通用磨坊 (GIS) 2010 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the General Mills second quarter fiscal 2010 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, December 17th, 2009.

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

Please go ahead, ma'am.

Thanks, Susie.

Good morning everybody.

I'm here with Ken Powell, our CEO, Don Mulligan, our CFO, and Jeff Rotsch, who is Executive Vice President and Head of Our Worldwide Sales Organization and I'm going to turn the microphone over to them in just a minute.

Before I dive into my usual housekeeping items, let me first thank you very much for joining us on this call, and for your interest in General Mills.

We do appreciate it.

And I also wish all of you a wonderful holiday season.

Our press release on second quarter results was issued over the wire services earlier this morning and it's also posted on our website if you need a copy.

We posted slides on the website too.

They support the prepared remarks we're going to make this morning and those remarks will include flames forward-looking statements based on management's views and assumptions.

The second slide in today's presentations lists factors that could cause our future results to be different from our current estimates, and with all of that I'll turn you over to my colleagues, beginning with Don.

Thanks, Kris.

I'll add my thanks to all of you who have joined us today.

As you've seen from our financial results released this morning, General Mills' resilient portfolio of leading brands continues to deliver strong growth.

I'd summarize today's key points this way.

First, our sales continue to grow even as we lap robust prior year increases.

Sales growth in the first half was ahead of our plan, led by good gains in our US Retail segment.

Our margins improved in the second quarter, Driven by a number of factors including lower input costs, good performance at our plants, and continued holistic margin management or HMM benefits.

We're adding $0.12 to our EPS guidance, bringing the range to $4.52 to $4.57 per share, before any mark-to-market effects.

This represents growth of 14 to 15% from comparable earnings of $3.98 per share in fiscal 2009.

As we move into the second half of fiscal 2010, we're making additional investments in marketing and merchandising programs to fuel continued growth of our brands this year and into fiscal 2011.

We've announced a second increase to our 2010 dividend.

The new quarterly rate of $0.49 per share brings our 2010 expected dividend per share to $1.92, A 12% increase from last year.

Slide five summarizes our second quarter results.

Net sales grew 2% on top of 8% sales growth last year.

Segment operating profit grew 13%, including a double-digit increase in media spending.

Net earnings totaled $566 million, and diluted earnings per share increased to $1.66.

These results include a net gain related to mark-to-market valuation of certain commodity positions and grain inventories.

That non-cash gain totaled $0.12 per share this quarter, significantly better than the $0.49 reduction of EPS recorded in the year-ago period.

Excluding the mark-to-market impact from both years, as well as the gain on the sale of Pop Secret in last year's second quarter, diluted earnings per share grew 13% to $1.54.

Our topline performance was a key driver of this growth.

Slide six summarizes net sales by segment on an as-reported basis.

US Retail sales rose 4%, on top of 10% growth in the same period last year.

International sales grew 7% as reported.

Growth here was helped by favorable foreign exchange, the price realization mix also contributed to the sales increase.

Our Foodservice segment reported a 16% decline in net sales.

But that includes the impact of divestitures and mix pricing tied to wheat markets that are currently below year-ago levels.

Underlying performance in this business segment was actually quite strong, well ahead of industry trends.

Ken will talk more about that in a few minutes.

Slide seven shows pound volume contribution to net sales growth, with the impact of divested product lines noted below the chart.

On a reported basis, pound volume contribution to net sales was flat, with divested products reducing growth by 2 points.

Pound volume for the US Retail segment was up 2%.

Pound volume for International was flat, but that includes a 2 point reduction from divested businesses.

And divested businesses significantly reduced volume in our bakeries and Foodservice segment.

Pound volume was down just a few points on a comparable basis, again, ahead of overall industry trends.

Gross margin recovery contributed significantly to our second quarter results.

Our gross margin as reported was 42.8%.

As you see on slide eight, that's up sharply from last year, with input cost inflation and mark-to-market effects significantly depressed our margin.

Excluding mark-to-market effects, our gross margin was 41.2% for the quarter.

Compared to just over 37% a year ago.

Several factors are contributing to this underlying margin improvement.

Our commodity and fuel costs were below year-ago levels in the quarter.

We started this fiscal year with an assumption of very low inflation and our supply chain input costs.

However, we've been able to hold cost below our planned levels through the first half and we no longer expect to see input cost inflation for the fiscal year in total.

We're running more cases through our plants which creates volume leverage benefits.

Our mix continues to be favorable.

And our HMM efforts are generating accumulating benefits with good productivity savings from logistics in particular during the second quarter.

We continue to reinvest funds generated by gross margin improvement to drive topline growth.

Our media spending was up 37% in the second quarter, as we continue to target a double-digit increase for the year in total.

We're focusing our spending on high ROI ideas with particular emphasis on multi cultural consumers and digital marketing, and we're investing strongly in International markets to build our global brands.

Slide ten shows our segment operating profit results for the quarter.

Combined segment profits grew to double-digit rate, reflecting good gains by both US Retail and bakeries and Foodservice.

International profits declined as reported, but once again that's a reflection of negative foreign exchange effects and divestitures.

Excluding these factors, international operating profits would show a strong gain, including a double continue it increase in consumer marketing spending.

After tax earnings from joint ventures grew 15% to $38 million for the quarter.

On a constant currency basis, sales for our CPW joint venture grew 4% and Haagen-Dazs Japan sales grew 1%.

Before I shift to the balance sheet, let me quickly cover a few additional income statement items.

Lower debt levels reduced interest expense by 8% for the period.

We expect full year interest expense to be comparable to 2009 levels, consistent with our first quarter guidance.

The effective tax rate for the quarter was 33.1%, basically in line with year-ago levels.

