Conagra Brands, Inc. (CAG) Q3 2018 Earnings Report, Transcript and Summary

Good morning, and welcome to the ConAgra Brands Third Quarter Fiscal Year 2018 Earnings Conference Call. All participants will be in listen-only mode. [Operator instructions] After today's presentation, there will be an opportunity to ask questions. [Operator instructions] Please note this event is being recorded. At this time, I would like to turn the conference over to Brian Kearney, Senior Director of Investor Relations. Please go ahead sir.

Good morning, everyone. During today's remarks, we will make some forward-looking statements. While we are making those statements in good faith and we are confident about the Company's direction, we do not have any guarantee about the results that we will achieve. So, if you would like to learn more about the risks and factors that could influence and impact our expected results, perhaps materially, we refer you to the documents we filed with the SEC, which include cautionary language. Also, we will be discussing some non-GAAP financial measures during the call today. References to adjusted items including organic net sales refer to measures that exclude items impacting comparability. Please see the press release for additional information on our comparability items. The reconciliations of those adjusted measures to the most directly comparable GAAP measures for Regulation G compliance can be found in either of the earnings press release or in the earnings slides, both of which can be found on our website at ConAgrabrands.com/investor-relations. Now, I'll turn it over to Sean.

Thanks, Brian. Good morning everyone, and thank you for joining our third quarter fiscal 2018 earnings conference call. We continued to make solid progress on our transformation plan during the quarter. Our primary focus this fiscal year has been on the top-line and we are particularly pleased with our momentum on this front as underlying sales trends, notably consumption continue to strengthen across our domestic retail segments. The investments we are making behind our brands to drive enhanced saliency, distribution and consumer trial are having the intended impact. These investments were largely above the line this quarter and consistent with our strategy to partner with retailers to acquaint our consumer base with our modernized brands and new innovation. The timing of these increased investments converged with greater than expected inflation in the quarter including higher transportation costs, as well as higher than expected reductions in retail customer inventories. Combined, these factors created near-term pressure on our gross margin despite the fact that we continue to price ahead of our categories. Our M&A activity continued this quarter. We were very disappointed in the Federal Trade Commission’s decision on the proposed Wesson sale and we are continuing to review Wesson’s role in the portfolio. But, we kept our M&A momentum nonetheless. Our solid performance has enabled us to raise our full year adjusted EPS guidance range. As a reminder, the guidance we most recently provided at CAGNY already accounted for the impact of the tax law changes. Today’s incremental increase is based on our underlying performance. Even without the aid of Tax Reform, we would still exceed the high-end of our original guidance range driven by a strong top-line. As you can imagine, this is very satisfying, particularly in a far more onerous inflationary environment than we planned for. At our inaugural Investor Day in the Fall of 2016, we committed to do three things; increase margins, improve top-line, and build a winning company. Strategically, our biggest priority this year has been strengthening top-line performance behind modernized brands and a strong innovation slate. After three quarters, we like what we see. Our focus on bending the trend on the top-line continues to gain traction. We expect to continue experiencing some variation in our results quarter-to-quarter, but over time, we also expect to grow. As you will recall from last quarter, our shipments exceeded consumption largely behind the hurricanes. Of our 230 basis point improvement in top-line growth in Q2, we estimated that approximately 220 basis points were related to the hurricanes. During our Q2 call, we shared that we expected a reversal of this dynamic in Q3 with consumption outpacing shipments, particularly in our higher margin Grocery and Snacks segment. That expectation played out. So taking a step back, combining Q2 and Q3 performance enables us to create a more normalized cohort that takes out the timing effect of the hurricanes and highlights the steady progress we are making to drive consumer takeaway. As you can see on Slide 9, we expect our strong top-line trends to continue in the fourth quarter. Our deliberate efforts to cut unprofitable SKUs and pullback on low-quality promotions are now largely behind us. In our largest segments, we’ve done a significant amount of the heavy value over volume lifting and the results are clear. As our new innovations have hit the marketplace, our top-line has responded with consistent, steady improvement. So while it remains early days, we are happy with our growth momentum and we are excited about the future. Our categories continue to grow largely driven by our efforts. And you can see that we are growing share. And Slide 11 highlights that the quality of our revenue base continues to improve. Total points of distribution are coming back in a much higher quality fashion, base velocities have improved dramatically and base dollar sales are in positive territory again. As you can see on Slide 12, these trends have allowed us to continue to price above our categories. We’ve also remained true to our value over volume strategy as the percent of products sold on promotion has decreased every quarter for more than two years. While that trend is not sustainable in perpetuity, this clearly indicates that our strong volume performance was not driven by deep discounts or price rollbacks. None of these results would be possible had we not set out to aggressively modernize our iconic brands. It’s been heavy lifting, but it’s also been tremendously rewarding and we are just getting warmed up with another robust innovation slate set to hit the market in fiscal 2019. As most of you know, we started our efforts to bend the top-line trend by focusing on Frozen, given the strong underlying fundamentals of the category and the untapped potential we identified in our brands. As you can see on Slide 14, our focus on innovation and targeted investments to drive brand saliency, distribution and consumer trial are clearly bearing fruit. We’ve experienced continued growth in Refrigerated and Frozen driven primarily by core business improvements and innovation launches in the Banquet, Healthy Choice, and Marie Callender's businesses. Frozen retail sales have improved materially. Frozen consumption was up nicely again in the quarter continuing a strong trend in the domain. And we think we have a lot of room to go from here as our distribution performance continues to improve and dollar sales growth has followed. Banquet, Healthy Choice, and Marie Callender's are our three largest brands in Frozen and received the most significant focus of our renovation work. These brands play distinct roles in our portfolio and in the Frozen category. Banquet is the number one brand in Frozen single-served meals by volume, providing American Classics to more than 40 million households. Healthy Choice, competes very effectively and has had a makeover to focus on active lifestyle. And Marie Callender's is known for its comfort food. By focusing on and leveraging the unique characteristics and strengths of these brands, we’ve returned each of them to growth and reestablished the relevancy of Frozen meals, and we see substantial runway for continued growth ahead. As we showcased last month at CAGNY, we are very excited about our fiscal 2019 Frozen innovation. We will extend into new day parts, expand modern wellness and new cuisine offerings, and pursue hand-held options. Sampling of these new innovations can be found here on Slide 18. Taking a step