General Mills' (GIS) CEO, Ken Powell on Q3 2017 Results - Earnings Call Transcript

| About: General Mills, (GIS)

General Mills Inc. (NYSE:GIS)

Q3 2017 Earnings Conference Call

March 21, 2017 08:30 ET

Executives

Jeff Siemon - Director, IR

Ken Powell - Chairman & CEO

Jeff Harmening - President & COO

Don Mulligan - EVP & CFO

Analysts

Andrew Lazar - Barclays

David Driscoll - Citi

Chris Growe - Stifel

Jason English - Goldman Sachs

Rob Dickerson - Deutsche Bank

Bryan Spillane - Bank of America Merrill Lynch

Steven Strycula - UBS

Operator

Ladies and gentlemen, thank you for standing by and welcome to the General Mills Quarter Three Fiscal 2017 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference is being recorded Tuesday, March 21, 2017.

I would now like to turn the conference over to Jeff Siemon, Director of Investor Relations. Please go ahead, sir.

Jeff Siemon

Thanks, Kelly and good morning to everyone. I'm here with Ken Powell, our CEO; Don Mulligan, our CFO, and Jeff Harmening, our President and COO. I'll turn you over to them in a minute, but first let me cover our usual housekeeping items.

Our press release on third quarter results was issued over the wire services earlier this morning. And you can find this release and a copy of the slides that supplements our remarks on our investor relations website. I'll remind you that our remarks will include forward-looking statements that are based on management's current views and assumptions. The second slide in today's presentation lists factors that could cause our future results to be different than our current estimates.

And with that, I'll turn you over to my colleagues, beginning with Ken.

Ken Powell

Okay, well thank you Jeff, and good morning to one and all. I'll cover the key headlines for the third quarter.

Our third quarter results finished in-line with our expectations and keep us on-track to deliver the guidance we updated last month. Our net sales declined due primarily to gaps in pricing and promotional activity in key U.S. businesses, and our cost savings efforts helped us expand our adjusted operating profit margin and drive growth in adjusted diluted EPS. We are highly focused on improving our topline growth trend. We've added support in the fourth quarter to strengthen key business lines and we're pursuing global growth priorities that will further improve our sales trends beyond fiscal '17.

Jeff Harmening shared those priorities with you in our presentation at the Cagny Conference last month and we'll come back to them when we discuss our fiscal '18 business plans in June. We are also reaffirming our full year guidance today.

So with that let me turn things over to Don to provide more detail on our financial performance.

Don Mulligan

Thank you Ken and good morning everyone. Slide 6 summarizes our third quarter fiscal '17 financial results. Net sales totaled $3.8 billion, down 5% as reported and on an organic basis. Total segment operating profit totaled $662 million, down 2% in constant currency basis. Net earnings decreased 1% to $358 million and diluted earnings per share were $0.61, as reported. Adjusted diluted EPS, which excludes certain items affecting comparability, was $0.72. Constant currency adjusted diluted EPS increased 8% compared to last year's results.

Slide 7 shows the components of total company net sales growth. Organic pound volume reduced net sales growth by seven points, it was partially offset by two points of positive mix and net price realization. In our foreign currency translation nor the net impact of acquisitions and divestitures had a material impact on net sales growth.

Before turning to our financial results by segment let me briefly review our new segment reporting structure which was highlighted in this morning's press release. Starting this quarter we're now reporting under four business segments aligned with the new global organization structure we announced in December. We've combined our U.S. retail and Canada businesses into a North American Retail segment due to their similar product portfolio and go-to-market structure. North America Retail is our largest segment representing roughly two-thirds of company net sales; and thanks to the large part to net scale is also our most profitable segment with fiscal '16 operating margin to 22%.

Our Convenience Stores & Foodservice segment which is unchanged from previous structure contributed 12% of total net sales -- total company net sales and posted a 20% operating profit margin last year. Our cumulated international segments; Europe and Australia, and Asia and Latin America represented 12% and 10% of fiscal '16 net sales respectively. In these two segments, we have less operational scale, we're investing for growth and we don't benefit from a higher margin cereal business which is captured in the results of our cereal partners worldwide joint venture. As a result, profitability in these segments is lower. And due to their smaller scale we expect more volatility in quarterly results which you will see in our third quarter numbers.

Slide 9 summarize our third quarter results across the new operating segments. North America Retail posted high single digit declines in organic net sales in constant currency segment operating profit. Convinience Stores & Foodservice net sales declined 1% while operating profit grew 3%. The Europe and Australia segment delivered 2% organic net sales growth and 39% constant currency growth in operating profit. And finally, organic net sales for Asia and Latin America declined 2% while segment operating profit increased to $10 million from $2.5 million dollars a year ago.

Turning to joint venture results, CPW net sales grew 4% in constant currency with growth across all regions. Häagen-Dazs constant currency net sales declined 5%, primarily due to the comparison against last year's third quarter which grew 22% behind the successful relaunch of Häanah Mochi [ph]. Combined after-tax net earnings from joint ventures totaled $11 million in the third quarter, down 35% in constant currency due to asset write-up for CPW and lower volume for Häagen-Dazs, Japan. Year-to-date constant currency net sales for CPW and Häagen-Dazs, Japan have grown 3% and 5% respectively. And constant currency combined after-tax earnings from joint ventures is down 3%.

