Kellanova

Good morning. Welcome to the Kellogg Company's first quarter 2021 earnings call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session with the 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. Good morning and thank you for joining us today for a review of our first quarter 2021 results, as well as an update regarding our outlook for the full year 2021. I'm joined this morning by Steve Cahillane, our Chairman and CEO, and Amit Banati, our Chief Financial Officer. Slide number three shows our forward-looking statements disclaimer. As you are aware, certain statements made today, such as projections for Kellogg Company's future performance, 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 the third slide of this presentation as well as to our public SEC filings. This is a 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 recording of today's webcast and supporting documents 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 an organic 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 doing well and staying healthy. Here at Kellogg, I'm continuously impressed by the way our organization has remained focused and engaged in executing through what are undeniably challenging circumstances, both at work and at home. Keeping employees safe remains job number one. And in quarter one, we continued to execute safety protocols while following the guidance of local health authorities. Supplying the world with food continued to require agility, including temporary labor and incremental capacity. And of course, we continued to actively support our communities. After all, the pandemic is not behind us. In fact, in some parts of the world, we are seeing it accelerate, and our thoughts and prayers go out to all those affected. Turning to slide number six, our deploy for balanced growth strategy remains as relevant and effective as ever during this pandemic. Its growth boosters continue to do their job. As much as anything else, this pandemic has prompted a shift in eating occasions. Our focus on occasions continued to be evident in the first quarter in our tailored consumer messaging and an innovation geared towards specific occasions. The portfolio that we've shaped toward growth has benefited from balance of convenient meals, snacking that can be done at home, plant-based foods, and sustained growth in emerging markets. Our building of world-class brands has been evident in our commitment to continued equity-building communication, as well as leveraging our data and analytics to devise creative ways to reach new consumers and sustain momentum in the marketplace. And our commitment to perfect service, perfect store, tested by the sudden and sharp rise in demand, has forced us to get creative around ways to increase throughput, even if it meant temporarily holding back on merchandising activity to ensure inventory and incurring incremental logistics costs to get food to our customers. and we continue to grow rapidly in e-commerce, leveraging our enhanced capabilities there. Environmental, social, and governance is not a new area of focus for Kellogg. It's been embedded in our history and strategy for a long, long time. Our ESG-oriented Better Days boosters, always a key element of our strategy, have become more important to our communities, employees, customers, and consumers. At Cagney a few months ago, We discussed our Global Better Days purpose and strategy, and on slide number seven, you can see that we continue to progress in this area, addressing the interconnected issues of health, hunger relief, and climate. On nourishing with our foods, we've continued to innovate and renovate our foods, providing choices across wellness and indulgence, and during the quarter, our Kashi became the first organic cereal to be authorized for the Women, Infants, and Children program in the United States. On feeding people in need, we've remained in an elevated level of donations, making accelerated progress toward our goal of feeding 375 million families. During the first quarter, Pop-Tarts joined with the United Way to raise money for school vegetable gardens. On nurturing our planet, we announced during the first quarter our commitment to achieve over 50% renewable electricity to address Kellogg manufacturing globally by the end of 2022. and we celebrated women farmers as part of International Women's Day. And underliving our founders' values, we launched in the first quarter our new equity, diversity, and inclusion vision and strategy to all employees in all four regions. Aligned with those values, we launched a campaign called A Call for Food Justice in Black Communities in partnership with World Food Program USA, tied to some of our biggest brands, including Special K, Morningstar Farms, Kashi, and Eggo. Our strategy and execution led to another good quarter, as highlighted on slide number eight. At-home demand remained elevated, more than offsetting continued softness in away-from-home channels and on-the-go occasions. Our biggest brands continued to show strong momentum, aided by sustained consumer communication and innovation activity. They're why we gained share in most of our key markets and categories around the world. We continued to bring on our planned capacity increases, which will continue to relieve supply tightness and enable us to return to normal levels of merchandising activity as we get through the first half of the year. Our emerging markets businesses accelerated their growth, proving their mettle in what are challenging conditions. From a financial perspective, we continue to seek and deliver balanced financial results, the kind we achieved in 2020, and that's what we did again in the first quarter. strong net sales growth even despite lapping last year's pandemic-related surge, and we delivered this organic growth across all four regions and all four global category groups for a fifth consecutive quarter. Positive price mix reflecting revenue growth management actions made all the more important by the recent rise in input cost inflation. Gross profit margin improved year on year despite higher costs and faster growth in our emerging markets, including our distributor business in West Africa. Operating profit increased year-on-year despite lapping last year's strong growth ex-investiture, driven by top-line momentum and despite a year-on-year increase in brand investment. Cash flow remained strong, and we were able to accelerate share buybacks into the first quarter. So a very good start to 2021, with the potential to put us a little ahead of where we thought we'd be through the first half and its extremely difficult comparisons. This enables us to raise the full-year guidance we provided for you in February, even amidst what is undeniably an uncertain business environment. 