Highlights From GIS's Q1 Conference Call: Delivered Sales and Earnings Growth Above Original Targets, But Guides Slightly Below

General Mills (NYSE: GIS) reports Q1 adjusted EPS of $0.41, even with the analyst estimate of $0.41. Revenue for the quarter was $3.6 billion, which compares to the estimate of $3.55 billion. Shares are trading down 3.01% today.

Highlights From GIS's Q1 Conference Call:

• Sees FY11 EPS of $2.46 - $2.48, versus $2.50 consensus.
  
• (Donal L. Mulligan, Executive Vice President and Chief Financial Officer) Fiscal 2010 was a terrific year for us. We delivered high quality sales and earnings growth, well above the original targets we set for the year.
  
• We generated more than $2 billion of cash flow, and we returned a significant portion of that to shareholders through share repurchases and dividends while also strengthening our balance sheet.
  
• We invested strongly in merchandising and consumer marketing efforts throughout the year, resulting in good fourth quarter sales growth and strong momentum as we begin our new year.
  
• Sales for the quarter totaled $3.6 billion, down 2%. Segment operating profit was $606 million, with gross margin in line with last year excluding mark-to-market effects and a 10% increase in media spending. Net earnings totaled $212 million, and diluted earnings per share was $0.31 as reported.
  
• Fourth quarter 2010 earnings include a net reduction of $0.05 per share related to mark-to-market valuation of certain commodity positions. We also recorded a $0.05 non-cash tax charge related to the recently-enacted healthcare legislation.
  
• Fourth quarter sales growth as reported, and then on a comparable week's basis. U.S. Retail sales rose 5% on a comparable basis, driven by a strong increase in pound volume. International sales grew 5% excluding the impact of the extra week. This includes 3 points of favorable foreign exchange. Volume growth drove the increase in sales on a constant currency basis.
  
• Our Bakeries & Foodservice segment reported a 5% decline in net sales on a comparable basis, but this includes the impact of divestitures and index pricing tied to wheat markets that have been below year-ago levels. Underlying performance in this business segment ranged quite good, as you'll see with our volume results.
  
• Volume trends accelerated in the fourth quarter across all of our segments.
  
• On a reported basis, pound volume contributions to net sales was unchanged verse last year, with divested products reducing growth by 1 point.
  
• On this basis, U.S. Retail pound volume increased 8% for the quarter. Pound volume for international was up 3% despite a 2-point reduction from divestitures. And in our Bakeries & Foodservice segment, pound volume, excluding divested products, would have increased in the quarter, well ahead of overall industry trends.
  
• Fourth quarter gross margin was 36.2%, down from last year when we recorded a $170 million mark-to-market gain. Excluding mark-to-market effects, gross margin matched year-ago levels.
  
• Following strong margin expansion through the first three quarters of this year, total segment margin declined in the fourth quarter. Some tactical increases in price promotion and a 14% increase in media spending resulted in a decline in U.S. Retail margins.
  
• After-tax earnings from joint ventures increased 25%, to $15 million for the quarter, including favorable foreign exchange effects. On a constant currency basis, fourth quarter sales for CPW grew 5%, with good volume growth and favorable net price realization and mix. Hagen-Dazs Japan sales declined at a double-digit rate due to the challenging economic environment.
  
• U.S. Retail sales grew 3%, led by strong growth in our Snacks businesses and Big G Cereals. Dollar sales increased across all of our U.S. Retail divisions, including baking when you look at absolute dollars, and that's with one less week of business. Comparable week sales growth was even stronger.
  
• Sales to foodservice distributors were down just 2% as reported. And while convenience store food industry sales continue to decline, sales of our brands grew 3% in 2010. Our consumer-branded products are leading our growth. Yogurt sales increased 1%.
  
• Sales of cereal grew 4%, and snack sales increased 6% in fiscal 2010. And again, comparable week sales growth was even stronger.
  
• 2010 sales growth was strong across our international markets as well. Excluding the impact of foreign currency, international net sales increased 3%.
  
