Mike Hsu: Yes. Okay yes. First of all, I think on the – yes I mean, you’re exactly right on the usage front. I mean, we do see in some markets, and I’d say it tends to be more developing in emerging markets where incomes are a little – budgets are a little tighter that you see the trade down. And that’s occurred – that occurred starting three years ago, four years ago now with COVID, and we saw that extensively in Latin America where people were stretching out usage. And if they were using, let’s say, three diapers a day, they had gone down to two. And so – and in some cases, I think that would explain, to your point exactly, Andrea, we’re trading up to a higher quality, maybe higher capacity diaper, we’ve seen some of that behavior.
But I think in Latin America, in particular, we’ve seen behavior shift. We had seen in the prior two or three years ago, some shift from premium to value. As I mentioned, we’re now seeing some shift from value to premium the other way, but we’ve seen that usage change before. A little less – I think we would observe that behavior a little less in developed markets like the U.S., but it still does occur nonetheless. So that’s kind of factored into our approach, and that’s why you’ll see from us, and I highlighted it in the prepared remarks. I mean we’re really going to emphasize our advertising, the value of our products and the performance of our products. And so, we’re really – we’ll address it that way, and also by cascading better features through our product line.
So I think that’s – maybe that’s the first part. And on the private label front, I think your question is correct. And certainly, as costs come down in the category, we might expect some pricing to come down. We’re still working through that. At this point, we’re still operating at the peak, even though we have a little bit of relief. We’re still operating at the highs and you can look at the forecast. I mean some of our costs have come down a bit, but costs remain still well above billions over what they were two or three years ago. And so, but we will plan for that. Nelson, anything to add?
Nelson Urdaneta: No. I think you’ve said it all, Mike okay.
Andrea Teixeira: Just as a quick one, Mike, and this is super helpful. When you say it’s going to take a while, so we’re looking at probably early next year where we might see things kind of leveling off or lapping on an inflation perspective?
Mike Hsu: Well I mean, I would hope that it comes really fast, but it’s not in our call right now. And so, we have – in the past, as you covered this category for a while now, and we’ve seen a more rapid reversion in the past. If you recall, I think 2018, we went to a record high and then on let’s say, eucalyptus. And then by 2020, we’re down to maybe a 10-year low. And so, it does move around quite a bit. We haven’t seen that action yet in a significant way, but I would anticipate it, so right.
Andrea Teixeira: Okay.
Nelson Urdaneta: And just to build on that last point, Andrea. For this year, still taking into account only commodities and ForEx at the midpoint of our guidance, we’re talking of another $0.5 billion. So it’s not an immaterial amount, albeit if we look at the prior two years, we were talking $3.2 billion. So net-net, based on the outlook for this year, when it’s all said and done, we have about $3.7 billion of headwinds that we’ve had to manage over the last three years when the year is done. So they remain high. Commodities remain elevated. ForEx remains volatile. Again, we’re seeing green shoots, but that’s the watch out. We still have disruptions in Europe. We still have items that we’re maneuvering through, but we are seeing some of the items also improve in things like transportation and energy to some extent. So again, we need to take it in strides in a quarter at a time as we progress.
Andrea Teixeira: Yes. But that $500 million and that’s an average, but if you think about like how it’s front-loaded, right? So it’s the $500 million on average, I’m just making it up numbers. But let’s say, it’s $1 billion in the first half and then it’s plus $500 million in the second half, reversing back. So what I’m saying is that, okay, retailers are smart enough to know because they own the private label and they know their contracts. So they will not immediately have to – that benefit or have to pass through that impact? But what I’m saying is that it will coincide that you’re going to lap the pricing and you’re going to start to see your inflation going the other way. So you’re starting to see deflation, not on an annualized basis, but you’re going to see on a quarterly basis. So I think what does that do with your – when you’re sitting down in the fall, to talk about pricing into spring of the following – or into the beginning of next year?
Mike Hsu: Yes. I mean I think you’re exactly right, and we’ll definitely take that into account as we plan. Obviously, I don’t want to sit here and telegraph what we plan to do on pricing in the second half of next year.
Andrea Teixeira: Yes, that’s fair. All right thank you so much. Appreciate the time.
Mike Hsu: All right thank you, Andrea.
Operator: Thank you. Your next question is coming from Jason English from Goldman Sachs. Your line is live.
Mike Hsu: Good morning, Jason.
Nelson Urdaneta: Hi Jason.
Jason English: Hi, good morning folks, thanks for having me in. So perhaps I missed it, which is totally possible, lots of distractions over here. But where are you expecting gross margins to land for the year?
Nelson Urdaneta: Yes, so for gross margins, Jason, at the very least, we’re expecting to expand them around 230 basis points year-over-year. Because remember, we’re expanding at the midpoint of our guidance, operating margin by 130 basis points. We took that up 50 bps versus our prior outlook. And we are putting in the incremental on 100 bps at least of investments into the brands. So that would put the year-on-year gain in gross margins at about 230 at the bottom.
Jason English: Got it. So that suggests that you’ve – you’re going to go kind of sideways from here. So you’ve reached another level, but you’re plateaued up here at this level with no more sequential progression. What does it take then to like find the next level? You mentioned in your prepared remarks, you’re still a couple of hundred bps below where you started. Is that – would we need commodities to come back in? Is that the enabler to get you next leg? And until that happens, sideways is the baseline expectation?
