通用磨坊 (GIS) 2016 Q3 法說會逐字稿

Welcome to the General Mills third-quarter 2016 earnings conference call.

(Operator Instructions)

As a reminder, this conference is being recorded Wednesday, March 23, 2016.

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

Please go ahead, sir.

Thanks, Denise, and good morning, everyone.

I'm here with Ken Powell, our CEO; Don Mulligan, our CFO; and Jeff Harmening, Chief Operating Officer for our US Retail segment.

I'll turn the call over to them in just a minute, but first, let me cover my usual housekeeping items.

Our press release on third-quarter results was issued over the wire services earlier this morning.

It's also posted on our website and you can find slides on our website that supplement this morning's presentation.

Our remarks will include forward-looking statements that are based on management's current views and assumptions and 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 Don.

Thanks, Jeff.

Good morning everyone.

Thank you for joining us today.

As noted in our press release, General Mills' third quarter results were in line with our expectations.

Net sales, total segment operating profit and adjusted diluted EPS results declined, reflecting the effects of foreign exchange and the Green Giant divestiture.

Net sales growth continues to be impacted by high levels of competitive activity in US yogurt and lower display merchandising for US Retail.

However, our effort to drive more from the core is leading to improved sales trends across a number of key US Retail businesses, which Jeff will expand upon in a moment.

We continue to maintain strong margin discipline, as evidenced by our fifth consecutive quarter of adjusted operating profit margin expansion.

Based on our results through nine months, we are reaffirming our FY16 growth targets.

Slide 5 summarizes our results for the third quarter.

Net sales totaled $4 billion, down 8% as reported and down 4% in constant currency.

Total segment operating profit totaled $679 million, down 1% on a constant currency basis.

Net earnings increased 5% to $362 million and diluted earnings per share were $0.59, as reported.

These results include $44 million of restructuring and project-related expenses and mark-to-market valuation effects.

Adjusted diluted EPS, which excludes certain items affecting comparability, was $0.65, down 7% from last year's third quarter.

Constant currency adjusted diluted EPS decreased 6% compared to a year ago.

Slide 6 shows the components of total Company net sales growth.

Pound volume reduced sales by 5 percentage points.

Positive sales mix and net price realization increased sales by 1 point, while foreign currency exchange reduced sales by 4 points.

The Green Giant divestiture reduced contribution from volume growth by 4 points and reduced net sales growth by 3 points in the quarter.

Turning to our segment results, Slide 7 summarizes US Retail performance.

US Retail net sales decreased 7% in the third quarter, driven primarily by the Green Giant divestiture, which had a 5 point negative impact on the segment's net sales growth and accounted for the entirety of the Mill's operating unit decline.

Year-to-date net sales were down 2% including a 1 point decline from the net impact of the Green Giant sale and the Annie's acquisition.

In our Convenience Stores & Foodservice segment, net sales declined 2% in the third quarter.

Our six focus platforms posted combined net sales growth of 8%, with the strongest growth in frozen meals and yogurt.

Net sales declined in the remainder of the business, driven by market index pricing on bakery flour as well as the exit of some low margin businesses in the fourth quarter of last year.

Year-to-date net sales were down 2%, with 6% growth on our six focus platforms.

Slide 9 summarizes our international segment net sales results.

On a constant currency basis, third quarter international segment net sales were flat to last year, driven by Latin America, where sales grew 16% including double-digit growth in Mexico.

Sales were up high single digits in Brazil, with good performance on snacks, benefits from pricing and incremental contributions from the addition of the Carolina Yogurt business.

Net sales in the Asia/Pacific region increased 4%, including double-digit growth in India and low single digit growth in China.

In Europe, sales were down 2%, as dairy deflation contributed to unfavorable net price realization for our Yogurt business.

In Canada, sales were down 14%, reflecting the Green Giant sale.

In total, the Green Giant divestiture reduced international segment net sales growth by 2 points in the third quarter.

We continue to make good progress on gross margin.

Slide 10 shows that third quarter adjusted gross margin, excluding certain items, increased 160 basis points.

This was primarily due to cost savings initiatives, more than offsetting modest input cost inflation.

Our latest estimate of input cost inflation now rounds down to 1% for the full year.

As of February, we're roughly 85% covered on our FY16 commodity requirements.

We now expect full-year gross margins to expand by approximately 100 basis points.

Turning to Slide 11, total segment operating profit was down 1% in constant currency.

US Retail third quarter profit essentially matched last year, with continued cost savings more than offsetting the divestiture impact.

Constant currency international profit declined 24% in the quarter due to currency-driven inflation on imported products in certain markets and the impact of the Green Giant divestiture.

In Convenience Stores & Foodservice, profit was up 31%, driven by increased grain merchandising earnings, favorable product mix, and our cost-saving efforts.

After-tax earnings from joint ventures totaled $16 million in the quarter, up 19% in constant currency, due primarily to volume growth from Haagen-Dazs Japan.

Third quarter constant currency net sales declined 1% for CPW, primarily due to lower sales in developed markets.

Haagen-Dazs Japan constant currency net sales increased 22% for the quarter, driven by excellent results on a new seasonal, Hana Mochi, which combines Haagen-Dazs ice cream with a traditional Japanese rice cake desert.

Slide 13 summarizes our noteworthy income items, other noteworthy income items in the quarter.

Corporate unallocated expenses, excluding certain items affecting comparability, increased by $12 million in the quarter.

We incurred $44 million in restructuring and project-related charges in the quarter, including $27 million recorded in cost of sales.

Net interest expense decreased 4% from the prior year, driven primarily by lower average debt balances, partially offset by changes in the mix of debt.

