Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)

General Mills Inc. (NYSE:GIS)

F2Q08 (Qtr End 11/25/07) Earnings Call

December 19, 2007 8:30 am ET

Executives

Kris Wenker - VP of IR

Don Mulligan - EVP and CFO

Ken Powell - President, CEO and COO

Chris O'Leary - EVP and COO of International

Analysts

Jonathan Feeney - Wachovia Securities

Eric Serotta - Merrill Lynch

Robert Moskow - Credit Suisse

Terry Bivens - Bear Stearns

Bill Leach - Neuberger Berman

Alexia Howard - Stanford Bernstein

Eric Katzman - Deutsche Bank

Edgar Roesch - Banc of America Securities

Andrew Lazar - Lehman Brothers

Operator

Ladies and gentlemen, thank you standing by, and welcome tothe second quarter fiscal 2008 results conference call. (Operator Instructions)

And I would now like to turn the conference over to KrisWenker, Vice President, Investor Relations. Please go ahead, ma'am.

Kris Wenker

Thanks, Jennifer. Good morning, everybody. I'm here with KenPowell, our Chief Executive Officer; Don Mulligan; our CFO; and Chris O'Leary,Chief Operating Officer for our International business. I'll turn you over toall of them in just a minute. First, I've got to cover my usual housekeepingitems.

The press release for our second quarter results was issuedover the wire services earlier this morning. It's posted on our website, if youstill need a copy. We've also posted slides on the website that supplement theprepared remarks we're making this morning.

This conference call will include forward-looking statementsthat are based on management's current views and assumptions. The second slidein today's presentation lists factors that could cause our future results to bedifferent than our current estimates.

And with all of that, I'll turn you over to Don.

Don Mulligan

Thanks, Kris. And thanks to all of you who have joined usthis morning. As you can see from the financial result that we have releasedtoday, General Mills continues to generate good growth and operating momentumin fiscal 2008.

Slide 4 summarizes results for the quarter. Net sales grew7%. Segment operating profit essentially matched last year's second quarterresult. Earnings after-tax were up 1% and earnings per share grew 6% to $1.14for the quarter. These results include significant input cost inflation,expenses associated with our November product recall of frozen pepperoni pizzaand double-digit growth in our consumer marketing investment.

Let me take you through the income statement and cover thosedetails. Our 7% sales growth from the quarter reflects a strong contributionfrom price and mix of six percentage points. Foreign exchange added anotherpoint of growth. Each of our three business segments contributed to the salesincrease. US Retail sales were up 3%, International segment posted 22% growth,and Bakeries and Foodservice sales grew 8%.

Our second quarter gross margin of 36% was below thecomparable period a year ago. Cost of goods for the quarter included $17million of accelerated depreciation expense related to restructuring actions.It also includes virtually all of the expenses related to our voluntary recallof pepperoni pizzas on November 1st. Total recall expense, including the costbooked in SG&A, was $20 million pre-tax and $0.04 per share. We resumedshipment of pepperoni pizza SKUs at the end of November and sales of our otherpizza varieties were not interrupted.

Our results for the quarter also included 10% increase inconsumer marketing expense. We believe this strong investment in our brandswill help fuel continued growth in sales, particularly baseline or non promotedsales. Through the first half of this year, combined baseline sales for ourmajor USretail businesses are up 3% in measured channels.

Slide 9 shows the detail of our segment operatingperformance in the second quarter. US Retail profit fell 2% including a recallimpact. International posted another quarter of strong double-digit profitgrowth and Bakeries and Foodservice profits declined 14%. That reflects highinput cost in very tough comparisons. Last year's second quarter profits grew40%.

Restructuring, impairment, and other exit costs totaled $3million in the quarter, compared to $1 million of income last year. Corporateunallocated expense is in total $26 million, which includes $17 million of costassociated with restructuring that appear in cost and income statement. Thedecrease in unallocated corporate expense for the quarter reflects a net $15million mark-to-market gain on commodity hedges and $11 million gain on thesale of a corporate investment.

Our joint ventures, particularly cereal partners worldwide,contributed strong double-digit earnings growth in the quarter. After-taxearnings from joint ventures totaled $28 million, and these results include $1million after-tax charge related to previously announced CPW restructuring inthe UK.Sales for CPW grew 21% in the period.

So, on the bottomline, diluted earnings per share totaled$1.14 for the second quarter, representing a 6% gain. This increase was on topof double-digit growth in last year's second quarter.

Let's move from the income statement to the balance sheetand core working capital items. In total, core working capital was up 12% fromlast November's levels. This reflects our higher sales levels and higher pricesfor inventories. For the full year, we now expect core working capital to growslightly faster than sales due to the same input cost increases we're seeing.

Our capital structure continues to get simpler. During thefirst quarter, we repurchased a net $897 million minority interest andrefinanced that piece of our capital structure with commercial paper and five-yearnote.

In the second quarter we completed our transaction withLehman Brothers, and used the $750 million of cash we received to pay downcommercial paper. In fact, our commercial paper balance is now lower than a yearago at this time.

And by the end of fiscal 2008, we expect total debt plusminority interest to be down compared to the combined balance last May. That'sconsistent with the guidance of mid single digit growth and interest expensefor the year we gave back in June.

Turning to the cash flow statement, our operating activitiesgenerated $444 million in cash through the first six months, down from $565million last year. This change reflects the higher use of the working capitalthis year, again, primarily due to inventory costs. Dividends through the firstsix months grew to $259 million. The current annualized rate of $1.56 per sharerepresents 8% increase over dividend paid in fiscal 2007.

First half capital expenditures totaled $186 million. Wecontinue to estimate that for the full year, capital spending will total $575million, including capacity additions on grain, snacks and yogurt, as well asproductivity projects.

We returned significant cash to shareholders through sharerepurchases in 2008. Through the first half we've repurchased a net 7 millionshares and over the last 12 months we've repurchased a net 14 million shares.As a result, we now expect average shares outstanding for the year of roughly350 million shares or 3% below last year's average share balance.