Third quarter adjusted gross margin was up 20 basis points with benefits from holistic margin management and our other cost savings initiatives more than offsetting the impact of volume deleverage and modest input cost inflation. For the full year, we continue and expect to deliver $380 million of cost of goods sold HMM savings which will more than offset our expectation of 2% inflation. Adjusted operating profit margin increased a 100 basis points in the quarter driven by higher adjusted gross margins and a 9% reduction in SG&A.

Slide 12 summarizes other noteworthy income statement in the quarter. We incurred $106 million in restructuring and project related charges in the quarter including $28 million recorded in cost of sales. Corporate unallocated expenses excluding certain items affecting comparability decreased by $22 million, a bit faster pace versus prior periods reflecting our costing initiatives plus the reduction in our incentive growth. Net interest expense decreased 1% from the prior year. We continue to expect full year interest expense will be roughly flat to last year.

The effective tax rate for the quarter was 23% as reported. Excluding items affecting comparability, the tax rate was 24.7% compared to 30.8% last year, driven by favorite impact of recent French tax legislation and a number of small discrete tax items that occurred during the quarter. We estimate our full year adjusted effective tax rate will be 29%, in-line with the updated guidance we communicated in February. Average diluted shares outstanding declined 3% in the quarter and we continue to expect a 2% reduction for the full year.

Turning to our nine months financial performance; net sales were down 5% on an organic basis, segment operating profit declined 2% in constant currency, and adjusted diluted EPS was up 4% in constant currency.

Turning to the balance sheet, our quarterly core working capital increased year-over-year for the first time since fiscal '13 due to the impact of late quarter volume shortfalls on domestic inventory, partially offset by continued improvements in accounts payable. We expect core working capital to improve in Q4 and be a source of cash for the full year, primarily behind for the benefits from payables. Nine month operating cash flow was $1.6 billion, down 16% from the year ago driven by non-core working capital items including changes in trade and advertising accruals, as well as changes in taxes payable, primarily related to capital gains on the Green Giant divestiture in fiscal '16.

We expect to derive significant growth in operating cash flow in the fourth quarter behind higher net earnings and working capital improvements. Year-to-date capital investments totaled $475 million and through the first nine months of the year we returned $2.5 billion to shareholders through dividends and net share repurchases.

Slide 16 summarized our fourth quarter outlook. We expect modest improvement in organic net sales trends driven by the trade and consumer support we've added to keep businesses in North America Retail, as well as the continued growth in Europe, China and our focused six platforms in Convenience & Foodservice. We also see significant margin expansion due to favorable mix, the comparison to margin contraction in last year's fourth quarter, and continued benefit from strong cost savings behind HMM, a global restructuring actions in zero-based budgeting.

Two final comments on the quarter; net sales growth in Europe and Australia segment will be negatively impacted by the comparison to a year ago period which included an extra month in results for [indiscernible] Europe as we align net business to our fiscal calendar. And note that in this year's fourth quarter our Asia and Latin America segment will benefit from an extra month of reported results from Brazil as we align that businesses calendar to our fiscal year. At the total company level, the combination of these two impacts will be a modest headwind to our fourth quarter organic net sales growth. On a full year basis, the impact is immaterial.

With those fourth quarter expectations we are reaffirming the fiscal 2017 full year guidance we communicated in February. Specifically, we expect organic net sales to decline approximately 4% for the year. Constant currency total segment operating profit is expected to be in the range of down 1% to up 1%. We expect our fiscal '17 adjusted operating profit margin to finish at 18% or higher which translates to at least 120 basis points of expansion versus last year. And adjusted diluted earnings per share are expected to grow between 5% and 7% in constant currency. We expect foreign currency translation will have a minimal impact to full year diluted EPS results.

Now I'll turn it over to Jeff to provide more color on our operating performance.

Jeff Harmening

Thanks Don and good morning everyone. As Ken described, our third quarter results were in-line with our expectations. Improved top line performance on our Convenience Stores & Foodservice, and Europe and Australia segments, and growth on our core business in China were offset by declines in our North America Retail segment, driven largely by yogurt, soup and refrigerated dough.

Let me provide a little more detail regarding our third quarter segment performance and our outlook for the remaining year. For our North America Retail segment, organic net sales declined 8% in the quarter; cereal net sales were down 1%, an improvement over first half net sales results. Mid-sales for U.S. Max were down 4% driven by declines in Fiber 1. In our U.S. meals and baking unit, net sales declined 10% as we didn't have competitive levels of promotion activity on soup and refrigerated baking products during their key seasons in the third quarter.

Declines on U.S. yogurt sales were led by [indiscernible] varieties as well as a widening gap from promotional levels between us and our competition. In constant currency net sales in Canada declined by 1% in the quarter. Constant currency segment operating profit decreased 7% in the quarter driven by volume declines that were partially offset by our cost savings initiatives. As we look ahead to the fourth quarter, we've added support to strengthen key businesses, improve our momentum and better position our brands as we head into fiscal 2018.

Globally, our cereal business is improving, it's growing in Canada, Cereal Partners Worldwide, and in U.S. food service outlets. In our U.S. retail cereal business, we're adding support in the fourth quarter behind taste and wellness news that is working. That includes taste news on Lucky Charms and Coco Pops with retail sales are increasing at low and mid-single digit rates so far this year. We're also adding media support behind gluten-free messaging on our Cheerios franchise including new Very Berry Cheerios that launched in January and are off to a good start. And we continue to support our whole grain message on a variety of our cereal brands.