We've modified our annual outlook slightly, and now expect our tax rate for the year to be between 33.5 and 34%.

In the second quarter, we recorded a $24 million non-cash charge for exiting some underperforming US Retail products.

We're still targeting $30 million of restructuring expense for the year in total.

Turning to the balance sheet, on slide 13, you can see that our core working capital grew 7% in the quarter, driven by a decline in accounts payable.

That decline resulted from the timing of the quarter end with the Thanksgiving holiday.

Accounts receivable inventories were up roughly in line with sales growth.

Cash from operations was up sharply through the first half, to $987 million.

We used some of our cash for capital investments to support our business, and then prioritized returning cash to shareholders through share repurchases and dividends.

Our average diluted shares outstanding were down 2% in the quarter and 3% for the first half.

As I mentioned earlier, we've announced our second dividend increase for the year, bringing the expected fiscal 2010 full year dividend to $1.92 per share, a 12% increase from 2009.

That represents a yield of 2.8% at recent share prices.

Which we think is pretty attractive given the interest rate environment.

General Mills' annual dividend has grown at strong rates over the last five years as shown on slide 15.

We paid dividends without interruption or reduction for 111 years and our goal is to continue increasing dividend as our earnings grow.

We have an expanding track record of consistent, superior earnings growth.

Slide 16 shows our diluted earnings per share progress over the last five years, adjusted for certain items that affect the comparability of our results.

Our new fiscal 2010 guidance of $4.52 to $4.57 per share, before any impact from mark-to-market effects represents a 14 to 15% increase from comparable 2009 results.

The fundamentals of our business are strong and we're delivering good performance on both the top and bottom line.

We're committed to driving continued gains, focused on the five growth drivers that have been key contributors to our recent performance.

One of those key strategies is partnering successfully with our customers.

I would now like to turn the microphone over to Jeff Rotsch, who will describe how we're collaborating with retailers today.

Jeff?

Thanks, Don and good morning everyone.

I'm pleased to have this chance to talk with you about how we are partnering with our retail customers to lead profitable growth and food sales.

Let me start with a little background on our sales force.

We have nearly 2,000 sales professionals, some here at our headquarters, some in our region sales office and more than 600 that are part of our national retail organization.

This last group are the people who are in stores every single day.

When you consider that our US Retail segment generates over $10 billion in annual sales, we average out to around $5 million in sales per employee.

So it's a very efficient group.

And an experienced one too.

Our typical salesperson has 11 years of service with General Mills.

These folks have expertise in 25 categories across three temperature states, refrigerated, frozen and shelf stable.

With this breadth of products touching many areas of the store, we have a significant impact on driving profitable growth for our retailers.

Our Retail Partners are continually evolving.

Ten years ago, traditional grocery chains represented close to three-quarters of our US Retail business.

Today, they're 60%.

And new formats from mass merchandisers to club stores to dollar stores and drug stores, now account for 40% of our US Retail business.

There's a reason all these retailers carry food.

It drives traffic into their stores.

Slide 21 shows the number of annual shopping trips per household for a variety of consumer products.

As you can see, consumers shop for food far more often than other categories shown.

Food's also profitable.

Slide 22 shows you that.

Based on a recent study by an industry consulting group, food products generate nearly $7.50 of profit per square foot in a typical grocery store.

That's more than twice the profit generated by our nonfood categories, and General Mills top ten categories are even more profitable.

Driving more than $8 of profit per square foot.

So our customers want to work with us to increase growth in these key categories in the store.

The categories we compete in lead sales growth for our retailers, because they are large and on trend with consumer demand for taste, health, convenience and value.

Slide 23 summarizes retail sales for our largest categories in just measured channels alone.

Each of our top ten categories generates over $1 billion in annual sales, and our brands hold significant dollar share positions within these categories.

Making us the number one or number two branded player in each of them.

Our categories are also growing faster than average, through the first half of the fiscal year, sales in the categories where we compete grew 3%.

That really outpacing total food and beverage sales.

And it's important to note that underlying this good sales growth is good, solid volume growth.

As shown on slide 25, our categories are posting steady growth in the number of units sold.

Our businesses are also driving category growth across many retail channels.

Slide 26 shows our deliveries, measured in equivalent cases, are growing in a variety of retail outlets through the first half of the fiscal year.

While our volume at traditional grocery stores is growing at low single digit pace, our business in super centers, club stores and discount drug and dollar stores is growing faster, up double digits.

As a branded food leader we really need to support retailers and drive growth in three ways.

First, we need to drive sales growth on our established products.

These are the items that our consumers appreciate for their high quality and regularly put them on their shopping lists.

Second, we need to innovate to successful new products that meet changing consumer needs.

We've had some great wins this past year with Macaroni Grill Dinner Kits, Pillsbury Savorings frozen appetizers, and Yoplait Delights yogurt parfaits.

We've also introduced new varieties of existing products like high fiber Progresso soups and Banana Nut Cheerios, which is the best-selling cereal introduced in calendar 2009.

And third, we need to invest behind our established and new products with strong levels of advertising support.

Advertising increases brand awareness and communicates news on our products, which ultimately drives traffic into our stores.

Our salespeople leverage our products and advertising to increase merchandising and product distribution.

Our national retail organization that I mentioned earlier works directly in our customers' stores, ensuring they have the right product selection on the the shelves, and the right products merchandised in order to optimize sales.

We also have a broad portfolio of tools and capabilities.

We provide category and shopper insights to retailers through tools like our virtual store, where we can simulate the shopping experience with a variety of shelf arrangements.

Our Shopper 360 tool is a survey we conduct to identify how and where different types of consumers shop.