We continue to expect interest expense will be down mid-single digits for the full year.

The effective tax rate for the quarter was 31% as reported, 5.5 points higher than the prior-year period.

Excluding items affecting comparability, the tax rate was 30.8% this year compared to 27.5% a year ago.

We continue to expect our full-year tax rate to be comparable to last year.

Average diluted shares outstanding declined 1% in the quarter, in line with our full-year expectations.

And one additional item to mention here, as noted in this morning's press release, we sold our Venezuela business after the close of the third quarter.

The business primarily manufactures and sells canned meats under the Underwood brand.

We expect to incur a non-cash charge of approximately $35 million pre-tax in the fourth quarter related to this sale.

This charge will be excluded from adjusted earnings and we anticipate the tax loss on this transaction will unlock approximately $20 million in incremental cash flow in FY16.

Now let me briefly summarize our nine-month financial performance stated in constant currency.

Net sales were down 1%, reflecting the net impact of acquisition and divestitures.

Segment operating profit increased 8% and adjusted diluted EPS were 10% above the prior year.

Slide 15 shows that our core working capital declined 40% versus last year's third quarter.

Half of the decline is due to Green Giant divestiture and foreign currency exchange effects and the other half reflects continued operational improvements across our businesses.

This is the 12th consecutive quarter we reduced our core working capital versus the prior year.

We continue to generate healthy levels of free cash flow.

Year-to-date free cash flow is $1.4 billion, up 29% versus last year.

We're on track to convert at least 95% of adjusted net sales into free cash flow this year, in line with our long-term goal.

We also continued to return significant cash to shareholders.

Through nine months, we've repurchased 10.6 million shares at an aggregate price of $602 million and we paid $795 million in dividends.

On March 8, we announced a dividend increase of 4.5%, payable on May 2. This marks the seventh time we've increased our quarterly dividend rate since 2010.

For the full fiscal year, we expect to return at least 90% of free cash flow to shareholders through share repurchases and dividends.

Cost savings from holistic margin management, or HMM and our incremental cost reduction projects represent an important component of our earnings growth in FY16.

We have good visibility to achieving $400 million in cost of goods sold HMM savings this year and we continue to make progress toward our goal of $500 million in savings from incremental projects by FY18.

For the full year, we are reaffirming the guidance we updated on the second-quarter earnings call.

Specifically, we expect a low single-digit decline in net sales from the 2015 level that included a 53rd week and a full year of Green Giant, total segment operating profit matching last year's levels and a low single-digit growth in adjusted diluted earnings per share, all in constant currency.

We now expect the impact of currency translation to result in an $0.08 headwind to full-year adjusted diluted EPS growth in 2016.

Included in this guidance is a fourth quarter where we expect low single-digit comparable sales growth.

Our reported results will reflect unfavorable foreign exchange, the impact of Green Giant sale, and comparison to an extra week in the year-ago period.

We anticipate adjusted gross margin will be below last year, reflecting our highest quarterly inflation rate compared to our lowest quarterly inflation rate a year ago.

And we expect media expense will be up, as reported, and up double digits, excluding currency effects, the 53rd week comparison and Green Giant.

With that, I'll turn the microphone over to Jeff.

Thank you, Don, and good morning, everyone.

I appreciate the opportunity to give you an update on our US Retail performance.

On Slide 20, I've summarized three main messages I want to leave you with today.

First, we've delivered strong profit growth and margin results so far this year.

Second, we're continuing to experience headwinds in our Yogurt business and in display merchandising that are dampening our sales results, and we're actively working to address these headwinds.

And third, we're encouraged by the progress we're making with our Consumer First Efforts in a number of key businesses.

Now let me go a bit deeper on each of these areas.

Through nine months, US Retail and net sales of $7.8 billion are down 2%, including 1 point of decline from acquisitions and divestitures.

Year-to-date segment operating profit of $1.7 billion is up double-digits versus the prior year.

This significant profit performance reflects our continued focus on cost savings.

We're generating strong cost of goods HMM savings in addition to the benefits from incremental cost-savings projects, including Project Century.

This gives us even greater confidence that our Century initiative will help unlock future HMM opportunities.

And importantly, we're expanding our margins while we are in -- make Consumer First investments on our products, our brands and our capabilities to drive improved sales growth.

We will give back margin in the fourth quarter for the reasons Don explained, but we still expect to expand US Retail operating profit margin by more than 100 points for the full year.

We continue to see growth in our categories, with aggregate Nielsen-measured retail sales up for the fourth consecutive quarter.

We estimate that our categories grew more than 1% in the third quarter when including faster growing, non-measured channels.

Our net sales results have not kept pace with category growth.

As I mentioned, our year-to-date net sales declined 2%.

The Annie's acquisition and Green Giant divestiture combined to contribute 1 point of that sales decline, with the impact following most significantly on the meals, which would be up, excluding our M&A activity.

Net sales for our Yogurt operating unit have been impacted by high competitive activity, while reduced display merchandising has particularly impacted our Cereal and Snacks results.

On Yogurt, we continue to see high levels of competitive investment as dairy prices remain near 20-year lows.

Merchandise volume is up double-digits for key competition in the category with significant increases in merchandising frequency, as well as lower price points in certain channels.

In addition, we're seeing competitive advertising spending more than twice the level of a year ago.

On the second quarter earnings call, we mentioned that to address these headwinds, we would increase our competitiveness in Yogurt in the second half of the year and we will.

However, given the increased competitive merchandising levels, it has taken us longer than expected to secure additional in-store activity.

We also said that we would remain disciplined and not chase unprofitable volume and we remain committed to that principle.

For USRO, our display merchandising, was down more than 30% at a key customer in the third quarter, with the impact falling most significantly on our Cereal and Snacks businesses.

