卡夫亨氏 (KHC) 2016 Q1 法說會逐字稿

Good day.

My name is Sabrina, and I will be operator today.

At this time, I would like to welcome everyone to the Kraft Heinz Company's first-quarter 2016 earnings conference call.

I will now turn the call over to Chris Jakubik, head of Investor Relations.

Mr. Jakubik, you may begin.

Good afternoon, and thanks for joining our business update for the first quarter of 2016.

With me today are Bernardo Hess, our CEO; Paulo Basilio, our CFO; and George Zoghbi, the Chief Operating Officer of our US commercial business.

During our remarks, we will make some forward-looking statements that are based on how we see things today.

Actual results may differ due to risks and uncertainties, and these are discussed in our press release and our filings with the SEC.

We will discuss some non-GAAP financial measures during the call today, and you can find the GAAP to non-GAAP reconciliations within our earnings release and at the back of the slide presentation available on our website.

And with that, let's turn to slide 2, and I'll hand it over to Bernardo.

Thank you, Chris, and good afternoon, everyone.

Here we are again.

It seems like only a few weeks ago we were reviewing Q4 results.

Last call, we gave our agenda for 2016.

So how we are doing so far?

We are off to a good start.

Good, not great.

As expected, some headwinds hung around, including consumption trends in some key categories that held us back.

On our last call, we spoke about plans to address categories such as UK soups, US mac and cheese, ready-to-drink beverage and frozen nutritional meals.

And while we are making progress against those opportunities, and expect better performance as the year unfolds, they held back our results in Q1.

At the same time, our emphasis on profitable sales growth is paying off.

Our market share trends are improving behind innovation and marketing investments.

For instance, investments we have made in our global ketchup franchise are leading category growth in the US, Canada and Europe, and driving strong growth for us in developing markets.

In Europe, outside of UK soups, the rest of the portfolio is improving share performance in a challenging consumer and retail environment.

And we are seeing good gains from investments in the rest of the world -- pasta sauce in Latin America, soy sauce in China, and soups and mayo in Australia.

We are also able to improve our sales and go-to-market execution in what remains a challenging retail environment.

For instance, our case fill rate in the United States was 98%.

Europe was above target at more than 99%, and Canada achieved for the first time 97%.

Why is this important?

As we implement our manufacturing footprint initiatives, we are trying to keep our focus in two areas.

Customer service, where we had a good performance with our customers which is shown by increased service levels in the quarter.

In fact, we are already becoming the benchmark for customer service in some key categories.

And second, product quality.

We are pleased to report progress in the quarter, but with a lot of work still to be done.

Regarding the integration program, I'm also happy to report that our savings are coming in faster than we were expecting -- roughly $225 million in Q1.

Paulo will speak more about where we stand with the overall program later.

But faster progress towards our goal to achieve best-in-class margins allowed us to invest with greater confidence as we laid the groundwork for future growth.

Our big-bet launches are starting to gain traction in the marketplace and you have more to come.

George will talk about our strong pipeline for US big bets.

In Europe, we continue to go after opportunities to grow condiments and sauces with the March launch of Heinz Seriously Good Mayonnaise in the UK, Spain, Italy and Germany.

In Italy, we launched Plasmon Nutrimune, which contains a proprietary functional ingredient that significantly improves babies' immune systems.

And in both Europe and North America, we are beginning to go after white-space opportunities in food service.

Finally, we took further steps to bring our performance-driven culture to life.

As part of our MBO process, management by objective process, first-quarter performance appraisals are going well.

We now have 6,000 employees worldwide who have MBOs, up from 3,000 at this point last year.

So overall, good operating progress that we expect to lead to better execution and profitable growth going forward.

But let's turn to slide 3 to see what this means for a Q1 financial results.

On the top line, while we saw less foreign exchange drag than Q3 and Q4 last year, it was still a 4.5% headwind on Q1 results.

That being said, we had a solid organic net sales performance, up 1.1%, driven by a good balance of volume mix and price.

Pricing was up 0.3 percentage points, reflecting gains in most segments despite inflation in key commodities in the United States and Canada.

Volume mix was up 0.8 percentage points, reflecting growth in, first, condiments and sauces globally, with particular strength in developing markets.

Second, Lunchables and P3 in the US.

