通用磨坊 (GIS) 2011 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the F '11 Q2 results conference call.

(Operator Instructions).

As a reminder, this conference is being recorded Thursday, December 16, 2010.

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

Please go ahead.

Thank you very much, operator.

Good morning everybody.

I'm here with Ken Powell, our CEO, Don Mulligan, our CFO, and John Church, who leads our Supply Chain organization.

And I'll turn the microphone over to them in just a minute.

First I am going to do my usual housekeeping items.

Our press release is out on the wire services, and it's also posted on our website.

We've posted slides on the website, too.

They supplement our prepared remarks this morning.

And the remarks 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 future results to be different than our current estimates.

And so with that, I'll turn you over to my colleagues, starting with Don.

Thanks, Kris, and hello everyone.

Thanks for joining us on this call.

As you know, we faced difficult comparisons in the first two quarters of this year, so we're pleased with the results we released this morning, which were essentially in line with our strong year-ago performance.

We have plans in place to deliver robust growth in the second half of our year, and are on track to achieve our full-year sales and earnings targets.

This morning, I'll review our financial results for the latest quarter and year-to-date.

And then John and Ken will talk about plans for the back half of the year.

Slide five summarizes our second quarter performance.

Net sales grew 1%, driven by pound volume increases.

Segment operating profit declined 3% in the quarter, primarily due to higher input costs and increased promotional spending.

Net earnings totaled $614 million, and diluted EPS increased to $0.92.

These results include a net increase related to mark-to-market valuation of certain commodity positions, as well as a net benefit from certain tax matters that we announced last month.

These items contributed $0.16 to our second quarter earnings this year.

Excluding these items, second quarter diluted earnings per share were $0.76, within $0.01 of very strong year-ago results.

Starting with the top line, slide six shows the components of total Company sales growth.

Pound volume contributed three points in growth for the quarter.

Net price realization and mix subtracted two points of growth, and foreign exchange did not materially impact total Company sales growth in the quarter.

Slide seven details our net sales performance by segment.

US Retail sales essentially matched last year's strong levels.

As we told you in July, our plans anticipated higher promotional levels across the US Retail food industry through our first half, and that's what we've seen.

For the second quarter, net price realization and mix subtracted three points of sales growth, which offset a 3% increase in pound volume.

International sales were up 4% as reported, and up 7% excluding the impact of foreign exchange.

Pound volume growth was even stronger, up 8%.

In our Bakeries and Foodservice segment, net sales were up 3% including the loss of two points of growth from a divested product line.

Our results in this segment continue to run ahead of industry trends.

Ken will talk more about segment operating -- segment performance a bit later.

Slide eight outlines our second quarter gross margin performance for the past three years.

On a reported basis, this year's gross margin was 40.2%.

But that includes changes in the market value of grain inventories and commodity hedges we use in future periods.

Excluding mark-to-market effects, our gross margin in the second quarter was 39.5%.

That's well above our margin for the same period two years ago.

But as we expected, it's below the very strong margin we delivered in the second quarter last year.

That's primarily due to higher input costs, and expenses related to capital projects that fell more heavily into the first half of this year.

We expect second half margins, excluding mark-to-market effects, to be above last year's levels.

And we still expect full-year gross margins before any mark-to-market effects to be comparable to last year.

Several factors give us confidence in this outlook.

Our plants continue to perform very well.

We expect to see improving price realization in the second half, as price increases take effect and promotional levels ease.

In the third quarter, we'll lap a $48 million charge taken last year for a change in the capitalization threshold for spare parts.

And we have strong Holistic Margin Management activities in place.

John will talk more about these efforts in just a minute.

We continue to invest at strong levels in advertising and media.

In 2011, we're seeing efficiency improvements in our spending, through HMM efforts, and the use of very targeted vehicles like digital.

Our total media expense in the second quarter was below last year's very strong levels, due in part to these efficiencies.

The change in media spending versus last year also reflects the fact that we added spending in the second quarter last year, while this year's second quarter reflects reductions in media expenses versus our plan.

However, the expense reduction doesn't signal reduced consumer pressure.

US TV impressions, which is the largest part of our media budget, and are measured by GRPs, were up at a double-digit rate in the quarter.

For 2011 in total, we're projecting a double-digit increase in TV GRPs, along with spending growth in targeted areas like multicultural media and digital.

Our in-market consumer pressure will remain strong in 2011, but we're expecting overall media expense will be somewhat below year ago levels.

Slide ten shows our segment operating profit for the quarter.

US Retail profit declined 4% from the strong year ago levels.

This reflects higher promotional spending, and the input cost increases we've been discussing.

International profit was up 25%, driven by strong growth in Canada, and favorable foreign exchange.

Bakeries and Foodservice profit was down 13% for the quarter, primarily due to lower grain merchandising earnings in the period, and timing of administrative expense.

After-tax earnings from joint ventures decreased by $3 million in the quarter, as higher media spending, and this year's step-up in service cost for CPW offset increased sales.

On a constant currency basis, CPW sales were up 1%.

Constant currency net sales trends for our Haagen Dazs joint venture in Japan improved in the quarter, but remained soft reflecting the challenging economic environment in that market.

Completing our review of the income statement, restructuring expense was below year ago, as planned.

Interest expense declined 8% in the quarter, reflecting a shift in our mix to more short term debt versus a year ago.

The effective tax rate for the quarter was 21.7%, well below last year, primarily due to a net benefit from two separate tax matters.

Excluding items affecting comparability, our second quarter tax rate was 33.5%.

That's in line with annual guidance which calls for our effective tax rate excluding items, to be comparable to our 2010 rate of 33.4%.

The average number of diluted shares outstanding was down 2% in the quarter, consistent with our target for the full-year.

