WK Kellogg Co
NYSE:KLG
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Earnings Call Analysis
Q4-2023 Analysis
WK Kellogg Co
The company has been deploying strategic initiatives such as premiumization, promotional effectiveness, and price-pack architecture to enhance financial performance. These efforts aim to create value, increase sales effectiveness, and improve the efficiency of their supply chain. Particularly, they plan to keep propelling the business forward into 2024 with ample investment dedicated to driving growth and optimizing operations.
Significant steps are being taken to modernize the supply chain, which includes partnering with stakeholders to enhance plant productivity and economics, and adopting high-performance work systems proven to boost workforce engagement and problem-solving abilities. Notably, the reliable supply of products has been an area of pride, as represented by improvements in Overall Equipment Effectiveness (OEE). Strong customer service has been achieved by focusing on discipline and execution, seen as a cornerstone of their success and expected to continue contributing to business growth.
Fourth-quarter sales were down slightly by 2.7%, yet this was offset by a notable increase in EBITDA of 43.2%, driven by price/mix improvements and commercial investment optimizations. Gross margins saw significant improvement due to a balanced commercial approach and operational efficiencies, with a full-year margin exceeding guidance at 9.4%, a robust uplift from the previous year. Looking ahead, gross margins are predicted to be the main driver for EBITDA improvements despite a small expected decline in free cash flow related to one-time investments for company development.
The company is carefully navigating through the after-effects of its most recent price increase in early 2023. The leadership is confident about the overall guidance for the year despite initial disruptions evident in market scanner data. They are focusing on revenue growth management initiatives, and the price realization is expected to be strong following the early year's pricing actions. As they lap the substantial price increase, the company projects low single-digit growth in price/mix for 2024, which is anticipated to drive profitability alongside strategic cost management.
On the investment front, inflation appears to be stabilizing at higher levels, with some commodities like corn and wheat showing deflation, while others, such as sugar and rice, remain elevated. The company plans to allocate approximately 2.5% of net sales to baseline capital expenditures and has designated an additional $80 million for stand-up costs, which will include a mix of one-time expenses and capital investments, primarily in CapEx.
The company is tapping into opportunities beyond traditional breakfast occasions, banking on its strength in the cereal market to expand into snacking and single-serve options. They have identified this adaptability to changing consumer patterns as a potential tailwind and are investing in innovation to capitalize on these trends. Furthermore, they have reaffirmed the existing plans for supply chain modernization, anticipating $400 million to $500 million of investment over time to improve margin expansion. The capital expenditure outlook and investment in the supply chain are integral parts of the plan, and more clarity on this will be provided later in the year.
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Good day, and welcome to the Q4 W.K. Kellogg Co Earnings Conference Call. Today's call is scheduled to last one hour, including remarks by management and then a question-and-answer session. [Operator Instructions]. I'd now like to turn the call over to Karen Duke, Vice President, Planning and Investor Relations. Please go ahead.
Thank you, operator. Good morning, and thank you for joining us today for a review of our fourth quarter results. I'm joined this morning by Gary Pilnick, our Chairman and Chief Executive Officer; and Dave McKinstray, our Chief Financial Officer.
Slide #2 shows our forward-looking statement disclaimer. As you are aware, certain statements made today, such as projections for the company's future performance are forward-looking statements. Actual results could be materially different from those projected. For further information concerning factors that could cause these results to differ, please refer to the factors listed on the disclaimer slide as well as those in our SEC filings, including the Risk Factors section.
As we discuss our results today, unless noted as reported, we'll be referencing the respective non-GAAP financial measures, which adjust for certain items included in our GAAP results and for periods prior to the spin-off, are also presented on a stand-alone basis. You can find definitions of each non-GAAP measure and GAAP to non-GAAP reconciliations within our earnings release and in the appendix to the slide presentation.
I will now turn the call over to Gary.
Thanks, Karen, and good morning, everyone. Thank you for joining us today to review our fourth quarter and full year 2023 results. For today's call, I will provide a summary of our 2023 results, market performance, 2024 guidance and discuss the progress we're making on our overall strategy and strategic priorities. Across each topic, you will hear about the benefits we're already seeing from a more focused and integrated team. I will then turn the call over to our Chief Financial Officer, Dave McKinstray, who will provide additional detail on our performance and guidance. We will close out the call with time for Q&A.
Turning to Slide 4, these are our key messages for the day. Our commitment to fulfilling promises, our focus on execution and the impact of our Engage team. We introduced ourselves in August at Investor Day before we were a stand-alone public company. At that time, we provided our outlook for 2023 and 2024. In November, we provided 2023 guidance ahead of our August outlook. And today, I'm pleased to report we've delivered net sales at the high end of our guidance range and EBITDA margin above our guidance range. The team has visibility to effectively plan our business, they are executing that plan, and we are on solid footing as we look forward.
