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General Mills, Inc. (NYSE:GIS)

F3Q08 Earnings Call

March 19, 2008 8:30 am ET

Executives

Kris Wenker – VP IR

Don Mulligan – CFO

Ken Powell –CEO

Analysts

Chris Growe – Stifel Nicolaus & Company

Andrew Lazar – Lehman Brothers

Eric Serotta – Merrill Lynch

Jonathan Feeney – Wachovia Capital Markets

Terry Bivens – Bear Stearns

Ken Zaslow – BMO Capital Markets

Todd Duvick – Banc of America Securities

Eric Katzman – Deutsche Bank Securities

David Driscoll – Citi Investment Research

Vincent Andrews – Morgan Stanley

Operator

Ladies and gentlemen thank you for standing by, welcome to the General Mills third quarter fiscal 2008 results. (Operator instructions). I would like now to turn the conference over to Kris Wenker, Vice President Investor Relations, please go ahead ma’am.

Kris Wenker

Thanks operator. Good morning everybody, we appreciate your interest in GIS today. I’m here with Ken Powell our CEO and Don Mulligan our CFO. I’ll turn you over to them in a minute. First I need to cover my usual housekeeping item. The press release on third quarter results was issued over the wire services earlier this morning. It’s also posted on our website, if you still need a copy.

On the website you’ll find posted slides that supplement the prepared remarks we’re making this morning. This conference call will include forward looking statements that are based on management’s current views and assumptions and the second slide in today’s pitch lists factors that could cause our future results to be different than our current estimates. So with that I’ll turn you over to Don.

Don Mulligan

Thanks Kris and thanks to all of you who’ve joined us this morning. As you see from the results we’ve released today, General Mills had an excellent third quarter. Slide 4 summarizes our results. Net sales grew 12% to $3.4 billion. Segment operating profit grew 14%, earnings after taxes were up 61% and earnings per share were up 66% to $1.23. This strong growth was driven by volume and net sales increases across our businesses. We also benefited from certain non cash items as shown on slide 5. First, we received a favorable ruling on a tax case for which we had previously established a reserve.

Reversing that contingency reduced our book income tax expense by $30 million or $0.09 per share. Second, valuing our current commodity positions at market prices resulted in a non cash gain of $151 million pretax or $0.27 per share. This net mark to market gain relates to hedges of open commodity positions as well as our grain inventories. Excluding these non cash items, earnings per share would have totaled $0.87, up 18% from last year. The key driver of that 18% EPS growth in the quarter was sales volume. A 12% sales increase reflects good pound volume growth, up 6%. Price and mix contributed 4 points and we gained 2 points from foreign exchange.

Each of our three business segments contributed to the sales increase. US retail sales were up 9%. The international segment posted 20% growth and sales for bakery and foods service grew 13%. Our third quarter gross margin of 39.8% was almost 5 percentage points above the comparable period last year as mark to market valuation of commodity positions, productivity and pricing offset significantly higher input costs. If you exclude the mark to market gains, $2 million of recall expenses on Progresso Italian Wedding soup, gross margin was 35.4% for the quarter, up 30 basis points from last year. For the year to date, the story is the same.

We are holding and actually slightly growing our margins. Mark to market valuation of commodity positions helped drive an increase in our reported gross margin to 37.7%. Excluding that non cash gain, recall expenses and the $17 million of accelerated depreciation as part of this year’s restructuring activity, our gross margin through nine months was 36.5%, up slightly from last year. And this strong performance is in the face of very elevated input cost inflation. Our ability to counter these higher costs allows us to maintain strong levels of investment in our brands. Our results for the quarter include a 13% increase in consumer marketing expense.

We believe this investment is and will continue to fuel sales growth. Slide 10 shows you the details of our segment operating profits in the third quarter. US retail profits increased 9%. International posted another quarter of strong double digit profit growth and bakeries and food service profits grew 68% driven by strong earnings growth from our grain merchandising activities. Now as background since our earliest days as a company, we’ve earned profits from buying, milling and storing grain. The recent large and rapid price grain increases this year have resulted in above average profits in this area. After tax earnings from joint ventures totaled $30 million in the quarter.

These results include a net gain of $11 million associated with the restructuring project CPW has underway in the UK. Excluding restructuring items in both years, joint venture earnings were essentially flat and that includes a $2 million gain on the sale of the 8 Continent Soymilk business during this quarter. Our Haagen-Dazs joint ventures in Asia recorded good sales and profit growth in the quarter. CPW sales grew double digits in the quarter, however profits were lower as we priced a bit behind inflation in the quarter and made some strategic consumer marketing investments.

Our year to date JV earnings growth remain strong, up 8% excluding the CPW restructuring and 8 Continent gain. Through nine months our joint ventures have contributed $80 million in after tax earnings to General Mills or $0.23 per share. Let’s move to the cash flow statement where cash from operations was lower in the third quarter due to increased working capital. As we discussed in the second quarter, inventories are the primary drivers of this increase as we reflect higher prices on higher levels of grain inventories. For the full year we expect core working capital to grow faster than sales due to the higher raw material prices we’re seeing.

General Mills has a strong tradition of returning cash to shareholders through dividends. Our goals is to grow dividends with earnings over time. On March 10th we announced an increase in the quarterly dividend rate to $0.40 per share. This is our seventh rate increase in the last 16 quarters and raised planned dividends for 2008 to $1.57 per share. In total, General Mills dividends have grown at a 9% compound rate over the last four years. We also returned significant cash to shareholders through stock repurchases. During the third quarter we repurchased 2.8 million shares at an average price of $55.00.

