Kellanova

Good morning. Welcome to the Kellogg Company first quarter 2019 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 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&A session. Thank you. Please note, this event is being recorded. 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. Good morning, and thank you for joining us today for a review of our first quarter 2019 results and update of our full year 2019 outlook. I'm joined this morning by Steve Cahalan, our Chairman and CEO, and Fareed Khan, our Chief Financial Officer, who has announced that he'll be leaving Kellogg this summer. Therefore, we were also joined by Ahmed Benadi, who is on the call not only as our current president of EMEA, but also as our incoming CFO. 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, May 9th. The call will also be available via webcast, which will be archived for at least 90 days. As always, when referring to our results in Outlook, we will be referring to them on a currency-neutral adjusted basis, unless otherwise noted.

And now I'll turn it over to Steve. Thanks, John, and good morning, everyone. I think it's appropriate to start the call with our news of a transition in our Chief Financial Officer role. As you saw in our press release, Fareed will be leaving the company following the completion of our second quarter. Fareed has contributed mightily to the completion of Project K and to the creation and launch of our Deploy for Growth strategy. He has shown a real passion for growing our business, and he's been a valued partner to me and to our entire executive committee. So thank you, Fareed, for your service. We are fortunate to be able to name a fellow executive committee member, Amit Binati, to succeed Fareed. Most of you already know Amit, who has been a driving force behind the transformation of our Asia Pacific, Middle East, and Africa business. Not only does he have EMEA on track to more than double in size during his tenure, but he has diversified its portfolio, improved the margins of the base, and posted consistently solid results. What you may not know about Ahmed is that he earned his finance stripes early in his career, which makes him a particularly effective and financially oriented general manager. Because these two gentlemen have worked together for the past couple of years, and because Farid is staying on to ensure a smooth transition, you can be confident that this transition will be orderly and will cause no disruption to our plans, our results, or our transparency with investors. You'll hear from both of them momentarily. Turning to the quarter, I would describe our Q1 as on strategy and on plan. During the quarter, we took further decisive actions under our Deploy for Growth strategy. Some of these are listed on slide number six. For instance, we continued to shape a growth portfolio, reaching an agreement to sell cookies, fruit snacks, pie crusts, and ice cream cones to Ferrero. While it's never easy to part with solid brands and talented employees, We feel good that they're all going to a quality company. And for us, this divestiture will focus our portfolio on our biggest snacking categories and brands and improve our financial flexibility through a better margin mix and reduced debt. We reached an agreement expediently and will likely record a small gain on the sale. So, a very good outcome. Importantly, we continue to expand our emerging markets presence. Focusing on affordability and occasions, we have broadened our product line, both in foods and packaging. And recognizing the critical importance of distribution in these markets, we have bolstered our go-to-market capabilities and reach. As a result, our emerging markets had another strong quarter of organic net sales growth, and that does not even yet include the double-digit growth of our Nigerian distributor, Multipro. We also continue to invest in capabilities and processes. As you know, we reorganized our North America structure for a flatter, more nimble organization. As our new ways of working get refined, we should see greater agility and focus. We realigned global resources around key commercial priorities, and we invested money and resources into areas like digital and e-commerce. All of this requires investments up front, but will enhance our competitiveness. We're also on plan as described on slide number seven. Last year we invested in revitalizing key brands. We adjusted their positioning and their messaging. We ramped up their brand support and commercial execution. And it's working. Brands like the ones listed here did swing into growth or accelerate in 2018. This continued in 2019 with moderating investment behind these now revitalized brands, all according to plan. We spent the last couple of years enhancing our innovation capabilities and rebuilding a pipeline. In Q1, we launched a significantly greater quantity and quality of innovation than we have in years. It's early days, but as we'll discuss in a moment, these innovations are off to good starts. We also invested in PAC formats, such as retail-ready cases, harmonized PAC sizes in cereal, and on-the-go and affordability offerings around the world, just as we said we would. Also, as we previously communicated, we implemented revenue growth management actions in the marketplace across the globe and across our portfolio. Some of these actions started in late Q4, and some of them were implemented during Q1. Our international regions are showing solidly positive price realization already, while North America's is just getting going but turned positive already. As a company, we returned to organic growth in net sales in Q1. And this was despite some headwinds in North America. As we'll discuss in a moment, our recall of certain RX bars required inventory write-offs at our customers, pressuring net sales and profit. And we saw timing differences between shipments and consumption in certain categories, notably U.S. cereal. But behind these headwinds was good growth on core brands in North America, and our international regions continued to grow strongly. So we come out of Q1 on track for our first half and full year earnings estimates. And our full year guidance does not change either, save for layering on the impact of our already announced divestiture. So we're on strategy and on plan. Now let me turn it over to Freed, who will take you through our financial results and outlook in more detail.

