Good day and thank you for standing by. Welcome to the Kraft Heinz Company Second Quarter Results Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I'd now like to hand the conference over to your speaker today, Anne-Marie Megela. Please go ahead.

Thank you, and hello, everyone. This is Anne-Marie Megela, Head of Global Investor Relations at the Kraft Heinz Company, and welcome to our Q&A session for our second quarter 2022 business update. During our remarks today, 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, which are discussed in our earnings release and our filings with the SEC. We will also discuss some non-GAAP financial measures today during the call, and these non-GAAP financial measures should not be considered a replacement for and should be read together with GAAP results. You can find the GAAP to non-GAAP reconciliations within our earnings release and the supplemental materials posted at ir.kraftheinzcompany.com. Before we begin, I'm going to hand it over to our CEO, Miguel Patricio, for a few quick opening comments.

Well, thank you, Anne-Marie, and thank you everyone for joining us today. I wanted to acknowledge the fact that we are living under a lot of uncertainty in regard to the external world. In that sense, I want to thank my team and congratulate my team for delivering another quarter of very solid results. Although we are mindful of the current inflationary environment and how it affects our consumers and our customers, we continue to develop solutions that benefit our consumers and our retailers. Our relationships with retailers continue to strengthen, and we have improved inventory and service levels, which gives us more optionality to execute more mutually strategic programs. With that, we are happy to take your questions.

Thank you. And our first question will come from Bryan Spillane from Bank of America. Your line is now open.

All right. Thank you, operator. Good morning, everyone. I have just one clarification question and then a second question. The first one, just for clarification. Andre, in the slide deck, I think it's slide 27, where you talk about there’s a portion or a section in there about gross margin, and it shows gross margin at 30.3%. I just want to make sure that that is not adjusted, right? So, that's just your gross margin. I think, as we did the adjusted gross margin calculation, it was like 31.5%. So, just wanted to clarify that margin you put in the slide deck is reported and not adjusted.

Good morning, Bryan. Thanks for the question. Very good, by the way. So, yes, you are right. This is the GAAP gross margin. To get adjusted, we need to increase this number by 110 basis points due to the change of realized hedge on commodities. In fact, if we adjust for that, our margin in Q2 is pretty much in line with the margin in Q1.

Okay.

If you compare to the prior year, you would see an expansion of margin if it were not for the dilutive impact of repricing to offset inflation.

Okay. Thank you for that. My question is just in the prepared remarks, Miguel, you mentioned some supply chain pressures in the back half of the year. If I recall last year, part of what happened in the U.S. was that you had some supply chain issues that affected service levels, especially around the holidays. Does the guidance assume that there will still be some pressure there and that you won't be fully merchandised for the holidays? Or are you in a position where you can be fully supplied and merchandised for the holidays in the U.S.?

Okay. Bryan, since your question is addressing more of the U.S., I will pass it to Carlos.

Okay. Thank you.

Thank you, Miguel. First of all, thank you for your question. The reality is that we have continued to improve our production and our service levels, as you saw in the presentation. Now that we are approaching the low 90s in terms of service in Q2, we will continue to focus on driving the right level of both service and inventory with our retailers. For us, it's important to see the continued progression, and we don't anticipate that to actually go against us as we move forward. In fact, as we go into Q3 and Q4, we expect the continued expansion of our service and the continued improvement in our performance. We saw that in Q2, where we were able to unlock opportunities within brands like Philadelphia or Heinz Ketchup, both of which achieved record shares and, in fact, higher than they have ever had in both those businesses. So, I think as we move forward, we are always going to continue to improve our position.

Okay. Thank you.

Thank you. And we'll take our next question from Ken Goldman from JP Morgan. Mr. Goldman, your line is open.

Hi, everybody. Thank you. You mentioned in the prepared remarks that you have the optionality now to execute mutually strategic programs with retailers. Now that your service levels are in a better place, I wanted to clarify, number one, is there any major difference between a mutually strategic program and just a really good promotion? That's more than just a discount, maybe it's just something more in-depth or creative than a usual promotion. I just wanted to clarify that definition. And then the second part is I wanted to ask if you're confident that these programs, if you do implement them, are being driven from a position of strength, right? Whereby you're able to do them versus doing it because the consumer is in a position of weakness themselves and is demanding it. Thank you.

