KHC
#Good day.
My name is Karen, and I will be your operator today.
At this time, I would like to welcome everyone to the Kraft Heinz Company's First Quarter 2017 Earnings Conference Call.
I will now turn the call over to Chris <UNK>, Head of Global Investor Relations.
Mr.
<UNK>, you may begin.
Hello, everyone, and thanks for joining our business update for the first quarter of 2017.
With me today are <UNK> <UNK>, our CEO; <UNK> <UNK>, our CFO; and George Zoghbi, the Chief Operating Officer of our U.S. Commercial business.
During our remarks, we'll make some forward-looking statements that are based on how we see things today.
Actual results may differ due to risks and uncertainties, and these are discussed in our press release and our filings with the SEC.
We'll also discuss some non-GAAP financial measures during the call today.
These non-GAAP financial measures should not be considered a replacement for, and should be read together with, GAAP results.
And you can find the GAAP to non-GAAP reconciliations within our earnings release and at the back of the slide presentation available on our website.
Now let's turn to Slide 2, and I'll hand it over to <UNK>.
Thank you, Chris, and good afternoon, everyone.
From an overall perspective, I will start by repeating what I said in today's press release.
While our top line results reflect a slow start to the year, we remain on track with the key initiatives that can drive another year of sustainable organic growth for The Kraft Heinz Company.
There is no doubt that the U.S. consumption was softer than expected.
As you know, the shift in merchandising window, such as Easter, was expected.
However, other largely calendar-related factors caused the overall consumer takeaway to be weaker than anticipated.
George will discuss this in more detail.
In addition, results in Canada also held back organic growth in Q1.
This was driven by go-to-market agreements with key retailers being made much later this year than in past years.
And this was largely due to our choice to not sign into significant price-oriented requests that have come about in the Canadian retail market.
As a result, we lost frequency and depth of promotion activity during the quarter.
We also choose to delay several innovation launches from March to April.
In the end, however, we are confident that the sacrifice we made in sales will lead to a resumption of profitable growth for both Kraft Heinz and for our retailer partners.
Another area that makes me confident for organic growth in the year to go is the solid returns we're seeing from our Big Bets that are already in the marketplace and the fact that the rest of our 2017 pipeline is on track.
I'm not going to get into the specific initiatives that have not hit the market yet, but what we saw in Q1 was a very healthy contribution from both Year 2 Big Bets and the new-to-the-world initiatives.
This included accelerated consumption in Mac & Cheese and frozen meals from products like Cracker Barrel Mac & Cheese and Devour Frozen Meals that you have seen in the United States; further gains from Heinz Serious (sic) [Seriously] Good Mayonnaise across Europe, Brazil and Australia; the growth of Planters in China; the launch of Heinz Serious (sic) Seriously Good Sauces and no salt, no sugar added Heinz Beanz in the U.K., just to name a few.
Importantly, the investments being made are driving the solid organic growth trends we are now seeing in both Europe and the Rest of the World markets.
In short, our strategy of prioritizing fewer, bigger and bolder bets is paying off.
Underpinning all of this, we remain on track with our cost savings initiatives, and the pace of savings is coming in very much as expected so far this year.
Commodity savings from our integration program are approximately $1.3 billion.
And we continue to generate savings from ZBB and supply chain initiatives in all our zones outside of North America.
Lastly, but just as important, in March, we strengthened our vision for growing a better world by unveiling new goals for sustainable sourcing and animal welfare.
This includes a commitment to reduce greenhouse gas emissions, energy, water and waste across our manufacturing network by 15% over the next 5 years.
We also committed to purchase 100% palm oil in derivatives from suppliers certified by the Roundtable on Sustainable Palm Oil.
And we implemented a 0 tolerance policy among suppliers for willful acts of animal abuse or neglect.
Finally, our commitment to fighting global hunger is even more aggressive, and I'm proud to say that by the year 2021, Kraft Heinz will donate 1 billion meals to families in need.
That's the broad overview of where we stand after the first quarter of 2017.
Overall, a soft start to the year financially but on track for another year of profitable organic growth.
So let's turn to Slide 3 to review the details of our Q1 financial results.
As it relates to total company sales, there are 2 things to highlight.
First, we have solid price realization in our Rest of the World market, particularly in Latin America, to offset higher local input costs as well as in the United States.
These gains were partially offset by promotional timing, primarily in Canada and Europe.
