WK Kellogg Co (NYSE:KLG) Q4 2023 Earnings Call Transcript

WK Kellogg Co (NYSE:KLG) Q4 2023 Earnings Call Transcript February 13, 2024

WK Kellogg Co misses on earnings expectations. Reported EPS is $0.18 EPS, expectations were $0.21.
KLG isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day and welcome to the Q4, WK, Kellogg Co. Earnings Conference Call. Today’s call is scheduled to last one hour, including remarks by management and then a question-and-answer session. All lines have been placed on mute to prevent any background noise. [Operator Instructions]. I would now like to turn the call over to Karen Duke, Vice President, Planning and Investor Relations. Please go ahead.

Karen Duke: Thank you, operator. Good morning and thank you for joining us today for a review of our fourth quarter results. I am joined this morning by: Gary Pilnick, our Chairman and Chief Executive Officer; and Dave McKinstray, our Chief Financial Officer. Slide number two shows our forward-looking statements disclaimer. As you are aware, certain statements made today, such as projections for company’s future performance, are forward-looking statements. Actual results could be materially different from those projected. For further information concerning factors that could cause these results to differ, please refer to the factors listed on the disclaimer slide as well those in our SEC filings including the risk factor section.

As we discuss our results today, unless noted as reported, we’ll be referencing the respective non-GAAP financial measure, which adjusts for certain items included in our GAAP results, and for periods prior to the spinoff are also presented on a standalone basis. You can find definitions of each non-GAAP measure and GAAP-to-non-GAAP reconciliation within our earnings release and in the appendix to the slide presentation. I will now turn the call over to Gary.

Gary Pilnick : Thanks, Karen, and good morning, everyone. Thank you for joining us today to review our fourth quarter and full year 2023 results. For today’s call, I will provide a summary of our 2023 results, market performance, 2024 guidance, and discuss the progress we’re making on our overall strategy and strategic priorities. Across each topic, you will hear about the benefits we’re already seeing from a more focused and integrated team. I will then turn the call over to our Chief Financial Officer, Dave McKinstray, who will provide additional detail on our performance and guidance. We will close out the call with time for Q&A. Turning to slide four, these are our key messages for the day, our commitment to fulfilling promises, our focus on execution, and the impact of our engaged team.

We introduced ourselves in August at Investor Day before we were a standalone public company. At that time, we provided our outlook for 2023 and 2024. In November, we provided 2023 guidance ahead of our August outlook, and today, I’m pleased to report, we’ve delivered net sales at the high end of our guidance range and EBITDA margin above our guidance range. The team has visibility to effectively plan our business. They are executing that plan, and we are on solid footing as we look forward. At Investor Day, we also reviewed in detail each of our strategic priorities. As you would expect, we’ve been executing on these priorities, making meaningful enhancements across each of our marketing, sales, and supply chain functions. During our early days, we are seeing the benefit of a more focused and integrated team.

We are indeed driving an integrated commercial plan to win as we launched our new marketing model and stood up our single category dedicated sales force. We are also modernizing our supply chain and driving operating efficiencies. Better yet, we are executing end-to-end with improved connectivity across the enterprise. Underpinning all of this is our effort to unleash an energized and winning culture, which is growing organically every day. Our people are engaged, focused, and eager to drive the business forward, and that engagement extends to our customers, communities, and other key stakeholders. This engagement is showing up in our performance. This confirms what we know to be true. We have the right team, the right strategy, and the right model to deliver value for our stakeholders.

Moving to slide five, let’s review our financial results. Dave will cover the full financials and guidance in more detail, and I’ll provide highlights here. For the full year 2023, net sales increased 2.8%, leading to a gross margin improvement of more than 400 basis points, with 290 basis points flowing through to EBITDA. Our performance reflects the benefit of positive price mix, our recovery from the fire and strike, and underlying business momentum. The year ended better than planned as we continue to improve our operational efficiency and maintain cost discipline. We exceeded the EBITDA guidance we provided in November and hit the high end of our sales guidance. For 2024, our guidance calls for net sales growth in the range of negative 1% to positive 1%, and EBITDA growth in the range of 3% to 5%.