Through nine months, our average shares outstanding were 346 million, down nearly 4% from last year’s average. I’d estimate that our average share count for the full year will be slightly higher than this but it will be below the 350 million we previously targeted. Slide 15 summarizes our financial results for year to date. Net sales have grown 8%, segment operating profit is up 7%, earnings after tax grew 21% and earnings per share are up 25% as reported to $3.19. Excluding tax and commodity gains, up $0.39 per share, our EPS grew 10% to $2.80. Through the first nine months of the year, General Mills has delivered strong net sales and volume growth across our businesses. Our underlying gross margins have held steady despite significantly higher input costs.

Our segment operating profits are up 7%, including double digit growth in our consumer marketing investments. And with this good performance we are clearly on track to achieve our full year earnings per share target. As we turn to the fourth quarter, we expect to record continued good sales growth but we’re not counting on sustaining the double digit pace we set in Q3. Our guidance would be for mid single digit growth in net sales. Input costs will show the highest percent increase we’ve seen this year and our plans include a double digit increase in consumer marketing investment in the final quarter which we expect to help us carry good top line momentum out of this year and into 2008, 2009.

For the full year, our reported EPS wills how strong double digit growth including the non cash tax item and commodity hedge gains that we estimate a combined $0.30 per share. Excluding these non cash items we expect EPS to total between $3.45 and $3.47. This represents high single digit growth from last year’s EPS of $3.18. We see this as good performance in a challenging cost environment. So that concludes my update on our financial results and with that I’ll turn you over to Ken for a review of our operating performance.

Ken Powell

Okay, well Don thank you very much. Good morning to one and all and let me join Kris and Don in thanking you for your continuing interest in General Mills. As we look at our results through the first nine months of this year, what pleases us most is the way we’re achieving our growth. Our product innovation in consumer marketing investments are driving strong growth on the top line. Cost savings efforts together with pricing actions are offsetting significantly higher input costs and they’re protecting our margins.

As we shared with you at CAGNY, our earnings growth in 2008 will exceed our original targets and most important, the actions we’ve taken in 2008 to protect our margins, to reinvest in our brands and to deliver health and convenience innovation for consumers will position us well for delivering good growth again in 2009. In talking with a number of you at CAGNY last month I know there’s concern about food price inflation and the potential impact on volume and sales and we’re going to continue to watch this closely but we are encouraged by the strong demand we’re seeing for our products.

Year to date, our volume is up 3% and net sales are up 8%. And in the latest quarter, the trends have accelerated with volume up 6% and sales up 12%. Now looking first at our US retail business, we see the same pattern of strong top line growth. Slide 21 shows you that year to date, US retail sales are up 6% overall with growth in every one of our divisions. And in the third quarter, sales growth accelerated to 9% overall with double digit gains for snacks, small planet foods, Yoplait and baking products. And we see several fundamental reasons for this good growth. First of all, we participate in growing categories.

The chart on slide 22 shows category growth in measured channels for our latest quarter. And not every category is up, but most of our categories are showing strong take away demand. Combined retail sales for our key categories which represent more than 95% of our business grew 3% in the quarter and this is in measured channels only. As you know, overall sales growth is stronger when you factor in non measured outlets. Sales for our brands are growing with or faster than our categories.

For the most recent quarter, our share is flat or up across our major categories and up slightly overall. Our fruit snack share is up 5 points, grain snacks share is up 4 points with the continuing growth of Nature Valley and the introduction of Fiber One bars. We also posted good share gains in soup, deserts and dinner mixes in the latest quarter. And our products offer consumers high quality at a good value.

As you know, we’ve raised prices over the last nine months in most of our businesses to partially offset higher input costs. Slide 24 shows the current national average non promoted or based price per unit for an assortment of our brands and the corresponding price per serving. Our leading brands are great tasting and they are affordable choices for today’s families. Successful innovation is driving growth on our brands. For example, slide 25 lists the top 20 items ranked by retail dollar sales in the ready to serve soup category for the past nine months. 11 of those top 20 soups are Progresso varieties.

The five light soups we launched last July were a great addition to our line and in fact two of those light soups are already in the top 20 and I believe that those are highlighted in yellow on that slide. All five of our light soups would make the top 25 and all five are among the fastest 16 turning items in the category and that is if you just look at turns per point of distribution. Our strong weight management and health news is driving double digit growth for Progresso again this year. Health news is also helping to drive strong growth in our Yoplait business. We’re helping to lead category growth with innovative weight management advertising and new product introductions.

These new products include Yo-plus which contains fiber and probiotic cultures and our new Fiber One yogurt which we launched in January. Retail sales are up 14% in the latest three months. Slide 27 shows the retail sales trend for Big G Cereals in channels where we have data. Here again our consumer movement has been accelerated with consumer take away up 5% in the latest month. Non-promoted or baseline sales are accelerating as well and were up 4% in February. We’re prioritizing our core brands and driving growth through increased investments and focus.

A great example of this focus is our Cheerios business. As you know, Cheerios is the number one ready to eat cereal franchise, representing 12% of category sales. Yellow box, Honey Nut and Multi-Grain Cheerios are all seeing strong sales increases. And our newest item, Out Clusters Cheerios Crunch is off to a great start. Combined retail dollar sales for all Cheerios varieties are up 5% year to date in channels where we have data and baseline volume is the key driver of this growth and is up 5% through nine months. We are also seeing good growth on other cereal brands we prioritized this year.

Cinnamon Toast Crunch is up 16%, Lucky Charms is up 10%, the Fiber One franchise is up 40% due in part to some great new varieties and other new cereals, including Chocolate Chex and a new variety of Cascadian Farms organic cereal or adding good incremental volume. Like Cheerios, these brands are growing in the right way through increases in non promoted baseline volume. So our US retail businesses are delivering strong results. We’re in growing categories. We offer consumers high quality products for a good value and we’re innovating and increasing investments in our brands to drive baseline growth.

