Good day, and thank you for standing by. Welcome to The Kraft Heinz Company First Quarter Results. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star one one on your telephone. You will hear a message advising your hand is raised. To withdraw the question, simply press star one one again, and be advised that today's conference is being recorded. I would now like to hand the conference over to Anne- Marie Megela, head of Global Investor Relations. The floor is yours.
Thank you. Hello, everyone, and welcome to our Q&A session for our first quarter 2023 business update. During today's call, we may make forward-looking statements regarding our expectations for the future, including related to our business plans and expectations, strategy, efforts and investments, and related timing and expected impacts. These statements are based on how we see things today. Actual results may differ materially due to risks and uncertainties. Please see the cautionary statements and risk factors contained in today's earnings release, which accompanies this call, as well as our most recent 10-K, 10-Q and 8-K filings for more information regarding these risks and uncertainties. Additionally, we may refer to non-GAAP financial measures, which exclude certain items from our financial results reported in accordance with GAAP.
Please refer to today's earnings release and the non-GAAP information available on our website at ir.kraftheinzcompany.com under News & Events for a discussion of our non-GAAP financial measures and reconciliations to the comparable GAAP financial measures. Before we begin, I'm going to hand it over to our CEO, Miguel Patricio, for some brief opening comments.
Thank you, Anne-Marie, and thank you everyone joining us today. We are proud and confident. We are so confident that we are raising our guidance on EBITDA and earnings. We are so confident that we are increasing our investments in marketing and in R&D by $100 million-$150 million versus budget, which represents a solid double-digit growth versus previous year. These results are not a coincidence. They are because of our confidence. We have been consistently saying that we'll grow through emerging markets, we grew 23% this quarter. We'll grow through food service globally, we grew about 29% this quarter. We'll grow through our priority growth platforms in U.S., Easy Meals and Taste Elevation, where we had double-digit growth. The rest of the portfolio has to free up resources to invest in our strategy.
These results are possible not only because of our strategy, but because of everything that is behind our strategy. Let me start with people. Today, we have a great team and very engaged team. Speed. Well, agility is a big word for us, and the pods that we have in place are transforming the company in innovation, in supply, in manufacturing, procurement, in sales, in logistics. Two good examples of that is innovation, where we have now a much stronger pipeline for the future, and we reduced the time of innovating from two years to a couple of months. In supply, that through the pods plus the partnership with Microsoft and the usage of artificial intelligence, we are improving our planning, our service levels, reducing waste, reducing fines. We are in a very different place today. Finally, efficiencies.
When we announced three years ago a $2 billion in five years of gross savings, there were a lot of people that were skeptical. That represented $400 million per year. We not only delivered this number in three years in a row, but we are now increasing this bar to $500 million a year. With that, I have here with me today Andre, our CFO, Carlos Abrams-Rivera, our Zone President for North America, and Rafael, our Zone President for international, that are joining me. Please, we are ready for the Q&A.
Thank you. As a reminder, that is star one one if you have a question. One moment while we compile the Q&A roster. Our first question comes from Bryan Spillane with Bank of America. Please proceed.
Thanks, operator. Hey, good morning, everyone. I just wanted to ask, I guess two questions related to the U.S. One is, I think as we kind of strip out the food service piece and look at what's underneath, it looks like there's a bit of a dismatch or mismatch, I should say, between kind of what we were seeing in the Nielsen data and what would have been reported underlying. Just trying to understand if there was anything there relative to timing of shipments or promotions that might have affected the cadence.
Second, if you can just talk a little bit about, in the U.S. specifically, kind of how you're seeing the promotional activity or the promotional environment as we kind of head into some of the big summer holidays. You know, is it intensified? Is it kind of in line with your expectations? Just kind of how you're seeing those summer holidays set up, please.
Andre, please.
Good morning, Brad. Good to hear from you. Thanks for the question. Look, when I look at the U.S. performance, I don't think there is nothing abnormal happening in the quarter. The inventory load was immaterial, given we're already landed at the end of Q4, as I said before. It's really a function of the sell out and the food service, which performed very well in the quarter in the U.S. zone. Maybe people underappreciate a little bit of impact of that. I believe it has something to do also with the fact that last year we with Omicron and things, everything was shut down.
