Campbell Soup Company (CPB) — Q1 2018 Earnings Call Transcript

Thank you, Candice. Good morning, everyone. Welcome to the first quarter earnings call for Campbell Soup’s fiscal 2018. With me here in New Jersey are Denise Morrison, President and CEO; and Anthony DiSilvestro, CFO. As usual, we’ve created slides to accompany our earnings presentation. You will find the slides posted on our website this morning at investor.campbellsoupcompany.com. This call is open to the media who participate in a listen-only mode. Today, we will make forward-looking statements which reflect our current expectations. These statements rely on assumptions and estimates which could be inaccurate and are subject to risks. Please refer to slide two or our SEC filings for a list of factors that could cause our actual results to vary materially from those anticipated in forward-looking statements. Because we use non-GAAP measures, we have provided a reconciliation of these measures to the most directly comparable GAAP measure, which is included in our appendix. In the first quarter of fiscal 2018, the Company adopted new accounting guidance that changes the presentation of net periodic pension costs and net periodic post-retirement benefit costs. Certain amounts in the prior year were reclassified to conform to the current year presentation. The reclassifications did not impact EBIT. Also beginning in fiscal 2018, the business in Latin America is managed as part of the Global Biscuits and Snacks segment rather than the Americas Simple Meals and Beverages segment as in prior years. Prior period segment results have been adjusted retrospectively to reflect this change. An 8-K will be filed on December 8th along with our 10-Quarter, which will recast historical quarterly and annual financial information, reflecting both of these changes. With that, let me turn the call over to Denise.

