家樂氏 (K) 2002 Q1 法說會逐字稿

Good morning Ladies and Gentlemen and welcome to the Kellogg's Company sponsored 1st Quarter Conference Call.

The floor will be open for

your questions and comments following the presentation. It is now my pleasure to hand the call over. Sir, the floor is yours.

Thank you and good morning.

Thank you for joining us today for a review of our 1st Quarter Results. With me here in Battle Creek are Carlos Gutierrez, John Bryant, CFO and Janet Kelly.

By now you should have received the press release by e-mail or fax and slides are available online at www.Kelloggs.Com on the Investors page. Before we begin we must point out that certain statements made today such as problems and Kellogg company future performance include earnings per share, operating profit, interest rates, share repurchases and shares and margins and synergies comments that are forward looking statements.

Actual results could be different from those projected.

For further information, please refer to the second

slide of this presentation as well as the FCC filings. Now let me turn it over to Carlos Gutierrez.

Thank you, John and good morning to everyone. We told you last time that after a year of making very big changes to our company last 2002 would be a year of acceleration and a return to internal sales growth and solid profit growth.

We're off to a very good start. All of the elements that we told you that would lead were evidence in this quarter. The proof is a higher price [INAUDIBLE] contribution and higher gross profit margin. In terms of managing for cash we continue to improve our cash flow and continue to use it to pay down our debt.

Our [INAUDIBLE] are working. We continued to improve our execution in U.S. cereal and other ports of our business.

Our strategy is working. Excluding the impact of a large legal settlement in our favor, our EPS in the 1st quarter was 35 cents in line with our 34 TOY -- -- it includes a strong increase in advertising and promotion investment. For the full year we continue to look for EPS of [1.7 $3].

In other words a growing moment allows us to hold our guidance despite several factors. A stronger U.S. dollar, an increase of diluted shares outstanding related to the increase in our share price and a slightly diluted divestiture and increased investment in brand building in addition, please note that this forecast no longer excludes integration cost.

I'll elaborate further in a moment but let me turn the call over to John Bryant.

Thank you, Carlos and good morning everyone, before I begin let me first discuss a factor that could alter our year over year comparisons somewhat.

As we told you in January, this move is related to SAP. Obviously putting all of our operations on the same reporting calendar cycle can [INAUDIBLE] generate fresh [INAUDIBLE].

However it can will create uneven comparisons, mainly for Keebler.

Keebler reported a 16-week 1st quarter. Last year because of timing of the acquisition, Keebler ended up having an abbreviated Q1.

Those extra weeks will be evenly spread out. In the 1st quarter, the impact was favorable but immaterial to earnings. In the 3rd quarter, however, there will be a significant negative impact which will offset the favorable affect of the other quarters.

To help you better analyze, we'll mainly discuss our results on a comparable basis which includes adjusting the year ago period to the same number of shipping days.

Slide six shows our key performance metrics. The first column shows the reported results in absolute returns.

The third quarter column to the far right shows growth on a comparable basis. The comparable basis is more meaningful.

It adjusts the year ago ago period to assume we had owned Keebler. It adjusts the year ago period of FAS 142 and it excludes this quarter favorable legal settlement and last year -- charges. Sales were up 2% on a comparable note. Excluding foreign currency comparable sales growth was almost 3%. Reporting operating profit was up 58% or 28% excluding the year ago restructuring charges.

This was driven by solid growth margin expansion which finance had a high single digit increase on a [INAUDIBLE] basis. As Carlos mentioned our reported EPS included 2 cents, including the legal settlements. Finally, cash flow in the quarter jumped year over year due the higher cash earnings, continued working capital focus and continued control on capital expenditures. It also reflects the timing of interest payments and the absence after. An $8 million cash outflow related to last year interest rate hedges. Our sales growth in the quarter was led by Kellogg USA. Slide seven shows that U.S. business posted nearly 4% on the sales growth compared with total company growth of 2%. Cereal was the main driver with sales up nearly 9%. Not only did we benefit from the successful launch of three Disney cereals, but Special K and Smart Start enjoyed a lift.

