通用磨坊 (GIS) 2006 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the General Mills first quarter 2006 results conference call.

During the presentation, all participants will be in a listen-only mode.

Afterwards we will conduct a question-and-answer session. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded Thursday, September 22nd, 2005.

I would now like to turn the conference over to Kris Wenker, Vice President, Investor Relations of General Mills.

Please go ahead, ma'am.

Thanks, Judith.

Good morning, everybody.

I'm here with Steve Sanger and Jim Lawrence.

Before they begin their remarks, I need to remind you that this conference call will include forward-looking statements that are based on management's current views and assumptions.

We have posted some slides on our website that supplement our remarks today and the second slide in that packet lists factors that could cause our future results to be different than our current estimates.

The press release that we issued earlier this morning is also posted on the web if you need a copy.

And with that I will turn you over to Steve.

Thanks, Kris, and hello everybody.

Thanks for joining us on the call this morning.

I'm pleased to report that fiscal 2006 is off to a good start.

Net sales for the quarter grew 3%, consistent with our goal of low single-digit growth on the top line.

Segment operating profits grew 21% overall to reach $500 million.

This strong performance by our operating divisions drove a 38% increase in after-tax earnings, and our net diluted earnings per share improved from $0.45 last year to $0.64 this quarter.

That's a gain of 42%.

These are our GAAP results and so they include the effect of contingent convertible accounting, which reduced this year's first quarter EPS by $0.04 and lowered year-ago results by $0.02.

Our sales performance in the first quarter reflected a combination of modest volume growth, 1% overall, and net price realization in each of our three business segments.

For U.S. retail, net sales grew 2% and unit volume matched year-ago levels, which were up a strong 4%.

International net sales grew 11%, with unit volume up 7% and foreign exchange contributing three points of that growth.

Net sales for bakeries and food service segments were down 1%, but sales were ahead of volumes, and profits for this business were up nicely.

In fact, all three of our business segments recorded solid double-digit growth in profits for the quarter.

For U.S. retail, the gain was 15%; international operating profits rose more than 60%; and bakeries and food service profits grew more than 40%.

With the exception of international, these gains are against weak performance last year, when significant increases in supply chain costs and promotional spending reduced our profits.

However, we were more -- we more than recovered the ground given up last year and profit results for all three segments are also above first quarter results for 2004.

In fact, the two-year average growth in our total operating profit is 5%, which is right in line with our mid single-digit ongoing objective.

Below the operating profit line we had some pluses and some minuses, but the net was positive.

On the plus side, our restructuring expenses were down year-over-year.

Interest expense was lower.

And average shares outstanding were lower due to last fall's share repurchase from Diageo, and open market repurchases during the quarter.

The minuses are all things we discussed back in June.

Higher unallocated corporate expense, higher tax rate, and reduced after-tax earnings from joint ventures because we know longer have the earnings contribution of snack ventures, Europe.

At the bottom line, it all adds up to a solid beginning for the year for us, and it keeps us on track to meet the 2006 guidance we provided back in June.

We continue to target low single-digit growth in net sales and mid single-digit growth in segment operating profits.

Our guidance for diluted EPS is a range of $2.78 to $2.83 per share, which includes an estimated $0.07 impact from contingent convertible accounting.

At this point I'm going to turn the call over to Jim, who will give you some more detail on our first quarter results.

Jim?

Thank you, Steve, and good morning, everyone.

Let's start at the top of the income statement, where you see our net sales growth of 3% overall.

And that 3% reflects one point of growth from unit volume and two points from pricing and mix.

Currency and promotional spending were both neutral factors in the quarter.

As noted in the press release, sales for our largest business segment, U.S. retail, grew 2% overall.

If you have our slides on the webcast, you'll see that slide 9 from the website gives you the detailed net sales and unit volume trends for our six biggest U.S.

Retail divisions.

In the Big G, strong net price realization offset a 6% volume decline, so overall sales were flat.

Our meals division, snacks, and Yoplait, all posted net sales growth for the period.

Net sales for the Pillsbury division and baking products were essentially flat to last year, but that was good performance against very strong gains a year ago.

Moving down the income statement, cost of sales was lower on an absolute dollar basis for the quarter, and, of course, lower as a percent of sales by 270 basis points.

Now, this performance reflects two primary factors: First, raw material costs in total were relatively stable, year-over-year.

Please remember that last year the first quarter showed our worst year-over-year inflation.

And second, our manufacturing systems performance was excellent in the quarter, which reflected favorable production mix and productivity savings.

I should add that our fuel expenses were up year-over-year in the quarter, but they were not above the plan that we had at the beginning of the year, and, in fact, we had the first quarter for fuel expenses fully covered at our planned rate.

SG&A was up as a percent of sales in the first quarter by 50 basis points and that was primarily due to higher freight charges for customer delivery and those we record -- we record that portion of shipping in SG&A.

As Steve mentioned earlier, if you flip over to the operating segment schedule, you'll see that our operating profit margin improved by 280 basis points to be 18.8% of sales in this quarter just past.

There are a couple of other items to note on the segment schedule.

You'll see this on slide 11.

