WK Kellogg Co

Good day and welcome to the Q3 WK Kellogg Co earnings conference call. Today's call is scheduled to last one hour, including remarks by management and then a question and answer session. All lines have been placed on mute to prevent any background noise. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, please press star followed by two. Thank you. I'd now like to turn the call over to Karen Duke, Vice President, Planning and Investor Relations. Please go ahead.

Thank you, Operator. Good morning and thank you for joining us today for a review of our third quarter results. I'm joined this morning by Gary Pilnick, our Chairman and Chief Executive Officer, and Dave McKinstry, our Chief Financial Officer. Slide number two shows our forward-looking statements disclaimer. As you are aware, certain statements made today such as projections for the 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 factors listed on the disclaimer slide, as well as those in our public SEC filings, including the risk factors in our registration statement on the form 10. As we discuss our results today, unless noted as reported, we'll be referencing the respective non-GAAP financial measure which adjusts for certain items included in our GAAP results and which also are presented on a standalone basis. You can find definitions of each non-GAAP measure and GAAP to non-GAAP reconciliations within our earnings release and in the appendix to the slide presentation. I will now turn the call over to Gary.

Thanks, Karen, and good morning, everyone. Thank you for joining us today on our very first earnings call as WK Kellogg Co. We're excited to be speaking with you as an independent company and to have the opportunity to share our confidence in the strategy we presented at our Investor Day. Today, we will share more detail about how we will be running the business. As a quick overview for today's call, I will provide a reminder that of the underlying logic for the SPIN, discuss our strategic priorities, and discuss our recent performance. I will then turn the call over to our Chief Financial Officer, Dave McKinstry, who will provide additional detail on our performance and outlook. I'll then provide closing comments and open the call to Q&A. Turning to slide four, the key takeaway from our call today is that we're on track, and we're on track in a variety of ways. We're on track to deliver 2023 slightly ahead of the financial targets we provided at Investor Day. We have positive margin momentum in the business as we begin our journey and continue to recover from the fire and strike. Second, we are on track to deliver 2024. And this morning, we reaffirmed our financial outlook. To be clear, during Investor Day, we provided guidance earlier in the cycle than we plan to going forward. and we did so to give clarity ahead of the spin. Today, we are expressing our continued confidence by reaffirming that guidance. We will come back in February during what will be our normal cadence to further refine our financial outlook for 2024. Next, we are on track with key separation milestones. We've successfully executed the spin with minimal business disruption, and we continue to build plans to execute and then exit The transition services agreement, again, with a focus on minimizing disruption as we stand up our independent company. Last, we're on track with each of our strategic priorities that we outlined during Investor Day. While we have been an independent company for just a few weeks, we got off to a fast start. We've been executing on each of our strategic priorities, that is, driving an integrated commercial plan to win, modernizing our supply chain, and unleashing an energized and winning culture. On slide five, I would like to start by recognizing our team and the tremendous work that went into establishing WK Kellogg as a publicly traded company. For over a year, my leadership team has been developing our strategy, creating our organization, building our culture, and executing with the attitude and entrepreneurial mindset of a startup with the discipline and expertise fitting of our 117-year history. The entire W.K. Kellogg Co. organization was enrolled on August 1, the day we entered into what we call company and company, and we have been off to the races ever since. I could not be more proud of how our team is operating and the passion they show every day to drive our business forward. This opportunity is unique, as is the depth and commitment of our people. We are all ready to deliver on our purpose of inspiring great days and to capture significant value for all of our stakeholders. If we zoom out on slide six, this all started with the belief that the cereal business would be stronger as an independent company. By doing so, we would be able to direct our resources towards our unique strategy and unlock the full potential of our business. It certainly comes through in how we plan to run the company very differently, which in turn, we believe, will drive very different outcomes. You can see here our strategic priorities, which have been designed to have the collective impact of driving stable top line and share growth, delivering outsized margin