Shifting now to bakeries and food service, this business segment has been affected to a greater degree by higher input costs. We have increased productivity and we’ve taken three pricing actions to counter this input cost pressure. These price increases have resulted in modest volume declines but a 6% increase in net sales through the first nine months of this year. Segment operating profit for bakeries and food service was up 16% year to date reflecting profits from grain merchandizing activities along with the higher selling prices on our product lines.

As I shared with you at CAGNY, a large portion of our business is in food service channels that don’t demonstrate the kind of cyclicality you may think of with restaurants. Examples include K-12 schools, colleges, hospitals and lodging chains. In fact, these food service channels are quite resilient. Slide 32 shows you the five year compound growth rate for these food service segments along with their growth in 2007 and projections for 2008. Of all these segments, only business and industry is projected to show a sales decline this calendar year. The rest of these channels are projected to show continued good growth.

So we see our bakeries and food service business on track to deliver good sales and earnings growth this year. We continue to focus on driving positive sales and profit mix by prioritizing the best industry segments and customers. Reported earnings for bakeries and food service will include strong profits from grain merchandizing this year which will make for a challenging comparison in 2009. Nevertheless we feel good about our business strategies and the long term growth prospects for this segment.

International continues to be our fastest growing segment. Year to date sales are up 20% reflecting gains across all geographic regions where we compete and segment operating profit grew even faster, up 30%. Slide 35 shows year to date sales growth by region. Excluding the impact of foreign currency exchange, Canada’s net sales are up 1% year to date. Sales are up 10% in Europe. Our Asia Pacific business is up 15% and net sales in Latin American and South Africa grew 35%. Foreign exchange contributed an additional 9 points of growth, bringing the international segment’s reported net sales growth to 20% for the first nine months.

This growth was driven by good performance on our core brands. In Canada, brand building investments on Multi-Grain Cheerios and the launch of Sweet and Salty Nature Valley bars drove growth on these priority brands. In Europe, Green Giant, Betty Crocker mixes and Nature Valley bars are selling well, particularly in the UK. In the Asia Pacific region, a strong Haagen-Dazs moon cake season and Wanchai Ferry growth are driving double digit sales increases in China. And in Latin America, sales increased 35% with good growth by Diablitos in Venezuela and Nature Valley bars which we launched in Latin America last March.

The cereal partners worldwide are 50/50 joint venture with Nestle continues to achieve sales and profit growth in cereal markets outside North America. Slide 37 shows our top ten markets ranked by tonnage. As you can see, we have leading share positions in these markets. So the global cereal business remains a strong growth engine for us. Across our worldwide food business, we’ve been steadily increasing our brand building investment and improving the effectiveness of our advertising. We now expect to increase our consumer marketing investments at a double digit rate in 2008, positioning us for continuing growth next year.

So to close this morning, let me give you a few preliminary thoughts about 2009 which is shaping up to be another good year for General Mills. We expect to achieve continued good top line growth in our fiscal year 2009. We’re targeting a mid single digit increase in net sales, somewhat above our long term growth model and we’ll share more details on our 09 growth outlook with you in June. We’re actively planning for another year of rising input costs and we have a pipeline of holistic margin management projects identified to help counter this cost pressure.

We will benefit next year from a 53rd week and we expect to reinvest that incremental contribution in business building initiatives both domestically and internationally. In total, we expect another year of continued good earnings growth consistent with our long term growth model. So that concludes our prepared remarks this morning and with that I’ll ask the operator to open the line for questions.

Question-and-Answer Session

Operator

(Operator instructions). And our first question comes from the line of Chris Growe with Stifel Nicolaus, please proceed with your question.

Chris Growe – Stifel Nicolaus & Company

Thank you, good morning. Nice quarter, I just had two questions for you. The first one is of course in your implied earnings growth as you kept your full year guidance the same, it seems like a pretty strong increase in marketing in the fourth quarter and as I was looking year over year you do have, you had a lot of charges in the fourth quarter of a year ago, so I just wanted to be clear on how to look at the fourth quarter, is it going to be just a significant increase in marketing or maybe there are more restructuring charges you want to bring through in the upcoming quarter.

Ken Powell

Chris, this is Ken, I think there are three things to remember about, keep in mind about the fourth quarter. First of all, we expect our sales will be strong but they won’t be double digit strong in the way that they were in the third quarter so we expect good solid sales growth but more in line with what you’ve seen you know as an average rate of growth over the last few quarters, so sales will moderate somewhat.

We do plan to increase investment in marketing at a good level in the fourth quarter, both to drive sales and also to help us continue momentum as we go into the next year. And also, finally the fourth quarter is the time when we really will face the highest input costs that we will see this year. And this is the time of the year when we start to move on to new contracts and we’ve seen costs edge up over the course of the year and the fourth quarter will be the highest cost quarter for us. So keep those three things in mind.

Don Mulligan

Chris, this is Don, the only thing I would add to that is that if you look at our full year tax expense guidance, you’ll see the fourth quarter is coming up from our year to date of our Q3 rates so we will have an adverse tax rate verse last year when we actually had quite a favorable rate because of some discreet adjustments in the quarter.

Chris Growe – Stifel Nicolaus & Company

But it doesn’t plan any big charges or anything coming through in the fourth quarter from a restructuring standpoint, correct?

Don Mulligan

No, that’s correct. Our full year guidance for restructuring is up a touch because of the $3 million that we put through this quarter related to the bakery and food service restructuring projects but that’s the only adjustment to our guidance in that area.

