Kellanova Q2 2024 Earnings Call Transcript

We appreciate that Ken. The way we look at it is the business is largely performing as we thought it might. As we entered the year, we were beginning to see the challenging consumer environment that certainly accelerated in the front half but we were able to reaffirm our financial guidance for the year. And when you talk about going forward, you can already see our confidence in our ability to change the trajectory of our volume and sales by being able to reaffirm our guidance, and we said in the prepared remarks, we are going to see sequential improvement in the back half in both volume and sales.

So in the front half, 9 of our 11 biggest brands are performing with or better than the category. We're very pleased with those activations. We're looking for the right returns in this environment that's particularly important. But we think you start to see that in the back half, and that would be our view going forward as well, Ken.

And Ken, one small dynamic I'd add there is if you look at volume, one thing to keep in mind is, and we mentioned in the prepared remarks, PPA, and we've talked about RGM in the past and wanting to continue to realize price and we're continuing to do that in the market. One metric we're also looking at is units. So as you're looking at the market data, I'd encourage you to also look at units and how they're progressing. We've seen them continue to trend higher. In fact, in the most recent data, we've actually seen units turn positive.

When we think about Special K, that's part of the 9 of the 11. So the 9 growing at or with the category or better than the category. The other 2 were Special K, as you said, one of our largest brands. When you take a step back, let's sort of zoom into this year, Ken, and then we'll zoom out again, if you don't mind. But this year, in particular, we had a slower start to the year. We had less activation this year compared to a big activation last year, just to give you a little bit of color there. In our innovation set, we had 6 launches last year to 2 this year. So that made a big difference as we started the year and then we lapped a specific customer activation in Q2.

Now you're asking, well, tell me more about the brand. We now have the full force of our integrated commercial team focused on this brand. We're doing that with Frosted Flakes and Raisin Bran and you see the improvements there. We are confident in the ability of this team now that we're a cereal only company to be focused on that.

Now in terms of the brand itself, special for a reason actually gives you something, some insight into the actual brand. It has a variety of foods, variety of nutritional benefits. And now we have a campaign that gets the target cohorts in a specific way to get them to get the message to them as to what they're actually looking for in our foods.

An interesting thing about the brand is, and we're also in premium, it tells you about the relevancy of the brand. Special K Zero, doing very nicely, a good example of a nutritional benefit to a specific cohort that is working even on the premium side. And you're right, there's work to be done. The team is on it. We believe we have the team to do something special with Special K.

Thanks for that. A couple of things about that. Let's first talk about market share. If you take a look at our market share performance, it has been quite stable since we've spun. We came out of last year around 27.6% [Phonetic] and we've hovered around that number each quarter since then. So it's stable. We would expect to see a sequential improvement as we move forward because that should move along with our sequential improvement in volume as well as our top line.

Now you talked a little bit about promotion as well and how we're thinking about that. We like the way we're executing our promotional plan. The key thing about promotion is its part of the equation when you're trying to drive value for your consumer. It's certainly an important part, but if it's just price, you're probably not going to get where you need to get to as a branded player. It needs to have an idea. You need to commercialize it with a campaign, maybe a collaboration with a partnership, essentially what I'm doing is describing what we've done with Frosted Flakes.

When you pull all that together, you get the lift you're looking for, you're looking for -- you get volume growth, you get sales growth as well. So we like where we are with our promotional plan. In our back half, we have the fuel that we need. A key thing that we do is we're always looking at returns. We want targeted investment. We want to make sure we're targeting the right brands and the right channels to the right customers and consumers to make sure we're getting the lifts we want. But for us, we like what we're doing in the front half, we like the plan we have in the back half, we're excited about that, and we have the fuel that we need.

And I say that you mentioned gross margin as well. We're very pleased with our gross margin performance. We were able to invest more and still deliver 30% gross margin. This business hasn't seen that in a while. It shows you the power of focus and discipline we have in the organization.

Dave, do you want to follow on?