We'll begin lapping these reductions at the end of the fourth quarter and will fully lap them after the first quarter of FY17.

These two factors combined to reduce our retail sales growth by more than 2 points in the third quarter.

Despite these headwinds, I am encouraged by the progress we're making to expand the impact of our Consumer First strategy across a number of important businesses.

We gained share in five of our top six categories in the third quarter.

Let me share some quick examples, starting with Cereal.

Retail sales trends in the Cereal category have been improving this fiscal year and we have returned to share growth in recent months behind Consumer First product renovation, on trend innovation, and effective messaging.

Our product renovation initiatives are working in our Cereal business.

Retail sales of gluten free Cheerios varieties are up 2% since we launched, after declining high single digits last year.

As of January, 75% of our Cereals no longer include artificial flavors and colors.

The seven Cereals that received recipe changes in January have posted 6% retail sales growth since launch, after posting a 6% decline last year.

And last year's largest Consumer First renovation news, more cinnamon in Cinnamon Toast Crunch is delivering 8% retail sales growth this year on top of 8% growth a year ago.

Nature Valley has been a key focus for our Cereal innovation efforts in recent years.

Initially, we launched the brand as a protein granola and have since extended it to ready-to-eat cereal, muesli, granola bites and oatmeal.

Retail sales for this franchise increased 44% last year and are up 35% so far this year through a combination of new product news, media support, and sampling.

The ready-to-eat cereals that we launched in January are performing well, and we will keep the momentum going next year with more news on the business.

So I'm bullish on our prospects for Cereal growth.

We'll start to lap some of the display headwinds in the fourth quarter.

But more importantly, we'll continue to expand the impact of our renovation and innovation news and we'll invest higher levels of advertising in the fourth quarter.

We believe that yogurt is an attractive growth category now and for the long term.

We're focusing on initiatives that help drive category growth by generating news, expanding usage occasions, and bringing new consumers to the shelf.

Over time, innovation and great marketing will be the key factors to winning in this category.

In January, we launched a whole milk, organic Annie's Yogurt into the fastest, one of the fastest-growing segments in the category.

We think Annie's all-family appeal and strong organic brand equity will bring new consumers to the shelf and we'll have more news to bring to the organic Yogurt segment this Summer.

We're expanding our usage occasions with our One Up Your Cup campaign, which encourages consumers to incorporate yogurt into their snacking routine.

Nature Valley bars, our largest business in Snacks, has been impacted by reduced display merchandising in certain channels, but in the traditional grocery channel, where merchandising has been more consistent, we've driven growth behind Consumer First renovation and innovation.

Our Nature Valley Crunchy Bar product renovation and our no artificial colors, flavors and sweetness advertising are working.

And we've seen excellent early results on our new Nature Valley Nut Butter Biscuit products.

As a result, year-to-date retail sales for Nature Valley Grain Snacks are up mid-single-digits in the grocery channel.

Larabar has delivered double-digit annual growth since we acquired the business almost eight years ago and we believe there is still an opportunity to broaden penetration and accelerate the brand's growth.

We recently began testing Larabar's first-ever TV campaign, supplemented with digital advertising, coupons, and in-store merchandising.

Since the campaign began airing, retail sales for Larabar are up more than 40%.

We are also maintaining positive momentum on Annie's.

Retail sales were up double digits in the third quarter and distribution is up double digits this year in each of Annie's Heritage categories.

As we told you at our Investor Day, there is still a great deal of distribution upside for this brand, so that will continue to be an area of focus for our sales teams.

Platform expansions also play a key role in growing Annie's.

We entered the soup and yogurt categories earlier this year and we'll launch three new cereals in the coming months.

We're encouraged by early feedback from consumers and customers on these launches.

And we'll continue to evaluate other new platforms to further expand the Annie's business.

These strong results on Larabar and Annie's have contributed to double-digit net sales growth for our US natural and organic business in the third quarter.

We have completed our soup and baking seasons and we are pleased with our performance.

In Ready-To-Serve Soup, we grew 2 points of share, driven by successful merchandising, product renovation news and good advertising.

Our Refrigerated Dough business had a good baking season, with growth in retail sales and market share up 1.8 points.

These results were driven by distribution gains on our top-selling products.

And we grew desert mix dollar share during the key baking season this year by aligning our prices more closely with our competition.

Next year we plan to bring news and innovation to help grow the dessert mixes category.

As we look ahead to the fourth quarter, there are a number of factors that will affect our US Retail performance.

We'll benefit from positive momentum on our renovation efforts and from increased media investment.

We'll also begin to lap display merchandising reductions in the quarter, and while we still expect yogurt to be a headwinds, we expect that headwind to moderate.

As a result, we expect improved fourth quarter sales performance on a comparable basis, although reported results will be impacted by the Green Giant sale and by a comparison to an extra week a year ago.

To summarize my US Retail comments, we are seeing strong year-to-date profit and margin performance, driven largely by cost savings realization.

Although we continue to experience headwinds in the display merchandising, we're encouraged by positive momentum we're seeing across a number of our businesses such as cereal, grain snacks, natural and organic, soup, refrigerated dough and desserts.

With that, I'll turn it over to Ken.

All right.

Well, thank you, Jeff.

And good morning, everybody.

You just heard about our performance in our US Retail segment and so let me give you an update on our other two business segments, starting with Convenience Stores & Foodservice.

Net sales for our Convenience Stores & Foodservice segment are down 2% so far this year, due to index pricing on bakery flour and business exits.

However, our six focus platforms of cereal, snacks, biscuits, mixes, yogurt, and frozen meals continue to deliver excellent sales growth, with combined net sales up 6% year to date.