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 10 offers an at-a-glance summary of our financial results for the first quarter. As you can see, they're quite strong, particularly when considering the year-ago growth they were lapping. Specifically, last year's first quarter featured 8% organic growth on net sales and operating profit that grew roughly 8%, excluding the impact of the prior year's divestiture. So we generated very good growth on growth. Net sales grew on a one-year and a two-year basis. In developed markets, it was aided by shipment timing and at-home demand remaining elevated, partially offset by continued softness in away-from-home channels. In emerging markets, we generated sales performance that was better than expected. Currency-neutral adjusted basis operating profit grew on a one-year and a two-year basis, driven by the net sales growth, an expansion in gross profit margin, and good discipline on overhead, all of which more than offset a year-on-year increase in brand building. Clearly, we're seeing good operating leverage from our strong top-line growth. Currency-neutral adjusted basis earnings per share grew on a one-year and a two-year basis, despite a higher effective tax rate. And in what is typically our lightest quarter for cash flow, it was stronger than anticipated for the quarter. Of course, it's down from last year's unusually high first quarter cash flow, but as you can see, it is ahead of the pre-pandemic 2019 level. Let's look at these metrics in a little more detail. Slide number 11 breaks quarter one net sales growth into its components. Volume declined against last year's March surge, but it was up on a two-year basis. At-home demand remained elevated. Emerging markets sustained momentum, and we did see favorable timing of shipments in the U.S. as expected. Price mix was again positive, which is important given the accelerated cost inflation we are seeing. During quarter one, we saw positive pricing in all four regions, reflecting revenue growth management initiatives, and we also saw an overall makeshift back towards snacks. Currency translation was a slight positive in the quarter. As we look to the remainder of 2021, we still expect to see a moderating top line. We face our toughest volume comparison in quarter two, and we are assuming continued deceleration in at-home demand. Slide number 12 offers some perspective on our profit margins, which held up very well in spite of higher costs. Our gross profit margin in quarter one improved on a one-year and a two-year basis as productivity and price realization were effective at covering accelerated input cost inflation, as well as incremental COVID costs against only a partial quarter of those costs in the year earlier quarter. we also more than offset a mixed shift towards emerging markets and particularly towards our distributor business in West Africa. The flow-through of this higher gross profit margin led to an increase in operating profit margin as well, as decreased overhead balanced out a high single-digit increase in brand building. The brand building increase reflects the phasing of our commercial plans relative to last year's modest decrease in quarter one at the onset of the pandemic even with this year-on-year increase in brand building we still grew operating profit at a double-digit rate this quarter as we look to the rest of the year we obviously face our toughest gross profit margin comparison in quarter two due to last year's outsized operating leverage that produced by far the highest gross profit margin of the past couple of years, as you can see on the slide. In the second half, we are working to hold our margin as close as possible to year-ago levels, in spite of our mixed shift towards emerging markets and accelerated cost inflation. Further down the P&L, we face our toughest comparison on brand building in quarter two as well. because last year's quarter two was when we delayed significant brand investment to the second half. That second half investment helped create the momentum we are seeing today, but we return to more typical levels of brand investment in this year's second half. Turning to the remainder of the income statement and slide number 13, we see that our below the line items were relatively neutral to earnings per share in quarter one. As expected, interest expense decreased year-on-year on lower debt, and this will continue for the remainder of the year, with quarter four additionally lapping the non-recurring $20 million debt redemption expense we recorded last year. Other income was lower year-on-year and modestly lower than what should be its quarterly run rate for the rest of the year. Our effective tax rate of 22.7% was higher than last year's relatively low level, and should still turn out to be around 22.5% for the full year. Average shares outstanding were flattish year on year, with the impact of quarter one's accelerated buybacks to be more pronounced in the coming quarters, resulting in a full year average shares outstanding that is a little more than half a percent lower than 2020. Turning to our cash flow on slide number 14, we had a strong start to the year. and maintained good financial flexibility. As expected, our cash flow in Q1 was lower than Q1 2020's unusually high level, not because of net earnings or working capital, both of which were favorable year on year, but because of year on year swings in accruals and other balance sheet items, as well as lapping last year's delayed capital expenditure. However, as you can see on the chart, quarter one 2021's cash flow was well above that of quarter one 2019 in what is always our lightest cash flow quarter of the year. Net debt is lower year on year, even despite our resumption of share buybacks, and we like the state of our balance sheet. As we look to the rest of the year, cash flow will likely remain below last year's COVID-aided levels, but still well above 2019 levels. And between our share buybacks, which we were able to accelerate into the first quarter, and an increased dividend, we are meaningfully increasing the cash returned to share owners. I'll conclude with a discussion about full year guidance shown on slide number 15. As Steve mentioned, a strong quarter one performance gives us the confidence to raise our guidance this early in the year. Our guidance for full-year organic net sales growth moves up to approximately flat year-on-year from our previous guidance of about negative 1%. This would equate to closer to 3% growth on the two-year compound annual growth rate, effectively eliminating the noise of lapping last year's COVID-related surge. Our guidance for currency-neutral adjusted basis operating profit improves to a decline of about 1% to 2% year-on-year versus our previous guidance of minus 2%. This equates to closer to 4% growth on a two-year CAGR basis, excluding our since-divested businesses from the 2019 base. Our guidance for currency-neutral adjusted basis earnings per share increases to growth of about 1% to 2% year-on-year, versus our previous guidance of up 1%. This equates to something around 5% growth on a two-year CAGR basis, excluding our since-divested businesses from the 2019 base. And our guidance for cash flow moves up to a range of $1.1 to $1.2 billion versus our previous guidance of approximately $1.1 billion. We think this guidance is prudent given that it is early in the year and given a business environment that is somewhat uncertain in terms of pandemic impacts and cost inflation. Obviously, we are pleased with our start to the year. We're in strong financial condition. Our brands and regions are performing well, and we are solidly on track for continued balanced financial delivery on a two-year basis. And with that, let me turn it back to Steve for a review of our major businesses.

