Kellogg Co

NYSE:K

Earnings Call Transcript 2021-Q3

[Operator]

Good morning. And welcome to the Kellogg Company Third Quarter 2021 Earnings Call. All lines have been placed on mute to prevent any background noise. 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]

Good morning, and thank you for joining us today for a review of our Third Quarter 2021 results, as well as an update regarding our outlook for the full-year 2021. I'm joined this morning by Steven Cahillane, our Chairman and CEO, and Amit Banati, our 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.

This is a particular note during the current COVID-19 pandemic, and supply and labor disruptions, when the length and severity of these issues and resultant economic and business impacts, are so difficult to predict. A recording of today's webcast and supporting documents, will be archived for at least 90 days on the Investor page of kelloggCompany.com. As always, when referring to our results and outlook, unless otherwise noted, we will be referring to them on an organic basis for net sales and on Currency-neutral adjusted-basis for operating profit and earnings per share. And now I'll turn it over to Steve.

[Steven Cahillane, Chairman and CEO]

Thanks, John. And good morning, everyone. I hope you and your families are doing well. After all, we're still managing through a pandemic and still nowhere close to what any of us would call life as normal. This is certainly true from a business perspective as well. Therefore, we remain focused on keeping our employees safe and aiding our communities is more important than ever. We also continue to supply the world with food. But as we and all companies have discussed previously, this has gotten extremely challenging. Importantly, we remain on our strategy, deploy for balanced growth, which is depicted on Slide number 6.

This strategy continues to keep us on our path for steady, balanced financial returns for shareowners. We also continue to make progress on Better Days, our ESG-oriented program. A few Better Days highlights from quarter 3 are shared on Slide number 7. This remains a critical element of our strategy. A clear focus of management, and a part of the DNA of Kellogg Company. And we have not lost sight of this during the current pandemic and business environment. And there is no question that today's business environment is as challenging as we've ever seen it.

Our organization has risen to all of these challenges using creativity, skills, and work ethic to manage through them. Slide number 8, attempts to categorize these challenges into 3 basic buckets. First, we're all familiar with the surges and market prices for commodities, packaging, and freight, all the result of supply demand and balances that may take some time to work out. We're working hard to mitigate the margin impact s of these high costs.

From our active hedging program, which has given a strong visibility into our commodity costs, to mitigating cost pressures with productivity initiatives and revenue growth management actions. Second, by now, we're also all aware of the economy-wide bottlenecks and shortages, that are not only pushing costs higher, but are also making it very difficult to supply the market. Here's where our supply chains-controlled power approach has provided us agility and addressing shortages, and gaps, and materials, equipment, and land and ocean freight.

We've also taken actions to reduce complexity in our portfolio and operations. And 3rd, we are seeing acute shortages in labor across all spectrum of the economy. This is resulting in absenteeism, high turnover, difficulty in attaining temporary labor, and for some of us, even labor strikes. To address this, we've had to recruit continuously, and we've executed contingency plans to sustain as much supply as possible in the face of open positions and work stoppages. Simply put, we are taking important actions to manage through today's unprecedented environment.

And through it all, we're executing well in market and delivering balanced financial growth, which continued in quarter 3 and as discussed on Slide number 9. Consumption growth remains elevated, as measured on a 2-year compound annual growth basis, even if it continues to decelerate as expected. We're seeing particularly strong consumption growth and share performance, in many of our biggest world-class brands.

We continue to sustain strong momentum in our emerging markets. This momentum has been evident for the past few years, and reflects our improved geographic footprint, the strength of our portfolio, our efforts to broaden our offerings into affordable price points, and our local route-to-market and supply chains. From a financial standpoint, these factors led to continued balanced growth. Strong organic net sales growth.

Strong operating profit growth. Strong earnings per share growth. And cash flow that remains well above pre -COVID 2019 levels. So, in spite of all the operating challenges, we continue to deliver. and today we are even raising our full-year guidance for net sales to reflect momentum in the business. At the same time, we're also reaffirming our guidance for operating profit, earnings per share and cash flow despite a worsened cost and labor and supply environment. I'm sure you can appreciate that even holding guidance amidst these kinds of challenges speaks to the kind of dependability we strive for, regardless of business conditions. Let me now turn it over to Amit so we can take you through our financial results and outlook in more detail.

[Amit Banati, Chief Financial Officer]

Thanks, Steve, and good morning everyone. Our financial results for the third quarter, are summarized on Slide number 11. As you can see, we delivered strong organic basis, net sales growth of 5% in quarter 3, on top of similar growth in the year earlier period. This came in better than anticipated due to exceptional growth in Europe and EMEA. Currency-neutral adjusted basis operating profit, increased by 11% year-on-year. This was driven by the strong top-line growth, as well as lapping a year-ago quarter, in which incremental brand-building investment had been shifted, from earlier quarters.

Currency-neutral adjusted-basis earnings per share increased by 18%. A strong operating profit growth was augmented by a decrease in average shares outstanding. And cash flow, while still below last year's unusual pandemic related search, remained well above the pre -pandemic 2019 level. In total, a very strong financial performance. Let's examine these results in a little more detail. We'll start with net sales on slide number 12. As you can see, the net sales growth in quarter 3 was driven by both volume and price mix. The 1% plus organic volume growth was driven by our international regions, most notably Europe and EMEA, where our Nigeria business had an exceptional quarter. This volume growth comes despite supply pressures, and lapping good year-ago growth.

Our 4% organic basis price mix, remains solidly positive in all 4 regions. The result of revenue growth management actions that we have been implementing, since the second half of last year, when input costs inflation began to accelerate. Finally, foreign currency translation was modestly favorable to net sales in quarter 3, decelerating from the first half as expected. So, through the first 9 months, you can see that on an organic basis, our net sales were up 3%, despite lapping the pandemic related surge, and they are up 5%, on our 2-year compound annual growth basis.

