Ladies and gentlemen, thank you for standing by, and welcome to the Second Quarter Fiscal 2019 Earnings Conference Call. As a reminder, today's conference is being recorded, Wednesday, December 19, 2018. I would now like to turn the conference over to Jeff Stevens, Vice President, Investor Relations. Please go ahead, sir.
Thanks, Jennifer, and good morning to everybody. I'm joined here this morning by Jeff Harmening, our Chairman and CEO and Don Mulligan, our CFO. In addition, John Nudi, who leads North America Retail segment is joining us for the Q and A portion of the call. And I'll turn the call over to them in a moment, but before I do, I'll cover a few housekeeping items. Our press release on 2nd quarter results was issued over the wire services earlier this morning, and you can find the release and a copy of our slides that supplement our remarks this morning on the Investor Relations website.
Please do note that our remarks this morning 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 to everyone. I'll start this morning by offering some quick thoughts on our year to date performance. I'm pleased to say that our results through 6 months keep us on track to deliver our full year targets. Our cost and capital discipline drove profit growth ahead of our expectations in the first half of our fiscal year.
Our job to do for the second half is very clear and that is to accelerate our sales growth in our North America Retail and Pet segments while we maintain our cost discipline. And we're confident in the plans we have to do just that. Now I'll turn it over to Don Mulligan to walk through our financial performance in the quarter. Then I'll come back to provide an update on our fiscal 2019 priorities and share a few highlights on our second half plans.
Thanks, Jeff, and good morning, everyone. Let's jump right into our Q2 financial results on slide 5. Net sales of $4,400,000,000 increased 7% in constant currency, including contributions from the Blue Buffalo acquisition. Organic net sales declined 1%. Strong cost discipline and positive net price realization and mix helped drive margin expansion resulting in adjusted operating profit of $765,000,000 up 8% in constant currency.
And adjusted diluted EPS of $0.85 increased 2% in constant currency, driven by higher adjusted operating profit and a lower effective tax rate, partially offset by higher net interest expense and higher average diluted shares outstanding in the quarter. Slide 6 shows the components of net sales growth in the quarter. Organic net sales were down 1% driven by lower contributions from pound volume, partially offset by positive net price realization and mix across all segments. Foreign currency translation resulted in a 2 point headwind to net sales and Blue Buffalo added 8 points to net sales. Turning to our segment results on slide 7.
North America retail net sales were down 3% as reported and on an organic basis. Consumer takeaway was stronger with U. S. Nielsen measured retail sales down 1% and share gains in the majority of our top U. S.
Categories. Through 6 months, our shipments have lagged consumer takeaway by about 1 point with organic net sales down 2% and U. S. Retail sales down 1%. The main drivers of that difference were the comparison against last year's results that included co packing sales related to the Green Giant divestiture, changes in customer inventory levels and minor differences in the phasing of trade between the first and second halves.
Looking ahead to the rest of the year, we expect our shipments to track more closely to consumer takeaway. Looking at operating profit performance, reported net sales in U. S. Meals and Baking U. S.
Meals and Baking were down 2% due to declines on Progressive Soup and Betty Crocker Desserts and the elimination of Green Giant co packing sales. These declines were partially offset by strong performance on Totino's Hot Snacks, Old El Paso and renovation news on Annie's Mac and Cheese. Canada net sales were down 7% as reported and 3% in constant currency. U. S.
Yogurt net sales decreased 4% as declines on Greek and Light segments were partially offset by growth on We by Yoplait and YQ as well as improved performance on Go Gurt and Original Style Yoplait. U. S. Net sales U. S.
Snacks net sales were down 4%, driven primarily by lower than expected merchandising levels on grain bars, partially offset by good performance on Andy's Fruit Snacks, Larabar and Epic. Net sales for U. S. Cereal were down 5% due to lower merchandising levels and the comparison against 7% growth in the same period last year, partially offset by growth on Trix and Lucky Charms. Constant currency segment operating profit matched year ago levels as cost of goods savings, positive net price realization and mix and lower SG and A expenses offset lower volume and input cost inflation.
In Convenience Stores and Foodservice, 2nd quarter organic net sales were flat versus prior year. Our Focus 6 platforms generated 2% net sales growth led by strong performance on cinnamon rolls and restaurants, couch breakfast and bowl pack cereals in K through 12 schools and Chex Mix, salty snacks and convenience stores, offset by declines on Bakery Flour and other non Focus 6 platforms. Segment operating profit increased 3% in the quarter, driven by positive price mix and COGS savings, partially offset by higher input costs. 2nd quarter organic net sales for Europe and Australia segment matched year ago levels, driven by growth on snack bars, ice cream and Mexican, 3 of our accelerate platforms, offset by declines in yogurt. 2nd quarter net sales were also impacted by the challenging retail environment in France.
We drove double digit retail sales growth on Nature Valley and Fiber One Snack Bars by continuing to secure distribution gains, invest in effective marketing and bring successful innovation to market. On Haagen Dazs, retail sales also grew double digits as we continue to expand distribution with stick bar, mini cup and pint innovations and as we execute local brand activations to drive trial. And we're encouraged by our improved performance at Old El Paso, driven by new products such as our gluten free tortilla kits as well as effective omni channel consumer support. Segment operating profit in Europe and Australia was $22,000,000 compared to $27,000,000 a year ago, driven by higher input costs, specifically significant dairy inflation and currency driven inflation on products imported into the U. K, partially offset by positive sales mix and lower SG and A.
In our Asia and Latin America segment, organic net sales increased 5% in the 2nd quarter with strong growth on our global Accelerate platforms and on Wanchak Ferry in China. We drove strong double digit growth on snacks in India and the Middle East as we continue to expand distribution on Pillsbury Cookie Cakes and Betty Crocker Mug Treats. And our Nature Valley and Yolky brands performed well in Latin America behind effective consumer news and successful in store executions. Haagen Dazs continues to grow across Asia behind consumer activations and new channel development, including significant growth in e commerce and distribution expansion in new Haagen Dazs shops. In China, our Wanchai Ferry business delivered another quarter of growth, driven by dumpling innovation and strong in store executions.
