Kellanova

Good morning. Welcome to the Kellogg Company's third quarter 2020 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session with publishing analysts. 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 third quarter results, as well as updates regarding our outlook for full year 2020. I'm joined this morning by Steve Cahillane, our chairman and CEO, and Amit Banati, our chief financial officer. Slide three shows our 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. This is of particular note during the current COVID-19 pandemic, when the length and severity of the crisis and resultant economic and business impacts are so difficult to predict. A replay of today's conference call will be available by phone through Thursday, November 5th. The call will also be available via webcast, which will be archived for at least 90 days on the investor page of KelloggCompany.com. As always, when referring to our results and outlook, unless otherwise noted, we will be referring to them on a currency-neutral basis for net sales and on a currency-neutral adjusted basis for operating profit and earnings per share. And now I'll turn it over to Steve.

Thanks, John, and good morning, everyone. I hope you and your families are holding up well in these turbulent times. Here at Kellogg, to get through this crisis, we are executing well against our key priorities during the crisis. We remain vigilant and active in keeping our employees safe, which remains job number one for us, and our employees have handled this extremely well. We continue to supply the marketplace with our foods, with no major supply disruptions and service levels gradually improving in the quarter. We continue to aid our communities with significant cash and food donations, not to mention the time our employees have generously volunteered to various initiatives and causes. And amidst very uncertain economies and financial markets, we have effectively preserved and improved our financial flexibility. These have been our priorities throughout the crisis, and we are executing very well against them. From the standpoint of financial results, we had another strong quarter with some highlights shown on slide number six. First, our results came in stronger than we expected. We posted another quarter of strong organic net sales growth with a good balance between volume growth and price realization and with growth across all four regions and across all four major category groups, cereal, snacks, frozen, and noodles. We expanded our gross profit margin as price, volume, and productivity more than offset sustained high levels of incremental COVID costs. And as we said we would, we shifted brand building investment from the first half into the second half, resulting in a double-digit year-on-year increase in quarter three. We generated better than expected profit and earnings in the quarter, and particularly important in an uncertain economy, we generated better cash flow than we anticipated, allowing us to further reduce our net debt. Second, our emerging markets continue to exceed our expectations in spite of challenging COVID and economic conditions. We generated double-digit organic net sales growth in both Latin America and EMEA. Across all of our emerging markets, we collectively recorded double-digit organic net sales growth in cereal and noodles, and we grew snacks at a high single-digit rate despite their on-the-go orientation their reliance on traditional trade that's been more disrupted by COVID, and being a more discretionary purchase in difficult economic times. The strength of our portfolio, the diversification of our geographies, and the experience of our management teams are clearly on display. And third, we've continued to perform well in market. As expected, at-home consumption growth for packaged foods in general decelerated across the quarter, and our categories were no different. The good news is that year-to-date we have held or gained share in markets that represent almost three-quarters of our annual net sales in measured markets. Most notable in quarter three was the United States, where we gained share in five of our six primary categories, in Europe, where we gained share in cereal across most of our major markets, and in EMEA, where we gained share of cereal in 11 of 13 major markets. Clearly, our brands and our brand building are resonating. And even in away-from-home channels, which remain soft during this pandemic, we gain share in most of our categories in the U.S. We also like how we're performing in e-commerce, an area in which we've invested in capabilities in recent years and in which we continue to grow rapidly, outpacing our categories in key markets. So we are winning in the marketplace and delivering better-than-expected financial results in the process. Turning to slide number seven, this sustained strong performance puts us in a good position to finish the year, not only with strong results and financial flexibility, but also with investment for the future. Let's take each in turn. First, we're again raising our full-year guidance based on the strength of our better-than-expected third quarter results. As Amit will explain, we are raising our guidance for full-year organic net sales growth currency-neutral adjusted basis operating profit and earnings per share, and cash flow. It's been a lot of work, but we're headed for a very strong year. Second, we continue to invest for the future. Our brand-building investment will be up double digits again in quarter four as we continue to reinvest funds that were delayed from the first half during the pandemic on top of what had been planned for quarter four. Now is the time to communicate with consumers who discovered our foods during the pandemic. Now is the time to emphasize new messaging around certain brands. Now is the time to further develop our master brand approach to advertising multiple brands in certain international markets. And now is the time to invest behind the launch of new brands like plant-based incognito from Morningstar Farms in the U.S. and market expansion of brands like Cheez-It in Canada. On top of that, we're investing in capabilities, such as in e-commerce, in packaging capabilities, and in capacity. Simply put, we are taking actions now to emerge from this crisis a stronger company and with increased confidence in our trajectory for consistent, balanced growth. We're seeking to retain incremental households. We're building on our strength in e-commerce, and we're ensuring that our emerging markets remain engines of growth for us. We're also strengthening our financial flexibility and delivering increased earnings this year for our share owners. So with that, let me turn it over to Amit, who will take you through our financial results and outlook in more detail.

