General Mills, Inc.

Greetings and welcome to the General Mills Second Quarter Fiscal 2022 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will conduct a question and answer session. At that time, if you have a question, please press the 1 followed by the 4 on your telephone. If at any time during the conference you need to reach an operator, please press star 0. As a reminder, this conference is being recorded Tuesday, December 21st, 2022. I would now like to turn the conference over to Jeff Seaman, VP of Investor Relations. Please go ahead.

Thank you, Sabah, and good morning, everyone. Thanks for joining us today for our Q&A session on second quarter results. I hope everyone had time to review our press release, listen to our prepared remarks, and view our presentation materials. are made available this morning on our Investor Relations website. It's important to note that in our Q&A session, we may make forward-looking statements that are based on management's current views and assumptions, including facts and assumptions related to the potential impact of the COVID-19 pandemic on our results in fiscal 22. Please refer to this morning's press release for factors that could impact forward-looking statements and for reconciliations of non-GAAP information, which may be discussed on today's call. I'm here with Jeff Harmony, our chairman and CEO, Kobe Bruce, our CFO, and John Doody, group president of our North America retail segment. So let's go ahead and get to the first question. Silvana, can you please get us started?

Certainly. If you would like to register a question, please press the 1 followed by the 4 on your telephone. You will hear a three-tone prompt to acknowledge your request. If your question has been answered and you would like to withdraw your registration, please press the 1 followed by the 3. If you are using a speakerphone, please lift your hands up before entering your request. One moment, please, for the first question. And our first question is from Ken Goodman with J.P. Morgan. Please proceed with your question. Close enough.

Good morning, everybody. You highlighted that your actions to offset supply disruptions and logistics issues, they're starting to bear fruit. Great to hear, obviously, but we've sort of been seeing a similar pattern from the whole sector for a while now, where these, I guess, quote, unquote, hidden costs are rising, management teams think the worst is over, and then the next quarter, unfortunately, the pattern repeats. So I guess my question is, in the wake of these exogenous issues continuing to crop up, Does your guidance have any sort of bigger cushion in it, bigger than usual, to kind of account for the potential that some of these logistics and supply shortages worsen once again in the back half of the year? Sure, Ken. This is Kofi. I appreciate the question. As you can obviously see, we gave a little bit wider guidance on operating profit than we did on the top line in EPS as So it reflects, I think, what you're alluding to, which is the underlying volatility in this environment. So at the root cause of this, we see about an eight to tenfold increase in the amount of disruptions in our supply chain. So the predictability has been at the core, but what we provision and expect in the back half is not much of an improvement to be candid. So as you think about it in relation to last year, We saw a ramp up in external supply chain costs in the back half of the year. We don't expect these costs that we're seeing for disruptions to really materially change in the balance of our year, just to replace the ramp up in those external supply chain costs. And the wider guidance reflects the volatility in the call. Okay, thank you for that. And then quick follow up, you know, in your cereal business, obviously, you've taken a great deal of share from your larger competitor that's having some unfortunate issues of its own right now. Can you walk us through a little bit where your plants are in terms of utilization in case that the demand for your products continues to grow over the next few months? Hi, Ken. It's John Doody. I would tell you we feel really good about our serial business. And while certainly there's been some short-term dislocation from one of our major competitors, our performance has really been over the long-term time. In fact, over the last four years, we've had really We feel we have the capacity we need to continue that. We continue to invest in our brands. We continue to innovate. And again, we expect to continue to grow, share, and get the category back to growth as well. So short term, we feel good about our ability to service the business. And we'll continue to do what we've done over the last four years. And that's to continue with the category. Please allow me to go to the next question.

Certainly, our next question is from Andrew Lazar with Barclays. Please proceed.

Good morning. Happy holidays, everybody. Jeff, I'm curious how General Mills thinks about sort of the balance between, let's say, shorter-term profitability given the dramatically higher cost to serve currently versus, you know, the potential for, you know, longer-term benefits from sort of, you know, sort of stepping up and servicing the customer and consumer in this difficult environment. So I guess what gives you the confidence that fulfilling this excess demand at this higher cost is sort of worthwhile? And, like, where's that cutoff and where you would decide to, like, forego a sale, not suggesting we're kind of at that point yet?

