The Kraft Heinz (NASDAQ:KHC) Q2 2020 Earnings Call

0:00 Good day. My name is Kevin, and I'll be your operator today. At this time, I'd like to welcome everyone to the Kraft Heinz Company second quarter 2020 earnings call. I will now turn the call over to Chris Jakubik, head of global investor relations. Mr. Jakubik, you may begin.

0:14 Hello, everyone, and thank you for joining our business update. We'll begin today's call with an overview of our second quarter 2020 results, as well as an update on our path forward. From Miguel Patricio, our CEO, Paulo Basilio, our CFO, and Carlos Abrams Rivera, the head of our U.S. business. We will then open the lines to take your questions. Please note that 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, and these are discussed in our press release and our filings with the SEC. We will also discuss some non-GAAP financial measures during the call today. 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. Now, let's turn to slide three and I'll hand it over to Miguel.

1:10 Well, thank you, Chris, and good morning, everyone. I think it's appropriate to start today by saying that more than anything else, the strength of our second quarter results Reflect the hard work and dedication of our remarkable employees around the world. Without them, we would not have reported numbers anywhere near what you saw in our press release today. On our April call, I said that the coming months would be critical in understanding the path forward and potential for our industry, for Kraft Heinz, and the pace of our turnaround. Three months later, I can tell you that while the path of the economy and consumer behavior remains difficult for any of us to predict, our team has done an excellent work anticipating and responding with speed, agility, and creativity.

2:12 And we can see this in the quality of our second quarter results. More importantly, we continue to make great progress on our turnaround. Our people are drawing functional excellence throughout the organization. We are developing better perspectives on where consumers are going and how we can win. Our productivity initiatives are progressing and strong free cash flow is further improving our financial profile. All these things are coming through in what we will cover today in our business updates, Where we will talk about how we are adapting to consumer needs, to Q2 results that were much stronger than expected due to continued momentum and strong consumer demand for our brands, as well as better than anticipated costs and supply chain performance.

3:12 And the fact that our solid execution is keeping us cautiously optimistic for the rest of the year. Carlos and I will begin today with how our business has responded so far and our current thoughts about the path forward before Paulo discusses the financials. And then we'll take your questions. The first chart I wanted to share is our underlying year-on-year sales growth by geography in both retail and food service channels. It shows the progression from Q1 to the April spike to the May-June settling out period. There are three important points to take away from this chart.

3:59 First, it's the tremendous and abrupt shifts in consumer behavior that we are witnessing. These are sales of food and beverage products, not micro-shifts. So to describe the magnitude of this channel shift as unprecedented, Feels like an understatement. Second, the numbers in the chart are Kraft Heinz sales, not the broader market, not the broader categories where we play. And it's important to recognize that our supply chain capabilities are largely split between capacity to produce and service retail sales and producing and servicing food service sales.

4:45 There is little overlap in terms of production lines So, what this chart reflects is that, during this period, we have been able to successfully adapt to such an abrupt, unprecedented change in consumer behavior, keep every one of our plants around the world up and running, producing at industry-leading quality and safety levels, and therefore enable us Thank you very much. and ultimately delivering roughly twice the organic growth we expected in April.

5:55 Which brings me to the third point, the source of Q2 upside versus our previous expectations. The decline we saw in food service sales on a global basis was largely consistent with what we had forecasted. Somewhat better in the U.S., and at the softer end of the range in our international business. At the same time, our retail performance was much better than anticipated. In the United States, which Carlos will speak to, in our international zone, where in condiments and sauces we grew double digits and in several markets achieved record market share. And in Canada, where we had double digit growth and gained share in 80% of our retail categories as the team invested to strengthen brand relevancy in areas like peanut butter, pasta sauce and craft dinners.

6:57 In addition, what is not shown on this chart but we will discuss later is the extraordinary retail sales growth came with favorable category and product mix. Together, The combination of favorable channel, category, and product mix resulted in better than expected EBITDA margins versus what we originally expected, most notable in our United States business. At the same time, and the second part of the business update, it's important to reiterate that we remain at the beginning stages of our turnaround. and are still not where we want to be on several fronts, which we will talk about in great detail in September.

7:48 We have done a lot to adapt to the pandemic, but we are also implementing a new operating model to improve our performance on a sustainable basis. We are making significant changes to how we work, how we are organizing our business, How we are developing our capabilities and how we are reinvesting in the business. Our actions have been broad-based with the intent to create sustainable competitive advantage across our value chain. For instance, we have continued to work urgently and diligently to ensure the health and safety of our employees.

8:34 Taking on additional costs for personal protective equipment in our plants as well as to accommodate working from home. At the same time, during the second quarter, we rolled out our new company purpose, vision, values, and leadership principles. We are redefining for our employees for the long term our true north and how we are going to win by working as a team, Inspiring excellence and navigate our future. I want to specifically mention one of our company values. We demand diversity. We live in a world where systemic racism and inequality exists.

