General Mills, Inc.

And welcome to the General Mills Second Quarter Fiscal 2020 Earnings Conference Call. During today's presentation, all participant lines will remain in a listen-only mode. Afterwards, we will conduct a question and answer session with instructions to follow. If at any time during today's presentation you need to reach an operator, please press the star followed by the zero on your telephone. Please note today's conference is being recorded Wednesday, December 18th, 2019. It is with pleasure that I now turn the call over to Mr. Jeff Seaman. Please go ahead, sir.

Hey, thanks, Bridget. And good morning to everyone. I'm here this morning with Jeff Harmoning, our chairman and CEO, and Don Mulligan, our CFO. Also joining us this morning for Q&A are Kofi Bruce, our Vice President of Financial Operations, who will take over for Don as CFO on February 1st, as well as John Newdy, who leads our North America retail segment. I'll turn it over to the team in a moment, but before I do, let me cover the usual housekeeping items. Our press release on our second quarter results was issued over the wire services earlier this morning, and you can find that release as well as a copy of the slides that supplement our remarks this morning on the Investor Relations website. Please note that 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 Jeff.

Thanks, Jeff, and good morning, everyone. I'll kick off this morning's remarks with our key messages on slide four. I'm encouraged by our second quarter performance, both on the top line and bottom line. This includes broad-based improvements in our organic sales trends, with strong performance in pet, good results in North America retail, and a significant sequential step-up in our remaining three segments. We generated strong first-half earnings results while increasing media investment behind our brands. And our cash discipline drove double-digit growth in free cash flow, which allowed us to reduce our debt by more than $600 million through six months. In the second half, we'll step up our investments in brand building and capabilities and future growth initiatives, and we expect to see further improvement in our organic sales growth. And importantly, we'll remain on track to achieve our fiscal 2020 goals for sales, profit, earnings per share, and we are raising our guidance for free cash flow conversion. Slide 5 summarizes our Q2 financial results. Net sales were flat to last year at $4.4 billion. Organic net sales grew 1%, led by strong growth in PET. All five segments contributed to profit growth, with adjusted operating profit up 7% in constant currency, driven by HMM cost savings, lower consumer promotion expense, and favorable manufacturing leverage, partially offset by input cost inflation and higher media investments. The manufacturing leverage favorability was driven by higher inventory balances at the end of the quarter, which is a timing benefit that will unwind in the back half of the year. Second quarter adjusted diluted earnings per share totaled 95 cents, up 11% in constant currency, driven by higher adjusted operating profit, lower net interest expense, and a lower adjusted effective tax rate. On slide six, you can see our three priorities for fiscal 20. As I reflect on our first half results, I'm proud to say we've made good progress on all three. First, we're on track to deliver accelerated organic sales growth in fiscal 20. We improved top-line growth in North America retail in the first half compared to fiscal 19, and we generated double-digit growth in the pet segment. I'll share details on these results in a moment. Our second priority is to maintain our strong margins. In fact, we're a bit ahead of our plan on the bottom line through the first half, which gives us flexibility to step up investment in the second half and strengthen top line growth. Our final priority is to maintain a disciplined focus on cash to achieve our fiscal 20 leverage target, and we're well on our way to achieving our goal of 3.5 times net debt to adjusted EBITDA by end of year. With these priorities in mind, I'll now cover our Q2 results by segment before turning it over to Don to review our performance on margins, and cash, and outlined back half expectations. Slide 7 summarizes components of net sales growth in the quarter. Organic sales were up 1% versus last year, primarily driven by organic volume. FX was a one-point drag in the quarter, resulting in flat reported sales. Turning to segment results, beginning on slide 8, second quarter organic sales for North America retail were in line with year-ago levels. Net sales grew 5% in US cereal and were up 2% in Canada on a constant currency basis. Net sales declined 1% in US meals and baking, 2% in US snacks, and 4% in US yogurt. Looking at our first half in-market results, we grew share in five of our top 10 categories, which comprised roughly 85% of our US retail sales. Constant currency segment operating profit increased 4% in the second quarter, driven by HMM cost savings and favorable manufacturing leverage partially offset by input cost inflation and higher media investment. With this as a backdrop, let's dive a bit deeper into our first half performance in North America retail, starting with cereal. I'm very pleased by our performance in U.S. cereal, driven by strong execution against the fundamentals. We grew our U.S. cereal retail sales modestly in fiscal 18 and in fiscal 19, and our results accelerated to 2% growth in the first half of fiscal 20. We've expanded our shared leadership position through investment behind compelling consumer ideas, such as our Cheerios heart health campaign, which drove 4% retail sales growth on the Cheerios franchise in the first half of the year. We benefited from consumer support behind Cinnamon Toast Crunch and our partnership with Travis Scott on Reese's Peanut Butter Puffs. And innovation continues to add to our growth with strong first-half performance on Blueberry Cheerios and Cinnamon Toast Crunch Cheerios. I'm also excited about the plans we have for the rest of the year to build on our leadership position in cereal. We'll continue to invest in our brands, including strong support behind the Cheerios Heart Health News. With more than 100 million Americans having some form of heart disease, Cheerios is on a mission to inspire happy hearts. For a limited time, we are changing some of the iconic O's into hearts, supported by new advertising, an updated box design, and a social media campaign. In addition to increased brand investment, We're launching a strong lineup of innovation in the second half, including an oats and honey variety of Cheerios Oats Crunch, Hershey's Kiss Cereal, and Trix Trolls. Turning to U.S. yogurt on slide 10, we improved our U.S. yogurt retail sales in fiscal 19 behind our strategy to expand into faster-growing segments of the category and to support our core with brand-building investment and on-trend equity news. Our goal in fiscal 20 is to further improve U.S. yogurt with a strong lineup of innovation, brand building, and product news. In the first half, our retail sales took a slight step back as we lapped a period of significant investment on We Buy, You Apply and had a more meaningful headwind from distribution. At the same time, we were encouraged by growth on our core products, with retail sales for original-style yogurt up 1% and Go-Gurt up 10% through the first half of the year. We fully expect to strengthen our U.S. yogurt performance in the second half of the year behind several specific initiatives. Our second half innovation lineup features a new coconut-based dairy-free offering on weed by Yoplait with the rich and creamy texture of weed delivered in our signature glass pot. We'll launch a new limited edition line of original style Yoplait in four signature Starburst flavors. And we'll launch Just Three