Thanks, Amit. I'll start with a quick review of the Quarter 1 results of each of our regions, and then I'll go a little deeper into some of our key brands and categories. The region's net sales and operating profit growth rates in Quarter 1 are shown on slide number 17. You can see that our growth was broad-based, particularly on the more meaningful two-year growth rates. In North America, our organic net sales grew on top of last year's high growth, with elevated at-home consumption and strong momentum in key brands, as well as favorable timing of shipments between quarters, partially offset by continued softness and away-from-home channels. Operating profit also increased year-on-year despite tough underlying comparisons. The two-year trends only further confirmed that this business got off to a good start to the year. Our business in Europe had another good quarter. Its solid one-year organic net sales growth was on top of last year's strong growth, and it was led by accelerated growth in Pringles. Resulting operating leverage produced strong operating profit growth. In Latin America, our strong organic net sales growth was driven by Pringles and cereal, and the resultant operating leverage boosted operating profit as well. Macro conditions in this region are challenging, so this was a terrific way to start the year. And in EMEA, our strong organic net sales growth was led by Multipro, the distributor portion of our business in West Africa, and across the region by Pringles, cereal, and noodles, leading to outstanding growth in operating profit as well. Now let's go a little deeper into some of our categories, markets, and channels. We'll start with our global category groups, as shown on slide number 18. As you can see from the chart, we grew all four category groups on both a one-year and two-year basis during quarter one, despite lapping last year's COVID-related surge and despite continued softness in away-from-home channels. Our largest global category, snacks, sustained growth in the first quarter on both a one-year and two-year basis, with growth in all four regions. And that's despite the on-the-go nature of many of its foods and pack formats. This is a testament to the strength of our snacks brands, as well as to our ability to adapt messaging and pack formats to current at-home occasions. In serial, we also recorded growth on both a one-year and two-year basis. We saw notable strength in Europe, with share gains led by power brands like Trezor and Crunchynut. We posted broad-based growth in Latin America, with share gains in key markets led by Cornflakes. We also recorded strong growth and share performance in EMEA, where our master brand approach is working well in Asia and innovation activity is contributing across the region. As expected, we had a slow start in the U.S. as we limited merchandising activity on supply-constrained brands, but this should improve in the second half as new capacity comes online. Frozen foods also grew net sales on both a one-year and two-year basis. This predominantly North America business sustained momentum in both Eggo and especially Morningstar Farms, and I'll come back to each of them in a moment. And our noodles and other business, which is predominantly in Africa, continued to generate rapid growth, both on a one-year and two-year basis as well. With annual net sales approaching a billion dollars, this is going to be a growth contributor for some time. So both on a region basis and a category basis, our reshaped portfolio clearly offers growth and diversification. And within each of these regions and categories are world-class brands that continue to grow. Let's take a look at a few of these important brands. We'll start with our largest global brand, Pringles, whose consumption trends for its biggest markets in each of our four regions are shown on slide number 19. This is more than a $2 billion global brand that has demonstrated exceptional momentum for some time in all four regions. During quarter one, this momentum continued, with Pringle sustaining growth on top of very strong year-ago growth. This was driven by effective brand building, including the incremental consumer communication we did in late 2020, plus important consumer activations in the first quarter, such as our Super Bowl campaign in the U.S., and our gaming-oriented commercial activations in Europe. The growth was also augmented by innovation launches, including our more intense flavors under the Scorchin' and Sizzlin' sublines in the U.S. and U.K., respectively, as well as uniquely local flavors in Asian markets. All of these innovations are off to great starts. It's also aided by increased local production in emerging markets, notably in Brazil, where this relatively new local capacity is enabling exceptional growth. Pringles is truly a world-class brand performing extremely well. Here's another really incredible brand, Cheez-It, shown on slide number 20. Its U.S. consumption and share growth has been exceptional over the last several years, and it has continued in the first quarter. The base product line continues to perform well, helped by effective advertising and sports-related activations, as well as new flavors and a reformulation of the Grooves subline. Meanwhile, the Snapped subline is providing incremental growth, enough that we had to add capacity in 2020 and only its second year since launch. And Cheez-It is no longer solely a U.S. brand. We expanded into Canada last year, and during the first quarter, it continued to grow rapidly. And in the first quarter, we brought Cheez-It to Brazil, where it's off to a very good start. This is more than a billion-dollar-plus retail sales brand that continues to outpace its category in the U.S. and one we have begun to expand internationally. And before we move on from our snacks discussion, I want to point out two other power brands in our snacks portfolio, shown on slide number 21. Since the outbreak of the pandemic, the portable wholesome snacks category has has been declining due to fewer on-the-go occasions. We've continued to gain share of this category, largely because of two brands that have been able to grow their at-home consumption. Pop-Tarts continued to post growth on a two-year basis in quarter one, lapping last year's extremely large growth and sustaining multi-year growth momentum. Rice Krispies Treats' consumption and share growth has been impressive over the last several years, and this momentum has continued in quarter one, aided by the launch of new home-style treats. Again, big brands sustaining momentum. Let's turn to serial markets and brands on slide number 22. Behind our one-year and two-year growth in global serial net sales in the first quarter are strong performances by key brands in key markets. The chart shows our largest international markets of each region with consumption growth on a two-year basis to avoid distortion from lapping last year's surge in March and share performance on a one-year basis to show how we're competing. In Europe, we've outpaced the category with share gains in key markets like the UK, which was propelled by power brands like Crunchy Nut and All Brand. And in other European markets, we saw particular strength in global brands like Trezor, our largest cereal brand in Europe, and Extra, a key wellness-oriented brand internationally for us. In Canada, where the category got more immediate lift than we did in the year-ago quarter, we outpaced the category in this year's first quarter on the strength of brands like Global Brand, All Brand, and Local Jewel Vector. We recorded strong growth and share performance in EMEA, led by our largest cereal market in that region, Australia. The outperformance was led by Global Brands, like our Australian version of Raisin Bran, as well as Local Jewels, like our wellness-oriented Just Right. We saw broad-based cereal growth in Latin America, where we continued to gain share in key markets like Mexico, Brazil, Puerto Rico, and Central America. In Mexico, you can see the strong share performance was driven by big brands like Corn Flakes and Choco Krispies, and across the region, our growth was aided by strong innovation. In short, we're seeing the impact of strong brands and strong execution in all of these markets. Let's discuss U.S. cereal for a moment, shown on slide number 23. As expected, we experienced a slow start in this market as we limited merchandising activity on supply-constrained brands. In scanner data, you can see this in our larger-than-category