Kellogg Co

NYSE:K

Earnings Call Transcript 2023-Q1

[Operator]

Good morning, welcome to the Kellogg Company's First Quarter 2023 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session with publishing analysts.

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.

[John Renwick]

Thank you, operator. Good morning, and thank you, for joining us today for a review of our first quarter results and an update on our outlook for 2023. I'm joined this morning by Steve Cahillane, our Chairman and Chief Executive Officer; and Amit Banati, our Vice Chairman and Chief Financial Officer.

Slide number 3 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.

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.

[Steven Cahillane, Chairman and Chief Executive Officer]

Thanks, John, and good morning, everyone. We are pleased to be able to report a very strong start to the year. In fact, it was stronger than we had anticipated and puts us in the enviable position of being able to raise our outlook for the full-year. Our topline growth momentum continues as shown on Slide number 5. This was our fourth consecutive quarter of double-digit organic net sales growth. And beneath the magnitude of our Q1 growth are promising trends. We continue to deliver above our long-term growth target. We continue to deliver broad-based growth across each of our four regions and across each of our four major category groups.

Our soon-to-be Kellanova businesses continue to grow strongly, led by snacks in emerging markets, all paced by our highly differentiated world-class brands. Our soon-to-be WK Kellogg Co. businesses continue to show recovery in net sales, consumption and share. We have continued to execute revenue growth management actions across our businesses right through the first quarter in order to keep up with high input cost inflation and we have supported our growth with sustained innovation and with the supply improving, increased brand-building investment. So we feel very good about our topline growth momentum and outlook.

We also feel good about restoring our profit margins. We said that this would be a year in which we stabilize and even improve our margins after being pressured the last couple of years by soaring input cost inflation, and inefficiencies in costs related to bottlenecks and shortages.

The chart on Slide number 6 shows that margins are indeed stabilizing. In fact, better than expected margins are what drove most of the first quarter over-delivery versus our expectations. Aside from what we are lapping, what’s behind us improving underlying margin performance is what gives us increased confidence in the full-year. Firstly, we continue to execute well on productivity initiatives and revenue growth management actions, both of which are starting to more fully catch up with our input cost inflation.

Second, we continue to improve our service levels and the bottlenecks and shortages that had created so much disruption are finally receding. So while costs remain high, we are pleased with the quick and pace of our profit margin recovery. And it's not just the financials that are off to a good start in 2023, Kellogg’s Better Days Promise, our social and environmental program continues to be a strategic priority for us.

And as shown on Slide number 7, we were as active as ever in these areas during the first quarter. From actions visible in the marketplace, shown on the left-hand side of the page, the philanthropic and sustainability activities in the middle column, we continue to take an action-oriented approach. And the far right column shows that these actions continue to be recognized. We believe ESG is one of Kellogg Company's differentiating strengths and it will continue to be when we are Kellanova and WK Kellogg.

And speaking of Kellanova and WK Kellogg, we are very pleased with how our spin-off work is progressing. Slide number 8 offers a high-level timeline of the work we are doing in order to be able to set up both companies for success, provide you with the strategic and financial information you need and execute the transaction. Everything is progressing well.

The announcement of new company names has been well received by stakeholders. The organizational design work is finishing up with leadership team members already announced, and the remainder of talent placements coming later in the second quarter. The design and setup of systems and processes for WK Kellogg is underway and various post-spin transition services continue to be ironed out. Prior year carve out financials are being prepared and we expect to have them audited in the next couple of months.

During the third quarter, we plan to test run WK Kellogg on its own from procurement to manufacturing, to invoicing to financials. And best of all, employee sentiment and engagement remain very high. We expect to be able to provide you with information via a Form 10 sometime in late summer, followed by an investor event, likely in late third quarter, during which we will be able to share with you the strategies, capital structures, and financial outlooks for both companies. That will all lead to the transaction, which takes place in the fourth quarter. Again, some of this is dependent on timing of regulatory and other customary approvals, but it should give you assurance that the information and transaction are not far away.

And most importantly, all of this preparation work has only strengthened our convection that this spin-off creates value for share owners. We are setting up both companies for success. WK Kellogg Co. will benefit from focus and resource prioritization and Kellanova will be a higher growth company with 80% of sales coming from snacks in emerging markets.

Now let me turn it over to Amit, who will provide you the financial details of our first quarter and full-year outlook.

[Amit Banati, Vice Chairman and Chief Financial Officer]

Thank you, Steve, and good morning, everyone. Slide number 10, provides a summary of our first quarter financial results. Obviously, it was a very strong start to the year. Our 14% organic net sales growth was driven by sustained growth in price and mix. Net sales were better than expected principally because of volume. As Steve mentioned, we also performed better on profit margins than we had expected, leading to a very strong 18% increase in adjusted operating profit on a currency-neutral basis.

This higher operating profit drove adjusted earnings per share to be 3% higher than last year on a currency-neutral basis. Remember, this growth is in spite of significant macro-related headwinds on our below the line items. In fact, higher interest expense and lower pension accounting income pulled EPS down by about 5 and 8 percentage points respectively, year-on-year in the quarter. Cash flow in the first three months decreased year-on-year as expected. This is related to the payout of 2022s incentive compensation in quarter one, cash outlets related to their spin-off and the timing of certain working capital items and capital expenditure.

Now let's look at each metric in a little more detail. Slide number 11 lays out the components of our strong net sales growth in quarter one. Price mix growth was sustained in the mid-teens, reflecting revenue growth management initiatives around the world, which we implemented during 2022 and right through quarter one 2023 as we continue to work to offset high input cost inflation. Volume declined reflecting price elasticity, though not as much as we had expected for quarter one.