Segment operating profit of $18,000,000 was down 6% in constant currency, driven primarily by higher input costs and higher SG and A expenses, partially offset by positive price mix. For our Pet segment, 2nd quarter net sales were down 7% on a pro form a basis, reflecting the comparison to 25% pro form a growth in last year's Q2 when Blue first expanded into the Food, Drug and Mass or FDM channels. Blues consumer pool remained strong with year to date retail sales up 9% in line with Blues 2 year compound growth rate for pro form a net sales. Segment operating profit of $71,000,000 was $18,000,000 below the prior year on a pro form a basis, driven by lower volume, significant input cost inflation, plant start up cost and intangible amortization, partially offset by cost savings and benefits from positive price mix. In a moment, Jeff will outline our second half expansion plans for Blue Buffalo, which will drive Blue to our full year targets of double digit top and bottom line growth.
Slide 12 covers our margin results in the 2nd quarter. Adjusted gross margin increased 10 basis points and adjusted operating profit margin was up 40 basis points over the prior year. Margin expansion was driven by increased savings, benefits from positive net price realization and mix, the addition of Blue Buffalo and tight control of our cost, partially offset by higher input costs. Slide 13 summarizes our joint venture results in the quarter. Cereal Partners Worldwide net sales increased 2% in constant currency due to strong performance in our Asia, Middle East and Africa as well as Europe regions, partially offset by declines in Latin America.
Haagen Dazs Japan sales were up 1% in constant currency, driven primarily by growth on core mini cups and multi pack offerings. Combined after tax earnings from joint ventures totaled $22,000,000 in the quarter compared to $24,000,000 a year ago, driven by higher input costs. Slide 14 summarizes our other noteworthy income statement items. Restructuring impairment and other exit costs totaled $209,000,000 including $193,000,000 of impairment charges related to the Progreso, Food2TasteGood and Mountain High brand intangible assets. Corporate unallocated expenses, excluding certain items affecting comparability increased by $13,000,000 in the quarter.
Net interest expense increased $58,000,000 driven primarily by financing related to the Blue Buffalo acquisition. We continue to expect net interest expense to total approximately $550,000,000 for the full year. Adjusted effective tax rate for the quarter was 23.8% compared to 29.3% a year ago, driven by net benefits related to U. S. Tax reform.
We continue to expect our full year adjusted ETR will be in the range between 23% 24%. And average diluted shares outstanding were up 4% in the quarter. Slide 15 provides our first half balance sheet and cash flow highlights. Of the Q2, our core working capital stands at $532,000,000 down 5% compared to the same period last year, as benefits from our terms extension program were partially offset by the addition of Blue Buffalo to our balance sheet. First half operating cash flow totaled $1,400,000,000 compared to $1,600,000,000 in the prior year, primarily reflecting less benefit from changes in accounts payable.
Year to date capital investments totaled $254,000,000 For the full year, we now expect capital investments to be approximately 3.5% of net sales. We converted 120 percent of adjusted after tax earnings into free cash flow through 6 months and we returned $589,000,000 to shareholders through dividends in the first half of fiscal twenty nineteen. I'll close my portion of our remarks by summarizing our year to date financial results and reaffirming our full year targets on sales, profit, EPS and cash flow as shown on slide 16. First half net sales increased 8% in constant currency. We expect net sales to accelerate to 9% to 10% constant currency growth for the full year, driven primarily by acceleration on Blue Buffalo.
Organic net sales essentially matched year ago levels through 6 months. Our full year expectations of organic growth remains between flat and up 1%. Year to date adjusted operating profit increased 5% in constant currency. These results include a 4 point headwind from the one time purchase accounting adjustment related to the Blue Buffalo acquisition. We continue to estimate constant currency adjusted operating profit will increase 6% to 9% in fiscal 2019, including a 2 point full year headwind from the purchase accounting adjustment.
First half adjusted diluted EPS was up 1% on a constant currency basis despite a 5 point headwind from the one time purchase accounting adjustment. These results were ahead of our full year guidance for constant currency adjusted diluted EPS, which is a range between flat and down 3%, including a 2 point full year headwind from the purchase accounting adjustment. We now expect currency translation will be a 1 to 2 point headwind to full year net sales, but won't have a material impact on operating profit or EPS. And as I mentioned, our first half free cash flow conversion was 120% ahead of our full year target of 95% or better. With that, let me turn it back over to Jeff to provide an update on our fiscal 2019 priorities and outline our key deliverables for the back half of the year.
Jeff? Thanks, Don. And on Slide 18, you can see the 3 key priorities we laid out at the beginning of our fiscal year: grow the core, successfully transition Blue Buffalo and deliver our financial commitments. Let me share our progress on each of these priorities through the first half of our year. At our Investor Day in July, we outlined 5 keys to growing the core and I'm pleased to say that through 6 months we've improved in each of these five areas relative to fiscal 2018.
We returned to market share growth in U. S. Yogurt. Year to date organic net sales in our emerging markets were up high single digits. We are seeing good results from our first half innovation and our U.
S. Distribution trends have improved and we grew our share of distribution in the 2nd quarter. And we're seeing a step up in contributions from organic price and mix from 1 point in fiscal 2018 to 2 points through the first half of twenty nineteen. Through the first half of this year, pricemix has contributed to net sales growth across each of our reporting segments. In North America retail, price mix contributed 2 points of sales growth, which is in line with the results we're seeing in the broader industry.
In fact, 8 of the top 10 U. S. Food and beverage manufacturers have generated positive price mix so far this year, including General Mills. We anticipate the strategic revenue management actions we implemented in the first half will continue to benefit our results as we move to the second half. We're competing well across most categories this year as measured by our market share performance.
On slide 20, you can see that we grew share in 6 of our 9 largest U. S. Categories in the first half. However, we know there's still work to do, including in cereal and snack bars, our top 2 categories. We have plans in place to improve our performance on these businesses in the back half of the year.
With this as a backdrop, let me share some specific examples of our year to date performance against our grow the core priority for our key platforms around the world. Our first half results in cereal were mixed across channels and geographies. In U. S. Retail, positive contributions from strong innovation including Cheerios Oat Crunch, Maple Cheerios and Lucky Charms Frosted Flakes were outweighed by reduced merchandising activities.
