General Mills (NYSE:GIS)
2008 Midyear Update
January 11, 2008 8:00 am ET
Kris Wenker - VP of IR
Don Mulligan - EVP and CFO
Ian Friendly – EVP and COO of U.S. Retail
Kimberly Nelson – President, Snacks Unlimited
Terry Bivens – Bear Stearns
Dave Palmer - UBS
Pablo Zuanic – JP Morgan
Eric Katzman - Deutsche Bank
Eric Serotta - Merrill Lynch
David Driscoll - Citigroup
Kenneth Zaslow - BMO Capital Markets
Good morning everybody, I think I’m going to have us get started here. For those of you that I haven’t had the good fortune to meet, I’m Kris Wenker with General Mills and I really want to thank all of you for joining us here this morning. I’d also like to thank everybody who’s listening into the meeting on the webcast. I’m going to do just a couple of quick housekeeping things and then turn your over to my colleagues here.
Our remarks today are going to include some forward-looking statements that are based on our management’s current views and assumptions and actual results could differ. That’s the end of the housekeeping and I will turn you over to Don Mulligan. Thank you.
Thank you Kris, good morning everyone. Let me add my thanks for you coming out this morning. I appreciate you making the effort and certainly the interest it shows in General Mills. What I am going to walk us through this morning, here’s the agenda of today’s meeting. I’ll begin with the recap of General Mills’ first half results which were released just before the holidays and then we’ll discuss the things we are looking at to drive results of the second half of our fiscal year. Then I’ll turn the program over to Ian Friendly who’s our Executive Vice President and Chief Operating Officer for our U.S. Retail Business and Ian will review the key strategies that we’re following to grow sales and profits in that, our largest operating business. Following Ian we’ll hear from Kim Nelson who is President of our fast growing Snacks Division. Then we’ll wrap up our prepared remarks and open the floor for some questions.
We released our second quarter results on December 19th. Now a lot of holiday meals and vacation days have transpired since then so let me just recap the results that we seen through the first half of our year. Net sales have grown a robust 7% to $6.8 billion. Segment operating profits are up 4% and that’s despite significant input cost inflation. Expenses associated with the product recall and double-digit increase in our consumer investments. Net earnings are also up 4%. Earning per share has grown at a high single-digit rate and dividends are up 11% through the first half of the year.
Here are the factors behind that good start to 2008. First, our net sales momentum is running well ahead of the low single-digit rate that’s part of our long term growth algorithm. The sales growth is broadly based with all three of our operating segments contributing to the total 7% increase and stronger product innovation is certainly a key driver. Second, our company wide focus on holistic margin management or HMM, as we call it, continues to generate results and helps us to affectively counter the input cost in place that is challenging all food manufacturers today. International operations are our third growth driver. Through the first six months total company sales are up $450 million. International segment is contributing $215 million of that increase. And the bottom line, the combination of our International segment and our joint venture earnings account for $30 million in after-tax profit growth.
Finally we believe that our sustained investment and advertising and other brand-building issues has been a key factor in our top line momentum and is continuing to contribute as we enter the third quarter, so we see a bit more by each of these growth drivers. This chart recaps the components of our first half net sales growth. Volume gains and currency translations each contributed a point of growth. The remained was split roughly equally between price and mix. Part of that mix [inaudible] reflects the good growth on established businesses such as Big G Cereals, which Ian will discuss in a minute, and Nature Valley Granola Bars which you’ll hear more about from Kim. And new product performance has been a key contributor to the positive trends as well. Across our three operating segments, we are successfully improving our new product offerings. The ideas are bigger; they’re more incremental drawing in new customers or tapping into new usage occasions, and an increasing percentage of these new items generate margins above our overall company average.
Two great examples pictured here, that you will hear more about from Ian and Kim, are Progresso Light Soups and our Fiber One Bars. We definitely sharpened our focus on margins given the sustained input costs inflation we faced in recent years. In 2006 and again in 2007 we were successfully using a combination of mix, pricing and productivity to offset higher costs for ingredients, packaging, fuel and other inputs and actually expand gross margins by 90 basis points. Through the first half of this year, gross margin is down. However, this year’s results include product recall expense and accelerated depreciation expense that is part of this year’s restructuring activity. Absent these two items, our first half gross margins would have exceeded last year by 20 basis points despite the significantly higher input costs we faced.
As we’ve discussed with you before we’re working across the company to focus on all the ways we can offset these cost pressures and protect margins. Our holistic margin management initiatives include launching new items with attractive selling prices and margins, eliminating slower turning or lower margin products, we’re focusing our trade spend on the most affective promotions and merchandising events with the goal of reducing trade cost per case. We’re simplifying our ingredient requirements to drive purchasing efficiency and lower supply cost and we’re using technology to streamline manufacturing and eliminate non value added costs.
Ian will give you some examples of HMM at work at U.S. Retail. Let me give you a couple of examples from our other segments. In Bakeries and Foodservice we’re making steady improvements in the overall profitability of our sales mix by product line and by customer. We’re also eliminating lower margin SKUs and improving our supply chain costs through restructuring actions. In our International segment we changed the formulation of several Canadian Green Giant vegetable SKUs to match the U.S. offerings. That’s generated purchasing savings which contributed significant margin improvements for that business. As we look ahead our various operational divisions have already identified a strong pipeline of additional savings opportunities and we’re capturing HMM efficiencies in our Administrative functions too. So we expect holistic margin management continue helping us sustain and grow margins in the years to come.
I listed the contributions of our growing International operations as a third key to our performance this year. As we detailed in our second quarter call our net sales for consolidated international businesses grew 20% in the first half. Net operating profits for the International segment have grown more than 30% through the first half has generated continued margin expansion in that segment of the business. In our International joint ventures, our other important source of earnings growth. In fact, our joint ventures contributed $50 million in after-tax earnings through the first six months of this year. The driving force behind these joint venture results is Cereal Partners Worldwide, our 50-50 partnership with Nestle marketing breakfast cereal outside North America. CPW operates in a calendar year basis and they just finished a terrific 2007. Net sales for the venture grew to $1.9 billion. That figure includes contributions from favorable currency and the acquisition of Uncle Toby’s in Australia, but organic net sales growth excluding [inaudible] acquisition benefits was a robust 8%. Profits grew faster than sales.
CPW today operates in 130 markets around the globe. These global cereal markets are growing. In 2007 CPW estimates that volume for the global RTE cereal category increased between 3% and 4%. Still our strongest performance last year came in Australia with good growth with both Uncle Toby Hot Oats and Ready To Eat cereals, France was another good established market for CPW with volume and market share gains powered by our Fitness brands. CPW recorded double-digit volume gains in several developing markets such as Russia, Brazil and Romania. So the global cereal markets mean a great growth vehicle for us.
The fourth driver of our growth in 2008 has been sustained brand-building investments. Projecting our margins helped us generate strong earnings and we reinvested some of these profits in consumer marketing activities including advertising, consumer promotions and product sampling. These initiatives helped drive consumer sales for our products frequently non promoted or base line sales. In recent years, we’ve accelerated the pace of the brand-building investment and we’ve seen our sales growth accelerate accordingly. Through the first half of this year our brand-building investment is up 11% and we continue to target a high single-digit growth in consumer marketing expense for the year in total.
