Ladies and gentlemen, thank you for standing by. Welcome to the General Mills third quarter fiscal 2018 earnings conference call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question-and-answer session. At that time, if you have a question, please press the one followed by the four on your telephone. If at any time during the conference you need to reach an operator, you may press the star followed by the zero. As a reminder, this conference is being recorded today, Wednesday, March 21st, 2018. I will now turn the conference over to Jeff Siemon, Vice President, Investor Relations. Please go ahead, sir.
Thanks, Nelson, and good morning to everyone. I'm here with Jeff Harmening, our Chairman and CEO, and Don Mulligan, our CFO. I'll hand the call over to them in a moment, but before I do, let me cover a few items. Our press release on third quarter results was issued this morning over the wire services, and you can find the release and a copy of the slides that supplement our remarks this morning on our investor relations website. I'll remind you that our remarks will include forward-looking statements that are based on management's current views and assumptions, and that the second slide in today's presentation lists factors that could cause our future results to be different than our current estimates. With that, I'll turn you over to my colleagues, beginning with Jeff.
Thanks, Jeff, and good morning to everyone. Let's jump right in and cover the key messages for today. Our primary goal entering fiscal 2018 has been to strengthen our top-line performance while maintaining our efficiency. We're delivering on the first part of that goal with stronger innovation, more impactful consumer news, and better in-store execution, leading to a second consecutive quarter of organic net sales growth. We're also generating significant growth in free cash flow through strong capital discipline. As a result, we're reaffirming our full-year organic net sales and free cash flow targets. While I feel good about our results on net sales and cash, I'm disappointed in our profit performance this quarter. Our third quarter operating profit fell well short of our expectations, and our full-year outlook has been impacted by an increase in supply chain costs in a dynamic cost environment.
We're moving urgently to address these rising cost pressures. We've taken actions to improve profitability in the near term, and we've launched initiatives that will reduce our long-term cost structure. While these actions will only partially offset the cost headwinds in fiscal 2018, we still expect to deliver profit growth in the fourth quarter, and we're confident these actions will strengthen our bottom-line results beginning in fiscal 2019. Beyond our current results and outlook, we remain confident in our ability to drive long-term value with our Consumer First strategy, which will be further strengthened with the addition of Blue Buffalo to our family of brands. Before turning it over to Don to cover our financial results, let me share some details on the cost increases driving our revised profit outlook and the steps we're taking to mitigate these increased costs going forward.
Between incremental costs we identified as we closed the books in the third quarter and a more unfavorable cost outlook for the remainder of the fiscal year, we now expect our full-year fiscal 2018 total segment operating profit will be 5%-6% below year-ago levels in constant currency. The key driver of this change is a significant increase in supply chain costs, which falls into two main areas. First, our input costs are rising faster than we had anticipated. In fact, we now estimate our full-year fiscal 2018 input cost inflation will be 4%, one point higher than our previous estimate. We called out increased freight costs at our update at CAGNY, but the cost pressure we're seeing is even higher than we thought at the time.
We're now having to go out to the spot market for close to 20% of our shipments versus a historic average of about 5%. Those spot market prices can be 30%-60% higher than our contracted rates. In fact, North American freight spot prices were near 20-year highs in February. Higher freight costs are impacting our raw material prices as well, as the cost to ship materials from our suppliers to our factories has risen significantly. We've seen higher prices in some key commodities, including grains, fruits, and nuts, further heightening the inflationary dynamic. The second main area of supply chain cost pressure is increased operational costs driven by higher volumes running through our network. We've seen increased volume on some capacity-constrained platforms and stronger results for our new products.
While I'm pleased with our increased volume performance, those factors mean we're utilizing more external manufacturing, where conversion costs can be significantly higher than our internal platforms. Additionally, we've seen increased expenses from intra-network shipments between our distribution centers as we move more products to the right locations to satisfy the strong demand. We're moving urgently to address this increasingly dynamic cost inflation environment and ensure that negative profit impact is limited to fiscal 2018. Some of the actions we're taking will have an impact already this fiscal year. We're addressing higher freight costs in the near term by qualifying more carriers and utilizing different modes of transportation. We're placing increasingly tight control over all expenses in the balance of this year. We're also taking smart actions to drive positive net price realization in a higher cost environment by pulling various levers within our strategic revenue management toolbox.
The specific SRM actions will vary across categories and vary across geographies, but will impact all four operating segments, with benefits starting to hit this fiscal year and more fully impacting fiscal 2019. We're also moving forward on initiatives to address our structural costs for fiscal 2019 and beyond. We're optimizing our distribution network between the factory and the customer to better align with the manufacturing footprint reorganization we completed over the past three years. We've approved additional cost savings initiatives designed to further optimize our global administrative structure. We'll continue to drive other savings efforts that will improve our efficiency, including our ongoing holistic margin management program, our global sourcing initiative, and other enterprise process transformation projects.
In addition to these profit actions, we will maintain our focus on improving our net sales through our compete, accelerate, and reshape priorities, because we know our job is to deliver both the top and the bottom line. Before I turn it over to Don, let me assure you that we understand the ramifications of changing current year outlook in such a short period of time, and we are taking steps to ensure this doesn't happen again. Our forecasting process has historically relied on a periodic in-depth analysis at key junctures during the fiscal year. In more stable times, that cadence served us well in forecasting our costs and margins. In an increasingly dynamic environment, we need to go deeper more frequently. While that would not have reduced the cost, it would've accelerated our mitigation efforts by a quarter or so.
While we're moving with urgency to address these higher costs, we're moving with equal urgency to adjust our forecasting process at all levels of the organization. Now, let me turn it over to Don to provide more details on the quarter and our updated outlook.