Thanks, Ken. Good morning and welcome everyone to our first quarter call. Today, we’ll discuss our results in the quarter, our updated outlook for the remainder of fiscal 2018 and the actions we’re taking to improve our performance and to position Campbell for long-term growth. When we last spoke in September, we outlined our expectations for fiscal 2018 and indicated that we anticipated a challenging first half. However, the first quarter was weaker than we expected, particularly for our U.S. soup business. In the quarter, our organic sales declined 2%, driven primarily by declines in U.S. soup. Adjusted EBIT declined 14%. There were several factors that contributed to this performance. First, in September, we discussed how a key customer’s different promotional approach to the soup category would negatively impact our U.S. soup business in fiscal 2018. This had a larger impact on sales than originally anticipated, primarily due to a lower seasonal inventory build compared to a year ago. The dialogue with this key customer remains open, and I’m very optimistic that we will reach a positive resolution. Second, unfavorable weather negatively impacted carrot crop yields and led to supply constraints and higher than expected costs. As a result, we placed customers on allocation in the quarter. We expect to be off allocation by December. And finally, the hurricane recovery efforts in Florida and Texas resulted in higher than expected supply chain costs due to the surge in demand for transportation and logistics. We’ll be impacted by this in the near term but the cost impact will moderate over time. As a result of the factors that impacted gross margin and our commitment to maintain investments in the business, we updated our fiscal 2018 guidance this morning. For fiscal 2018, our outlook for sales remains unchanged. We continue to expect net sales to be in the range of minus 2 to flat for the year. However, we have lowered our earnings outlook reflecting our gross margin performance in the first quarter and our outlook for the remainder of the year. We now expect adjusted EBIT to change by minus 4% to minus 2%, previously minus 1 to plus 1%, and adjusted EPS to change by minus 3 to minus 1%, previously flat to plus 2%. The operating environment remains challenging for many reasons we’ve cited over the past year, but we continue to believe that it’s imperative to invest back in our business to differentiate our brands, to drive innovation, particularly in health and wellbeing, and snacking to accelerate our e-commerce capabilities and to diversify our portfolio. That’s why we remain committed to reinvest a portion of our ongoing cost savings into the areas that hold the greatest prospects for growth. In Q1, we continued to invest back in our core business and in the pursuit of new growth opportunities including support for our product innovations, our real food efforts, building our e-commerce unit as well as funding longer-term innovation efforts. First, we’re supporting our new product innovations such as Well Yes! soup and Chunky Maxx soups, Pepperidge Farm farmhouse cookies and Bolthouse Farms plant protein milk, a dairy alternative with 10 grams of protein. Second, in real food, we completed the transition out of BPA in our can linings in the United States and Canada, and continue to convert our soups to chicken with no antibiotics. Third, our newly formed e-commerce unit in North America has been very active. While small, our e-commerce sales increased significantly in the quarter. We launched several meal kits through our strategic partnership with Chef’d. We also made progress on enhancing our distribution capabilities in partnership with DHL, opening a facility in Fort Worth and breaking ground on another in Ohio. This will help meet the growing demand for customization from both traditional and e-commerce customers. In health and well-being space, we continue to fund Habit, a personalized nutrition start-up. Habit is an example of how we’re investing in new models of innovation. Over time, we expect multiple business models to emerge. Following the national launch of its nutrition test kits in August, the Habit team is expanding rapidly and adding top talent. And we also continued our venture capital activities as the single limited partner in Acre Venture Partners. However, these efforts are not enough. While we’re moving in the right direction and positioning the Company for long-term success, our Q1 results are a clear indication that we have more to do to complete our strategic transition, including more innovation focused on health and wellbeing, and snacking, gaining a larger share of e-commerce revenue and a greater presence in growth channels, increased expansion in developing markets, and continued focus on external development. Speaking of external development, as you know, on September 27th, we delayed the closing of our acquisition of Pacific Foods of Oregon, pending their resolution of some recently filed litigation unrelated to Campbell. While the timing is not yet definite, we have reason to believe that conditions will be met that will allow us to complete the transaction by the end of 2017. With that as context, I’ll review our performance across our divisions. Let’s start with Americas Simple Meals and Beverages where sales and operating earnings both declined. The decline in the topline was driven primarily by U.S. soup and V8 beverages. U.S. soup sales declined 9%. As I stated earlier, a lower seasonal inventory build versus a year ago at a key customer accounted for 7 points of the decline and 2 points were due to reduced consumer takeaway. There is positive performance in the balance of the marketplace, where our soup program has been well received and consumer takeaway is up slightly. We have strong business plans with our key customers; we’re driving trial of our new products, Well Yes!, Chunky Maxx, and Swanson soup kits. And we continue to support our brands with competitive levels of advertising and consumer promotion. While we’re experiencing private label competition in our broth business, private label market share in soup is below average for center store food categories and up slightly. We constantly innovate and test our products to ensure they meet or exceed consumer taste preferences. We believe that innovation and brand differentiation are critically important in the soup category, which is why we’re continuing to invest in our brands. The shelf-stable beverage category remained challenged, and sales of V8 products declined. Despite this decline, we’re seeing positive consumption trends on V8 Vegetable Juice and V8 +Energy. We’re pleased with the sales gains of our Simple Meal products, driven by Prego as well as sales growth in Canada in food service. Looking ahead, we expect the operating environment to remain challenging. And therefore, we’re taking additional actions to improve our performance. We started to shift our soup marketing spending from equity building campaigns to a sharper focus on product attributes that differentiate Campbell brands. We’re increasing in-store presence with stronger messaging and we’re aggressively ramping up our ecommerce plans. Now, shifting to our Global Biscuits and Snacks division. Overall, I feel good about our performance in Global Biscuits and Snacks to start the year. This division delivered growth on both the top and bottom lines. Sales gains were primarily driven by the continued solid performance of Pepperidge Farm. This sales growth was fueled by our snacks business with a one-two punch from crackers and cookies. Our Goldfish crackers continued to outperform the category in a meaningful way. In fact, Goldfish became the number one snack cracker in the category over the last quarter. The brand’s continued growth was fueled by our increasing ounces into houses approach. This is all about providing wholesome delicious snacks that can be enjoyed in a variety of new packaging formats including single-serve multipacks. The second driver of our sales growth was our cookie business behind the successful launch of the Farmhouse brand, Milano cookies, and the rejuvenated Pepperidge Farm chunk cookie line. The Farmhouse launch is one of Pepperidge Farm’s best product introductions in over a decade with strong trial and repeat. Made with simple ingredients, this thin, crispy cookie is the type of snack consumers are seeking and has been incremental to the category. We employed a similar approach with our Pepperidge Farm chunk cookies. We improved our recipes using larger chocolate chunks and cage-free eggs, while also updating and simplifying our packaging. It’s satisfying to see our real food philosophy resonating with consumers in our cookie portfolio. Outside the U.S., Asia-Pacific sales were mixed. Sales declines in Australia were partly offset by gains in Indonesia. We faced increased competitive activity in Australia’s chocolate biscuits but delivered solid results in savory crackers behind the reintroduction of original shapes crackers where we gained share. Now, let’s turn to Campbell Fresh. In Campbell Fresh, sales were comparable to a year ago. We’re encouraged that our CPG products grew for the second consecutive quarter behind Garden Fresh Gourmet and Bolthouse Farms salad dressing. Sales of Bolthouse Farms beverages were comparable to the prior year. We are now back to normal beverage capacity. Our new co-packer was fully operational midway through the quarter. And our service levels steadily improved, helping us instill confidence with customers. As a result, we started to return to more normal levels of promotional activity late in the quarter and expect that trend to continue in the second quarter. Looking ahead, we have strong innovation plans in place with the continued rollout of Bolthouse Farms plant protein milk, new Garden Fresh Gourmet’s fresh soup and salsa products in the first half and a range of Bolthouse Farms dressing and beverages in the back half. Turning to farms. Sales of carrots declined in the quarter. Our carrot crops were negatively impacted by adverse weather. Due to these low yields, we placed customers on allocation in the quarter. Learning our lesson from a similar experience in 2016, the new Campbell Fresh team did not compromise the quality of carrots we delivered to customers. As stated earlier, we expect that we’ll be off allocation by December. We continue to expect Campbell Fresh to return to profitable growth this fiscal year. While I’m not satisfied with our results this quarter, I’m also not deterred. Despite challenges within U.S. soup, V8 and carrots, other parts of the business are growing. The Global Biscuits and Snacks division remained a bright spot, especially Pepperidge Farm. Simple Meals, Canada and food service performed well, and the Campbell Fresh turnaround is progressing. We’re taking the appropriate steps to address our immediate issues and remain focused on the actions that will position Campbell for long-term growth. We will continue to invest to differentiate our brands, enhance our real food credentials, drive innovation, particularly in health and wellbeing and snacking, build our e-commerce organization, and pursue smart external development. Thank you. And now, I’ll turn the call over to our Chief Financial Officer, Anthony DiSilvestro.