Thanks, Steve. And good morning, everyone. Let me start by saying how much I've enjoyed my time at Kellogg and working with all of you. And I can assure you that you're in very good hands with Amit, and you'll continue to drive Kellogg in the right direction. Now to our results. Our Q1 results are summarized on slide number nine. Let's first recall how we had indicated 2019 would play out. We said that organic next sales growth would improve gradually as revitalized brands sustain momentum, as price realization improves, and as multi-pro anniversaries and contributes to organic growth in the second half. We said gross margin would be down in the first half, going to a tougher input cost comparisons, and the fact that our on-the-go price format margins remain a year-on-year negative until major corrective actions kick in during the second half. The result would be year-on-year decreases in operating profit during the first half returning to growth in the second half. And we noted particularly difficult year-on-year comparisons for tax rate during the first half, further adding to its first-half, second-half disparity on EPS. Q1 played out according to this script. Net sales grew year over year, including on an organic basis. Operating profit declined, as we said it would, because of higher input and mixed related costs. It actually came in a little ahead of our expectations, in part because of some investment that we delayed. EPS was where we said it would be, largely because of the below the line items we had discussed previously. This EPS was ahead of our expectations, though much of this was timing and effectively comes right out of Q2. Our cash flow came down with a lower net income, as well as the timing of tax payments and capital expenditures within the year. However, Q1 is a seasoning light quarter for cash flow. It's important to note that our cash flow in Q1 came in higher than we expected. Overall, these results put us right on track for the first half and four-year guidance we gave back in February. Let's go into a little bit more detail. Let's start at the top of the P&L with net sales growth in slide number 10. Obviously, much of our reported net sales growth came from the consolidation of MultiPro into our results. This will anniversary in early May, and Multipro's net sales will start contributing to our organic growth. A good portion of this was offset in Q1 by a particularly adverse currency translation. Due to a strong dollar year-on-year, the dollar, as you know, began strengthening in Q3 last year and even strengthened further in Q1. Importantly, we returned to net sales growth on an organic basis. Volume was down slightly year-on-year, owing mainly to shipment timing in U.S. cereal. Our price mix turned positive in Q1 as a result of revenue growth management actions we've been taking since late Q4. Every region posted positive price mix, and K&A's modest price realization would have been higher were it not for the write-offs of trade inventory related to the RX recall. So slower start because of the RX bar recall and the serial trade inventory decrease, both of which should be Q1-specific events. Both these events you can clearly see we are back on the road to steady organic growth. And our consumption trends confirm this. Now let's turn to our gross profit margin on slide number 11. As expected, our gross margin declined year on year. Let's look at each of the three buckets we've been using to explain this margin pressure. The first is mechanical. About 110 basis points of this decline was simply the mechanical impact of consolidating multipro, which was not in our P&L in the year-ago quarter. We will have one more month of this mechanical impact in April, after which Multipro will have a much smaller mix-related impact. The next bucket is what we call growth-related. As in recent quarters, this bucket was negative year over year. One driver was the RX bar recall, which is now behind us, but most of the growth-related impact in Q1 was related to the mix and cost impact of our shift towards emerging markets, and notably towards on-the-go pack formats in our North American snacks categories. We've talked about this in recent quarters, and you'll recall that that our strategy of pursuing single-serve led to an aggressive increase in on-the-go SKUs, along with an acceleration of demand for these products, and this resulted in sizable extra costs for redeployment, co-packing, and even repacking. We have taken steps to mitigate this impact, such as SKU rationalization and revenue growth management, but the bigger solves, such as centralized packing centers and repatriating some co-packed volume, don't kick in until the second half. The good news is that the impact in Q1 was as expected, and we expect to see less and less impact as the year progresses. The final bucket is what we call ongoing. As we've discussed previously, this turned negative this quarter because of input cost inflation and the comparisons with last year. While exchange-traded commodities have largely moved sideways in recent months, many of our very favorite hedges from last year have rolled over and we're experiencing accelerated inflation in fuel and various non-exchange-traded inputs. In Q1, we also faced our toughest comparison of the year as the year-ago quarter was the one quarter in which our COGS rate was not inflationary. This was all anticipated when we spoke to you back in February. The good news is that we remain confident in our gross margin that we'll get less and less negative as the year goes on. And remember, this will be driven by revenue growth management actions, many of which were implemented during Q1, efforts to restore margins on on-the-go items, which will have a larger positive impact in the second half, and easier comparisons for ongoing input costs in the second half. As we make our way to EPS, it's important to remember some of the drivers below operating profit. Some of these are shown on slide number 12 and selected to remind you that there'll be earnings headwinds in the year. The biggest headwind, of course, was tax rate. Our effective tax in Q1 came in at 20.5%, right in line with our full year guidance of approximately 21%. However, because of a sizable discrete benefit in the year earlier quarter, This was a significant drag on EPS growth in Q1, as we had forewarned. We'll face another comparison against a year ago discrete benefit in Q2. Interest expense, for example, was a €5 million headwind because the year-ago quarter did not yet have the borrowings for additional stakes in Nigeria. Going forward, the year-on-year increase in interest expense moderates as we lap this Nigeria investment, although the rates are somewhat higher. Other income is down year-on-year, as we've indicated, because of the impact on pension expense of higher interest rates and a pension asset base that declined sharply with the financial markets last December. This will continue to be a drag all year. Before we get into our guidance for the year, it's important to discuss the only element of our guidance that's changing, our pending divestiture. So let's go to slide number 13. We'll begin by making sure everyone is clear on what we are selling. While we are selling the Keebler brand in the transaction amongst other brands, we are not selling the entire business that we acquired in 2001. We're selling cookies, pie crusts, and ice cream cones collectively, which was a small portion of that acquisition, plus fruit snacks. We are not selling the larger, more profitable portion of that Keebler acquisition, which is crackers. To give you an idea of the size of the business we're divesting, we've disclosed previously that they generated close to 900 million net sales in 2018, and about 75 million of operating profit, including all indirect expenses. As Steve mentioned, we're very pleased that these great brands and the talented employees are going to a company of Ferrero's caliber. Now let's talk about the near-term financial impact of this divestiture. Slide number 14 reviews the details and the financial implications we disclosed in early April when we announced we had the agreement to sell these businesses. We are still anticipating a close of the transaction at the end of July. There's still details to be worked out, and we'll know more, obviously, in the coming months. Of the $1.3 billion sales price, we believe the after-tax net proceeds will be somewhere between $900 million and $1 billion. And our plan is to use all of it to pay down debt. This will enhance our financial flexibility. And all of this was disclosed back in April. So now let's turn to our full-year guidance in slide number 15. As we've mentioned, we're right on track for the guidance that we gave a few months ago, so no change to our pre-divestiture guidance. While we won't close on the divestiture transaction until the end of July, many of you have already adjusted your earnings models for this divestiture using the information we provided on our April 1st announcements. We're making no change to that estimated divestiture impact today. Everything remains on track. We can give you a little bit more detail on this divestiture impact, and it's shown on slide number 16. Let's take each metric in turn, assuming the transaction closes at the end of July, which means it impacts Q3 and Q4. Pre-divestiture currency neutral net sales is expected to be up 3.4%, as previously guided, but the divestiture would reduce this outlook by two to three points from losing the divested brand's net sales for the five months or so, depending on the closure date. There is no change to our outlook for organic next sales growth of 1% to 2%. Organic, by definition, excludes any divestiture impact. And while the absence of these businesses may improve our organic growth, it's a very slight impact over the next few months. Pre-divestiture currency neutral adjusted operating profit is expected to be flat per our previous guidance. But the divestiture would trim four to five points from this due to not having the divested brand's profit for five months. This impact may seem large relative to the true operating profit of these brands, but remember that much of the indirect expenses stay with us at least during the transition period before we can reduce them ourselves. Pre-devastator currency neutral adjusted EPS is expected to be down 5% to 7%, which has been our guidance. The divestiture, as we have shared with you last month, is expected to be less than 5% dilutive, which would bring the EPS decline to something more like 10% to 11%. It's too early to call the impact on cash flow. It'll depend on upfront costs related to the transaction, the transition of the businesses to the new owners, and any business realignment required after the divestiture. And we'll certainly keep you posted as we gain better visibility on this. These are the impacts for 2019, but let's review the longer-term implications of the divestiture summarized in slide number 17. Longer-term, this divestiture should have a positive impact on our long-term growth and return on invested capital. Firstly, these are businesses that have not been resourced as much as many of our other categories and brands, and they have declined in recent years. Divesting them adds to our underlying growth profile. Similarly, because these businesses collectively generated lower margins than our portfolio average, divesting them adds to our margin profile. There's also a benefit of simplifying our portfolio and our supply chain. We can reduce complexity with this divestiture, offering opportunities for efficiencies. We can also better focus resources on our biggest and most profitable brands. And finally, by using the proceeds to pay down debt, we can enhance our financial flexibility. This puts us in a better position to take advantage of high return opportunities to invest. So there's some very clear long-term benefits from making this transaction. In summary, we feel good about our financial position coming out of Q1. We're making good progress on top-line growth with our biggest brands and our emerging markets leading the way. We're starting to generate the price realization needed to offset cost inflation, and we are taking steps to mitigate the margin drag of our on-the-go price formats in the U.S. Our Q1 puts us right on track towards our original pre-divestiture guidance, both for the first half and for the full year. And there's nothing new to our full-year guidance, nor to the expected dilution from the divestiture. We're on strategy and on plan. So with that, I'll turn it back to Steve, who will discuss the performance of each of our regions. Thanks, Farid.