Chris Growe – Stifel Nicolaus & Company

Okay and I just wanted to ask a final question if I could on the US retail division and there was less pricing sequentially quarter to quarter, was that in say promotion or was there something unique that worked against the overall price and mix realization in the quarter?

Ken Powell

Not really Chris I mean we’ve taken I think as you know pricing on now across many if not most of our businesses. We’re realizing that as we go through the year. We did have very strong tonnage growth in the quarter but you know which was good. I think what I focus on is the nine month cumulative, I think we’ve got 3% of volume growth, 2% increase from realized from sales and 2% from mix. And you know the quarter to quarter can be somewhat lumpy and I think I’d focus on that nine month trend as a more accurate indicator of where we’re at. We feel good about the pricing that we’re realizing and is coming through as planned.

Chris Growe – Stifel Nicolaus & Company

Okay, thank you.

Operator

And our next question comes from the line of Andrew Lazar with Lehman Brothers, please proceed with your question.

Andrew Lazar – Lehman Brothers

Good morning. Just two quick things, one you talked about the volume uptick in the quarter and obviously is shows through very clearly, particularly in US retail, I’m curious how much of that you think is attributable to maybe it’s selling ahead of price increases which I realize would be an industry wide phenomenon but it just seems that kind of an uptick in volume particularly as you’re trying to get more pricing through and we do see pricing coming through at least in the scanner data, it just looked odd to me.

Ken Powell

Yeah, Andrew if you look at the nine month data for US retail, our sales compared to consumer take away, they’re really quite close, I think our sales for this year to date 6% and our consumer take away as we can measure it in the channels that we track and retail link is between 5-6%, so you know year to date they’re tracking quite closely. I think what I would, the point I would make on tonnage, Andrew, particularly quarter to quarter I mean, there’s a mix element here that you have to watch out for.

We’ve got businesses where you know the density of the prospect is pretty low. In the cereal business but we’re also in the flour business and the canned vegetable business and you know we had a not quite as good a quarter in veg and flour in the second quarter and that probably depressed our tonnage a little bit. Those businesses were stronger this quarter and they drive mix. So you know tonnage is what it says it is. It’s pounds and it’s sort of a lumpy measure for us and I’d focus on the nine month data where we’re 3% on tons and good retail take away, I think I’d look at that.

Andrew Lazar – Lehman Brothers

Okay and you’re measuring volume in tonnage this year and that is different I think than last year if I’m not mistaken, was it units last year?

Ken Powell

Right. That’s why Andrew we try to point out or helpful details on the unit sales. For instance, as you know our tonnage in cereal is down a little bit this year because of right size, right price, I think it’s down 3-4%. But our unit sales in cereal which I think is the most key and relevant measure is actually up 5% through the first nine months of the year.

Andrew Lazar – Lehman Brothers

Got it, okay. And then the last thing is, this fiscal year it seemed like your productivity and you’ve talked about the holistic margin has ramped up to perhaps cover more than half if not much more than half of the incremental input cost inflation that you’re seeing and you talked a little bit about the pipeline or you mentioned it.

Can you talk about your visibility into the cost save pipeline going forward and I guess is this magnitude of savings the type of level you think you can deliver incrementally next fiscal year because obviously the worry is you know input costs are clearly not going down and maybe they’ll continue to go up and as you roll over some contracts and things, that becomes more onerous next year, putting more pressure on price and productivity.

Ken Powell

Yeah, well first thing I’d want to say Andrew is we are, this productivity focus that we have is proving tremendously helpful to us, we have good momentum there right now. You said covering much more than half which I don’t think that’s correct, I think if you thought of it as covering perhaps a half, in that neighborhood, that would be closer, but that’s very, very significant and it allows us to manage prices as best we can. So it’s about covering about half.

We are expecting more inflation although we really don’t know exactly what the magnitude will be yet. We also, we do have very good visibility on our productivity pipeline going forward. I think you know as I’ve said to you before, this is a strategic activity for us, this focus on margin. We meet with our division leaders several times a year to review what they’re doing here.

We look at a three year pipeline of ideas and initiatives and I will tell you that over the last several years that pipeline has gotten stronger as the divisions have gotten more deeply into this holistic margin management exercise. So we feel very, very good about our ability to continue to with this strong productivity momentum that we’ve had.

Don Mulligan

Andrew, this is Don, I’d just add one more aspect to that as we think about our gross margin and that is the mix component as well. We separate that out on the top line impact but the bottom line impact is equally if not more meaningful. It’s the advantage of us having a broad product portfolio and changing the way, you know everything from the way we think about it internally to actually manage our sales force from an incentive standpoint to put more weight on the profitability on the product we’re selling and not just sort of the volume itself.

And we’ve combined that with much more stringent new product guidelines that are focusing us on launching margin accretive products at a much higher rate, much more highly incremental but also much more highly margin accretive products than we have. And that continues to improve so I think that factor as well has a very material impact on our gross margins.

Andrew Lazar – Lehman Brothers

Okay, thanks very much.

Operator

And our next question comes from the line of Eric Serotta with Merrill Lynch, please proceed with your question.

Eric Serotta – Merrill Lynch

Good morning, just to follow up on Andrew’s question in terms of the pre-buy ahead of price increases. Were there any specific price increases that are going in around now or early this quarter that there might have been pre-buy ahead of or you know do you think that it, I know that you didn’t point to much pre-buy overall but do you think that there could have just been general anticipation of price increases given the commodity environment?

Ken Powell

There were no price increases Eric at the end of the quarter that would have caused that. You know the one thing that I might point to here is one of the very strong features of our third quarter was that we had a very good baking season and by that I mean both our Pillsbury division and our Betty Crocker baking divisions were very, very strong and they were strong throughout the quarter.