These tools help our customers better understand their shoppers, and determine the most effective product selection and store configuration.

Our promotion and pricing analytics determine the best merchandising strategies to attract consumers, and we have some great merchandising platforms such as "Box Tops for Education" and our tie into the popular TV show, "The Biggest Loser.

" These capabilities combined with strong brand building advertising and new product innovation are how our customers really drive profitable growth.

As we bring news to our categories and invest behind our brands, we're driving baseline or our non-promoted sales growth.

The most profitable products for retailers are the ones that sell for full price.

We are the industry leader with a 12% share of baseline food sales.

And our baselines have been growing around 2% in the last 12 months, well outpacing total food and beverage categories as well as the other top 10 branded manufacturers.

When it comes to merchandising, we have been very disciplined in our promotional spending.

As a result, we have been able to decrease trade cost per case in each of the past four years.

We entered this year with a goal to hold our trade cost per case flat to last year but as you know, promotional activity has been increasing in the industry.

As we look out in the second half, we see a few product lines where we need to increase our merchandising activity in order to protect market share.

As a result, we now expect our overall trade costs per case will be up modestly over last year but will still be below rates from two years ago.

Our sales capabilities have been particularly valuable lately as retailers have increased their emphasis on store brands and SKU rationalization efforts.

Despite these retailer actions, we've actually increased our distribution as we introduced successful new products and have held distribution on our established brands.

Over the last 52 weeks, our total points of distribution were up nearly 2%, and we're the only top ten branded manufacturer to post distribution growth as shown on slide 32.

We're also a growth leader for our customers.

General Mills accounts for more than 3% of total food and beverage sales in Nielsen measured channels and the latest 52 weeks we generated more than 4% of industry sales growth.

Well ahead of the majority of the top ten branded food manufacturers.

We've also been getting positive feedback from our customers on the strength of our brands and our sales force.

In the annual Cannondale survey, retailers rated General Mills number four among our peers.

More importantly, we've seen strong improvement in our composite score.

It's up 5 points over the last two years.

This Cannondale survey asks retailers to evaluate manufacturers on eight different criteria.

One of the questions they ask is which manufacturer offers the best combination of growth and profitability, and we are very pleased to say that we are rated number one on this measure this past year.

We'll be working to raise our scores on all of these metrics in the years ahead.

And I'm confident we can because we have great brands, great tools and capabilities, and I think have the best people to partner effectively with all our customers to grow both our businesses, ours and theirs, very effectively.

With that, let me turn it over to Ken Powell.

Thanks, Jeff and good morning to one and all.

Clearly, the talent and the skills of our sales force are a competitive advantage for General Mills.

As you've heard both Don and Jeff describe, our businesses are performing very well as we move into the second half of our fiscal year.

Consumers are shopping our categories, and appreciate the nutrition, the convenience, and the value of our leading brands.

Our input costs are coming in a bit better than planned.

We continue to reinvest in our businesses at increasing levels.

Advertising spending was already planned to be up by double digits and we're adding more.

And as Jeff described, we're making some limited tactical increases in trade spending in response to heightened competitive activity.

Foreign exchange is a bit less of a drag than we planned but it will continue to impact our reported results for the year.

Remember that back in July we told you that roughly 85% of our FX headwind relates to transaction effects and we hedged some of this exposure for fiscal 2010.

All in, the strength of our overall performance has allowed us to raise our earnings guidance for the full year.

Our US Retail business is performing particularly well, with sales up 5% through the first half of the year.

That's on top of 11% growth in the same period last year.

Big G is leading US Retail with sales up 10%.

Key baking season has been good for our Pillsbury and baking division, driving 5 and 4% sales growth for those divisions respectively.

Snacks and Yoplait are up 4%.

Sales for meals are up 1% year-to-date, despite really tough comps.

And while Small Planet Food was down 4%, reflecting soft organic food industry trends, our Cascadian Farms cereals and Lara Bar line recorded good market share gains.

This good net sales growth has been supported by good volume growth.

Over the past year and-a-half, we've seen above average price increases taken by food manufacturers to deal with sharp input cost inflation, then followed by little to no pricing in recent months.

But as slide 39 shows, we've posted steady volume gains throughout this period.

This good underlying volume performance has been a key to our results.

We'll work to keep our sales and volume momentum going with a variety of marketing events coming in the back half.

Once again, General Mills has teamed up with "The Biggest Loser" on our pound for pound challenge.

For every pound consumers pledge to lose, we'll donate enough money to deliver a pound of food to Feeding America food banks.

Totino's is a sponsor of the Winter Tour of Action Sports.

This April marks the 44th Pillsbury Bakeoff, America's longest running recipe contest.

And Shrek is back this spring in another movie and we'll tie in with a variety of products from cereals to snacks.

We also have a gone lineup of new product introductions planned.

Wheaties Fuel will hit store shelves in January and so will Chocolate Cheerios, our latest addition to our best-selling Cheerios franchise.

Yoplait will be introducing a line of Greek-style yogurt and Nature Valley will be bringing chocolate to the line for the first time here in the US with a new dark chocolate granola bar.

We also expect continued good contributions from many of our first half launches, products like Yoplait Delights yogurt and Wanchai Ferry frozen entrees are exceeding our expectations and getting great consumer response.

Moving into the second half, we expect continued good growth for our US Retail segment.

Our categories are growing.

Our plans for the back half include additional new product innovation, consumer market and merchandising reinvestment.

For the full year, we're targeting low single digit net sales growth, including the impact of one less selling week in fiscal 2010.

And we believe we'll deliver operating profit growth well above our original plan.

For our bakeries and foodservice segment, reported results certainly don't tell the full story.