Among the many signs that Deploy for Growth is gaining traction is the fact that our improvement in top-line performance is broad-based. As shown on slide number 19, each of our four regions is showing undeniable improvement. Yes, North America was still down in Q1, but we've explained the unusual factors that caused that. Write-offs related to the RX bar recall, which is behind us, and the shipment timing in U.S. cereal. Even with these factors, North America is clearly progressing toward a return to growth. And look at the three international reasons. Europe accelerated its growth despite some very difficult developed markets. And Latin America and EMEA, home to most of our expanding emerging markets businesses, both sustained their recent accelerated momentum. Let's look at each region in turn. Let's start with North America in slide number 20. We knew Q1 could be challenging because of everything we were implementing in the quarter. For example, we moved into a completely new North America organizational design at the beginning of the year. Recall that this included the elimination of standalone business units, reshaping into specific category teams supported by total North America sales, supply chain, and support functions. This flatter and more focused organization will improve our agility going forward. Another major initiative, we launched the first phase of a pack size harmonization in cereal. This required working down inventories of the previous packs and getting the new ones on shelf. This isn't easy, but it will improve shopability in the aisle and our ability to cross promote brands. And thirdly, we were in the midst of a product recall for RX Bars. You may remember that this was related to a third party supplier and an ingredient that contained a potentially undeclared peanut allergen. We initiated the recall in December and then added SKUs in Q1, resulting in more write-offs flowing through net sales and delaying our restocking of shelves. The good news is that we made good progress and worked through these headwinds, as well as some trade inventory reduction in cereal, delivering only modest declines in net sales and operating profit. Importantly, we launched our largest wave of innovation in several years the outcome of investing in our capabilities and pipeline. We also implemented various revenue growth management actions that began to restore positive price realization even in Q1. And we delivered good sales and profit growth in specialty channels and in Canada. Let's take a closer look at each of our major category groupings in North America. We'll start with the biggest, snacks, shown on slide number 21. I mentioned the RX bar recall. It was an unfortunate event, but we're proactively ensuring quality control with our suppliers. The good news is that RX bars are back on shelf, and the latest four-week data shows ACV back above 70% where it was prior to the recall, and consumption up nearly 30% year on year. So this should be behind us. Excluding the recall impact, our North America snack net sales grew at a mid-single-digit rate year-on-year. Driving this strong growth is the momentum we've sustained in our biggest brands. Deploy for Growth has us executing stronger brand building and innovation for these world-class brands, as well as growing our on-the-go formats to win occasions. Look at the strong consumption growth rates of these revitalized top five snacks brands. Pop-Tarts returned to growth in the second half of 2018, and in Q1, we launched a new Bites line, which is off to a great start. Cheez-It accelerated its growth, and its new Snapped line is off to a good start as well. Rice Krispies Treats continues to grow, augmented by its new Poppers offering and aided by newly added capacity. And Pringles continues to grow, even on top of its year-ago acceleration, with New Wavy also off to a good start. We've talked a lot in recent quarters about how we aim to correct our under-indexing in on-the-go offerings, like immediate consumption packs and multi and variety packs of single-serve items. The chart here shows that our growth in these pack formats has continued to accelerate, even as we have taken actions to shore up their margins. So our North America snacks has underlying momentum. It's important to note that the top five brands shown in this slide account for more than 60% of our measured channeled snacks consumption. so their revitalization and growth is a very important sign that we can grow this business. Now let's talk about cereal, shown on slide number 22. We're disappointed by the start we had in North America's cereal. As I mentioned, we knew the transition of certain brands to the harmonized pack sizes would create some initial softness, particularly as we held off promoting those brands. In fact, during the first two weeks of January, our consumption was down 6%. but it was down only about 1% for the rest of the quarter, in line with the category during those remaining weeks. While our consumption trend didn't change much overall, our shipments definitely lagged in the quarter, suggesting a reduction in trade inventory. While sizable and fairly sudden this quarter, it is not uncommon to experience these timing differences. This is probably more related to previous quarter's timing differences rather than to any new trend. Among our brands, Special K had a very soft quarter. We knew it was lapping strong promotional activity in last year's Q1. It turned out to be the only one of our core six brands to lose share in Q1. And excluding this one brand, our overall consumption was flat and our share increased by 20 basis points. Outside of Special K, our adult-oriented brands gained share thanks to our efforts to emphasize simple health and other wellness attributes. Corn Flakes had another great quarter, and Raisin Bran and Mini Wheats also continued to rebound. We launched Happy Inside, a unique cereal that offers the digestive health benefits of having prebiotics, probiotics, and fiber all in one great tasting cereal. This will be a gradual launch, but it gives you a glimpse into how we are thinking about next generation wellness trends. In the taste fun segment, our big Frosted Flakes and Fruit Loops brands held share amidst heightened competitive activity, and we launched some promising innovation, notably Pop-Tart Cereal, Strawberry Rice Krispies, and honey nut frosted flakes, each of which is off to a good start. We recognize that we have work to do to stabilize our cereal business, but we're making important changes and there are signs of progress. So let's conclude our North America discussion with our frozen foods, shown on slide number 23. Frozen net sales were off about 1% year on year, but that compares against a year ago quarter in which its growth had accelerated to a strong double digit growth, both in net sales and consumptions. We're pleased that Eggo posted consumption growth in Q1 on top of that strong year earlier gain. We continue to grow our highly successful thick and fluffy premium waffle line. We grew our pancake business and we have exciting news with innovation on our core kid offerings. We will look to build on this momentum in Q2 with two exciting launches, a new higher protein offering called Off the Grid and a brand new thick and fluffy French toast line. Morningstar Farms is also lapping very tough comps. Innovation and good commercial execution is growing our business on the chicken-oriented segment, and we have more plant protein news and communication to come. We feel good about our frozen business. So overall, North America did run into some headwinds in the first quarter, but the underlying business continues to improve. Let's now talk about Europe, shown on slide number 24. Europe's consistent growth continued in Q1 with revenue growth management improving our price realization and good volume growth led by snacks. Pringles had an exceptional quarter. As you can see, we're well past comparing against the disruptions we had in early 2017 with the brand returning the solid growth on top of growth. Driving this growth has been a very effective marketing campaign around gaming. as well as the launch of Rice Fusion, a rice-based crisp with Asian-inspired flavors that is exceeding our expectations. We also returned our Wholesome Snacks business to growth. Transforming this business was a priority for us this year, and we've gotten off to a better start than we anticipated. Driving this turnaround are Special K, behind new protein offerings, Rice Krispies Squares in the UK, and the launch of Extra Brand Granola Bars in Russia. We also continue to expand our natural WK Kellogg brand into wholesome snacks. Our cereal sales continue to show the moderation of declines we realized in 2018, down only about 1% in Q1. The decrease was isolated to the challenging UK and France markets, despite good performance by focus brands like Extra, Crunchy Nut, and Crave Trezor. The good news is that we grew cereal sales virtually everywhere else in the region. An important element of our strategy is expanding our business in the emerging markets of Russia and Central Europe. Russian net sales in Q1 again grew at a strong double-digit rate, both in cereal and in snacks. In cereal, our consumption in Russia was up over 20%, gaining two points of share, aided by the introduction of extra brand granola. So we're pleased with our start in Europe and our progress on key strategic priorities. We also had another good quarter in Latin America, as shown on slide number 25. Growth was again led by Mexico, our biggest market in this region. Mexico's cereal consumption growth continued to accelerate, as shown on this chart, and we continued to gain share behind strong commercial programs, effective in-store execution, and continued expansion in high-frequency stores. In Brazil, there is no question that the 2016 acquisition of Paraty was a game-changer for us. This business continues to pose strong net sales, consumption growth, and share growth across not only biscuits, but also powdered juices and other categories. And it's helping us expand the rest of our portfolio in high-frequency stores. Across the region, Pringles continues to pose strong growth. Argentina is a relatively small market for us overall, but it is an important market for Pringles, and the economic and currency situation there certainly was a headwind. but we grew the brand in Latin America despite that, up double-digit outside Argentina. We had some incremental investments in Q1, so the region's profit decline this quarter was only timing-related. Latin America remains in a good position to continue to drive growth for the company. Now let me turn it over to Amit for one final review of EMEA. Amit?