Thanks, Jeff, and good morning, everyone. Slide eight summarizes third quarter fiscal 2018 financial results. Net sales totaled $3.9 billion in the quarter, up 2% as reported. Organic net sales increased 1%. Total segment operating profit totaled $628 million, down 6% in constant currency. Net earnings increased 163% to $941 million, and diluted earnings per share increased 166% to $1.62 as reported. These results include one-time and ongoing benefits related to U.S. tax reform. Adjusted diluted EPS, which excludes the one-time impacts related to tax reform and other items affecting comparability, was $0.79, up 8% on a constant currency basis, reflecting a lower ongoing tax rate and fewer average diluted shares outstanding. Slide nine shows the components of total company net sales growth. Organic net sales increased 1% in the third quarter, driven by organic sales mix and net price realization.
Foreign currency translation yielded a two-point benefit to net sales. Divestitures reduced net sales growth by one point, reflecting co-packing sales made in last year's third quarter related to our Green Giant divestiture. Turning to Slide 10, third quarter adjusted gross margin decreased 250 basis points, and adjusted operating profit margin was down 120 basis points. As Jeff mentioned, we experienced a significant increase in supply chain costs, including higher freight, commodities, and operational costs. We now expect our fiscal 2018 input cost inflation will be 4%, one point higher than our previous guidance. We also had higher merchandising activity in the quarter, including greater than expected seasonal performance on soup and refrigerated dough, and stronger merch results in cereal and snack bars, which more than offset the benefit of trade expense phasing from the prior year.
These margin headwinds were partially offset by lower SG&A expenses, including a 22% reduction in advertising and media expense in the quarter. Year to date, media expense is down 5%, as we have shifted some dollars to vehicles closer to the point of sale, including customer events, in-store theater, loyalty programs, sponsorships, and sampling. Our Million Acts of Good activation with Ellen is a great example of this type of spending. These initiatives get our brands in front of the consumer, usually in the store, but aren't captured in the media line in the P&L. We expect our total consumer-facing spending this year, including media as well as non-media vehicles like the ones I just mentioned, to be roughly in line with prior year levels. Slide 11 summarizes our joint venture results in the quarter.
CPW net sales increased 2% in constant currency, with growth across all four CPW regions and strong performance on our granola and Mueslix product lines. Häagen-Dazs Japan constant currency net sales were down 3% due to unfavorable net price realization and mix. On a year to date basis, constant currency net sales were up 1% for CPW and up 2% for Häagen-Dazs Japan. Combined after-tax earnings from joint ventures totaled $17 million, up 30% in constant currency, primarily driven by volume growth at CPW. Slide 12 summarizes other noteworthy income statement items in the quarter. We incurred $11 million in restructuring and project-related charges in the quarter, including $3 million recorded in cost of sales. Corporate unallocated expenses, excluding certain items affecting comparability, decreased $4 million from a year ago.
Net interest expense was up $13 million, primarily driven by the early repayment of certain medium-term notes, which resulted from the Blue Buffalo acquisition. This one-time item is excluded from adjusted earnings. The effective tax rate for the quarter was impacted by a one-time provisional net benefit of $504 million related to tax reform. Excluding items affecting comparability, the tax rate was 15.2% compared to 24.7% a year ago, driven by the lower corporate income tax rate resulting from tax reform, partially offset by non-recurring favorable discrete items in the prior year period. Average diluted shares outstanding declined 1% in the quarter. We continue to expect average diluted shares will be down approximately 2% for the full year. Turning to our nine-month financial performance, net sales of $11.85 billion were down 1% on an organic basis.
Segment operating profit declined 10% in constant currency, and adjusted diluted EPS were down 2% in constant currency, including the impact of the lower corporate tax rate and lower average diluted shares outstanding. Turning to the balance sheet, slide 14 shows that our core working capital decreased 57% versus the prior year, driven by continued benefits from our terms extension program. For the full year, we continue to expect our core working capital balance will finish well below fiscal 2017 levels, driven by significant improvement in accounts payable. Nine-month operating cash flow was $2.1 billion, up 29% over the prior year, driven by our working capital improvements. Year-to-date capital investments totaled $398 million, and through the first nine months of the fiscal year, we returned nearly $1.4 billion to shareholders through dividends and net share repurchases.
Slide 16 summarizes our fourth quarter outlook, excluding the impact of the proposed Blue Buffalo acquisition. We expect to deliver another quarter of organic net sales growth driven by positive price mix across all four segments. Remember that our results in Asia and Latin America segment will be negatively impacted by the comparison to last year's fourth quarter that included an extra month of results in Brazil as we align net markets reporting calendar to our corporate calendar. We continue to expect accelerated cost savings in the fourth quarter, driven by benefits from our new global sourcing initiative. That increased cost savings plus positive price mix and the initial benefits of the actions Jeff highlighted will help drive constant currency growth in total segment operating profit and adjusted diluted EPS. I'll close my portion of our remarks by summarizing our updated fiscal 2018 guidance.
As I just noted, this outlook does not include any impact from the Blue Buffalo acquisition. We continue to expect organic net sales growth to be flat to last year. As Jeff mentioned upfront, we now expect total segment operating profit growth will be down 5%-6% on a constant currency basis. Our full-year adjusted effective tax rate is now expected to be approximately 26%, or 1% below our most recent guidance. We continue to estimate that tax reform will have a two-point favorable impact to our fiscal 2018 adjusted effective tax rate. Our updated full-year adjusted diluted EPS outlook is in the range of between flat and up 1% in constant currency. We expect currency translation will add one point of growth to net sales, total segment operating profit, and adjusted diluted EPS in fiscal 2018.
Finally, we continue to expect full-year free cash flow growth of at least 15% this year. With that, I'll hand it back to Jeff to cover our segment results.