by Yoplait, a new line of traditional yogurts with just three simple ingredients. We'll also increase our consumer support in the second half on our core products and on We by Yoplait. And finally, we'll face reduced distribution headwinds as we move into calendar 2020. In total, we expect these efforts will result in improved retail sales growth for our U.S. yogurt business in the second half of the year. Now let's turn to U.S. snacks on slide 11. Coming up at Disappointing Fiscal 19, our goal in Fiscal 20 is to improve our performance behind innovation, renovation, brand building support, and in-store execution. We're pleased by our U.S. Snacks improvement in the first half. Retail sales for Nature Valley improved behind a stronger back-to-school merchandising season and a successful launch of Nature Valley Crispy Creamy Wafer Bar. Retail sales for Fiber One have also improved since we reformulated the product line to be more relevant for modern weight managers. While we're still lapping distribution losses from earlier this calendar year, our turns per point of distribution, an important leading indicator of growth, have stepped up meaningfully across both of these important brands. On fruit snacks, we drove 3% retail sales growth in the first six months of the year, and we returned to share growth in the second quarter behind strong performance on Disney Equity fruit snacks. Our back half plans on U.S. snacks include continued contributions from Nature Valley Innovation and the Fiber One renovation, greatly improved distribution on bars, and increased brand building behind both bars and fruit snacks, all of which should drive another step up in our U.S. snacks retail sales trend in the second half. We're focused on competing effectively everywhere we play, including our $4 billion U.S. meals and baking operating unit. We returned soup to both retail sales and share growth in the first half. Retail sales for Progresso were up 3%, primarily driven by product renovation on Rich and Hardy. First half retail sales for Old El Paso grew 6%, and we grew share behind increased distribution, consumer news, and price realization across channels. We had a great year on Pillsbury Refrigerated Dough in fiscal 19, driving more than one point of share growth. We've continued to grow share in the first half of fiscal 20 thanks to distribution gains, contributions from new products like sweet biscuits, and good results on cookies. Retail sales in the first half declined 3% due to the later Thanksgiving holiday. However, fiscal year-to-date retail sales for Pillsbury through the first week of December, which is just for the holiday timing, were actually up below single digits. In total, we're off to a good start, and we feel good about our plans for the key soup and baking seasons. And we believe we are set up to have a successful year on U.S. meals and baking. Overall, I'm encouraged by our first half results in North America retail. In the second half, we'll drive improvement in U.S. snacks and U.S. yogurt, while lapping more challenging retail sales comparisons in U.S. cereal. And we remain on track to achieve our goal of improved full-year organic growth for the segment. Shifting gears to our pet segment on slide 13, I'm pleased to say that we had a great second quarter. with net sales up 16%. Our Q2 growth was driven by strong growth in the food, drug, and mass and e-commerce channels, positive price mix, and a benefit from the timing of shipments in advance of holiday merchandising. This net sales performance was led by strong double-digit growth on Blue's two largest product lines, Life Protection Formula and Wilderness. Looking at in-market performance, we drove first-half all-channel retail sales up low double digits, and we grew share. in the pet food category. On the bottom line, second quarter segment operating profit grew 14% versus a year ago, driven by higher net sales partially offset by higher media expense. On slide 14, you can see how the key components of the pet segment's first half double-digit retail sales growth break down by channel. Retail sales were up more than 100% in the food, drug, and mass channel, as we benefited from our expansion to new customers and the launch of wilderness into the channel in last year's fourth quarter. Importantly, retail sales for food, drug, and mass customers who have carried blue more than 12 months were up 45% in the second quarter. As we expected, retail sales in pet specialty continued to decline by double digits. This is an important channel, though, for Blue, and we continue to support the channel through unique programs and innovation. And Blue continues to win in the rapidly evolving e-commerce channel, with retail sales up high teams through the first six months of the year. Looking to the second half of the year, we have an exciting lineup of consumer initiatives, such as our Blue Years of Resolution promotion. We'll invest in media support behind our broad portfolio of products, and we'll continue to drive distribution ensuring we have the best of Blue everywhere pet food is sold. For the full year, we remain well on track to deliver 8 to 10% like-for-like growth in the pet segment, excluding the benefit of the calendar differences in fiscal 20. We remain confident in the long-term opportunities for Blue Buffalo, and we're excited about the growth prospects ahead. Shifting gears to the convenience and food service segment on slide 15, organic sales were flat in the quarter, a four-point improvement over our Q1 result with volume growth offset by unfavorable price mix. The Focus 6 platforms led the segment with 2% growth behind cereal, frozen baked goods, and yogurt, with strong contributions from our two-ounce equivalent grain cereal offering and bulk Yoplait yogurt. Second quarter segment operating profit grew 5% versus a year ago, driven by COGS HMM savings partially offset by input cost inflation and unfavorable price mix. In the second half of the year, we'll continue to see strong performance on the Focus 6 platforms led by our K-12 schools. In Europe and Australia, second quarter organic sales were down 1%, a four-point improvement over Q1 results, with declines on yogurt partially offset by growth on old El Paso Mexican foods and snack bars, two of our Accelerate platforms that also drove mid-single-digit retail sales in the quarter. Second quarter segment operating profit increased 45% in constant currency, driven primarily by a timing difference in brand building investment that was neutral through the first half of the year. Looking to the second half for Europe and Australia, we'll improve top-line growth versus the first half due to increased merchandising and brand building support behind Old El Paso Mexican food and our portfolio of snack bars, including Nature Valley, Firewad, and Larabar. And in Q4, we'll begin to lap the impact of reduced Haagen-Dazs distribution in France. In Asia and Latin America, second quarter organic sales increased 1%, which was also a 4% improvement over the first quarter. In Latin America, growth was driven by route-to-market changes in Brazil, resulting in improved performance on our Yogi brand. In China, net sales were up due to expanded distribution and pricing actions on Wanchai Ferry. In India, sales declined as we continue to change our distribution network to focus on more strategic and profitable outlets. Second quarter segment operating profit in Asia and Latin America was up 42% in constant currency, driven by lower SG&A expense, partially offset by lower volume. We expect a step up in second half growth in Asia and Latin America, driven by benefits from our strategic revenue management actions and continued distribution expansion on Wan Chai Ferry. With that, I'll turn it over to Don to cover joint ventures, margins, and cash, as well as our back half expectations. Don?