Net sales decreased 16% in the first half.

But divestitures accounted for more than half of the decrease year-to-date, and indexed pricing tied to wheat markets drove most of the rest.

The operating environment for this business segment is still challenging.

We remain focused on the customer channels and products that have the best opportunities for growth.

As a result, our sales with Foodservice distributors were down only modestly in the first half and our sales in convenience stores grew 4% as we gained distribution in this channel.

In terms of our branded products, cereal sales matched year-ago levels.

Sales for yogurt are up 5% and snacks are up 7% through the first half.

This very deliberate mix strategy of focusing on our branded products and the best channels is working.

Over the past several years, we have grown our operating profit for this segment and so far this year, favorable mix including the absence of divested businesses, coupled with lower input cost and strong performance across our supply chain has driven significant margin expansion.

I don't think we'll hold this strong pace for the full year, but we do expect to show good margin expansion for this segment in fiscal 2010.

For the full year, we'll maintain our strategy of focusing on our branded products and the customer segments with the best potential for growth.

We still expect full year sales and volume to be below last year's, due to divestitures, lower index pricing and the continued weakness in the industry.

However, earnings are now expected to exceed 2009 levels, and longer term we still like our growth opportunities for the $0.5 trillion US market for food away from home.

Outside of the US, our business is generating good growth.

In total, International segment net sales were up 4% through the first half.

on a constant currency basis.

Sales in Canada grew 10%, excluding currency effects, led by strong cereal performance.

Grain snacks are also performing well.

Sales in Europe matched prior year levels through the first half.

as increases in grain snacks and old El Paso Mexican products were offset by slower sales for Haagen-Dazs ice cream.

In Latin America, first half sales grew 2% with good performance on local brands such as La Saltena pasta and Diablitos sandwich spread.

That growth would be even stronger if the you excluded the impact of divested businesses in this market.

And in the Asia-Pacific region, sales were up 6% in the first half.

Sales in China were particularly strong with solid contributions from Wanchai Ferry Dim Sum items and Haagen-Dazs Moon Cakes.

Let me say a quick word also about our cereal partners worldwide joint venture.

Net sales here are up 3% through the first half, on a constant currency basis.

Economic challenges in Europe continue to have an impact on this business.

However, we're seeing good growth in France and other Southwestern European markets.

Australia and Mexico also are performing well.

CPW remains focused on its core cereal brands and is supporting them with increasing marketing investment.

In addition, they continue to expand their reach in emerging markets such as Russia and Southeast Asia, where they already hold solid share positions.

We expect CPW to post volume and share gains for the full year, and longer term we see continued category growth potential as per capita cereal consumption increases in worldwide markets.

So for our International operations in total, foreign exchange will continue to have a negative impact on our reported results, but on a constant currency basis, we continue to target mid single digit sales growth and double-digit operating profit growth for the year.

Let me summarize my comments this morning by saying that our business model continues to work very well.

It starts with holistic margin management.

Our unique discipline of leveraging productivity, mix and price to offset input cost inflation and protect our margins.

Keeping our margins healthy allows us to invest increasing levels of consumer marketing to support our brands.

You just heard Jeff describe how we're leveraging our great brands and sale expertise to drive profitable growth for our customers.

All of these things combined are helping us fuel sales growth for our brands and our categories around the world.

We're beginning to turn our thoughts to fiscal 2011.

Our additional advertising and merchandising investments are expected to fuel sales growth for the remainder of this year, and provide momentum going into 2011.

As we have told you before, we think the current operating environment represents a great time to innovate.

We're investing in new product development to keep our innovation pipeline full, and we've got a good lineup of new items coming next year.

While input costs are currently favorable, we don't expect that to be a long-term trend.

We believe we'll see renewed input cost inflation in fiscal 2011, and we expect inflationary pressure on ingredients and energy over the longer term so it's critical that we've got a great pipeline of HMM initiatives in place to help offset future inflation.

In total, our brands and categories are performing well.

They've proven to be resilient in the current economy, and we expect their strong performance will continue as the economy improves.

So we see excellent prospects for continued top tier sales and earnings growth in the years ahead.

You'll hear more about our plans for the remainder of this year and for 2011 at several upcoming events.

On January 8th, Don Mulligan will host our mid-year update in New York.

Joining Don will be John Church, our Senior Vice President and Head of Supply Chain Operations.

John will be talking about our HMM initiatives.

And Ian Friendly will give you an update on our brand-building initiatives in US Retail.

Then I'll see you all at Cagney for our breakfast and presentation on February 16th.

And then finally, please mark your calendars for an Analyst Day in Minneapolis in late June, where we'll outline our growth plans for fiscal 2011.

We'll be sending you more information on that event in the spring.

So that concludes our prepared remarks, and we'll now open the call to questions.

Thank you.

(Operator Instructions).

One moment, please, for the first question.

Our first question coming from the line of Ed Aaron from RBC Capital Markets.

Please proceed with your question.

Great.

Thank you.

Good morning everybody.

Good morning.

Just hoping you could maybe elaborate a little bit first off on the meals category.

Looks like that category was down maybe a little bit in the quarter.

And within that, could you talk a little bit about what you're seeing in soup.

I think the press release you talked about actually seeing good growth in that part of the meals business but the recent sell-through trends have been fairly weak, so just trying to reconcile that.

Thanks.

So Ed, your second question was on which segment within the category?

Soup, yes.

Okay.

So we had a low single digit growth in the meals category for the quarter and that was in comparison to a very tough comp and I think one of the issues in the category is, as you said, for the overall segment is the soup category which is running down some year-to-date, and we see the issue there fairly tactically at this point, as we compare particularly this quarter to the quarter a year ago.