You can see that restructuring and other exit costs in the quarter totaled $9 million pretax, and that's well below last year's cost of $40 million in the period.

Unallocated corporate expense was $37 million for the period, up from 20 million last year.

As we noted in our press release, the primary factors here are higher employee benefit costs, which we discussed with you back in June, and also a $10 million write-down of a low-income housing investment that we had made some 15 years ago to reflect the current value of that investment.

Our increased corporate expense was offset by a reduction in interest, and that primarily is the result of last year's debt pay-down and also the maturation of various interest rate swaps.

As you have seen from the release, we did make significant share repurchases in the open market during the quarter.

In total, we bought back 15.9 million shares, at an average price of just under $47.00 apiece. 4 million of those shares were purchased late in the quarter, in a secondary offering by Lehman Brothers, that I know many of you are aware of.

That transaction essentially represented the market distribution of Diageo's remaining stake in General Mills.

Our share repurchases during the quarter contributed only about a penny of our EPS growth.

Once you factor in the timing of those purchases, you get the weighted average share count.

But the number of basic shares outstanding at quarter end was 355 million, down more than 3.5% from the start of the fiscal year, and more than 6% below the balance at the end of August one year ago.

And that is because we repurchased shares from Diageo last October as well.

So in total, the average diluted share balance for the first quarter is down 3% to 402.

That number includes the 29 million shares we're required to add under CoCo accounting.

But as you saw in the put option notice that we issued last week, we intend to settle our CoCo bonds in cash, not shares.

Therefore, if you exclude the CoCo impact, our average diluted shares were down to 373 million, and first quarter EPS, when you exclude the $0.04 impact from the CoCos, would total $0.28.

Beginning this quarter -- sorry.

Apologies: $0.68.

Beginning this quarter, we're including the cash flow statement with our earnings releases.

And we have that as slide 14 on the webcast.

You will note that cash from operating activities is up sharply, to 138 million.

Capital expenditures were lower in the period and totaled 45 million.

Dividend expense rose to 123 million, as the recent 6% increase in the quarterly rate was partially offset by our share repurchases.

And you will also see that the cash used for share buybacks recorded under the financing activities.

Core working capital was fairly flat overall this quarter, with seasonal increases in accounts receivable and inventories largely offset by increased payables for the quarter.

So to summarize our first quarter financials results, we feel that we've made a very solid start to the year, but the comparison in the first quarter was not a difficult one for us.

As we look ahead to the second quarter, we see a more challenging comparison.

First of all, last year's second quarter was quite a good one.

Net sales were up 4% and our EPS grew 20%.

In addition, we're beginning to feel the pressure of higher fuel costs in the second quarter.

We've covered our needs for this period, but it's at a blended rate that is above the plan assumptions that we had made last spring.

And finally, we know the general operating environment here in the United States is going to be disrupted to some degree by the damage of Hurricane Katrina, and possibly of Rita, I think it's really too early to forecast with any precision what level of disruption that will be or how long it will last, but we and other manufacturers are likely to see higher prices and possibly disruption in delivery schedules for some of our raw materials, at least over the short term.

As we told you today, this has not changed our overall expectation for the year.

But we do think that Katrina will add some costs in our second quarter.

On the positive side, a number of our major businesses have some very good momentum going as we move into the second quarter.

Now I'll turn you back over to Steve.

We'll talk some more about that.

Okay.

Thanks, Jim.

We've talked about the 2% net sales growth for U.S.

Retail in the quarter.

If you're following on the webcast, slide 17 shows our retail take-away trends.

Consumer purchases of our major products also grew, up 1% overall in Nielsen measured channels, including projections for Wal-mart.

Slide 17 shows the consumer sales trends for our major retail businesses.

We had double-digit retail sales growth in our Nature Valley business, Progresso soup, and Yoplait yogurt.

We also saw good retail sales performances from Green Giant frozen vegetables, Totino's hot snacks. and Pillsbury refrigerated dough.

There were some product lines where retail sales were down year-over-year.

However, for both desserts and microwave popcorn, that's a function of very difficult comparisons to a strong growth a year ago.

For Gig G cereals, where retail sales were down 4%, the decline reflects the fact that last year's first quarter market shares were strong, up around 32%.

And this year's share levels reflect the fact that we still have some work left to do in restoring full merchandising support for our brands, which dropped significantly this past spring, when our targeted promotional prices were uncompetitive.

Let me say just a bit more about the progress we're seeing in Big G. I know many of you had a chance to hear Ken Powell's remarks at an industry conference two weeks ago.

Ken outlined our plans for renewing growth in Big G this year.

The three key objectives are: first, to restore fully competitive levels of merchandising activity; second, to increase brand building activity, particularly on our largest cereal equities; and finally, to bring a higher level of new product activity to the cereal aisle.

The adjustments we've made to our merchandising strategies in cereal are bearing fruit.

As slide 19 shows, we've seen sequential improvement in our market shares since April.

In recent weeks, share levels are back roughly in line with our 12-month share.

And we expect our market shares to strengthen further as the year progresses.

We launched seven new cereal items in the first quarter.

They include three new varieties of Total and two of Yogurt Burst Cheerios.