Looking to the fourth quarter, we expect sustained price mix growth, based on the revenue growth management actions we've taken. Though we are a bit more cautious on volume, given the current labor negotiations, and a prudent view towards decelerating at-home demand, and emerging markets growth. Moving down the Income statement, Slide number 13 shows our gross profit performance. As we had anticipated, both our gross profit and gross profit margin, declined year-on-year in quarter 3, as we lapped last year's strong operating leverage, and as we faced this year’s unusually high-cost pressures.

While our productivity and revenue growth management actions continue to cobble, market-driven cost inflation there was significant incremental costs and disruption stemming from the current operating environment that came on top of that. Our gross profit margin was further weighed down by disruption and costs related to fire and one-off our plans and are more pronounced than usual mix shift towards the emerging markets. Most notably, our distributor business in Nigeria. Importantly though, while our gross profit percent margin decreased to below the level of pre -pandemic Q3 2019, our gross profit dollars remained higher than that period.

And if you look at the right-hand side of the slide, you can see that our gross profit dollars are up through the first 9 months of this year, both on a year-on-year [Indiscernible] on a 2-year basis In this high-cost environment, we have to focus on both margins and dollar growth. On Slide number 14, we see a driver of year-on-year profit change, that is really more of a phasing dynamic. SG&A expense is comprised of advertising and promotion, R&D, and ROI. Last year's quarter 3 was unusual, in that it included incremental A&P investment, delayed from the first half because of the pandemic. It also included a sizable increase in incentive compensation accruals.

But comparing SG&A to the third quarter of 2019, we see it was lower both on a percentage margin and dollar basis. This two-year decrease is related to both the work we did to remove stranded costs after our divestiture, but also to our decision detail to pull back on investment behind specific supply constrained brands. You can also see that through the first 9 months, our SG&A dollars are roughly flat with the same period of 2019. And that's probably how we'll finish the sale. If we look at operating profit in the same way, on slide number 15, we find that in dollars, our operating profit in this year's quarter 3 was not only higher than it was in last year's quarter 3, but also higher than what it was in quarter 3, 2019.

Again, this focus on dollar profit is important as we manage through this challenging environment. Now, we do think that quarter 4 will be a little different. Contrary to our prior assumptions, we are seeing no moderation of the economy-wide bottlenecks and shortages deal in the 4th quarter. In fact, we're now experiencing incremental disruption and costs further compounded by a labor strike. So, for quarter 4, we are forecasting gross profit dollars and operating profit dollars, to be below quarter 4 of 2019, even if both metrics finish the full-year above 2019 levels. Moving down the P&L, let's turn to Slide number 16. While operating profit drove most of our growth in earnings per share in quarter 3, we also benefited from modest net favorability in below the line items.

In quarter 3, interest expense decreased on lower debt, which will continue to be a year-on-year driver in quarter 4. With quarter 4 comparison also lapping, the 20 million debt redemption costs we recorded last year. This decrease in interest expense was more than offset by a decline in other income, which compared against an unusually high-level last year. We expect quarter 4s other income to be similar to that of quarter 3.

Our effective tax rate in quarter 3, came in lower than last year. We believe quarter 4s rate, will come in higher than the 22% rate we're now forecasting for the full-year. JV earnings and minority interest together were favorable to last year, though that mostly reflects the consolidation of a couple of our smaller investment phase joint ventures, invest Africa into operating profit. An average shares outstanding decrease year-on-year, reflecting the impact of quarter ones buybacks.

We still expect full-year average shares outstanding to be around 0.5% lower than 2020. Outside of the currency-neutral EPS that we manage and guide to, we did experience continued year-on-year favorability, though modest, from foreign currency translation. Based on where exchange rates are today and what we're lapping, there will be little to no benefit from foreign currency translation in quarter 4.

Let's now discuss our cash flow and Balance Sheet shown on Slide number 17. Year-to-date, our cash flow remains below last year's unusually high level as expected. Mostly as we lapped last year's timing-related increases in various accruals during the height of the pandemic. The more relevant comparisons therefore, are the year-to-date periods of 2019 and 2018. As you can see from the slide, the sale cash flow continues to track well above those pre -COVID time periods.

This is driven by our operating profit, as well as reduced restructuring outlays and continued effective management of co-working capital. Meanwhile, our balance sheet remains solid. Net debt remains roughly even with last year, and lower than each of the prior two years. Even despite this year increase in cash return to share-owners in the form of resume share buybacks, and increased dividend. So, our financial condition remains quite strong. Slide number 18 shows where our results stand after the first 9 months of 2021. Obviously, we've had a good year so far producing strong and balanced financial results on a two-year basis, and staying ahead of our own internal focus.

This year-to-date performance is all the more impressive when you consider just how challenging the business environment has been. Let's now turn to our updated guidance for the full-year 2021 as shown on slide number 19. Given the better-than-expected momentum we are seeing in our international regions, we are raising our guidance organic net sales growth to a rate of 2% to 3%. This is a solid performance, particularly given the comparisons against last year's pandemic related search.

At the same time, we are reaffirming our guidance for currency-neutral adjusted basis, operating profit, and earnings per share, as well as for cash flow. While net sales are coming in higher than previously expected, we are incorporating costs and disruptions, related to the current supply, and labor conditions. In fact, given this current environment, we will likely land towards the lower end of the guidance ranges for these metrics. Our guidance assumes a reasonable conclusion, to the current labor stoppage at our U.S. cereal plants.

However, as you can appreciate, there is always uncertainty regarding labor negotiations. In the meantime, we will continue to execute our contingency plans to mitigate disruption. Overall, despite an incredibly challenging operating environment, we remain in strong financial condition and our full-year results are expected to sustain balanced financial delivery on a 2-year basis. And with that, let me turn it back to Steve for a review of our major businesses.

