General Mills (GIS) Presents at 2019 Bernstein Strategic Decisions Conference (Transcript)

General Mills, Inc. (NYSE:GIS) 2019 Bernstein Strategic Decisions Conference May 29, 2019 4:30 PM ET

Company Participants

Jeff Harmening – Chief Executive Officer

Conference Call Participants

Alexia Howard – Sanford C. Bernstein & Co

Alexia Howard

It's my very great pleasure to welcome, Jeff Harmening, to our Strategic Decisions Conference for the first time. Now Jeff has been CEO of General Mills since June of 2017. And he joined the company in 1994 serving in many parts of the business including Big G Cereal, Cereal Partners Worldwide, Big G New Enterprises and food service new business in both marketing and general management roles.

Now General Mills has been stepping up its investments in innovation with a percentage of sales from new products introduced over the past year, now above 5% globally in fiscal 2019. And the other big initiative, recently has been the acquisition of Blue Buffalo in April of last year with the roll out into the pet food shelves of Walmart stores that happened in March of this year.

Here to tell us a little bit more about the Company’s strategy and outlook, I'll hand it over the Jeff. Thank you.

Jeff Harmening

I guess we will do here, this – the chair is so comfortable. Why don’t we just do it from here. I don't have 20 slides to tell you about the Company, I've only got three and I see a lot of familiar faces in the room. So, I’ll keep the upfront remarks short and Alexia let you ask the questions you want and then any, any more questions we have from the audience.

But just as a reminder to people as we think about it, our growth strategy is pretty straightforward. We want to compete effectively across all brands and all geographies and, then we want to make sure we would accelerate certain parts of our portfolio. And so we've identified four businesses that make up about $4 billion of sales. So, that's Häagen-Dazs ice cream, bars, Old El Paso, and natural and organic.

And then finally we said, look, we need to reshape our portfolio for growth. And obviously the Blue Buffalo acquisition fits into that. What I'm pleased is that we made progress on all three of these. There's more to do, and I will certainly talk about that hopefully today. But we feel good about the progress we've made in the U.S. and the compete effectively where we're growing share in seven of our top 10 categories.

So we feel good about the progress we've made there. There's more work to do in yogurt, there's more work to do in snack bars. But overall we feel good about our progress. We've accelerated our portfolio. Häagen-Dazs is growing at double-digits in retail outside the U.S that part is growing at more than 30% outside the U.S. And so we've made good headway in accelerating our businesses that we meant to accelerate.

And then Blue Buffalo is performing well. And I'll talk about that in a minute. So the first step of our reshaping is going well. And in fact, today we, because Blue Buffalo closes at the end of April, unlike the rest of our business which closes at the end of May, we thought we'd just give a brief update on Blue Buffalo and on what happened in the fourth quarter and where it is for the full-year.

And in the fourth quarter we grew our sales at 38% and our operating profit at 82%, which includes purchase accounting. If you back out the purchase accounting, actually 88% growth and both those numbers are roughly in-line with what we expected, for the end of the year. And as result, our net sales for Blue Buffalo are up 11% for the year. And our segment operating profit is up 11% for the year. And we promised double-digit growth and we're pleased to say that we're able to deliver that.

And so then finally, I guess what I would say is that we had, we set out three broad priorities for General Mills for fiscal 2019. And we've already said that we're on track to meet or exceed all of these priorities. One was to grow our core business with topline growth of 0% to 1%, we said we're on track to do that.

The second is transition Blue Buffalo effectively. As I just mentioned, we've been able to hit double-digit sales and profit growth, which was our goal coming into the year. And then finally to be able deliver on our financial commitments, and, we've said we'll be at the top range of our guidance on earnings for the year and ahead on earnings per share for the year and also ahead on free cash flow conversion.

So, we feel good that we've been able to deliver on our core and deliver on Blue Buffalo and deliver on our financial commitments. So, with that, those are my only prepared remarks and we'll turn it over Alexia to your questions and questions from the audience.

Question-and-Answer Session

Q - Alexia Howard

Perfect and if you do have questions for Jeff, I'm sure you discovered during the course of the day that question cards are on your tables, we'll collect those up and I will do my level best to work those in as well.

So Jeff, just to get things started, it's been exactly two years since you became CEO at the beginning of June of 2017. Congratulations on the anniversary. What accomplishments are you most proud of since you took the helm?

Jeff Harmening

Well, I think the, what I'm most proud of is, is something that I don't get asked a lot, but it is really hard to model, but it's the change in culture. And as we think about our business, as we were here a year ago, you mean we missed our third quarter earnings guidance and missed our guidance, financial guidance for the year last year. And I'm not a believer that adversity creates character, but I think it reveals it. And I think the fact that we've been able to grow our core this year and grow Blue Buffalo ahead from financial commitments, there's a lot about General Mills and the character.

It's hard. I know it's hard for a lot of you out there to model culture, but it makes this huge difference. And I think what I'm pleased with is, we've brought in a lot of people from the outside of the organization who have added a lot of value in things like strategic revenue management or global sourcing or e-commerce or a new Chief Marketing Officer. And we’ve blended that with our internal talent.

I'm pleased that we're able to make decisions faster than we were two years ago. We flattened our organization and all the segments now report into me. I'm pleased that we are able to share ideas better than we have before. We created these accelerated platforms and you can see it what, we're sharing a lot more across boundaries on Häagen-Dazs and an Old El Paso and on bars.

For example, we just launched the Lärabar, end of the UK and are doing that effectively and we've taken some advertising from the U.S. in Old El Paso and brought that into the UK. And you'll see next year we're leveraging what we do in yogurt. Some of the things we do in France, we're going to leverage that in Canada. So we really, so I'm really pleased with the way the organization has responded and I think you see then in our growth and our ability to execute against what we said we're going to.