And finally, food-service expansion in the US.

At EBITDA, we drove strong dollar growth in margin performance, both year over year and sequentially from Q4 despite the Venezuelan devaluation impact that began in Q3 2015.

This was driven by a combination of our strong cost savings performance, favorable pricing relative to key commodity costs over the prior year and profitable top-line growth.

At the EPS line, adjusted EPS was up 37.7% versus the year-ago period to $0.73, primarily reflecting the growth in adjusted EBITDA.

Now I will hand over to George and Paulo to talk more about how we did in each reporting segment and what to expect going forward.

George?

Thank you, Bernardo and good afternoon, everyone.

Turning to slide 4, overall, we are encouraged by our US results so far this year, as it reflects steady commercial execution in a year of transformation.

In the first quarter, we had a mix of positives and negatives we have seen before.

We have continued our momentum from investments in Heinz ketchup and mustard, Philadelphia Cream Cheese, Lunchables and P3 and ready-to-eat refrigerated desserts.

At the same time, consumption and share challenges in ready-to-drink beverages, mac and cheese, frozen nutritional meals, and salad dressing remained.

And I will mention what we are doing about it in a moment.

We did deliver sequentially stronger organic growth in Q1.

Although, you will note that our growth was above consumption, which you would have seen in our first-quarter scanner data.

This was due to three factors.

First, we saw solid growth in our food-service business and nontraditional retail channels like club and dollar stores.

This is consistent with the business development for white-space opportunities I mentioned on our last call.

Much of it has been enabled by the combination of the Kraft and Heinz food service teams, and we should continue growing in coming quarters.

The other two factors were new product pipeline fill from our solid innovation agenda and shipment timing between quarters.

Which we do not expect to repeat in the second quarter.

We also saw our cost-saving initiatives pick up pace sequentially from Q4.

This is from ZBB and procurement savings adding momentum to the organizational structure savings we saw in the fourth quarter of last year.

It positions us well as we ramp up modernization and capability building within our manufacturing footprint.

And continue to invest behind our brands and big bets over the rest of the year.

I hope you have seen some of our advertising already, but our big bets activities are beginning to gain some traction in the marketplace, with more activities to come.

For example, the launch of our Kraft mac and cheese renovation has been well-received by consumers.

And we supplemented that with the launch of new premium mac and cheese under the Cracker Barrel brand in the same category.

We launched Capri Sun Organic and renovated our Kool-Aid Jammers product with fewer calories and no preservatives.

We added a new line of premium pasta sauces under the Classico Riserva brand made with no artificial ingredients or added sugar.

We strengthened our barbecue sauces business by adding new lines under the Heinz brand, betting on consumer regional preferences in this category.

And we added new lines to our salad dressing business, including new packaging formats.

It's very early days and we are not claiming victory in any category.

But to the extent we can prove the trend-bending ability of our big bets, it's not only good for Kraft Heinz; it's good for the center of the store in general.

With that, I will turn it over to Paulo to wrap up our prepared comments.

Thank you, George.

And good afternoon, everyone.

I will start on slide 5 and add a few notes on US Q1 financials.

Within organic growth, pricing was flat, reflecting pricing gains across most categories despite headwinds from deflation in key commodities.

Flat volume mix mainly reflected innovation in Lunchables and P3, the food-service gains, and shipment timing George discussed and gains in coffee that were partially offset by lower shipments of ready-to-drink beverages, where we were up against a pre-price increase buy-in with Capri Sun last year as well as lower consumption of bacon and frozen nutritional meals.

The Easter holiday shift did not play a significant role versus last year.

In terms of adjusted EBITDA in margin expansion, this was driven by integration program savings as well as two other factors.

One was favorable pricing relative to lower key commodity prices.

And the fact that we were comparing against Q1 last year, where the Kraft business saw pricing sales trail the impact of key commodity costs.

While we have seen a similar benefit for the past couple of quarters, we expect the pricing to be more in line with key commodity costs as we move forward.

The other factor, an offsetting impact was unfavorable volume declines in ready-to-drink beverages and frozen nutritional meals.

Let's turn the slide 6 to talk about the key factors impacting Canada in the first quarter.

In Canada, we continue to see strong currency headwinds, but the negative 10 percentage point impact from currency was slightly less intense than what we saw in Q3 and Q4 last year.