This EBITDA forecast is ahead of what we said at Investor Day and during the Q3 earnings call. We continue to be on-track with key separation milestones, on-track with our strategic priorities, and we are on-track to deliver our financial outlook. Now let’s take a look at the cereal category on slide six. Cereal is a repertoire category with a fast purchase cycle, nearly 50 million purchase decisions each week. Consumers typically have multiple boxes in their pantries, and are looking for cereal to satisfy a variety of consumer needs and occasions. It’s also a remarkably affordable category, and delivers the type of value consumers are looking for, as cereal, milk, and fruit is less than a dollar per bowl. Even with consumers under pressure and exhibiting value-seeking behavior, it’s notable that the premium segment performed very well in 2023.

Cereal is a dynamic category serving many consumer preferences and delivers on taste, convenience, nutrition, and affordability. In the U.S., the category grew 5% in 2023, mainly through positive price mix, demonstrating the durable nature of the category. These are a few of the many reasons we are so very excited about the cereal category. Now let’s look at how our business is performing on slide seven. For the year, we grew U.S. retail dollars at 6.3%, leading to market share growth of 40 basis points. Full year share was 27.8%, which represents a nearly 260 point improvement from our low point in 2022. Our performance for the year was broad-based across our portfolio, and builds on our recovery from the fire and strike as we regain share on our core six brands while executing the spin.

In Canada, we’re the market leader at 37.9%, and improved our position 160 basis points in 2023, highlighted by our performance in December when we achieved a 40% share. This is testament to the relevance of our brands and our team’s ability to execute an exciting commercial plan. We’re pleased with our recovery to-date and have further opportunity ahead of us. Now let’s look at how the execution of our strategy is underway. On page eight, let me first remind you of our strategic priorities. Our integrated commercial plan to win brings together our demand-creating infrastructure with our in-store activation. This priority allows us to operate more seamlessly end-to-end with greater agility. Next, we’ll update you on our second strategic pillar, modernizing our supply chain.

I’ll talk about how we’re working with key stakeholders to improve plant productivity and economics, as well as taking action to improve our operating efficiencies through new ways of working. Our third strategic pillar is to unleash an energized and winning culture. Our people are the most valuable asset, and I could not be more proud of how they’re showing up and driving meaningful change. Now let’s take a look in more detail at how our integrated commercial plan to win is coming to life. On slide nine, let’s start with the first half 2024 innovation. We all know innovation is critical to the cereal category. It delivers consumer excitement, grows the basket, and drives points of distribution. We have a strong record of cereal innovation, including the introduction of three top innovation items last year.

That same team is now part of WK. They continue to lead our commercial organization and developed another strong innovation plan for 2024. What’s different about this year’s innovation is that it includes the launch of two new premium brands, Mouth Off and Extra. Mouth Off delivers against current food trends with 22 grams of protein and zero sugar. Extra is a taste-led granola. These brands have been launched in an agile way, leveraging social media to drive awareness. As we have discussed, the premium segment is growing, and we have been participating with Special K Zero and Special K High Protein. We’re excited to add Mouth Off and Extra to our premium offerings this year. The next element of our innovation is expanding appeal of our existing brands across cohorts.

As we reignite Kashi, we launch Smoothie Loops, a cereal with all family appeal. Our innovation on brand and Special K drives excitement and focuses on the nutrition seeking consumer. And finally, we continue to expand in occasions, introducing mini snacks. We know cereal is consumed during a variety of occasions, having discussed our recent cereal for Dinner campaign and that growing occasion. Snacking is yet another moment where cereal hits the mark and these innovations drive right at it with our brands and unique food. This is just the beginning. We have more innovation coming later this year that will tap into seasonal excitement and cultural relevance. It’s worth noting that all of this was achieved while preparing for the spin throughout 2023, a good example of the focus and agility of the team.

