K - NYSE

Good morning. Welcome to the Kellogg Company’s First Quarter 2021 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks there will be a question-and-answer session with the publishing analysts. Please note, this event is being recorded. At this time, I will turn the call over to John Renwick, Vice President of Investor Relations and Corporate Planning for Kellogg Company.

Thank you. Good morning and thank you for joining us today for a review of our first quarter 2021 results as well as an update regarding our outlook for the full-year 2021. I’m joined this morning by Steve 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 when the length and severity of the crisis 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 a currency-neutral adjusted basis for operating profit and earnings per share. And now I will turn it over to Steve.

Thanks, John, and good morning, everyone. I hope you and your families are doing well and staying healthy. Here at Kellogg, I’m continuously impressed by the way our organization has remained focused and engaged in executing through what are undeniably challenging circumstances, both at work and at home. Keeping employees safe remains job number one. And in quarter one; we continued to execute safety protocols while following the guidance of local health authorities. Supplying the world with food continued to require agility, including temporary labor and incremental capacity. And of course, we continue to actively support our communities. After all, the pandemic is not behind us. In fact, in some parts of the world, we are seeing it accelerate, and our thoughts and prayers go out to all those affected. Turning to Slide 6. Our deploy for balanced growth strategy remains as relevant and effective as ever during this pandemic. Its growth boosters continue to do their job. As much as anything else, this pandemic has prompted a shift in eating occasions. Our focus on occasions continue to be evident in the first quarter in our tailored consumer messaging and an innovation geared towards specific occasions. The portfolio that we have shaped toward growth has benefited from balance of convenient meals, snacking that can be done at home, plant-based foods and sustained growth in emerging markets. Our building of world-class brands has been evident in our commitment to continued equity building communication as well as leveraging our data and analytics to devise creative ways to reach new consumers and sustain momentum in the marketplace. And our commitment to perfect service, perfect store, tested by the sudden and sharp rise in demand has forced us to get creative around ways to increase throughput, even if it meant temporarily holding back and merchandising activity to ensure inventory and incurring incremental logistics cost to get food to our customers. And we continue to grow rapidly in e-commerce, leveraging our enhanced capabilities there. Environmental, social and governance is not a new area of focus for Kellogg. It has been embedded in our history and strategy for a long, long time. Our ESG oriented better days boosters always a key element of our strategy, have become more important to our communities, employees, customers and consumers. At CAGNY, a few months ago, we discussed our global better days purpose and strategy and on Slide #7, you can see that we continue to progress in this area, addressing the interconnected issues of health, hunger relief and climate. On nourishing with our foods, we have continued to innovate and renovate our foods, providing choices across wellness and indulgence and during the quarter, our Kashi became the first organic cereal to be authorized for the women, infants and children program in the United States. On feeding people in need, we have remained in an elevated level of donations making accelerated progress toward our goal of feeding 375 million families. During the first quarter, Pop-Tarts joined with the United Way to raise money for school vegetable gardens. On nurturing our planet, we announced during the first quarter, our commitment to achieve over 50% renewable electricity to address Kellogg manufacturing globally by the end of 2022, and we celebrated women farmers as part of International Women’s Day. And under living our founders’ values, we launched in the first quarter our new equity, diversity and inclusion vision and strategy to all employees in all four regions. Aligned with those values, we launched a campaign called a Call for Food Justice in Black Communities in partnership with World Food Program U.S.A., tied to some of our biggest brands, including Special K, Morningstar Farms, Kashi and Eggo. Our strategy and execution led to another good quarter, as highlighted on Slide #8. At home demand remained elevated, more than offsetting continued softness in away-from-home channels and on the go occasions. Our biggest brands continued to show strong momentum, aided by sustained consumer communication and innovation activity. There why we gained share in most of our key markets and categories around the world. We continue to bring on our planned capacity increases, which will continue to relieve supply tightness and enable us to return to normal levels of merchandising activity as we get through the first half of the year. Our emerging markets businesses accelerated their growth, proving their metal in what are challenging conditions. From a financial perspective, we continue to seek and deliver balanced financial results. The kind we achieved in 2020, and that is what we did again in the first quarter. Strong net sales growth, even despite lapping last year is pandemic-related surge, and we delivered this organic growth across all four regions and all four global category groups for a fifth consecutive quarter. Positive price mix, reflecting revenue growth management actions made all the more important by the recent rise in input cost inflation. Gross profit margin improved year-on-year despite higher costs and faster growth in our emerging markets, including our distributor business in West Africa. Operating profit increased year-on-year despite lapping last year is strong growth ex divestiture, driven by top line momentum and despite a year-on-year increase in brand investment. Cash flow remained strong, and we were able to accelerate share buybacks into the first quarter. So a very good start to 2021 with the potential to put us a little ahead of where we thought we would be through the first half and its extremely difficult comparisons. This enables us to raise the full-year guidance we provided for you in February even amidst what is undeniably an uncertain business environment. So with that, let me turn it over to Amit, who will take you through our financial results and outlook in more detail.