Switching to the balance sheet, core working capital increased 3%.

Higher International sales, which tend to have longer customer payment terms, drove an increase in receivables.

And inventory values were up, reflecting the rise in input costs.

Cash flow from operations totaled $600 million in the first half.

That's below last year, due to timing of accruals related to trade and promotional spending, as well as the increase in core working capital.

Operating cash flow will improve in the second half, as earnings improve, and our use of working capital declines.

We remain committed to returning cash to shareholders, through share repurchases and dividends.

Our 2011 annualized dividend rate of $1.12 per share represents a 17% increase from last year's rate.

And we repurchased 26 million shares through the first half.

In total, we returned more than $1.3 billion to General Mills shareholders year-to-date, more than twice the amount during the same period last year.

The operating environment through the first six months of this year included high levels of price promotion by food manufacturers and retailers.

So we were happy to see all three of our operating segments post net sales and volume increase for the first half, as shown on slide 16.

In total then, through the first half, net sales were up 1%, earnings after tax totaled nearly $1.1 billion, and diluted earnings per share were $1.63.

Excluding certain items effecting comparability, our adjusted earnings per share totaled $1.40, roughly in line with last year's very strong first half results.

As we look ahead to the second half, we expect to see our pricing trends improve over the period, as promotional spending levels ease, and pricing increases take effect across a number of our businesses.

This trend should unfold as the second half progresses.

We have good product news and marketing support in place to fuel sales growth of our brand, and strong levels of productivity savings from HMM initiatives will contribute to gross margins above last year's level.

Protecting our gross margins is one key to delivering our 2011 targets.

I'll turn the microphone over to John Church ,who will talk about our plans for that.

John?

Thanks, Don.

Good morning, everyone.

I'm pleased to be here to discuss how HMM continues to help General Mills protect margins and fuel our business growth.

Let me give you a quick refresher on how our approach to holistic -- on our approach to Holistic Margin Management.

It includes many levers we can pull to protect our margins, from mix management, to list price increases, to promotional spending efficiency.

As Don just mentioned, improved price realization and mix are definitely part of our plan for fiscal 2011.

HMM also includes improvements we're making to various administrative processes.

And of course, it includes supply chain productivity.

The size of each of these efforts varies by business and time period, but COGS productivity is the largest contributor to HMM cost savings, and is where I'll focus my comments this morning.

We use the savings we generate from all of these efforts to offset inflation and fund consumer investment, which ultimately grows our top line.

We adopted our HMM business model back in 2005.

Over the ensuing five years, we faced high levels of input cost inflation.

And then in fiscal 2010, there was a brief period of deflation.

But we're seeing inflation again this year, around 4% to 5%, on total input costs for us.

The biggest drivers behind this are dairy ingredients, resin-based packaging, fuel, cocoa and wheat, actually some of the same items that drove deflation in 2010.

We're now about 80% covered for our fiscal 2011 commodity and energy needs.

We expect input cost inflation to continue beyond fiscal 2011, driven by global macroeconomic factors, so HMM remains a key component in managing our margins.

With HMM, we've been successful in offsetting input cost inflation and protecting our margins.

As Don just told you, we expect our fiscal 2011 margins, before any mark-to-market effects to be comparable to last year, despite renewed inflation.

That will require margins to come in higher than last year's in the second half.

We're confident we'll see that, for all the reasons Don listed, including our pipeline of HMM initiatives.

We continue to work on product specific efforts, but we're also identifying initiatives that reach across broader product platforms.

We're expanding the way we think about our supply chain to more fully integrate our customers and our suppliers, and we're benefiting from increased global scale.

Let me give you a few recent examples of each of these efforts.

We're identifying ways we can reformulate specific products to improve manufacturing efficiencies, without compromising our quality.

For example, a change in the product formulation of Yoplait's Thick and Creamy yogurt has allowed us to streamline production.

The product is now made with a unique process that eliminates a production step, which saves us energy and increases our manufacturing capacity, all while maintaining the product quality consumers expect.

Here's another example.

The Big G team identified a new variety of rice for Rice Chex cereal.

The source of this rice is much closer to our manufacturing plant.

So we get the same quality ingredient, but a lower transportation cost.

We also developed a formula for the chocolate chips in Cookie Crisp cereal that make the chips adhere better to the cereal.

And we can make these chips in-house, rather than purchase them from a supplier.

That reduced the amount of wasted chocolate chips in our system, and it reduced the amount of ingredient and shipping costs too.

We're engaging our 18,000 supply chain employees around the world, to look for opportunities across product platforms to run our plants more efficiently.

We have cross functional teams in our US Retail divisions, and in each of our International markets that are actively sharing best practices, and we're starting to reap the benefits of this process of continuous improvement.

On our growing snack bars business, we're working in plants around the world to eliminate waste and reduce down time.

Consequently, we're able to make more consistent products, and have increased manufacturing capacity to support future growth.

Now we have been milling flour since 1866.

But through dedicated efforts started a couple years ago, we've been able to significantly increase yields from our milling facilities, essentially getting more flour out of the same amount of wheat.

This improvement benefits a number of our product platforms from cereal to baking mixes to food service products.

We're also looking outside our walls to partner with customers and suppliers on cost savings opportunities.

For example, we worked with one of our can suppliers to lower cost for the Green Giant business in Europe.

Our supplier is now located directly inside our manufacturing facility, which has significantly reduced inventory levels of cans, and the associated transportation costs.

We see HMM opportunities in our growing international business continuing.

We saved 10% of packaging costs for the Old El Paso brand, for the Old El Paso brand in Australia, by using one packaging supplier identified through our global sourcing initiative.

We are now looking at opportunities to leverage the same supplier for our European Old El Paso business.