Another example of agility to quickly activate end-to-end is on slide 10, and that was the recent collab with the University of Michigan to celebrate the College Football National Championship. In just three days, we went from idea to product and at midnight, immediately following the Wolverines victory in the game, we launched a Fruit Loops National Championship box which sold out in a matter of hours and we had to produce even more. This was a chance for us to connect with our Michigan community and importantly, we generated significant media value from the coverage, garnering close to 100 million impressions. In fact, you could see that Toucan Sam was invited to the championship parade in Ann Arbor and received a victor’s welcome from fans chanting his name along the parade route.

This is a great example of the power and cultural relevance of our brands. Just on slide 11, we’ll discuss how revenue growth management is strategically designed to deliver on our financial commitments. Our 2024 RGM activities are focused on three main areas, premiumization, which we discussed previously, promo effectiveness and price pack architecture or PPA. Promotional effectiveness is about designing and executing our promotional activities to drive better returns. The integration of our teams across marketing, sales and supply chain gives us increased visibility, which allows us to more optimally design and plan. Through our dedicated sales force, we can also execute those promotions better and our single category focus means we can drive better merchandising and amplify promotions in store.

Finally PPA, we have launched new standardized pack sizes across multiple brands to address both customer and consumer preferences, ensuring we have the right pack at the right price in the right place. This also drives more standardization in our business, which creates efficiency within our supply chain and allow customers to offer the type of unique value their consumers are looking for. This was a huge undertaking and a team is successfully executing this transition. In summary, we’re moving fast to drive our financial performance through innovation, improving promotional effectiveness and an RGM plan designed to create value. Now during this slide 12, let’s discuss how we’re advancing our priority of modernizing our supply chain and how we’re improving plant economics through new ways of working.

During the Q3 earnings call, we told you we’re already working with key stakeholders in certain locations to improve plant productivity and economics. In Q4, we were excited to announce that in partnership with our Battle Creek plant employees and their union, the city of Battle Creek and the state of Michigan, we unlocked the solution where our business, our people and our community win. We are now working collaboratively with our people to begin implementing high performing work systems, the operating model utilized in our most efficient plants. As a reminder, high performing work systems result in a more agile, capable and engaged workforce, a disciplined approach to problem solving and consistent governance, all of which drives improved performance.

We all know this model works as we see it every day where it’s already implemented effectively. Also important, the city and state provided meaningful financial support to help offset the cost of the investment in our Battle Creek plant. This is a good example of the way we’re going to work with our people and our communities to drive business forward and improve productivity, efficiency and engagement. Another step in modernizing our supply chain is to improve the ongoing efficiency and effectiveness of the network. On slide 13, you can see our customer service levels and the trajectory of our improvement, a key step in strengthening trust with customers. Customer service is about discipline, focus and execution. That is a key to our success and you can see the impact the WK team is making already.

In Q4, we achieved our highest level of customer service since March of 2020 and we even saw meaningful improvement versus Q3 2023. We’ve been able to reach these levels by improving plant reliability and efficiency. Overall equipment effectiveness or OEE improved in Q4 across our plants, leading to a more reliable product supply. Its early days and we’re just getting started. These are the type of benefits we expect to drive into the future as we modernize our supply chain. Finally, on slide 14, let’s see how it all comes together. We speak about how we’ll focus, integrate and invest. We’re a focused company. Everything is in service of cereal. That focus resulted in the right strategy and we have the right team with the right capabilities and resources to execute our plan.

We are an integrated company, driving greater visibility across the enterprise which allows us to make quicker decisions and rapidly bring ideas to life. And that focus and integration informs how we invest in our infrastructure, capabilities and most importantly, our people. When you bring all of this together, our performance improves. We drive better business outcomes and we gain momentum. Now, I’ll hand the call over to Dave to take you through our financial results and outlook.