Thanks, Steve. Good morning, everyone. Slide 10 offers an at-a-glance summary of our financial results for the first quarter. As you can see, they are quite strong. Particularly when considering the year ago growth they were lapping. Specifically, last year is first quarter featured 8% organic growth on net sales and operating profit that grew roughly 8% excluding the impact of the prior year is divestiture. So we generated very good growth on growth. Net sales grew on a one year and a two-year basis. In developed markets, it was aided by shipment timing and at home demand remaining elevated, partially offset by continued softness in away-from-home channels. In emerging markets, we generated sales performance that was better than expected. Currency-neutral adjusted basis operating profit grew on a one year and a two-year basis, driven by the net sales growth and expansion in gross profit margin and good discipline on overhead, all of which more than offset a year-on-year increase in brand building. Clearly, we are seeing good operating leverage from our strong top line growth. Currency-neutral adjusted basis, earnings per share grew on a one-year and a two-year basis despite a higher effective tax rate. And in what is typically our lightest quarter for cash flow, it was stronger than I anticipated for the quarter. Of course, it is down from last year is unusually high first quarter cash flow but as you can see, it is ahead of the pre pandemic 2019 level. Let’s look at these metrics in a little more detail. Slide 11 breaks quarter one net sales growth into its components. Volume declined against last year is math surge, but it was up on a two-year basis. At home demand remained elevated. Emerging markets sustained momentum and we did see favorable timing of shipments in the U.S. as expected. Price/mix was again positive, which is important given the accelerated cost inflation we are seeing. During quarter one, we saw positive pricing in all four regions, reflecting revenue growth management initiatives, and we also saw an overall mix shift back towards snacks. Currency translation was a slight positive in the quarter. As we look to the remainder of 2021, we still expect to see a moderating top line. We faced our toughest volume comparison in quarter two, and we are assuming continued deceleration in at home demand. Slide 12 offers some perspective on our profit margins which held up very well in spite of higher costs. Our gross profit margin in quarter one improved on a one-year and a two-year basis as productivity and price realization were effective at covering accelerated input cost inflation as well as incremental COVID costs against only a partial quarter of those costs in the year-earlier quarter. We also more than offset a mix shift towards emerging markets and particularly towards our distributor business in West Africa. The flow-through of this higher gross profit margin led to an increase in operating profit margin as well as decreased overhead balanced out a high single-digit increase in brand building. The brand building increase reflects the phasing of our commercial plans relative to last year is modest decrease in quarter one at the onset of the pandemic. Even with this year-on-year increase in brand building, we still grew operating profit at a double-digit rate this quarter. As we look to the rest of the year, we obviously faced our toughest gross profit margin comparison in quarter two due to last year is outsized operating leverage that produce, by far the highest gross profit margin over the past couple of years, as you can see on the slide. In the second half, we are working to hold our margin as close as possible to year ago levels. In spite of our mix shift towards emerging markets and accelerated cost inflation. Further down the P&L, we faced our toughest comparison on brand building in quarter two as well. Because last year is quarter two was when we delayed significant brand investment to the second half. That second half investment helped create the momentum we are seeing today. But we return to more typical levels of brand investment in this year is second half. Turning to the remainder of the income statement and Slide 13, we see that our below the line items were relatively neutral to earnings per share in quarter one. As expected, interest expense decreased year-on-year on lower debt and this will continue for the remainder of the year, with quarter four, additionally lapping the nonrecurring $20 million debt redemption expense we recorded last year. Other income was lower year-on-year and modestly lower than what should be its quarterly run rate for the rest of the year. Our effective tax rate of 22.7% was higher than last year is relatively low level and should still turn out to be around 22.5% for the full-year. Average shares outstanding were flattish year-on-year, with the impact of quarter one’s accelerated buybacks to be more pronounced in the coming quarters, resulting in a full-year average shares outstanding that is a little more than 0.5% lower than 2020. Turning to our cash flow on Slide 14. We had a strong start to the year and maintained good financial flexibility. As expected, our cash flow in quarter one was lower than quarter one 2020’s unusually high level, not because of net earnings or working capital both of which were favorable year-on-year, but because of year-on-year swings in accruals and other balance sheet items as well as lapping last year is delayed capital expenditure. However, as you can see on the chart, quarter one 2021’s cash flow was well above that of quarter one 2019 in what is always our lightest cash flow quarter of the year. Net debt is lower year-on-year, even despite our resumption of share buybacks, and we like the state of our balance sheet. As we look to the rest of the year, cash flow will likely remain below last year is COVID-aided levels but still well above 2019 levels. And between our share buybacks, which we were able to accelerate into the first quarter and an increased dividend, we are meaningfully increasing the cash returned to shareowners. I will conclude with a discussion about full-year guidance shown on Slide 15. As Steve mentioned, our strong quarter one performance gives us the confidence to raise our guidance this early in the year. Specifically, our guidance for full-year organic net sales growth moves up to approximately flat year-on-year from our previous guidance of about negative 1%. This would equate to closer to 3% growth on our two-year compound annual growth rate, effectively eliminating the noise of lapping last year is COVID-related surge. Our guidance for currency-neutral adjusted basis operating profit improves a decline of about 1% to 2% year-on-year versus our previous guidance of minus 2%. This equates to closer to 4% growth on a two-year CAGR basis, excluding our divested businesses from the 2019 base. Our guidance for currency-neutral adjusted basis earnings per share increases to growth of about 1% to 2% year-on-year versus our previous guidance of up 1%. And this equates to something around 5% growth on a two-year CAGR basis, excluding our thins divested businesses from the 2019 base. And our guidance for cash flow moves up to a range of $1.1 billion to $1.2 billion versus our previous guidance of approximately $1.1 billion. We think this guidance is prudent, given that it is early in the year and given a business environment that is somewhat uncertain in terms of pandemic impacts and cost inflation. Obviously, we are pleased with our start to the year. We are in strong financial condition. Our brands and regions are performing well. And we are solidly on track for continued balanced financial delivery on a two-year basis. And with that, let me turn it back to Steve for a review of our major businesses.

