Good day. My name is Joelle, and I will be your operator today. At this time, I would like to welcome everyone to the Kraft Heinz Company's Third Quarter 2019 Earnings Conference Call. I will now turn the call over to Chris Jakubik, Head of Global Investor Relations. Mr. Jakubik, you may begin.

Hello, everyone, and thank you for joining our business update. We'll begin today's call with an overview of our third quarter and 9-month results as well as an update on our path forward from Miguel Patricio, our CEO; and Paulo Basilio, our CFO, and then we'll open the lines for 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. And you can find the GAAP to non-GAAP reconciliations within our earnings release. Now let's turn to Slide 3, and I'll hand it over to Miguel.

Thank you, Chris, and hello, everyone. On our previous call, I promised to be candid with you from the start and to update you on our progress along the way. I also highlighted some potential risks to the second half performance. 3 months on, and we are getting to deeply understand our business. That business is on a better footing because we are increasing visibility and control of our costs. The team is making excellent progress and we are gaining confidence in our path forward. We are not where we believe we can be, but we are excited with the evolution we had in the third quarter and what we have ahead of us. This comes from directing our efforts to 3 work streams: stabilizing the business as we execute to the 2019 plan; setting our near-term transformation in motion; and establishing a true north through our enterprise strategy work. As we committed to you earlier, we will give you a detailed plan coming out of the enterprise strategy work early next year. But we do want to share the progress we have made and set early high-level observations with you today. In terms of delivering our 2019 plan and how we are running the business day-to-day our performance improved from the first half of the year, and we are seeing signs of continuous improvement taking hold. As I said on our last call, my #1 focus is our people and developing the team because it's our people that will deliver continuous improvement and the turnaround of Kraft Heinz. Since our last call, we have made a number of moves to enhance our leadership team, both at the global level and within business units. For instance, I named Nina Barton to a new role, Chief Growth Officer, where in addition…

Thank you, Miguel, and good morning, everyone. I will start with a quick overview of our third quarter performance, which showed both sequential improvement versus the first half as well as the beginning of business stabilization. Our top line improved versus the first half, with organic net sales down 1.1%. Pricing turned from negative in the first half to positive in the quarter. This was driven by realization of the pricing actions we announced in the first part of the year in the United States and EMEA as well as ongoing pricing to offset inflation in Latin America. Vol/mix was lower versus the prior year as we are lapping the strong gains in the prior year and continue to see unfavorable changes in retail inventory levels versus the prior year. In Q3, retail inventory change resulted in a negative 110 basis point impact to U.S. vol/mix. That translated into a roughly 80 basis point decline versus the prior year for total Kraft Heinz results. And for the fourth quarter, I will note here that we currently expect a roughly 50 basis point headwind from lower retail inventory levels for our U.S. business. With respect to profitability, EBITDA is beginning to stabilize. Constant currency adjusted EBITDA in Q3 was down 4.6% versus the prior year. And this includes a roughly 1.5 percentage point negative impact from divestitures. Excluding these factors, the reduction in EBITDA was driven by a mix of negatives and positives. On the positive side, we are getting supply chain costs under control in the U.S. EMEA returned to EBITDA growth on a constant currency basis. And we had favorable timing of marketing and selling expenses in the U.S. versus the prior year. At the same time, supply chain costs were still negative year-on-year on a global basis in…

[Operator Instructions]. Our first question comes from Alexia Howard with Bernstein Research.

So obviously, this was a pretty encouraging quarter relative to the first half of the year. Investors that I speak to are very keen to know about what the path forward is to stabilization. We don't need to worry about 2020 at this point. But as you look out to the fourth quarter, I think Paulo alluded to this, are you expecting to see a similar pattern to what we saw this quarter in terms of broadly stable or maybe slightly down top line and something broadly in line with the fairly modest declines in EBITDA that you saw this time around?

Alexa, thanks for the question. This is Paulo. So as we're sitting here, as well, when we see our Q4 results, we expect very similar year-over-year performance versus -- as we saw in Q3 versus prior year, both in sales and EBITDA. And this is pretty much driven by, we have divestitures, FX, higher commodity costs that we expect in Q4, and we'll be lapping a strong vol/mix comp, mainly in U.S. And in the positive side, we're going to have all the results from the price actions that we're taking. And the best -- better visibility in cost and net inflation. So we are expecting pretty much in sales and EBITDA similar year-over-year performance as we saw in Q3. And below the line, we are expecting roughly $0.10 -- up to $0.10 headwind versus prior year. So pretty much that's how we're seeing Q4 performing in this year.