Foreign currency translation reduced net sales by about 3 points, reflecting the stronger U.S. dollar against key currencies versus the prior year. As we will discuss in a moment, we are raising our organic net sales guidance for the year. Our outlook continues to prudently assume that price elasticities will sustain their upward move towards historical levels, and depending on the direction of input cost inflation that price mix will begin to lap last year's sizable revenue growth management actions.

Nonetheless, there is no question that posting better than expected growth yet again in quarter one indicates strong underlying momentum in our business, giving us good confidence in our outlook.

Next, let's review our gross profit performance on Slide number 12. As we've discussed numerous times, our objective in this high inflation environment has been to protect gross profit dollars via productivity savings and revenue growth management. As you can see on the chart, we have done a good job at this even considering the large and transitory impact in quarter four, 2021 and quarter one, 2022 of a fire and strike. And we've done this in spite of economy-wide bottlenecks and shortages, which have created significant inefficiencies and incremental costs.

In the first quarter, we made our most progress yet. Productivity and revenue growth management continued to catch up to a high market-driven input cost inflation. Bottlenecks and shortages did diminish in the quarter a little sooner than we had projected. We did lap a negative residual impact from the fire and strike, but even excluding that estimated impact from last year, our gross profit dollars increased year-on-year.

We also improved gross profit on a percentage margin basis as we lap the fire and strike and narrowed our underlying margin decline by more than we expected. Our plan was always to have a better second half than first half due to gradually improving supply conditions and the lapping of accelerated input cost inflation. This quarter one performance gives us that much more confidence that we can finish the year better than the flattish margin we had discussed previously.

Slide number 13 depicts our SG&A expense, whose quarterly year-on-year changes this year are greatly affected by year-ago comparisons. As expected, our SG&A in this year's quarter one increased at a double-digit rate year-on-year as we lap in unusual decline in the year earlier period. That was when brand building had been pulled back because of supply disruptions, most notably during North America cereals inventory rebuild and as we lapped overhead, that was low because of low travel and meetings during the pandemic.

As you can see on the slide, we start to lap a resumption of brand building and travel and meetings in quarter two, but it was really the second half last year when we move toward full restoration of both and also raised our incentive compensation accruals. But in absolute numbers, we feel good about our levels of investment in brands and capabilities and we remain on track for the full-year.

Moving to Slide number 14, we can see that our growth in net sales and gross profit were more than enough to cover this year-on-year rise in SG&A expense, resulting in our 18% currency-neutral growth in adjusted basis operating profit. This is a fourth straight quarter of solid year-on-year growth. Importantly, we have sustained a multi-year upward trajectory on operating profit. Even excluding from the year earlier quarter, an estimated impact of the fire and strike, we continued to grow our dollars year-on-year in quarter one. In fact, our quarter one operating profit was higher than previous years quarter one operating profit as well, even dating back to prior to the Keebler divestiture. So obviously a strong start to the year and this gives us the confidence to raise our full-year guidance.

Moving down the income statements, Slide number 15 shows that our operating profit growth was more than enough to offset what were severe headwinds within our below the line items. These below the line pressures were expected and will continue through the year. Interest expense increased significantly year-on-year due to higher interest rates. In dollars, we should see something close to this in each of the remaining three quarters of the year. Other income decreased sharply year-on-year, reflecting accounting of pension and post-retirement plan asset values and interest rates stemming from last year's decline in financial markets.

Because of some favorability in some other items in this line, this quarter one figure is probably a little higher than what we will see in the remaining quarters. Our effective tax rate came in a little higher than expected, largely due to country mix and some other differences, and it was a little above a tax rate of about 22%. Average shares outstanding were up slightly year-on-year and we would expect that to be the case for the full-year as well.

In addition, foreign currency translation was a headwind of a little more than 2%, believe foreign currency translation out of our guidance because it is out of our control and difficult to predict, but today's exchange rates would suggest a sequentially smaller impact in each remaining quarter, finishing the year with a negative impact of 1% to 2%. So while these below the line items are weighing down EPS as expected, it is important to remember that the operational side of our P&L through operating profit is very strong.

Now let's turn to our cash flow and balance sheet and Slide number 16. As I mentioned earlier, our cash flow in quarter one was lower than last year's as we had expected. In addition to lapping a particularly strong year-ago period, this quarter, we experienced the payout of 2022s incentive compensation as well as incremental cash outlays related to the spin-off. Cash flow was also impacted year-on-year by timing of working capital and capital expenditure. We remain on track for our full-year guidance. Meanwhile, our net debt has been trending lower, contributing to our strong financial flexibility.

So let's now summarize our guidance on Slide number 17. Keep in mind that while we expect the spin-off to be transacted during quarter four, our guidance assumes it takes place at year-end purely for simplicity reasons. Similarly, while the divestiture of our Russian business awaits government approval, our guidance assumes it remains in our portfolio for the full-year and the divestiture impact will be immaterial to adjusted basis EPS.

We are raising our guidance for organic net sales growth to 6% to 7%, reflecting our better than expected performance in quarter one, which continue to demonstrate price realization and solid momentum across our portfolio. We maintained our assumption for decelerating growth as the year progresses, which reflects a likely return of elasticity towards historical levels as well as lapping a particularly substantial revenue growth management actions in the second half of last year. This 6% to 7% organic growth is well above our long-term target.

We are raising our guidance for adjusted operating profit growth to 8% to 10% on a currency-neutral basis. This percentage point increase to the range reflects our stronger than expected quarter one. We feel increasingly confident in our ability to improve margins this year, which combined with our above target net sales growth will deliver operating profit growth that is also above our long-term target. Based on that improved operating profit outlook, we are raising our adjusted earnings per share guidance as well, now looking for a year-on-year decline of 1% to 3%.