Thanks, Denise, and good morning. Before getting into the details, I wanted to give you my perspective on the quarter and revise 2018 guidance. Our first quarter results were below our expectations, largely for three reasons. First, while we anticipated that U.S. soup sales would be negatively impacted by reduced support levels with a key customer, the sales decline in the quarter was more than anticipated, primarily due to a lower seasonal inventory build with this same customer, which accounted for 7 points of the soup sales decline. Given the seasonality of our soup business, quarterly fluctuations in retailer inventory levels are mostly timing related. Second, as a result of unfavorable weather, we experienced lower crop yields on carrots, which had a negative impact on our gross margin performance. And third, also impacting our gross margin, we experienced higher transportation and logistics costs, reflecting the impact of industry-wide carrier capacity issues. On a positive note, we continued to make progress against our cost savings target of $450 million by the end of fiscal 2020, delivering another $20 million of savings in the quarter. This brings the program-to-date total to $345 million. And as Denise highlighted, we will continue to reinvest a portion of the savings back into the business to drive growth over the long term. As you’ve seen in the release, we are revising our full-year guidance. While we are not changing our range for sales, we are lowering the ranges for adjusted EBIT and adjusted EPS by 3 percentage points, which equates to about $45 million in EBIT. This change primarily reflects the impact of carrier shortages on our transportation and logistics costs and the unanticipated impact of the weather-related carrot yield issue. Now, I’ll review our results in more detail. For the first quarter, as reported, organic sales declined by 2%. The decline in organic sales was driven by lower sales in Americas Simple Meals and Beverages, partly offset by growth in Global Biscuits and Snacks. Adjusted EBIT decreased 14% to $417 million, reflecting a lower adjusted gross margin, lower sales, and higher administrative expenses, partly offset by lower marketing and selling expenses. Reflecting a reduction in the tax rate and a lower share count, adjusted EPS decreased 8% or $0.08 to $0.92 per share. Breaking down our sales performance for the quarter. Organic net sales declined 2%, all driven by lower volume. Volume declined in Americas Simple Meals and Beverages, reflecting declines in U.S. soup and V8 beverages, partly offset by gains in Prego pasta sauces. Volumes also declined in Campbell Fresh, which was entirely attributable to the decline of carrot, a direct result of placing customers on allocation, as Denise mentioned earlier. This was partly offset by volume gains in Global Biscuits and Snacks, reflecting continued momentum on Goldfish crackers and Pepperidge Farm cookie. Overall, promotional spending rates were comparable to the prior year. And although it rounds to zero on the chart, we did have a slightly positive impact from currency translation, principally the Canadian and Australian dollar, bringing the change in our as reported sales to minus 2%. Our adjusted gross margin percentage decreased 210 basis points in the quarter. First, cost inflation and other factors had a negative impact of 250 basis points. Almost two-thirds of this was cost inflation, which on a rate basis increased about 2.5%, reflecting higher prices on meat, steel cans, aluminum and dairy. The remaining third was driven by several factors. As I mentioned, we had higher carrot costs and higher transportation and logistics costs. In addition, we incurred losses on open commodity hedges as compared to gains in the prior year quarter, and we had higher costs associated with investments in our real food initiative. These negative drivers were partly offset by benefits from our cost savings initiative. Mix had a negative impact of 80 basis points, primarily due to the impact of lower U.S. soup sales. Pricing and promotional spending had little to no impact on the quarter. Lastly, our supply chain productivity program, which is incremental to our cost savings program, contributed 130 basis points of margin improvement. All-in, our adjusted gross margin percentage decreased 210 basis points to 36.5%. Marketing and selling expenses declined 5% in the quarter, reflecting lower advertising and consumer promotion expenses, and benefits from our cost savings initiatives. Adjusted administrative expenses increased 17%, primarily due to higher information technology costs, expenses related to the pending acquisition of Pacific Foods, inflation, and investments in long-term innovation. Looking ahead, we do not expect this rate of increase in administrative expenses for the balance of the year. For additional perspective on our performance. This chart breaks down our adjusted EPS change between our operating performance and below the line items. Adjusted EPS decreased $0.08 from $1 in the prior year quarter to $0.92 per share in the current quarter. On a currency-neutral basis, the decline in adjusted EBIT had a negative $0.16 impact on EPS, two-thirds of which was driven by our gross margin performance. Net interest expense was up $2 million, reflecting higher rates and had no impact on EPS. Currency translation from both a stronger Canadian and Australian dollar added a penny EPS benefit. Using access cash flow to repurchase shares reduced our share count, adding a $0.03 EPS benefit. Our