At Investor Day, we also reviewed in detail each of our strategic priorities. As you would expect, we've been executing on these priorities, making meaningful enhancements across each of our marketing, sales and supply chain functions. During our early days, we are seeing the benefit of a more focused and integrated team. We are indeed driving an integrated commercial plan to win as we launched our new marketing model and stood up our single category dedicated sales force. We are also modernizing our supply chain and driving operating efficiencies. Better yet, we are executing end-to-end with improved connectivity across the enterprise. Underpinning all of this is our effort to unleashed an energized and winning culture, which is growing organically every day. Our people are engaged, focused and eager to drive the business forward, and that engagement extends to our customers, communities and other key stakeholders. This engagement is showing up in our performance. This confirms what we know to be true. We have the right team, the right strategy and the right model to deliver value for our stakeholders.
Moving to Slide 5, let's review our financial results. Dave will cover the full financials and guidance in more detail, and I'll provide highlights here. For the full year 2023, net sales increased 2.8%, leading to a gross margin improvement of more than 400 basis points, with 290 basis points flowing through to EBITDA. Our performance reflects the benefit of positive price/mix, our recovery from the fire and strike and underlying business momentum. The year ended better than planned as we continued to improve our operational efficiency and maintain cost discipline.
We exceeded the EBITDA guidance we provided in November and hit the high end of our sales guidance. For 2024, our guidance calls for net sales growth in the range of negative 1% to positive 1% and EBITDA growth in the range of 3% to 5%. This EBITDA forecast is ahead of what we said at Investor Day and during the Q3 earnings call. We continue to be on track with key separation milestones on track with our strategic priorities, and we are on track to deliver our financial outlook.
Now let's take a look at the Cereal category on Slide 6. cereal is a repertoire category, with a fast purchase cycle, nearly 50 million purchase decisions each week. Consumers typically have multiple boxes in their pantries and are looking for cereal to satisfy a variety of consumer needs and occasions. It's also a remarkably affordable category and delivers the type of value consumers are looking for as cereal, milk and fruit is less than $1 per ball.
Even with consumers under pressure and exhibiting value-seeking behavior, it's notable that the premium segment performed very well in 2023. Cereal is a dynamic category, serving many consumer preferences and delivers on taste, convenience, nutrition and affordability. In the U.S., the category grew 5% in 2023, mainly through positive price/mix, demonstrating the durable nature of the category. These are a few of the many reasons we are so very excited about the cereal category.
Now let's look at how our business is performing on Slide 7. For the year, we grew U.S. retail dollars at 6.3%, leading to market share growth of 40 basis points. Full year share was 27.8%, which represents a nearly 260-point improvement from our low point in 2022. Our performance for the year was broad-based across our portfolio and builds on our recovery from the fire and strike as we regained share on our core six brands while executing the spin.
In Canada, we're the market leader at 37.9% and improved our position 160 basis points in 2023, highlighted by our performance in December when we achieved a 40% share. This is testament to the relevance of our brands and our team's ability to execute an exciting commercial plan. We're pleased with our recovery to date and have further opportunity ahead of us.
Now let's look at how the execution of our strategy is underway. On Page 8, let me first remind you of our strategic priorities. Our integrated commercial plan to win brings together our demand-creating infrastructure with our in-store activation. This priority allows us to operate more seamlessly end-to-end with greater agility.
Next, we'll update you on our second strategic pillar, modernizing our supply chain. I'll talk about how we're working with key stakeholders to improve plant productivity and economics as well as taking action to improve our operating efficiencies through new ways of working. Our third strategic pillar is to unleash an energized and winning culture. Our people are the most valuable asset and I could not be more proud of how they're showing up and driving meaningful change.
Now let's take a look in more detail at how our integrated commercial plan to win is coming to life. On Slide 9, let's start with the first half 2024 innovation. We all know innovation is critical to the cereal category. It delivers consumer excitement, grows the basket and drives points of distribution. We have a strong record of cereal innovation, including the introduction of three top innovation items last year. That same team is now part of W.K. They continue to lead our commercial organization and developed another strong innovation plan for 2024.
What's different about this year's innovation is that it includes the launch of two new premium brands, MOUTH OFF and EXTRA. MOUTH OFF delivers against current food trends with 22 grams of protein and zero sugar. EXTRA is a taste-led granola. These brands have been launched in an agile way, leveraging social media to drive awareness. As we have discussed, the premium segment is growing, and we have been participating with Special K Zero and Special K High Protein. We're excited to add MOUTH OFF and EXTRA to our premium offerings this year.