9:21 And righting these wrongs requires an equally systemic response from everyone, including global corporations like ours. Thank you for joining us. and Expanded Talent Recruitment Partnerships, to supplier training programs for minority and women-owned businesses, and the creation of a cross-functional inclusion council, we are proactive and hold ourselves and our company accountable for bringing about the positive change.

10:24 Changing times demand fresh, new approaches for consumers We are actively modeling multiple growth scenarios and defining new initiatives to adapt to each scenario. At the same time, we have now reorganized our business units around new consumer-led platforms so we can better address our consumers with our customers and in marketing on improving communications today, but also improving How we deploy our resources to drive growth going forward. With customers specifically, collaboration has been key as we are creatively addressing immediate customer needs on one hand while simultaneously trying to set plans for the coming year.

11:19 In supply chain, the difference a year has made is simply incredible. We are finding efficiency to mitigate incremental COVID costs while taking actions to optimize and ensure production. At the same time, we continue to implement continuous improvement processes and programs for sustainable savings for the years to come. In many ways, we are leveraging our intentional strategic changes to better respond to an environment with significant uncertainty. As a result, I'm confident that we'll emerge a stronger Kraft Heinz, and the strategic direction we have set is the right one, and one that we look forward to discussing in detail with you on September 15.

12:15 I will close my opening comments here by summarizing a few points. We have stronger than expected Q2 results, reflecting continued momentum and strong consumer demand for our brands. We are implementing our new enterprise-wide strategy at the same time we are adapting to the pandemic. After a year as CEO, I can see our business transformation well underway with strong employee morale, a well-defined strategy and a team in place working together with speed to bring agility with scale. and our work to date has only confirmed that we are on the right path.

13:03 To bring this more to life, I'm going to ask Carlos to provide more color on how our U.S. business is performing in the marketplace and how he sees the path forward.

13:19 Thank you, Miguel, and good morning, everyone. My comments today are going to focus on what we have experienced so far. How we are preparing for the road ahead and hopefully address a number of the questions many of you have raised about our recent performance. In terms of what we have experienced, to say it's being intense, dynamic, and rewarding will be an understatement. We have been working hard to optimize our manufacturing capacity to meet extraordinary demand, running some of our plants 24-7. This has caused us to cancel some programing and reallocate spending to the second half of the year. So for instance, we had to pull back on Memorial Day events for the first time ever. And not having that event removed the drive period in the quarter when we typically have very high market share.

14:10 And our average price gaps increased versus the prior year as a result. In areas like our needs and craft single businesses, our share has been negatively impacted by sustained Elevated consumption versus supply chain constraints. While more vertically integrated players have been able to shift capacity from their food service businesses to retail. So while we're growing strongly in those businesses, we are seeing some share loss. Elsewhere in the portfolio, Heinz, Jell-O, Oreida are gaining share even with this accelerated consumption. In a nutshell, Promotional activity and the pace of inventory recovery, both ours and our retail partners, have been dictated by the balance of supply and demand.

14:57 What that means for us is growth has been good, but in certain categories we know we can do better. If demand remains extraordinarily strong, growth should be fine, but share is likely to be challenging in certain categories. Which brings me to how we are preparing. From a consumption perspective, we are preparing for all the economic letters, the V, the U, the W, etc., but with an eye to the long term, investing to win on a sustainable basis. So to that end, we have now realigned our U.S. business unit structure, designed around the new platform-based strategy, which we will unveil in September. We are implementing a new operating model to ensure we operate with a growth mindset, A high level of accountability and streamlined roles, responsibilities, and decision rights for each role.

15:54 We are capturing savings from continuous improvements, leveraging the upside we have seen to date to invest even more than anticipated to renovate and differentiate our brands. And we are working hard to understand who is new to our brands and the best ways to meaningfully connect with them. So regarding our path forward, While the depth and duration of this downturn will guide consumption in the near term, we are transforming our business for a better growth trajectory in the medium to long term. And consumers' embracement of our brands are providing us a significant opportunity right now. For instance, household penetration is one of the inherent strengths of our portfolio relative to the industry. And you would think that there was not much more room to go.

16:45 Our household penetration has strengthened further in the last 16 weeks. In fact, 75% of our brands are growing household penetration, and the majority of our brands growing household penetration are up double-digit percentage points versus the same period last year. Across our iconic brands, we are experiencing growing household penetration and increasing the rate of repeat among new buyers. This includes big brands. that were already well-established and significant leaders in their categories, such as Heinz in ketchup, Kraft Mac and Cheese, Orida, Planters, Philadelphia, and Capri Sun. In terms of repeat rates, new buyers are repeating at higher rates than in the past and buying more frequently. In fact, 75% of new buyers since the pandemic started are still buying our products now.