adjusted tax rate in the quarter declined by about 4 percentage points to 28.2%. The lower adjusted tax rate in the current quarter was driven by favorable settlement of certain U.S. state tax matters. The lower tax rate increased adjusted EPS by $0.05, completing the bridge to $0.92 per share. Now, turning to our segment results. In Americas Simple Meals and Beverages, organic sales declined 5%, driven primarily by declines in U.S. soup and V8 beverages, partly offset by gains in Simple Meals driven by Prego pasta sauces and excluding the favorable impact of current translation, gains in our retail business in Canada and our North America food service business. Sales of U.S. soup decreased 9%, driven primarily by declines in condensed and broth. The lower sales reflect a 7-point decrease due to a lower seasonal build of retailer inventory. Consumer takeaway measured channels declined by 2% in the quarter. Both the inventory-driven decline and reduction in consumer takeaways reflect our performance with a key customer we’ve referenced. Operating earnings decrease 14% in the quarter to $328 million. The decrease was primarily driven by lower sales volume and a lower gross margin percentage, partly offset by lower marketing and selling expenses. Segment gross margin performance was impacted by higher transportation and logistics costs and negative mix. Here is a look at U.S. wet soup category performance and our share results as measured by IRI. For the 52-week period ending October 29, 2017, the category as a whole increased 10 basis points. Our sales in measured channels declined 40 basis points. We had a 58.5% market share for the 52-week period with a share loss of 30 basis points. Private label grew share by 130 basis points, primarily reflecting gains in broth, finishing at 14.3%. All other branded players collectively had a share of 27.2%, declining 100 basis points. In Global Biscuits and Snacks, organic sales increased 2%, driven by continued gains in Goldfish crackers, which benefitted from promotional activity and new items and gains in Pepperidge Farm cookies, benefitting from the launch of farmhouse cookies as well as growth of Milano and chunk cookies. Excluding the favorable impact of currency translation, biscuit sales in the Asia Pacific region were down slightly as lower sales in Arnott’s Australia were partly offset by growth in Indonesia. Operating earnings increased 4% to $120 million, primarily driven by higher sales volumes. In the Campbell Fresh segment, organic sales were comparable to the prior year at $234 million as sales gains of carrot ingredient, Garden Fresh Gourmet and Bolthouse Farms salad dressings were offset by declines in carrots. Sales of Bolthouse Farm beverages were comparable to the prior year. With our new beverage co-packer now up and running, we expect to have sufficient product supply to support our promotional program going forward. As a result of the crop yield issue, carrot sales were on allocation for part of the quarter, resulting in the sales decline. The segment generated a $6 million operating loss for the quarter as compared to $1 million of earnings a year ago. The year-over-year decline was primarily driven by the cost impact of lower carrot yield. Cash from operations was $188 million compared to $221 million in 2017. The decline reflects higher payments on hedging activities and higher seasonal working capital requirements, partly offset by higher cash earnings. For the full year, we expect to generate strong cash flow from operations of approximately $1.2 billion. Capital expenditures were $58 million, $10 million higher than the prior year. We paid dividends, totaling $111 million compared to $100 million in 2017. The increase reflects our 12% increase in the quarterly dividend to $0.35 per share, as announced in September of fiscal 2017. In aggregate, we repurchased $86 million of shares in the quarter, $75 million of which were under our strategic share repurchase program. The balances of the repurchases were made to offset dilution from equity-based compensation. Net debt of $3.3 billion was comparable to last year. Now, I’ll review our revised 2018 outlook. As I said earlier, we continue to expect sales to change by minus 2% to 0%. Consistent with our previous guidance, we expect sales declines in Americas Simple Meals and Beverages, driven primarily by U.S. soup will be partly offset by growth in Global Biscuits and Snacks and in Campbell Fresh. We now expect our adjusted gross margin percentage to be comparable to last year, lower than previously anticipated, primarily due to higher transportation and logistics costs and the cost impact of lower carrot yields. Reflecting the reduced expectation on gross margin, we now expect adjusted EBIT to decline by minus 4% to minus 2%, and adjusted EPS to decline by minus 3% to minus 1%. Both earnings ranges are 3 percentage points below our previous expectation. We continue to expect our cost savings program which is incremental to our ongoing supply chain productivity gains to deliver $60 million to $70 million of savings, most of which will impact costs. This guidance assumes that the impact of currency translation will be nominal and that the adjusted tax rate is expected to be approximately 32%. Given the seasonality of our business and the timing of these unforeseen cost issues, we expect to see significantly weaker performance in the second quarter followed by improvement in the second half. That concludes my remarks. And now, I’ll turn it back to Ken for the Q&A.