Nelson Urdaneta: That’s a good follow up, Jason. So the thing would be – it wouldn’t be necessarily sideways. Because as I said, I mean, we do expect to see continued progression in gross margin. I wouldn’t call it linear. I don’t expect it to be a straight line between now and Q4, because we have a few puts and takes with how commodities and pricing and FORCE will play. But we do expect to exit the year above the average for the full year. Does that help?
Jason English: Yes, or exit the full year at the rate you just delivered in the first quarter. I mean that’s what that 230 implies?
Mike Hsu: Well, let me just – I’ll give you a little more perspective, Jason, because here’s the deal. Look, we updated the outlook – I think it definitely reflects the strength of the first quarter relative to our expectations at the beginning of the year and our growing confidence in our underlying plan assumptions. I think we’re off to a good start. And so the unset part of it is, I would say, Nelson and I, we probably had more muted expectations for our first quarter, closer to what you guys were all thinking and so hey, we had a very strong start. As I mentioned, the other underlying category performance has been healthy. The cost environment has been stable. But that said, but I would say also in the first quarter, the shape of the P&L has performed very well.
And I’d say the cost – the quarter, I think, exceeding our own internal expectations pretty healthy in a way that I would say the primary drivers were volume, price and cost. So if you take those three factors, those are pretty good quality factors. Could it continue to get better? It could. But I think we’ve made our call on the outlook and generally it feels a little soon to call – revise our guidance up after the first quarter. But based on the strength of the first quarter, we felt like we should. But is there more room as we go through the year? There could be. But there’s also a lot of volatility that remains, which is kind of why we call it the way we’ve called it. And so what are the down factors on volatility? We’re all seeing the same reports about recessionary risk in the second half.
We don’t exactly know what’s going to happen to the cost – input costs and currency. And so, there are a lot of factors on both the plus side and the negative side. And so we’re – we feel like this is a good call for now. And we were – I think I will retain the right to change our mind later.
Jason English: Understood makes sense. And I agree with all your comments on the first quarter. Congrats on a strong start and I’ll pass it on.
Mike Hsu: Thanks, Jason.
Nelson Urdaneta: Thanks, Jason.
Operator: Thank you. Your next question is coming from Lauren Lieberman from Barclays. Your line is live.
Mike Hsu: Hi Lauren.
Lauren Lieberman: Great thanks. Hi, how are you? I wanted to talk about consumer tissue innovation. I know it’s a topic that we’ve touched on before without going back into the detailed poop conversation?
Mike Hsu: Yes.
Lauren Lieberman: But you guys have talked for a long time about the ability or the intention to elevate the category and bring innovation there, and this seems like the big – the first kind of like, big chunky move in that direction. I was curious your view on kind of category development, right? If I think about it, I would argue that you’re probably the only player that’s really focusing on innovation and premiumization in the category in this demonstrative way? How are you going to see the category evolving over time, right? Is there a higher margin profiles that’s structurally more interesting? Does this kind of raise the innovation game for everyone, more bifurcation between private label and branded? I’m just – yes, curious on views on what your initial research and maybe test markets have shown you, if you’ve done that on them, and how the category could evolve things with this move on innovation?
Mike Hsu: Yes, I mean Lauren we definitely think it’s the right thing to do. I mean, this category is – I mean, we invented the category. Scott Paper invented roll bath tissue over 120 years ago, and it hasn’t changed that much fundamentally since then. And we all know the category talks about the attributes of soft and strong and every bath tissue is a version of that. But the reality is as our team has done a harder digging, and the 50% of the consumers are dissatisfied what the products deliver for them. And so we think – the core of the issue is around a better clean. It turns out, and you may not be surprised to know this, but the vast majority of the consumption of bath tissue is female. And just by that, you can see the category doesn’t set itself up that way.
And so, we definitely think there’s a lot of ways to innovate from a product perspective and a communication perspective to deliver better clean. You’re going to see some of that in advertising. We have shared some of that with our customers. They’re very excited. I think we’re just on the – I think, at the beginning stages of this approach. But I think it’s the right one for the category. Because it’s a huge category, and there’s a lot of different ways to build. But I think creating more value added and giving consumers a better way to clean is a good one.
Lauren Lieberman: And then just from a profitability standpoint with this, right? So margins made a big step up this quarter in consumer tissue. But if I think back, the story in this category for KC for a long time has been recognizing the cyclicality of the cost environment that you’ll see here. But making the — raising the bar, right, the highs are higher and so are the lows, right, in terms of margin percentage. But as you push forward on innovation here, I mean, is there a scope for this business to have peak margins that are, I mean, call me crazy, like 19%, 20%? I think prior peak is maybe around 18%. But just not thinking this year, obviously, but over a multiyear horizon, what this means, could mean structurally for profitability in the category.
Mike Hsu: Yes. Well, let me go back broader, Lauren. I mean when I came into this role back in 2019, I think I started off with saying, hey, margin expansion is a goal, right? And so we got pushed back because when I said that, I wasn’t anticipating $3.7 billion of additional cost and currency headwinds. But I think the team is doing an excellent job working to offset a lot of that. And I think you saw it this quarter. And — but right around that ’20 — I’d say, 2017, 2018, 2020 period, our tissue margins in North America did kind of hit those rates. And so our goal right now is to get back into that range. But certainly, with the strategy that I just outlined and with the overall strategy of the company, to elevate our categories and expand our markets, I think the long-term goal remains margin expansion through innovation and building up the categories.
Lauren Lieberman: Okay. That’s great. Thanks so much.
Mike Hsu: Thanks Lauren.
Nelson Urdaneta: Thank you.
Operator: Thank you. Your next question is coming from Javier Escalante from Evercore. Your line is live.
