Kellogg Company
Q2 2016 Earnings Call Transcript

Published: 4 Aug 2016

[Operator:]

Good morning. Welcome to the Kellogg Company Second Quarter 2016 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period Please note that today's call is being recorded. Thank you. At this time, I will turn the call over to John Renwick, Vice President of Investor Relations for Kellogg Company. Mr. Renwick, you may begin your conference call.

[John P. Renwick, IV:]

Thank you, Gary, and good morning, everyone, and thank you for joining us today for a review of our second quarter 2016 results. I am joined here by John Bryant, Chairman and CEO; Ron Dissinger, Chief Financial Officer; and Deanie Elsner, President of U.S. Snacks. The press release and the slides that support our remarks this morning are posted on our website at www.kelloggcompany.com. As you are aware, certain statements made today, such as projections for Kellogg Company's future performance including earnings per share, net sales, margin, operating profit, interest expense, tax rate, cash flow, brand building, upfront costs, investments and inflation, are forward-looking statements. Actual results could be materially different from those projected. For further information concerning factors that could cause these results to differ, please refer to the second slide of this presentation as well as to our public SEC filings. As a reminder, a replay of today's conference call will be available by phone through Thursday, August 11. The call will also be available via webcast, which will be archived for at least 90 days. And now, I will turn it over to John Bryant.

[John A. Bryant:]

Thanks, John, and thank you, everyone, for joining us. We are pleased to report another quarter of operating profit margin expansion. Obviously, we're still challenged as to our top-line (2

[Ronald L. Dissinger:]