Advertising and other consumer support for these new cereals begins in October, which should contribute to momentum for Big G. Advertising for a number of our established cereal brands is increasing, too.

In total, Big G plans call for a double-digit increase in advertising support this year.

We'll have consumer -- excuse me.

We'll continue to reinforce the whole grain benefits each of our cereals offers to consumers, because we believe this health news is one of the reasons for the cereal category having picked up this calendar year.

Slide 21 shows the category sales, which picked up noticeably this spring and have been running at a rate that we haven't seen for some time.

Pricing is a factor here, too, but pound sales for the cereal category are also running up in recent periods and we're obviously pleased to see that.

We're also pleased to see the continuing strong growth in our yogurt business.

Yoplait's established product lines are doing terrifically well, led by Yoplait Light, which posted 20% growth in first quarter retail sales.

We've also launched a number of promising new yogurt items into the market this summer, including three chocolate varieties and an assortment of new yogurt beverages.

We'll have consumer marketing support behind these new items in the second quarter and right now, as I speak, you'll see pink lids on all of our Yoplait products, as Yoplait conducts their annual fall merchandising event in stores nationwide to raise money for breast cancer research.

In our Meals division, Progresso soup is carrying good momentum into this year's soup season.

Retail sales for Progresso were up 13% in the latest quarter, as this brand continues to post strong baseline sales gains, driven by effective advertising.

Shipments of our new line of soups in microwaveable bowls begin next month.

Account acceptance has been excellent, and we expect this to help Progresso build distribution during soup season this year.

We're also seeing good baseline momentum on our core Hamburger Helper business.

This overall dinner mix category was down in the first quarter, as sales for several recent new product -- new entries in the category declined, but Hamburger Helper, the core brand, is performing very well and picked up five points of market share.

In Refrigerated Dough, we're seeing continued good growth from Pillsbury ready-to-bake cookies.

Baseline sales are up and we've reconfigured our packaging to a vertical format that gives us more facings on the shelf.

The Perfect Portions line we introduced a year ago has brought new users into the section and we've just added three new varieties to that line.

And in the freezer case, Totino's keeps posting good retail sales gains, including a 4% increase for pizza rolls in the latest quarter.

We're bringing some real innovation to the dessert aisle this year, with the launch of Warm Delights.

This is a line of single serving, microwaveable desserts, and it's off to a promising start.

In Snacks, our fastest growing business is Nature Valley, which posted first quarter consumers sales growth of 40%.

We've got a runaway hit on our hands with new Sweet & Salty nut bar varieties.

In fact, we're working quite hard to keep up with demand on that one.

Two new chocolate flavors of Chex Mix that we launched over the summer are also doing well.

So, to summarize the performance we're seeing from our U.S.

Retail businesses, we started this year well overall.

We still have some work to do to fully restore Big G merchandising support to competitive levels, but our recent market shares shows sequential improvement.

In addition, we feel good about the increased product news and marketing activity we've got planned, and we like the improved sales trend we've been seeing in the category overall.

Beyond cereal we have strong baseline momentum across most of our U.S.

Retail portfolio.

And we expect to achieve margin growth for this segment of our business in 2006, with the help from better sales mix, carry-over benefit of last year's various pricing actions, and moderating inflation on agricultural commodities and productivity savings.

Turning to our bakeries and food service business, last year's goal was to stabilize operating profits and they did.

This year the goal is to renew operating profit growth, and they certainly got a good start in the first quarter.

Profits were up $10 million for the period, reflecting improved focus on more profitable products and accounts.

In addition, margins benefited from productivity initiatives and good net price realization.

Our International division just posted another quarter of strong profit growth, fueled by excellent performance on the top line.

Slide 29 shows that the 7% combined unit volume increase for International included gains in every region where we do business.

Volume in Canada was up, including an 11% increase in cereal shipments; volumes were up in Europe and Latin America as well; and volumes in the Asia Pacific region grew 15%, including good performance from Old El Paso in Australia and from Wanchai Ferry, Haagen-Dazs, and Snacks in China.

So I'll wrap up our prepared remarks this morning by summarizing where we see General Mills today.

The new fiscal year is off to a good start, with solid net sales performance and good margin recovery.

The second quarter was always going to be a tough comparison and Katrina and potentially Rita's effects on the operating environment could make it at bit more of a challenge.

But on the whole, we feel good about the baseline momentum we're seeing in a number of our businesses and we feel good about our ability to capture productivity savings and expand our margins this year.

So we continue to expect full-year results in line with the guidance that we provided in June.

With that I will ask the operator to open up the lines for questions.

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from the line of David Adelman from Morgan Stanley.

Please go ahead.

Good morning, everyone.

Hi, David.

I wanted to ask you a few things, Steve.

First, the substantial increase in the U.S.

Retail operating margins, can you help me understand, how much of that is due to the fact that you were facing a fairly easy comparison and how much of that is due to the realization of pricing as time has gone on?

Well, I think you're right to point out that both of those factors played a role.

Obviously, the first quarter last year was a tough one.

That was when we experienced a supply chain cost increase that amounted to $0.12 a share.

So we expected to do much better than that in this quarter.