Second, for the reasons I noted early, we saw volume/mix declines in North America, and these more than offset the solid and encouraging gains in the Rest of the World and Europe markets from condiments and sauces as well as the Big Bets highlighted.
At EBITDA, quite simple, our first quarter results were held back by a combination of the volume/mix declines in North America and the business investments to support our growth agenda in the Rest of the World market.
And these more than offset the benefit of ongoing cost savings initiatives in North America and Europe.
That said, we expect this to improve in the second half of the year.
At adjusted EPS, however, we continue to see strong growth, mainly driven by the refinancing of the preferred stock.
Going forward, we expect a combination of profitable top line growth and EBITDA to again become the main drivers of the EPS growth for the full year.
Now I will hand it over to George and <UNK> to highlight our performance in each reporting segment and what we expect in each area going forward.
George.
Thank you, <UNK>, and good afternoon, everyone.
Let's turn to Slide 4 and our performance in the United States.
There is no questioning the slow start to 2017 with greater-than-expected declines in January and February both for Kraft Heinz and the food industry in general.
However, we saw marked improvement as the quarter progressed, and we feel good about the early read of Easter trading and the balance of the year, especially the second half.
Let's start with the 2 areas that represented headwinds to us in Q1 versus prior year.
The first includes several calendar changes versus the prior year.
As we highlighted on our Q4 call, we faced a shift in our merchandising windows versus last year, driven by Easter timing and the impact on measured channel consumption as well as our market share, where we typically over-index during that period.
We also experienced 1 less day in the quarter due to comparisons with leap year in 2016 as well as a delay in tax returns from February last year to March this year.
That impacted families that claimed child tax credits.
Importantly, these families are a big, core component of the Kraft Heinz consumer base.
Together, these changes in the calendar versus last year drove more than half of the 3.6% decline in measured channels category growth and market share you can see in the chart on the right.
The second factor is distribution losses of certain less profitable products and measured channels, primarily club, that affected our consumption numbers in certain cheese and meat categories.
Beyond that, the combination of our nonmeasured channel performance and other trade-related impacts essentially offset one another.
On our last call, I also mentioned that we exited the year with some of our Q4 shipments needing to be worked off in January.
While this did, in fact, occur, it was partially offset by some shipments related to retailer demand for early Easter builds in certain categories like cream cheese.
Going forward, however, I do feel good about our chances of driving sequential improvement in organic growth from Q1 to Q2, and more importantly, from Q2 through the second half of the year.
As a start, we've already seen more favorable consumption trends in both March and April.
Also, our Big Bets that are now in the market are driving consumption gains, including double-digit growth in frozen entr\u0102\u0160es after years of decline behind the successful introductions of Devour and SMARTMADE brands.
We also had strong growth in our Mac & Cheese portfolio from renovation and innovation last year as well as ongoing innovation-lead growth in Lunchables.
And we have more to come, including new ways to enjoy Philly with the launch of Philadelphia Cheesecake Cups, along with bagel chips and cream cheese dips, which have had strong initial consumer response; the launch of Capri Sun Sport and Cracker Barrel Oven Baked Mac & Cheese; as well as the renovation of our Oscar Mayer hotdog line with simpler ingredients, no nitrites or nitrates, no artificial preservatives, no by-product and no change in the price.
Importantly, as we begin to complete key modernization projects within our footprint activity and remove a self-imposed restriction on introducing new products in our meat business, we will start to increase both innovation and renovation activities to improve our performance in challenged categories, particularly at the back half of the year.
And beginning in Q2, you're going to start to see us better leverage Kraft Heinz scale at retail.
This will come in the form of increased in-store activity with several scale events in Q2, including Easter, Memorial Day and Feed your Family, Feed the World scale event we launched just last week as part of our fight to end the global hunger that <UNK> mentioned earlier.
With that, I'll turn it over to <UNK>.
Ken, this is <UNK>.
Sorry, I don't remember we mentioning it during the call, but in terms of the gross margin, which is pretty much flat year-over-year, it's kind of encouraging to us given the commodity headwind that we had this quarter comparing to the prior year's quarter, first quarter, and also the geographic mix that we have this year with the decline of the higher-margin business in North America.
<UNK>, here's <UNK>.
Thanks for the question.
Look, I think like you said, we need to separate what's perception and what are facts, right.
And so if you think about our culture and what it's all about, it's actually quite simple and very consistent over decades.
It's all about ownership, meritocracy, high performance, [growth programs] and dreaming big.
It's all about those 5 things.