Alexia Howard

Right, let's dive into Blue Buffalo, which has obviously been big news over the last year. It's now being rolled out more broadly into mainstream channel, literally as we speak. Are you able to quantify how big an opportunity that could be for the company over time and perhaps go into what you see the risks could be in terms of competitive reactions or perhaps over extending distribution?

Jeff Harmening

Yes, so on Blue Buffalo, I'm thrilled with the Blue Buffalo team with what we've been able to do this year. We not only hit our sales targets, but also we hit our distribution goal. We said we're going to get to about 65% distribution and we're about 68% as of the end of April. And we've done that pretty seamlessly and up through a lot of hard work, from the Blue Buffalo team. And so as we look at the Blue Buffalo business we've seen a lot of growth – we see a lot of growth ahead for the business. And Jeff Siemon probably has not provided forward-looking guidance.

So I'm not going to do that today. But what I will tell you is that we think we can keep growing our distribution, we’re at 65%. There's no reason that we can eventually get the 80% distribution. And beyond that we think we can grow the amount of distribution, the number of SKUs we have in stores, because we're off to a good start with our Wilderness launch and the food, drug, and mass channel. And we're the number one brand in e-commerce and we're the number one wholesome natural brand now in the food, drug and mass channel on the pet specialty.

So we've added a lot of distribution. We think this is a business we can innovate on. That some have called into question can we really innovate into pet? I think we'll start to show in fiscal 2020 we can innovate in pet. And I think we'll see that again in fiscal 2021. One of the things we're most excited about is matching General Mills’ innovation capability with the pet capability of Blue Buffalo. It’s one of the very first things when we took Billy Bishop through our corporate offices. I think probably the most excited I saw him was when he saw our R&D capabilities and he said this is stuff we can apply to Blue Buffalo.

Alexia Howard

And we as analysts really only see the food, drug and mass data, which is obviously where you're rolling out at the moment.

Jeff Harmening

Yes.

Alexia Howard

Are you able to give any comments about how things are going on in the e-commerce channels, the Blue Buffalo and also in pet specialty just so we can get them more all around view of what's happening.

Jeff Harmening

Yes sure. One of the things – yes I will certainly do that. One of the things that is interesting about Blue Buffalo that we find in our other businesses like Cheerios is that great brands travel. You asked about risk in going across channels. What we have found is that in our space, great brands travel. I mean we sell Cheerios at places like Whole Foods, we sell it in e-commerce, we sell it at Walmart and at Kroger, and it travels well across those different channels. We're seeing the exact same thing with Blue Buffalo. And so Blue Buffalo is the number one in pet specialty channel, its number one on e-commerce.

And our e-commerce business is growing at double digits this year, which is what we expected. Our pet specialty business is declining double digits, which is unfortunate. So it doesn't make us happy, but it's declining in line with what we expected it to. And our food, drug, and mass business, is growing at triple digits, which is also what we expected. And so one of the things we're pleased is that when you buy a business and a category that you haven't participated in before, you think you understand the category when you purchase it. But it's good to feel a year later that when you look back, yes we actually did know about the business that we are purchasing. And it's played out almost exactly as we thought it would.

And I think over time we'll be able to improve our pet specialty business as we're able to innovate specifically for that channel, whether it's through new products or through promotions, much in the same way as we've done in their organic channel with brands like Annie's and Lärabar.

Alexia Howard

Great. Should we then switched to the broader industry questions here? In your view was the focus, the industry focus on cost cutting and zero-based budgeting to extreme over the past few years? And is there a need for reinvestment to rock to drive a recovery in top line growth from here?

Jeff Harmening

Well, the short answer to the first question is yes. And I mean it's really hard to really focus on cost and growth at the same time. I mean you can become more efficient and we certainly have with our Holistic Margin Management program because it's part of the culture. But when you're doing Holistic Margin Management, and you're taking out capacity, and you’re changing logistics network, and you're doing zero-based budgeting, and doing all at the same time, it's hard to do all of that and maintain your focus on growth.

And what I feel great about is our current strategy, we rebalanced the equation. What I call it staying in the middle of both. We want to stay in the middle of the both. Yes, we want to grow a little bit faster, we also want to make money while we do it. And that's more in our wheelhouse. And that's why, I think, you see our percentage of new products coming – our percentage of sales coming from new products has grown to 5% over the last couple of years because we've invested more time and energy into growth and our new products growth and less time on the cost cutting side.

Having said that, it's also interesting that our Holistic Margin Management at the same time has probably reached record highs. And so we've been able to become more efficient while we've been able to spend more time on growth. And I think that’s better balance for us right now. I mean, I think, it's showing up in our income statement and then in our results as a company.

Alexia Howard

If you take a step back, how has the industry structure changed in recent years? Do you think that barriers to entry are as strong as they once were given the emergence of challenger brands and maybe the increased retailer focus on pricing and private label? And what do you think that means for a longer term earnings growth algorithm across the space?

Jeff Harmening

Yes, so I mean, I think, the industry has really been dynamic over the last few years, it’s much more dynamic than it has been historically and certainly that presents challenges. But I also think it presents opportunities because anytime you see change in an industry, there's going to be an area for opportunity. And the three biggest changes we've seen are in the change in consumer food values, change in the retail landscape, particularly with e-commerce and with discounters. And the third change we've seen is – it's in the structure and this focus on costs and how CPG companies have gone to market. So those are the three big changes we've seen. And for us those changes going on around us. So the question we have to ask ourselves is how do we adapt to those changes?