back, one of the things we are most determined about in Frozen is that given our strong performance we have ample room to capture our fair share of shelf space and grow organically. As highlighted in the chart on Slide 19, we have much larger share of dollar sales than we have of TPDs. We are working with retailers to highlight this fact as they review their planograms, we expect them to trim over skewed products those that are showing above 100 in this index and add more of the underskewed products like ours that have earned more space on the shelf. We expect this to be a tailwind for our Frozen business going forward as we gain our fair share of distribution. Progress we’ve made in Frozen demonstrates that our plan is working and we are not resting on what we’ve accomplished to-date. Turning to our Grocery and Snacks segment on Slide 20, as we noted earlier, we expected this segment’s sales to be down in Q3, given the impact of the hurricanes in Q2. Recall, we saw sales exceed consumption in the second quarter. However, in Q3, sales were down more than expected, primarily related to an unanticipated reduction in retail customer inventory levels near the end of the calendar year. While this adjustment in inventory levels negatively impacted the quarter, we expect this shift in customer behavior to be a one-time transitory occurrence. Despite the unexpected impact of the reduction in retail customer inventory levels in Q3, when you look at the normalized cohort of Q2 and Q3 combined, which removes the impact of these timing dynamics, we remain on track. The improvement in the segment is encouraging and we have concrete plans in place to renovate certain brands and provide the appropriate investment support behind them similar to the work we’ve done in our Frozen portfolio. Although it’s certainly early days, we are pleased with the underlying consumption trends in our Grocery and Snacks portfolio, which bodes well for this segment’s long-term top-line growth prospects. When you look just at our base business in Grocery and Snacks, trends are even more encouraging. Non-promoted consumption exceeded our internal expectations in the quarter and we’ve seen solid share performance as well. As you can see in the chart on the right, base dollar sales turned positive in the quarter for the first time in more than two years, a promising sign of what’s to come. A particular note, we are seeing growth from both iconic established brands like Chef Boyardee, Orville Redenbacher's and Swiss Miss, as well as newly acquired brands like Angie's BOOMCHICKAPOP, Duke's and Bigs. Again, these are encouraging signs and reflect the impact we can have as bring the right approach to brand building and innovation across our portfolio. We expect to accelerate from here with a particular focus on snacking. We are energizing our snacking playbook with ramped up innovation, a focus on driving impulse consumption, marketing with a purpose and better price pack architecture. We are creating a culture within a culture to fit the unique attributes of the Snacks business which has different products and purchasing behavior. And as I mentioned earlier, it’s not just what we do with our snack brands, it’s how we do it. We need to be faster, introducing new varieties across the portfolio like the exciting new innovation you see on Slide 25, which will hit the market in fiscal 2019. While we are excited about the opportunity in Snacks, we remain focused on our Grocery brands. Slide 25 also shows some of our upcoming innovation and renovation in the Grocery business where we see growth opportunities in condiments and enhancers, and are working to keep our lucrative shelf-stable meals inside the business reliably contributing. We are renovating these brands with modern flavors, simplified ingredients, and new graphics to better appeal to today’s consumers. Similar to what we’ve done in our Frozen business, as we innovate, we expect to see benefits from improving sales mix, through premiumized products and more relevant brands. With all of our strong innovation hitting the market, we’ve made the strategic decision to add incremental support behind our brands to enhance saliency, distribution and consumer trial. We recognize that today’s world requires a different approach to marketing. We are focused on making investments that engage the consumer with our brands and that could include traditional TV and print ads, distribution investments, merchandizing, sampling, digital marketing and even customer loyalty programs. As you can see on Slide 26, we are focused on reaching the consumer where they are on their path to purchase including by leveraging targeted digital engagements and incentives prior to their arrival in the store. On Slide 27, you can see a sample of some of the brand investments we are making with our retail partners. Some of our marketing investments may appear above the net sales line and some of it may be below. But the overall goal is to add incremental support, especially where we have new renovation and innovation. These investments will be brand and customer-specific, as we acquaint consumers with our modernized portfolio and new innovation. And based on our strong consumer trends, these efforts are clearly paying off. As I noted at the outset, the timing of these investments converged with higher than anticipated inflation. As highlighted on Slide 28, inflation is trending well above the 2.7% we anticipated as part of our initial fiscal 2018 guidance. The inflation impacts both input costs and transportation costs, which have risen sharply across the industry. The net result in Q3 was that despite our actions to price ahead of our categories, gross margins were pressured. As we’ve said before, margins may move around quarter-to-quarter beyond our normal seasonality and as we continue through our transformation, we will look to exit lower margin businesses and enhance our portfolio with margin-accretive innovation and acquisitions quarter-to-quarter. We’ll also invest where we believe we can achieve a high ROI and of course, we’ll see fluctuations in input costs. However, we are confident that regardless of short-term impacts, we will continue to move the centerline of our profitability north over time as we have for the past several years. We are proud of the 430 basis points of margin expansion we achieved from fiscal 2015 to 2017 and we are not done. While there were a few transitory factors impacting our gross margin performance in Q3, overall, our operating margin remains strong and our fiscal 2018 guidance shows that we continue to see operating margin expansion. Dave will provide a bit more detail on the specific factors that impacted near-term margin performance, but the bottom-line is that none of these factors change our long-term margin outlook or our commitment to chip away at the margin opportunity over time. Turning to Slide 31, M&A remains a central part of our plan. We intend to pursue modernizing acquisitions, synergistic acquisitions and select divestitures. We’ll continue to strike the right balance between being aggressive and being disciplined. In the third quarter, we completed our acquisition of Sandwich Bros and announced plans to divest our Canadian Del Monte fruit and vegetable business. We also announced the termination of our agreement to sell the Wesson oil business. As I mentioned earlier, we intend to continue to evaluate the role of this business within our portfolio. In summary, we are pleased with our continued progress on the top-line and encouraged by the performance of our innovation. We intend to continue supporting growth through disciplined and strategic investments to drive brand saliency, distribution and trial while we manage through a near-term inflationary environment. And we continue to be supported by a strong balance sheet with the financial flexibility to pursue M&A opportunities to enhance our portfolio. Given our solid performance, we’ve updated our fiscal 2018 guidance to raise adjusted EPS above the previously provided range which already accounted for the impact of tax reform. With that, I’ll hand it over to Dave to share more on the financial details of the quarter.