2nd quarter cereal merchandise volume was down 7% as we focused on implementing pricing and pack changes at the shelf early in the quarter. With those changes behind us, we were able to get back to more typical merchandising levels by the end of the quarter, helping drive November cereal retail sales in line with last year. And we're confident we can improve on our first half cereal performance as we rebalance our merchandising levels in the second half. In Convenience Stores and Foodservice, we continue to drive low single digit cereal net sales growth led by good performance in our K-twelve schools and colleges driven by excellent performance on We by Yoplait and on Go Gurt. Driven by excellent performance on We Buy Yoplait and on Go Gurt.
We continue to impress with retail sales up double digits to the first half led by core SKUs and innovation such as We Petit. In fact, We Buy Yoplait has grown to a 2 share making it our 3rd largest business within the yogurt category behind Original Style Yogurt and Go Gurt and helping us to build a leadership position in the fast growing Simply Better Yogurt segment. On Go Gurt, great equity flavor additions like Sour Patch Kids drove 3% retail sales growth so far this year. It's also worth noting that our original style yogurt business stabilized in the first half of the year behind more real fruit product news and solid in store execution. Outside of our core global platforms, we like the way we're competing in a number of regional businesses this year.
In the U. S, our Pillsbury refrigerated baked goods are off to a strong start as we enter key baking season with retail sales up 2% year to date and 3% in the latest quarter, fueled by our Made at Home media campaign, strong innovation and in store display. Cucino's Hot Snacks grew retail sales 6% driven by solid marketing and our expansion of value size offerings. And we continue to generate excellent growth on Wan Chai Ferry in China with retail sales up high single digits through the first half of the year. New flavors on the dumpling line such as cucumber have created excitement on the core business and our superior taste campaign continues to resonate with consumers.
The second component of growing the core in fiscal 2019 is increasing growth on our 4 global accelerate platforms. Global retail sales for Old El Paso were up 2% in the first half led by the U. S. Where retail sales were up 6% to date and 7% in the most recent quarter driven by distribution gains and consumer investment. Our innovation Hint of Lime Stand and Stuffed taco shells continues to drive variety for taco night for consumers and we're bringing back our highly successful in store Old El Paso taco stand displays in the second half of the fiscal year.
Our natural and organic brands are incredibly relevant with consumers today. While our aggregate retail sales are being slowed by the exit of some unsuccessful category expansion volume, we're seeing excellent results as we increase our focus and support behind our core products. We love the results on Annie's Mac and Cheese. We renovated our classic SKUs and increased our support behind the business, resulting in double digit gains in distribution and in retail sales. Annie's is now the number 1 boxed mac and cheese in a number of accounts including Whole Foods and Target.
We're driving solid performance on Annie's fruit snacks and pancake mixes as well and we see more opportunities to grow our core natural and organic products. For example, we recently updated our packaging on Muir Glen product line, which celebrates the brand's star ingredient, the tomato and gives a nod to Muir Glen's California heritage. Global snack bar growth took a step back in the 2nd quarter with year to date retail sales down 1%. We're seeing 2 different stories between our international and North American bars businesses. International bars growth continues as strong double digit sales rates.
Europe and Australia is driving retail sales growth with strong in store execution and distribution gains on Nature Valley Protein and Fiber One Brownie. Contributions from innovation remained strong behind nut butter biscuit line extensions and Fiber One popcorn. In our Asia and Latin America segment, the investments we have made in India in distribution expansion, innovation and consumer engagement are paying off for us. We're building on the success of Pillsbury branded cookies and pastry cakes by expanding into new flavors and formats. In the U.
S, our barter's results have underperformed our expectations through the first half of the year. Nature Valley performance weakened in the 2nd quarter driven by lower merchandising support and customer inventory reductions. We have plans in place to increase merchandising frequency in the second half. Our Fiber One bars performance in the U. S.
Has remained challenged. We expect continued declines in the near term as we cycle through distribution losses. Looking further ahead, we see an opportunity to renovate the Fiber One product line and make it more relevant and we'll share more as those plants get closer to completion. On the positive side in bars, Larabar retail sales continue to grow double digits in the first half behind expanded distribution, innovation and brand support. Protein 1 while small is showing early signs of success and you'll see a new Protein 1 social media campaign launched in January featuring celebrity Mindy Kaehle.
And retail sales of Epic for Epic are growing double digits driven by the core meat bar SKUs and snacks as well as the new Epic Performance Bar we launched this summer. On Haagen Dazs, our final Accelerate platform first half retail sales were up 13% led by double digit growth in Europe behind mini cup expansion in the U. K. And peanut butter innovation in both pints and sticks. Retail sales in Asia grew low single digits due to continued success on innovation and strong consumer activations.
We delivered broad based market share growth across our Asia Haagen Dazs countries. As we shift our focus to the second half, we're looking to improve our top line trends in a few different and specific areas, most notably in U. S. Cereal and Snacks. Our second half plans call for stronger merchandising support on these businesses with a focus on greater frequency as opposed to depth of promotion.
We have a really good slate of second half consumer news, events and partnerships with equities like Pokemon and Avengers and we like our back half innovation lineup including Cinnamon Toast Crunch Churros, Fruity Lucky Charms and Nature Valley Snacks Mix. And we've addressed some capacity issues which constrained growth on both cereal and snacks in the first half. In total, these initiatives will set us up to deliver improved growth on our U. S. Cereal and snacks businesses in the second half.
Now let's move to our 2nd priority this year, successfully transitioning Blue Buffalo into the General Mills family. We feel good about the progress we're making here and we continue to see tremendous long term growth for the Blue brand. Still, I'm sure many of you have questions about Blue's sales performance this quarter. As we said on the Q1 call, we expect the timing of channel expansion will continue to drive significant variability in our quarterly net sales results. In the first half, our net sales results lagged consumer takeaway.