This sales performance, combined with continued benefits from cost savings initiatives, is translating into margin expansion for our Convenience Stores & Foodservice business.

Segment operating profit is up 8% so far this year, increasing this segment's profit margin to 19%.

Frozen meals are leading our performance in Convenience Stores & Foodservice with strong double-digit sales growth year-to-date.

Mini bagels continue to grow as part of school breakfast programs and we applied our Consumer First approach to product development in this channel when we introduced products for school lunches a year ago.

Pillsbury Cheesy Pull-Aparts are our most recent introduction.

Launched in November, these individually wrapped versions of cheese-stuffed bread are heated and served right in their packaging, saving labor costs and waste.

Our bowl packs in schools are driving mid-single-digit growth for our Cereal business fiscal year to date, as we're leveraging our no artificial colors or flavors messaging with Foodservice operators.

And our Yogurt business also is posting mid-single-digit net sales growth so far this year on the strength of Yoplait Parfait Pro in a variety of food service channels from colleges to hospitals.

We also saw good momentum on our kid yogurts in the third quarter as we gained distribution for our Simply Go-GURT products in K through 12 schools.

So we continue to like the performance we're driving for this segment by focusing on the most profitable products in the most attractive Foodservice channels.

Turning to our International segment, net sales are up 2% so far this year on a constant currency basis.

The Green Giant divestiture reduced international sales growth by 1 point this fiscal year to date.

Constant currency segment operating profit declined 1% through the first nine months of the year, primarily due to currency-driven inflation on imported products in certain markets and a comparison to the year-ago period, when profit increased 8%.

In Canada, constant currency net sales are down 2% so far this year, with growth in a number of business lines offset by the impact of the Green Giant divestiture.

Our Grain Snacks business continues to deliver good results.

Retail sales are up 11% year to date on the strength of new product launches like Nature Valley Nut and Seed Bars, and Fiber One Crumble Bars.

An innovation on our Old El Paso Mexican meals is contributing to 2% retail sales growth for this leading brand of Mexican foods.

In Europe, net sales are up 1% fiscal year to date on a constant currency basis, led by good performance on ice cream and meals.

Haagen-Dazs Premium Ice Cream Bars are driving 13% retail sales growth so far this year.

We're introducing two new flavors this month and have plans to expand these bars into additional markets.

Innovation also is contributing to 1% retail sales growth for Old El Paso dinner kits, driven, in large part, by increased in-store events and higher levels of advertising support.

In Yogurt, retail sales are down year to date as dairy deflation has led to unfavorable net price realization.

However, we posted modest share growth so far this year in Europe, with good performance on YOP Yogurt beverages and Perle De Lait varieties in France.

Our focus on execution on the fundamentals drove the improved net sales performance in emerging markets in the third quarter.

Year-to-date net sales in Latin America are up 11% on a constant currency basis.

We posted high single-digit net sales growth in Brazil in the third quarter, with good performance on our Snacks business, benefits from pricing, and incremental contributions from Carolina Yogurt.

As we mentioned at CAGNY last month, we acquired the Carolina business in December, along with the manufacturing and distribution infrastructure for dairy products and we're excited about our growth prospects for yogurt in this market.

We also continued to post excellent sales growth in Mexico, led by solid performance on snack bars, Fiber One bars, in particular.

We introduced the Fiber One brand in Mexico a little over a year ago and retail sales for our wholesome snacks are up double digits so far this year.

Now as you can see on Slide 42, constant currency net sales for our Asia/Pacific region grew 3% year to date.

We saw improved performance in China in the third quarter, with net sales up low single digit.

Wanchai Ferry contributed to this growth, with good performance on our new Rainbow TangYuan Dim Sum Products during the Chinese New Year.

And Yoplait Yogurt continues to perform well, with market share in Shanghai at 10% in the third quarter.

We saw good growth on the Perle De Lait Bonus Packs, launched in conjunction with the Chinese New Year, and we're increasing our marketing and promotional activities on the Yoplait brand to drive increased consumer awareness.

Finally, we continue to generate double-digit sales growth so far this year in the Asia, Middle East and Africa region.

Sweet snacking is leading that growth.

This year, we launched new fruit flavors of Haagen-Dazs ice cream, which has driven high single-digit net sales growth.

Betty Crocker Cookie Cakes, launched last Fall, contributed to double-digit Snacks growth in the region fiscal year to date.

We're also posting strong double-digit net sales growth in India where we've been increasing distribution on our cake mixes and recently launched a line of chocolate spreads.

Overall, we're pleased with the improvement we saw in emerging markets this quarter and we remain focused on innovation and fundamental execution to drive continued growth in these markets going forward.

So that completes the highlights from our three business segments.

I'll wrap up this morning's remarks with this summary.

Our third quarter results were in line with our expectations.

Foreign currency exchange and the Green Giant divestiture are impacting our reported figures.

Our financial discipline is driving operating profit margin expansion while still allowing us to invest in Consumer First renovation and innovation, and we are confident we will deliver our 2016 growth targets.

That concludes our prepared comments this morning and I'll ask the operator now to open up the call for questions.

(Operator Instructions)

Our first question comes from the line of David Driscoll with Citigroup.

Great.

Thank you and good morning.

Hi David.

Good morning.

I wanted to ask a little bit about the sales growth expectations in the fourth quarter.

So there -- what you guys wrote in the press release and stated on the call here is that you expect -- fourth quarter is expected to be positive on a comparable basis for sales.

But can you discuss kind of what has to happen for the guidance to work out as recent US and European Nielsen data shows some fairly significant declines?