Thank you, Sean. Good morning everyone. Slide 34, outlines our financial performance for the third quarter versus the prior year. I’ll walk through our results at the total company and segment levels and you are going to hear some themes. First, our investments to drive the top-line are working. While the third quarter organic net sales were negatively impacted by hurricane-related timing shifts between the second and third quarters, as well as some unexpected customer inventory contractions in the third quarter, we see continued net sales progress. Our value over volume strategy and product innovation are working. Second, gross profit was impacted by several factors this quarter including our intentional choices on how to invest in the top-line. We continued to focus our brand building activity on above the line marketing investments with retailers and we reduced A&P investments. This impacted gross margin. We also saw challenges on the cost side. Our core productivity programs continue to deliver. But their benefits were more than offset by significant input cost inflation in the quarter including transportation. Since we don’t provide gross margin results at the segment level, you’ll see this flow through to operating margin in the segment performance. Also, the Grocery and Snacks segment experienced some transitory operating costs that impacted operating profit and margin. While the quarter presented a variety of dynamics to work through the teams stayed focused on fundamentals and as you can see, we’ve reconfirmed our net sales guidance and increased our EPS outlook for the year. So let’s dig into the details. Reported net sales for the third quarter were up 0.7% while organic net sales were down 2.2% reflecting timing shifts in sales between the second and third quarters and overall customer inventories contracting more than anticipated around calendar year end. As Sean mentioned, total organic net sales for the second and third quarter combined, grew 0.1% showing continued positive momentum. Adjusted gross profit dollars were down $27 million or 4.3%. Adjusted gross margin was 30% for the third quarter, in line with the second quarter and down approximately 155 basis points from the prior year. A&P expense decreased 13.7% or $12 million. As seen in the second quarter, the decline in A&P was more than offset by increased above the line marketing investment with retailers to drive brand saliency, enhanced distribution and consumer trial in-store. These retailer investments helped deliver strong consumption growth in the quarter. Adjusted SG&A was relatively flat to the prior year and was 10% of net sales, slightly favorable to the year ago quarter as we continue to run a lean organization. We like that our adjusted SG&A spend as a percentage of net sales remains top tier in the industry. Adjusted operating profit was down $12 million or 3.6% for the quarter. This was due to inflation of 3.7% driven primarily from input costs and transportation, along with the retailer investments mentioned earlier. Although gross productivity was strong for the quarter, realized productivity was suppressed by higher than normal transitory operating costs. Adjusted diluted EPS was $0.61 for the third quarter, which was up 27.1% driven primarily by lower tax rates. Slide 35 outlines the drivers of our third quarter net sales change versus a year ago. Total company organic net sales were down 2.2%. Volume decreased 2.8%, driven mostly by the shift in timing of sales between the second and third quarters, as well as a higher than expected reduction in retailer inventories near the calendar year end, particularly in the Grocery and Snacks segment. Overall price mix increased primarily from favorable products and customer sales mix in Foodservice, along with positive pricing in the International segment, and favorable price mix in the Refrigerated and Frozen segment from new products. This was partially offset by continued increases in above the line marketing investments. The acquisitions of the Duke’s and Bigs brands in the fourth quarter of fiscal year 2017 and Angie’s and Sandwich Bros in fiscal year 2018 added 240 basis points to third quarter net sales growth. The impact of favorable FX also contributed 50 basis points of reported net sales growth. Slide 36 outlines the adjusted gross margin and adjusted operating margin declines in the third quarter. Inflation in ingredients, packaging and transportation were the major drivers of gross margin decline. Inflation of 3.7% in the quarter drove approximately $50 million of gross profit decline, negatively impacting gross margin by 2.5 percentage points. Transportation represented approximately 25% of total inflation for the quarter. Above the line marketing investments with retailers to drive enhanced distribution and consumer trial represented eight-tenths of a percentage point of the gross margin decline. Favorable price mix and strong gross productivity mitigated some of the gross margin decline, but realized productivity was suppressed due to transitory costs in our Grocery and Snacks business, which I will discuss shortly. Moving to adjusted operating margin, the 1.6 percentage point decline in gross margin drove operating margins down for the quarter. This was partially offset by SG&A and A&P favorability as we continued to manage SG&A tightly, and shift A&P investment to above the line marketing investment with retailers. We expect A&P to fluctuate quarter-to-quarter as we continue to evaluate the balance between below and above the line marketing opportunities. Slide 37 highlights our results by reporting segment. In our Grocery and Snacks segment, reported net sales of $838 million were down 1.3%. Acquisitions added 500 basis points of growth in the quarter, organic net sales were down 6.3%. Consumption trends continued to improve in the quarter. However, organic volume declined 4% as we shipped below consumption in the third quarter after shipping above consumption in the second quarter. Volume was also impacted by higher than expected retailer inventory reductions and deliberate actions to optimize distribution on certain low margin items. Additionally, price mix declined approximately 2% as we increased above the line marketing investments with retailers. This investment is paying dividends as overall Grocery and Snacks consumption has improved driven by base velocity improvements as Sean discussed. Adjusted operating profit of $178 million decreased 16% or $34 million with adjusted operating margins down approximately 370 basis points versus the prior year. The segment’s operating margin compression was driven by four discrete items including some network transitory in nature. First, input costs and transportation inflation were the largest headwinds on operating profit and margins in the quarter representing $15 million of operating profit decline. Second, we increased above the line marketing investments with retailers to drive brand saliency, enhanced distribution and consumer trial of key brands. Consumption improved in both the second and third quarter supported by these investments. Third, despite strong gross productivity cost savings in supply chain, realized productivity in the quarter was reduced by certain transitory operational offsets. For example, we had unexpected plant maintenance and production downtime, higher than normal inventory write-downs on certain discontinued and slow moving items, and unfavorable overhead absorption given the volume declines in the quarter. Lastly, while the recent growth-focused acquisitions aided the segment’s operating profit growth rate, they also reduced the operating margin percentage. This is because these businesses have maintained strong A&P investments as well as elevated SG&A levels as they integrate into the company. In our Refrigerated and Frozen segment, reported net