Thanks, Steve. Good morning, everyone. Slide number nine summarizes our results for the third quarter and first nine months. As Steve mentioned, our third quarter results came in better than anticipated. particularly on operating profit and cash flow. Net sales benefited from elevated at-home demand during the crisis, though this clearly moderated across countries and categories over the course of the quarter and was partially offset by continued softness in away-from-home channels. An important highlight of the quarter was the strength of our emerging markets, whose return to double-digit growth came significantly. despite very challenging conditions, including economic and COVID impacts on the traditional trade. Operating profit increased on a reported basis because of a reduction in one-time charges, now that recent years' substantial restructurings are largely behind us. It declined on an adjusted basis because of the absence of businesses divested last year, as well as higher expenses for performance-based compensation and a significant planned increase in advertising and consumer promotion. Operating profit declined less than we expected, in large part because of our positive performance in net sales and gross profit margin. Earnings per share declined with operating profit, along with an effective tax rate that was higher than last year, as expected. And cash flow continued to come in better than planned, bringing our year-to-date cash flow above what had been our forecast for the full year. A reflection of our elevated earnings, reduced restructuring outlays, good working capital management, and capital expenditure that has been delayed during the pandemic. Let's take a look at these metrics in more detail. We'll start with net sales growth and slide number 10. While moderating from recent quarters, currency translation was a negative impact of about 1% in the quarter, largely due to Latin American currencies devaluation against the U.S. dollar. Last year's divestiture of our Keebler cookies, pie crusts, ice cream cones, and fruit snacks anniversaries at the end of July. So we had one month of impact in the quarter, pulling down net sales by just under 2 percentage points. organic net sales growth was 4.5% in the quarter. We had anticipated a meaningful deceleration from last quarter's 9% growth. And sure enough, we did indeed see a moderation in at-home consumption growth across our categories and continued softness in away-from-home channels and on-the-go products. Nevertheless, this quarter three organic growth performance was very promising. It was driven by organic growth across all four regions and across all four global category groups. It also featured a better balance between volume and price mix, and it was supported by consumption growth and share gains in key categories and markets, in turn buoyed by effective brand building activity. Now let's turn our discussion to profit margins with slide number 11. Going into the quarter, we had assumed that gross profit margin would contract a bit in quarter three as we anticipated less net sales growth to cover sustained incremental COVID costs. However, our gross profit margin ended up expanding slightly as growth, productivity, and price realization more than offset a resumed mixed shift towards emerging markets including Multipro, our distributor business in Nigeria. We expect to see gross profit margin to expand modestly again in quarter four, and therefore for the full year, despite sustained incremental COVID costs. Another important impact on our operating profit margin was our increase in brand investment. Back in July, we discussed the postponement of advertising and consumer promotions during the height of the pandemic in the first half, and our intention to reinvest those funds into brand building during quarter three and quarter four. The slide shows that delay in advertising and consumer promotion during quarter two, and how it was followed by a double digit increase in quarter three, along with a similar double digit increase planned for quarter four. This, along with an increase in expense for performance-based compensation, was the primary driver of our operating profit decline in quarter three, and will be again in Q4. Below operating profit, our interest expense remained below last year as expected. Other income, which is predominantly related to our pension plans, remained higher year-on-year also as expected, reflecting the impact of higher asset valuations at the beginning of the year. These favorable items were more than offset at earnings per share by a higher effective tax rate and an increase in average shares outstanding as we continue to refrain from share buybacks to prioritize financial flexibility during the current crisis that brings us to cash flow and capital structure on slide number 12. a lasting impact of this year will be the stronger than projected cash flow enabling a faster than expected reduction in net debt as shown on the top graph Our cash flow this year has significantly outpaced that of the past couple of years, even beyond lapping unusual outlays in each of the prior two-year-to-date periods. As I mentioned, this is a result of higher-than-expected adjusted basis earnings this year, as well as the fact that we have gotten past the major restructurings and reorganizations of the last few years, which had required significant cash outlays. but it also reflects our effective management of co-working capital and the capital expenditure we've had to prioritize or delay during the pandemic so as to not impede capacity utilization in any way. This cash flow has enabled further increases in liquidity and further reductions in net debt as shown on the bottom chart. Strong liquidity and lower net debt against stronger cash flow give us enhanced financial flexibility. Let's now discuss our rest of year outlook, starting with slide number 13 and our planning assumptions around the pandemic for the fourth quarter. While the direction of the pandemic remains uncertain, we are making certain planning assumptions. To that end, we assume that at-home demand growth will continue to decelerate, while sizable away-from-home sales declines moderate. These are simply continuations of trends we have seen in recent months. The reason we assume our away-from-home sales will take longer to stabilize is because of our waiting in segments like schools and travel and lodging, which are expected to take longer to recover. We also assume that growth in emerging markets will decelerate amidst COVID-related economic softness, as well as some unusual market-specific factors in quarter four, such as school food programs being shut down in North Africa and the impact of new labeling regulations going into effect in Mexico. And finally, there is the investment that we delayed from the first half. Just as in quarter three, this first half funding will be implemented during quarter four on top of previously planned activity. The result should be another double-digit increase in advertising and consumer promotion in quarter four. Slide number 14 shows what this all means for our full year outlook. As Steve mentioned, we are once again raising our guidance for the year. This time to reflect our better than expected quarter three results. Less any timing related factors from that quarter and less some incremental investment that we are adding to quarter four. Our full year guidance shows for organic net sales growth improves to just about 6% from our previous guidance of around 5%. This reflects a better than expected 4.5% growth in quarter three and a modest increase to our outlook for quarter four. So the latter still assumes a deceleration for the reasons we just discussed. Our full year guidance for currency neutral adjusted basis operating profit improves to growth of approximately 2% from our previous guidance for a decline of about 1%. This positive swing reflects our better than forecast operating profit in quarter three with some timing related shifts in costs into quarter four, along with the incremental advertising and promotion and other costs and investments I just described. This drives a similar increase in our full year guidance for currency-neutral adjusted basis earnings per share, which goes to growth of approximately 2% from previous guidance for a decline of about 1%. Our guidance for cash flow increases to 1.3 to 1.4 billion, a substantial improvement from our previous guidance of approximately 1 billion. This reflects our stronger-than-expected delivery in quarter three, let some elements that are likely timing related, such as capital expenditure delayed from earlier this year. Putting it all together, we're in position to finish 2020 with a strong financial performance, featuring a good balance of growth, profitability, investment, and cash generation. And we'll enter 2021 in a very solid financial condition. And with that, let me turn it back to Steve for a review of each of our major businesses.