[Steven Cahillane, Chairman and CEO]

Thanks, Amit. I'll start by emphasizing the broad-based nature of our sales growth. Slide number 21 shows the 2-year compound annual growth rates in net sales across our 4 regions. It's in North America where we've had the most supply disruption and most significantly in cereal. This has restrained our overall growth in quarter 2 and quarter 3 this year. But as we'll see in a minute, our snacks continued to grow nicely year-on-year. And frozen breakfast and plant-based foods have continued to post good growth on a 2-year CAGR basis. Europe sustained impressive growth in quarter 3.

Pringles has driven exceptional growth for us in snacks, and cereal sales have remained strong there as well. In our Latin America and EMEA regions, we are clearly demonstrating exceptional momentum, collectively sustaining double-digit growth on a 2-year and 1-year basis in the third quarter. In fact, if you turn to slide number 22, you can see that this emerging markets growth is anything but new. Collectively, our emerging markets had already been growing consistently at or above our long-term target of mid-single-digit growth for these businesses. This year we've seen double-digit growth.

Elasticity to our cost-related price increases have run lower than historical levels. We have continued to expand Pringles across these markets, with especially strong growth in Russia and Brazil. We have also continued to grow cereal across our emerging markets, with particular strength this year in Asia. Our growth in Africa this year has been nothing short of spectacular, driven by noodles, cereal and snacks. Equally important to our long-term prospects, is the health of our big world-class brands.

In Q3, their momentum was sustained as much in developed markets, as an emerging markets. Slide 23 shows the two-year categories for consumption growth for Pringles in the U.S. This brand continued to gain share in the third quarter, propelled by incremental innovation, effective brand-building campaigns, and strength in multipacks. In slide number 24 shows that Pringles momentum is truly global. Similar to the U.S., the brand's strong growth and share performance is being driven by incremental innovation like Sizzl'n Platform in Europe, or local flavors like seaweed in Asia, and by various active brand-building, particularly its 360-degree campaigns around soccer and electronic gaming.

On top of that, it continues to gain distribution, particularly in emerging markets. So, this $2 billion global retail sales brand continues to perform well. Let's check-in on another world-class brands, Cheez-It shown on slide number 25. In the U.S. this brand continued to grow consumption and gain share in the third quarter, sparked by strong brand-building activity and growth in multi-packs. Meantime, it continues to gain distribution and share in its newly launched markets, Canada and Brazil.

This is a billion-dollar plus brand that continues its long track record of consistent growth. Pop-Tarts is another world-class brand that is performing well. It's 2-year growth has well outpaced the portable Wholesome Snacks category, as shown on Slide number 26. Another big brand with over $750 million sales at retail in the U.S. alone, it's showing good momentum. To give you an idea of how relevant this brand is, our latest ad has generated nearly 40 million views on YouTube. Our what-would-Pop-Tarts-do hashtag has shown up 5.7 billion times in TikTok, and the brand has enjoyed more than 2 billion earned impressions this year.

Big growth has continued for us on Rice Krispies Treats shown on slide number 27. This brand even accelerated its consumption growth and share gains during the third quarter, aided by effective brand-building and the success of innovation like Homestyle Treats. This brand generates close to $350 million in retail sales in the U.S. and it continues to grow. In cereal, the performance of key brands in the U.S. has been impacted by supply complications in North America, but internationally, we're seeing good growth. On slide number 28, our two world-class brands in Europe are worth highlighting.

Tresor, also known as Krave in some markets, is a taste segment brand that has become the number 1 cereal brand in Europe, and has dramatically outpaced the category this year in key markets like France and Germany. Extra meanwhile is geared more towards adults, and it too has strongly outpaced the category this year in markets like Italy and Spain. Over in the frozen aisle, Eggo is clearly a world-class brand, and it is performing well.

Slide number 29 shows that it is sustaining solid mid-single-digit consumption growth in spite of capacity constraints. Yet another big brand with close to $900 million in retail sales in the U.S. continuing to grow. MorningStar Farms are leading plant-based proteins brand is shown on Slide number 30. This is another world-class brand and is sustaining strong consumption growth even as the category decelerates as expected, and even as we run up against capacity limits in some of our product segments.

This is a $400 million retail sales brand with momentum and strong prospects. In fact, as you've seen, the fundamentals momentum and growth prospects for many of our biggest world-class brands remains solid. Now let's review each of our regions, starting with North America in Slide number 31. Net sales were flat year-on-year in the third quarter, with underlying consumption growth well exceeding our shipments due to supply constraints. Many of these constraints were economy-wide, including shortages of materials, labor, and freight.

But we had some internal challenges as well. As you know we entered this year tight on capacity for growing food formats in cereal frozen from the [Indiscernible] and plant-based protein as well as certain pack formats and snacks. Add to that, the fire that interrupted production at one of our cereal plants. And you can appreciate just how constrained we have been. The good news is that we remain in growth on a 2-year CAGR basis, and that our revenue growth management actions are resulting in good price mix growth.

This price realization, along with good execution of productivity programs, is crucial for mitigating the margin pressures of high-cost inflation and incremental costs and inefficiencies related to the broader bottlenecks and shortages in the economy. Slide number 32 breaks our North America in net sales growth in the category groups. You can see the good momentum we've seen in snacks and frozen, despite these supply constraints and the fact that away from home sales remained lower on a two-year basis.

Cereal net sales have been flattish on a two-year category basis in the first half, roughly in line with the U.S. category's performance. In quarter 3 however it faced the worst of its supply challenges and is now down about 1% year-to-date on a two-year category basis. Importantly, our underlying consumption trends remained solid across most of the portfolio, as shown on slide number 33. In all 3 of our snacks categories, we saw an acceleration in two-year categories in quarter three. Continuing to well outpace their individual categories.