We have also improved the manufacturing capability for Old El Paso tortillas and reduced product waste, saving $2 million in costs.

As we expand Nature Valley granola bars to more markets, we're using a package design first implemented in Europe, and we're taking it to Australia and India.

We kept the bars the same size, but made the boxes smaller, allowing us to fit more boxes in a case, saving us packaging and transportation costs.

And HMM is also being deployed at CPW.

For example, we have several manufacturing facilities in developing markets where the cost to procure, ship and store raw materials is high.

We started a initiative to actually mill the flour as needed on site at each of our manufacturing plants.

This eliminates shipping and storage costs for raw materials, and improves product quality because the flour is fresher.

The results of all these actions has been reduced manufacturing costs and increased productivity.

Slide 28 shows our productivity as a percent of cost of goods sold across our US and wholly-owned International businesses.

We've seen good improvement in our COGS productivity, and are on track for further increases in fiscal 2011.

I've given you a few examples of the productivity initiatives we have around the world, and I think we're well positioned to keep the HMM wheel rolling.

We have visibilities to specific projects going out at least three years, and our pipeline of ideas has not fallen off.

In fact, we've seen the pipeline grow each year, because HMM is an innovation process.

We found that the improvements we make to our current systems, often reveal new opportunities that we hadn't previously considered.

Our cost savings are offsetting input cost inflation, and protecting our margins.

We're reinvesting those cost savings back to our brands in the form of marketing support, which in turn drives top line growth.

The more top line growth we get, the more efficient our supply chain becomes, and the cycle keeps building on itself.

We'll continue to be successful with our HMM initiatives because the efforts are grounded in some of these key elements.

First, HMM is driven by consumer and customer needs, focusing on what's valued by the folks that matter most to our business is helping us challenge the way we do things.

Secondly, this is a collaborative effort, employees across our business are empowered and engaged in improving our performance.

That approach fits the unique culture of General Mills, which is why it's been so successful for us.

Our culture embraces collaboration, and we're highly focused on innovation that meets the consumer needs, improves our processes, and ultimately drives shareholder value.

We are finding that HMM is scalable, across different brands, different businesses, and different countries.

It's a systemic approach to productivity, and it's supported by proven tools that can be used anywhere.

All of these things together, make it sustainable.

We're seeing more creative ideas, which inspire even more ideas, and a whole new way of thinking.

And that continues to feed our HMM pipeline.

We are well on our way to realize the $1 billion in COGS productivity worldwide by fiscal 2012.

Looking farther ahead, we expect total worldwide supply chain productivity of more than $4 billion over the next decade.

So to wrap up my comments this morning, we're using all the levers we have available to protect our margins in 2011.

We expect our full-year gross margins to be comparable to last year's before any mark-to-market effects.

We've generated significant savings to date, and we have many initiatives under way.

And we see many more opportunities for HMM savings around the world.

By engaging all of our employees in the way we do business, I'm confident we can sustain our HMM-fueled results for years to come.

And with that, I'll turn it over to Ken Powell.

Thanks, John.

Good morning to everybody.

I think as you've just heard, clearly our program of Holistic Margin Management is a source of competitive advantage for General Mills.

While the operating environment remains challenging, we expect net pricing realizations, combined with our strong innovation and brand building activities to contribute to very good sales and earnings growth for General Mills in the second half of this year.

Let me give you a brief operating update for each of our business segments, and highlight some of the initiatives we have planned for the second half.

I'll start with US Retail, where we're seeing solid performance on top of good prior year growth.

Net sales for this segment grew 1% in the first half, on top of 5% sales growth in the year-ago period, and 11% growth the year before that.

As Don showed you, volume growth was the driver of our 2011 sales increase.

Slide 36 summarizes first half consumer take-away trends for our key product lines.

Overall, we've continued to see stronger growth in channels not captured by IRI or Nielsen data.

Remember that for us, these non-measured retail channels represent about 40% of our volume.

We're committed to leading growth in all of our US Retail categories.

The way to do that sustainably is to innovate.

We launched a great lineup of new items in the first half of fiscal 2011, and they contributed to share gains in some of our larger categories including cereal, grain snacks, desert mixes and ready-to-serve soup.

In the second half of fiscal 2011, we'll be highlighting the strong health benefits of several of our products.

We'll have a new national media campaign telling consumers that General Mills cereals are America's number one source of whole grain at breakfast.

We'll also break the first national media campaign behind the gluten-free benefits of our Chex cereals.

And we'll continue to remind consumers about the health benefits and great taste of Progresso soup.

Our yogurt business has strong health news too.

Yoplait Original now provides half of a woman's daily calcium requirements in one serving.

That's twice the amount of other yogurts, and with no sacrifice on taste.

We'll be putting significant marketing support behind this highly relevant category news.

We've also got some great solutions for consumers that resolve to lose weight in the new year.

Our Yoplait two-week tune-up is a clinically proven plan to help you lose up to five pounds in two weeks by eating Yoplait as part of a balanced diet and exercise program.

Progresso Light soups offer consumers 14 great tasting varieties with 100 calories or less per serving.

We'll be putting additional media support behind this message in January.

And our Fiber One 90 calorie bars and Nature Valley granola thins are great tasting snacks, that are also low in calories.

Now, we've been seeing very strong growth in our snack brands, and could not fully support customer demand during the first half.

So we're glad we're entering the second half with more snack bar capacity, and we expect to accelerate grain snack growth in the second half of the year.

We have a variety of in store merchandising events planned in the second half.

We've teamed up with the Biggest Loser TV show, our pound for pound challenge will drive donation to the Feeding America Food Shelf network And we'll also have multi-grain Cheerios and Progresso featured during episodes of the Biggest Loser show.

