Mondelez International, Inc. (MDLZ) Q2 2020 Earnings Report, Transcript and Summary

Good day, and welcome to the Mondelez International Second Quarter 2020 Earnings Conference Call. Today's call is scheduled to last about one hour, including remarks by Mondelez' management and the question-and-answer session. [Operator Instructions] I'd now like to hand the call over to Mr. Shep Dunlap, Vice President, Investor Relations from Mondelez. Please go ahead, sir.

Good afternoon, and thanks for joining us. With me today are Dirk Van de Put, our Chairman and CEO; and Luca Zaramella, our CFO. Earlier today, we sent out our press release and presentation slides, which are available on our website. During this call, we'll make forward-looking statements about the Company's performance. These statements are based on how we see things today. Actual results may differ materially due to risks and uncertainties. Please refer to the cautionary statements and risk factors contained in our 10-K, 10-Q and 8-K filings for more details on our forward-looking statements. As we discuss our results today, unless noted as reported, we'll be referencing our non-GAAP financial measures, which adjust for certain items included in our GAAP results. In addition, we provide our year-over-year growth on a constant currency basis, unless otherwise noted. You can find the comparable GAAP measures and GAAP to non-GAAP reconciliations within our earnings release and at the back of our presentation. In today's call, Dirk will provide a business update then Luca will take you through the financials and our outlook. We will then close with Q&A. With that, I'll now turn the call over to Dirk.

Thank you, Shep. Let me start off by sharing an overview of our Q2 performance on Slide 4. Overall, we are pleased with our results, our business has been resilient, and our execution has been strong. Our first priority remains the safety and wellbeing of our colleagues and our communities as we navigate COVID-19. Because there still are areas of high risk, we are preparing the reopening or already have opened some of our offices around the world. And it is clear that the situation will remain volatile for at least the remainder of the year. Our second priority also remains business continuity. I am very proud of what our colleagues have and are doing to keep our operations running well. Here also, we need to remain vigilant because with the growing number of cases, the risk of business disruption continues to exist around the world. Our overall results for Q2 are good. Despite the fact that COVID has impacted various markets in quite different ways. Our portfolio of trusted brands as well as excellent execution have helped us to weather the high volatility reassuring us that our business fundamentals are solid. Particularly our execution in supply chain as well as our commercial operations have been superior in a very challenging environment. For instance, today, approximately 90% of our plants are running in line or above historical performance. Although we had already good market share momentum going into the crisis, this combination of the strength of our brands and our superior execution have helped to drive unprecedented gains. While the business environment globally remains very volatile, our strategy has proven to be a strength in these difficult circumstances, so we don't see a need to make changes, but we do see opportunities to double down and accelerate certain areas. For instance, due to our current momentum, some overall cost savings and our market share momentum, we are increasing investments in our brands in H2. That virtuous cycle of investment in our brand is an anchor stone of our strategy. Looking at the second half, we expect to see volatility continuing, but we are well positioned for several reasons. Overall snacking tends to be a very resilient category, even in times of recession, meaning we are generally in the right categories. Our brands are some of the most preferred brands in our categories, both local and global. Our geographical footprint is diversified, meaning that while COVID might impact one location, others might be doing better. And finally, our people are responding very well with agility and resilience, and our local-first culture is an advantage in this environment where decision-making needs to be fast and made with the local consumers in mind. Switching to Slide 5. Despite serious challenges caused by COVID effects on trade channels and consumers, we delivered solid results across the board, giving us confidence for sequential improvement in the second half as well as confidence to maintain the course of the strategy we announced almost two years ago. Our revenue growth was 0.7% in Q2 and is 3.7% for the first half. I consider this pretty good given that during the quarter, at one stage or another, every country and many trade channels were in lockdown. There are parts of our business that have slowed down significantly, such as the gum category, world travel retail, away-from-home and the traditional trade channel in some key emerging markets. At the same time, the grocery business in most of the world is well above normal trend. The combination of these two extremes give an almost 1% growth as an average, which we feel good about given the circumstances. Emerging markets were more affected than developed markets and declined in Q2. The good news is that they showed a sequential improvement during the quarter, and they exited the quarter with growth. We are maintaining or gaining share in markets, representing around 85% of our revenues in year-to-date 2020. This is driven by a number of key reasons. We are seeing consumers turning to brands and products they trust. We have many of these trusted brands around the world. Within our category, there is also a shift to segments that are better fit for at-home consumption. So we are stronger in these segments like tablets versus pralines or bars in chocolate. And our supply chain has kept functioning quite well throughout a shortage of labor or lockdowns providing us with a competitive advantage. Our adjusted EPS grew 16.1% in Q2 or 8% for the first half. Luca will provide the details, but despite the extra COVID-related costs, our operating income fell only marginally. Thanks to some offsetting cost-containment activities. We generated very strong cash flow. In the first half, free cash flow was $1.1 billion, and we raised our quarterly dividend by 11%. Transitioning to Slide 6. As mentioned, our long-term strategy does not change. But seeing our current momentum, we are accelerating some initiatives which will allow us to emerge even stronger from this crisis. As it relates to growth strategies, we are planning a significant increase in investments behind working media in the second half, capitalizing on the strength and demand for our brands and built on our increased market share. We are also making adjustment to some of our advertising copy and campaigns to make them more relevant in the current context. Seeing the fact that the consumer is driven more to our core offerings, it is an ideal moment to simplify our portfolio as well as our innovation pipeline to focus on our value-driving core. So we are removing 25% of SKUs which will simplify our supply chain, reduce our cost and inventories and increase our sales and our customer service. With the consumer probably focusing more on value, we are amplifying and accelerating our efforts on revenue growth management, and we believe there is significant potential to capitalize on the increase in e-commerce, particularly with many first timers buying their groceries online. In execution, we were always very cost conscious, but we're taking a fresh look at cost opportunities, reducing in areas like travel and office costs. Costs also benefits from a smaller number of projects and initiatives as well as the reduction of our inventory levels. Out of an abundance of caution, we've decided to only invest CapEx this year in essential projects. And we are accelerating a number of key supply chain initiatives which are aimed at improving our efficiency. Finally, all of these changes are enabled and underpinned by the continued evolution of our culture. Our local-first approach is enabling agile decision-making and adaptation in market. We also see we can evolve the way our people work, helping them with a better balance of life-work. For instance, going forward, we see more people working more time from home. Some of the changes due to COVID will be permanent. So we are redeploying resources to the areas with the highest return opportunities and areas that will be critical post COVID, as an example, e-commerce. Now moving to Slide 7. Despite the current volatile and unpredictable environment, we believe ESG is as important as ever, if not more so, and we remain committed to making progress in this space. In terms of social impact, we have now made cash and in-kind donations of more than $25 million related to COVID-19, through product donations, but also cash support as actions by brands and teams to donate PPE and other essential items. Our responsibility, the communities we operate in has also been highlighted by the recent attention on the racial justice and equality movement. Without question, there is no place for racism in our company or in our society, and it's critically important that we, along with other companies, show measurable action in helping to redress some of the injustices that exist in our society. My leadership colleagues and I have spent time listening to our employee resource groups and colleagues across the business. We've heard that colleagues want actions that are sustainable, impactful and generally make a difference. We want to build on our historical efforts in this area, and so we've organized ourselves across three pillars: colleagues, culture and communities. In our supply chain, we continue to advance our work on creating a sustainable supply of critical ingredients. One of the biggest challenges in this space is deforestation, and the result impact or the resulting impact on CO2. This quarter, we have launched as part of the Consumer Goods Forum, the Forest Positive Coalition with other CPG companies encouraging our suppliers to be more transparent on the land used to grow our ingredients. And finally, we are on track to meet our 2025 goal of 100% recyclable-ready packaging. I am proud of the fact that we've been continuing to work on these critical long-term ESG topics throughout this crisis. And with that, I hand it over to Luca.