Thanks, Ahmed. Let's begin with North America in slide number 16. As we had expected, and as you've seen in the scanner data, at-home consumption growth decelerated throughout the third quarter, while away-from-home channels saw some moderation in their steep declines. The result for our North America region was just under 3% organic net sales growth in quarter three. Note, while we experienced a continued, though moderating, double-digit decline in away-from-home sales, as expected, the rest of North America business turned in a solid mid-single-digit growth performance. And while our deceleration from Quarter 2's surge was inevitable, we're very pleased with how we performed within our primary categories. In Canada, we grew consumption in all six of our primary categories, including gaining significant share and distribution in crackers with Cheez-It. In the U.S., we held our gain share in five of our six primary categories at retail, as well as in the vast majority of our categories in measured away-from-home channels. We'll visit these key U.S. categories in more detail in a moment, but this in-market performance is a key reason we're confident that we are strengthening our business amidst this crisis. Household penetration and buy rates have increased across our categories since the pandemic began, and we are focused on retaining as many of these consumers and occasions as we can. This relies on effective marketing and sales execution, of course, but it is also dependent on our supply chain to get food to the marketplace. Our plants are running well, still focused on throughput and still up against capacity in certain categories and food forms, requiring tremendous agility. Our supply chain clearly has risen to the challenge. Operating profit decreased as planned in quarter three as brand investment was shifted out of the first half and into the second half, and as we had less incremental sales to cover sustained levels of incremental COVID costs. But North America is on track for a very good year of net sales and operating profit growth. Let's take a quick look at each of our three major category groupings in North America, starting with our largest, snacks, on slide number 17. North America's snacks continued to post strong growth, even if at-home demand decelerated from quarter two's highs. and away-from-home channels and on-the-go pack formats remained in decline. In the U.S., Pringles continued to post double-digit consumption growth, holding share despite continued softness in on-the-go pack formats as expected. In crackers, we continued to outpace the category's solid mid-single-digit growth in the quarter. Cheese had snapped. continues to grow strongly in its second year, supported by recently added capacity, while accompaniment-oriented cracker brands, Club, Townhouse, and Cars have collectively gained share as well. In portable wholesome snacks, the category remains pressured by reduced on-the-go occasions during the pandemic. And while this has impacted on-the-go brands in our portfolio like RX and Kashi, we've been able to gain share on the strength of our growing Pop-Tarts and Rice Krispies Treats brands. So our snack brands business is in great shape. Now let's turn to North America Cereal and slide number 18. Our North America Cereal net sales grew again in quarter three, though reflecting a deceleration in the category in retail channels and continued declines in away-from-home channels. But what is so encouraging is what we're doing within the category. In U.S. measured retail channels, we again outpaced the category. And we did it on the strength of renewed advertising support and refreshed messaging for brands like Special K and Mini Wheats, and on innovation like Jumbo Snacks and Mashups that have helped us lead the category and share of innovation this year. We have added more household penetration during the pandemic, and we've held on to more of it than the category. And the same goes for buy rates. Our enhanced data and analytics give us the ability to target the right consumer and occasion with the right messaging for that consumer and occasion, and we're seeing the results. So we're executing well in North America cereal. We're also executing well in North America frozen foods, shown on slide number 19. Our North America frozen foods categories didn't decelerate as much as cereal and snacks during quarter three, and as a result, we continue to deliver high single-digit organic net sales growth. and that is despite capacity constraints and declines in away-from-home channels, as well as the phasing out of certain non-core product lines. Our core businesses are performing very well. In U.S. retail channels, our Eggo brand grew consumption by almost 13% in the quarter, with strong growth in waffles, French toast, and pancakes, and continuing to gain share. Our Morningstar Farms brand grew consumption by nearly 18%, trailing the frozen veg vegan category's exceptional growth as we ran up against our capacity. Morningstar Farms' meat alternative sub-brand, Incognito, was launched during the quarter. It's early days, and we're still building up our distribution, but we have launched burgers, sausage bratwurst, and ground beef into the refrigerated aisle. And into the frozen aisle, we've launched Disney-shaped chicken nuggets, the first kid-oriented offering in this plant-based category. We are expecting a gradual distribution build, and we're confident about our food, branding, and breadth of offerings. So, like our other North American businesses, Frozen Foods is performing very well. As we look to the remainder of the year for Kellogg North America, we expect the deceleration in at-home demand growth that we discussed earlier. We're focused on restoring service levels, particularly in capacity-type brands and categories, and will continue to reinvest the funds we deferred from the first half. We have no doubt we will emerge from 2020 with a stronger North America business. Now let's discuss our international businesses, starting with Europe on slide number 20. Kellogg Europe hosted its 12th consecutive quarter of organic net sales growth in quarter three. Growth decelerated as expected as the COVID-led surge in at-home cereal demand moderated while declines persisted in away-from-home channels. In cereal, our net sales increased at a low single-digit rate in the quarter. Category growth rates finished the quarter in roughly that range, and we added to our year-to-date share gains in key markets across the region. In snacks, our net sales were down very slightly in the quarter. Pringles growth improved from last quarter, led by accelerated consumption and share growth in the U.K., Even amidst altered commercial plans because of COVID, we've gained share this year in our three biggest