And I truly believe those 5 things are applicable in many companies, in many segments and so on.
So to this culture we have, and so I don't think it will be more difficult or easier to do any other transaction.
About the perception, and again, I think you pointed well, we ---+ it's a little different story, right.
Because when people think about cost-cutting and so on, we're much more in line to get efficient, to fuel and invest behind profitable growth.
That's what we're going to do, right.
Our selling expansion is going up.
Our working dollar is going up.
Exactly, our go-to-market capability is going up because those are things we believe, for the long run, can build profitable growth like we're here for.
So in that sense, you may be right, there is a perception problem or not.
That's not for us to judge.
I can say that the values we have, those 5 things I just mentioned, we truly believe can be applicable in many companies and many segments.
Rob, it's <UNK>.
In respect to Canada, I think it's a very hard question given our weak performance in the quarter, right.
Yes, we are satisfied with the agreements we reached.
We reached 5 agreements with our top clients.
That's about 80% of our sales in the beginning of March.
And so ---+ and the fact that took us a little longer to achieve those agreements will affect especially the inventory and activities we had in January and February that's reflected in the results we are all seeing, right.
Given what we're seeing now in April and May, we're already seeing the level of events and inventory coming back to normal and the planning, looking at second half, is a much stronger one.
So we truly believe you're going to see sequentially better results as we move in the country.
Before moving to the U.S., I think it's important to say that we didn't believe at that time in January we had agreements with what was a win-win situation with our partners, the retailers ---+ discussions about ---+ between consumption and shipment, the levels of profitability and price points in the market.
All of these make us pause and say, hey, it's better to delay a little bit the agreements but get the right spot to have a win-win situation, what we believe we have moving forward.
Again, what's not ---+ without paying like we're seeing the results, I just described it.
But we're confident that the performance will be improving from now on.
George, can you take the U.S., please.
<UNK>, yes.
Look, I strongly disagree with this statement.
And if you see it, actually, our model has been working for many, many, many years, decades and so.
And if you look at the facts and data, you're going to see we're growing organic rates pretty much in line with average with our peers, but with ---+ the profitability level we have today allows us to invest strongly behind our brands and product quality.
So with that in mind, our strategy really continues to be focusing on creating profitable growth within the company through really 4 things: first, Big Bet innovation, doing bolder and stronger product development; second, achieving a higher share of voice with more working media dollars behind our brands; third, investing behind our go-to-market capabilities, touching the shelves in a much more structured way; and fourth, achieving the operation efficiencies so we can support and invest behind growth.
Those are the 4 things we have been doing since the merger and the things we'll continue to build moving forward.
So I strongly disagree with this statement.
Sure.
If I think about ---+ just let me step back to give more color on the main impacts we had in the quarter.
So pretty much our North America EBITDA declined around $40 million, $45 million.
The main impact we had was driven by volume/mix.
And this impact offset the savings initiatives on the $100 million that we have, additional savings and the pricing we got in the quarter.
So pretty much we had the commodity headwinds we faced this quarter being really responsible of the size of EBITDA that declined.
Prior year, in the same quarter, we had a much bigger favorability in that, almost twice the size if you go back to Q1 '16.
A question on cash flow.
Your cash balance ended a lot lower than we thought this quarter.
It looks like a lot of working capital leakage.
Is this timing-oriented.
What exactly drove that.
No ---+ yes.
So you're right, the majority of the cash declines we had was pretty much driven by typical seasonal working capital.
Q1 is a quarter that, I think, normally lose a lot of working capital.
There's a singularity on that.
And on top of that, we had inventory increase to prepare because we're preparing to all the footprint activities we are going to execute during the year.
So the majority of this is just timing, and we expect recovering in the following quarters.
Okay, good to hear.
And then turning your attention outside of the U.S. Can you give us a sense of the magnitude of reinvestment in the Rest of the World.
Because, jeez, the EBITDA decline on ---+ prior year EBITDA declines for Rest of World and your combined, from a headline perspective, is discouraging to see.
I think when I see that ---+ just to restart, we are still seeing that.
And we said that before, that we would have ---+ had investments in the Rest of the World business.
The growth is coming, and we expect the growth even to ramp up going forward.
And I think to better answer the question, we are still seeing the margin there at around 20% being representative for the margin that we're going to see in this unit going forward.
And <UNK>, just to add, on the commercial side, like we said before, a lot of the growth are coming, really, from 2 venues, right.
One is whitespace.