Remember that this decline is more than explained by the year-on-year reduction in pension and post-retirement income, a non-operating non-cash item that is expected to have a negative impact of nearly 7 percentage points on EPS this year. The negative impact of higher interest expense due to higher interest rates in the economy is another 4% plus.

If it weren't for those two macro-related impacts, our guidance for EPS would be well above our long-term growth target. Our guidance for cash flow remains at $1 billion to $1.1 billion. Recall that within this guidance, we are expecting a year-on-year increase in our underlying cash flow, offset by one-time cash costs and capital related to the spin-off.

So to summarize our financial position, sustained price realization continue to generate strong topline growth around the world and across our category groups. We like how our businesses are performing and we have confidence in our full-year sales outlook. Productivity and revenue growth management actions, along with diminishing bottlenecks and shortages and improving service levels have gotten us off to a good start towards improving our profit margins.

Our financial flexibility is strong, marked by a solid balance sheet and cash flow that remains in good shape, even with some adverse timing in the first three months. Our guidance for 2023 has moved higher, continuing to expect net sales growth and operating profit growth that are above our long-term targets. The fast start of quarter one gives us that much more confidence in this full-year outlook, even giving us some flexibility relative to readying ourselves for the spin-off.

We continue to make good progress on setting up both Kellanova and WK Kellogg for financial success. In addition to carving out of their financials, we are managing upfront expenditures, minimizing standalone costs for WK Kellogg and stranded margin for Kellanova, and we are ensuring solid capital structures and financial flexibility for both.

And with that, I'll turn it back to Steve to walk you through our individual businesses.

[Steven Cahillane, Chairman and Chief Executive Officer]

Thanks, Amit. We'll organize our discussion around the businesses that will comprise Kellanova and WK Kellogg. Slide number 20 reminds you of the composition of the two businesses. And on the slide, you can see how our topline momentum in quarter one continue to span across our portfolio with both Kellanova and WK Kellogg posting double-digit organic net sales growth. Clearly, we are heading into the spin-off with good momentum.

Let's start by discussing the Kellanova businesses leading off with our emerging markets regions. Slide number 21 shows the financial performance of our EMEA region. As you can see, this region sustained its exceptional momentum in the first quarter, posting a third consecutive quarter of organic net sales growth of at least 20%. And equally impressive, it expanded its operating profit margin and accelerated its operating profit growth to 21% year-on-year, and all this in spite of exceedingly high cost inflation and reinvestment into the business.

Let's break the region down into key category groups, starting with snacks on Slide number 22. EMEA snacks posted yet another quarter of explosive topline growth in the first quarter, growing net sales at an organic rate of 26% year-on-year. This growth was broad-based across all of our major sub-regions, and it was led by its biggest brand Pringles. In market, Pringles continues to significantly outpace the high-teens growth of the salty snacks category in the region with notable growth and share gains in markets like Australia, Korea, Japan and Thailand.

EMEA cereal also sustained strong momentum. As shown on Slide number 23, this business delivered double-digit organic net sales growth again in the first quarter. And this growth was broad-based with growth across each of our major sub regions, Asia, Australia, Africa and the Middle East, North Africa, Turkey region.

In market, we have outpaced the cereal categories mid single-digit consumption growth in the region, which brings us to noodles and other in Slide number 24. Led by Multipro in Nigeria, this business continued to deliver organic net sales growth in excess of 20% in the first quarter. Even amidst high inflation and a currency demonetization initiative, Multipro continued to thrive, clear evidence of its competitive advantage and experienced management team.

Meanwhile, we continue to expand our Kellogg Noodles business outside of Nigeria. So clearly, Kellogg EMEA is firing on all cylinders. For the full-year, we continue to expect sustained momentum across all three category groups, delivering yet another year of organic net sales growth, all while improving our profit margins.

Now let's discuss Latin America, starting on Slide number 26. Kellogg Latin America in the first quarter delivered another quarter of double-digit organic net sales growth. This growth was led by Mexico, but we also saw strong growth in Brazil and our Central America and Caribbean sub-region. We expanded our operating margin in the first quarter, helping to grow our operating profit by 20% year-on-year, albeit lapping notably high cost in the year earlier quarter.

Our snacks business in Latin America continued to deliver double-digit organic net sales growth as shown on Slide number 27. This growth was led by Pringles with notably strong growth in Mexico and Brazil. In market, the salty snacks category sustained double-digit growth in those two markets, and Pringles gained share in both. We also have kept pace with a very strong portable wholesome snacks category in Mexico and stabilized our share in cookies in Brazil.

Kellogg Latin America also recorded double-digit organic net sales growth in cereal as shown on Slide number 28. This growth was broad-based with good growth across each of our sub-regions. In market, category growth rates remain robust in the region, and our consumption has kept pace in Mexico and gained share in Brazil and Puerto Rico. So Latin America continues to perform well. And for the year, we continue to expect this region to sustain strong topline momentum. It will be led by snacks, but also by growth in cereal with both supported by strong innovation and relevant brand news.

We also expect Latin America to improve its profit margins this year, and it plans to do all this while working on separating its Caribbean cereal business as part of the spin-off. So both of our emerging markets regions are showing current momentum to go with their outstanding long-term prospects.

Now let's turn to our developed markets, starting with Kellogg Europe in Slide number 30. Here we continued to post strong 8% organic net sales growth in quarter one with organic growth across our categories, salty snacks, wholesome snacks and cereal. The Kellogg Europe net sales growth would have been in the double digits were it not for Russia, which we were in the process of divesting.

