Amit Banati
Vice Chairman and Chief Financial Officer at Kellanova
Thank you, Steve, and good morning, everyone. Slide number 10 provides a summary of our second quarter and first half results. Net sales growth in quarter two was 7% on an organic basis. Importantly, this growth remained broad-based across category groups and regions, and paces us a little ahead of our previous full-year outlook.
Operating profit grew 14% on an adjusted basis. This growth came on top of last year's 10% currency neutral growth, and it featured the sooner than expected recovery in gross profit margin that Steve discussed. This operating profit performance puts us a little ahead of our previous full year outlook.
Earnings per share grew 5% on an adjusted basis, sustaining mid-single-digit growth in spite of macro-related headwinds versus last year on below-the-line items such as interest expense and pension income. Cash flow through the first half is down year-on-year because of outlays related to the pending spin-off but on track for the full year.
Let's now discuss each of these in more detail. Slide number 11 splits our year-on-year net sales growth into its components. Price mix growth was sustained in the mid-teens with growth in both developed markets and emerging markets. As expected, price elasticities continued to move higher around the world, and this weighed down our volume.
Also contributing to our volume decline was lapping last year's replenishment of trade inventories, particularly as we recovered from the serial strike. Foreign currency translation continued to negatively impact net sales growth by nearly 3% year-on-year in the quarter.
If today's exchange rates versus the US dollar were to hold, we would expect to see a similar impact in the second half, as the favorable impact of lapping last year's dollar strengthening is offset by the recent devaluation of the Nigerian naira.
So our top line growth in quarter two supports our long-standing planning assumptions for elasticities to rise and for revenue growth management actions to begin to anniversary.
Next, let's discuss gross profit shown on slide number 12. As we've discussed numerous times, our objective in this high inflation environment has been to protect gross profit dollars via productivity savings and revenue growth management. In quarter two, our adjusted gross profit increased by 9% year-on-year.
On top of a year ago quarter that itself was up more than 6% on a currency-neutral basis.
From a margin perspective, recall that our expectation was for a gradual improvement as the year progresses. But as Steve mentioned, we are ahead of pace in this recovery with year-on-year expansion coming sooner than expected. Much of this is driven by bottlenecks and shortages receding, which eliminates many of the inefficiencies and
Incremental costs experienced over the past year or more.
In addition, productivity and revenue growth management continue to catch up to a high market-driven input cost inflation. So while we have a ways to go before we get back to pre-pandemic levels, this performance gives us increased confidence in our ability to recover margins.
For 2023, there is no change to our outlook for expansion in the second half, but Q2's better-than-expected performance moves up our full year outlook for gross margin to be somewhere around 50 basis points of expansion year-on-year.
Operating profit, as shown on slide number 13, grew 14% year-on-year in quarter two, even as it laps a robust 10% gain in the year earlier quarter, and even with advertising and promotion investment increasing year-on-year. Through the first half, our operating profit was up 16% year-on-year.
Our second half comparisons get a little tougher, and we have begun to run W.K. Kellogg Company in parallel requiring incremental expenses year-on-year that are already baked into our guidance. That, we are ahead of pace, and this gives us the confidence to raise our full year operating profit guidance.
Moving down the income statement. Slide number 14 shows that our earnings per share growth has been attributable to operating profit, which has grown enough to more than offset what are severe macro-related headwinds in within our below-the-line items. These below-the-line pressures were expected and will continue through the year.
Interest expense increased significantly year-on-year due to higher interest rates. In the second half, we expect to see modestly lower interest expense than we recorded in the first half, owing to the timing of cash flow.
Other income decreased sharply year-on-year in each of the first two quarters this year. reflecting the accounting of pension and postretirement plan asset values and interest rates stemming from last year's declines in financial markets. Owing to favorability in some other items in the slide, Q2 came in higher than both Q1 and the run rate we would expect for the remaining quarters.