expansion, and generating long-term value for our stakeholders. You have heard us highlight three key themes that cut across all of our efforts. That is focusing, integrating, and investing. For example, we will focus only on winning in cereal. We will integrate the business end-to-end to drive better execution. We will invest in capabilities, technology, and infrastructure, and we'll do so in a targeted, highly disciplined manner. And none of this would have occurred but for the spin, again, reinforcing why we believe W.K. Kellogg is stronger as an independent company. Now, let's look at how the strategy is coming to life. Slide seven. speaks to our strategic priority of driving an integrated commercial plan to win. You will see there are three pillars to this priority. The first pillar brings together the demand creating infrastructure, starting with combining five distinct businesses under the leadership of one commercial team. That is the running the business as one unit while preserving what is unique across the region and channels. This allows us to bring together brand and channel strategies across the business. And we're doing the same with data and analytics, harnessing the power of those efforts under this team. These businesses have already been joined up and we're operating under the new organizational structure. With this demand-creating infrastructure in place, our second pillar will be to drive our consumer impact. By executing our new marketing model, we will focus on delivering greater return through more effective and efficient commercial investments. all of which is underpinned by enhanced data and analytics to drive deeper consumer and customer understanding, the combination of which is intended to be a catalyst for winning in the marketplace. Our third pillar brings this to life in store, what we call the moment of truth. We will activate these ideas with a focused and dedicated sales force selling only cereal. As a reminder, the integrated Kellogg Company sales force was responsible for several categories, most of which were a higher priority than serial. The sales force has been operating since August 1 and has substantially the same customer coverage as did the Kellogg Company sales force with their time and efforts now fully dedicated to driving serial conversion for our customers. This is a place where we chose to put our investment as we designed our organization. Driving an integrated commercial plan to win will allow us to scale up big ideas, drive consumer demand, and more effectively execute with our customers. On slide eight, we'll discuss how integrated commercial strategy is already coming to life. Back in August, our sales force started showing up with customers as W.K. Kellogg and included everything from ordering to shipping to billing. Early feedback has been quite positive. This also allowed us to meet with customers and share our 2024 innovation that has been well received. That said, we aren't waiting for 2024 to win in the market. Here's just one example. Our newly integrated commercial team recently relaunched the Bare Naked brand, which was disproportionately hurt due to manufacturing complexities as a result of the fire and strike. The relaunch focused on increasing taste appeal and driving fun and took an end-to-end approach to enhance the eating experience, new packaging to highlight the food and brand, and new media campaign which surpassed our expectations. Now it's in the good hands of our dedicated sales force to drive merchandising, distribution, and overall performance. Next on slide nine, we outline our second strategic priority, how we will invest to modernize our supply chain. Our balance sheet flexibility will allow us to move from maintaining to modernizing our supply chain, leading to a much more efficient cost structure and agile system. This priority is the centerpiece of our plan to capture the 500 basis points of margin expansion we discussed at Investor Day. Again, there are three pillars to this strategic priority. First, we will be consolidating production, leveraging our more efficient and cost-advantaged facilities and platforms. As we said at Investor Day, there is an approximately 50% cost differential between our highest and lowest cost facilities. We have the ability to move and consolidate production across our network, and we have effectively implemented these types of changes successfully in the past. For example, we continue to expand our production capacity in our Belleville facility. In addition, we're already working with key stakeholders in certain locations to improve plant productivity and economics. Second, as we consolidate, we plan to invest in new infrastructure including adding significantly more flexible and efficient manufacturing and packaging capabilities. Third, we're implementing improvements in our plant operating practices to unlock further efficiencies, which I'll provide an example of in a moment. Consolidating production, investing in new equipment and infrastructure, and improving how we operate would result in a more agile, reliable, cost-effective, and modern supply chain. Looking further at our operating practices on slide 10, we are already