Operating profit declined slightly year-on-year, but it was comparing against an unusually strong year earlier quarter. In addition, if we were to exclude the Russia business, Kellogg Europe's operating profit would have been up year-on-year in the high-single digits. So our underlying European business is performing very well.

In snacks, which represents just over half of our sales in Kellogg Europe, we posted another strong quarter as shown on Slide number 31. In fact, the first quarter marked a seventh quarter in the last nine in which we have posted double-digit growth in our European snacks business. Specifically, our organic net sales growth accelerated sequentially in the first quarter to 14% year-on-year, and this growth would have been almost twice that if it were not for Russia. In market, Pringles has sustained its double-digit growth momentum, gaining share in the region led by the United Kingdom and France.

And in portable wholesome snacks, we are experiencing double-digit consumption growth overall, and we have gained 2 full share points in the UK led by Rice Krispies Squares. Our cereal business in Europe also sustained growth in the first quarter, as shown on Slide number 32. The growth was slower than recent quarters, as we have seen rising price elasticity as well as intentional reduction of certain less profitable merchandising activities. Nevertheless, we continue to execute well in a challenging market.

So when we look at the full-year for Kellogg Europe, we continue to expect the region to post another year of solid topline growth led by snacks. In fact, this should be a 6th consecutive year of organic net sales growth in our European snacks business. As mentioned previously, we are navigating through cost and supply pressures, which are particularly heavy in the first half, and we are in the process of divesting our Russia business, a transaction that is contingent on Russian government approval.

And now we'll turn to Kellogg North America, beginning with Slide number 34. As you can see, it was a very strong quarter for Kellogg North America. We recorded organic net sales growth of 14% with price mix accelerating for a fourth consecutive quarter as we continued to implement revenue growth management actions in order to catch up with input cost inflation. This revenue growth management, along with productivity and diminishing bottlenecks and shortages, enabled an expansion in profit margins that drove operating profit up 21% year-on-year. Importantly, we again generated organic net sales growth in all three category groups during the first quarter.

Slide number 35 shows how our largest category group snacks sustained its net sales momentum by growing 15% in the quarter. In market, Pringles well outpaced the U.S. salty snacks categories double-digit growth led by our multi-packs and our core four flavors. In Crackers, Cheez-It lapped an exceptionally strong year earlier quarter, but we did see double-digit consumption growth by our Club and Townhouse brands. And in portable wholesome snacks, our decision to discontinue various Kashi bars and the prioritization of capacity constrained Pop-Tarts SKUs, masked continued momentum in Rice Krispies Treats, and a resurgent Special K bars business.

Our Frozen Foods business also grew net sales in the first quarter, as shown on Slide number 36. Here the growth has been more modest in part because of supply disruptions both in our Eggo frozen breakfast business and especially in our Morningstar Farms plant-based foods business. Meantime, both Eggo and Morningstar Farms are leading brands with strong commercial programs planned. So we are confident in our ability to improve our frozen performance as the year progresses. All of the regions and categories we've discussed up to now will be part of Kellanova and all of them are showing strong and continued net sales growth to go with progress toward recovering margins.

Now we're going to turn to our North America cereal business, which forms the vast majority of what will be WK Kellogg Co. As shown on Slide number 37, this business continues to recover rapidly and posted another quarter of double-digit organic net sales growth. In the U.S., the cereal category grew at a double-digit rate in the quarter, and we gained nearly 3 points of share year-on-year as our resumed commercial activity is producing share gains across our portfolio led by Rice Krispies, Special K, Raisin Bran and Frosted Flakes.

This recovery is evident in our U.S. away-from-home business as well. We gained several points of share across each of our major channels, convenience stores, food service and schools. And in Canada, where the restoration of inventory has come a bit more recently, our consumption growth was even more pronounced, and we gained roughly 6 points of share year-on-year. So the recovery continues in our North America cereal business.

Turning to Slide number 38, our North America region is off to a strong start in 2023, giving us confidence in the full-year. Snacks is expected to sustain its momentum, while we have plans in place to improve our performance in frozen and our North America's cereal business continues its recovery. We are off to a good start on a margin recovery in North America, even as we reinvest in our brands. So the business is in good shape as we setup for the spin-off of WK Kellogg.

So let me summarize on Slide number 40. We are off to a very strong start to this year. Around the world and across our key categories and brands, we have clearly sustained growth momentum and our profit margins impacted over the last 18 months by accelerated input cost inflation, economy-wide bottlenecks and shortages and even a fire and strike are starting to recover. These underlying trends with a strong first quarter already in the books are what give us increased confidence in a raised full-year outlook that had already called for sales and profit growth above our long-term targets.

But while we are executing our plan and delivering on our current year results, we are also busy creating the future. This includes most notably our plan spin-off of our North America cereal business. We are full steam ahead on this work as we work through every detail of this important undertaking, we have become only more confident that this will create real value for our share owners.

We will have a more focused WK Kellogg able to leverage its scale in North America cereal with a fit-for-purpose strategy, expertise and resource allocation, and we will have a greater visibility into a global snacking-oriented Kellanova that has been and will continue to be delivering above average financial performance. I couldn't be more proud of and grateful for our team members around the world who are executing with agility and passion emits in an external environment that remains incredibly dynamic.

And with that, we'll open up the line for questions.

[Operator]

Thank you. We now begin the question-and-answer session with publishing analysts. [Operator Instructions] Our first question today comes from the line of David Palmer from Evercore ISI. Please go ahead. Your line is now open.

