通用磨坊 (GIS) 2008 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome the second quarter fiscal 2008 results conference call.

During the presentation, all participants will be in a listen-only mode and afterwards, we will conduct a question-and-answer session.

(OPERATOR INSTRUCTIONS) And as a reminder, this conference is being recorded Wednesday, December 19, 2007.

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

Please go ahead, ma'am.

Thanks, Jennifer.

Good morning, everybody.

I'm here with Ken Powell, our Chief Executive Officer, Don Mulligan, our CFO, and Kris O'Leary, Chief Operating Officer for our International business I'll turn you over to all of them in a minute.

First, I've got to cover my usual housekeeping items.

The press release for our second quarter results was issued over the wire services earlier this morning.

It's posted on our Web site if you still need a copy.

We've also posted slides on the Web site 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.

The second slide in today's presentation lists factors that could cause our future results to be different than our current estimates.

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

Thanks, Kris, and thanks to all of you who have joined us this morning.

As you can see from the financial results that we released today, General Mills continues to generate good growth and operating momentum for fiscal 2008.

Slide 4 summarizes results for the quarter.

Net sales grew 7%.

Segment operating profit essentially matched last year's second quarter results.

Earnings after-tax were up 1% and earnings per share grew 6% to reach $1.14 for the quarter.

These results include significant input cost inflation, expenses associated with our November product recall of frozen pepperoni pizza and double-digit growth in our consumer marketing investment.

Let me take you through the income statement and cover those details.

Our 7% sales growth in the quarter reflects a strong contribution from price and mix, up 6 percentage points.

Foreign exchange added another point of growth.

Each of our three business segments contribute to the sales increase.

U.S.

Retail sales were up 3%, the International segment posted 22% growth and Bakeries and Foodservice sales grew 8%.

Our second quarter gross margin of 36% was below comparable period a year ago.

Cost of goods for the quarter included $17 million of accelerated depreciation expense related to restructuring actions.

It also includes virtually all of the expense related to our voluntary recall of pepperoni pizzas on November 1st.

Total recall expense, including the costs booked in SG&A, was $20 million pretax, or $0.04 per share.

We resumed shipment of pepperoni pizza SKUs at the end of November and sales of our other pizza varieties were not interrupted.

Our results for the quarter also include a 10% increase in consumer marketing expense.

We believe this strong investment in our brands will help fuel continued growth in sales, particularly baseline or non-promoted sales.

Through the first half of this year, combined baseline sales for our major U.S.

Retail businesses are up 3% in measured channels.

Slide 9 shows you the detail of our segment operating performance in the second quarter.

U.S.

Retail profit fell 2% including the recall impact.

International posted another quarter of strong double-digit profit growth and Bakeries and Foodservice profits declined 14%.

That reflects high input costs and very tough comparisons.

Last year's second quarter profits grew 40%.

Restructuring, impairment and other exit costs totaled $3 million in the quarter compared to a $1 million income last year.

Corporate unallocated expenses totaled $26 million, which includes $17 million of costs associated with restructuring that appear in COGS in the income statement.

The decrease in unallocated corporate expense for the quarter reflects a net $15 million mark-to-market gain on commodity hedges and an $11 million gain on the sale of a corporate investment.

Our joint ventures, particularly Cereal Partners Worldwide, contributed strong double-digit earnings growth in the quarter.

After-tax earnings from joint ventures totaled $28 million and these results include a $1 million after-tax charge related to previously announced CPW restructuring in the U.K.

Sales for CPW grew 21% in the period.

So on the bottom line, diluted earnings per share totaled $1.14 for the second quarter, representing a 6% gain.

This increase was on top of double-digit growth in last year's second quarter.

Let's move from the income statement to the balance sheet and core working capital items.

In total, core working capital was up 12% from last November's levels.

This reflects our higher sales levels and higher prices for inventories.

For the full-year, we now expect core working capital to grow slightly faster than sales due to the sustained input cost increases we're seeing.

Our capital structure continues to get simpler.

During the first quarter, we repurchased a net $897 million minority interest and refinanced that piece of our capital structure with commercial paper and five-year notes.

In the second quarter, we completed our transaction with Lehman Brothers and used the $750 million of cash we received to pay down commercial paper.

In fact, our commercial paper balance is now lower than a year ago at this time.

By the end of fiscal 2008, we expect total debt plus minority interest to be down compared to the combined balance last May.

That's consistent with the guidance of mid single-digit growth in interest expense for the year we gave back in June.

Turning to the cash flow statement.

Our operating activities generated $444 million in cash through the first six months, down from $565 million last year.

The change reflects the higher use of working capital this year, again, primarily due to inventory costs.

Dividends through the first six months grew to $259 million.

The current annualized rate of $1.56 per share represents an 8% increase over dividends paid in fiscal 2007.

First half capital expenditures totaled $186 million.

We continue to estimate that for the full-year, capital spending will total $575 million, including capacity additions on grain, snacks and yogurt as well as productivity projects.

We returned significant cash to shareholders through share repurchases in 2008.

Through the first half, we repurchased a net 7 million shares and over last 12 months we've repurchased a net 14 million shares.

