Yahoo Finance

Question and Answer Session

Operator

(Operator Instructions)
Andrew Lazar, Barclays.

Andrew Lazar

Great. Thanks so much. Carlos, you mentioned in the prepared remarks that the revised outlook provides the necessary flexibility to dial in on investments as deemed appropriate. And that said, this is not the first time, right, Kraft Heinz has sort of used this language around proposed investments. And so far, it's not proved enough, although admittedly in a very dynamic consumer environment. Many industry players I think have taken the approach of kind of like increasing investments on what seems to be more of an incremental basis to see how the consumer reacts, almost like a sort of a test-and-learn approach. The magnitude of today's guidance is larger than previous ones. But I'm still getting all the questions from investors, I guess, as to whether this is more of the same sort of approach or if you see it as more comprehensive in some way. Thanks so much.

Carlos Abrams-Rivera

Good morning, Andrew. Thanks for your question. First, let me just say, we are continuing to invest in the business despite what we are seeing in terms of the macroeconomic uncertainty. Frankly, because the company decided that we have. And I think in moments like this, company can be sometimes overly cautious on defenses or play offense. We are choosing to play offense with discipline. So we're going to expect prioritizing investments in marketing, R&D, and technology.
And the way we're doing that, Andrew, we focus on increasing returns of our marketing dollars by shifting more towards a consumer-facing marketing. We're also make sure we're optimizing the allocation across the brands and media types so that, in fact, we make sure we have the best ROI, with an improved quality of the messaging at the same time.
I mentioned investing in R&D. We are going to continue to invest behind innovation pipeline. We are making sure we are closing the gap to our investment levels that it is 1% of net sales. And I mentioned technology. We are going to continue to invest in our technology as well because that actually has helped us in terms of driving the efficiencies in the business by investing in things like automation and enhanced digital tools.
I think you also talked to why is this different, what's different now versus in the past. And I'll tell you, one of the important parts of what is different is the fact that we're also investing through the brand growth system. And if you recall, the brand growth system is our repeatable global model for understanding how we see opportunities within our brands and how do we make sure we drive superiority on those brands through both type products and packaging and making sure that every communication has the right brand resonance value equations and on the execution.
So it's not just what we are spending or how we are spending. And we mentioned in the past that we have done this in about 10%, one of our brands in 2024 (inaudible) to pilot. That is, in fact, now being scaled up to 40% of our business by the end of this year.
So that idea of us having more confidence in investing because now we have proven that brand growth system help us find the right opportunities and allows us to make sure we take the right steps in order to fuel the investments I think is part of why we are going to be playing offense with discipline. So you'll see us actually the step up our investments in marketing and also to make sure that as we renovate our products, we are supporting it with the right focus on the consumer communication.
So we invested behind the BGS. We make sure we have the great products, packaging quality. And then we make sure we have the right communications to support it and drive that forward. It's something that helped us work with our Philadelphia brand in 2024. It helped us in our Heinz UK business in the last year. And now, we are going to be seeing that across all of our brands towards 2025 here in the U.S.

Andre Maciel

Good morning, Andrew. Just to add to Carlos, remember that in our prior guidance, we already had contemplated a step-up in price investments and just roughly speaking to the extent of 100 bps on the top line. So it was a relevant investment and concentrated on those categories we have previously described.
And we also had in the prior guidance already contemplated a double-digit increase in media. So we were still retaining our marketing percentage on revenue of 4.5% in the prior guidance. And with that, by reallocating expenses within the marketing bucket, we could free up double-digit increase in media.
Now in this new guidance, we have opened the room to further accelerate our marketing investments. Remember that in our long-term algorithm, we want to be -- approximately, that's 5%. We had at the midpoint of guidance around 4.8% of market, so a 30 bps step-up. Still, this December, we might flip it a little bit up or down depending how the dynamics happen throughout the year including final impact on tariffs. But we want to accelerate the step-up to reach the 5%.
And we also had in the guidance some impact in COGS linkage to product renovation. As Carlos said, as we continue to deploy the brand growth system, we are seeing opportunities not only to improve quality of messaging and media pressure, but also to renovate the products and ensure stronger superiority.