Thanks, Jeff, and good morning, everyone. Let me begin on slide 19 by summarizing our joint venture results in the quarter. Serial Partners Worldwide posted top-line growth for the fifth consecutive quarter, with constant currency net sales up 1%. That growth was broad-based, including positive results in the UK, Australia, Turkey, and the Middle Eastern markets. Haganash Japan net sales declined 6% in constant currency, driven by slower category performance in the quarter. Second quarter combined after-tax earnings from joint ventures totaled $25 million, up 11% from last year, driven by positive price mix and benefits from cost savings at CPW, partially offset by lower net sales at HDJ. Turning to total company margin results on slide 20, second quarter adjusted gross margin and adjusted operating profit margin were up 80 basis points and 110 basis points respectively, driven by COGS HMM savings and favorable manufacturing leverage, partially offset by input cost inflation and increased media expense. As Jeff mentioned, the favorable manufacturing leverage was a timing benefit resulting from higher inventory balances at quarter end. We built inventory in the second quarter to protect service while we worked through labor contract negotiations. With those negotiations now successfully concluded, we expect inventory levels to normalize, which will result in unfavorable deleverage in the back half of the year. For the full year, we expect input cost inflation and COGS HMM savings will each be approximately 4% of cost of goods. Slide 21 summarizes other noteworthy Q2 income statement items. Unallocated corporate expenses excluding certain items affecting comparability increased by $6 million in the quarter. Net interest expense decreased $13 million, driven by lower average debt balances. The second quarter adjusted effective tax rate was in line with our full year expectations at 21.9%, but was favorable to our 23.8% rate a year ago, primarily driven by the timing of discrete tax benefits and more favorable earnings mix. An average diluted shares outstanding were up 1% in the quarter. Now let's cover our first half results on slide 22. Net sales totaled $8.4 billion, down 1%. Organic net sales were flat in the first half, with positive price mix offset by lower volume. Adjusted operating profit was up 7% in constant currency, driven primarily by positive price mix a one-time purchase accounting adjustment in the Pets segment in last year's first quarter, and the timing benefits referenced earlier, partially offset by higher input costs. Adjusted diluted EPS of $1.74 increased 12% in constant currency, driven by higher operating profit, lower interest expense, and a lower adjusted effective tax rate. Slide 23 provides our balance sheet and cash flow highlights for the first half of F-20. First half cash from operations was $1.4 billion, up 4% from the prior year, driven primarily by higher net earnings. Our core working capital balance totaled $429 million, down 19% from a year ago, driven by continued improvements in accounts payable. Capital investments in the first half totaled $158 million. This resulted in free cash flow of $1.3 billion up 14% from last year. We paid $596 million in dividends and reduced debt by $655 million in the first half of fiscal 20. Slide 24 outlines our expectations for the second half. We expect to maintain our in-market competitiveness in North America retail and will continue to drive strong retail sales growth for the pet segment. We expect total company organic net sales growth to accelerate in the back half due to improved results in the convenience stores and food service, Europe and Australia, and Asia and LATAM segments, as well as the extra month of results in PET as we align that business to our fiscal calendar. We expect second half profit to be impacted by mid-teens percent increase in brand building investment, increased investments in capabilities and future growth initiatives, the unwinding of the favorable manufacturing leverage and pet shipment timing benefits we saw in q2 from a phasing standpoint we expect year-over-year profit results to be more favorable in q4 than q3 given that q4 includes the extra month of sales for pet in the 53rd week for the remaining segments as jeff mentioned up front we are reaffirming our key fiscal 2020 guidance metrics for sales profit EPS and leverage, and increasing our guidance for free cash flow conversion. You can see our current expectations for these measures on slide 25. Namely, we expect organic net sales to increase 1 to 2 percent. We continue to expect a combination of currency translation, the impact of divestitures executed in fiscal 19, and contributions from the 53rd week in fiscal 20 to increase reported net sales by approximately 1%. Constant currency adjusted operating profit is expected to increase 2% to 4%. The benefit of the extra fiscal week is being reinvested in capabilities and brand building initiatives to drive improvement in the company's organic sales growth rate in 2020 and beyond. Constant currency adjusted diluted EPS is expected to increase 3% to 5% from the base of $3.22 earned in fiscal 19 We continue to estimate that foreign currency will be immaterial to adjusted operating profit and adjusted diluted EPS. Given our strong first half results, we now expect to convert at least 105% of adjusted after-tax earnings into free cash flow, which is up from our previous guidance of at least 95% conversion. And we'll maintain our fiscal, our disciplined focus on cash to achieve our targeted year-end leverage ratio of 3.5 times net debt to adjusted EBITDA. Now I'll turn it back to Jeff for some closing remarks.