[David Palmer, Evercore ISI]

Thanks. Question on gross spending. I would imagine this is the year that you're getting past a lot of supply chains, both supply chain issues both upstream and within the company. And I'm wondering, if you could just talk to where the biggest growth spending energy is being applied, whether that's advertising and promotion and innovation in areas of the world and parts of the business? Thanks.

[Steven Cahillane, Chairman and Chief Executive Officer]

Yes. Thanks for the question, David. I want to make sure I understand the question. But in terms of reinvesting in the business, we are certainly investing in brand building. There's no question about that. We're investing in innovation and we're investing in capacity. And so we are obviously coming out of the pandemic and the supply disruptions, the bottlenecks and shortages as so many other companies are, and we're investing for growth. And you see that, you see that in our upgraded guidance for the topline, you see that in the better service levels that we're delivering to our customers, you see that in Pringles expansion around the world, which requires CapEx. And so it's really in those main areas. And again, if I understood the question, that's essentially where we're looking to deploy those resources.

[David Palmer, Evercore ISI]

Yes. I mean, I guess, I'm just looking for examples and metrics with regard to the number of new products, the ability for you to get those things on the shelf and whether you're going to be layering in promotion spending as you go through this year, I think there's some concern that volumes in this space don't improve or don't hold up through the year as pricing rolls off. So these types of things can help people feel better about those volume metrics as you get later in the year.

[Steven Cahillane, Chairman and Chief Executive Officer]

Yes. I see, David. So I have heard some of the commentary around promotions and so forth, but brand building is up, innovation is up. And this notion that merchandising is returning to pre-pandemic levels. We're not quite there yet, but it's improving. And remember, merchandising, which some see is one element of the outcome of price promotion, get your product out on the floor, gets your consumers interrupted in their shopping patterns and we see it as a good thing.

In terms of just going forward in innovation, the bar of innovation, I've said this in the past, has clearly gone up as SKU counts went down during the pandemic. So that's been raised. And we are very pleased with our topline performance. We're pleased with our ability to raise that guidance. And we're pleased with our margins where they are in the recovery in margins. So all that being said, I think the environment is a good environment. It's an environment that we're being successful in, we're being competitive in. And I think it's a positive environment as we look into the future.

[David Palmer, Evercore ISI]

Thank you.

[Operator]

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

[Andrew Lazar, Barclays Bank PLC]

Great. Thanks. Good morning, everybody. Steve, I guess I've got a bit of a higher-level sort of – hi there – a little bit of a higher level industry question for you. It looks as though we may finally be heading in earnest towards a more normal operating environment following three-plus years of all of the anomalous dynamics. And I guess I'm curious how you think this transition for the group to normalcy will look not just for Kellogg, but where the industry as a whole. I guess, in other words, do you think this transition to normalcy can be made in a somewhat orderly way? Or should investors have their expectations in check, maybe potentially for more uneven results for some time as pricing has lapped and perhaps it takes more time for volumes to pivot more positively. Basically, I'm just trying to assess whether we see more of like a hard or a soft landing, if you will, for food manufacturers as we kind of move into the more normal operating phase, if you will. Thanks so much.

[Steven Cahillane, Chairman and Chief Executive Officer]

Yes. Thanks for the question, Andrew. I love some of the words you used in their normal and predictable and soft landing. Clearly, we've come through the last three-plus years in facing all these unprecedented challenges. We said as Kellogg that we would exit the pandemic a stronger company. And many of our competitors said the same thing, and we certainly have. And I think that puts us and the industry in a good position to actually come into this next kind of era, if you like, in a much stronger fashion without some of the disruptions and challenges that you alluded to.

I mentioned to David in the earlier comment, the BARDA innovation has been raised. That is unquestionable. There is no question that innovations have to be better. They have to be performing right out of the gate. Shelf space is more valuable than it's ever been today in my years in the business, supply chains have had to become more agile. There's no question about that. Our supply chains have all been challenged to the degree they never have before.

They've become more agile, but they've also used and utilized new technologies. We're deploying technologies like artificial intelligence, machine learning. We're getting better and better at predictive really end-to-end. The relationships with our customers, I think, again, during the pandemic, it was about how do we serve our consumers, our joint consumers in ways that we never had to face before. We had all sorts of challenges with respect to that. But now supply chains have come through stronger as well and the relationships with consumers, I think, are more end-to-end than they've ever been before.

And so looking to eliminate friction is something that we talk to our customers all the time about joint business plans start with how do you eliminate waste end to end, how do you grow the size of the prize, while we serve the common consumer. And I guess the final thing I'd say is the whole world of marketing has changed like it never has before. The true promise of one-to-one marketing that we've been talking about for so many years is upon us with data and analytics, more sophisticated than they've ever been, first-party data, more robust and more available than it's ever been to really target consumers in a way that marketers have dreamed up for years.

And so you put all these things together, and it's not 1987 anymore. I think it is a really – it's not to be too rosy about it, but it's a new morning and it's, I think, a very, very promising outlook as we look towards how our industry and how Kellogg will perform in the future, we're very optimistic about the future for all of those reasons.

[Andrew Lazar, Barclays Bank PLC]

Really appreciate the thoughts. Thank you.

[Operator]

Thank you. The next question today comes from the line of Bryan Spillane from Bank of America. Please go ahead. Your line is now open.

[Bryan Spillane, Bank of America Merrill Lynch]

All right. Terrific. Thanks, operator. Good morning, everyone. Amit, I wanted to just ask a little bit about inflation. I'm not sure, I might have missed it, but did you give us an update on where cost of goods inflation was in the quarter and what you're expecting, I guess, for the balance of the year? And maybe if you can just give us a little bit of color on kind of what's moving in each direction. I think we're beginning to see some relief on like resins, some packaging costs. So just if you can just sort of unpack for us a little bit just kind of the COGS basket, where it stands and kind of what we should be looking at as we go forward.