markets in the region, the UK, Germany, and Russia. Meanwhile, portable wholesome snacks continue to feel the impact of fewer on-the-go occasions during the quarter as expected, though its declines moderated from the previous quarter. Overall, in emerging markets, mainly Russia and Central Europe, we experienced a decline in net sales, reflecting challenging economic conditions, particularly in snacks. The good news is that cereal remained in solid growth and Pringles has gained share. As in our other regions, Europe reinvested a good portion of brand building that had been delayed from the first half. This is important for solidifying our competitive positions, and we'll see this again in quarter four. So we really like how we've been executing in Kellogg Europe. Let's turn to Kellogg Latin America and slide number 21. Given the challenging macro conditions in this region, we'd expected decelerating net sales growth. Instead, Kellogg Latin America posted double-digit organic growth, and this double-digit growth was broad-based across all four sub-regions, Mexico, Brazil, Pacific, and Caribbean Central America. The growth was again led by double-digit organic net sales growth in cereal, whose consumption growth remained elevated in modern trade channels, even if we did see category growth rates decelerate during the quarter. Snacks, which has been negatively impacted by the pandemic's lockdown and recessionary environment, bounced back in quarter three with low single-digit organic net sales growth. Leading this growth was our business in Brazil, where local production and a new strategic distribution partner are benefiting Pringles, and we continue to gain share in cookies. Higher net sales more than offset adverse transactional foreign exchange and COVID-related costs, not to mention a significant double-digit increase in brand building. Profit growth also continued to lap last year's costly distributor transitions, as well as startup of local production in Brazil. So we're performing well in spite of tough conditions. We expect decelerating at-home demand to slower cereal sales in quarter four, and we face some uncertainty in Mexico regarding new labeling regulations, which we've mentioned previously. And we'll see another quarter of increased brand building. Nevertheless, we're clearly executing well in Latin America in a difficult macroeconomic environment while also reinvesting for the future. And finally, we'll discuss EMEA, shown on slide number 22. Like Latin America, EMEA turned in better-than-expected double-digit organic net sales growth. Growth was broad-based across Australia, Asia, Africa, and the Middle East, and across cereal, snacks, noodles, and other. As you can see on the chart, cereal demand remained elevated in many markets. The result was high single-digit organic net sales for cereal in the region, But just as important have been the share gains we realized in key markets like Australia, South Korea, Saudi Arabia, and South Africa. In snacks, double-digit organic net sales growth was led by Pringles, which returned to growth momentum as we restored supply. Category growth rates have moderated, but we gained share in Australia and key markets in Asia, Africa, and the Middle East. In noodles and other products, double-digit organic growth in net sales reflected expansion of our Kellogg's noodles in the Middle East and South Africa, as well as a strong sequential acceleration in growth for Multipro, the distributor portion of our business in West Africa. This business showed great resilience in a difficult environment in Quarter 3. Like our other regions, EMEA increased its brand building at a double-digit rate in the quarter, reflecting investment that was shifted from the first half, but the same sales growth and operating leverage was enough to more than offset this investment. We do expect slower growth in EMEA in quarter four, reflecting not only the deceleration we've been seeing in serial categories throughout the region, but also the impact of COVID-related school closings, which affect important school programs we supply in North Africa. And it will be tested further by protests currently disrupting business in Nigeria. But there's no question we are executing well in EMEA, managing through some challenging macro conditions while continuing to invest for the long term. Let's wrap up with a brief summary on slide number 24. First of all, I'm incredibly proud of the way our organization has rallied to execute well through unprecedented and challenging conditions. Everything starts with protecting our people, and we are indeed keeping each other safe. We're also doing a good job supplying the marketplace, and we're supporting our communities. We're preserving and enhancing our financial flexibility. To do all this in a time of turmoil and uncertainty is a testament to the character of this organization. Second, we're pleased with our in-market performance. Even having to replant our commercial calendar, we're executing well in the marketplace. We've expanded household penetration. We're growing across retail channels, notably in e-commerce, and we're finding ways to adjust to difficult conditions and away from home channels. Importantly, we're holding or gaining share in most of our markets, notably in the U.S., where we held or gained share in the majority of our retail categories last and our categories in away-from-home channels. This reflects how we are competing. Third, we're pleased by our performance in emerging markets. In spite of challenging conditions, we've continued to grow in these markets with much less slowdown than we anticipated. This is a credit to our experienced management teams, our diversified geographic footprint, our local supply chains, and the strength and breadth of our portfolio. And fourth, we're happy to be over-delivering our financial plan this year. We are again raising our full-year guidance for net sales, operating profit, earnings per share, and cash flow, which has us getting ahead of our plans for enhancing financial flexibility. And we're doing this without cutting back on reinvestment in brands and capabilities. In fact, we've stepped up our investment, which will help us long into the future. In summary, we are confident that we will emerge from this crisis an even stronger company. We've reached new households and supported our most powerful brands. We've enhanced capabilities such as data and analytics, e-commerce, and revenue growth management. We've strengthened our supply chain, and we've optimized SKUs. And we've strengthened our portfolio and operations in emerging markets. Our goal is sustained balance between top-line and cash flow growth, We are on firmer footing now more than ever. And with that, we'll open it up for your questions.

