Welcome to the FY '11 Q2 results conference call. (Operator Instructions) Now, I'd like to turn the conference over to Kris Wenker, Vice President, Investor Relations.

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'm going to do my usual housekeeping item. 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 for 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 our 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 for another 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 5 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 cost 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 the 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 was $0.76, within a penny, a very strong year ago result. Starting with the topline, Slide 6 shows the components of total company sales growth. Pound volume contributed 3 points of growth for the quarter. Net price realization and mix subtracted 2 points of growth. And foreign exchange did not materially impact total company's sales growth in the quarter. Slide 7 details our net sales performances by segment. U.S. retail sales essentially matched last year's strong levels. As we told you in July, our plans anticipated higher promotional levels across the U.S. retail food industry through our first half and…

Thanks, Don. Good morning everyone. I am 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 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 are 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 this 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 topline. 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 are seeing inflation again this year around 4% to 5% on total input cost for us. The biggest drivers behind this are dairy ingredients, resin-based packaging, fuel, coco and wheat, actually some of the same items that drove deflation in 2010. We are 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…

Thanks, John, good morning to everybody. I think as you 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 realization, 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 U.S. Retail, where we are 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 takeaway 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 are committed to leading growth in all of our U.S. Retail categories. The way to do that sustainably is to innovate. We launched a great line-up 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, Dessert Mixes and ready-to-serve soup. In the second half of fiscal 2011, we will 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…

(Operator Instructions) Our first question comes from the line of Eric Serotta from Wells Fargo Securities.

Ken, wondering whether you could give us some perspective as to whether you have 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 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 are also aware that a number of players in our space are also beginning to announce certain list price increases. I mean, 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 through the next 12 to 18 months going forward, we believe we are 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've said.

And maybe I missed it, but could you touch upon the soup category in a little 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 comment 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 say the environment in the soup category is constructive right now. We believe that the messaging across the category that we see which is really very focused on case 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's still down in the first quarter, down really overall for the second quarter but not nearly as much. And in the most recent period here in November, which is, as we are really getting into the season now, I believe that we had double digit growth. And so we think that this is going in a good direction. Clearly there is more to do and more work to do here, but we like the messaging. And the trends look like they are started to head in a much better direction.

The thing I would just add there is that it's fair to say at this point, units are stronger than dollars sales in that category. That would be true for some other categories as well, but as the promotional environment eases, you are going to see the dollar side on some of those categories continue as they have.

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

Can I ask about the cereal category in the U.K.? It's a little bit of a mystery to me what's going on over there. The pricing is obviously down heavily for the category year-on-year and volume seems to be extremely sluggish. Can you just give us a little bit more color on what you think is going on over there?

I can give you I think a little bit of color. I think you have obviously a very challenging kind of macroeconomic environment in the U.K. And it's very difficult there right now, and I think U.K. retailers (in their state), that has lead to an intensely promotional environment across a lot of categories. And so I think that's what we are seeing right now. And as we move on to an economic recovery, albeit we think it will be slow, we think that those trends will moderate. But right now, it's just very promotional there across many categories. And we are feeling that. Although I would say, overall, for CPW and for our international businesses in total we're having quite good performance. We're feeling the promotional intensity on Cereal in the U.K. General Mills wholly on the International businesses in the U.K., are really doing quite well. Very good growth on Old El Paso, very good growth on Häagen-Dazs ice cream, and we are seeing those growth trends really across Europe. So U.K. is a standout with the promotional intensity right now, but overall for us, our International business is performing quite well right now. And the places where we really need to see that which is in our core global brands.

And just a quick follow-up. Several companies have said that they are seeing a bit of light at the end of the tunnel on the Foodservice side here in the U.S., a bit of a pick-up into the restaurant's strengths. Are you seeing that as well, or is it still pretty dire?

No, I would say that we would agree with that view. Our restaurant trends, we are still down a titch. Away from home trends, we are still down a little bit in the most recent period but we are talking tens of basis points now. So it's nearly flat in the most recent period, which obviously is 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 are seeing quite a good pickup in trends there and that's a great channel for us. And we are gaining share strongly in that segment. So I would agree with what you're reading. 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 U.S., 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.

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

As you talked about your earnings expectations for the fiscal second half require pretty meaningful step-up as you go through the second half. And from John's comment, it seems like you certainly have a lot of visibility around the HMM and productivity side. And obviously pricing or net price realization becomes a little bit more of a factor to watch. Just 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 to 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 come and get there or is it just starting to move in a positive territory year-over-year?