Dave McKinstray: Thank you, Gary. Today, I will focus my comments on our fourth quarter financial results and the related drivers. My commentary will be on a standalone, adjusted basis as we believe that provides the best representation of our business going forward. Further detail of these measures and reconciliations have been provided in today’s press release and the appendix to this presentation. To begin, I’m pleased with how we executed our plan and delivered results ahead of expectations. Since relaunching the business in the second half of 2022, we’ve reshaped the timing of our brand investments. Those investments were diligently planned week-by-week and we saw the benefits through improved ROI throughout 2023. Now looking at our results on slide 16, you will see the net sales for the fourth quarter were $651 million, a 2.7% decline versus a prior year period.

This performance reflects positive price of 7.5% offset by volume declines of 10.1% related to among other things, rising price elasticity due to the timing of our price increases. We spoke about this dynamic on our third quarter call and said at the time that we expected to continue into Q4 and early Q1. From a brand’s perspective, Rice Krispies and Corn Flakes benefit from seasonal recipe execution and our Canadian business continued its strong performance in the quarter behind brands like Frosted Flakes and Vector. For the full year, we delivered net sales of $2.74 billion, which was at the high end of our guidance, a 2.8% increase versus a prior year, which lagged our in-market growth of greater than 6% due to the impact of lapping a retailer inventory rebuild in the front half of 2022.

EBITDA for the fourth quarter was $53 million, a 43.2% increase versus a prior year quarter, driven by the benefit of price mix, improved productivity, and optimized commercial investment. Our significant EBITDA growth is a result of our improved supply chain execution and focus on operational discipline that Gary outlined. Full year EBITDA of $258 million is a 50% increase versus a prior year and reflects the benefit of lapping the fire and strike in the first half and positive price mix. Again, our increased focus and improved execution allowed us to deliver EBITDA ahead of our guidance and creates a strong foundation to build from in 2024. Turing to slide 17, I will now focus on our operational highlights. Gross margin for the fourth quarter was 29.2%, a 300 basis point improvement versus a prior year.

This improvement was a result of our balanced commercial approach and operational efficiencies within our supply chain. For the full year, gross margin improved 410 basis points to 28.9%. This improvement was primarily driven by positive price mix and further recovery from fire and strike. As a reminder, our full year gross margin also benefited from a one-time insurance recruitment of $16 million in Q2 of 2023, which was worth 60 basis points at gross margin for the year. EBITDA margin in Q4 was 8.2%, a 270 basis point improvement versus a prior year period, driven by the flow-through of gross margin improvements and the re-phasing of our brand billion investments to quarters with higher levels of ROI earlier in the year and the impact of incentive compensation.

For the full year, we delivered EBITDA margin above the high end of our guidance range at 9.4%, a 290 basis point improvement. This improvement reflects the drivers I mentioned earlier in gross margin and EBITDA. Looking forward, we expect gross margin to continue to be the primary driver of our EBITDA improvement. Looking at our below-the-line items, interest expense in Q4 was $10 million and other income was $9 million. Our adjusted effective tax rate for full year 2023 was 24.9%. For 2024, we expect our full year effective tax to be in the range of 24% to 25%. Turning now to slide 18, for the year, our business has performed as we’ve expected and we continue to show steady improvement. We showed this slide at the Q3 column and have updated it to show our trailing 12-month performance through the end of Q4.

We’re pleased to see the continued trajectory improvement. Looking at the slide, you can see we are consistently delivering net sales and the $2.7 billion range. Our stable top-line performance has been a catalyst for our margin improvement and has been enabled by our improving supply reliability. Next, you’ll see that since Q1, we’ve seen meaningful increase in gross margin. We’ve gained 210 basis points and in Q4, achieved the highest level of gross margin of the last 12 quarters. This improvement is primarily related to driving operational efficiencies within our supply chain and from positive price mix from our revenue growth management initiatives. Finally, looking at EBITDA margin, you can see that our gross margin improvement is largely flowing through and profitability has significantly improved, moving from 7.8% to 9.4%, a 160-point increase.