As you know, this is the time of year when consumers are entertaining and holiday baking and that sort of thing so that we thought they’d do well and they did better than we thought. I think it’s possible that because Easter timing was a few weeks earlier, we got a little bit of a kick there but I don’t think it’s, I mean I don’t really think it’s overly significant. As I said they were strong throughout the quarter and we’re starting off March very solidly. So, there may have been a little bit of benefit from the earlier Easter.

Eric Serotta – Merrill Lynch

Okay and then shifting to Big G, through the fiscal first half it seemed that your shipments were a little bit stronger than we had anticipated, particularly in the second quarter after the very strong first quarter. You had a what looks like a very good shipment quarter as well as consumer take away quarter in the fiscal third quarter. Just wondering whether you could comment on customer inventory levels and you know how this is all washed out after nine months, how you feel about inventory levels and the overall success of right size, right price.

Ken Powell

Well, I mean, Eric we feel really, really good about right size, right price. It’s fully behind us now. We have you know we have established the new retail prices. We’ve monitored those, those have been very, very stable. We’re seeing very good improvements in baseline sales over the course of the year in line with what we predicted. We’re seeing good consumer initiatives across the cereal business.

We’ve tried to show you how strong our Cheerios franchise is but also we have our major kid brands are growing strongly now. You know as are several of our adult brands. So we feel that right size, right price has been very successful for us, it did just what we wanted it to do and thought it would do and we see good momentum continuing in our cereal business. We’re going to have a good year on cereal.

Eric Serotta – Merrill Lynch

And in terms of customer inventories, are they at, are you comfortable with customer inventory levels, are they a little on the high side still?

Ken Powell

We’re very comfortable with the inventories there.

Eric Serotta – Merrill Lynch

Great, well thanks a lot, great quarter guys.

Operator

And our next question comes from the line of Jonathan Feeney with Wachovia, please proceed with your question.

Jonathan Feeney – Wachovia Capital Markets

Good morning, thank you. Wanted to dig in a little bit more on, a lot of talk about trading down out there. Could you comment on, particularly in Big G but you know just across your portfolio on price gaps relative to private label and you know do you have those gaps generally narrowed or widened in the most recent round of price increases and what affect that’s sort of having on your pretty strong volumes here?

Ken Powell

Hi Jonathan, you know we’re very closely monitoring that. We know that you’re interested in it and we’re looking at it and I think at CAGNY a few months ago we reported to you that the private label share, aggregate share for our categories, so this isn’t for the whole industry but just for our categories, but we’re in a lot of categories, but the private label share was flat year to date for our categories and we’ve updated that and

I’ll tell you it’s again flat. It hasn’t moved at all. So we’re not seeing in our categories the private label competitors gain share, they’re absolutely flat, I mean if anything they’re down just slightly. So it doesn’t look like we’re seeing trade down in our categories. You know we do monitor how our pricing is passed through and how their pricing is passed through and we have noticed that the price increases for our private label competitors have tended to be bigger on a percentage basis than ours have been and I think that reflects the margin structure and the scale of those competitors, they need to take more to cover cost increases. And so we’re seeing perhaps a little bit of a narrowing of the price gap. I wouldn’t say it’s dramatic yet but if anything it’s narrowing.

Jonathan Feeney – Wachovia Capital Markets

Thanks and just one follow up. How about percent, rough percent of sort of volume or dollars bought on deal, bought on, you know at merchant, some sort of special across your portfolio, have you seen any uptick or unusual gyration in that data?

Ken Powell

Not really, I mean that’s been pretty stable and I think as we’ve told you before, for our cereal business in fact we expect our merchandising spend on that business to be down a little bit for the year.

Jonathan Feeney – Wachovia Capital Markets

But that’s mainly really it’s your right size.

Ken Powell

Yeah, we haven’t changed any merchandizing price points or done anything like that. It’s been pretty stable.

Jonathan Feeney – Wachovia Capital Markets

Okay, thanks very much.

Operator

And our next question comes from the line of Terry Bivens with Bear Stearns, please proceed with your question.

Terry Bivens – Bear Stearns

Hey, good morning everyone. I have a couple of things, going back to the volume, you know traditionally General Mills productivity has been driven by volume and I guess one of the impact of right size, right price would be for a period of time your pound volume would probably be reduced but your price per pound up. So I’m just wondering how this shakes out as we go forward given the importance of Big G to the US retail division, do you see pound volume now as a source of productivity for the cereal line as well as the division? How should we look at that?

Ken Powell

I don’t know if you will recall this Terry because it was kind of an inside baseball look at right size, right price, but as part of that right size, right price exercise which involved changing the size and shape of all of our cereal boxes, we also were able as part of that exercise to kind of revise you know and improve the way the cereal boxes go through the manufacturing line, the way the cases work, the way they fit on pallets and all of this sort of thing. And so you know there’s actually going to be a quite significant productivity gain in the cereal business from moving to those revised right size, right price package configurations.

So those sort of productivity opportunities which were inherent in right size, right price coupled with the fact that our unit sales are up quite nicely this year and it’s really units that we make in our factories is we see many opportunities for driving productivity in the cereal business going forward. I would say we’ve increased you know the size of that pot significantly over the last year and a half as we’ve focused on it. So we’re going to see continued productivity growth in that cereal business, part of it because of the more efficient right size, right price box sizes.

Terry Bivens – Bear Stearns

Okay and just a question on innovation. We hear Kellogg is gearing up to launch several new products this summer, including a new line that may go after Toaster Strudels. We were also looking at some data that suggests that curves may not be doing as well as you’d like, so can you kind of address the innovation effort. Should we look for kind of an on trend innovation effort as we move into fiscal 09? Will it be geared up? How should we look at that as well?