Okay. Ken, I'll give you two examples of these programs that, because we have much better service levels we can implement. One is what we call the Art of the Burger, which has been a very successful program, especially during summertime when people barbecue more. We can put together our sauces, our teas, along with supermarket chains, and it has been very well accepted by our customers. Another example is during a moment like this, as we are exploring value propositions together with customers, an example being grilled cheese, which can be offered for less than $1. We do programs with our customers, putting together our cheese, our mayo, and with their brand as well. These are two examples of bringing value that our customers are receiving, and this is extremely well. It’s exciting to bring a little bit of creativity about our products using the value that they provide.

Thank you for that. The second part of my question was about whether you're doing this from a position of strength rather than feeling obliged because the consumer is demanding it. I wanted to clarify that.

The other thing I want to mention, Ken, is regarding stickiness. We continue to engage in very productive conversations with our customers that are beneficial for both parties. We feel very positive about it, and we are enthusiastic about the momentum we have with our customers and consumers.

Understood. Thanks very much.

Thank you. And we’ll take our next question from Andrew Lazar from Barclays. Your line is open.

Thanks very much. In the slide deck, you provided a breakdown of categories that are more and less sensitive to price gaps with private label. I think 15% of sales are in categories that are more sensitive where gaps are increasing. I'm curious how you approach these businesses in terms of balancing share and profitability. Do you take the necessary price to protect profit and deal with the short-term pressure on share, or protect share and take the short-term profit hit? You talk about another 25% that are sensitive to private label gaps but currently stable. If those expand from here, what gives you confidence you can manage this bigger segment concerning your growth algorithm? Thanks so much.

Let me start this, Andrew; the question specifically relates to the U.S., so I'll take a shot. For us, the reality is that even as we think about those businesses, a very small part of our portfolio is just more exposed to private label. One of the things we are doing is working differently in how we’re offering consumer solutions at a time when they are looking for different choices across the spectrum of economic development. So one of the things we're looking at is allowing consumers to stay within our iconic brands because of the range of our products across our pricing ladder. For example, Oscar Mayer has natural, deli fresh, and regional options that allow consumers to have an option within our brands. Over the last couple of years, we've also renovated many of our iconic brands and invested behind them. We have improved quality, which makes our brands even more valuable to consumers. We are seeing this play out, as shown with the Kraft Mac & Cheese portfolio, where we are gaining share as well.

It’s really category-by-category. Even in the 15% where prices are expanding, the stories differ greatly. For example, with cheese and cold cuts, we have an excellent price ladder. We have VELVEETA priced at or below private label, Kraft Singles, and Deluxe. We are gaining share in the last several months, so it's working well for us. In Ore-Ida, the partnership with Simplot is beginning to unlock a lot of capacity later in the year, allowing us to promote more of these brands, which we haven't been able to do consistently for years. It's really monitored category-by-category, ensuring we do what makes sense for both the top and bottom line.

Thank you.

Thank you, Andrew.

Thank you. And our next question will come from Chris Growe from Stifel. Your line is now open. Mr. Growe, please make sure your line is not on mute.

Can you hear me now?

Yes, sir.

Thank you. I just had a quick question regarding the revenue growth in the quarter outpacing consumption. I'm curious how much of that was due to Foodservice strength and the non-measured channels versus actual inventory rebuilding. I think this fits with an earlier question about whether you see product availability as a constraint for the third and fourth quarter performance in the second half, or if that's behind us now.

It's a combination of these factors. Foodservice, as you have seen in our presentation, is growing north of 20%, which represents roughly 30% of our total revenue. We have been performing well in non-measured channels in the U.S., especially in club and dollar stores, where we are gaining share because we are prepared for a gradual shift toward those channels. We had mentioned in Q1 that the minor impact in Q2 is not attributed to either. Regarding service levels, we are still in the low 90s, where the ideal level is in the high 90s. Some categories are in great shape, returning to historical service levels, while others are still in need of improvement. On shelf availability, we are getting closer to historical levels.

Would there still be continued inventory build you'd expect at retail as you improve your service levels?