And General Mills hasn’t been around 150 years because it's failed to adapt. It has been around for 150 years because it has adapted. And as we see the e-commerce landscape, I mean our business is – we have a higher share in e-commerce than we do in brick-and-mortar, and it's not an accident. We have the biggest brands plus we've invested behind that. The same would be true as we've seen consumer values have shifted, we've shifted our portfolio.

You asked about barriers to entry. I think barriers to entry are less than they have been historically. And on one hand that's a threat. But it's also a big opportunity. I mean if you look at our acquisition of Epic Provisions, which is a business we absolutely love, we were able to get that because we're looking outside our four walls for innovation. We set up 301 Inc., which is our internal private equity group to make minority stake investments in businesses, things like Beyond Meat as a matter of fact and others like Kite Hill and GoodBelly. And so we have about a dozen investments.

And so we're adapting to the external landscape. And so while the barriers to entry may have come down, there's a lot more innovation than there has been historically. And the only question is, are we going to tap into that? And so far the answer for us has been yes we have. And we think we've got a good line of sight to tap into it in the future.

Alexia Howard

As you look across your U.S. portfolio, where do you see the biggest growth opportunities? And where might you need to be more selective in your resource allocation?

Jeff Harmening

Yes, so I mean the biggest growth opportunities we see are in the business that we said we are going to accelerate as we said globally. But that also – a lot of those apply to the U.S. And so Old El Paso, we've been growing at mid-single digits. I'm really pleased with what we've seen in the growth of that business. So Totino's hot snacks, we've been growing at mid single-digits and that might be our next billion dollar business, it’s been a great growth business for us. And we need to improve our snack bars business. That should be a great growth business for us. It has historically but it hasn't this past year.

And we think that we can return our yogurt business to growth. We returned to share growth this past year and that's a great moral victory, but we're looking for absolute victories. And our goal is going to be to get our yogurt business back to growth. And we've maintained the growth of cereal while we've done that. And there had been a lot of discussions, if you hear industry speak, you'd think no one's eating breakfast cereal anymore. But we know we grew breakfast cereal last year. We're on track to grow it this year and we've got a line of sight to grow it again next year.

Alexia Howard

So maybe just taking into some of those categories that you mentioned, what do you think the lessons learned from the experience in yogurt have been so far? And how do you see the route to getting the category and your business back on track that to complete?

Jeff Harmening

Well, to understate the case, we had a little bit of a rough experience in yogurt for about five years. After growing share steadily for 35, we had a rough five-year patch. The first lesson learned is that you need to lead innovation. If you're a leader in the category, you need to lead innovation and whether that's in breakfast cereal or whether that's in yogurt or whether that's in pet food. If you want to be the category leader, you need to lead the innovation. That's what leaders do and we didn't do that with Greek.

The second lesson is, I mean, you really need to look around the outside of what's going on externally and what's going on around you. And part of the reason we formed this 301 Inc., which is our equity firm, was internal equity firm, one is to make sure we make investments in businesses that we think might be attractive but also because it gives us a lens to what's happening externally. And I don't think we saw what was going on with the Greek yogurt fast enough, but I can guarantee you we do now. And whether that's in Greek yogurt or whether that's in bars or what have you or whether that's in cereal.

We see things a lot faster than we did before. So I think the two lessons for us learned are one, if you're going to lead the category and we view ourselves as leaders then you need to be the first innovation. And the second is you need to have your head on a swivel when it comes to innovation and what's going on in the world around you. And what happens within the four walls of General Mills is interesting but there's a broad world out there and you've better be paying attention to what's going on.

Alexia Howard

And what two diagnosis about – around the snack bars segment at the moment, you obviously had a big burst of innovation, I think it's going to step up, was coming up, which works very well for a period of time and now things seem to be getting tougher. What's the solution there?

Jeff Harmening

Well, I think it's going to get back to some fundamental innovation. And what I would say is on our snack bar businesses, we have about five snack bar businesses, three are doing pretty well. So Lärabar is growing at double-digits, EPIC bar is growing double-digits. We have a Cereal Treat bar business that's really growing rapidly. So those three businesses are good and no one ever asked me about those and so I get that. On Nature Valley, two years ago we grew at an 8%, this last year was we declined.

And Nature Valley really is about executing well and about getting back to innovation. I mean, it is the bar that nature intended and is well positioned, it's got a great brand equity. And so I'm highly confident we can improve on last year's performance on Nature Valley. And the one that's really been a trouble for us has been Fiber One and we're working on fundamentally repositioning that. We'll certainly talk more about that repositioning in our Investor Day in July and maybe a little bit on our Q4 earnings.

But fundamentally, Fiber One used to be a part of about half the diets in the U.S. and now it's about – and one point on weight watchers, now it's a part of about 2% of diets in the U.S. and about six points of weight watchers. So we have some work to do on Fiber One but parts of the business that we, again, we've led innovation for a long period of time and we didn't do that this last year. We thought we're going to get back on the horse this coming year.

Alexia Howard

Okay. What changes do you see in the U.S. retailer environment, is they wrestle with the dual challenges of online retail, how it is counters out of Europe? And what does that mean for you as a CPG supplier and maybe linking that to the pricing question. How easy is it to take pricing these days?

Jeff Harmening

Well, I don't think I've seen a retail environment in food that’s more dynamic than the one we see right now. And for the reasons you've just mentioned because you see a lot of growth in ecommerce and whether that's direct store delivery or whether that's stuff delivered through click-and-collect or whether it's discounters. I think being a retailer in the U.S. now is probably as tough as it ever has been in the food sector.