As a result, we now expect average shares outstanding for the year of roughly $350 million, or 3% -- 350 million shares, or 3% below last year's average share balance.

So I'll summarize my remarks this morning this way.

General Mills second quarter showed continued good sales growth.

Segment operating profit matched last year's despite higher input costs, recall expenses and increased consumer marketing and EPS increased 6%.

We simplified our capital structure.

For the full-year we are on track with our projected uses of cash for dividends, capital expenditure and share repurchase.

And importantly, we are on track to deliver our targeted EPS growth.

With that, I'll turn you over to Ken for a review of our operating performance.

Ken?

So thanks, Don, and good morning to one and all.

The second quarter results Don just shared with you build on a strong first quarter for General Mills and we expect our broad based sales momentum to continue in the second half of this year.

Our key challenge will continue to be input costs.

They're coming in higher than planned and almost all of the added costs will fall in our second half.

Now, we've shown you this chart before, which traces the sustained input cost pressure we've experienced in the last several years.

Our original plan for fiscal 2008 included an estimated 5% inflation rate on input cost, but commodity prices have tracked above our estimates and now, with the majority of our coverage locked in for this year, we see our inflation rate coming in higher at roughly 7%.

Now, this is a significant increase in cost pressure, but our good first half results offset some of the added costs.

In addition, we have identified additional pricing and productivity to counter second half cost pressure.

And our plans include continued solid consumer spending through the second half of the year to keep our top line growing.

And these factors together give us confidence we can offset the added costs we're seeing and deliver our targeted results for the year.

Our top line growth through the first six months was led by International, which generated almost half of our dollar sales increase.

U.S.

Retail contributed another $200 million in sales growth, and Bakeries and Foodservice added a $32 million sales increase in the first half.

Segment operating profits are up 4% through the first half.

That's on top of 9% growth in the same period last year and it includes the various expense items that Don just outlined for you.

So our fundamental business momentum is quite good going into the second half.

I'll give you a bit more detail on the growth drivers for U.S.

Retail and Bakeries and Foodservice.

Then Chris O'Leary will provide an update on our International segment.

Today's press release included second quarter sales growth rates for each of our U.S.

Retail divisions.

Slide 24 shows net sales growth by division for the first half.

As you can see, net sales are up for all of our divisions.

Snacks posted the fastest growth rate with sales up 14%.

Yoplait sales are up 7% through the first half.

Our organic division, Small Planet Foods, generated sales growth of 6%.

Both Big G Cereals and Baking Products posted 4% growth.

Meals is up 3% and the Pillsbury division sales were up slightly despite the recall, which resulted in one month of lost sales on the affected SKUs and product returns that also reduced net sales.

Let me highlight some of the businesses driving our sales gains.

Our grain snack business continues to post substantial growth.

Retail sales are up 34% through the first half of fiscal 2008 in channels where we have data.

This growth has been generated by both the core Nature Valley granola bars, as well as new, highly incremental products like Fiber One bars and Curves bars.

For Yoplait, new Fizzix carbonated yogurt and Yoplait Kid beverages are off to a good start.

And in the adult segment, we're seeing continued strength from Yoplait Light yogurt and our convenient fridge pack configuration.

And new Yo-Plus yogurt with probiotic cultures and fiber is off to a good start as well.

Yoplait's first half retail sales grew 5% in channels where we have data.

Second quarter retail sales growth accelerated to 10%, driven by pricing and performance from new products.

Big G Cereal performance through the first half has exceeded our expectations.

Conversion to the new package sizes has been completed at retail and shelf prices are tracking closely to targeted levels.

One of the key goals of this initiative was increased baseline sales and we're seeing that with first half baselines up 2%.

Dollar market share for Big G in measured channels is down about a half point year-to-date and this primarily reflects lower merchandising levels in recent months.

We have stronger merchandising planned in the second half.

We do expect full-year trade expense for Big G will be lower than last year.

Through the first half, retail sales in channels where we have data are up 2% and we'd estimate that Big G's retail sales across all channels are growing slightly faster.

Overall, we see the business well on track to its goal of low single-digit sales growth for the full-year.

In the meals division, retail sales for helper dinner mixes are running below strong year ago levels when we launched Hamburger Helper Microwave Singles.

Now, that continues to be a good line extension for us but it's not fully matching last year's introductory sales levels.

We are launching two new Skillet Helper varieties featuring whole grain pasta in January and that should help renew growth momentum on this line.

Progresso soups posted 12% retail sales growth in the first half and baseline performance has been the driver here, non-promoted sales are up 11%.

Progresso Light soups, which carry a zero point per serving endorsement from Weight Watchers, are off to an excellent start and are proving to be quite incremental to our existing line.

Retail sales for Pillsbury refrigerated dough products grew 2% through the first six months of the year in channels where we have data.

Core profitable products including crescent rolls, sweet rolls and our tubes of cookie dough drove the growth, including our results to date in this year's key baking season.

Toaster Strudel also contributed to Pillsbury's top line growth with a 14% increase in first half retail sales.

Now, as Don mentioned earlier, we resumed shipments of pepperoni pizzas at the end of November.

Sales for our other Totino's pizzas and pizza rolls stayed steady throughout the recall.