But the -- as you can see, the price realization is up.

We had price realization in the U.S.

Retail business of two percentage points, and we didn't really announce any pricing in this quarter, so we're getting the carry-over from that pricing that was announced last year, and that should continue for some time.

And were the results in the quarter -- Steve, I know you don't give quarterly guidance, but did the first quarter earnings, did it exceed your internal expectations?

Well, we expected them, as I said, to be up substantially from last year for the reasons that I cited, but it came in a bit stronger than we had planned, and I think that's a good thing, because as I said, we face some uncertainty, and particularly in the second quarter, around the effects of Katrina and Rita and what that will do to the overall operating environment.

Okay.

Last thing, with higher U.S.

Retail gas prices, at this point, do you see any visible impact on consumer purchasing behavior that's adversely affecting either your business or category growth?

I don't at this point, David.

We may not have just caught up with it in the Nielsens, but our categories performed well in the first quarter.

Our own retail take-away performed well in the first quarter and we're not seeing any change in that as we move into September, and so if there is an impact there, it is not yet visible to us.

Okay.

Thank you very much.

Our next question is from the line of David Driscoll from Citigroup.

Please go ahead.

Hello.

This is Michael Avery for David.

Your food service profitability performance, obviously, was very strong, but could you talk about the volume decline a little bit?

That was against an easy comp as well, wasn't it?

It wasn't a terribly strong comp during the first quarter last year.

In food service, we have a couple of things happening there.

One is that the volume decline was on some restaurant business that tends to be relatively low margin, whereas the strength is in our basic food service distributor business, which is our highest margin business.

So the mix of business came in just as we would want to.

And that, coupled with the fact that we also had closed a bakery flour mill last year, and so that took a percentage point or two out of the volume growth.

So I think we still expect, over the long term, to have sales growth and volume growth in bakeries and food service, but what we had in this quarter was a decline in low margin volume and very strong performance among our higher margin segments of the business.

And one last question too, on the cereal.

What's your second quarter merchandising and marketing look like?

Is that set to pick up in the second quarter, or would you see that coming a little later?

My expectation and hope would be that the second quarter merchandising levels would be quite competitive.

If you looked at the trends across the first quarter, it clearly -- our merchandising strengthened as we got into August, and it's continuing in September.

And so our first quarter pattern was quite weak in June, July, and then quite a bit stronger in August, and that's pretty consistent with what I said back in June, when we said we thought that the steps we had taken to restore competitiveness in our merchandising price points would probably begin to be visible right around the end of the first quarter.

So we're expecting to be competitive in the second quarter and beyond.

I'd just add two little points to that.

Our annual fall Salute to Savings event is a fall event, cereal participates in that, so we should have some cereal merchandising around Salute.

In addition, remember that a lot of the new products that we shipped in Big G shipped toward the end of the quarter, so there should be some in-store merchandising on those new items.

Thank you very much.

Next question is from the line of Terry Bivens from Bear Stearns.

Hi, good morning, everyone.

Hi, Terry.

Couple of things.

Steve, in the quarter we were looking at basically volume declines in Big G offset by pricing.

How would you expect that equation to kind of change as we move into the second quarter and into your second half?

What are you looking for there?

Well, I think the magnitude of the gap between pricing and volume will narrow as we move forward.

As we -- as our merchandising picks up and our merchandise price points become more competitive, you will, I believe, see -- continue to see some pricing realization as we move into the second quarter, but it won't be a six-point gap like it was in Q-1.

Okay.

All right.

And I guess, given the robust nature of the first quarter, I've been getting some questions on why the guidance hasn't been raised for the year.

Is that a function -- obviously we've got a lot of unknowns out there, particularly in the Gulf area.

Is that the way you're looking at it, that it's just -- it's a little bit too early, given all that, to get a little bit more bullish on the year?

Well, I would say yes, Terry, that's right.

We know that -- Jim said, our first quarter, our energy costs were at our plan rates.

And we know our second quarter energy costs will be at a blended rate that is above our plan rate.

We've already got that covered, so we know what that's going to be.

And the uncertainties from the disruptions in the Gulf, I think it's really very difficult at this pont to know exactly what the impact of those are going to be.

So if you ask me about how I feel about our operating performance, I feel very good about the underlying trends in our business as a result of the first quarter, but there are uncertainties out there that are primarily related to energy prices and the results of these hurricanes that cause us to want to be cautious, and particularly, we know we've got a very strong second quarter to go up against.

Okay.

So I think the last time I checked you were looking at about 170 million-something in higher input cost.

That is the delta we should primarily focus on in looking at the rest of the year?

We actually called out in June for this year, Terry, that we had 40 million higher ag costs in our plan.

Right.

And 65 million higher fuel-related costs, so not quite the number you're talking about.

Okay.

So more like -- all right.

But, we said that what was baked into our plan for fuel related costs wasn't an assumption as high as the current market price we're seeing.

Okay.

Fine.

And just one final quick one.

And forgive me if I missed this.

The swing in inventories on the cash flow statement?

Yes, Terry.

I didn't catch that.

Actual growth, year on year.

Okay.

Okay.

Very good.

Thank you.