This is the type of improvement we expect as we finish 2023. Next, I’ll discuss our debt position on slide 19. We ended the year with $499 million of debt and cash and cash equivalents of $89 million, resulting in net debt of $410 million. As we said on our Q3 call, at the completion of the spin, we drew $500 million on our term loan A and $164 million on our revolver to fund the dividend back to Kellanova. These debt levels were temporarily elevated as core working capital had not yet reached run rate levels at the time of the spin. Working capital largely normalized throughout Q4 and as a result, we exited Q4 at target debt levels and with zero balance on our revolving credit facility. We ended 2023 with a leverage ratio of 1.6 times net debt to adjusted EBITDA and expect to end 2024 with leverage of approximately 1.8 to 2 times adjusted EBITDA.

Increased leverage in 2024 is due to one-time investments of approximately $80 million to stand up the company as we work towards TSA exit. This leverage ratio excludes the impact of investment to modernize our supply chain, which we’ll provide an update on later this year. In 2024, we’ll continue to generate positive underlying cash flow. However, we expect our total free cash flow to be slightly negative due to the one-time investments and standing up the company. Similar to what I noted prior in the leverage discussion, this cash flow excludes the impact of investment and modernizing our supply chain. Turning now to our outlook on slide 20, based on the momentum in our business and confidence we have in our plan, we are providing EBITDA guidance ahead of the outlook we provided at Q3.

We expect 2024 full-year net sales growth to be in the range of negative 1% to positive 1%. Due to our revenue growth management initiatives, we expect full-year price to be positive low single digits and volume to decline low single digits. For 2024 EBITDA, we expect growth in the range of 3% to 5%, which reflects EBITDA dollar delivery of between $265 and $270 million. This is an increase versus the $255 to $265 million range we provided Investor Day and reaffirmed on our Q3 call. Importantly, this EBITDA growth includes the lapping of the benefit of the one-time insurance recruitment in Q2 of 2023 of $16 million. For the full-year 2024, we expect total interest expense of approximately $40 million and other income to be approximately $25 million.

Other income includes the benefit of pension income of $45 million, which is a non-cash item. Similar to our leverage outlook I covered on the previous slide, this interest expense excludes any impact of increased debt-to-fund our supply chain modernization. And now I will hand it back over to Gary to close out the call.

Gary Pilnick : Thank you, Dave. As we sit on the top of the call, and what we hope you heard today is that we are fulfilling promises, that we are focused on execution, and that our engagement is driving impact. 2023 was a transformational year for WK. As we stood up an independent company and delivered strong performance aligned to our strategic priorities and our expectations. I would like to thank our team of more than 3,000 colleagues for their efforts and contributions to a successful year. In 2024, you can expect more of the same as we focus on delivering our financial model, bringing even more excitement to the cereal category, and executing like a soon-to-be 118-year-old startup. I’ll now open the call to Q&A.

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Q&A Session

Operator: Thank you. [Operator Instructions]. Our first question for today comes from Andrew Lazar of Barclays. Your line is now open. Please go ahead.

Andrew Lazar: Great. Good morning and thanks. Good morning, Gary and Dave.

Gary Pilnick: Good morning, Andrew. How are you?

Dave McKinstray: Good morning Andrew.

Andrew Lazar: Good. Thank you. So to start off, maybe I was hoping you could talk a bit about what you’re seeing in terms of the overall cereal category at this stage. One of your competitors, I think, recently said something to the effect that maybe towards the end of the quarter, the declines in the cereal category had maybe started to moderate a bit. I’m wondering if you’re seeing sort of something similar, and if so, if you think it’s attributable to maybe some one-off factors, whether, et cetera, or maybe the start of something a little more sustainable?