The next element of our innovation is expanding appeal of our existing brands across cohorts. As we reignite Kashi, we launched Smoothie Loops, a cereal with all family appeal. Our innovation on brand and Special K drives excitement and focuses on the nutrition-seeking consumer.
And finally, we continue to expand in Occasions, introducing mini snax. We know cereal is consumed during a variety of occasions, having discussed our recent cereal-for-dinner campaign and that growing occasion. Snacking is yet another moment where cereal hits the mark and these innovations drive right at it with our brands and unique food.
This is just the beginning. We have more innovation coming later this year that will tap into seasonal excitement and cultural relevance. It's worth noting that all of this was achieved while preparing for the spin throughout 2023, a good example of the focus and agility of the team.
Another example of agility to quickly activate end-to-end is on Slide 10, and that was the recent collab with the University of Michigan to celebrate the College Football National Championship. In just three days, we went from idea to product and at midnight, immediately following the Wolverine's victory in the game, we launched a Froot Loops National Championship box, which sold out in a matter of hours, and we had to produce even more. This is a chance for us to connect with our Michigan community. And importantly, we generated significant media value from the coverage, garnering close to 100 million impressions. In fact, you could see that Toucan Sam was invited to the championship parade in Ann Arbor and received a Victor's welcome from fans chanting his name alone the parade route. This is a great example of the power and cultural relevance of our brands.
Next, on Slide 11, we'll discuss how revenue growth management is strategically designed to deliver on our financial commitments. Our 2024 RGM activities are focused on three main areas: premiumization, which we discussed previously, promo effectiveness and price pack architecture or PPA. Promotional effectiveness is about designing and executing our promotional activities to drive better returns. The integration of our teams across marketing, sales and supply chain gives us increased visibility, which allows us to more optimally design and plan.
Through our dedicated sales force, we can also execute those promotions better and our single category focus means we could drive better merchandising and amplify promotions in-store.
Finally, PPA. We have launched new standardized pack sizes across multiple brands to address both customer and consumer preferences, ensuring we have the right pack at the right price in the right place. This also drives more standardization in our business, which creates efficiency within our supply chain and allow customers to offer the type of unique value their consumers are looking for. This was a huge undertaking and the team is successfully executing this transition. In summary, we're moving fast to drive our financial performance through innovation, improving promotional effectiveness and an RGM plan designed to create value.
Now turning to Slide 12, let's discuss how we're advancing our priority of modernizing our supply chain and how we're improving plant economics through new ways of working. During the Q3 earnings call, we told you we're already working with key stakeholders in certain locations to improve plant productivity and economics. In Q4, we were excited to announce that in partnership with our Battle Creek plant employees and their union, the City of Battle Creek and the State of Michigan we unlock the solution where our business, our people and our community win. We are now working collaboratively with our people to begin implementing high-performing work systems, the operating model utilized in our most efficient plants. As a reminder, high-performing work systems resulted in more agile, capable and engaged workforce, a disciplined approach to problem solving and consistent governance, all of which drives improved performance. We all know this model works as we see it every day where it's already implemented effectively.
Also important, the city and state provided meaningful financial support to help offset the cost of the investment in our Battle Creek plant. This is a good example of the way we're going to work with our people and our communities to drive business forward and improve productivity, efficiency and engagement.
Another step in modernizing our supply chain is to improve the ongoing efficiency and effectiveness of the network. On Slide 13, you can see our customer service levels and the trajectory of our improvement, a key step in strengthening trust with customers. Customer service is about discipline, focus and execution. That is a key to our success, and you could see the impact the WK team is making already. In Q4, we achieved our highest level of customer service since March of 2020 and we even saw a meaningful improvement versus Q3 2023. We've been able to reach these levels by improving plant reliability and efficiency.
Overall Equipment Effectiveness, or OEE, improved in Q4 across our plants, leading to a more reliable product supply. It's early days and we're just getting started. These are the type of benefits we expect to drive into the future as we modernize our supply chain.
Finally, on Slide 14, let's see how it all comes together. We speak about how we'll focus, integrate and invest. We're a focused company. Everything is in service of cereal. That focus resulted in the right strategy and we have the right team with the right capabilities and resources to execute our plan. We are an integrated company, driving greater visibility across the enterprise which allows us to make quicker decisions and rapidly bring ideas to life. And that focus and integration informs how we invest in our infrastructure, capabilities and most importantly, our people. When you bring all of this together, our performance improves. We drive better business outcomes, and we gain momentum.