Thanks, Don. And before we close, I'd just like to take a minute and acknowledge a key leadership transition with Don Mulligan's upcoming retirement. After a distinguished 21-year career at General Mills, including the last 12 years as CFO, Don will be retiring at the end of this fiscal year. He'll be stepping into an advisory role effective February 1st and will retire on June 1st of 2020. As most of you listening already know, Don has served the company and his function with distinction. He is a true expert in his field and has provided steady leadership throughout his tenure. As you can see by our results so far this year, he is certainly running through the tape. Today, on his 50th earnings call, I'd like to personally thank Don for his contributions to the company and for the counsel he has provided to me in his role. We'll certainly miss him and wish him all the best as he begins a new chapter. I'm also pleased to introduce Kofi Bruce, will be taking over as CFO effective February 1st. Kofi has been with General Mills for 10 years in a variety of roles, including treasurer, segment finance leader for convenience and food service, and most recently as vice president of financial operations. Kofi brings a wealth of external perspective from prior experiences at Ecolab and the Ford Motor Company. Kofi is well suited for this role, given his experience, his track record of delivering exceptional results, and his passion for developing talent in our organization. In closing, I'd like to summarize today's key messages. I'm encouraged by our performance. We drove broad-based improvement in organic sales trends in the quarter, generated strong first half earnings and free cash flow results, and we reduced our debt. In the second half, we'll increase our investments and growth, and we'll further improve our top line trends. Importantly, we remain on track to meet or exceed all of our key goals. for fiscal 2020. With that, let me open up the line for questions. Operator, can you get us started?

Thank you very much. We do welcome all questions or comments. To register, please press the 1 followed by the 4 on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration, please press 13. Again, to register questions or comments, please press 1-4 on your telephone. One moment, please, for the first question. And our first question comes from the line of Ken Goldman of J.P. Morgan. Please proceed with your question.

Hi. Good morning, everyone. And, Don, thank you for all your help over the years. Thank you, Ken. I wanted to ask a couple questions. First, are you thinking, this is more of a technical question, but on slide 24 you had mentioned that Blue Buffalo is the only business not to have an extra week. But I thought previously we were modeling this, and maybe I just didn't understand it correctly. We were previously modeling five extra weeks in the fourth quarter and then subtract a week that went away in the first quarter. That gets us four net for the year. I thought we were previously guided to having an extra week in Blue Buffalo for that fourth quarter, but maybe I missed it. I thought it was five total.

This is Jeff Seaman. You're right. The extra month is five incremental weeks in Q4. As we define organic versus not organic, all that change in Blue Buffalo falls under organic sales definition. The extra, the 53rd week in the remaining segments is above and beyond in the inorganic calculations.

Okay, so nothing has changed there, just to make sure.

Nope, correct.

Okay, thank you. And then my next question is, you have a little bit of controversy on your hands, at least in the investor community right now, obviously, on the grain-free side. You know, we met with you guys a month ago. You didn't sound very concerned about it. Has your concern level changed at all in the last few weeks about grain-free and some of the FDA reports out there, or are you still not really necessarily seeing consumers react as feared?

Yeah, thanks for the question, Ken. I mean, you know, contrary to what's been written, we actually really haven't seen an impact on our business as witnessed by the strong Q2 results on Blue Buffalo, including Wilderness, which happens to be grain-free. That, along with life protection formula, really led our growth in the quarter. I do think it's important to take a step back and remember, why did we get into this in the first place? What we bought was a great brand and a great category, and a brand that travels across different diet types, both grain-containing and grain-free, and travels across channels. You can see that with our results in e-commerce and FDM. While there's been a lot of talk of grain-free, we haven't seen it in our business. And our trends, even in pest specialty, really haven't changed on grain-free. And I also think it's important that in this discussion we don't lose sight of the fact that the FDA has really, they have not identified a causal link or drawn any conclusions. They have brought it to people's attention, clearly, but they have not drawn a causal link. And I would also like to say that along with our human food, we work closely with the FDA and the rest of the pet industry is as well. Now, there has been slowdown in the grain-free category, but there are a lot of moving pieces. I mean, part of that's probably a shift to Blue Buffalo, and part of that is channel shifting and all the rest. But there has been a slowdown in the grain-free segment, although Blue Buffalo and our grain-free products, we really haven't seen that. Thanks so much.

And our next question comes from the line. of John Baumgardner of Wells Fargo. Please proceed.

Thanks for the question. Jeff, I also wanted to stick with the topic of DCM and maybe just looking at it differently. Can you frame the situation as you see it maybe in terms of options for the portfolio and supply chain, whether it's with reformulations or anything else? How do you think about the optionality there?

Well, I mean, I think that I start that question, look, I'll start answering that question with something I mentioned briefly, and that, you know, blue buffalo plays really well across all diet types. And I think that's really important to note. The second thing I guess I would like to say, that we have some product lines that even though they're technically grain-free, they also have a, they're also benefited as high protein. So I look at wilderness, and while it's grain-free, it's also true that it's high in protein, and many consumers buy because of that. We certainly don't have any plans to reformulate products, but if we ever needed to, we can certainly shift. We currently can make some shifts and make some changes. As I said, we don't have plans to do that now because we haven't seen an impact and we don't feel the need, but should that need arise, we certainly can.