We had very high levels of support, concentrated in the second quarter, both media and there was -- and trade promotion and we have a much more balanced plan this year that really covers the full soup season but the spending levels are down some from the second quarter a year ago and we think that that explains much of the difference.

We continue to feel the soup category and the ready to soup category is a great place for consumers, responds really well to innovation.

We're very happy with our high fiber soup launch.

We've got new advertising on the air which perhaps some of you have seen which is very focused on the taste benefits of soup and of Progresso soup and so we see kind of that year-over-year comp as the issue right now.

There may also be some overhang from the negative advertising that we saw in the category last year and we expect that to recede over time and we -- this is a big category and a great consumer category and so we're quite optimistic going forward.

Thank you.

Just as a follow-up, could you maybe elaborate a little bit, when you talked about the need to dial up the promotional spending, just given the environment, can you elaborate where you're seeing that perhaps the most, just category-wise?

Well, we don't want to -- it's selected categories and that will unfold as it unfolds.

But I think really I would just repeat what Jeff said, which is we monitor this obviously.

We want to be in the competitive zone from a merchandising standpoint, and we feel that there are some categories where we're not fully there right now.

So on a very selected and a very precise basis, we're going to add some merchandising but I would say the total impact for the year, if you wanted to look at our merchandising cost per case, I mean, we're talking about a few cents of increase.

So it's -- this is very careful and very selected.

Jeff, would you want to add anything?

I think you've got it right.

I think there are some key categories, we want to make sure that we're competitive in but nothing really out of the ordinary, Ken.

Just really reacting to day-to-day pressures in the categories.

Thanks.

I'll pass it on.

Thank you.

Our next question coming from the line of David Palmer from UBS.

Please proceed with your question.

Thanks.

Good morning.

Your gross margins are reaching that 40% type level that you had about six years ago and that doesn't seem to be a long-term barrier, but perhaps you could give us some considerations about long-term gross margin potential.

What is your -- given your base case of steady inflation in fiscal 2011 and beyond, how are you thinking about that potential and what things can we think of that could help us get comfortable about a long-term growth in that number?

David, this is Don.

We are very pleased, obviously, with our gross margin performance.

As you said, we recovered back to where we were several years back.

As we look forward, as Ken alluded to, whether you look at our F 2011 expectations or longer term, we see a return of inflation.

We believe that our HMM initiatives will be substantive enough to offset that inflation, and as we think about margin improvement it's going to come from a couple different areas.

One is mix management, which has been a key contributor to us for the last several years.

And that's mix within the divisions within the segments and certainly across the segments.

The second is that we continue to gain scale within our International business and as we've highlighted before, if you look at the main growth drivers internationally, our key platforms of cereal, healthy snacking, soup, premium ice cream and the convenient meals, those all have operating margins above our Company average, and will certainly help average up our results as they grow.

And lastly, in our bakeries and Foodservice division, the restructuring that we have had under way for the last several years, which we are clearly seeing the benefits of in this year's results, will continue to hold.

We don't believe that the performance this year in our bakeries and Foodservice is a one-year phenomenon.

We think we're reaching a new base level for that business to grow from and as Ken alluded to, as the economy improves and we get better trends within the industry we'll benefit from that as well.

Those are probably the key aspects that I would mention that gives me confidence that our gross margins will continue to hold and expand slightly and give us an opportunity to reinvest back into the business, both in terms of our brand support, our sales capabilities and our International infrastructure.

Small, separate question.

Do you anticipate that you and perhaps even the competition are anticipating that the consumer is going to be more willing to try new things this next year and that we're going to see maybe not in the first calendar quarter of 2010, but perhaps as early as then and increasing through the year that pace of innovation pick up as folks maybe held back their pipeline this year and are letting it out a little bit more next year?

How should we think about that?

David, our view, I think as you know, our view on innovation in this environment has been that it's been a great time to innovate and our pace of new product innovation, has not declined at all during the last couple of years and really we've had some terrific successes really going back over the last three years and this year's been no different.

Yoplait Delights, which we launched this past summer, we thought it was a great idea and it's well ahead of expectations.

Wanchai Ferry frozen meal kits has been a very strong success for us.

So, we've got new cereals coming here in January.

Wheaties Fuel and Chocolate Cheerios which we think is going to be a very strong entry.

We like the looks of the Greek yogurt segment which is still emerging but becoming strong on either coast and we think we've got a great tasting entry in Yoplait Greek.

So the direction that we've given to our US and our International teams on innovation is full steam ahead, and we think that that's really -- it's been a great time to have that orientation.

Thanks.

Thanks, guys and congrats.

Thank you.

Our next question coming from the line of Vincent Andrews from Morgan Stanley.

Please proceed with your question.

Thank you and good morning everyone.

I guess my question maybe relates to a little bit what the section that Jeff was -- came on the call for.

I'm just curious, you highlighted the huge channel migration that's been going on for a while now but we're also seeing some of those traditional retailers starting to report kind of challenging quarters as they're lowering price themselves, trying to keep traffic in the store.

What are you hearing from them in terms of their view on how they want pricing to proceed on an ongoing basis?

Are they comfortable sacrificing that margin themselves or are they starting to come to the manufacturers and asking for give-backs.

I think if you analyze and get in a little deeper on what's going on a lot of those retailers, perimeter pricing kind of follows commodities.

When I talk perimeter, I'm talking dairy, meat, bakery, et cetera, produce, so forth.

That's really where some deflation has hit them.

I think taken their top line down.

Center store, which is really where we compete, has been fairly stable is what I would say and very good sources you saw in my presentation of their profit.

So they are continuing to look to us to bolster that whole area and make sure that we continue to bring innovation to them and really drive that center store profit really which has been carrying them.