Just as importantly, our cereal business realized a higher price mix contribution and to last year summer's modest price increase.

Best of all we recorded this growth while maintaining trade inventories that are down year over year to the lowest levels in nearly three years.

Snacks were flat.

As expected, we increased -- we experienced declines in contract manufacturer arrest [INAUDIBLE] and other non-branded businesses.

In biscuits a good performance in crackers offset a softness in cookies. This was in line with our expectations given the very challenging comparisons Keebler faced as well at number of SKU's we eliminated last year.

Star brands continue to post solid growth in the quarter.

As we have mentioned in the past, our budget assumed that Keebler and the big kit category would start off slowly due to difficult comparisons.

The biggest news was the performance of Rice Crispy treats and Nutri-Grain bars.

Growth of over 25% in the 1st quarter. Carlos will discuss these again in a moment. The segments other refers to Pop-tarts, Eggo and Food away from home businesses.

Collectively these operations posted 4% growth in the quarter. Pop-tarts continue strong [INAUDIBLE]. Good growth was also reported by -- non cereal products. It was a good quarter for U.S. sales growth.

Turning to international business in slide eight. Kellogg International posted modest local currency sales growth of about 1% in the quarter. In Europe, volume edged higher despite of the discontinue [INAUDIBLE] of the private label program in Germany and its price mix contribution was up as well. If we exclude Germany, our sales were up 3%. Sales gains were notable for the Healthy Snack products in UK. In the UK the Healthy Snacks growth was [INAUDIBLE] in by last year's new fruit -- line as well as by the launch of Special K Snack bars. Latin America sales were soft as we warned you they might be. Political and economic turmoil are having a negative impact on our important Venezuela business as well as Argentina. Our Mexican sales were up 5% in U.S. Dollars but flat in local currencies as we face difficult comparisons.

The [INAUDIBLE] good news that's our share is up year over year with [INAUDIBLE] exceeding shipments and we continue to improve our price mix contributions in that core market. Sales decline was due to a decline in Asia and convenience foods. Australia posted solid sales growth. That business benefited from higher price mix and a stronger focus on its core brands. In Canada a return to brand building helped restore growth. Specifically that category rose by 4% in the quarter and {INAUDIBLE]'s Canada [INAUDIBLE] jumped by 30%. We've been focusing so far on a comparable basis growth but I want to talk about reported net sales growth. This does not attempt to adjust the year ago period and I show it because this is what we've shown fiscally. The important thing to note from slide nine is that we posted solid internal net sales growth of 4.4%: Volume was up only 0.4% but this has to do with our volume to value efforts. We've been attempting to shift our mix away from products that are heavy but carry a low price per pound.

Our units were up. And best of all, they were sold at a higher average price per pound. Related to these mix efforts our last year's substantial -- eliminations as well as the discontinuation of a private label in Germany -- both of which did not -- until midway through the 1st quarter.

So volume to value is reflected in yet another strong quarter up 4% year over year. Slide 10 reviews our operating profit growth by region on a comparable basis.

Our plan was to prioritize. And shift our reinvestment toward key international markets in 2002.

Sure enough, that's what this slide shows. In the U.S. Our solid net sells growth favorable mix and Keebler cost synergies allowed us to increase our advertising and promotion investment and still post double digit profit growth.

Some was related to Keebler's heavy spending before we closed the acquisition. However significant gross margin [INAUDIBLE] was -- profit was posted with a double digit in morning foods alone.

In Kellogg International was boosted our marketing spending at a mid- to high single digit clip and yet it was too early to expect any impact. The decline in the European profit was driven by a -- recall and by a write off of a product decline. Marketing was up at a high single digit in UK. In Latin America we experienced [INAUDIBLE] in Venezuela.

It was also pulled down by [INAUDIBLE] increases in advertising and promotions. Our cash flow is affecting our earnings per share, so let me discuss cash flow. Cash flow was an area of outstanding progress to Kellogg during 2001. And we continue to increase it in the 1st quarter of 2002. This increase is shown on the right-hand side of slide eleven. This comparison was helped by $88 million outflow when the interest rate held but our cash flow is up significantly year over year and ahead of head of our plan. We continue to make progress on reducing working capital as a percentage of sales. Every business units has goals to reduce it and this is shown on the left-hand side of the slide. I've noticed that some of you are tracking working capital performance.