Great. And then, you know, Don, very strong quarter for margins. You mentioned the benefits there from the manufacturing leverage, but how is the pacing coming through from the global sourcing and some of the logistics work you're doing, you know, both in North America and Europe? Where do those initiatives stand, you know, kind of going forward in terms of incremental benefits for the back half of that median to fiscal 21?

You know, we continue to see, you know, a strong return on the investments we've made in global sourcing, for example. Our HMM is tracking on plan. It will fully offset our 4% inflation this year. It is running fairly consistently quarter to quarter. We expect both in the front and the back half for inflation and HMM to kind of run in lockstep, and that's with an elevated HMM results, partially driven by the global sourcing that you referenced. Great. Thanks for your time.

And our next question comes from the line.

Andrew Lazar of Barclays please proceed morning everybody happy holidays I guess first off more of a quick one I guess um Don are you able to help maybe quantify or maybe put some parameters around the benefit from some of the timing that you talked about in pet shipments and manufacturing leverage in any retail that is set to unwind in the second half

Sure. I guess I'll step back first and just talk about margins more broadly. You know, we are pleased with the way the middle of the P&L is developing this year. You're seeing a consistent improvement in our expansion, our gross margin. And even when you strip out lapping the inventory step up on PET from last year and the timing benefit this year, you're seeing a 30 to 40 basis point improvement in margins and gross margins in both the first and second quarter. And you're also seeing that we're investing that back in higher media, which has been running mid-single digits and actually increased in the second quarter versus the first quarter. And our admin is well-controlled, so we're getting leverage there, which is leading to the improved – through the first half, the improved operating margin as well. So we like the structure. As we look to the second half, there's three things that we referenced. We are going to see a step up in our brand investment. That's going to be in the mid-teens. And to put it in perspective, we run an annual media budget of – last year it was around $600 million – We'll also see increase in investments. We talked at the beginning of the year about getting deeper in data analytics to support our strategic revenue management and e-commerce activities, and we'll continue to invest in those and increase that investment in the second half. And we'll also start spending some money on pet innovation, which, again, will benefit beyond our F20. And the last piece is the shipments. And the reason I recap them, or the timing, excuse me, and the reason I recap them is because, really, that is the order of impact as well. So I want to make sure the first two pieces are not lost. So the third on the timing, there's two components. It's the manufacturing leverage in North America retail, which was created as we increased inventory in the second quarter and will unwind largely in the third quarter. And then a small benefit from shipment timing in PET. Together, those will be about a $25 million benefit or benefit in Q2, reversed in the second half, again, largely in the third quarter. But, again, there's three components. All are material, and the timing is actually the smaller of the three.

That's helpful. And then your comment on PET is a good segue into the next question, which is, you know, in thinking about the runway for growth there, this fiscal year obviously has seen the benefit from the white space distribution fill and the FDM channel, and not only from life protection formula but wilderness, you know, sub-brand as well. Is the opportunity as we head into fiscal 21 become, you know, less about channel fill and more about, I guess, product form, you know, thinking about, like, wet and treats? And if so, I guess, what does the analysis suggest to you around, you know, the magnitude of that opportunity as we go forward? Thank you.

So, as we, you know, as we look ahead, Andrew, I mean, I think one of the things I would say, first of all, that we're most encouraged by is if you look at the growth we have in pet and distribution we've had for more than a year, it's up 45%. And so, the idea that once distribution stops and growth stops is not something we subscribe to. And And that actually follows what happens in human food. A lot of times when we launch new products into a channel, people are still finding those products for a couple of years. And so it's actually not surprising to us that we would see continued growth in pet and channels where we already exist. It's actually quite good. So as we look at F21, the first thing I would tell you, even though we have quite a bit of distribution already, I think pet parents are still going to be finding Blue Buffalo, especially in the food, drug, and mass outlets. So I think we'll see continued growth from that. On pet specialty, we'll look to turn around some of those trends in the pet specialty because we think that we can do better through promotions that are suited to that channel as well as some new product innovations. Carnivora is just the beginning. Thank you.

Can you hear me, guys?

Yes. All right.

Andrew, sorry.

We're back. Don just said in 50 calls, this is a first for him. So I'm going to pass it back to John. Jeff was, I think, probably talking for a little while longer about our pet growth opportunities. So we'll cycle back to that.

Yeah, I can help you there. We got cut off right after Jeff had said you still see opportunity, obviously, in some of the core channels that you're in, and then you were just going to kind of transition to the next part of the point.

Great. Okay, good. I don't want to miss it. It was sheer brilliance, Andrew.

We'll never know. We'll never know.

I'm sorry you denied that. Look, the other thing I was saying then was the other opportunity is really through innovation, through wet and treat. And, you know, one of the things we're spending more money in the back half of this year on is on innovation. And you'll see that come to fruition in F21. And to dimensionalize it, the wet and treat part of the pet food category is about 10%. 45% of the caviar is almost $15 billion in sales, and we weigh under index. So our share of dry dog food is probably about 10%. Our share of wet and treat is somewhere in the 3% to 4% range. And so the opportunity is enormous. And so as we look to next year, we think we can grow through continuing to do what we do well, which is build a blue brand, continue with pet parents finding a channel, and through wet and treat innovation. Thank you. Yeah.

Thank you. And our next question comes from the line of Dara Mosenian of Morgan Stanley. Please proceed.

Hey, good morning, guys. So two questions. First, just in U.S. retail, cereal had a strong quarter. It's a continuation, really, of the solid results you mentioned over the last couple of years with the growth. Um, but obviously you also need to comparison this year with the merchandising shift last year. And one of your key competitors has talked about increasing merchandising in that business. So Jeff was just hoping for a bit of a state of the union there and your serial performance, the key growth drivers going forward and where you're focused and expectations for the back half of the year. And then a similar question on us yogurt trends did we can sequentially in the quarter. I think you've had some greater competition on the low end, so maybe you can talk about the competitive environment in yogurt, your prospects for the back half of the year, and with a number of the drivers you mentioned, do you think that business could actually get to growth in the back half of the year? And expectations there would be helpful. Thanks.