decline in percent of volume sold on promotion. We will be caught up on supply and capacity around mid-year, as we've mentioned previously. But in the first quarter, those supply-constrained brands, Frosted Flakes and Fruit Loops, Two of the stronger brands in the category accounted for all and more of our share decrease in the first quarter. Excluding them, our consumption kept pace with the category, so our underlying business remains in good shape. We're very pleased with our innovation, which not only outpaced the category's innovation in the first quarter, but is showing very strong velocities already. This includes additions to the jumbo snacks line we successfully launched last year, as well as mini-wheats, cinnamon roll, Little Debbie, Special K blueberries, and keto-friendly Kashi Go offerings. So, we get back up to adequate supply and capacity and return to a normal commercial calendar. Particularly in the second half, we expect our U.S. cereal performance to improve and perform like our other big developed markets. Slide number 24 calls out another big brand that is sustaining growth on a two-year basis. Eggo's reliable growth in consumption over the past few years accelerated to nearly 17% in 2020, gaining nearly two points of share but leaving us very tight on capacity. In quarter one, Eggo sustained strong two-year growth of plus 5% despite capacity limiting its upside. This is one of the brands for which we are freeing up capacity over the course of this year. And when you add in Kashi, our overall from-the-griddle consumption outpaced the category on that two-year CAGR basis. Eggo is in really good shape with more capacity coming on. With effective advertising and promising innovation on the way, this is a nearly $1 billion retail sales brand with an outlook for sustained growth. And even better growth is being generated by our leading plant-based brand, Morningstar Farms, shown on slide number 25. Our overall Morningstar Farms brand franchise is over $400 million in retail sales and is poised to sustain strong growth for years to come. This brand's consumption growth in the first quarter, even on a one-year basis, added to its multi-year growth trend. And with incremental capacity in place, this brand gained share as well. There is no question that consumers are becoming more aware and interested in plant-based foods. Morningstar Farms has increased its household penetration in the last year to a level that remains well above any of our competitors, and yet it's still only 8%, suggesting significant room to expand. Morningstar Farms is also unique in the breadth of its offerings. This is evident in our share gains across a spectrum of segments in Quarter 1, ranging from breakfast meats to breakfast handhelds to sausage to poultry. Our new Vegetizers line has created a whole other occasion for plant-based foods. And now we are reaching an expanded consumer base. A recently launched Incognito by Morningstar Farms sub-brand is aimed at incremental, flexitarian consumers. It continues to expand retail distribution, both in the refrigerated and frozen aisles, and it continues to add food service customers. It's early days, but Incognito is great food and is showing a lot of promise. Just this week, The National Restaurant Association awarded 2021 Fabby Awards for the year's most delicious, unique, and exciting food for restaurant operators and consumers. Among those awarded were three incognito products, homestyle chicken tenders, Italian sausage, and original bratwurst, as well as an iconic veg-forward offering, Morningstar Farms Chipotle Black Bean Burger. Simply put, Morningstar Farms is the largest brand with the highest penetration, the broadest portfolio, and the most occasions in this plant-based category. So we are realizing good underlying momentum across our major category groups and led by world-class brands. Let's now shift our discussion to geographic markets, specifically our emerging markets highlighted on slide number 26. Emerging markets accounted for more than 20% of our net sales last year, among the highest percentages in our peer group. This is important because these markets represent outstanding long-term growth prospects for packaged food, owing to their population growth and expanding middle classes. In 2020, despite COVID-related shutdowns of retailers and schools, economic disruption from depressed oil prices, and even bouts of political and social unrest, our geographically diverse emerging markets businesses actually accelerated their net sales growth. This is a credit to our product portfolios, our brand strength, our local supply chains, and experienced management teams in these markets. And in the first quarter of this year, despite lapping in an unusually strong year-ago quarter, we sustained this momentum, even accelerating again. In Africa, our multi-pro distributor business grew more than 20% year-on-year in quarter one, even as it lapsed strong high teens growth in the year earlier quarter, and we also continued to grow our Kellogg's branded noodles business. In Asia, we sustained double-digit growth in Pringles and cereal. In Russia, we recorded double-digit organic growth in cereal and in snacks. In Latin America, strong quarter one growth was broad-based and led by cereal in Mexico and Pringles in Brazil. And let's finish up with a couple of channels to call out on slide number 27. In the first quarter, we sustained tremendous growth momentum in e-commerce. The investments we had made in this channel, everything from reorganizing around it, bringing in external talent and developing capabilities, paid off in a big way in 2020 when our e-commerce sales doubled year on year. And in the first quarter, our growth was about 75%, even as it lapped the year-ago quarter's acceleration. This is a shopper behavior that is likely to stick. Now roughly 7% of our total company sales, we know that our brands and categories play well in this channel, and we are building this business for the long term. Of course, on the other end of the spectrum during the pandemic are away-from-home channels, which have declined sharply amid shutdowns and restrictions. The slide shows that our U.S. away-from-home business continued to moderate its declines as measured on an average two-year basis to better gauge the trend. Important to know is that we have not been sitting still, waiting for consumer mobility to resume and away-from-home outlets to reopen. We have been actively securing future business, signing up new accounts for brands ranging from RX to Morningstar Farms and Incaimito. These actions today will pay off well into the future. Let's wrap up with a brief summary on slide number 29. Quarter 1, 2021, was yet another quarter of good performance and investment in the future. We have sustained strong momentum in most of our biggest world-class brands, never having let up in innovation or communication with consumers. We are unlocking capacity so we can resume full commercial activity in some of the foods and brands that had reached capacity limitations after good growth in recent years and acceleration since the pandemic. This added capacity will continue to come on stream during the year, continuing to improve service levels and return to full merchandising activity with our retail partners. Our emerging markets have not only managed through challenging macro environments over the past year, they've actually accelerated their growth. And we continue to build scale in these long-term growth markets. We're leveraging capabilities that we've been enhancing over the past few years, from data and analytics to e-commerce to innovation. These capabilities have only become even more important since the pandemic. Our cash flow and balance sheet are strong, and we have increased cash return to share owners while maintaining financial flexibility. Our results for quarter one were particularly strong, but more importantly, they reflected high-quality, balanced financial delivery. We sustained net sales growth, expanded gross profit margin, remained disciplined on overhead, and invested behind our brands, and still delivered growth in operating profit and earnings per share, leading to strong cash flow. all of which adds up to an early increase in our full-year outlook. As always, I want to salute our 31,000 employees whose dedication and creativity have made this performance possible despite the most challenging of business conditions. And with that, we'd be happy to take any questions you might have.