Thanks, John, and good morning. Slide 5 shows highlights of the financial results for the second quarter. Keep in mind that when describing our results and outlook, we will be referring to them on a currency-neutral comparable basis, unless otherwise noted. And, in many cases, we'll also give you the same metrics excluding Venezuela. We do this because we know you prefer this basis for analyzing our underlying business performance. And, of course, the appendices to our presentation provided with the detail on both our GAAP and non-GAAP performance. Second quarter net sales increased by 8.6% and, like last quarter, these results included the impact of pricing actions in Venezuela. Net sales excluding the impact of Venezuela declined by 2%. Our operating profit increased by 10.6%, driven by savings from Project K and Zero-Based Budgeting in North America, as well as by price increases in Venezuela. Excluding the impact of Venezuela, operating profit increased by 5.3% and exceeded our expectations. On a comparable basis, earnings per share were $0.91 in the quarter, due to operating profit performance. This included $0.09 of currency headwind, $0.06 of which was due to the mid-2015 currency remeasurement in Venezuela. As a result, currency-neutral comparable earnings were $1 per share for the quarter, which represented a year-over-year increase of 8.7%. Now, let's turn to Side 6 and the components of the second quarter sales. Volume declined by 1.6%, and roughly the same ex-Venezuela. We'll discuss some of the markets where we saw declines a little later. Price/mix contributed more than 10 percentage points to sales growth, due to the impact of pricing in Venezuela. The price/mix, excluding the impact of Venezuela, declined by half a percentage point, held down by category, channel and SKU mix in various markets. And finally, you can see on this chart that the impact of foreign exchange lowered reported sales growth by 15 points, with almost all of it coming from Venezuela. And in the second half, we will have lapped the Venezuelan remeasurement, so its impact will be much smaller. Slide 7 shows our currency-neutral comparable gross profit margin for the quarter. Venezuela's inflation and currency remeasurement can be a bit distorted, but you can see that, excluding Venezuela, our gross profit margin was flat in the quarter and very close to flat for the year-to-date period. Our Productivity, Project K and Zero-Based Budgeting initiatives all delivered as planned in the quarter. This was most evident in North America, where our gross profit margin increased meaningfully, in spite of investment in food at Kashi, adverse transactional currency impacting Canada and some adverse mix in Morning Foods and Snacks. Offsetting this strong North America performance were gross margin declines across our international businesses. These declines were primarily driven by the adverse transactional currency impacts on dollar based commodities and other inputs and a deflationary retailer environment in Europe. Slide 8 shows a currency-neutral comparable operating profit margin, excluding Venezuela, for the quarter. And on that basis, operating margin increased by 110 basis points in the second quarter. It was led by North America, which is where we have rolled out ZBB. Operating margin was up internationally as well, though expansion was a bit more modest, owing to the gross margin pressures described previously and to the fact Zero-Based Budgeting is just starting up in these regions. Slide 9 summarizes the regional financial performance for the second quarter on a currency-neutral comparable basis. I'll focus on the profit and margin performance and then Deanie and John will follow with more color around the top-line. The first thing that you'll notice is that, excluding Venezuela for Latin America, every region posted profit growth and margin expansion in the quarter. In North America, operating profit increased by 5%, as savings programs more than offset a decline in sales. Operating margin improved by 1.4 points, driven by Project K savings, the ZBB initiative and lower net input costs. In Europe, operating profit increased by 4% on flat sales, with an operating margin that increased by 0.5 point, largely on efficiencies and timing of brand building as well as savings in overhead. In Latin America, operating profit increased substantially because of inflationary Venezuela. Excluding Venezuela, operating profit also increased by 4%. Operating margin, excluding Venezuela, improved by nearly a full point, led by price realization and cost management programs. Asia Pacific's operating profit jumped by a little more than 17% in the quarter, partially driven by sales growth. Operating margin increased by nearly a full point, as the timing of investments more than offset unfavorable transactional currency impacts. Slide 10 shows our cash flow for the first half of the year. You may recall that our first quarter cash flow included the impact of a bond tender offer, which lowered cash flow by approximately $145 million. Related to that, we did get a cash tax benefit in the second quarter, so the net after-tax cash impact of the tender year-to-date is approximately $97 million. And still, our year-to-date cash flow through the second quarter was $399 million, which is about $76 million better than that for the year-ago period. And importantly, we continue to reduce our core working capital as a percentage of sales, both sequentially and year-on-year. This improvement was again led by the accounts payable initiative that has been benefiting working capital over the last year. We are still on track to deliver our targeted $1.1 billion of full year operating cash flow, after capital expenditure. Full year capital spending should still be in a range between 4% and 5% of sales, including investment for Pringles growth and Project K. We bought back shares worth approximately $176 million in the second quarter, bringing our year-to-date total to $386 million, all this under our current $1.5 billion authorization. Slide 11 shows our latest guidance for the year, again on a currency-neutral comparable basis. Our net sales guidance does not change, but we believe we will come in at the low end of the 0% to 2% range that excludes Venezuela. Our operating profit guidance moves higher because of Venezuela's profit performance in the first half. And excluding Venezuela, we are not changing our guidance range, but we expect to achieve the high end of the 4% to 6% range. This is related to Zero-Based Budgeting, which is now projected to deliver roughly $150 million to $180 million of savings in this year. North America has confirmed more savings than anticipated and our international regions now have savings commencing in the second half. We're allowing more of our projected savings to flow to the bottom line, more than offsetting the impact of sales coming in toward the lower end of our guidance range. Between this higher ZBB savings and the performance of our Venezuela business, we expect our currency-neutral comparable earnings per share to be about $0.11 higher than the range we gave previously. I will point out that on a comparable basis including currency, our earnings per share outlook range actually comes down $0.06, owing to further devaluation of currencies against the U.S. dollar. Our increased outlook for operating profit has been offset by a higher average share count, due to an increase in share price and dilution from options activity. This $0.06 of additional negative currency translation is from the British pound primarily, following the vote to exit the European Union. From a phasing standpoint, the additional $0.06 of impact from currencies is evenly spread across Q3 and Q4. Remember, the impact of Venezuela is immaterial in our second half, as we have lapped the year-ago remeasurement. The Q3 earnings per share will be a little lighter than Q4, owing to the timing of investment, particularly around the Olympics and some media campaigns that were shifted from first half into the third quarter. Slide 12 shows other elements of our guidance. And first, you can see the currency impacts we just talked about. Interest expense should come in at around $400 million, which includes roughly $150 million from the bond tender, which has been excluded from our comparable results. Our comparable tax rate will be approximately 27%. Share buybacks are expected to be approximately $700 million to $750 million, though, as I said, a higher share price and increased options exercises will translate into a higher average shares outstanding. Full year up-front costs remain consistent with our original guidance of between $200 million and $250 million, or approximately $0.40 to $0.50 per share, net of tax, about half of which should be in cost of goods. And full year integration costs are still anticipated to be between $0.02 and $0.03 per share, net of tax. For both the up-front costs and integration costs, we are showing on the slide the post-tax values as well, from new disclosure rules. And with that, we'll now discuss the performance and outlook of each of our business units. We'll start with our largest business, U.S. Snacks. And with us today's is Deanie Elsner, President of U.S. Snacks.