17:42 And finally, Regarding new buyer demographics, smaller households, including those with no kids, are finding our brands. And a new buyer household skews to higher income, younger, and more diverse parts of the population, areas we have historically under-indexed. All this means we have a tremendous opportunity to build our base of loyal consumers, and we're going after this aggressively. with a second half plan that includes a 40% increase in working media dollars versus a year ago. To close, I just want to say how very proud I am of our colleagues for how they have responded to the challenges of the moment across our value chain and are showing tremendous agility in redeploying marketing investments to connect with the millions who are now making our brands part of their everyday lives.

18:35 With that, I will turn it over to Paulo to talk through our financial results and now look for the second half.

18:43 Thank you, Carlos, and good morning, everyone. Before I get into the details of our results, I think it's useful to outline some overall key drivers of the quarter that were consistent across our different segments. On our April call, I'll outline four factors we expected to drive better profitability in Q2 versus Q1. One was improved product mix, mainly from categories within retail, as well as a favorable shift between retail and food service. Two, higher volumes. Three, greater efficiency in operations as we were adjusting to the higher volumes. And four, a better balance between price and commodity costs.

19:30 In the end, all these factors came into play and were directionally consistent with our expectations. What pushed our growth and profitability higher than anticipated was a combination of stronger retail demand for longer than we anticipated, a better than projected relationship between price and commodity costs, and a more favorable category and product mix within our retail sales. These factors were most pronounced in our U.S. business, so that's where I will start. Organic net sales in the U.S. increased 8.5%. This was mainly driven by 6.2 percentage points of volume mix growth led by the strong retail performance Carlos described.

20:19 Pricing was up as it reflected lower promotional activity to capacity constraints in certain categories. Taking together volume leverage, favorable channel and product mix, as well as favorable pricing, adjusted EBITDA in the second quarter increased 17.6%. Specifically regarding mix, we saw favorable category mix in the form of relatively stronger demand and market share performance in areas like ketchup and condiments, mac and cheese and frozen potatoes. We also saw favorable SKU mix within categories due to supply chain constraints and, therefore, Greater sales of core items within our product lines.

21:07 Looking forward, we are not anticipating retail demand to remain as strong as we saw in Q2, and likely to moderate further from recent levels, with category mix normalizing and food service being a greater part of total sales. In addition, keep in mind that the McCafe exit is now underway, and will therefore temper organic growth beginning Q3. As a result, at this point, while Q3 profits should be higher than we anticipated three months ago, Q3 margins are likely to be closer to prior year levels as organic growth moderates, the favorable mix we saw in Q2 fades, and pressures from the recent spike in commodity inflation, specifically in cheese, come into play.

21:57 While this would represent a significant change sequentially from Q2 to Q3, We believe it is the most realistic expectation based on the best estimates in consumption and cost trends today. Moving to our international segment, results were largely consistent with our initial expectations, with organic net sales up 5.5% versus the prior year period, and roughly equal contributions from volume mix and pricing. Pricing accelerated to 2.6%, from a combination of reduced promotional activity, carryover benefits from previous pricing actions, and inflation-related pricing in Brazil.

22:42 Volume mix increased 2.9% from strong growth in condiments and sauces, along with growth in meal-oriented categories. More than offset a decline in both food service and infant nutrition. Looking forward, we are expecting the deceleration we saw in growth during the second quarter to continue into Q3 as markets normalize, particularly in our biggest market, the UK. And while the pace of normalization is unpredictable, we currently anticipate back half results, both organic sales growth and margins, to soften compared to the first half. Finally is Canada, where the Q2 turnaround we anticipated was even stronger than expected.

23:29 In April, we said we thought that organic sales growth would improve sequentially, but remain negative versus the prior year, given the McAfee exit, lower food service sales, and lower year-on-year pricing. In the end, our Canada team delivered 2% organic growth, with pricing turning positive for the first time in seven quarters, and retail consumption growth in every category. The positive pricing reflected a combination of reduced promotional activity versus the prior year, as well as successful implementation of select but necessary list price increases. Also, volume mix was positive as stronger than expected retail takeaway, more than offset lower food service sales, and a negative 4.4 percentage point impact from McAfee exit.

24:24 At EBITDA, We initially expected Q2 margins to begin returning to prior year levels. Actual results were slightly better, with an adjusted EBITDA margin up nearly 30 basis points versus the prior year, as improved supply chain performance added to gains from pricing and volume mix. For the second half of the year, we would expect the improved performance in Canada to continue, with a sustained recovery in profitability although with more normalized retail takeaway trends being offset by the ongoing headwinds from Macafe exit and lower food service sales. Turning now to total company results and our outlook for the year, there are just three additional notes I would make on our Q2 results.