So through the first half, the combined Totino's businesses generated retail sales growth of 7%.

So we had a number of product lines that contributed to the strength in our first half U.S.

Retail results.

Shifting now to Bakeries and Foodservice, this business segment has been affected to a greater degree by higher input costs.

We have taken two pricing actions so far, one in July and a second increase in November, to counter this cost pressure.

These price increases have resulted in modest volume decline but a 4% increase in net sales through the first half.

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

Looking at our sales by customer segment, business with foodservice distributors and restaurants matched prior year levels.

However, core branded products, like Pillsbury Place and Bake muffins, breakfast cereals, snacks and Yoplait yogurt, all generated good growth.

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

So the key initiatives for growth in our Bakeries and Foodservice business are, first, prioritizing our best customers.

We're focusing on our branded products and our best customer segments to drive profit and margin growth.

Second, we believe our conversion to a direct sales force for part of this business will provide us with better insight to our markets and customers and our brands will get more focused sales support.

And third, we continue to focus on holistic margin management in this business segment.

These initiatives are working and our Foodservice division is expected to deliver good sales and operating profit growth for the full-year.

That profit gain may be high single-digit rather than double-digit due to increased input cost inflation, but this will still represent ongoing progress for the division.

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

Chris, over to you.

Thanks, Ken.

Good morning, everybody.

To remind you, net sales for our entire International business, including our proportionate share of sales from joint ventures, totaled more than $3 billion in fiscal 2007.

My remarks today will be focused on our consolidated International businesses, about two-thirds of that total.

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

Slide 36 shows our sales growth by region.

Excluding the impact of foreign currency exchange in the second quarter, Canada's net sales grew 2%, Europe was up 11%, our Asia-Pacific business was up 16%, and net sales in Latin America increased 41%, reflecting market share gains and pricing actions in key markets.

This performance was fairly consistent with first quarter results, so through the first half our sales are up 12% before currency exchange benefits.

Foreign exchange contributed an additional 8 points of growth, bringing the International segment's reported net sales growth to 20% for the first half.

Our International business has shown accelerating operating profit growth over the past several quarters, as shown on Slide 37.

Input cost pressure will be greater for this business in the second half, and as a result, we think the rate of segment operating profit growth will slow a bit.

But we continue to target another year of strong double-digit profit growth for 2008 in total.

We're generating this growth by building on three global product platforms.

First, super premium ice cream where we have the pre-eminent brand in Haagen-Dazs.

Next, world cuisine where we compete with old El Paso and the Wanchai Ferry brand.

In healthy snacking where our International brands range from popcorn and Cheerios snacks in Canada to Nature Valley granola bars now available in more than 50 markets worldwide.

These global platforms are strong growth drivers for us, with net sales at constant foreign exchange rate from ice cream and world cuisine each up approximately 10% in the first half and healthy snacking up 30%.

As we expand these global brands around the world, we will drive continued margin improvement for the International segment overall, as all three of these brand platforms have operating profit margins higher than the General Mills overall operating margin.

Let me now give you some highlights from each of our regions beginning with Canada.

Cereal and granola bars have been the growth drivers in Canada so far this year.

We executed our right size, right price initiative in Canada on the same timing as we did in the United States and results are good year-to-date.

Cereal share is up half a point through the first six months and retail sales have benefited from strong baseline growth on key established brands like Multigrain Cheerios and Fiber One as well as successful new product launches including Fruity Cheerios.

In the granola bar category, we captured share leadership for the first time driven by two new product lines, Second Cup Cafe Delights and Nature Valley Fiber Source.

In Europe, the U.K.

and France represent more than half of our net sales.

The U.K.

was the leading contributor to top line growth with strong sales of Nature Valley granola bars and Old El Paso Mexican foods.

And France generated double-digit sales growth in the second quarter, led by Haagen-Dazs.

Moving to the Asia-Pacific region, it was a record year for Haagen-Dazs moon cakes in China with sales up 30% over last year.

Moon cakes are a traditional Chinese treat given as a gift during the mid-autumn festival.

This year we estimate that 10% of Shanghai's 5 million or so households preordered this specialty ice cream moon cake from Haagen-Dazs during the two-week festival this past September.

Growth in greater China was also bolstered by the launch of new flavors of Wanchai Ferry frozen dumplings and our expansion into the Taiwan market.

India was among the good contributors to top line growth in this region.

Pillsbury Atta flour used in traditional Indian cooking posted good double-digit growth.

And growth in Australia, especially from branded retail products like Old El Paso and Latina pastas was good as well, driven by increased investment in advertising and distribution gains.

Before I leave the Asia-Pacific region, let me comment briefly on recent news from our Haagen-Dazs joint venture in Japan.

Two new indulgent ice cream deserts called Dolce were launched there this year.

Dolce has become the largest new product introduction in Haagen-Dazs' history.

Annual sales are projected to reach $70 million and we estimate that 50% of these sales are from consumers new to the Haagen-Dazs brand.

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

Looking to the second half of fiscal 2008, we expect to see continued net sales growth across our regions driven by momentum on our base businesses and new product introductions.

We have pricing and productivity initiatives in progress to offset commodity inflation so as a result, we anticipate double-digit sales and earnings growth for our International business in 2008.