Thanks, Steve. Let me first state how excited I am for the opportunity to succeed Fareed as CFO. Fareed has done a great job and he leaves the company in solid financial condition. It has been a pleasure working with him and I'm sure all of you have enjoyed working with him as well. I'll be working closely with him during our transition over the next couple of months and I look forward to meeting all of you in the coming weeks and months as well. So let's finish our Q1 review with our Asia Pacific, Middle East and Africa business shown on slide number 26. As you know, our Middle East, North Africa, and Turkey operations, which we call MENAT, were moved out of Kellogg, Europe, and into this region. This consolidates all of our Africa businesses under a single leadership. And what an exciting opportunity Africa is for us. Our MENAT business posted double-digit growth in quarter one, driven by growth in cereal, biscuits, and noodles. In West Africa, our operations with partner Tolaram continue to expand. Multipro, the West African distributor whose results are consolidated into ours, continue to grow at a double-digit clip in Q1. And not included in EMEA's net sales or operating profit, but equally exciting, is the continued growth of Doofel, the noodles manufacturer in West Africa, and the very strong growth in our joint ventures that manufacture and market Kellogg's brand of cereals, snacks, and noodles. Pringles continued its consistent growth, growing at a mid-single-digit rate, even before including the year-on-year growth of Meenat. With Meenat's growth, our region's Pringles net sales accelerated to a strong double-digit gain across the region in quarter one. The drivers of this growth remain strong commercial execution, geographic expansion, and the expansion of more affordable pack sizes. And we should mention Australia, the most developed market in this region. Australia's net sales were up in quarter one, with good growth in Pringles. And even excluding Pringles, we grew in Australia, continuing to show how we can stabilize and grow cereal consumption in a very developed market. So, another strong performance by EMEA. And with the portfolio and geographic expansion we are doing in a region ripe with population growth and economic upside, EMEA is going to be a growth driver for Kellogg for a very long time. And now, I'll turn it back over to Steve to wrap up.