Thanks, Amit. I will start with a quick review of the quarter one results of each of our regions, and then I will go a little deeper into some of our key brands and categories. The region’s net sales and operating profit growth rates in quarter one are shown on Slide 17. You can see that our growth was broad-based, particularly on the more meaningful two-year growth rates. In North America, our organic net sales grew on top of last year is high-growth with elevated at home consumption and strong momentum in key brands as well as favorable timing of shipments between quarters partially offset by continued softness in away-from-home channels. Operating profit also increased year-on-year despite tough underlying comparisons. The two-year trends only further confirmed that this business got off to a good start to the year. Our business in Europe had another good quarter. Its solid one-year organic net sales growth was on top of last year is strong growth, and it was led by accelerated growth in Pringles, resulting operating leverage produced strong operating profit growth. In Latin America, our strong organic net sales growth was driven by Pringles and cereal and the result in operating leverage boosted operating profit as well. Macro conditions in this region are challenging. So this was a terrific way to start the year. And in EMEA, our strong organic net sales growth was led by Multipro, the distributor portion of our business in West Africa, and across the region by Pringles, cereal and noodles, leading to outstanding growth in operating profit as well. Now let’s go a little deeper in some of our categories, markets and channels. We will start with our global category groups, as shown on Slide #18. As you can see from the chart, we grew all four category groups on both a one-year and two-year basis during quarter one despite lapping last year is COVID-related surge and despite continued softness in away-from-home channels. Our largest global category snacks, sustained growth in the first quarter on both a one-year and two-year basis with growth in all four regions, and that is despite the on the go nature of many of its foods and pack formats. This is a testament to the strength of our snacks brands as well as to our ability to adapt messaging and pack formats to current at home occasions. In cereal, we also recorded growth on both a one-year and two-year basis. We saw notable strength in Europe with share gains led by power brands like Tresor and Crunchy Nut. We posted broad-based growth in Latin America with share gains in key markets led by corn flakes. We also recorded strong growth and share performance in EMEA, where our master brand approach is working well in Asia and innovation activity is contributing across the region. As expected, we had a slow start in the U.S. as we limited merchandising activity on supply-constrained brands, but this should improve in the second half as new capacity comes online. Frozen Foods also grew net sales on both a one-year and two-year basis. This predominantly North America business sustained momentum in both Eggo and especially Morningstar Farms, and I will come back to each of them in a moment. And our noodles and other business, which is predominantly in Africa, continue to generate rapid growth both on a one-year and two-year basis as well, with annual net sales approaching $1 billion, this is going to be a growth contributor for some time. So both on a region basis and a category basis, our reshaped portfolio clearly offers growth and diversification. And within each of these regions and categories are world-class brands that continue to grow. Let’s take a look at a few of these important brands. We will start with our largest global brand, Pringles, whose consumption trends for its biggest markets in each of our four regions are shown on Slide 19. This is more than a $2 billion global brand that has demonstrated exceptional momentum for some time in all four regions. During quarter one, this momentum continued with Pringle sustaining growth on top of very strong year ago growth. This was driven by effective brand building, including the incremental consumer communication we did in late 2020, plus important consumer activations in the first quarter, such as our Super Bowl campaign in the U.S. and our gaming oriented commercial activations in Europe. The growth was also augmented by innovation launches including our more intense flavors under the scorching and sub-lines in the U.S. and U.K., respectively, as well as uniquely local flavors in Asian markets. All of these innovations are off to great starts. It is also aided by increased local production in emerging markets, notably in Brazil, where this relatively new local capacity is enabling exceptional growth. Pringles is truly a world-class brand performing extremely well. Here is another really incredible brand, Cheez-It, shown on Slide 20. Its U.S. consumption and share growth has been exceptional over the last several years, and it has continued in the first quarter. The base product line continues to perform well, helped by effective advertising and sports-related activations as well as new flavors and a reformulation of the Grubes sub line. Meanwhile, the Snap sub line is providing incremental growth enough that we had to add capacity in 2020 in only its second year since launch. And Cheez-It is no longer solely a U.S. brand. We expanded into Canada last year. And during the first quarter, it continued to grow rapidly. And in the first quarter, we brought Cheez-It to Brazil, where it is off to a very good start. This is more than $1 billion-plus retail sales brand that continues to outpace its category in the U.S. and one we have begun to expand internationally. And before we move on from our snacks discussion, I want to point out two other power brands in our Snacks portfolio, shown on Slide 21. The since the outbreak of the pandemic, the portable wholesome snacks category has been declining due to fewer on the go occasions. We have continued to gain share of this category, largely because of two brands that have been able to grow their at home consumption. Pop-Tarts continued to post growth on a two-year basis in quarter one, lapping last year is extremely large growth and sustaining multiyear growth momentum. Rice Krispies Treats consumption and share growth has been impressive over the last several years. And this momentum has continued in quarter one, aided by the launch of new home style treats, again, big brands, sustaining momentum. Let’s turn to cereal markets and brands on Slide 22. Behind our one-year and two-year growth in global cereal net sales in the first quarter are strong performances by key brands in key markets. The chart shows our largest international markets of each region, with consumption growth on a two-year basis to avoid distortion from lapping last year is surge in March and share performance on a one-year basis to show how we are competing. In Europe, we have outpaced the category with share gains in key markets like the U.K. which was propelled by power brands like Crunchy Nut and all brand. And in other European markets, we saw particular strength in global brands like Tresor our largest cereal brand in Europe and Extra, a key wellness oriented brand internationally for us. In Canada, where the category got more immediate lift than we did in the year ago quarter, we outpaced the category in this year is first quarter on the strength of brands like global brand, all brand and local jewel vector. We recorded strong growth in share performance in EMEA, led by our largest cereal market in that region, Australia. The outperformance was led by global brands like our Australian version of Raisin Bran as well as local jewels like our wellness oriented Just Right. We saw broad-based cereal growth in Latin America, where we continued to gain share in key markets like Mexico, Brazil, Puerto Rico and Central America. In Mexico, you can see the strong share performance was driven by big brands like Corn Flakes, and Choco Krispies and across the region; our growth was aided by strong innovation. In short, we are seeing the impact of strong brands and strong execution in all of these markets. Let’s discuss U.S. cereal for a moment, shown on Slide 23. As expected, we experienced a slow start in this market as we limited merchandising activity on supply-constrained brands. In scanner data, you can see this in our larger than category decline in percent