[Adrienne Deanie Elsner:]

Thanks, Ron, and hello, everybody. Let's go to Slide 13. Before we jump into our Q2 results, let me quickly re-ground you on what I told you back at November's Day at K investor presentation. First, we're a big business with good profitability. We compete in five different categories, each with their own dynamics and in different aisles of the store. Second, we have a strong portfolio of great brands, which participate in the mega consumer trend towards snacking. This slide points out the size of some of our key brands. Third, and importantly, I laid at the opportunities that exist to get this business back to growth again. And I shared with you the key priorities we're focused on this year. Among those were the following

[John A. Bryant:]

Thanks, Deanie. Let's turn to Slide 19 and walk through our business segments' Q2 performance and full-year outlook. In U.S. Morning Foods, like Snacks, our margin expansion efforts are clearly bearing fruit. Project K savings and ZBB efficiencies contributed to an expansion in operating profit margin of nearly four points, an acceleration from Q1's strong performance. In Cereal, the category came back to flat after down Q1, which is encouraging. Our share was off slightly in the quarter, mainly due to the timing of commercial activity, with our core six brands held firm and remain up in share year-to-date. Toaster pastries, meanwhile, continue to perform well, growing consumption by 5%, with food contribution from the new soda flavors. As we look to the second half of the year, we continue to expect improvement in top-line performance, particularly timing of promotions like the Olympics. We feel good about our business and strong profit margin expansion should continue to drive profit growth. U.S. Specialty Channels is shown on Slide 20. The segment posted another quarter of growth in sales, profit and profit margins in Q2. In Foodservice, we sustained strong growth in Cereal, Crackers, Veggie and Wholesome Snacks; all categories with leading shares. In Convenience, we gained share in Cereal, Salty Snacks and Crackers. Innovation continues to perform well, and we feel good about the momentum we have in our business. We also feel good about our profit margin performance, which continued in Q2. Good price realization and the early benefits of Zero-Based Budgeting are resulting in improved profitability. We expect this to continue in the second half. Rounding out North America on Slide 21 is our North America Other segment. During Q2, our North America Other segment posted the lowest sales and profit, as each of its component businesses progressed through transitions. U.S. Frozen Foods is an example of a portfolio in transition as we have reshaped the portfolio for Eggo and transitioned to new packaging across the entire MorningStar Farms line. Even as we made these major moves, this business posted improvement in profit margins, driven by Project K and Zero-Based Budgeting. Kashi is also amidst a major overhaul of its portfolio. We are investing heavily in our food. During the quarter, we completed an overhaul of our portfolio, making every product non-GMO verified. We also launched several new products; in fact, we believe this was the most innovation launched in Kashi's history. And finally, we redesigned our packaging across our Kashi portfolio. In Canada, we leaned into price realization in order to cover the transactional currency impact on our cost of goods. This caused some elasticity impact on consumption in the quarter, but it will help us better offset our adverse cost going forward. The good news is that we continue to see share gains in our renovated and repositioned Special K. So the North America Other segment is clearly in transition, but we expect to see gradual improvement in sales and profit margins in the second half. Turning to Slide 22 and Europe, we've been expecting sequential improvement in sales and profit in Europe. We saw that in Q2. Sales were flat following Q1's slight decline, and our operating profit margin expansion led to better profit growth. We are extremely pleased with our Pringles business, which grew at a double-digit rate. Wholesome Snacks also had another good quarter, growing in a mid-single digit rate, led by the U.K.'s 5.5% consumption growth and broad-based improvement in trends in most markets. Cereal, though, was disappointing in Q2, mainly in the U.K. The category there remains very soft in a difficult economic and retail environment, and we lost share. Management worked (28

[Operator:]

We will now begin the question-and-answer session. Our first question comes from John Baumgartner with Wells Fargo. Please go ahead.