That impacted the sell out in retail in the industry at the beginning of the quarter, but also helped a lot food service to have a very strong performance. When it comes to promotions, as we have said all along, what we have said all along, we expect an increase in promotions year to go. That's what has been in the guidance included on our plan from the beginning, so nothing changing there from that regard. Always in a prudent way and always emphasizing that we are before 2019 levels. You saw with Kevin, Max, how well we are doing in terms of continuing to improve our ROI with the tools that we have in place. Nothing to do. I'll give some color, to pass over to Carlos to give some color on the promotional environment.
The one thing I guess I would add, Bryan, to what Andre just said is, as you mentioned, you know, the ROIs continue to improve. Let me give you a little more color as to what's behind that. You know, we have spoken abouat the Agile@Scale and how that has reengineered kind of Kraft Heinz. Part of that is us creating ownable agile revenue management tools that actually allows us to improve the returns of our promotion. Like for example, we have a trade management system that we created in-house, and it gives us real-time access to essentially over 10,000 promotional events. Then what we do is we actually create digital tools that leverage that large amount of data to provide insights and recommendations in a very simple way.
Those solutions then help us to make sure that allows us to figure out what is the right depth of discount, what is the right time of the year, and what are the right promotional tactics we have seen. If you look at our Q1 numbers, we saw about a 10 point improvement in ROI in this particular quarter versus what we saw a year ago. It's about 15 points if you compare that to 2019 of Q1.
Again, our ownable tools continue to help us make sure that we are driving that investment. You know, as we go forward, our continued focus is make sure that we invest in the business, that we are focused on the renovation of our business, the marketing, driving a stronger quality with those event-based activities that really have the high ROIs.
Rafa, I don't know if anything you wanted to comment on what you're seeing international promotions.
Well, it's not very different than what you described, Carlos. I think, you know, what Andre mentioned, we might see a bit of an increase. We'll see a bit of an increase in some market and promotional activity through the year to go, but nothing significant that is not included in our guidance.
Thanks, Bryan.
All right. Thanks, guys.
Thank you for the question. One moment for our next. It comes from the line of Andrew Lazar with Barclays. Please go ahead.
Great. Thanks. Good morning. I think, you outperformed expectations, obviously, in the first quarter on organic sales growth and maintained the full-year outlook, I guess, you know, potentially implying slower go forward trends maybe than originally planned for. Is there something you're seeing in the market that necessitates this adjustment? Or is this more a function of sort of conservatism? I appreciate the full-year outlook is already above your sort of long-term algorithm.
Hi, Andrew. Andre, maybe you want to answer that question.
Sure. Good morning, Andrew. Hear from you, too. Thanks for the question. There is nothing that changed expectation. We are holding the guidance in bottom line. If I look at versus what I believe market was expecting, we over-deliver, quite a lot in the international zone, which I think people still, they don't fully appreciate the impact of emerging market growth in our portfolio and the food service portion of the international market in our portfolio as well.
They've been performing extremely well, as Miguel indicated, and they continue to do so. Momentum is very solid. When it comes to the U.S., nothing changed in our internal expectations. We just think that at this moment it's good to be prudent given macroeconomic uncertainties about interest rates and how consumers might respond on that, but nothing special.
Great. Thank you so much.
Thank you. One moment for our next question, please. It comes from the line of Ken Goldman with JP Morgan. Please proceed.
Hi. you know, there's been some anecdotal evidence that consumers are beginning to trade down in terms of where they're doing their grocery shopping, either going from premium channel to more mainstream or mainstream to discount. I'm curious if this is something you're starting to see as well, even if it's just on the margin. If so, is it in any wayI guess, informing your decisions about product mix, new products, you know, things like that?
Maybe Andre and Carlos can comment.