It's clearly the latter. As we enter 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 digit is driven by volume mix and a little bit of pricing, and that still holds to your point, we're relatively flat or slightly down the first half. We'll have to get some back in the second half, but it's going to be measured in a 100 plus basis points and not multiples of that. You're going to see a moderate in the back half, a moderate increase in the back half.

So hopefully in the back half, I guess that I'm reading it 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 was talking about the timing of when you'd see the pricing reflect. It is early to be starting in January and February. So it's going to be late third quarter and the fourth quarter, when you'll really start seeing it visibly.

So volumes still then, I guess is expected to, and sort of need 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 they hit the kind of earnings goals that you're looking for as well, does that make sense and how do that take into effect, your thoughts on elasticity?

Well clearly we do factor in our elasticity expectations, and that 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 are very bullish on that line. We have strong merchandising and marketing support for that. I think Ken alluded to that, but I think this would emphasize the fact that we had some shortages of shipping on our grain snack, which we required robustly, because it's a capacity constraints that have now been resolved, we're going to have the capacity to fully meet all demand for grain snacks. So that will be a plus in the second half as well versus the first half.

And then just last quick thing Don. I know there were some heavier sort of CapEx spending in the fiscal 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 anything we can helps us try to, if we're looking at puts and takes to the second half to get some comfort around gross margins improving way to quantify that or put that in perspective?

I think you're thinking about the second half gross margins were down 100 plus basis points in the first half, and you have to get obviously that plus some back in the second to get to neutral versus last year for the full year. That will give you some more components that are going to be contributing. One 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 in the capital projects. That's much smaller than the sales, if you measured in tens of basis points and not hundreds of basis points. We're going to be laughing in the third quarter, the $48 million charge we took for the change in the capitalization threshold for the spare parts, within the second half, that's going to be a 60 or 65 basis points plus. And then also a smaller contributor, but our transaction FX, plus that we said we'd come through in the year is more back half loaded. And all that obviously will also 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 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.

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

I want to ask, in the quarter, in particular in U.S. 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?

The primary contributor was the promotional and the merchandising activity. We are very planful in terms of the merchandising, whether it was the beginning Box Tops merchandising the beginning of the quarter, soup sampling last month. So the promotional and the merchandizing calendar was probably was the largest contributor. We 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 little less grain snacks growth in the second quarter versus the first, and a little more (bakey). And for us that's a bit of a negative trade off from a top-line standpoint.

Chris, maybe it's repetitive, but what we did in Q2 was what planned to do. So we have a very powerful Box Tops merchandizing 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 merchandizing. We did fairly extensive soup sampling campaign that was accompanied by merchandizing. And 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 plan 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.

And I want 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 slower, a more methodical approach to pricing because of the state of 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 in shopping less and use of couponing and these sorts of things. But I think the fundamental aspect of our business is that the grocery store is 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 underway 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 markets. And we think that those inflation trends are telling us that we are going to need to have some pricing in certain categories and so we have announced those. But all-in-all, we manage it as a broad mix of activities. The goal is to continue to have strong margins, and we think we are in a very good position to do that now.

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

I guess my first question, there is a slide that I guess, John, went to 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 HMM the standalone number that we look at, 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 overtime. Our long-term model that we've talked about is a 4% to 5% kind of model. We think that's probably right. Clearly there is a bumpy ride. We saw deflation last year and previous to that we saw about 9% inflation. But over the course of this decade and we think that beyond as to 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 roughly. And so to kind of offset that, I guess most of the companies do it dollar for dollar. That's like 2% to 3% pricing to offset the four to five, if you just focus on the dollars and not the margin. So is that kind of how to think about how the models work in long-term. And then the differences, the other levers that you're going to pull to fund advertising and grow EBIT?

Actually, I'll backup, if I understand your question. We expect input cost inflation all of them, so that's a combination of our commodity spend. But also all of the other things we incurred labor cost, benefit cost, our capital expenditures and the depreciation associated with that, and 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 is a long-term prediction, it's 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 FY '20, because it will inflate. But that's all the cogs HMM slide is showing you as a savings slide.

If you go back to slide on Page 20 that showed all the leverage in HMM, with John, just alluding to was the cogs productivity portion of that. Yes, which is we said is the largest piece of the pie, but we also have mix management, admin, the consumer, others that we will pull to help offset that 4% to 5% inflation. And in those years, as John has alluded to, when we have particular spikes, all those activities will not be enough to offset inflation. That's when you'd see pricing come in. And so over the longer term, as you think about pricing, it is portion of, but a small portion of that low single-digit sales increase that we are targeting. I mean we always talk about, when we talk about our model of low single-digit sales gains, I mean we're always looking at that as being composed of some unit volume growth, some mix price increase and some mix improvement. So pricing is a factor, but it's not the only factor. And as we've said, its certainly not the only factor in how we manage our margins, it's really one of our long list of things that you guys are well acquainted with.