We'll see this reverse in the second half, specifically in the Q4 when we take another big step in our food, drug and mass expansion. Amid this variability, we think the right measure to track is Blue's end market performance. And I can confidently say that on this measure Blue continues to succeed. First half retail sales were up 9% and market share was up 40 basis points across all channels. Blue's expanded availability is helping reach more pet parents with household penetration up 26% this calendar year to date.
Blue is the fastest growing pet brand in food, drug and mass and has become the number one branded dog food in a few leading food, drug and mass retailers. And Blue remained the number one brand in pet specialty and the number one pet food brand online. On slide 28, you can see how Blue's 9% retail sales growth breaks down by channel. While we haven't added any new significant Food, Drug and Mass accounts in recent months, we're still seeing strong performance in the accounts that have carried Blue for more than a year, with progressive share gains each quarter. Blue retail sales across all food, drug and mass channels increased by triple digits versus last year's first half.
Blue continues to see double digit retail sales declines in the Pet Specialty channel in line with our expectations. We will keep engaging with this important channel and bringing product variety, unique innovation and consumer education that helps ensure Pet Specialty remains special. And Blue continues to grow and gain share in the important e commerce channel, which makes up roughly 25% of Blue's net sales. First half retail sales and e commerce grew 30% and we expect continued strong growth as we move into the second half of the year. Our second half plans for Blue Buffalo will strengthen both top and bottom line growth for the business.
On the top line, we'll launch Blue into new food, drug and mass customers in the back half that will double our ACV distribution by the end of the fiscal year. In addition, we'll expand the variety of Blue product offerings available in the Food, Drug and Mass channels, which will accelerate growth even further. These actions will begin in February, which falls in Blue's 4th quarter. We expect Blue Buffalo's 3rd quarter net sales results will improve over Q2, though they will likely continue to lag our retail sales trends. In addition to top line acceleration, we also have significant actions underway that will improve our profit margins in the back half.
For example, we expect to deliver increased savings including benefits from a new distribution center that opened last month. We'll see our synergy savings ramp up, we'll benefit from strategic revenue management actions we've implemented recently and we'll see a more profitable mix of business with a greater proportion of food, drug and mass sales in the higher margin wet and treats segments. These second half plans keep us on track to deliver double digit top and bottom line growth for Blue Buffalo as we outlined at the beginning of the year. Shifting gears to our 3rd priority, delivering on our financial commitments. You've heard a number of these things throughout today's presentation.
We're generating increased COGS savings this year, including benefits from our global sourcing efforts. Our efforts on strategic revenue management are paying off driving price mix contributions ahead of last year. And we're exhibiting strong discipline on our cost and capital resulting in 2nd quarter margin expansion, lower capital spending and reductions in our core working capital balances. While we feel good about the progress we've made against our fiscal 2019 priorities, we know that there is still work to do to ensure that we deliver a successful year. Slide 31 summarizes the 3 most critical jobs to be done in the second half.
First, we will improve our top line performance in North America retail. I already mentioned the plans we have to strengthen U. S. Cereal and Snacks results. We'll also see benefits from areas that have been working so far this year, including strong innovation, increased price mix from strategic revenue management actions we implemented in the first half and continued improvement on U.
S. Distribution trends. 2nd, we'll execute our food, drug and mass expansion for Blue Buffalo, which will keep us on track to deliver double digit net sales and operating profit growth for the business, excluding acquisition related charges. And third, we will continue to maintain our strong cost and cash discipline, driving increased benefits from continuing our spending discipline in SG and A and capital expenditures and realizing further improvements in core working capital. I'll close by summarizing today's key messages.
Our first half results keep us on track to deliver all of our full year targets. Good cost control drove first half profit results ahead of our expectations. We have clear plans for the second half to improve top line trends in North America retail and to significantly expand Blue Buffalo availability, while maintaining our cost and capital discipline. With that, let's open the line up for questions. Operator, can you please give us the first question?
Thank you. You. Our first question comes from the line of Ken Goldman with JPMorgan. Please proceed with your question.
Hi, good morning, everyone. Thank you. If I could ask one on Blue Buffalo and then one on costs. When Buff first went into the FDM channel, there was obviously some blowback from legacy customers as expected. But now you're adding some more varieties into FDM.
Can you talk a little bit about what that means? Are you adding Wilderness? Can you talk about what you're modeling in terms of additional maybe negative reactions from legacy customers as you do add these varieties? I just want to get a little more sense of what actually the products are going and where those products are going?
Okay. Thanks for the question Ken. I'll give you some level of specificity, but maybe not all the way to what you seek. What I would say is that in terms of varieties, we do plan a significant expansion of varieties. And one of the things I'm most pleased with is that given the success we've had in food, drug and mass so far,
we'll see a
lot of variety expansion and it will be highly incremental to what we currently have. And I think that strength speaks to the strength of the Blue Buffalo brand and FDM and the success we've had in rolling it out not only in terms of distribution growth, but actually maintaining and even growing the sales in places where we have it. I think that's probably the most important takeaway. In terms of Pet Specialty, I mean we've declined double digits and look, we're not happy with that long term trajectory. On the other hand, it's what we modeled would happen.
And so it's kind of in line with our expectations. We're dedicated to the pet specialty channel for the long term. And what's interesting is that in some pet specialty customers that have continued to feature Blue and have distribution and go with their innovation and promotion plans, their categories are actually doing better than those that haven't. And so think which is not a surprise given that Blue Buffalo is 2 times the next largest brand in that channel. And so we think we haven't modeled our Pet Specialty business to increase for the rest of the year, but we're certainly hopeful over time that it can and we know what it will take.
It will take really good innovation. It will take partnering with our accounts to keep the in store experience what it always has been which is one of the points I think of competitive advantage and good promotion plans. And so we haven't counted on our performance improving in Pet Specialty, but we're certainly dedicated to the channel and we're optimistic that we can actually turn that performance around over time.
Okay. Thank you for that. And then my follow-up is a few quarters ago, I think it's fair to say Mills ran into some bumps regarding cost visibility, especially on the transportation and logistics side. Can you walk us through a little bit which improvements you made toward improving this visibility? One of the things I hear from some people is they sort of got burned that quarter a little bit and they're just a little bit nervous about being confident in your cost visibility there.