25:13 First is that each business segment reported organic sales and EBITDA growth in Q2, and we hope this indicates more stable performance across our businesses going forward. Second are taxes. On our last call, I flagged the possibility of a higher effective tax rate in Q2 to the possible enactment of UK tax legislation and a related non-cash adjustment to deferred tax liabilities. This was delayed, contributing to better than expected EPS and is now expected to happen in Q3. So, we would now expect a tax rate on adjusted earnings in the high 20s for Q3 While our expectations for the full year remains in the 22% to 24% range.

26:03 Third is free cash flow, which is up significantly versus the prior year on a year-to-date basis. This has been driven by a combination of EBITDA growth, lower working capital, somewhat lower capital expenditure, as well as significantly greater accrued liabilities due to the timing of cash outflows versus the prior year. Looking forward, we expect working capital to revert as we rebuild our inventories. And cash outlays related to accrued liabilities for taxes, trade spend, and marketing are second half-weighted this year. In addition, we continue to plan for CapEx and roughly $750 million this year, although we have had some delays so far this year and may not spend the full plan.

26:54 Taking all of these into account, we do feel good about the quality of our free cash generation year-to-date and are confident that 2020 free cash flow will exceed 2019. Which brings me to our financial outlook. I think it's helpful to come back to the fact that we are in the first year of our multi-year turnaround. The current environment has presented us with opportunities to be there for our consumers. And to the extent we are successful now, it puts a wind at the back of our turnaround efforts. And we will be in a stronger position on a sustainable basis in the future. To that point, we do expect the upside in results we have posted during the first half of the year, both sales and EBITDA, to stick for the full year.

27:45 And while there is still significant work to do ahead of us, We believe that we are very well positioned with each of the three priorities we set for 2020. To establish a strong base of sales and earnings, to rebuild underlying business momentum, and continue to reduce debt while maintaining our current dividend. That being said, I think it's important to highlight the key drivers at work in the second half of the year as we establish that strong base of sales and earnings, and work to rebuild our underlying business momentum. Specifically, we see four discrete factors, the same four we have talked about before, that will hold back second half EBITDA versus the prior year.

28:32 One is the MECAFA exit that has been underway in Canada and began in the United States in July. Two is the higher incentive compensation we mentioned on our prior call. This greater commodity volatility we had warned about in April and we now expect will result in unfavorable key commodity costs in Q3, specifically in our US cheese business. And four, is currency translation due to dollar strength relative to last year. Together, these factors currently represent an approximately 900 basis point headwind to second half adjusted EBITDA growth versus the prior year. That's greater than the 700 basis point headwind we were expecting when we last spoke at the end of April. And we expect slightly more of this pressure to fall in Q3 than Q4.

29:27 During the first half of the year, incremental consumer demand more than offset these headwinds. From where we stand today, we are anticipating organic growth will moderate, and the favorable mix we saw in Q2 will fade. As a result, In terms of adjusted constant currency EBITDA, we currently expect organic gains and the 900 basis points of discrete headwinds I just outlined to essentially offset one another in the second half of the year. The other part of establishing our base comes from below EBITDA, where for the full year we continue to expect a roughly 38 cent headwind from the combination of lower order income A higher effective tax rate and higher stock-based compensation versus the prior year.

30:18 Here to date, we've seen roughly 19 cents of the 38 cents. So the second half should see another 19 cents of pressure versus the prior year. As for our third priority for 2020, to continue to reduce debt while maintaining our current dividend, we have made great progress and are well positioned going forward. Through July, we have now fully paid the $1 billion of our 2020 debt materials with cash, reducing our gross debt outstanding. We fully repaid our precautionary revolver drawdown at the end of Q2, and $4 billion remains available to us. And we are in an extremely strong liquidity position, with more than $2 billion of cash on hand, no meaningful refinancing needs for the next five years, as a result of our leverage neutral tender and refinancing transaction in May, and we simplified our capital structure, eliminating any remaining secure debt.

31:17 So, we are in a strong position to continue reducing our debt while maintaining our current dividend. Finally, I would also like to note that with the filing of this quarter's 10-Q, we expect to have remediated all previous material weaknesses identified in our 10-K we filed in June last year. In summary, we have had stronger than expected results through the first half of the year. Solid execution across the company keeps us cautiously optimistic for the balance of the year. And, as Miguel said, our business transformation is well underway. Employee morale is strong. We have a well-defined strategy, and our team is in place.

32:03 Working together with speed to bring agility with scale. Now, we would be happy to take your questions. Ladies and gentlemen, if you have a question or a comment at this time, please press the star, then the one key on your touchtone telephone. If your question has been answered or you wish to move yourself from the queue, please press the pound key. Our first question comes from Chris Grory with Stiefel.

32:35 Chris, I think your line is open. Chris, if your line is muted, could you please unmute it? Did you want me to go ahead and on to the next question?

32:52 Yeah, let's go to the next question. We can come back to them, man. Okay. Our next question comes from Rob Dickerson with Jefferies. Great. Good morning, everyone.