[John Joseph Baumgartner:]

Hi, good morning. Thanks for the question. John, I'd like to ask about the changes underway in the DSD system. As that delivery sales force reorganization concludes, how are you thinking, going forward, assessing the opportunities for further efficiencies in that route to market, either personnel or overhead related? And maybe where can you better leverage DSD for that increased distribution in Snacks that Deanie discussed?

[John A. Bryant:]

As I said on DSD, obviously, it's a powerful go-to-market engine. It's one that we constantly look to optimize and improve. Over the years, we've taken things in and out of DSD and we're always looking to make that system more effective and efficient. So we've seen some good progress. We're very excited to have the reorganization behind us. We expect to see the business be stronger in the back half of the year. We're making good progress.

[Adrienne Deanie Elsner:]

Just to add to that, John, as I talked about the price/pack architecture and specifically the expansion in formats, we have the opportunity in our current grocery channels, that are serviced by DSD, to expand the formats in those channels as well as outside of the traditional grocery channels. And so we will be pushing those initiatives into our DSD system.

[John Joseph Baumgartner:]

Is that more of a back half focus or more 2017?

[Adrienne Deanie Elsner:]

You'll see us expanding as early as we speak, back half now.

[John Joseph Baumgartner:]

Great, thank you.

[Operator:]

The next question comes from Matthew Grainger with Morgan Stanley. Please go ahead.

[Matthew C. Grainger:]

Hi. Good morning, everyone. Thanks for the question, as well. I wanted to just ask about the revised margin targets. So you're on track to deliver $200 million plus in incremental cost savings this year. And with the ZBB, I think you had around $550 million in total. So even if we assume some incremental savings on international ZBB, right now, the formal cost savings seem to give you visibility to about half to two-thirds of the margin that you're targeting, if that all kind of flows through to the bottom line. So can you just talk about the other factors that you've mentioned, like improving mix, revenue management, how those bridge the gap to get you to the 18% target? And are you comfortable that there is enough margin for error in your model and in your cost savings pipeline that you can definitely reach that target, even in the event of weaker volumes or higher inflation?

[Ronald L. Dissinger:]

Sure, Matthew. In short, yes, we are. And let me just run through some of the elements of that 350 basis points of margin expansion. And remember, that's off of a 2015 base. And it's also important to note that, that expansion is based on essentially a flat sales expectation. So, of course, we have a continuation of Project K savings and we've talked about this before. As we look at 2017, 2018, we have in the range of $130 million to $150 million worth of savings. Our Zero-Based Budgeting program, we communicated for 2016, $150 million to $180 million. We now have visibility for both North America and our international businesses, of savings over that period of $450 million to $500 million. So that's over a three-year period, 2016 through 2018. The other thing, as we discussed we're doing, is we're putting a more concerted effort behind revenue growth management, to generate stronger price and mix improvement. So we have very good line of sight to achieve that margin expansion goal on essentially a flat sales expectation. Of course, our goal would be to do a little bit better on sales. If we do, then 18%, the 350 basis points expansion is not a ceiling. It's a target or a goal at this point in time, and we have a strong plan and good visibility to get there.

[Matthew C. Grainger:]

Okay. That's helpful. Thanks, Ron.

[Operator:]

The next question comes from Eric Larson with Buckingham Research Group. Please go ahead.

[Eric Larson:]

Yes, this is a question for John. In the early part of your prepared comments, it's kind of a little bit of a tag on the last question, your new marketing model, and I think that you said that it might result in less reinvestment, does that mean that your advertising spending as a percent of sales, which is running roughly about 8% – I think it's amongst the highest in the industry – will that percentage come down over time a little bit? And will actual dollars in advertising ease as you become more efficient? How should we look at that?