of volumes sold on promotion. We will be caught up on supply and capacity around midyear, as we have mentioned previously. But in the first quarter, those supply-constrained brands, Frosted Flakes and Fruit Loops two of the stronger brands in the category accounted for all and more of our share decrease in the first quarter. Excluding them, our consumption kept pace with the category. So our underlying business remains in good shape. We are very pleased with our innovation, which not only outpaced the category’s innovation in the first quarter, but is showing very strong velocities already. This includes additions to the Jumbo Snacks line we successfully launched last year as well as Mini-Wheats Cinema rolled, Little Debbie, Special K blueberries and Keto-friendly Kashi Go offerings. So we get back up to adequate supply and capacity and return to a normal commercial calendar particularly in the second half, we expect our U.S. cereal performance to improve and perform like our other big developed markets. Slide 24 calls out another big brand and is sustaining growth on a two-year basis. Eggo’s reliable growth in consumption over the past few years accelerated to nearly 17% in 2020, and gaining nearly two points of share, but leaving us very tight on capacity. In quarter one, Eggo sustained strong two-year growth of plus 5% despite capacity limiting its upside. This is one of the brands for which we are freeing up capacity over the course of this year. And when you add in Kashi, our overall from the griddle consumption outpaced the category on that two-year CAGR basis. Eggo is in really good shape with more capacity coming on. With effective advertising and promising innovation on the way, this is a nearly $1 billion retail sales brand with an outlook for sustained growth. And even better growth is being generated by our leading plant-based brand, Morningstar Farms, shown on Slide 25. Our overall Morningstar Farms brand franchise is over $400 million in retail sales and is poised to sustain strong growth for years to come. This brand’s consumption growth in the first quarter, even on a one-year basis, added to its multiyear growth trend. And with incremental capacity in place, this brand gained share as well. There is no question that consumers are becoming more aware and interested in plant based foods. Morningstar Farms has increased its household penetration in the last year to a level that remains well above any of our competitors. And yet is still only 8%, suggesting significant room to expand. Morningstar Farms is also unique in the breadth of its offerings. This is evident in our share gains across a spectrum of segments in quarter one, ranging from breakfast meats, to breakfast handhelds to sausage to poultry. Our new line is created a whole other occasion for plant based foods. And now we are reaching an expanded consumer base. Our recently launched Incogmeato by Morningstar Farm sub-brand is aimed at incremental flexitarian consumers. It continues to expand retail distribution, both in the refrigerated and frozen isles and it continues to add food service customers. It is early days, but Incogmeato is great food and is showing a lot of promise. Just this week, the National Restaurant Association awarded 2021 Fabby awards for the year is most delicious, unique and exciting food for restaurant operators and consumers. Among those awarded were three Incogmeato products, homestyle chicken tenders, Italian sausage and original broad worst as well as an iconic veg forward offering, Morningstar Farms Chipotle Black Bean Burger. Simply put, Morningstar Farms is the largest brand with the highest penetration, the broadest portfolio and the most occasions in this plant-based category. So we are realizing good underlying momentum across our major category groups and led by world Class brands. Let’s now shift our discussion to geographic markets. Specifically, our emerging markets, highlighted on Slide 26. Emerging markets accounted for more than 20% of our net sales last year, among the highest percentages in our peer group. This is important because these markets represent outstanding long-term growth prospects for packaged food, owing to their population growth, and expanding middle classes. In 2020, despite COVID-related shutdowns of retailers in schools, economic disruption from depressed oil prices and even bouts of political and social unrest. Our geographically diverse emerging markets businesses actually accelerated their net sales growth. This is a credit to our product portfolios, our brand strength, our local supply chains and experienced management teams in these markets. And in the first quarter of this year, despite lapping an unusually strong year ago quarter, we sustained this momentum, even accelerating again. In Africa, our Multipro distributor business grew more than 20% year-on-year in quarter one, even as it lapped strong high-teens growth in the year earlier quarter, and we also continue to grow our Kellogg’s branded noodles business. In Asia, we sustained double-digit growth in Pringles and cereal. In Russia, we recorded double-digit organic growth in cereal and in snacks. And Latin America’s strong quarter one growth was broad-based and led by cereal in Mexico and Pringles in Brazil. And let’s finish up with a couple of channels to call out on Slide 27. In the first quarter, we sustained tremendous growth momentum in e-commerce. The investments we had made in this channel, everything from reorganizing around it, bringing in external talent and development capabilities paid off in a big way in 2020 when our e-commerce sales doubled year-on-year. And in the first quarter, our growth was about 75% even as it lapped the year ago quarter’s acceleration. This is a shopper behavior that is likely to stick. Now roughly 7% of our total company sales, we know that our brands and categories play well in this channel, and we are building this business for the long term. Of course, on the other end of the spectrum, during the pandemic are away-from-home channels, which have declined sharply amidst shutdowns and restrictions. The slide shows that our U.S. away-from-home business continued to moderate its declines as measured on an average two-year basis to better gauge the trend. Important to know is that we have not been sitting still waiting for consumer mobility to resume and away-from-home outlets to reopen. We have been actively securing future business, signing up new accounts for brands ranging from Rx to Morningstar Farms and Incogmeato. These actions today will pay off well into the future. Let’s wrap up with a brief summary on Slide number 29. Quarter one 2021 was yet another quarter of good performance and investment in the future. We have sustained strong momentum in most of our biggest world class brands, never having let up an innovation or communication with consumers. We are unlocking capacity so we can resume full commercial activity in some of the foods and brands that had reached capacity limitations after good growth in recent years and acceleration since the pandemic. This added capacity will continue to come on stream during the year, continuing to improve service levels and return to full merchandising activity with our retail partners. Our emerging markets have not only managed through challenging macro environments over the past year, they’ve actually accelerated their growth. And we continue to build scale in these long-term growth markets. We are leveraging capabilities that we have been enhancing over the past few years from data and analytics to e-commerce to innovation. These capabilities have only become even more important since the pandemic. Our cash flow and balance sheet are strong, and we have increased cash return to share owners while maintaining financial flexibility. Our results for quarter one were particularly strong, but more importantly, they reflected high-quality balanced financial delivery. We sustained net sales growth, expanded gross profit margin, remain disciplined on overhead and invested behind our brands and still delivered growth in operating profit and earnings per share, leading to strong cash flow. All of which adds up to an early increase in our full-year outlook. As always, I want to salute our 31,000 employees whose dedication and creativity have made this performance possible despite the most challenging business conditions. And with that, we would be happy to take any questions you might have.