And then maybe related to this, could you also comment on what your take is on the February Nielsen data, which showed a marked decline from the trend line that we were seeing -- and this doesn't just relate to General Mills, it relates much more broadly to all US food.

Thank you.

Well, I would say on the -- David, on -- for our US business, what has to happen and what we're expecting to happen in the fourth quarter is for our sales growth to accelerate and we expect it behind a couple of important businesses.

One is Cereal and the second is Snacks and we expect that because we are starting to lap the merchandising headwind we're seeing at one of our biggest customers in the fourth quarter and because our advertising is going to be up significantly on both grain and Cereal, because we really believe in what we're seeing, the results from our renovation efforts.

We also think, even though Yogurt will continue to be a headwind in the fourth quarter, that, that business will improve behind the merchandising we talked about in the second quarter.

So for us to see improved US sales results, really, it is a matter of Cereal and Snacking behind things we understand in the merchandising area and behind great advertising.

I'll just comment on the other two segments because we expect all three segments, David, to improve and accelerate in Q4 versus year-to-date, or versus Q3 in particular.

As Jeff alluded to higher advertising, we're going to see it in USRO, we're also going to see it in international.

International, also which Ken alluded to, has a number of new products, both innovation and renovation in the marketplace that will continue to build in the quarter.

In addition there's some other things we are lapping, some of the merchandising in USRO.

We had business exits in our C&F business in Q4 last year that will lap and the index pricing we talked about in bakery flour in C&F that is profit neutral because we price with the market, but the grain prices really started coming down last year in Q4.

So we will begin lapping and that will be less bad in Q4, which will help our comparable sales growth.

And then we'll have continued growth acceleration in our emerging markets, including some pricing in Latin America and so there's a number of factors that go into improved performance in Q4.

(multiple speakers)

Jeff, can you guys just comment on that February question I had about macro (multiple speakers) the big picture?

Thank you.

Yes, we're going to do that.

Happy to do that.

So the -- as we look at it, what I would say in general, our Nielsen data was up more than it had been in the month of January and it was down more than we had seen in the month of February and there's nothing fundamental that we see that has changed between January and February.

The -- certainly, it could be the effects of weather at the end of January and stock-up trips that happened this year whereas last year, we had a couple of big weather events in the Northeast, in particular, in February.

So there could be some weather-related activity and we certainly see that.

But nothing -- there's nothing fundamental that we see and that would have changed the categories from January to February.

And our focus remains clearly on the things that we can control, which are marketing and innovation activities.

Thank you.

Our next question comes from the line of Matthew Grainger with Morgan Stanley.

Great, thanks.

Good morning, everyone.

Hi, Matthew.

So Jeff, I wanted to come back -- I think we've kind of talked about this at CAGNY and in recent quarters, but just to the big picture on your merchandising levels in the US.

And even though they're down at the key customer you mentioned, your levels of trade promotion still appear to index fairly high relative to the industry average in a lot of your key category.

And I know you're planning to take some of these higher, given that the industry trend is typically going in the other direction, how are you thinking about the right level of merchandising going forward?

Is there really room to cut in the scope of how you plan to run the business or is that less feasible given that you need to support the categories in your competitive positions?

Yes, thanks for the question, Matthew.

Let me start by kind of saying that this fiscal year, we've actually seen price appreciation, as we've seen in our categories.

And we've also seen the effectiveness of our merchandising improve as we cut back lower ROI trade activities and focus on high ROI activities.

As I think I've mentioned, the -- we view how we look at trade as we do HMM and other areas and we're also -- we're always looking to get more effective than we are right now and we've seen good gains in HMM on our trade, which is why we see the lifts improving and the ROIs improving in our area of trade.

But that will continue -- we will continue to focus on that area because one of the things we find with HMM is that the more we look, the more we find.

And I am certain with as big and complex as the trade bucket is, that we will continue to find opportunities to further improve our effectiveness and our efficiency in the area of trade.

Okay.

Thanks, Jeff.

And just one follow-up, I -- probably for Don.

I just wanted ask about the margins and Convenience & Foodservice, they've been pretty strong the past two quarters.

Surprised to see 20% margins and so those recent months, so how should we think about the sustainability there?

Is there a big benefit from grain merchandising in that number or are we at the stage where just the mix of the portfolio has really improved that much in that operating segment?

Yes, very pleased to say it's the latter.

Grain merch will have a quarterly impact year on year, but if you look at the overall business, the fundamental change in the margin is because of the business structure.

And the improvement you're seeing this year is primarily driven by the fact that we're seeing -- excuse me, 6% year-to-date growth on our focus six platforms, which all have higher-than-average margins, higher than segment average margins, higher than Company average margins as well.

And combine that with the cost savings initiatives Compass in -- or sorry, Catalyst and Century that we initiated last year, we had some benefit to C&F as well.

So very much a substantial and sustainable change in the margin structure for that business.

You know, I would just maybe to gild the lilly a little bit here, Matthew, if you go back five or six years in this business, we've nearly doubled the margins.

Its been more than the last couple years has been continuous improvement over a long period of time, as we've completely restructured that business so that it's, as Don said, very, very focused on the best channels and our most profitable categories.

And this year similar, Jeff talked about his business increasing margins by over 100 basis points.

We'll see the same thing in our C&F business this year.

All right.

Great.

Thanks again, everyone.

Our next question comes from the line of Ken Goldman with JPMorgan.

Good morning.

Thank you for taking the question.

Jeff, you highlighted your -- and this is my phrase, your lack of interest in chasing Yogurt prices lower but looking forward, milk remains cheap.

One of your competitors, I think, continues to have a capacity utilization issue and they are incented to drive volumes.