Thanks, Ahmed. Let me finish with slide number 28. As I said at the outset of this call, we remain on strategy and on plan. During Q1, we continued to take major actions to improve the trajectory of our company, from reorganizing our biggest region to shifting resources and enhancing capabilities, from continuing to invest in the revitalization of our biggest brands to continuing to expand our reach and portfolio in emerging markets. We even took another major step in our efforts to reshape our portfolio with the agreement to divest our cookies, fruit snacks, pie crusts, and ice cream cones businesses. We are confident that these great brands and the talented employees that manage them are going to an outstanding new home in Ferrero. And we come out of Q1 on plan. Our top line improved despite some temporary headwinds, and we have every reason to believe it will continue to improve. Our profit performance keeps us on track for our full year guidance. This guidance does not change, nor does the impact of the pending divestiture, which we disclosed back in early April. Deploy for Growth is working. Our portfolio is being shaped towards growth, our brands are revitalized, our capabilities are being enhanced, and we're becoming that much more competitive in the marketplace. As always, I salute our employees for their dedication and hard work to make all this happen during a period of incredible change. Our people truly are our competitive advantage. And finally, we wish Fareed the very best in all of his next adventures, and we welcome Ahmed to his new role. 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 speaker phone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Again, please limit yourself to one question. The first question comes from Lawrence Grandet with Guggenheim. Please go ahead.

Hey, good morning, everyone, and thanks for the opportunity. I'd like to focus on SG&A. Significant improvement in SG&A in this quarter, despite you saying this quarter you will continue to invest significantly behind your brands. So how should we understand the first quarter performance? Is it just a phasing of marketing investment that has been pushed later in the year? Could you please give us more color here for the quarter and how we should think about SG&A going forward? Thank you.

Yes. And thank you for the question, Lauren. I'll start and maybe Fareed will build on it. From an SG&A perspective, it's important to note a couple of things. First, on a currency neutral basis, SG&A was down about 2% year over year. So currency did help there. Brand building was also down year over year. As you'll recall, we were lapping nearly a $50 million increase that we put into the first quarter of last year. And so we're lapping that. We also delayed some brand building investment particularly for RX during its recall, because you don't want to be advertising against empty shelves, for example, and also some capacity-constrained items in snacks and frozen, as well as the SKU changes that we're undertaking in cereal. Overhead increased mainly because of the multi-pro consolidation, and we continue to invest in capabilities such as RGM, e-commerce, integrated business planning, as well as the RX international expansion. But, you know, I'd close that by saying we feel good about our brand-building investment overall, again, lapping the big increase from the last quarter, pushing some of that into later in the year. And in general, we feel good about our SG&A performance, as well as the brand-building levels of investment that we have currently and in the plan.

Thank you very much.

The next question comes from Rob Dickerson with Deutsche Bank. Please go ahead.

Great. Thank you very much. Um, thank you for you too. Um, you know, kind of a question, uh, on gross margin. Um, you know, I, I don't think historically you've got the gross margin, but obviously the gross margin is a, you know, a large piece of the year, first half, second year, I mean, first half, second half, sorry. Um, so, you know, as MultiPro comes out, you know, after April, um, the single serve piece is supposed to be kind of, I think, shipped out kind of after Q2. Should we be expecting a stabilization in the gross margin as we get to the back half or the other buckets or the, you know, the gross-related bucket? Could that still potentially pressure the gross margin? And the reason why I asked Steve just to keep it simple is really, you know, obviously operating profit is still flat on the guide. You're investing up in the business, which is likely the right thing to be doing. But that gross margin piece, obviously, over a very long period of time, much, you know, before you arrived, just kind of continue to drift down. I just want to make sure, you know, the line of sight is that gross margins actually improve at some point. Thanks.