Thanks, Don. Now let's look at each of our segment results and talk a little bit about our upcoming news and initiatives. In North America Retail, organic net sales were up 1% in the third quarter. U.S. Snacks posted 3% net sales growth driven by Nature Valley, LÄRABAR, and fruit snacks. The U.S. Meals and Baking operating unit generated 2% net sales growth behind a strong baking and soup season. Canada net sales were up 1% in constant currency, led by our natural and organic platform. U.S. net cereal sales were down 1%, reflecting a reduction in customer inventory levels, while cereal retail sales in Nielsen measured outlets were up 2% behind innovation and effective messaging across our core brands. U.S. yogurt net sales were down 8%, which represents the third consecutive quarter of improvement as our portfolio benefits from successful innovation in faster-growing yogurt segments.
Constant currency segment operating profit was flat compared to the year ago period, driven by higher sales, offset by higher input costs. As I outlined at CAGNY, our top priority for returning to consistent top-line growth is to compete effectively on every brand across every geography. Growing with our categories is the first measure of success, and I'm pleased to say that we have accomplished that in the U.S. in the third quarter, with retail sales up 1%, marking the fourth consecutive quarter of sales improvement, and we grew market share in seven of our top nine U.S. categories. Our improvement is driven by solid fundamentals. Our baseline sales trends are 500 basis points better than last year and are driving 75% of our retail sales improvement.
This is a result of good consumer news and strong messaging through traditional media like TV and digital advertising on Nature Valley, Pillsbury, and Totino's, as well as the activations that go beyond traditional media, like our Ellen partnership on Cheerios. We're also delivering better innovation this year with our average new product turning nearly 50% better on shelf compared to last year. This includes Chocolate Peanut Butter Cheerios, which is the biggest launch in the cereal category this year, and Oui by Yoplait, which is the largest launch in the yogurt category this year. The third leg of our improvement is our in-store execution. We were back in the zone on seasonal merchandising this year, which drove significant improvement in soup and refrigerated dough.
We're winning a higher share of display, the best type of merchandising vehicle, on some of our most productive categories, including cereal and snack bars. These efforts are translating into broad-based improvement in our U.S. retail sales trends, with absolute retail sales growth in seven of our top nine categories in the third quarter. In addition to our strong fundamentals, we're maintaining a disciplined approach to our pricing. As you can see in the chart, our baseline and merchandise price points have been higher than last year throughout fiscal 2018, including the third quarter. Our average unit price was slightly down in the quarter as our proportion of merchandising was higher this year. This was really driven by prior year comparison when our merchandising levels were abnormally low.
When you look over a two-year period, our average prices across our portfolio are up 4% and are outpacing our aggregate categories. With that as a backdrop, let me share some third quarter highlights from North America retail and talk a little bit about what's to come for the remainder of the year. Our U.S. cereal retail sales were up more than 2% in the third quarter, driven by the same things I mentioned for the segment, better news and messaging, innovation, and execution in store. There's no shortage of examples of good news and messaging on our cereal business this year. One of the most fun is our marshmallow news on Lucky Charms, which has helped drive double-digit retail sales growth so far this year. We just announced our most recent initiative, Magical Unicorn Marshmallows, which are in store now.
On Cheerios, our partnership with Ellen and activation across TV, digital, and social media, on pack, and in store have helped improve our baseline sales growth nearly 400 basis points since the campaign first launched. On Reese's Puffs, we're launching a fourth quarter seasonal bunnies version to help continue the double-digit retail sales growth that brand has enjoyed so far this year. On the innovation front, we've had a stellar year. We launched Chocolate Peanut Butter Cheerios last October, and it was the best-selling new product in the category last quarter. We'll continue to look to bring fun limited edition seasonal flavors of Cheerios to the shelf with the launch of a new peach flavor that's rolling out now. On U.S. yogurt, we've improved our retail sales trends by 16 points this year by innovating into faster-growing spaces.
Our retail sales were down just 3% in February, and we actually grew market share in the grocery channel last month. We're pleased with our U.S. yogurt improvement, we're not yet fully satisfied. We continue to improve by building on recent successes and by launching new category expanding innovation. For instance, we recently launched new flavors of Oui by Yoplait and Yoplait Mix-Ins, the top two yogurt launches this fiscal year. We have another important launch plan for this summer that addresses some of the biggest health and wellness barriers in the yogurt category. You'll hear more about this news in the coming months. Shifting to snack bars, Nature Valley has posted double-digit retail sales growth this year and is generating more retail sales dollar growth than any other brand in the category. These results have been driven by innovation.
Nut Butter Biscuits and Granola Cups are the top two new products in the category for the last two years, we're seeing solid results from this year's launches, including new layered bars and filled soft-baked bars. U.S. retail sales for LÄRABAR are up 30% this year behind our Real Food advertising campaign, they're up almost 70% in Canada. We're also driving improvement on Fiber One by communicating what consumers value most about the brand, permissible indulgence. Retail sales trends for Fiber One last month were 900 basis points better than our fiscal 2017 growth rate, thanks in part to our Brownie and Cookie Bites innovation. Our soup and baking businesses rebounded from a challenging fiscal 2017 to grow retail sales and market share during the key season this year. We have great news planned in the fourth quarter on other meals and baking businesses.
We just launched Totino's Mini Snack Bites, adding more fun and variety to this business that grew retail sales 9% in the third quarter. We'll look to drive more visibility for Old El Paso by securing 4,000 taco truck displays, which will be parked in the front of the store where Mexican food merchandising performs best. Finally, our North American natural and organic portfolio continues to lead our growth with third quarter net sales of high single digits, including good performance on Annie's, LÄRABAR, and EPIC. In our convenience stores and food service segment, third quarter net sales were up 3%, driven by a low single-digit growth for the Focus 6 platforms and benefits from index pricing on bakery flour. The frozen meals platform continues to perform well, including the new Pillsbury Stuffed Waffle, which is the top turning breakfast item in C-stores where we have distribution.