Yeah, Andrew. I mean, you know, one of the things we spend quite a bit of time looking at the trade-offs between things like customer service and margin and sales growth and that sort of thing. And, you know, we always try to make sure we play the long game in looking at these things. You know, we've been around for 155 years because we played the long game. You know, what I would say in this environment, there isn't a huge trade-off. In fact, I'm not sure there is a trade-off between higher service levels and cost. And that's because you know, if we were to take our foot off the gas on service, what we would find is that, you know, we create more deleverage, and, you know, we would incur fines because it would be more inefficient. We'd get fines from a retail customer because we're more inefficient, and then we'd be shipping truckloads of stuff, you know, that were probably less efficient. And so there really isn't a cost tradeoff. So we would not be making more money if we lessened our services. We feel like our responsibility at the end of the day is to the end consumer and making sure they have the products they want and to our retail customers. And by fulfilling that, you know, we're doing our job. The only thing we would gain by lessening service, our margins would look a little bit better, but our sales would be down. But we wouldn't make any more money for general mill shareholders, and we certainly wouldn't generate more cash than we're generating now either.

Got it. And then, thanks. And then, Kofi, just a quick follow-up. In the outlook, I think you say General Mills expects back half EPS growth to be more weighted to fiscal 4Q. Does this mean you see some, even if modest, EPS growth in 3Q and just far more in 4Q, or do I not have that right? Thanks so much.

I appreciate the question. What it really reflects is our expectation that we will see an improvement off of the margin decline from Q3 to Q4. Thank you.

Our next question is from Nick Modi with RBC Capital Markets. Please proceed with your question.

Thank you. Good morning, everyone, and happy holidays. I guess the question, Kofi, is if you can just give us some context on the inflation delta in terms of the guidance. Where were things worse than you expected? The other question I had around price elasticity, I mean, we've heard a lot of companies talking about things are better than expected, but it just seems like the retailers aren't passing all the pricing on. So I wanted to get your thoughts around that as we kind of go forward over the next few months and quarters.

Sure. Let me start with your first question. So just as a reminder on the frame here, about 55% of our input costs are sitting in remainder in logistics. And what we really saw that kind of accelerated was, in particular, our raw impacting materials moving up to double digits. Logistics, which we now expect to, which was already in the double digits, continued to rise up a little off of that pace. And manufacturing remaining in the low single digits. aluminum, resin, fiber, raw materials, grain, fats, and oils, and meat are particular pressure points as well as creating fuel as we look at the logistics cost structure. And then on your second question in relation to elasticity, Yes, sure, Nick. It's John. So one of the things we're really pleased with is our S-run capabilities that we've built over the last five or six years. And we've got a lot more data and analytics that we've leveraged, a lot more talent from the organization. So we've been closely monitoring. Obviously, the price can be taken on reflection of the market, and it's really meeting our expectations at this point. If we move to the back half, we expect to see a bit more elasticity, and we'll continue to monitor that with our capabilities today. It's really an always-on type of system where we're literally looking at pricing on a daily basis. We'll continue to monitor and adjust as needed.

Great. Thanks a lot, guys.

Go ahead. Our next question comes from Robert Moscow with the credits. Please proceed.

Hi, thanks. Hope everyone's well. I wanted to know, when you're raising your prices, John, and you're showing customers your inflation and your ingredients, like 8% to 9%, do you also show them the supply chain disruption costs that you're incurring? And is it possible – to justify the pricing based on this? Because a customer could argue that maybe some of that's transitory. So I wanted to know how that conversation goes.

So I've been in this for a long time, and I can tell you today the conversations are no easier than they have been in the past. I think everyone recognizes it's not only inflation, and obviously our job is to provide justification. So we spend a lot of time voting the case. Most of that case is built around inflation, really the market basket. So I think with that, we believe that will stick over a longer period of time. Certainly retailers are very aware of some of the short-term supply chains really focusing on some of the more macro factors from inflation to justify the pricing.