In February, just in time for the Daytona 500, we'll be in-store with Nascar-themed packaging and Hot Wheels cars in over 10 million boxes of cereal.

And we've expanded our successful Box Tops program.

We've added more General Mills brands, and new corporate partners, and we're launching dedicated national advertising.

We're launching some great new products in January too.

For example, Cinnamon Burst Cheerios provides 20% of the adult daily value for fiber, and it tastes great.

So it's a high fiber cereal that everyone in the family can love.

We're adding new flavors and packaging formats to our Yoplait Greek yogurt line, which competes in the fast growing segment of the yogurt category.

And we're adding new varieties to our popular fruit snacks line.

We also expect continued good contributions from many of our first half launches, Pillsbury Sweet Moments, Wanchai Ferry, and Macaroni Grill frozen entrees, and Yoplait Smoothies are all getting great response from consumers, and are expected to deliver over $200 million in retail sales in 2011.

We have taken pricing actions on several businesses, as a result of higher input costs.

List price increases in several categories are effective in the second half.

We have also made trade merchandising changes in various categories.

We will continue to monitor inflation and category pricing levels across our portfolio.

So for our US Retail businesses, we're working to lead category growth through innovation.

We believe that the return of input cost inflation will result in improved price realization and sales trends in our categories.

And we see our US Retail business on track to meet our fiscal 2011 targets of low single digit sales growth and faster growth in operating profits.

Moving to our Bakeries and Foodservice business, we continue to outperform industry trends and gain market share.

For example, we continue to extend our strong performance in the growing education channel with products like mini pancakes, a great innovation providing operators with an ultra convenient way to serve a hot breakfast that kids love.

First half convenience store sales were up 12%, driven by distribution gains and good new item performance.

And across this business segment, we saw strong growth on key branded product lines, led by a 12% increase in first half sales for yogurt, and a 9% increase in snacks.

We're innovating to meet the diverse needs of our customers, while leveraging our powerful brands.

Great new products like Sweet and Salty Bugles and Lucky Charms treat bars are driving growth in our convenience store businesses.

Pillsbury-branded (inaudible) and mini pancakes are driving growth and market share in our Foodservice distributor segment.

And we have another round of strong product innovation planned for the second half, including Pillsbury mini cinnis, and Crescent Scrambles, and Betty Crocker Indulgent snack bars.

Growth prospects in our Bakeries and Foodservice business remain excellent.

Industry trends are improving.

We're bringing great innovation to customers.

Our direct sales force is a source of competitive advantage, leading to distribution gains for our products.

And our focused mix management strategy is working well.

We remain on track to deliver net sales in line with last year, and double-digit operating margin in our Bakeries and Foodservice segment.

Outside of the US, our businesses are generating solid growth.

First half net sales for our International segment rose 6% on a constant currency basis, driven by pound volume increases.

First half constant currency sales in Canada were down 1%, reflecting a challenging comparison to 10% growth in the year-ago period, along with a highly competitive retail environment.

Constant currency sales in Europe were up 7%, very strong performance in a challenging economic environment.

Sales in Asia-Pacific increased 9%, led by continued strong growth in China.

And sales in Latin America increased 11%, including price increases in Argentina and Venezuela.

We're very encouraged by the trends in our European business.

Sales increased for all of our key global brands, led by a strong double-digit gain in grain snacks, and a mid to high single digit growth by Haagen Dazs ice cream and Old El Paso Mexican products.

We plan to continue our growth in Europe in the second half of the fiscal year with continued marketing support behind key brands, good new product contributions from Nature Valley, and improved net price realization on our Hagen Dazs business.

In China, Haagen Dazs sales were up nicely in the first half.

Sales of our Haagen Dazs moon cakes, a popular gift during the mid-autumn festival, grew at a double-digit rate.

Our Haagen Dazs shops also performed well, particularly in Shanghai, where the World Expo was held earlier this year.

We also recorded growth in our Wanchai Ferry frozen dumpling business.

In total, we expect our China business to generate nearly 20% top line growth for the year, bringing sales to over $400 million in fiscal 2011.

We've got strong innovation working around the world.

Nature Valley bars have entered Australia, and they're doing well.

We added Banana Nut Cheerios to our cereal line in Canada, helping drive nearly a full point of share growth fiscal year-to-date.

Wanchai Ferry has entered a new market segment in China with the introduction of frozen noodles, and the launch of Crunchy and More Nature Valley bars in the UK drove strong double-digit sales growth in the first half for our grain snacks in that market.

So our International segment continues to perform well.

We remain confident in our ability to achieve our targets for mid single digit constant currency sales growth, and double-digit operating profit growth for the year.

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

Net sales are up 2% through the first half of the year, on a constant currency basis.

Our results reflect category weakness in the UK, but good performance in other established markets like Australia.

We had strong double-digit growth in emerging markets like Russia and Brazil, and high single digit growth in Turkey.

Across all markets, our performance was led by high single digit sales growth by the Cheerios and Nesquik brands.

Second half plans for CPW include the launch of Plus, a new adult targeted cereal starting with the French and Belgian markets.

This brand offers great tasting fiber and anti-oxidant benefits.

We expect another year of volume and share gain for CPW in fiscal 2011.

And longer term, we see excellent category growth potential as per capita cereal consumption increases in markets around the world.

So to summarize today's update on General Mills, sales for our leading food brands continue to grow in markets around the world.

That's because these products meet consumer demand for high quality foods that are great tasting, nutritious, easy to prepare, and offer good value.

Our continuing focus on Holistic Margin Management gives us confidence in our ability to protect margins, and maintain strong investments in brand building and innovation.

With the first half of fiscal 2011 now complete, our expectations for the year are unchanged.