Our cereal platform delivered mid-single-digit growth this quarter, driven by continued distribution gains. Segment operating profit was down 10% in the quarter, driven by higher transportation and logistics costs, as well as commodity inflation. Turning to Europe and Australia, third quarter organic net sales were down 1%, with strong growth in snack bars offset by declines in other platforms. Constant currency segment operating profit was down 46% versus last year, driven by significant raw material inflation and a comparison against 39% constant currency growth in last year's third quarter. Through the third quarter, our Europe and Australia segment is growing with its categories. Our snack bars and Häagen-Dazs platforms are performing exceptionally well with double-digit retail sales growth driving strong market share gains.
On yogurt, although our retail sales in total are down, we are driving growth in many of our core brands, including Panier, Perle de Lait, Liberté, and Yop. The fourth quarter is a key innovation window across all of our priority platforms in Europe and Australia. In yogurt, we will be the first major brand launching into the kids' organic segment with our leading Petits Filous brand. On Old El Paso, we're responding to the increasing number of gluten-avoiding consumers by introducing new gluten-free tortillas and Mexican kits. We're launching new flavors to bring excitement to the freezer on Häagen-Dazs ice cream, and we'll continue to invest in TV media and Nature Valley snack bars to drive increased household penetration. In Australia in January, we began advertising Fiber One for the first time, which has helped drive 20% retail sales growth for the brand.
In our Asia and Latin America segment, third quarter organic net sales were in line with last year, with good growth in our Asia markets, offset by continued top-line challenges in Brazil. While our improvement in Brazil has taken longer than we expected, we're making progress and delivered net sales growth in the quarter on some key businesses, including Yoki Popcorn and Kitano Seasonings. The third quarter is typically this segment's lowest operating profit quarter of the year, which means even smaller absolute dollar changes drive big percentage changes in results. Last year, we earned a $10 million profit in the quarter, and this year's result was a loss of $2 million. The $12 million change was primarily driven by lower volume and higher manufacturing and logistics costs in Brazil. We expect this segment will return to profit growth in the fourth quarter behind strengthening top-line performance.
Our snack bars and ice cream platforms led Asia and Latin America net sales performance in the quarter. Net sales for our snack bar business in India more than doubled in the third quarter, driven by continued distribution expansion of our Pillsbury cookie cake and the launch of our new Pillsbury pastry cake. We're also launching a similar pastry cake to our Middle East markets under the Betty Crocker brand. Häagen-Dazs retail sales increased high single digits the last three months in Asia, driven by our mochi innovation and activation during the holiday season. Looking ahead, our refreshed Häagen-Dazs packaging is rolling out across Asia, and we are supporting this with a campaign to celebrate the extraordinary creations of artisans around the world. We're also launching spring limited edition flower flavors, Cherry Blossom and Lavender Blueberry, and will support them with an omni-channel activation, including in our shops.
At CAGNY, I outlined our compete, accelerate, and reshape framework for restoring consistent top-line growth. I just shared how we're competing more effectively in fiscal 2018 across many of our brands and geographies. We've also taken a significant step this year to reshape our portfolio with the acquisition of Blue Buffalo Pet Products. Before I close, let me refresh you on the details of the transaction and share why we're so excited about adding Blue to our family of brands. Last month, we announced our intent to acquire Blue Buffalo for $40 per share, representing an enterprise value of roughly $8 billion. Blue Buffalo is a highly attractive asset playing in the fast-growing, wholesome natural pet food category with $1.3 billion in revenues, 25% EBITDA margins, and a consistent history of double-digit growth on the top and bottom lines.
After the deal closes, which we expect will occur before the end of May, Billy Bishop, the current CEO of Blue Buffalo, will lead a new pet operating segment for General Mills. Blue Buffalo is a truly unique asset in an attractive category that is still in the early stages of transformation. At $30 billion in sales in the U.S. pet food market, it's one of the largest in the center store. It has generated consistent growth and strong profitability over many years with low private label exposure. These days, more and more pet owners, especially millennials, see their pets as another member of the family. This humanization of pets, combined with a growing consumer interest in more natural products, has driven a dramatic increase in what we call the wholesome natural pet food category.
This transformation is still in the early innings, with wholesome natural products still making up only 10% of total category volume, up from 5% five years ago. What's most exciting to us is that Blue Buffalo is leading the category transformation. The Blue brand has the strongest brand equity in the category, with a clear number one position in wholesome natural pet food, as well as the number one overall pet brand in the e-commerce and pet mass channels. Blue is still in the early stages of expanding into the broader food, drug, and mass, or FDM channels, which represent fully half of pet food retail sales in the U.S.
Since the announcement, I've had some analysts and investors ask me, "Isn't this a new category?" "How will General Mills create value in this transaction?" I think they've been pleasantly surprised when I explain that in many ways, pet food is not a new category as some people think, and the value creation playbook will look similar to the one we've used very successfully for the Annie's acquisition over the last three years. Our industry-leading retail sales force, retail partnerships, and sales capabilities will help increase the likelihood of success of Blue's FDM expansion. We will also leverage our technical capabilities in extrusion and thermal processing to drive innovation across dry and wet pet food. We'll utilize our sourcing expertise and distribution network to enhance Blue's supply chain efficiency.