sales grew to $689 million, a 3.2% increase. Organic net sales grew 2.6% as the acquisition of Sandwich Bros added 60 basis points of growth. Volume increased 2% due to core business improvements and innovation launches in the Banquet, Healthy Choice, and Marie Callender's businesses. Price mix increased 1% as mix improvements from recent innovation more than offset retailer investments to drive enhanced distribution and consumer trial. Adjusted operating profit of $127 million decreased 0.6% in the quarter. The benefits of net sales growth and realized productivity improvements were more than offset by increased input cost for proteins, packaging and higher transportation cost. In our International segment, reported net sales were approximately $223 million for the quarter, up 8.9% versus the prior year. This reflects approximately 1% growth in volume and nearly 3% improvement in price mix as the International team continued to focus on value over volume. FX favorably impacted net sales in the third quarter by roughly 5%. International adjusted operating profit was $30 million, up 67% or $12 million versus the prior year driven primarily by increased pricing and lower A&P spending. In our Foodservice segment, net sales were approximately $244 million for the quarter, down 6% versus the prior year. We also continued to implement our value over volume strategy in Foodservice. Volume decreased approximately 13% in the quarter as the Foodservice team exited non-core and low-performing businesses. Price mix increased 7% driven by favorable product and customer mix as well as pricing. Foodservice adjusted operating profit was $24 million, down 13.4% versus the prior year with operating margins decreasing 85 basis points. Favorable price mix was more than offset by the impact of volume declines and increased material and transportation cost. Adjusted corporate expenses were $38 million for the quarter, down 27.4% reflecting a decrease in certain IT projects and incentive costs, slightly offset by a reduction in income from two terminated transition service agreements. Moving to slide 38, this chart outlines the drivers of the 27.1% adjusted diluted EPS improvement in the third quarter versus a year ago. Adjusted gross profit dollars decreased $27 million in the third quarter, driving $0.04 of the EPS decline. Lower SG&A and A&P expense added $0.02 of the EPS improvement with some of the A&P investment moving above the line as discussed. Favorable interest expense and an increase in Ardent Mills joint venture income added $0.01 of EPS improvement. EPS was favorably impacted by $0.09 as the adjusted effective tax rate in the third quarter was 19.7% versus 31.4% a year ago. The lower tax rate in the third quarter reflects the favorable impact of tax reform. Our estimated full year adjusted tax rate is 29% to 30%. Share repurchases added $0.04 of EPS improvement as we continued our repurchase activity in line with our outlook. Slide 39 summarizes selected balance sheet and cash flow information for the quarter. Net cash flow from operating activities was $808 million for the year-to-date period, up from $804 million for the same period a year ago. We had capital expenditures of $176 million through the year-to-date period, up from $159 million in the comparable year period. We repurchased approximately 8 million shares of stock at a cost of approximately $280 million in the third quarter. Total year-to-date share repurchases were $860 million. We ended the third quarter with net debt of approximately $3.5 billion, up from $2.7 billion at fiscal year-end 2017. This increase supported our share repurchases and acquisitions. As we have stated previously, we remain committed to an investment grade credit rating for the business. As shown on Slide 40, we made a voluntary $300 million pension contribution on the first day of the fourth quarter. It was funded with a one year term loan at a rate of three month LIBOR plus 75 basis points. Given the timing of this contribution, we deducted this payment on our fiscal 2017 tax return at the old rate reducing cash taxes by approximately $105 million in the fourth quarter of fiscal year 2018. Please note that this does not impact our adjusted book tax rate that runs through the P&L. The rating agencies view underfunded pensions largely as debt. We share this view since the net obligation is recorded as a liability on our balance sheet. By funding this contribution with debt, the transaction is effectively debt neutral. This contribution will reduce our variable PBGC premium paid by the Pension Plan Trust, which is calculated based on the plan’s underfunded status. Currently, the PBGC charges pension plans a variable expense of just over 3% on underfunded pension obligations. Moving our pension plan towards fully funded status allows us to reduce future volatility as we can now better match our asset returns with the liability payments. We will give more color on the P&L impact of these actions when we share our fiscal 2019 guidance next quarter. At that time, we will also provide additional information on the impact of the change in accounting that requires all pension costs and benefits other than service cost to be presented outside of operating profit. Slide 41 outlines our updated guidance for fiscal year 2018 and reflects a few changes since our CAGNY presentation. We expect organic net sales growth to remain near the high end of our range which was previously communicated at minus 2% to flat. Reported net sales growth is expected to be 150 basis points higher than the organic net sales growth rate due to acquisitions and FX. This has been updated from our previously communicated range of 100 to 150 basis points higher. We expect adjusted operating margin to be near the low end of our range of 15.9% to 16.3%. We continue to expect inflation to be 3.7% for the full year, but it is expected to moderate in the fourth quarter as we start lapping the input cost inflation we experienced in the fourth quarter a year ago. We continue to expect our full year fiscal 2018 adjusted tax rate to be in the 29% to 30% range reflecting the lower federal tax rate. In addition to our pension investment that I just discussed, we continued to review investment opportunities associated with our estimated reduction in cash taxes in line with our balanced capital allocation approach and we’ll provide more details when we provide fiscal 2019 guidance in our fourth quarter earnings release. We expect adjusted diluted EPS from continuing operations in the range of $2.03 to $2.05 up from the range of $1.95 to $2.02 provided at CAGNY. We remain on track to repurchase approximately $1.1 billion worth of shares in fiscal 2018 subject to market and other conditions including the absence of any synergistic acquisitions. Regarding steel and aluminum tariff, we expect no impact to fiscal 2018 given our inventory position. We are still evaluating the estimated impact to fiscal 2019 and are working through our mitigation plans up and down the value chain. Our trade group and other advocacy partners are also working on options. In summary, ConAgra Brands is making strong progress. We continue to see consumption trends momentum and have made great progress upgrading our volume base. We are investing in our businesses despite increased inflation in transitory costs. We’ve made several modernizing acquisitions over the last year, and our balance sheet remains strong, giving us flexibility to pursue additional acquisitions to drive shareowner value. We are reconfirming our full year organic net sales guidance near the high-end of the range and have raised our adjusted EPS guidance for fiscal year 2018. Thank you. This concludes my remarks. Sean, Tom McGough and I will be happy to take your questions. I will now pass it back to the operator to begin the Q&A portion of the session.