And one of the – I think the question is then how do you deal with that? I think a lot gets made about the tensions that might exist between retail and CPG, but our retail customers are all looking for one thing and that's growth. And so they're looking for the people who can deliver solutions to them, growth solution to them. And whether that's through your new products or through your data and analytics capabilities, what have you. That's why when I talk about, I've talked about growing share in seven of our top 10 categories. That's really important because our customers are looking for people who can help them grow.

And pricing conversations are never easy. We never – I mean, we don't take prices just because we think it's a good thing to do. We'd take them because we see inflation. And those conversations are always difficult. They're really difficult if you're not helping somebody grow, if your retail customers are convinced that you're trying to lead their categories and their business back to growth, it's not as if they welcome you with open arms, say, hey, that's great. Let's take any prices you want. But the conversations are a lot better if you can assure them that you're plowing those investments back into growing your business and growing their business for them.

Alexia Howard

Just sticking with the other pricing theme, a question from the audience, how closely do you track your pricing to the private label alternative in each of your categories and you bumping up against any spread differential issues?

Jeff Harmening

So one of the things I'm most proud of is the degree with which we've improved our strategic revenue management capability over the last two years. We've gone from kind of an episodic player in pricing to a full blown global capability. As we look at pricing, I mean, context is everything. And so we certainly look at what's going on in the category around us. And when we talk about private label, we talk about them as retail brands. We don't even say private label at General Mills, we say retail brands because they are competitors.

And so as we look at it, we look at not only the spread or pricing to our – to the national brand competitors but what is the spread between our – us and retail brands, and what's interesting is our prices have gone up over the last year about 2%. Our competitor prices have gone up and interestingly retail brand prices have also gone up. And I'm certainly not going to call out anybody by name of how their prices have gone up, but if you look the whole industry is, the pricing has gone up and it's gone up because we've all faced the same kind of pressure from input cost inflation, labor inflation, logistics inflation. So we track it pretty closely.

Alexia Howard

One of the things that we've been hearing recently is that retailers may be becoming more sophisticated around analytics, about optimal shelf space allocations and price elasticity. What does that mean for the category captain role is if the retailers are getting those skills and capabilities built up?

Jeff Harmening

Yes. I think if you look at retailers and aggregator, it’s clear the retail channel there, they are driving a lot more innovation through their data and analytic capabilities. And it varies by customer to customer. So it's not that – it is certainly not ubiquitous across the channel, but certainly some customers becoming a lot more sophisticated. I think that helps companies like General Mills.

We've always been very data driven and we're investing in our data and analytics capabilities as well. And so for us, it's actually helpful to have conversations with retailers where you're feeling like you're talking to them on the same plan. And what they can offer is a lot of information on the customers that go into their stores. But we can offer is a lot of information on how people stop across channels and across categories, because we participate in 26 different categories here in the U.S.

Obviously we were at every retailer and – but a lot of people of mill by General Mills, we have also have our own unique data capabilities. We have three of the top five food websites in the U.S., bettycrocker.com and tablespoon.com and pillsbury.com. So we have tens of millions of consumers in the household database. And so we can educate our retail customers on what's going on more broadly across channels, because we see what consumer shopping behaviors are more broadly. So I think as our retailer customers increase their level of sophistication about data and analytics. I think it presents an opportunity for those CPG companies who are equally driven by data and analytics.

Alexia Howard

That actually segues quite well into this question about retailer investments, which I think you just alluded to. Many companies seem to be spending more on retailer investments and a bit less on advertising spend these days. And what did those investments actually by you? Is it in-store information on consumers in-stores? What else does it get you?

Jeff Harmening

Well. There are certainly some retailers who have become more sophisticated and how they can identify shoppers and shopper behavior and have marketing work through them. For when it comes to marketing, we've been pretty – we've been agnostic for a long time about where our marketing spend takes place. And whether it's on TV or whether it's on Hulu or whether it's through search on Google, I mean the key for us has always been and will always be what is the objective you're trying to accomplish and what is the best way to do that.

And I'll give you a couple of examples just kind of bring that to life. If you talk about cholesterol and Honey Nut Cheerios and you're going to market to that somebody who's 65 years old, I probably wouldn't do that through Hulu. That probably wouldn't be the best use of time, but if you're going to have a coupon in the Sunday newspaper, it probably works. If you're going to invest in Old El Paso through millennials, if you're going to do that through recipes, and those recipes are mostly going to be online because people are looking for those of 35 years old and they don't have recipe cards sitting on their counter.

And so the way you would do that would be different. The same would be true if you're trying to read people on Blue Buffalo and they're trying to compare one dog food to another, then may go through Google Search to do that. And so as we think about our investments in marketing with retailers, we'll look at those through the same eyes as we would the rest of our advertising dollars. And to the extent that advertising through retailers, returns the same ROI and can help us accomplish and objective. We're happy to invest in marketing through our retail customers as long as it's going to build the brand equity.

Alexia Howard

What are the international sales growth opportunities that you're most excited about today? And are there any challenges on the horizon in the international markets that we should know about?

Jeff Harmening

Yes. For our global markets, there are certainly plenty of challenges and there are certainly plenty of opportunities. I think for our developing markets, the challenge for us is to maintain our growth rate on the top line, which is kind of mid-single digits this year, which I'm pleased with how we're doing. And increase the profitability of those businesses. And we have a line of sight to do both of those things. Our business in India is growing nicely. Our business in Brazil has returned to growth. We're growing well in Latin America. So to on developing markets, I feel good about how we're doing, our focus on our platforms of bars and Häagen-Dazs are global platform is really paying dividends for us, because those platforms are not only ones where we have a right to win, but they're also profit accretive.