In the frozen, from the griddle category, we also saw accelerated 2-year growth during the third quarter, and in frozen veggie vegan, even as the category decelerates as expected, our growth remains strong. Even in cereal, which is a category has been flat on a two-year basis this year, we are holding consumption relatively flat despite all the supply challenges we've been facing. And before we move on from our discussion of North America, we should touch on our U.S. away-from-home business in slide number 34.

The slide shows rolling two-year average growth rates in our net sales over the past few quarters in these channels. As restrictions eased and consumer mobility increased, we saw year-on-year growth starting in quarter 2 and continuing in quarter 3. Our sales remained below 2019 levels, but you could see that a gradual recovery continues. The recovery has been a little quicker in channels like convenience stores and schools, and much lower in channels like vending and in travel and lodging.

There is no question that our North America region is facing the toughest of the global supply challenges, and the team has risen to the occasion. We are presently working to restore full production at our fire damaged cereal plants, while negotiating with the union regarding its strike against all of our U.S. cereal plants. Indeed, North America faces even tougher quarter, in the quarter 4. Nonetheless, we're executing well in market and our brands are in great shape. Now let's turn to our international regions and Slide number 35.

You can see that in each of these 3 regions, we are sustaining strong momentum, both in the form of year-on-year growth and on a 2-year CAGR basis, which eliminates the impact of comparing against last year's surge, especially in Latin America. Let's look at each of these regions a little more closely. Slide number 36 shows the results of Kellogg Europe. Europe streak of quarterly organic net sales growth continued impressive fashion in the third quarter.

Driven by both volume and price mix, this growth was led by Russia and the UK, but broad-based across the region. Double-digit growth in snacks was driven not only by Pringles sustaining its momentum, but also by a rebound in portable wholesome snacks. Cereal sales grew on top of last year's growth, and we are particularly pleased with the magnitude of our share gains in the UK.

As we look to the fourth quarter, we lapped a particularly strong organic net sales growth performance, and on operating profit, we are managing through high costs and supply challenges, as well as lapping a 53rd week. Nevertheless, we expect to sustain our end-market momentum in cereal and snacks, and Europe is on track for another strong year. Now let's talk about Latin America in Slide number 37. The year-ago quarter included out-sized gains in sales and profit.

So, comparisons are masking a solid performance for us in the third quarter. Organic net sales continued to grow year-on-year, despite the comparisons with notable strength on a two-year CAGR basis. The growth was broad-based and supported by strong in-market performance in cereal, led by Mexico, as well as by Pringles across key markets. We saw particular strength in Brazil, where Pringles is showing outstanding momentum.

Despite decelerating at-home demand trends and extremely high-cost inflation, we expect Latin America to continue to grow in quarter 4, completing what has been a very strong year. And we'll finish our business review with EMEA in Slide number 38. Once again, we saw exceptional growth in this region. We generated organic net sales growth in Australia, led by cereal, and in Asia, driven by both cereal and snacks, despite COVID-related production restrictions on Pringles for much of the quarter.

The biggest star in the quarter was Africa, where we are generating double-digit growth in both volume and in price mix. The top-line growth was strong enough to overcome double-digit cost inflation, delivering operating profit growth. As we look to the fourth quarter, we expect to see continued top-line momentum and bottom-line growth in EMEA, despite cost inflation, and supply challenges. Allow me to wrap up with a brief summary on Slide number 40. Our portfolio is in good shape.

Our world-class brands have great momentum and our emerging markets businesses continue to exceed even our expectations. The result is strong, top-line momentum. We're taking action to mitigate the profit impact of what is the highest cost inflation we've seen, in a decade or more. To do that, we're executing productivity initiatives, we're being disciplined on overhead, and selective on brand investment, and we're carefully executing all levers of revenue growth management.

Bottlenecks and shortages are ramping across the economy right now, and we're experiencing our own, particular labor and supply disruptions. However, we are managing well through these difficult supply conditions. Our people are demonstrating why there are competitive advantage, going the extra mile to supply the market when everything, procurement, manufacturing, shipping is more challenging now than ever. In the end, we expect to remain on our path of balanced financial growth.

We've delivered on its so far this year, and we are reaffirming our full-year guidance today, even in spite of the current operating environment. I want to commend and thank our entire organization for their dedication and GRIT and for finding a way to deliver on our commitments in what is obvious an unusual environment. And with that, we'd be happy to take any questions you might have.

[Operator]

Thank you. As a reminder for anyone who does wish to ask a question [Operator Instructions]. And we do ask you ensure your line on too closely. Our first question today comes from Andrew. Andrew, your line is open. Please go ahead.

[Andrew Lazar, No Description]

Thanks. Good morning everybody.

[Steven Cahillane, Chairman and CEO]

Good morning Andrew.

[Andrew Lazar, No Description]

Just one from me. Your Europe trend is obviously remaining incredibly strong and accelerated on a 2-year basis. Even as many of those markets have been reopening at a faster pace than we've seen here in the U.S. So, I guess what are the learnings, if any from Europe, maybe that can help you inform the debate a bit in the group on whether some of the new households gain the past 2 years can be somewhat more sticky over time as markets in the U.S. more fully reopen?

[Steven Cahillane, Chairman and CEO]

Yes. Thanks, Andrew. We have seen terrific growth in all of those international markets driven by increases in penetration and increases in buy rate. And so obviously those two things are important. They work in concert together and we've seen the business stick even as mobility has increased. And so, what we've always said is, we're looking at 2019 as a comparison, and obviously is still very relevant.

The U.S. continues to open up slowly and we're hanging onto those buy rates, especially in the U.S. And so, we anticipate, even as the U.S. continues to open up, what we've talked about is the lasting impact is something we're confident in. And as we've said, time and again, our goal all along was to exit the pandemic stronger than when we went in. And we're more confident than ever that that's happening. That's absolutely happening.