So I'll summarize my remarks this morning this way. GeneralMills, in the second quarter, showed continued good sales growth. Segmentoperating profit matched last year despite higher input costs, recall expensesand increased consumer marketing and EPS increase of 6%. We simplified ourcapital structure. For the full year we are on track with our projected uses ofcash for dividends, capital expenditure and share repurchase and importantly weare on track to deliver our targeted EPS growth.

With that I will turn you over to Ken for a review of ouroperating performance. Ken?

Ken Powell

So thanks, Don, and good morning to all. The second quarterresults Don just shared with you, build on a strong first quarter for GeneralMills. And we expect our broad base sales momentum to continue in the secondhalf of this year. Our key challenge will continue to be input costs. They arecoming in higher than planned and almost all of the added costs will fall inour second half.

Now we've shown you this chart before, which traces thesustained input cost pressure we've experienced in the last several years. Ouroriginal plan for fiscal 2008 included an estimated 5% inflation rate on inputcosts, but commodity prices have tracked above our estimates and now with themajority of our coverage locked in for this year, we see our inflation ratecoming in higher, at roughly 7%. Now, this is a significant increase in costpressure, but our good first half results offset some of the added costs.

In addition, we have identified additional pricing andproductivity to counter second half cost pressure. And our plans includecontinued solid consumer spending through the second half of the year to keepour topline growing. And these factors together give us confidence we canoffset the added costs we're seeing and deliver our targeted results for theyear.

The topline growth through the first six months was led by International,which generated almost half of our dollar sales increase. US Retail contributedanother $200 million in sales growth and Bakeries and Foodservice added a $32million sales increase in the first half.

Segment operating profits are up 4% through the first half.That's on top of 9% growth in the same period last year, and it includes thevarious expense items that Don just outlined for you. So our fundamentalbusiness momentum is quite good going into the second half. I'll give you a bitmore detail on the growth drivers for US Retail and Bakeries and Foodservice, thenChris O'Leary will provide an update on our International segments.

Today's press release included second quarter sales growthrates for each of our US Retail divisions. Slide 24 shows net sales growth bydivision for the first half. As you can see, net sales are up for all of ourdivisions. Snacks posted the fastest growth rate with sales up 14%. Yoplaitsales are up 7% through the first half.

Our organic division, Small Planet Foods, generated salesgrowth of 6%. Both Big G Cereals and Baking Products posted 4% growth. Meals isup 3%, and the Pillsbury division sales were up slightly despite the recall,which resulted in one month of lost sales on the affected SKUs and productreturns that also reduced net sales.

Let me highlight some of the businesses driving our salesgains. Our Grain Snack business continues to post substantial growth. Retailsales are up 34% through the first half of fiscal 2008 in channels where wehave data. This growth has been generated by both the core Nature Valleygranola bars, as well as, new, highly incremental products like Fiber One barsand Curves bars.

For Yoplait, new Fizzix carbonated yogurt and Yoplait Kid beveragesare off to a good start. And in the adult segment, we're seeing continuedstrength from Yoplait Light Yogurt and our convenient fridge packconfiguration. A new Yo-Plus yogurt with probiotic cultures and fiber is off toa good start as well. Yoplait's first half retail sales grew 5% in channelswhere we have data. Second quarter retail sales growth accelerated to 10%,driven by pricing and performance from new products.

Big G Cereal performance through the first half has exceededour expectations. Conversion to the new package sizes has been completed atretail, and shelf prices are tracking closely to targeted levels. One of thekey goals of these initiatives was increased baseline sales, and we're seeingthat, with first half baselines up 2%.

Dollar market share for Big G in measured channels is downabout a 0.5 point year-to-date and this primarily reflects lower merchandisinglevels in recent months. We have stronger merchandising planned in the secondhalf. We do expect full year trade expense for Big G will be lower than lastyear.

Through the first half, retail channels, retail sales inchannels where we have data are up 2%, and we'd estimate that Big G's retailsales across all channels are growing slightly faster. Overall, we see thebusiness well on track to its goal of low single-digit sales growth for thefull year.

In the Meals division, retail sales for Helper dinner mixesare running below strong year-ago levels when we launched Hamburger HelperMicrowave Singles. Now, that continues to be a good line extension for us, butit's not fully matching last year's introductory sales levels. We are launchingtwo new skillet helper varieties featuring whole grain pasta in January. Andthat should help renew growth momentum on this line.

Progresso soups posted 12% retail sales growth in the firsthalf, and baseline performance has been the driver here. Non-promoted sales areup 11%. Progresso Light soups, which carry a zero point per serving endorsementfrom Weight Watchers, are off to an excellent start and are proving to be quiteincremental to our existing line.

Retail sales for Pillsbury's refrigerated dough productsgrew 2% through the first six months of the year in channels where we havedata. Four profitable products, including crescent rolls, sweet rolls and ourtubes of cookie dough, drove the growth, including our results to date in thisyear's key baking season.

Toaster Strudel also contributed to Pillsbury's toplinegrowth with a 14% increase in first half retail sales. Now, as Don mentionedearlier, we resumed shipments of pepperoni pizzas at the end of November.

Sales for our other Totino's pizzas and pizza rolls stayedsteady throughout the recall. So, through the first half, the combined Totino'sbusinesses generated retail sales growth of 7%. So, we had a number of productlines that contributed to the strength in our first half US Retail results.

Shifting now to Bakeries and Foodservice, this businesssegment has been affected to a greater degree by a higher input cost. We havetaken two pricing actions so far: one in July and a second increase in Novemberto counter this cost pressure. These price increases have resulted in modestvolume declines, but a 4% increase in net sales through the first half.

Segment operating profit for Bakeries and Foodservice wasdown $3 million through the first half, reflecting higher input cost and $3million of expense associated with our recent shift to a direct sales force fora part of this business.