Yeah, so that's kind of my question, John. So is it more difficult then to factor in supply chain disruption as justification? So like the pricing that you're taking, is that designed to offset 8% to 9% inflation longer term, or is it also designed to offset some of this disruption as well?

at, you know, if you look at our pricing as well as H&M, we believe that offsets the inflation. It's really the short-term supply chain costs that we're seeing that are really the bogey for us. And that is our conversation with retailers. And again, we want to make sure that we price in a way that is right for our consumers as well, so we're balancing that we've built up. So we're trying to take a long view from a crisis standpoint, and clearly there's some short-term times that are challenging as we speak now with the supply chain costs. But, you know, Rob, I think you bring up a good point. John answered it well. But, you know, some of these supply chain disruptions, I mean, they will be transitory. And we don't expect them to improve for the rest of our fiscal year, as noted by Kofi earlier. But over the longer term, I mean, the supply chain will get more efficient. We've got terrific HMM productivity capabilities. And so we are highly confident that these costs over time are costs that that the business will not bear. And so even if it's a tougher conversation to have with retailers now, we are confident over time, once the market stabilizes, these are costs that we can recoup in our P&L. Got it. Okay. Maybe Jeff, this is Jeff Steven. I'd add one more point to that to maybe... Hit the nail on the head. While we don't expect the disruption environment necessarily to improve meaningfully in the back half, as Kofi said, we do expect our margin performance year over year to improve, which is really all about the comparisons, which get quite a bit easier as we have more other supply chain costs in the back half of last year. So the cost that we're seeing this year on year over year basis will be less of a headwind, which really drives growth and operating margin improvement in the back half. Okay.

I actually have more questions, but it's Christmas, so this is my gift to you is to not ask. Small gift, but something.

Our next question is from Jason English with Goldman Sachs.

Please proceed. Hey, good morning, folks. Happy holidays. Jeff Seaman, you just clarified one of my questions with Kofi, but I'm going to still ask the question with a finer point. Year on year, obviously, the gross margin pressure is going to subside just given the comps you have. But you've got price mounting or climbing through the rest of the year. I also know you have inflation coming. As we think about sequentially, if gross margins dip down in the second quarter, is this a floor level based on what you know today? Should we expect sequential growth in gross margins? I think what you can expect is we will see improvement off of the decline and sequential improvement as we move through from Q3 to Q4. And that's That's about as far as we've implied in the guidance we've given you. Okay. Okay. So implicitly, the 3Q margins could be weaker than 2Q. Next question. The U.S. consumer is still obviously very flush with cash, but one of your competitors has already noted that trade-down equities begin to resume in categories like cereal. Are you seeing something similar across any of your categories? And what are you planning for in regards to trade-down behavior, price elasticity, et cetera, as we begin to cycle pretty big stimulus checks early next year? Ladies and gentlemen, we have not seen a dynamic play out. In fact, we look at our business. the labels last year during the pandemic to continue to lose shares. So, and we'll continue to monitor that. We believe that building a brand and innovating and doing what we know best will drive our business. And if you look back historically, when, you know, during the time of the recession, again, our brands tended to perform well. So at this point, we haven't seen any change in benefits. And I would add on that, Jason, we haven't seen a food service either. We haven't seen an iPad. We haven't seen it in Europe. We haven't seen it in China or Brazil. So we simply haven't seen that behavior. yeah i haven't seen it either i was surprised by their competitor noting it which is why i asked the question but thanks a lot for the clarification guys happy holidays our next question is from steve powers with deutsche bank please proceed yes hey thanks and good morning for me as well um you know on on the supply chain disruptions um that you're seeing in labor shortages etc um taking all your prior comments in context, I guess, are there, is there a cadence that you're expecting or places where you're a little bit more optimistic, whether categories of bottlenecks or geographic overlays? Is there places in what you're facing now where you're relatively more optimistic versus not in terms of finding that relief? I'm just curious. Yeah, it's John. One of the challenges right now is that the disruptions are really across the entire supply chain. So in some cases, it's material destruction is really impacting a category. In other cases, we're capacity constrained. Obviously, for logistics, it's a challenge for all of our businesses. I'd say probably the one area that we do believe will get better is moving to the back half, material disruptions. And then due to the actions that we're taking, we're bringing on alternative suppliers where in the past it might have and great job really identifying solutions. And we'll see some of those things come online for some key ingredients that really hurt us through Q2. So I'd say that's the one area that we do expect to get a bit better. We'd expect our service levels to remain challenged through the back half of the year. We think Q3 will look a lot like Q2. We think Q4 will get a bit better, but look more like Q1. So on average, we think our service will look similar in the back half of the first half. Okay. Great. Just to clarify that, so you're you're expecting that relief to come in the ingredient sourcing, but more because you're diversifying less because the conditions get better. Is that fair? That's fair. And, you know, today we've not seen a significant improvement in availability across materials. And every time we see something get better, something else goes the other way around so it can use deeper charging. Yeah. Okay, great. And then the other question I had was just on Europe and Australia where the margin pressure is higher. you know, obviously exceptionally acute. Just as you go into, you know, annual price negotiations there, just your – based on what you're talking about so far, just your relative confidence that that will be a source of relief, of further relief in the fourth quarter as those negotiations take effect? I think you've outlined the – on pricing in that environment. There is a pretty firm negotiation window for pricing. I can't comment on anything forward-looking, obviously, but what I will confirm is that that's why you've seen our margins on EUAU be under a little bit more pressure. on reflected there so we'll leave it there and it's a very good and I just add it's also you know it's just it's a small business so it's about 10 percent of our our total sales yeah understood our next question is from Wendy Nicholson with Citigroup please proceed hi good morning