And then along those lines, are you seeing any easing in your freight expenses ahead? We've seen spot transport rates peak and at least temporarily and oil prices are certainly down. So any color there would be helpful.
Sure, Ken. This is Don. We did you're exactly right. We ran to above, but we didn't have the visibility we needed. We made some changes from a systems and a process and an information flow standpoint internally to make sure that we are getting the sufficiently granular look at what the costs are.
And also make sure that we were talking about what were the drivers, drivers so we had a better sense of how they could evolve over time, what the range of potential outcomes were. And that is the combination of those things has given us much greater visibility into our cost structure. And it's one of the reasons that it's allowed us to over perform on the bottom line. We came ahead of our plan in the Q1. We essentially matched our plan in the Q2.
So we're exiting the first half slightly ahead on the bottom line. And I think all the work that we did on the systems and the process and the information flow has paid dividends and helped support that. As far as inflation, we're still expecting 5% across the company for the full year same as we guided. There are obviously, there's been some movements up and down over the course of the year with tariffs and just harvest and so forth. But in total, we're still at 5%.
And as far as logistics and our freight costs in particular, we still see those being up double digits. As we talked in some detail last year, we do annual contracts that are tied to our fiscal year. And that contract this year reflected the higher in market costs, which again we expect to see throughout the balance of our fiscal.
Great. Thanks,
Don. Our next question comes from the line of Chris Goe with Stifel. Please proceed with your question.
Hi, good morning.
Good morning, Chris.
I just had a couple of questions for you here, if I could. I did want to ask, you had a number of factors that aided your gross margin performance in the quarter. It was better than what I expected as well. I just was curious, did pricing and I guess your overall SRM initiatives, did those get to a point where they overcame cost inflation in the quarter? That is your pricing mix and promo.
And then I'm just curious with the promotional spending kind of variations in the business, I'm thinking like the U. S. Cereal. How did that did that flat of the gross margin, but obviously it could hurt sales and will that kind of reverse in the second half of the year?
Well, yes. So year to date, I'll focus on the second quarter. We had operating margins were about 40 basis points ahead of last year. Gross margins were about 10 points ahead of last year. There was really 3 key contributors.
One obviously was addition to Blue Buffalo, which is a higher margin business both in the gross margin and the operating margin level. We talked about tight cost controls that was in the plants, it was in our administrative functions and that was a benefit to the operating profit but also to the gross margin. And then and price mix together more than offset our input cost inflation. And those 3 Blue Buffalo, the ongoing cost controls and price versus inflation contributed an equal measure to our over performance and our growth operating margin in the Q2. Obviously, it was offset there was some offset from lower volume and the deleverage that we saw there, but those were the 3 primary drivers of the improved performance.
They were about an equal measure. And so we are seeing the benefits of our SRM activities come through.
And the second part of your question Chris I think is also important as we think about the second half of the year and price and mix. And look we realized about 2% price mix in the first half and we'll think and importantly we realize that across all segments. So I think that's important. And we see continued benefits from price mix in the second half of the year. And I mean I suppose if you're listening and you hear us talking about need to make sure our merchandising on cereal and snacks is a little more competitive, you might wonder, okay, does that mean we're going to take a margin hit in the second half or can we generate pricing?
And the answer is, look we're talking about 2 specific categories. The rest of our top eight, our pricing is in good shape. And for the rest of the company, we feel like we got good pricing plans in place. On top of that, something you might not think about, but certainly we do is that on an enterprise level, to the extent that we grow Blue Buffalo double digits in the back half, which we have a great line of sight to doing and we pick up our growth on cereal and snacks, There is a net price mix at the enterprise level even without taking pricing because the price per pound that we get from pet and from cereal and from snacks and as well as actually some of the other accelerated categories like Haagen Dazs and Olapaso, they're better than the company average. And so as we look at the back half of the year, we see an ability to continue to generate price and mix in the marketplace.
Okay. Thank you. That's helpful. And then just one quick follow-up for you on cereal. You gave the consumption data by month and negative 3, negative 2 in cereal, how it got better throughout the quarter.
Your cereal sales were down 5. Obviously, there's a bit of a gap there and I'm sure it's driven by the promotional cadence. Our inventories do they have to rebuild? Are they at the right level here from this point going forward?
Hey, Chris, it's John. One of the things to keep in mind last year in Q2 cereal, R and S was up 7%. So again, we've got a tough comp there. Overall, we bled some inventory through the first half across U. S.
Retail and cereal is a part of that. And we expect as we move through the back half of the year that that won't be as big of a headwind. So again, we think the comps get better for us, where merchandising will come back and we believe that we'll have a much stronger back half from a cereal standpoint.
Okay. Thank you.
Our next question comes from the line of Robert Moskow with Credit Suisse. Please proceed with your question.
Hi, thanks. I guess I have two questions. One is on Blue Buffalo. Sales in 2nd quarter were lower sequentially than 1st. And I guess that's the result of things getting a little weaker in the specialty channel.
Is that a fair assessment? And then secondly, when you launch it in this big retailer and double the ACV, how comfortable are you that these are completely incremental sales? Like there must be pet consumers who are going to shift their channel shopping from one channel to the other. What's the algorithm on that in terms of incrementality that you've seen historically? Then the last part about that incremental question, I guess, is, you talked about wet and treats.
Is Blue really good at wet dog food? Is it really good at pet treats? And what's the durability of these types of extensions because those areas I guess aren't exactly what consumers are familiar with from the core blue? Thanks.
Hey, Rob, this is Jeff. And you asked a number of questions. Let me make sure I hit. If I don't hit all of them, it's not because I'll try to avoid it. I just forgot one.
So let me try to hit them kind of sequentially. In terms of the Q2, the slowdown in reporting net sales, it actually isn't fair to say that it was a slowdown in pet specialty or pet specialty declines were pretty much the same year over year. It really is a matter of our comparisons to a year ago and inventory builds. And so the way I like to think of it in the Q2 of this year, we're comparing to 25% growth last year, we declined 7% this year. So over a couple of year period that's about 9% compound annual growth.