Good morning. Look, as you have seen since last year, the channel migration has started. We don't see like an abnormal accelerated trend or that. We have seen consistently now for several months, the dollar channel and the mass merchandising gaining ground consistently. As this is not a new phenomenon, we have been prepared for that for a while. I'll pass to Carlos, if he could talk about the type of activities we are doing those channels, but we don't see anything abnormal happening, and it's expected.
Yeah. What I would add in terms of color, I guess first in retail, I mean, there have been some channel shifting, which we expected. You know, for the lower income consumers, it means kind of moving to more value-focused retailers or into dollar channel. As Andre said, we anticipated this.
Now for higher income consumer, that also means, you know, thinking about what are the places that they can go in instead of maybe the specialty retailers to more traditional grocery and club. For us, what we're looking to do is actually making sure that we have the right solutions for those that are specific channels. So whether that is more club-sized packagings and brands like Mac & Cheese and Jell-O and adding more dollar SKUs so that consumers who are stressed are actually able to stay within the category.
As we talked earlier, you know, being savvy about how we go about our promotional activities in certain categories so that we can in fact be there with consumers with the right overall kind of meal solution. If you think about what a, you know, grilled cheese sandwich can do with Kraft Singles, what a Kraft Mac & Cheese can do in terms of families, what Oscar Mayer lunch can do, us being able to be there for those kind of meal solutions is part of our answer as well.
The one other thing I will say is, if you look at that same channel shift within food service, we're also making sure that we are adjusting too for that. We are seeing how business continues to grow in QSR, and for us it's continued to grow that, you know, business.
We are doing that, and we're growing share of that business as well. It's making sure that our consumers are shifting to, from certain restaurants to QSR. We are making sure we are there for them too to continue to drive our products and continue to drive our growth, which is the way resulted in Q1. Thank you for the question, Ken.
Thank you. One moment for our next question, please. It comes from the line of Jason English with Goldman Sachs. Please proceed.
Hey, good morning, folks. Thanks for spotting me in. Two quick questions. First, the gross margin outlook for the year, great to see it moving up. It implies that your gross margin for the year is gonna look a lot like your first quarter, which would of course mark an end to what has been like a sequential build with every quarter moving higher. I guess my question is, why would that be the case, especially given that the cost inflation appears to be moderating?
To that? Sorry, Jason, could you repeat the question talking about the trajectory of the gross margin throughout the year?
Yeah. Gross margin's been building sequentially, right? You even have a chart in the, in one of your slides showing it every quarter moving higher. Your full year guidance implies that it kind of goes sideways, that you're gonna finish the year at a margin rate very comparable to the first quarter. My question is why shouldn't we expect it to continue to grind a little higher as cost inflation moderates?
No, the gross margin will increase a little bit throughout the next quarter. We should see Q4 will be the highest one. Q2 goes a little bit sideways. There is a component of mixing our portfolio as well, given the type of products that sell more during Q1 and Q4 in comparison to what sells in December. Beyond that, no, because the costs are continued to ease, the price is, we put a lot of price in the middle of the quarter, so we have full reflection of that now into June. Remember as well, and then I'm gonna talk to that something from last year, right? No, the gross margin will gradually increase throughout the year.
Okay. That's helpful.
It's the expected expectation that you read is because of product mix, which notices on anything.
Yeah. That's helpful. I appreciate that. Then free cash flow. Can you tell us what your outlook is for the full year in terms of conversion or level, however you want to communicate that? I know you talked about working inventory down. It built a lot last year, and obviously there's still a heavy usage of cash again in the first quarter. How much of that do you think we could get back out over the course of this year? Or do we have to kind of bleed into next year before we can normalize those levels?
Yeah. Free cash flow, as we said, last quarter, we expect this year to close in the 75%-80% range, which is in line with our plan. We even talk about that in CAGNY. We expect by 2025 to go up to 100%. This has to do maybe with the CapEx ramp up that we have done this year and next year, which is close to 4% and then expect to wind down. Working capital, yes, was a drag last year, and in Q1 was also a negative hit.