33:04 So great results in Q2. I guess just to start kind of more broadly, you know, as we think forward with respect to the turnaround, you know, now obviously there's been, you know, this tailwind, which is in place, which is great. But I guess, you know, if we think about later this year and then, you know, in the next year and then go forward, this is probably more for Miguel, excuse me. How are you thinking now about specific brand strength and actual media spend reallocation, and then also just maybe further simplification of the portfolio? It sounds like you got to see some at-home lift, certain categories versus other, more so certain capacity constraints and certain categories versus more so, which will lead me to believe that you're able to kind of see maybe where you think you can more effectively compete.

34:03 So I can get a higher lift off of further spend in some categories versus others. So I'll just pass that and pass it on. Thanks.

34:14 Okay. Look, near term, we are adjusting our content and delivery to reflect, you know, the greater household penetration and the new consumer's That are rediscovering our brands and Carlos mentioned a little bit about that. But that is absolutely critical. I wanted to say it's critical. We are learning about who these new consumers are and that is our obsession at the moment is to keep them with us. They are new consumers and they are repeating the purchase of our products.

35:02 We cannot miss this opportunity. It's an unbelievable opportunity. I would say it's almost a sampling opportunity that we are having, and we have to keep these consumers with us. Beyond this, you are going to see us reorient around how consumers think to a few specific platforms that are globally relevant. In other words, we're going to share with you in September more choices and where we believe we have a chance to accelerate big time our growth and give in the portfolio a role for different products for sure. Some will have a role of bringing more profitability.

35:49 Some will have a role of growing at sales. At this moment or until now, we never had is very clear. And so I think that at the same time, you know, and that is why we are right now increasing, as Carlos mentioned, media in the second half to put more steam behind brands that we saw a big household nutrition growth. At the same time, we are Making a big change in marketing over all the company. We just hired three new heads of marketing for each one of our geographic zones. We are changing and evolving.

36:43 We want to be much more consumer-centric. We want to be much better in marketing. And Thank you so much. Thank you. Thank you, Rob. The next question comes from Chris Grohe with CECL.

37:33 Hi, good morning. Good morning. I'm just so excited for that first question. I lost the line there, so sorry for that. I wanted to go back to some discussion you had, Paulo, around EBITDA growth for the second half of the year. You did talk about some of the drags you have on EBITDA growth, the commodities, McCafe, foreign exchange. And I think you gave some sort of offsets to that, if you will, for the second half. So I wanted to just go back to that kind of discussion and what's going to offset some of those drags in e-without growth, number one, and then to understand, like, have you pushed marketing in the second half of the year? To what degree will that be kind of a further burden on the second half? And then what is marketing doing for the year, perhaps in relation to where you started your expectations for the year?

38:24 Hi, Chris. So yeah, so let's start from the last point. So as Carlos said, we are going to have a higher media spend. We're going to increase versus prior year in the second half. Overall, in terms of marketing total spend and the way that we've been planning to that, market is not going to be a significant drag for the second half of the year, okay, for us. I think the main areas, the main headwinds that we're going to have in our EBITDA are pretty much the four that I mentioned, like the same four items that we mentioned like end of last year, beginning of this year. That is pretty much incentive compensation, so variable compensation when we compare versus prior year. Also, we are seeing a more unfavorable commodity cost, meaning cheese with this recent volatility that we saw in the price of the commodity.

39:22 The Exit of McCafe and NFX, right? So those are the those four compounds that the majority, the key headwinds that we see for the second half of the year. In terms of offset, you know, we still expect a again, strong we still see a strong demand for the second half. I think we're operating much better in our mix and also in our supply chain efforts that we're seeing. We also think it's going to be some Some areas of, you know, when you compare versus prior year, for example, supply chain losses, many other areas of the organization that we are evolving will be offsetting, we expect to be, to offset these headwinds that we have. So, again, sales, mix, the pricing progress that we have, supply chain performance, I think, will be offsetting the headwinds that I've mentioned. Marketing is not, should not be material for us when you compare, you know, When you compare to these other factors.

40:23 That's complementing what Paulo said, Chris, to not create confusion. Carlos mentioned a big increase in media in the second half, but we'll compensate that big increase with reduction on other parts of the market investment. It shouldn't be material, the market increase, but what consumers see, which is media, it will be material.

40:50 That's great. Just a quick follow-up. Are you pricing to some of the commodity changes you're seeing right now? Is this an environment where you're doing that, or is it simply managed via promotional spending, which has been down?

41:05 So in terms of overall the company, when you think about this commodity that is happening, we had some price, and you saw this in the beginning of the year. We had some price initiatives that we set to prepare for the year. and, you know, we, of course, our price strategy will follow the market. We also, as we said before and as we mentioned the call, we expect to have a more normal merchandising in the second half. That's what we saw in Q2. But we'll be operating, you know, in line with what is going to be the market for this commodity that we're seeing. Okay. Thank you so much.