[Operator Instructions] Our first question comes from David Palmer with Evercore ISI.

The question about the 2021 guidance and the implications of that. You had a 3% two-year CAGR that is implied by that. And obviously, this has been an unusual year in 2021. Even if we look past 2020, there is still some COVID related factors. You mentioned supply chain. I think you would take a 3% organic growth rate most years. But could you maybe talk about that 3% CAGR? What has sort of been a tailwind? What has been headwinds? And how would we think about that as you are really executing this turnaround plan, like how you are basically setting up for 2022 and beyond?

Yes. Thanks, David. I will start, and Amit can build. But what I would say is it is important to look at those two year CAGRs, as you point out, that is what we have been talking about because 2020 was such an unusual year. Right. But what’s underlying our confidence in that CAGR is the brand performances that we talked about as we went through the prepared remarks. Our snacks business, our frozen business, our veg business, our international business, our emerging markets business, all performing very strong and if you think about our new guidance for 2021, essentially, just from a top line basis, we are saying flat. So what many companies thought of 2020 when there were COVID beneficiaries would be a high watermark is, in fact, we are going to lap that. And so that is because of the strength of our brands, the execution in the marketplace and the plans that we have put in place. So Amit, do you want to…

Yes. I think it reflects the strength of our portfolio, and you are seeing that come through I think from a pure guidance standpoint, we are expecting that elevated demand will moderate a little bit from quarter one. So I think that is what’s built into the guidance. We are expecting growth in emerging markets to sustain, maybe not at the double-digit rates that we saw in quarter one. But certainly, we continue to expect growth in the emerging markets.

The next question is from Ken Goldman with JPMorgan.

It is Tom Palmer on for Ken. Wanted to ask on the inflation picture. So during the prepared remarks, you made mention of rising cost inflation. Could you provide a bit more detail on the inflation you are seeing right now and then what you expect to see as the year plays out and just the timing of your hedges rolling off and then your comfort in terms of offsetting it? I guess, really the major tool, I’m curious about color on is how you think about list pricing. And instituting that this year?