Andrew Lazar

Great. Thank you, both.

Operator

Yasmine Deswandhy, Bank of America.

Yasmine Deswandhy

Good morning, everyone, and thank you for the question. So I kind of wanted to dig in a little bit on North America and the organic sales guidance update for this year. So just for 2Q specifically, there's a few items here to consider. You talked about the Easter timing shift and then there's a plant closure (inaudible). But there are also impacts last year on multiples from the consumer part. And then you had the Capri Sun reformulation impacting consumption. So can you help size the impact, if any, to the second quarter? And if there's anything else that we should consider that will drive a gap between North America shipments versus consumption?

Carlos Abrams-Rivera

Sure. Good morning. Thanks for the question. Look, we expect second quarter top line to be better than the first quarter top line. The effect of Easter, as I have said before, is approximately 90 bps, 100 bps. So that will be a tailwind in the second quarter.
In addition to that, we had emerging markets (inaudible) we have emerging markets further accelerating from where we were in Q1. And aside from Easter, we're going to see improvement in the (inaudible) platforms. So cream cheese and Ore-Ida, for example, they declined in Q1, and this was totally expected because we are lapping competitors with out-of-stock issues last year. But now, we restored growth. And you're going to see growth in those two categories in the quarter.
And your point, we will see some improvement in Lunchables, still not the levels that we believe we can achieve, as the newer innovations hits the market in the second quarter. But we'll see Lunchables improving, particularly, after mid-May and June because that's when we really start to have fully lapped the consumer reports from last year.
On the Muscatine, on the factory, we are lapping that as we head into the second quarter. But taking to mind that the industry (inaudible) has gone down quite a lot this year. So we are not going to see certainly a growth in away-from-home in the second quarter. But beyond that, you will see they accelerate platforms, sauces, cream cheese, meals, and snacking with a better performance in comparison to Q1.

Yasmine Deswandhy

Okay. Great. Thank you. That's really helpful. And a quick follow-up to that. Just looking into the second half of the year, obviously, understanding that 2Q you'll see some nice improvement on volumes given the one-time items that you just mentioned. Your organic sales cut was basically all volumes and the pricing contribution was left unchanged. Do you see a need for North America volume to inflect positively in the second half in order to hit your guide? Or do you expect growth in international, particularly in emerging markets, to be enough to hit your guidance for the year?

Carlos Abrams-Rivera

No, we don't. In fact, in the midpoint of our guidance, the total company does not get to positive in any quarters.

Yasmine Deswandhy

Okay. Great.

Carlos Abrams-Rivera

(inaudible) Okay?

Yasmine Deswandhy

Thank you, guys.

Operator

Tom Palmer, Citi.

Thomas Palmer

Morning and thanks for the question. I wanted to ask on the COGS inflation on the revised outlook. Just any breakdown of how much of that is related to tariffs versus maybe other drivers of that increase? And then just the timing of when we really start to see that step-up? Thank you.

Carlos Abrams-Rivera

So in our outlook, we had inflation at 3%. So before any tariffs, our guidance has step-up to 5% of COGS, particularly in some commodities like coffee and meats, we saw a big increase in comparison to the rest of the last time we met. So the base inflation was already up to 5%. And now with the tariff impact, I mean, obviously, a lot of uncertainty still on that. But we do estimate we thought we know so far an impact in 2025 of 150 to 200 bps on the COGS. Timing-wise, look, we don't know for sure. But we are assuming that it's a bit concentrated in the second half. Maybe there'll be some impact in the second quarter. We built some inventory where possible in certain items as we anticipate that to happen. So that gives a little relief of amounts needed to in some of the items. But the impact should be mostly concentrated in the second half.

Thomas Palmer

Perfect. Thank you for that. And I noticed that there wasn't a change in kind of that pricing outlook, as Yasmine just noted. But it sounds like there's price investment in some areas and then there is incremental pricing in other areas? Maybe just any detail you can provide there?