So how do you -- unless you're paying more to get that promotional space you get, you're expecting to get, how do you -- how should we have confidence that this will really turnaround for you?

And how should we have confidence you'll get that merchandising that you didn't get as you expected this past quarter?

Well, look, we're always looking to balance growth and return, as we talked about at CAGNY, and our [yield] returns have been pretty good, as we haven't been very disciplined.

And what we need to do is make sure we balance that out with some growth as well.

And that's what Ken mentioned in the second quarter, when he said our merchandising activity will improve in the second half and we will see that in the fourth quarter.

And so as we look into the fourth quarter, we'll improve our merchandising competitiveness because we need to improve our growth.

At the same time, we're also mindful of maintaining our returns and so we'll balance that out a little bit in the fourth quarter but we've got a good line of sight now to when our merchandising is going to occur and what merchandising is going to occur and have a high level of confidence that will improve in the fourth quarter.

But I guess that means if you're rebalancing a little bit, that you'll have to pay a little bit more and that perhaps we should expect a little bit better sales growth but a little bit worse margin on the Yogurt business in the fourth quarter or is that the wrong way to look at it?

No, I think that's a fair way to look at it.

I think that is a very fair way to look at it and we'll still see good margins because of the dairy pricing but maybe not as high as they are right now and we expect our growth to improve.

Can I ask a quick follow-up?

There's sort of a growing assumption among industry observers that food producers over time will follow the [3G model/promo] spending and not really spend much back to offset it.

But you've talked in the recent past about higher in-store marketing and you said today, you're not just cutting trades, you're really looking to shift that to better ROI projects.

Is that the right way to look at it?

Do you think that maybe some observers who were calling for massive trade promos, it all flows to the bottom line.

Is that too -- is that overstated at this point, as people look at the whole food industry?

I know you can't answer for everyone else but you guys are obviously one of the larger cap ones out there.

I'm just curious how you think about that whole balance there.

So we think about it, Ken, in the following terms.

We think that a sustainable business model needs to have both margin expansion and top line growth, so we're very -- as we've said many, many times, we're very focused on both.

Clearly, we acknowledge that the bar is higher now than it used to be on expectations for margin.

And we've -- we're addressing that very diligently through HMM, which we've had going for many years and the many other restructuring initiatives and other cost savings activities that you've seen us initiate over the last several years.

So we're very highly focused on the margin piece and you're seeing that this year with good gains and we expect that to continue as we go forward.

But the additional part for us is that you've got to have top line growth and so we're very focused on innovation and being responsive to the consumer by keeping our core brands relevant, advertising that works, and to drive growth.

And where we're getting that formula right, we're seeing good growth in our core categories.

So for us, it's finding that balance of both.

We think that's the key to sustainability in this environment and in particular, the focus on innovation and Consumer First, we think, is critically important in an environment where consumer attitudes and values about food, as you guys all know, are changing very, very rapidly.

So that's really how we approach it.

Thank you.

That's helpful.

Our next question comes from the line of Michael Lavery with CLSA.

Good morning.

Good morning.

Just looking at Cereal you talked about how you're seeing the lift from gluten-free Cheerios or some of the renovation on the other big brands but in total on the quarter, it still was down 2%.

So what's the offset there?

And how big are those declines?

And what's the outlook for where that can go?

Have you seen it stabilize or is there improvement on the way?

The -- yes, Michael, the -- look the biggest offset by far is one that I mentioned earlier, which is our Cereal merchandising at one of our biggest customers.

And we've got a good line of sight to seeing that improve in the fourth quarter, so by far, that is our biggest headwind in Cereal.

Because we feel great about the renovation initiatives we have and the innovation we've just launched in the third quarter so we're confident we will see that business continue to improve, as it did in the third quarter, continue to improve in the fourth quarter as we lap that merchandising.

Well, I guess I understand that but I guess I'm looking at it when you're talking by brand, you're seeing Cheerios is -- and they're not all third quarter, on slide 26, for instance.

But Cheerios is up 2%, the other seven are up 6%, and you still have momentum, it looks like on Cinnamon Toast Crunch.

So regardless of channel, that's your whole business, I assume.

Is that correct?

And so if that's the case, then which brands are the drag?

Is Chex or Wheaties down double digits or how -- what's the total picture look like?

We don't have -- Michael, we don't have any one brand that's dragging it down, so there's not a smoking gun at one particular business.

The -- if you look at particular brands, there are -- even there are a couple businesses in particular.

One we're lapping a lot of Cheerios Protein from a year earlier which is, of course, is not gluten free and the second is our adult brand, Fiber One, is not performing particularly well and the -- our Chex business is down a little bit.

But there's not one of those that you point to and say look that is it.

The biggest challenge we have is certainly the merchandising but within our brand portfolio, those are ones that are not performing as well as they did a year ago.

Okay.

That's very helpful and then just on Venezuela, with that divestiture, would that have been a material contributor to the double-digit sales growth in Latin America from the third quarter?

No.

No.

Venezuela is 0.1% or 0.2% of our sales, so very small.

It will be immaterial.

Okay, perfect.

Thanks a lot.

Our next question comes from the line of Jason English with Goldman Sachs.

Hi, good morning, folks.

Hi Jason.

Good morning.

Thank you for letting me ask a question.

I want to come back to, Jeff, as we have the US retail trends.

You guys have conditioned us over the years to focus on base trends and say kind of ignore the incremental, it's noise.

You're chalking up the weakness this quarter to some of that incremental noise, merchandising competitive dynamics.

But when we look at base trends, they're eroding pretty hard and pretty fast for your overall US retail portfolio.

So can you talk more about the drivers of the underlying base sales weakness in your portfolio, broadly speaking?