At this point, I'll turn you back over to Ken to wrap up our comments this morning.

Okay.

Chris, thank you for that.

So with our good first half performance and our expectations for the second half, I'd summarize the 2008 operating outlook for General Mills this way.

We're excited about the momentum of many of our businesses and we expect our good top line results to continue fueled by additional new product introductions, selected pricing actions and ongoing investment in brand building activities.

And we continue to expect consumer spending for the year to be up high single digits.

For the year in total, we now estimate that our net sales will grow at a mid single-digit rate exceeding our long-term goal of low single-digit growth.

We expect to see higher input cost inflation in the second half and full-year inflation will be greater than originally estimated, however, we expect to offset this with our good first half performance, additional pricing and increased productivity savings.

This will keep us on track to deliver mid single-digit growth in segment operating profits for the year.

And so, we continue to target high single-digit EPS growth again in 2008.

Our EPS guidance for this year remains $3.39 to $3.43 per share.

So that concludes our prepared remarks this morning.

I'll ask the operator to now open the line for questions.

Thank you.

(OPERATOR INSTRUCTIONS) The first question comes from the line of Jonathan Feeney from Wachovia Securities.

Please proceed with your question.

Thank you and happy holidays.

You, too.

Happy holidays, Jonathan.

Ken, I guess, there's a lot of concern about the consumer wallet out there and you guys are taking some substantial price mix to offset this cost inflation.

Are you hearing or are you worried about consumer pushback either in the form of leaving any of your U.S.

Retail categories or trade down to private label in those U.S.

Retail categories, in your conversations with the retailers or the data over the past quarter?

Jonathan, I would say we're not worried about that.

You know, you've seen that we've had growth in all of our divisions through the first half.

Also, I think there's so much in the news about inflation across commodities and dairy and energy that I don't think consumers are all that surprised by the price increases that they're seeing scattered across the grocery store.

We're not seeing long or difficult conversations with our customers about the pricing that we've taken and so I think that there's an expectation that prices are going to go up some in the food area because of input costs and we're really not seeing right now on the retail side any resistance or slowdown that we would attribute to pricing.

I think if you look on the Foodservice side of the business, you know, there with the tracking mechanisms that we have we may be seeing a little bit of shift in that sector, a little bit of shift away maybe from casual dining and maybe more towards quick serve restaurants where you can eat for less.

So we might be seeing the beginnings of a change there, but I wouldn't call it pronounced at this point.

Ken, is there a margin mix issue there?

I mean, if, say, we do go within Foodservice from casual dining to towards QSRs, does that affect your business any meaningful way?

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

Okay.

Just finally, if you wouldn't mind, when you talk about mid single-digit revenue growth for '08, what kind of volume growth maybe in U.S.

Retail are you thinking about, roughly, to support that mid single-digit rev growth?

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

We told you generally that we think we'll be taking more pricing in the second half and I think that the combination of stable volume and the pricing that we anticipate will -- we're pretty comfortable that that's going to get us to that mid single-digit revenue growth.

Great.

Thanks very much.

Thank you.

The next question comes from the line of Eric Serotta from Merrill Lynch.

Please proceed with your question.

Good morning.

Good morning, Eric.

Just wanted to -- good morning.

Just wanted to follow-up on Jon's question regarding top line growth and volumes in particular.

Ken, you mentioned volumes are about flattish through the fiscal first half.

This quarter in U.S.

Retail they were down slightly.

Wondering whether you could give us some color as to what some of the -- what kind of an impact some of the one-off items like the Totino's recall, the, I wouldn't call this a one-off item, but the right size, right price initiative in which you're shipping fewer pounds in cereal had on volumes for the first half.

And overall, how would you describe or how would you characterize the volume performance versus your expectations?

And particularly in light of the, are you seeing any elasticity impact from the pricing that you've taken?

Well, Eric, thank you for asking that question and also for in a way partly answering it.

Some of it is the -- some of it is Totino's.

I don't know that we have a very detailed -- we don't have it, but some of it was the Totino's recall which fell right smack in the middle of the second quarter.

And then I think more importantly is right size and right price which you alluded to.

And here, this is a deliberate reduction in tonnage that was sort of a fundamental part of that activity.

Recall that we reduced the average size of a cereal box as part of that initiative, by about 10% and we reduced prices by kind of a mid single-digit level as well.

So there was a reduction in tonnage and I think we're starting to see that hit in the second quarter.

Now, in terms of the right size, right price, I think we would say that we're very happy with how that's worked.

The execution has been virtually flawless.

The pricing, we've hit the pricing targets that we had for that initiative.

And I think most importantly, we're seeing a shift in mix in our Big G Cereal business, so we're seeing more baseline sales growth now after the implementation of right size, right price and overall we're seeing net sales growth of, I think, it's, what, 3 to 4% through the first half, 3% in the second quarter.

So while there is a tonnage reduction in cereal, Eric, we're quite pleased with how the whole right size, right price initiative has played out for us.

And then like I just said to Jonathan, you know, I wouldn't say that we're seeing at this point any resistance to the pricing that we've taken.