Thanks, Anthony. We will now start our Q&A session. Since we have limited time, out of fairness to the other callers, please ask only one question at a time. Okay, Candice?

Hi. Thank you very much. One of the questions I get on Campbell, Denise, is, what is the Board’s thought on the carrot business at this point? Because obviously, the carrot business, I think has underperformed expectations, it’s fair to say. And at this point, it’s volatile and unpredictable. And from an investor perspective, that leads to uncertainty which leads to lower multiples. So, I’m just curious how committed the Board is to sort of keeping the carrot business itself as opposed to the rest of Bolthouse, which obviously still has some upside from a packaged food perspective?

There is no question, Ken, that we have experienced volatility in the carrot business due primarily to weather issues in California dealing with extremes in rain and heat, which has affected the crop. While we can’t control the weather, we can control what we do about it, and I believe that we did the right thing this time around by putting customers on allocation, not harvesting early, and keeping the quality of our carrot. Understand that the role of carrots in this business is it’s the scale of distribution for the CPG products. And one of the reasons why we acquired the business was to grow the CPG portion and recognize that the carrots are the chassis for distribution at best pricing. So, we’ll continue to take this into consideration going forward. We’d like to get to the point of stability in carrots and growth in CPG, and that’s our strategy.

Okay. Thank you for that. My follow-up is, Denise, you talked about getting a little bit optimistic or maybe you are optimistic about conversations with the key customer that the promotion has maybe been lost early with. Can you give us a little more color where that optimism comes from and when the earliest it might be that you might get that promotion back in some form?

Well, I can’t talk about any specifics. I can say that the dialogue remains open and it’s very positive.

I wanted to ask another follow-up on the soup issue. Most of your competitors have characterized this specific circumstance in soup with this one retailer as a very isolated case. And I think what we’re hearing from others is that there is just a need for greater levels of innovation, and that’s going to be sufficient to protect relationships with key retailers, provide value for all stakeholders and avoid having others run into a similar situation. So, I guess, do you agree with that characterization of soup being an isolated pressure point in the industry? And if that’s true, what could you have done differently or do you need to do differently to avoid this, going forward? To the extent that this perhaps is an issue that’s disproportionately affecting the condensed business, is there a need to try and bring some type of innovation to that area or the business that’s been a little bit more static from a product standpoint in recent years?

I’ll answer that question from a couple of perspectives. First of all, in the rest of the market, soup programs have been very strong. New products have been well-received, with the new Well Yes! achieving 83% ACV distributions. We're supporting the brands, and new Chunky Maxx has been launched with 40% more protein, which is currently on trend. We are pleased with the performance across the market, as consumption has slightly increased. We believe this momentum will carry into the second quarter. Additionally, our other lines of business with this key retailer are very robust. Therefore, I agree that the soup situation is isolated.

I understand this might be a challenging topic to address, and you may choose to defer your response. However, it seems that you evaluated the situation and chose not to meet their requirements for the soup category. Meanwhile, you're observing steady consumption or slight growth among other customers in that category. Considering these factors, do you have any insights into how they perceive the return profile of their strategy for the soup category this year, especially since they are losing a significant share in a high-margin segment? What might this mean for the likelihood of encountering similar situations in the future?

You’re right. I’ll defer.

Just one last question on that issue. When you mention the dialogue being positive and open, could this potentially have a positive impact this fiscal year, or are we at a stage where plans are already in place and you have implemented strategies that other retailers find effective? Is this more of a scenario for fiscal year 2019, or is there a way to salvage some of this year? Also, Anthony, at the last call, you indicated that this promotional issue would likely result in about a 1% top-line decline for the full year for the Company overall. Is that still the case, or has the first quarter changed that outlook? Thank you.

I’ll take the first part, Andrew. We said this in September, but we expect that the first half on soup will be weaker than a year ago, and we expect some more momentum in the second half.

On your other question, yes, we did say that the soup performance would have about a point impact on total Company. I would say it still rounds to 1 but probably a little bit higher.

Okay. And then, the last thing would just be, I think you mentioned, obviously a big part of what we saw in the fiscal first quarter was the lower year-over-year inventory builds. In fiscal 2Q, was there also an inventory build seasonally last year that we wouldn’t get this year or would soup shipments look a little bit like consumption this time around as we go into the 2Q?