Looking at our sales by customer segment, business withfoodservice distributors and restaurants matched prior year levels. However,core branded products like Pillsbury Place ‘n Bake muffins, breakfast cereals, snacksand Yoplait yogurt, all generated good growth.

Convenience stores and vending generated 5% net sales growthin the first half, driven by distribution gains and new product success in oursnacks business. And our sales to bakery customers grew 7% through the firsthalf.

So the key initiatives for growth in our Bakeries andFoodservice business are, first, prioritizing our best customers. We arefocusing on our branded products and our best customer segments to drive profitand margin growth. Second, we believe our conversion to a direct sales forcefor part of this business will provide us with better insight to our marketsand customers and our brands will get more focused sales support.

And third, we continue to focus on holistic marginmanagement in this business segment. These initiatives are working and ourFoodservice division is expected to deliver good sales and operating profitgrowth for the full year. That profit gain may be high single-digit, ratherthan double-digit due to increased input cost inflation. But this will stillrepresent ongoing progress for the division.

So, now, let me turn you over to Chris O'Leary for somehighlights on our International division's recent performance. Chris, over toyou.

Chris O'Leary

Thanks, Ken. Good morning, everybody. To remind you, netsales for our entire International business, including our proportionate sharesales from joint ventures totaled more than $3 billion in fiscal 2007. Myremarks today will be focused on our consolidated international businessesabout two-thirds of that total.

In our international segment, first half sales rose 20%reflecting gains across all geographic regions where we compete. In secondsegment, operating profit grew 32%.

Slide 36 shows our sales growth by region. Excluding theimpact of foreign currency exchange in the second quarter, Canada's net sales grew 2%, Europewas up 11%. Our Asia-Pacific business was up 16% and net sales in Latin America increased 41%, reflecting market sharegains in pricing actions in key markets. This performance was fairly consistentwith first quarter results. So through the first half, our sales were up 12%before currency exchange benefits. Foreign exchange contributed eight additionalpoints of growth, bringing the International segment's reported net salesgrowth to 20% for the first half.

Our International business has shown accelerating operatingprofit growth over the past several quarters, as shown on slide 37. Input costpressure will be greater for this business in the second half and a result wethink the rate of segment operating profit growth will slow a bit. But, wecontinue to target another year of strong double-digit profit growth for 2008 in total.

We are generating this growth by building on three globalproduct platforms. First, super-premium ice cream, where we have the preeminentbrand in Häagen-Dazs. Next, world cuisine, where we compete with Old El Pasoand the Wanchai Ferry brands. In healthy snacking, where our internationalbrands range from popcorn and Cheerio snacks in Canada to Nature Valley GranolaBars now available in more than 50 markets worldwide. These global platformsare strong growth drivers for us, with net sales at constant foreign exchangerate, from ice cream and world cuisine each up approximately 10% in the firsthalf and healthy snacking up 30%.

As we expand these global brands around the world, we willdrive continued margin improvement for the International segment overall, asall three of these brand platforms have operating profit margins higher thanthe General Mills' overall operating margin.

Let me now give you some highlights on each of our regionsbeginning with Canada.Cereal and granola bars had been the growth drivers in Canada so far this year. Weexecuted our "Right Size, Right Price" initiative in Canada on the same timing as we did in the United Statesand results are good year-to-date.

Cereal share is up half a point through the first six monthsand retail sales have benefited from strong baseline growth on key establishedbrands like Multi-Grain Cheerios and Fiber One as well as successful newproduct launches including Fruity Cheerios.

In the granola bar category, we captured share leadershipfor the first time, driven by two new product lines, Second Cup Cafe Delightsand Nature Valley Fiber source.

In Europe, the UK brands represent more than halfof our net sales. The UK wasthe leading contributor to topline growth with strong sales of Nature Valleygranola bars and Old El Paso Mexican foods. And France generated double-digit salesgrowth in the second quarter led by Häagen-Dazs.

Moving to the Asia Pacific region, it was a record year for Häagen-Dazsmooncakes in Chinawith sales up 30% over last year. Mooncakes are a traditional Chinese treat,given as a gift during the Mid-Autumn Festival. This year we estimate that 10%of Shanghai'sfive million or so household's preordered this specialty ice cream mooncakefrom Häagen-Dazs during the two week festival this past September.

Growth in greater Chinawas also bolstered by the launch of new flavors of Wanchai Ferry frozendumplings and our expansion into the Taiwan market.

Indiawas among the good contributors to topline growth in this region. PillsburyAtta flour, used in traditional Indian cooking, posted good double-digitgrowth. And growth in Australiaespecially for branded retail products like Old El Paso and Latina Pasta's wasgood as well driven by increased investment in advertising and distributiongains.

Before I leave the Asia-Pacific region, let me commentbriefly on recent news from our Häagen-Dazs joint venture in Japan. Two new indulgent ice creamdesserts called Dolce were launched there this year. Dolce has become thelargest new product introduction in Häagen-Dazs history. Annual sales areprojected to reach $70 million and we estimate that 50% of these sales are fromconsumers new to the Häagen-Dazs brand.

Finally in Latin America, we have some strong regionalbrands that are performing well, such as Diablitos meat spread in Venezuela and La Salteña bread products in Argentina.

Looking to the second half of fiscal 2008, we expect to seecontinued net sales growth across our regions driven by momentum on our basebusinesses and new product introductions. We have pricing and productivityinitiatives in progress to offset commodity inflation. So as a result, weanticipate double-digit sales and earnings growth for our internationalbusiness in 2008.

At this point I'll turn you back over to Ken to wrap-up ourcomments this morning.

Ken Powell

Okay, Chris, thank you for that. So with our good first halfperformance and our expectations for the second half, I'd summarize the 2008operating outlook for General Mills this way. We are excited about the momentumof many of our businesses and we expect our good topline results to continue;fueled by additional new product introductions, selected pricing actions andongoing investment in brand building activities.