Thank you, Mr. Marberger. We will now begin the question and answer session. [Operator Instructions] The first question will come from Andrew Lazar of Barclays. Please go ahead.

Good morning everybody.

Good morning, Andrew.

Good morning.

I guess my question is, given the broader industry trends we’ve seen on things like inventory destocking and the shift of dollars from SG&A to above the line as you’ve talked about, how confident are you that the expected retail consumption is acceleration in fiscal 4Q, I guess, can fully materialize into your reported sales, right, because you are looking for a pretty big step-up or for, I guess, for consumption to better match your reported sales in the fourth quarter.

Yes, Andrew, Sean here. I am very confident in that. The inventory destocking piece, there are two aspects to that. First of all, that we got to kind of separate. One is the hurricane which caused us to ship ahead of consumption in Q2 and reverse in Q3. The second was more of the unexpected decline in a handful of customer inventories near the end of the calendar year. I have seen that pattern before in my career numerous times. It tends to happen near the end of major customers’ fiscal years. In previous experience, it tends to almost always be transitory. So, I have no reason to believe that we are not going to see shipments and consumption converge. And then when you couple that with the fact that we’ve got very strong innovations in the marketplace today, our baseline velocities continue to improve and our total points of distribution continue to improve and the fact that we don’t have that much left to go in the balance of the fiscal year, we are very confident and really encouraged by the top-line expectations we have for the fourth quarter.

The next question will come from Bryan Spillane of Bank of America. Please go ahead.