Organically, we delivered sequentially better sales performance with pricing gains exceeding the related decline in volume/mix.

As we said on the last call, heading into 2016, we were facing challenges to increase prices in order to offset higher input costs in local currency terms.

As a result, we saw positive pricing of 3.7% despite headwinds related to deflation in selected key commodities.

Volume mix went down 2.2 percentage points as solid growth in condiments and sauces was more than offset by a decline in cheese due to a reduction in promotion activity versus Q1 last year, as well as lower coffee and food-service shipments.

Adjusted EBITDA was up 33.6% versus the year-ago period despite a negative 14.2 percentage point impact from currency.

Adjusted EBITDA growth was driven by gains from cost savings initiatives and favorable pricing relative to higher local input costs that were partially offset by unfavorable volume/mix.

Overall, we saw a lot of EBITDA favorability this Q1 in Canada.

However, I would note that some of the Q1 upside was driven by favorable timing of pricing versus declining commodity costs.

As a result, we will not expect our EBITDA margins in Canada to continue at that level in Q1, as price levels are expected to be more consistent with the key commodity costs in coming quarters.

That brings us to Europe on slide 7.

In contrast to Q1 profitability in Canada being better than we would expect for the balance of the year, we expect the balance of the year in Europe to be progressively better than what we saw in Q1.

While we saw sequential improvement in Europe's organic sales performance in Q1, including an improving the volume mix trend, it was still down, and down largely due to higher promotional spending versus the prior year.

The increase in promotional spending was due to two factors.

First was a return to more normal promotional frequency in UK beans versus the prior year.

And as a result, we saw a solid lift in UK bean volumes.

The second factor affecting pricing was a Q1 infusion of promotional spending in UK soup to address distribution losses from Q4 programming execution.

While this led to a solid March performance, our January and February results were much more like what we saw in Q4, made worse by the fact we were at the high of the soup season.

This, along with the lower shipments of infant nutrition in the UK and Italy, led to a volume mix decline of 0.8 percentage points.

And offset both the solid volume gains in UK beans as well as ongoing growth in condiments and sauces across Europe.

Constant currency EBITDA also went down versus prior year and margins were less, both sequentially versus prior year.

Again, this was primarily due to investments in pricing to defend UK soups as well as weaker category consumption in that category.

We also had higher marketing costs versus the prior year in Q1 driven by investments behind big bets, but coming ahead of growth from these initiatives that we expect later in the year.

In the end, we feel better about the health of our European business than our Q1 numbers might indicate and are continuing to invest in profitable growth as we move forward.

Finally, we will look at the rest of the world on slide 8. Here, we saw slightly less foreign currency drag in Q1 versus Q3 and Q4 but still over 25%, mainly due to recognizing the devaluation of the Venezuelan bolivar at the end of Q2 2015.

In terms of organic growth, we saw greater organic sales growth for the second quarter in a row, driven by a good balance of volume mix and price.

Pricing of 2.1% was mainly driven by pricing to higher local input costs in Latin America.

Volume mix went up 8.3 percentage points due to strong growth in condiments and sauces in all regions, as well as strong beverage growth in Indonesia versus the prior-year period.

But I would note that the Indonesian beverage growth was mainly due to an earlier Ramadan shipments, so we will get back part of this favorability in Q2.

At EBITDA, we saw a 12.1% decline in adjusted EBITDA due to a negative 38.2 percentage point impact from currency, 29.5 percentage points of which was from the Venezuelan bolivar devaluation.

Constant currency adjusted EBITDA was up strongly in Q1, driven almost exclusively by volume gains and mix improvement.

That covers our Q1 results.

Before we go to Q&A, I want to quickly provide an update on two areas: our capital structure, and our expectations for the balance of 2016.

I will start with capital structure on slide 9.

I think it's important to recognize the significant steps we've taken and plan to take to strengthen our capital structure.

As you may have seen in our 10-K, we've taken steps to reduce and de-risk our pension and post-retirement liabilities.

We froze or ended executive retirement benefits plan where possible.

And during both last year and the first quarter, we've taken actions to improve our funded status by approximately $1.7 billion and further de-risk our plans by an additional $1.7 billion through terminations, buyouts and lump-sum offerings.