Ken Powell

Well Terry, first of all I’d tell you that this year we think our innovation has been very, very strong. Oat Clusters Crunch Cheerios has been one of the strongest new cereals in the market and then as you go across our portfolio we’ve had a spectacular success with Fiber One bars, we’ve had a great success with light soup. You know we’ve just launched Fiber One yogurt and we’re very optimistic about that.

Yo-Plus yogurt continues to develop well and gain trial has very strong repeat and gaining trial and that brand is now over a share point in the yogurt category. So we feel quite pleased with the innovation and the new products that we launched this year and we are preparing our new launches for the first quarter of next year and I will tell you that we’re very happy with how that’s coming together. We think it’s going to be another good year of highly incremental innovation. We’ll tell you more about that in June but I’ll tell you we’re very focused on continuing keeping that pipeline of innovation going.

Terry Bivens – Bear Stearns

Okay, thank you very much.

Don Mulligan

What I would add to that is I think one of the things that’s really helped up perform this year is the fact that we’ve had really good new product innovation in the marketplace combined with our higher consumer investment to support those new products and while we’ve spent a lot of time over the last few months talking about inflation and how we’re acting to counter that, I think the basic blocking and tackling of the business of new products and increased consumer investment is really what’s driving us and will continue to drive us in 2009. So to Ken’s point, that has continued to be an area of focus for us and we’ll share the specifics when we get together in June.

Terry Bivens – Bear Stearns

Okay, thanks again.

Operator

And our next question comes from the line of Ken Zaslow with BMO Capital Markets, please proceed with your question.

Ken Zaslow – BMO Capital Markets

Hey, good morning everyone. Just turning to a different business sector, the general bakery margins exceeded our expectations and I was just kind of looking at what do you think the key factors were, I’m assuming they exceeded your expectations as well. What do you think the key factors were and do you think this type of margin structure is more sustainable even in the face of higher wheat prices?

Kris Wenker

Ken, can I just clarify, are you asking about bakeries and food service?

Ken Zaslow – BMO Capital Markets

Yes.

Ken Powell

Well a factor you know an important factor in their performance this year as we’ve said has been you know the benefits that they’ve gained from our General Mills grain merchandizing operations and I think as you may know General Mills literally since the company was listed in 1928 and before then, the name of the company is General Mills and so we have grain elevators, we have grain mills, we buy grain, we store it, we process it, we have assets and we have expertise in acquiring and taking positions in grain and managing our, and we manage our costs that way.

Much of those, and we concentrate that effort in two areas, wheat and oats which are the two primary grains that we use in the business. And much of the benefit and the gain from that operation which you know creates value for General Mills year in and year out. You know much of that benefit goes to the bakery and food service division because they’re using a lot of flour and we sell a lot of bakery flour to everybody from Wal-Mart to other grocery stores and up and down the street. So a large part of their gain this quarter was their benefit from that operation.

Ken Zaslow – BMO Capital Markets

Okay, great, thank you.

Don Mulligan

And Ken, just to your point on margins, you know the unusual run up in grain prices benefited that operation in this quarter and year to date, so we have seen some margin expansion beyond where we would have otherwise. But as we look at the underlying business, we still see stable margins and we still have confidence in the strategy that we’re undertaking to move more to branded, to move more to the higher margin, higher growth opportunity segments is playing out. It’s being challenged this year because of the high inflation that we’re seeing across the board but we are confident that we’ll still be able to protect our margins this year and grow them in the future.

Ken Zaslow – BMO Capital Markets

I guess the only thing I was trying to get at is exactly that, when you get the pricing power that you got in this division seems to be higher than I would have thought and it seems to have kind of funneled through to the margin level so I understand that there’s this grain gain that you were enjoying during this quarter but it seems like again that some of the margin structure in this business is a little more stable than I guess I would have originally thought given that the pricing power seems to be more there, that’s all I was trying to get at.

Ken Powell

And that’s a good insight because we are, as we demonstrated or showed at CAGNY we are very pleased with the categories that we play in. We’re very pleased with the margin performance that we’re seeing, [unintelligible] we want to be long term as we’ve said but we’re moving in the right direction and certainly if you look at our performance verse most of our competitors the strength of our strategy is playing out in the financial results.

Ken Zaslow – BMO Capital Markets

And your ability to actually get the access to the wheat, even if there is a shortage again because you have the milling side of it, there’s no inability for you to actually supply your operations, is that fair?

Ken Powell

That’s correct, we purchase more wheat and oats than we use and part of what we earn in that, that gives us two advantages, one we get to sort for the highest quality but second we also have some additional excess inventory that we can sell into the market. So we have no issues with supply and again an advantage as [unintelligible] quality and a pricing standpoint.

Don Mulligan

And also Ken just remember in terms of you’re talking about our pricing power we have I mean obviously we’re taking multiple price advances but so is the market and so are our competitors and so we’re moving aggressively in a general market that’s also moving.

Ken Zaslow – BMO Capital Markets

Great, I appreciate it.

Operator

And our next question comes from the line of Todd Duvick with Banc of America Securities, please proceed with your question.

Todd Duvick – Banc of America Securities

Thank you, good morning. I wanted to ask a balance sheet question or two. You’ve got a $1.15 billion convertible note that is maturing in 2037 and I think you said in your 10K that you expect that to be put to you next month. Is this still the case and if so what refinancing plans do you have for that?

Don Mulligan

Todd we do expect it to be put to us, it’s not in our hands, it’s in the holder’s hands to decide that, but we do expect just based on the economics of the bond to actually be put back to us in the middle of next month. Our plans are to refinance it in the near term with commercial paper. As you may be aware we did a $750 million seven year note last week to free up the capacity at our commercial paper to accommodate the fact that that’s going to be put back to us.