We prioritize service level recovery because, I mean, the payback is obviously there. What I can tell you is we have a very robust plan to bring the inventory down to level before. We have been working with buffers, I mean, as everybody in the industry does, given all the uncertainties about supply chain volatility and resilience.
We have a very clear line of drive path to bring it down throughout the year. The expectation for inventory is to land the year at similar levels to where it was the pre-pandemic level as a percentage of COGS.
Got it. Thanks, Jason. I'll pass it on.
Thank you. One moment for our next question, please. It comes from the line of John Baumgartner with Mizuho Securities. Please proceed.
Good morning. Thanks for the question. I wanted to come back to promotion in the U.S., Carlos. There were a few categories that drove the bulk of U.S. share loss in Q1. I think those are also categories where your promotion levels really seem below branded competitors. Is it fair to isolate the share losses to reduce promo and lingering supply chain issues, or are there other factors in play outside of promo and supply chain?
Listen, John, I think that's a fair assessment, but I guess let me start with the fact that as we think about growing the business, you know, we have a very disciplined approach of how we're gonna do that. We are, and Miguel mentioned, we're gonna focus on our growth platforms and the growth they have in our portfolio. We wanna make sure we're building innovation that's disruptive and that we continue to adapt the core to the consumer trends. We're gonna manage the margin with efficiency to reinvest in the business with, you know, with the double-digit investments in marketing, technology and R&D. As you said, there are a few kind of categories where we saw a slowdown.
Let me remind you too that we took pricing in the middle of the quarter as we were catching up to margins. If you think about a couple of those categories, let me highlight a couple of them. One, you know, cream cheese, for example. We did see some supply chain challenges that we had in the quarter. Those are things that prevented us from really taking advantage of the Eastern Time period. In fact, we are now in a position that we'll be better off as we go into the year to go. Another one I'll tell you is cold cuts, in which we began the year with a low inventory situation in our business.
Again, as we think about cold cuts by the end of the summer, we should be in a much better place in terms of complete supply in the overall business. That a sense of the short-term supply constraint is an assessment, well assessment of how we see the quarter as well. The one thing I would add, too, is that there are places where in categories we're simply not gonna be chasing volume down. If you think about bacon, it's a category that, you know, that probably was about a point of headwinds, you know, when you look at the data and consumer data, but we're simply not gonna be chasing volume that is not profitable. That gives you a sense about how kind of we're looking at business and what drove that first quarter.
Okay. Thanks, Carlos. On the international side, your categories, I guess historically your categories have been pretty defensive in terms of demand during economic weakness. I'm curious, you're doing a lot of good things, ramping distribution, launching new products. As you transform the business with growth in food service, the new sauces, the beef partnership with ABI, how do you think about the marginal structure? Are these new outlets and products introducing greater volatility into the business, or do they benefit you in that they reduce some of the impact of private label and price sensitivities in places like the U.K. and Europe? How do you think about the net resilience you're building outside the U.S.? Thank you.
Rafael, do you wanna answer that one?
Yeah. No, happy to. I think we need to differentiate a bit what, how we're growing, in emerging markets and the developed markets across international. I think, I mean, what you described probably applies a lot to the, to the developed markets because as you know, as we've been talking about across emerging markets, we are growing significantly and the go-to-market and the opportunity we have in execution of this go-to-market has been significant and continues to be. On the developed market, I mean, it's a mix. I mean, we've been renovating our portfolio significantly in all the places, especially you mentioned Europe. Then launching products that have been incremental, not only in sauces but in the easy use category.
Like, those are the two platforms that we've been growing, especially the sauces that take innovation. This has been the focus. I mean, right now is delivering the results that we expect. Again, providing the gains that we need and the resourcing from the core and the innovation growth that comes from those introductions.
Just to add to that. Just to add to that. If you remember, again, international zone, you have the developed markets, the emerging markets, right? Emerging markets, 10% of our business. We expect to grow double digits like we have been doing. There's a different implant about expanding distribution, but it has to be done in a profitable way. You might have noticed in the prepared remarks that since we start to require from our emerging markets a certain level of minimum ROIC or EVA, I think we're seeing a very healthy balance between top and bottom line. We saw very significant gross margin expansion in emerging markets across the board in the quarter. I think we have expectation for that to continue to improve.