We might. Obviously, we cannot comment on how inventory management will go forward. However, if you look at historical capacity levels, there might be room for further inventory buildup.

Thank you. Our next question will come from Steve Powers from Deutsche Bank. Your line is now open.

Yes. Hey, good morning. You talked about your outlook contemplating greater price elasticity negatively impacting volume and mix over the balance of the year. Is there a way for you to help us think through the P&L impacts of lower volumes at this point? Clearly, there are many other moving parts. But all else being equal, if volumes are to move lower in places where you anticipate, how material is that on margins regarding fixed cost deleverage per unit sold? I'm just asking how fixed versus variable the cost structure is at this point.

Thanks for the question. At this point, it is not really a drag because we are still building inventory. Remember, our service levels are in the low 90s. So, as we continue to produce more than what we sell, it has a slightly positive effect at this moment. We are monitoring demand curves closely and will adjust our labor accordingly to prevent an overhang in the future when we reduce production. For now, this is not an issue.

Great. Thank you. You provided good color on the cost outlook for the remainder of 2022. I'm curious how you see early positioning looking out to 2023. On one hand, you mentioned costs hopefully peaking and maybe starting to ease; on the other hand, they are still quite high year-over-year. You presumably have some hedges rolling into the year that will roll off on both commodities and currency. Can you provide some color on early positioning and visibility regarding constant currency for the first part of 2023?

There’s still a lot of volatility out there. Yes, costs have eased, but they remain very high. We are developing different scenarios for next year and have been taking prices throughout the year, which we hope to carry over into next year, particularly in the first half of the year. So that will help, but it's early to tell.

Thank you. Our next question will come from Robert Moskow from Credit Suisse. Your line is now open.

Hi. Thanks. Your income statement shows losses on your derivative hedges in Q2. I imagine that commodity inputs are now falling. Should we assume at some point that this necessitates more counts in your existing products? Then a quick follow-up.

Thanks for the question. First, to clarify, we typically price based on market changes, not our hedge position, which is important to note. What you see in the P&L is the change in the unrealized hedge on commodities, meaning it is not about whether the hedge is positive or negative but a change from period to period. We had hedge gains in both Q1 and Q2; however, the realized portions created a negative effect. We look at market prices and base our pricing decisions on those.

Okay. Following up, I think you mentioned you did shift above consumption in Q2 and indicated you'd be refilling shelves. Can you provide any specifics on that amount just in Q2?

The inventory effect in Q2 is very small. We are refilling our own inventory because we believe historical levels are important. Eventually, this will extend to retailers. Carlos, would you like to add something?

Yes, I mean, if you look at our presentation and consider we moved from low 80s to low 90s service levels, we're leveraging our entire supply chain in a way that, with appropriate inventory levels in many categories, we can provide that service. While we are still in the low 90s, we have the opportunity to continue driving to the high 90s by adjusting our internal inventories.

Thanks. Thank you for the clarification.

Thank you. We'll take our next question from Alexia Howard from Alliance Bernstein. Alexia, your line is open.

Thank you. Good morning, everyone.

Good morning, Alexia.

Can I ask about the comments you made in your prepared remarks regarding the International Zone and the expansion of distribution points? It seems as though there has been a very substantial expansion of distribution points in some of those emerging markets. How do you ensure that you've got the critical mass in those new outlets to turn a profit? I don't know whether you can provide data on profitability in some of those regions, but we have seen other companies kind of dig themselves a profit hole while trying to expand. I want to understand what guardrails you have in place regarding that expansion. Thank you, and I will pass it on.

Carlos, your views?

To be honest, we are extremely proud and happy with what's happening with our go-to-market model, as it is very comprehensive. We start by analyzing where we can make money, looking at the gross profit of each channel or submarket. In vast countries like Brazil, Russia, and China, profitability can differ significantly across regions and channels. So we begin by assessing that and execute from there. We've implemented this model in Brazil since 2018, and it has been adapted and copied to Russia and then to China. We expect 75% of our markets to be using this model by the end of the year. The results speak for themselves—growth in all implemented areas significantly outpaced other emerging markets. We will continue to roll this out, ensuring a comprehensive analysis that leads to profitability, backed by disciplined execution.