The perimeter has been a very competitive, tough area and as I said, that deflation has really hit them there and actually hurt their top line a little bit.

You think it's a completely bifurcated issue, center versus perimeter.

Completely is probably an overstatement.

I would say it leans that way extremely heavily, though.

Thank you very much.

The thing I would add to that, Vincent is I would say 90% of the conversation that we have with our retail partners is about growth and they really want to talk to us about their -- particularly their center store categories because that's where we focus.

They want to talk about what we can do together to drive growth, what kind of innovation we can bring to excite consumers and bring them into those categories and I would say that that is the vast, vast majority of the conversation with our retailers.

Our mantra we take, Vincent, to these customers is leading profitable growth, how do we lead their profitable growth in these categories that are growing beyond their expectations, so that's really what we're trying to do.

Really not a price point conversation.

We've been hearing a lot of stuff that innovation was becoming very price point oriented.

It has not been.

We partner with them and bring them a lot of other capabilities which I touched on today, intellectual capabilities to really drive that top line and drive that bottom line for our customers so that's really what we try to do.

Thank you very much.

Thank you.

Our next question coming from the line of Chris Growe from Stifel Nicolaus.

Please proceed with your question.

Hi, good morning everyone.

Hi, Chris.

Good morning, Chris.

Hi.

I just had a couple questions for you.

Wanted to follow up on a couple of the questions we've had and kind of in relation to your promotional spending.

November seemed to be a month that was quite weak across a lot of the IRI data.

Just curious if you saw that same degree of weakness and maybe if you had a better explanation for kind of what happened in that month.

Maybe it's just a month and a blip.

Do you see it as a trend where the consumer's kind of belt tightening if you will and if that's what's driving some of your promotional increases.

I'll start, Kris.

Good morning.

Jeff will jump in.

November for us was -- our shares have actually over the last 12, six, three, however you want to look at it, our shares have been very constant, sort of modestly up over the course of the year, running around 25.

November was a very challenging comparison for us for a variety of reasons, having to do the promotional concentration and planning that we had last year versus this year, so while our share was very much in line with what we've seen over the past many months, November it was down from a peak a year ago and frankly we expected that and planned for it.

Our merchandising plan is very balanced over all four quarters this year and we knew November would be tough for us.

But as we go into the second half, I mean, we have continued very good levels of support and good merchandising activities and so we expect to see good share development and continued good top line through the end of the year.

I would just -- this is Jeff, Kris.

I'll just chime in here.

Our categories in the month of November were actually up almost 1%.

The issue was last year was our largest month in terms of comp on the consumer take-away side.

So we were up against a very tough month but our categories continue to do well and we did quite -- we did fine within that.

So we have a very balanced plan as Ken said and I think what you'll see is a good run out here the next six months for us.

Doesn't sound like you see much of a change in the consumer that may have driven that weakness.

That's I guess encouraging.

Two quick ones to follow up, if I could.

In terms of the gross margin, Don, you gave some good breakdown last quarter of kind of in rough terms, half the gross margin was driven by volume and mix.

Could you give that same degree of disclosure this quarter as well, kind of given that big improvement in the gross margin?

Certainly.

We had a significant drop in our cost of sales this quarter, about 70% of that, little over 70% was due to the change in mark-to-market where we had a credit this year and a charge last year.

Of the other 30%, about two-thirds of that was ate and mix which was really driven by the strong plant performance, the strong HMM initiatives we are seeing and favorable mix I referenced earlier and the balance is the reduction in COGS is from the divested businesses that we exited last year.

So that's the breakup.

The biggest single component was the change in the mark-to-market.

Okay.

And just one quick one, if I could.

Could you tell us how much the FX negatively affected your International division from a profit standpoint?

That was obviously some of the transaction costs are still a negative for you given the translation turned positive.

As we said at the beginning of the year, we expected a $0.15 EPS negative impact from foreign exchange both transaction and translation.

As Ken referenced today, a portion of that, a significant portion of that transaction was hedged so we continue to see that coming through.

We expect to be a few pennies better than that.

We still expect a negative drag about $0.12 to $0.13 for the full year which is consistent with what we saw at the end of the first quarter.

That sounds great.

Thank you.

Thank you.

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

Please proceed with your question.

Hi.

Good morning, everybody.

Hey, Eric.

Hey, Eric.

Okay.

A couple of questions.

I guess the first one to Don.

It's not exactly clear to me why interest expense should be flat.

I mean, you're running right now at a $360 million run rate for the year versus 390 last year so how exactly are you assuming that rates go up so much that you're going to be flat year-over-year?

Eric, well, there's a couple of things I would point out.

One is that last year we did have a fairly significant reduction in our debt in the second half that we're kind of rolling over now as we get into it so the reduction in our total debt balance will probably be less in the second half than it was in the first, and the other thing is given the long-term rates, we are looking at potentially terming out some of our commercial paper which would have an impact on our interest expense this year.

Okay.

I guess next question to Jeff.

The thing that -- obviously the team you manage has been very strong, the results speak to that.

But the one thing that I always have difficulty with is it seems like every single category that every Company talks about is the most important category to the retailer, both in terms of sales and profit and yet the industry is facing pressure from retailers to cut SKUs and I think you guys saw that in Pop Secret and your decision to exit out of that business.

So I'm just kind of wondering what categories from your perspective, maybe you're not involved in them, but what categories are seeing pressure from the retailers because they truly don't stack up in the top quartile or what have you?

Yeah, part of that was really in my pitch where I went through food versus the health and beauty aids and nonfood and so forth.

There is pressure though literally in every category.

There's SKU rationalization going on by categories.