Now I'll hand the call over to Dave to take you through our financial results and outlook.
Thank you, Gary. Today, I will focus my comments on our fourth quarter financial results and the related drivers. My commentary will be on a stand-alone adjusted basis, as we believe that provides the best representation of our business going forward. Further detail of these measures and reconciliations have been provided in today's press release and the appendix of this presentation.
To begin, I'm pleased with how we executed our plan and delivered results ahead of expectations. Since relaunching the business in the second half of 2022, we've reshaped the timing of our brand investments. Those investments were diligently planned week by week, and we saw the benefits through improved ROI throughout 2023.
Now looking at our results on Slide 16, you will see that net sales for the fourth quarter were $651 million, a 2.7% decline versus the prior year period. This performance reflects positive price of 7.5%, offset by volume declines of 10.1% related to, among other things, rising price elasticities due to the timing of our price increases. We spoke about this dynamic on our third quarter call and said at the time that we expect it to continue into Q4 and early Q1.
From a brand's perspective, Rice Krispies and Corn Flakes benefit from seasonal recipe execution and our Canadian business continued its strong performance in the quarter behind brands like Frosted Flakes and Vector. For the full year, we delivered net sales of $2.74 billion, which was at the high end of our guidance, a 2.8% increase versus the prior year, which lagged our end market growth of greater than 6% due to the impact of lapping a retailer inventory rebuild in the front half of 2022.
EBITDA for the fourth quarter was $53 million, a 43.2% increase versus the prior year quarter driven by the benefit of price/mix, improved productivity and optimize commercial investment. Our significant EBITDA growth is a result of our improved supply chain execution and focus on operational discipline that Gary outlined. Full year EBITDA of $258 million is a 50% increase versus the prior year and reflects the benefit of lapping the fire and strike in the first half and positive price/mix. Again, our increased focus and improved execution allowed us to deliver EBITDA ahead of our guidance and creates a strong foundation to build from in 2024.
Turning to Slide 17. I will now focus on our operational highlights. Gross margin for the fourth quarter was 29.2%, a 300 basis point improvement versus the prior year. This improvement was a result of our balanced commercial approach and operational efficiencies within our supply chain. For the full year, gross margin improved 410 basis points to 28.9%. This improvement was primarily driven by positive price/mix and further recovery from fire and strike. As a reminder, our full year gross margin also benefited from a onetime insurance recoupment of $16 million in Q2 of 2023, which was worth 60 basis points of gross margin for the year.
EBITDA margin in Q4 was 8.2%, a 270 basis point improvement versus the prior year period, driven by the flow-through of gross margin improvements and the rephasing of our brand-building investments to quarters with higher levels of ROI earlier in the year and the impact of incentive compensation. For the full year, we delivered EBITDA margin above the high end of our guidance range at 9.4%, a 290 basis point improvement. This improvement reflects the drivers I mentioned earlier in gross margin and EBITDA. Looking forward, we expect gross margin to continue to be the primary driver of our EBITDA improvement.
Looking at our below-the-line items, interest expense in Q4 was $10 million and other income was $9 million. Our adjusted effective tax rate for full year 2023 was 24.9%. For 2024, we expect our full year effective tax to be in the range of 24% to 25%.
Turning now to Slide 18. For the year, our business has performed as we expected, and we continue to show steady improvement. We showed this slide at the Q3 call and have updated to show our trailing 12-month performance through the end of Q4. We're pleased to see the continued trajectory improvement. Looking at this slide, you can see we are consistently delivering net sales in the $2.7 billion range. Our stable top line performance has been a catalyst for our margin improvement and has been enabled by our improving supply reliability.
Next, you'll see that since Q1, we've seen meaningful increase in gross margin. We've gained 210 basis points and in Q4, achieved the highest level of gross margin of the last 12 quarters. This improvement is primarily related to driving operational efficiencies within our supply chain and from positive price/mix from our revenue growth management initiatives.
Finally, looking at EBITDA margin, you can see that our gross margin improvement is largely flowing through and profitability has significantly improved, moving from 7.8% to 9.4%, 160-point increase. This is the type of improvement we expect as we finished 2023.