Our next question is from the line of Chris Growe from A.G. Edwards.

Please go ahead.

Good morning.

Just had a couple of questions for you.

I guess the first one would be that -- as I calculate it in the first quarter in U.S. retail, you had -- the majority of your pricing came from cereal.

Are there other categories within U.S. retail?

I know you had raised some prices there earlier.

Some of that should be fulling through, at least for the next couple quarters, that would help bring up pricing, if your price points do come down a little bit for cereal?

It's always a mix, Chris, of prices and it partly depends on timing of merchandising categories, too.

I think we would expect to continue to see positive price realization in our refrigerated dough business, a carry-over from last year, and probably still some in our meals business.

You remember soup pricing, we saw go up -- it made a start to go up early last year, but it really didn't go up until late in the year.

So we should have some carry-over pricing there, as we anticipate both higher retail and higher merchandise price points in soup this season.

So, if I'm looking at U.S. retail and your price realization, sort of an expectation for the year, something north of 1%?

Is that too low, based on the first quarter experience?

Or --

I don't want to give public guidance for the components of our net sales increase.

I think our low -- I would tell you that our low single-digit net sales increase includes both volume and pricing, and mix.

Sure.

A combination.

Okay.

And then just two quick ones.

Do you have any foresight that you have here on restructuring costs at this time?

We know what they were for the first quarter.

Do you have any better ability to predict those for the remainder of the year, roughly, what they may be?

We will certainly let you know what those costs are as the year goes along, as we incur them.

We're not forecasting those separately, as you know, because we really do see them as basically related to the operating nature of our business.

And so, we're not going to call them out separately, going forward, but we will tell you what they are each quarter, as they occur.

And they are baked into the guidance that we give on earnings for the full year.

Sure.

And then the last one was a quick one, I guess for Jim, and that is on share repurchase.

In terms of -- I assume this first quarter is not a run rate to assume, but should we assume again that this continued aggressive share repurchase activity -- looks like you were a little more aggressive even than what I was expected in the first quarter.

Well, the guidance that we gave at the beginning of the year was that over a three-year period of time you should expect that we would on average repurchase a net/net 2% per year, so that at the end of three years we would have on net repurchased 6%.

What we also said was that we would be opportunistic in the sense that if we saw the share price not reflecting the underlying fundamentals of the business, that we would purchase more heavily.

On the other hand, share price begins to better reflect the underlying performance, we would ease off that, and that's something which I think should remain true over the three-year period unless we say something different.

So no change in that guidance.

Okay, thank you.

Thank you, Chris.

Our next question is from the line of Andrew Lazar from Lehman Brothers.

Good morning.

Hi, Andrew.

Steve, I understand with the merchandising situation over the last quarter or two being not as competitive as you would have liked, why incremental volumes on cereal were as weak as they were.

And your focus now, I know, is also on baseline going forward, but can you explain maybe to me a bit more why the baseline volume numbers or sales numbers in cereal have also been as weak as they have?

I think when -- quite often when your incremental volumes are down and others are getting a disproportionate amount of merchandising -- and there was plenty of merchandising in the cereal category during this time -- it affected not only -- that affected our baselines as well.

And the fact is, our average prices were higher during that period for two reasons.

One, because we had increased them, but secondly because a smaller percentage of our sales were on merch, and so essentially the price gap, I think, was a factor, both in incremental sales and baseline, and I would expect to see those improve.

Particularly we should see them improve with the increased consumer support we're putting behind the business and also with the increased contribution from new products.

Got it.

Then just a follow-up.

In terms of the improved merchandising levels that you're currently seeing and hope to continue to see as this quarter unfolds, what is the -- sort of the risk associated with that merchandising?

So, in other words, you've kind of waited your turn in line, if you will, to get back into the retailers' shelf stats and merchandising stats and all of that.

Once that's kind of been done and you start to see it, -- how much execution risk is there around that, or is that -- you can really plan on seeing that increased level of merchandising actually happen because you've kind of contracted for it with a retailer, et cetera?

I'm trying to get a sense of if the competitive level of merchandising increases like you would expect, even if nothing else changes, wouldn't we expect volume to be less weak, sort of, next quarter in cereal?

I'm trying to get a sense of how much risk is around that.

We expect volume to be stronger next quarter in cereal, if that's what you're asking.

It is.

I just didn't know --

-- give quarterly forecasts, but the trend is, what I've said is we expect our sales to be up for the year in cereal, and we started out flat, but -- and I expect that the volume growth will be a bigger component of that going forward than, obviously, it was in the first quarter.

Right.

So, what would be the variable?

We expect to see better cereal performance from here out.

Okay.

And I'm assuming the variables then, that affect sort of getting that merchandising level, because you've already sort of planned for it, if you will, with the retailers.

I'm trying to get a sense of would could happen that would lead for that not to happen.

Or, all things even, you'd expect it because you've kind of planned for it and you're in the sort of schedule with retailers and that kind of thing.

Well, nothing's certain until it happens, but what I would say is, whereas earlier on, the retailers were telling us, we see your program but the prices are not such that we want to feature in a big way and display at those prices because we have better prices from your competition.