Thank you, Dirk, and good afternoon. Second quarter performance was solid in terms of growth, share gains, earnings and cash flow given the circumstances. We delivered positive revenue growth through a combination of resilient categories and superior execution despite facing significant disruptions and operating restrictions from the crisis. Our developed market continued to perform well, with strength in North America and Europe mass retail, confirming elevated momentum as seen in Q1. Emerging markets were significantly impacted by broad lockdowns, especially during April and into May. Despite this dynamic, we are doing well on a relative basis compared to peers as we are gaining share. I would like to unpack our topline cadence to give you some context of how we ended the quarter, as that might be more indicative than the pure Q2 number. Prior to COVID, we were seeing strong momentum in both developed and emerging markets, and that was both due to snacks categories, momentum and share gains. Once we move into late March and for the month of April, we saw significant divergence between developed and emerging. In developed markets, we saw a spike in consumption. And despite some challenges, our ability to operate was still okay. On the flip side, we enforced lockdowns and curfews in emerging markets. We encountered significant operating restrictions. These markets were most impacted in April with double-digit topline declines as high percentage of outlets were inaccessible to consumers and to us. As a result, total revenue declined low-single digits in April. As we moved into May, things began to improve. And in June, our emerging market turned positive and posted low single-digit growth. We expect this trend of improving growth to continue into July as the majority of these markets are on better footing. We also expect strong demand in North America and Europe mass retail, albeit not as elevated as in H1, but total company is trending better in July than in Q2. Turning to Slide 11. You can see that Q2 revenue growth was driven by positive volume and pricing. This comes despite some significant mix headwinds presented by lower revenue from world travel retail and gum. Biscuits is seeing elevated demand and led growth at more than 9%. Chocolate declined slightly, but this includes three points of headwinds from world travel retail. In addition, chocolate was also impacted by lockdowns in emerging markets, mostly India. It is worth noting that India was nearly flat in May and posted positive growth in June. Gum and candy declined double digit, primarily driven by gum as it skews toward away-from-home consumption and convenience. This channel has seen significantly reduced traffic during the crisis. Turning to category and share highlights on Page 12. Consistent execution, preferred brands and our investments in brands and capabilities continue to drive strong share results. Year-to-date, we have held or gained share in 85% of our revenue base, and our overall share is as high as it has ever been. Biscuits and chocolate drove the overall outcome. More specifically, we gained share in the latest three month period across a number of our biggest markets including U.S. biscuits, Europe, with U.K. and Russia and France standing out; in EMEA, China and Vietnam biscuits, but also Australia, New Zealand and India chocolate; in Latin America, we saw some improvement in Brazil chocolate and powder beverage share, along with Mexico. Our categories held up relatively well with the exception of gum. However, it is important to note that year-to-date category growth of 4.5% doesn't reflect unmeasured channels, such as convenience and world travel retail or the lag effect of some emerging market readings. Now let's review our profitability performance on Slide 13. As expected, our estimated COVID-related costs during the second quarter were more than $100 million, including over time, protective equipment, frontline bonuses, incremental logistics costs and lower cost absorption in emerging markets. Ex this cost, gross profit would have shown solid growth in line with last year's growth rate. In fact, volume leverage in both North America and Europe as well as cost containment efforts across the business enabled us to offset much of this on a gross profit basis as it declined less than $10 million versus previous year. Operating income declined 3.8% for Q2 due to the decline in gross margin, which was partially offset by lower A&C and higher overhead due to COVID as well as the other line impacted by some legal accruals. We continue to expect COVID-related costs in the second half, however, we believe improved leverage and cost mitigation efforts will more than offset these dynamics as we progress through the second half. Especially in Q4, with Q3 still somewhat impacted. Moving to regional performance on Slide 14. North America grew 11% driven by strong share gains and elevated biscuit consumption. Our DSD network continued to demonstrate its value in keeping shelf stock and enabling significant share gains. Gum was down double-digits. North America operating income increased by more than 20%. North America will continue to grow above the historical rates, but we expect lower growth than Q2 as we move throughout the year. Europe