The factors behind our good first half are fueling continued growth in the third quarter and we see ourselves firmly on track to achieve our full year financial objectives. We expect 2008 net sales to grow to mid single-digit rate above our long term targeted rate. We expect mid single-digit growth in operating profit too consistent with our long term objective. We expect to achieve diluted EPS of $3.39 to $3.43 which would represent high single-digit growth from the $3.18 per share earned in 2007. Our annual incentive grid is based on these growth measures, net sales, segment operating profit and EPS along with the fourth metric, improvement on return on capital. We expect to increase our return on capital again in 2008. Our goal is an average annual increase of 50 basis points.
And finally we have a goal to grow dividends in line with earnings over time. The current annualized dividend rate of $1.56 per share for 2008 represents a high single-digit increase over the dividends of $1.44 paid in 2007.
With these annual objectives in sight our priorities for the second half are first, continue fueling the good momentum we’ve got in the top line. This will include additional new product introductions and continued good levels of brand-building, supported behind both new and established businesses. Second, as we have identified several additional pricing and productivity opportunities to counter the increased input costs we’re expecting in the second half. And third we have a sharp eye on cash use, particularly working capital and fixed asset investment.
Let me say a bit more about each of these. In terms of new products, we’ll see continuing incremental benefit from the 200 new SKUs we introduce worldwide during the first half of this year. We’ve got another 140 SKUs slated for introduction during the second half which will also fuel sales momentum. I’ll let Ian talk about the new items coming from U.S. Retail. In Bakeries and Foodservice we’ve got new Savory Snack items for convenience stores and new easy to prepare bake goods for in-store bakeries. In the International segment, our introductions include new dumplings products in China and Taiwan and a new flavor of our very successful Dulce Ice Cream Desserts in Japan.
We’ll support both new and established products with continued strong levels of advertising and other consumer marketing investments. We expect our consumer spending to be up in both the third and fourth quarters on track with our targeted high single-digit growth for the full year. We also expect our net sales to reflect additional pricing actions taken to combat higher input costs. Back in June we discussed pricing actions taken at the start of the year in various businesses. This slide lists more recent pricing actions effective since November 1st. They include additional line pricing in Bakeries and Foodservice, price increases and additional SKUs in Yoplait, a line-wide price increase in Green Giant canned vegetables, increases on Toaster Strudel and selected Pillsbury Refrigerated Dough products and price increases across a number of our organic brands.
We have plans for some additional pricing later in the fiscal year. As we look ahead we believe we can continue to offset input cost pressure with a combination of pricing, mix and productivity. Our second half priorities also include sharp focus on our cash use, particularly fixed assets and core working capital. As you know our budget for capital spending this, we increased our budget for capital spending this year to $575 million. As shown by the pie chart on this slide, just over a third of this investment is for essential maintenance. The rest, 65% reflects growth or cost savings projects. The growth projects include that our first European-based manufacturing line for Nature Valley Granola Bars and new packaging capacity for Yoplait here in the U.S. Cost savings projects include initiatives such as the new warehouse under construction at our Cedar Rapids facility which will generate distribution costs savings. As I said before, our capital investment trend will be lumpy from year to year. This year’s budget is higher and next year’s budget will be below the $575 million that we see in 2008. But averaged over several years, our capital investment needs should run just under 4% of sales.
In the case of core working capital we have seen our use of cash increase through the first half of this year. That’s our typical pattern based on the seasonality of our businesses. However the increase has been sharper this year driven primarily by higher inventories, particularly grain inventories. In the back half we expect core working capital to decline as in past years. However, as I said in December we estimate core working capital will grow slightly faster than sales for fiscal 2008 due to the significant spike in input costs.
Let me make clear here that I’m talking about 12 months to May. Over the longer term, we continue to expect growth in core working capital to be at or below sales growth. These core working capital needs we see for this year do not in any way change our goals for dividend, share repurchase, capital investment or debt leverage.
Let me quickly summarize 2008 midyear update for General Mills. The year is off to a good start with strong net sales growth and high single-digit growth at earnings per share. This momentum is continuing in the early weeks of the third quarter and we see ourselves on track to achieve our full year financial targets. This will represent a third consecutive year of growth and returns consistent with our long term model. Since we established that model at the start of 2006 our net sales growth has met or exceeded our low single-digit target. Segment operating profits have been growing at a solid mid single-digit rate. Our earnings per share growth is on pace with our high single-digit target. And we’ve combined this good growth with increased returns on capital. We think this balance of growth and return is fostering sustainable growth in our business and we believe it’s a balance that we can deliver consistently for our shareholders in the years to come.
Now that concludes my remarks this morning. I would like to do now is turn it over to Ian for discussion of our U.S. Retail business. Thanks.
Thanks Don and good morning everyone here in the room as well as listening in on our webcast. It’s a pleasure to be here to discuss recent performance of the U.S. Retail segment and our strategies for growth in 2008 and beyond.
Our U.S. Retail businesses were strong contributors to General Mills first half growth. Net sales grew 5%; segment operating profit was up 1% despite higher input costs, a strong increase in consumer marketing investment and product recall expenses. Excluding the $20 million in recall expenses our operating profits would have been up 3%. We posted net sales growth across all of our divisions. Snacks had the fastest growth at 14%. Kim will discuss that performance with you later this morning. Yoplait generated 7% sales growth. Sales for Small Planet Foods were up 6%. Both Big G Cereals and Baking Products posted 4% growth. The Meals division generated 3% sales growth and Pillsbury division sales were up slightly despite the pizza recall. We estimate our sales would have been up 2% without the recall.
Let me cover a few highlights of the first half beginning with the improving results of our Big G Cereal business. As Ken reported last month, Big G performance through the first six months exceeded our expectations. The right size, right prices conversion was executed extremely well. Today our shelf prices per box and our box sizes are much better aligned with competitive offerings. Big G net sales are up 4% through the first half driven by the low single-digit price increase that was part of this initiative. Our consumer retail movement shows a higher percentage of full price boxes, or base line sales in our mix and we’re seeing good sales growth on core established brands that we’ve prioritized for investment.
Let me say a bit more about each of these key points. Strengthening our base line sales was a key objective of right size; right price and results to date are encouraging. After declines in base line sales for both fiscal 2006 and 2007 non promoted sales are running up 2% so far this year and these are by far the most profitable type of sales. As base line trends improve our merchandising becomes more efficient. As shown on this slide, our average merchandise price point hasn’t changed year over year. But our percent of volume sold on deal is down two percentage points. And our trade expense is down by a greater amount because few trade dollars are needed to bridge between our new lower shelf prices and the merchandise price. This increased merchandise efficiency contributes to net price realization and profitability.
Our first half market share in Neilson measured outlets was down about half a point. But as you know, that’s only a partial view of our consumer movement. In the faster growing non measured channels which account for roughly 40% of annual Big G sales, we estimate based on our own sales volumes and consumer panel data that our shares are up. These faster growing channels include Wal-Mart, the Club Store chains and the major Drug, Dollar and Discount Store format. We’re also generating sales gains on key brands that we’ve prioritized for investment. Cheerios is the leading franchise in the U.S. cereal category and our core brands are performing well. Retail sales for yellow box Cheerios are up 3% through the first half in outlets where we have take-away data. Both Honey Nut and Multigrain Cheerios are growing even faster, up 5%. We’re fueling growth in all three of these brands with strong levels of consumer marketing support and compelling health messages.