In U.S. snacks, Nature Valley has gained nearly two points of dollars share so far this year in the grains next category. As the new product we've launched such as granola cups, and a new flavor of nut-butter biscuits hit shelves in January and we're increasing media support in the fourth quarter behind the Nature Valley brand. We also continue to post strong growth on Larabar. Year-to-date, retail sales are up 44% in Nielsen measured outlets, thanks to broadened consumer awareness and expanded distribution across mainstream channels. In fact, household penetration for a Larabar has grown 30% in the past year as we found new ways to reach consumers including targeted T.V. advertising.

We're also seeing good growth on Epic, natural meat snacks with retail sales more than doubling so far this year on good innovation and strong distribution gains. And we see considerable opportunity to expand household penetration on this growing brand. As we have previously discussed, we have work to do to reposition our U.S. yogurt portfolio and to faster growing more premium yogurt segments. We'll do that through core renovation on our existing lines and innovating on emerging segments in the yogurt category. We've recently renovated a significant portion of our core yogurt business including a complete reformulation and relaunch of Yoplait Greek 100 which now has more protein, less sugar and a significantly improved texture and taste. We've also refreshed packaging on our original Yoplait and we are adjusting the pack size of Gogurt to deliver more value to the consumer.

On the innovation front, we're capitalizing on increased consumer interest in snacking with the recent launches of Yoplait Dippers, Yoplait Custard, and a new regional yogurt drink that gets us into the fast growing beverage segment. The natural organic yogurt segment is growing by double digits, and we're strengthening our position in this space by building distribution on our Liberte, Annie's and Mount High yogurt varieties. And we're starting to see consumers looking for more simple, better tasting yogurts that feel more are seasonal. This summer we'll launch a new line here that leverages our French heritage to bring an entirely new yogurt taste and texture to the U.S. market.

Within our meal and baking operating units, we continue to post solid results on Old El Paso with retail sales up 4% so far this year on the strength of our innovation and brand messaging. In the fourth quarter, we'll be providing additional consumer support with the [indiscernible] event that includes TV advertising and social media marketing efforts. Totino's frozen and hot snacks continue to grow as we have taken a strong consumer first approach on this brand with innovative campaigns using digital assets that resonate with the Totino's consumers. Our fourth quarter activities include additional media support and a tie-end with the massive-X [ph] video game release this month. And we're also putting support behind refrigerated baked goods with in-store promotion as well as a new recipe and coupons on digital outlets for the Easter season.

Our natural and organic portfolio continue to drive double-digit sales growth and as we reframe our view to capture all of North American business, our natural and organic brands will generate more than $1 billion in net sales in fiscal 2017. Annie's is our largest brand and retail sales are increasing nearly 40% so far this year in U.S. Nielsen measured outlets. We continue to gain distribution on Annie's established businesses including macaroni and cheese, fruit snacks, and cracker lines that were in the market when we acquired the brand. Year-to-date retail sales for those categories combined are up 18%. And as you know, we've also introduced this brand into new categories with ready-to-eat popcorn being our latest addition to the portfolio. In the fourth quarter we'll increase our promotional activity with in-store and consumer events tied to Easter [ph].

Turning to Canada; our fourth quarter plans build on a solid year-to-date growth we've seen on Old El Paso, grains next cereal, and Liberte yogurt; and we're very excited about the recent launch of Annie's into this market. Early consumer response to Annie's has been very positive and there is still plenty of run way for growth here. We're also celebrating Canada's 150th Anniversary next quarter with limited edition maple-flavored Cheerios along with variety of online and in-store promotion events to mark this milestone.

So in total, we expect to see improvement and topline performance in the fourth quarter for our North America Retail segment driven by increased contributions from our product innovation and core renovation efforts and increased consumer and trade support on key businesses like cereal, snacks, Old El Paso Mexican products and Tortino's hot snacks. And we expect to pose good segment operating profit growth in the fourth quarter as we start to realize benefits from our recent global restructuring and we'll have double-digit profit declines in the U.S. business a year ago.

Turning to our Convenience Stores & Foodservice segment; organic net sales declined 1% in the quarter. However, our Focus 6 platforms posted 2% net sales growth led by cereal, yogurt and biscuits. We saw good growth on ballpack [ph] cereals and [indiscernible] as our no artificial colors and flavors messaging continues to be popular with cafeteria operators. Yopliat park play pro [ph] is driving growth on our yogurt business and pricing actions we have taken on biscuits drove high single digit sales growth in the quarter.

Segment operating profit increased 3% in the quarter primarily driven by benefit from cost savings initiatives and lower input cost. Our net sales trajectory for this segment has improved each quarter this year. In the fourth quarter we expect the post growth on our Focus 6 platforms led by cereal, yogurt and biscuits. We'll also benefit from increased distribution on our frozen bread products and in-store bakeries and we expect to reduce headwind from bakery flour index pricing in the fourth quarter.

Now let's turn to our international segments. In Europe and Australia, organic net sales increased 2% in the quarter led by good growth on Old El Paso, Häagen-Dazs and Nature Valley and Fiber 1 snack bars. Here too we've seen improved top line trends in each of the last few quarters after a slow start to the year. Third quarter segment operating profit increased nearly 40% on a constant currency basis primarily driven by favorable mix and cost savings. A large driver of our improving performance in Europe has been our Häagen-Dazs business.