We'll look for ways to help the Blue Buffalo team nurture and grow this modern, authentic 21st-century brand. We'll stay out of their way where they don't need us. Finally, we'll be selective in where we can drive admin synergies with a focus on back office and public company costs. We took a very similar approach to Annie's. It resulted in net sales doubling in a little over three years since the acquisition. I can tell you, if we're even half as successful as Blue Buffalo, our shareholders will be very happy with this acquisition. Over the past month, key leaders from my team and I have spent time in Wilton, Connecticut, with the Herd, as they call themselves, and Billy and his leadership team have visited our marketing, sales, and R&D teams in Minneapolis.
The more we get to know each other, the more we see how compatible our cultures are and how synergistic our capabilities are in a variety of functional areas. We cannot wait to get moving on continuing to grow this terrific brand as part of the General Mills portfolio. Let me wrap up by summarizing today's comments. We're competing more effectively and it's translating into good momentum on the top line in fiscal 2018. At the same time, we've been challenged by sharp increases in supply chain costs that have negatively impacted our bottom line outlook. We're moving with urgency to address these rising costs, with some actions taking effect now and more significant impact expected in fiscal 2019. Finally, we're as excited as ever about Blue Buffalo, and we're confident that this transaction will deliver long-term value for our shareholders. Now, let's open the call for questions.
Operator, will you please get us started?
Thank you. Ladies and gentlemen, if you'd like to register a question, please press the one followed by the [four]. You will hear a three-tone prompt to acknowledge your request. If your question has been asked by another and you would like to withdraw your registration, please press the one followed by the three. If using a speakerphone, please lift your handset before entering your request. Our first question comes from the line of David Driscoll with Citi. Please proceed.
Great, thank you. Good morning.
Good morning.
Morning.
Morning, David.
Given the retail environment, I get just a lot of questions about pricing and the ability for manufacturers to realize pricing at retail. You have profit challenges that you're talking about because of inflation. Jeff, I think a lot of people are really going to wonder, is this because of the inflationary side, or is it because you just can't get pricing at retail? Then I think what you were saying on the call is maybe there was a bit of an internal failure to recognize the higher inflation as quickly as you would probably expect your organization to do so. I would really emphasize the fact that investors just worry so much that the retail environment is so difficult that companies like Mills can't get pricing.
I'd really appreciate your thoughts on that question and just a little bit more explanation on what happened here and then how it really goes forward if you do in fact have the ability to recognize some price increases.
All right, David, let me start out by addressing the pricing environment and what we're doing to offset our costs just in general, then I'll turn it over to Don if he has any more specifics. In terms of the pricing environment itself, first of all, I would say is that we will address our increased cost by a combination of factors, which starts with addressing our cost structure itself, and there are some near-term things we can do with supply chain. There are some longer things we can do in terms of our logistics network. We have our ongoing HMM program, in addition to what we're doing with ramping up global sourcing.
The first line of defense against rising costs is to make sure we're managing our costs effectively, and rest assured that we are doing that and moving with an increased sense of urgency since discovering that we'll have higher input costs than we had thought. On the net pricing realization side, I can imagine people listening could be nervous because we took pricing a couple of years ago, and that didn't exactly go out as planned. What I would tell you on that is a couple of things. First is that the environment now is very different than two years ago. In the environment two years ago when we took pricing, there was really a deflationary pressure on input costs. Now we see an inflationary pressure in.
As I said, we're looking at our input costs going up by 4%, and a lot of the spot market for commodities are that high or even higher. We see a very different environment from that sense. What I will also tell you is that what we see on the logistics side is very real, and our customers face it all the time, and we get a lot of questions from our customers about what we're doing to offset logistics costs because they see the same kind of pressures in their business. The environment is different. The second thing is that I would say is, a couple of years ago, we took more pricing than clearly we should have, and we took about 5% pricing in fiscal 2017. We don't need that kind of pricing to offset the kind of environment we have right now.
Just a little bit of pricing. Our categories are already seeing 1%-2% pricing consistently quarter-to-quarter. Just a little bit of pricing combined with these cost measures will really help alleviate the pressure on input costs. Finally, I would say that our capability is a lot greater in our strategic revenue management now than it was two years ago. We've hired some people from the outside, combined with some internal experts in. We can realize prices in a variety of ways, and that includes trade optimization and price pack architecture, in addition to some more of the traditional pricing. We feel as if our capability is a lot greater than it was a year ago. In terms of costs and seeing the cost, Don, do you have anything that you want to add to that?
I guess let me just finish the point that Jeff talked about on pricing. If you look at our results year-to-date, we are seeing better competitiveness in the store, but it's also being supported by pricing. Our Q3 organic positive price mix is higher than in the first half, and for three of our segments, it was up low single digits. In R where it was flat, as Jeff showed, both our base and our merchandise prices were up. The flat was more of a product of the mix of those. We do believe it's an environment issue with the inflation where you can get price, and Jeff alluded to many of the instruments that we will use. The other aspect of your question, David, was visibility to our cost. Again, Jeff touched on it upfront, but I think it's worth going into again.
Historically, this year, we've done deep dive estimates on our cost at regular intervals during the course of the year. That cadence has typically served us well in managing our costs and our margins. Frankly, if you look back over the years, we've seldom had a profit miss in a year such as this one when our sales are tracking at or better than planned. Clearly, in hindsight, this year was a very dynamic cost environment. The combination of our higher volumes, some constrained platforms, the increasing inflationary environment, we should have gone deeper more frequently. It might not have reduced the cost, but it would've gotten us out ahead of it faster. As I look at it, we need to be just as agile in how we manage our cost structure as we've been this year in meeting consumer demands.
That's what we're focused on doing. The actions that we're taking now are to make sure that we address the cost structure in the marketplace, but we're moving just as urgently to look at our estimating and forecasting process to make sure this doesn't happen again.