Yes, Jason, as we look at our third quarter baseline results, remember there are two things that we talked about.

One was the merchandising at one of our key customers.

The other is Yogurt and our base sales trends on Yogurt are really driving the negativity for our baseline sales for the USRO categories in the third quarter and that is largely due to the competitive activity we talked about earlier.

So we've seen double-digit baseline declines on our Yogurt business which is due to the competitive activity which is served to bring down, if you look across the baseline performance of the portfolio.

Okay, and another question for Don then.

Gross margins, Don, you're calling for negative inflection in the fourth quarter.

By our math, maybe Green Giant divestments adding 30 to 40 bps of gross margin; is that fair?

And if so, the implied underlying weakness in the fourth quarter is even more substantial.

Is this really an inflection that we should expect as we bleed into next year or is it just a blip due to timing factors?

Yes, it's the latter.

As we -- as the years unfolded, in the fourth quarter, we're still going to benefit, obviously, from strong HMM.

But the merch timing that we talked about and particularly, what we're lapping a lower merch period last year with higher this year.

The inflation which is actually the single biggest factor because last year, Q4 was our lowest inflation of the year.

This year, it's our highest inflation of the year.

Last year is really when, in the fourth quarter, is when dairy and grains came down and while they're still down, they're at decelerating more so we're lapping that.

And we have continued inflation in our manufacturing, logistics, sugar, nuts, fruit, eggs and obviously, I'd say more broadly just in the Latin American region, again, more broadly.

So it is very much an inflation story in the quarter.

The just phasing of it is different this year than last year with a low point last year and a high point this year.

I wouldn't read anything into it, as we look into FY17 and we'll share more full guidance with you for FY17 in a couple months.

But as we talked about at CAGNY, we are projecting 200 basis points of margin expansion by 2020 and we expect the majority of that [clout] to come through COGS and come through gross margin.

Very good.

Thank you very much.

Our next question comes from the line of Eric Katzman with Deutsche Bank.

Hi.

Good morning, everybody.

Hi Eric.

Two questions, if I could.

One is question for Ken.

I've heard from a number of other CEOs, both currently in the industry and formerly in the industry, who are getting more concerned about the pressure to cut costs and the risks to food safety and quality.

You guys have done a very good job over time but even you had to -- a recall earlier.

And so I'm wondering if you could maybe speak with an industry head on about the choices that are being made as the market pressures the industry to cut costs.

And then second, around, I think at CAGNY the last couple of years, Ken, you've talked about kind of how some of these smaller companies get distribution to a certain point, they hit a wall and that's -- that wall is where the large cap companies, such as yourself, can really leverage that capability.

But it seems like in Yogurt, it just keeps going the other way.

There's so many brands out there now, it doesn't seem like they're hitting that wall.

It seems like the only Company that pulled back was actually the PepsiCo-Muller joint venture; otherwise, there's just more and more brands being added to the category.

And Annie's is just another example of that and how long does it take for scale to really win out, if it does?

Thanks.

Okay, so -- well, let me, I'll answer the first one first and I can't really -- I understand the observation, Eric, and the concern that you might hear.

I can't speak for the industry.

I can only speak for us and clearly, we are very, very focused on product safety and product quality.

It's central to our mission and that's the kind of capability that we would maintain and actually build upon even in this environment because we just think that consumer trust is job one for us.

So -- but it goes to -- your question goes to the earlier question as well about what are we trying to do and we're trying to do two things.

We're very, very focused on margin expansion and we think we have a good line of sight.

And we've performed well there over the last couple of years.

We have a good line of sight on other things we can do to continue that good work but we're equally focused on maintaining the capabilities that we need in order to drive top-line growth.

And so we're preserving -- we've got a very strong marketing organization in CI, we've got excellent R&D and so those are very important things and our product quality organization has been maintained at a very high level so that's how we look at it.

I understand the question and I understand the concern but that is the sort of thing -- we would not compromise in that area.

To your comments on Yogurt, there's -- I don't have the numbers in front of me on how -- from what's come in and what's gone out over the last couple of years.

And Jeff may have those and so there is a tremendous amount of new product activity in the Yogurt area.

Lots of them don't stick around for very long so it is -- there are a lot of them though and it's become a more competitive category but again, where we focus on the right innovation and the right renovation like expanding Annie's into the yogurt/dairy case and other yogurt innovation initiatives that we'll announce this Summer.

Where we have good ones, we're able to succeed because of the scale and the distribution power that we have, so we're confident that we can continue to grow there.

It's an exciting space and huge category globally.

We have very high capability and so we're just going to stay focused on the kind of innovation that will work in the category.

I can come back to you, Eric.

We can get some numbers maybe on how many have come in and how many have gone out but your observation that there's a lot more in Yogurt, I think, is correct.

I don't know if you want to add anything, Jeff?

The -- yes, the observation that there is -- there are a lot of players in Yogurt is certainly correct.

It's also true that we've grown distribution over this time as well but if we think more broadly about the kind of capabilities of big company and the scale General Mills can bring, I don't think you have to look farther than Annie's.

We've driven double-digit distribution increases on Annie's over the last two years in the grocery trade, but even beyond that, looking at the club channel, we've grown distribution in our Foodservice area.

We're growing Annie's in our Foodservice channels.

And so broadly speaking, we see the kind of capability that General Mills can add to some of these smaller players and when they hit the wall, how much better we can do.

And we're starting to see the same thing with Epic, even though we've just bought that business and we have a high degree of confidence that we'll be able to do a lot more faster than the founders alone could have done with their limited resources.

Thank you.

Our next question comes from the line of John Baumgartner with Wells Fargo.

Good morning.