Yes. Thanks, Tom. So what I would say is we have talked about the inflationary environment, which is real. We have also talked about the hedging, and I will let Amit build on that, that we have got in place for the first half of the year as well as the back half of the year. On the pricing front and just the cost pressure front, what I would say is we have a host of tools at our disposal. So we think about the suite of offerings we want to always start with productivity and drive productivity as hard as we possibly can. And then we are going to look to revenue growth management and the tools that we have in revenue growth management, whether they be price package architecture, whether they be pricing, which would include list pricing. All of those are at our disposal. But at the end of the day, we have to earn that price in the marketplace, through investing in our brands, through innovating through putting the types of performances that we have been able to put against our brands, which puts us in a good position to have the confidence to slightly raise our guidance even despite increased cost pressures that are quite real. Amit, do you want to?

Yes. I think cost for inflation, no question, it is accelerated. I think we are now looking at it being in the high end of the mid- single-digit rate for 2021. We are seeing it across our cost basket from exchange-traded commodities to diesel and energy, ocean freight; we have seen a spike in ocean freight as well. I think all of that has been incorporated into the guidance that we provided today. From a hedging perspective, we are about 76% hedged on the exchange-traded commodities. Obviously, there are other cost pressures outside those as well. But I think we have reflected that in our guidance. And you would have seen that in our quarter one results, we had strong pricing and mix come through. And as Steve mentioned, it is across the whole range of levers, including productivity, including list price increases, including trade optimization and price pack architecture. So the whole suite of revenue growth management tools.

Okay. And just to clarify, where would you have been in the first quarter in terms of that inflationary environment?

I think similar levels. Though, obviously, it is accelerating through the year. And then obviously, in quarter one, we were in more hedged than in the later part of the year, as you would expect.

The next question is from Steve Powers with Deutsche Bank.

Maybe just to round out that conversation a little bit more. I think you had said on the last quarter that you were targeting 2021 gross margins ahead of 2019 levels. Is that I guess, first off, is that still realistic? Or has that been ratcheted down a bit and you are thinking. And then given that relatively extensive coverage from a hedge position, it would appear, just given the cost curves that we are seeing in the spot market, it implies some residual inflation carrying over into 2022. I don’t know if there is a way you can kind of frame the extent of that carryover to 2022. But I’m really curious about, given that, if I’m right about that outlook, does that does that impact your plans around the timing of pricing or other discretionary spending at all as 2021 progresses.

Yes. So I think our goal is still to expand our gross profit margin on a two-year basis. So I think that is still our goal. And in that context, from a 2021 standpoint, obviously, we were ahead in quarter one. Quarter two is going to be our biggest lap as we lapped last year is outsized operating leverage. And then for the balance of 2021, our goal would be to be as close to flat as possible. So that is kind of the way we are thinking about gross profit margin. Too early to talk about 2022 right now. But certainly, as Steve mentioned, from a revenue growth management standpoint, we are looking at a whole range of tools to offset the inflation that we see.

The next question is from Jason English with Goldman Sachs.

One quick housekeeping question and then a more robust question. First, housekeeping, I thought I heard you say that the markets benefited from shipment timing in the quarter. Am I right? Did I pick that up; can you clarify and provide any sort of quantification?

Yes. So we definitely did benefit somewhat from shipment timing. And if you think about - back to quarter one 2020 where U.S. consumption growth exceeded shipments fairly markedly because of the surge. You almost have the mere reflection in quarter one 2021 where the reverse was true, where U.S. net sales growth exceeded consumption. And as we have said many times in the past, consumption is a good guide. It evens out over time. And some of this was clearly borrowed from or taken from quarter four, which we talked about when we did our quarter four call. But that is essentially where the net of Amit, you want to?

Yes. I think just to build on what Steve said, Jason, in addition to last year is factors and timing versus last year, as we had mentioned in our last call, some of this came from quarter four. Most of it, I would say, the timing came from quarter four. There is been a little bit as it relates to quarter two. So there was some shipment ahead of activities, but most of it came from quarter four.

Okay. And then on those activities, Steve, we certainly heard you talk a lot about bringing merchandising activity back to try to get the market share going the right way. How do we think about that in context of the price equation? I mean, the pricing we saw this quarter was phenomenally robust, particularly in EMs, but also in DMs as we think about the glide path forward, net of this more merchandising activity, can you hold the serve like the levels we are looking at or should we expect sort of a migration to net neutral, but how a for the back half of the year, at least within DMs?

Yes. No, thanks, Jason. I would say, obviously, we can’t comment on forward-looking pricing and promotions and so forth. But what we are seeing, what we would expect is a gradual return to normal levels of merchandising activity. As more and more people start to emerge from the pandemic, as capacity for ourselves and others starts to become more normalized. I would just expect that you’ll see a more normal return to levels; I wouldn’t see anything really above that. I wouldn’t see the macro conditions that would drive that. And so yes, I think we can hold serve. And we are off to a good start. It is clear the areas where we want to work on, where we need to work on. And it is clear where we have really good momentum, and we want to continue to push against that as well.

The next question is from Michael Lavery with Piper Sandler.