My first question has to do just in terms of the magnitude of the pricing that we should expect to see on shelf. I think the last two months you said it was 9% average increase at retail in North America. Can you give us a sense for how high you think that will be maybe over the next six months?

No, I think, you know, we generally don't comment on forward-looking pricing. And just know that we have pricing already in the marketplace that we've already announced to our customers. And so we're confident that it will be higher in the second half of the year. But as a rule, we don't comment on the specifics of forward-looking pricing.

Okay, fair enough. But I guess my question is, you know, with regard to the competitive activity, I know you said private label really isn't a threat and they're not gaining share. But sort of over a longer-term basis, Your share trends have been terrific, but I assume at some point, you know, competition is going to start to fight back harder. And maybe in terms of serial, your competitor, your major competitor has their hands tied behind their back a little bit from a supply perspective. But can you talk about what you're seeing? maybe from some of the other branded guys in North America in your other categories? Are they being as equally aggressive on pricing? Do you expect them to step up promotion in an effort to gain share? Just maybe what you're seeing kind of in the store right now.

You know, I think it's probably best to let our competitors talk about what their pricing is going to be and what their outlook for their business is. One of the things I'm most proud of, Wendy, that you did note, and I'm glad you noted, is that we've gained share over a long period of time, and we've been doing it in North American retail. We've been doing it in our pet business. We've been doing it in Europe and in China and Brazil. And so one of the things I'm most proud of, even in this tough environment, we continue to compete very, very effectively. And I think that's a sign of the quality of our execution and our customer service levels. And so no matter what, and that was happening before the pandemic, it's happened through the pandemic, it's happening now. And so I think that is the most important thing. And a lot of that time, our competitors were not constrained by supply. and they did not have material disruption. And so, you know, those things come and go, and we take them as they come and go. But one of the things I am most pleased with is our performance. And we've been able to do all of that while we're shaping our portfolio. And so we've added Pepper Hands, and it's worked really well. We've divested our yogurt business in Europe, and now, you know, announced the dough business. And we've restructured our organization. And so we've been able to have all this competitive, you know, quality without – wow – while navigating a lot of change internally as well as externally.

In terms of the North America business, I assume one of the big contributing factors to your market share gains has been the innovation we've seen which has been terrific um seemingly across the portfolio in north america retail but i assume innovation kind of comes in waves um you know some quarters are stronger than others and i'm not looking for specifics or things you haven't announced yet but just generally you know can you comment kind of thinking maybe about calendar 2022 if you think the innovation pipeline things to come are as strong as you've launched over the last six to 12 months Just sort of conceptually, is innovation still said to be a good, strong driver of hopefully even more market share gains? Thanks.