We continue to believe industry sales trends will strengthen in the second half of our fiscal year, as promotion levels ease in response to renewed cost pressure.

We expect our earnings to show good growth across this period, with the fourth quarter likely showing the stronger increase.

And we see our business on track to achieve our full-year sales and earning targets.

So thanks for your interest in General Mills.

That concludes our prepared remarks, so we'd now be happy to answer your questions.

So operator, could you please get us started?

Hello?

(Operator Instructions).

First question comes from the line of Eric from Wells Fargo Securities.

Please proceed.

Good morning, everyone.

Hi, Eric, how are you?

Not bad.

Ken, wondering whether you could give us some perspective, as to whether you've seen your competitors either follow some of the list price increases you've announced, or pull back on some of the aggressive merchandising activity that we saw in the fiscal first half?

So Eric, as I noted in my remarks and during the presentation, we have taken -- announced a number of list price increases across several of our categories, and those will begin to take effect in January.

And we also very much expect the promotional environment to moderate as we go into the second half.

And I think you're also aware that a number of players in our space are also beginning to announce certain list price increases, and I think we should let them talk about the detail of those increases.

But I do think that as we see the inflationary environment kind of clarify for the next 12 to 18 months going forward, we believe we're beginning to see the industry respond with some list price increases.

And we expect to see a moderation in the promotion environment as well, as we said.

Okay.

And maybe I missed it, but could you touch upon the soup category in a bit greater detail?

How did that perform in the fiscal second half, and what are your expectations for the rest of the soup season, especially in light of Campbell's comments that they expect to be pretty promotional in their fiscal second quarter, and then try and raise prices in their fiscal second half?

So just very generally, Eric, I'd say in the -- I'd say the environment in the soup category is constructive right now.

We believe that the messaging across the category that we see, that is -- which is really very focused on taste and variety is just what the doctor ordered for the category.

So we think that that's quite positive now.

And as you look over the last two quarters, I mean, I guess I would characterize the category as improving.

It was still down in the first quarter, down really overall for the second quarter, but not nearly as much.

And in the most recent month, most recent period here in November, which is as we're really getting into the season now, I believe that we have -- I'm looking at Kris here -- we had double-digit growth.

And so, we think that this is going in the good direction, a good direction.

Clearly there's more to do and more work to do here but we like the messaging.

And the trends look like they're starting to head in a much better direction.

The thing I would just add there is, it's fair to say at this point units are stronger than dollar sales in that category.

That would be true for some other categories as well.

But as the promotional environment eases, you're going to see the dollar side on some of these categories continue to tick up.

Okay.

Thanks a lot.

I'll pass it on.

Okay.

Thank you, Eric.

Thank you.

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

Please proceed.

Good morning, everyone.

Hi, Alexia.

Hi.

Can I ask about the cereal category in the UK?

It's a little bit of a mystery to me what's going on over there.

The pricing environment, or the pricing is obviously down heavily for the category year-on-year, and volumes seem to be extremely sluggish.

Could you give us a little bit more color on what you think is going on over there?

Well, Alexia, this is Ken.

I can give you I think, a little bit of color.

I mean, I think you have a very -- obviously a very challenging kind of macroeconomic environment in the UK.

And it's very difficult there right now, and I think UK retailers -- that has led to an intensely promotional environment across a lot of categories.

And so I think that's what we're seeing right now.

And as we move on to economic recovery, albeit we think it will be slow, I mean, we think that those trends will moderate.

But right now, it's just very promotional there across many categories.

And we're seeing -- we're feeling that, although I would say overall for CPW and for our International businesses in total, I mean, we're having quite good performance.

We're feeling the promotional intensity on cereal in the UK.

General Mills wholly-owned International businesses in the UK are really doing quite well.

Very good growth on Old El Paso, very good growth on Haagen Dazs ice cream, and we're seeing those growth trends really across Europe.

So UK is a stand-out with the promotional intensity right now, but overall for us, our International business is performing quite well right now, and in the places where we really need to see it, which is in our core global brands.

Great.

Thank you.

And just a quick follow-up.

Several companies have said that they're seeing a bit of light at the end of the tunnel on the Food Service side here in the US, a bit of a pickup in terms of restaurant strength.

Are you seeing that as well, or is it still pretty dire?

No, I would say that we would agree with that view, Alexia.

Restaurant trends were still down a titch, our away from home trends were down a little bit, in the most recent period but we're talking tens of basis points now.

So it's nearly flat in the most recent period which is obviously -- it's not a strong tailwind, but it's no longer a headwind either.

And then on the convenience store side, which is an important channel for us, we're seeing quite a good pickup in trends there.

And that's a great channel for us, and we're gaining share strongly in that segment.

So I would agree with what you're reading, but it's -- we're going sideways now in the Food Service area, which is much better than the declines that we've been seeing over the last two years.

Given the high unemployment in the US, I don't think it's likely that we would see a super strong acceleration in those trends, but it's again, good to see it moderate.

Great.

Thank you very much.

I'll pass it on.

Thank you.

Our next question comes from the line of Andrew Lazar from Barclays Capital.

Please proceed.

Good morning, everyone.

Good morning, Andrew.

Hi, Andrew.

As you talked about -- your obviously earnings expectations for the fiscal second half require a pretty meaningful step-up as you go through the second half.

And from John's comments, seems like you certainly have a lot of visibility around the HMM and productivity side.

And obviously your pricing or net price realization becomes a little bit more of the factor to watch.

I guess what I'm trying to get a sense of is, what sort of net price realization are we looking for in the back half of the year?

It was kind of flattish in the first quarter, down two in the second.