revenue declined 1.2% in the quarter. Headwinds from world travel retail, which was a drag of 2.5 percentage points as well as gum and the instant consumption channels, drove this dynamic. We saw strength and good execution in several key markets, including mass retail which grew high-single digits, and in chocolate, where we posted significant share gains in the U.K., in France, in Russia and Benelux. Although we expect continued challenges in world travel retail, we are more constructive on the state of convenience and traditional trade, which are expected to be much less of a headwind in the second half. We saw improved exit rate in June and good growth into July. Overall, we expect EU to return to growth in Q3, unless there is a material COVID relapse. Adjusted OI dollars declined as a result of significant COVID costs and unfavorable mix. These results should improve as we progress through the second half of the year. AMEA declined 3.1% with conditions that vary greatly by market. China continued to recover, growing double-digits. Southeast Asia grew mid-single digits. India declined double-digit due to significant lockdowns and store closures in April and May before it turning to mid single-digit growth in June. As we move into the second half, and based on the dynamics we see today, we are expecting this improvement to continue, unless there are additional shutdowns in key markets. AMEA operating income dollars declined by approximately 5%, due primarily to lower-than-typical volume leverage and additional COVID-related expenses. AMEA executed well on cost containment actions. Latin America decreased 11% due to traditional trade disruptions in most of the key markets, while Argentina posted growth due to inflation-driven pricing. Ex Argentina, Latin America declined by 15%. Mexico declined low-double digits due to a significant decline in gum and candy. In Brazil, we declined high-single digits due to significant disruptions in traditional trade. Our Western Andean countries, which were among the most impacted by COVID, also declined. We did see improving share trends in several notable markets. Adjusted OI dollars in Latin America declined by 78%, primarily due to headwinds associated with negative mix, under absorption and an accrual for a legal-related matter that accounted for one third of the decline versus previous year. We expect the environment in Latin America to remain challenging in the second half given the restrictions in place in most markets and the impact that those restrictions are having on economic growth. We remain focused on what we can control, which is executing our plans and driving better share performance. Now turning to earnings per share on Slide 18. Q2 EPS grew 16%. Operating gains in the quarter were impacted by COVID costs, which were north of $100 million which means more than $0.07 impact. I'll now move on to our free cash flow on Slide 19. We delivered free cash flow of $1.1 billion in the first half. Strong working capital discipline was a big driver as we improved our cash conversion cycle by eight days. We also had deferred tax payment for more than $200 million, which will mostly reverse in the second half as well as lower CapEx and cash restructuring. Our priorities for the remainder of the year stay clear, and we will continue to be disciplined. I wanted to provide some thoughts on our joint ventures, specifically our participation in the successful IPO of JDE Peet's. Prior to transaction, we exchanged our JV investments for an investment in JDE Peet's. JDE Peet's then went public for €31.50 per share at the end of May. The stock now trades at around €38 per share, which places the value of our stake at approximately $5 billion. This was a great result as it provides more flexibility and a public bar for this financial investment. Moving to Slide 22. As previously disclosed, due to the COVID pandemic, visibility remains limited at this time in a number of key markets. As a result, we are not providing a full-year financial outlook. However, we continue to expect the following for 2020. An effective tax rate in the low- to mid-20s; adjusted interest expense of approximately $380 million; and we now expect exchange translation to negatively impact our reported revenue by 3% and EPS by $0.05 based on current market rate. Although we're not providing full-year guidance at this time, I wanted to share some thoughts regarding how the second half will play out. We expect improving conditions in many markets that experienced significant store closures in late Q1 and Q2. In-home consumption is expected to be at elevated levels, which is helpful in developed markets such as North America. And we expect to make critical investments behind our brands to continue to drive momentum on a relative basis. On the flip side, we expect the negative impact to continue in some emerging markets, mostly in Latin America. World travel retail is expected to continue its negative trend. And although there is no way to know exactly how the pandemic will evolve, there will always be a potential for a second wave of shutdowns. In aggregate, we expect positive revenue and the sequential improvement in the third quarter based on what we see through month one of Q3. With that, let's open it up for Q&A.