The customer cuts across the store to make sure each of those SKUs is donating profit to the customer and the customer's bottom line.

But I did show on that side that our categories do contribute and that really is a very good study we did on a per square foot basis with an outside Company.

But if you look at health and beauty aids, paper packaged goods, et cetera, a lot of these that are bulky, that take a lot of space on the shelf that don't have the turns or the margin with those turns to contribute profit, those are the ones that they've been skinnying back on.

Our categories, thank goodness and part of it is due to our good products we have on there but part of it is really due to we're fortunate that we are in categories that are still growing quite nicely and still contributing I'd say a very good bottom line profit.

So they have looked across our categories.

SKU rationalization has gone across cereal, a number of different categories and we actually have fared quite well.

I showed you the distribution where we actually have gone up a number of items this year, not down.

We've been fortunate to continue to sell a good mix of products that drives a lot of product for them.

The only thing I would add, Eric, is that if you go back many years through heavy proliferation of flavors and line extensions and a lot of these categories that we were in, General Mills as usually the leader in those categories, we tended to be -- and I think you would find this very typically across many categories.

We tended to be the guy that was squeezed on shelf space so we were often a little bit undershared versus how we actually turned.

Because they were trying to squeeze in some marginal items and so what we've said really very consistently as we've had this conversation with retailers and as you've asked us about over the last year is we really thought that this effort by retailers to prune their categories and get it down to the high turning items would benefit us and that in fact is what you're seeing.

Really I think the last several times we've reported to you we've been able to tell you that our distribution is actually up and I think, Jeff, that that's true.

That's true.

For the latest quarter.

It is.

Yet again so this is an environment we think where with leading brands that turn well we will gain distribution and that is exactly what is happening.

The only other thing I would add, across all categories, those brands that are number three, four, five, et cetera, they are the ones that are really scratching and scrimping and trying to stay on the shelf.

It's been a very difficult time for them.

If I could ask one more follow-up, Ken.

I'm asking you to put on more of an industry hat than a General Mills hat.

It seems like the concern among investors, at least what we hear, is every Company in calendar 2010 is talking about an absence of pricing but some volume driven growth with promotion kind of backing that up.

And so what I hear from investors is the fear that well, if everybody's building in volume growth assumptions and everybody's got this big gross margin tailwind to spend back into the business, why isn't this going to be a kind of a fight to the bottom?

And so maybe you can comment on that as to why investors should not fear that kind of scenario in 2010?

Well, what we see has happened over the last couple of years was a period of very high inflation a year ago, really the highest in many, many years, followed by a recovery, a falloff, a return to more -- to normal prices this year, which -- so which has meant really zero inflation.

So you've had that up and then that snap back down and of course this year that's meant margin recovery and significant margin expansion, which in some categories has led to a somewhat more intense promotional environment.

But as we look, as we look going forward, we think we're going to move to a little closer to normal.

We think that we're -- we're planning on sort of business model in line with business model growth where we have low single digit volume growth which we would typically see year in and year out with potentially some pricing.

We expect to see a return to some inflation in our input markets.

We're already seeing that in some areas.

We're seeing dairy prices, for example, are starting to ease up some and coincidentally as we see that, we're seeing the promotional intensity in the yogurt category ease off and so that's really the scenario that we see, low single digit levels of volume growth, a little bit of pricing, a return to some inflation which we think we're well positioned to offset with our HMM initiatives and that's the kind of environment that we can manage very, very well through.

Okay.

Thank you.

I'll pass it on.

Thank you.

Our next question comes from the line of Alexia Howard from Sanford Bernstein.

Please proceed with your question.

Good morning everyone.

Good morning, Alexia.

Hi.

Just wanted to ask about the distribution increase that was on the chart in the presentation.

I think it was up 1.8%, and I think that's a Nielsen metric.

Could you describe what that -- where that's -- what product categories, what kind of outlets you've been able to get that distribution increase in and is there more of that to come?

That is a Nielsen metric so that is measured channels.

I would add that non-measured channels has been even stronger than that for us as our number of SKUs carried in those non-measured has gone up even faster so I did not talk about that.

That has really been across a number of our key categories.

Cereal has been a beneficiary of that.

Grain snacks have been a beneficiary of that.

We've had some very strong distribution gains across a number of those categories.

My sense is that will continue for us.

We have number of new items we are introducing.

The good news is our established brand items are turning quite nicely so they are not in jeopardy right now.

We have a pretty good track record over the last five years of adding distribution year on year and my sense is that will continue, Alexia, so that's my sense.

Okay.

Great.

Thank you very much.

I'll pass it on.

Thank you.

Our next question comes from the line of Ken Zaslow from BMO Capital Markets.

Please proceed with your question.

Hey, good morning, everyone.

Hi, Ken.

Good morning, Ken.

I just have a couple points of clarification.

Don, when did you the breakdown of the cost of goods sold you didn't mention anything about commodity prices being lower or higher.

Can you just ensure that that's how I heard it?

I just want to make sure that -- I think you said two-thirds rate mix and one-third divested, there wasn't any comment on commodities.

Within rate would be where we capture the inflation and the commodity movement so it was part of that rate and mix figure that I mentioned.

Okay.

In terms of looking into 2011, when you guys say prospects excellent for continued top tier growth, and earnings growth, I guess that's -- is that fair to imply that you're looking to say that your long-term business model should still be appropriate for 2011?

At least that?

Is that a fair commentary?

Very much so.

That's absolutely right and we believe strongly in the strength of that model and that's our starting point.

Okay.

And then my last question is Jeff, you talked about different channels.

Are there certain channels which General Mills has under-penetrated or where there might be some more outside gains in terms of gaining share or how do you see the different channels laying out over the next couple years?