Yes. The seasonal build goes through the second quarter, I mean, it’s kind of hard to say. Obviously, we didn’t build as much in Q1. But, given where we sit today and given our outlook for consumption, it’s hard to say what’s going to happen relative to inventory moves going forward. But, I would expect them to be significantly more muted than the Q1 impact.

Hi. I wanted to clarify your comment, Anthony. Are you indicating that you expect there to be continued deloading in the second quarter, meaning that your shipments will lag behind soup consumption during that period? Additionally, is this situation specific to one retailer, or are you observing deloading across multiple retailers?

So, I’d be careful with the term deloading. Yes, the impact is all one customer. And basically, you have a curve that builds kind of steeply in Q1 and less steeply in Q2, and certainly, the seasonal build through Q1 was significantly below last year. And that curve starts to kind of come down a little bit or increase at a slower rate in the second quarter. And it’s really difficult to predict shipments vis-à-vis consumption, but I would expect to have a much more tighter delta between shipments and consumption in the second quarter than the first.

Okay, I think I get it. And in one of your slides, you show that private label soup has expanded market share by over 100 basis points. Has this retailer really pushed private label as a substitute for your brand in the category or is that private label gain happening across multiple retailers?

I don’t believe private label is a new trend. It is quite common, and we have observed an increased emphasis on private label within the broth market overall. In fact, the share of private label in condensed soup and ready-to-serve soup is considerably lower than the average in other center store categories and has only increased slightly. However, broth has certainly been affected.

And how would you expect that to impact the Pacific Foods business? I think Pacific is largely broth, isn’t it?

The Pacific Foods brand is highly differentiated, being organic and natural. So, we believe that will be a good add to our line.

I wanted to follow up on gross margin and clarify if you expect it to face more pressure in the second quarter compared to the first quarter, but improve in the second half of the year. Additionally, could you elaborate on the actions you are taking to enhance gross margins? Are you planning to raise prices or focus on increasing productivity? I'm trying to understand what steps will lead to improvements in gross margins throughout the year.

Yes. I think the first part of that question is understanding what happened in the first quarter. I mean, we were down couple of hundred basis points, primarily due to three things, two of which we’re going to stay on the year and one of which is going to turn. The higher transportation and logistics costs certainly had a negative impact on Q1 that’s going to impact the year. The second is the carrot. A cost issue related to yield that impacted the first quarter and will also stick on the year. The third, and this one is primarily timing, we took down 9% in the first quarter. There is a pretty significant negative mix impact from that and most of that should turn. So, as we look at the full year now, we would say, we expect gross margin to be about flat. And I think the way to decompose that is to think about our productivity savings. So, we’re targeting 3% of costs. And that will just about offset cost inflation as well as some of the investments we’re making in real food. Denise mentioned what they were. And then, the other two components, we had previously expected and still expect to deliver cost savings of $60 million to $70 million, most of which will impact costs and to a largest extent, that’s largely offset now by these unanticipated cost issues, both transportation and logistics, as well as the carrot yield. Now, in terms of phasing, given the seasonality of the soup business, certainly the consumption expectation will have a more significant impact on Q2. The timing of those two cost issues, transportation and logistics and carrots, are more impactful on Q2, and then, we would expect to see improvement in the back half.

Okay. So, the second quarter isn’t under more pressure than the first quarter. In the first quarter, you also experienced a challenging gross margin for carrot compared to last year.

Hi. Good morning. Just a follow-up on Bryan’s question. Does this imply that gross margin in the back half of the year going to be up about 150 basis points or greater? Just want to make sure I am thinking about that correctly. And I’ve got a follow-up.

Yes, we would expect to be up in the second half, for sure.

Okay, great. That’s helpful. And then, Denise, can you comment a little bit about the overall category right now? Are you seeing any shrinkage in total points of distribution at retail across the U.S. channel place right now or are you just seeing a little bit of rotation between the little bit of private label and branded mix here and there? Thanks.

Just for clarification, because we’re in the snacks category and many fresh categories, are you referring to the soup category?

Yes, specifically. But while you’re at it, if you want to comment on snacking, given what we’re seeing with Kellogg’s DSD transition that would be helpful too. Thanks.

Okay. Let me start there. In our Pepperidge Farm business, we’ve seen a lot of robust consumption, particularly on Goldfish and cookies as I stated before. We continue to increase our shelf space merchandising. So, they are really doing a great job. In Campbell Fresh, again, the CPG part of the business has returned to growth, up a couple of points for the second consecutive quarter. And we didn’t start promoting beverages until October. So, we will now return to a normal promotion schedule in quarter two and we have a huge innovation suite coming to market in quarter three. So, we believe that the CPG part of Campbell Fresh will have momentum. In the soup category and the rest of the market, we continue to see robust plans. We do audit shelf every year, but we have not gotten results of that. We’ll let you know when we do. And so, we’re just running our play.