We're not hearing that now.

That's helpful.

Thank you.

The next question is from the line of Bill Leach from Newberger.

Please go ahead.

Good morning.

I'm kind of confused by your full year guidance.

If you take the upper end of your guidance and add back the CoCo charge, you have 290.

That would imply about a 5% decline in operating EPS for the rest of the year.

So, it doesn't seem that that's really what you're saying.

Your businesses seem quite strong.

Could you just run through that again?

Are you including substantial write-offs that you won't talk about?

As I said earlier, it does include any charges that we'll take for the year.

So that is baked into that guidance.

How can you give us a number, though, and not tell us what those charges are?

You've got to remember what we walked you through in terms of pluses and minuses for the full year, back in June.

We had told you that our forecast now includes restructuring charges, because we see them as less substantial than the kind of thing we've been running with the last couple of years as we were integrating Pillsbury and we see them as part of the ongoing business, but what else did we call out for you?

The real thing that we called out was what we felt we were going to see in corporate expense, particularly from employee benefits, and if you remember the big factors there were a year-over-year increase in parented non-cash, but pension and post-retirement expense, restricted stock expense, and health expense.

It's those employee benefit related costs and corporate unallocated that were one of the key points we made to you in June.

But you don't really expect your EPS to decline for the rest of the year, do you?

That's what your forecast is saying.

No, we gave full-year guidance on a GAAP basis, and certainly it is going to be down from the $3.08 GAAP number a year ago.

We don't have a one-time sale like SBE.

Well, of course not.

But I'm talking about operating numbers.

If you look at the operating number, ex-CoCo, being $0.69 this quarter, subtract that out, you would have a 5 or 6% EPS decline for the balance of the year.

There must be some write-offs embedded in that.

Doesn't make any sense.

If you have write-offs embedded in your guidance -- it seems like it's incumbent to be a little bit more explicit as to what they are.

It makes a big difference if they're $0.02 or $0.20.

I understand.

And you're going to see our results reported to you just like you've seen them this quarter.

I think it's pretty clear on our income statement and in the segment results where those restructuring charges are.

I think it's pretty clear where the benefit pressure comes in corporate unallocated, at least I hope our reporting is simpler and cleaner to you.

And --

That's not the point, Kris.

The point is, if you're giving us a full-year number, you need to tell us what basis it's on.

You can't just give us a 290 number and not tell us whether it includes charges or not.

Because otherwise it's a meaningless number.

That's all I'm saying.

You need to give us some range of charges, at least, even if you're going to embed them in your earnings going forward.

This is where we are because we think it's part of the ongoing business.

We don't forecast all the other cost pressures that are built into our plan this year, either.

I think, to your point on operating profit, one of the things we're very clearly trying to call out is what we expect from segment operating profit this year.

You know that our goal is mid single-digit growth in segment operating profit, and I think that's probably the key to the operating performance question that you're asking.

Okay.

Can I ask two other questions?

What would you advise us to use for shares outstanding and interest expense?

Well, the interest expense is 420 million for the year, and I don't think we give guidance on shares outstanding for the balance of the year because that will depend on whether we are back in the market, repurchasing shares.

We have given explicit statement, obviously, of where we are at this point, but where we'll go in the balance of the year depends on what shares we repurchase and also depends on what shares -- what options are exercised by employees.

And the tax rate should be about 36%?

35.5 is what we're using.

Okay.

Thanks a lot.

Thank you, Bill.

Next question is from the line of Philippe Bousans from Credit Suisse First Boston.

Please go ahead.

Good morning.

Couple of questions here if I may.

The first one, Jim, with regard to the expected interest expense of 420 for the current fiscal year, I'm still assuming that you're going to refinance the CoCos next month with the commercial paper.

Now, given the rise in interest rates and the expectations of more to come, does that imply that you actually have started to hedge some of those future commercial paper borrowings, given that you're maintaining your 420 million interest expense forecast?

Let me give you two answers.

The first, your presumption is correct.

We expect to redeem those continued convertibles next month.

We have said that we will pay for them in cash, and as we've been saying for some time, the expectation we have is to refinance and the plan we have is to refinance them with the commercial paper.

We have not hedged that commercial paper take-town.

We'll be taking down that commercial paper immediately prior to redeeming the contingent convertibles.

We have built into the 420 our expectations of what the commercial paper cost will be, but, of course, once we take it down, the cost will be what the market says.

And that's an example of one of the uncertainties that you have as you put together any set of expectations for the full year.

It's just one of the many elements which are uncertain as you come into your full-year guidance.

But based on how much higher interest rates might go at the short end, particularly given that we're getting a more and more flatter yield curve here, might you still deviate from those plans, in terms of maintaining that amount in CP and still try to hedge it, either through derivatives or turning some of it out in the long-term market?

We always can consider going into the long-term market if we think that would be the best for the capital structure of General Mills over the long term, and if the market presents a particularly good opportunity, but our plan at the moment is unchanged from what we said in June and through today.

Okay.

My second question and final one is for both yourself, Jim, and perhaps also Steve.

If you look back at history, in terms of the impact of higher fuel prices, if you try to contrast your food service business and then your retail business, which one of the two would be most susceptible to higher fuel prices?