Hey, good morning everyone.

Hi, Bryan, good morning.

I guess, I had a – just maybe a more philosophical question. As you are kind of looking out beyond 2018, this year you’ve had good success investing to drive the top-line and you’ve been able to sort of protect your margins. I guess, if you look at next year with tax reform maybe share repurchases, would you sort of look to continue to drive that spend to drive that top-line growth even if it might moderate operating profit growth given all the inflation and given that you’ve got some tailwinds below the line or would you think differently about that going into next year?

Okay, let me try to tackle that. I’m not going to get into any guidance-related stuff for next year at this point. But I think where you are getting at is, do I anticipate some kind of a material step-up in absolute total marketing spend going forward. Look, here is how I think about that. When it comes to total marketing spend at our company, we have – and we’ve talked about this repeatedly, a very strong ROI mindset, in fact, over the last few years, our marketing analytics around trade and A&P have improved dramatically. And that has enabled us on average to cut non-working dollars in both trade and A&P and redeploy them to better programs, be they above the line or below the line. It’s also enabled us on average to avoid the dreaded A&P rebase while we execute our transformation plan. So going forward, I think we are going to continue to find pockets of inefficiency in existing spend. And therefore, when the time comes to support incremental innovation in Snacks as an example, it won’t necessarily require incremental spend. Obviously, that may not be true in every single quarter, because we may have more spend in periods where we are in launch mode as I describe it. But I’d like to think that overall, our spend is in the ballpark, I think in general, we’ve done a pretty good job of that if you look at a significant body of time there may be variance in the quarter, but I think our overall spend is in the ballpark over a sustained period of time.

The next question will be from David Driscoll of Citi. Please go ahead.

Great, thank you and good morning.

Good morning.

My question is on the gross margins and retail pressures, so Sean, gross margins were down meaningfully in the quarter. There are certainly some management actions that are deliberate, but most of the pressure appears to be inflation-related. So, just two points here. First, how do you see gross margins going forward? Are you satisfied with this performance given the environment you are in? And then, separately, I would really appreciate it if you could give us some of your color to describe the retail environment and the ability of the ConAgra portfolio to achieve price realization in an inflationary environment?

Sure. Real quick upfront, David. As I mentioned in my prepared remarks, some of these transitory factors we are dealing with right now, we don’t expect them to have an impact on our longer-term margin outlook. But obviously, kind of the topic of the moment right now in our industry is inflation, productivity, pricing. So, let me tell you how I think about those things, big picture. I’ll start with inflation. Obviously, inflation happens, it is a fact of life and we view it as our job to navigate it as effectively as we possibly can to protect our margins. Productivity and pricing are two critical levers and we’ve got strong capabilities around each of those levers. That doesn’t mean that there won’t be short-term volatility, particularly when you are in a window where commodity inflation pivots from being benign to being acute as well as being in a window where you’re simultaneously investing to drive consumer trial of a very strong innovation slate. On productivity, the way I think about it is our team continues to do an excellent job executing on their projects in delivering strong gross productivity. As Dave pointed out though, there were some transitory offsets that suppressed what we call realized productivity in this quarter, but those won’t be reoccurring. Then when it comes to pricing, as you’ve seen over the past few years, we’ve been quite focused on liberating our brands from ultralow, legacy price points where our brands were stuck for decades. But principally, we think about pricing three ways. First, inflation-justified pricing, second, trade efficiency, and third, premium priced innovation which has been significant for our company as you saw in the CAGNY presentation. All three of these pricing tools have and all three will continue to play a role. And pricing isn’t easy. Frankly it never has been. I wouldn’t have all these white hairs if it was, but, it’s tough and it’s often complex. But as I think most of you know, we are partnering very, very closely with our customers these days and our customers are quite happy with the innovation programs that they are getting from ConAgra Brands and they understand that the fuel for those innovations comes from our margins. Now obviously, not every brand and every category is created equal, which is why we think about revenue management and integrated margin management broadly. But overall, I am confident that we will continue to move the centerline of our profitability north over time and then, simultaneously reduce the standard deviation around that centerline over time.

The next question will be from Akshay Jagdale of Jefferies. Please go ahead.

Good morning. Thanks for the question. Sean, I wanted to ask you about the sales growth acceleration. Isn’t that a leading indicator of the strength of your brand and the portfolio and longer-term, sort of the gross profit pool expansion, right. So, in other words, the sales growth acceleration that we are seeing from you and a lot of other peers in the industry shouldn’t that bode well for profit pool sort of growth over time and this cost increase is transitory. So, over time though, doesn’t the sales growth actually tell us that you should feel better about passing on these transitory costs? Thanks.

Well, obviously, Akshay, we believe in strong brands, because strong brands tend to equate with lower elasticities of demand, lower elasticities of demand tends to equate with greater ability to price for the desired impact. But I think it’s important to point out that brand strength is not a right, it has to be earned and there have been a lot of legacy brands in our industry that have weakened over time because they were neglected over time. We have worked incredibly hard to infuse modern attributes into our brands, so that we can reacquaint consumers with our brand and re-earn their respect and re-earn the credibility of those brands and we are doing it in a way that translating to higher price realization and over time will translate to higher margins. And it’s been our value over volume strategy where we pull the lot of the weak stuff out of the base. We’ve backed off on promotions and we’ve strengthened the fundamentals. So now, going forward, as we talked at CAGNY, when you think about the runway, we see in Frozen and then you think about at applying this playbook to other parts of the portfolio, yes, we believe it should translate to ongoing strength or long-term outlook calls for that. And that’s where we are going to stay focused on.