We have also been able to match our debt with our underlying business structure and believe we've made our balance sheet and P&L well-protected against currency volatility.

Going forward, we remain confident in reducing leverage from roughly 4 times net debt to rolling 12-months adjusted EBITDA at the end of Q1 to less than 3 times over the medium term.

In addition to growing EBITDA, three factors will also help us to get there.

One important step will be refinance our preferred stock when it becomes redeemable in June.

At current interest rates, we expect this will be a highly accretive action from both an earnings and cash flow perspective.

Second, we continue to expect to pay down $2 billion of debt by July 2017.

And third, we aren't planning to commence any common stock repurchases until at least July 2017.

Overall, we are making good progress in balancing a conservative financial policy while remaining committed to a strong dividend payout.

That brings us to slide 10 and our outlook.

First, we remain on track or ahead in each of the three areas of our integration program: organization structure, ZBB, and manufacturing footprint.

All our targets remain the same: savings and costs to achieve.

We continue to target cost savings of $1.5 billion net of inflation fully realized in 2017.

And we still anticipate $1.9 billion of pretax P&L costs including $1.1 billion in cash.

Through Q1, we've been taking roughly $1.1 billion, or just over half of the total P&L costs, including roughly $700 million or 65% of our likely cash expenses.

On the capital expenditure side, we continue to anticipate $1.1 billion of CapEx from the integration program.

To date, integration-related CapEx has been just over $300 million or roughly 30% of the CapEx spend we are anticipating.

But keep in mind that integration-related CapEx is in addition to the 2.5% to 3% of net sales we expect to spend on an ongoing basis.

As far as our 2016 outlook goes, based on our results through Q1, we remain confident that we will make meaningful progress this year towards our goal of achieving best-in-class margins.

That being said, as I mentioned earlier, pricing is likely to be more in line with key commodity costs going forward.

And faster ZBB savings will give way to organizational structure savings beginning to lap around September.

By contrast, we expect to see stronger EPS in the second half of the year due to expected earnings accretion from refinancing our preferred stock in June.

That is our current expectation from a financial perspective, but we have significant work ahead of us to realize our potential.

We have additional big bets to launch as the year progresses, and we continue to lay the groundwork for white-space expansion of both Kraft and Heinz brands in both food service and international channels.

We are also ramping up our IT and supply chain footprint activities significantly, and we are highly aware that in many ways we have benefited so far by a lack of business disruption.

And making sure that remains the case will be a key area of emphasis throughout the year.

Kraft Heinz is in a good position to unleash profitable growth.

But as Bernardo said on our last call, it is also a time of significant challenge for the Kraft Heinz Company.

Thank you.

And now I would be happy to take your questions.

(Operator Instructions) Chris Growe, Stifel.

Just had a question for you in relation to the synergies in the savings coming through, when you see the incremental savings, I think I heard you discuss, Paulo, some discussion about ZBB savings coming through this quarter.

I just was curious as well is that the main driver of the incremental savings sequentially, or are there footprint savings coming through as well?

I thought of those being more back half of the year.

Hi, Chris.

This is Paulo.

You are right.

And we are seeing this savings appearing in our results earlier.

And the majority of this is coming from our ZBB program and in some part also from the footprint that we started, but the majority of them are coming from the ZBB.

And should we think about the footprint savings then continuing through Q2 and those are just starting earlier?

Or is it still more back-half loaded in 2016?

It is still more back-half loaded in 2016 and 2017 (multiple speakers).

Okay, thank you.

And just one quick follow-up, I think you mentioned in the US there was very little Easter effect.

Were there any -- I heard a couple of unique factors that affected this quarter.

Was Easter a factor overall for the business, perhaps in Europe as well?

Hi, Chris.

This is George.

Thank you for that.

Easter for us was a factor mainly in shipment.

As I said in my remarks, what we saw, the difference between shipments and consumption was due to three factors mainly.

One of them is the shipment timing as we anticipated large uptake on promotions for Easter, and that was one-off and will be giving back in the following quarter.

The second one was filling the pipeline for the big bets NPD that we had, and that was a one-off.

And the third one, we have about 20% of our US business comes from food service and non-measure channels.

And that for us was growing healthy at mid-single digit in Q1, and we will continue to have a positive outlook on that part of the business.

Okay.

