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WK Kellogg Co (NYSE:KLG) Q1 2024 Earnings Call Transcript

WK Kellogg Co (NYSE:KLG) Q1 2024 Earnings Call Transcript May 7, 2024

WK Kellogg Co 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 Q1, 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 first 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.

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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. For periods prior to the spinoff are also presented on a standalone basis. For periods after the spinoff, results are presented on an adjusted basis and compared to our 2023 standalone adjusted results. 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.

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Gary Pilnick: Thanks, Karen, and good morning, everyone. Thanks for joining us. For today's call, I will discuss first quarter results, business performance and the progress we are making executing our strategy. You will hear how we're on track and delivering on our commitments. You will also hear how we're optimizing our business by being a focused, integrated team, which leads to our stable top line and expanding margins. I will then turn the call over to our Chief Financial Officer, Dave McKinstray, who will provide additional detail on our Q1 performance. We will close out the call with time for Q&A. On Slide four, before moving to our financial results, I would like to remind you of the unique opportunity that we have at WK Kellogg Co. If you zoom out and simplify our approach, there are two things that we believe will deliver outsized value: First, maintaining a stable top line and second, expanding EBITDA margin by 500 basis points as we exit 2026.

This is the goal of our first strategic horizon. We believe we will deliver significant value for our stakeholders by growing our margin from 9% to 14% while maintaining our top line. You have already seen the early results as our top line has improved quarter over quarter. Add to that, we have discussed improvements in our operating efficiency, our customer service and capacity during our Q4 call and at CAGNY. What you will hear more of today and our future calls is how strategic priorities are working together to deliver on our unique opportunity. As we have said, a 14% adjusted EBITDA margin is a milestone, not a destination. We will focus on continuing to drive margin improvements beyond 2026 during our second strategic horizon. Now let's look at our financial results for Q1 and see how our performance fits squarely in line with our expectations for this year as well as our long-term model.

Looking at slide five, you could see our financial results for Q1. For the Q1, adjusted net sales declined 0.8%, in line with our full year guidance and a sequential improvement versus Q4 2023. We previously discussed that we would be lapping our last price increase in March, and you likely saw in the public data that our results improved as we moved through the quarter. Adjusted gross margin expanded 240 basis points. This performance reflects the benefit of everything we do being in service of cereal and focusing our organization on continued operational discipline and enhanced execution. We delivered adjusted EBITDA of $75 million, 13.6% growth versus year ago and a margin of 10.6%, reflecting the benefit of improved gross margin. We are encouraged by our start to the year and how the organization is executing our priorities.

Turning to slide six. The U.S. cereal category improved sequentially and was broadly flat in Q1, with volume declining low single digits and, as we mentioned on previous calls, the gap between price and volume narrowed. Our performance in the U.S. lagged the category slightly as we continue to see the impact of our 2023 list price increase, which we did not fully lap until March. We are pleased with the performance of our core portfolio of iconic brands. Four of our core six brands grew in the quarter despite the headwind from lapping price. And our Canada team delivered excellent results, growing 4.6% during the quarter and extended our category leading share position by 240 basis points to 39.3%. Overall, the business performed largely as expected, and our Q1 performance has us on track for the year.

Now let's look at our strategic priorities on slide seven, all of which you've seen before. Today, I will start with a brief reminder of each and then give you a tangible example of how our priorities work together to drive the business end to end. Our first pillar of driving an integrated commercial plan to win brings together our demand creating infrastructure with our instore activation. This priority allows us to operate more seamlessly as we move our products from idea to shelf to consumers' pantries. Next, our second strategic pillar, modernizing our supply chain, is about delivering meaningful operating improvement, gaining flexibility and agility to win in the market and driving increased reliability. As we have said, this is the centerpiece of our margin expansion efforts and also helps to drive our top line.

Finally, our third pillar, unleashing an energized and winning culture. This underpins how we do things at WK. It's something we call the WK Way. Now let's look at an example of how our strategic priorities work together and operate in an integrated way to drive the business. Slide eight demonstrates how we are executing end to end with our largest brand, Frosted Flakes, which grew dollar sales 1.4% in the U.S. in Q1. First, we are executing our new marketing model, and Frosted Flakes is one of the first brands on which we focused. It starts with a new ad campaign, which we're running in both the U.S. and Canada. The next generation of Their Great campaign was developed with additional assets specifically designed for a variety of media channels, including TV, digital and social.