[Andrew Lazar, No Description]

Great. Thanks so much.

[Operator]

Our next question today comes from Steve Powers of Deutsche Bank. Your line is open, please continue.

[Stephen Powers, Deutsche Bank]

Thanks, and good morning from me as well. Two questions related to the supply of production backdrop in the U.S. First is can you give us some color on, how your service levels and fulfillment rates are holding up? How you expect them to trend for the fourth quarter and into the next -- into fiscal '22? Whether we should worry about, out-of-stocks accelerating or anything on that front? Relatedly, as you manage through these situations and you're pulling back, as you say, on investment spending, what's the risk as you see that begin to lose ground more structurally versus competition. I appreciate everyone's on the same boat directionally, but your situation is obviously a bit more severe at the moment. So, I'm wondering how you assess that risk. Thank you.

[Steven Cahillane, Chairman and CEO]

Yes. Thanks, Steve. So, as you pointed out, the environment is challenging for all of us, there is no question about that. Our fill rates and our customer service levels are not where we want them to be. And we're not alone in that either, but we hold ourselves to a very high standard and we aim to get better and better. And so, let me point out a couple of things around your question. We have one particular area that is more challenging than others, and that's our Cereal business.

And that's obviously been compounded because of the strike that we're going through right now. But outside of that, which is 20% of our global business, outside of that, we're in the same boat as everybody else and you can see based on the type of performance outside of cereal in the U.S., we have posted some very, very strong gains, so we don't believe there's going to be anything structural to our disadvantage as we continue to make our way through the pandemic, through the supply grid lock into a more normalized environment.

And we've got mitigation plans based on where we are with our current cereal plants in the U.S. as well. So, by no means are we complacent. We've got big challenges in front of us, but we're quite confident that we're not going to be at a long term or any kind of permanent disadvantage. This is a transitory event and we'll work our way through it.

[Amit Banati, Chief Financial Officer]

And I think just on the investment levels, our investment levels are broadly flat versus a year ago, so while we pulled back on some supply constraint platforms, when I look at the overall level of investments, we're flattish. And in fact, our advertising is up, so we continue to invest at appropriate levels.

[Stephen Powers, Deutsche Bank]

Okay. Very good. And just to -- Amit on that point just -- is that -- does that -- I think that's a regional statement. Does that apply to the U.S. cereal as well?

[Amit Banati, Chief Financial Officer]

I think it would vary across category -- I think it would vary across categories because as Steve mentioned different categories, the supply and service levels vary by category. So, I was talking on a global level, on our levels of investment.

[Steven Cahillane, Chairman and CEO]

And really Steve, based on supply, we're not, we're not going to advertise and promote heavy areas that are severely constrains at the moment.

[Stephen Powers, Deutsche Bank]

No, that makes sense. Just want to clarify. Thank you very much.

[Operator]

Thank you. Our next question today comes from Pam Kaufman of Morgan Stanley, your line is open. Please go ahead.

[Pamela Kaufman, Morgan Stanley]

Hi. Good morning. I just had a question on -- I had a question on the guidance for the full year, so the full-year guidance implies a relatively wide range for Q4 top-line growth. Can you talk about the factors that would contribute to your results coming in towards the low versus the high end of the rates? And what impact are you expecting from the labor strike?

[Steven Cahillane, Chairman and CEO]

Hi Pamela, so I'll start and Amit can pick up. So, what we've said is, we're taking a reasonable approach to what we think will happen with the labor strike, and that's in our guidance. Our top-line, obviously, continues with great momentum. But you heard what we said about the other three elements coming in perhaps more towards the lower end of the guidance. So, let me talk about what our thinking behind the strike and what I can share with you. We are in the process of negotiating right now.

And so out of respect to that process, I'm not going to get into a lot of detail which I am sure you can appreciate. But we have always treated our employees with respect and fairness, and that includes industry-leading compensation and benefits. The offer that we have in front of the unit right now is increased compensation on top of that already industry-leading compensation and benefits, and we're not asking to take anything away, despite what you may have heard publicly. So, we think a fair resolution should be in the offing.

We think that this type of offer is fair, reasonable, and again, increases on top of the industry-leading compensation already. So, this would allow our employees to get back to work. We want them back to work. I think they want to be back to work. But because these negotiations are ongoing, we can't go into much more detail than that, but I think -- we're hoping that we'll come to a reasonable conclusion. And that's what we're working towards.

[Pamela Kaufman, Morgan Stanley]

Great. And can you give more color on your growth margin expectations for the fourth quarter and how that will compare to the third quarter? And then just looking towards next year, do you think you've taken enough pricing and implementing enough productivity to preserve year-over-year gross margins?

[Amit Banati, Chief Financial Officer]

Yes. So, I think just on gross margin, I think we expect quarter 4 to continue to be challenging from a cost standpoint. So, I think the environment remains challenging and we'd expect that to continue in fact, on certain packaging and in certain commodities, we expect inflation to be higher than what we've seen in quarter three. Overall, I would say that we're expecting inflation to be in the high single-digits.

Like it was quarter three similar levels, slightly higher in quarter four. And then of course, compounded by the strike, right? And the disruptions as a result of that. So that's the outlook on gross margins from quarter 4 standpoint. And I think as I mentioned in our in my prepared remarks, from an absolute dollar standpoint, we expect it to be higher for the full-year versus 2019 levels. So that's the outlook on gross profit.

[Steven Cahillane, Chairman and CEO]

And Pamela, on the pricing which you asked about we're not going to comment on forward-looking pricing for obvious reasons. But I think if you look at where we are with price mix and you look at what we've been able to accomplish, that would be our goal going into the future. So obviously the very cost, it's a very inflationary environment driving up costs. Our first line of defense is always productivity. And as we plan out 2022, we'll plan for the same levels of productivity or greater, and then look to the revenue growth management that we've successfully employed in order to protect our margins into next year.