And so to the extent that we can grow those, it's actually a form of internal portfolio shaping. Our toughest market outside the U.S. by far is France. That's the toughest market we compete in. And it's tough because we have a big dairy business in France, because we have Yoplait, but we also have Häagen-Dazs. And we see a lot of dairy inflation in France and France is a tough place to take pricing and their economy is not on the upswing at the moment.

And so probably the toughest market for us outside of the U.S. is France. And it's a big market for us. I don't think it's uniquely tough for us. But what's interesting is that you might think it'd be Brexit. You may not think with Brexit would be the UK. Actually we are growing really nicely and we're growing mid-single digits in the UK and feel great about our UK business. And we're growing through Häagen-Dazs. We're growing in the Old El Paso. We're growing really well in bars in the UK. But for us it's actually France is probably the toughest environment for us.

Alexia Howard

Interesting. Let's talk about innovation and the pace of innovation and how it's accelerated in the last few years. I think from 3.8% of sales in fiscal 2017 to over 5% globally this year and another 6% in North America. Are we now had a new normal level? And what level of organic sales growth cannot drive over time. And perhaps most importantly, how can you be sure that you can earn an adequate return on those investments and it's not just going to push your margins down.

Jeff Harmening

Yes, so on innovation, I'm really pleased with the level of innovation we have right now, particularly with regard to where it was a couple of years ago. And again, I think there would be two keys for us. One is that focusing more on growth and a little bit of last on just cost has been helpful. But we've also changed the way we do innovation. And we're much more iterative at how we do innovation. And we studied how entrepreneurs do innovation and we do a lot more innovation like they do.

I can tell you that when we started on Oui by Yoplait, which has been a huge success for us. The initial prototypes of that we're not – there was not in a glass jar. It was not called Oui. It actually was not anywhere similar to what it was. But over the – over time, we iterate on that offering and really listening to what consumers wanted and actually made a pretty quick turnaround on that business.

So as we look at innovation, we're doing it differently and we're focused more on it. And the key to innovation I think is going to be, you're going to have some misses when it comes to innovation. It's inherently more risky. The key is when you have something big that you're right – that you really right at and we've had that with Oui, we've had that in some of our Cereal launches. And when you have something that doesn't work, you call it and you don't keep throwing, you don't throw good money after bad, because you just realize that innovation is a fundamentally tougher business, but a few successes and innovation, pay off wildly. And the key is to make sure you limit your losses on the things that aren't working. But innovation, you have to make enough bets, because some of the things just not going to work.

Alexia Howard

So when you talk about it being more entrepreneurial, is it more testing out there in the marketplace more quickly and is it a faster pace of distribution rollouts. So just how is it different from the Oui?

Jeff Harmening

Yes. So, the way we would go about it internally is that and it's really interesting. We actually have dedicated team of people, so from different functions, marketing and R&D and even finance. And we put that team together and they do nothing but work on new products. And it's an iterative process. And so I'll give you an example. So the team will come up with an invention in yogurt, let's talk about we. They’ll go in and try to sell, they'll come up with something, they'll actually go out try to sell it in store and nothing brings reality home, like actually trying to sell. What you're trying to sell? And it's a humbling experience.

But what we’ll able to do is based on consumer feedback, we can then go back to our R&D labs and overnight change the packaging or change the product or change the name and then go back out the market the next day and try to sell it again. And we will find out, we've got some things right, we've got some things wrong and they we'll do things overnight, we'll come back the next day and try to do it again. And so it really isn't a faster rollout of distribution, it's actually failing faster. Because you're going to fail if you do broad, the key is do it fast and cheap. And so through our new methodology we call consumer first design, we're able to fail a lot faster and a lot less expensively, which allows us to succeed faster and less expensively.

Alexia Howard

Okay, so the U.S. birth rate seems to be dropping, I think we're at 32 year lows at this point, I think I read this morning. Is this likely to constrain cereal category growth? Because I think there was a hope that maybe that would pick over time.

Jeff Harmening

Yes. So this is where the statistics can get you in trouble or lead you to victory. The birth rate is actually declining, but the number of people giving birth is actually accelerating. And then, when you had immigration on top of that, the number of young kids is actually flat or increasing a little bit. And so as we look at – and so I go through all that math only to tell you that I don't think that birth rates or lack of birth rate is going to be a negative on the cereal category. I'm not sure it's going to be a huge tailwind, but I don't think it's going to be a negative either. I think we're in an environment – where I would say a few years ago the number of babies being born was lower and so that was probably a headwind. So now I think we're entering a period for the next few years where it won't be a tailwind, but it won't be a headwind either.

Alexia Howard

So just coming back to the North American retail segments. I think when you actually look at the quarterly results you've been more successful than other companies in actually realizing price mixed improvements over the last year up 2%, I think last quarter. Do you expect to be able to continue to realize those kind of price increases over time just broadly and what form might those take?

Jeff Harmening

Yes. I think, first I will go back to something I said earlier. I mean our ability to do pricing and do it profitably has really improved dramatically over the last couple of years, something we're really proud of. But if you look at it, we're not alone in taking our prices up. I think one of the keys has been as if you look across our different categories, most of our key competitors have raised prices and retail brands have been able to raise prices. So the environment for pricing has been more conducive because we've all seen the same kind of inflation.

And so while I'm pleased with our efforts of what we able to do, I'm not sure that we’re unique in taking pricing. If you look at the last quarter for example, we had tremendous price mix because we sold a lot more cereal and it was also the key season for brands like Pillsbury. And so, as I look ahead, I'm not sure we're going to see the kind of price mix that we saw in the last quarter. Although I think, to the extent that there is pricing available, I think we'll be able to get our fair share of it because our capability has improved.