[Amit Banati, Vice Chairman and Chief Financial Officer]

Sure. So I think if you look at cost came in largely in line with expectations from a commodity standpoint. I think our outlook for the year continues to be mid-teens inflation. So no significant change than what we had talked in our last call. Certainly, there are some movement in some commodities. But like we've talked previously, we obviously have a hedging program. So some of that would flow through as hedges roll across. Very pleased with the performance in the first quarter. I mean if you look at our gross profit dollars, they were up 16% on a currency-neutral basis, so strong double-digit growth in our gross profit dollars.

No question aided by the fire and strike in quarter one. But even if you look at it from a full-year standpoint, I think based on our quarter one performance, we are now saying that our gross profit dollars would be slightly ahead of our net sales growth. So we had talked previously of flattish gross margins for the year. I think based on what we're seeing right now, we expect our gross margins to be up slightly for the year.

[Bryan Spillane, Bank of America Merrill Lynch]

Okay, great. Thanks for that. And just as we're thinking about the flow of that, does the inflation moderate as the year goes on? Or is it pretty steady through the year?

[Amit Banati, Vice Chairman and Chief Financial Officer]

I think the lap – I'd say, overall, it's in the mid-teens inflation. I think the lap would moderate in the second half because that's when we saw commodities kept going up last year. So you'll start lapping that in the second half. So the year-on-year moderation will certainly be more back half weighted.

[Bryan Spillane, Bank of America Merrill Lynch]

All right. Terrific. Thanks, Amit.

[Operator]

Thank you. The next question today comes from the line of Ken Goldman from JPMorgan. Please go ahead. Your line is now open.

[Kenneth Goldman, JPMorgan Chase & Co.]

Hi. Thanks very much. I wanted to ask a quick question on LatAm. The volumes were down year-on-year. I think by the largest negative number in a few years. Obviously, a lot of that was to be expected given the pricing. But just sequentially, pricing wasn't up quite as much as 4Q, and the volume comp wasn't, I guess, that burdensome. So I'm just curious how you think about that particular region. Some of the tonnage numbers we're seeing there and how that relates to the previous questions about leaning into promotions a little bit more.

[Steven Cahillane, Chairman and Chief Executive Officer]

Yes. Thanks, Ken. I'd start with overall very positively disposed to our results in Latin America. When you look at the disruption and you look at from a macroeconomic standpoint and all the things that are challenging in emerging markets in general, Latin America has been a pretty kind of steady place to be for the last several years up until about two years ago where we started to see a return to some of the macroeconomic challenges, the geopolitical challenges and so forth. So with that, we're very pleased with our performance. But we are seeing a rise in elasticity in Latin America. And that's no surprise. You see very high price increases to overcome the input cost inflation, and it's worsened by transactional ForEx over the past several quarters as well. It's been most pronounced in cereal, but we continue to perform well in cereal, in Mexico, especially big cereal business.

And then when you look at our Pringles business in key markets, doing very well. Obviously, we added some capacity a couple of years ago in Brazil, put some lines of Pringles in. Pringles continues to perform very well in Latin America. So our outlook for Latin America remains strong, we're pleased with the performance there, but it's obviously an emerging market. So it comes with some volatility.

[Kenneth Goldman, JPMorgan Chase & Co.]

Great. Thanks, Steve.

[Operator]

Thank you. The next question today comes from the line of Jason English from Goldman Sachs. Please go ahead. Your line is now open.

[Jason English, Goldman Sachs Group, Inc.]

Hey. Good morning folks. Thanks for spot me in. The comment you made early, Steve about Cereal Co. or WK Kellogg Co. I think is what we're calling it, maybe not the Co at the end. But if that business effectively being stood up and running independently in the third quarter, it was interesting. How much functional overlap will there still be? And I guess what I'm kind of angling at here is it sounds like you may actually be. We're all breaking out about like how big the stranded cost and separation is going to be. What's the incremental cost nuggets could be? It sounds like you may actually be absorbing a lot of that in this year's guidance. Is that right? Thanks.

[Jason English, Goldman Sachs Group, Inc.]

That is right, Jason. That is in our guidance, the incremental cost of standing that up. We're doing something called company and company, which is essentially running water through the pipes so that we make sure that when we do spin-off the business, it's ready to go. And what I'd say in terms of stranded costs, trended margin, obviously, that's coming, but any kind of – the way you portray that, I would say, we're very confident, very confident in our ability to stand up these two companies with strong capital structures and very strong outlooks. And so I think many investors will be quite pleased when they see us come in the summer time during our Investor Day.

We can't say much right now. But I'm very confident that those two businesses will be stood up, stood up strong with very strong outlooks. And I think you'll see the value creation and the value unlock will be an aha, aha moment for those who don't quite get it yet.

[Jason English, Goldman Sachs Group, Inc.]

Great. I'll leave it there. Thanks.

[Operator]

Thank you. The next question today comes from the line of Alexia Howard from Bernstein. Please go ahead. Your line is now open.

[Alexia Howard, Sanford C. Bernstein & Co.]

Good morning, everyone.

[Steven Cahillane, Chairman and Chief Executive Officer]

Good morning, Alexia.

[Alexia Howard, Sanford C. Bernstein & Co.]

Hi. I think you mentioned at the beginning of the prepared remarks that volume came through a little better than expected. I know it's still down, but it sounded though that was stronger. Can you give us a bit of color about where it was stronger? And do you expect that volume trajectory to improve as price growth flows through the course of the year? Or how much do you expect it to improve?