These assets allow us to target and expand our reach to different cohorts, notably without additional cost. Second, our dedicated sales force is activating in store. During the quarter, we leveraged in store programming to highlight the brand and are better utilizing our data and analytics to drive store specific insights. One example of how our commercial teams are working in tandem is our collaboration with Crocs. Our growth team secured a relevant partner, developed specialized food with a cobranded box and offered specialty Crocs shoes to consumers. The partnership of our iconic Tony the Tiger and Toucan Sam characters with the popular Crocs brand brings excitement to the category, and our sales team is selling the collaboration all the way through.

They brought our innovation to customers and secured merchandising, allowing us to be ready on shelf and display to excite consumers and to drive conversion for our customers. And third, this is all enabled by a reliable supply chain. Better customer service enabled by OEE improvements means we can fulfill our customers' needs consistently and win new opportunities. Unique pack sizes and culturally relevant innovation allow us to win in different channels and with different consumers. This ability to reliably supply our core and innovation as well as the different pack sizes and formats consumers are looking for is resulting in success across multiple channels. We recognize this is one brand, and we still have work to do as we transform our business.

But this is a great example of how we're executing our integrated strategy end to end across marketing, sales and supply chain to drive positive business results. Now let's turn to slide nine to discuss how we're advancing our supply chain priorities. Here's a reminder of how we approach modernizing our supply chain with some of the proof points we've discussed with you. Our approach of investing capital, building capabilities and consolidating the network will result in more reliable and efficient operations, delivering enhanced margin performance. First, we talked to you about investing capital, for example, in Belleville, where we are expanding the facility and installing new equipment to shift production to one of our most efficient and effective locations.

We also work with city and state officials to supplement investments at our Battle Creek location. Next, on our Q4 call, you heard about how we are building capabilities through implementing high performing work systems and through our WK Academy, a comprehensive training program. Combined, these investments in our people create even more capability and engaged teams that drive continuous improvement. Through the WK Academy, our capability building is already taking root, creating higher levels of engagement, which is showing up in our results. For example, in Q4, we achieved our highest level of customer service in four years, which we delivered by improving plant reliability and efficiency. OEE improved across our plants, allowing us to enter 2024 in a more reliable product supply posture.

And we are pleased that we have maintained that higher level of efficiency into the Q1. Finally, at CAGNY, we shared how we are consolidating production on our shred platform that produces mini wheats from three lines at three separate facilities to two lines at two of our lower cost facilities. Now let's turn to slide 10 for another proof point. Since we became an independent company, we have been working to establish better integration across our teams in Q1. That integration enabled us to better align our demand plan with our production plan. This provides better visibility to our procurement team when sourcing materials and ensures our manufacturing teams are producing the right product at the right time. This end-to-end connectivity within our supply chain has allowed us to reduce waste through fewer inventory write offs, which was a positive driver of our Q1 gross margin performance.

While we're just getting started transforming our supply chain, this is a good example of how our focused and integrated team can drive enhanced margin through improved end-to-end business planning and enhanced supply chain reliability. Each time we have spoken with you, we have provided updates on our supply chain. You can expect that to continue, and we'll provide another update on our next earnings call. Finally, let's turn to slide 11. Since Investor Day last August and at every investor call since, we've shared with you the ways in which we're making meaningful progress against our strategic priorities. Our transformation is underway. You can see that in the way our new marketing model is coming to life. You can see it in how marketing, sales and supply chain are operating in an integrated way.

And you could see it how it's coming through in our financial results. This is all underpinned by the WK Way, our strong and unique engagement across our organization. As I said, it's early days and there's much work to be done both near and longer term, but we are encouraged by our start to the year. We're executing our plan, and we're focused on delivering on our commitments. And now I'll turn the call over to Dave to walk through our financial results in more detail.

Dave McKinstray: Thank you, Gary. As a reminder, due to the spin, our first quarter results and future 2024 results are based on a comparison to our 2023 standalone adjusted results as we believe this provides the best comparable for our business. Further detail of these measures and reconciliations have been provided in today's press release and the appendix to this presentation. Now looking at our results on slide 13, you will see the adjusted net sales for the first quarter were $707 million a 0.8% decline versus the prior year period. This is an improved trajectory versus our fourth quarter results. As we spoke about on our fourth quarter call, the gap between price and volume continued to narrow for both us and the category during the first quarter.

Price realization for WK was 6.3%, offset by volume decline of 7%. Recall, in the fourth quarter, our net sales declined 2.7% with positive price of 7.5% and a volume decline of 10.1%. This improved trend in volume is due in part to the lower impact of price elasticities as we lapped our last major price increase in March. Shipment volume also benefited from an increase in retailer inventory versus last year, which we expect to normalize in the second quarter. In the U.S. Frosted Flakes, as Gary outlined, along with Raisin Bran and Rice Krispies were three of our fastest growing brands in the first quarter. In Canada, the business continued its strong performance behind brands like Frosted Flakes and Mini Wheats. Adjusted EBITDA for the first quarter was $75 million a 13.