Just a question for you to follow up on an early question in relation to the change in promotional program at this key customer. If you were to effect some sort of plan now or soon, given the seasonality of this business, could it be in place by the end of the soup season? Could you guys be promoting relatively quickly if something got worked out there?

Yes. I’m not going to comment on the specifics of customer programs.

Okay. Even the timing of what you could affect the promotion?

Yes. I mean, all I’m willing to say is that we are in open discussion and positive about it.

And then, if I could just ask a quick question on the margin recovery in the C-Fresh division. You are back to promoting more heavily. I think you mentioned that Anthony, and you do have some easy comps. And I know carrot costs will be an ongoing issue. But, it seems like that should get back to generating operating profit. Does that happen as quickly as Q2 or is there an upfront investment that may kind of slow that rebuild in profitability of division?

A couple of things, I would say, if we didn’t have this yield issue in Q1, Campbell Fresh division would generate a profit. So, yes, it can turn around pretty quickly. We’ll have a little bit of lingering impact of the carrot yield issue into the second quarter. Denise mentioned, we’re on allocation; that should be behind us by December. So, we would expect to see profitability pretty quick in Campbell Fresh. And as we’ve said before on a full year basis, we would expect to deliver both top and bottom-line growth.

Chris, in addition, we have a very robust supply chain productivity program. Since we’ve integrated the supply chain into Campbell’s and put them on our productivity program, we have a very good line of sight to some significant cost savings, which will enhance the profitability of the business.

Good morning. I have a follow-up question regarding soup. Have you conducted any audits concerning your experiences with retailer issues in that category, especially in relation to the price gap with private label and the increasing focus on private label? There's a theory that these price gaps have widened in recent years. A concern is that these issues might not be isolated to just one retailer and that we could see a broader push for private labels from others. Any comments on this would be appreciated. Thank you.

We do very robust analytics on our price gaps and thresholds of the brands versus private label. So, we have a good indication of what that looks like, both from the regular retail pricing and also the merchandising pricing with the frequency that we merchandise. So, that’s under constant watch. And that’s not different. We’ve been doing that forever. So, I would just say that in the broth business, what we have done to address private label, and that’s where we have experienced the competition, is, we’ve changed our advertising messaging more to house ones and is differentiated versus private label, starting with the fact that the first ingredient in Swanson is chicken stock whereas the first ingredient in most private labels is water. And so, we’re calling attention to some of the attributes that distinguish the Swanson brand from private label. And then, of course, the pending acquisition of Pacific, as I mentioned, we’re pretty enthusiastic about what differentiation that brand brings to the line.

That’s helpful. Thank you.

So apologies for some more soup questions that keep coming. Soup inventory, Anthony, could you just talk about why this doesn’t impact guidance? I think you called out the carrot issue and the supply chain, the freight issue as the big changes to the guidance. But, I’m not a 100% clear why the soup inventory issues in Q1 don’t also impact the guidance? And the simple question would be, if the big retailer is not ordering product, why doesn’t this have some kind of impact on upcoming sales?

So, it’s probably the end of that question. I think it’s likely that lower inventory build would have is an indicator of near-term consumption. So, I think we would expect to see some consumption decline. And then, the other question, yes, both the carrot issue and the freight issues are both unanticipated in impacting the year. But, I think the way to think about retailer inventory, they start our fiscal year at relatively low level; they go through a significant increase in Q1 and Q2 and then come back down in the back half. So, it really is volatility amongst the quarters as opposed to an impact for us on our fiscal year, given our fiscal year is about when those inventories are at their lowest point. So that one is more about timing, which is why we didn’t talk about it in terms of our full year guidance.

And then, related to that, soup takeaway is down 2% and soup is not really a factor in the guidance change. Is it fair to say that your full-year expectation for the soup season is down about 2%?

I don’t want to give you a specific number, but probably a little south of that.

Finally, can you discuss how the freight situation will evolve over time? I'm a bit unclear about the influencing factors. We have an issue with Hurricane truck availability that should improve, which seems positive as time goes on. However, I believe there are some upcoming regulations that could have a negative impact. So, regarding the freight costs, are we looking at improvements or further deterioration as time goes by?

This one is difficult to discuss. Clearly, we have felt the effects of the hurricanes and the shortages, which pushed us into the spot market, increasing our costs. We have also incurred additional inner plant and warehousing costs as we worked to rebalance our network in response. We expect this impact to lessen as we move through the remainder of our fiscal year, but it has taken time. Currently, capacity reports show levels well above what we have seen over the past six or seven years. While I cannot specify when things will begin to improve, we anticipate it will take some time.

Thank you guys for taking the question. I am going to cramp two questions in, if I may. First, in terms of topline drivers, can you help us understand why you are not seeing any sort of promo price mix benefit as you suffer so much volume loss related to subsidized promoted sales?