We've been expanding our very successful stick bars into markets across Europe, and we're supporting the brand with strong marketing initiatives such as our partnership with Wimbledon that expand the brand awareness. We also launched Häagen-Dazs in Australia this year and have already secured a 40% dollar share of the super-premium ice cream category there. We'll continue that momentum in the fourth quarter by introducing new stick bar flavors and launching new mini-stick bars in markets across Europe. We're also relaunching Häagen-Dazs in the UK with stick bars, mini cups, and new more contemporary packaging and marketing communications. So we're seeing good trends in our portfolio and these developed markets.

In the Asia and Latin America segment organic net sales declined 2% in the quarter reflecting macroeconomic challenges in Latin America and the restructuring of our snacks business in China. Segment operating profit increased to $10 million from $2 million dollars a year ago. China is our largest market in this segment and we're seeing good growth on our core business there. We're posting mid-single digit sales growth at Häagen-Dazs and Wanchai Ferry so far this year. And Yoplait yogurt is growing at a triple digit rate driven by continued kind of trading games in Shanghai and our expansion into Beijing. We expect performance momentum on these brands to continue into the fourth quarter. We've seen same-store sales return to growth on our Häagen-Dazs shops, and we recently launched new flavors of our retail new flavor for our retail channels including Toffee Mochi, and Fruit and Flower ice cream varieties. On Wanchai Ferry, strong promotional plan on core pork and shrimp dumplings along with a new line of dumplings for kids will contribute to growth in the quarter too.

In Latin America, the operating environment remains challenging but we expect to see performance improve in the fourth quarter behind an expanded promotional plan for Fester Janina [ph], an annual celebration that starts at the beginning of the Brazilian winter. We'll also he continued distribution gains on Carolina yogurt including our new renovated Greek yogurt line which is receiving good early feedback from consumers.

So as we look across our entire portfolio, we expect modest improvement in our top line trends in the fourth quarter due to increased consumer and trade support on key brands across our U.S. businesses, as well as continued growth in Europe, China and on our Focus 6 platforms in the Convenience Stores & Foodservice segment. We also expect to generate significant operating margin expansion driven by mixed strong cost savings and a favorable comparison versus last year's fourth quarter.

And with that I'll turn it over to Ken for some closing comments.

Ken Powell

Alright well, thanks Jeff. So to summarize our comments this morning, our third quarter results were in-line with our expectations and keep us on-track to deliver the guidance we updated last month. We're highly focused on improving our topline performance, we've added support in the fourth quarter to strengthen key businesses and we'll look to further improve our sales trends beyond fiscal '17. Our plans for next year will balance stronger product news, define our global growth priorities, refined levels of investment across our categories and continued margin expansion.

So I'll close this morning by reiterating our commitment to our shareholder return model which consists of balanced top line growth in margin expansion combined with disciplined cash conversion and cash returns, that's the formula we believe will generate top two returns for General Mills shareholders over the long-term.

Jeff Siemon

With that we'll turn it over to Q&A. Operator, you can go ahead and get us started.

Question-and-Answer Session

Operator

Thank you, sir. [Operator Instructions] Our first question comes from Andrew Lazar with Barclays. Please proceed with your question.

Andrew Lazar

Good morning everybody. I think as of the fiscal second quarter you were looking for full year gross margin expansion in a sort of 100 to 120 basis point range. I'm trying to get a sense if that is still what is embedded in your thinking when you're thinking about the overall operating margin expansion for the year? I know you've got an easier gross margin comp and you mentioned the mix and things of that nature. So I guess if that's still reasonable or if more of the operating margin expansion for the full year at this point comes from the SG&A side just given some of the volume deleverage?

Don Mulligan

Andrews, this is Don. Yes, as we look at the full year, again we still expect to drive operating profit margin expansion of 120 points plus a greater portion of that will come from SG&A that we originally anticipated. Our gross margin expansion will partly been in the 50 to 100 basis points range versus the 100 plus that we talked about earlier and it is for the factor that you reference with bit more volume deleverage in particular. But importantly, as we go into Q4 as you also referenced, we have every expectation of seeing significant margin expansion, particularly given the fact that we see a bit more modest inflation outlook versus what we saw a year ago in the fourth quarter and last year's fourth quarter we saw some significant margin contraction. So we expect to improve margin performance in the fourth quarter but for the full year we expect gross margins to be more -- expand more in the 50 to 100 basis point range.

Andrew Lazar

Thanks for that. Just a quick one and on just the growth versus sort of foundation strategy; we're a couple of quarters into it now and I know it's always tough to gauge at the start of something like this when you're reallocating resources around to different brands and categories and such -- what sort of impacts will be but maybe if there is just a -- maybe a key learning or two from the first couple of quarters of undergoing this process and maybe what it means for how you view that rubric [ph] kind of going forward? Thank you.

Jeff Harmening

So Andrew, this is Jeff. You know what I would say is that -- you know, we're satisfied with our strategy on growth versus foundation brands and we mean the brands we set for growth we think are the right ones and the foundation ones as well. And how we're managing those, we feel fine we're fine with that. I mean the challenge for us as Ken and we've talked about this a lot is that -- as we look at this year it's not really growth versus foundation for us, it's just in some key categories. We haven't had the promotion mix right and we haven't been as competitive and pricing as we could have been. So yogurt which is a growth brand for us, as well as refrigerated baked goods and soup; and so it really is a matter of our price competitiveness, as well as our innovation on yogurt and getting back to innovation -- levels of innovation in yogurt that we feel are going to be more than competitive and can get us back to growth on that business. So as we look at our strategy and growth and foundation, we're satisfied with that as well as the brands we have and kind of in each bucket but it really is our promotion competitors on some of our biggest businesses.