Yes, sure. Hi, Wendy. As Jeff noted, we've been performing well over a long period of time. And to his point, it's really by focusing on the fundamentals. And one of those fundamentals is innovation. So brand building and innovation are key to our brands over time. And one of the things that we didn't do during the pandemic was pull back on innovation, et cetera. In some cases, we've got some bigger ideas that we're quite excited about. So at the end of the day, whether there's inflation or not, the fundamentals matter. It's about building our brands. It's about innovating. We'll continue to do that as we move forward.

Terrific. Thank you.

Our next question is from Pamela Kaufman with Morgan Stanley. Please proceed with your question.

Good morning. Happy holidays. Happy holidays. So during the quarter in North America, you mentioned that your shipments lagged consumption by about 2% because of the service challenges you experienced. Can you just elaborate on what some of the dynamics were that contributed to that? And would you expect this to continue into the back half of the year? I guess as a follow-up, is it related to inventory levels? And do you feel like you have adequate inventory levels to meet elevated demand into the back half?

Yeah, Pam, you know, clearly, as we've talked about, lots of challenges in the supply chain, and those have impacted our ability to service our customers, our service levels. You know, during the quarter when the low-to-mid 80s versus high-90s were the targets, it was a result. You know, we couldn't shift all the demand that we saw, so it's a result. Resellers drew down a little bit of inventory in the quarter, and that led to the gap that you talked year. Clearly, our goal is to continue to strengthen our supply chain as we get into fiscal 23 and beyond. We do believe that we'll be in better shape and be able to service all of us and that it's there. One of the things that we pivoted to is a new metric on shelf availability. We think that's really important. And while it's certainly not where we want it to be, it's better than our competition and our share of sales that we're losing due to not being on the shelf as that we have with our customers.

Great, thanks. And can you talk about what short-term initiatives you have on the operational side to manage the disruption that you're experiencing in the supply chain? And I guess over the longer term, are there any changes that you're making to operations or increasing investments and capabilities or automation in response to the current operating environment?

Yeah, for sure. We went back to a lot of the practices that we put in place at the beginning of the pandemic. So one of the things we have are daily control tower meetings at the working level. challenges that are out there. We're leveraging data analytics, one of the things Jeff's been committed to for a long period of time, is really increasing our investments and our capabilities there. And that's starting to bear some fruit. So if you think about the number of trucks we have running across North America, if we can ensure that they're more full than they are currently, that's good for us. It's good for our business, good for our customers, good for our margins. We're starting to leverage some of that technology. And there's probably some opportunities to automate some of those facilities where we're challenged right now from a labor standpoint. So we have a host of things happening. And at the end of the day, communication is probably one of the most important things. supply chain standpoint. Really wanting to know real time where we are and working with them to make sure we can service them the best we can and ultimately service their consumers.

Thank you.

Our next question is from David Palmer with Evercore ISI. Please proceed.

Thanks. Good morning. Happy holidays.

Just looking back at your presentation, slide number 32, which is that gross margin waterfall chart, thanks for that. There's no numbers on some of those steps in the chart, but it looks like the supply chain disruptions, the leverage and other is a large part of the, or the majority of the decline if you net out everything else. In other words, about 300 basis points. Maybe you can confirm if that's at least ballpark correct. But also, obviously, these effects are not new to the quarter. I mean, how would you think about that same line item, supply chain disruptions to leverage another, you know, through the year and what's implied in the guidance for the second half? Yeah, so thank you for the question, David. Let me start with Q2, and then I'll talk about what to expect going forward. So I think your read is, those disruption factors and the HMM and price mix in the quarter offset the impact of inflation. But I think going forward, what you can expect as you move into the back half is a step up starting in Q3 and the contribution from price mix. I expect inflation to be roughly equal front half, back half. so nothing material there. And then, you know, in easing in the drag or the headwind from the other supply chain disruption costs, not because the costs themselves are easing, but because as you think about the comparison the last year, we saw a ramp up in other costs, primarily driven by our step into greater Q3 to Q4.