Hi, Darrell. This is John Newdy. I'll jump in and take both those questions. On cereal, we feel really, really good about our performance to date. The quarter was a terrific one. We were up 5% from an R&F standpoint. And it's really being driven by fundamentals. If you look at our marketing, we feel great about where we are in our major brands. In fact, we had the best quarter on Cheerios in over a decade with our total Cheerios franchise up 6.5%. Jeff mentioned some of our kid cereals and Reese's Puffs and Travis Scott collaborations. So we're really good about our marketing on our big brands. At the same time, our innovation is quite strong as well. In fact, we have the top four new products introduced over the last year. in the category, and nearly 50% of all the new category volume from new products is coming from General Mills. So I feel really good about the fundamentals. And you mentioned the comp. We were a bit softer last year in Q2 from a merchandising standpoint, and obviously we benefited from that. Our comps get a bit more challenging in the back half, but as I look at the fundamentals behind marketing and innovation, we feel like we're going to compete very effectively as we move through the back half of the year. So we feel really, really good about serial. And importantly, the category. was actually flat for the first time in quite some time in the quarter as well. It continues to get better over time, and we feel good about the future of the category and certainly the way that we're competing. Switching to yogurt, as Jeff mentioned, our goal that we set at the beginning of the year was to improve from a minus two that we delivered in fiscal 19. We took a bit of a step back. We were down 3% through the first half, and really two major drivers of that. One was that we lost some significant distribution at several major customers. last January. We'll lap those distribution declines next month, and again, we think that'll be an inflection point. And also, in the summer of fiscal 19, we brought up a second line on WE, and as a result, we spent a tremendous amount around marketing support to really drive that business. In fact, in Q2 last year, WE was up almost 40%. So our comps normalized in the back half on WE, and that will help us from a comp standpoint. We feel really good about our core business, original-style yogurt was up 1% in the quarter. Yogurt was actually up 10% behind some really great taste news. And we feel good about our new product lineup for the back half as well. As Jeff mentioned, we're launching a new non-dairy wheat, which is coconut-based. We've got a Starburst promotion as well. So we believe that we are still on track to meet our objective of improving from the minus 2, and we'll see our yogurt strengthen as we move to the back half.

Okay, can you just talk a little bit about some of the low-end competition you're seeing and if that's an issue, how you view that in yogurt? Thanks.

Yeah, I would tell you I don't think that's something that we're super focused on. You know, again, we think that across each of our lines, we're very clear who our consumers are. On OSY, original-style Yoplait, again, that's where we probably see the highest private label interaction. And as I mentioned, we grew 1%, even seeing private label gain pretty strongly. So we believe if we focus on innovation and building our brands, we can be successful. And again, we believe that we're going to have strength in the back half and meet our objectives. Great. Thanks.

Thank you.

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

Hey, good morning, folks. Congratulations on your pending retirements on, and welcome, Kofi. I'm looking forward to working with you. I want to bring us back to PET with a couple of quick questions on it. First, performance in pet specialty, I guess I'm surprised by the continued double-digit erosion, particularly in context of the much-improved results you're seeing out of Petco and PetSmart. and the Carnivora launch, can you give us some context around what's driving the sustained share losses there? And also, the teens-type growth on e-commerce, obviously strong and absolute quantum of growth, but we're hearing Nielsen talk about 40%-plus growth in e-com, and obviously we've seen the robust results continue at Chewy. The data suggests you may be losing share in e-commerce as well, if you could weigh in on your perspective there.

Yeah, with regard to pest specialty, the results aren't particularly surprising to us in pest specialty. It doesn't mean we like them and we're not working to turn them around. And, you know, the reason we've had tough results in pest specialty, I think there are two reasons. One is that in two of our biggest players, you know, we're down on distribution quite a bit. And until we start lapping that, which will be in the back half of the year, we'll continue to be down. And the second is we haven't had a lot of off-shelf results. placements on marketing in those channels, which we're also looking to turn around. And so that's not all that surprising. The other thing is that the e-commerce channel does interact quite a bit with pet super stores, and we've had strong performance in e-commerce over the years, including this latest quarter. And so that probably accounts for some of the declines as well. But it's an important channel for us, and even if we're not surprised, it doesn't mean we're happy. And so our goal will then be to improve that performance in the near term. When it comes to e-commerce, there's been a lot written about e-commerce, and I think especially about, I think Chewy announced, I think last quarter, 40% growth in their business. I think it's important to remember that their growth also includes pharmacy and hard goods, and not only pet food. In terms of our growth, we feel great. We're the number one pet food online. We're the number one CPG brand online, and we continue to grow with pet parents, and so In terms of market share, there are probably three different sources for market share. We use two of them. And according to that, we're actually growing share in the channel. We haven't used Nielsen, frankly, because their data has not been as reliable as we would have wanted it to. To the extent that that changes here over time, we'll pick up Nielsen. But we stopped using them because the data was not as robust as we needed it to be. I think it's also important to remember that Nielsen includes all e-commerce channels, not just... like Chewy and Amazon, but things like Target and Walmart and all the rest.

Got it. That's really helpful. One more and I'll pass it on. On the portfolio overall, you obviously have a sizable grain-in offering as well as grain-free. Is there a meaningful margin delta between those two? And also, what's the general price spread between those two? Thank you.