Next, I'll discuss our debt position on Slide 19. We ended the year with $499 million of debt and cash and equivalents of $89 million, resulting in net debt of $410 million. As we said on our Q3 call, at the completion of the spin, we drew $500 million on our term loan A and $164 million on our revolver to fund the dividend back to Kellanova. These debt levels were temporarily elevated as core working capital had not yet reached run rate levels at the time of the spin. Working capital largely normalized throughout Q4, and as a result, we exited Q4 at targeted debt levels and with zero balance on our revolving credit facility. We ended 2023 with a leverage ratio of 1.6x net debt to adjusted EBITDA and expect to end 2024 with leverage of approximately 1.8 to 2x adjusted EBITDA. Increased leverage in 2024 is due to onetime investments of approximately $80 million to stand up the company as we work towards TSA exit. This leverage ratio excludes the impact of investment to modernize our supply chain, which we'll provide an update on later this year.
In 2024, we'll continue to generate positive underlying cash flow. However, we expect our total cash -- free cash flow to be slightly negative due to the onetime investments in standing up the company. Similar to what I noted prior in the leverage discussion, this cash flow excludes the impact of investment in modernizing our supply chain.
Turning now to our outlook on Slide 20. Based on the momentum in our business and confidence we have in our plan, we are providing EBITDA guidance ahead of the outlook we provided at Q3. We expect 2024 full year net sales growth to be in the range of negative 1% to positive 1%. Due to our revenue growth management initiatives, we expect full year price to be positive low single digits and volume to decline low single digits. For 2024, EBITDA, we expect growth in the range of 3% to 5%, which reflects EBITDA dollar delivery of between $265 million and $270 million. This is an increase versus the $255 million to $265 million range we provided at Investor Day and reaffirmed on our Q3 call.
Importantly, this EBITDA growth includes the lapping of the benefit of the onetime insurance recoupment in Q2 of 2023 of $16 million. For the full year 2024, we expect total interest expense of approximately $40 million and other income to be approximately $25 million. Other income includes a benefit of pension income of $45 million, which is a noncash item. Similar to our leverage outlook, I covered on the previous slide, this interest expense excludes any impact of increased debt to fund our supply chain modernization.
And now, I will hand it back over to Gary to close out the call.
Thank you, Dave. As we said on the top of the call and what we hope you heard today is that we are fulfilling promises that we are focused on execution and that our engagement is driving impact. 2023 was a transformational year for W.K. as we stood up an independent company and delivered strong performance aligned to our strategic priorities and our expectations. I would like to thank our team of more than 3,000 colleagues for their efforts and contributions to a successful year. In 2024, you can expect more of the same as we focus on delivering our financial model, bringing even more excitement to the cereal category and executing like a soon-to-be 118-year-old start-up. I'll now open the call to Q&A.
[Operator Instructions] Our first question for today comes from Andrew Lazar of Barclays.
So to start off, maybe, I was hoping you could talk a bit about what you're seeing in terms of the overall cereal category at this stage. One of your competitors, I think, recently said something to the effect that maybe towards the end of the quarter, the declines in the cereal category had, maybe, started to moderate a bit. I'm wondering if you're seeing sort of something similar. And if so, if you think it's attributable to maybe some one-off factors, weather, et cetera, or maybe the start of something a little more sustainable?
It's a great question. Thanks for asking that, Andrew. So when we think about the category, we -- what we're seeing in the category is, it's quite stable right now. The category has a lot of tailwinds to it. And when overall, when you zoom out, when you look at it over a quarter, over the last year, even as we enter 2024, we're seeing a good stability across the category. And we're one of the beneficiaries of that.
So -- and we think there's a variety of reasons. You talked about whether you talked about other things where we go to on the top of that would be the consumers under pressure. This category is quite affordable. We talked in our prepared remarks, Andrew, about how a bowl of cereal with milk and fruit is under $1, you could see people trading into consumers trading into our category so we do think there's a lot of tailwinds for the category, but we're actually quite pleased with the way the category is performing.
And then maybe I was hoping you can provide just a bit more color on how you see the shape of the year playing out on the top line. I think on the 3Q call and then today as well, you stated you expected maybe still some volume pressure in the first part of the year, partly given some of the timing of your pricing actions versus others. So I was hoping you could get into a little bit more detail on kind of you see the first part of the year playing out in terms of that price/mix versus volume combination.
Yes, Andrew, I think that's quite fair. And that was what we talked about in Q3, so I appreciate you raising that. The first thing I think we would say is, and because you mentioned Q3, I'll mention it here. The business is performing as we expected. We forecasted the business. It's playing out as we thought. I give the team a lot of credit for the way they're forecasting. And you're exactly right. We had talked about what the balance of the year would look like. Now we're careful, we don't give quarterly guidance. But you're exactly right. We talked about the impact on our business of lapping pricing. Our last major pricing action of last year happened in March so we're going to be experiencing that and managing through that as the year began. So I think you're right about the pressure that you just mentioned.