taking actions to improve engagement and institute change. In addition to our supply chain investment, our goal is to drive end-to-end operating efficiencies through high performing teams to instill the right mindset and fully leverage our assets. Let me give you a recent example of how our new ways of working can expand capacity, reduce cost, and drive engagement. I wonder if our facilities are cross-functional team of subject matter experts, leverage data and analytics to reduce complexity and streamline processes, which decrease downtime and increase capacity. As you would expect, we are using this as a blueprint to implement these learnings across our network. While just an early example, it's a big change in the ways of working and demonstrates our holistic approach to modernizing our supply chain. Unleashing an energized and winning culture is our third strategic priority on slide 11. Again, three things worth mentioning. First, we recognize this is foundational to everything we do. Having the right culture alone can change the trajectory of a business. And this gives us even more confidence because of the hand-picked organization that the leadership team designed and created over the past year. Second, we will execute this priority like any other. with specific plans, goals, and performance measures to ensure we are executing this well given its significance to the business. And third, it's already coming through the organization. It's coming through our sales force, our manufacturing team, in the Caribbean, in Canada, at our Battle Creek headquarters, across the organization. Our people are engaged, empowered to make decisions, and are driving towards common goals. Turning to slide 12, you could see that we're delivering the consistent foundation that makes our financial model work. By holding our top line flat and executing our supply chain modernization, we will deliver outsized EBITDA growth. Let me provide some context, as there have been meaningful discrete events that have impacted the business the past few years. We relaunched the business in the second half of 2022 as we were coming out of the fire and strike. We had limited investment in the front half of 22, as we were reestablishing supply with our customers. We turned on our commercial activation in a big way in the second half, which included increased investment. We resumed more normalized commercial activity in 2023, where our investment was more evenly spread across the year. The good news is that it has resulted in the type of consistent top line we expect going forward. We started 2023 strong with the launch of our innovation executed pricing, and regained our footing from the fire and strike, all of which allow us to win in the marketplace. We have maintained our consistent delivery into Q3, even in the face of rising price elasticities and a challenged consumer. Now on slide 13, let's take a look at our brands and performance year to date. These brands have broad appeal across cohorts, are supported by proven marketing capability, and have a track record of successful innovation. In fact, WK owns nine of the category's top 20 brands across the US and Canada. This is core to what we bring to the table, a strong foundation from which WK will build. In the US, our share of the market is up 70 basis points this year. Our big six brands are performing well with share growth on Special K, Raisin Bran, and Rice Krispies. We have increased total points of distribution in the US on Frosted Flakes, Fruit Loops and Rice Krispies, and continue to build plans to gain more points of distribution. In Canada, share is up 180 basis points, driven by growth in Frosted Flakes, Rice Krispies, and Vector. The business is on track, and we're executing our plan as expected. Let's look now at how consistent top line is benefiting our profitability on slide 14. On a year-to-date basis, gross margin has improved almost 5%. full percentage points, with three points dropping through to EBITDA. Our improved cost structure reflects our underlying business momentum and our recovery from the fire and strike. We will continue to focus on winning in the marketplace and driving margin improvements. Now let's turn to slide 15 to bring it all together. From this point forward, everything we do is in service of Cereal. Our team wakes up every day focused on executing our strategic priorities. We're leveraging our integrated organization and demand-creating capabilities to drive our commercial plan to win in the market. We are relentlessly pursuing opportunities to unlock profitability and optimize our cash flow. We are not waiting. You already heard about focused initiatives we're implementing to drive better outcomes for this business. We mentioned a couple of examples of how we will operate differently to drive high return on our investments and unlock EBITDA margin growth. When you bring it all together, we plan to win in the market through the launch of our new marketing model, activated in store by our dedicated sales force, and enabled by a modern and reliable supply chain. We are just getting started. I will now hand the call over to Dave to take you through our financial results and outlook.