And we continue to expect consumer spending for the year tobe up high single digits. And for the year, in total, we now estimate that ournet sales will grow at a mid single digit rate, exceeding our long-term goal oflow single digit growth.

We expect to see higher input cost inflation in the secondhalf and full year inflation will be greater than originally estimated.However, we expect to offset this with our good first half performance,additional pricing and increased productivity savings. This will keep us ontrack to deliver mid single digit growth in segment operating profits for theyear. And so, we continue to target high single digit EPS growth, again, in2008. Our EPS guidance for this year remains $3.39 to $3.43 per shares.

So that concludes our prepared remarks this morning. I willask the operator to now open the line for questions.

Question-and-AnswerSession

Operator

(Operator Instructions)

And the first question comes from the line of JonathanFeeney from Wachovia Securities. Please proceed with your question.

Jonathan Feeney -Wachovia Securities

Thank you. Happy Holidays.

Kris Wenker

You too.

Ken Powell

Happy Holidays, Jonathan.

Jonathan Feeney -Wachovia Securities

Ken, I guess there's a lot of concern about the consumerwallet out there. You guys are taking some substantial price mix to offset thiscost inflation. Are you worried about consumer pushback, either in the form ofleaving any of your US Retail categories or trade down to private label inthose US Retail categories in your conversations with the retailers or the dataover the past quarter?

Ken Powell

Jonathan, I would say we're not worried about that. You'reseeing that we've had growth in all of our divisions through the first half.Also, I think there is so much in the news about inflation across commoditiesand dairy and energy that I don't think consumers are all that surprised by theprice increases that they're seeing scattered across the grocery store.

We're not seeing long or difficult conversations with ourcustomers about the pricing that we've taken. And so, I think that there is anexpectation that prices are going to go up some in the food area because ofinput costs. And we're really not seeing right now on the retail side anyresistance or slowdown that we would attribute to pricing.

I think if you look on the Foodservice side of the business,there, with the tracking mechanisms that we have, we maybe seeing a little bitof shift in that sector, a little bit of shift away maybe from casual dining,and maybe more towards quick-serve restaurants where you can eat for less. Soyou might be seeing the beginnings of a change there, but I wouldn't call itpronounced at this point.

Jonathan Feeney -Wachovia Securities

Ken, is there a margin mix issue there? I mean if, say, wedo go within Foodservice from causal dining towards US R's, does that affectyour business any meaningfully?

Ken Powell

It wouldn't be a margin mix issue for us there, Jonathan.

Jonathan Feeney -Wachovia Securities

Okay. Just finally, if you wouldn't mind, when you talk aboutmid single digit revenue growth for '08, what kind of volume growth maybe in USRetail are you thinking about roughly to support that mid single digit revgrowth?

Ken Powell

Well, we're about flat, I think, through the first half ofthe year, and I think we would expect to see that or maybe a little better overthe course of the rest of the year. And then of course, we have the pricingthat we've taken.

We told you generally that we think we'll be taking morepricing in the second half. And I think that the combination of stable volumeand the pricing that we anticipate, well, we're pretty comfortable that that'sgoing to get us to that mid-single-digit revenue growth.

Jonathan Feeney -Wachovia Securities

Great. Thanks very much.

Operator

Thank you. And the next question comes from the line of EricSerotta from Merrill Lynch. Please proceed with your question.

Eric Serotta -Merrill Lynch

Good morning.

Ken Powell

Good morning, Eric.

Eric Serotta -Merrill Lynch

I just want to --- good morning. I just want to follow up onJohn's question regarding topline growth and volumes in particular. Can youmention, volumes are about flattish through the fiscal first half? This quarterin US Retail, they were down slightly.

I'm wondering whether you could give us some color as towhat kind of an impact some of the one-off items like the Totino's Recall -- Iwouldn't call this a one-off item, but the "Right Size, Right Price" initiativein which you're shipping fewer pounds in cereal had on volumes for the firsthalf?

And overall, how would you describe or how wouldcharacterize the volume performance versus your expectations? Are you seeingany elasticity impact from the pricing that you have taken?

Ken Powell

Well, Eric, thank you for asking that question and also in away for partly answering it. I don't know that we have a very detailed -- wedon't have it. But some of it was the Totino's Recall, which fell right tosmack in the middle of the second quarter. And then I think more importantly isRight Size and Right Price, which you alluded to. And here, this is adeliberate reduction in tonnage that was sort of a fundamental part of thatactivity.

Recall that we reduced the average size of the cereal box aspart of that initiative by about 10%, and we reduced prices by kind of amid-single-digit level as well. So there was a reduction in tonnage. And Ithink we are starting to see that here in the second quarter.

Now, in terms of the "Right Size, Right Price" Ithink we would say that we're very happy with how that's worked. The executionhas been virtually flawless. We hit the pricing targets that we had for thatinitiative. And I think most importantly, we are seeing a shift in mix in ourBig G cereal business. So, we are seeing more baseline sales growth now afterthe implementation of "Right Size, Right Price". And overall, we areseeing net sales growth of -- I think it's, what, 3% to 4% through the firsthalf, 3% in the second quarter.

So, while there is a tonnage reduction in cereal area, we'requite pleased with how the whole "Right Size, Right Price" initiativehas played out for us. And then, like I just said to Jonathan, I wouldn't saythat we are seeing at this point any resistance to the pricing that we'vetaken.

I think another category I might highlight to illustrate thepoint is yogurt, where, as you know, this summer, we took a mid-single-digitprice increase. And in the second quarter, we've actually seen our yogurtbusiness accelerate to about the 10% growth in sales. So, we are not reallyseeing it out there today.