Would it be the food service component?

Well, one aspect in food service that I would say, they both will feel the cost pressures. food service, though, we have taken some pricing already in response to the higher fuel costs, and that tends to be a business where, when costs rise, the prices are moved relatively quickly to compensate for it, whereas retail, the pricing is a more complex set of merchandise price points and base list prices and so on, and, of course, for us, retail is simply a bigger business.

So I think that's probably where we would feel more of the impact.

But you would not see more of a drop-off, Steve, in demand, as people stay more at home rather than go out to the PSRs, as their fuel bills increase?

I don't think we've seen anything yet, but --

what -- it could, it depends on --

-- on how high they get, I guess.

When we had a recession back in 2001 and the beginning of 2002, that definitely impacted the food service business.

So if fuel is able to impact the economy, it is conceivable the economy could impact food service.

But we have not as yet, even with quite a rise in fuel prices over the last 14 months or so, we have not seen that impact food service.

Great.

Thank you.

Thank you.

Our next question is from the line of Leonard Tietelbaum from Merrill Lynch.

Please go ahead.

Well, there you go.

A new record.

Good morning.

Good morning, Leonard.

Yes, well, there you go.

Jim, you had given us in a previous conference call, and I really can't find it in my notes now, but I will, at what point you felt the ouch point was on oil.

I thought you said it was around $57 a barrel had been baked into the plan.

Can you give us what level it is, just so we can have some kind of a guideline here?

Leonard, you did not find it in your notes because it was not in your notes.

We never did give a number as to what our fuel number was in our plan.

What we did say was that the number in our plan was higher for this fiscal year than the actual fuel cost in last fiscal year.

And, Kris, did we quantify that?

No, but the point is, even in June, when we were talking to you and told you that the assumption was up year-over-year, we told you it wasn't at then-current market rates.

All right.

So there's -- can you give us some kind of a feel as to where you've set your budget, in terms of fuel?

All I can do, Leonard, is really repeat what we said earlier, which was that in the first quarter --

-- right --

-- we were on our plan because we had hedged that out at the beginning of the year.

In this second quarter that we are now running, we have locked in our fuel cost for this quarter, and that is at a price higher than we have for a plan, and then for the balance of the year, we obviously don't know what the market price is going to be, and we do not know what our price will be because we're not hedged out for the balance of the year.

Crystal clear.

Thank you.

Second, the CoCo goes away mid-October, I presume.

Correct, just at the end.

End of October.

when you take a look at your average shares outstanding, where CoCo was in and CoCo was out, are you going to take the reported shares?

Is that how it works?

I believe that once the cocoa has been paid out, then the theoretical as-if issued shares simply come out entirely, and they're gone, and they're not in the weighted average, they're just gone, gone, gone.

All right.

But you would take what was reported in earlier quarters as reported, not --

The earnings per quarter, as reported, remain the same.

All right.

Then the last -- just so that I can try and get a little clearer in my mind, if we started the year at a merchandise price on cereal at two for five and Kellogg was at two for four, can you give us some kind of a feel right now as to where you think the average promoted price is for you all?

It's come down.

The data I was looking on the other day, showed that on a per unit it had gone from about $0.40 above year-ago down to about $0.20 above year-ago.

This was out of the Nielsen data, which I think is -- logically reflects a blending of -- there's still from two for five merchandising out there on cereals, but there's also a blend of two for four's and two for five's, and there's been some modifications in frequency of promotion on some of the items, so -- but I think the best benchmark is probably the first one I gave you, which is that the increase in our merchandise price is probably about half of what it was prior to our adjustments.

Thank you very much.

Thank you.

Our next question is from the line of Eric Katzman from Deutsche Bank.

Please go ahead.

Good morning, everybody.

Hi, Eric.

I guess my first question, Steve, has to do with -- it's been, obviously, a rough few years since the acquisition with Pillsbury, and I'm kind of wondering if, even with cereal still struggling, is this kind of -- you feel like we're starting to see the power of the combined companies emerge?

And then also, if you could kind of put that same question in context, sequentially in the fourth quarter of last year, it was a tough period for Big G, but the rest of U.S. retail did pretty well, and yet your earnings were much, much better this quarter than last, looking at it on an operating basis, and is it really -- is there something else going on, or is it just Big G sequentially showing some improvement?

Well, certainly the improvement in Big G is important to our long-term -- meeting our growth goals.

I would say that if you looked at our business over the last couple of years, there was a lot of evidence of the power of the combined companies, but it tended to be offset by a weakness in one area or another.

For a while it was bakeries and food service, which no longer is a drag on our results.

And then in the latter half of last year, because of the unique circumstance around merchandise price points, it was cereal.

I think at this point, what you can say is the line -- the operating elements of the line is more consistently sound and solid.

Not that everything is growing at exactly the same pace, but the -- the -- across our divisions are operating at the level we expect them to now, and that's reflected in the strong operating profit growth you saw in the first -- in the first quarter.

I would just add that obviously, as well-known, we paid down the targeted debt that we needed to pay down for the acquisition at the end of last year and you now see the flexibility that we have which we did not have heretofore, and you can see the sort of cash flow generation, what we can do with that.