Health news and product innovation are driving growths for our Fiber One franchise. Retail sales are up 35% in channels where we have take-away data due in part to the strength of Fiber One Raisin Bran Clusters which was added to the line in March. In fact, we have a number of new products that are contributing to Big G’s growth this year. Back in the summer we launched four new cereals including Chocolate Chex and two varieties Curves cereals, many of you this brand equity as the largest women’s fitness club chain in the world. And our biggest new brand in the first half was Oak Cluster Crunch Cheerios. Year one retail sales for this newest member of the Cheerios family are currently projecting to be about $50 million. This makes Oat Cluster Crunch Cheerios one of the two largest cereals launched in calendar 2007.
All of these cereals will contribute to our sales momentum in the second half and we’re launching several more items including Strawberry Chex, Caramel Delight Fiber One and an organic variety of Nature Valley Cereal.
So as Big G enters the second half of the year, our key established brands are performing well. We have a good line up of new products that will contribute to sales growth. Our plans for the second half a higher number of in-store merchandising events than were planned in the first half. So we expect merchandising activity to be up. But our trade expense will be down both for the half and for the year in total due to the efficiencies I talked about earlier. December retail sales for Big G were up 5% and our market share in measured channels matched the prior year and was over 31%. For the year in total, Big G is well on track to achieve its goal of low single-digit net sales growth. We expect this division to generate margin expansion as well despite the higher input costs and the year one expenses associated with our right size, right price initiative. So we’re pleased with the improving performance we’re seeing from Big G and its contribution to overall growth for the U.S. Retail segment.
A second highlight for U.S. Retail this year is stronger new product performance. We have increased our discipline around the quality of the new products we introduce and we measure each new item on the following criteria, its contribution to net sales, the incrementality of those sales. What we’re measuring is whether the product is bringing new users to the brand or extending it to new eating occasions. We track the product’s impact on the division’s margin. We’re also looking for bigger ideas. We want more items that will generate at least $15 million in ongoing net sales for us. And finally, we track the annual net sales generated for SKUs launched.
We’ve adopted these new products metrics in 2006. We’ve posted improvements on each measure in 2007 and we’re tracking higher on each measure again in 2008. Across all of our U.S. Retail divisions new products launched in the first half of 2008 are off to a good start. In total we expect new SKUs to contribute between 5% and 6% of the segment’s net sales in 2008. I’ll give you some more details on these new products throughout my presentation.
The first half also included a successful key baking season for our Pillsbury and Betty Crocker lines. Pillsbury Crescent Rolls and Sweet Rolls continue to lead our performance in refrigerated dough. For overall retail sales grew 1% during the key months of September through December. We posted good sales growth in dessert mixes during this period too and retail sales of Gold Medal Flour were up 10% during key baking season.
We are supporting both new and established brands with stronger levels of consumer marketing. Through the first half, U.S. Retail consumer spending was up 8% above last year’s levels. We plan to sustain good brand-building levels in the second half of the year. I’ll discuss that in more detail in a moment. Advertising is the real driver here and strong increases in our brand-building support translate into growing share [of voice] in key product categories. This chart shows growth in our share of measured media spending for the June through September period we have available. Across all of our major U.S. retail categories, our spending in measured media is up 13% and our share of spending is up two percentage points. Now it’s not up in every category. For example, our share [of voice] in adult yogurt was down slightly in the period even though our total spending grew by a strong double-digit amount. But we’ve achieved strong of voice gains in adult cereals, soup and snack bars. This strong investment level builds our brands and helps fuel category growth.
So we’re off to a good start in 2008. We’ve got broad based sales momentum with all of our divisions posting sales growth. New product innovation is strong and we’re seeing good base line growth across many of our product lines and we’re supporting our businesses with increased investment in consumer spending. As a result we’re on track to achieve good sales and earnings growth for the full year.
Beyond 2008, we feel very good about the prospects for long term growth by our U.S. Retail businesses. We hold leading positions in an attractive set of categories that are on trend with consumer demand for health and convenience, and we have a great set of iconic brands. You know them; Cheerios, Pillsbury, Betty Crocker and many others that are well known by U.S. consumers. We’re leveraging this overall portfolio strength to bring product news and innovation to our categories. We plan to drive continuing growth by focusing on three key priorities.
First, we are generating the resources we need to fund our growth and build our brands. We’re doing this with a company-wide focus on holistic margin management. Our second priority is to focus our innovation efforts on our best growth opportunities. That means innovating around key consumer trends and growing our trends with strategic retail customers. And our third priority is to extend our leading brands into new categories, new channels or new usage occasions.
This morning I’d like to discuss each of these growth drivers in more detail starting with our disciplined approach to resourcing growth. We’re fortunate to have a U.S. retail business with strong margins. I’ve seen research reports from several of you questioning whether our margins are sustainable. I can understand the question. But we believe we can sustain the profitability of the U.S. portfolio and grow our margins over time. Mix management is one of the tools we’re using to do this. It’s important to remember that we have a wide number of divisions and product lines in this segment. Four of our U.S. Retail divisions Big G, Meals, Yoplait and Pillsbury, have operating profit margins that are above the overall company margin. The three remaining divisions currently are at or below the company average but each of them has good margin expansion potential. So we see opportunities within our mix of divisions and when you consider the mix of profitability by product line, there is additional opportunity. Items like dessert mixes, organic foods and our salty snacks currently generate good attractive margins. The margins on Progresso Soups, Nature Valley Grain Snacks, Yoplait Yogurt and Pillsbury Refrigerated Dough are stronger. And the profitability of breakfast cereals, Hamburger Helper, Old El Paso and Totino’s Pizza Rolls are stronger still.
So working our mix in U.S. Retail is one clear opportunity for overall margin improvement. We’re also sustaining our margins through holistic margin management which Don described earlier. Let me give you some examples of how we’re using all these levers within our U.S. Retail segment. We’ve improved our sales mix on Green Giant vegetables by introducing new value added products. The increased convenience from Simply Steam Microwavable Vegetables to Just For One Individual Serving results in a higher price point. We’re also improving our mix by eliminating slower turning SKUs. This year we plan to eliminate over 140 SKUs across U.S. Retail. But the largest reduction is coming in our Snack, Pillsbury and Meals divisions.
We’re achieving increased efficiency in our trade promotion spending. We’re reduced our trade costs per case in each of the past two years and we have a goal of reducing it further this fiscal year. Through product simplification, we’re increasing our manufacturing efficiency. For example, in our Pillsbury and Baking divisions, product reformulations have allowed us to reduce the variety of fats we use across our portfolio. This has improved our manufacturing efficiency and created purchasing leverage for those ingredients. We’re now expanding this idea across the Bakeries and Foodservice and International segments.
And finally we’ve been investing in technology to improve our manufacturing efficiency. For example, our customers continue to request more unique packaging configurations. Increased use of robotics let’s us meet these requests more efficiently using one packaging line for multiple product configuration. We reinvest some of our productivity savings into brand-building. This fuels sales growth, particularly base line sales which further enriches our margin mix. Our levels of consumer spending in U.S. Retail have increased over the past several years after declines in the wake of the Pillsbury acquisition in 2001. Last year our spending grew 6% and this year we plan to grow our brand-building investment at a high single-digit pace. We’ve got some great new advertising campaigns that began airing this fall and are really working. Let me show you some of our newest T.V. commercials.
After resourcing our growth our second key strategy is to focus on our best growth opportunities by innovating around key consumer trends and growing our business with strategic retail customers. In other words, it’s not about spending more it’s about increasing investment behind the best growth opportunities. When it comes to consumer trends, aging baby boomers are increasingly interested in health and wellness and they’re looking for foods that provide clear health benefits. According the U.S. Census Bureau, one-third of the North American population will be at at least 50 years old by 2030 so this interest in health and wellness will continue into the future.