[John A. Bryant:]

It's a good question. As we think about brand-building it's an important part of our mix. What drives our categories are strong brands, strong innovation, good in-market in-store execution. And as we continue to have industry-leading levels of brand-building and we continue to invest in our brands, how we invest in the brands is obviously changing, so the importance of TV versus digital, social, mobile, etc. all that is changing the mix. As we do that and we apply Zero-Based Budgeting to our principles to that work, we're finding

[Eric Larson:]

Okay. And then, just a tag-on question for Ron and then I'll pass it over, but sort of your new margin target goal for 2018, does it include any additional cash investment? Or is this just a better outlook for all the programs that you already have in place, i.e. Project K and ZBB, is there cash impact?

[Ronald L. Dissinger:]

So our Project K is on track at this point in time. And it's on track both from an investment and a savings standpoint, so there are no additional cash requirements for us to achieve this margin goal.

[Eric Larson:]

Okay. Thank you.

[Ronald L. Dissinger:]

Yep.

[Operator:]

The next question comes from Mario Contreras with Deutsche Bank. Please go ahead.

[Mario Contreras:]

Hi. Good morning. Thanks for the question.

[John A. Bryant:]

Morning.

[Mario Contreras:]

I just wanted to ask a little bit more on the revenue management initiatives that you have in place. Can you give a little bit more detail on what exactly that entails or at least the detail you can provide now over the next couple of years? And what the type of volume elasticity that you're looking at relative to some of the pricing and productivity changes you plan on making?

[John A. Bryant:]

Yeah, so we are launching a greater focus on revenue growth management in the company. As you'd expect, we've always had a focus on it, but what we've historically focused on, a lot has been trade analytics. And we're finding there's opportunities in some other areas, such as price/pack architecture, and, of course, continue to drive a focus on mix. And for those of you who followed the Kellogg Company through the 2000s, we had a significant benefit in price realization in what we called a volume-to-value model orientation. We're actually bringing that orientation back to the company to ensure that we are focused on price/mix. Our price/mix realization as a company has actually been lagging our peer group over the last few years. And so, I don't view this as a radical shift. I view this is an increased focused in this area. And I really want to see better performance from the company going forward. To give you an example, since we have Deanie on the call, I'll let Deanie talk about one example in the Snacks business.

[Adrienne Deanie Elsner:]

Yeah, and John is exactly right. The opportunity for Kellogg is greater price realization across all three levers of revenue growth management. So I mentioned earlier the Cheez-It example. And in Cheez-It, we assessed our portfolio pricing across all of our channels. We expanded our formats to meet the needs of consumers by channel and that included large sizes and On-the-Go and smaller sizes, in addition to opening price points. The format's changed by channel. We optimized our trade and that gets really to the trade optimization that John talked about, is a towering strength of Kellogg's and the results and you can see them in Q2, consumption is up 5.4%. We've had strong volume mix. Our base sales are up. Our distribution is up and our operating margin has expanded. And so when you look at revenue growth management holistically and in totality across all three levers, there really is strong opportunity for the Kellogg Company going forward.

[Mario Contreras:]

Okay. Thank you very much.

[Operator:]

The next question comes from Chris Growe with Stifel. Please go ahead.

[Christopher Growe:]

Hi. Good morning.

[John A. Bryant:]

Morning, Chris.

[Christopher Growe:]

I just had a question, if I could, and forgive me if I missed this earlier, but have you said how much the total cost savings will be in fiscal 2016, so adding international, the ZBB? How much more is that contributing to your available cost savings this year?

[Ronald L. Dissinger:]

Yeah, good point, Chris. So when we started the year, we said we had about $100 million worth of Project K savings. We're still on track to deliver against that. And we said from a ZBB savings standpoint, we expected about $100 million of ZBB savings. We are now at a range of $150 million to $180 million worth of Zero-Based Budgeting savings. So that's allowed us to cover sales coming down to the low end of the 0% to 2% range and increase our operating profit guidance to the high-end of the 4% to 6% range all ex-Venezuela.