And I'm just trying to get a sense of -- I guess the magnitude on average, of the sorts of pricing moves or promotional changes you've taken, as it relates to the overall portfolio on average.

Is it dramatic in terms of what's needed to kind of get there, or is it just starting to move in positive territory year-over-year?

Andrew, this is Don.

It's clearly the latter.

As we entered the year, we indicated that we would expect to see some promotional easing in the back half of the year, and our full-year guidance on sales of low single digits is driven by volume mix and a little bit of pricing.

And that still holds.

To your point, we're relatively flat to slightly down in first half.

We'll have to get some back in the second half, but it's going to be measured in 100 plus basis points, not multiples of that.

So it's -- you're going to see it moderate in the back half, and moderately increase in the back half.

So, hopefully the back half -- I guess I want to make sure I'm reading you right, you see some positive year-over-year contributions from net price realization.

But, again, we're not looking for anything dramatic, it takes time for this to kind of work itself through, would be my sense?

Correct.

And to Ken's point, he -- you're talking about the timing of when you'd see the pricing reflected, it's really going to be starting in January and February.

So it's going to be late third quarter, into the fourth quarter, when you really start seeing it visibly.

Got it.

So volume still then, I guess is expected to and sort of needs to still be in reasonably positive territory as well, right, to get the kind of full year top line that you're looking for, and ultimately I think to hit the kind of earnings goals that you're looking for as well?

Does that make sense?

And how does that take into effect your thoughts on elasticity.

Well, clearly, we do factor in our elasticity expectations, but you also have to understand it's going to be supported by the innovation.

Ken took you through a bit of a snapshot in terms of what we're going to be launching in the second half.

We're very bullish on that line up.

We have strong merchandising and marketing support for that.

And we also have -- I think Ken alluded to -- but I think it's worth emphasizing, the fact that we had some shortages of shipping on our grain snacks, which grew quite robustly.

But because of capacity constraints that have now been resolved, we're going to have the capacity to fully meet all the demand for grain snacks.

So that will be a plus in the second half as well, versus the first half.

Got it.

Then just last quick thing, Don.

I know there was heavier sort of CapEx spending in the first half, of which some of those expenses flowed through, that will be lighter in the fiscal second half, which also helps from a margin perspective.

Is there any way you can help us try to, if we're looking at puts and takes for the second half, to get some comfort around gross margins improving, way to quantify that, or put that in perspective?

Sure.

I think you're thinking about the second half gross margins.

We were down 100 plus basis points in the first half.

We have to get obviously that plus some back in the second to get to neutral versus last year for the full year.

It will give you several components that are going to be contributing.

One is the sale -- is the price realization we talked about earlier, which is going to become a positive in the second part of the year.

We do have the expense timing on the capital projects.

That's much smaller than the sales.

That can be measured in tens of basis points, not hundreds of basis points.

We have -- we're going to be lapping in the third quarter, the $48 million charge we took for the change in our capitalization threshold for spare parts within the second half.

That's going to be a 60 to 65 basis points plus.

And then also, a smaller contributor, but our transaction FX plus, that we said would come through in the year is more back half loaded.

And all of that obviously will be supported by very robust HMM pipeline that John took us through.

So there's a number of things that are going to improve our gross margin profile in the back half, that we have a very clear line-of-sight on, and gives us confidence to be able to commit to holding our gross margins for the full-year versus last year's very robust gains.

Great.

Thanks very much.

Thank you.

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

Please proceed.

Hi.

Good morning.

Hi, Chris.

Good morning, Chris.

Hi.

I wanted to ask -- in the quarter and in particular in US Retail, with the sort of negative 3% price mix, could you give a sense of how much mix was a factor in there?

Is that something that worked against you in the quarter?

It was -- the primary contributor was the promotional and the merchandising activity.

We were very planful in terms of the merchandising, whether it was the Box Tops at the beginning, Box Tops merchandising at the beginning of the quarter, or soup sampling last month.

So that -- the promotional and the merchandising calendar was probably the largest -- was the largest contributor.

However, also did have some negative mix, which was a little different in the first quarter.

It goes back to my point on grain snacks, where we had a little less grain snacks growth in the second quarter versus the first, and a little more baking.

And for us, that's a bit of a negative tradeoff, from a top line standpoint.

Okay.

And then I just want to ask -- sorry, go ahead.

Chris, I would just -- maybe it's repetitive, but we did -- what we did in Q2 was what we planned to do.

So we have a very powerful Box Tops merchandising platform that's kind of back-to-school, September.

And that was a very effective program for us.

We did have quite a bit of new product merchandising.

We did a fairly extensive soup sampling campaign, that was accompanied by merchandising.

We definitely thought that was the right thing to do to get people back into that category.

So these were things that we wanted to do and planned to do.

We think that they helped things.

We also as we have said, though, expect these levels to moderate as we move into the second half.

Okay.

And I wanted to ask a question about really more from a big picture standpoint, kind of the state of the consumer, and generally how that's affecting your pricing.

Are you taking a more -- a slower, a more methodical approach to pricing, because of the shift in the consumer today, I guess would be the general question?

Well, the consumer does I think continue to be careful, and we see that in different kinds of behaviors, the way they plan and shopping lists and use of couponing and these sorts of things.

But I think the fundamental aspect of our business, where our products, the grocery store's still a terrific place to find value.

That remains very, very true.

So as we take pricing, we always look at pricing in the larger context of all the activities that we have under way to help us grow our margins.

And so pricing isn't the only thing that we do, as you know, and you heard us say that many, many times.

But having said that, we also monitor very closely the inflationary trends in our input categories, our input markets.

And we think that those inflation trends are telling us that we're going to need to have some pricing in certain categories and so we've announced those.

But all in all, it's -- we manage it as a broad mix of activities.