Can you give a sense of how your conversations with retailers are going with respect to pricing? And maybe specifically, are they more sensitive to list pricing and more receptive to other approaches? Or is it similar across the board? Just kind of love to get a temperature check on where they are and how much kind of wiggle room you have from here out?

Yes. Thanks, Michael. So obviously, I’m not going to comment on any specific customers, but we have a mantra here that we talk about all the time, we have to earn the pricing that we get in the marketplace. Clearly, there is an inflationary environment that is real. Clearly that is across broad swaths of the economy. And clearly, there is been a lot of reporting on that. But we approach it with the humility that says we have got to invest in our brands. We have got to bring innovation. We have got to do everything that we can to continue to earn our place in the marketplace. But I would also say, we did raise guidance, and we are talking about holding as close to possible to our gross margins. So that reflects the type of confidence that we have that we will be able to get through this by managing our price, mix, innovation with our customers.

And how much can you balance the EBIT margin targets with the brand spending and inflation pressures. Is there some interplay there or do you want to protect the brand spend specifically to allow pricing?

Well, we have said in the past, we like the brand building that we have got in place. We like the levels that we have in place. In the back half of last year, we were very purposeful in saying what we pulled from the second quarter we are putting in the back half of the year because brands need investments. And we kept to our overall budget from last year, although it was back-half weighted, and that clearly gave us momentum as we entered 2021, whether it be the Pringles example in the U.S. and in Europe. But we like our levels of brand building spending. We think they are important. They clearly give us the opportunity to drive our brands. And as I said, earn what we get in the marketplace. And so I think we are well balanced. I think we are confident. Again, we raised our guidance based on that. And it is still very early in the year, so there is a lot of uncertainty at play. But we like the way it is shaped up. We like the way it started, and we like our plan going forward from a brand-building perspective and a profit delivery perspective.

The next question is from Chris Growe with Stifel.

Just a bit of a follow-on to that last answer and to Michael’s question. I guess, just to get a sense of the first quarter profit performance and EPS performance being so much stronger than expected. I guess I want to understand, were there any unique factors. We talked about some maybe some over shipment in relation to consumption. But just to understand kind of how that kind of took hold during the quarter and then the degree to which inflation, I guess, is obviously picking up through the year. Is that picking up more than you expected, such that there is maybe more of a limitation on earnings growth in the remaining quarters. It just seems with this degree of outperformance in the first quarter that it would have led to a stronger performance for the year overall, unless there is some other unique factors I’m not just incorporating here.

Yes. Thanks, Chris. I will start, and Amit can build as well. We did raise guidance, and I think I heard your question, why not more, but we are being prudent. Obviously, we are still in a pandemic, where others are really not even giving guidance beyond the next quarter. We are trying to be as helpful and as transparent as possible. We still have COVID. Obviously, we have lots of challenges in emerging markets based on COVID and other things, but we are off to a good start. And we are confident, and we feel like we can manage all the things that you mentioned, the inflationary environment, the potential disruptions, but we want to be prudent, and we want to be able to deliver what we say we are going to deliver.

And just to build on that, maybe a couple of additional points. Just on the shape of the year. So I think quarter two is when we have got the biggest lap, right. So if you look at it from a gross margin standpoint, that was the quarter where we saw the operational - the outsized operational leverage come through. So we are going to lap that in quarter two. Our quarter two was also when we delayed our brand-building into the rest of the year. And just if you recall, quarter two operating profit last year, in 2020, was up 24%. So I think that will just give you a sense of the lap ahead of us and just the shape of the year. I think, like I said, from a gross margin standpoint, in the second half, we target to get as close to flat as possible, recognizing that inflation continues to rise and recognizing that we are probably about 76% hedged. And the SG&A comp should moderate in the second half.

That is next question is from Bryan Spillane with Bank of America.

So two quick ones from me. First is just a follow-up on some of the inflation and commodity question. I mean, we have heard for some other companies, there has been - with some commodities like soybean oil, for instance, where availability is actually a question. So can you just, I guess, give us some insight in terms of your confidence in the availability or your ability to source the raw materials you need?

Yes. I think from a sourcing standpoint, we feel very confident in terms of our diverse supplier base. So while, obviously, with ocean freight and containers and the Suez crisis, there is been pressure in the system. But I think from a supply and a security of supply standpoint, we are confident about that.

Okay. And then, Steve, it is been a few years now since the supply for balanced growth and I know there is been some disruption with COVID over the last year or 13-months or so. But I guess, just stepping back, can you just give us a little bit of insight in terms of like where you think you are maybe ahead of what your expectations would have been, kind of what’s in line? And then maybe just where you still think there is some work to do.