And so penetrating new category that we established ourselves like cheese in the Middle East, cheese in Russia, Kraft sauces in Europe, Australia and New Zealand; the nuts business in China and U.K.; Mac & Cheese in Latin America and U.K. So you have the core.
And not only the whitespace, you have also the core that's pretty much the beans, soup in New Zealand and Australia and condiments and sauces almost everywhere.
It's still growing strongly on the Rest of the World.
So we will continue to see us investing behind and supporting this growth.
So looking at that, it's very in line what we have been saying we'll be doing in ---+ for the rest of the year.
Yes.
Chris, that's very much in line with what you said about the start plan to create the 3 global brands and platforms, right, behind Kraft, Heinz and Planters.
It's still early stage, but I think the most part of the countries we wanted to penetrate on '17, we already create the supply chain.
And that's exactly the whitespace I was talking about early on when we talked about we're growing or we're starting to penetrate on cheese, we're starting to grow on nuts, U.K., China and now going to continue to Continental Europe, Mac & Cheese in Brazil and U.K. and so on.
So those brands are growing in line with our expectations for the year, and we're starting to accelerate as much as we can.
That being said, given the size of the business and so on, the magnitude they have is still not significant to, for example, offset our performance we had in the United States and Canada.
<UNK>, this is <UNK>.
So to think about the way that we think about our M&A framework, which it hasn't changed since the beginning, and the framework is pretty much that we want to own brands that we will have all these brands for the long run, brands with strong equity, strong relative market share, brands that can travel.
But we also analyze a lot how the business operates, the go-to-market of the business and more important than that, how the business operates better ---+ how they would operate better, how they will grow fast being together, okay.
And of course, during this analysis, we take everything into consideration, including all the synergies that we have, all the options that we have in terms of getting a better performance.
And again, everything that you said is always to improve our portfolio, right, when we have this type of framework.
And more important and also very important, that we're always going to be very, very disciplined on price.
<UNK>, so it's <UNK> again.
So we when we enter the second year of the integration, it's much better to track for cumulative savings than trying to track a run rate given the structure of our savings that is net of inflation and net of investment.
So we ended prior year at $1.2 billion cumulative savings.
We are ending this first quarter at $1.3 billion level, and we said that we're still in the path to get to $1.7 billion.
So out of the $500 million that we expect to deliver this year, additional, we delivered $100 million in the first quarter.
And again, we still have $400 million to deliver going forward in the next 4 ---+ 3 quarters.
And again, you're right that we said that we expect additional savings ---+ the majority of the savings to be in the second half.
Jon, the answer to your first question is, quite frankly, no.
There were places we wanted to increase cost that will sell in the market and we did.
Sometimes we go after the sales on the things that have been working.
And George talked about like the renovation, the Mac & Cheese, the hotdog campaign we're starting now in the United States, the Philadelphia Cheesecake, the Heinz Serious (sic) [Seriously] Good in Europe, the Heinz Serious (sic) seriously Good Mayonnaise in Brazil and Australia, Planters in China, Planters in Russia.
If we should not have grown even more, that's something we ask.
But that being said, there was absolutely no efficiencies or something that took over the capacity of the company to generate the things I said before: To focus on Big Bets, to focus on go-to-market capability, to grow our share of voice behind our brands and so.
So it's a no.
On the second part of your question about why we believe we can accelerate the growth on the Rest of the World, because we're still underpenetrated in most parts of those markets, right, we see our size of the business in countries like China, Russia, Brazil, Eastern Europe, Middle East, Indonesia, even developed countries like Japan.
And so it is still ---+ we can be much bigger through our cohort categories that we already operate in whitespace that I mentioned.
So we are confident in our capacity through the global brands and the local [juries] we have to generate profitable growth.
<UNK>, this is <UNK>.
So on the first question, let me start from there.
So the first question was about the divestiture.
So according to the divestiture of the brand, today, we feel comfortable with the brands and the category that we operate.
We think we have scale and we operate well there.
Again, as soon as if we decide to divest any categories or any brand in any specific geography, we will communicate this properly to the market.
So related to the Unilever potential transaction, we really believe that, as I said in the M&A framework, it is kind of ---+ again, if you go back here in terms of only consumer brands, brands with a strong market share, brands that can travel, similar go-to-market, similar operation ---+ I think, at the end of the day, these 2 segments of the consumer product goods are very similar.
And that's the reason why we see also many companies operating brands for consumers, maybe sometimes food, sometimes personal care, sometimes health care.