I think another category I might highlight to illustrate the point is yogurt where, as you know, this summer we took a mid single-digit price increase and in the second quarter we've actually seen our yogurt business accelerate to about 10% growth in sales.

So we're not really seeing it out there today.

Okay.

And then to follow-up on commodity costs, we're now more than halfway through fiscal '08.

I realize that commodity costs seem to be changing daily here, but could you give us some sense as to your visibility or coverage for fiscal 2009?

Have you been opportunistic or have opportunities arisen to lay in some hedges?

And should we expect, knowing what we know today, should we expect to see any sort of step change in the rate of commodity inflation for fiscal '09 versus fiscal '08 as some of the favorable hedges that you had this year roll off?

Well, let me begin, Eric, by saying that, you know, first of all, we expect this general inflationary environment that we've been in for the last four or five years, where we've seen inflation run at 4 to 5% to continue into the foreseeable future and the reason for that is global economic growth, which is creating really strong demand for all these basic commodities.

So we expect that environment to continue and, as you know, this is something that we've been working hard on and focusing on for several years with a very major effort on productivity and so we don't see any of those factors or our approach to it changing.

In terms of '09 itself, I think you're right.

I mean, that's -- with the volatility that we're seeing in those markets right now, I think it would not be wise for me to predict what's going to happen six or 12 months from now, but we think we're going to continuing inflation.

Okay.

Well, thanks a lot and have a great holiday.

Eric, let me ask Don, though, to give you a little bit of an update on what we're seeing for the rest of F '08 because, certainly, we've taken a look at what that commodity cost number is for this year and we put on a little coverage.

You want to flush that out?

Yes, we have, Eric, we've extended our coverage for the year where both across energy and commodities we're about 85% covered.

Where we are not is because we do think we have some spot buying opportunities in the back part of the year.

The inflation that Ken alluded to for this year for 5% going to 7%, 2 points higher than our plan is largely back loaded.

But as Ken also alluded to, given our strong first half, our top line momentum, pricing that we'll be taking, some additional productivity that we have identified and are already acting upon, we can still reaffirm our full-year guidance for F '08.

Okay.

And just to clarify two quick points on that.

The 85% covered on energy and commodities that's 85% covered on energy and hedgable commodities or is that 85% overall?

Hedgable commodities.

Okay.

And on the second point, the increase from 5 to 7% in overall inflation, what does that equate to on, I realize this isn't apples to apples, but what are you guys looking for in terms of input cost and fuel?

I think you originally put out up $275 million for the year, you know, is that 325 now?

We actually put out the initial guidance was 250.

That is roughly $75 million higher now with the current estimate.

Okay.

Thank you.

Thank you.

The next question comes if the line of Robert Moskow from Credit Suisse.

Please proceed with your question.

Hi.

Good morning.

My question is, I seem to recall from last quarter that the expectation was, especially after coming off a 5% sales growth number for Big G, that you might expect kind of the reverse with consumption picking up and then net sales on a shipment basis coming down a little bit.

Did that -- it seems like that didn't quite happen the way that you thought maybe the retail consumption was a little bit lower than what you thought it would but at the same time your shipments actually look okay.

So did the quarter come out differently than the way you thought for Big G?

I think it may have.

I think I would say it was maybe a little better than we thought in terms of net sales and we did have some, as you know, Rob, we did have some inventory that we signaled at the end of the first quarter, but retail sales through the first half are running around 3%, or 3% for the quarter and so I think our retail momentum is pretty solid and shipments at 4%, you know, through the first half of the year, okay, a little bit ahead of that.

But I think that that gap is narrowing.

There's probably still some inventory to work through but I think we're working through it and it's -- retail sales are -- we're a little better than we thought and so I think we'll continue to work through that through the second half.

But at this point, I think mostly it's behind us.

Okay.

And are you going to do any kind of consumer testing, you know, post the right size initiative, just to check again with consumers to see if they notice a difference or if they care?

I know you have lots, it seems that you have a lot of anecdotal evidence already that the transition is okay.

We've been doing that, Rob, on an ongoing basis.

We've been checking with consumers in a variety of ways.

And again, I think you said, you know, didn't notice and don't care and I'd say that's a pretty good accurate characterization.

They really haven't noticed it.

You know, those cereal box changes, I think as you guys, as we showed you when we were right in the middle of this, were pretty subtle and so consumers haven't really noticed.

But they have in aggregate noticed that our prices have come down a little bit and, you know, as we modeled and as we predicted, that's resulting in some baseline strength on that core cereal line and we're very encouraged by that.

Okay.

And then lastly, in terms of working capital, you know, your core working capital is up 12%.

You're now saying it's going to grow a little faster than sales.

Are you, do you have any changes in your expectations for cash flow for the year, you know, you're also down in terms of cash flow for the first half.

Rob, this is Don.

You know, we expect to generate, again, another strong year of cash flow with a little bit of pressure from the working capital which will be more of a use than a year ago.

As we look at our use of cash for Cap Ex or dividend and for share repurchase, that small movement or small variance to plan in working capital is not going to change our plans in those regards so we're still confident in our planned use of cash.

Can you remind me, is there a guidance range for operating cash flow for the year?

No.

No?

Okay.

All right.

