spillane with Bank of America. Please go ahead.
Hey, good morning, everyone.
Just two questions I guess relative to cash flow. One is just the the base business outlook for this year is now at at the high end So billion I know, there's a lot of sort of transient issues that will knock that down for this year, but as that billion still a decent sort of baseline that we should think about as we're looking forward.
And I guess second to that just I don't know if I saw it or not but just how capex changes now with the divestitures.
Yes, so I think I think that the billion is a is a good baseline and going forward.
And I think on Capex, you know that we we do the ongoing prioritization of Capex.
That you would expect us to do I think Steve mentioned, we're seeing good demand in some of our.
In some of our areas and so we have brought rising cap at capacity to service that demand.
But nothing nothing really significant in change from a capex standpoint.
Okay. Thank you.
The next question is from Steve Strycula with US. Please go ahead.
Hi, good morning.
So a question on two of your larger acquisitions from the past two years out multi prong party, how do we think about what multi pros growing I know, it's only a month of inclusion organic sales calculus, but it appears like there must be growing at least 20% right now and then what is really the strategy for growing multipro in parity on their respective markets that'd be helpful. Thank you.
Yeah, I'll start and turn it over to Ahmed who obviously is close to multi approach as you can get.
We are encouraged to strip out guidance or results on those but we're talking about strong double digit growth and what it really unlocks the similarity between parity and Multipro is it really gives us access to a broad based distribution with affordable locally relevant foods that resonate with the consumers air and allowing us to build our portfolio on top of that so that's that's a similarities between those two and the other similarities or both.
Outstanding countries to be in Nigeria, with 200 million consumers growing middle class vibrant.
The economy in Brazil, obviously.
Also a very very attractive emerging market. So we like both of those acquisitions. We think both acquisitions. We don't think we are confident both acquisitions will continue to do well they have done well I don't know if there's anything you want to add.
Just just to give you a little bit more color on on Multipro I think if you kind of step back and look at it I'd Africa strategy.
We've decided that all three economies in Africa, Nigeria, South Africa and Egypt.
We've made investments in all three that places us that places us really well.
In terms of the Africa opportunity going forward.
So let's start with that.
I think it will within Nigeria, which is the largest economy in Africa. We've made a number of investments. So multi pro is the distribution arm and the activation all.
We've also made an investment in newfield.
Which is a leading food company in Nigeria, It's the number one player in nodes, which is the number one package foods category in that country and we have close to an 80 shared in autos.
We've also set up a joint venture for cereal and snacks.
We've launched again old range of snacks.
We've put in a new manufacturing facility in Nigeria.
And you know that's off the already strong stock.
We see a big opportunity on snacks in that market. The snacks category is still forming.
To to shape that category in the next decade.
So multiple is one element a critical element of our overall win in Nigeria and win in Africa strategy.
Great. Thank you.
Your next question comes from Andrew Lazard with Barclays. Please go ahead.
Good morning.
And is it part of the revenue growth management benefits that you're seeing or is it really completely separate from that thanks. So much.
The transformation we had.
A very large number of different size SK use could not ship on the same palettes could not display on the same pallets and looked awkward on the shelf next to each other so it allows for cross brand promotion allows for better Shopability. Yes. There is a benefit in the factories, obviously when you take out complexity in the number of SK use clearly that's in there. So there is a lot of meaningful benefits that accrue to the moves that we've made but it really starts with the consumer first approach to making our brands simpler to shop.
Operator, I think we have time for one more question and that question will come from John Baumgartner with Wells Fargo. Please go ahead.
Good morning, Thanks for fitting me in.
Yes, I wanted to come back to price mix in promotion in North America, I understand the moving parts around the cereal business, but promo levels are also down across pretty much all the main categories in the portfolio and that's kind of been the trend for the past year or so so how much of that movement in promo outside of serial should we consider as kind of the new normal given the revenue management activities versus I guess, how much of it is just a more kind of programming and timing related.
Yeah, John Thanks for the question I think.
You, probably should think about a lot of it being timing related I wouldn't point to any meaningful change in the competitive landscape in North America in any of our categories.
We're happy that we're seeing stronger base sales that's coming from the brand building investments. The good innovation is the momentum in the brands I mean, when you have a brand.
A number of brands that are growing double digits, obviously, the retailers happy with that consumer is happy with that we're happy with that.
Allowing for that base business to continue to grow, but I wouldnt point to any significant.
Change in the competitive landscape.
We're just we're feeling very good about where our brands are relative to the momentum, particularly in snacks and frozen and a clear understanding of very clear right understanding of what we need to do in the U.S. cereal.
To get to a better a better place as well.
Okay, and then Steve just on that the positive 3% price mix in North America for Q2 can you give any clarity there on how that splits out between price and mix is the mix a tangible benefit at this point in time.
Yes, I think we're just a little bit.
Looking that up I think it's across its across price mix.
Yeah, pretty even yes fairly balanced between price and mix.
Great. Thank you.
This concludes our question and answer session and the conference is also now concluded. Thank you for attending today's presentation. You may now disconnect.
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