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're using a speakerphone, please pick up your handset before pressing the keys. If you wish to remove yourself from the queue, press star, then two. As a courtesy to your colleagues, please limit yourself to one question. Our first question comes from David Palmer with Evercore ISI. Please go ahead.

Thanks. The question about the 21 guidance and the implications of that, you had a 3% two-year CAGR that's implied by that. And obviously, this has been an unusual year in 21. Even if we look past 20, there's still some COVID-related factors. You mentioned supply chain. If you think about, you know, I think you would take a 3% organic growth rate most years, but Could you maybe talk about that 3% CAGR? What has sort of been a tailwind? What has been headwinds? And how do we think about that as you're really executing this turnaround plan, like how you're basically setting up for 22 and beyond? Thanks.

Yeah, thanks, David. I'll start and Amit can build. But what I'd say is it's important to look at those two-year CAGRs. As you point out, that's what we've been talking about because 2020 was such an unusual year. But what's underlying our confidence in that CAGR is the brand performances that we talked about as we went through the prepared remarks, our snacks business, our frozen business, our veg business, our international business, our emerging markets business, all performing very strongly. And if you think about our new guidance for 2021, essentially just from a top-line basis, we're saying flat. So what we thought potentially, what many companies thought of 2020 when they were COVID beneficiaries would be a high watermark is, in fact, we're going to lap that. And so that's because of the strength of our brands, the execution in the marketplace, and the plans that we've put in place. So Amit, do you want to?

Yeah, I think, you know, it reflects the strength of our portfolio, and you're seeing that come through. I think, you know, from a pure guidance standpoint, you know, we are expecting that elevated demand will moderate a little bit from quarter one, so I think that's what's built into the guidance. We're expecting growth in emerging markets to sustain, maybe not at the double-digit rates that we saw in quarter one, but certainly we continue to expect growth in the emerging markets. Thanks. I'll pass it on.

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

Good morning. It's Tom Palmer on for Ken. I wanted to ask on the inflation picture. So during the prepared remarks, you made mention of rising cost inflation. Could you provide a bit more detail on the inflation you're seeing right now and then what you expect to see as the year plays out and just the timing of your hedges rolling off? And then Your comfort in terms of offsetting it, I guess really the major tool I'm curious about, Coloron, is how you think about list pricing and instituting that this year. Thank you.

Yeah, thanks, Tom. So what I'd say is we've talked about the inflationary environment, which is real. We've also talked about the hedging, and I'll let Amit build on that, that we've got in place for the first half of the year as well as the back half of the year. On the pricing front and just a cost pressure front, What I'd say is we have a host of tools at our disposal. So we think about the suite of offerings. We want to always start with productivity and drive productivity as hard as we possibly can. And then we're going to look to revenue growth management and the tools that we have in revenue growth management, whether they be price package architecture, whether they be pricing, which would include list pricing. All of those are at our disposal. But at the end of the day, we have to earn that price in the marketplace through investing in our brands, through innovating. you know, through putting the types of performances that we've been able to put against our brands, which puts us in a good position to have the confidence, you know, to slightly raise our guidance, even despite increased cost pressures that are quite real. Amit, you want to?