[Operator Instructions] And your first question is from the line of Ken Goldman with JPMorgan. Please go ahead.

Hi. Thank you, and good afternoon, everybody. Two for me, if I can. I wanted to first touch on your share gains. Some of these gains, I think, are due to your North America supply chain, which obviously is quite advantaged and some perhaps due to your competitor struggles globally. But you did highlight some brand strength, other positive factors in your prepared remarks. So just as you think about your expectations for market share in the back half of the year, can you walk us through what you think some of the more sustainable drivers are. I'm guessing higher marketing spend is one of them. And maybe what drivers could back off a little bit versus the first half.

Hi, Ken. Yes, sure, with pleasure. If I maybe explain where are the share gains happening and then go a little bit into the drivers and then in what we think will happen. First of all, as we said in the presentation, we've gained share in 85% of our revenue base, so it's very broad-based. It is in biscuits. It's in chocolate. It's across the geographies, I would say, almost in every single market around the world and certainly not important markets. We see significant market share increase. For instance, biscuits China, biscuits U.S., biscuits in France, but also chocolate in the UK, chocolate Australia, chocolate India. And we also see it across smaller categories. So it's very widespread. And on top of it, we see that it's our global and our local brands. It's not just one brand. It's across our brand. And one of the interesting factors that our penetration of our brand is increasing overall, and also that we see some very good repeat of those new users. So what is the reason? I think fundamentally, during the COVID crisis there, there are three. First of all, as you alluded to, we have had a very good performing supply chain around to market. You could sort of say that not only in the U.S., but in other markets, we increased our share of the distribution points. Not so much because we increased our distribution, but customer service level and our on-shelf availability was better than our competition. And so for instance, in the U.S. or in other markets around the world, DSD is a key advantage. The other one is that we usually have sort of the strongest brands in our categories around the world. And consumers have been going back to the brands they know and trust. And so an Oreo, as an example, or a Milka or some of the other local brands that we have, have clear consumer trust. And we see that's why we see all of them increasing their share also. And then within snacking, if you look at it sort of category by category, we are in those segments within the categories that are benefiting from at-home consumption. For instance, tablets in chocolate do better than bars or better than pralines. And in biscuits, it's your more traditional biscuits that is a segment where the consumer is going to. I would say these are the three big drivers. When will they go away? Well, it's difficult to say. Supply chain, I assume that everybody is catching up on their supply chain. Although with what we are seeing in the U.S. and some other places around the world, having your supply chain perform is not as simple as it might sound. I do think that this trend to go to bigger brands and more known brands is here to stay for a while. And then the mix with the in-home consumption, I think that's going to last for a while, too. We are now clearly talking about this change to our lives continuing well into 2021. I would also like to point out that we have momentum before the crisis. We were already increasing our market share before this started. And so underlying, there is a fundamental share increase that was taking place. I also think the repeat rates of our brands of the new users, that's important to notice. And then I talked about that increase in working media with significant increases in the second half of the year, which should also give a good pull on our brand. And then I think what we're doing with our business, simplifying everything, eliminating SKUs, going to fewer innovations, all that will give us even more strength in execution. So overall, I'm pretty optimistic. I think that a big part of this market share will stick.

That's helpful. Thank you. And then quickly on my follow-up, speaking of the higher marketing spending, you talked about in the third quarter I know you're not giving guidance today, but I wanted to poke it a little bit into what you were talking about to make sure I understood. You talked about better revenue into the third quarter, and you've talked about some simplification of the business. But you've also talked about ramping up your marketing spending, like I said. So just trying to get a sense among all these factors and maybe some that I'm missing. Is it reasonable to expect improved operating income in the third quarter as well in addition to better revenue? And the reason I'm asking is The Street's modeling an increase year-on-year in your third quarter EBIT. Is this reasonable given what you know right now? Or is it really just too early to say?

I can maybe I’ll…

Maybe Luca, you want to take this one? Yes.

Yes, I'll. Welcome back Ken. Nice to have you again on…

It's good to be back. Thank you.

Yes. Look, I believe it is a little bit premature to give you a precise number here, but we gave you a few indications in the prepared remarks for Q3 enough to simply said, we expect North America to continue with increased momentum. Certainly, we are not going to see as high of a number as we saw in Q2. Having 11% topline was fairly exceptional and 20-plus percent OI. Europe is expected to return to growth overall despite world travel retail. And I would expect, for sure, better profitability and better leverage. Some of the COVID costs will subside. AMEA as well is expected to return to growth in Q2 in Q3. And there should be, again, lower COVID cost and better volume outcomes. Latin America is, quite frankly, expected to meaningfully improve, particularly on the OI line into Q3, but we are not going to see necessarily a positive year-on-year profit. So I would say that overall topline for Mondelez in Q3 is expected to be better than Q2. As we look at July, we see good numbers coming in at this point in time. But obviously, I have to make a disclosure here, which is that is absent a material relapse or issue in one of the biggest market or in more than one. As far as bottom line is concerned, I think there will be a sequential improvement in Q3 from where we see today. Whether it will be all the way to bright, I am not sure as there will still be some COVID-related cost and all the actions we are putting in place actually will come into full fruition in Q4. So you will see some improvements in Q3, but you will see even more in Q4 from what we see today.

That's helpful. Thanks so much.

Thank you, Ken.

And your next question is from the line of Andrew Lazar with Barclays. Please go ahead, sir.

Great. Thanks very much. Dirk, with some concern over economic recession in some key emerging markets, can you remind us of, I guess, Mondelez ability to manage through these sorts of macro events in terms of down trading, unit pricing and such. And the reason I ask is with global category growth year-to-date up around 4.5% and Mondelez holding or gaining share in 85% of categories. I guess, what realistically would hold Mondelez back at this stage from delivering at least 3% organic growth for the year, even if global category growth slows a bit from here, let's say, due to some recession?