[Christopher Growe:]

Okay. That's helpful. Thank you. And just kind of related to that, as I listen to the commentary about more savings and the focus on margin, I think that's great. I guess what I'm trying to understand is, as you have more savings coming through, or, I should say, as you better focus on margin, does that allow you to also reinvest to generate better top-line growth? So are there more savings coming through that are allowing you to reinvest and to pursue a top-line growth target along with the margin target or could you speak to that maybe over the next couple years?

[John A. Bryant:]

So we are continuing to reinvest back in our business, as you mentioned. We've invested back in our sales capabilities. We're also investing back in our food. I think Kashi is an example of investing to go non-GMO is a major investment by the company. And so we'll continue to ensure our food and packaging is on-trend as we go forward. And so there will continue to be investments in that area. So as part of our margin goal, we do have an expectation to reinvest some level of savings back into the business. We are giving a sales guidance here over next couple of years of flat, and that's less than what we would normally do. A couple of reasons for that; one is what we're seeing is from an economic model perspective, from an analyst perspective, if you put in flat sales and the 350 basis points of margin expansion, we think it's a good way of modeling the company. Quite frankly, we will shoot to do better than that and actually grow the top-line from an internal perspective, but we're not relying upon that to get to the operating margin expansion. The margin expansion is coming more from productivity and price/mix realization rather than, say, volume-type growth. In addition to all of that, as we go through the next few years, we might see some elasticity as we improve the price realization. And we might see some parts of the portfolio that is lower profit, that we de-emphasize as we continue to grow other parts of our business, such as Pringles, which has been growing mid to high single digits the last couple of years.

[Christopher Growe:]

Okay. Thank you for that color.

[John A. Bryant:]

Thank you.

[Operator:]

The next question comes from Robert Moskow with Credit Suisse. Please go ahead. Robert Moskow - Credit Suisse Securities (USA) LLC (Broker) Hi, Ron. I was hoping you could help me on one thing that you mentioned. When you said $150 million to $180 million of ZBB this year, I think in the same breath you also said $450 million to $500 million over three years? And I was just wondering. Did I get that right? And if so, does that assume that there's no improvement in 2017 and 2018 on those ZBB savings; that it's kind of like a one-time help and then you just hold onto it each year? Thanks.

[Ronald L. Dissinger:]

So, Rob, we have $150 million to $180 million visibility in 2016 and then that will build over 2017 and into 2018 to a run rate of $450 million to $500 million. The other thing that I'd point out, so that savings in ZBB... Robert Moskow - Credit Suisse Securities (USA) LLC (Broker) Okay.

[Ronald L. Dissinger:]

Yes, that's on top of Project K. That's on top of our base productivity savings as well, Rob. So we have a lot of productivity savings coming through our P&L. Robert Moskow - Credit Suisse Securities (USA) LLC (Broker) Okay. So it's not a cumulative number. It does built each year, which is very different from what I thought. So can you give me a sense of what gives you confidence that it can build to that degree? Is it rolling out in different functions of the organization and geographies? And then what percent of those functions and geographies do think it's in right now?

[Ronald L. Dissinger:]

So it's certainly in North America. And we have line of sight year-by-year. Rob, some of the things are very easy to change and to get the cost savings. There are other things, within supply chain and other areas of our business, that take a little bit more time to recognize the savings. So we're certainly doing it as quickly as we can. In terms of the rollout through the international regions, certainly our Europe and our Latin America business are well underway. And we're getting some of those savings end of 2016 related to them. Asia Pacific, we'll see more of that savings coming into 2017. But international overall has a stronger tranche of savings in 2017, whereas North America, their savings really was ramping up here through 2016. Robert Moskow - Credit Suisse Securities (USA) LLC (Broker) Can I ask if Kashi is going to go through this process?

[Ronald L. Dissinger:]

Kashi has been involved in the process throughout 2016 as part of the North America implementation, Rob. Robert Moskow - Credit Suisse Securities (USA) LLC (Broker) Got it. Thank you.

[Ronald L. Dissinger:]

Yes.

[Operator:]

The next question comes from Dave Driscoll with Citi. Please go ahead.