Carlos Abrams-Rivera

In the mid-point of the new guidance, we don't have further investments in price in addition to the approximately 100 bps we already had contemplated in the initial outlook. So the incremental investments, as I said, is mostly on marketing, particularly, media, on product renovation. And there is some sampling investments because remember that as we renovated products, including the ones that we have renovated last year like Capri Sun, we really need to step up the trial curve. So we are stepping up sampling investments ahead into the summer.

Thomas Palmer

Perfect. Thank you for the details.

Operator

David Palmer, Evercore ISI.

David Palmer

Thanks. A couple of questions. You updated your inflation guidance, and thanks for your commentary around the tariffs being incorporating in that. I'm wondering how you're thinking about pricing offsets to that. And when it gets to a certain level of input inflation and your willingness to price that away, are there levels where you have to be cognizant of rising price elasticity, perhaps, over a few percent, for example, where you're more aware of any sort of list pricing and you have to start moving towards other types of adjustments or offsets?
And then separately, Andre, I know you've been very active in thinking about promotional activity and returns on that promotional activity. When we look at our data, it looks like Kraft Heinz has been a little bit different than some of the other larger food companies and that it's well below 2019 levels in terms of its volume on promotion where some many, many years now, most other companies look like they're at those levels already and continuing to rise. I'm wondering if you kind of recognize that juxtaposition. And how you think about the promotion strategy going forward, is that something that you're noticing as well? Thank you.

Carlos Abrams-Rivera

Let me start with the second part. It's Carlos. And then have Andre comment a little bit on the first part of your questions. First of all, what you are seeing is the fact that it follows our strategy. I mentioned earlier that we're going to continue to make investments and play offense with discipline. I think for us, it's the opportunity to make sure that what we are investing, we are doing with this in a way that is thoughtful about the return on investment and that we are building something that support our strategy and allows us to grow, not only in the short term, but really in the medium to long term.
So why we're investing in pricing for our promotional events is because we believe that actually creates the kind of base volume opportunities as we go post that particular event. So you'll see us continue to invest in times of the year the consumer needs as, whether that is now Memorial Day, whether it's July 4th, whether it's back-to-school. We're just going to do it in a disciplined way to make sure that, again, it's supporting the strategy that we have and not just chase a short-term volume that actually doesn't essentially all you do is kind of rent volume for a short period of time.
The other piece that is important to note is that when we're making those investments, we're also doing it in concert with our brand growth systems investments so that when we are going for a back-to-school time period and we have now a renovated new Lunchables, we have a renovated new Capri Sun, that's a moment for us to know we stimulate the demand, but also making sure that the consumers get to try the best product that we have ever made on those categories.
So I think it's that combination that is kind of guiding our principles versus kind of how competitors are playing at this particular time. There are some different strategy. We want to make sure that we're doing things smartly because our focus is continuing to drive profitable growth for the future. Andre, do you want to comment on the first part?

Andre Maciel

Yes. Hi Dave. On the promo side, Carlos said, we'll continue to be disciplined and really seeking those promotions with good returns. You will see a step-up in promotional activity during the key windows, particularly now in summer. So you'll see that number stepping up as part of our initial guidance. Again, we have approximately 100 bps of incremental price investments in the U.S.
In regards to pricing, the tariffs, look, we are trying to do everything we possibly can to minimize the amount of price necessary. So even things like the delay, we have anticipated some purchases, we are looking at alternative sourcing. There is opportunity for, in some cases, reformulation, which takes a little bit longer. There are opportunities on the mix side. There are certain SKUs within (inaudible) less impacted than others when it comes with tariffs. So all of that is at play. We are stepping up productivity in the year. We started the year expecting 3.5% of COGS. Now, we are expecting a little more than that. So we are taking all the possible levers. But pricing might be necessary. But again, I think there is work in progress.

Operator

Chris Carey, Wells Fargo.