The goal is to continue to have strong margins, and we think we're in a very good position to do that now.

Okay.

Thank you.

Thank you.

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

Please proceed.

Hi.

Good morning, everybody.

Happy holidays to you and your families.

I guess my first question -- there's a slide that I guess John went through page 31, that has to do with the long-term HMM savings.

And I'm kind of wondering, within the $4 billion of savings, what kind of like long-term inflation assumption is built into that?

Well, within the -- the HMM is a stand-alone number that we look at.

We -- that would be an offset to the inflation in our total profitability.

So the HMM numbers that I'm quoting have to do with our ability to continue to generate a pipeline.

If you're referencing each dollar you save is inflated over time, our long-term model that we've talked about is a 4% to 5% kind of model.

We think that's probably right.

Clearly, we -- there's -- that's a bumpy ride.

We saw deflation last year, and the year previous to that we saw about 9% inflation.

But over the course of this decade, and we think to be honest, the next four to five years, we're going to see that 4% to 5%.

And so we have factored that into our long-term estimates around HMM capture.

So you're saying the 4% to 5% is the inflation assumption built in.

Correct.

Roughly.

And so to kind of off set that, I guess most of the companies do it dollar for dollar, that's like 2% to 3% pricing to offset the 4 to 5, if you just focus on the dollars and not the margin?

So is that kind of how to think about what you're -- how the model is working long-term?

And then, the difference is the other levers that you're going to pull to fund advertising and grow EBIT?

Actually, I'll back up.

If I understand your question, we expect input cost inflation all-in.

So that's a combination of our commodity spend but also all of the other things we incur, labor costs, benefit costs, our capital expenditures and the depreciation associated with that, all of those kinds of logistics and fuel, that we expect on an average basis to go up 4% to 5%.

The HMM dollars that you see as a long-term prediction, is based on our ability to save.

And there is a factor that would say, if I save $1 million of wheat today, and I expect that to inflate at 4% to 5% on an ongoing basis, that will be worth more dollars in F '20 because it will inflate.

But that's all this -- the COGS HMM slide is showing you is a savings slide.

And, Eric, this is Don.

If you go back to -- the slide on page 20 that showed all the levers in HMM, what John was alluding to was the COGS productivity portion of that.

COGS only.

Which is as we said, was the largest piece of the pie but we also have mix management, admin, the consumers, others that we will pull to help offset that 4% to 5% inflation.

And in those years, as John was alluding to when we have a particular spikes,when all those activities will not be enough to offset, inflation, that's when you see pricing come in.

So over the longer term, when we think about pricing, it is a portion of, but a small portion of that low single digit sales increase that we target.

Okay, so -- Go ahead.

We always talk about low single digit sales gains, I mean, we're always looking at -- looking at that as being composed of some volume, unit volume growth, some list price increase, and some mix improvement.

So we -- pricing is a factor, but it's not the only factor.

And as we said, and it's certainly not the only factor in how we manage our margins.

It's really one of a long list of things that you guys are well acquainted with.

Okay, and then, I guess regarding, the advertising dollar or advertising percentage drop in the second quarter -- and then I guess you said for the year you're expecting it to also be down, I'm kind of wondering, you don't really tell us what you -- the amount of promotion that you have between gross and net, but I'm just kind of wondering, given that you had such strong volume growth, even though advertising spending was down year-over-year, was there -- kind of like an off -- like an equal kind of offset, if you look at promotional dollars?

I don't know if it was equal, Eric, but I would -- let me make a couple of comments.

First of all, our advertising last year, through the first half, was up nearly 30%.

So we've had really very significant increases in advertising going back the last four or five years, and so we were lapping very strong period.

And I think -- and we're going to be off a bit in half one, and we'll be off for the year a little bit, but we'll still be at very high levels.

And to your question, I think given the -- that we have been in a period of more intense merchandising, we think that this has been appropriate, a kind of appropriate re-mix.

But as the promotional environment moderates, as we see a little pricing come through, our long-term goal would be to grow advertising in line with sales.

And that's what we would expect to get back to.

Also, I guess the only other comment I would make is that we -- there are ways to increase efficiencies, and make sure that that advertising spending is really going to the best places.

We're actually going to have an increase in GRP delivery this year behind our US brands.

I believe it will be high single or even low double digits.

Double digits.

So there's very good advertising impact this year.

We made adjustments for -- the intense merchandising which we think are appropriate, and as we said which we also think we'll begin to see that merchandising moderate.

What I would a add is, as we look at the full year, our total advertising spend will be a bit below last year.

But it was accent waited in the second half.

When you make a change to your full year estimate, you have to do year-to-date catchup.

So last year in the second quarter, we increased our full-year spending projections.

And so we took an accrual catchup, which increased our spending, our expenses in the second quarter last year.

This year, which is the opposite direction and quite honestly that explains the bulk of the shift between the two years.

As Ken alluded to, the pressure in the market which is more reflective of actual cash at work, was up double-digits in our US GRPs.

Okay.

Okay.

That's good.

That makes it a little clearer.

I'll pass it on.

Thank you.

Thank you.

Our next question comes from the line of Jonathan Feeney from Janney.

Please proceed.

Good morning.

Thanks very much.

Hi, Jonathan.

Good morning.

I was wondering, just on holistic margin management, a number of -- we did some work recently, looking at a number of competitors particularly in the cereal industry who have significant cost savings.

And I guess my question to you, would be two-fold.

The first would be, the kind of cost savings you're getting, could you explain in the a little more detail where you think those cost savings sit competitively, like is everyone seeing the kind of holistic margin opportunity that come from factory efficiency, and some of the great things you guys have been working on?

Do you get the sense a lot of your competitors, particularly the marginal competitors, have those similar benefits, as we enter 2011?