If you look at our takeaway in retail sales, it's about 9% compound annual growth. So it really the deceleration in RNS has nothing to do with takeaway, nothing to do with a decline further decline in pet specialty. It has everything to do with lumpiness of RNS as it relates to inventory build. We will see that reverse completely. In fact, we will see it reverse completely and then some in the back half of the year specifically in the Q4 starting in February as we build inventory and ahead of our new distribution gains.
In terms of incrementality, one of the reasons why I mentioned household penetration is because there are a lot of numbers I could throw out about incrementality and we've done a lot of studies. But and what we found is that our launch into food, drug and mass has been highly incremental for the Blue Buffalo brand. But one of the measures is household penetration and one of the things I'm most pleased with is our household penetration is up 26% as opposed to our retail sales being up 9%. And as we've launched into these other channels, it's really good to see our household penetration expand because that says there's all of the gains are not coming out of our current business and not just trading out what we've done in pet specialty or online, but the brand continues to grow, continues to gain new consumers. We saw the same kind of phenomenon with Annie's.
We've seen it with Larabar. We've seen it with Epic. And when you can get household penetration increasing ahead of your consumption, it actually portends really good things. Your last question is about wet and treats. And right now Blue Buffalo under indexes on wet and treats.
I think it's a huge opportunity for us. And for treats, I mean that's just pet food speak for snacking. And we see snacking can trend in human food and we see it in pet the same way. And one of the things when we bought Blue Buffalo we were excited about was that the humanization of pet food, we see the same kind of trends that we do in human food. And so we can we feel like we've got good visibility to where the consumers' minds are.
And we think that the treats business is going to continue to grow and we enter index and we think it's a huge opportunity and we're pleased to see that it's growing. And the nice thing is as we grow that differentially, we'll see improved margins because the margins on those businesses tend to be better.
Got it. All right. Well, I guess the question that I had about sequential is because I don't see a lot of seasonality in the business in pet food. Pet owners just keep feeding their dogs the same amount every time. So that's why I was looking at the sequential growth coming down.
So is there any reason to believe that that's not the right way to look at it? Why would seasonality matter?
Seasonality really doesn't matter much. You're right. Pets tend to eat about the same amount every day. And it really has to do I think the most important point Rob is to take away is this building of inventory and how it looks quarter to quarter. And that's why I get back to the retail consumption as being the main driver because I'm going to tell you our Q4 is going to be really high and it's going to look really good for Blue Buffalo and it will be good.
But we have to keep but the key is really making sure we have the underlying consumption in mind.
Rob, this is Jeff Siemon. I would just I would mention Q1 of a year ago for Blue Buffalo, net sales grew in the low teens maybe close to 15%. Q2 it moved up to 25%. So that's why you see this year's deceleration is really the acceleration you saw last year in the comp driven by the Food, Drug and Mass launch. Q3 last year was about 15% growth in net sales.
And Q4 was only up low single digits. So again, you saw a lot of variability last year. As we comp that this year that will have variability. And then as Jeff said, our Q4 as we expand Food, Drug and Mass, you'll see a big acceleration.
Okay. Thank you.
Our next question comes from the line of Jason English with Goldman Sachs. Let's proceed with your
question. Hey, good morning folks.
Thank you for letting me ask a question. I want to come back to margins and ladder into the U. S. Retail segment. First, going back to gross margins, just to make sure I kind of have the numbers right.
We've got Buff adding maybe 80 bps or so. So underlying, we're looking at down 70 bps, which looks like the math would suggest just the volume leverage. Is that roughly right?
Buffalo was probably a little less
of that in the quarter. It will be in that neighborhood for the full year, even a little higher for the full year as we alluded to when we announced the deal. But in the first in the second quarter, excuse me, it was
a little less than that
just given the fact that we had some volume deleverage in the inflation and plant start up cost in the number.
Got it. That's it.
But you're directionally correct. Pet Pet added and the base business was slightly down on a gross margin basis year over year.
So it's not surprising to see the base business down a bit. Clearly, it's sequentially getting better, which is the right trajectory. I was surprised that you still had with basis as gross margins down, you still had as much margin leverage in North America retail. Can you help me understand some of the drivers? And I guess what we're also going to is, is this another quarter where you pull back a lot on A and P?
And if so, is there do you see any parallels with the sequentially eroding volume trend for now sort of the Q4 row with sort of consistent pullback on A and P?
No. What we saw in U. S. Retailer NAR was the same trends we saw for a total company standpoint. We have strong we have price mix benefit coming through.
We had really strong cost control in our plants. So our manufacturing costs came in very tight. And those combined to deliver better profitability at the bottom line than sales.
So it's not just marketing related then, it's sort of core underlying, is that the message?
I think it is. I mean, it really is a matter, Jason, of price mix and exceeding inflation. And the what I and I think you see that because our Q2, it was our merchandising results that really lagged our expectations. What we sell at an everyday price was actually at or above our expectations and that's the best margin. And so from a margin standpoint, we're really pleased with what we're selling at an everyday price And what we merchandised was really what drove what was really the cause for our sales being a little below what we had anticipated, which has
a pretty good margin impact. Just to build on what Jeff laid out, our baselines through the first half were flat in North America retail, which we feel really good about. It was really merchandising, which was all of our declines and primarily in cereal and snacks. So we feel like our total commercial investments in a really good place. We feel like our innovation is really working.
Our marketing is strong and the base business is performing. We clearly had some execution issues, particularly on cereal and snacks merchandising. We've got plans in place to fix that. And you saw in November, cereal get better as we got our merchandising more in line. So we have good confidence that we can accelerate the top line and at the same time continue to drive good margins in the back half.
Good stuff. Thanks guys. I'll pass it on.
Okay. Thanks.
Our next question comes from the line of Pablo Zviyanik with SIG. Please proceed with your question. Mr. Zvanik, your line is open. Please go ahead.
Thank you. Good morning, everyone. Two questions on pet food. The first one is more just bigger picture. On the one hand, as we see more premium pet food brands in mass, we hear about consumer pushback about Walmart consumer $40,000 a year, not being interested in this type of products.