Thank you for your time.

Ken Goldman, JPMorgan.

There's this thesis out there, and I'm sure you've heard it ready espoused by some of your competitors, that you are ripping out promotions too aggressively.

These reductions you are making, they are helping now.

But potentially you will tick off your customers, you will lose some display space and you will suffer.

So I'm just curious, now that you are further into the development of this particular business, can you talk about why that is not a fair assessment?

And I know you talked about customer service being a key focus area going forward, but how is your relationship with your larger customers today, and do you see any meaningful risk of shelf space losses ahead as a result of maybe being very aggressive with pulling out some promotions?

Here's Bernardo here.

I'm going to try to address part of your question.

Then I'm going to ask George jump in to talk about the relationship with the clients and so on.

The reason we are confident about the model in moving forward -- if you think about it, because we believe that efficiencies we are generating put us in a competitive advantage to really support and push an agenda of profitable growth, by investing in the things we believe can really affect the marketplace.

And like we say are really three pillars is innovation, both big bets strategy, more marketing expenditures and building the go-to-market capability.

And if you see what's happening to companies, actually, the opposite is you see marketing expenditures going up, selling expenditures going up, and the big bets are coming at a faster pace.

So there are a lot of challenge in our categories.

And like George was saying before, it's still a lot for us to do to overcome them, not only here in the United States but also in different areas of the world.

But we truly believe we are preserving and investing where our consumers can see in the marketplace, and the efficiencies can help us to have a competitive advantage to push the agenda of profitable growth.

With that, I'm going to let George complement with the clients relationship.

Thank you, Ken.

I think for us, it's worth looking at different category performance.

We have some performance in categories we are really over-performing the categories like ketchup, mustard, pasta sauces, cheeses, Planter's, single-serve coffee.

And we have categories where we are underperforming like frozen meals, bacon, hot dogs, salad dressing.

I think where we are underperforming is largely sometimes we are missing the mark from a consumer trends point of view rather than having a different business model.

Our business model applies to all categories similarly.

So from a relationship with retailers, we believe we have a very strong relationship, we have a positive relationship and we see a positive outlook there.

The most important things between us and our retailers in my discussion with many of them was whether we can maintain the service level up or not.

And we have demonstrated not only we can maintain the service level and the case for rate, but we actually increased and we feel good about that.

Great.

Thank you very much.

Bryan Spillane, Bank of America.

Just two questions around the EBITDA growth year over year.

I guess if you look at it, there was about $100 million -- almost $120 million of EBITDA growth that was above and beyond your cost savings.

So one question related to that is how much of that is tailwinds from legacy programs?

How much of it is just the favorable spread on price versus commodities?

And I'm just trying to get under how much of that we should keep in our base as we think about the full year.

And then the second related to that is with some profit upside, will you consider it all either accelerating your investment on revenue-generating programs, whether it's big bets or filling white space, or will you maybe spend more than you are originally thinking because you have got upside there?

Hi, Brian.

This is Paulo.

I'm going to answer the first part of your question and then ask Bernardo to get the second.

If you think about the EBITDA, if you isolate the North America that is US and Canada, the two countries that are really more exposed to the big four commodities in this savings initiatives that we are having this year, the EBITDA improves around $400 million.

Out of this, $225 million are coming from our savings program, as we disclosed.

A bit more than half the rest is coming from price net of commodity favorability versus prior year that we are not expecting to repeat going forward.

The balance is coming from a combination of other impacts including marketing timing.

Brian, on your question about accelerating the sales initiatives and so on, it is really not too related to the financial capability in that sense and how much you can invest.

So there are other considerations like George was saying by -- with the product pipeline, having the right consumer insight, testing well, having the right communication about it.

So that it takes some time and each category is a little different for us to -- really what we call a big bet that we believe can generate the ROI in a significant step forward.

So it's not really having more financial capability or less, but having the discipline in the process to have a product and a proposition that we consider a winning proposition.

Thank you.

Andrew Lazar, Barclays.

Of the three items that you talked about as causing some of the differential between shipments and consumption in the first quarter, the first two being Easter and the filling of the pipeline behind some of the new items are the ones that are -- you talked about as really not recurring, if you will.

Is there a way to help quantify the impact that those two things had on overall organic sales in the first quarter to get a sense of what maybe a more sustainable rate of organic sales were in the first quarter?