Fantastic. And given the comments on the uses of cash and the leverage and the investment-grade rating that you made at the end of the prepared remarks, should we assume that, at least for the time being, there are no plans to cut the dividend? Or is that something that we'll have to wait for the Investor Day early in 2020 to get confirmed?

So Alexa, first of all, I think investment-grade status for us is -- continues to be very important. We've just declared the dividend, as you saw. And again, we are in a very solid position in terms of liquidity after the recent refi we did and also in the cash flow generation that would allow us to reduce our leverage over time. But now we are going to a very deep strategic review of the business, understanding how we're going to see the future performance of the company. And in this analysis, in this review, a capital structure is going to be a very important chapter. So we expect to come back to the market with our full view and full picture of how we're expecting the company's performance, the company's strategy for the future, including capital structure at the beginning of next year.

Our next question comes from Andrew Lazar with Barclays.

Miguel, you discussed a little bit about your desire or the plan to move the organization more in the direction of a continuous improvement, productivity sort of mindset from what I think you described as more integration-led cost-savings programs that we all kind of know proves less sustainable. I realize you're probably not in a position yet to fully size this sort of opportunity. But I guess, do you see any structural reason that would preclude KHC from driving similar levels of sort of ongoing productivity as peers, let's say, as a percent of cost of goods. And the reason I ask is because I presume this is where it can be quite helpful in terms of funding the media spend investment that you mentioned today on the call, other things, inflation and such that come up all in the context of managing EBITDA to be more stable within the confines, I guess, of a constrained balance sheet. So perhaps, any color on that you can provide would be helpful.

Andrew, thank you very much for your question and I think we think alike. From day 1, when I looked at the past and I saw that there was a pretty big deterioration of gross profit because of decrease of COGS, we made -- we defined supply as a big area for improvement for 2 reasons. First, because we had pretty big disruptions in the past with our customers for -- because of low service levels. But second, because COGS has been increasing in our company. And I do not see a reason for that. I think that if we changed the mentality to the company for a mentality of continuous improvement, if we invest on that, on people, in our factories, in our way of thinking on believing if we change the mentality from basically cost-cutting into continuous improvement, I think we can do it and we should do it. And as you said, I see it as a great source of -- for investment in the business. I was very glad to see that in this quarter we could stabilize cost of goods sold. And this is big for us. We are all relieved with that. It's just the first step. Everything to be proved, but the first step was good and gives us a lot of faith, a lot of hope that we are in the right direction.

Our next question comes from Jon Feeney with Consumer Edge.

You mentioned -- Miguel, you mentioned in your remarks, capability gaps. And I thought that was an interesting way of putting it. Could you be more specific about the kind of capabilities where you see gaps that need to be funded? Like is it something different than we all think about media spend, we think about product quality, as things that pay off right now? Are there big structural investments as far as generating insights where you feel like there are gaps that require investment? If so, like, where specifically? And maybe related to that, the SKU reduction, is there anything related to like new insights, new capabilities that, that would now would be the time to look at reducing SKUs in North America? It seems to me like -- I don't know, that seems to be something where I think Kraft Heinz has been great at taking a look at where SKUs don't make sense and focusing. So what -- maybe what insights related to that drove that decision?

Thank you, Jonathan. Specifically, let me start specifically with the SKUs that you are mentioning, and then I go -- I'll tell you overall my point of view about that. I think we -- the company has been on a frenzy of innovation in the last 2 to 3 years and trying through launching new products to compensate the decline in net sales. We have not been successful on that. We really have not been successful on that. Yes, we brought a lot of complexity to the system but this innovation was not translated into additional sales. It was very cannibalistic and brought much more complexity. And as a consequence, a lot of supply chain losses and lower margins. Many of this innovation was done through third-party manufacturers. So of course, that's, for me, when I arrived and with fresh eyes, I asked the obvious questions and one of them is, let me understand profitability by SKU, let me understand volume by SKU, and there's a big tail of SKUs that, yes, actually, with a negative margin or are not important at all, very, very small or both. And that can just generate a lot of complexity in the system. And so yes, we are going to reduce this, we are going to reduce. We have to have the discipline that, at the same time that we innovate and we put new products in the market we have to have the discipline to clean the tail of low margin, negative margin or a low volume, very low volume, that are really not [indiscernible] just creating more complexity in the system. And this is a capability. So going back to your point about capabilities. I think that innovation is an area that we have to increase, we'll have to improve dramatically. There are other areas that I think that we have to improve our capabilities. And -- but I think that innovation is one that I'm very focused on. It is a big driver for growth for the future, has to be especially in the food industry, but we have to do bigger innovation. We have to do fewer innovation. We have to do bolder innovation. We have to do profitable innovation and has to be incremental instead of doing everything and old products innovating and vouching and throwing new products in the market that will not really generate extra profitability to our company.