The next question will be from Chris Growe of Stifel. Please go ahead.

Hi, good morning.

Hi.

Just had – hi, just had a question around the cost inflation and productivity savings by division and not to get so exact, but if you think about what’s kind of your cost inflation versus productivity savings in Frozen versus Grocery and Snacks, are either one of those divisions better positioned around either one of those factors and maybe could require less pricing going forward, if you’ve got more offset – more kind of net productivity savings coming through? Thank you.

Yes, Chris, this is Dave. Let me – it’s a good question. There is a lot to this. So let me just start from the topic you look at gross margin, right, we are down 160 basis points, inflation was 250 basis points with a headwind and we also made the conscious decision to invest in above the line marketing with retailers which was 80 basis points. So, clearly, they were headwinds due to gross margin. From a productivity perspective, the gross productivity which in the first half was about 3.1% of cost of goods sold came in at that same level for the third quarter. So, when you convert that to a gross margin impact, that’s about 2% a little bit above. So, we are seeing that. The other thing that hit us were and I talked about some operational offset, some were transitory, some were not. I talked about ones that were transitory in terms of inventory write-offs and dynamics around that and in some plant maintenance and production dynamics. So, that was about 50 basis points in terms of what was transitory in the quarter for total company. When you kind of peel it out by segment, if you look at Frozen, the inflation for Refrigerated and Frozen and the inflation for Grocery and Snacks is about the same. It’s actually a little bit higher. Right now in Refrigerated and Frozen just because of the amount of proteins and the inflation that we’ve seen there. But we will start wrapping on that in the fourth quarter. So that won’t be as big of an impact. Transportation and freight, obviously affects us across our entire portfolio. And then from a productivity perspective, we are pretty balanced there. Maybe a little bit more in our Refrigerated and Frozen versus our Grocery and Snacks. So, our productivity is probably a little bit lower in Grocery and Snacks. That combined with the – these operational offsets that I talked about, that’s what had the bigger impact on operating profit in Grocery and Snacks for this particular quarter. So, that’s basically, in terms of inflation, we also have it in Foodservice, International as well. But there is the dynamic as you look at total and then you break it down by segment.

The next question will be from Rob Dickerson of Deutsche Bank. Please go ahead.

Thank you. So, in terms of this Grocery and Snacks division, on the price mix side, I know, obviously there – it seems like there, few more incremental investments that are now on marketing of other line, or within COGS relative to SG&A, but I am just trying to get a better sense of price mix in Q3 and what we saw, I know, I guess, you kind of point to this investments in brand saliency, et cetera. But, like, was there some additional promotional spend to push some of the innovation to get the distribution or I am just trying to get a sense as to why price mix would have decelerated sequentially, and then also why it should accelerate going forward? Thanks.

Let me take a shot at that, Rob. So, in terms of Grocery and Snacks, we talked about – we had a significant investment in above the line marketing with retailers. So I talked about 80 basis points for total company. More than half of that was in Grocery and Snacks. So, we are making those investments. There was some price mix benefit there, but that was more than offset by the additional investments we made with retailers. And these are – this is just not price discounting these investments that we are making. These are investments to improve merchandizing. Sean talked about it in his piece. So, we have significant investments in Grocery and Snacks. We also have the above the line marketing investments in Refrigerated and Frozen. But with our innovation now that that you’ve seen, we are starting to benefit from that component of pricing that Sean talked about which is based on innovation and margin-accretive innovation and the benefits that has on the price mix line. So, that’s why when you look at Refrigerated and Frozen, we are actually one percentage point favorable price mix because the benefits we are getting from the innovation are more than offsetting the investments we are making with retailers. So, making investments in both segments a little bit higher in Grocery and Snacks and we are not seeing as much of the innovation yet in Grocery and Snacks, but that will be more to come next year. Sean?

Rob, if I could just add one thing to that too. The other question is, what’s the impact to these investments above the line and as I mentioned in my prepared remarks, the impact has been very positive. Keep in mind, Grocery and Snacks is a space where we haven’t done a fraction of the material innovation yet that we’ve done in Frozen. So we’ve been making these investments to basically get a lot of our preexisting items back in front of consumers and get our consumers to retry them. And as you saw in the presentation today, our consumption has been quite strong and as importantly the non-promoted piece of that has actually been above what we expected. So, it’s working and I think that that suggests that we’ve got a solid foundation here to build off of as we move more of our innovation emphasis into this other reporting segment .

The next question will come from Matthew Grainger of Morgan Stanley. Please go ahead.

Good morning. Thanks for the question. I just wanted to get a better sense of how you are thinking about the freight cost outlook going forward and I guess, more specifically, does your inflation outlook take into account the potential for those costs to move higher again over the next quarter or two, which seems to be what we are hearing from some of the freight providers or do you see things as having reached more of a new normal? And then, follow-on, just proactively, what steps are you taking or can you take going forward in the supply chain to help mitigate that?