On a 12 month rolling basis our cycle was 39 days an improvement of more than 20% over the 49 days recorded last year's quarter.

Returning to the income statement, other income jumped because of the $16.5 million legal settlement. But if we exclude this settlement, we actually experienced a negative swing to a net expense thanks to a decline in interest income. Our tax rate came in at just over 37% for the quarter in line with guidance. We continue to look at a 37% tax rate for the full year. Average shares outstanding continue to edge up. Remember, our priority of free cash flow is paying down debt. Also keep in mind that our higher share price creates a higher diluted shares outstanding. As many of you have already [INAUDIBLE] [INAUDIBLE] had interest expense is coming in lower than expected. We now expect interest expense to be $40 million this year with any savings reinvested in marketing. Carlos told you that we're leaving our EPS forecast unchanged, but we can give you some better guidance and this is shown in slide 12.

We feel comfortable with the forecast of 42 cents for 2nd quarter but recall the switch in the 13 week quarters -- as a result.

[INAUDIBLE] of you have a too high forecast in 2003 and too light for 2004.

On a reported basis, the 3rd quarter will look distorted by the number of shipping days.

And with that, let me turn it

back over to Carlos.

Thanks, John.

Obviously we're very pleased with this quarter. Now that you've heard a detailed rundown of the quarter I'd like to provide you with more color on how our strategy is building momentum.

Specifically I'll like to point to solid evidence that four important initiatives on working. Volume to value which is creating sales and profit growth. Managing for cash.

And our new capabilities which are helping to improve our competitiveness. You combine these factors with better overall execution and you can see why we're confident in our outlook.

I'd like to start with volume to value. We're focusing on what is important. Value instead of just volume which is one component of net sales growth.

It's not that we've given up on volume. That's far from it. It's a just that we're focusing on all of the sales growth levers so that the volume we sell gives us the greatest return on investments.

Kellogg has been able to consistently gain dollar share.

Obviously better execution is part of the success. We've executed better in innovation, advertising and consumer promotions and we've also put salespeople back in the stores.

But volume to value has achieving growth through mix. Selling fewer pounds but slightly more units and selling more units that carry a higher price per unit and that's the way the model works.

After 2001 in which we recorded our largest single year category share gain since 1985, we have continued to gain dollar share in 2002.

If you examine the category data more closely you'll see further evidence of volume to value.

Base or non promoted volume.

Our 10% gain in base same during the 1st quarter continued to outpace the category. Our incremental or price promoted volume declined by more than the category but we'll gladly take that trade-off.

In addition by relying on brand building instead of price promotion. We also have lifted our overall price per pound by more than the category. Because better execution and volume to value, our shipment sales in the 1st quarter represented the second consecutive quarter of high single digit sales growth for our U.S. cereal business.

We don't expect it to continue through the year but our strategy is working.

Slide 16 offers some examples of recent brand building efforts. The new Disney cereals launched in January follow it perfectly.

Higher price per unit and less trade spend. And they are off to a terrific start.

The two-week challenge is another example. This was even more successful than anticipated but we don't need to restrict our discussion of volume to value to U.S. cereal only. While Keebler cookie sales slipped last year we continue to gain dollar shares in crackers.

Pop-tarts continues to gain dollar share as well. Outside of the U.S. Canada offers a prime example of volume to value at work.

That category has been revitalized by brand building. During the quarter, the Canadian cereal category increased 4% and [INAUDIBLE] gained significant value share.

We did this by value added promotions.

In [INAUDIBLE] fashion we've sustained our trend of year over year -- volume to value is working and it will continue to be a key driver for us going forward. Volume to value doesn't just affect sales growth, it also contributes to our gross profit margin. Continue the trend we started in 2001 we increased our gross margin again.