Eric Serotta -Merrill Lynch

Okay. And then to follow up on commodity costs, we are nowmore than half way through fiscal '08. I've realized that commodity costs seemto be changing daily here. But, could you give us some sense as to yourvisibility or coverage for fiscal 2009? Have you been opportunistic or haveopportunities arisen to lay in some hedges? Knowing what we know today, shouldwe expect to see any sort of step change in the rate of commodity inflation forfiscal '09 versus fiscal '08 as some of the favorable hedges that you had thisyear roll off?

Ken Powell

Well let me begin, Eric, by saying that first of all weexpect this general inflationary environment that we've been in for the last 4or 5 years and we've seen inflation run at 4% to 5% to continue into theforeseeable future and the reason for that is global economic growth which iscreating really strong demand for all these basic commodities. So, we expectthat environment to continue. And as you know, this is something that we'vebeen working hard on and focusing on for several years with a very major efforton productivity. So, we don't see any of those factors or our approach to itchanging.

In terms of '09 itself, I think you’re right. I mean, withthe volatility that we're seeing in those markets right now, I think it wouldnot be wise for me to predict what's going to happen 6 or 12 months from now.But, we think we're going to see a continuing inflation.

Eric Serotta -Merrill Lynch

Okay. Well, thanks a lot and have a great holiday.

Kris Wenker

Yeah. Eric, let’s ask Don to give you a little bit of anupdate on what we are seeing for the rest of F'08. Because, certainly we'vetaken a look what that commodity cost number is for this year and we've put ona little coverage. You want to flush that out?

Don Mulligan

Eric, we've extended our coverage for the year where bothacross energy and commodities grew about 85% covered where we are not isbecause we do think there will be some spot buying opportunities in the backpart of the year. The inflation that Ken alluded to for this year of 5% to gointo 7%, 2 points higher and our plan is largely back loaded. But, as Ken alsoalluded to, given our strong first half our top-line momentum, some pricingthat will be taken, some additional productivity that we have identified andare already acting upon, we can so reaffirm our full year guidance for F'08.

Eric Serotta -Merrill Lynch

Okay. And just to clarify two quick points on that. The 85%covered on energy and commodity, is that 85% covered on energy and hedgeablecommodities or is that 85% overall?

Don Mulligan

Hedgeable commodities.

Eric Serotta -Merrill Lynch

Okay. And on the second point, the increase from 5% to 7% inoverall inflation, what does that equate to on? I realize this isn'tapples-to-apples. But, what you guys are looking for in terms of input cost andfuel? I think you originally put out up $275 million for the year, is thatthree and a quarter now?

Don Mulligan

The initial guidance was 250, that is roughly $75 millionhigher now with the current estimate.

Eric Serotta -Merrill Lynch

Okay. Thank you

Operator

Thank you. And the next question comes from the line ofRobert Moskow from Credit Suisse. Please proceed with your question.

Robert Moskow -Credit Suisse

Hi, Good morning.

Ken Powell

Hi, Rob.

Robert Moskow -Credit Suisse

My question is, I seem to recall from last quarter that theexpectation was, especially after coming of a 5% sales growth number for Big G,that you might expect kind of the reverse with consumption picking up and thennet sales on a shipment basis coming down a little bit. Did that, it seems likethat didn't quite happen the way that you thought, maybe the retail consumptionwas a little bit lower than what you thought it would be. But at the same timeyour shipments actually looked okay, so did the quarter come out differentlythan the way you thought for Big G?

Ken Powell

I think I would say it’s maybe a little better than wethought in terms of net sales and we did have some, as you know, Rob, we didhave some inventory that we signaled at the end of the first quarter, butretail sales through the first half are running around 3%, over 3% for thequarter. And so, I think our retail momentum is pretty solid and shipments at4% through the first half of the year, okay, a little bit ahead of that but Imean, I think that that gap is narrowing, there's probably still some inventoryto work through, but I think we're working through it and its retail sales area little better than we thought and so I think, we'll just continue to workthrough that in the second half, but at this point, I think, it’s mostly behindus.

Robert Moskow -Credit Suisse

Okay and are you going to do any kind of consumer testing,post the "Right Size" initiative, just to check again with consumersto see if they notice the difference or if they care. I know you have lot,since you have lot of anecdotal evidence already that transition is okay.

Ken Powell

We've been doing that, Rob on an ongoing basis. We have beenchecking with consumers in a variety of ways and again I think you said, didn'tnotice and don't care, and I would say that's a pretty good accuratecharacterization. They really haven't noticed it, the cereal box changes, Ithink as you guys, as we showed you when we were right in the middle of this,we are pretty subtle and so our consumers haven't really noticed. But theyhave, in aggregate, noticed that our prices have come down a little bit and aswe modeled and as we predicted that's resulting in some baseline strength onthat core cereal line and we are very encouraged by that.

Robert Moskow -Credit Suisse

Okay and then lastly, in terms of working capital, your coreworking capital is up 12%. You are now saying it is going to grow little fasterthan sales. Do you have any changes in your expectations for cash flow for theyear, you are also down in terms of cash flow for the first half?

Don Mulligan

Rob this is Don. We expected to generate again anotherstrong year cash flow with a little bit of pressure from the working capital,which will be more of a use than a year ago. As we look at our use of cash forCapEx or dividend and for share repurchase that small movement or smallvariance to plan in working capital is not going to change our plans in thoseregards. So we are still confident in our planned use of cash.

Robert Moskow -Credit Suisse

Can you remind me, is there a guidance for operating cashflow for the year?

Don Mulligan

No.

Robert Moskow -Credit Suisse

No. Okay. All right, well, thank you very much.

Don Mulligan

Thank you.

Operator

Thank you, and the next question comes from the line ofTerry Bivens from Bear Stearns. Please proceed with your question.

Terry Bivens - BearStearns

Good morning, everyone.

Ken Powell

Hi, Terry.

Terry Bivens - BearStearns

And happy holidays out there from me as well. First a quickquestion on the overseas operation. I noticed Green Giant wasn't on the slide.Has there been some change there? I thought that was one of your overseaspillars of growth.