Yes. I can take that one. What’s happening, and the reason you don’t see a promotional lift in terms of sales is there are a couple of offsets. One is, if you look at the dollar spend for promo on soup, for example, it is down double-digit in the first quarter. But what’s happening is, we’re thinning back a little bit on broth; we’re spending back a little bit on both the Prego business and on V8. And the other reason you don’t see as much as with soup volumes being down as part of mostly related to that inventory issue, we calculate trade rates on a rate basis. So, the volume decline is muting the promotional rate a little bit. But, I think the better indicator is on a dollar basis, our trade is down significantly on soup.

Thank you for that. For the second question, I believe it ties back to many of the questions you’ve received today. It also relates to your credibility in achieving the acceleration you mentioned for the second half of the year. Denise, it seemed you suggested that soup could possibly see growth in the latter half. Steve raised a question regarding gross margin, implying that your guidance indicates at least 150 basis points of expansion in the back half of the year. Could you provide more details about the factors driving these dynamics to help strengthen confidence in that acceleration path?

Yes. We said in September and continue to believe that we will have a weaker first half than second half in soup, based on what we know at this point. And in terms of the gross margin, Anthony, do you want to handle that one?

Yes. I’d say, typically, our cost productivity program is more kind of, I would say, backend weighted as opposed to frontend, given the seasonality of the business and our ability to getting into some of the plans, when there is some downtime. So, that’s certainly more back half than front half. The other thing is, this mix issue of soup in the first quarter in effect should turn as we go through the balance of the year. So, that’s a positive. And the third, as I said before, on our cost savings program, which is in addition to the productivity program, a lot of that should be coming in the back half as well. So, we do expect to see improved gross margin performance in the back half.

Yes. In the back half, we have a greater mix in our Global Biscuits and Snacks business in Campbell Fresh.

I just want to understand this, Anthony, something you just said is, if I’m hearing right, it sounds like you’re expecting the 7 points of lost inventory build to come back over the course of the year. And if that’s correct, can you explain why you think that’s the case?

Yes, I want to reiterate something I mentioned earlier regarding the seasonality of the soup business and its impact on retailer inventory levels. Essentially, our fiscal year marks the lowest point for retailer inventory, after which inventory builds significantly during the first and second quarters. The timing of that inventory build between the first and second quarters creates some volatility from quarter to quarter. By the end of the fiscal year, inventory levels normalize. Therefore, a lower seasonal build at this point will lead to a smaller seasonal decline in the second half of the year, effectively balancing things out.

Okay. The main thing to focus on is the consumption; in the quarter, soup consumption was down 2.3%.

Can you help me understand a little bit of the dynamics with this promotional change? Because that’s how you’ve typically characterized it. But, it also sounds like if it’s simply were a question of spending more money and adding promotional dollars and that would benefit you, then, you would have probably simply just done it. So, how many pieces of the puzzle are there, beyond that? Because it sounds like there is potentially or maybe even probably some shelf space changes. Is that a fair assumption? And if so, then, wouldn’t that perhaps have a lasting impact on the inventory level through the course of the year?

I would say, we really haven’t seen any shelf space changes. When we deal with our customers, we agree around a promotional program that includes new items; it includes merchandising amongst other things, and promotional programming. And so, it isn’t just a dollars and cents kind of thing. I think the thing that impacts the inventory build is what is the merchandising program on a go forward basis? And that’s why I said earlier that this lower retailer inventory build could be an indication of what’s going to happen to consumption, say for example, the second quarter.

Okay, thanks. And just one last unrelated one. You touched on significant growth on your e-commerce business. Can you just give a sense across your portfolio of what types of products lend itself to good performance online? I would assume it probably varies a bit. Are there some that tend to do much better than others and what would those be?

Yes. We have a couple of things going on there. And our e-commerce business is still small and for the industry, it’s small. But, we’re focused on building capabilities in terms of really understanding the consumers’ path to purchase in that space. We are working predominantly with pure play e-tailers and also omni, and we’re working with Chef’d on meal kits in that space. So, we’re trying some different things. We’re working literally across all of our brands and bundling brands based on what the customer wants to do in that space. So, I think we’re trying a lot of things. One of the things that’s very encouraging though is we’ve brought in some top talent. And we believe that as more consumers shift to e-commerce, whether it’s order online pick up at store or order online and deliver to home, will be well-poised to participate and lead in that space.

Thank you, Candice. We thank everyone for joining our first quarter earnings call and webcast. A full replay will be available about two hours after our call by going online or calling 14045373406. The access code is 6692642. You have until December the 5th at midnight at which point we move our earnings call strictly to the website investor.campbellsoupcompany.com under News and Events. Just click on Recent Webcasts and Presentations. If you have any further questions, please call me at 8563426081. If you are a reporter with questions, please call Thomas Hushen, Associate Director of Communications, at 8563425227. Thanks everyone. Happy Thanksgiving.