We also note that the number of multi cultural consumers is increasing with Hispanic consumers growing the fastest. The average Hispanic family is twice the size of the non-Hispanic households and our products are well suited to these larger families. I’ll describe how we’re addressing these trends beginning with some examples of health news on our brands.
Last year Yoplait launched Yo-Plus Yogurt. This product combines probiotic cultures and fiber to aid in digestive health. It’s off to a good start in contributing to overall growth for Yoplait. Retail sales for our Adult Cup Yogurt businesses are up 8% so far this year with accelerating growth in the second quarter. Green Giant Healthy Blends Vegetables are designed to meet specific health goals. They were launched this summer and consumer response has been very positive. We expect annual retail sales on this line to reach $15 million. We introduced Progress Light Soup this summer and it’s off to a strong start. We estimate that year-one retail sales for Progresso Light will exceed $60 million and those sales have been over 60% incremental. Retail sales for the entire Progresso line grew 12% in the first half and our market share is up too, building on steady gains over the last several years.
We’re bringing back our Bestlife Diet promotional event to drive in-store merchandising during diet season. For the second year, we’re teaming up with Bob Green, Oprah’s personal trainer, to promote sales of Big G cereals, Yoplait Yogurt, Nature Valley Snacks and other healthy brands. Bob will be appearing on the Oprah show this month to kick off his program and will be supporting it with coupons, sampling and in-store displays over the next several months. We’ll also be offering an exclusive Bestlife Diet magazine available with our displays. Last year this program was a great success driving good sales lift on participating brands and we expect another year of great performance in 2008.
In addition to health benefits we are innovating across convenience. We increased our portfolio of microwavable products with Warm Delights Minis and Hamburger Helper Microwave Singles. These items have been incremental to their lines. In the case of Warm Delight Minis we estimate this product is 60% incremental to the Warm Delight’s line growing this brand to more than $50 million in annual retail sales. We also provide Heat and Eat convenience with new flavors of Murglen Soups, Cascadian Farm Purely Steam Vegetables and Pillsbury Simply Bake Bars. New versions of Pillsbury Sweet Rolls are fast and easy to make. So are our two newest versions of Hamburger Helper. New Wholesome Classic contains whole grain pasta and are good sources of calcium and vitamin D.
Portability is the ultimate form of convenience. This year we’ll launch many new flavors of Granola Bars, new Snack Mix varieties and even a carbonated yogurt in a tube for consumers looking to eat on-the-go.
We’re also working to increase our appeal to multicultural consumers. Our products are well suited to the needs of these busy families who enjoy cooking at home. Over the past several years we’ve increased resources dedicated to the multicultural marketing, including a double-digit increase in marketing spending this year alone. We’ve also strengthened and expanded our relationships with leading advertising agencies focused on Hispanic and African American consumers. As a result we’ve developed several award winning T.V. ads that include Hispanic consumers. As another example, we’ve partnered with Bea Smith a well known restaurateur and lifestyle expert, to promote our Grands Baked goods. Bea appealed to a wide variety of consumers but has a particular appeal among African American consumers. Her presence has contributed to dollar share gains on our Grands lines so far this year.
I’d like to just take a moment to show you several of our recent multicultural T.V. ads featuring Honey Nut Cheerios, Yoplait Yogurt and Grands Biscuits.
We are also focusing our efforts to help our retail customers grow. The majority of our sales today are still in traditional grocery stores but we’re seeing a rapid growth in a variety of other retail channels. In Drug and Discount Stores our sales are increasing at a double-digit pace through the first half of the year. In Dollar Stores, which provide a limited assortment of product sold at every day low prices our sales are up nearly 30% so far this year. We’re partnering closely with our growing customers to help drive results for us and for their stores.
Here are some examples of how our products are supporting key customer strategies. Our 35 oz. high fiber cereals, Heart Healthy Blend, is a perfect fit with Costco’s desire to provide more healthy food options for their customers. At Dollar General, we’re trying our Cheerios Spoonful of Stories promotion into their inspire reading literacy initiative. Our packages support both reading programs. And at Wal-Mart, a Cheerios promotion leveraged their in-store pharmacies and generic prescription program. At our traditional customers we’ve added resources and focus to grow our business at the largest grocery chains. These initiatives get us additional display, support and prime merchandising placement in stores. Our Small Planet Foods Organic Division had great performance in the first half with sales growth in mainstream retail chains and in the natural channel. New grain snacks and soup introductions did well. In addition, retail sales for our Cascadian Farm Organic Cereals were up 25%.
So partnering with key retail customers across channel format to drive growth in their stores will remain a key focus for us. Our final priority is extending our most iconic brands into new categories, into new channels and new usage occasions. Let me show you how this strategy is driving growth.
Progresso Soup is a great example of how we’re attracting new consumers to an existing category. Six years ago, Progresso was available nationally but it really was a north east brand. We introduced rich and hearty varieties that appealed to soup lovers in the rest of the country. We brought new consumers to the brand with reduced sodium and light varieties. And we extended Progresso to new eating occasions with a microwave version. In the last four years alone, these extensions have driven nearly 60% sales growth for the Progresso business.
Our Chex brand started as a line of cereals. But Chex Mix Snacks are favored in the snacks aisle too and we’ve created new flavor profiles such as Hot ‘n Spicy Chex Mix specifically for convenience store consumers who appreciate a little kick in their snacks. The one and only Cheerios brand has extended to the snack aisle too with Cheerios Snack Mix. We launched this two-flavor line of salty snacks in September and consumer response has been very positive.
Nature Valley Granola Bars were launched in 1975 and we’ve expanded this brand into different formats within the snack bar category. Last year we brought this popular brand to the cereal aisle with two flavors of Nature Valley cereals. This month we’re introducing a new organic version of Nature Valley Cereal. We think this is a great addition to the wholesome, all natural Nature Valley brand. I hope you had a chance to try a bowl at breakfast this morning.
Finally we’re extending the Fiber One brand into a variety of categories. With a name like Fiber One consumers instantly recognize the health benefits of this cereal. One year ago we launched Fiber One Snack Bars which have been a great success. Kim will be telling you more about them in a moment. Later this month you’ll find Fiber One Yogurt in the dairy case. This four flavor line contains 20% of your daily value of fiber with just 80 calories per serving.
These are just a few examples of how we’re expanding our brands and we’re just getting started. We think there are many more opportunities across our portfolio. Several of these examples involve snack products. To tell you more about this growing business I’ll turn the floor over to Kim Nelson.
Thank you Ian and good morning everyone. I’m very pleased to be here to discuss recent performance in the Snacks division and the growth opportunities that we see ahead. I had a chance to meet some of you back in June during our Investor Day in Minneapolis. As I described at that meeting we compete in the “better for you” segment of the snacking category. This segment includes items such as snack bars, popcorn, crackers, nuts, dried fruit, fruit snacks and other healthier snacks like baked chips and pretzels. Retail sales for this segment have been growing at 7% compound growth rate over the past six years reaching nearly $18 billion in 2007.