Hi, David. Just on your question on the gross margin for back half and some of the sequencing, if you will, of the P&L or the shape of the P&L, I would say if you look at our first half gross margin delivery, you can kind of pencil that into the back half. Now if you look at the slide, we had the slide in the prepared remarks of the overall shape of our margin trajectory. And then I'd remind you for the back half, if you think about EBITDA margin, our shape will look similar to that. Q3 would be kind of -- our EBITDA growth will be in line with our annual guidance. For Q4, remember, we are lapping the incentive comp in Q4. So maybe a little bit of a higher growth in Q4 versus Q3, but that will just kind of give you an idea of how to shape the rest of the year.

Yes, David. So, for the $390 million, we said in the prepared remarks, it will be approximately $40 million in '24. Just from a sizing perspective, I'd say that the bulk of the majority will come in 2025, but we'll give you explicit detail on that exact number as we provide guidance for 2025 in Q1 of 2025. So just -- again, simple phasing, $40 million this year. The bulk of the remaining in '25, with some into '26. But we'll give you more exact numbers as we give guidance next year.

Thanks, Peter for the question. The way we would look at this when you talk about company sales, we are going to be in a good position, a very good position to supply our customers and deliver our targets post modernization because you have it right. When you think about what we're doing, I think what you should have in your head is production shifting more than anything else, shifting from our oldest facilities to more efficient facilities and from older, more rigid platforms to new or more agile one. So while you do that, that's why we have confidence that we'll have the production and capacity we need to drive this business forward.

The other thing that we -- you should consider when we've talked about our supply monetization program, we certainly talk about that being the centerpiece of our margin expansion program. It also enables and drives our top line because it will become a more reliable and resilient supply chain that allows us to be a more reliable partner for our customers, and that has an ongoing impact for our business going forward.

In terms of utilization and capacity and what you're describing about the performance of our plants, what we're already seeing in our organization is improving OEE. We talked a little bit about that in previous quarters. We've shown improved service. We're able to create capacity with the team working through that, reducing waste as well. So the energy that our team has around the supply chain, driving engagement and building capability, we already see that paying off and giving us good returns. The best part is that engagement is something that keeps delivering as we move forward.

Yes, Peter, I think I would tell you, there's an and there. So we have a couple of things going here. Number one, you just heard that we're reinvesting. We increased our investment in the second quarter. We said we have fuel in the back half as well. And we have our confidence in our ability to grow our margin from 9% to 14% exiting 2026. We even said that's not a destination that is a mile marker as we move forward because that's simply what we would call the median of our peers. So we think over time we'll do even better. But our view is we do have the right amount of fuel in our P&L.

And you should look at our profit delivery and it give it -- give you even more confidence in our ability to create the flexibilities we could drive into the business. As we like to talk about, we're always talking about returns. So when we're investing more into our business, we need to make sure that we're getting the return back. We gave you a couple of good examples in the prepared remarks where that's working well for us. As a maturing organization, we're going to be able to do that more broadly across our portfolio.

Yes, the way we would look at it is we think the category is holding up well. It's a unique environment. I think we would all say it's a unique environment and this environment is cutting across a variety of categories. But when we stare at the detail, if you look at the category TDPs up modestly, displays are up. So in-store holding up well. And the category is actually performing as we would have expected. We talked about our assumptions, our planning assumptions coming into the year. And despite the macro environment, the price volume gap continues to narrow. And then over the -- during the first half of the year, it was down about a little over 1 point in the last 4 weeks a little bit under 1 point. So it's performing where we would expect it to perform from our perspective.

In terms of category dynamics, a couple of different things that are happening. You see private label growing, but that growth is moderating. That makes a lot of sense in the context of the value-seeking consumer. An interesting thing about our category innovation is an important driver to the category. And when a consumer is looking for more certainty, the innovation is not performing as well as it has in the past. But what's interesting about that is, that means it goes to the core. So that innovation point was about the category and our performance but where the consumers are going to our core. You look at Frosted Flakes, blue box. You look at Fruit Loops, you look at red box. That's doing better for us.