Andrew Lazar

Thank you.

Operator

Our next question comes from David Driscoll with Citi. Please proceed with your question.

David Driscoll

Great, thank you and good morning. I wanted to ask first about Pillsbury and Progresso in the brands -- just kind of your assessment of the brands at this stage; the volumes in our AOC per see data were down 20% and 16% respectively for those two brands. So the question is -- you know, after the season is over how significant is the damage to those brands given -- I don't have any other word to say here; staggering declines in the volumes. We'll just like to understand kind of what you do going forward and is this something that we have to think has really impacted these brands on a more permanent basis or is there something that you could call up that would be more transitory regarding the trends on those two brands?

Jeff Harmening

So David this is Jeff. I look at the fair question given the decline we've seen on the brands but I will tell you, there is nothing wrong with either the Pillsbury or the Progresso brand. I'm in fact we -- you know, we grew those two businesses a year ago and so whatever -- it is fully transitory. And you know with refrigerated baked goods, we took a significant amount of pricing and we've paid the price for taking more than we should have and you see it in our pricing versus competition, you particularly see it as retail brands private label, that's kind of filled the promotional void that we left. And so for us on refrigerated baked goods; for -- if refrigerated baked goods is really is getting back to being price competitive and we think we'll have a much better year next year than we had in 2017. And on Progresso as well, I mean we were out to merchandise this year, our Progresso Brand and our price points weren't particularly good and we didn't probably execute the way that we wanted to and so there is nothing wrong with either of those brands although I can understand how you would think that given the volume decline but it really is transitory, they are both great brands and we think we can improve performance on both of them.

David Driscoll

My second question is on the cost reduction efforts; do you believe that the cost reduction in these programs are in the whole or in part to blame for the significant revenue problem that the company is having? And then if you could just give some detail why or why not I think people would greatly appreciate that.

Ken Powell

So as we look at the biggest challenge that we've had this year with are -- our retail sales have been two-fold and it really has been the pricing and the price discrepancies we've had in our biggest categories as well as our innovation on yogurt and we need to get back to fundamentally strong levels of innovation. Those are the two biggest drivers by far. Now we have gone through about as much organizational changes one can go through in the last three years and so you know does that have an impact, I suppose it does. And if you look at our results in Europe for example, where we had an independent Yoplait organization and an independent General Mills organization, we put them together and you see our first quarter results in Europe from what we wanted but that we've been getting better and better as the quarters have progressed and I think part of that is due to the fact that we've put the organizational change we've undergone.

And North America has probably been through a lesser extent; the issues although -- we have changed quite a bit with our supply chain and you know from time to time we've had service challenges especially in the first quarter of this past year but those things are behind us now; and so as we as we look ahead, I wouldn't expect any impact from our cost savings initiatives. And frankly, over the last year even though we've had some -- the vast majority of our challenges have really been due to the pricing we've had in the marketplace and an innovation on yogurt.

David Driscoll

Well, just one fast follow-up. Do these issues on the revenue line and in whatever connection it had to the cost reduction program, does it make you fundamentally more nervous or wanting to move in a slower fashion on future cost reductions?

Ken Powell

Well, look -- I mean most of the big supply chain restructurings we have are behind us now. We've already implemented ZVB. The cost savings initiatives that we've seen in front of us, things like going to global sourcing and things like that -- you know aren't going to have an impact on how we execute in the marketplace. And so whatever I say a lot of the big organizational changes that we think could have an impact commercially we're not going to see going forward. And as I said even though there has been a lot of change that's not -- I really don't think that's been the primary driver of our performance this year.

David Driscoll

Thank you.

Operator

Our next question comes from Chris Growe with Stifel. Please proceed with your question.

Chris Growe

Hi, good morning. I just had a question for you if I could, if you're putting more support back behind the business in the fourth quarter isn't investment more transitory short-term kind of reacting to the current environment or are you treating some of these -- in particular, the foundation brand differently than you thought when you've learnt of their strategy, so I'm thinking like soup and baked goods. You have to get little more aggressive behind those and therefore less margin improvement than you expected from those categories?

Ken Powell

Well, as we look at the fourth quarter Chris the -- we're putting more emphasis behind our cereal and snack brands first and foremost, and then a little bit behind Old El Paso. And because we -- you know, if we like the marketing efforts we have on all those brands we've seen good results on Nature Valley and snacks and we like we have included Cheerios and Lucky Charms and so forth. We're also adding a little bit back to our Pillsbury business on Easter which is later this year; so Easter is in April as opposed to March and so we won't see results on that until April. So we are adding a little bit back for our refrigerator baked goods. What I would say is that the -- we're not going to have a tons back on soup because the soup season is kind of over and after Easter the baking season is kind of over until next fall.

We expect good margin improvement on soup and refrigerated baked goods but we also have to make sure that we were supporting those business properly as well and we've had a significant volume deleverage this year which has partially offset some of the cost savings that we've had. And so our expectation is that we go forward, that we'll continue to grow margin in those brands but we'll do it with a little bit less of the leverage and a little bit more support.

Jeff Harmening

And Chris, I guess what I would add to that is, you know, as we've talked about we have a couple of opportunities in front of us. One is to get sharper on price and as we do that we think that will have long-term benefits and you expect that to continue. And stronger support behind some of our best marketing ideas and you know, as we said before as we look at our media investment for the back half of the year; excluding U.S. yogurt which we said we were right sizing, the other growth businesses will see an increase in media in the back and that's been consistent since we've decided to put money back -- more money back into the business in December. Again, we're going to -- we're expecting good returns on that and we continue to expect to support our brands as we go forward beyond the fourth quarter.