Yes, I can – first of all, good to hear you, Andrew. And yes, I can certainly explain that a little bit better. First of all, as it relates to that 4.5% growth in categories, those are the measured categories. And as we, for instance, explained world travel retail is not included in the measured channels and some of the foodservice and so on. So we think that overall, the category growth is not the 4.5% seen that those are the channels that are more severely affected by COVID. As it relates to our categories and our strategy in the recession, I would say that, first of all, we look back at history, and the history has shown that over biscuits and chocolate tend to be quite durable in a downturn in developed markets, but also in emerging markets. And in fact, biscuits, in general, are not affected by the recession, and actually sometimes accelerated during the recession because, again, there is this switch to more in-home consumption which biscuits benefit from. Chocolate is a little bit more of a mixed picture. Some markets, it went down. Some markets, it went up. But overall, I would say it's also quite resilient with a very fast recovery as the recession starts to fade away. Candy was solid, very little change, and it's gum that suffers in a recession in our case, as we currently are seeing, but that's more driven by the fact that gum is an on-the-go product and that a lot of these channels have been closed. But also in a recession since, again, there's more in-home consumption, gum suffers. As it relates to the price points, I think we've done a good job around the world. I'm thinking India or Brazil or Mexico of overall, making our products quite affordable and covering all the price points. And I think we are set up now to really play in the different segments that you will see. Another thing, I think, that's important in our categories as it relates to a recession, is that private label penetration, particularly in emerging markets, is very limited compared to other food categories. So let's say that we were expecting the categories to grow about 3% pre-crisis. It maybe that they slowed down slightly. But I think together with our market share gains and the opportunities that we have as it relates to adjacencies to our categories, we should be able to get to that level as you were talking about. I also think internally, we are stronger. We have invested more in our brands. I think our brands today are stronger than they were two, three years ago. We are modernizing our portfolio. We have communications that are more effective. Execution is good. In the past, our execution was maybe sometimes not as great. Now supplies in North America is an example for us. And so I don't see us as a company not being able to deal with the recession. I think we can enter it with a position of strength as it relates to execution and being present. And so I believe that overall, we have work to do, don't get me wrong. For instance, we are working quite hard on what we call revenue growth management to make sure that we get the right price points completely squared away. A lot of price pack architecture, understanding what will happen in the different channels, so all the business units are hard at work to prepare for that. But I do think that we are set up to do well. And if we can keep the momentum going on our market share, I would agree with you. I don't see a reason why we cannot deliver against our long-term algorithm.

Thank you so much.

And your next question is from the line of Dara Mohsenian with Morgan Stanley. Please go ahead.

Hey. Good afternoon, guys.

Hi, Dara.

Hi.

So clearly strong organic sales growth in the U.S. in the quarter, can you unpack how much of that was true sort of underlying demand at retail? Was there any retailer inventory build? Or was this more strong retail sales growth? And just the sustainability of that sales growth going forward given it look like U.S. trend slowed a bit sequentially in the scattered data towards the end of the quarter would be helpful.

Yes. Maybe I'll…

Okay.

No, go on Dirk.

Okay. Well, I would say that the reason of the increased sales in the U.S. is driven by the Biscuit segment, and the Biscuit segment is heavily influenced by in-home consumption. And as long as the consumer will be more at-home and more consuming at-home, I think we will see an increase in our sales in the U.S. versus previous year. Of course, in the beginning, at the start of the crisis, there was some – a little bit of pantry loading, but that is out of the equation now. So what we are seeing now is continued consumption, I would say. And I would expect that sort of foreseeable future, not a change in that in-home consumption phenomenon. Now to be clear, gum is a contrary of that. It's very negatively impacted by that in-home consumption. It skews out-of-home, it's on-the-go consumption. And so that's going to be lower during the crisis. As it relates to the trade, if anything, I would say that the trade inventories at the moment are low because it has been difficult to keep up with demand. We significantly have reduced our assortment of SKUs just to provide a good customer service. And so if anything, I would say as our demand would slowdown a little bit, that will give us an opportunity to bring the trade stocks back in line with where they should be. So from my perspective, I feel pretty strong, certainly about Q3 and Q4 in U.S., I don't really expect, it might slowdown a little bit, but we’re still in high single-digit growth rates, to my opinion, which is much better than it was in the past. Luca, go ahead.

No. I second all the points you made. And to be – by transparent as we usually are, where we can be – trade stock is lower in the U.S. than it used to be. And it is not the only place where we have lower trade stock. And just to give you another data point, you're absolutely right, that there was a little bit of a slowdown in consumption, but as we look at some of the numbers we have for July, it feels like there is still opportunities for us to grow as Dirk says in the high single-digit territory. So we feel good about what we see. As Dirk pointed out, it is true that gum is a little bit on a downtrend at the moment, but I would also say that it is sequentially improving. And the last point I'd like to make is, particularly in candies like Swedish Fish and Sour Patch, we are seeing quite a bit of growth at the moment as well. So all is pointing in the direction of continued momentum, albeit it might not be the 11% that you saw in Q2, might be a little bit lower.

Great. Thanks guys. It's very helpful.

And the next question is from the line of John Baumgartner with Wells Fargo. Please go ahead.

Good afternoon. Thanks for the question.

Hi, John.

Hi, John.