The other thing that's worth mentioning is in Q2 that we had a onetime benefit from the insurance payment last year of $16 million. So that's also something that we'll be lapping when we get to Q2. But overall, we feel good about what the shape of the year looks like. And one thing that we did mention that's worth mentioning here about volume was in Q3, we talked about the narrowing of the gap between dollars and volume. We saw that happen between Q3 and Q4. If you look in the public data for P1 for January, it's happening even more and you add to that a stable category, we actually think that's quite good for the category, good for our business and good for our people.
Our next question comes from David Palmer of Evercore ISI.
Congratulations on the improving profitability. I guess my question is on reinvestment this year. You talked about a couple of things, your efforts to improve service levels and supply chain. In the past, you've talked about efforts in merchandising and perhaps that would require some in-store trade and you talked about a couple of brand launches and then, of course, there's advertising. Could you just talk about where the best dollars spent will be for Kellogg this year and longer term and where you are reinvesting some of this profitability to get the flywheel going?
David, I appreciate the commentary, and we are very proud of the results. This is our first quarter as a stand-alone company. So on behalf of the entire team, we appreciate the congratulations you just provided. And when we think about where we're investing, we're investing across the enterprise. As a new company as we're standing up, there's a couple of different areas that we're going to focus on, and our P&L and our budget were fully loaded to do so. So you would start with supply chain. You're already starting to see the benefits in our performance in our P&L. You heard us talk about what's happening with K's sale, with OEE. That is the very beginning of the impact that our team is making. Sherry Brice is our Head of Supply Chain, the work that she and her team are doing across the network is already starting to pay dividends. We'll continue to invest there as part of our program to modernize our supply chain, and that's investing capital as well as building capability.
You add to that what we're doing on the commercial side. What we like to talk about is when we're talking about in-market pressure, it's about returns, it's about ROI. How do we make sure that we're in market that we're balancing profitability as well as volume? We'll continue to do that. And as the year moves forward, we're constantly looking for other places to invest. And when we find areas to invest, they get a great return, we will certainly do that. But, David, our budget is fully loaded. We have the investment dollars that we need to drive this business going forward and into 2024.
And just a quick follow-up on that. Just if we're tracking these data, as you know, we look at scanner data, and everyone looks at scanner data closely in recent four weeks would be down a couple of percent. Your guidance is a little bit better than that. Is there a road map or timing that you think you're going to see more improvement and what metrics would you have us focusing on?
Yes, David, we look at those metrics, too. So we appreciate the question. I'm really glad you asked it because it lets me reinforce the unique circumstances that we are working through. We talk about two different things that we were lapping in Q4, and that was the relaunch of the business, the previous year as well as the lapping of pricing. You might recall that we took pricing, we took it later than a lot of the other manufacturers in our category. That's because we were still recovering from the fire and the strike. Our last substantial price increase was in March of 2023 so the beginning of the year, we're still working our way through that. You see it in price realization in the data so that's what's happening early on. Again, we feel very good about our overall guidance and the shape of the year, but that's a unique situation that's happening right now.
Our next question comes from Max Gumport of BNP Paribas.
I was hoping you could provide a bit more color on the drivers of the better-than-expected gross margin expansion in 4Q. I think I heard you mentioned a balanced commercial approach and operational efficiencies. And then how this informs your outlook for '24 and gross margin?
So I think if you look back at 2023, and we had the slide that really showed the progression throughout the year. And we talked about the front half of the year really benefiting from the lapping of the relaunch of the business. We talked about the price realization that played through to gross margin and the benefit of that price/mix. The other thing Gary talked about as we move to the latter part of the year, that focus on operational discipline, and Gary mentioned the metric OEE, we're really focused on making sure that we're running our plants efficiently, effectively, making sure that we're maximizing output, getting the right food and all those things are really playing through just that focus has really helped in the back part of the year.
And yes, we did talk about the optimization of our promotional plan in the market, really balancing our returns against profitability and volume. We talked about that dynamic on the Q3 call, and we continue to do that through Q4. So those are really the big drivers as we move through 2023. And as we think forward to 2024, that's where our focus is. It's continuing to drive that ROI. It's continuing to drive that discipline throughout not just our plants, but the totality of our supply chain. And again, as Gary mentioned, we're planning on making sequential improvements in gross margin into 2024 despite that onetime lapping impact of the insurance recoupment. So we're pleased with our performance here as we finished out the year and as I mentioned in the prepared remarks, how that sets us up for 2024.