[David Cristopher Driscoll:]

Great. Thanks a lot. Good morning.

[John A. Bryant:]

Morning, Dave.

[Ronald L. Dissinger:]

Morning.

[David Cristopher Driscoll:]

John, wanted to go back to this sales comment that you're making about 2017 and 2018 and the flat numbers. I want to say that back at analyst day, there was a lot of energy about rebuilding the top-line momentum and getting the company back on revenue growth. You've made repeated comments about the operating leverage that revenue delivers to the business model. So, you've made a couple of comments here, but I'd just like to push it a little further. Is it you're just trying to set up some kind of super reasonable expectation going forward, i.e. a very achievable numbers at this early date? Or is there something about all the growth plans and reinvigorating Cereal and Kashi and all those things that you just have less confidence in and says, hey, let's take this down to a zero-growth expectation.

[John A. Bryant:]

Thank you for giving the opportunity to clarify if that's a concern out there. I feel very good about the progress we're making on the top line. If you look back over the last three or four years, we've talked about the importance of stabilizing the large four core cereal businesses. I'm happy to say that if you look at the U.S., Canada and Australia, if you look at the measured data, you can see the categories are stable and our share is stable across those three businesses. The U.K. continues to be a work in progress. That's one we're not happy with its performance, but we expect to see improving results in the back half of the year in the U.K. So core Cereal is looking a lot better than it was, say, a couple years ago. Special K has been a major drag. In fact, pretty much all the loss of sales the company has had over the last few years has been Special K. And what you're seeing in markets like Canada and the U.S., particularly in Cereal, that business has stabilized. And we've still got some work to do in some snacks, extensions of Special K, but we're feeling better there. And so we do think that the growth from Pringles and so on will keep coming through. An element of why we're being cautious and saying flat sales again, is because, one, we're being, I think, prudent from a modeling perspective. And clearly, if we can get sales growth, it will give us even more flexibility in the P&L. So one, I think we're trying to avoid overstating expectations, over-cooking expectations, so we're being prudent on the economics. And secondly, as we do drive for more price realization, as we do deemphasize some lower profit elements of the portfolio, we might see some drag on the top-line, but it's a drag that I wouldn't be concerned about, because we're building a stronger core business over time with a better growth profile. So I think we're just giving prudent guidance at this stage.

[David Cristopher Driscoll:]

Thank you. Could I just sneak one in for Deanie? Your largest competitor was complaining of higher trade and promo spending by the competition. Can you discuss your view on promo spending and how rational it is right now in your big categories?

[Adrienne Deanie Elsner:]

Yeah, I'd love to, Dave. It's never productive to comment on competitors, but I'll give you a perspective of how we are looking at the category. For me, the category dynamics appear pretty rational. If you look both across Cookies and Crackers, both categories are up in consumption. Average price is up in both categories, both on a per pound basis as well as a per unit basis. Quality merchandising is flat. Features and displays are up, displays are down. (51

[David Cristopher Driscoll:]

Thank you.

[Operator:]

The next question comes from Alexia Howard with Bernstein. Please go ahead.

[Alexia Jane Howard:]

Good morning, everyone.

[John A. Bryant:]

Good morning, Alexia.

[Alexia Jane Howard:]

Can we ask about the ramp up in your cost-cutting efforts? They've obviously accelerated for the near-term here. If I compare that to the $1 billion challenge where there were execution problems through that cost-cutting program, issues of morale, cultural upheaval, what's different? How are you thinking about making sure you learned lessons from that experience to make sure that this time it's smooth sailing? Thank you and I'll pass it on.

[Ronald L. Dissinger:]

This is Ron, Alexia. So when you look at Project K, and we've discussed this before with analysts and investors, it's very different than that $1 billion challenge. Where we took capacity out of our network, we were actually closing down facilities. That previous $1 billion challenge, we were simply taking people out of the organization and asking the organization to do the same with less people. That was a bit harder for them to accomplish. So we feel good about Project K and the integrity of our infrastructure as a result of the actions we're taking there. Zero-Based Budgeting, it's really just a refreshing way to look at our cost structure and ensure that the investments that we have are prioritized and aligned with our strategy, so it's nothing more than that. We're being very thoughtful on how we take costs out of our business and make sure that the investments we're making are aligned with our priorities and strategy.