This is shown in our comparable basis on slide 17 but you'll see the it was up on a reported basis as well.

Productivity efforts drove some of this improvement as did cost savings. However, much of the gain was attributable to mix as we focused on our most profitable products.

Remember that these figures are rotate for the accounting changes.

-- like toys in the box for example, which are value added consumer promotions. Their now included in the cost per unit sold. We expect continued gross profit, expansion in 2000 two. I'd like to talk now about our new capabilities.

I've announced how we're getting better distribution. SAP is already offering us new capabilities even as we continue to roll out that conversion the system.

But the biggest new capability for us is in director to door distribution.

Slide number 18 updates you on how DSD is already lifting the growth rates of Rice Crispy treats and the Nutri-Grain bars.

But even if we don't adjust for the SKU's dollar consumption in the quarter grew 6% for Rice Crispy Treats and 23% for Nutri-Grain Bars. DSD is a powerful new capability for our company both for existing and future snack products. In fact, DSD is already being used to launch new products.

During the 1st quarter we launched new Nutri-Grain Yogurt Bars which are doing extremely well and coming soon Nutri-Grain miniatures. Managing for cash refers to the metrics we have follow through the business. We delivered in 2001 when we set an all-time record for our company by generating over $850 million in cash flow and as John mentioned we continue to deliver in the 1st quarter of 2002. We have more than tripled our cash flow year over year. Both come ago USA and Kellogg International continued to boost expected cash flows and we believe there is still room for him improvement. Cash flow will continue to be a priority for us going forward and it will continue to improve our financial flex bill. At the end of the 1st quarter we had less than $6.1 billion outstanding representing a reduction of nearly $8006 million of debt since the same time last year. We've told you that we expect our cash flow to come in somewhere between the 2000 and 2001 levels.

Our 1st quarter performance should give you confidence in this forecast. So in our view, each of the last few quarters have shown signs of progress and colleges turn around and our strategy is working. We set right measures and that is reflected in our efforts which is lifting our sales growth, dollar share and gross profit margin.

And better execution is evident in everything that we do.

The Keebler acquisition is working as well. Our integration has gone well and our cost synergies are moving along on target.

We saw some good performance. There were a lot of SAP continues to make good progress and most obvious, DSD is accelerating the growth of our snack products. Despite a host of [failures] we're not changing our full year earnings guidance. The situation in Venezuela has worsened. The U.S. dollar has strengthened. We just made a divestiture that makes good sense but is slightly diluted to EPS. And we no longer exclude integration cost from our guidance, and yet we feel we're right on track to achieve our guidance because our cash flow is reducing our debt and interest rates remain low and because we feel good about the understand lying momentum about our business.

Those are the prepared remarks. Weld appreciate it if you could limit your questions to one and we'll try to steer you in that direction.

Thank you.

Ladies and gentlemen, the floor is now open for questions. If you have a question or comment, you may indicate now by pressing the numbers one followed by four on your touch tone phone.

If at any point your question has been answered you may remove yourself from the queue by pressing the pound key.

Once again, ladies and gentlemen, that's one followed by four on your touch tone phone. Our first question from Bill Leach of Bank of America.

Good morning. I just wanted to clarify your guidance. Does that include the 2 cents legal gain? 1st quarter.

No. We have a [INAUDIBLE] that out.

Okay then, my real question is can you address the Keebler biscuit sales trends and what you're going to do to turn those around.

We knew that the 1st quarter would be difficult especially for cookies.

And as we also mentioned we expect to get back to [invasion] and really playing in that category towards the back half of the year.

We saw growth in crackers in the 1st quarter.

We are we're seeing better trends. We saw a better period [INAUDIBLE] for all business I can.

We're up -- some difficult comparisons. We're comparing against also a time when we were beginning to cut some SKU's but as we mentioned before we've got a plan.

We're on plan. We expected the 1st quarter to be slightly soft in biscuits.

We're pleased with how our crackers are doing and you'll see innovation rolling out.

Yes we're on track. We're on plan and our revenue is going to be in the 3-4% range.

Okay. Thanks a lot.

Thank you. Our next question please.