Our next question comes from Robert Moskow with Crédit Suisse.

A couple of questions. One is, Miguel, on the slides, you focused a lot on giving us a plan for 2020 but I kind of thought that investors were looking for like a 3-year plan or something of a longer-term nature. Are you going to give us kind of a ramp of what those next 3 years might look like when you give us the review? And then secondly, a more detailed question. In your conversations with customers, have you found that customers are giving you any kind of insight on their perception of Kraft versus your peers? My perception is that Kraft has had some pretty rigid structures in terms of pay-for-performance with customers, and maybe that led to some of the disputes that you've had in the past. Is there any insight you can give us in that regard?

Yes. So two very different questions. Let me answer first the first one, Robert. I'm working at the same time in the -- well, in delivering the results for 2019 on building the budget for '20 and on the future, right? For 2020, I need the strategy, but this -- 2020 is going to be more about continued stabilization. And then this is what I aim, is that 2020 is a year that we stabilize the business and that we build the foundation for growth in 2021. So the answer to you is yes, when we present the strategy that we are working on, that is going to be a long term with a long-term view. So we -- our 3-year plan will be addressed. Regarding customers, yes, I've been talking to customers and learning a lot from them. And I can tell you that their biggest concern is what you call the disputes and then that translates into service levels. So we had problems in the past, several problems in different types of products with our service level. And that although we haven't had any big problem this year, so we are in a much better year in terms of service level, there are still scars from the past. And then when they remind us of all the problems that we had in the previous years in terms of service level, they questioned that if this is sustainable or not. They also -- so this, I would say, that is -- their number one concern, really, service level. But they're also concerned about planning and strategy. So we need to be better on our planning with them and adapt our planning cycle to their planning cycle. I think there's a big opportunity to do that, and we are going to address that. At this moment, because of the way we are planned -- that we plan on our budget cycle that doesn't tie with their budget cycle, the feeling I have is that we are always late and the feeling that they have is the same. The other part is related to strategy that they want to see us communicating to them and teaching them and is training them in a more strategic way on a long term. And then I would put a fourth point that the -- that is about execution, that we can have better execution in their stores. So I would say that these are the four items that we -- that I'm -- when I think about customers that I'm focused on, really, service level, planning, strategy and execution.

Our next question comes from Bryan Spillane with Bank of America.

So I think about the follow-up on Andrew's question about -- so, I guess, supply chain opportunities or opportunities within COGS and maybe, Paulo, if you could help us sort of get a little bit of a bridge. If we go back to EBITDA for fiscal '17 and then compare it to where we are the last 12 months, there's an EBITDA decline of about $1.6 billion or so. And can you give us a little -- a bridge of kind of what the drivers were that got us from there to here? And I guess what's really underneath the question is just trying to understand how much of it was items that were outside of the company's control and then items that are sort of within the control and are potentially addressable?

Sure. So thanks for the question. When you go back from our peak 2017 margins. And again, when you bridge these two, let's say, our last 12, as I said, pretty much we have two big drivers, two big areas of decline, right? 60% of the decline roughly is coming from gross margin. And this -- you could split this in mainly the inflation we have in our supply chain with not enough initiatives to offset that; investments that we had in service level for the customers; an unfavorable product mix that we saw in the launch of the business, and this is part of the type of incrementality, the innovation that we had that Miguel was talking about. And also, the fact that with all of this inflation and not enough savings or efficiency initiatives to offset that, we were slow in moving our prices. So I think this is pretty much 60% of the gap. The other 30% of the gap is driven by SG&A. So 60-plus around gross margin, 25% to 30% around SG&A. 70% of that was pretty much commercial investments we made. We had international go-to-market initiatives, new areas inside the company like digital and also additional market investments that we put that is -- because of our fragmentation of innovation, ended up going too much to nonworking piece to support the innovation pipeline. And the remaining, also we have like of 30% of the 25% from the SG&A is pretty much lapping bonds accrual that we didn't have in 2017. So a 6% gross margin, 30% SG&A, with 70% of this 30% coming from these commercial investments that we made that we are assessing now. The other 30% of the 25% decline, driven by bonds that we didn't have in 2017. I think it's…

Our next question comes from John Baumgartner with Wells Fargo.