Don, one follow-up. The first half of the year had a very sizable trade accrual phasing expense comparison issues. They were negative, and it was supposed to get significantly better here in the back half. Given all that's happened on the cost side, I can't really tell what's occurred on the trade phasing. Did the trade accruals perform as you expected? Can you give some color on that?
Yeah, they did, David. Thank you. We had a headwind the first half. We'll have a tailwind in the second half. Well, actually, that's part of the reason that we're more confident in profit growth in the fourth quarter. In the third quarter, because we had very strong merchandising take at our seasonal businesses and in some of our other lines here in the U.S. because we had very strong offerings in the store. Again, not lower price, but better offtake from a consumer standpoint. As I referenced, we are also moving more of our consumer funds to in-store activity, which much of that is recorded as a deduction to sales as opposed to in the advertising or the admin, or the SG&A line. The combination of those things offset the benefit from the tax accrual reversal and the trade accrual reversal, excuse me, in the quarter.
Great. I'll pass it along. Thank you.
Thank you. Our next question comes from the line of Robert Moskow with Credit Suisse. Please proceed.
Hi. I think I have two questions here. Don, I have to ask again about the presentation at CAGNY and what kind of data you had at hand at the time because you did lower guidance for higher freight costs at that time. You must have had some kind of a roll-up of how much spot activity was going on during the quarter. What was wrong with the data, I guess? That's the first question. Second, I guess broader on pricing. You do have on slide 22 a chart that shows that your baseline pricing is still positive, but it keeps decelerating, and it's now at 0.8%. It needs to go the other way to offset all this inflation that you're talking about. I think you've kind of stopped short today of saying that you're looking at taking list price increases again.
It seems like you're talking about revenue management and some other things, can we see some list price increases coming maybe in the back half? Thanks.
Well, I'll hit the CAGNY one first. Obviously, when we gave our guidance at CAGNY, that was based on the best information we had at the time. I mentioned the fact that we do periodic cost deep dives. We did one in February, at the end of February, and we did it as we closed the books on the quarter in early March, and that is when these costs really came to the fore more clearly. That's what's prompting the guidance change today. As I referenced in the answer to David, we have done these at regular intervals. Clearly, in today's environment, we have to do them more regularly and be more agile in terms of identifying the cost trends and making sure that they are surfaced and acted upon. We will do that. In terms of pricing, we are going to use a number of levers.
In some markets and some businesses, it's going to be list price increases. Again, we talked at CAGNY about our convenience and food service business. We're seeing the same in our European business, particularly in response to Brexit, that continues to have a ripple effect in the U.K. and certainly in some of our emerging market businesses. That is part of the toolkit, again, the toolkit for our SRM is broader than that, we're going to use all the levers as we attack what is clearly a higher inflationary environment.
Okay. Thank you.
Thank you. Our next question comes from the line of Andrew Lazar with Barclays. Please proceed.
Morning, everybody.
Morning, Andrew.
I know it's obviously too early to talk about specific sort of guidance and such for fiscal 2019. I guess I was hoping maybe, Don, you could go through just a couple of the puts and takes that we should be cognizant of even directionally as we think towards, I guess more specifically, how operating profit sort of shapes up for next year. Obviously, you've already talked about at CAGNY looking to reinvest, I think it was the majority of the benefit from tax reform, that obviously has an impact around EBIT growth next year. I was hoping you could, because there's just so many factors that are playing into this today, anything you can get into around the puts and takes would be helpful.
Yeah, Andrew, obviously we're not going to give FY 2019 guidance today. What I will say is that the actions that Jeff walked us through as part of the prepared remarks will have some benefit in FY 2018 and have more full benefit in FY 2019 and beyond, frankly. That will come into play as we think about 2019. You did mention the tax reform, and that will give us some potential flexibility to reinvest back in the business. Again, we have the three planks that we are working to ensure that we drive a more competitive top line. That's compete, accelerate, and reshape. I think you're seeing this year how we're competing better. We've begun to put some money behind our accelerator platforms. We see a little bit of benefit this year, and we'll see more of that benefit as we move into 2019.
Okay, then on the reshape part, obviously you talked about looking to divest a certain portion of the portfolio as well. Is that something that we think plays out over the course of the next, call it year or so? I'm trying to get a better sense of the timeframe on that. Obviously on some of these businesses, I would anticipate you probably have a fairly low tax basis as well, which I guess could potentially have an impact on EPS as well. I'm trying to get a sense of how to better think about that.
Our focus right now obviously is closing and transitioning Blue into the family. We will quickly pivot following that to look at divestitures. Obviously, the timing of any divestiture, you'd have to have a willing buyer to go with a willing seller, and we have to make sure the economics work to your point about tax rates. We'll work on that diligently, and I believe just as we've been successful on the acquisition side with identifying and bringing Blue in, we will do the same on the divestiture side.
Okay. Thank you.
When it comes to divestitures, what I would also add to that is that, we don't have to do all the divestitures at the same time. We can do those at different times. The second is that we're only going to do them when they make sense for shareholders and so when they're accretive to shareholder value. We'll act with a sense of urgency, but we will also act with a sense of our shareholders in mind to make sure that as we go to divest some businesses, that we're doing so with an eye to that.
Great. Thank you.
Thank you. Our next question comes from the line of Michael Lavery with Piper Jaffray. Please proceed.
Thank you. Just looking at the fourth quarter, you've had an operating income decline year-to-date around 9% or 10%, even with a little bit of currency. Can you just help us understand how you really get to. It looks like you need maybe another 10% in the fourth quarter. You've touched on some accelerating savings, can you just really give us a roadmap for how you execute that sharp an improvement?