Thank you, Gary. My commentary today and details around financial results will be provided on a standalone adjusted basis. which we feel is the best depiction of our business going forward. Full detailed results and reconciliations have been provided in today's press release and the appendix to this presentation. Turning to slide 17, you will see that net sales for the third quarter were in line with our expectation at $684 million, a 1.9% decline versus a prior year period. While year-to-date net sales were up 4.6%, reflecting positive price realization and good momentum as we continue to rebuild the business from 2022 to press levels, specifically in the first half. Our product performance is highlighted with share growth led by Special K, Rice Krispies, and Raisin Bran, and slightly offset by our health and wellness portfolio, which includes Kashi and Bare Naked. For the third quarter, volume was impacted by increasing levels of price elasticity, lapping inventory rebuild in the prior year period, and a more disciplined promotional approach focused on balancing volume and profitability. As previously mentioned, we relaunched the business in the second half of 2022, which included increasing our commercial investment and led to elevated levels of promotional activity. On price elasticity, we have seen an increase in Q3 versus levels we previously saw throughout this inflationary cycle. These levels are tracking with the expectations we laid out in investor day, and we expect they will continue into the fourth quarter and early 2024 as we lap list price actions. All this was expected and we remained confident in our ability to deliver our financial commitments for the year. Gross margin for the third quarter was 28.5%, a 290 basis point improvement versus a prior year reflecting the benefit of positive price mix. Our year-to-date gross margin improvement of 460 basis points is elevated above Q3 levels due to the lapping of fire and strike in the first half and an insurance recoupment in Q2, which we previously disclosed in our Form 10. This one-time recoupment was an 80 basis point benefit to gross margin on a year-to-date basis. EBITDA for the third quarter was $51 million, a 65% increase versus the prior year, driven by improved productivity and increasing levels of operational discipline. EBITDA margin for Q3 was 7.5%, a 310 basis point improvement versus a prior year period. Note, Q3 EBITDA margin reflects our seasonally highest level of brand building to support our back-to-school activity. Year to date EBITDA is $206 million, up 50% versus prior year and reflects the aforementioned drivers and gross margin in EBITDA. This resulted in EBITDA margin year to date of 9.9%, a 300 basis point improvement. For the year, our business has performed as we expected and we are showing steady improvement on a rolling 12 month basis. We are on track to deliver against our financial commitments for both 2023 and 2024, which we'll cover in just a moment. Looking now at slide 18, this chart demonstrates the improvement we've seen in our business throughout 2023 on a trailing 12-month basis. We already saw the consistency of our top line. Looking at net sales on the slide, you can see we are delivering in the $2.7 billion range. Our top line performance has been a positive catalyst for our margin improvement. Looking at gross margin, you'll see that since Q1, we've gained 140 basis points due to positive price mix driven by revenue growth management initiatives and increased efficiencies. Finally, looking at EBITDA margin, profitability has dropped through, which has resulted in 100 basis point improvement. Through the third quarter, EBITDA margin is 8.7%, and in line with our expected margin trajectory, realizing price, and recovery from the fire and strike. This is a type of study improvement we expect to continue as we finish 2023. Moving to our opening debt position on slide 19. At the completion of our spinoff, our debt balances consisted of $500 million on our term loan A and $164 million of borrowings under our revolver. At the end of Q3, we had cash in equivalent position of $64 million, And in addition, we received $44 million of cash at spend from Calanova, resulting in an implied net debt of $551 million at spend. As you'll recall from Investor Day, the proceeds from our debt were largely intended to fund the dividend back to Calanova for the purposes of splitting the balance sheet. We initially estimated this dividend would be $400 million. However, the amount increased to account for the timing difference in net working capital. This timing difference will normalize in Q4 as working capital accounts reach ongoing run rates. We expect net debt to be in targeted levels by the end of Q4. In fact, we already paid down our revolver balance to zero as we start to realize cash inflows related to this normalization of core working capital balances. As a reminder, our Term Loan A has a capacity up to $750 million with a $250 million delayed draw feature and will primarily be used to fund our supply chain modernization. Our revolver has a capacity up to 350 million and will primarily be used to supplement our seasonal cash flow as needed. Turning to our outlook on slide 20, for 2023, our guidance is slightly ahead of the targets provided at investor day. We expect net sales to be in the range of 2.72 billion and 2.74 billion which reflects growth of 2.1 to 2.8%. We expect EBITDA margins to be between 9.1 and 9.2%. This compares the 2.7 billion in net sales and approximately 9% EBITDA margin we discussed in Investor Day. Additionally, for Q4 2023, our below-the-line assumptions include consolidated OIE expense of approximately $5 million and an effective tax rate of approximately 24%. Moving now to 2024, we are reaffirming the financial outlook we provided at Investor Day, where we said net sales would be approximately flat and EBITDA dollars would be in the range of $255 to $265 million. As mentioned, we provided early guidance in August for increased visibility heading into our spend, and we remain confident in our ability to achieve those numbers. We will come back to you in February with more specific guidance. Additionally, for 2024, our below-the-line assumptions include consolidated OIE expense of approximately $15 million and an effective tax rate of approximately 24%. Again, all of this is consistent with what we said on Investor Day, and we will refine our 2024 financial outlook further in February at our Q4 earnings call. Let's now move to slide 21 and take a look at our capital allocation. First, we'll be focused on high ROI investments to unlock our margin expansion opportunity, moving us closer in line with our center of store mid-cap peers. Second, we'll be focused on returning capital to shareholders. And with that, we declared our very first dividend for Q4 of 16 cents a share. Last, we covered our debt position on a previous slide, and our long-term focus is maintaining a leveraged position of approximately two times EBITDA, which we feel provides the right level of strategic flexibility. As we begin to execute our supply chain modernization, our daily focus is on driving disciplined business decisions that improve our profitability and optimize our cash flow for the short and long term. In summary, we execute the spend with the balance sheet in line with expectations Our top line is delivering consistently against our expectations, and our EBITDA margin improvement journey is off to a great start. With that, I will now turn the call back over to Gary.