[Pamela Kaufman, Morgan Stanley]

Okay. Thank you.

[Operator]

Thank you. Our next question comes from Ken Goldman of JP Morgan.

[Ken Goldman, JP Morgan]

Hi, thanks so much. I know this is a difficult question to answer, so just trying to look for some rough ideas here, but there's the normal headwinds that every sort of food manufacturers is facing right now. When I say normal, I mean, the ones that are across the entire industry, whether it's labor challenges, logistics, or so forth, higher raw materials. And then there's the sort of Kellogg 's specific one of the strike.

And I'm just trying to get a better sense of as you look to your fourth quarter guidance and you think about early next year, how do we think about the impact on whether it's your gross margin or your EBITDA dollars, however you want to think about it on the labor strikes alone, I am just trying to get a sense of how to parse that out as we think about the headwinds there and any help you can give will be great.

[Steven Cahillane, Chairman and CEO]

Yes. Ken, I appreciate the question, but I think you can appreciate, based on the sensitivity of where we are, and the fact that we're in negotiations, we're not going to be able to quantify any of that. We've taken what we think is a very reasonable view of getting to an agreement. We've also taken into account the contingency plans that we have in effect. We knew -- we've been talking for a year now, because we had a year extension, we knew the contract was expiring on October 5th, so we took all sorts of measures to prepare ourselves, including building inventory.

Building inventory was a little bit challenge because of the fire in Memphis, but we also have deployed our white-collar workers, we've deployed outside labor to keep the plants running, to get the plants running, they're gaining productivity each and every day. We've also leveraged our global supply chain network for cereal to also mitigate. And so, we're working very, very hard on two fronts to mitigate the effects of the strike. On the one hand, and we're doing that successfully and getting better every day.

But also, to get our workers back to work. We want them to get their paychecks, we want them to enjoy their healthcare. We truly want them back to work and we think we've got a very, very good proposal. Again, with increases on top of already industry-leading compensation. So, I think reasonable heads should prevail, based on all that. And that's the view that we're taking. We want to get to a negotiated settlement, get back to work, and we think we've given the best guidance that we can based on all those different factors.

[Ken Goldman, JP Morgan]

Thank you for that. And then a quick question follow-up just thinking about modeling on it. You've had similar adjusted SG&A the last couple of quarters, a little under $720 million. As we think about a run rate, going forward, is that a reasonable number? I know it's going to vary, obviously from quarter-to-quarter. I'm just trying to get a sense because we've had some ups from the last year. What we should be thinking about going ahead here.

[Amit Banati, Chief Financial Officer]

Overall, I'd say flattish to 2019 levels is kind of a good run rate to assume Ken. I think the sales has been phasing. We're lapping the phasing of the brand-building and obviously we also lapping the incentive compensation accruals from last year.

[Ken Goldman, JP Morgan]

Thanks so much.

[Operator]

Thank you. Our next question comes from Nik Modi of RBC Capital Markets.

[Nik Modi, RBC Capital Markets]

Yes, thanks. Good morning, everyone.

[Steven Cahillane, Chairman and CEO]

Morning, Nik.

[Nik Modi, RBC Capital Markets]

I was hoping maybe you can just -- good morning. I was hoping you can give us some context on inflation just kind of the key buckets in how you see that playing out. And then Steve, if I could throw in a question to you just strategically and philosophically, we're obviously seeing a lot of onetime events that are causing a lot of disruption of these one-time events feel like they just keep on happening. So, I wanted to get your thoughts on capex and doesn't make sense to just have a super cycle in the near-term, just to automate as much as possible and just really evolved the infrastructure to be ready for handling these tend to shock? Thanks.

[Amit Banati, Chief Financial Officer]

Nick, just on the inflation, I think as we expected and as we had previously communicated, inflation came in at high-single-digit rates in quarter 3, it accelerated through the quarter. And as I mentioned earlier, we expect it to further accelerate into quarter 4 as well. And we kind of look at it in two buckets. There's the market-driven costs in commodities like oil, dairy, ingredients, like rice, potatoes and packaging. And actually, packaging was the one where we saw significant acceleration in quarter 3. So that's -- we think inflation, fairly broad-based, I'd say, across our commodities.

And then of course, the operating environment continues to be challenged. Whether it's freight markets, whether it's ocean freight, whether it's labor shortages, as well as shortages across our suppliers, and our supply chain. So that's -- and I would expect a similar outlook for quarter four with slightly higher -- still in the high single-digit rates, but slightly higher levels of inflation into quarter four. And I think from a pricing standpoint and from a revenue growth management standpoint, we're obviously taking action and broadly, I'd say covering our commodity related costs and our direct costs. I think some of the disruptions are hard to predict. And so that's kind of the color on inflation.

[Steven Cahillane, Chairman and CEO]

And Nick, it's a really interesting question that you raised strategically, and I think for everybody, the pandemic has brought all sorts of different consequences, right? And it's almost an old joke by now, there's no pandemic playbook, but we've all had different challenges, some very common and some unique. Unique to us to obviously is a fire that we talked about, the strike that we're dealing with right now. So, there's clearly some uniqueness. But I think one thing that we are definitely looking towards is how we continue to grow. Because despite this, we've had lots of I wouldn't call it pockets, we've got real growth happening in most of our business that is very resilient, robust, and sustainable.

But the future of work is clearly going to change and our capital plans over the next couple of years will reflect that. When I say the future of work, the obvious -- what happens in office environments, where work gets done, how work gets done, but then also, from a capacity standpoint, and how factories run, and where work gets done there, where product gets made to allow ourselves even more resiliency going forward is clearly something that is on the cards for us.

[Nik Modi, RBC Capital Markets]

Great. Thanks.