Todd Duvick – Banc of America Securities

Okay, alright and then I guess with respect to the balance sheet, I think you made earlier commitments, earlier in the fiscal year that your combination of debt and minority interest at the end of the fiscal year which is going to be May is going to be at or below year ago levels and I wanted to know if you could clarify if you remaining on a net debt and minority interest or just total debt and minority interest and if that means you’re going to be paying down some additional debt in the next fiscal quarter?

Don Mulligan

Well it was on our gap debt plus minority interest basis. We are actually not projected to see that increase slightly at year end and that’s directly driven by the fact that in January when the equity markets declined, we took the opportunity to go in and repurchase what we think are some very undervalued General Mills shares as we noted in our release. That is going to put some pressure on our debt line at the end of the year. We do expect to pay down something a bit form where we are at the end of Q3 to year end but we are now projecting that at the end of the year our combined gap debt and minority interest balance will be above last year.

Todd Duvick – Banc of America Securities

Okay and then just one final question. I guess with respect to your debt balance overall, are you fairly comfortable with the overall debt balance and are you also comfortable with the mix between the short term and the long term?

Don Mulligan

Yes we are on both. You know our commitment is that we are focusing not so much on the dollar balance as in the metrics, our coverage ratios for example and given the improve performance, financial results beyond our original plan, that gives us a little bit of flexibility on that debt line while maintaining our liquidity and financial metrics. You know we did have proactive discussions with the rating agencies [unintelligible] with the market in January just to make sure that they were clear on our intent and what our projections are and they were comfortable with that. And that’s important to us because we are very committed to maintaining our triple B plus credit rating and we keep that always in mind whenever we make any of our financing plans.

Todd Duvick – Banc of America Securities

Okay, very good, thank you.

Operator

And our next question comes from the line of Eric Katzman with Deutsche Bank, please proceed with your question.

Eric Katzman – Deutsche Bank Securities

Hi, good morning everybody. I guess my first question maybe is a follow up on the balance sheet, I’m not exactly clear as to how interest expense is down even though your net debt year over year is up 24% I think, can you kind of walk me through that?

Don Mulligan

Yes it’s a combination of two things Eric, the primary driver is the fact that because we very actively used commercial paper, we have been the beneficiary of the 200 plus basis points drop in our CP rates from last year to this year. Another smaller factor is that we have accumulated some cash offshore and we have some interest income netted against energy expense line this year, it’s a little higher than it was a year ago. But the primary driver is the fact that we’ve been on the front end of the yield curve.

Eric Katzman – Deutsche Bank Securities

I see, so given your responses to Todd and as you look, should we expect interest expense in 09 to be basically flat or down given what you’ve done on the front end of the curve?

Don Mulligan

Well we’re not going to provide guidance on that just yet but as I’ve said we will be going into the year with a higher balance this year than we exited last year and we would expect that balance to grow through next year again as we keep our metrics flat, earnings and cash flow grow and our debt would grow in accordance with that. So that’s going to clearly drive up our interest expense. We will have to see where the markets are as we think about what our commercial paper rates are going to be.

But we would expect that our mix of commercial paper would be roughly consistent with where it has largely been this year, that is we expect to continue to run at a $2-$2.5 billion average balance in our commercial paper but it’ll be a little higher in the front end of the year as we’re building inventory for our key selling seasons and it’ll come off a little bit in the back half as it has typically done.

Eric Katzman – Deutsche Bank Securities

Okay, let me switch, Ken I guess my first question is it seems like the environment has become a little bit more high low than EDLP and historically pre-Pillsbury General Mills was a very strong, had a very strong sales force and culture that was really excelled in the high low environment. I know when you bought Pillsbury you know that added some expertise on the EDLP front with people in Bentonville but do you still think that the sales force culture excels in a high low and does that give you some competitive opportunity?

Ken Powell

Well I mean we have a very, very capable sales force and some of our customers, many of them continue to be high low and pretty aggressive merchandisers, some as you know are EDLP. I mean I would say if anything you know our customers are looking more these days at hybrid versions, some EDLP on certain items coupled with ongoing merchandizing so I would say if anything the trend is towards a little bit more awareness of EDLP opportunities and you know and our guys are very, very comfortable working in both of those kinds of environments.

I mean I would say you know so that’s one part of what we’re trying to do but you know our sales force has you know over the last five years especially I would say, we’re not only bringing merchandising programs and initiatives to these important customers, we’re bringing them all kinds of services and other capabilities, Eric, we’re bringing them know how in consumer insights and marketing in store, helping them work with us to reduce logistic costs and all of these things are really quite important in building that strong partnership with our major customers now and we’re very, very good at all of those things. And I’d say you know as well as operating in the two different kinds of merchandizing environments, EDLP and high low. So I think we’re very, very, we feel very good about our capabilities there.

Eric Katzman – Deutsche Bank Securities

Okay and then just the last follow up. It seems like and I want you to put more of an industry hat on as opposed to a General Mills hat since you have broad exposure, but it seems like a lot of the companies you know we’ve all raised prices but I understand form contacts that the coverage on the price increase for many companies is extending into the summer and I’m wondering, do you think that there’s a risk that we start to see this trade down to private label or demand elasticity hit when the price coverage programs that are out there and in the real kind of hit on the shelf, hit to the family in their wallet.

Kris Wenker

Can I just, because I’m getting a little bit of a puzzled look across the table, Eric what you’re talking about is for some companies when they take a list price increase for a period of time, they’re protecting merchandizing events that they’ve already scheduled with retail and so for a while you’re spending back against that, that’s what he’s asking about is the industry branded guys, that’s part of the mix here.