But on the other hand, clearly, more retailers are adding more space to premium pet food. So try to resolve that conflict for us or that contradiction. And my visits to stores, for example,
I would say Target these days seems
to have eliminated a lot of the mass brands and you're seeing a lot more premium. So when you launch at these new retailers, let's say, including Walmart, are other brands on the premium side also entering that aisle? So again, the big picture question is trying to reconcile this idea of pushback on the consumer on this more expensive pet food, but on the other hand, apparently, a number of retailers continuing to add a greater percentage of space to premium pet food? Thanks.
Well, Pablo, I appreciate the question. I think what we see is that first as Blue has entered, it's been really successful. And in fact, year to date has driven something on the order of 40% of the growth in food, drug and mass. And so this premium part of the pet food segment especially kind of the wholesome natural area, Blue Buffalo is driving that growth. And interestingly as Blue has come into the Food, Drug and Mass segment, it's actually grown the whole segment.
So the whole segment is growing. And the customers that have taken Blue Buffalo are growing faster than the ones that haven't. And so what that said to me, there is a premiumization going on in pet food similar to what we see in human food and what you see in what we've seen in natural and organic. So again the trends there are very similar. And we've had I think it also what also speaks to the success we've had with Blue Buffalo and Food, Drug and Mass as well as e commerce by the way, It's number 1 online and it's number 1 in pet specialty.
So it's doing well across channels and great brands do well across channels. And we see that with Cheerios and we see that with Annie's. And so what we're seeing in Blue is kind of what we expected and it's importantly it's driving success in the whole segment of wholesome natural and food, drug and mass. And it's really some of the mainstream brands that have seen declines.
Right. And just a follow-up. So Petco has made some news in the trade press in terms of making significant assortment changes to a portfolio there, taking out brands, focusing on natural ingredients. Any impact on Blue Buffalo? Can you try to quantify the exposure for your business there?
We don't comment on any specific retailers, but I will say that all our brands are natural. And so we feel good about the ingredients in Blue Buffalo and certainly wouldn't anticipate any negative consequences from that activity.
Thank you.
Our next question comes from the line of John Baumgartner with Wells Fargo. Please proceed with your question.
Good morning. Thanks for the question. Hi, John.
John, I just wanted
to come back to the softer merchandising in Q2. I mean, there's been a lot of talk about shifting your approach to, I guess, more non price promo. And I'm curious as to how this influenced performance. Was the softness kind of a function of competitor stepping with sharper elbows for price promo or and you have to I guess increase your price promo going forward more than you thought? Or is the non price promo just see weaker lifts?
Just curious on more of the background there and the transition moving forward?
Yes, sure, John. Great question. What I would say was there is really 2 specific categories and some specific issues within each which drove to our merchandising softness. So for cereal, we executed a pack price architecture project through the first half that touched nearly 70% of our alliance. So it was a major project.
On top of that, we had capacity constraints in our flake cereals. And combined, the 2 caused some disruption in our execution, particularly in the months of September October, and we didn't get the merchandising that we had expected. We got back into business from a merchandising standpoint in November, and we saw our business bounce back. For snacks, we've had capacity constraints on 2 of our major platforms there as well and also some timing shifts from major retailers from Q2 to Q3. So we feel really good about our ability to get merchandising and actually get back to plan from a merchandising standpoint.
That will shift out again from Q2 to Q3. You're starting to see it already. Again, November was a much better month. Through 2 weeks of December, the Nielsen that's out, you can see that our momentum continues and we're actually up 1 overall in dollars. So it was really cereal and snacks.
There are specific drivers that again are in the past. We feel good about our ability to execute moving forward.
Great. And then just a follow-up for Don. In terms of some of the businesses that you're thinking about maybe selling some of the slower growth assets, any updates there in terms of timing or maybe what you're how the volatility of the market impacts some of those plans going forward?
Yes. There's no update. We spoke in the past about looking at roughly 5% of our portfolio that's still in line, but we don't have any update until we're ready to pull the trigger on something.
Great. Thanks for your time.
Our next question comes from the line of Akshay Jagdale with Jefferies and Co. Please proceed with your question.
Good morning. Thanks for taking the question. So my first question is on Blue Buffalo. As far as the mass or the FDM expansion goes, I think it's well publicized now that there's a delay in the resets at 1 major retailer by about 7 weeks or so. And so in light of that, you've still maintained your guidance.
So that leads me to believe that you weren't really baking a lot of that in your guidance to begin with. But can you just help us understand some of the delays in shelf resets, how that has impacted your numbers? And then related to that, I think Jeff, you made a comment about how the mix of that business is actually margin positive. I think there's a big disconnect in expectations on this on our side as to the FDM channel being sort of margin mix neutral to positive going forward?
Yes. So in terms of the second half distribution, Bill, when we came into the year, it's fair to say that we assumed that we would have a big push in our distribution plans kind of at the end of January. And for a variety of reasons that's going to be delayed by a few weeks. To be honest, in the life of a brand, it's not a big deal. What it means is that it because it really starts in February now instead of January it pushes it into our 4th quarter instead of our 3rd.
But in terms of what it means for the brand, to be honest, it's not a huge deal. And what I would also say is that we have been while that delay may have impacted the year a little bit to the negative, our product expansion, our variety expansion to other customers is going to be frankly the uptake on that is going to be better than we anticipated because Blue has been so strong in those initial customers we launched into a year ago. So when you net those things together, we'll have strong growth in Food, Drug and Mass for the year. So we feel really good about that. In terms of wet pet food and treats, if I understand your question correctly, what we see is that there will be a product mix in Food, Drug and Mass.
It will be a little bit different and skew a little bit more toward the Wet and Treat segments where the profit margins are better. I mean, first of all, they're all good. All the profit margins in Pet are good. Certainly relative to General Mills average, those tend to be particularly good. And as we push into that, that's one of the reasons our household penetration is up higher than our sales because as we expand into food, drug and mass and also why it's incremental because we see product mix.
Perfect. And one follow-up maybe for John related to North America and the recovery in the context of your guidance again, right? So you maintained your sales growth guidance implies a pretty significant turnaround in the businesses in the back half. And you pointed to some, what I would call, tactical changes or improvements, right? So can you help us understand how like better merchandising, let's say, on snacks could have a material impact like because it seems like that's what needs to happen to get to the top line numbers?