Yeah, I think, you know, cost for inflation, no question, it's accelerated. I think, you know, we're now looking at it being in the high end of the mid single digit rate for 2021. We're seeing it across our cost basket, you know, from exchange traded commodities to diesel and energy, you know, ocean freight, We've seen a spike in ocean freight as well. I think, you know, all of that has been incorporated into the guidance that we provided today. From a hedging perspective, we're about 76% hedged on, you know, the exchange-traded commodities. Obviously, there are other cost pressures outside those as well. But I think, you know, we've reflected that in our guidance. And you would have seen that in our quarter one results. you know, we had strong pricing and mix come through. And as Steve mentioned, you know, it's across the whole range of levers, including productivity, including list price increases, including trade optimization, and price pack architecture. So, you know, the whole suite of revenue growth management tools.

Okay, thank you. And just to clarify, where would you have been in the first quarter in terms of that inflationary environment?

I think similar levels, though obviously it's accelerating through the year. And then obviously in quarter one, you know, we were more hedged than in the later part of the year, as you would expect.

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

Yes. Hey, guys. Thanks. Maybe just to round out that conversation a little bit more, when the I think you'd said on that last quarter that you were targeting 21 gross margins ahead of 19 levels. Is that, I guess, first off, is that still realistic or has that been ratcheted down a bit in your thinking? And then given that relatively extensive coverage from a hedge position, it would appear, just given the cost curves that we're seeing in the spot market, that it implies some residual inflation carrying over into 2022. I don't know if there's a way you can kind of frame the extent of that carryover to 22. But I'm really curious about, you know, given that, if I'm right about that outlook, does that impact your plans around the timing of pricing or other discretionary spending at all as 21 progresses? Thank you.

Yeah, so I think, you know, our goal is still to expand our gross profit margin on a two-year basis. So I think, you know, that's still our goal. And, you know, in that context, from a 21 standpoint, obviously we were ahead in quarter one. Quarter two is going to be our biggest lap as we lapped last year's outsized operating leverage. And then, you know, for the balance of 21, our goal would be to be as close to flat as possible. So that's kind of the way we're thinking about gross profit margin. You know, too early to talk about 2022 right now. But certainly, as Steve mentioned, from a revenue growth management standpoint, we're looking at a whole range of tools to offset the inflation that we see.

Okay, thank you very much.

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

Hey, folks. Thanks for stopping me in. One quick housekeeping question, then a more robust question. First, housekeeping. I thought I heard you say that developed markets benefited from shipment timing in the quarter. Am I right? Did I pick that up? Can you clarify and provide any sort of quantification?

Yeah, so we definitely did benefit somewhat from shipment timing. And if you think about, go back to quarter one 2020, where U.S. consumption growth exceeded shipments fairly markedly because of the surge. you almost have the mirror reflection in quarter one 2021 where the reverse was true, where U.S. net sales growth exceeded consumption. And as we've said many times in the past, you know, consumption is a good guide. It evens out over time. And, you know, some of this was clearly borrowed from or taken from quarter four, which we talked about when we did our quarter four call. But that's essentially where that ends up. Amit, do you want to?

Yeah, I think just to build on what Steve said, Jason, you know, in addition to last year's factors and timing versus last year, as we had mentioned in our last call, you know, some of this came from quarter four. Most of it, I'd say the timing came from quarter four. There's been a little bit, you know, as relates to quarter two. So there was some shipment ahead of activities, but, you know, most of it came from quarter four.

Okay. And then on those activities, Steve, we certainly heard you talk a lot about bringing merchandising activity back to try to get the market share going the right way. How do we think about that in context of the price equation? I mean, the pricing we saw this quarter was phenomenally robust, particularly in EMs, but also in DMs. As we think about the glide path forward of this more merchandising activity, can you hold the serve at, like, the levels we're looking at, or – Should we expect sort of a migration to net neutral by the time we get to the back half of the year, at least within DMs? Thank you.

Yeah, no, thanks, Jason. I'd say, you know, obviously we can't comment on forward-looking pricing and promotions and so forth. But what we are seeing, what we'd expect is a gradual return to normal levels of merchandising activity. As more and more people start to emerge from the pandemic, as capacity for ourselves and others starts to become more normalized, I would just expect that you'll see a more normal return to levels. I wouldn't see anything really above that. I wouldn't see the macro conditions that would drive that. And so, yeah, I think we can hold serve. And we're off to a good start. It's clear the areas where we want to work on, where we need to work on, and it's clear where we have really good momentum, and we'll want to continue to push against that as well.

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

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

Thank you. Good morning. Good morning, Mike. Good morning. Can you give a sense of how your conversations with retailers are going with respect to pricing? And maybe specifically, are they more sensitive to list pricing and more receptive to other approaches? Or is it similar across the board? Just kind of love to get a temperature check on where they are and how much kind of wiggle room you have from here out.

Yeah, thanks, Michael. So obviously, I'm not going to comment on any specific customers. But, you know, we have a mantra here that we talk about all the time. And that's that we have to earn the pricing that we get in the marketplace. Clearly, there is an inflationary environment that's real. Clearly, that's across broad swaths of the economy. And clearly, you know, there's been a lot of reporting on that. But, you know, we approach it with the humility that says we've got to invest in our brands. We've got to bring innovation. We've got to do everything that we can to continue to earn our place in the marketplace. But, you know, I'd also say we did raise guidance. And we're talking about holding, you know, as close to possible to our gross margins. So that reflects the types of confidence that we have that we'll be able to get through this by managing our price, mix, innovation with our customers.