Eric Katzman – Deutsche Bank Securities

You know, nobody expect there’s one company out there, but basically none of the companies are saying we’re seeing any demand elasticity but then again there’s a lot of price protection going on and I’m kind of wondering what happens when the full price increase goes through this summer, like is that when we see it?

Ken Powell

You know, I wish I could put my industry hat on for you Eric but I’m not sure I can. But what I can tell you is we look at how our own pricing is passing through. We look at that very closely to see if it’s happening, when it’s happening, how it’s happening and what I can tell you is that we’re seeing exactly what we would expect to see across categories where we’ve taken pricing.

I mean there is sometimes a delay but it’s not a long delay and we’re seeing our customers pass through all of the full impact of the pricing. They’re not passing through more than that, but they are passing the full impact through and so we don’t think there’s any sort of lag affect here waiting to hit us, it’s, the pricing that we’ve taken is already, has already appeared at retail and consumers are seeing somewhat higher prices already. Now I don’t, Don, think we’ve looked at it across other categories or maybe we have but we’ve certainly focused on our own.

Don Mulligan

Yeah, we’ve look at our categories and to Ken’s point kind of on a dollar for dollar basis, pricing is translating through, it differs a little by category but on average it’s going through on a dollar for dollar basis which does mean that the retailer is not taking the margin on it but at least passing it through.

And I guess the other comment I’d make is you know to the extent that there is any trade down, there’s more trade in if you will because clearly some of the restaurant chains are seeing an impact in their traffic and that traffic is trading into grocery, so net-net to Ken’s earlier point, we’re not seeing private label pick up any share and if anything the branded guys in certainly in our categories, we’re seeing stronger performance. So the combination of our new products and our consumer advertising consumer marketing investments are allowing us to maintain and grow our share across most of our categories. And helping offset whatever risk of trade down there may be.

Eric Katzman – Deutsche Bank Securities

Okay, thank you.

Operator

And our next question comes from the line of David Driscoll with Citi Investment Research, please proceed with your question.

David Driscoll – Citi Investment Research

Thanks a lot, good morning everyone. Don I wanted to start off with the commodity hedging gains. There was $0.30 I think so far for the year or thereabouts, can you just describe to me. These gains are gains that will ultimately be something that would apply to future periods. So its hedges that you’ve put into place for future quarters which is why you guys are kind of backing it out and looking at sort of the core operations for the quarter. Conceptually am I right on that statement?

Don Mulligan

Yeah, that’s exactly right. They are gains on our open hedge positions as of the end of the quarter and this is based on the new accounting treatment that we implemented at the beginning of this fiscal year for positions taken in this fiscal year and we mark to market based on our coverage, open hedge positions based on market price at the end of the quarter. We also mark to market our grain inventories and that’s been our historical accounting, so that’s not new, it’s just it’s usually immaterial but with the recent run up its become more material so we wanted to segregate that piece out as well. Both of those, to your point are future, they will settle in the future and they’ll impact our results at that time period.

A couple of important things to note is that these gains are not in our operating profit, so these hedges and inventory gains will move to operating profit when the commodity is used and the contract settles. So the operating profit matches with the coverage so there you get a clean line of sight on our margins. It’s also as we’ve segregated out in the slide, we’ve segregated the gross margin impact for that same reason is to give you a line of sight on the underlying performance. So that is the commodity gain in a nutshell, it is for future positions to be closed in the future.

David Driscoll – Citi Investment Research

And those positions would go out how far approximately, the next three quarters?

Don Mulligan

Well they will go out as we said at CAGNY about the end of the calendar year, cover through the end of the calendar year roughly.

Kris Wenker

And it’s going to vary by commodity.

Don Mulligan

By category. So some of that will reverse in the fourth quarter and that’s why we signal a $0.30 for the full year as opposed to where we are at a year to date basis. So a portion of it will settle in the fourth quarter.

David Driscoll – Citi Investment Research

My second question is that in the quarter it appears that you had a $14 million gain on the sale of an asset in the joint venture line and then also a $1.7 million gain from the sale of your 8 Continent, that amounts to about $0.05 a share, is that $0.05 a share included in your $3.45-$3.47 estimate?

Don Mulligan

Yes it is and that we had a net gain in CPW joint venture of $11 million for the restructuring activity this quarter which includes the gain on the piece of property that you mentioned and the $1.7 on 8 Continent. So both of those are in our numbers in the quarter and our underlying projections, guidance for the year.

David Driscoll – Citi Investment Research

Great, thanks a lot everyone.

Kris Wenker

And operator I’m going to cut in, we’re kind of at the end of our hour, let’s take one more and then I apologize to anyone who’s still in queue, please call me afterwards.

Operator

Perfect then the next question comes from the line of Vincent Andrews with Morgan Stanley, please proceed with your question.

Vincent Andrews – Morgan Stanley

I’ll just ask one quick one then. In terms of the grain merchandizing as it relates to bakeries and food service, does that factor into the 2% nine month volume decline? Or how should I think about that?

Ken Powell

It’s all capture Vincent in our cogs line. So what [overlay] externally is in the sales line, not necessarily what we mill and transfer internally.

Vincent Andrews – Morgan Stanley

So then the answer is that that 2% volume decline has nothing to do with the grain merchandizing?

Ken Powell

Correct, that’s right.

Vincent Andrews – Morgan Stanley

Okay, thank you very much.

Kris Wenker

Thank you everybody, if you have follow up questions please give me a shout.

Operator

Ladies and gentlemen that does conclude the conference call for today, we thank you for your participation and ask you to please disconnect your lines.

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Source: General Mills, Inc. F3Q08 (Qtr End 02/24/08) Earnings Call Transcript
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