But as I look ahead, I mean our third quarter was pretty unique and kind of all elements came together. And while I think we'll still be able to generate positive pricing, even if you look at Nielsen, you would see for the last quarter, we've got about 1% pricing, whereas about 2% before that. So as we start to allow pricing we've taken before and maybe if we don't see the same amount of mix, I don't know that we'll see the same amount of pricing. But I feel confident in our ability to achieve whatever pricing is available in the marketplace.

Alexia Howard

Okay. We've heard from some other companies that had dialing back their investments in the e-commerce channel, half because Amazon and others are charging so much for the online shelf positioning. How do you see the e-commerce opportunity, particularly in the pet food area where it's really well developed already?

Jeff Harmening

Yes, I mean, there's no question that e-commerce is going to continue to grow for our food business, human food business. So aside pet for a minute, I'll come back to that. For our human food business, it's roughly 3% of our sales here in the U.S. now. As I look over the next five years, e-commerce will certainly account for a fair amount of our growth in the U.S. But I don't necessarily think it's going to get beyond 10% of our business over the next five years. And I just size that opportunity because we spend a disproportionate time collectively talking about e-commerce and it's big and it's important and it'll be a big part of our growth. But that means that 90% will not come from e-commerce.

And so as I think about it, we need to make investments in e-commerce that will help us be successful. But we also have to pay attention to the 90% that will not be e-commerce. The thing is – the second thing I would tell you is, it’s pretty clear in food anyway, so there'll be a variety of winners in e-commerce. I don't think e-commerce is going to be dominated by one player especially in the U.S. market. We see that in Europe, it's not dominated by one player and I don't think that's going to be the case in the U.S. We're seeing a lot of competitors, whether it’s traditional grocers or whether it's new entrance in just pure play e-commerce being successful. I think we're going to see that. I think the implication for us is that we're going to have to be good with multiple customers. It's just not going to be good enough to win with one customer.

In terms of pet, I think pet is tailored made for e-commerce and whether that's direct to consumer or whether that's a click and collect model. No one wants to lug 30 pound dog food bags around and especially if you've got two kids with you. So I think, the reason pet food, so much of our sales have now come from e-commerce is because it's a channel that's really made for subscription based kind of service. And people don't want to lug 30 pound dog food bags around. So I think it really is a channel that is tailored made for pet food.

And we've seen our e-commerce grow 20% this year in the last quarter or two it slowed a little bit, but I think it will pick back up, especially now as we're more developed in the food, drug and mass channel because you see a lot of players like Target and Kroger and Walmart and people like that really developing their e-commerce capability. And I think, to the degree we were successful with those customers in that channel and I think we will be, well I think we'll see our e-commerce business in pet accelerate actually.

Alexia Howard

You mentioned the holistic margin management program earlier and how it's actually developed overtime and it’s actually running at a pretty high rate at the moment. Is that current run rate something that can continue over time or are you at a peak sort of level of right now?

Jeff Harmening

Well, we've been doing holistic margin management for about 15 years and every, every time that we think we've hit a peak or someone else thinks we've hit a peak, we managed to keep pushing through and doing more. And over that time, we've generated roughly $400 million a year in holistic margin management savings, which was about 4% of cogs. And I don't see a reason why that shouldn't continue.

And we generated a little bit more than that this year, and whether we generate a little bit more or less, we'll talk about in June and when we talk about her and guidance for next year. But we've generated about 4% every year through different means for the last 10 or 15 years. And it feels to me like we should be able to continue to do that. And one of the things that creates a good environment for holistic margin management is actually growth and change. And to the extent you're growing and changing, you can actually generate more savings from holistic margin management.

Alexia Howard

Questions that's coming. Returning to the Blue Buffalo question, what have been the most challenging pots of integrating the Blue Buffalo business for you?

Jeff Harmening

So, it's interesting when I – when we talked about – when we talked about Blue Buffalo, first of all it's going really smoothly. And I think because the culture of Blue Buffalo and the culture of General Mills are very compatible. And I think this element of culture when you talk about, acquisitions, it's probably an underappreciated and the cultures are very similar. And so from that standpoint it's been pretty easy. The thing I would say is that it's – when we brought it into General Mills, we actually didn't talk about it being an integration. We've talked about being in transition. Even in the slide that I have up here, you see it says transition Blue Buffalo is not integrate. And that was very purposeful because, there are some things that been able to integrate like David, – our strategic revenue management capability Blue Buffalo has taken on, our HMM capability, Blue Buffalo has taken on.

We haven't actually integrated our sales organization because there are a lot of unique channels too to say on that. So I think we've been, some of our back office stuff we have integrated because it made sense. So it's actually been – it's actually been really, really smooth. If I have an example of a big road bump that we've had, I wouldn't tell you about it because I want to make sure I'm transparent, but we actually haven't had a big, if you haven't had a big road bump because we've been very thoughtful about how we've transitioned and I think it's been helpful over the last 20 years. General Mills has acquired a lot of natural and organic businesses and we've learned a lot of lessons over those 20 years. And I'm glad we've learned those lessons because we can apply them as we bought, we pay $8 billion to buy Blue Buffalo, it's good to learn on the small ones and not the big ones.

Alexia Howard

And maybe that's a perfect segue into this other question that’s coming about, Annie's, what worked, what didn’t work as well, what have been the main lessons learned and how is it doing now?