We will now begin the question and answer session with publishing analysts. Analysts may enter the queue by pressing the star key and the number one on their telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. As a courtesy to your colleagues, please limit yourself to one question. Our first question comes from Nick Modi with RBC Capital Markets. Please go ahead.

Yeah, good morning, everyone. Steve, I was hoping maybe you can help us gain a little more granularity on what you're exactly doing in terms of this customer retention. You know, obviously every company is talking about, hey, we've recruited all these consumers and we're spending behind it. But can you just talk about specifically what you're doing? Because it seems like this is going to go on for at least another six months, if not longer. And so it seems like you have a good window here to really influence consumer behavior. So any thoughts on that would be really helpful.

Yeah, thanks for the question, Nick. First of all, you know, you can see what we've done in terms of our marketing and brand building investments. So we're concentrating that in the back half of the year as we said we would. So we've got lots of funds directed exactly at that. The second thing is we have really enhanced our data and analytics. So we have a better understanding now more than ever about consumers and occasions at a very granular level. So the messaging that we're getting out there, digital, social, and otherwise, is directed in a more micro way against consumers and occasions that drive the type of behaviors that we want. And we're seeing real results. So if I give you just a couple of examples in terms of penetration, you know, the ARTEC category is growing penetration, not quite at 1%, and we're more than double that at nearly 2% ARTEC penetration. And we're also retaining those households. Same thing in salty snacks. So it's really about understanding the consumer, the consumer occasion, what drives behavior and getting that message out there. And we've got a lot of investment behind that. So, you know, more to go. We're pleased with where we are, but it's really based on the fundamental improvements in data and analytics and our ability to micro-target against those consumers, supplemented with the right level of investment behind it.

Great. Thanks, Steve. I'll pass it on.

The next question is from Steve Powers with Deutsche Bank. Please go ahead.

Yes. Hey, good morning. Thanks. So I wanted to talk about the strong emerging market performance, which was clearly, you know, a call out in the quarter. I guess, can you talk just a bit more around how much of that do you think, you know, was isolated to the quarter versus something that's, you know, more structural that you can build upon in the future? I know you called out some specific headwinds in the fourth quarter in North Africa and Mexico. Maybe you can quantify those, but I'm really asking the question more in terms of the medium term on a normalized basis.

Yeah, so thanks, Steve. You know, we were very pleased with the performance in emerging markets in this quarter, obviously. You know, it was led by cereal, which saw elevated demand based on some of the lockdowns. We continue to expand our noodles business very successfully, so we're pleased about that. But, you know, in quarter four, obviously, we see the potential for, you know, some slowdowns, which, you know, is what we talked about. We've got unusual situations, the school closings in North Africa. That's a big bit of business for us. The labeling regulations in Mexico, uncertain if and how that will impact the business. It's across really all consumer packages, so hard to say. And then Nigeria, obviously in the news very much, as you can see, with protests and disruption. which disrupts our business, has disrupted our business there. So always watch out in emerging markets to be sure. And when you have this type of environment coupled with a recessionary environment, you always want to stay close and watch it. But very proud of the way the organization in quarter three came through in emerging markets and delivered a better than expected performance.

Great. Thank you. Thanks, Steve. The next question is from Ken Zaslow with Bank of Montreal. Please go ahead.

Thank you. Good morning, everyone.

Good morning, Kevin.

You made a comment, and I always like to hear this comment, is you're going to emerge stronger out of the COVID-19 experience. Can you talk about how that would affect your financial outlook in terms of what that really means in terms of qualitative as well as quantitative outlook of what you think? What does it mean to emerge stronger? Does it mean a higher growth rate? Does it mean higher margins? Does it just mean more spending? How do you frame that and just put context on that? That would be very helpful. Thank you.