Thank you, Dave. On slide 22, let's take a final look at how we're viewing the opportunity that lies ahead. We operate in a large, durable category with many of its most iconic brands. Our singular focus on cereal while integrating the business will drive delivery of stable top line and share growth. Our actions to invest in our people and optimize our resources will allow us to realize the full benefit of our supply chain investment and deliver outsized margin growth. And finally, executing on our strategic priorities will lead to a significantly more cash-generative business producing attractive returns for our shareholders. Our team of 3,000 colleagues across WK Catalog Co. is excited to be at the helm of this new independent company. And Dave and I would like to personally thank each one of them for what they've done, what they're doing, and what they will do to bring this strategy to life. We hope you can hear our confidence and see the progress we are making in just the first month of being an independent company. I will now open the call to Q&A.

Thank you. If you would like to ask a question, please press star followed by one on your telephone keypad. If for any reason you would like to remove that question, please press star followed by two. Again, to ask a question, please press star followed by one. We kindly ask that each person limit themselves to one question and one follow up. Thank you. Our first question today comes from the line of Max Gunport from B&B Paribas. Please go ahead. Your line is now open.

Hey, thanks for the question. And it was nice to see the 23 and 24 outlook reaffirmed. I was curious on the share loss trends we're seeing. You did highlight you've gained share this year, but I think more recently, meaning over the last couple of quad weeks, we've seen share losses resume in serial and they're pretty meaningful. So wondering what the drivers are and how that informs your view of delivering stable growth in 2024. Thanks.

Thanks, Matt. Terrific question. I'm glad that you're here with us today. And let's start with, as we answer these questions, as we were forecasting this business back at Investor Day, a lot of this has already been baked in. And the reason you can tell that we were thinking that because that gave us the ability to reaffirm this morning our 23 forecast as well as our 24. but it's a very fair question about the way our share performance is moving in the category. When we see this, there's a couple different things that are worth mentioning. First, price elasticity. Price elasticity has hit the market pretty meaningfully in Q1. You might recall that there's been about 35% of price increases over the last couple of years for us, and the elasticities were fairly benign for quite some time with a significant uptick recently. So price elasticity has come in. Again, this is something that we saw coming and it was part of our forecast. The second thing for us is where the impact of the timing of pricing actions on our business. As we were recovering from our fire and strike max, we actually took pricing a little bit later than other folks. And you can see in the market data that we have the highest price realization in the quarter and gives you a sense of the impact of the timing delays or the different timing for those pricing actions. So if you look at volumes over a shorter period of time, if you look at share over a shorter period of time, it has a pretty pronounced impact. But over time, it starts to then even out. Now, as we continue thinking about what's happening with our share, there's been a disproportionate impact on us because of the way we're handling promotions. Last year, we were relaunching the business. In the first half of the year, it was really about reestablishing supply. Back half of the year, we turned on our commercial activation, including promotion. When you see the year-over-year comparison this year, we're down pretty significantly, and that was intentional. That was part of the plan. We're looking for a more balanced approach where we balance volume and profitability. So all those things together, that's what's having an impact on our volume. One last thing that's worth mentioning is what's happening with our health and wellness brands, Kashi and Bare Naked. They're getting hit even harder. Now, you heard in our prepared remarks, we see this as an opportunity going forward. We've already relaunched a bare-naked brand with new food, new packaging, new messaging. So we think we could do something special with those brands. But it's a combination of those things that in the nearer term has impacted our share. We do think that continues into the fourth quarter as we start lapping the price increases and as we start lapping what was last year a very meaningful investment in our commercial activations.

Thanks. Very helpful. And one follow-up on that topic is just specifically what you're seeing with regard to value-seeking behavior, whether it's a move to private label or reducing of waste, or maybe it's a move from more premium-oriented brands to more mainstream brands. Just curious for any signs you're seeing of value-seeking behavior and if things are to be getting more extreme or if they've peaked to some degree. Thanks very much, and I'll leave it there.