Chris Growe

Okay, thanks for the color. And then just -- if I can ask a quick overall question; in some of the recent IRI and Nielsen data has been very weak for General Mills and for the industry overall; I just want to get a sense -- was this fact of that – obviously, the weight on your third quarter performance; are there any unique factors that are worth considering in relation to that weakness in the data we're seeing broadly in the industry?

Ken Powell

So as we -- you know, we're obviously seeing the same trends for the industry. If you look at kind of where the food and beverage industry is now versus a year ago, there is about a four point difference from where it was than to where it is now; so sales were up about 1.5 this quarter a year ago and now it's down to -- about half of that is due to pricing; and so we've seen deflationary pricing across food and beverage over the past quarter and so as we think about that 4 point gap, half of that is pricing and so the unit volume really is about 2 points and there is really not one factor that impacts it. Although there are -- certainly there is movement for the perimeter over the store and there is even more deflation in categories like meat and dairy; but also you see significant growth and increasing growth in channels that aren't measured by Nielsen and e-commerce is certainly one of those which is growing at between 35% and 50% this year and is probably upto 1.5% of total food and beverage sales. And so without doubt there is increased growth and channels as not measured by Nielsen.

Chris Growe

Okay, thank you for the time today.

Operator

Our next question comes from Jason English with Goldman Sachs. Please proceed with your question.

Jason English

Good morning, thank you for letting me ask the question. Back to the top line, I hear your message loud and clear that maybe from a support and execution perspective you are bit-off kilter. But when we try to dissect that data, roughly three quarters your measured declines appear attributable to distribution losses and it seemed pretty broad-based across a number of different categories, not just a problem children that you're pointing to. So I was hoping you could give us some color on what do you think is contributing to the drop in gross distribution or total distribution points? Sequentially it looks like it's still falling -- your velocity is still falling despite the survivor bias and that data is -- the data would suggest like we still have a lot of room to go before we can find a floor there but you guys obviously see a lot more granularity there than we do and you understand what's going on that looks better; so I was hoping you can give us a little more context, a little more color that hopefully leads us to some visibility of when we can find that support level on distribution?

Ken Powell

So as we look at distribution, our distribution is down in our U.S. business this year and a fair amount of that was planned as we did SKU rationalization in Pillsbury and Progresso. And that part was down more certainly than our yogurt business. But also as we look at it, you know we've got -- even though our distribution is down, we've replaced a lot of slower turning SKUs with faster SKUs, and we call those our Priority 450. And so the -- our P450 SKUs are actually up, and so even our distribution is down in a few categories, the level of distribution on our highest turning has [indiscernible] SKUs is actually growing and so for that reason distribution is not really the contributing cause to our decline this year. It may be a little bit in yogurt but that we expect it but for the rest of our businesses really distribution declines are not the driving force, it really is more about our price competitiveness and the marketplace support we've had.

Jason English

Okay, that's helpful. And one other more housekeeping oriented question and then I'll pass it on to others in queue. The year is not quite shaping up as you expected at the onset, is it safe to presume that there has been some incentive compensation adjustments that if a company at the shortfall? In a so can you give us a sense of magnitude as we think into next year sort of how much cost may be deferred into next year if assuming a reset?

Jeff Harmening

Jason, I mentioned in my script -- you know, a part of the same which you see in the quarter is our incentive reduction which obviously we reset after our December earnings reduction and then reset again this quarter. It's probably going to be about a $40 million savings in the year, a reduction to expense in the year which obviously will look factor into our planning for next year.

Jason English

Thank you guys very much. I'll pass it on.

Operator

Our next question comes from Ken Goldman with JP Morgan. Please proceed with your question.

Unidentified Analyst

Good morning. It's actually Josh [ph] on for Ken. I was hoping you could help us out just to comment on at export, I know you've talked a bit about the trade spending and getting there on price points and obviously some increased advertising around a bunch of brands in the fourth quarter. But I guess when you talk about how much of the added sort you are putting in a market, at least I guess try to get a sense of that magnitude? And then as a follow-up, I think you've -- I guess obviously there you haven't provided much of an update on '18 but I believe the last time you gave guidance, you had said you expect modest growth in '18. I guess that still holds and if so how much of it do you think depends on a positive response from some of this added support?

Jeff Harmening

So Josh, this is Jeff. You know, a couple of points in the fourth quarter and then 2018. On the fourth quarter we are adding support, it will mostly hit in April and May, and that's partially due to the timing of Easter when we've added back some support for our banking business. But also when we enter -- when we left the second quarter, the time you can get merchandising and advertising back into the marketplace is going to be mostly seen in April and May. So our improvement in the fourth quarter will mostly be April and May. I think also importantly that even though we're adding support in the fourth quarter our merchandising levels are still going to be down, they just won't be down as far as they were before; so it's not that we're going to one end of the shift to the other in terms of pricing support. You know whether that's in cereal or whether that's in snacks or whether that's in other places; so while we are adding support in April and May our merchandising will still be down it just won't be down as much as it has been in the last quarter. And then as Ken said in his remarks, we'll give increased guidance and thoughts in June when we deliver our fourth quarter results for 2018.

Unidentified Analyst

Got it. Alright, I had to try on '18. And Don, I guess I was hoping to ask just on the inventory build in the quarter; I know in the year ago there were some issues just around with the Green Giant sale but I guess in turn the increase was -- was there anything else? I guess was there an issue with any timing factors, anything you can help with that? Thanks.