Ken Powell

Green Giant is still one of our businesses. It's a regionalbusiness for us, Terry. What I was highlighting was the three global platformsthat I first started talking about last year at [CATNEY] that being superpremium ice cream, world cuisine and healthy snacking, our Green Giant businessaround the globe is healthy and we are looking for opportunities to expand it.But it's not something that we see as a global platform for us.

Terry Bivens - BearStearns

Okay. That sounds like a little bit less than a rangeendorsement of that brand. Moving on to Cereal and this would be my lastquestion. Ken, thinking about your remarks, you're basically saying "RightSize, Right Prices" out there now.

Ken Powell

That's correct.

Terry Bivens - BearStearns

Okay

Ken Powell

Absolutely. It's out there and it's done.

Terry Bivens - BearStearns

Okay. My question is this, we were just looking at some dataon some of your innovation of late. Obviously, there is always an uptick as youare introducing stuff and it always bleeds off a little bit, then hopefully, itwill grow. But how would you characterize the way you are feeling about yourinnovation with some of the new stuff? Are you satisfied with it? Do you thinkyou need to put forth a bigger effort there? I just like to get your idea onthat.

Ken Powell

I feel quite good about it, Terry. This year, in the firstquarter, we launched Oat Clusters Crunch Cheerios, which has been a goodsuccess for us, Chocolate Chex and Curves. And I would say all of thoseproducts are in line with expectations. We always get a huge trial when welaunch a Cheerios flanker. And that was no different for the one that we justlaunched.

Chocolate Chex and Curves are a little bit smaller, but verymuch in line with expectation. Curves, I think, as you know, we launched both acereal and a bar. And those products are building. Those are moreadults-oriented products. And typically, the pattern there is a slower trial buildthat we like. We like that franchise, and we think there's going to be anopportunity for us to expand and grow that Curves business. As you know, we'repartnering with the Curves chain of fitness centers on that product, which isthe largest chain of fitness centers in the country.

So, we feel good about the innovation that we've had incereals so far this year. There will be more new products coming, but we thinkso far so good. As we look beyond cereal to the rest of the portfolio, I wouldsay, again, we've had very strong innovation this last year. Chris talked aboutsome of the Häagen-Dazs innovation coming out of Japan. This Dulce product has beena real hit. 0 Point Soup has been, in these early days, a very hot product forus. We're very excited about that.

And so, I would say, also we've just extended our WarmDelights business in Betty Crocker with Warm Delights Minis. That product isoff to a good start. Our yogurts are off to a good start. So we feel quite goodabout the innovation that we have. It's more incremental. The margins arebetter. And so, all-in-all, we like the direction we're going in.

Terry Bivens - BearStearns

Okay. Thanks for that. And just one last quick thing. I amjust looking at some IRI data, I can see that your base sales are pretty muchtracking where you said they were in Big G. It does show promotional down by apretty significant amount, mid-teens. I understand why that would be lookingbackward. Looking forward, I think you alluded in your remarks that promotionalspending will be up on the brand or at least more promotions. Is that really afunction of just kind of returning to business as normal now that you have thenew shelves set in place? Is that kind of what you were getting at, doing yournormal promotions on cereal?

Ken Powell

Well, that's right, Terry. First of all, I want to confirmthat the gap, I think, in the first half, if you will, that has been ourpromotional and merchandising pressure and it has been a little bit behind ofwhat we expected. And so, that's been really the shortfall there.

Terry Bivens - BearStearns

Right.

Ken Powell

And going forward, we want to fine tune and adjust that aswe get the whole in "Right Size, Right Price" initiative, absolutelylocked in on shelf as we do now. We'll fine tune that promotional spending andjust make sure that it's right and at the right levels, bearing in mind alwaysthat we are happy with the kind of merchandising price points that we see inthe category, which have risen slowly over the last year-and-a-half and we likethat trend. So, we're not going to play around with that at all.

I think it will be more focusing on getting the quality ofperformance and have our sales force focused more on execution than maybe theywere in the first half when they were heavily preoccupied with getting that"Right Size, Right Price" initiative executed.

Terry Bivens - BearStearns

Okay. Fair enough. Thank you. And again, happy holidays toeveryone.

Operator

Thank you. And the next question comes from the line of BillLeach from Neuberger Berman. Please proceed with your question.

Bill Leach -Neuberger Berman

Good morning. Don, could you run through the non-recurringitems again slowly? You have a lot of things, which I didn't quite catch intothe Totino's, the restructuring. I think you mentioned the commodity hedge andthe capital gain.

Don Mulligan

Yes, there were a few moving pieces. Let's get those listedout. We had $20 million charge for the Totino's Recall that was largelyessentially $19 million [indiscernible] in our gross margin.

Bill Leach -Neuberger Berman

Okay.

Don Mulligan

We had $17 million in associated cost, which was associatedwith our restructuring. There was accelerated depreciation that was in ourgross margin. And then, within our corporate unallocated, we had $15 millionbenefit from our mark-to-market on commodity hedges.

Bill Leach -Neuberger Berman

Okay.

Don Mulligan

The new accounting treatment that we started at thebeginning of this fiscal year where we no longer apply FAS 133. We also had an$11 million gain on the sale of a corporate investment. We also had a smalldifference in our restructuring cost in this year and last year. With thisyear, it was $3 million charge. Last year, it was a $1 million income.

Bill Leach -Neuberger Berman

So total restructuring was $20 million?

Kris Wenker

That's right.

Don Mulligan

The total restructuring this year between the cost and grossmargin and cost of restructuring were $20 million, correct.

Bill Leach -Neuberger Berman

And what is your guidance assuming in terms of thesenon-recurring items in the second half?

Don Mulligan

The restructuring, our guidance for the full year was $41million, which is $48 million in restructuring charges offset by a $7 millionin gains from the sale of excess property from one of last year'srestructurings, $41 million. That is $3 million higher for the full year wewould have guided in last quarter. And that's because we took one additionalaction in the second quarter to close our Poplar, Wisconsin manufacturingfacility.