[Operator]

Thank you. Our next question comes from David Palmer of Evercore.

[David Palmer, Evercore]

Thanks. Good morning. You mentioned that in, I think it was answer to Ken 's question and the high-single-digit inflation in the fourth quarter. If input costs remain at these current levels and considering contracts and hedges rolling off, will the -- will COGS inflation slow in the first half of '22 or remain near those high-single-digit levels? And I have a quick follow-up.

[Amit Banati, Chief Financial Officer]

Yeah. I think we'll obviously provide detailed guidance right in our quarter 4 earnings call in early February. I think to your question on from an inflation standpoint, I think on a planning basis, we're assuming that the high levels of inflation will persist for the foreseeable future. But I think that's what -- that's the assumption that we're working with. I think from a hedging standpoint, we have a continuous hedging process, so they continue to roll. So, we do not anticipate any sudden cliff at the start of the year. that said, obviously the hedges are rolling up at higher prices.

And so, from a lapped standpoint, the current hedges are higher than the hedges that are dropping off. And so all-in-all, we're planning for a high inflation environment in 2022. I think you don't from a shortages and disruption standpoint, that's harder to predict. But we are assuming that they will persist. And so, from a productivity standpoint and from our revenue growth management standpoint, we will be taking actions in '22 to offset them and continuing to drive balanced financial delivery.

[David Palmer, Evercore]

And thanks for that. And if we were to look back where we can almost, now, look at '21 with pretty good visibility, I would imagine. And if you were to look at the friction costs, COVID related, strike related, just put it all into one bucket and God willing, you'll be able to lap these friction costs with less friction in '22. But how would you say or estimate those friction costs have been a drag to your gross margins in 21, I'll pass it on.

[Amit Banati, Chief Financial Officer]

Yeah. I think it's hard to model that because there's so much that's happened during the course of this year. I think and like I mentioned, from our '22 planning standpoint, we're assuming that the current environment is going to persist. And we're focused on productivity and pricing and revenue growth management actions, to try and offset those costs. And continue to drive balanced delivery.

[Operator]

Okay. Thank you. Our next question comes from Laurent Grandet of Guggenheim.

[Laurent Grandet, Guggenheim]

Yes. Good morning, everyone. And 2 questions. The first one is more follow-up actually. You said in your per remark, U.S. shipments were lagging behind consumption. So, what is the current level of inventory at retailers? And how it compares to rate should be. So that's the first question. The second one is really about Europe. It's from a strong gross in Europe this quarter were higher than what we expected.

And you mentioned in your pro-market performance was driven by the U.K. and Russia. So, could you please give us a bit more color there? There were so -- I mean, we heard about disruption and the neighboring that truck drivers into U.K. And are you seeing any kind of disruption there in the U.K? but also in shipments between the U.K and Europe? Thank you.

[Steven Cahillane, Chairman and CEO]

Yes. Thanks. Laurent, I'll start and then Amit can fill in as well. From a U.S. shipment standpoint, I would say shipments are lagging consumption probably mid-single digits is probably a reasonable assumption there. I'd say inventory levels across the whole landscape are low, obviously. It's been well-documented in all the supply chain challenges and disruptions and so forth.

In terms of Europe, I mean Europe team continues to deliver at a very high level. And if you look at the UK and Russia performance, we highlighted that and if you look at across Pringles and Cereal and the Wholesome Snacks has bounced back, as we said as well. And so, it's really just high levels of execution, lapping a very strong performance last year and continued demand creation activities that have been very, very successful in terms of the disruptions, there clearly are disruptions.

They're not quite as acute as they are in the U.S., but they are real. There's friction also that has to do with Brexit. When you think about supply chain that is on Continental Europe, as well as the UK. We're working our way through that. You're seeing good results despite that. But the same issues around freight and truck drivers exist in the UK and in Continental Europe, but particularly the UK as they do in the U.S. as well.

[Laurent Grandet, Guggenheim]

Thank you. I'll pass it down. Thanks.

[Operator]

Thank you. Our next question comes from Robert Moskow of Credit Suisse.

[Robert Moskow, Credit Suisse]

Hi. One of your big competitors is talking about price increases beginning in January and snack. And there's a lot of [Indiscernible] food companies that are introducing new pricing. Can you talk a little bit about like what your plans are for pricing in 2022? What have you talked to the trade about so far? And then a quick follow-up?

[Steven Cahillane, Chairman and CEO]

Yes. Thanks, Rob, I appreciate the question, but we do not talk about forward pricing for a number of reasons. But again, if you look backwards and you see what we've done, we've been successful at driving pricing. The good news is elasticities have performed very well. They've been lower than historically. That was our expectation.

And I think a lot of expectations based on just the totality of the inflationary environment. And as we look to 2022, as we said, we'll deploy productivity, we'll deploy revenue growth management. And we'll look to be competitive in market and to create value and to provide for a plan that delivers balanced financial growth going forward.

[Amit Banati, Chief Financial Officer]

And I think if you look at our -- quick look backwards, our price mix has been at around 4% and within that actually mix has been negative because of -- in this quarter, because of country mix. And so not only is that of -- not only the 4% offsetting the mix. But obviously the pricing is at a high level than that. So, it's coming through.

[Robert Moskow, Credit Suisse]

Okay. My follow-up on plant-based. You said that the category is declining as you expected off of tough comps. Is there a risk that these declines continue into next year? When do you think it comes back to positive again?

[Steven Cahillane, Chairman and CEO]

Yeah, Rob, I think it does come back to positive next year. The lap is really what's occurring right now. And if you go back to see what happened 2 years ago. There was an enormous excitement around the new entrants. Lots of new distribution being built. Lots of doors, frozen doors, refrigerated doors being added. And so, we always anticipated, as we said, that the hurdle of that would be difficult. But when you look to consumer behavior, when you look to the consumer research we have, there's still a lot of enthusiasm and excitement around plant-based. And so, we think going into next year, you start to see healthier growth rates on a year-over-year basis because of those comps.