Miguel, I'd like to come back to the innovation approach. Because when you speak to the fewer, bigger, better ideas, I'm curious as to how you think about the capabilities there. Because those are, as you say, bets which may or may not work out. So can you speak to where the company stands right now and its ability to identify the idea that could become successful, big bets, because the company has pursued this for the last couple of years of very limited success. And I guess my follow-up would be, what's changing or what still needs to change in terms of the capacity there?

Okay. So a very good question. And I'll tell you, I think that there's a fundamental change that -- or we need to do a fundamental change in the company, from a company that was much more focused on today and probably pursuing a strategy that was more focused on inorganic growth to a company that needs to pursue organic growth and needs to understand the future better than anybody else. That's a big change. You need to change, you need to put first the mindset in a direction. Second, really a strategy, where do we think that the growth is going to happen? So we need to transform this company into a much more consumer-driven company in a much more looking-forward type of company rather than just operating the present. It's not either one or the other. We need to do both. And I think that we can and we should do both. So as a consequence, I think that the innovation was we did a lot of plan extensions. We were relying too much on things that were not really incremental and we need to do more things in areas that we believe are going to grow. The last call, I gave the example of Boca, and I think is a good example. We were the first company introducing veggie burgers 15 years ago. But because we didn't have a good vision about how the world would progress, Boca has not been a focused brand. And as a consequence, we never really took advantage of everything that is happening in this area. So understanding the future, understanding the consumer, I think, is the way to go. Of course that -- for that, we will need much more better insight, much better creativity. We'll need a more united R&D. So we didn't have a Head of R&D. R&D was in all departments of the company. We are now unifying R&D in the company, having one head of R&D. We are defining our strategy. We also appointed a Chief Growth Officer. Pull things into this direction, right. Hopefully, I was -- I gave you the answer you were expecting, John. I don't know if you want to ask anything else related to that.

No, No. I guess, maybe just as a follow-up in terms of rebuilding the R&D pipeline. How long does it take to really kind of get the ideas going, kind of getting the pipeline full again? Is this like a five year plan? Is it a three year plan, how do you think about that?

So on that, we also have to work on process to speed up innovation. In my previous world, in my previous role and previous company, we reduced the development of products from a 2-year to 6 months by changing process methodologies, basically introducing the agile type of building innovation. We're going to do the same here. So we need to be much faster. And that is also what I previously said, John, that in 2020, needs to be a year of stabilization to give us the time to be working on the pipeline for the future, for the years to come. What we have in the pipeline for 2020, it's still, of course, not under the strategy that we are going to present to you at the beginning of the year. During 2020, we will have to define and develop the pipeline for the future.

Our next question comes from Steve Strycula with UBS.

Miguel, I have a quick follow-up to Alexia's question, and I appreciate you haven't fully ironed out the Board plan at this point in time. But can you help investors at least think through the obvious and, more importantly, the less obvious implications of the dividend policy as you think forward? That would be helpful. And then I have a quick follow-up.

Can you help me giving you exactly what you have in mind, Steve? I want to address your question in the right way.

Sure. Yes. So when I have conversations with investors, we receive the puts and takes of whether the company has excess capital to really pay out at the levels that they do today. And how do you think about some of the considerations of, if you have fewer brands in the portfolio moving forward, or the priority is to paying down debt? So to sum up, the question would really be, what are the very obvious considerations of keeping it versus not keeping it? And then what would be some of the unintended consequences that maybe most investors might not see from our vantage point?

This is Paulo. Let me try to address how we're thinking about that. So in the cash flow information, and I know that we're going to see these later in our Q. In -- for example, in Q3, we generated a free cash flow to equity after CapEx of $860 million. So sufficient to pay the dividend at roughly below $500 million. But the important thing here is that now, what we are doing that, as Miguel mentioned, we are discussing the future of the company, the strategy of the company, how we're going to, where are we going to invest to grow the business for the next 3 to 5 years. And developing this plan, for sure, as you can imagine, like capital structure is a key chapter of this as I said. And for us, being an investment-grade company is -- remains very, very important. So our time line here is that we are going to develop our strategic plan, we are going to set our future expectations for our performance, addressing our portfolio, our categories, our brands, our regions and also our capital structure to support that and share with the market early next year.