Bill Leach -Neuberger Berman

And you are not assuming any more commodity hedge gains orcapital gains in your guidance?

Don Mulligan

Well, there will be some, but it's going to depend on wherethe markets are. And as Ken alluded to, I'm no more contemplating what they'regoing to be at any quarter-end or yearend than he is. So there will be somecommodity hedge mark-to-market gain or loss, depending on our position eachquarter-end going forward that will distinctly identify what that is. For thefull year, if we look at our guidance, we assume that we would be net neutralfor the year. So, if there is a plus or minus, first that number that wouldcome through in the year end results.

Bill Leach -Neuberger Berman

Okay. Sorry, go ahead.

Kris Wenker

I would add one other thing. Somebody asked me this questionearlier today, whether there was any more Right Sized, Right Priced expense inthe quarter, and the answer is yes. If you remember, we said that the year onecost for that was $30 million, $17 million of it fell in the first quarter.There is another $8 million in the second quarter. So, that leaves 5 just burnthrough the back half somewhere.

Bill Leach -Neuberger Berman

Okay. And Don, looks like your option expense was about$31.5 million pre-tax in the quarter, is that right?

Don Mulligan

Excuse me.

Bill Leach -Neuberger Berman

Your non-cash option charge? Just looking at your cash flowstatement, your stock based compensation charge?

Kris Wenker

I think its 31 or 32. Just a second, I am looking.

Bill Leach -Neuberger Berman

Yeah.

Don Mulligan

Well, I am flipping through pages quickly here.

Kris Wenker

Yeah. It's 32 in the quarter versus 28 in the same period.

Bill Leach -Neuberger Berman

All right. That will help a little bit.

Don Mulligan

Little over 10% for the quarter.

Bill Leach -Neuberger Berman

Okay. Thanks a lot. And have a good Christmas.

Kris Wenker

You, too.

Operator

Thank you. And the next question comes from the line ofAlexia Howard from Stanford Bernstein. Please proceed with your question.

Alexia Howard -Stanford Bernstein

Thank you. Hello, everybody.

Ken Powell

Hi, Alexia.

Kris Wenker

Hi, Alexia.

Alexia Howard -Stanford Bernstein

Hi, two quick ones. First of all, just following on fromTerry Bivens question on innovation. Do you set out goals for what percentageof sales from your products you'd like to get to and where are you at themoment in respect to those goals? Because it does seems as though there hasbeen amount set off in the kind of incremental innovation that you put outthere in the last, I guess, few quarters now.

Ken Powell

Alexia, we aim to hit around 5% from new products in eachyear. And it can bounce around slightly from that. And I would say this year weare tracking very much in-line with that goal, maybe a little bit ahead ofthat. But, in addition to that sort of broad volume and sales goal we have veryspecific goals for the incrementality of the new products. We want to make surethat we are introducing items that are really offering a new benefit andbringing new consumers into our franchises, and this is a measure that we'vefocused on over the last three years and we are seeing progressive improvementsin this measure.

Another key measure for us is margin and we want these newproducts to be either margin neutral or margin accretive and this is anotherarea where we had high focus. And again, we are seeing very consistentimprovements in our performance in this area. So, we actually have quite anumber of ways that we look at these new products and measure and monitor them.And we are feeling quite good with the direction that we are heading in on bothincrementality and profitability.

Alexia Howard -Stanford Bernstein

Great. And then another real quick one. You have been verytransparent in describing the merchandizing strategy around Big G Cereals. Canyou give us any thoughts on what the strategy is going forward on the soupsbusiness? It's been growing extremely rapidly in the first half, very stronginnovation there with low calorie piece. What time going forward are we goingto see the same kind of levels of trade support or how do you see that businessdeveloping in the second half?

Ken Powell

I would say, very broadly speaking what we have seen in thesoup category over the last couple of years has been a movement away from deepdiscounting across a high number of multiples and we are very happy with thattrend and expect to continue in that direction. Our core strategy in our soupbusiness is baseline building through advertising, good advertising, expansionof distribution and remember, it wasn't that long ago that Progresso soup andProgresso Foods business was primarily a northeastern based business and so westill have lots of distribution opportunities around the central and thewestern US. And then, finally, our new product innovation, last year welaunched low sodium soups, which have been a success for us. And now this yearwe have the zero point soup, which also looks like it's going to be a success.So our game is expanding distribution, base line building advertising and whatwe think have been very exciting new products coupled with the appropriatelevel of merchandise.

Alexia Howard -Stanford Bernstein

Great, okay, thank you very much, I will pass it on.

Kris Wenker

And, Alexia I'll just throw one factoid in their baselinegrowth for soup for us in the first half was 11%.

Alexia Howard -Stanford Bernstein

Great, thank you.

Operator

Thank you and the next question comes from the line of Eric Katzmanfrom Deutsche Bank. Please proceed.

Eric Katzman -Deutsche Bank

Hi, good morning, everybody.

Ken Powell

Hi Eric, how are you.

Eric Katzman -Deutsche Bank

I've got a few questions, I guess first, Ken, you aresuggesting that the input cost inflation situation is going to stick with usfor the foreseeable future, I agree with that. Make the cases as to why youshould stick with the back of the house Foodservice baking operation. That wasreally on Steve and Jim's watch, you were going to consolidate that category,it's not going to happen or it's not worth it and it seems like in Foodservice,you are always going to be trailing the inflation curve?

Ken Powell

Yeah, well, I think that our very, very clear directionwhich we've articulated a number of times in that Foodservice business, Eric,is that we are focusing on our branded business, we are focusing on thedistributor led segment, which is delivering those products to schools,hospitals, business cafeterias, that sort of thing. That is very, very clearlythe focus of that business along with other baked goods where we have scale andinnovation that gives us margins that we like.