We believe that being positioned in the “better for you” snacks segment is a strategically strong place for General Mills. This segment leverages our core competency in developing healthy, grain based products and it allows us to affectively leverage some of our company’s terrific “better for you” brands. It’s on trend with consumers’ interest in healthier food options and it’s growing faster than the total snacks category. Our General Mills product portfolio provides many “better for you” options. The Snacks division generated $1.1 billion in sales last year with nearly half of our sales coming from grain snacks and the remainder split between fruit and savory snacks, which includes popcorn as well as our salty snacks.
We’re driving strong growth on our business by focusing on three key areas. The first is brand-building. Last year we increased our investment in consumer marketing by 11% driving 10% net sales growth for the division. We’re targeting another year of consumer support growth this year with spending up in the high single-digits. Our second key focus area is strategic growth channels. Only half of our division sales are from traditional grocery stores. The other half is in faster growing outlets such as Wal-Mart, Club and Discount stores. While our retails sales are growing at a double-digit pace in non measured channels we’re also driving strong high single-digit growth in traditional grocery. Our third key area of focus is on margin expansion. In the Snacks division we’ve been focused on increasing productivity and we’ve generated cost savings in several ways. We’ve eliminated slower turning SKUs, particularly in our fruit snacks portfolio and we’ve simplified the number of ingredients in our products generating manufacturing efficiencies. And we’ve reduced the amount of packaging on several product lines reducing costs and waste.
All of these efforts are contributing to strong sales growth for the division. As I mentioned earlier our net sales increased 10% in fiscal 2007 and that momentum is continuing in fiscal 2008 with net sales up 14% through the first half. As you can see, grain snacks are driving our growth with retails sales in channels where we have data up 34% through the first half of this year. Our fruit snacks line is showing strong sales growth too and we posted share gains on three of our four snacks platforms.
Let me talk about what’s driving these gains. I’ll start with fruit snacks. Back in June I mentioned that one of our objectives this year was to ignite growth on fruit and through the first half, we’ve done that. Retail sales have grown 9% and we’ve also profitably gained nearly four points of dollar share. This solid performance has been driven in part by our new product introductions. In the fourth quarter of last year we expanded our established Fruit Rollups and Fruit By The Foot brands with mini varieties and our Crazy Pix launch extended the Fruit Rollups franchise with distinct varieties for boys and girls. And then in the first quarter of this year, we launched the new Stakerz Fruit Snacks. Consumer response has been strong and this item has been the second fastest turning product in the entire fruit snacks category. Let me show you the T.V. ads that we ran in conjunction with this new product launch.
I’ll turn now to our savory snacks where we’ve been focused on increasing profitability. Over the past few years we’ve improved our margins at a double-digit rate as we continue to work on productivity initiatives, such as ingredient simplification and sourcing efficiencies. At the same time, we’re bringing incremental innovation to this part of our portfolio. We compete in the warehouse delivered segment of salty snacks. As Ian mentioned, this year we extended our cereal-based snacking platform with the launch of Cheerios Snack Mix. The mix has 60% less fat than regular potato chips and like it’s namesake cereal, it’s a good source of whole grain. Cheerios Snack Mix has been a successful product in Canada for many years. U.S. consumer response to this product has been strong exceeding our expectations for the initial launch. In addition, margins on this product are above the division average improving our snacks product mix.
We believe that this snack line has the potential to generate $25 million in annual sales. Turning to our Chex Mix business this month we’re adding a new dark chocolate variety to our successful Chocolate Chex line. We’re also bringing news to the popcorn aisle with the launch of Curves Microwave Popcorn this month. This product is designed to appeal to consumers who are counting calories. Each serving contains three grams of fiber and only 90 calories. With Curves, we’re increasing our position in the health segment of the popcorn category which is where the category is growing fastest.
Our largest snack platform is grain snacks. Over the past two years the combination of strong core business growth and highly incremental new products have driven significant share growth for our grain snacks portfolio. So far this fiscal year we’ve gained over three and half points of dollar share and over the past two years, we’ve grown our share by more than five points.
Nature Valley is the preeminent brand within our grain snacks portfolio. We created the granola bar category with the launch of our Crunchy Bar back in 1975. Since then we’ve expanded this brand with Chewy Trail Mix Bars, Yogurt Bars and Sweet and Salty Nut Bars. These highly incremental launches have grown the Nature Valley franchise to five times the size it was seven years ago.
Roasted Nut Crunch Bars are our newest addition to the Nature Valley franchise. These bars have a very simple ingredient listing; just six items. They’re made with whole roasted nuts and there’s nothing like them in the market today. Early reads on these bars are strong and this line is proving to be incremental to the current Nature Valley franchise. Increased consumer support also is driving growth for Nature Valley. In each of the past two years, we’ve increased our consumer spending at double-digit rates. This has driven steady increases in our base line volume which in turn, has allowed us to reduce our traded cost per case. We expect our spending growth to moderate a bit in 2008 but we’re still targeting another double-digit increase.
We’re being strategic in how we reach our Nature Valley consumer advertising the brand in a variety of ways and in a variety of different venues. Since the Nature Valley consumer has a healthy, outdoor mindset our print ads can be found in magazines like Shape and Cooking Light as well as Golf Digest and National Geographic. Our T.V. ads air on channels like Discovery and The Travel Channel. Let me show you our most recent television ad.
Much of Nature Valley’s advertising actually occurs outside of traditionally measured media. We’re sponsor of the PGA Golf Tour so we have sample products at many golf tournaments. Sampling has proved to be a tremendous driver for retail purchases for Nature Valley. We’re also sponsor of the U.S. Ski Team so we place outdoor advertising at ski slopes like Stowe and Vaile and Breckenridge. This slide shows how advertising appears when you’re out on the slopes.
We’re also working to create a sense of community amongst our consumers. Our website invites visitors to submit videos telling us about their nature valley and we’re sponsor of The Save The Trails Program at three of the country’s largest national parks, Yellowstone, Yosemite and the Grand Canyon. Finally you heard Ian mention how we’re expanding the Nature Valley brand beyond snack bars; well we’re also expanding the brand around the world. Nature Valley Granola Bars are now available in more than 54 countries bringing even more growth to this popular brand.
But our grain momentum is fueled by more than just the Nature Valley brand. This summer we launched the new Curves Bars which contain 100 calories per bar and five grams of fiber. These bars increase our presence in the growing weight management segment of the grain snacks category and they’ve received great consumer response.
Fiber One Bars also compete in the weight management space. As I mentioned back in June, growth on these bars has been tremendous. These bars do the nearly impossible. They make a high fiber product actually taste great, really great. In their first year, our initial two SKUs achieved more than a 4% dollar share of the grain snacks category in measured channels. We believe this line provides a great opportunity for expansion, so this month we are adding a caramel variety to the line. I hope you got a chance to try these bars at breakfast this morning.
So in summary, the outlook for our snacks business is very favorable. We’ve seen explosive growth on grain snacks, due in large part to the continued success of our Nature Valley franchise and the outstanding performance of Fiber One Bars.
We’ve renewed growth on our fruit snacks portfolio, with new product introduction driving share. Productivity gains are further improving our strong, savory snacks platform.
As we enter the second half of 2008, I am confident that we will meet our growth targets for the full year, and our prospects for future growth in the snacking category are very strong.
That concludes my prepared remarks. I would be happy to take any questions, but before I do, I will turn it back over to Ian for closing comments. Thank you.