Steven, just repeating what Paulo said. I think that when we define our strategy, we'll define what are the areas that we think that we can have substantial growth. What are the areas that we don't think we can have substantial growth but can generate very good cash to support the growth? And what are the areas that our products or categories that actually could have a better fit with somebody else. And I think that with this in mind, we can identify categories that we can have divested in the future.

And then a quick follow-up related to innovation, Miguel. What's your personal philosophy or strategy as you think about the patience to seed and build growth and, call it, longer-term categories? They might not be very large today, but might be the future of, call it, the portfolio or areas that could be a few hundred million dollar brands. So I guess to sum up, the question would really be, how does a company that's so ZBB focused think about immediate return on investment versus necessarily seeding and needing to grow for the longer term?

And now I think that your question is very important, but let me tell you that, yes, I love ZBB. I really do. In my previous company, I worked for 22 years and I learned to love ZBB. But for one reason, because ZBB was a big lever or made it possible to grow the business throughout the year. So when I look at ZBB, I look at it as a discipline to make things every day better, so we can free up resources to invest in other products. I don't look at ZBB as a way to basically cut costs and cut costs. I see it as a way to do things better every day and have -- the consequence of that is to be more efficient and to free up resources to invest in the business. But addressing your second point about how are you going to invest in things that today are small, and tomorrow can be big, are you going to have that discipline? I think that question is very, very important. I think companies tend to invest on what's big and not what it will grow, and I think we need to do both. And then we really need to understand what will grow and bet on it. It may be smaller today, but you need to have the patience to nurture these categories, these products, these brands to be big one day. I'm looking at this right now, not only brands but also channels that today may not be so representative, but have a great potential for the future. So I tend to agree with you, and I don't think that, that has to do with ZBB. It's just the opposite. I think that ZBB will free up resources to invest in these categories.

Our final question comes from Laurent Grandet with Guggenheim.

Yes. Thanks, Miguel, for sharing in details your progress. Very insightful, thank you. Actually, I do have two quick ones. I mean, first is other income. Could you please explain what is in the other income line this quarter? As you'd explained, about half of the beat in the quarter are about $0.08 in our math. And then more on the Plasmon business in Italy. Could you please explain why you changed your position in regards to the divestiture? And it will be interesting for us, I mean, in understanding the rationale here, I mean, as we further assess, I mean, other possible, I mean, the right opportunities for you?

Thanks for the question. This is Paulo. So let me -- again, I'm going to -- I'm not going to comment on the consensus expectations for other income. But at the level of our other income, it was very similar to the levels that we had in prior year, pretty much the same type of level. Versus our expectations, it was a little bit better and pretty much driven by three factors. It's the first one, we had better return to the capital markets from our investments. We had some gains in hedging positions and also favorable FX in the balance. So this is pretty much how we -- how this other income line performed versus our internal expectations. So for Q4, to give a little bit more color here, we're expecting the other income to go down by around $20 million. It's part of the -- versus -- go down $10 million versus prior year. That's part of the headwind that we disclosed below the EBITDA lines. About divestitures, Miguel, would you want to comment?

Yes, sure. No, I wanted to tell you about baby food, that I think it's -- we have a business that if you look at -- in baby food, if you look it individually at the countries where we have baby food, it's not very meaningful. We have baby food in a lot of countries, in Russia, in China, in Australia, in Italy, in U.K., in New Zealand, in Canada, in Colombia, in Mexico, all tiny business. Maybe the biggest one is in Italy. But all very tiny business. But when you put them together, it's $0.5 billion business, it's sizable. We are declining in the majority of these countries. And I tell you, I think that is basically because it's not very important in each one of the countries and also because we really do not have expertise, really expertise, big expertise on baby food. And if you look at the countries individually, we don't even have the scale, I think, to have this expertise. Now with the changes that we made in structure, with the appointment of Rafael as our Zone President International when we put Latin America, Asia Pacific and Europe together, then he will have all this business or basically all this business together and becomes meaningful in his portfolio. He will put a team working on baby food. Understanding what moves baby food, understanding these sites, understanding the trends, understanding the needs of the moms and the babies that, because of scale, we didn't have today in each one of these countries. So it's a good example of capabilities that we have to build that by changing structure, we can get there. So that would be my comment about baby food.

Thank you. This concludes today's question-and-answer session. I would now like to turn the call back over to Chris Jakubik for any further remarks.

Well, thanks, everyone, for joining us this morning. For the analysts that have follow-up questions, both myself and Andy Larkin will be available. And for members of the media that have follow-up questions, Michael Mullen will be available to take your calls as well. Thanks very much, and have a great day.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.