Yeah, so thanks for the question, Ken. Obviously, we're not going to get into any 2021 guidance at this stage. We're still working through our plans. But when we talk about emerging as a stronger company, we're making lasting impact to the business. You see that in the financial flexibility, the type of cash we've been able to generate. You see that especially in the investment in the brands and capabilities that we're putting into the marketplace to drive penetration, to drive retention, to keep those households. You see that in our digital and e-commerce capability that we're continuing to invest in. And then our supply chain, as I said, very proud of our supply chain and the way they've been able to be agile and meet this unheard of surge in demand and this this lengthy, you know, the length at which it's occurred. And so we're investing in capability and capacity in the longer term in our supply chain as well, which we mentioned. So all of those things give us very good confidence that we are emerging stronger. And, you know, when we get to February, we'll talk about in more detail what that looks like.

Amit, do you want to add anything? Yeah, and I think just to add to that, I think, you know, you look at the strength of our cash flow. I think, you know, that's allowed. We always said that, you know, our priority this year would be to reduce our net debt And I think the strength of our cash flow is allowing us to accelerate that net debt reduction. And so I think, you know, that allows us much more financial flexibility as we emerge out of this crisis.

Okay. And just to be clear, I wasn't looking for next year's guidance. I was kind of thinking more about, like, bigger picture, longer-term guidance, your growth algorithm, or anything like that that would be quantitatively different. That was kind of what I was looking for. I wasn't trying to get the next year's number, just any other – Bigger picture financial outlook, you know, it seems like the reduction of debt, but is there more spending that goes into data analytics? Is there anything else that you – and then I'll leave it there, and I appreciate it.

Yeah, no, I think I just – exactly. It's confidence in the trajectory based on the investments that we just talked about. And, you know, it's – you know, as you know, Ken, there's so much uncertainty right now, how long this goes, what consumer behavior really changes and how it lasts. And so we're leaning into it. We're very much leaning into it, but we believe that this crisis, as terrible as it's been, has given us an opportunity to really engage with consumers in meaningful and lasting ways and to make those investments to emerge stronger.

Great. Thank you.

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

Thanks. Your guidance assumes that at-home demand continues to decelerate Doug McMillan, though, said this week he's seeing consumer stock-up behavior actually rising in certain areas. Are you – I guess I'm curious, are you seeing any indication that your larger customers are preparing for a wave two of pantry loading, or is this really not anything you're anticipating at this time?

Yeah, thanks, Ken. Again, there's so many things that are unknowable right now, and so it's really our planning assumptions – And to the best of our ability, what we're thinking of is the away-from-home channels, as we talked about, not really recovering very quickly. We're weighted towards schools and travel and leisure. So the ones that are recovering, convenience and so forth, QSR, you're starting to see stabilized, but not where we're weighted. And then in terms of retail channels, we were talking about in the third quarter about a deceleration. It did decelerate. It continues to decelerate. At what level it stops and starts to go back up again isn't unknowable. You know, we see the same news reports. We obviously see the same terrible trends in the COVID virus. And so this is our planning assumption. And, you know, we hope. You know, we hope for a recovery, obviously, as everybody does in terms of these lockdowns and so forth. But to the best of our ability, this is what we see. And at a point in time, we just have to make a call and say the continuation of the deceleration is, you know, what we see. But you have to be agile just in case that changes.

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

Hey, good morning, and thanks for taking the question. Steve, I wanted to ask about incognito. We've noticed seeing the advertising presence as you've launched the product. I guess a couple of questions. One, just as you look at the strategy tactically as you launch the product, do you think there's an opportunity there in terms of just having a better, especially traditional media presence versus you know, the existing kind of established brands. And then second, if you can talk a little bit about shelf space and, you know, just how far along you are in terms of distribution. And then finally, just you touched on capacity constraints. So just what the plans are there to expand capacity as you build up distribution.

Yeah, thanks, Brian. So the first thing I'd say is it's early days, obviously. And we're all learning what it means to launch a new brand in a pandemic environment where shoppers' behaviors are different, right? And so, you know, we've talked about how big brands are resonating. People trust big brands. They get in and out the shopping experience as quickly as they can. And so we do believe that launching Incognito under the halo of the Morningstar Farms brand gives it a real advantage. And when you look at Morningstar Farms, you know, up – and I think it's 27% year-to-date through quarter three, obviously really strong growth, and, again, launching incognito underneath that. And it was really, you know, scheduled for a March 31 launch. We had to delay that based on retailer resets. We have got our burger, our ground bratwurst and sausage products off. We're launching our Disney chicken nuggets. We're very strong in chicken, and obviously the Disney franchise, and this is a Mickey franchise, offering, we think we'll get a lot of traction. And so the national distribution is really just building as we speak. But we're pleased with where we are. We're pleased with the early returns. But it is. It is very early. So everything that we talked about in terms of the strategy we think holds true, particularly the strength of the product offering itself and the strength of launching under the Morningstar Farms, Halo, we believe still remain very relevant. But we're vigilant. You know, we've got our sales organization out there each and every day checking on placements, you know, and doing everything they can to advance the visibility of incognito in the marketplace.

Is it just capacity?

Oh, capacity, yeah. Yeah, so capacity, you know, we ran up against capacity. Nobody planned for 27% growth, obviously. But we've got, you know, in the short term, you know, really working on crewing and getting everything we can in terms of throughput. And as we enter 2021, we do have plans for additional lines and so more significant capacity coming on. So in short term, it's about crewing and throughput. In the longer term or the median term, which is really next year, it's about additional lines to really add to capacity. Because we see this as a last thing. You're not going to see this type of elevated demand, I would suspect, going forward, but plant-based is a real megatrend. It was before the pandemic, and the type of trial that you're seeing is really going to, we think, accelerate what was already a meaningful trend in this space.