Secondarily, I guess Ken this is probably specifically for you, I know you can't comment really on what anybody else is going to do, but do you get the sense from retailers or high level conversations you've had, that they just -- they expect the industry to become more efficient over time, and that needs to be reflected in net pricing, or is there no such expectation out there?

Thanks.

Jonathan, thanks for your question.

As we look at our HMM portfolio, and our track record of capturing those savings and being able to reinvest, I guess I don't have a great line of sight as to what everyone else's opportunity is in the industry.

I can just look at the gross margin performance, and let that kind of speak for itself.

You can make those comparisons probably better than I.

What I'll tell you is the nature of our savings, I think it may be different from what people expect.

And as we first started talking about this it became evident, I think there's this expectation that all of this productivity, if you will, leads to rationalization and plant closings and those kind of things, and that is not our process.

Our process is really starting at the core of how we define value, and how we ensure every dollar we invest in our brands, in the form of formulation, in the form of manufacturing costs, in the form of marketing spending and promotional spending yields the optimal value.

And we think that's what's hopefully driving a competitive advantage for us, and as we do the comparison, it looks like it is.

I think the benefit of this innovation process is you're not cutting, and so your well doesn't go dry.

As a matter of fact, as we continue to find -- as we find a new, stable and better platform, we see things we couldn't see before.

And so that's why we have a high degree of confidence this will continue.

So Jonathan, to your other question, which was addressed to me, I mean, I'd make a couple of points.

First of all, we know that our retail partners monitor inflation as closely as we do.

We also know that during the most recent really significant inflationary spike, they advanced prices on their own brands, and in aggregate, at a faster rate than we did, I think reflecting the fact that they have less margin to work with.

And so they behaved or have behaved, and we think will continue to do very rationally, very close eye on inflation.

But the other answer to your question is, that we actually work very closely with them, to find areas of waste in the supply chain between -- particularly in the logistic area.

So not only I think did they expect the industry to be working on productivity, and to be working to do everything we can to offset inflationary increases, this is an area where I think the industry, and by the industry I mean the manufacturers and the retailers, have worked very closely together to take cost out of the supply chain.

And, frankly, it's -- John touched on it in his remarks, it's part of -- one of our HMM strategies is this kind of cooperative development with our retail partners to find costs that we can take out of the supply chain.

Okay.

Thank you very much.

That's very helpful.

Operator, let's sneak one last one in here before we're out of time.

Thank you.

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

Please proceed.

Good morning, everyone.

Hi, Ken.

Good morning, Ken.

Actually wanted to go through, there was one slide that you guys made between non-measured and measured channels.

And it looks like most of them are somewhere -- you've outperformed about 2 to 3 percentage points.

Two categories, though that seem to be extreme outliers.

One was the cereal category.

So my question on that is, is there a sense of why thats was such a strong outperformance on the non-measured side?

Is it sustainable?

Is there going to be a reversion?

Just kind of can you talk about that, because that seemed relatively impressive.

Ken, --

If I'm reading it correctly.

It sounds like measured channels were down 3%, and the non-measured was up 4%, so the spread was 7 percentage --

I got it.

I got it.

I think, Generally, in aggregate, for us over a long period of time, we've seen our non-measured channels grow faster than the measured channels.

And this is something that goes back for a while.

Within that, in any given period, I mean, you could see some change.

There can be some wobble and some change.

But I think what I would take away from this, is that our pattern of very strong development in those non-measured channels continues.

And this period we had a little bit of a bigger gap on cereal.

But I mean, I would say that's a period to period thing, and overall we expect growth in both channels.

And we believe that non-measured will continue to be a real driver for us across all of our categories.

Would you use the same explanation on the flip side for the soup, because that underperformed?

So I just was trying to figure out -- if there's a similar explanation for that?

Or is there anything specific we should be thinking about that one, because that differential was negative 500 basis points.

Yes, I don't think there's -- I don't think there's much specifics there.

I mean we did have in the quarter, we had a weaker period in the club channel on soup.

So you do -- can get into channel by channel and account by account issues that can be related to a bunch of factors.

But I wouldn't -- I would I guess go back to the larger trend, which was that in general this channel has been a good driver for us, and we expect it to continue to do that.

And there are always going to be variations during short periods of time, not only within the broader measured and non-measured, but even from an account to account level.

And my last question is, not to extend the call that long is, looking at your emerging markets, international margin structure, can you just talk -- I know you won't give specifics, but can you talk about the progression of your margin structure in your emerging markets like China?

Have you seen some turning points?

Have you seen it getting closer to different levels?

Can you just talk about it, as specifically as you can, but my sense is you'll give only general comments, but just kind of getting a picture of that?

Thanks for giving us that qualifier already, so I don't have to repeat it.

Ken, we're pleased, we're very pleased with our margin progression in the emerging markets.

And when you look at that, you really have to focus on your gross margins.

What you all see obviously at our international segment, is the operating margin.

And in market like China, for example, as we prove up the concept with gross margin improvements and acceptable levels, we very proactively reinvest back against the business to grow, and that's both in terms of the sales force and advertising.

And so we reinvest part of that plus back, and so you don't see as much of it flow through to the operating margin.

Our goal in a market like China, or as CPW expands in eastern Europe is to grow the entire business, and not just the operating margin percentage in the near term.

But have you seen progress on the gross margin side or -- ?

Absolutely.

It's one of the contributors to International's margin expansion, and by extension the Company's.

And you don't want to give any magnitude of how much margin expansion you've seen?

No.

Okay.

Understand.

Thank you very much.

Thank you.

Thanks, everybody.

Give a shout if you've got questions still.

Have a great holiday, everybody.

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

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