• Sales in Canada were up 2% before currency benefits as we continue to drive growth in our key categories, resulting in share gains in cereal and grain snacks.
  
• Asia Pacific sales grew 9%, driven by good performance by Hagen-Dazs Shops and Wanchai Ferry in China. Sales in Europe were up 2%, led by growth for Nature Valley Granola Bars and Old El Paso.
  
• And Latin America sales matched last year's levels despite the loss of sales from divested product lines.
  
• In total, our segment operating profit margin increased by 130 basis points in 2010, to 19.3% of sales. Strong operating performance, effective cost savings initiatives, and lower input costs more than funded a 24% increase in media spending. International margins were down, but that was due to foreign currency effects. We saw good growth in both U.S. Retail and Bakeries & Foodservice.
  
• Our fourth quarter debt tender resulted in a $40 million pre-tax charge this year, but that will benefit us next year when we're estimating a mid single digit decline in interest expense.
  
• Core working capital was up 3% verse last year. Inventory essentially matched last year's levels, while receivables increased ahead of sales growth, due to sales timing shifts and foreign currency translation. Payables were slightly above last year's levels.
  
• Our operations generated over $2 billion of cash in fiscal 2010, up almost 20% from last year, driven by our strong earnings growth. We used some of that cash for capital investments. Capital spending totaled $650 million for fiscal 2010, as we added manufacturing capacity in cereal, snack bars, and yogurt.
  
• Our 2011 plans call for operating results in line with our long-term model. We expect volume gains to drive low single-digit growth in net sales, and segment operating profit to grow ahead of sales, despite renewed input cost inflation. We're projecting the increase of 4 to 5% in our commodity and fuel cost next year, after a 3% decline in 2010. Key drivers of our 2011 increases are energy, resin-based packaging, and dairy.
  
• Our corporate unallocated expense will increase next year, driven by non-cash pension expense. The increase in fiscal 2011 is driven by a decrease in the discount rate used to calculate pension expense, reflecting the low interest rate environment.
  
• We don't believe that the current low interest rate environment will last forever, but this discount rate decrease will drive an increase in expense of roughly $100 million in expense - in non-cash pension expense next year. Now, the funded status of our qualified plans is still quite healthy, and we saw a good double-digit
  return on plan assets for 2010. Looking forward, we haven't changed our long-term return assumption, and we aren't required to make any cash contributions to our plans in 2011.
  
• So to sum up our financial targets for 2011, we're expecting to deliver strong sales and operating profit growth in line with our long-term model.
  
• We're targeting earnings per share of $2.46 to $2.48 before any mark-to-market effects. That represents growth of 7 to 8% from this year's adjusted EPS of $2.30. And we'll continue to return strong levels of cash to our shareholders. Just yesterday, we announced a 17% increase in our expected fiscal 2011 dividend rate, to $1.12 per share. And our board approved a new 100 million share repurchase authorization.
  
• We don't give quarterly guidance, as you know. But if you take a look at the sell-side estimates posted out there for 2011, it appears that you all do remember that we had an exceptionally strong start to 2010. Our plan doesn't assume EPS growth for the first quarter, but the absolute level of earnings for the first quarter will be quite strong again. It will put us nicely on track to achieve our full-year EPS target.
  