Thanks, Kim. I will summarize our performance in U.S. retail this way: we had a strong start to the year, and we are on track to deliver good sales and profitable growth in 2008. We are sustaining our margins in the face of rising input costs, and that generates resources to support continued growth. We are building our brands through increased investment in our consumer marketing; we are sharpening our new product innovation; we are focusing on key consumer trends and growing customers, and we are leveraging our iconic brands into new categories. Our prospects for long-term growth are excellent.
That concludes our prepared remarks this morning. Now I will open up the floor for questions to any of us here today. I think Kris will be coordinating that.
Please wait for the microphone because we have webcast people too. Raise your hands if you are looking to ask a question.
Good morning. Don, in particular you’ve done a nice job of updating us on your expected input cost inflation. I wonder if you have a new number for us this morning.
An update on our inflation?
The input cost number. You started at 250 back in November and I think you took it up to 325.
325, that is still our number for the year.
Let’s see those hands again.
Terry Bivens – Bear Stearns
Ian, I think this one is probably for you. It is probably no secret to you, Kellogg has pointed out to some of the retailers some of the – I won’t say flaws, but – issues Right Size, Right Price may have created for them.
Looking back, they are in a period of what I would call unusual promotional activity. So the question would be this: I know you seem very pleased with the way the restaging of the cereal line has gone, but do you think Kellogg’s actions are going to create any issues once we get to that period where we are apples to apples with Right Size, Right Price?
Thanks, Terry. Specifically, no I don’t. I think the cereal category across competitors is acting quite rationally. I don’t know if all of you saw December data or not yet, but the category growth in December was twice the rate it has been running for the 12 months. I think with us doing the right things, Kellogg’s doing the right things, and hopefully the rest of the competitors doing the right things, promoting our brand is going to be a very positive story for the category.
A zero category tends to flourish in tough economic times. I actually am very bullish about the prospects for the cereal category. Competitively, it is always a dog fight in any category and we will all do our best, but I think the behavior in cereal right now is pretty good and everyone is focused on fundamental consumer demands and needs and innovation. That is the game we want to play.
Dave Palmer - UBS
There have been some trends in many of your categories. I was wondering about the dough business in particular, that has been showing some deteriorating trends lately, and I think inside the company you were bullish about the second half for the dough business. I am wondering, we saw a couple of new products out there on one slide, but is that a business that has some brightening prospects in the near term, in your view?
Our dough business has actually been quite strong this year, and we very much registered an improved performance. In that division, if we had not had the Trattino’s recall, and they obviously feel the bulk of it because that business is in their division, but otherwise our Pillsbury U.S.A. business is running well ahead – well ahead – of their plans for this year and through the mid year.
Dough I think is looking pretty good. There is one segment, which is a small segment of the dough business which is the cookie segment, which has been declining in Neilson over the last many months, and we do feel that that is going to be – I think both we and our key competitor in that segment have probably backed off a little bit and that is going to need some innovation to spur more growth. We are working hard on that.
But the bulk of it, which is really the other products like crescent rolls and so forth, we feel really good about. We are seeing good trends on that.
Dave Palmer - UBS
That deterioration that we see is really that recall effect?
Well that is in the total Pillsbury U.S.A. if you were looking at Nielson’s –
Dave Palmer - UBS
I was just looking at the dough category. And that is based on the cookies?
It is mostly in the cookies/sweet part of that business. It is not the majority of that segment, or of the refrigerated baked goods segment, but that is where the deterioration is the most pronounced.
Dave Palmer - UBS
And the net effect of your other dough business and the cookie segment, is that your prospects look better in terms of –
Our net business in RBG is positive and is ahead of plan right now. I am talking about the growth plan, both top and bottom line.
Dave Palmer - UBS
That is a change versus the first half?
No, it was through the first half we have been ahead of plan.
Dave Palmer - UBS
And so the IRI trends, those sort of trends are more or less what we should continue to see?
We are seeing, as I reported, very low single digit growth in our RBG business.
I just wanted to ask you two questions. The first one was in terms of your U.S. retail portfolio, are you seeing broad market share gains across the business? Do you have a composite market share number from all of these new products and the marketing and all of these good things that are going on? Can you report on that or give us some idea?
Yes, I will, I can. We do look at that, although it gets down to category by category is really the way we tend to manage that. Overall, I would say we are down mildly on our total market share over the U.S. retail portfolio.
Cereal is probably the major driver of that, I presume?
Cereal was. The story is, the story as of November as we report, I think if any of you have seen December data you will see that, and I have reported in my remarks, it is a very stable share and a very high absolute share. As we look forward to our plans in cereal, we feel good about what we are doing.
I will remind everyone in the room – I know you know it, but – 40% of our business is not tracked in the Nielsen markets, and we have had a very focused effort in a lot of those areas and we are seeing really tremendous growth in results there.
The other question is on your productivity savings. You haven’t quantified those this year, but should we presume that they are running in line with historical rates at around $150 million a year?
Maybe you can give us an idea of if going forward, that sort of level is sustainable in this input cost environment?
I might turn that over to Don in a moment to maybe comment on it in a broader perspective, but looking at U.S. retail, one of the things we do every six months is we sit down with all of the operating divisions and we review HMM plans, holistic margin management. And the same way you might review a new product plan and a three-year forward-looking perspective of all of the initiatives, both on the books and ones they are working on and then we wrap it all up and we get a pretty good line of sight on what our future productivity will be and how it will flow in on that element.
What’s really been encouraging about that, and we have been doing that for about two-and-a-half years, is every single time we have sat down, the number goes up. So our productivity, I believe, is rising.
Now the thing when we put our final plan together for next year will be, what is our final view on commodity inflation? But I would say we are very bullish in our ability to use both pricing/mix and increasing productivity to offset the inflation that we expect to continue.
I would add just a couple of comments to it. First building on the point that Ian raised about the review process that we have, when we look at the pipeline we very much mirror it after our new product reviews, where we looked at a rolling 12 quarter pipeline for HMM projects and the benefit.
That is hugely beneficial to give a clear line of sight on where those savings are going to be; any capital we may have to commit to it and what human resources we have to commit to getting executed. It gives us the advantage of a much clearer line of sight and confidence in terms of what we are going to be able to deliver not only this year, but in the coming years.
Now to your question, Chris, in terms of the productivity. It is going up each year. It is going up for a couple of reasons. As Ian alluded to, each time we have looked, every six months we have looked at our pipeline, it is enriched. But also, we are expanding where that pipeline goes, where the review goes.
Now it is much more prevalent internationally now than it was a couple of years ago. The process and the tools started in the U.S. and we have begun to implement those internationally, we are seeing a richer pipeline out of our international business, and we are starting to apply those same tools to our administrative costs and we are seeing costs come out there as well.
So you are seeing a higher number of productivity; the whole HMM bucket is getting larger as well because we are seeing even greater mix opportunities and some pricing more recently.
Pablo Zuanic – JP Morgan
Two questions, one on soup and one on brand building. When you think of the response you have had on the light soup platform, and the reduced sodium, could you make the argument that the light soup response has been a lot better and we could conclude that the need out there for light soup was greater than reduced sodium?
Pablo, you are quite right in your observation so far, six or eight months in. The light soup range is about 25% higher than low sodium in turns, in terms of turns on the shelf, and the low sodium turns pretty similar to our top SKUs in our base range.
But even during all of that period, our low sodium has grown. We have six SKUs in low sodium and we have three or four of those in the top five in that category in terms of turns. So the low sodium continues to do well. There is no doubt that so far the light range has been that much stronger.