Thank you. The next question is from Eric Larson with Seaport Global Securities. Please go ahead.

Yeah, thank you. Thanks for the question, everyone, and hope all is well. I just want to drill down a little bit more on your cash flow. That's sort of the important metric that I'm focused on. So it looks like you've maybe deferred a piece of your capital expenditures, which will obviously come back next year. And I'm curious also if you're running your plants yet to just meet demand or if you now have enough capacity to kind of rebuild, you know, maybe some inventories here. So in that difference in your guidance of a billion to a billion, three billion, four, how much of that goes away with, you know, increased cap X next year and maybe some working capital rebuild? So what is sort of the net cash flow improvement that we can look for?

Yeah, so I think just on the cash flow, right, there are a number of factors that are driving our improved cash flow, right? So part of it is driven by just higher earnings, higher adjusted earnings. a significant reduction in restructuring outlays, good working capital management that we've seen across all our businesses, and then the capital expenditure, some of which has been delayed. Now, we are hoping to catch up on capital expenditure in quarter four, and that has been reflected in our outlook with planned downtime to get some of the capex away. and some of it will be delayed. But I think, you know, as Steve mentioned, right, from a CapEx standpoint, I think our focus is on getting the capacity in all our constrained platforms as quickly as possible. So I would say part of it, you know, part of the cash flow is timing and phasing. But, you know, equally, a part of it is as well, you know, just sustained improvement in our earnings. you know, reduction in restructuring as well as working capital, which we would expect to sustain.

Yeah, just so to finish up on the one part of the question, I'll be done with this after this. So are you able to run your plants today to help build some of your inventory and maybe some retail too? We know those inventories are depleted. Or are you still just running to kind of meet current demand?

I think it depends on the platform. And, you know, I think it depends. So, you know, in some platforms we're running flat out to service, you know, the elevated demand. In others where we can, you know, we're taking the opportunity to catch up on capital expenditure. So I think, you know, it varies across the platforms.

Okay. Understood. Thank you.

The next question is from Michael Lavery with Piper Sandler. Please go ahead.

Good morning. Thank you. I just want to actually go back to Morningstar Farms. Clearly, it's got outstanding growth and stands out against your other categories. How do you think about the opportunity outside the U.S.? We've seen competitors make a push there. Certainly, there's some scale that's not the same as you have in the U.S., but what are your ambitions to launch internationally?

Yeah, thanks for the question, Michael. What I say is right now the priority is the United States. It's a huge opportunity. Morningstar Farms is a very big brand, so clearly winning in the U.S. and competing in the U.S. is the number one priority for us. We are outside the U.S. in Australia and New Zealand currently, and so we are experimenting, and we'll see what the opportunity is and how it presents itself, but we believe that that priority one is the United States because of the size of the market and because of the advantage we have having Morningstar Farms as a very established brand.

Okay, great.

Thanks very much. Thanks, Michael. The next question is from David Palmer with Evercore ISI. Please go ahead.

Thanks, and good morning. Steve, you mentioned investing for future in your summary slide, and certainly that's not new to Kellogg's this year. It seems three-plus years you've been doing, you know, a lot of heavy lifting in your business, particularly in the U.S., you know, the rolling thunder of investments from Saks and Cereal and Frozen this year, and it seems like you've done some good repositioning that In addition to COVID-related demand, maybe creating additional room to invest or reinvest. So I'm wondering how you're thinking longer term about the need to reinvest versus the investment rates you've been doing in recent years. And what are you reviewing as you get through COVID to assess that need to reinvest? Thanks.

Yeah, thanks, David. So, you know, we have put money behind our brands. We've put investment behind our brands, and we've seen the benefits of that flowing through. And we are singularly focused on balanced growth. So we're pleased with the top-line performance pre-COVID, and obviously we get the bump from COVID. And when you look at the financial results of this year, based on the new guidance that we just updated today, you see a P&L that looks very solid and very balanced, you know, with good top-line growth, you know, margins. improving and a nice bottom line performance. And so we also like the type of investment that we have currently behind our brands when you think about a percentage of net sales, for example. And so as we think forward, you know, we like where we are in terms of our brand building spend and we would see that, you know, continuing. So we don't see any great need for a big insurgent into any particular area. We've benefited from being able to invest in this year. In particular, when you think about the level of investment in the second half of the year because of the COVID crisis, we had this concentration of lots of consumer messaging going into the back half of this year into the fourth quarter, we believe will allow us to enter 2021 with lots of good momentum and lots of brand building and equity that's been invested into our brands. And so we like where we stand today in terms of the health of our brands and the momentum of our brands.

Thank you.

The next question is from Chris Grohe with Stiefel. Please go ahead. Hi, good morning.

Hi, I just had a question for you in relation to the progress you've made towards that $60 million spending that you talked about from the first half shortfall. I know you're at double a digit this quarter and expect to be in the fourth quarter as well. Can you say how much of that you got done in the third quarter? And I'm curious if that, maybe not so much that figure, but if your rate of spending overall has changed, has it gone up at all by chance, just given the rate of elevated demand and the returns you're seeing from that investment?