Yeah, it's free. Let me take that, Rob. So we expect sequential improvement in gross margin as we go through the year. And there's several drivers of that. You know, they'll come together. Let me just walk you through the main moving parts. The first is that we initiated revenue growth management actions sort of Q4 and Q1, and we expect that to flow through as we get into Q2. And there's evidence of that that you see in our price mix. The second thing is as we go deeper in the year, some of the year-over-year cost inflation that we saw starts to lap, and that will be less pressure on that sort of ongoing cost inflation bucket that we have You mentioned the mechanical impact of multi-pro. We've got one more month of that in the quarter. And on an ongoing basis, we will see a little bit of emerging markets mixed. We've got a much more focused emerging market strategy. We're putting bets on specific markets. But as those businesses build scale, we'll see margin improvement over the longer term. And the last thing is single serve. And we've always talked about how we can take some short-term things around single serve. We love the growth. We love the market opportunity. It's an under-indexed area for us. But the real fixes to the profit flow through that business is going to come from some of the supply chain changes. And as you know, we've put those initiatives in place. We've put CapEx up against those. But that's really going to be a second-half impact. So when you kind of put all those dynamics together, you get a line of sight around an improving market. gross margin pictures you go to. You're at a good exit rate.

Thank you.

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

Hey, good morning, folks. I guess I just want to follow up on Rob's question. I don't think you answered his question on whether or not you would expect gross margins to become stable or up as we progress through the year. I heard you a lot in clearance of sequential improvement, but is this sequential improvement into growth?

Yeah, margins are going to be improving as we go through the year, and we will see some growth coming, yes.

Yeah, you should anticipate us by the end of the year exiting the year with growth in gross margin.

Excellent. Thank you very much for that. And then I wanted to come back to Xero real quick. I appreciate some of the turbulence early on with some of your pack size reconfigurations. As we're looking – in the data, despite which we recognize there's ample imperfections there. A lot of your share weakness and frankly some of the categories weakness suggest it could be due to promotional intensity. Promoted sales are down a lot. I suspect that reflects a slightly more subdued level of merchandising out there. As you work your way through this transition, should we expect the promotional intensity, the merchandising intensity behind the category to improve? If so, are you expecting this to be an enabler of not only your market share improvement, but hopefully some of the category trend improvement as well?

Yeah, Jason, what I tell you is a couple of things. As we went through this whole transition, we essentially deprioritized promotions in the first couple of weeks of the year, obviously because we're going through this transition, and that's where we saw our steepest drop. You should expect to see a return to what I would call normal in terms of promotion activity, merchandising effectiveness as we continue to go through the transition.

And what is the timing there? You mentioned this is first phase. Do we have another phase? So in other words, could this transition, how long does the net transition span?

Into the middle of the year. And so we've done our adult portfolio. We'll do our kids portfolio next, or the other way around. Sorry, we did our kids portfolio first. We'll do our adult portfolio later. And so there'll be some turbulence, but we learned a lot going through the first phase that will apply into the second phase.

Thank you so much, guys.

The next question comes from Alexia Howard with Bernstein. Please go ahead.

Good morning, everyone. Can I stick with this question of pricing dynamics in North America? It may be to do with the promotional changes calendar that you just described, but the on-shelf pricing is over 3% in on-shelf measured channels in North America across the portfolio, and yet you did only see about 0.2% price mix improvement in North America. If retailers continue to manage some of these products with faster on-shelf price growth, then you're able to realize how will the volume trends improve if you're having to peddle against those higher on-shelf prices. And I guess linked to that, just a quick question on cereals. Are you seeing any destocking in cereals? We've heard that from other companies as part of the reason that the shipments were behind the takeaway on the cereal side. Thank you.

Yeah, thanks for the question, Lexi. A couple of things. First, I tell you, our Q1 price realization in North America was blurred by the RX bar recall, which was about a full point in pricing. So you'd expect to see something above 1, closer to 1.2, without that. The other thing is in serial and the rest of the portfolio, we did take pricing in Q4 and Q1. We're expecting that to flow through later, essentially in Q2, not much flowed through or not as much flowed through in Q1 based on protecting promotions and things that are very standard in terms of you take a price but you have promotional activity booked in the first quarter. So you should see that happening. And the last part of your question, if you look back over time, both from an average number of SKUs and ACV-weighted distribution, there has been virtually no change in serial for the last several years. And then one additional point in terms of trade inventory, we did see a reduction in trade inventory for cereal, which we're expecting not to be a trend, but it looks to be kind of a one-off. So hopefully that answers your question.

So in terms of the retailer on-shelf pricing, do you have control over that, or are you worried that they're taking pricing up more quickly, or is that just not a concern?

We do not control retail pricing. We never have, and retailers, it's up to themselves. But we have, you know, you will see us having more price realization flowing through our P&L in the second quarter and beyond.

Thank you very much. I'll pass it on.

The next question comes from Chris Grohe with Stiefel. Please go ahead.

Hi, good morning.

Good morning.