Thanks.
Yes. So I'd say 2 things. 1, again, as we look at the underlying health of our business through the first half, we feel good about it. Our baselines were flat. Distribution points are heading in the right direction.
We feel good about innovation and marketing. So the base business feels strong. It was really merchandising that we saw the missed plan. And as I mentioned before, we have a good line of sight to getting that merchandising back into the back half. The other thing that I believe Don touched on in the prepared remarks is through the first half there was a difference between what we reported in R and S and what Nielsen movement was.
Some of the drivers there were the Green Giant comp that we had through the first half that goes away as we go into Q3 and into the back half. We did see some significant inventory reductions at some major customers in the first half as we've had collaborative discussions with those customers. We don't believe that we'll see another downshift in the back half of this year. And then finally, as Don mentioned, there were some trade phasing that some minor differences that were a bit of a headwind in the first half become more of a tailwind in the back half. So really I think from an execution standpoint, if we get our merchandising where we expect it to be, continue the baseline strength, we believe that we can be where we need to be to deliver for the company.
And I would build on that. I agree with everything that John said. And I would build on it by saying, I mean, if you look at what we had and Don had in one of our slides, if you look at the first half of the year, our organic sales were flat. And our guidance for the year was flat to up 1%. And so on our organic business, we don't need to jump out of our shoes in order to hit our guidance for the year.
We need do we need to improve a little bit? Yes. But we don't need to improve so significantly that we feel like we have to go out and buy volume at any cost in the back half of the year to hit our sales guide. That's not the case at all. We just need to improve a little bit in a couple of specific areas.
The biggest improvement you're going to see in our back half of the year is going to be on Blue Buffalo. And you'll see that because of the comps and the fact we're lapping the inventory from Q2 and we're not doing that again in the back half and doubling our distribution. That will be the biggest increase and we have very tangible plans in place in order to recognize that.
Thank you.
I think maybe we'll try to get one more on please.
Thank you. Our next question comes from the line of David Driscoll with Citi. Please proceed with your question.
All right. Well, I appreciate making it in under the wire. Good morning.
Good morning, David. Good morning, David.
Wanted to ask a few questions on Blue Buffalo. Can you guys quantify the growth in wet treats and other and in dry food?
From a retail sales standpoint, if you look across channels, we're seeing wet and treats growth in the 20% range, so well ahead of the total. So we feel really good about where we're seeing that. And as Jeff said, Food, Drug and Mass is where we're seeing particular outperformance for Wet and Treats.
Okay. And then on dry, do you have any number that you can give us? Of course, that's the biggest piece of it. So I would assume that it was down related to the FDM launch from the year ago. But any quantification you'd give on that, Buck used to give those disclosures and I think it's pretty helpful.
Yes. David, what I was just referencing were our retail sales, net sales, right. Net sales were down, and I actually don't have the split on net sales between dry and wet and treats. But from a retail standpoint, again wet and treats were driving some nice growth. But in total with dry being the bulk of the business you still saw positive trends there.
But I think your instincts Dave That's fine. I think your instincts are right and that because it was the inventory build into food, drug and mass last year on the life protection formula a big piece of which was dry, it's fair to assume that that business on a reported net sales basis didn't perform as well because that's where we had the inventory build. So I think your instincts are right if even if we don't have the exact numbers in front of us right now, I think your instincts are correct.
And then on the Wilderness brand, that's the 2nd largest brand at the company. Can you make any comments about how that brand is growing?
Well, it's a first of all, Wilderness is a great brand. And with some I think some of the best packaging we have at General Mills and some of the best equity in. And I can tell you it's kind of a tale of 2 things. We don't have it in FDM at the moment, but in specialty it's doing okay, but it's declining a little bit because our business in Pet Specialty is declining and e commerce is on fire. So the amount of our growth in e commerce is wilderness as well as the life protection formula.
And what I can tell you that that is a that's a great sub line. And we think it has a lot of potential just like we think Life Protection Formula has still has a lot of potential.
Okay. Two more BUFF questions and then one question for Don. The 2 final ones on Buff were just, I think you mentioned on your new product plans that you would be launching new varieties. But just for clarity, are these new varieties in the marketplace in any marketplace? Or are these varieties that were in some channels previously and you're moving those kind of existing varieties into FDM.
I just want to be clear if it's really a new product or if it's existing product channel expansion?
It's fair to assume that it's existing products that we're expanding channels. So products with a proven track record of success that we are expanding.
Okay. And then for Don, two questions for you. 1 on the start up of the new plants for Blue Buffalo. Can you give us any quantification as to either the dollar expenses of these new start ups sorry, the plant startup costs on your P and L and or the gross margin impact? Because in the past for Blue, these were significant expenses.
And then I have a debt question for you. Just would like you to talk about your debt, your pay down plans, your debt to EBITDA targets and I believe you have a $1,000,000,000 maturity in February. And I asked all this in light of what's happened to your dividend yield and just your thoughts there. Thank you.
Sure. Yes, in terms of Blue, plant start up, if you think about the profit decline in the quarter, it was about onethree from lower sales, onethree from plant startup costs and onethree from the impact of inflation. And so to your point, it was a significant factor and that's something that we will roll through as the year unfolds. So that's I think your recollection of the impact is correct. As far as debt, year to date from the end of the year till now, our debt is down about $500,000,000 We do have that maturity coming up.
So we'll have the opportunity to bring that down further in the back half of the year, not by the full $1,000,000,000 but by some additional amount. And we still target to exit F 2020 with our leverage ratio at 3.5, which is what we announced at the time of the deal.
Great. I appreciate the comments. Thank you and happy holidays.
Happy holidays, Kevin. Thank you, David.
I think that's all the time we have. Thanks everyone for hanging with us. Appreciate all the good questions and please reach out with further questions. We're around all day. Thanks so much.
Have a great holiday season.
Ladies and gentlemen, this does conclude today's conference call. We thank you for your participation and ask that you kindly disconnect your
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