41:44 I was going to add something. If I was going to add something to what Paolo said, it simply is, you know, the pressure that we're seeing on the natural cheese, you know, really is a short-term thing because of the government program. But, you know, if we go into the second half, that may be a small amount of unfavorable in our commodity, but something that we feel that we can handle if we go forward. Thank you. Thank you. Our next question comes from David Dristel with DD Research.

42:25 Great, thank you. Good morning. So I had two questions I wanted to ask. The first one was just on the capacity constraints. What are you doing to address these constraints? When do you think you'll see relief on some of the key constraints? And then was there any ballpark estimate you had on what those constraints kind of Theoretically cost you in the quarter. Could you have seen another, you know, three or four percentage points of revenue growth if not for the supply constraints?

42:58 Let me start with the perspective in the U.S. So, you know, essentially what we saw was some isolated capacity constraint on certain products. I mean, if you think about areas like Kraft Singles and Mac and Cheese Cobs, and, you know, not surprising, some of our pork and beef-based meats. Now, we're working to mitigate those near-term capacity constraints, both in terms of their supply side and the demand side. So, in the supply side, I'll tell you, listen, our employees have shown incredible dedication, adding weekends and overtime shifts, and we're securing more capacity with external manufacturers. and we're also fast-tracking CAPEX projects to improve even more our throughput.

43:45 So moving forward, we actually have projects underway that we're gonna reduce our downtime, reprioritize our CAPEX and build additional raw materials inventory. Now, on the demand side, we've also rebalanced all of our merchandising, promotion, our marketing through the lens of that available capacity and we are making sure that we safeguard our customer service to the best of our ability. And I would say to the end of your question, I would say it's really difficult to quantify the impact of that, but I feel good as we stand here as we go into the second half.

44:23 Great. And then if I could just follow up on one other item. I just want to say it sounds like on a longer-term basis all the things that are happening now in terms of the advantages of this demand Thank you for joining us. This is a little bit of a, I'm trying to tease out maybe a little bit of what you might say in September, but are you willing to agree with my comment?

45:11 Am I interpreting you correctly?

45:14 Look, David, we've said that we expect to find efficiencies to pay for the necessary investments. This quarter is a great example of that. We had significant increase in supply costs in overtimes. In bonus to employees, in PPEs, hygiene, temperature checks. But even with all these increases, we were able to mitigate these costs and costs of goods sold. You can see they were very, very good. And so we remain confident that this will be the case. We'll give you more transparency, more details in September.

46:02 That's the way that we are working moving forward.

46:07 Thank you very much. Our next question comes from John Baumgartner with Wells Fargo.

46:16 Good morning. Thanks for the question. I want to come back to the U.S. Carlos, you referenced being prepared to deal with any sort of path the economic recovery may hand you. and in that vein, how do you think about the portfolio barbell strategy in terms of premium versus opening price points? In what parts of the US portfolio do you think you have the most premium opportunities in terms of development going forward? And then at that low end, the opening price point, how is the supply chain now in terms of being able to meet that demand at margins with minimal dilution, let's say?

46:51 So, thanks for the question. Let me, I guess part of I will start with, let's put COVID aside for a second, and I think getting to what your point is, which is what we see in the current economic pressures, ultimately that's going to be consumers, how they're going to be purchasing will be a function of basically how the economy is going to drop and how much time it will take to recover. Now, both of those things at this point, it's really hard to know how that's going to sort out. When we look back to some of our, in the past of our recessions, whether that was in the U.S. in 2001, 2008, and 9, you know, our portfolio organic growth remained essentially largely consistent with what we saw pre the recession performance, with the exception of food service.

47:41 In food service, we actually saw a decline across both recessions because of the lower foot traffic in restaurants. So that takes me, I think, to your question of where do we stand today? What I would say is I think we're well positioned. I think we have good momentum in the household penetration, as I mentioned. We are in better position on the promotional front end as we go into the second half of the year where we can invest back into our brands. And investment is not just in the promotional event. As I mentioned earlier, we are also investing back in media. So we are seeing a 40% greater investment in the second half as we go into closing the year. So So I think that, you know, from what we have learned and what we are today, I feel good about where we are.

48:27 Okay. And then just in terms of the write-downs taken in the quarter, there was also some commentary regarding increases in fair value estimates in other areas across the business. Can you walk through the areas of positive revisions and maybe elaborate a bit on the reference to recalibrating future investments going forward? Thank you.

48:46 No, sure. I think when you look at, you know, we have many areas in our portfolio and that, you know, the values ended up moving up as I mentioned in the call and areas like the value went down. It's important to remember that, listen, we do this annual test every year in Q2. And as you mentioned, we saw many areas in our portfolio that are doing well and have better Strategy, and we expect to get, for example, our condiment and sauce portfolio across the globe, including the U.S., some new portfolios that we have. We saw, you know, these reporting units going up. Even in a reiterated part of the business unit, also, we saw some value increases. And, you know, the areas that we really, the reporting units that went down, was pretty much related to Canada, food service and retail, and also the food service in the U.S.