Great. That's helpful. Thank you. And then you mentioned in one of your remarks that you thought that price elasticity would perhaps get a little less good, you know, less favorable later in the year. And what is your thinking there? I think it was John that made that comment. I mean, how much something we've been thinking a lot about

Is it the lapping of stimulus or greater availability of private label or value brands that have perhaps been more supply chain constrained? What you're thinking about price elasticity as you get further into, say, calendar 22? Thanks. Yeah, exactly. Okay, yeah. So let me start first. I think I might have misspoke. I said inflation would balance. Inflation actually steps up in the back half. HMM is balanced. But to your question on elasticity balance, We are assuming a moderate increase in price elasticity, although still below our historically model levels in the back half. So that's what's contained in our sales and profit guidance. I think we're just trying to be pragmatic, right? So all the reasons. Got it. Thank you.

Our next question is from Chris Crowe with Stiefel. Please proceed.

Hi. Good morning. Good morning. I'll add my happy holidays as well. I had just two questions. The first one would just be in relation to this incremental $500 million in inflation from your initial expectations. I'm just curious, you know, if you could frame how much of that's cost inflation and how much of that is supply chain disruption, because I think you said that's incorporated into that figure, just to get a sense of, like, what's ongoing, what you have to file for, if I can say it that way, and what, you know, hopefully will be transitory. Yeah. Great question, Chris. Let me take a crack at it. So as you think about the half a billion dollars of increased cost that came in since the start of the year in our expectations. About half of that, a little less than half of it, is sitting in inflation, which we're now estimating to be 8% to 9% for the full year, and that implies it. So double digits in the back half. The other half is really related to what Okay. Thank you for that color there. And then just a follow-up question, I think a bit to Dave's question. So, this quarter had a stronger pricing performance than I expected, but the gross margin was weaker. And I'm just trying to understand the incremental inflation you're feeling. Did more of that, as you think about for the year, did more of that come through in 2Q, causing that weaker gross margin? I'm trying to flip that with your comments about second half inflation stepping up a bit versus first half. But in the quarter, was that a heavier drag on the gross margin? The drag came from a combination of inflation and really we saw a step up in the cost of disruption in Q2 as we moved from Q1 to Q2. So that was actually a bit more of the driver as we looked at the quarter. And then I think as we go forward, as I from actions that we've already announced and negotiated with customers to start probably mid-quarter and then ramp fully into Q4. Okay. Thank you for your time. Thanks, Chris.

And our final question will be from Michael Lavery with Piper Sandler. Please proceed with your question.

Thank you. Good morning. You've obviously talked a lot about the disruptions in the various stages of the supply chain. Can you just give us a sense in your guidance what you're assuming relative to a vaccine mandate and what that might do to impact the labor market or testing costs or both? We actually don't have a specific provision for the vaccine mandate. Obviously, it's still working its way through the course, but we aren't expecting it to have a material impact on our guidance beyond what we've already baked in. So if it did stick, you feel like the incremental costs would be pretty modest or just captured in what you already allow for? Yeah, I think it's probably more the second, Michael. It gives us coverage. Okay, great. And then on the North America retail components, your snacks business is pretty significantly outperforming, but it had been for a while one of the laggards. Can you just maybe give a sense of of what's really given that a boost and and is it related to a better ability to supply products or is is there is it more innovation than some other factors yeah michael um yeah so so we see the green category the bar category really you know celebrating after the lockdown and people got back to being more mobile So the categories up nicely. Our business actually on bars was up 16% in Q2, just not up quite as much in the categories. And we'll continue to stay focused on the building of brands. We're still in the number one brand in the category with Nature Valley. We've been doing innovation with Nature Valley Muffin Tops this past first half. And then we're seeing a lot of growth in the kids segment. That's probably the one area that we're not products like Rice Christmas Treats that are growing really nicely off the big bait. So that's probably the one area that we're losing a bit of share. But overall, we like the way that we're competing in bars, and we can just focus on innovation and brand building. The other snack product or category that we really like is fruit snacks. It's been an amazing category for us over the last four or five years. Our biggest challenge has been keeping up from the capacity standpoint. nice double digits, which is really exciting. So we like our snacks. Okay, great. Thanks so much. Okay. I think that's all the time we have this morning. Appreciate everyone's interesting, good questions and discussion. Thanks for sticking with us during the holiday week. We wish everybody a restful holiday season and look forward to catching up in the new year. Thanks so much.

That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.