[Alexia Jane Howard:]

Thank you very much. I'll pass it on.

[John P. Renwick, IV:]

Gary, I think we have time for one last question.

[Operator:]

The last question will come from Michael Lavery with CLSA. Please go ahead.

[Michael Lavery:]

Morning. Thank you.

[John A. Bryant:]

Good morning.

[Michael Lavery:]

You touched on Kashi and its sharing in some of the savings efforts, but obviously there's investments there, too, and that Other segment margins are still down. Can you give us a sense of what that trajectory looks like? And should we expect those margins to increase over the back half or is there some other investments still to come we should be factoring in?

[John A. Bryant:]

On Kashi, we feel very good about where we are from an investment perspective. So now we have the entire portfolio GMO-free, we can turn the marketing program on in the back half of the year. We had a very strong slate of innovation go through here at the middle of the year, so we expect to see Kashi return to growth in the back half of the year. Now, there are some parts of the Kashi business, some frozen pizza items and some other items, that we've culled out of the portfolio, so that might continue to drag on the business, but they were relatively low margin segments of the portfolio anyway. So we feel good about where we are in Kashi in terms of positioning it for long-term growth. If I could just say on K and the Other (55

[Michael Lavery:]

Okay. That's helpful. And can I just add one quick last follow-up? On the flat sales expectation, can you give any sense of what the split might be between volume and price/mix?

[John A. Bryant:]

No. Look, we haven't given that sort of guidance. I think we'll wait until each annual discussion when we provide more color as to why it is what it is. But clearly, within a flat sales guidance, you would expect volume to be down a little bit and price/mix providing some benefit. And again, let me reiterate, internally, we'll chase better numbers than that, but we don't want to promise those numbers. Clearly, we want to deliver them, though, when the time comes.

[Michael Lavery:]

Okay. Thank you very much.

[Operator:]

(57

[John P. Renwick, IV:]

That went faster. We can do one more.

[Operator:]

Okay. The next question comes from Ken Zaslow with Bank of Montreal. Please go ahead.

[Kenneth Bryan Zaslow:]

Hey, good morning, everyone.

[John A. Bryant:]

Hey, Ken.

[Kenneth Bryan Zaslow:]

Just two quick questions, one is when you talk about the flat line growth over the long term, can you segment it between how you're seeing about the U.S. because it seems like there's a lot more activity in the U.S. Would you expect that to be ahead of the rest of the world, just given the activity? And then my second question is when you think about the margin expansion of the 350 basis points, that does include this year's benefit of Venezuela or does that not?

[John A. Bryant:]

Let me answer the sales question and I'll hand over to Ron to answer the margin question. On sales, I'd say the heavy lifting on margin expansion is going to be more in North America and Europe, just given the size of those businesses. And I would expect those businesses to be slightly lower in growth than the portfolio average, with more growth coming from Latin America and Asia Pacific. So I would say, again, flat is a range. Flat is not 0.0%. So I would hope that even those two big businesses can be in the flat ballpark in terms of top-line growth. But I wouldn't point out that I expect them to grow faster, say, than the portfolio average. Ron, you want to talk about the margin goal?

[Ronald L. Dissinger:]

Yeah. Ken, the way I think about the margin growth, so it's off of a 2015 base and I would look at it on an ex-Venezuela business. Venezuela is just distorting mainly the 2016 results, but I think about that growth on an ex-Venezuela basis.

[Kenneth Bryan Zaslow:]

Great. Thank you.

[John P. Renwick, IV:]

All right, Gary, I think we're finally out of time.

[Operator:]

This concludes our question-and-answer session. I'd like to turn the conference back over to management for any closing remarks.

[John A. Bryant:]

Thanks, everyone. I appreciate the time on the call and John Renwick and the team are available for follow-up calls throughout the day. Thank you.

[John P. Renwick, IV:]

Thank you.

[Operator:]

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.