The I would say for wilderness, our pricing is higher on average than it is for the rest of the line, and our margins are very robust. I'm not going to get into specifics of that, but our margins are very robust, as it is with all of our pet food. So I would say wilderness is our biggest grain-free line, and it's got good margins and a higher price point.

Thank you very much.

Yep, thank you.

Our next question comes from the line of Faiza Alwi of Deutsche Bank. Please proceed.

Yes. Hi. Good morning. Thanks for the question. So I had a couple of questions. First, I just wanted to go back to the DCM issue only because, as you are aware, it's a big focus point for investors. And one is it's clear that you're not seeing an impact from retail sales. But are you seeing any impact as you're looking at consumer sentiment out there? And is there anything sort of beneath the retail sales where you're potentially concerned about DCM at all? And then my second question is just a little bit broader question around your priorities. I guess if you just look at this quarter alone, you could come up with a perspective. that you are prioritizing profitability and deleveraging, which is great, and I don't mean to look at it on a glass half-empty point of view, but maybe could you give us a little bit more comfort in terms of your priorities around top-line growth and sort of what's driving this shift in investments toward the back half versus this quarter? Thank you.

Yeah, so on DCM, I'll probably reiterate a statement I made a little bit earlier, which is to say that we haven't seen an impact on our business from this. Now, there are a lot of moving pieces with channels and distribution bills and all the rest, but we have not seen an impact on our business from the discussion of DCM. And there has been quite a bit of discussion. There's been a slowdown in the grain-free segment within the category. So that also has to be said. And some channels are impacted more than others, particularly the pet specialty channel, more than the food, drug, and mass channel. And so we'll certainly keep an eye on that. But from what we see now, it hasn't had an impact on our business. And of course, we're dedicated to Blue Buffalo was created with a mission to create the healthiest pet food possible and we'll maintain on that mission. With regard to DCM and any other issues affecting pets, we're in constant communication with the FDA as well as the rest of the pet industry. In terms of our first half versus second half and what we're prioritizing, I guess I would say our goal has been for the last few years and again this year is really to stay in the middle of both. And we're increasing our organic sales, but we want to make sure we do that in a way that is disciplined. And I think if you look at our full year, we'll be able to accomplish that. And we'll be able to accomplish that by increasing our organic growth rate, and we'll accelerate that in the back half of the year, as well as raising guidance on our free cash flow conversion and maintaining our guidance on our profitability. So if you look at the whole year, I would say that our goal is to increase our organic growth rate, but to do so in a way that is as efficient as possible. It is true that in the first half of the year, we accelerated our profitability more than we did our organic growth. And I think you'll see a little bit of a change to that in the back half of the year as we spend more on brand building and we have confidence in the ideas that we have. We've got really good ideas on really big brands. So whether it's in snacks with Nature Valley and Fiber One, or whether it's in yogurt or whether it's on things like Cheerios or Cinnamon Toast Crunch, we have really good marketing ideas on really big brands. And so you'll see us spend behind that in brand building in the back half of the year to accelerate organic sales growth.

Okay, thank you very much.

Thank you.

Our next question comes from the line of Nick Modi of RBC Capital Markets. Please proceed.

Good morning. This is actually Steve Chemish on for Nick. Just another quick one on PET. As we approach the leadership transition in Blue, just wanted to get a sense of if there have been or will be any significant operational changes. And I guess on that point, will Blue still have a somewhat independent sales force, or is that going to be integrated into the broader general mail sales force? Thank you.

Well, first I would say that our pet performance seems to be pretty good right now, so we're going to keep doing what we've been doing and add innovation on top of that. A couple things I think to remember. The first is that the Bishop family, Billy and Bill Sr. and his brother Chris, they'll still be involved in the business as advisors going forward, and I just had a conversation with Billy yesterday. And so they bring a lot of pet expertise, and they'll continue to bring that expertise. It just won't be in an operational role. It'll be in an advisory capacity. The second is that we have a strong leadership team in place that's going to carry over. So we have someone who's been Blue Buffalo for a long time leading our marketing organization and leading supply chain. We have an HR professional that's been there for a while, as well as someone in finance. And so the leadership surrounding Bethany who are going to remain in place, and they've been very effective. And then finally, Bethany herself. We have a tremendous amount of confidence in Bethany, and she's a great culture builder, and it's proven she can drive growth, as she has in CNF. And she's excited to do the same thing and pet with the team around her. So we feel good about the leadership transition. Obviously, the bishops are fantastic, and we will miss them, but they'll remain involved, and we have a great deal of confidence in Bethy and the rest of the herd.

Okay. Thank you very much.

Our next question comes from the line of Robert Moscow of Credit Suisse. Please proceed.

Hi. Thanks for the question. Two things. In the guidance for the back half, I think consensus is expecting operating profit to be flat to down already. Is that kind of what you're thinking if we had to isolate third quarter in particular because of the comparisons and the 25 million and all of that? I wasn't sure from the script. It sounded like the opposite, but I couldn't tell. And then secondly, I noticed in the press release that lower consumer promotional expense was one of the drivers of the gross margin being higher. Does that include trade promotion, or is it specific consumer promotions that you're talking about? And to what extent is that, I guess, being offset by the higher media expense? And maybe you can give us a little more clarity on how much media is going to be up for the year. A lot of questions in there, but sorry. I'll do my best, Rob. I tried to be clear, if nothing else.