Well, thank you very much.

Thank you.

Thank you.

The next question comes from the line of Terry Bivens from Bear Stearns.

Please proceed with your question.

Good morning, everyone.

Hi, Terry.

And happy holidays out there from me as well.

First, a quick question on the overseas operation.

I noticed Green Giant wasn't on the slide.

Has there been some change there?

I thought that was one of your overseas pillars of growth.

Green Giant is still one of our businesses.

We have that -- it's a regional business for us, Terry.

What I was highlighting was the three global platforms that I first started talking about last year at Cagney and that being super premium ice cream, world cuisine and healthy snacking.

Our Green Giant business around the globe is healthy and we are looking for opportunities to expand it, but it's not something that we see as a global platform for us.

Okay.

That sounds like a little bit less than a ringing endorsement of that brand but.

Moving on to cereal, and this would be my last question.

Ken, I think by your remarks you're basically saying right size, right price is out there now.

That's correct.

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

Okay.

My question is this, we were just looking at some data on some of your innovation of late and, you know, obviously, there's always an uptick as your introducing stuff and it always bleeds off a bit then hopefully to grow but, how would you characterize how you're feeling about your innovation with some of the new stuff.

Are you satisfied with it?

Do you think you need to put forth a bigger effort there?

I'd just like to get your idea on that.

I feel quite good about it, Terry.

This year in the first quarter we launched Oat Clusters Crunch Cheerios, which has been a good success for us, Chocolate Chex and Curves.

And I would say all of those products are in line with expectations.

We always get a huge trial when we launch a Cheerios flanker and that was no different for the one that we just launched.

Chocolate Chex and Curves are a little bit smaller but very much in line with expectations.

Curves I think, as you know, we launched both a cereal and a bar and those products are building.

Those are more adult oriented products and typically the pattern there is, you know, a slower trial build but we like that franchise and we think there's going to be an opportunity for us to expand and grow that Curves business and, as you know, we're partnering with the Curves chain of fitness centers on that product which is the largest chain of fitness centers in the country.

So we feel good about the innovation that we've had in cereals so far this year.

There will be more new products coming but we think so far, so good.

As we look beyond cereal to the rest of the portfolio, I would say, again, we've had very strong innovation this last year.

Chris talked about some of the Haagen-Dazs innovation coming out of Japan.

This Dolce product has been a real hit.

Zero point soup has been in these early days a very hot product for us.

We're very excited about that.

And so, you know, I would say, well, we just also we've just extended our Warm Delights business in Betty Crocker with Warm Delights Minis.

That product is off to a good start.

Our yogurts are off to a good start.

So we feel quite good about the innovation that we have.

It's more incremental.

The margins are better.

And so all in all, we like the direction we're going in.

Okay.

Thanks for that.

Just one last quick thing.

I can see -- I'm just looking at some IRI data.

I can see that your base sales are pretty much tracking where you said they were in Big G.

It does show promotional down by a pretty significant amount, you know, mid-teens.

I understand why that would be looking backward.

Looking forward, I think you alluded in your remarks that promotional spending will be up on the brand or at least more promotions.

Is that really a function of just kind of returning to business as normal now that you have the new shelf set in place?

Is that kind of what you were getting at doing your normal promotions on cereal?

Well, that's right, Terry.

I mean, we, first of all, I want to confirm that we, the gap, I think, in the first half, if you will, has been that our promotional and merchandising pressure has been a little bit behind what we expected and so that's been really the shortfall there.

And going forward, we want to, you know, we want to fine-tune and adjust that as we get the whole right size, right price initiative absolutely locked in on shelf as we do now.

We'll fine-tune that promotional spending and just make sure that it's right and at the right levels.

Bearing in mind, always, that we are very happy with the kind of merchandising price points that we see in the category, which have risen slowly over the last year and-a-half and we like that trend and so we're not going to play around with that at all.

I think it'll be more focusing on getting the quality of performance and have our sales force focus more on execution than maybe they were in the first half when they were heavily preoccupied with getting that right size, right price initiative executed.

Okay.

Fair enough.

Thank you and again, happy holidays to everyone.

Thank you.

The next question comes from the line of Bill Leach with Neuberger Berman.

Please proceed with your question.

Good morning.

Don, could you run through the non-recurring items again slowly?

You had a lot of things which I didn't quite catch, the Totino's, the restructuring, I think you mentioned a commodity hedge and a capital gain.

There was a few moving pieces.

Let's get those listed out.

We had $20 million charge for the Totino's recall that was largely, essentially $19 million of it in our gross margin.

Okay.

We had $17 million in associated costs, which was associated with our restructuring.

There was accelerated depreciation that was in our gross margin.

And then within our corporate unallocated we had $15 million benefit from our mark-to-market on our hedges, on our commodity hedges.

(Inaudible) a new accounting treatment that we started at the beginning of this fiscal year where we no longer apply FAS 133.

We also had an $11 million gain on a sale of a corporate investment.

We also had a small difference in our restructuring cost between this year and last year, where this year it's a $3 million charge, last year it was a $1 million income.

So total restructuring was $20 million?

That's right.

Total restructuring this year between the cost in gross margin and the cost in the restructuring ladder were $20 million, correct.