Yeah, thanks, Chris. So, Roughly speaking, we got about a third of it off in the third quarter. And so we're obviously planning on two-thirds of it off in the fourth quarter, which leads to double-digit brand building against various platforms. That's on top of what we'd already planned. And so that's what I was just saying in the previous question. That's why we've got this concentration of really good brand messaging happening in the back half of the year. And with good ROIs. And so we're very pleased with the type of performance we're getting from it. But remember, too, that, you know, these are, you know, a lot of this is to build the longer-term equity of our brand and enter 2021 with good momentum. Now, having said all that, there's all this uncertainty, right? And so what happens with... Everything from movie releases to college football bowls in the fourth quarter remains an uncertainty. So we'll continue to have to be agile in how we think about where the right places to invest are. But we're determined to invest against our brands to continue to build the equity, to drive the right ROIs, and to enter 2021 with real solid momentum.

Thank you.

The next question is from Robert Moscow with Credit Suisse. Please go ahead.

Hi, thank you. Steve or Amit, I was wondering if you could give us a sense of what total advertising will be for the year. Is it going to be up a lot or because you're giving first half, second half kind of information, but it's hard for us to put in context for the whole year. And also, you know, when you look at the 10K, you know, your advertising was down 10% last year. So, On the percentage of sales basis, can you give us some color on what you think the right level is?

Yeah, thanks, Rob. So for the full year, we'll be up mid-single digits, X the divestiture, right? And we'll be up, as I just mentioned, double digits in the second half of the year. And so that's why I talk about 2021 entering with real momentum. And we believe that that gives us the right level from a percentage of sales, roughly speaking, of where we want to be. Now, we always reserve the right with great ROIs and great ideas to go plus or minus. But when you look at the momentum that we've got in our net sales pre-COVID and what we built last year, we felt like we were getting significantly good returns on our advertising spend last year. And if you'll recall, we exited fourth quarter with 2.7% and that was pre-COVID. So we were clearly getting the benefit of the type of investments that we were making over the course of the last three years, really. And it came with some surges and some tactical movements around. But if you just go back to the top line and see the top line momentum that was building over the course of last year, we feel like we were deploying that advertising spending in very good ways with good returns that were getting us exactly what we wanted And obviously, this year, everything went completely into replanning after COVID. But again, we'll finish the year with mid-single-digit advertising spend, ex-investiture, with real momentum in the back half of the year because of the concentration and double-digit nature of the investment in quarter three, quarter four.

And just to follow up, is mid-single-digit pretty much what you were expecting to do, or did you increase it beyond? Because you've had a lot of comments here about now is the time. So... Is this an increase versus the original plan?

It's a slight increase, Rob, to the original plan, but pretty close. And so if you recall last quarter on our earnings, I talked about how we were bound and determined to spend what we planned on spending, and that gives us the type of concentration in the second half and the momentum. So up slightly from even that, but just slightly. But you can think about it kind of in terms of spending our full year allocated budget against our brands. Thank you.

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

Hey, good morning, folks. Congrats on another strong quarter. A couple quick questions for me. First, we've obviously seen serial sales decelerate from where they were last quarter, but the sub-1% growth figure from you this quarter did surprise me. Is that reflective of maybe some inventory that had to come down after you restocked last quarter, or is it food service now or the education facilities becoming a bigger part of the business? What exactly is driving that weakness?

Yeah, thanks, Jason. You can point to the double-digit declines in away-from-home channels, and that's a sizable portion of our business today. as well as the on-the-go pack formats. If you take away those declines, the away-from-home in particular, the rest of the business was up mid-single digits, right? And if you look at our consumption, you can see that as well, you know, up mid-single digits. So it really is the away-from-home channels that drove that.

And is away-from-home a bigger piece of the business as we get into the school year?

Yes. The answer to that is yes. And now there's a great deal of uncertainty, obviously, with what really happens with schools. And we all see that in our daily lives. You know, schools going back and then, you know, going into hybrid and then getting shut down. And so it's a very fluid situation. But from a consumption standpoint, you know, we still see the elevated demand. and we still see the benefits, you know, of COVID, but it is definitely counterbalanced by the away-from-home softness.

Sure. My next question is on trade spend. Lots of other folks in the industry are seeing really good price realization right now because promotional levels are so subdued. The Nielsen data certainly suggests promotion levels are equally subdued for you, but we're not seeing the same type of price benefit – Why is that? Is your trade spend not coming down? And if it's not coming down, if it's staying where it is, where's the money going if it's not funding promotions?

So, Justin, you know, we won't get into the specifics of trade. But I think, you know, from an overall standpoint, we're seeing, you know, we're seeing the price mix come through. I think within that, you know, there is a very marked category shift. I think we talked about that in our last call. just the mix between cereal and snacks and different rates there, different rates between the channels, I think that's probably driving, you know, some of the negatives. But overall, we're seeing price mix come through.

Okay. Thanks a lot, guys. I'll pass it on.

Operator, we are at 1030, so we're going to have to wrap it up.

Okay, 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 if you have follow-up questions, please do not hesitate to call us.

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