Dirk or I guess, Luca – how are you doing? I guess what aspect of your revenue growth story over time is that penetration rates across emerging markets are still low and the white space opportunity can be still fairly impactful. So in the context of the fallout from COVID, to what extent is that kind of creating delays against the plan to enter new points of distribution or causing you to reprioritize your growth drivers over the next year or so?

At this stage, it doesn't feel to us that we need to reprioritize. We feel that a lot of the slowdown that you've seen in emerging markets has really gone directly related to the COVID crisis, and the fact that consumers were already locked down or distributors couldn't operate or the stores were closed. And as we open up the channels, we will see through which levels we go back. If I would take India as an example, India, of course, in April was not that great. I mean May was back to flat versus last year, and in June, started to show a low single-digit growth versus last year. In July, they will be higher than that. Will India go back to double-digit growth in the coming months? Maybe not, but if India delivers us a 6%, 7%, 8% topline growth, that's more than enough for us to keep on going on our plan. We were planning to expand our distribution in India for the year in hundred thousand stores or more. We probably had to slow that down a little bit during the COVID crisis, but we are planning to pick it right up where we left it off and keep on growing. At this stage – and India is an example for what we see in other countries. So for me at this stage, there is no reason to change our strategy. We might have, at this stage, maybe a quarter of delay, but we will try to catch up as much as we can. And certainly for 2021, we are planning to keep on going in the direction that we had set.

Thanks, Dirk. Thanks for your time.

Okay.

And your next question is from the line of Chris Growe with Stifel. Please go ahead.

Hi, good afternoon.

Hi, Chris.

Hi, Chris.

Hi, guys. I just had two quick questions sort of related, but I'm just curious, we know that the gum category was a pretty significant detractor from the quarter, the world travel retail and away-from-home. Can you say how much of those were dragging on revenue in the quarter? And then, I guess somewhat related, I'm curious if you look at – you defined the COVID costs, you also I think have indicated there's been some benefits from leverage and some of your own expense control to overcome that. Where would net COVID costs come off of the quarter, if you were to kind of put that against the savings you realized in the quarter? Thank you.

Yes. I'll start and then…

I think that sounds one for you, Luca.

Yes. I'll take these. So Chris, I think you know that gum is around about 7% of our revenue and there was a material decline in Q2. It was in the tune of, I would say, 35%, 40% in total, depending on the market. It is somewhat driven by share, but 80% of it is due to market, quite frankly. The market is really being impacted by all these shutdowns. And we are told that it is very difficult to do with the mask as well in certain places. So we saw a little bit of an issue in that market. Having said that, as we look at July, we see it coming better. I called it out in the U.S., but it is also in other markets. I can tell you one notable one for us is, is China. In Latin America though, we still see a bit of a continued challenge particularly in Mexico and Andean. Then world travel retail, it is give or take, $0.25 billion business for the year and it was nearly zero in Q2. We expect it to improve particularly towards Q4, but it was a material drag. We called out in the prepared remarks, both the impact on Europe and chocolate, and it is 2.5, 3 points of a drag both on Europe, which declined 1% plus. So you can do the math of how much Europe grew, excluding world travel retail. And the same on chocolate that was almost flat, but it would have been much better. So as we look forward, as I said, we feel quite good about Europe in Q3. Europe was another one that was impacted a little bit by trade and stock in Q2 as well. So we see that coming a little bit back in Q3. And importantly in chocolate, across the board, we see a quite solid category growth at this point and share as well. The biggest differential in chocolate is going to be India coming back. And as I said, India closed the quarter in June in good growth territory. And as we look at July specifically, India is quite solid. So we would expect India to be in a good growth territory in Q3. So that gives you a little bit a sense of these headwinds and how they impacted the quarter for us.

That was great.

On the COVID…

Yes. Thank you.

So the COVID costs, look we had more than $100 million in the GP line, and we have another $20 million, $25 million in the overhead line. So I would call it for lack of a better number, $130 million plus of an impact. We did cut travel, clearly, but the biggest upside both in terms of switching from non-working media to working media, other promotional spending items, some cost containment actions that we are taking in our factories. They had an impact that if I had to guess it would be around about $20 million in Q2. The big upside for all these actions is going to come in the second part of the year and specifically in Q4. I think you will see in Q4 this cost savings being meaningful and total profit being materially better than it is today or in Q3 for that matter. Both because this will come to fruition also because the COVID-related cost in Q4 will subside in our current outlook. So we will see what those costs are exactly, but that's the – how we see things at the moment.

Okay. That was very good color. Thank you for that.

Thank you, Chris.

You have the next question from Bryan Spillane, again with Bank of America.

Hey. Good afternoon, everyone.

Hi, Bryan.

Hi, Bryan.

Hi. So I just wanted to go back to – I think it might be related to John Baumgartner's question. But Dirk, you – in the prepared remarks, you talked about SKU reduction and also, I guess a slowing of some of the new product introduction. So just wanted to know a) is that more of a near-term response? Would the SKU reduction at all in the near-term create any kind of drag on revenues? But then more kind of longer term, how does that square with the presentation you made at CAGNY, where you talked about channel expansion, adjacent categories as part of the growth agenda. So just trying to square a kind of SKU reduction and fewer new product introductions with how that sort of relates to the growth – you've presented back at CAGNY.