Our effective tax rate in quarter two was back to the kind of 22% rate we would expect for the full year after being a bit above that in quarter one. Average shares outstanding were up slightly year-on-year in both quarter one and quarter two. And we would expect that to be the case for the full year as well.
Foreign currency translation turned slightly positive to EPS in quarter two, finishing the half with about a negative 1% impact. We leave foreign currency translation out of our guidance because it is out of our control and difficult to predict. But if we took today's exchange rates, including a substantially devalued Nigerian Naira partially offset by the lapping of other currencies a year ago weakening, we would estimate a similar impact for the full year as that of the first half.
A key message here is that these below the line items are collectively weighing down EPS as expected, but it is important to remember that the operational side of our P&L through operating profit remains very strong.
Turning to slide number 15, we see that cash flow is below last year's high level. This is due to three factors. First, one-time cash outlays related to the spin-off amounting to roughly $130 million. Secondly, lapping unusually strong inflows in the year-ago period, including some related to derivatives. And thirdly, timing of capital expenditure, which last year was much more weighted to the second half due to supply disruptions earlier that year.
So while it is down from a high level last year, we believe cash flow is right on track to achieve our full year guidance. Meanwhile, we continue to reduce our debt leverage year-on-year, further enhancing our financial flexibility. All in, our second quarter performance puts us slightly ahead of pace for the full year. Accordingly, we are once again moving up our full year guidance as shown on slide number 16. We are raising our guidance for organic net sales growth to approximately 7%, which is the high end of our previous guidance range.
Our quarter two performance was consistent with our assumption of decelerating growth as the year progresses, which reflects a likely return of elasticity towards historical levels as well as lapping of particularly substantial revenue growth management actions in the second half of last year. This 7% organic growth is well above our long-term target. We are raising our guidance for adjusted operating profit growth to 9%-10% on a currency-neutral basis, which is the upper half of our previous guidance range. This raise reflects a stronger-than-expected Q2 performance, particularly our earlier recovery in gross profit margin, and yet still accounts for some investment shifts into the second half as well as incremental costs in the second half for operating WK Kellogg Company in parallel as a company within a company.
We expect to improve margins this year which combined with our above target net sales growth will deliver operating profit growth that is also above our long-term target. Based on the improved operating profit outlook, we are raising our adjusted earnings per share guidance as well, now looking for a year-on-year decline of 1% to 2%, the upper portion of our previous guidance range.
Remember that all and more of this decline is explained by the year-on-year reduction in pension and post-retirement income, a non-operating, non-cash item that is expected to have a negative impact of nearly 7% on EPS this year. The negative impact of higher interest expense due to higher interest rates in the economy is another negative impact of more than 4%.
If it weren't for these two macro-related impacts, our guidance for EPS growth would also be well above a long-term growth rate. Our guidance for cash flow remains at $1 to $1.1 billion. Recall that, within this guidance, we are expecting a year-on-year increase in our underlying cash flow offset by one-time cash costs and capital related to the spin-off.
A couple of elements to keep in mind regarding this guidance. First, while we expect the spin-off to be transacted during quarter four our guidance assumes it takes place at year-end purely for simplicity reasons. And secondly, the impact of our recently completed divestiture of our Russian business does not have a material impact on our guidance.
So to summarize our financial position on slide number 17, quarter two was yet another quarter of over-delivery and we have plans in place to sustain our earnings momentum. Accordingly, we are again raising our full year guidance for 2023. Our profit margins have expanded sooner than anticipated and this should continue, particularly as our service levels return to normal.
Our net sales growth remains strong and while we are keeping our assumption of rising elasticity in the second half, along with lapping sizable revenue growth management actions, we are confident enough in our top-line growth to raise our full-year outlook. Our financial flexibility is strong, marked by a solid balance sheet and cash flow that remains in good shape, even with some adverse timing in the first half.
We continue to make good progress on setting up both Kellanova and WK Kellogg for operational and financial success, and we are looking forward to sharing with you the two companies' exciting strategies, capital structures, and financial outlooks next week.
And with that, I'll turn it back to Steve to walk you through our individual businesses.