Gary Pilnick : It’s a great question, and thanks for asking that, Andrew. So when you think about the category, what we’re seeing in the category is it’s quite stable right now. The category has a lot of tailwinds to it, and when overall, when you zoom out, when you look at it over a quarter, over the last year, even as we enter 2024, we’re seeing a good stability across the category. And we’re one of the beneficiaries of that. And we think there’s a variety of reasons. You talked about whether you talked about other things. Where we go to on the top of that would be the consumers under pressure. This category is quite affordable. We talked in our prepared remarks, Andrew, about how a bowl of cereal with milk and fruit is under a dollar. You could see people trading into — consumers trading into our category. So we do think there’s a lot of tailwinds for the category, but we’re actually quite pleased with the way the category is performing.

Andrew Lazar: Great. Thanks for that. And then maybe I was hoping you could provide just a bit more color on how you see the shape of the year playing out on the top line. I think on the 3Q call, and then today as well, and you stated you expected maybe still some volume pressure in the first part of the year, partly given some of the timing of your pricing actions versus others. So I was hoping you could get into a little bit more detail on how you see the first part of the year playing out in terms of that price mix versus volume combination? Thanks so much.

Dave McKinstray: Yes, Andrew. I think that’s quite fair, and that was what we talked about in Q3, so I appreciate you raising that. The first thing I think we would say is, and because you mentioned Q3, I’ll mention it here. The business is performing as we expected. We forecasted the business. It’s playing out as we thought. I give the team a lot of credit for the way they’re forecasting, and you’re exactly right. We have talked about what the balance of the year would look like. Now, we’re careful. We don’t give quarterly guidance, but you’re exactly right. We talked about the impact on our business of lapping pricing. Our last major pricing action of last year happened in March, so we’re going to be experiencing that and managing through that as the year begins.

So I think you’re right about the pressure that you just mentioned. The other thing that’s worth mentioning is in Q2 that we had a one-time benefit from insurance payment last year of $16 million, so that’s also something that we’ll be lapping when we get to Q2. But overall, we feel good about what the shape of the year looks like, and one thing that we did mention that’s worth mentioning here about volume is in Q3, we talked about the narrowing of the gap between dollars and volume. We saw that happen between Q3 and Q4. If you look in the public data for P1 for January, it’s happening even more, and you add to that a stable category. We actually think that’s quite good for the category, good for our business, and good for our people.

Operator: Thank you. Our next question comes from David Palmer of Evercore ISI. David, your line is now open. Please go ahead.

David Palmer: Thanks. Good morning and congratulations on the improving profitability. I guess my question is on reinvestment this year. You talked about a couple things, your efforts to improve service levels and supply chain, and in the past you’ve talked about efforts in merchandising, and perhaps that would require some in-store trade, and you talked about a couple brand launches, and then of course there’s advertising. Could you just talk about where the best dollars spent will be for Kellogg this year and longer term? And where you are reinvesting some of this profitability to get the flywheel going? Thank you.

Gary Pilnick : David, thank you, and I appreciate the commentary, and we are very proud of the results. This is our first quarter as a standalone company, so on behalf of the entire team we appreciate the congratulations you just provided. When we think about where we’re investing? We’re investing across the enterprise as a new company as we’re standing up. There’s a couple different areas that we’re going to focus on, and our P&L and our budget were fully loaded to do so, so you would start with supply chain. We’re already starting to see the benefits in our performance in our P&L. You heard us talk about what’s happening with Case Fill with OEE. That is the very beginning of the impact that our team is making. Sherry Bryce is our head of supply chain.

The work that her chain or team are doing across the network is already starting to pay dividends. We’ll continue to invest there as part of our program to modernize our supply chain, and that’s investing capital, as well as building capability. You add to that what we’re doing on the commercial side. What we like to talk about is when we’re talking about in-market pressure, it’s about returns. It’s about ROI. How do we make sure that we’re in market, that we’re balancing profitability as well as volume? We’ll continue to do that, and as the year moves forward, we’re constantly looking for other places to invest, and when we find areas to invest, they get a great return. We will certainly do that, but David, our budget is fully loaded. We have the investment dollars that we need to drive this business going forward and into 2024.