[Robert Moskow, Credit Suisse]

Great. Thank you.

[Operator]

Our next question comes from Chris Growe of Stifel.

[Christopher Growe, Stifel]

Hi. Good morning.

[Amit Banati, Chief Financial Officer]

Morning.

[Christopher Growe, Stifel]

Quick question for you on mix as you were talking to Rob there. Does lower mix at the revenue line mean lower mix at the profit line, whether it be gross profit or operating profit? So, is that a factor weighing on your gross margin as well?

[Amit Banati, Chief Financial Officer]

Not necessarily. I think it's -- there are 2 factors in play at a high level. One is obviously your geographic mix. A Multipro, it does impact both NSP and gross margin because it's a distributor business. And obviously in quarter 3, like we -- like I mentioned, we had a huge quarter in Multipro in Nigeria, driven really by pricing to cargo inflation and volume growth was strong despite the significant pricing that came through. On that one, it flows through. I think on the categories, I'd say it's a lot more balanced between snacks and cereal.

[Christopher Growe, Stifel]

Okay. And then I had a second question just around pricing and two elements of that. One would be that you noted the Europe pricing to offset inflation, but some of these disruptions and supply chain challenges are -- have been an issue for your gross margin. As you, I think you noted as well that you expect those to continue next year.

So, does that mean that your pricing would be below whatever the total amount of inflation is next year if the supply chain challenges don't get better? And then if I could add to that, you talked about a low level of plasticity, especially in the emerging markets to pricing, does that push you to price even more there than what you would expect around the level of inflation in those markets? Thank you.

[Amit Banati, Chief Financial Officer]

I think to the extent that we can focus the disruptions. I think it's hard to focus and that's been the challenge this year, because it's just common in so many unexpected places. I think to the extent that it's sustained and we're able to focus it. Obviously, that will go into the mix of how we offset through productivity and revenue growth management.

So, I think that's the way we're thinking about it. I think to the areas that we think that's going to persist, we'll obviously take actions to offset that. And I think on your point on emerging markets, yes, the volume has come through stronger than we had expected. And so, I think elasticities have been lower. No question.

[Christopher Growe, Stifel]

Thank you.

[Operator]

Thank you. Our next question comes from Ken Zaslow of Bank of Montreal. Your line is open.

[Ken Zaslow, Bank of Montreal]

Good morning, everyone.

[Amit Banati, Chief Financial Officer]

Good morning.

[Steven Cahillane, Chairman and CEO]

And good morning, Ken.

[Ken Zaslow, Bank of Montreal]

Can you talk about the auctioneer

[John Renwick]

Can you hear us?

[Ken Zaslow, Bank of Montreal]

That you have with Pringles and where you think that the new markets will be. And when you think about it in a couple of years, how big you think this brand will be?

[Steven Cahillane, Chairman and CEO]

Yes, thanks, Ken. So, we're very excited about the Pringles momentum obviously. It's a great brand, it's highly differentiated. It handles innovation extremely well. It carries flavor, like no other snack. And so, we see continued growth in the markets where we are. It's got pretty good distribution countrywide.

So, most of the growth is going to come from continuing to penetrate and increased by rates and household penetration in some of the developing markets. You've seen in Central Brazil and other emerging markets quite successfully so. And we put a couple of lines in our Brazilian plant for Pringles as well. The Malaysia plant has been running strong for us and that provides good growth opportunities across Asia. So, we think -- I'm not going to predict how big it can get, but it keeps getting bigger for sure and generating very solid growth for us.

The other thing I'd mention where we have a lot of opportunity from snack and expanding distribution Cheez-It, which doesn't have the same footprint as Pringles, not even close. And we've now launched in Canada and Brazil and it's done extremely well. So now, as we look to the globe, we look to brands like Cheez-It and even Pop-Tarts and others that would have global aspirations. And so, we continue to look at our Snacks portfolio as something very exciting with a lot of growth potential.

[Ken Zaslow, Bank of Montreal]

My second question is, for the last couple of quarters, you've tried to temper the emerging markets growth. This is probably the first quarter you haven't done that. And you continue -- you actually sound a little bit more optimistic about the outlook emerging markets. Not that you haven't been optimistic, but you're not trying to taper off expectations on that. What are you seeing in emerging markets to give you increased confidence that maybe this is much more sustainable than you may have thought for the last 3 quarters to 4 quarters. And unless I misread what you're thinking. And I'll leave it there [Indiscernible].

[Steven Cahillane, Chairman and CEO]

[Indiscernible]. Ken, sorry. We do assume a slowdown in emerging markets in quarter four. And we've been -- we've been pleasantly very, I wouldn't say surprised, but they're great, great numbers that have been posted in the emerging markets. You look at the Africa business. And so, we don't plan on that sustaining, but have been very pleased with what's been achieved.

[Amit Banati, Chief Financial Officer]

And I think if you looked at our prepared remarks, we talked about growth accelerating. We saw it all the way through last year, and it's further accelerated. So, we had double-digit growth through the year. Overall, it's been sustained through the year, through last year. And I think from a growth standpoint, we continue to see it as a growth opportunity.

[Ken Zaslow, Bank of Montreal]

Appreciate it. Thanks

[John Renwick]

Operator. Thanks, Ken. Operator, I believe we are at 10:30, which means we need to wrap it up. We'd like to thank everybody for their interest and their questions. And if you do have any follow-up questions, please do not hesitate to call us.

[Steven Cahillane, Chairman and CEO]

Thanks, everybody.

[Amit Banati, Chief Financial Officer]

Thank you.

[Operator]

Thank you. This conference call has now concluded, and you may now disconnect your lines.