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

The restructuring, we are, our guidance for the full-year now is $41 million, which is $48 million in restructuring charges offset by $7 million in gains from the sale of an excess property from one of last year's restructurings.

So $41 million.

That is $3 million higher for the full-year than we would have guided in last quarter and that's because we took one additional action in the second quarter to close our Poplar, Wisconsin manufacturing facility.

And you're not assuming any more commodity hedge gains or capital gains in your guidance?

Well, there will be some but it's going to depend on where markets are and as Ken alluded to, I'm no more confident in predicting where they're going to be at any quarter end or year than he is.

So there will be some commodity hedge mark-to-market gain or loss depending on our position each quarter end going forward and we will distinctly identify what that is.

For the full-year as we look at our guidance, we assume that we'll be net neutral for the year.

So if there's a plus or minus (inaudible) that number that will come through in the year-end results.

Okay.

I'm sorry, go ahead.

I'll add one other thing because somebody asked me this question earlier today, whether there was any more right size, right price expense in the quarter and the answer is yes.

If you remember, we said that the year one costs for that were $30 million, $17 million of it fell in the first quarter.

There's another 8 in the second quarter.

So that leaves 5 to spread through the back half somewhere.

Okay.

And, Don, it looks like your option expense was about $31.5 million pretax in the quarter.

Is that right?

That our, excuse me?

Your non-cash option charge.

Just looking at your cash flow statement.

Your stock-based compensation charge.

I think it's 31 or 32.

Just a second.

I'm looking.

Flipping through pages quickly here.

Yes, it's 32 in the quarter versus 28 in the same period.

So it was up a little bit.

Little over 10% for the quarter.

Okay.

Thanks a lot.

Have a good Christmas.

Thank you.

Thank you.

The next question comes from the lines of Alexia Howard from Stanford Bernstein.

Please proceed with your question.

Thank you.

Hello, everybody.

Hi, Alexia.

Hi.

Two quick ones.

First of all, just following on from Terry Bivens' question on innovation, do you set out goals for what percentage of sales from new products you'd like to get to and where are you at the moment in respect to those goals?

Because it does seem as though there's been a marked step-up in the kind of incremental innovation that you've put out there in the last, I guess, few quarters now.

Alexia, you know, we aim to hit around 5% from new products in each year and it can bounce around slightly from that and I'd say this year we're tracking very much in line with that goal, maybe a little bit ahead of that.

But in addition to that sort of broad volume and sales goal, we have very specific goals for the incrementality of the new products.

We want to make sure that we're introducing items that are really offering a new benefit and bringing new consumers into our franchises and this is a measure that we've focused on over the last three years and we're seeing progressive improvement in this measure.

Another key measure for us is margin and we want these new products to be either margin neutral or margin accretive and this is another area where we've had high focus and, again, we're seeing very consistent improvement in our performance in this area.

So we actually have quite a number of ways that we look at these new products and measure and monitor them and we feel -- we're feeling quite good with the direction that we're heading in on both incrementality and profitability.

Great.

And then another real quick one.

You've been very transparent in describing the merchandising strategy around Big G cereals.

Can you give us any thoughts on what the strategy is going forward on the soups business?

It's been growing extremely rapidly in the first half.

Very strong innovation in there with the low calorie piece.

What's the plan going forward?

Are we going to see the same kind of levels of trade support or how do you see that business evolving in the second half?

I would say very broadly speaking, what we've seen in the soup category over the last couple of years has been a movement away from deep discounting and across a high number of multiples and we're very happy with that trend and expect it to continue in that direction.

Our core strategy in our soup business is baseline building through advertising, good advertising, expansion of distribution and remember, it wasn't that long ago that Progresso soup and the Progresso foods business was primarily a northeastern based business and so we still have lots of distribution opportunities around the central and the western U.S.

and then finally, new product innovation.

Last year we launched low sodium soups, which have been a success for us and now this year we have the zero point soup which also looks like it's going to be a success.

So our game is expanding distribution, baseline building, advertising, and what we think have been very exciting new products, you know, coupled with the appropriate level of merchandising.

Great.

Okay.

Thank you very much.

I'll pass it on.

And, Alexia, I'll just throw one factoid in there.

Baseline growth for soup for us in the first half was 11%.

Great.

Thank you.

Thank you.

The next question comes from the line of Eric Katzman from Deutsche Bank.

Please proceed.

Hey, good morning, everybody.

I've got a few questions.

I guess, first, Ken, you're suggesting that the input cost inflation situation is going to stick with us for the foreseeable future.

I agree with that.

Why, I mean, make the case as to why you should stick with the back of the house Foodservice baking operation.

You know, that was really on Steve and Jim's watch.

You were going to consolidate that category.

It's not going to happen or it's not worth it and it seems like in Foodservice you're always going to be trailing the inflation curve.

Yes, well, I think that our very, very clear direction, which we've articulated a number of times in that Foodservice business, Eric, is that we are focusing on our branded business.

We are focusing in the distributor-led segment which is delivering those products to schools, hospitals, business cafeterias, that sort of thing, that is very, very clearly the focus of that business, along with other baked goods where we have scale and innovation that gives us margins that we like.