Yes, I mentioned in my comments that we've seen high single digits along -- across some different channels that we have not been as strong in in the past.

Club channel we've had around for a long time before we've had a a good breakthrough there with some new items getting in, some good rotations going in.

Our club business is up double-digit.

Our drug, dollar and discount business is also up double-digit and those are channels that in the past we probably have not spent as much time on that we have really focused on here over the last four or five years and really is growing nicely.

I see that growth continuing as we move forward.

So my sense is we will continue to add items there and get rotations and turns in a lot of those alternate channels that now are really becoming very main stream for us.

So the patterns of your growth that you showed in the exhibit is similar to what you would expect going forward?

Yes, it is.

Great.

I appreciate it.

Thank you.

Thank you.

Our next question coming from the line of Todd Duvick from Banc of America.

Please proceed with your question.

Good morning.

Good morning.

Wanted to ask a little bit about the balance sheet.

According to our calculations your leverage of 2.2 times is down not only from a year ago but also I think it's about the lowest it's been since the Pillsbury acquisition.

And Don, I heard your comments about terming out some commercial paper earlier.

Can you just kind of update us on your thinking in terms of the balance sheet and it seems like you've got some dry powder that you could use for acquisitions.

Can you tie that into how you're thinking about acquisitions and also potential share buybacks?

Sure.

Well, as we said at the beginning of the year, on a I'd say a short-term tactical basis we were hooking to pay down some debt this year to ensure that we get to the ratings, both the ratings and the outlook that we want from all three rating agencies and we're confident that we'll do that as this year unfolds.

As a result of that as you mentioned Todd we are reaching leverage ratios that as strong as they've been since before the Pillsbury acquisition so we do think they merit the kind of ratings we're looking to secure.

As we go forward, our projections or our expectations on cash usage and plans remain the same as they have been which is we're not looking to build a cash balance.

We're going to return cash to the shareholders through dividends, through share repurchase, at the same time we're going to make sure that we have adequate reinvestment in the business to ensure growth and to drive the cost savings projects.

So you'll continue to see that aspect of our shareholder return model be very consistent with what we have talked about and delivered against over the last few years.

As far as the terming out the commercial paper that I mentioned, again, that's really just tapping into the fact that today's interest rates, the long-term interest rates in absolute terms are as low as they've been in any recent memory and we think they're a good opportunity to term out some of our ongoing debt balances and so we're going to continue to look into that and may well take advantage of it in the back half of this fiscal year.

Okay.

And then just to follow up, related to commercial paper, historically at least the last several years you've held a fair or quite a bit more of your debt in short-term debt, specifically commercial paper.

Is this kind of a change in philosophy that you're trying to term out more of the debt and have a larger fixed portion of debt?

No, not necessarily.

I expect over the next few years we'll get back to the ratios of a third of our debt being commercial paper, but when you look at today's interest rates where you can get ten year paper for less than 5% and 30 year for less than 6%, kind of hard to turn your back on that.

So it's really more taking advantage of today's interest rate environment.

Okay.

That's helpful.

Thank you very much.

Let's take one more question and then we're going to be to the end of time here.

Very good.

Thank you.

So our last question coming from the line of Terry Bivens from JPMorgan.

Please proceed with your question.

Thank you.

Happy to sneak in under the wire here.

Happy holidays to all.

Two quick things.

Ken, I think as we look at the numbers, it looks like there's been a lot of gnashing of teeth over this cleaning up of action alley at Wal-Mart.

It looks like General Mills should be less affected by that than most companies, given the fact that two of your top three are in the refrigerated case.

And our other information is you seem to be doing extraordinarily well in yogurt there, perhaps each picking up some share in cereal.

So it looks like as we look at the difference between what Nielsen says and what your reported results are, that Wal-Mart is a pretty heavy contributor to this channel thing.

Is that a reasonable supposition there?

Well, Terry, as Jeff said and really showed you in the slide in his presentation, I would say that really across the board in those sort of newer channels area, we're doing quite well and so we have a good relationship with Wal-Mart and I would say that we're seeing good, solid, broad-based growth there across our categories.

But as Jeff said just a moment ago, we also like the opportunities that we see in the club channel, dollar stores have really emerged as a great opportunity for us and so I would say that our growth really is nicely distributed and broad-based and Wal-Mart continues to be a great partner for us.

And our traditional stores had growth in that first half too of almost 4% so low single digits, so very nice across the board, very balanced I would say, Terry.

Okay.

And just one last one.

As you look at the ready to serve cereal category, it looks very rational to us right now.

Your dollar share is up it looks like, sales volume are up, ditto for your biggest competitor.

Have you -- I guess as we look at it, we see some risk that perhaps the number three player would need to become more promotional and kind of upset the apple cart.

Have you seen anything that suggests that may be in the offing or do you see kind of continued rationality in cereal?

Well, I would echo your initial comment, Terry, which is we think the category's quite stable and as you said rational right now and driven by innovation and good growth in the category and that third -- that number three competitor that you referenced has some really nice consumer brands, really outstanding franchises and we would guess that as they just digest and integrate those brands, they will figure out how to build those brands.

I would just echo Ken's comments on rational.

It's been very rational and the metrics have been quite nice over the last six months with baselines up, incremental up in that category and also dollar sales up in the category.

So it looks very rational.

It looks like a nice growth pattern for us and we feel very comfortable it will continue.

We would agree completely.

Thank you for taking the question and again, happy holidays to you.

Thanks.

Thanks, Terry.

Thank you, everybody for dialing in and if there are follow-ups please give me a shout and we'll try and help.

Happy holidays.

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.

Have a great day.