49:50 But those are pretty much the areas that we saw ups and downs in terms of our impairment exercise. Okay, thanks for your time. Welcome. Our next question comes from Michael Lavery with Piper Salmon. Good morning, thank you. Good morning.

50:10 Can you use it? You mentioned that you expect more normalized merchandising levels in the second half. Would we hear that correctly to mean that you don't really have any need to pay back the savings from less promotional spending in the second quarter? Or would the more normalized levels maybe even have a little tick up to sort of smooth out the year?

50:36 I guess I could take that question. You know, when you look at our promotional activities, we think about a second half, but I would say, you know, right now, both our inventories, our production levels, as they are improving, we are, in fact, going to be able to put some additional promotional activity into three. In fact, you'll see that in our first draft period, which is, you know, a big draft period happens around Labor Day. So, we'll see that in our brands and categories. So far, what we have been able to do is we have been able to be very surgical about pulling back on promotions. And you saw some of that in the scanner data, but that really has been very focused on certain categories. Now, in going forward, you know, our focus continues to be is making sure that we service demand because we know there is still a significant amount of pull there from our consumer base.

51:29 So, yes, we're going to be building back our promotion. But at the same time, I feel like we're doing it in a balanced way as we are now being able to support those businesses that do have the right level of inventory.

51:43 Okay, that's great.

51:44 Thank you.

51:46 Just one more looking ahead as you start to plan for 2021. Clearly, there's lots of uncertainty, but what's your planning stance as far as elevated demand levels? And do you anticipate that carrying into next year? And are you planning for that accordingly?

52:08 Look, as you said, it's very hard to anticipate the demand for 2021. I can tell you that we've been working on a lot of scenarios and building scenarios. The truth is that we, at the same time, the same way that you, I'm sure, do not see Thank you very much. to keep them with us so we can in 2021 progress.

53:08 If the pandemic continues in 2021 and then we'll continue with that and that will play in our favor. If not, we have a base of consumers that is higher than we had before and they tried and they continue trying, they continue consuming and we want them with us. We continue to carry out the strategy that we've set and and look for additional and continuous improvement opportunities in everything we do. I think that's one thing that is critical for us is that we are starting to share with our customers at this moment, you know, plannings already for what's going to happen in next year and we'll start this now in the second half of the year.

54:00 And that is crucial. We've been able to anticipate the planning cycle for the future, which is very important both for us and for our customers.

54:14 That's a couple of callers. Thank you very much. Our next question comes from Scott Musking with R5 Capital.

54:24 Hey, guys. Thanks for taking my questions. So I wanted to look at the third quarter just for a second. I know you said you're expecting things to kind of, I guess, slow down a little bit. And I was wondering, you know, we're seeing, especially in the U.S., a resurgence of corona cases. And I know the retailers are seeing still very, very strong sales. So I was wondering if you could maybe flush out a little bit why you think things are going to really take a step back in 3Q as far as sales in the U.S.?

54:54 Listen, I can take that and maybe after Carlos can also build if needed. But again, at the end of the day, when we compare our Q3 expectations with Q2, we saw already inside Q2 a deceleration from the retail side of the business. On top of that, we also are seeing a food service kind of recovering and offsetting part of this decline of the retail. We have McAffair also started playing. The exit of McAffair is also going to start impacting us.

55:40 So again, those are pretty much the deceleration factors in sales that we're seeing for Q3 second half versus the first half. The normal You know, deceleration from the retail side. And the McAfee that starts playing out also, the exit of McAfee in the West that starts impacting us in July. Margin-wise, when you talk about EBITDA, that was the comment I made, I think there are two big components, right? One component is mix. I think the mix benefits that we saw in Q2 will fade, both because of the relative retail food service channel mix, and also The category product level mixed gains that we are expecting to see going forward versus what we saw in Q2.

56:28 And, you know, the price relative to commodity, as I mentioned, you know, with the spike mainly in the cheese cost that we're seeing this happen in Q3 versus what we had in Q2, that was a benefit for us. But those are the main drivers that we are seeing in terms of relative performance, year-over-year performance, You have to go versus what we saw in the first half.

56:54 Okay, great. And as a quick follow-up, I was wondering, maybe you don't want to talk about this yet, maybe it's for September, but any thoughts on the innovation pipeline? I know you touched on it, that you wanted to accelerate innovation and renovation. Any further comments there? And then I'll yield. Thanks.