So that is the focus. If you look at what we have done overthe last three or four years we have significantly restructured that business,I don't have the numbers right in front of me but I believe we've reduced thenumber of manufacturing locations by half.

We've reduced the number of SKUs by half and most of thepieces that we sold off have been back of the house. Our baked bread, otherbaked goods these kinds of things. And so without predicting specifically whatwe're going to do in the future, I think it's pretty clear by what we've saidand by our actions in the past that how we are trying to redirect thatbusiness.

Eric Katzman -Deutsche Bank

Okay. Then also kind of as a follow up, I also think it'sreasonable for you to kind of take your sales target up and kind of assume alittle lower or if any margin expansion given the input environment. But Iguess maybe this question is for Don. If inflation keeps raging and workingcapital is more of a use over time, does that mean that we should assume freecash flow grows at a lower rate than net income?

Don Mulligan

I think not necessarily, Eric. I think that your point onkind of where sales growth is going to be and the margins, as Ken alluded to,we have a very robust internal process we call holistic margin management,which is aimed at addressing the margin challenges and inflation challenge thatwe face today, and has been working for us very effectively for the past threeto four years where we have been able to increase our gross margins and ouroperating margins even after increasing our consumer spend year-over-year. Wehave a little pinch, and this quarter we will certainly, I think, believe, fillout to the balance of this year.

So I think that the opportunity for us in terms of growingour operating profits at mid-single-digits could be more price and mix balanceas we've seen this year, that's a probability certainly in the near term as wesee the inflation come through.

Turning to the cash flow, we're going to continue toaggressively manage our balance sheet, and our commitment is to continue to useour cash, continue to use our share count like 2% of average per year, notnecessarily each and every year, but over time, as well as increase ourdividend with our earnings growth. And as we project forward our cash position,we're very confident of our ability to deliver those cash back to theshareholder while still reinvesting in the business at a rate that we believeis the right pace, which is roughly about 4% of sales in terms of capitalreinvestment.

Eric Katzman - Deutsche Bank

Okay. MaybeI'll follow on that one offline. But last question is, we've been kind ofhearing there is some speculation, and it wouldn't surprise me, given thateverybody in this business has to raise prices, but Kellogg's is looking toraise prices in cereal at the start of the new year.

One, can you talk about that? Have you heard about that? Andhow does that kind of fit in with your move just recently on the weight out. Imean, are we going to like go to one box one flake or would it be a listpricing increase? And I just kind of wonder if there is a list price increasein the industry, how you kind of handle that, given what you just did with theretailers?

Ken Powell

Well, I think the first point I would like to make is, Ithink we've to let Kellogg's talk about what they are going to do, and I don'twant to speculate on that. Having said that, clearly we are in an environmentwhere there is a significant commodity and cost of good inflation. We'vealready told you very directly that we will have more pricing in the second half.And we are very closely monitoring opportunities that we may have across all ofour business segments.

And as we have those detailed conversations with ourcustomers about precisely what we are going to do, we will then communicatewith you the details of the plan for the rest of the year.

Eric Katzman -Deutsche Bank

Okay. All right. See you in early January, I guess.

Kris Wenker

Yes, operator, let's try and take two more calls. And then,I apologize to anybody who is further in the queue, but we are kind of a littlepast time here. I'm going to try and grab two more of you. Can you each ask onequestion each, so we can get two more on here?

Operator

Thank you. And the next question comes from the line ofEdgar Roesch from Banc of America Securities. Please proceed.

Edgar Roesch - Bancof AmericaSecurities

Good morning. One quick follow-up on the input cost outlook.I mean, you had the 5% target for the year previously. Don, maybe you couldspeak to this, but was that second half weighted in the first place? And now,even if you are expecting 5% in the back half now with the increase to 7 thatimplies, I guess, a 9% increase for the second half. Can you just tell me ifit's second half weighted in the original outlook?

Don Mulligan

It was a bit second half weighted in the original outlook.It's clearly much more second half weighted now where most of our variants toour expectations is falling in the second half. So, most of that $75 millionincreased cost I alluded to is falling in our second half.

Edgar Roesch - Bancof AmericaSecurities

Okay. Thank you. And I'll stick with the one question.Thanks.

Kris Wenker

Thank you.

Operator

Thank you. And the next question comes from the line ofAndrew Lazar from Lehman Brothers. Please proceed with your question.

Andrew Lazar - Lehman Brothers

Good morning.

Ken Powell

Hi, Andrew.

Andrew Lazar - Lehman Brothers

I'm kind of wondering with the industry having to playcatch-up around costs all this time in terms of pricing, why isn't the industryor General Mills able to or try to take pricing, frankly, ahead overall this tothe extent you need to sort of price some of it back if the time comes asyou've managed that price line balance, you can do so. But, I’m wondering whythere is a constant sort of game of catch-up?

Ken Powell

Well, I think, Andrew, as we went into this year, we said wewould have $250 million input cost inflation, which was significantly ahead ofwhat we had the previous year, and I think some of you were surprised that weforecast that level of inflation for the year and we took it up to 5%. And so,we thought we had a line of sight on accelerating inflation for this year andour business plan called for much more aggressive pricing than we've seen inthe last couple of years.

I mean the bottom-line is, it's just been, I think, morethan we saw or any other saw, and now we are trying to catch up. We have to dothis and there is a competitive world out there. But, we are catching up and weare very focused on this. And what I can tell you is that you will continue tosee pricing from us for the rest of the year.

Andrew Lazar - LehmanBrothers

Great. Thanks very much.

Kris Wenker

Thank you everybody and I apologize to those you that wedidn't get to. Please call me and I'll try and get your questions answered.

Operator

Ladies and gentlemen, that does conclude the conference callfor today. We thank you for your participation, and ask that you pleasedisconnect your line.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: General Mills F2Q08 (Qtr End 11/25/07) Earnings Call Transcript

Check out Seeking Alpha’s new Earnings Center »

This Transcript
All Transcripts