Pablo Zuanic – JP Morgan
On Campbell’s they have started advertising the fact that they have 80 soups below 100 calories and that you guys have 25. Are you seeing any impact from that? What do you think about that?
Well you get to look at the data as much as we do. We have been able to consistently grow our share in the RTF side which is where we are focused. We think it is a good message. I think it is a good message, for the soup category, to be honest. I think consumers are not fully aware of how calorically beneficial the soup category is, but we continue to do very well. We have noticed certainly no impact from that initiative, particularly from Campbell’s.
Pablo Zuanic – JP Morgan
Thanks, and just one more on brand support. It is increasing every year ahead of sales, and obviously we are seeing the impact on sales below but as a percentage of sales, are you where you want to be? What is your target? Other companies provide a number [inaudible]. Where are you and where do you need to go.
In terms of where we want to go, we are not fully where we want to be. It is not easy to benchmark the total spending against other companies, but what I can tell you when we look at what is reported, we are amongst the food group, probably in the top quartile, certainly above the median. When we look at a broader set of packaged goods companies we are probably just above the median.
I think relatively speaking, we will want to continue to expand our spending as a percent of sales over time to at least about a point higher than where we are at today.
Eric Katzman - Deutsche Bank
First, SUPERVALU talked about the consumer trading down. Maybe that isn’t affecting your business, but can you talk just broadly in the categories that you participate, are you seeing others suffer from trading down?
We have not really seen that effect. Now we have some categories and brands that thrive in that kind of environment; Hamburger Helper usually does very well in that environment; Tattino’s Pizzas are $0.99, that is a tremendous value in the store. And cereal, all in, is still a very cheap, very inexpensive meal when you look at it for breakfast.
So as I said, many of our categories and our brands within those categories are very strong. So we haven’t really seen that impact. I think what you might see is some movement, potentially, certainly away from home eating to at home eating as people potentially economize in that area. And then I think when people buy their groceries, they are really looking for brands they like and they are used to and brands that are continuing to support and talk to them during this inflationary period.
I can’t say that we’ve seen really any impact of that nature so far.
Eric Katzman - Deutsche Bank
A follow up to Chris’ question for Don. Maybe you can walk through the math a little bit more, but I am not exactly clear as to if we have 300 – just to use this year as the right example – if we have 325 million worth of incremental input costs, you are spending $150 million roughly on cost-savings projects.
But you are saying that – I guess I wonder about the cash returns on these savings programs as opposed to let’s say the incremental margin return.
One of the arguments that has been made about General Mills over the years is that the balance sheet is used aggressively to preserve the 22% U.S. retail margin level. With that kind of cash going out, I wonder how we can keep track of whether in fact the returns are increasing, as you are saying.
I also find it hard to get comfort level if more of the savings going forward are coming from much smaller buckets like international?
There are a couple of questions embedded in there. The CapEx first of all, as I mentioned in my remarks, we did have some larger projects this year that increased our capital spending to the $575 million level this year, and we fully intend to have that come down.
Next year in our long term view is that CapEx should trend somewhere just under 4% of sales, so the cost savings would come down accordingly. Not only do we have hurdle rates for our projects going in, we also track performance after the fact and to be quite honest with you, the cost-savings projects that we’ve had are very much more of the surer bets because they are typically direct costs that we can see the benefit of as we take them out.
Now the 150 that we spend this year, we will get paid benefits for partially this year but more fully going forward, so it will become part of our cost savings as we look forward. And to my answer to Chris, we do see productivity increasing as we look into the future. Part of that is because of the capital we are putting in place today.
You are right in terms of the areas that I mentioned in terms of expanding HMM international and admin are smaller buckets, but they are incremental buckets to where we have seen productivity more recently and cost savings more recently. Many of those areas do not require capital that we are seeing in some other aspects of our business, so there will be a good return on that investment; it should mostly be human investment, putting people’s time against those projects.
Eric Serotta - Merrill Lynch
Obviously this year you are tracking well above your long-term growth algorithm on the top line. I am not going to ask you if or when you are going to raise that. But thus far this year mix has been, by my calculations, at half of the price mix component, or 2.5% or so on the top line. It seems that if you are able to sustain this mix level, that mix alone could account for the bulk of your top line growth going forward.
I am wondering if you could help put it into some perspective or roles, the relative roles that pricing, mix improvement given all of the things that you have talked about, and then volume growth should play in this low single-digit, top line growth algorithm?
Let me tackle two aspects of that question. One is we are committing this year to increase our sales growth at the mid single digit above our long-term growth objective, and that’s a bit of a unique environment because we did have a spike in cost. We put additional pricing through as we outlined versus what was in our original plan.
Our long-term growth model, as we look at it in the near-term, does assume inflation as what we’ve seen over the past several years, which is in that 4% to 5% range. We think with productivity, we can offset that to drive not only the single digit sales growth but then mid single digit operating profit growth.
When you have a year like this year where that number spiked, the inflation number spikes, you have to take additional actions. In this case, it was pricing that ended up that our sales growth was going to be in the mid single digits, so that’s a bit of a one-year anomaly versus our long-term trends.
Now, on those long-term trends going forward, we do expect a portion of that low single digit to be volume growth and we expect a portion of it to be sales and mix and again, that sales and mix distribution will differ from year to year depending on the program. But we expect it to be fairly split between volume and price mix when we think about that low single digit.
Eric Serotta - Merrill Lynch
Okay, and you are still comfortable with -- are you still comfortable with being able to drive that volume component in an environment of continued compounding pricing, not just from you guys because you guys have obviously been doing more than just -- you’ve got more than just the pricing lever to pull but your reported volumes year-to-date have been relatively anemic. It’s been masked by a lot of factors that you’ve spoken about but are you confident in being able to drive volumes in an environment of pricing perhaps getting tougher from here?
Let me just start with some macro comments and I’ll ask Ian to add in, particularly on U.S. retail. But if you think about our first half results, there’s been I’d say three factors that have put a particular drag on the volume piece of our sales growth. One is the two pricing increases we’ve taken in bakeries and food service, which is a business that has the narrowest margins and feels that pressure most directly.
Second is in right size, right price, part of the program was to move less tonnage but have a better price per ton or per ounce.
And then the third is we had the Totino’s recall, so we did have a couple of drags, a couple unplanned, one obviously planned, that typically impacted our first half that will not reoccur over the longer term, which will help us get back to that volume growth.
Ian, if you want to add any other comments on U.S. retail.
-- what’s behind the question is concerns about the impact of pricing and so far, the pricing has gone remarkably well. Our customers in our retail trade understand the high inflation. They are certainly seeing it in their businesses that they source directly and with consumers, I think because it’s broad-based in the store and it’s not in any one particular category, and private label is pricing as well, that the whole playing field is adjusting where it is relative to this commodity input inflation.
And so we feel pretty good and we’re not having to pass on everything to consumer. Our productivity efforts and our mixed management efforts have really allowed us I think to be more than competitive in this area while also holding our margin. So we feel pretty good, even though you don’t wish for the headwinds of inflation but we feel pretty good about our ability to handle it and handle it in a very competitive fashion and still support our businesses and grow them.
And I think in environments like this, it is going to be strong brands and strong productivity initiatives that can allow companies to win.
David Driscoll - Citigroup
Good morning. It’s David Driscoll from Citigroup. So to follow-up on that food at home versus food away from home, you are making an argument here that I’d like you to respond to this point -- you are saying that you had a couple of planned actions that would result in volume declines but I certainly don’t think that you planned for economic slowdown, now would you plan for consumer shifting from food away from home back to food at home, thus there would be any expectation to see volumes overall in the grocery store life.