Yes.

Thank you, Andrew.

First, let me clarify something, that we are unlikely to have shipment exactly in line with measure channel consumption in any given quarter.

And this is -- the fact is that the major big -- the major and big holiday week where sales for us consistently spike in consumption, and many times they fall in different quarters to where the shipment goes.

So your question is very good about, okay, how we can quantify that.

The best way to look at it is about 20% of our business doesn't come from major channels.

For the rest, you can see the scan data the way we see it.

That business for us in Q1 grew at around low to mid-single digits.

And we expect to continue seeing positive outlook on that business.

The other two, one of them was completely one-off.

We launched four big bets in Q1.

So we had one-off pipeline that would have a neutral effect moving forward.

And one was timing of shipments between Q1 and Q2 that will see some of it reversing.

Okay.

And then I think on the last call, George, you talked about the goal really for organic sales this year as a whole was really to kind of show sales that were stable.

And I don't think by stable you necessarily meant flat year over year, but just not really subject to a lot of disruption, let's say, from the integration of Kraft and things like that.

Even accounting for some of these things like pipeline fill and whatnot in the first quarter, it kind of seems like maybe organic sales were maybe more than stable, and others -- you didn't have any big disruptions, and perhaps organic sales were give or take still flattish or so.

So I guess we are just trying to get a sense of whether you feel like you are even maybe ahead of plan with respect to just organic sales already in this year relative to what maybe your initial hope or expectation had been.

And if so, would love to get a sense of the drivers there.

Thank you, Andrew.

You are right that we did not have any disruption.

We have been working very hard to ensure that we didn't get any disruption, and we will continue working very hard not to get any disruption moving forward.

However, there are a lot of headwinds coming at us, as you know, that is putting downward pressure on sales.

Because historically in the US market, the growth did not come from volume.

If you look back for the last number of years, it came from inflation, and that inflation was based on commodity inflation.

Now we are living in an environment where there is no inflation in commodities.

So it is harder to be able to say -- to have a bullish approach to growth.

What we said, and we will continue to maintain, that we would have stable top line.

And as you know we have an exposure to a large number of commodities, so it's very hard to put an exact number to it.

But we feel that stability for us is a very good outcome.

Okay.

Thank you.

Pablo Zuanic, Susquehanna.

Just two questions.

To be clear, you mentioned that $220 million of the $225 million came from North America.

I don't know if you've given the number for the total $1.5 million before, if you can comment on that.

And the second question, EBITDA growth in this quarter was about half driven by those cost savings, and then you qualify in one of the previous questions the fact that some of the drivers of the other half of that EBITDA expansion would not be there in the second half, and that we should assume that EBITDA growth in the second half is going to be mostly driven by the cost savings.

So if you can just expand on that, please.

Thank you.

Hi, this is Paulo, Pablo.

Let me maybe repeat what I said and explain the bridge.

So what I said was that we have two countries that are exposure today for the savings or integration plans that we have that are US and Canada.

So when you get the EBITDA improvement from these two countries for the region, for North America, the EBITDA improves by $400 million.

$225 million came from the savings initiative that we have.

The balance, more than half -- a little bit more than half off the balance is coming from price net of commodities that we are not expecting to repeat going forward.

And the balance is a combination of other initiatives, including marketing timing.

That was the debut that we have.

Going forward, we expect our program savings are still ramping up to the year every quarter until we get to the $1.5 billion savings -- savings that you expect to see 2017.

Thank you.

Just a quick follow-up.

When do you start -- on a different subject, when do you start looking at SKU rationalization -- or is that already happening -- and looking at divestitures?

And related to that, back in the day Burger King lost the Heinz -- the ketchup business with McDonald's.

Is that a risk that you could lose the [McCafe] brand in the coffee business at some point?

Thanks.

Thank you, Pablo.

This is George.

Let me start answering this backward.

On the second half of the question -- excuse me for not commenting on commercial relationship between us and our customers.

This is a practice that we adopt for all our customers, not just the quick-service restaurant.

On the first one, from the SKU rationalization, as part of the merger, there was no need for us to run a major SKU rationalization program.

So it did not exist to bringing the two businesses together.

However, having said that, SKU rationalization -- or pruning, what we call it -- is always looked at as part of our assortment efficiency.