[Steven Cahillane, Chairman and Chief Executive Officer]

Yes. Thanks, Alexia. I'll start, and Amit may want to add. And so volume was clearly better. And if you look at it compared to historical elasticities, it's better everywhere. There's no question about that. And that's not unexpected in a world where inflation is across the board, right? So it's all relative, and you have to think about the relativity of our categories versus more discretionary categories. Having said that, very good performance in North America relative to historical elasticities, very strong performance in EMEA relative to elasticities. I talked about Latin America, where we had elasticities rising a bit more, Europe, you see a lot of noise in there based on Russia and so forth, but a little bit more elasticity there. And so across the board, very good performance, standout performance in North America and EMEA relative to overperforming versus elasticities.

When we think about the back half of the year, the remainder of the year, we are prudently assuming that elasticities start to increase and approach not quite historical levels, but on a march towards historical levels. And we think that's just a smart planning assumption. We'll see how it unfolds.

[Alexia Howard, Sanford C. Bernstein & Co.]

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

[Operator]

Thank you. The next question today comes from the line of Steve Powers from Deutsche Bank. Please go ahead. Your line is now open.

[Stephen Powers, Deutsche Bank]

Great. Hey. Thanks, and good morning. I was actually going to ask a very similar question to the one that the Jason answer or asked. I think you answered that one pretty clearly. I guess the only thing I'd tack on to it maybe is you mentioned you cited that both Kellanova and WK Kellogg pro forma grew low-double digits in the quarter, and I realize you're constrained by giving us too much detail. But just given that disclosure, and I'm thinking about – as I think about the 6% to 7% full-year organic growth guide, is there any way you can frame us a little bit about how you expect those two businesses to be contributing to that 6% to 7% on the year so we can get a little sense of expected momentum as we go into the new regime. Thank you.

[Amit Banati, Vice Chairman and Chief Financial Officer]

Yes. I'd say, Steve, we've got great momentum in both businesses. I think you've seen the results of Kellanova, good broad-based growth across all our categories, both in the U.S., internationally and across our categories as well. I think North America cereal, we're very pleased with the recovery that we are seeing there from a share standpoint, and that would continue to be the focus for the rest of the year. So there's good momentum across both the businesses.

[Steven Cahillane, Chairman and Chief Executive Officer]

Did we understand your question correctly, Steve?

[Stephen Powers, Deutsche Bank]

Sorry, I was on mute. Yes. Thanks. I guess, if there's any way to provide a little bit of quantification around sort of the contribution of each of those businesses to that 6% to 7% on the year, that would be helpful. Thank you.

[Amit Banati, Vice Chairman and Chief Financial Officer]

Yes. We don't have that, Steve. So I think what we'll do is probably in the Investor Day, we'll probably give you a lot more details of each of the two businesses. I mean, obviously, Kellanova is about 85%. So the 6% to 7% that we're talking for the overall companies being driven by Kellanova. And I think like on North America cereal, what you saw in the first quarter, we were clearly lapping the fire and strike. So the double-digit growth was lapping that. You'd expect that to normalize as we go through the course of the year.

[Stephen Powers, Deutsche Bank]

Yes. Okay. Thank you.

[Steven Cahillane, Chairman and Chief Executive Officer]

Steve, maybe if it's helpful. As you look at syndicated data, you can look at the North American cereal business, and you see a lot there. And then as Amit said, 85% of the business is Kellanova. You look at the EMEA results, you look at the Europe and look at North America snacks, you can probably get a pretty good sense of what that looks like.

[Stephen Powers, Deutsche Bank]

Yes. No, I think that's all fair. I was just looking to see if you had, if you, I get it. Thank you very much.

[Steven Cahillane, Chairman and Chief Executive Officer]

You bet.

[Operator]

Thank you. Your next question today comes from the line of Pamela Kaufman from Morgan Stanley. Please go ahead. Your line is now open.

[Pamela Kaufman, Morgan Stanley]

Good morning.

[Steven Cahillane, Chairman and Chief Executive Officer]

Good morning.

[Pamela Kaufman, Morgan Stanley]

Question on your EPS guidance for the year. Just given the magnitude of the Q1 beat, why not raise your full-year guidance by more than 1% were Q1 results more in line with your internal expectations versus where the street was? Or are there factors weighing on the EPS growth outlook over the rest of the year that temper the flow-through of Q1 upside?

[Amit Banati, Vice Chairman and Chief Financial Officer]

Yes. I think like we talked earlier in the call and in the prepared remarks, obviously, very pleased with the Q1 over delivery. I think it's still early in the year. We talked a little bit about being prudent on our elasticity assumptions and price elasticity assumptions for the rest of the year. We're being prudent from a separation and spin standpoint, Steve talked a little bit about building into the guidance some of the costs associated with the spin in quarter three. So I think it's a balance of being prudent on our volume assumptions and our elasticity assumptions for the year. And it's early in the year, but obviously, very pleased with the underlying momentum in the business and the strong start.

[Pamela Kaufman, Morgan Stanley]

Got it. Thank you. And then just on Europe, pricing came in very strong there, but volumes did soften – what are you seeing in terms of consumer behavior in Europe? And have you finalized your price negotiations there?

[Steven Cahillane, Chairman and Chief Executive Officer]

Yes, Pam. So what we're seeing in Europe is, as I mentioned earlier, a little bit more elasticity a little bit more channel shifting than we're seeing in some of the others. Obviously, a big impact on Russia, which obviously, we stopped shipping in Russia and we're divesting the business in Russia. But getting back to Continental Europe, shoppers are doing some channel shifting, as I just mentioned, hard discounters, clearly growing their businesses. That has a disproportionate benefit to private label. Within our portfolios, we're seeing a little bit more. And these are modest coming from small bases, but a little bit more private label growth in Europe, in Europe, cereal than we would be in the rest of the world.