Thanks for the question.

Jeff, I'd like to ask in terms of the US retail business, the top 450 SKUs you've isolated for us in the past, maybe if you could update your progress there in building distribution for that group?

How the increasing merchandising plays into that And then maybe how we should be thinking about the magnitude of those SKUs beyond sales for the next few quarters

Yes, the -- look we are really pleased with what we've seen with developing the distribution of our top 450 SKUs.

We're right on track where we thought we would be.

We're up over 5% in distribution of our top 450 SKUs.

I'm really pleased with that performance and it's pretty broad performance over a number of categories and we've even seen the benefits of things that we've discontinued.

We discontinued a line on Hamburger Helper and we've seen the distribution there decrease but we've seen an increase on our top SKUs and as a result, we're actually starting to see our turns increase on Hamburger Helper.

We've also seen the benefits of distribution on Pillsbury Dough business and one of the things that's driving growth on our Pillsbury business is getting out of SKUs that were relatively unproductive and getting into more SKUs that are relatively productive so we're pleased with the progress we've seen.

We have more to do.

We'll keep at this; it's a multi-year plan to get all of our distribution on our top items but we're progressing as we thought we would.

And we see more room to go and the more we see that we can do, the more we like this initiative.

Great and then just a follow-up in terms of Yogurt and the comments around the innovation in the category and the competition there.

Aside from the merchandising increase in Q4, can you speak to any opportunities you see and maybe improve your mix or maybe where your under-mixing right now?

And maybe why we should be comfortable that we're not getting seeing the beginning of another 2011, 2012 peak of a performance there?

Well, on the innovation front, we feel good about some of the innovation that we have launched and we see some more good innovation on the way.

So for example, our Greek Whips, which we launched a year ago, are doing quite well and we see an opportunity to expand those further.

We've seen good initial results from our Annie's organic yogurt and we see an opportunity to expand Annie's further in yogurt as well as expanding into some other organic areas.

So we feel good about the innovation we've done but as we look ahead, we, actually, we see even greater potential for innovation in some faster growing segments.

And whether that's building on things like Whips or getting into even further into organic, there is certainly runway ahead of us for innovation and we know in a category like Yogurt, just like in Cereal, it is going to be the innovation and the marketing that drives long-term growth because dairy prices are at a 20-year low.

And we'll see how long they stay there, but eventually, they will go back up and it will be a matter of innovation and marketing that's going to win the day in yogurt.

Great.

Thank you very much.

I think we have time for one more question, Denise.

And our next question comes from the line of Chris Growe with Stifel Nicolaus.

Hi good morning.

Hi, Chris.

Hi.

I had just a question for you, if I could, on as you think about all of the incremental cost savings coming through this year from all of the various programs, catalysts and all those programs, just are -- should we still expect about half of those to be reinvested back in the business?

Is that occurring?

It sounds like you're going to have an increase in overall investment in the fourth quarter.

Are you really accelerating that investment in the fourth quarter and should that continue into 2017 as well?

Chris, this is Don.

I think the mix that we talked about at the beginning of the year about reinvesting roughly half of our savings is still where we are at.

It is phasing a little bit differently.

As we said, I think advertising at some of the merchants are a little more back-loaded than we originally anticipated but for the full year, it will be in that same range.

And actually, obviously, we haven't completed our plan for next year so I can't give you an exact figure but you would expect that we are going to be continuing to reinvest some of those savings back.

And next year, we also expect to have a little bit more leverage from higher top-line growth to add to the margin expansion.

Okay, and I had just a follow-up question, if I could, on the international profits.

We're a little softer this quarter underlying than what I expected.

Can you talk about some of the key factors involved in that?

You gave a little bit of an overview earlier on in the discussion but maybe from, just to get an idea, like in the fourth quarter.

So we'll see those profits improve and maybe some of the key factors in areas that are leading to that weakness in this quarter.

Yes, sure.

First off, our international business, in total, we feel good about where the top line has moved solid growth in developed markets really at that low single-digit level that will continue even if it's tempered a bit by some of the Yogurt pricing in Europe.

Encouraging acceleration in emerging markets that Ken took you through, which is both innovation, our execution and some pricing and as with other segments, we expect that to strengthen in the fourth quarter.

In terms of the margins, there's a couple things that are at play.

One is, obviously, Green Giant does impact our profit in international.

We sold the North American business, so Canada, you're seeing the impact of that and that's a low to mid-single-digit drag on the earnings for international.

The other you see, we mentioned this as a currency-driven inflation on certain products.

I mean, that's a long way of saying we have some transaction FX impact for businesses that we source across borders.

So for example, much of our Canadian product is sourced from the US so as the Canadian dollar weakens, that increases the cost in Canada.

We have the same thing across some borders in Europe and that has been a larger drag in the second half just due to currency movements and some hedge positions that we had and that's what you're seeing in the quarter.

It will continue into to the fourth quarter as well but if you strip out Green Giant and some of that transaction FX, the underlying growth, profit growth you're seeing in international is holding up quite well and that's what we would expect to continue to see as we move into 2017.

Thank you, Don.

Just to be clear, is the $0.08 FX drag you outlined, does that include -- that's exclusive of the transaction FX effective -- (multiple speakers)?

No, that does not include any transaction.

That's all translation FX.

Thank you for asking that to clarify.

Just wanted to be sure.

The $0.08 is all translation.

Okay, Denise, I think that's all the time we have.

So I know some of you were queued up and we couldn't get to your questions so I'm available all day on the phone so please give me a ring.

And thanks so much for your attention and questions this morning.

Ladies and gentlemen, that does conclude the conference call for today.

We thank you for your participation and ask that you please disconnect your lines.