And so that is the focus.

If you look at what we've done over the last three or four years, we have significantly restructured that business.

I don't have the numbers right in front of me, but I believe we've reduced the number of manufacturing locations by half.

We've reduced the number of SKUs by half and most of the pieces that we've sold off have been back of house, par baked bread, other baked goods, these kinds of things.

And so without predicting specifically what we're going to do in the future, I think it's pretty clear by what we have said and by our actions in the past, how we're trying to redirect that business.

Okay.

Then also kind of as a follow-up, you know, I also think it's reasonable for you to kind of take your sales targets up and kind of assume a little lower or if any margin expansion given the input environment.

But I guess maybe this question is to Don.

If inflation keeps raging and working capital is more of a use over time, does that mean that we should assume free cash flow grows at a lower rate than net income?

You know, I'd say not necessarily, Eric.

I think that your point on kind or where sales growth is going to be and the margin, as Ken alluded to, we have a very robust internal process we call holistic margin management, which is aimed at addressing the margin challenge and the inflation challenge that we face today.

It's been working for us very effectively for the past three to four years where we've been able to increase our gross margins and our operating margins even after increasing our consumer spend year-over-year.

We have a little pinch this quarter.

We'll certainly, I think, believe we'll feel that for the balance of this year.

So I think that the opportunity for us in terms of growing our operating profit at that mid single-digit remains -- could it be more price than mix balanced as we've seen this year?

That's a probability certainly in the near-term as we see the inflation come through.

Turning to the cash flow, we're going to continue to aggressively manage our balance sheet and our commitment is to continue to reduce our -- use our cash to continue to reduce our share count by 2% on average per year, not necessarily each and every year but over time as well as to increase our dividends with our earnings growth.

And as we project forward our cash position, we are very confident in our ability to deliver those cash back to the shareholder while still reinvesting in the business at a rate that we believe is the right pace, which is roughly around 4% of sales in terms of capital reinvestment.

Okay.

I'll follow on that one offline.

And the last question is we've been kind of hearing, there's some speculation, and it wouldn't surprise me given that everybody in this business has to raise prices, but Kellogg is looking to raise prices in cereal at the start of the new year.

One, can you talk about that?

Have you heard about that?

And how does that kind of fit in with your move just recently on the weight out?

I mean, are we going, like, go to one box, one flake or would it be a list price increase?

I just kind of wonder how -- if there's a list price increase in the industry, how you kind of handle that given what you just did with the retailers?

Well, I mean, I think the first point I'd like to make is I think we have to let Kellogg's talk about what they're going to do and I don't want to speculate on that.

Having said that, you know, clearly, we're in an environment where there is significant commodity and cost of good inflation.

We've already told you very directly that we will have more pricing in the second half and we're very closely monitoring opportunities that we may have across all of our business segments and as we have those detailed conversations with our customers about precisely what we're going to do, you know, we will then communicate with you the details of the plan for the rest of the year.

Okay.

All right.

See you in early January, I guess.

Okay.

Operator, let's try and take two more calls and then I apologize to anybody who is further in the queue but we're kind of a little past time here.

I'm going to try and grab two more of you.

Can you each ask one question each so that we can get two more on here?

Thank you.

The next question comes from the line of Edgar Roesch from Banc of America Securities.

Please proceed.

Good morning.

One quick follow-up on the input cost outlook.

I mean, you had the 5% target for the year previously.

Don, maybe you could speak to this, but was that second half weighted in the first place and now even if you're expecting 5% in the back half, now with the increase to 7, that implies, I guess, a 9% increase for the second half.

Can you just tell me if that's second half, if it was second half weighted in the original outlook?

It was a bit second half weighted in the original outlook, it's clearly much more second half weighted now where most of our variance to our expectations is falling in the second half so most of that $75 million increased cost I alluded to is falling in our second half.

Okay.

Thank you.

And I'll stick with the one question.

Thanks.

Thank you.

Thank you.

And the next question comes from the line of Andrew Lazar from Lehman Brothers.

Please proceed with your question.

Good morning.

Hi, Andrew.

Ken, I'm wondering, why do you think with the industry having to play catch-up around costs all this time in terms of pricing, why isn't the industry or General Mills able to or try to take pricing, frankly, ahead of where all this is, to the extent you sort of need to price some of it back if the time comes as you manage that price volume balance you can do so, but I'm wondering why it's this constant sort of game of catch-up?

Well, you know, I think, Andrew, as we went into this year we said we would have $250 million of input cost inflation which was significantly ahead of what we had the previous year and I think some of you were surprised that we forecast that level of inflation for the year and we took it up to 5%.

And so we thought we had a line of sight on accelerating inflation for this year and our business plan called for much more aggressive pricing than we'd seen in the last couple of years.

You know, and I think, I mean, the bottom line is it's just been, I think, more than we saw or any of us saw and now we're trying to catch up in a -- we have to do this in a -- there's a competitive world out there but we're catching up and we're very focused on this and what I can tell you is that you will continue to see pricing from us for the rest of the year.

Great.

Thanks very much.

Thank you, everybody, and I apologize to those of you that we didn't get to.

Please call me and I'll try and get your questions answered.

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

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