And on that as well, I saw the case fill improvement that you're making progress on. That was nice to see, but you are still well below historical levels and the broader packaged food industry seems to be catching up to, I'd say, more normal levels already. So I'd imagine that there's more improvement you can make on this metric in '24, and that could open up some opportunities on gross margin and the broader supply chain. Can you just talk more about what that might open up for '24, maybe even '25?
So you're right. We're not yet to our goal. We had that outlined on the slide in the prepared remarks. We are happy with the improvements we made, and we've made them in a relatively short amount of time here. But as we head into 2024, we're aware that there's opportunity. And again, that operational discipline. It's not just on the cost side, but it's making sure that we're having and producing the right product and making sure that we're filling orders and servicing our customers at a level that they expect and frankly, that we expect.
Our next question comes from Pamela Kaufman of Morgan Stanley.
I just wanted to dig into your outlook for price/mix to be up low single digits in 2024. And how you're thinking about the balance between price realization with increasing promotional activity. To what extent does the low single-digit pricing growth reflects the carryover benefit of pricing from last year? And can you elaborate on the RGM initiatives that would contribute to your price realization in '24?
So I think Gary mentioned that we'll lap our last list price increase at the beginning of March. So there is that impact in there, at least for a couple of months of the year of the list price lapping Gary did talk then further about our other RGM initiatives that we're focused on in 2024. Those being promo optimization, I'll start there, and that's something that's really a continuation from 2023, and that's the focus on ROI making sure that we're getting maximum dollars for every dollar that we're putting into the marketplace. The second is our price pack architecture initiative, again, really focused on getting the right product, the right sizes and the right customers for our consumers to enjoy all of our foods.
And then the last one, Gary mentioned is the premiumization. We're excited about our two new innovation launches that Gary mentioned, MOUTH OFF and EXTRA and those just mechanically through that premium offering drive price realization through the P&L. So those are the factors and I highlighted what we expect kind of the shape. Is that, yes, volumes will decline low single digits, and then we'll realize price from there to get back within our guidance range.
And just on the competitive dynamics in the category, can you talk about what you're observing? And do you anticipate gaining market share in cereal this year?
When we think about what's happening in the competitive set in the category. So if you zoom out, when we think about the pressure in the market right now, we think about promotion and investment in the key category. So Dave talked about our approach, which is we focus on returns, we focus on balancing, volume as well as profitability. And this has been going on in the cereal category for years. It is worth noting, it's good for the category. Well-designed promotions really drive category performance. And in fact, it has some of the best lifts in retail when it's done well. And when we take a look at the data, Pam, we're not seeing anything particularly unusual. We sort of go back in time and see compared to previous periods. And there's nothing unusual in there. And in terms of growing market share, we've talked about winning in the market and winning as a company. And what makes our model work is a stable top line so our profit expansion can rattle through the P&L. We also think part of that is winning market share over time. And that is certainly one of our many goals.
Our next question comes from Peter Galbo of Bank of America.
Dave, maybe just two really quick cleanup ones and then Gary, a broader one. Dave, if you strip out the -- I think you said it was 60 basis points of benefit from insurance to the base gross margin for '23. Just as a building block, what's your base inflation that you're baking in for 2024 on the COGS line? And then also if you had a CapEx number you could help us with on the free capital side.
Yes. Thanks, Peter. So a couple of things that I'd start with. On the -- sorry, your first question was on inflation so let's start there. On the inflation side of things, I think, generally speaking, we've seen what I would call more of a stable environment at these elevated price levels. So if you look at aggregate, we're not seeing a significant amount of deflation in 2023 or in our outlook in 2024. If you go into specific areas of our cost structure or our basket of goods, if you will. There's a couple of areas we're seeing the deflation. You guys can see it, namely corn, wheat, but there's a couple of others that had been what I would call resiliently high and have actually worked the other way. Those being sugar and rice is a couple of examples. And we saw some of the CPI data even as recently this morning where we're continuing to see inflation in the marketplace, be relatively sticky is a word I would say. But again, I'd characterize it for us more of a stabilization at these higher levels.
If we then think about our capital plan for next year, we're targeting the 2.5% of net sales as a base CapEx. As you think about that $80 million that I overviewed to stand up, there will be some CapEx in that $80 million. So it will be split between onetime cost and CapEx, probably a little bit heavier on CapEx in that $80 million.
So those are the two pieces. To be clear, Peter, we have about a 2.5% of net sales base capital plan. And then that $80 million will be split between CapEx and onetime cost, but a little bit heavier on CapEx.
And then Gary, just one thing that's come up in a bunch of other calls this earning season, particularly around the volume discussion has been a shift back to more away-from-home occasions. And while that has with a negative impact on the volume or on the tonnage side, it's having a positive impact on mix, like single-serve items, that sort of thing. Just curious, like, are you observing that at all? It's been something we've seen across other categories. So I would just love your perspective on that.