Yes. Well, in a nutshell, it's all part of the same thinking. The way I would try to explain it is that if you look at our business, we have an opportunity to simplify our business and my experience in many other consumer goods companies is that in general, what has happened over the years is that people are chasing growth. And as a consequence, they keep on launching new products. And that gives you a short-term benefit. But at the certain stage, you need to clean that up. You need to look at your SKUs. You need to take a look at your innovation pipeline, and sometimes also at your brands and say, can these be simpler. But it's always a big discussion because the teams feel uncomfortable doing it. Although if you maintain the same shelf space, and I've done it several times in my career, what you will see is that not only do your sales increase because now the best selling items get more space. Your supply chain costs go down because of longer runs, less changeover, less inventory, less waste, and it also has a big benefit on your cash. So it's a good exercise to do. Just to think about us having thousands of SKUs, and every year, a few thousands of innovation projects, a lot of small ones, and to be frank it's – we were looking for a reason to break this chain because we do believe there is a much better way to do this. The reason why we want to do it now, we want to reaccelerate it now is that, I would say, the stars have lined up. The clients want great customer service. They want a cleaner shelf. They want to make sure that they can serve their customers. And we have the same initiative. So we were already obliged in this crisis to work with a much smaller set of SKUs in order to make sure that the key SKUs are on the shelf. And what do we see? Our sales are better, the shelf looks cleaner, and we get some benefits from it. So we're kind of pushing through using the opportunity to say, this is the moment we do it. Those 25% SKUs represent less than 2% of our sales. And I think we will see no effect from taking them out. Now it's not in one go. This takes a while. It's going to run over a few months. And we probably – out of those 25% of SKUs, somewhere at the beginning of next year. That doesn't mean that we will not do channel expansion and adjacency. The 25% is net. It means that we will launch a number of new items, particularly focused on price pack architecture to hit those price points that we need in specific channels and specific sizes for channels, or we needed because of the revenue growth management that we are applying. And we also will launch a number of items in adjacencies. So the 25% is net of all that. So I see it as part of the same strategy, and I'm really looking forward to be at the other end of this because I think we will have a much cleaner SKU portfolio, a much cleaner innovation portfolio, and hopefully, we can also clean up a few brands, so that we're lean as a company at the end of this.

That's great. Thanks for the clarity, Dirk. It really ties it together. Thanks again.

Okay. Thank you.

And your next question is from the line of Alexia Howard with Bernstein. Please go ahead.

Good afternoon, everyone.

Hi.

Hi, Alexia.

Hi, Dirk. So a couple of questions for me. Firstly, you called out the negative mix impact of, I think, minus 2.6% this time. Could you help us understand what was driving that and whether that headwind is expected to continue into the second half? And then my second question is just around the e-commerce dynamics. As we think about the U.S., Europe and China, how fast is e-commerce breaking out in each of those areas? And do you expect that to continue? Thank you. And I'll pass it on.

Maybe Luca, you do the first one on the mix and I'll do e-commerce.

Absolutely. Let's do that. Let's team up here. So on the negative mix impact, 100% of it is attributable to two categories, I would say, world travel retail, which is a business that has quite good margins. We sell predominantly Toblerone there, which is a great brand with quite solid gross margin, and that's the number one driver. And the other one is the gum category that, as I called out before, it declined 35%, 40%. I said about world travel retail that it was almost zero in the quarter, so I expect an improvement, particularly in Q4 around that business. And equally for gum, I expect a material improvement, particularly as we exit the year. I'm not sure it will improve dramatically in Q3. But certainly, as the situation stabilizes and trade starts to be open particularly in emerging markets, I mean traditional trade. We expect to see a gradual improvement compared to the current declines in gum. So the mix situation should improve throughout the year. And it has always been a fairly neutral number for us, I would say, as some emerging markets have a little bit of lower margins than some of the developed markets. And I was happy we were keeping it in control quite well. Obviously, gum and world travel retail are a little bit of a driver at this point in time.

And then to link in with e-commerce. So the number on e-commerce are a growth of 91% in Q2, so e-commerce last year was about 3% of our net revenue. In Q1 of this year, it was 3.5%, and in Q2, it's 6%. The biggest increase we saw was in the U.S., close to 200% increase. And that was driven by the fact that people that already shopped online bought more online, but also a significant amount of first timers that started to buy their groceries online. And so the penetration of last year of e-commerce went from 4% to 9%. So we do expect that e-commerce will remain a large part of our U.S. business after the crisis. The growth rates are high across all platforms, click and collect and delivery. And also our market share we gained, for instance, about four points of market share in biscuits online. And so we had already a good momentum before the crisis, and we've doubled down. Of course in click and collect, since we had a very strong performance of our DSD operation and since they picked the products out of the store that has helped our performance. As we go to Europe, we're talking about growth in UK and France, which was 100% and 50%, respectively, so also very, very strong growth. And China, where e-commerce is already 18% of our sales, we had a growth of 20%, which is consistent with the growth that we saw in 2019. The penetration there is already very high compared to our other markets around the world. In fact, if I reflect on e-commerce, I think we've got good momentum. We are increasing our market shares. We have some PPA gaps. We cannot yet always offer the consumer the sizes at the prices that they want. So we will continue to launch e-commerce specific packs, which is a little bit more difficult in click and collect. And we are also further investing in people and in infrastructure. So overall, we see very strong momentum in e-commerce.

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

Thank you.

And your next question is from the line of Jason English with Goldman Sachs. Please go ahead.

Hello and good evening folks.

Hi, Jason.

Hi, Jason.