Hi, I just wanted to ask a quick question, a bit of a follow-on. With SG&A being down in the quarter, As I was just thinking back to some of your commentary from the fourth quarter call, you did talk about a heavier innovation pipeline in the first half of the year. I guess I'm trying to understand, is there more marketing perhaps to come in the second quarter as part of your investment behind these new products? If I could just add to that, as you make investments and capabilities and that kind of thing, and those were a heavier expense in the second half of last year, and those would theoretically flow through this year. Are those more SG&A or cost to get sold, and where are those investments falling? Are those kind of in line with what you expected?

Yeah, I'll start, and I'll let Fareed build. We do have good support around some of our innovation launches, and we feel very good about that. If you look at just a couple of them, Cheez-It, Snapped, Pop-Tarts, Bytes, both over close to 60% ACV distribution with velocities greater than their categories. So the support that we're putting behind them is clearly working. The biggest change in SG&A, as I mentioned, was pushing out some of the RX spend into later in the year due to the recall. We do continue to invest in capabilities, a lot around RGM, a lot around business planning, and that should continue throughout the year. But when we look at our overall performance, brand building levels. As I mentioned earlier, we feel good that the very significant step up that we started in 2017 and into 2018 puts it at about the right base level in terms of what we should expect going forward. We want to maintain our agility as we go forward, but we see good support around the investments that we're making in innovation and we're seeing that very successfully in the marketplace.

And the only thing I'd add is that our investments against the brands, we're taking a very nimble approach. We like what we're seeing with the big brands and the in-market performance. And so we can react when RXBAR recall, for example, and pivot some of that investment. We also have, through Project K and through some of the organizational changes that we've talked about in North America, savings coming through, and that's what's allowing us to fuel some of the reinvestments, the list that Steve gave, and I'd also add to that analytics and digital and international RX expansion as well.

And so would you expect SG&A to be down? You had some nice statements there last year. That sounds like it should be down again this year, even with some spending being up. Is that correct?

Well, I'd put that in the context of our overall guidance, and, you know, we'll continue to see savings come through. We'll make targeted investments, brand building. You know, there's a little bit of phasing there, but I think generally the sort of first half, second half, it'd be pretty close to how we frame the full year before the recall.

Okay. Thank you. The next question comes from Robert Moscow with Credit Suisse. Please go ahead.

I'm going to try to sneak in two questions. One is when we take a look at second quarter, I think you said that you would shift some of your investment spending out of first and into second. How should we think about earnings and profit growth as a result in second quarter? Will it be down versus a year ago? And then a broader question about spending at the retailers. In your brand building, do you include the money that you give to retailers for digital commerce and the omni-channel kind of efforts that they have, the advertising on those omni-channel efforts, I understand that the retailers are pushing harder and harder for more resources in that regard. Thanks.

Yes, so as we said in the prepared remarks, Rob, much of the brand building will be shifting into Q2, right? So you should think about the guidance that we've given in terms of first half, second half as remaining the same. In terms of the way we spend with retailers for competitive reasons, we're not going to get too much into the detail. But retailer data, if it's good data, we will engage with them, right? And so we're looking always at the ROI of our spend. And if you look at some of the, you know, retailers with excellent data, and I mean consumer shopper data, you combine that with our shopper data combined with our consumer data, you know, one plus one can really equal three. So I look at it as, you know, the continued digitization of the opportunity to engage with consumers. And where we can make good investments, we'll make those good investments. But, you know, it'll be our choices.

And just to build on sort of the operating profit sort of outlook for the year without getting to specific quarters, that whole gross margin conversation that we had I think is very applicable to this topic as well with the caveat of sort of the brand building, which is kind of a Q1, Q2 dynamic. But if you go back to that whole dialogue about gross margin, that's sort of a similar shape to OP as well. Thank you.

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

Hi. Thank you. Marie, best of luck to you. Thanks for all your help. Thank you, Ken. Steve, you said Special K had a very soft quarter. I just wanted to pick your brain a little bit on your thoughts on this brand, which I think was supposed to be doing much better by now. Was the corporate weakness a little bit of an anomaly, or is it something where you're actually rethinking the strategy that you're applying to it at this point?

Thanks for the question, Ken. I wouldn't say we're rethinking the strategy so much as we were lapping a very, very strong promotion in the first quarter of 2018, and we decided not to put that level of investment against it. We still have work to do on Special K in the United States. We're learning from some of the successes we've had in Australia, New Zealand, and the United Kingdom around Special K to get that brand to stabilization. But we think about the opportunities in cereal as a total portfolio. And so if you look at some of the other adult – I mean, consumption on Corn Flakes was up nearly 22% in the quarter. Raisin brand was up almost 5%. Mini Wheats was up almost 1%. And so we're making good progress in a number of our big brands, and we still have to fix Special K. And we're bound and determined that we will do it. But we have to think about portfolio investments and getting the most out of our serial business, and that includes all of our brands.

Thank you.

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

Hey, good morning, everyone. I'm going to try to just get one clarification and then a question. On other income, Fareed, I guess we're still guiding for it to be down because of the value of the pension assets. But with the markets up as much as they are, is there a chance that that will get re-measured at some point and potentially be less of a drag?

Yeah, unfortunately, we'll re-measure once a year. And that's the end of Q4 measurement. And those assumptions on the returns stick for the full year. And then we'll re-measure it again. So it's a fixed assumption as we go through. Now, as we re-measure it, that will have a different dynamic.

Okay, thanks. And then, Steve, just a bigger question. There's been a lot of energy around the plant-based meat alternatives recently. You've got a couple of companies that are really emerging with, I guess, next-generation products. So as you look at Morningstar and you evaluate, you know, I guess the market opportunities, is there a potential that you'll begin to maybe look to flex more resources there? as a way to enter that market, you know, as it evolves?