And then finally, we are pleased that Diageo now is, in effect, completely out of our stock with the transaction they did in August.

So in that sense, we're past another important milestone.

Okay.

And then, as follow-up, Jim, the identified items that you had this quarter, is the 35 -- I guess what tax rate should we apply to those items, if we were going to make that adjustment on our own?

35.5.

35.5.

Okay.

And then stock option expense, FAS 123, have you made any comment about that yet?

We have said that we will be adopting stock option expensing when required, which will be in the first quarter of our next fiscal year.

Okay.

And then --

We've been recording, as other companies, for some time, in footnotes what that cost would be on the basis of Black-Scholes, and so it's quite easy to just draw that off the footnote to see what the run rate is.

I can maybe give you one more piece of help there, Eric.

For fiscal '05 the Black-Scholes calculation, it's in the 10-K, shows you it was about $0.09 a share.

If you're trying to think about this next year, you want to think about a number lower than that, less than that, somewhere in the neighborhood of $0.05 to $0.06.

One of the factors that drives that number down is we will have completely amortized the last big all-employee grant.

Okay.

And then, I guess last question, and I'll pass it on, is -- Steve, do you feel that given all of the pricing that you've taken, I mean, it seems like you've got some, some decent benefit out of it this quarter.

It was a little bit less obvious in the last few quarters.

Do you think that with higher oil and gas costs and pressures on resin and everything else that's going on out there, do you feel that you have the flexibility, given what you can read from the consumer, if need be, to go back and raise prices again?

Or are you -- do you feel that you're -- you're kind of tapped out here and we shouldn't see much more pricing out of your lineup?

No, I don't -- I believe that pricing is attainable in our business.

I think our goal has always been to offset input cost increases with productivity improvements, and we have a lot of good productivity initiatives that we have on the radar screen that are going to help us offset some of the cost increases we're seeing, but I think you can never say that there may not be a need for pricing because we really don't know just how severe the cost increase will be.

I think that's the big uncertainty as we look, particularly at energy, over the balance of the year.

And so if there need be [inaudible] pricing, certainly I think it affects everybody, and you could see some additional price inflation.

As always, our first goal is to try to offset that with productivity.

And obviously, we don't comment on pricing in advance during it.

We comment on it after we've done it, as Steve said, we have done it.

I meant just more kind of your read of the consumer as opposed to specifics on action you're going to immediately take.

I understand that.

But, okay.

I'll pass it on.

Thank you.

Thank you Eric.

Your next question is from the line of Todd Duvick from Banc of America Securities.

Good morning.

Could you give us an update on the outlook for your debt levels going forward?

It looks like you used short-term bank financing for share repurchase recently, and you really don't have any near term maturities until the end of 2006.

Can you just give us an idea of what we should expect going forward?

Sure.

The way our calendar runs, we have a very big second quarter and so there's a natural run-up in inventories over the course of that.

There's a natural cycle to our fiscal year, and we did, indeed, use short-term borrowings to finance the share repurchases.

But in the back half of the year, we'll be generating lots of cash, and we expect for the full year to end the year on a year-on-year basis with our definition of net debt down one to 200 million versus the ending point last year.

Okay, very good.

Thank you.

Operator, I think we've got time for one more.

Thank you.

Our next question is from the line of Eric Miller from Lehman Brothers.

Thank you.

Lehman Brothers Fixed Income Research.

Todd just asked one of my questions.

But I guess if you could also follow up around, if you -- do you have any changes in your financial policies as it relates to debt leverage and in terms of your commitment to current ratings and/or reachieving single-A category ratings.

Has anything changed in that respect following this pretty sizable share repurchase during the quarter?

Eric, absolutely nothing has changed.

As I said, we expect to end the year 100 to $200 million down in net debt, and we have as a goal to return to single-A for our long-term obligations in A-1 P-1, for our short-term obligations just as soon as we can without specifying a calendar target for that.

Would it be fair to say that if we see a more challenging environment later into fiscal '06 and the free cash that you're hoping for or expect to generate doesn't materialize the number you think, that you would look for ways to either cut back on the share repurchase for the current year to maintain those leverage targets and/or net debt targets?

Our intention is -- and we have every expectation that we will be able -- to improve our key credit ratios this year versus last year.

There's nothing we see in the current environment which suggests that we will not be able to do that.

We have no plans to -- no specific plans or commitments to make any further share repurchases through the balance of the year.

That does not mean that we may not make them, but we have no plan to make them as such over this particular year.

I would reiterate what I said earlier, which is over a three-year period of time, we expect, on average, to take down our shares by a net 2% per year, with at the end of that three-year period being down 6%, and we'll take action as we see opportunity in the market, but there's no plan to buy further shares in the balance of the year.

That's very helpful.

Thank you, Jim.

Thank you, Eric.

Thanks, everybody.

I think we're going to wrap it at that point.

If there are others of you that have some follow-up questions, please give me a call.

Ladies and gentlemen, that does conclude the conference call for today.

We thank you for your participation and ask that you please disconnect your lines.

Thank you and have a good day.