So no surprises. Europe is a challenging environment. But again, our results in that challenging environment are something that we're very proud of, very proud of the way the team has delivered. And as we said in our prepared remarks, when you strip out the effect of Russia, you see even better performance there. So one to watch, but one that we're – we've got very, very good plans in place for the back half of the year and even indeed into next year.

[Pamela Kaufman, Morgan Stanley]

Thank you.

[Operator]

Thank you. The next question today comes from the line of Max Gumport from BNP Paribas. Please go ahead. Your line is now open.

[Max Gumport, BNP Paribas Exane]

Hey. Thanks for the question. In the release and in the prepared remarks today, you discussed supply bottlenecks and shortages that are beginning to moderate. This has been a key pressure point for the industry, both in terms of supply chain disruptions we've seen and also inflation given conversion costs associated with upstream suppliers in particular. So I was hoping you could double-click on the drivers of the improvement that you're seeing there? And also how much recovery is still left to go? Thanks.

[Steven Cahillane, Chairman and Chief Executive Officer]

Yes. So Max, I'll start, and again, Amit can add. I'd say the easy answer – the short answer to that question is supply constraints, bottleneck shortages are improving almost everywhere. And so everything from the driver shortages that we talked about, the ocean freight shortages, containers being in the wrong place at the wrong time. All these things that only a year ago, the entire industry was struggling with had become much more normalized.

We still have the odd shortages, inventory not being in the right place from some of our suppliers. But I mean literally, every day, it's getting better. We talked – I know a couple of times on these calls, about a control tower approach that we took and things that were elevated to the top of the control tower, if you like, that took manual interventions to get done, those are down dramatically. So the type of automation and the type of supply chain that we had before the pandemic is much closer to being real today than it was. We're not back to just-in-time inventories. We're not back to where we were. I don't think anybody is. But we're much closer and the outlook going forward continues to be one – definitely much more of optimism than what we saw up to this point. In the second half of the year, we see continued improvement.

[Amit Banati, Vice Chairman and Chief Financial Officer]

The only thing I'd add is we're seeing that flow through into the P&L. And I think that was one of the drivers of the improved margin performance in quarter one. And certainly, the reason why we have confidence in raising our guidance for gross margin.

[Max Gumport, BNP Paribas Exane]

It's all great to hear. Thanks very much.

[Operator]

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

[Robert Dickerson, Jefferies]

Great. Thanks so much. Maybe just a quick question for you, Amit. Just around your – I guess, around Steve's comments, about kind of the potentially very attractive momentum in the two separate businesses. Remember, CAGNY, you kind of went through some incremental detail, I believe, in the TSA agreement. So excuse my ignorance here if everybody already knows this, but I was just kind of looking for kind of maybe a kind of a clarification how the TSA agreement actually works because my sense is kind of what I feel is the there's actually a payment to the Snacks Co. that provides you time to offset dis-synergies, if that makes sense. And maybe if you could just kind of clarify how that works? That's all I have. Thanks.

[Amit Banati, Vice Chairman and Chief Financial Officer]

Yes. So we're making good progress on the TSAs of the transitionary service agreements across a number of areas, and we're putting those into place. I mean these TSAs cover areas like IT services, global shared services, transportation, logistics. So those will be the bulk of the transitionary service agreements. They are varying in nature and from a timing standpoint, but could extend up to two years. And obviously, that provides a stability, business continuity as well as helps offset the dis-synergies and gives both organizations time to address and put in place the right long-term structures appropriate for their businesses. So that's kind of where we are.

[Robert Dickerson, Jefferies]

All right. Super. That's all. Thank you.

[John Renwick]

Operator, we have time for one quick last question.

[Operator]

Perfect. Thank you. The next question today comes from the line of Michael Lavery from Piper Sandler. Please go ahead. Your line is now open.

[Michael Lavery, Piper Sandler & Co.]

Thank you. Good morning. Just was wondering if you could elaborate…

[Steven Cahillane, Chairman and Chief Executive Officer]

Good morning.

[Michael Lavery, Piper Sandler & Co.]

Yes. Good morning. I was wondering if you could elaborate a little more on the restoration of marketing spending. And specifically, maybe if you're thinking of that in dollar terms or as a percent of sales, obviously, with pricing driven sales growth on a unit basis, the spend goes a little further if you do it as a percent of sales. Just curious where you land there and how to think about how that all evolves.

[Amit Banati, Vice Chairman and Chief Financial Officer]

Yes. So we're pleased with the overall level of spending. And we'd expect it to be up, overall SG&A to be up similar to what it was up last year, low single-digit rates. I think within the year, obviously, there's a lot of phasing. If you recall, last year, we had pulled back in the first quarter. And then even in the second quarter, as we were restoring supply on the U.S. cereal business. This year, obviously, we've got a full commercial plan. And so I think in the quarter, we were up double-digit against a low base, I think you'll see that reverse out in the rest of the year. But overall, when you kind of look at it and if you put aside the noise of the lap of the fire and the strike, we're very pleased with the levels of investment. As Steve mentioned, we're investing across the world, both in our brands as well as in innovation, and we're pleased with the levels of spend that we have.

[Michael Lavery, Piper Sandler & Co.]

Okay. Great. Thanks so much.

[Operator]

Thank you.

[John Renwick]

Operator, we are at 10:30. So if you don't mind, we'd have to close it out right now. But if anyone has any follow-up calls, please do not hesitate to call us.

[Operator]

Thank you. This concludes today's conference call. Thank you all for your participation. You may now disconnect your lines.