Sure. There's a few components to it, Michael. It starts with another quarter of solid organic sales growth. As we look forward, we expect mix to strengthen in each of the segments. Cereal and snacks will be the driver in NAR, and it will also actually benefit from a little less from our meals and baking, our seasonal businesses. The Focus 6 businesses in C&F will accelerate in the fourth quarter. Old El Paso and Häagen-Dazs behind the initiatives that Jeff talked about in EU-AU and Häagen-Dazs and snacks in Asia, LATAM. We have good programs behind each of those areas that will continue to drive our top-line growth. We'll add some net price realization, pricing in Brazil. I mentioned C&F in the U.K., and then the various SRM initiatives we're executing in the U.S. and elsewhere.
Again, we'll have the trade accrual reversal that will benefit the top-line and our profit in Q4. That's really the main driver. When you translate that into profit, you're going to have the benefit of that mix, the benefit of the trade realization. ASLA will actually also get the benefit of some volume leverage in Brazil as we improve our volume performance in that important market behind a couple of strong promotions, one around the World Cup. We'll get increased benefit from our global sourcing initiative that will increase our HMM in the quarter. Then again, the other items that Jeff talked about, particularly around our freight spending will begin having some impact, some favorable impact in the fourth quarter.
The combination of those things in relatively equal measure, a little bit more from price mix, but relatively equal measure across will benefit Q4 and help drive a profit growth figure for the quarter.
Is it fair to assume that what had initially, at the beginning of the year, been a headwind from higher incentive comp maybe isn't anymore? Could you quantify what that may be doing to help?
Yeah, that will be less of a headwind for the year. That is true, that will benefit the fourth quarter.
Just lastly, on the portfolio, when you think about some divestitures, you've got at the moment this logistics and freight pressure. You also have dry, refrigerated, and frozen supply chains. Does reducing that complexity come into your thinking at all in how you evaluate what you may think about divesting?
Really good question. It doesn't come into play into what we think about divesting. As we're thinking about our supply network, we need to think about what we're divesting as we think about retooling that. It's a really good question, it doesn't impact what we would intend to divest, it would have an impact on how we think our logistics network ought to be set up going forward. We think about those two things going together.
Okay. Thank you very much.
Thank you. Our next question comes from the line of Ken Goldman with JP Morgan. Please proceed.
Hi, I just wanted to follow up a little bit on Dave Driscoll's question earlier because I think the answer focused on now versus two years ago. If you go back a little longer in time, go back to fiscal 2008, Mills had 7% inflation, yet it still beat its earnings target. Fiscal 2009, 9% inflation, gross margin barely changed. I know you guys were in different seats at the time, but something has changed. Again, to Dave Driscoll's question, is it just this much harder to take list pricing no matter what? Or is it more a case of, hey, maybe items like freight, items on the sort of perimeter that are not exactly food stuff oriented are harder to pass on? I'm just trying to get a sense of really. I know you've addressed this to some extent, but Dave's right.
This is really the question we're getting a lot of really what the problem is this time, because the inflation's not nearly as bad as what you experienced 10 years ago, and yet the results are much worse.
A couple of things. You referenced 2008 and Ken, I was sitting in the cereal chair in 2008, which is when we did Right Size, Right Price, which is kind of a fancy term for price pack architecture. When you think about strategic revenue management, that was kind of the mother of all strategic revenue management initiatives. When I talk about price pack architecture and trade optimization and those kind of things, 2008 was a year that we certainly did that in the cereal business and saw great results from that. A lot of positive lessons to be learned from that. I would tell you what's different about now is that the inflation, as you mentioned, 4% is certainly a point higher and a significant inflation above three, is not something that can't be managed.
We just had to make sure we see it coming. Now that we know that it's coming, now we feel like we can manage it effectively because as the input costs, whether they're 4% or 5%, is not unprecedented, it's just higher than we had expected, and we hadn't taken the actions to offset it. Now that we see it, we have a good degree of confidence that with combining what we can save on logistics costs and way that we can reframe our logistics network combined with a little bit of net price realization, we can actually combat this because as you said, we've done it before. We just didn't have the line of sight to it until recently that we needed to have to combat it.
A quick follow-up from me. You're using more co-packers, I think, than you expected, you're also hopeful that your volumes continue to rise. If this is the case, if your volumes do improve, you'll need to rely even more on co-packers, which I'm sure you don't want. As we think about 2019 and beyond, again, you're not giving guidance, is it reasonable for us to expect you'll want to invest in CapEx a bit? Otherwise that, I guess co-packing issue will just accelerate further.
Ken, we've always used co-packers, particularly for a lot of our new product volume, because there's a lot of times ready capacity and capability, and obviously there's a bit of risk mitigation from our standpoint as well. What we've seen is that as new products become stable in the marketplace, that we bring them internally and we see savings and that's what we put capital against. We'll take the same approach here. It doesn't necessarily mean that CapEx will be higher than normal, we just may be skewing more toward bringing this new product volume in-house.
Okay, thanks so much.
Thank you. Our next question comes from Alexia Howard with Bernstein. Please proceed.
Good morning, everyone. Thanks for the question.
Good morning.
I guess to begin with, it actually looks as though the profit pressure is greater in the international market at the moment. Yet a lot of the conversation today has been about perhaps not realizing the kind of profit growth that you might have expected in North American retail. I'm just wondering if you can just go region by region and talk about what's happening to the creating profit declines in those international markets. Then secondly, on the Blue Buffalo acquisition, do you have a new updated guide on where the leverage might go to in light of the EBIT shortfall this year? Thank you.