Yeah, thanks, Brian. It clearly is an exciting category. It's been much in the news. We're excited about where Morningstar Farms is. You know, as I mentioned on the prepared remarks, we've got a lot happening in chicken, but we see a lot of opportunity to do things beyond that. And for competitive reasons, I wouldn't get much into that except to underscore, you know, what you said. It's an exciting space. It's a space where we feel like we have the right to win. You know, you've heard us talk about ourselves being kind of the original plant-based protein company. We believe that. And so we'll continue to innovate in that space. And I would just say, you know, watch this space. Okay, great. Thank you.

The next question is from Priya Origupta with Barclays. Please go ahead.

Thank you so much for the question and best of luck. Just a quick question on the debt pay down comments using the divestiture proceeds. I was hoping you could give us some context as to how to think about prioritization in using those proceeds. You do have some maturities later this year. Would those be first and foremost or would you look to perhaps bring down some of the higher coupon debt that you have to help with interest expense. Thanks.

Yep, so many of those factors would go into our thinking. As you know, we've got some maturities that are coming up in in the near term, but we would look across the entire profile and make those best choices. I don't want to give any specific tranches that we would or wouldn't go after, but it's a balanced approach, and optimizing both the maturities and interest, all that would factor into our decisions.

Great. Thank you.

The next question is from David Driscoll with Citi. Please go ahead.

Great. Thank you, and good morning. For me, I'd just like to say thanks for all your help. And, Amit, welcome to the new job. I wanted to ask a little bit of just a clarification on divestitures and then a question about the on-the-go snacks. The divestitures, I think you presented information that it's 4% to 5% dilutive this year, but it's just a partial year. But then in another slide, the full 12-month dilution stays at just 5%. I assume this relates to the timing and the use of the proceeds. Can you just clarify here, you know, just on the surface, the numbers are the same, even though it's only, what, five, six months dilutive or gone this year, whereas the full 12 months next year?

Yeah, so you're right, David, Farid. So, you know, it's more of an impact in 2019, and it's really those dynamics around, you as the business goes, the costs that stay, the transaction support for the buyer, for the business, and that all factors into it. So you're right in terms of the way that's weighted across 19 and into 20.

All right. The follow-up question or the main question is just on the go. Obviously, last year, you had a surprise on the margin structure of that business. And I think your comments about gross margins are probably a portion of the answer. But I want to be real specific here. Are you on track for the insourcing of these on-the-go products? And Steve, I'd just like you to comment. You've got all these new products in Snacks. You've got the the size change going on in cereal in North America, and you've got the insourcing of all these on-the-go products. There's just a lot of complexity. And for me, this is an executional question for the organization. How do you feel about all these things happening? And then specifically, are we on track for the on-the-go insourcing?

Yeah, David, thanks. The short answer to your question, yes, we are. In Q1 and Q2, it's really about skew rationalization and revenue growth management. In Q3 and Q4, it's around centralized packing sites getting opened, and so therefore repatriating that volume inside. And so we're very confident that we have a gross margin path towards, you know, this is part of it, but an important part of it where I said, you know, we'd exit the year on a path towards gross margin growth. So the answer to the question is yes. And we continue to see outstanding growth, as you saw in one of the slides, in those on-the-go packs. In terms of overall, like, the innovation and the complexity and all the things that we're doing, we feel very confident about that. And, you know, if I just, you know, I threw out some numbers before, but if you look at just the consumption in the United States in Q1 on the big brands that we're investing against and innovating around, Pop-Tarts was up 14%. Cheez-It was up over 12%. Rice Krispies Treats was up 8%. Pringles was up over 4%, and so forth and so on. So these are the brands that we said we're going to invest in around our Deploy for Growth strategy. These are the brands that have the on-the-go pack formats, and these are the brands that have the new big innovations. And it's working. It's working in the marketplace. and therefore we're going to continue to focus on that. And it's not about proliferation. It's about innovating around the big brands from a pack format, but also from an innovation food format. And we feel good about what that's giving us in the marketplace.

Thanks for all the detail.

Operator, I think we only have time for one last question.

And that question will come from Eric Larson with Buckingham Research Group. Please go ahead.

Yeah, thank you, everyone. And good luck to you for Reed as well as Amit. Looking forward to working with you now as well. So, you know, Steve, the follow-up question here that I have is, again, on snacks, which is really working for you. And you're a bigger snacking company today than you're a cereal company, and so this is important. Now, the goal of changing your DSD was to free up, you know, the resources, the marketing resources, so that you can invest against the brands. And I think you sort of lapped, I think mid part of last year, you finally lapped all of that conversion process. So my question is, you talk about spending all, are we still looking at a, a significant year-over-year increase in, let's say, your advertising slash promotional investment in North America snacks? Are we halfway through that, and this year still can – I'm just trying to gauge the great sustainability you've got here of the top-line momentum.

Yeah, thanks for the question, Eric. We have fully lapped the DSD transition. and that includes the investments that we shifted from DSD capability into brand building. And so, as I said before, we're going to maintain our agility, but we feel like we have the right levels of investment against the right brands. And it's working in the marketplace. It's showing good consumption growth against those brands that I just rattled off. And you can look at the same Nielsen numbers we look at when you look at things like conversion of feature and display. You know, we feel good about the way we're executing in the marketplace in a post-DSD world. So fully lapped, right levels more or less of brand building against those brands and good execution in the marketplace, and the consumption is showing that it's working. Okay, thank you.

Operator, I think that's all we have time for.

This concludes our question and answer session. I would like to turn the conference back over to John Renwick for any closing remarks.

Thanks, everyone, for your interest, and I am around all day, so give me a call. Thanks.

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