So for the second half, yeah, if you just do a squeeze on operating profit, we're 7% up in the first half. Our guidance is 2 to 4, so it squeezes to flat to slightly down the second half. I mean, that's just the math. And as we alluded to, there's particular pressure because of the unwinding of the inventory and the pet sales timing in Q3. And we'll also see a step up in our media and in the capability building in Q3 and through the fourth quarter. So you will see those pressures come through probably more acutely in the third quarter than the fourth quarter. And the fourth quarter, obviously, will also benefit from the extra month in PET and the extra week across the business. So that's the phasing. You know, the promotional expenses were not trade. They were actually in what we call other consumer. So they're in SG&A. And to your point, they were down a touch, but media was up strong mid-single digits in the quarter. And, again, as we said in the second half, we expect media to be up mid-teens in the balance of the year. So we continue to invest behind our brands. We're seeing it more directly in our media budget and media spending this year, and we expect that to step up in the second half.

And, Don, can you give us any – color on trade spending. There's been a shift in the industry overall towards higher trade spend and then lower brand building. Are you saying that your trade spending is going to be about the same, and then in addition to that, you're going to increase the direct-to-consumer as well? How would trade spending be affected by this, if at all?

I'd say it's not. The media spend is, in addition... I'll let John talk a little about trade in a second, but I'll just go back to the comment I made to Andrew's question is, if you step back and look at the shape of the P&L, the way it's coming in this year, you're seeing the benefit of all the work that we're doing in terms of gross margin, extra timing in the purchase accounting adjustment from last year, gross margin expanding about 30 to 40 basis points in the first half, and that was in both quarters. Media is up mid-single digits through the first half, and again, accelerated in the second quarter, and our admin expenses have been held in check, and so we're leveraging those to drive operating margin expansion. And that's what we expected to do during the year. As Jeff alluded to, we actually came in a bit more with a bit higher profit in the first half than we had originally anticipated, and that gives us some flexibility to invest in the back half. That investment is going to be in media, in capabilities, in future growth initiatives such as the pet innovation, not in higher trade. So, John, if you want to come maybe a bit about the environment you're seeing.

Yeah, so, Rob, I'd say our trade spending in the U.S. is relatively stable year over year. You know, we're leveraging strategic revenue management to try to get more from those dollars and leveraging that whole toolkit, but relatively stable. And we're really excited about the opportunities on the brand building side. I tell you that we've got probably more ideas than ever in terms of where we can get behind, and they're proven drivers. Again, when we invest behind big brands like Cheerios with Heart Health News, we're seeing amazing results. So we'll be competitive and compete in our categories from a trade standpoint, and we'll build our brands via media as well. So we feel really good about the fuel we have to drive our business forward. Okay, great. Thank you.

And our next question comes from the line of Laurent Grande of Guggenheim Partners. Please proceed.

Yes, good morning, everyone, and congrats, Don, and welcome, Kofi. Just a follow-up on the U.S. yogurt category. Could you please update us on how you see the state of the yogurt business, the recent relaunch of YQ, I mean the launch of Good Betty and Oui Petite that we unfortunately can't see in Nielsen, and also could you share your aspiration for Oui Dairy-Free? that you just announced and how it fits with your overall plan-based strategy that most probably include your investment in KiteHale. Thank you.

Sure, Laurent. This is John. So, as I mentioned earlier, we were a bit softer in the first half than we'd like on our yogurt business. And as I mentioned, we feel like we've got drivers in place to improve in the back half. You know, some of the things you asked about are, you know, good belly as well as YQ. I would tell you candidly, they did not perform as well as we would have hoped through the first half. I would say distribution is a bit lower than what we would have liked. Particularly on GoodBelly, we've got some real pockets of success, and we're drilling in to understand what's working and how we can expand that brand out. As we pivot to the back half, we are excited about our innovation lineup. As you know, plant-based yogurt is growing nicely. It's still relatively small. And we think that coming with the WE packaging will be a real point of difference. And we love the product as well. So we think that will help us as we move forward and play a really important part of the category that's growing quickly. So we'll continue to innovate and iterate in that category. I'll tell you, there's probably more innovation in yogurt than the other 25 categories we compete in in the U.S. And we, as a result, recognize that we're going to have to have a strong pipeline and continue to bring ideas as the consumer is continually looking for new things in the category.

Thank you very much, Anil. I've got the time for a second question. So I'd like to understand, I mean, the risk targeting change between, I mean, Dana McNam moving from CERNs to Europe. I mean, any update on that transition? I mean, how it is, which would impact, I mean, your European business, you think? And also, I mean, how, I mean, you would feel – issues in the U.S. cereal business that's working very well for now.

Yeah, so the transition is going smoothly. Dana is being replaced in cereal by Ricardo Fernandez, who's an exceptional leader with really good knowledge of the cereal category. So one of the things I feel great about is that we have a very good team of people, cereal experts here at General Mills. And I would also say Dana has had a great team in Cereal, and they're remaining in place. We've got good people in marketing and finance and operations, and so the rest of that team is remaining in place, and they're a very talented group. And so my expectation is that we'll continue to grow Cereal as we have in the U.S. Dana's a fantastic leader. She knows Europe very well. She spent time with me at CPW, so I know Dana well. And so she knows the European market context. She's a very good marketer. She really likes to grow. And so looking forward to what she can do with that business and continue some of the trajectory we've had on Old El Paso and maybe even improve it further and improve what we've done on bars, which has been really good, and Haagen-Dazs. And then she'll have a chance to make sure we get our yogurt business in Europe back to growth, which has underperformed around with the rest of the yogurt category. So she's a terrific leader who understands the market, and she'll be starting there in about 10 days.

Okay. Thank you. Have a good time. Thank you very much.

All right, Bridget, I think that's, unfortunately, I think that's all the time we have. So thanks, everyone, for your questions this morning. I know we didn't get to everyone, so please feel free to follow up over the course of the day. And happy holidays, everyone. Thanks for listening in this morning.

And that does conclude today's presentation. We do thank you for your participation and ask that you please disconnect your lines. Have a great rest of the day and happy holidays, everyone.