So we do that as part of the disciplined business practice.

It does not have a significant impact that is worthy of reporting.

And that's why we do not mention it in our numbers here.

Thank you.

[Avec Shivada], Goldman Sachs.

Just a question on [trade] optimization in Europe.

In 2015, you were able to have better pricing on back of promotion cuts in the UK.

How does 2016 look in terms of promotions in the UK?

And are there any new geographies in Europe where you are thinking of promotion cuts?

Hi, Vivec.

It is Bernardo.

Thanks for the question.

I think this -- your question allows me to comment a little bit about the outperformance in Europe.

And I think here it's important to really separate a continental Europe from the UK.

We had actually a very solid first quarter in continental Europe from the Netherlands to Germany and France, Spain, even Italy that has been more challenged for us.

On the infant category, we had a better first quarter.

On the other hand, the UK, that's a significant part of our business.

In Europe, had key categories that experienced challenges, especially the soup one that is related to a question about a promo activity.

And in the soup, Paulo mentioned that during the remarks, we came -- given the underperformance we had on the fourth quarter during the soup season, we decided to protect market share and distribution infusing trade through the system.

When we do that, we have already seen in March better volumes and better results.

And moving forward in UK, we believe with the summer season coming and so on, we should see and should experience a sequential better quarters moving forward in the UK.

I think in Europe as a group, what happened in the soup UK is in a specific category and is a specific challenge situation from the repay environment and competitors.

Matthew Grainger, Morgan Stanley.

You called out a few of the factors impacting EBITDA in Europe during the quarter in promotion and marketing spend.

As we think about the near-term impact on results of a white-space launch into a new category like mayonnaise, are there meaningful upfront costs associated with that kind of expansion?

How should we think about the impact of a launch like that during its first year in the market?

Hi, Matthew.

No, I don't think -- it's not in our plan already.

So in a sense, it's not that we are going to have higher costs because of the white space.

You are right to say that given these estimates and so on, there is a migration of margins that's going to fill a rate in the second year, third year.

And so as we ramp up the awareness and distribution and so on.

But I don't think that's significant to change the way we think about the business in that sense.

I think it's fair say that our underperformance in the soup season in the UK forced us to take other matters to protect distribution and market share.

That's correct.

Okay.

Thank you.

And then could I just ask one more on the US coffee category?

You called out category as an area where you had strong PNOC and also some volume growth.

Based on scanner data, it seems to be a case where the volume is mostly coming from single-serve, while in roasting grounds you're sacrificing some amount of volume.

I guess on the roasting ground piece specifically, are you comfortable with the balance you have there between promotional spending and volumes?

Yes, thank you, Matthew.

This is George.

I will take that.

In the coffee category, you are right to separate the roasting grounds from the pods business or the single-serve.

The decline in roasting grounds is largely due to pricing.

As you know, we had a deflationary impact in the marketplace, and that put downward pressure on pricing.

The volume is declining but that's slightly.

So that's not the bigger issue for us.

And we are seeing, and it has been going on for some time now, consumer shift towards the more convenient pods or single-serve category.

In this category, we are very pleased with our performance.

As you know from the scanner data, we grew at over 13% year to date compared to a category growth of 6.9%.

So that is twice the category growth, and that is where we believe the future is going to be.

We are also comfortable with our -- where we are at from a profitability point of view during the time of deflation.

Great.

Thank you, George.

Michael Lavery, CLSA.

Just as you look at your margin opportunities, say, two or three years out, how do you think about what the opportunity is over and above the savings?

Do you do a bottoms-up view?

Do you do benchmarking.

Is it both of those?

And where do you see where that can go?

And then just a housekeeping question -- on volume and mix, can you give a sense of what the split is between those two?

Yes, Michael, let me start with the second.

We don't break down volume mix.

When you see the number of categories in brands that we have, we don't provide this breakdown.

In relation with the first question, again, we have this program today that we are very focused to deliver.

And then again, when you see -- we are always going to be looking for -- we always benchmark ourselves.

We benchmark the expense that we have.

A lot of work in terms of what is the best way for us to provide and the cost to serve in the Company.

But, yes, that's right.

We are keeping -- we're going to keep -- the ZBB program is a program that it refresh itself every year.