Jeff Harmening

Yes. So with Annie's – I mean Annie's has been really successful for us. We doubled the business in the first four years, and we actually improved their growth rate from when we acquire them. I think the biggest thing we learned on Annie's that we carried over to Blue Buffalo is just – there were really good marketers than Annie's, and Blue Buffalo people are really good marketers, and they build great brands. And in the first thing, the first rule is respect to brand. People get in trouble when they either don't understand the culture or they don't respect the brand. I mean, you can get by if you stumble on logistics or something doesn't go quite right in your financial integration. But if you screw up our brand, that lasts a long time.

And so one of the things we very respectful of Annie's and also epic and now with Blue Buffalo is very respectful. The people who built those brands and that's one of the biggest lessons learned. The other is that, we probably integrated Annie's into our logistic network too fast, and I'm ready to do that again. I would have done that more slowly because you take a lot of really small SKU and you put it into a really big logistics network. And it creates a lot of pain in the short term. We did not do that with Blue Buffalo. Frankly, we couldn't, but we also didn't try to. And on Annie's, I think we've got a lot of Annie's right. If we would've – if I would've had it to do over again, that really the only thing I would've changed, I would've probably kept logistics, their network separate from ours longer to have really understood that business a lot better than then. I would have been integrated it selectively. We applied some of that learning to Blue Buffalo.

Alexia Howard

So maybe like since it's a more organizational questions. How would you describe the main components and objectives of the company's short term and longer term incentive plan?

Jeff Harmening

Yes. Well, first I would say, overarching comment, our incentive plans are really well aligned with the incentive our shareholders as it should be. And in the short-term our incentives are equally split among our divisions, are equally split with sales and profitability. So if you're in an operating segment is equally split on sales and profitability. And when I talk about staying in the middle of the boat externally to all of you, it's the same thing I use internally to our employees. And that means we want to try to grow and we want to try to grow profitably.

So it's aligned to what I tell you all externally is really aligned with our metrics internally, because we looked at over the longer term, there are really two key drivers, I think our shareholder value for food company like ours. The first is sales growth and the second is free cash flow. And if you can grow your top line and you can generate strong free cash flow, your shareholder returns going be pretty good. And so for us there's metrics we have for our long-term incentive, our center around sales growth, but also a free cash flow which takes into account obviously profitability, but also how efficient are you with working capital and is a leading metric where you look on return on invested capital.

Alexia Howard

And then sticking with the organizational side of things, have there been any changes to the companies organizational structure over the last few years as the company has pursued cost saving programs all the time and how that affected the business?

Jeff Harmening

So over the last few years, we have certainly become more efficient in lot of areas. But one of the things I think is probably underappreciated, as we've actually made investments in others. And so, while we have cut layers out of the organization and we've taken away our international division and we had really good people in our international division, but it was costing us time and effort. And now that we have all the segments reporting directly on our senior leadership team where a lot faster as a company, but we've also invested in capabilities.

So strategic revenue management and e-commerce, that has really shaped our business. We've also brought in a lot, as I said, a lot of people from the outside who had expertise that we really needed. And it's been really – it's been really gratifying to see the impact that they've been able to make internally. Because for awhile, we did – the kind of the narrative was that – people from General Mills came and they stayed forever and ever. And we still have a lot of people that do that and add a lot of value. But we've been able to bring in experts from expertise that we didn't have and they've integrated very well and to the rest of our business.

Alexia Howard

Are you able to give any sort of examples of capabilities that the company didn't have before, but through bringing people in from the outside, things have definitely improved?

Jeff Harmening

Yes. So the person who leads our strategic revenue management capability, he came from a beverage company. And there were a lot more sophisticated in their strategic revenue management than we were. And we've been able to bring a couple of more people in externally from, other companies who have been more advanced than we are in strategic revenue management.

And importantly, we’ve paired them with people internally. We really know our business well and are very analytically sound and so they are able to transfer their knowledge of the business to the new people and the new people have been able to transfer their knowledge of things like strategic revenue management.

We’ve done the same thing in the e-commerce. The person we brought in for e-commerce, came from a clothing company and they’ve seen a lot more in the e-commerce space than we have. He has seen movie before and again we pair those, came up with some people internally who know a lot about of our business in the food industry, so we can transfer that learning back and forth.

Alexia Howard

Are there any particular pieces of – I mean we have the 10 strategic revenue management a lot but is it more about the pack sizes or the pricing all that, I mean what have been the big lessons learned at the industry wasn’t really focused on before?

Jeff Harmening

Yes, there are a lot of there, you could play buzzword bingo when it comes to the pricing, strategic revenue management. But look there are only about four main components. One of them is everyday price. The other is price pack architecture. The third is trade promotion and the fourth is mix. Those are the four components and we call it strategic revenue management to make ourselves sound smarter. But those are really the four components.

And the key is to have an ongoing capability and play those four different components differently in different categories because you’re not going to be able to do the same things in cereal that you are an old El Paso, you’re not going to be able to do it. It’s not going to work the same way in the UK as it is going to work in China, as it is going to work in Brazil. So the key is to have a common framework across the company we have, but to make sure that you use the levers according to the different businesses and the different geographies. So you’re specific about how you apply those and then it’s an ongoing capability. It’s actually not more complicated than that.

Alexia Howard

Maybe I could do the same thing, you mentioned e-commerce and bringing somebody in from the retail side because they’ve seen the playbook before. Are you able to give any more color on specifically what is it that they know that CPG companies don’t pass on to familiar with because it’s earlier in the day.

Jeff Harmening

Well, it’s really when you talk about e-commerce is really about connecting what consumers do all the way through to their purchase cycle. Again, it’s about as straightforward as that. And then a lot of times the CPG company, you have marketing on one side and sales on the other. They’re actually merging and the key that e-commerce is to make sure whatever you’re doing on the marketing side flows all the way down through the point of sale.