How much can you balance the EBIT margin targets with the brand spending and inflation pressures? Is there some interplay there, or do you want to protect the brand spend specifically to allow pricing?

Well, you know, we've said in the past we like the brand building that we've got in place. We like the levels that we have in place. You know, in the back half of last year, we were very purposeful in saying what we pulled from the second quarter we're putting in the back half of the year because brands need investment. And we kept to our overall budget from last year, although it was back half weighted. And that clearly gave us momentum as we entered 2021, whether it be, you know, the Pringles example in the U.S. and, you know, in Europe. But we like our levels of brand building spending. We think they're important. They clearly give us the opportunity to drive our brands and, as I said, earn, you know, earn what we get in the marketplace. And so I think we're well-balanced. I think we're confident. Again, we raised our guidance based on that, and it's still very early in the year, so there's a lot of uncertainty at play. But we like the way it's shaped up. We like the way it started, and we like our plan going forward from a brand-building perspective and a profit-delivery perspective.

Okay, great. Thanks so much.

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

Hi, good morning.

Good morning, Chris.

Hi. Just a bit of a follow-on to that last answer and to Michael's question. I guess just to get a sense of the first quarter profit performance and EPS performance being so much stronger than expected, I guess I want to understand, were there any unique factors? We talked about maybe some over-shipment in relation to consumption. But just to understand how that kind of took hold during the quarter and then the degree to which inflation, I guess, is obviously picking up through the year. Is that picking up more than you expected, such that there's maybe more of a limitation on earnings growth in the remaining quarters? It just seems with this degree of outperformance in the first quarter that it would have led to a stronger performance for the year overall, unless there's some other unique factors I'm not incorporating here.

Yeah, thanks, Chris. I'll start, and Ahmed can build as well. We did raise guidance, and I think I hear in your question, why not more? But we're being prudent. Obviously, we're still in a pandemic where others are really not even giving guidance beyond the next quarter. We're trying to be as helpful and as transparent as possible. We still have COVID. Obviously, we have lots of challenges in emerging markets based on COVID and other things, but we're off to a good start and we're confident and we feel like we can manage all the things that you mentioned, the inflationary environment, the potential disruptions, but we want to be prudent and we want to be able to deliver what we say we're going to deliver.

And just to build on that, maybe a couple of additional points just on the shape of the year. So I think quarter two is when we've got the biggest lap, right? So if you look at it from a gross margin standpoint, That was the quarter where we saw the outsized operational leverage come through. So we're going to lap that in quarter two. Quarter two was also when we delayed our brand building into the rest of the year. And just if you recall, quarter two operating profit last year in 2020 was up 24%. So I think that'll just give you a sense of the lap ahead of us and just the shape of the year. I think, you know, like I said, from a gross margin standpoint, in the second half, you know, we target to get as close to flat as possible, recognizing that, you know, inflation continues to rise and recognizing that we are probably about 76% hedged. And, you know, the SG&A comp should moderate in the second half.

Okay, that's great. Thank you for the color on that. The next question is from Brian Spillane with Bank of America. Please go ahead.

Hey, good morning, everyone.

Good morning, Brian.

So two quick ones for me. First, it's just a follow-up on some of the inflation and commodity questions. I mean, could you, you know, we've heard from some other companies there's been with some commodities like soybean oil, for instance, where availability is actually a question. So Can you just, I guess, give us some insight in terms of, you know, your confidence in the availability or your ability to, you know, source the raw materials you need?

Yeah, I think, you know, from a sourcing standpoint, you know, we feel very confident in terms of, you know, our diverse supply base. So while, you know, obviously, you know, with ocean freight and containers and the Suez crisis, you know, there's been pressure in the system, but I think from a supply and a security of supply standpoint, you know, we're confident about that.

Okay. And then, Steve, you know, it's been a few years now since Deploy for Balance grew. And I know, you know, there's been some disruption with COVID over the last year or, you know, 13 months or so. But I guess just stepping back, can you just give us a little bit of insight in terms of, like, where you think You're maybe ahead of what your expectations would have been, kind of what's in line, and then maybe just where you still think there's some work to do.

Yeah, thanks, Brian. So I'd say we're really where we want to be, right? We're always, you know, constructively discontent. We want to do better. We, you know, demand of ourselves to do better. But when you think about things like shaping a growth portfolio, you know, that came through and it delivered. You know, the divestiture is behind us. It was a smart thing to do. It was the right thing to do. But you see our emerging markets, you see our snacks brands, you see our you know, many of our portfolio brands really executing well for us. When we think about perfect service and perfect store, you know, built perfectly for the type of pressure that we had to face last year and ongoing and facing this year. You know, we talk about building world-class brands and, you know, we put some investment surges into our brands, you know, unapologetically in the past. And because of those things, you know, before the pandemic, you know, I'd remind you that You know, we exited the year before the pandemic with, you know, 2.7% organic sales growth, right? And we were getting to balance. And then the surge happened and, you know, COVID happened. And, you know, here we are and we've had this, you know, unbelievable sampling opportunity, this reappraisal opportunity, which we've, you know, aimed to make the most of. But when you look at the two-year stacks and you look at our portfolio and you look at our performance, we're delivering top-line growth. We're back to growth reliably and for a lot of quarters now. And we're delivering balanced growth as well. And it's through the strength of our brands and the strength of the execution of our strategy. So we remain eager to do better. We remain hungry to But I think there's no question that Deploy for Growth has delivered and we are back to a balanced growth performance.