Yes. Thanks, Bryan. So I would say we are really where we want to be, right. We are always constructively discontent. We want to do better. We demand of ourselves to do better. But when you think about things like shaping a growth portfolio, that came through and it delivered. The divestiture is behind us. It was a smart thing to do. It was the right thing to do. But you see our emerging markets, you see our snacks brands, you see our many of our portfolio brands really executing well for us. When we think about perfect service and perfect store, built perfectly for the type of pressure that we had to face last year and ongoing and facing this year. We talk about building world-class brands. And we put some investment surges into our brands unapologetically in the past. And because of those things, before the pandemic, I would remind you that we exited the year before the pandemic with 2.7% organic sales growth, right? And we were getting to balance. And then the surge happened and COVID happened. And here we are, we have had this unbelievable sampling opportunity, this reappraisal opportunity, which we have aimed to make the most of but when you look at the two-year stacks and you look at our portfolio and you look at our performance, we are delivering top line growth. We are back to growth reliably and for a lot of quarters now. And we are delivering balanced growth as well. And it is through the strength of our brands and the strength of the execution of our strategy. So we remain eager to do better. We remain hungry, but I think there is no question that deploy for growth has delivered, and we are back to a balanced growth performance.

I think the only thing I would add is that we delivered balanced delivery last year. Our goal is to grow our gross margin on a two-year basis. And our cash flow convergence. Last year was an exceptional year. But even if you set that aside, our goal is to increase our cash flow conversion. And our new guidance on cash flow would indicate around 75% to 80% conversion.

Our next question is from Robert Moskow with Crédit Suisse.

The 5% pricing or price mix in the quarter is a lot higher than what I had modeled, and I think others had too. I think the perception was that the pricing from a list basis and maybe revenue growth management, too, would come later in the year as your hedges roll over. Does this mean that you can accelerate pricing even above 5% as the year goes on or is there something unusual about the 5% maybe related to the timing of promotional programs that would indicate that, that is your peak.

Yes. I think most of the price mix came from pricing in the quarter. And like I mentioned, that was the whole range of tools across all the regions. I think in some of our EMs, we took significant pricing to cover for commodity. And remember, in some of these markets, we have also had transactional ForEx impacts through the back half of 2020 into 2021. So you have seen pricing to offset that come through in the pricing. I think we also benefited from mix. With snacks growth coming back certainly from a mix standpoint, that is a positive. So that is kind of what drove the quarter one results.

Okay. So as snacks comes back, that boosts your price mix, but what does it do to your gross margin and operating margin? Is that dilutive to both or just one of those?

Yes. We don’t get into the by category profitability, but I would say that, yes, I mean, it is kind of at the mix level, at the margin level, it kind of is neutral-ish at the price level, it is accretive.

The next question is from Andrew Lazar with Barclays.

Just a quick one, Steve, on the capacity additions that you talked about. I’m curious if you can maybe dimensionalize a little bit how much of that capacity, broadly speaking, would be sort of internal versus, let’s say, leveraging external third-party sources? And really, the reason I ask is just because to the extent that more of the capacity is internal that has the implications for, obviously, your level of conviction around stickiness of demand or elevated levels of demand going forward, let’s say, versus pre pandemic versus if you were doing more of this externally.

Yes. Thanks, Andrew. So I would say most of what we talked about is internal capacity, right? Many times, we look to external capacity when we are starting out. So if you look at like a Cheez-It Snap’d line, we might start with the first-line being external, but I got lots of conviction that second-line was internal. And so when we talk about cereal capacity, when we talk about Eggo capacity, we are talking about internal capacity building and expansion. So you can take from that, that there is real conviction. But what I would say is we are not building based on any kind of pandemic that is going to go away. We are building on what we really need, right? And so like others, we operate our capacity pretty tightly, right? And historically, when you are in categories that are growing low single digits, you would expect that, the surge created a whole different set of circumstances but as I said, 2020 is not really going to be our high watermark, right? And so we are going to lap those things in 2021. And we are going to need the capacity to do that in things like certain elements of our ready-to-eat cereal in Eggo, in some of our Cheez-It lines, but we are in pretty good shape. And so it is all embedded in our guidance, and we feel like we have got a good plan.

I think, operator, we have time for one more question.

And that question comes from Rob Dickerson with Jefferies.

Great. Maybe two quick questions. And one, just a quick follow-up from Andrew on capacity. As that comes on, it sounds like increasingly later this year and then into next year, is that just one of the drivers very simplistically as to why you might feel a little bit better on the gross margin side. I mean, I would assume, right as that comes on, third-party goes away, but then maybe there is also a double positive effect by just bringing more in internally off the volume leverage piece?

Not really, Rob. A couple of years ago, when we were doing a lot of on the go. We were attacking the on-the-go occasions, and we did a lot of third party, but we also had a lot of manual work being done, that was the case. But now we are more in a normalized environment where we are building capacity based on increasing demand. So not really.

Okay, great. Cool. And then just other quickly, just on the EM pricing piece. I know you said right, there is some transactional impact, obviously, and then also on the cost inflation side, it was very high, right, in EMEA, it is impressive. like was there pricing in there that you would say could also have just been opportunistic given what you are seeing across all of those countries within that segment such that you weren’t pricing that much historically, but maybe there was, like you said, some of that brand building could have been targeted to some of the areas within EMEA. And therefore, you kind of stuck in and took maybe a little bit more pricing that FX or cost inflation may have excuse me I suggested. That is it.

No, I think just looking at the cost situation, commodities, ForEx, and obviously, we have seen inflation in both. So I think trying to preserve your margins while also balancing out volume growth and share, I think, and triangulating between those drivers.

Alright, well that concludes it. Thanks very much, everyone, for your interest. And if you have follow-up questions, please do not hesitate to call us.