Chris Carey

Hi everyone. I wanted to ask a question about gross margin, then just a follow-up elsewhere. From a gross margin perspective, specifically the Q2 weakness that you're expecting and in the context of just how this typically works, is the primary driver of Q2 gross margin weakness coffee inflation? And I guess I asked that question in the context of, historically, this is really a pass-through category where pricing comes through to offset the inflation, understanding there's always going to be quarter-to-quarter volatility. But are you seeing perhaps less ability to pass through the coffee inflation just given your overall coffee inflation backdrop?
And then just secondly, are there any areas within your portfolio or broader portfolio where you're seeing more bright spots from a marketshare perspective? Because I think similar to last quarter, where we continue to struggle is the categories of clearly softened, but market share performance has come under more pressure. And so what are those things that you've been doing over the past few months, maybe specifically, where you're saying, okay, that specific strategy is working to kind of right (inaudible) here? Because it's been a bit harder to see here in the data. So thanks for those two items.

Carlos Abrams-Rivera

Sure. Thanks for the question. I will start with the Q2 margins. So basically, we do expect the pressure on the gross margin in the second quarter. And there are a few different items affecting the margin. The first one is, as I just had in the prior question, we do expect a step-up in the promotional activity as we start the shipment for the summer season. So we will see a lower price in the P&L.
The second, we are facing impact of some hedge losses in the second quarter. They are quite large. And the good thing is that once they roll off heading into Q3, we'll start to see some of those commodities that's starting to come down, like dairy, start to flow through the P&L.
Then third, to your point, there are some increases in certain commodities in Q2. And the way we see right now, some of them are going to reach the peak in Q2 and that (inaudible) start to go backwards or decelerate, at least, as we head into the third quarter.
So those three elements are the key contributors for the gross margin pressure that we are seeing. There is a little bit as well of the product renovations that we are starting to step-up. So as a result of that, plus we're starting to step-up investment in marketing, we do expect that operating income should decline double-digits in the second quarter.
In regards to the bright spots, I'll hand over to Andre.

Andre Maciel

I think if you look at our year-to-date -- latest five weeks versus the year-to-date, you'll see us making progress in all of our accelerate businesses, whether (inaudible) renovation, whether it is ready-to-eat meals, whether it's snacking. So all those things are progressing. I think in Q1, obviously, we had the impact of Easter. So I think as we are seeing other data with several weeks of the (inaudible), you are going to continue to see that improvement.
And I think, for example, in a business like our Philadelphia Cream Cheese, which as we now kind of passed the Q1 lapping of the private label not have been on the business in the category last year, you'll see that continue to drive growth, whether you see that in our desserts business that continue to drive growth after reformulations and focusing on better-for-you products in that category.
So you will see that many of the investments we're making will continue to play off as we go through the year. And I mentioned that in the opening statement which is a lot of the great things that we are seeing in terms of the building blocks are not yet all reflected in the data. But those are things that you'll see us as we continue to progress throughout the year.
I'm also, frankly, very encouraged by the fact that some of the big innovations we have done have continued to now drive growth. So a business like our (inaudible) strategy that we didn't have two years ago, we grew double digits last year, and we are growing double-digits again this year. So that also give me confidence in the fact that as we are building innovation, we're doing it with the right insight with consumers to drive growth that is sustainable and profitable for the long term. Thanks for your question.

Anne-Marie Megela

Operator, we have time for one more question.

Operator

[Megan Clapp], Morgan Stanley.

Good morning. This is [Alexia], on for Megan. In the prepared remarks, you guys mentioned the wider operating income guide partly reflects a change in policy landscape. Should we be thinking about that from a top line perspective or is that related to costs? Just any incremental color you could give there would be great. Thanks.

Carlos Abrams-Rivera

Thanks for the question. Look, there are, as you know, a lot of things being discussed and under consideration that might have implication on the business, positive or negative. So part of the reason why we have this wider range is to contemplate a whole different set of scenarios that can come into play.

Andre Maciel

So we're trying to just provide the flexibility, knowing that there is a number of things that are still volatile. But in that guidance, you'll see that we are acknowledging some of those things, we are preparing for those things, and also at the same time, making sure that we have the right flexibility to invest back into business in order to drive the strategy that we have and then fuel the opportunities that we are seeing with our brand growth system to (inaudible) back in our brands. So that's all reflected in the way we're kind of shaping the year ahead.

Carlos Abrams-Rivera

Thank you, Alexia.

Anne-Marie Megela

Thank you, everyone, for joining us. Operator, that concludes our Q&A session.

Operator

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a great day.