Thank you very much. I’ll pass it on.

On the profitability side, which is obviously very important, we are cautious. To give you an example, in Brazil, we have about, I don't know, 1 million points of sales that we could hypothetically serve. We are still in the 100,000 to 140,000 range. Part of that pertains to our scaling limits. We are exploring partnerships to increase penetration in some markets, so there might be more opportunities in the future. Profitability remains an important consideration.

Since we're discussing Brazil, I think that with the acquisition of Hemmer, which is very strong in the South, while Heinz is strong in the Southeast, this gives us an even bigger opportunity to expand our distribution and brand strength. We are thrilled with the scale we are achieving in Brazil and the plans we have for the business there.

Great. Thank you very much. I will pass it on.

Operator, we have time for one more question.

Thank you. Our last question will come from David Palmer with Evercore ISI. Your line is open.

Thanks. In your prepared remarks about gross margins, you mentioned protecting profit dollars and not margins, which caused a 450 basis point decline, and that calculation makes sense. However, I'm sure there's more going on underneath the surface regarding gross margins, like supply chain friction costs and potential timing with regard to pricing versus inputs. Can you call out any additional factors in gross margins that we should consider for 2023 comparisons?

Thanks for the question. This is by far the highest impact. Other than the need for growth efficiency, remember that the $2 billion target we communicated is on track; we delivered the first two years as expected. We continue that trajectory. The mix effect is relatively small. It was slightly positive this quarter as we accelerate higher-margin growth platforms. Moving forward, we should expect to deliver these growth efficiencies. As inflation starts to ease, this could place us in a better position to recover margins.

Thanks for that. On Foodservice—very impressive growth there. The over 20% growth in North America suggests there’s something significant happening, potentially big market share wins. What’s driving that, and is that growth sustainable? I understand you're citing big global QSRs as momentum drivers internationally, and does that sound sustainable in your view?

Thanks for the question. Two things: First, I want to highlight that our Q2 Foodservice revenue is now 14% higher than Q2 2019, which is remarkable. There's also a pricing component; our prices took into consideration what we've been doing in retail. However, the volume continues to grow as we expand distribution and gain market share in North America, Europe, and Central markets. As for QSR, Rafael can elaborate on our international strategies.

Before Rafael speaks about the International Zone, I want to say that in 2019, Foodservice was transactional for us, not a strategic focus; it was a smaller part of our business. Today, we have a great team with significant ambition, viewing this channel as critical for brand penetration globally. This momentum in emerging markets is partly due to consumers engaging with our brands through Foodservice. This ensuing change in mindset is reflected in our entire team, which has shifted significantly since 2019. Rafael, please share more.

To build on Miguel's point, we use a model we define for Foodservice: we own the chef, own the kitchen, and own the customer. This reflects our investments in chefs, as they are extremely important, especially in the QSR sector. This investment allows us to develop recipes and limited-time offers, nurturing relationships with customers that lead to innovation. As these partnerships deepen, we can price better and navigate outside of commodity competition. We continue to leverage this channel to build our brand further, as it offers fantastic opportunities.

Rafa, I want to add that we look at this model globally, utilizing our distribution points away from home to build our iconic brands in retail. This virtuous cycle is something we plan to continue as it pays off. Over the past two years, we reorganized our team to focus on having the right expertise in Foodservice, while simplifying our portfolio. We’ve reduced the number of SKUs in the U.S. Foodservice by around 30%. This strategic approach allows us to pivot toward what matters, ensuring customer service and value in away-from-home settings.

You’re right; this model we have is key for us, as we can leverage the scale we have now built. Each of these investments builds on each other. Individuals may not see Foodservice’s potential, but it’s critical for our brand, especially with the momentum we’re having through these partnerships. Thank you all for your questions today. As you've seen, we are a company in the midst of transformation. We are proud of what we've done so far, but every day, we continue to improve and evolve. We are just getting started; we have many opportunities ahead of us. Thank you very much for your ongoing interest in Kraft Heinz.

Thank you. This concludes today's conference call. Thank you for your participation, and you may now disconnect. Everyone, have a wonderful day.