The thing that we always look at and we say, that's such an interesting thing about our category is bifurcation. Granola doing well and growing. Premium doing well and growing, it's actually up 15%. So that's an interesting thing for us that actually speaks to the affordability of the category. In any event, we think that the category is performing as we would have expected and holding up nicely in this environment.

I'll repeat a little bit of what I've said, but that's -- I understand the question. Innovation in general, for the category is down. Our innovation performance is down as well. In terms of Special K, that's just as we are balancing out the portfolio that was a decision that we made. We're thinking about what we want to do for next year. Remember, that innovation plan was created prior to the spin. Now we move forward after the spin. This will be our first innovation set as an independent company.

And when you talked about some of our innovations this year, they're highly incremental because they're doing the job of bringing new consumers into the category. What's interesting about that, when you do that at a time where the consumer is looking for more certainty, that's actually there's a rub. But at the same time, we feel good about the job that it's doing. We're going to keep doing that. And some of our innovations recently like Special K Zero, that goes to the high end and adds nutrition to our portfolio. That's actually doing quite well as well.

So we're looking at the overall innovation while it's down this year. We think that's more about the environment than about our plan, and we're excited about our 2024 plans as well as 2025.

Hey, Scott. Thanks. So as we think about it, we've not really changed much from this standpoint back when we started talking in August, but I'll just kind of size it for you. Yes, obviously, our guidance implies 3% to 5% growth this year. I'd say as we look forward to 2025, you can kind of expect similar, now that's not an official guidance. We'll come back with an official number in Q1. But just from a sizing perspective, probably not all that dissimilar to 2024.

2026, you mentioned it. We've been explicit in saying exit. As we're exiting the year, we'll be at 14%, but that's not a full year number. So as you think about the growth from EBITDA in 2026, it will probably be higher than '25 and '24, but it's not going to be the full run rate. You'll start getting the full run rate in the end of '26 as we exit and then carry that into 2027.

So when we came out, we were -- we've said that we had a delayed draw feature on our term loan arrangement that we have with our partners. And so as we think about that, we're going to start drawing on that as we start spending those cash flows. I mentioned the cash flow for this year, negative approximately $50 million for a full year. Just remember, it's not just a supply chain initiative, it's also that overall standup initiative that we have going through kind of the first half of 2025. So those two things combined is that we'll get to about 3 times adjusted EBITDA in early 2026.

As we think about that, we have that funded through our current debt arrangements that we have with our lenders. They've been lockstep with this, understanding the cash needs, where it's going, how it's being spent, the returns we're getting for it. So we have all that funding committed to us, and we feel good about that.

Thanks, Rob. Nobody asked that first question. So let me just -- I'll do a full throated answer to that one. I think what we would say is nothing -- in the plant we just announced, there's nothing in our arrangements with our union that prevents us from executing these plants. Now you step back, and these are our people. This is the arrangement that we entered into with our people. Of course, we're going to honor the letter and spirit of the agreement. We've spoken to our people in the union this morning. But we -- the agreement in place right now gives us the flexibility to execute on the plan that we announced this morning.

In terms of the contracts, I think maybe what you're referring to is the master contract that we have with our plants, that expires in October of 2026. So that would be the next date that's probably quite relevant. I think that's what you were asking.

In terms of capacity, I think what we would say is we feel like we're in a very good position to supply our customers and deliver our targets after we modernize our supply chain and actually, of course, during the execution of this project as well. The best way to think about this is we're shifting production from the oldest facilities to more efficient facilities and also from older platforms that are more rigid to newer, more agile technologies. So we feel good that we have the right capacity, the right ability to produce going forward as we execute on this project.

Thank you for joining our call today. I hope you can see that we're on track in executing our strategy, and we look forward to sharing our Q3 results with you in November. Thank you so much for joining us.