Okay, Alexia, to hit both regions. In the EU-AU, the year-to-date margins are being impacted primarily by raw material inflation, especially dairy and vanilla, which have spiked significantly this year. Then we have some currency-driven inflation on products imported in the U.K., so some transaction effects. Both of those are particularly pointed in our EU-AU business this year. As we look at Q4, we expect to see some improvement. We're going to get some price mix improvement. I mentioned that Old El Paso and Häagen-Dazs will lead the growth, and those are both higher margin lines. We do see moderating input cost in EU-AU, a little bit different than here in the U.S. as they lap some of the initial spikes in the dairy and vanilla costs from a year ago. We're going to see increased cost savings.
One of the manufacturing consolidation projects that we've had underway was in EU-AU, we're still in the first year of seeing those savings, so those will increase. It will be partially offset with some higher media and advertising expense to support that top line. We expect to see improvement in the fourth quarter. ASLA, I mentioned that, actually, frankly, a lot of the same factors in terms of transaction effects, the maybe more unique factor to ASLA because of Brazil is lower volumes as well. As we look at Q4, we're going to see improvement because we're going to get better price mix. We're going to get better volume performance in Brazil as we come out of an ERP installation. The COGS headwinds will lessen a bit.
That's in the quarter, I think your question's a broader one as well, I think it is a good one. As we look at those two segments, we're very pleased over the long run with our top line. We've been very competitive and actually market leading in both of those areas over the longer term in our top-line growth. We have been investing in those businesses to maintain that growth or to drive that growth. I think we have the opportunity as we go forward to better balance the top-line growth and the margin performance. As we build our FY 2019 plan and beyond, that'll certainly be something that we have in mind, in both of those regions.
Then on the leverage?
On the leverage, it may go up a tick because of the lower profit. I think we guided to 4.2, 4.3. If it moves, it'll be by 0.1.
Thank you very much. I'll pass it on.
Thank you. Our next question comes from the line of Akshay Jagdale with Jefferies. Please proceed.
Good morning. Thanks for the question. I wanted to sort of unpack the profit equation a little bit. I need your help in understanding what you think is transitory versus structural, right? You've got an issue with the commodity costs spiking. I think what I see as different from years past is these costs that have gone up aren't hedgeable, right? The visibility on them is inherently lower, the reaction time, I guess has to be faster. In the months to come, in the quarters to come, you'll have to show that your brands are strong enough to pass that on, right? That will have to play itself out. What I'm more concerned about, the questions we get, is you're having this really nice performance and improvement on the sales side.
How much visibility do you have on the incremental profitability from these new products and the sales growth that you're seeing? Are these inherently lower profitable products, or how are you thinking about that? You've had some issues with visibility. I wonder if this sales growth is coming at any cost, right? Is it a competitive issue? I'm just trying to better understand that, because it has major implications going forward. Thank you.
Sure. We obviously look at all of our new products in terms of their incrementality, both from the top and the bottom line. Oui is a great example where we're generating more on a per cup basis than on our base product, even though the margin percentage themselves are not materially different, you have a higher price point. What we're seeing this year is our new product volume is performing very well, as Jeff showed, almost 50% better than a year ago. Because we do those externally, because we're seeing also the need to, from a co-packer standpoint and within our logistics network, more miles as we reposition product to meet consumer demands, we're having additional costs accrue to those businesses. It's not necessarily because of the new product economics.
That is, as we bring those in-house, as we structurally change our logistics network, the margins on those products are gonna be very competitive with our current business. It's a matter of getting the structure right, as Jeff alluded to, that's one of the projects that we have underway to enhance our entire cost structure, that will accrue to the benefit of many of these new products that are driving the higher volume.
Look, I'll put a finer point on that. I think it's a good question, Akshay Jagdale. I want to reiterate. On our top-line performers, particularly in North America Retail and C&F and Europe and Australia and even Asia, I couldn't be more pleased with the way that we have been able to pivot and grow our top line and the economics behind that. There've been a lot of questions about that and the environment, and did we buy volume? I just want to unequivocally say I love the way that we're executing. Our sales and our marketing teams are executing well together. Our marketing campaigns are better. Our new products are together. I am certainly displeased with our profit performance in the third quarter and the fact that we didn't see some of this coming as much as we should have.
I'm really pleased with what the organization has done about returning to growth. You asked about the cost. I would say that I think from a logistics standpoint, I think it is more structural. We have a shortage in labor supply. We have new regulations that started in December, which will fully become operational in April, and we are hitting a moving target. I think our logistics costs are structural. I don't think that they're going to go down. What we're seeing on the commodity side is certainly going up, and it ebbs and flows over time. I'm not sure that's structural as much as it is point in time. I think the logistics costs are, which is one of the reasons why we need to have some net price realization and why we feel like we can, because everyone's feeling it in the industry.
Our competitors are feeling it. We're feeling it. Our customers are feeling it. As we look for net price realization, I think that part is structural.
Any implications from everything you're facing in your base business on how you think about integrating Blue Buffalo?
No, I'm glad you asked about that. First of all, I think about Blue Buffalo, I think of a transition rather than an integration. Blue Buffalo is gonna be a separate operating segment. There'll be some integration, and the synergies we have accounted for are actually quite low relative to other deals that we have done. It will operate relatively independently, and we'll help them on the sales side where we can. We'll help them on the supply chain costs. I can tell you, even over the last month since we've announced the deal and gotten to know their leadership team, they've got a very strong leadership team.
I think their strong leadership team, and not only Billy Bishop, but the rest of the team, combined with our capabilities, I will tell you that even in the month since we announced the acquisition, we feel more confident than we have even before about our ability to execute against Blue Buffalo well.
Thank you. I'll pass it on.
All right. Unfortunately, I think we're past time. I know there's still a lot of questions out there, please don't hesitate to give me a call later today. Thanks for everyone for joining us this morning, have a good rest of your day.
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