Good morning.

I guess for those us last year who penalized you for the restructuring cost, now this year you're including them.

It seems like you're almost kind of penalizing yourself a bit.

How much of these costs are you going to incur this year and also you didn't mention cost savings from the restructuring. Can you give us an update on

where that stands?

Yes. Let me just answer that kind of conceptually.

We're trying to be as transparent as possible here.

Not getting into nit-picking. We've [INAUDIBLE] our integration cost in the 1st quarter.

We've also shown you the favorable impact of additional days in the quarter. We've absorbed some minor unusual items in Europe so again, we're very sensitive and very conscious that we want to report results without cost or unusual items, and that's what we're trying to do in the 1st quarter. Let me turn it over to John so he can address the synergies and the full year interest [INAUDIBLE] cost.

Thank you.

Just to -- the integration costs this year are immaterial. They are less than a cent in any particular quarter and they are phased across the year.

In terms of the restructuring charge, we took in the first quarter and the cost savings from that, a part of that Keebler synergies was to prepare us for the Keebler acquisition and as you recall on the synergy front we expected $20 million last year in synergies and we achieved $40 million.

This year we increased our target to $100 million and coming out of 1st quarter we've achieved another additional $20 million.

An additional $22 million with synergies and we're on track for the year.

But in terms of the comparison, I mean if you're including the charges this year, the right comparison versus a year ago would be $1.24 I would assume.

I would exclude the numbers from a year ago and I would ignore the integration costs this year because they are immaterial.

Okay.

But you're right. It all depends on what you have in your base.

All right. Thank you. Good luck.

Our next question from David Nelson. Mr. Nelson, your line is live.

Good morning. Congratulations.

Thank you.

Maybe following on Eric -- first of all you're getting a lot of fuel from Keebler will -- Keebler synergies, it's now been a year since the acquisition closed anyway, could you comment on how you feel about having fuel from your business on an organic basis providing the necessary fuel for top line growth beyond when the Keebler synergies were off.

We feel very good and increasingly every quarter we feel better. We have been able to reinvest in our cereal business in the USA as we've seen good trends and we've got some momentum in that business and we continue to believe that we can grow that business in dollars.

We're beginning to see that model work in international markets.

And we're able to do that in some of the international markets because we've got the Keebler synergies working for us in 2002, so the same model that we've seen work in the U.S. Is beginning to take hold in some more international markets. We've also seen that DSD works for our snack products.

Rice Crispy Treats and Nutri-Grain Bars that was an important assumption in the acquisition, so we've got some momentum in those brands. We've got new products lined up for DSD, so I feel increasingly good about our ability to grow organically and our ability to show the kind of internal sales growth we showed in the 1st quarter.

4th quarter of last year was 3.7%.

This quarter is 4.4 and we like what we're seeing. We feel good about our

business and about our organic growth and our momentum.

Thank you.

Thank you.

Our next question is coming from Terry Bivins.

Good morning.

Just a quick question.

I know we're clearly managing for value but could you give us your cereal volumes for the U.S., overseas and total.

Let me just say something about that before going into the numbers.

Because I want to make sure that we're viewing success in a similar fashion. For us, top line success is revenue. And we're managing for revenue. It's a [INAUDIBLE] part of our business model. And volume is one component of revenue, but volume isn't the end game, and I want to make sure is that as we look at Kellogg and measure [INAUDIBLE] that we both look at success in the same way and we recognize that we have a business model that calls for revenue growth.

Having said that, Terry I'll answer your question and talk about volume.

Globally, consolidated volume was up slightly.

About.4. U.S. Volume was up a little bit over 2% international, down slightly.

Having said that, volume trends even within our new business model look better than they did last year.

Our U.S. Volume is up over 2%. Our European volume grew about 1%. Latin American volume is slightly off but that is primarily attributable to the situation in Venezuela and all other is primarily convenience foods in Asia and a little bit softness in convenience foods in Canada. Our Canadian country volume is strong. So that is where we are in volume.