Why haven’t you seen a lift more than the 1% so far? And Ian, if you can comment directly on it, would you then expect to see volumes start to pick up in the subsequent quarters if in fact the explanation is as given?
Yeah, and again the movement I think from away from home to at home is an hypothesis on my part but I think it’s a reasonable one, based on historical precedent.
I do expect that volumes growth will normalize to what it once was. We’re in a period right now though of a lot of pricing and some of it being catch-up pricing to deal with inflation. And when we price, we have very good volumetric models and elasticity models to really understand the impact of that pricing.
And no doubt when you price, you expect, you fully expect to have some impact on volume. And the industry and ourselves, we’ve been doing quite a bit of pricing disproportionately you might say in the first half. I think that still will carry through to some degree in our fiscal year but over any meaningful period of time, I think it will be sort of a back to normal with a mixture of volume and mix and pricing driving the top line.
Let me also add, by the way, to Don is we had some very specific situations even in addition to the one he mentioned in the first half. For example, a very large volume and weight mass business for us is our canned vegetable business in Green Giant and there we are seeing tremendous commodity inflation on the corn side, which is a big part of our business. And we really backed off very deliberately how much trade dealing and expensing we did on the Green Giant business, which is going to have a highly disproportionate impact on pound volume. It had a very positive impact on the return to shareholders on that business.
So again, I think we are in a little bit of a transition period here this year on some decisions that we and I think competitors as well are making on their businesses, but I don’t expect that that’s the norm over the long period.
David Driscoll - Citigroup
And just one final question, specifically on soup; the difference between Progresso’s growth and the category growth in ready-to-serve has really been quite extraordinary recently. Can you comment on promotional activity by Progresso? Is it substantially different? Is there a seasonality component to it? Sometimes the quarterly pattern on [inaudible] shipped?
And secondly, again on soup, are you seeing -- do you believe that there’s been a negative impact to the category because of weather trends?
Let me answer the first question, which is promotional activity. As you probably know from the data, both our average price and our merchandise prices are up this year and our activity is moderately down. I would say competitive and we don’t see that -- there is a seasonality of that business between the cold months, essentially. But between the second quarter and third quarter, we don’t foresee any great changes in our plans.
What’s really driving our growth has been the innovation and particularly the light soup innovation and that really has nothing to do with merchandising or price discounting. So we are pretty pleased with where we sit on that business. We always watched the competitive environment carefully.
I think weather does affect the timing, to your second question. I think weather does affect the timing to when soup season cuts in and certainly as temperatures get colder or winter gets stronger, you can see that in that business. But from our standpoint, we don’t see it as material over our fiscal year.
Thanks. Ian, I’m curious -- I understand why the industry and General Mills has been playing catch-up around pricing versus input costs, because it kept going higher beyond anyone’s expectations. But in the way you think now going forward about the pricing that you are thinking about or the industry is thinking about, are you thinking about it in a way of let’s try and get ahead of where these input costs may go down the line because we really don’t know? And then you can always use other levers to kind of bring it on back if that’s not where they ultimately go, so you are not in this constant game of catching up.
Because it seems like if the pricing window is open now, which it seems to be for the first real time in a decade plus, without getting ahead of yourself as an industry, it would seem like this is the time to think that way.
I think that’s a very correct and sharp comment. That the lag between -- we were just talking about that earlier -- the lag between when you see inflation coming and when pricing actions occur I think was getting long and I think that lag, if there is going to even be a lag, is shortening. And I think it’s got every company’s attention and therefore you have a fairly rational marketplace, both on the branded and private label side as it relates to the need to price to deal with this inflation and it’s not something you -- I think anyone who has been behind the curve hasn’t particularly liked it later.
And so I do think that across the industry, you will see pricing more in sync with what one needs to offset inflation. Again, in our case, I just want to underscore -- we do not need to price fully to offset the input inflation. We have a tremendous amount of productivity in place to offset the bulk of it.
And then one for you, Don; you mentioned that your margins were up a bit excluding some of the recall costs and things in the first half, despite the input cost environment. But given the top line that you’ve been putting through, are you satisfied with the kind of operating leverage that you are seeing in the business? A question I get a lot is with a top line like that, even understanding input costs it would seem like, particularly in General Mills, given some of the contribution margins of your businesses, the operating leverage has in some ways seemed stronger over time. So I didn’t know if there’s been a change there or if I’m just not seeing all the components.
There has not been a change. We run very high utilization at our plants in the U.S. so we tend to see pretty consistent leverage in that business. What you do see is the international business grows faster. There is a little bit of segment mix that works against us as we are still building up the margins in that business or that segment, so you see a little bit of that.
But primarily what you are seeing is the fact that we are running plants that are already very highly utilized, which is our modus operandi in our supply chain. So you will get, in some short period of time some leverage but over time, because we do run a high utilization, we tend to see pretty consistent margins and where we get the upside in our margins is through mix, through product mix. And that’s why we’re so heavily focused when we think about new products, we think about where we put our advertising behind existing or established products to think about the mix impact so that we’re driving higher profit products through those highly utilized manufacturing lines.
Kenneth Zaslow - BMO Capital Markets
Progresso Soup has moved beyond the Northeast -- Ken Zaslow with BMO -- are there other material products in General Mills’ portfolio that can gain distribution or national distribution beyond its current regional aspects? Is there anything that we should be thinking about?
Well, we do have some -- we have a variety of brands that are regional in scope, none quite as pronounced an opportunity as Progresso.
The other one I would say, it’s not geographical so to speak, but our organic brands still have a tremendous upside opportunity in being distributed through traditional retail as opposed to the natural and organic channels where they have very good penetration. And so that certainly is an opportunity for us as that trend continues to build and grow.
I can’t think of off-hand any regional brand in a similar example to the Progresso one.
Kenneth Zaslow - BMO Capital Markets
And then my final question is obviously everybody’s been talking about the commodity environment but is there any reason to believe that General Mills cannot generate EPS growth of a high single digit in each of the next two years? Are we in an environment that anything would jeopardize your target rates -- not just for this year but going beyond 2008?
I’ll tell you and Don will tell you the real story, but -- no, I would tell you our confidence internally even with this inflationary headwind hasn’t been higher in a number of years. We see all sorts of opportunity. We do review our pipelines on both productivity and new products and our base businesses and we are expanding our brand support. And so we feel really quite good about our prospects within U.S. retail to at least meet the long-term goals that we’ve set out.
Again, I’ll let Don comment a little further but I think our international business, as you saw how strongly they performed in Q and they have also I think a very positive upside to them. Don.
I would just reaffirm the confidence. We are doing it this year despite some headwinds, both from inflation and recall standpoint. We are doing it the right way, which makes it sustainable, which is putting the investment behind our brands to grow the top line, which we are then seeing the benefit from in terms of our sales growth, but then the productivity of that allows us to enhance.
And as we look at our cash generation, which consistently allows us to deliver the dividends and the share buy-back that we’ve committed to, we feel very confident that the double-digit EPS is the right target for us and is very achievable for us in the coming several years.
We are actually at the end of our webcast time window, and some of you may be have some other things on your calendar as well, so I am going to ask you to sign off on the webcast. Thanks to those of you that were listening in and thank you very much, everybody, for joining us this morning. We appreciate it a lot.
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