Yes. What you're getting at is occasions for us. And when we think about our business, we think you have it exactly right. We think there's an opportunity for us. When you think away from home, you think single-serve. When we think about cereal, we clearly are the #1 choice for breakfast. We've talked about cereal for dinner, but we also believe there's real opportunity in snacking. So that we do believe is a tailwind for us. You saw in the innovation comments that we had that we're leaning into that right now. So is it a trend? I don't know, but we think it's a real opportunity for us one way or another, and we're going to be getting after it.
Our next question comes from Matt Smith of Stifel.
I had a follow-up question on the CapEx outlook for the business. You've stripped out the additional capital spend associated with supply chain modernization in the guidance that you've given us. And from a high level, given the faster progress against EBITDA and some of the underlying operational efficiencies you're seeing, does that affect your outlook for the $400 million to $500 million of investment for that supply chain modernization over time to unlock the margin expansion? Is there an opportunity for that to move lower? Any comments you can make there would be appreciated.
No, I'd say that everything that we've said to date on our supply chain modernization program still holds. So we haven't changed any of the direction there. I would say, and as I said in the prepared remarks, we'll come back later this year with further detail and be precise more on timing and all those elements. But so far, what we've said, the date still holds.
As a follow-up to your commentary around the investments you're making to stand up a stand-alone company, is there any phasing to the coming off of TSAs between you and Kellanova that we need to be aware of? Do you still plan to be on a significant amount of TSA support exiting '24? Or do you expect to lower your exposure there pretty meaningfully this year?
Yes. In how I would characterize as a phased exit. So we'll [indiscernible] exiting elements to the TSA in 2024, and some will be totally off of in 2024 as we move into the back half of the year. Other ones will be in through 2025. So it's not a clean hey, here is the end of it, but rather a phased exit really over the next, call it, 18-ish months from here.
Our next question comes from Robert Moskow of TD Cowen.
With all the discussion about revenue growth management, and mix improvement through premiumization, I could -- it's not just you, it's also your competitors to using that strategy. Is it likely that this will lead to kind of like a low single-digit volume decline for the category for the next few years? And maybe that's okay because it's mix positive and it's margin positive. Is that a scenario that you have thought through as you go through your supply chain revitalization planning? And is it fair to say that's contemplated as a possibility in your margin targets as you go forward?
It's a fair question, Robert. The way we look at it is, look, we talked about price realization, you identified the different ways we're going about it. And there are just certain outcomes that come from those activities. There's outcomes that come from a bunch of other activities we have as well. But yes, we have taken into consideration that impact would be, how that impacts our supply chain, how that impacts our business, it's all baked into our overall plan. So yes, we certainly did consider that as we plan the business going forward.
[Operator Instructions] Our next question comes from Robert Dickerson of Jefferies.
Look, just given there have been a lot of questions around more singular category, fairly comprehensive. I just wanted to touch quickly on some of the below-the-line items on guidance. Like I realize kind of what the net debt level is year-end '23, but clearly, right, there were incremental capital raise needs for the supply chain improvements that you've been speaking about since the Investor Day. So maybe if you could just provide any color as to what potentially those needs could be at least in '24? And then also, I guess, kind of using some rational interest rate assumption, what could that be incrementally relative to the guide on interest?
Rob, we're not going to give at this time any further direction on the supply chain modernization beyond what we've given. As I said in the prepared remarks, we'll come back later this year with what that will mean for 2024 and what that will mean beyond and the absolutes and everything else. So we'll come back with that later this year.
All right. And then I guess just D&A. D&A was lower than even speaking about or speaking to, maybe just kind of why the change is that just kind of push forward and some of the timing?
Yes, exactly, Rob. I think your characteristic there is correct. So if you think about Q4 of 2023, we had about $17 million of D&A. We had in our press release this morning, $75 million to $85 million for next year for the full year. And really, the driver of that is back to that $80 million. And I mentioned the majority of that are the over half of it will be on CapEx on the $80 million as we stand up, that will move into the depreciation line. And that's what leads to that, I'd call it, a slight increase year-on-year from current run rates.
Thank you. At this time, we currently have no further questions. So I'll hand back to CEO, Gary Pilnick, for any further remarks.
We'd like to thank all of you for joining our call today. This being the very first call of our very first quarter that we had as an independent company. I hope you can hear the confidence we have in our business. We look forward to sharing our Q1 results with you in May. Thank you very much for joining us.
Thank you for joining today's call. You may now disconnect your lines.