So, again, all the tools that we have, I'm sure that you allow us to be every time reviewing this and pushing more to have a more and more efficient Company.

And just in terms of where you might ever hit a wall or if there's limits to that, do you have ways you can measure or try to quantify that?

Hi, Michael.

It's Bernardo.

Look, the experience we have and the way we think about those two Pablo has mentioned just a couple of minutes ago is much more as a system than really a one-off or -- it's not the way we do things here.

That's why our thinking is very long-term in that sense.

So ZBB, MBO, revenue management -- all the innovation pipeline, the way we follow through the process here, we are looking 2016, 2017, 2020, 2025, and it's a system.

So our experience tells us that it's not a question of having a wall or not a wall like you are saying.

It's a question as a system to prepare and to accept value where there are.

And sometimes, you're going to be infusing costs or taking costs; that doesn't matter.

But the system works in a way that you can identify the opportunity and invest behind.

Not only from a top line, but from a bottom line.

So if the process is working properly, I don't believe it's a situation of a one-off to cross the line because we self-correct ourselves in a very fast way.

Okay, that's helpful.

Thank you very much.

David Palmer, RBC Capital Markets.

Your gross margin gain of over 550 basis points in the quarter, that was even more than the fourth quarter, which surprised us.

And I -- particularly because the promotion comparisons were not as easy at that quarter, you mentioned that pricing net of commodities was favorable.

How much of the gross margin gain would be what you would call commodity timing?

And perhaps what are some of the other drivers that you would call out for gross margins specifically?

Hi, David.

Again, I think -- as I was explaining, we had this benefit from the price net of commodities in the first quarter, the rest prior year, that for sure was a benefit in terms of gross margin.

We also had a piece of our savings, a little bit less than half of these savings, that $225 million, that is going -- is coming, is appearing in the COGS.

That both of these factors -- those are of the impact the gross margin.

And I kind of explained the majority of the improvement we had in the gross margin ratio.

Again, that's not the way -- the clear way that we track the business down.

We separate more between -- on our contribution margin, variable costs and fixed cost.

But those were the main impacts we saw -- that we had in the gross profit.

Is there any color that you could offer about what is driving that mid-single-digit growth that you see sustainable in the food-service area?

Thank you, David.

Yes.

The food service is not just the food-service area.

It's food service and other non-measured channels.

So it is anything that goes into club stores, commissaries, food service and Dollar General.

For one, these businesses tend to have a higher rate of growth than the measured channels.

And two, as I mentioned on the last call, we initiated a major white space and business development program that started to pay off.

And we continue to see a positive outlook for these businesses.

And then one last one on advertising spending.

In the quarter, does that increase come behind some of those big bets?

And what is your general plan for ad spending for the year?

Thanks very much.

Yes, the advertising, as we said on the last call, that would be increased in the US by about $50 million year on year.

And the majority of this is being put behind big bets.

You would have seen the advertising so far on the new items that we have launched.

This Q1 and Q2 where most of these advertising actually being spent, and we will continue into Q3 and Q4.

Thank you.

Priya Ohri-Gupta, Barclays.

Two, if I may.

First, can you just talk about how do you think about some of the secured debt in your structure, whether there is a focus on trying to clean that up and have only unsecured borrowings given that you are an investment-grade issuer?

And then just secondly, can you talk a little bit about the rationale behind the $4 billion commercial paper program you put in place recently, and just in terms of the size of that versus your ongoing needs?

Thank you.

Hi, Priya.

Again, as you know, we have intentions to redeem the prefer as soon as that's callable at the beginning of June.

We've talked a lot how accretive this transaction will be in terms of cash flow and earnings and EPS for the Company.

We are considering how close we are to access the market.

I would prefer and I will disclose this information soon -- as soon as we access the markets.

But we are intending to access the market in the near-term.

Thank you.

And I would now like to turn the conference back to Chris Jakubik for closing remarks.

Okay.

Thanks, everyone, for joining us today.

For any of the analysts who have follow-up questions, Rashid Nadarajan and myself will be around to take your calls.

And if anybody from media has any follow-up questions, Michael Mullen will be happy to take your calls.

Thanks very much and have a great night.

Thank you.

Thank you.

Thank you.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude the program.

You may all disconnect.

Everyone have a great day.