I think undoubtedly the consumer is under pressure. I read a report this morning about dropping consumer confidence, so we recognize that's happening in the broader environment. Now, it's interesting for us, the serial category tends to perform well in situations like this when the economy is behaving the way it is, and we have seen private label has actually gained some share. If you take a step back and you look at private labels, Earlier this year, their TDPs went up, and TDPs are highly correlative with sales growth. So that's what happened during the course of this year. If you look at some of the near-term data, it looks like the share has leveled off around 7%. And when we see that, private label has had a meaningfully lower stake in our category than many others in dry grocery, probably for a couple reasons. One, this is a highly branded business, and the big manufacturers They invest a lot in innovation, in brand building, into this category, and that's what makes this category so very special. The other thing about private label stake in the category is it's already quite an affordable category. Cereal with milk, a bowl is less than a dollar. That's a meal, so it's already quite accessible to a lot of consumers. And what's most interesting about what's happening right now in the category, because you're right, the consumer is under pressure, but the premium end, of the category is growing, which I think gives you a sense of, even at the premium side of the business, that it's still very accessible and affordable to our consumers. In fact, we're playing there already. We introduced the first zero-added sugar cereal to the category. We have Special K high protein, and we're expecting to do more. So that's actually an exciting place for us. So yes, I think consumers are making choices there, undoubtedly, but these category dynamics is something that we actually think could work in our favor longer term.

Great. Thank you, and congrats on completing the split.

Hey, thank you, Max. Our next question today comes from the line of Ken Goldman from JP Morgan. Please go ahead. Your line is now open.

Hi. Good morning. Thank you. I just wanted to clarify, is the messaging about volume, just given that your commentary about share still being hit into the fourth quarter and you're lapping some meaningful investments, is the messaging that we shouldn't necessarily get ahead of ourselves and model a meaningful improvement in your volume number in 4Q versus 3Q? I just kind of want to get a better sense of the cadence for that volume number into the next quarter and as we begin next year.

No, that's a great question. Dave, why don't you give them the shape of how we're thinking C3Q?

Yeah, Ken, I would suggest that the volume will be relatively consistent from Q3 levels into Q4, right? And as we head into next year, I would expect Q1 to start seeing a little bit of improvement. Now, one thing that we think about volume is we think price realization is is an important component of our overall profitability journey, right? So our GM initiatives as we go forward, we expect those things to continue. And we want those things to continue as they drive meaningful amounts of profit for us. So it'll change, we think. We'll change from some of the list price behavior that we've seen over the last couple of years. But going forward, after we lap the price increases really around the end of Q1, we'll probably see an improvement in volume. But again, I do want to emphasize that we like our game. We want to try to continue to realize price in the marketplace. And that's part of our initiatives to drive profitability.

So just to build on that, is it possible that we will see, you know, positive price into 2024? And will some of that be on the list price side? Or is that more on the I just want to get a sense of kind of the shape of that or a little more help on that comment and what that necessarily means for the shape of the year.

Yeah, I would expect that we do see positive price realization throughout the year, not at the same levels we have, especially, you know, after Q1. And as I mentioned, I think on the prior piece of the question, I don't expect it to be heavily list prices. We've seen kind of the inflationary environment stabilize at the current levels.

Great. Thank you.

Thanks, Ken. The next question today comes from the line of Rob Dickerson from Jefferies. Please go ahead. Your line is now open.

Great. Thanks so much. Maybe follow-up to follow-up. So I guess, you know, what we're hearing is it continued kind of volume pressures if the quarters didn't elapse and a lot of moving pieces. But then it's like we think about next year, maybe there's some ongoing go forward RGM potential. But clearly, as you said, the investor day and kind of reiterate today, sales should be flat for next year. So I guess kind of the first basic question would be kind of the assumption would be that I guess volumes would still be down next year. And then I kind of more broadly you can kind of just kind of want to ask like you know do you feel like you're kind of you know operating with this like very fine line with respect to like rgm thought process vis-a-vis kind of maybe volume reaction on the go forward um because you've also clearly implied that you know you do expect to take category share which sounds like for dollar share maybe even volume share that's all thanks

No, thanks, Rob. I think the way we would look at it is you take a step back and look at what the business was doing over the last couple of years. Remember, in 2022, we were supplying the categories, supplying our business, the back half. We had meaningful investment as we turned our commercial activation back on. That's what we're lapping right now. And it was a different promotional approach, a different level of investment, and I think you'll see that even more in Q4. So that is what we're working through right now as we're lapping that again. That was all part of the plan. The business is executing the way we thought it would be executed. And that's why we're able to reaffirm 23 and 24. Now, going forward, you have it exactly right. We're looking for a flat top line. That's going to mean with our assumptions that we would win back market share. We will use RGM as one of those levers. We think that's an important way to do that. Looking backwards, there's been significant price increases. We don't think that's what's going to be happening going forward. There's ways for us to manage this business where we maintain that top line to RGM and to other activities. But we're also going to be turning on all the new ways we're doing business. You have to remember, we just started operating five weeks ago. So we're integrating our commercial plant to wind and serial. That means integrating five separate businesses, finding all the opportunities there, including our new marketing model, We're just getting started with our fit-for-purpose sales force where all they're going to do is be selling cereal, and then over time our supply chain gets that much more reliable. So if you think about that flywheel as the demand creating, the sales force, and the supply chain functions are all working together, you can see the dynamic impact that should have on our business as a whole. But you're right, RGM is going to be important to us. Doing that the right way, the balanced promotional approach we're going to have, All of that collectively will have the impact on our top line going forward. All right, cool. Thank you so much.