Don Mulligan

No. It was really the fact that you know we had a production set for the plants and volumes still little short of the quarter unfolded and obviously that mean that those products ended up in inventory that we sold through in the fourth quarter. The only thing to keep in mind about Green Giant is actually on the tax side. Last year we had a -- we paid a capital gains tax on that divestiture and that was an outflow in Q4, so you think about our free cash flow generation. One of the reasons to be confident that we'll accelerate in the fourth quarter, in fact that we will be rolling over that outflow from a year ago but Green Giant didn't have an impact -- a material on inventory.

Unidentified Analyst

Thanks very much.

Operator

Our next question comes from Rob Dickerson with Deutsche Bank. Please proceed with your question.

Rob Dickerson

Thank you very much. So just kind of go obviously back to the top line again, so main topic of the day. You know, if I just look at Q4 organic sales, I think about the year guidance around down 4% because there is no FX impact and I think about kind of comparing it like your stock basis relative to Q3. I mean it seems like sales kind of implied for Q4, organic sales are down 2.5% to 3% let's say which is like it's just a pretty decent sizable improvement relative to what we're seeing in Q3 if we include the year ago comparison. I'm just curious with the increased -- let's say pricing support in April and May as just mentioned, obviously there is still lot of competition, that way you know what's -- what's really the hope here, what's the core driver of that acceleration in Q4? I mean it sounds like it's basically volume but it might not be volume coming from yogurt percentage, it might be coming from some of the other pressure categories. So any color you have there?

Ken Powell

So I mean -- look I think you're in the right ballpark in terms of the improvement we expect to see in the fourth quarter for sales. So I think your math is pretty good on about what we expect to see. You know, what I would tell you is that if you look at our business outside the U.S. retail, so for Convenience & Foodservice and for Europe, we continue to look for good performance there as well as a our business in China. So we feel good about performance in those areas. And then when it comes to our U.S. business, you are right in assuming -- we're not assuming a turnaround in our yogurt business in the fourth quarter, we think the businesses that will get better in the fourth quarter in April/May particularly are going to be our cereal business and our snacks business. And with continued good growth from Old El Paso and Tortino's because that's where we put more of the pressure whether it's a little bit of pricing pressure or as importantly, if not more so, some of our consumer marketing pressure because we feel like we've had -- we have good ideas in cereal, we have a good ideas in Nature Valley as well as Old El Paso and Tortino's and we think we can drive those businesses better by spinning some more marketing support behind those key businesses. So that's where we really expect to see the growth and improvement in the fourth quarter.

Jeff Harmening

Rob, this is Jeff. I just add that the waiting of our business shifts as you go into the fourth quarter, you move away from the big kind of winter season businesses like soup and refrigerated dough where we've seen the largest -- some of the largest decline, so just from a portion of portfolio standpoint those declines will become less a portion of our business as we get into the fourth quarter.

Rob Dickerson

Okay, great that very helpful. And then just second question on cost savings; I believe you've had this $4 billion HMM target out for many years; as we approach that target I'm curious -- if I just think about what the implied savings are HMM left if we just assume that that you actually hit that target. It seems like there would be some decent step down year-over-year over the next few years at HMM but what my sense is maybe that that's not true, it sounds like maybe there is a decent probability that you exceed that $4 billion cost savings target and cost savings over the next few years would be a bit higher than what's implied?

Ken Powell

That right. Yes, I think your sense is good, we assume they don't expect any slowdown in the annually HMM contributions. And so given that there is a good likelihood we'll see that $4 billion for the decade.

Rob Dickerson

Okay, great, thanks. I'll pass it on.

Operator

Our next question comes from Ken [ph] with Bank of Montreal. Please proceed with your question.

Unidentified Analyst

Good morning, everyone. Just two questions; one is -- is there a way to -- what are the steps I guess to improve your promotional activity going forward that you won't end up in this situation in the '18, '19 or '20 or going forward; how do I think about that and what steps can you take to change how you do the promotional spending? The second thing is, to what extent have you seen changes in your personnel -- to keep personnel levels at the brand management level? And can you talk about how you're doing that as well; so maybe there is some shifting on the personnel that we would see some changes and activity at that level?

Ken Powell

Well, I'm looking at the pricing, I mean -- you know, I think we've been pretty good at pricing for a while and we've been -- basically, worked within the context of the marketplace. In this year we were just priced way higher than the market, so we didn't really anticipate as well as we could have I suppose the market dynamics. And you know what I would tell you is that we -- as we've said, maybe a quarter ago we haven't improved our strategic revenue management capability and we're still improving that, we've brought in resources from outside of the company to help us with that and I think that's going to -- that is certainly going to help us as we look ahead and so we've strengthened our capability there and I think we'll continue to strengthen our capability there. And in terms of answering the question on personnel, we feel like we've got the right personnel in the right place, we've got segment leads who are good at driving growth whether that's in North America here or whether that's in Europe or Asia and we've had a SPU on Häagen-Dazs in yogurt and so we feel really good about the talent that we have in place that can drive our business across our segments.

Jeff Harmening

And the only thing that I would add on the promotional side is, we might be adding back promotional dollars, it is about frequency more than depth. So it's really that as we look back over the course of the year, it's we have missed some windows that we would have typically have gotten. And putting money back and getting – reearning some of those windows; so it's about frequency, strategy, not just depth.