Okay. And Carlos I know you had expected profitability from the international operation to be up this year despite your clearly -- given the fact that we have run into a bit of tough sled [INAUDIBLE] Latin America, do you still think international comes in on an operating basis up in 2002?

What we had talked about last year is that we expected international profits to be somewhat flatish.

And that we would use 2002 as a year where we were reinvesting in key markets, having the benefit of Keebler synergies, and we continue to feel good about that.

We're looking for top line growth.

We are we beginning to invest in these markets and it takes longer to show up. If you look at inside the business, Venezuela was a hit for us. Mexican business continues to look really good locally. Our consumption in local currency was up double digit. We think that there was a little bit of with anticipation of the value added tax coming in we think that customers may have bought in last year, the value added tax didn't come in but the Mexican business continues to look strong. And Latin America really is a Venezuela story.

So rolling out volume to value and that takes a little bit of time. The important thing that's we've got a model that has worked in the U.S. business and that we're beginning to see it work internationally.

So expect a little bit of top line growth in international

and sort of flatish province.

Thank you.

Next question.

Good morning. Could you revisit why you expect the 4th quarter earnings growth to be so strong, because the days adjustments are similar to what you experience in Q1 and Q2.

Correct.

In Q4 we have the extra week of Keebler shipments, plus we have a favorable tax comparisons.

That's the two things.

Okay, can you comment on the U.S. cereal dynamics. There are some signs of life that the trends are improving.

The category year to date grew a little over 2%.

In dollars. Which we like to see. Our dollars at retail grew over 6%. Our base dollar sales which is really what we're after, grew over 9%. Our base volume was up 3%. So you know it's still early days, but we like what we're seeing and we like the fact that we're proving our ability to grow our revenue in the category, a sign that the category is responding and also growing in revenue, so we're feeling a lot better about our cereal business.

Thank you.

Our next question is coming from John McMillan.

Good morning.

Congratulations for these cereal numbers. The U.S. volume that you gave for tier was up 2. Can you just break that down

between cereals and non-cereals?

U.S. cereal was up 2% in volume.

And then snacks was flatish.

Okay. That equals two I guess.

Yes a little over two.

And marketing expense in the quarter?

We actually increased our marketing expense if you take advertising, promotion and the inserts that are in -- that are sold at a double digit rate, we also increased our advertising at a double digit rate. We were able to do that because we saw some gross profit expansion.

And the other key thing John, is that we're able to do that at a time when we grew the top

line and the bottom line.

And just in terms of the 3rd quarter guidance, and think you've laid out the reasons why but why was it to some extent this told earlier?

John, we haven't spoken since the 4th quarter release.

We talked a little bit about the fact that we're going to a

445 reporting cycle on January 29th. So you know this is just the right time to disclose that.

Just the timing and marketing plans.

Not at all. We had talked about this in late January, that we were going to a 445 reporting period and we're just confirm that now.

Just to finish on David Adelman's questions, it does appear that Post has fought back.

Is the category more

aggressive more competitive or less aggressive or about the same as what it was when you talked in january?

This has always been and continues to be a very intense and competitive category.

Worse thing on our strategy of

volume to value and and the good news that's we're able to execute that strategy successfully within the category but this has always been and will always continue to be a competitive category.

You're competing well. Thank you.

Our next question is coming from Chris Growy.

Why thank you.

Good morning. I just wanted to clarify on this Mexican value added tax.

In your [INAUDIBLE], is that just being sent back in the form of marketing now internationally.

We were expecting the value added tax to come in and because of that, we actually pulled back a little bit on some of our marketing programs because we just thought that that would cause a lot of noise in the marketplace and a lot of movement in prices.

The value added tax did not materialize.

But there really isn't a big switch in terms of marketing spending.

We've got our programs kicking in in the 2nd quarter. So if anything, we have actually pulled back a little

bit and our value add programs are kicking in Q2.

Okay.

And then from a SKU rationalization standpoint, what

effect does that have?

We haven't quantified that in terms of unit volume as we mentioned before.

We've got -- we've done significant SKU rationalization and just to remind you, cereal over 25% of the SKU's.

On snacks we took out over 40%.