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 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 equal kind of offset, if you look at promotional dollars?

I don't know if it was equal, Eric. 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 to last 4 or 5 years, and so we are lapping a very strong period. And we are going to be off a bit and half, and one will be off for the year a little bit. But we'll still be at very high levels. And now to your question, I think, given that we have been in a period of more intense merchandising and we think that this has been kind of appropriate remix. But as the promotional environment moderates us, we see a little pricing coming 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 there are ways to increase efficiencies and make sure that that advertising spending is really going to the best places. We actually are going to have an increase in GRP delivery this year behind our U.S. brands. I believe it will be high single or even low-double digit. So there is very good advertising impact this year, and we made adjustments for the intense merchandizing environment which we think are appropriate, and as we have said which we also think we'll begin to see that merchandizing moderate.

Eric, what I would add is as we look at the full year, our total advertising spend would be a bit below last year. But it was extenuated in the second half just because of the accrual accounting for advertising. So when you make a change to your full year estimate, you have to do a year-to-date catch up. So last year in the second quarter, we increased our full year spending projections. And so we took an accrual catch-up which increased our expenses in the second quarter last year. This year, we are just at 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 the actual cash at work, was up double digits in our U.S. GRPs.

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

I was wondering just on holistic margin management, we did some work recently looking at a number of competitors, particularly in the cereal industry, who have significant cost savings. My question to you will be twofold. The first would be the kind of cost savings you are getting, could you explain in a little more detail where you think those cost savings sit competitively? Is everyone seeing the kind of holistic margin opportunity that come from factory efficiency and some of the great things you guys been working on? Can you get a sense of all your competitors, particularly the marginal competitors, have those similar benefits as we enter to 2011. Ken, this is probably specifically for you. I know you can't comment really on what anybody else is going to do. But can you get a sense from retailers, high level conversations you've had that they just expect the industry to become more efficient over time and that needs to be reflected in net pricing, or is there no such expectation of that?

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 someone else's opportunity is in the industry. I can just look at the gross margin performance and let that speak for itself. You can make those comparisons probably better than I. What I'll tell you is the nature of our savings is maybe different from what people expect. And as we first started talking about this, it became evident that there is this expectation that all of this productivity, if you will, leads to rationalization and plant closing and those kinds 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 that every dollar we invest in our brands in the form of formulation and in the form of manufacturing costs and 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 that 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 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.

Jonathan to you other question, which was addressed to me, 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 we will continue to have a very close eye on inflation. But the other answer to your question is that we actually work very closely with them to find areas or ways 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 in area where I think the industry, and by the industry I mean the manufactures and the retailers, have worked very closely together to take costs out of the supply chain. And frankly, as John touched on in his remarks, 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.

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

There was one slide that you guys did between non-measured and measured channels. And it looks like you've outperformed about 2 to 3 percentage points. There are two categories that seemed to be extreme outliers. One was the cereal category. So my question on that is, is there a sense of why that was such a strong outperformance on the non-measured side? Is this sustainable? Is there going to be a reversion? Can you talk about that? That seemed relatively impressive. I'm reading it correctly. It sounds like measured channels was down 3% and the non-measured was up 4%.

I think what I would say is 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, 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, very strong development in those non-measured channels continues. And this period, we had a little bit of a bigger gap in cereal, but 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's underperformed? I just was trying to figure out if there is a similar explanation for that one, or is there anything specific we should be seeing about that one, because that differential was negative 500 basis points?

I don't think there are much specifics there. In the quarter, we had a weaker period in the Club channel on soups. So you can get into channel-by-channel and account-by-account issues that can be related to a bunch of factors. I would I guess go back to the larger trend, which is in general this channel has been a good driver for us, and we expect it to continue to do that. 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.

Looking at your emerging markets' international margin structure, can you just talk about the progression of your margin structure in your emerging markets, China. Have you seen some turning points? Have you seen it getting closer to different levels? Can you just talk about it specifically, as you can? My sense is you'll give only general comments.

Ken, 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'll see obviously in our International segment is the operating margin. And in a market like China, for example, as we prove up the concept with gross margin improvements and at acceptable levels, we very proactively reinvest back against the business to grow, and that's both in terms of the sales force and advertising. So we reinvest part of that plus back. So you don't see as much of it flow through to the operating margin, but 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?

Absolutely. It's one of the contributors to International's margin expansion and by extension the company's.

You don't want to give any magnitudes of how much margin expansion you're seeing?

No.

Thank you everybody. Give us a call if you've got questions.

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.