The only thing I'd add is that we delivered balanced delivery last year. I think our goal is to grow our gross margin on a two-year basis and our cash flow conversions. Last year was an exceptional year, but even if you set that aside, our goal is to increase our cash flow conversion. our new guidance on cash flow would indicate around a 75% to 80% conversion.

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

Hi. The 5% pricing or price mix in the quarter is a lot higher than what I had modeled, and I think others had too. I think the perception was that the pricing from a list perspective basis and maybe revenue growth management too would come later in the year as your hedges roll over. Does this mean that you can accelerate pricing even above 5% as the year goes on? Or is there something unusual about the 5% maybe related to the timing of promotional programs that would indicate that that's your peak?

Yeah, I think, you know, most of the price mix came from pricing in the quarter. And, you know, like I mentioned, you know, that was the whole range of tools across all the regions. I think in some of our EMs, you know, we took significant pricing to cover for commodity. And remember, in some of these markets, we've also had transactional Forex impacts through, you know, the back half of 2020. into 2021. So, you know, you've seen pricing to offset that come through in the pricing. I think, you know, we also benefited from mix, you know, with snacks growth coming back, you know, certainly from a mix standpoint, that's a positive. So, you know, that's kind of what drove the quarter one results.

Okay. So as snacks comes back, that boosts your price mix. But what does it do to your gross margin and operating margin? Is that dilutive to both or just to one of those?

Yeah, you know, we don't get into the by category profitability, but I would say that, yeah, I mean, you know, it's kind of at the mix level, at the margin level, it kind of is neutralish. At the price level, it's accretive. Okay. All right. Thank you.

The next question is from Andrew Lazar with Barclays. Please go ahead. Thanks.

Good morning, everybody.

Good morning, Andrew.

Just a quick one, Steve, on the capacity additions that you talked about. I'm curious if you can maybe dimensionalize a little bit how much of that capacity, broadly speaking, would be sort of internal versus, let's say, leveraging external third-party sources. And really the reason I ask is just because to the extent that more of the capacity is internal, that has implications for obviously your level of conviction around the you know, stickiness of demand or, you know, elevated levels of demand going forward, let's say, versus pre-pandemic versus if you were doing more of this externally. Thanks so much.

Yeah, thanks, Andrew. So I'd say most of what we talked about is internal capacity, right? Many times, you know, we look to external capacity when we're starting out. So if you look at like a Cheez-It Snap line, we might start with the first line being external, but get lots of conviction that second line was internal. And so when we talk about serial capacity, when we talk about ego capacity, we're talking about internal capacity building and expansion. And so you can take from that that there is real conviction. But what I would say is we're not building based on any kind of pandemic that's going to go away. We're building on what we really need, right? And so, like others, you know, we operate – our capacity pretty tightly, right? And historically, when you're in categories that are growing low single digits, you'd expect that. The surge created a whole different set of circumstances. But as I said, 2020 is not really going to be our high watermark, right? And so we're going to lap those things in 2021. And we're going to need the capacity to do that in things like certain elements of our ready-to-eat cereal and in EGO, in some of our Cheez-It lines, but we're in pretty good shape. And so it's all embedded in our guidance, and we feel, you know, we feel like we've got a good plan. Thank you.

I think, Operator, we have time for one more question.

And that question comes from Rob Dickerson with Jefferies. Please go ahead.

Great. Thanks so much. Maybe two quick questions. One, just a quick follow-up from Andrews on capacity. As that comes on, it sounds like, you know, increasingly later this year and then in the next year, is that just one of the drivers, very simplistically, as to why you might feel a little bit, you know, better on the gross margin side? I mean, I'd assume, right, as that comes on, third-party goes away, but then maybe there's also a double positive effect by just bringing more in internally off the volume leverage piece. Thanks. Thanks.

Not really, Rob. A couple of years ago, when we were doing a lot of on-the-go, you know, we were attacking the on-the-go occasions, and we did a lot of third-party, but we also had a lot of manual work being done. That was the case. But now we're more in a normalized environment where we're building capacity based on increasing demand. So not really.

Okay, great. Cool. And then just other quickly, just on the EM pricing piece, you know, I know you said, right, there's some transactional, you know, impact, obviously, and then obviously, and then also on the cost inflation side, it was very high, right? It's impressive. Is that like, was there pricing in there that you would say could also have just been opportunistic given, you know, what you're seeing across all of those countries within that segment? you know, such that, you know, you weren't pricing that much historically, but maybe there was, like you said, some of that brand building could have been targeted to some of the areas within EMEA. And therefore, you know, you kind of stepped in and took maybe a little bit more pricing that, you know, FX or cost inflation may have, excuse me, may have suggested. Thanks. That's it.

No, I think, you know, just looking at the cost situation, commodities, Forex, and, you know, obviously we've seen inflation in both. So I think, you know, trying to preserve your margins while also balancing out, you know, volume growth and share, I think, you know, and triangulating between those drivers.

All right, super. That's all I have. Thank you, everyone. Thank you.

Thank you. All right. Well, that concludes it. Thanks very much, 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.