Thank you so much for squeezing in. I very much appreciated. I wanted to come back to the productivity comments, and it sounds like you have a lot of initiatives under way. Obviously cutting 25% of SKUs and the impacts on your supply chain can be quite robust. I think your productivity has been tracking south of 2%, net productivity fell up to 2% of COGS the last year or two. A) Is that right? And b) as we think about the sort of run rate into the fourth quarter, where do you think that figure's going to fall by the time we hit the fourth quarter.

Yes. Maybe I'll comment on this, and then Dirk can chip in. I think you got the number on about right. There have been quarters where the number has been a little bit higher, quarters where the number has been a little bit lower. And remember, the impact that is due to what we call supply chain reinvention is a little bit lower than it has been in the past. We count on volume leverage above all to get our productivities stepping up. We count on other small changes that we're going to make in some places and bigger one and others. And we count on this concept of continuous improvement. We have a new leader in supply chain, and she has developed quite a bit of a strategy. And I think we have what it takes to continue to deliver profit through productivity. To your point, obviously, when you look at some of the numbers across the board, you can realize that productivity in Latin America this quarter wasn't great because of clear volume declines. And if you talk about productivities, including COVID costs, productivities haven't been great in Q2 overall as we had to incur additional cost. You will see an improvement in Q3. And in Q4, you will see a full effect of COVID costs coming down quite a bit. And also on the flip side, you will see material cost savings that we are about to implement, and we have, for some part already implemented in terms of tightening the belt, not only in the supply chain, but also in the overhead area, so all of this should come to maximum fruition in Q4.

Okay. I guess what I was really angling at was it sounds like you're going to have a very large productivity year in 2021. Because if you hit the run rate in 4Q, that's a modest spillover. And it sounds like some of these initiatives. You're not even going to have fully impacted until you bleed into the early next year. So I'm going to try one more time to come back at that number. That legacy sort of 2%, what do you think it might look like next year in context of all these initiatives?

Look, it should be better than quite honestly, than that number. That is the expectation, obviously. Having said that, we don't know exactly how Q3 and Q4 will play out, imagine about 2021. But do we expect by lapping some of these extra COVID costs and the fact that, as you pointed out correctly, we are having a spillover impact into next year of all these cost savings. Do we expect the benefit? Yes, absolutely. I think the counter to that is, in some cases, a little bit of more inflation around certain cost areas. But overall, the simple straight answer is, do we expect that the productivities next year? At this point, I would say so.

Yes. Thank you very much.

You're welcome, Jason.

And your final question is from the line of David Palmer with Evercore ISI. Please go ahead sir.

Thanks. And thanks for your earlier comments on Europe. It sounds like the trade shipment timing and the travel channel each hurt the second quarter organic revenue. You made also a comment. I think it was an answer to a question that you would get back to growth in the third quarter. Is that because of the shift in retail inventory? Or is there other consumer or channel trends that are giving you confidence into the second half in Europe?

Yes. I would say that in Europe, if you exclude because for historical reasons, we've always added world travel retail into our European numbers. And so the number you've always seen includes world travel retail. Now world travel retail in this quarter is virtually zero because there was the duty free shops were closed. If you take that out, Europe was already growing low single-digit but it was growing. The reason why it was not higher than low single-digit is that they have a number of other channels, particularly foodservice, and impulse, so convenience, which are about 20% together with world travel retail of their sales, they were affected by the lockdowns and the consumer not being out and about. Europe is going back to normal, better than what we're seeing in North America. So we are seeing gradually those two channels coming back. We're even expecting world travel retail to start showing a little bit of sales in Q3. So that's really the effect we're talking about and why we feel that Europe will show positive numbers, including world travel retail going forward.

And then just on products line – go ahead. Sorry, Luca.

And if I may maybe add one thing. I think the other thing that is more predominant now is our share gains and share gains are expanding in Europe in the latest region. So we see a benefit coming out of share and chocolate consumption as we look at Q3 is going to be quite good. So as Dirk said, there is a little bit of trade stock repiping, there is a little bit of an improvement in all these channels that created a headwind in Q3. But importantly, the underlying consumption in the rest of the business, due mostly to share, and I would say also solid category is improving in Q3 from where we sit today.

And I think you just touched on it a little bit. I'm just wondering about the profit or the leverage line to this organic revenue. You said COVID costs and mix headwinds leading to that negative 11 or how much are those headwinds going away into the second half for that segment? Or do you expect that this topline growth will lead to a bottom line growth as well?

In relative terms, the supply chain in Europe has been the most impacted by COVID extra costs. You will still see an impact in Q3. And so profit will be better in Q3. Again, it won't be all the way to bright. You will see a much better profit number again from where we sit today and what we see into Q4 at this point in Q4. So there is a material cost. We have multiple plants that serve multiple countries in Europe. So logistically, it is more difficult for people to get into the plant as they come, in some cases across the borders. And it is more difficult as there was in some places, a little bit of higher absenteeism that we still see to a certain extent. And importantly, some of the cost that we saw to protect all our people have been for one reason or the other a little bit higher than Europe, and so you will still see an impact in Q3.

Got it. Thank you very much.

Thank you, David.

And there are no further questions in queue at this time. I would like to turn the call back to our speakers for closing remarks.

Well, thank you for connecting. And I think I can wrap it up by saying, from our perspective, it was a solid Q2, particularly seeing the circumstances that we faced around the world. We exited the quarter with very good momentum, and we see a confirmation of that momentum in July. We have the fuel to invest in our growth within our P&L for the second half, and so we feel very confident that we will exit 2020 with some strength and are heading for a great 2021 also. So thank you again, and looking forward to talk to you in the coming quarters.

Thank you.

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