On biscuits almost 15%. But these were small SKU's but you add them all [INAUDIBLE]

may not represent a lot of volume but they do represent a lot of complexity.

I would just echo that.

We have had additional innovation coming into the marketplace and we're continuing to grow the business sites, very hard to distinguish the

impact of units off volume.

There has to be some impact chris.

Sure.

And we just haven't [INAUDIBLE] find that.

On the addition of these direct sales and throughout the course of the year, I really expected more of a volume push as a result and think we've beat this one to death today, but from a [INAUDIBLE] standpoint, is that the correct way to look at it?

You're talking about the Sales Reps in warehouse?

That's right.

You know the best way to look at that is that our base sales were up 9%. We're getting great merchandising on our new products. So the fact that we're growing our base volume and our base sales and getting displays.

We're just getting those displays without the deep price points that we once had. I think that's a great tribute to the sales force that they are able to get merchandising without having to give away the products.

Okay. Thank you.

Thank you.

Our next question is coming from Jane Merring.

Thank you.

Good morning. INAUDIBLE] my one question, can you clarify the answer that you gave to John Macmillan on

the break down in volume. Total volume you said was up more than 2%.

That's correct.

And you said that U.S. Cereal was up 2 and snacks were flat so what is the component that gets you up more than two?

We saw growth in other businesses. Pop-tarts.

Okay.

It's the other. My question was during the commentary on gross margin, I heard you talk about various parts of the various business having gross expansion but I didn't hear you say cereal had gross margin expansion.

Morning foods did see a good gross margin expansion.

So you just left it out.

It's part of the morning foods business.

Okay. I hear what you're saying.

Did I actually mention that we saw some gross profit expansion and that that is why we were able to increase our brand building within that business.

Okay.

I must have missed it. All right. Well then I'm going to ask one more question. Back on slide 10, can you just go back again through European profitability.

I know you were absorbing some things in there but that was a bigger decline than I was expecting. Can you talk about your some expectations for European profits?

We had a couple of unusual items in Europe. We had a product recall that we fixed and the product is back on the market but that represents some unusual expenses in the 1st quarter.

How much was that?

It's not something that you can have [INAUDIBLE] find here, and then we also have a write off of a new product line. So we had a couple of unusual expenses in Europe in the 1st quarter that we won't have going forward, but we are reinvesting and rolling out volumes to value.

But your a -- you're right. It's lower than what the actual underlying business would cut.

Just a follow on that remember that the UK marketing 3 is up high single digit and we're reinvesting in Europe this year and we do expect Europe to be down slightly on operating profit as a result of that investment.

On a local currency basis or dollar.

Flatish on the local currency.

Can you remind me when the private label in Germany anniversary is?

Around the middle of the quarter?

Which quarter?

This quarter.

No. The 3rd quarter.

Thank you.

Our next question is coming from Kristine McCracken.

Thank you.

Just wondering. You had mentioned the contribute FRGS these Disney cereals in the quarter. I'm wondering if you could give us more color on that as it relates to if some of them are doing better than others.

If your plan is to continue rolling those out or if they are in full distribution now and just on top of that if you could possibly give us a better idea as it relates to the profitability of those cereals.

I've noted on an ounce ber ounce basis they are favorable. But if you could elaborate on that.

Sure.

We had a slide earlier on that, had the $1.8 share for the line. The interesting thing is that at this point, it's still early days, but the SKU's are about each of the three brands are about the same size.

Our distribution was achieved in record time.

If we compared to anything else we've done in the past, we've never achieved distribution as quickly as we did for Disney which is a testament to the fact that our customers have gotten behind this.

You're right. These brands do have -- they contribute to mix. They have a higher gross profit margin so our profitability is actually better than you would expect on the typical new product and that's all I should say about the profits but we're very pleased with how they started out.

We're very pleased with the support. We're pleased with consumer reaction and so far, so good.

If I remember correctly, this is a program with Disney that there was some co-promotion involved? Is that accurate?

We have a long-term reliance with Disney and that [INAUDIBLE] -- shovels promotion and involves their characters and theme parks.