You're welcome. Thank you. The next question today comes from the line of Peter Calbo from Bank of America. Please go ahead. Your line is now open.

Hey, Peter.

Hey, guys. Good morning.

Thanks for taking the question. Hey, good morning. Dave, I know you don't want to get too much into 24 official guidance, but I was just wondering if you could talk a little bit about, you know, the cadence of gross margin. Obviously, you've had some nice progression here in 23. I think there were maybe some one-off factors as well in the year. But just as we're starting to think about kind of 24 relative to 23 gross margin, if you could discuss some of those non-repeating factors and then maybe some of your expectations on underlying improvements.

Yeah, I appreciate the question. So, I would start by saying, yeah, we'll come back with further detail in February and refine these numbers for you. But, Peter, where I would start is, you know, you can pretty quickly get to that we're expecting some level of margin improvement into 2024 from our current 2023 guidance that we're giving today. I would suggest that the majority of that comes at gross margin, right? So you'll see a pretty close flow through from gross margin to EBITDA margin in total in 2024. Again, a little bit early for us to quantify that. We'll come back to it. I did mention some one-time things that we had. We talked about the recoupment and the impact that that had on this year, and that will be a lap for us that even with that one-time thing coming away, we do expect gross margin to continue to improve into next year.

Got it. Okay, now that's helpful. And maybe just, and I don't want to pin you down to it, but any early thoughts on a couple of cash flow items for next year? You know, capital spending, you know, free cash flow, just how we should kind of start to think about that.

Yeah, again, we'll come back in February with more detail on it. I think one thing that we said on Cash Flow Investor Day is we expect to convert around 100% of net income to cash before our investments. We're still working on you know, the exact detail, exact timing of those cash outlays is, you know, they aren't insignificant as we think about our modernization program. So still further refinement there, and we'll come back in February with more details. But, you know, I think we've given some simple direction on base cash flow, and then it's really coming back to refine those investment assumptions. Great. Thanks very much.

Thank you.

Our next question today comes from the line of Andrew Lazar from Barclays. Please go ahead. Your line is now open.

Great, thanks. Good morning, Gary and Dave. Good morning, Andrew. Good morning. Great. You know, Gary talked a little bit about sort of the promotional or merchandising approach, right, trying to balance sort of the profitability and the merchandising aspect of it. I'm curious if you could talk a little bit about what you're seeing in terms of the effectiveness of of the promotional or merchandising activity that you're putting out there. You know, a lot of this merchandising activity for, I think, for most of the industry tends to be pretty high return, and it generates, you know, typically a lot of incremental volume when sort of done the right way. What are you seeing in terms of the trends in your incremental merchandising that you're putting out there in terms of the return profile to the extent that you can, you know, sort of measure it in that way?

I appreciate you asking the question, and Andrew, promotions have been and always will be an important part of our business. And we talked earlier about a balanced approach, so we can just repeat that as we enter into this answer, which is we're balancing this year more about volume and profitability as we're thinking about our promotions. And we do believe it's delivering what we expect it to deliver. Again, I know I'm repeating myself, Andrew. It's one of the many reasons we're able to reaffirm 23 and 24. Now, we did talk at Investor Day that we think there's a meaningful opportunity for us in merchandising and promotion in general. When you think about 2019 levels, we're not back there yet. The category is. We think there's opportunities for us to get there. And cereal does have some of the better lifts in dry grocery. So for us, it's doing what we expected it to do. But I would also tell you, given to what we're doing in our business and our strategy, we would expect to execute this even better going forward. When you have the demand-creating infrastructure that's being integrated together with our Salesforce, we absolutely believe, and one of the things that we believe will help drive the business going forward is the way we execute. So where we are right now is what we were expecting, but we think we'll do even better as we go forward as we turn on this new machine that we're creating at WK Kellogg.