• (Q&A) Just a quick question on the environment. I know folks are wondering about why it seems so difficult, just meeting a lot of the companies that we've seen lately privately, they'll say it's maybe the most difficult environment they've seen in a long time. I don't know if you share the same sentiment about the environment. What is different today? Clearly we see protracted lack of inflation that's out there, at least in terms of retail prices, and the lack of traffic at retail. But in terms of a packaged food manufacturer, how is it different today? And then maybe give the texture of what we see in the measured channels, versus what you see across all channels? (A) Yeah. Certainly. Well I think your view of the environment is going to be colored a little bit I think by the categories that you play in and the position that you have in those categories. And what we see in our categories is, while there is certainly some challenge on pricing, given the inflation - the deflationary environment that most of us have experienced in the past year, what we also see is that traffic into our - volume traffic into our categories, continues. And as we bring new products, as we increase our brand support, we continue to see traffic in our categories, which you'll see, whether you look at our pound movement that I just spoke to, or if you look at our baseline growth as measured in Nielsen. So it is a challenging environment in terms of the deflationary aspects, and certainly from a recession standpoint, some of the pressure on the consumer. But as we look at our categories, we see opportunity to grow, and we've seen that growth again, as we continue to play our game plan, along new products, along bringing customer benefits to drive traffic into their stores. And then the growth that we expect to see - and some flexibility, I guess I should say, potentially in pricing, as inflation begins to return, as we talked about, we expect for 2011. In terms of the split between measured and non-measured, we continue to see more rapid growth in non-measured channels, in club stores and in Wal-Mart (NYSE: WMT). That's a continuation of a trend. You see that in our numbers as well, the split between the Nielsen and the non-measured growth. We don't see that difference necessarily changing as we look forward. We certainly continue to expect to see growth in the traditional channels, but we expect to see the non-measured continue to grow at a slightly more rapid rate, just given the slightly different offering that they have for consumer.
  
• Is it your gut that by the second half of this - your fiscal year, that you'll start to see net pricing realization, and maybe not so much in the first half your fiscal year? Is that the general way it might play out? (A) Yeah, I think that's a fair assessment. As we look at our year, we think the rest of calendar 2010 is going to be a bit more like what you've seen for the last couple of quarters. We think if people start seeing inflation, that will begin to change in the back part of our fiscal year. That's what our plans would look like.
  
• My questions go to the gross margin. I think certainly relative to what we were looking for, that's where we were a little bit surprised. Two parts. I think the price investment here - I hear what you say about the advertising, Don. But it seems to us that maybe the price investment was a little bit steeper than we expected to get this kind of volume growth. So the question would be, is this the kind of price investment, do you think, that we will see as we go into fiscal '11? And the other side of things was, I just wanted to ask you quickly about any possible mix effects here from selling? It looks like your canned veggies perked up a little bit, at least in the recent going. If there was any kind of negative mix benefit from that? Just those two things. (A) Certainly. A couple things on the gross margin. The largest dynamic in the quarter for the margin was clearly the fact that we went from a positive price mix last year, about 5%, as we still continued to see some carryover pricing from earlier in 2009, to minus 3% this quarter, which was really a reflection of where inflation was going, to a great extent. I think the important thing also to understand is that as we look at - in pricing, or price mix, over an extended period of time, we have been pretty restrained in that, and we've been able to, because of HMM. In the past year, our gross margin has improved by 330 basis points. Over two years, that's over 400 - almost 450 basis points, and that's largely driven by HMM pricing, measured in Nielsen for example, over those two years. We've taken less than a percent of pricing verse peers, which are about 2%, and actually retailer brands, which are closer to 5%. So what you saw in the fourth quarter was a bit of us making sure that we had our merchandise levels right as we exited the year and entered the New Year. And that's something that we anticipated as 2009 unfolded. We've talked about that in, I think in probably our mid-year meeting, when we looked at the environment, and said, it's probably going get more promotional in the back half as everyone is seeing deflation. We're not going to lead pricing, but we have to be in a certain price zone to be competitive. And that's what you saw us do really in the last half of the year. As we look to next year, as I just mentioned to Dave, we don't - we expect to see some pricing opportunity as the year unfolds, as inflation is being seen by our competitors and our retailers through their retail brand. So we would expect that to - that complexion to change as fiscal 2011 unfolds.
  
• Well, the fear among investors is clearly that higher promotional levels are going be the rule of the day going forward. So I guess what you're saying is, they showed up that way in the fourth quarter, but don't necessarily look at this as kind of a run-rate sort of picture. Is that a fair statement? (A) Yes, that's a fair statement. And I think you'll probably get a much better feel for our broader plans on Thursday, when you have a chance to hear from Ian and Kris and John and many of our division presidents. And our plan for next year is founded on the same kind of growth that drove us this year, which is around new products, more impactful - ever more advertising. And that's where we're going to be leaning into next year. It's not going be a price game.

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