Has that kicked in at this point? Have you started for example advertising these products?

Yes, we have.

We just started advertising for them in the U.S. and you'll be seeing that. You'll be seeing promotions in the future. Another interesting thing about Disney is that we haven't yet started the international roll out.

So at this point it's just a U.S. effort in the first

quarter. Three brands and throughout the year we'll be rolling these out in international markets.

Is it accurate to assume that the Disney line will I guess go into biscuits and you'll start rolling those out as you come out with new products?

Yes.

Kristine, the agreement is -- includes cookies and other categories so you will be seeing Disney on categories other than cereals which makes it bigger and more exciting so that's correct.

Great. Thanks.

Our next question is from John O'Neill.

Good morning. You mentioned that U.S. cereal sales were up 9%, which is faster than consumption. So the question would be, was there some trade build up but then you said inventory levels are very low.

Can you comment on that and give more color on inventory levels, and do you see volumes

shipping in lines with consumption in a similar volume to value benefit being sustainable?

Let me just confirm.

Our trade inventory at the end of the 1st quarter are the lowest we have over the past three years and we think that's great news.

That we were able to increase our shipments at the pace that we did. High single digit sales growth. And still end the quarter with low stocks.

And that's just very healthy, because the last thing we want to see is going into the 2nd quarter with high stocks in the trade.

Looking forward, we're going to continue with our focus on volume to value so you should see mix improvement.

And you'll see dollars outpacing volume.

Okay. I guess, did you under ship consumption last year? Is that why the numbers look unusual?

You would have to go back and look at inventory levels last year's first quarter.

And right -- the 4th quarter of 2000.

Also the data that you're looking at doesn't include a very large retailer. But the key thing and I think the real good news here is that we're going into the 2nd quarter with the lowest trade stocks we've had in three years and that's exactly where we want to be.

That's a sign of health.

That's great and I just wanted to clarify, earlier you had mentioned that you see international profits as flatish but then someone mentioned that European profits should be down. Does that suggest that other international profits will be up a little bit or is it going to be flat excluding Europe?

We have more operating profit growth in other parts of the world. A little bit more coming out of Latin America. So as you look across the portfolio, Europe is a little bit down. Latin America is a little bit up but we're flatish on operating profit year over year.

And for some of these other markets to be up, can you achieve that level of profit growth in the current economic and foreign exchange environment or do you need things to change?

No.

We believe we can, John. And we're actually seeing a little bit of -- we're seeing some local currency strengthening more than they were a month ago. And as you know, the Mexican peso has remained quite strong, so we've got a plan.

We've laid it out throughout the countries and areas. We're looking closely at local currency growth and exchange

rates. And everything we could look at says that the plan still works.

Thank you very much.

I think we have time for one more.

Our last question is going to come [INAUDIBLE].

Thank you and good morning.

In your strategy,[INAUDIBLE] and if you set a margin goal or given thought to that and maybe kind of tell us what that's and when you might reach it. You had a 17.5% operating margin.

You're about 150 basis points under that. There is a level by which you go over it, you don't think

you're supporting the brands heavy enough?

The real margin we're focused on is gross because that what is enables us to increase our brand building. I don't have a goal to throw out or a number to give you, but suffice it to say that we want to increase that on an ongoing basis and you should be looking at gross margin expansion as we move forward.

Are you thinking 100 basis points is too much to look for or is that a reasonable goal?

Is that too light? And I'm not talking about next year.

Just as a strategic goal.

I would love to see 100 basis points.

Some of your competitors have done it in other categories. Does this -- is that something that could be achieved within a couple of years?

As you know, we had 1.7 in the quarter.

Yep.

So that said, that we're off to a good start. It also demonstrates that our model is capable of increasing gross margins. We increased gross margins last year, so looking at one point increase for the year, I don't think is unreasonable [INAUDIBLE] thing is consistently so that we're able to sustain our brand building investments.

And did you get any kick from the Olympics that skewed volumes at all?

Not anything that would have made a difference.

Okay. Thank you very much.

Thank you.

I think that's it, operator.