Matt, so, let me take a shot at that. So, yes, from the top, our inflation outlook of 3.7% for the year which hasn’t changed with this quarter incorporates our estimate of inflation for freight and transportation. So that’s in there. That’s in our fourth quarter estimate at this point in time. As you look at this more broadly, we have a really seasoned team here in our supply chain organization that manages transportation and freight and it’s an area that we look at every day. At the highest level, this comes down the basic supply and demand, right. If there is more demand to carry loads and there are drivers to carry that. So this creates a challenge. It really relies on our relationships with our carriers and our contracts that we have with them. So, when demand spike, we have to go into the spot market like other companies. And we are hiring spot markets than historical, but our overall spot market levels are lower than peers given our approach and the way that we manage this. When you look at our total freight and transportation and warehousing costs, they are roughly 10% of total cost of goods sold. But they are obviously increasing at a higher rate. So, as I mentioned in my remarks, 25% of our total inflation came from transportation and freight. So, we are proactively evaluating and adjusting our approach to minimize cost increases going forward and we view the cost increase just like all other input cost increases, when we look at overall inflation that we must try to offset with any pricing.

The next question will be from Ken Goldman of J.P. Morgan. Please go ahead.

Just to follow-up on that. Dave, I’d like to understand a little bit better how, in your opinion, you’ve been in the food group for a while now. How most agreements with trucking vendors work in this industry? Because, we’ve heard lately from a different, one of your peers that they were surprised by higher transportation costs and it sounds like part of the issue was that, maybe certain agreements with vendors were locked in for rates. But not miles, so that vendors were able to effectively opt that on these arrangements when rates rose. I guess, I am just trying to get your opinion on the group in general, is this a typical set up where vendors have this flexibility or is it somewhat unusual? Again, just trying to sort of better understand some of the risks for the group and I know you’ve seen a couple of different perspectives here.

Well, again, you’re right. I’ve been around a long time. But I am not a expert in freight transportation. But, I’ll kind of tell you what I see. The dynamics are interesting around the freight, because you can have different philosophies. You can have fewer carriers and try to leverage scale with those carriers or you can have more carriers and maybe that will – you won’t get the scale benefits, but then in situations like this, you have more flexibility, because you have more competition basically and more options, right. So, you have to look at that. We tend to have a lot of carriers. So, that’s kind of the way we manage it. We have a lot of strong relationships. So, there is a lot of dynamics like that that come into play, because supply and demand is challenged and when we need carriers can really vary, right, versus other companies. So, I can’t sit here and do it just this. I can tell you that this is obviously something that we’ve been focused on and we’ve been watching and we talk about all the time and Sean is involved with those conversations. So, we have a great group here. We do everything. We are looking at different options to try to manage it. But, there is a lot of dynamics in here. It’s not just one simple answer in it. You really have to kind of understand a little bit the philosophy that a company has around this area in managing the support for it.

The next question will come from Robert Moskow of Credit Suisse. Please go ahead.

Hi, thanks for the question. I am going to carry on with the theme, maybe a little differently on freight. Everybody sees it and your customer see it too and my understanding is that you are probably in a negotiating season with your freight providers. So, isn’t it logical to assume that if you and everyone else are going to experience higher freight costs through those negotiations and that maybe a 12 month timeframe. Couldn’t you go to your customers and say, hey, this is widespread, everyone has a time for the consumer to pay for some of it. It seems like a logical argument and yet, I think you and others have been a little cautious about what kind of promises could be made in that regard. Thanks.

Rob, it’s Sean. If freight were the only thing we were dealing with, I think it’s more logical that we would go have a direct conversation specifically about freight. But when you are dealing with inflation across a variety of different things, beyond freight, we’ve got protein inflation, we got other things that are experiencing inflation. It really pivot the discussion more to, how do you holistically find different ways to pursue pricing in order to try to protect margins and it – as I mentioned earlier, it varies by brand and by category, but really, we’ll try to bundle all of the things that are inflating in cost and let that total net delta inform the different strategies we might pursue to create offsets. So, that is that what you talked about which is a freight-specific conversation looking for offsets we’ve contemplated that. Who knows, it may evolve going forward, but we are really looking at all of the inflation and looking at the three pricing levers as well as productivity as I mentioned before.

The next question will be from Steven Strycula of UBS. Please go ahead.

Hi, and good morning. Sean, a quick question on the inventory destocking. What percentage of the portfolio would you say has already been touched by inventory destocking across major retailers? And are we running at what we would call minimum threshold of the inventory? Basically, can we see any more excess weeks of supply taking out or are we just really running on a just in time system? Thank you.

Yes, Steve, I think it’s closer to just in time. You’ve heard other companies in the last month or so referenced this kind of unexpected inventory destocking at certain customers near the end of the calendar year. And during that window, at least from what we could see, it got extremely low, unusually low versus typically what we see. And we don’t like to see that, because it typically means there is out of stocks on the shelf for consumers. So, I tend to think that doesn’t ultimately benefit anybody, but, we’ve seen that kind of move back to more normal levels. There aren’t absolute lean inventory levels in the industry right now and across categories. That’s been the case for a number of years, but it got really lean for a bit there, which is what we saw in Q3, but I think that’s largely behind us. Obviously, we are always trying to anticipate if that’s going to happen, but you never kind of know until you are in the thicker things. But I think we are tracking more just in time, more ship to consumption. At least, that’s the way we forecast it.

Thank you. And ladies and gentlemen, this will conclude our question and answer session. I would like to turn the conference over to Brian Kearney for his closing remarks.