6% increase versus the prior year quarter, driven by the benefit of price mix and improved productivity. Our EBITDA growth is a result of our improved supply chain operations sustained improvements realized in late 2023. In Q1, we also benefited from increased end to end focus, which significantly reduced waste. As we step back, the business is performing as we forecasted and volume and price are narrowing. Our top line has been stable and we delivered profitability improvement. Turning to slide 14, I will now focus on our operational highlights. Building off our net sales performance I spoke about on the prior page, adjusted gross margin for the first quarter was 29.2%, a 240-basis point improvement versus the prior year. This was largely the result of our operational efficiencies referenced on the prior slide.

Recall that in Q4, our gross margin reached the highest level in 12 quarters at 29.2%, and we have sustained that meaningful improvement in gross margin during the first quarter. This reflects a tangible benefit of the focused and integrated way in which we are operating. Adjusted EBITDA margin in Q1 was 10.6%, a 130-basis point increase versus the prior year period, driven by the flow through of gross margin, which was partially offset by higher brand building in the first quarter as we rephased investment from the second half of the year. Looking forward, we expect gross margin to continue to be the primary driver of EBITDA improvement. On our below the line items, interest expense in Q1 was $8 million and other income was $6 million. Our reported tax rate for the first quarter was 25.9%.

For 2024, we now expect our full year tax rate to be approximately 25%. Slide 15 demonstrates how the unique opportunity of a stable topline and margin expansion is already coming through our results. We showed this slide previously and have updated to show our trailing 12-month performance through Q1. Looking at the slide, we are consistently delivering net sales in the $2.7 billion range. Our stable top line performance has been a positive catalyst for our margin improvement and has been enabled by our improving supply reliability. Next, since Q2 2023, we've seen meaningful increase in adjusted gross margin, gaining 200 basis points. 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 adjusted EBITDA margin, our gross margin improvement is largely flowing through, and profitability has significantly improved, moving from 8% to 9. 8%, a 180-basis point increase on a trailing 12-month basis. Earlier, we spoke to the unique opportunity for WK. In our short time as an independent company, we are already making progress against our first horizon goal of 14% adjusted EBITDA margin as we exit 2026. Next, I'll discuss our debt position on slide 16. We ended the first quarter with $494 million of debt and cash and equivalents of $70 million resulting in net debt of $424 million an increase of $14 million versus last quarter. This increase is driven by seasonal impacts of first quarter cash flow, largely due to the payment of incentive compensation within the quarter.

Overall cash flow for the quarter was slightly ahead of our expectations, driven mainly by timing of investments to stand up the company and exit TSA agreements. We continue to progress on our work in this area, and there is no change to our estimated cash investment of approximately $80 million this year. As noted on our fourth quarter call, in 2024, we'll continue to generate positive underlying cash flow, and we expect our total free cash flow to be slightly negative due to the aforementioned onetime investments in standing up the company. Note, this excludes the impact of investment in modernizing our supply chain, which we will provide an update on later this year. Turning now to slide 17. Today, we are reaffirming our 2024 guidance we provided in February on our fourth quarter call.

We expect full year 2024 adjusted net sales growth to be in the range of negative 1% to positive 1%. As a reminder, Q2 net sales will be impacted by the retailer inventory build in Q1. We expect adjusted EBITDA growth in the range of 3% to 5%, which reflects dollar delivery of between $265 million and $270 million. Importantly, recall, this EBITDA growth includes lapping the benefit of the onetime insurance recoupment in Q2 of 2023 of $16 million which impacts the shape of our first half profit delivery. And now I'll hand it back over to Gary to close out the call.

Gary Pilnick: Thank you, Dave. As we said at the top of the call and what we hope you heard today is that we're on track, executing our strategy and driving margin improvement. We know it's early days with more work to do. That said, we are certainly pleased with our first quarter results and how our team is executing, and it provides us with even more confidence for the year. Importantly, every day, I see how our culture is building and growing organically. How we are collaborating across the organization to drive the right outcomes for the business is exceptional, and it is showing up in our results. I would like to express my thanks to our team for their continued efforts to drive this business forward. We are executing like a 118-year-old start up, and we're just getting started. I will now open the call to Q&A.

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To continue reading the Q&A session, please click here.