57:15 Let me, I guess I'll comment on the innovation piece, and you're right. Phew. You're going to hear quite a bit more about our plans in September, so look forward to seeing you then. But I will tell you is that when we think about 2020, really the impact has been kind of limited in terms of what we have seen and changing our plans of innovation. If you recall, we are actually in 2020 have half the projects that we had a year ago, so we actually didn't see as much of an impact because of the changes. As we go to 2021, We'll be going into a little detail in September, but I can tell you that we're going to be focused on fewer, bigger innovation. And the good news is that our R&D facilities actually have been open for about six, seven weeks. So actually, we feel very good about our pipeline as we go into next year. And I'm looking forward to kind of share you with the details of how that's going to come to life in September. Thank you.

58:11 Okay, guys.

58:12 If we could take one more question. Okay. Our last question comes from David Fong with Evercore ISI.

58:21 Thanks. A question on pricing net of commodities and also on market share and maybe how those are playing against each other. It looked like your pricing net of commodities was a positive in the second quarter, specifically in cheese. We saw those prices low for much of the quarter, and you mentioned that cheese was flipping to a headwind. and as one of the reasons why the EBITDA headlines would be created is that simply because of the fact that we've seen the dairy spike in June into July here or is there some other reinvestment needed? I ask that because cheese like some of your other commodity oriented categories you've had some sustained market share losses for a while and I'm wondering if you're not just seeing a cycle reason but Perhaps you're drawing a line in the sand about market share in some of these categories and you're making a decision to defend on market share.

59:19 Thanks.

59:22 I'll take that. I think the question is probably more about the U.S. So I guess I will say is let me start by I think a point that we have made earlier, but I'll revisit it, which is our focus really is on driving household penetration and retaining all those new consumers that are coming to our brands. Now, In the context of that market share specifically, what I would say is the way I see it, there's been like three moments since the COVID began. I think there was an initial moment in which the demand really spiked, and we had high levels of inventory, which is normal, but we do at that time of year, so that actually helps us gain share. Now, when we saw demand stay high through May and into June, we also wanted to make sure we better manage our service levels.

1:00:09 So we actually lost some share in certain categories. And as I mentioned earlier, you know, we pulled back on promotions in places like Memorial Day, which we have never done. We also focused our SKUs in our core businesses so that we can maximize our throughput. That also had an impact on share, as you think about less distribution. And then we also had to respond to the fact that there was some supply tightness across the value chain and From end to end in places like meat and in some parts of our, mostly in a pork and beef business. Now, today, what I'll tell you is our retail demand remains strong. So we are, because of that, we're focused on areas that we can actually control.

1:00:54 And let me tell you the three things we're doing. One, we're bolstering capacity to make sure that we get more of our assets and we are expanding our number of co-packers. Investing to be working. Now, because of that, we actually then expanded the number of SKUs back into our shelves where customers really need them. And the third thing is we're also getting back to investing. I mentioned we're investing back in promotional events in the second half and investing back in media as we go into the second half. So when you take these actions, you know, the reality is that we actually see progress. In fact, our share over the last two weeks have been positive, and we see some improvement as we go forward. So we take it all together, but I'll say our focus for our entire team is how do we make sure as we go into the second half we maintain that positive momentum in the business and we focus on connecting with our new and existing consumers.

1:01:57 Thank you. Thank you. I would now like to turn the call back over to Miguel for any closing remarks.

1:02:05 Well, I wanted to thank you for all the time you've been on this call with us, and before finishing, I just want to summarize the way that we are seeing this quarter and moving forward. We, for sure, had stronger than expected results, and that reflected, you know, it's reflecting our continued momentum and a strong consumer demand for our brands, and we are Very excited with that. We had a strong category and brand growth on household penetration, coming from household penetration, but also from repeat rates. We had better than anticipated costs in supply chain, and that despite the fact that we had a big inflation, big cost increase because of the COVID.

1:02:55 And now for 2020, our priorities and our actions are are on track, and the results will be better than anticipated. We expect the first half upside to hold, and solid execution is making us cautiously optimistic for a second half. There's a lot of uncertainty. Are kids going back to school or not? Are we going to open our offices or not? This can change. Still a lot. But if the consumption stays strong, yes, we may have an upside on the second half.

1:03:42 The other thing is at the same time that we are dealing with this unprecedented change in consumption partners, and we've been adapting very fast, we are working on parallel on our transformation. Our transformation is underway. And still in the The early stages of bringing the agility to our company. We have a lean structure, a culture based on ownership, which is a critical ingredient for agility. Yes, we have to correct other things, but we are excited about bringing agility to a company that has the scale that we have.

1:04:28 I think that together with the scale of our business, You know, we are going to bring a benefit to our shareholders, to our customers, and to our consumers. And looking forward, we are looking forward to provide you with more details on our strategy, priorities, and initiatives, and our new operating model during our Virtual Investor Day on September 15. So thank you very much, and see you soon. I'll talk to you soon. Ladies and gentlemen, this concludes today's presentation. You may now disconnect and have a wonderful day.