And they really is integrating your marketing and having seen that before and help us to understand how to navigate that and structural organization in the way that we could do that seamlessly. And that’s one of the things about General Mills about our culture that that actually lends itself to something like e-commerce is a very collaborative culture. And if you’re going to be successful something like e-commerce, you need to make sure you have marketing and sales and logistics everybody collaborating. That’s one of the keys. Yes.

Alexia Howard

Turning on to the more financial side of things. At the end of 2018, you were – I believe, 4.2 times net debt-to-EBITDA and that’s obviously come down since the acquisition of Blue Buffalo and you plan to get this down to 3.5 times about a year from now. Will you be looking to do more large scale deals over time and which areas of focus are you looking for the M&A side of things?

Jeff Harmening

Yes, so as we’ve talked about capital more broadly, I mean our first priority is making sure we maintain our dividend and we’ve done that for over a 100 years. So we don’t take that lightly. The second is to make sure we pay down our debt and we’re well on our way to do that. That’s why free cash flow conversion is so important. And the fact that we’re over 100% for this year is important as well as hitting our financial targets. So as we said at the end of the third quarter, we’re well on track to reducing our debt levels that the rate we suggested both for this year and for next year.

And that’s important because as we look at M&A, the next first priority for us on M&A is to look at divestitures and we’re not divesting because we need to raise cash because we have plenty of cash. And I say that because we’re not just going to give assets away because we need to raise cash to pay down debt or to pay a dividend. We’re not in that position. Even if we don’t do any divestitures, we will continue to pay down debt and to pay our dividends.

The reason for us to do, to look at divestitures because we think there are some businesses where we’re just not going to invest enough in order to be able to grow those businesses and our resources are going to be better focused on things. We think we have a better chance of growing and give us a better return for our shareholders. So I’ve said publicly that we’re looking to divest roughly 5% of our business that’s still our target. And people have asked, well, what would cause you to change that? Well, we think the value we want. So we’re not going to – I’m not going to be strategically correct and actually pragmatically wrong.

We will divest the businesses to the extent that we see a good financial return. And if we don’t, I’ll come back and tell you we couldn’t do it, but it’s not to raise cash. Then you ask about businesses that M&A on the acquisition front. Our next couple of years really there’s going to be about paying down debt and paying our dividend and divestitures.

Having said that, we’ll look at acquisitions the same way we have historically which is going to be, is there a path to growth, is there an asset we can grow and do we think we have a right to win. And in that right to win is being able to lend our capabilities. And I know the pet food for many people when we bought pet food, they’re kind of shaking their heads and said, well, right, what right do you have to win in pet food?

But we have every right to win an extrusion technology. We have every right to win in thermal processing technology. We understand the channels that the pet food competes in and humanization of the categories one of the biggest trend and people talk about treats and pet food and if it’s something magical, it’s actually pet foods be for snacking, which were pretty big in.

So as we look at acquisitions in the future, we’ll look at places where we think we can grow, but also where we have a right to win. And we won’t go places where we don’t think we have a right to win. And having a right to win will mean that we have a chance to be successful in continuing to grow it, but we’ll probably also means synergies because if we have a right to win, there’s some capability that we can lend to that business already.

Alexia Howard

Do you target a specific dividend payout ratio or how do you manage the dividend at that time?

Jeff Harmening

We do not target a specific dividend payout ratio. And we’ve maintained, grown up for more than a 100 years. I think that’s pretty good record.

Alexia Howard

Okay. What are you investing in today that you think will have the biggest pay off over the next five years?

Jeff Harmening

Well, it’s hard to indicate any one thing that’s going to have a big payoff for the next five years. I would say we’re investing in our business to accelerate growth. So when bars and Häagen-Dazs and Old El Paso, we think that’ll have a big pay off. But if I were going to take a step back, I would say is continuing to invest in data and analytics and the key for us there I think is going to be, you have to invest in scale to make a meaningful difference. But you also have to be specific about what you invest in. So you don’t throw away money.

You don’t say you’re going to invest a certain amount of money in digital analytics and it doesn’t make any sense to me. The question is, can you do it, can you invest at scale and can you do it? Things that are specific enough that can help you grow and help you save money. So I think five years from now we’ll be able to look back and say, yes, we made some really good investments in data and analytics that are going to help our underlying growth as well as our underlying cost structure.

Alexia Howard

And then just finally to wrap it up with other items it’s as though analytics is sort a big piece of your agenda for the next few years. There are other general items that you’d have for you personally leading the organization over the next three to five years.

Jeff Harmening

Well, it was really, the tone gets set at the top of any company and show me a company with a leader who cares about culture and I’ll show you a culture. So for me it’s about leading intentionally with our culture and that’s one that’s going to be accountable culture, but also in a very inclusive culture, which I think is important in today’s environment. And internally we call it creating a culture and belonging. And that’s really important, especially as you see divisiveness, whether it’s economic or political or religious.

We’re creating a culture of inclusion, which is really interesting. And I think it’s helpful to understand that that’s what employers are looking for. And if you show me a culture that that people feel like they can belong, I’ll show you a company that can attract great talent that can keep great talent, and that can get great talent engaged. And when you have that as a company, then your chances are growth or a lot better and it’s hard to put that on the spreadsheet. So I can tell you that is the single biggest contributor to growth, it’s going to be a company that is looking for growth and that feel like they’re belonging somewhere and they are engaged.

Alexia Howard

Great. Thank you very much for joining us today. I really appreciate it and same thing here as well.

Jeff Harmening

Yes, thank you.

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