Great. And then a quick follow-up just on a specific brand. I remember... A couple of years ago, Special K, a very big brand, was trying to move through a process to sort of reinvent basically what the brand proposition to consumers. It was going from sort of what had been more like a weight loss-oriented brand to I guess more of a wellness type of approach. Those types of things and redefining a brand to consumers can be tough, but it sounds like That band is now on a much better track, if I'm hearing you right. So I'm curious, how has that process played out in that brand, and where is it now with respect to sort of, I guess, consumers?

I would agree with you. We talked a lot about this quite some time ago about Special K was positioned as a diet brand. And let's remember, Special K was really benefited from that, but the world then turned against diet brands, Special K and others like that in the industry. And you're right. Turning a brand like that is not easy to do. We feel good about where Special K is right now, and it's getting after health and wellness and better diets and just wellness of our consumer. A couple of recent examples of what brings to life the way the team is thinking about the brand would be Special K Zero, the first zero-added sugar cereal into the category, as well as Special K High Protein. Two things there. You can see the nutrition credentials in the food just in the names of the products, but it's also these businesses are really about how do we drive this forward and how do we drive the business into more premium products as well. But both of those things, health and wellness, we're moving it to premium. But look, Special K is also for all consumers. So I think the team's done a terrific job of transitioning that brand, evolving it as we go forward to match changing consumer behaviors. which is what we need to do as a business going forward.

Great. Thanks so much.

The final question today comes from the line of David Palmer from Evercore ISI. Please go ahead. Your line is now open.

Thank you. Just to confirm just on sales guidance and what it implies, Are you thinking down 3% to 4% organic sales in the fourth quarter in a roughly flat cereal segment, and your 24 guidance implies that you're going to stabilize share in a flat cereal segment?

Yeah, I think if you look at Q4, you can pretty quickly get to what we think of Q4, and it's going to be not all that dissimilar, maybe, you know, down in the 2% to 3% range for Q4. So, again, not all that different from where we're at in Q3, our current trajectory. Remember, though, we're lapping quite a bit of promotional activity. We spoke about that in the base year. We also had a step up last year in Q4 in brand building. So we have those two things that were kind of tailwinds in the second half of last year, driving incremental volume for us that now we're lapping as we got back to the more disciplined, I'll call it, approach. The other thing to remember in Q4 is Q4 is seasonally our lowest dollar value quarter of the year, and not insignificantly so. But as we transition going forward, I think you said it well, is that we expect the category to kind of return to the pre-pandemic levels and that we be at a more of a flattish net sales level. So I think you said it well there, David, and that's what we expect over the next quarter and beyond.

And then just broadly, you're not repeating some promotional activity. And we can see it in the data that you've lost share of promotional activity out there. Clearly, you didn't want to repeat some of that. And I guess going forward, maybe you can characterize what type of activity that was that may not have had a positive ROI and the type of thing that growth spending you would like to make as you try to stabilize market share. I think that would be helpful, and thank you.

Yeah, Dave, that's the right observation. And I think the best way for us to answer that is to sort of compare and contrast last year to this year. These were intentional choices that we made, and it was intentional last year. As you're reestablishing the business and turning your commercial activities back on in a big way, we leaned into promotions. We're now at a different year. We've normalized the way we're spending our advertising and promotion, much more evenly balanced throughout the year. So we were making different choices in the back half because you're simply smoothing it out more. What you can think about is the way we think about promotions going forward, it's about doing the right promotions and driving the right return with those promotions, that balance of volume, consumption, and profitability. And for us, and I'm going to repeat myself a little bit here, what gives us a lot of confidence going forward is we're going to have better supply as we move forward. We're going to have a dedicated sales force as well. And the integrated demand creating infrastructure we're pulling together, it's going to let us design these promotions and execute them even better. So that's how we're thinking about this. But again, this is a choice that we made, the right choice. And I think you can sense that we knew that was going to be the impact because that's how we forecasted the business back in August.

Okay, thank you.

You're welcome. There are no additional questions at this time, so I'd like to pass the call back over to Gary Pilnick for any closing remarks.

Well, we'd like to thank you all for joining our call, our very first earnings call as WK Kellogg Co. We look forward to sharing our Q4 results with you in February. Very much appreciate it, everybody. This concludes today's conference call.

Thank you all for your participation.