We feel very good that part of the investments that Miguel has said about the $150 million, which is going across marketing, R&D, technology and in some cases, sales headcount. In the case of emerging markets, we are accelerating the go-to-market expansion. We always keep our stability top of mind here. We don't wanna grow without delivering returns. On the developed markets, not only in the U.S., but also in selected countries being developed, we are using part of these incremental investments to reset the marketing levels and accelerate, in some cases, the innovation agenda. We feel very good because that allow us to continue to build the future growth of the company.
[Ella], let me mention one thing that you said that you mentioned that entering new categories with innovation. You're right. I mean, we launched in U.K., Heinz Pasta Sauces and in a couple of months we achieved 7% share and we continue growing. We just launched a vodka pasta sauce with Absolut that is being extremely successful in the market. It's not only in Europe. I mean, if you look at the profile of innovation that we are having right now in U.S., it's very different from the past. In the past, we had a lot of innovation, but really not incremental. It was very cannibalistic. Just think about what we've been launching, like Nautical, that it's going to be national during the summertime. It's basically 80% incremental to the category.
Just Spices that we just launched in U.S. through direct to consumer, which is spices, which is a huge market where we don't play today. Tingly Ted's that we are launching globally throughout the year, that is in hot sauces. That is a pretty growing category that we were not playing. Even KRAFT Mac & Cheese Frozen that we are launching, that we are leader with KRAFT Mac & Cheese. We have a very strong portfolio of frozen, but we didn't have an option of KRAFT Mac & Cheese Frozen. I can continue this list and tell you about HOMEBAKE and increased home microwave. A really, real incremental innovation that will start to change the profile of innovation in our company.
Operator, we have time for one more question.
Thank you. One moment, please. A question comes from Stephen Powers with Deutsche Bank. Please go ahead.
Great. Thank you. I just wanted to follow up on the supply topic. It sounds like you've made good headway and have good visibility to improvements going forward. I guess just framing that, is there a way to think about what the supply challenges in the first quarter cost you? As you move forward, with those supply bottlenecks resolved, do you kind of, you know, resume a more normal growth trajectory in those categories? With those issues behind you, do you sort of accelerate catch up over the next couple of quarters, as you dig out of the hole?
Is there, you know, is it more prudent for us to think about, you know, a more gradual ramp of recovery, you know, again, as those issues abate? Thank you.
Andre, maybe Carlos then.
Okay. good morning, Stephen. Thanks for your question. look, we obviously expect as some of the solutions, the problems get solved, as Carlos indicated, we expect over time to be reducing inventory to retailer, and that should come together with some improvements in the top line performance. again, it's all contemplated in our guidance here. remember that our priority in the U.S. is to grow in the growth platforms. The priority growth platform have performed very well in the first quarter, particularly Taste Elevation and Easy Meals. We expect categories like reduced to improve their performance throughout the year as those problems get behind us.
In other categories, like in meats, as Carlos also said, not necessarily we're gonna be strong acceleration in growth because we're also trying to be prudent about having the profitability there. It's about having the right balance. Yes.
I mean, you know, there's not much to add. What I would say is we continue to see the improvements in service levels. Just to give you a, you know, kind of a framework. Last year, I think at this time of the year, we were kind of in the mid-80s. We are now, you know, in the mid-90s, actually closer to the high levels of 90s as we exit the first quarter. I feel like, you know, we do have a couple of categories that I mentioned earlier, where we have some isolated challenges, but overall, the business, we are certainly in the right trajectory to continue to service the business the right way as we go forward.
Thank you very much.
Operator, that'll be it for the Q&A session. I'd like to turn it over to Miguel for some closing comments.
All right. I just wanna thank you, for the time you spent with us. Looking forward to sharing more information and more results with you. Thank you so much.
Thank you. With that, we conclude today's conference call. Thank you for your participation. You may now disconnect.