Unidentified Analyst

Great. And Ken, the only thing I'm trying to figure out is, I agree your history has been there, I just can't figure out exactly what went wrong and why it won't happen again but…

[Technical Difficulty]

Ken Powell

We'll move on to next.

Operator

Our next question comes from Alexia Howard [ph] with Bernstein. Please proceed with your question.

Unidentified Analyst

Good morning everyone. So can I ask about the retailer environment because it think to me that even as recently as December I think on the last earnings call you were talking about wanting to pull back on in effect of promotional activity, obviously that's been harder to gauge given your comments to-date and now you're going in the other direction and reinvesting back in promotion. Can you comment on how hostile are the retailers being in pushing for incremental reinvestment back in pricing? It seems to me that Wal-Mart and others are worried about competition from hard discounters, so the retailer environment is getting tougher; private label share gains are picking up, distribution trends as Jason mentioned earlier seems to be coming down, maybe just some comments for you on that? Thank you and I'll pass it on in the interest of time.

Ken Powell

Well, you have some fair observation but what I would tell you is that, as we look ahead we will be -- we're not going to be increasing our level of promotion in the fourth quarter. Our level of promotional will still be down year-over-year, we'll be just down a lot less than it was before. And so while we are adding back spending, we're not kind of going from one side to the other. In terms of retail environment; what I would say is, it's always been competitive as it is right now, in fact private label shares in our categories are actually down and they're down in almost all of our categories year-on-year. And so as we look at the private label impact, actually for us it's not really -- at least in our categories it's not increasing but private label shares are actually declining. And while the -- while retailers are competitive, they've always been competitive and we don't feel like it's any more competitive environment with regard to retail that it has in years past, it's always been that way and we remain -- they don't feel particularly hostile to us and we've got good relationships with all of our major retail customers, and that's been unchanged.

Unidentified Analyst

Thank you very much. I'll pass it on.

Operator

Our next question comes from Bryan Spillane with Bank of America Merrill Lynch. Please proceed with your question.

Bryan Spillane

Good morning everybody. Just one question for me. I guess you know -- from as an outsider looking in, it look -- it's just seems like in 2017 one of the things this maybe didn't exist within the plans or at least the guidance that you gave in the street was just not enough flexibility to deal with some of what was going on at retail with merchandising and price point. So can you just kind of talk about '18, '19, you've got margin calls out there; just whether or not you feel like you've got enough flexibility giving kind of what the environment it is today to sort of do what you need to do and still have those margin goals or just how you would think about that if you continue to face this kind of volatility? Thank you.

Ken Powell

Well Bryan, as we went into the year, we went in with a certain expectation on volumes. And as that didn't eventuate we were able to pull certain levers because given the magnitude of the top line it was hard to contain it for me from a profit standpoint. That said we will still have a lot in the site to hold level on SOP, drive our EPS growth and drive a 100 points in margin expansion; so there is a lot of things that we had planned for the year that will still come through but clearly, you know, as we're sitting here now with the sales expectations of minus four, you know, 200 to 300 basis points lower than coming into the year which is kind of hard to contain that in a given fiscal year.

Jeff Siemon

Okay. I think we've got time for one additional question operator if you don't remind.

Operator

Certainly. Our last question comes from Steven Strycula with UBS. Please proceed with your question.

Steven Strycula

Hi, good morning. Two questions; first would be a question on snacking which is little bit softer in the quarter. Just wondering what's going on in the snacking category, it sounds like you're going to put a little bit more incremental spend in the back half or in the fourth quarter, but just curious as we're anniversarying [ph] kind of the [indiscernible] initiative. And then the second part would be with respect to the unit volume declines that we've seen on a year-over-year basis in some of the categories or maybe there were lot of price gaps; how do we think about the recapture of that unit share? Where these like bad promotions that you're divorcing yourself from? Where these like unit volumes that you want to recapture ultimately? And the fact you know -- the back half of calendar 2017? Thank you.

Ken Powell

So on the snacking question, we have two businesses we feel in the U.S. We have two businesses we feel really good about and we're added support behind that. So Nature Valley is the biggest one, it's our biggest snacks bars business and we've gained share on that and we like our marketing on that; and so we're going to add support because that's our biggest business and we like what that's doing. And Larabar has also been growing. The challenge we had in the third quarter is really behind our Fiber 1 business and our Fiber 1 business has been declining, and we're working to improve that but we won't get back to growth on Fiber 1 certainly in the fourth quarter; and so what we're doing is we're going to place more bets on things that are working well in our snacks business and we feel confident that that can improve our snacks performance in the fourth quarter.

As far as recapturing unit volume, it really depends category by category, that's what I would tell you. And that -- you know, in cereal we don't think we're far off so there's not a lot of volume to be recaptured. I mean we -- you know, we're only down 1% this quarter and so while we would like to grow it wasn't too bad and we think actually as importantly as trade spending in cereal really is actually marketing spending because we feel good about our ideas. I contrast that with refrigerated baked goods where we feel like we really have to add some money back to our merchandising as we look at the back half of '17 to make sure that our merchandising is in the right place because we lost a lot during merchandizing.

So it really does depend category by category and that's how we'll look at it as we head into next year.

Steven Strycula

Alright, thank you.

Jeff Siemon

Okay. Kelly, I think that's all the time we have. So everyone thanks so much for the questions and I'll be on the phone all day if you want to reach out and have additional follow-ups. So thanks again. Have a great day.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and we ask that you please disconnect your lines.

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