家樂氏 (K) 2002 Q2 法說會逐字稿

Good morning.

My name is Elizabeth, and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the Kellogg Company second quarter 2002 earnings conference call.

All lines have been placed on mute to prevent background noise.

After the speakers remarks, there will be a question-and-answer session.

If you would like to ask a question during this time, simply press star then the number one on your telephone keypad.

If you would like to withdraw your question, press the pound key.

Thank you.

I will now turn the call over to Mr. John Renwick, Vice President of Investor Relations.

Mr. Renwick, you may now begin your conference.

Thank you Elizabeth, and good morning everyone.

Thank you for joining us for our review of our second quarter, 2002 results, and for some discussion of our strategy and outlook.

With me here in battle Creek are Carlos Gutierrez, Chairman and CEO, John Bryant, CFO, and Janet Kelly, Executive Vice President, Corporate Development and Administration, and General Council.

By now, you should have received the press release by e-mail or by fax.

And the slides that accompany todays presentation are available online at www.Kelloggs.com, on the investors page.

Quick note here.

The press release provides our income statement, balance sheet and cash flow figures on a reported basis.

But for analytical purposes, during this call we will also discuss our sales, profit, and EPS growth on a comparable basis.

Comparable growth figures for net sales and operating profit adjust the year ago results to exclude the sales and profit impact of last years Keebler integration activities, this years bake line private label biscuit divestiture, the amortization eliminated by FAS-142, and a change in the number of shipping days in the period.

For EPS, comparable growth figures are only adjusted to exclude from year ago results the profit impact of last years Keebler integrations activities, and the amortization eliminated by FAS-142.

We must point out that certain statements made today, such as projections for the Keebler Foods Company integration, Kellogg Company's future performance,including earnings per share, growth, operating profit, interest expense, investments, tax rate, cash flow, innovation, currencies, share repurchases, capital expenditures, shares, margins, returns, and synergies, are forward-looking statements.

Actual results could be materially different from those projected.

For in further information concerning factors that could cause these results differ, please refer to the second slide of this presentation, as well as to our public SEC filings.

Our next public prospectation will be an industry conference on the morning of September 24th, and that will be webcast.

Now, let me turn it over to Carlos Gutierrez, Chairman and Chief Executive Officer.

Thanks John, and good morning to everyone.

Over each of the past few quarters, we have been able to give you increasingly compelling evidence that our turn around is taking shape.

Today, I am pleased to announce another very solid quarter.

For the second quarter, our EPS was right on target at 42 cents.

In a moment, John Bryant will walk you through the progress.

This included accelerating our sales growth, expanding our gross profit margin, investing in brand building, and continued strong cash flow performance.

We're doing what we said we'd do.

We've made important changes to how we manage our business, and we're executing a lot better than we have in years.

And the results are coming through.

Before we discuss the specific results of the quarter, I want to highlight three key businesses.

U.S. cereal, U.S. snacks, and International.

These are the three principle engines of our future sales growth.

And in the second quarter, each was able to post growth, despite being in different stages of our strategy implementation.

I'd like to start with our U.S. ready to eat cereal business.

This was the first business for which we prioritized resources and made substantial changes to the way we managed it.

We needed to improve our competitiveness, and we achieved this through more and better brand building, through improved and more focused innovation, and through strengthened in-store execution.

In the quarter, our cereal sales through the retail channels rose 6% year over year, continuing a solid trend of year-over-year growth, and included impressive high-single-digit gains in the fourth quarter of 2001 and the first quarter of 2002.

Our innovation is clearly working.

The new Disney line holds about one share of the suggest category, and repeat consumption has been good.

Special-K Red Berries, which commands a 1 1/2 share, is still the most exciting new cereal product in years.

Our brand building initiatives are also working.

During the quarter, we ran a second installment of the "Loose six pounds in two weeks" campaign, and it continued to boost consumption of Special-K.

In fact, this promotion also continued to drive repeat purchases of Smart Start, which was only resolved in the first round of this campaign back in the first quarter.

We ran a promotion tied to the "Spider-Man" movie, and it was a very big success.

The food and packaging, the marketing program, and our sales execution was outstanding.

And with our trade inventories kept low, we were able to get the product on and off the shelf on time.

These trade inventories continued to decline in the quarter, down more than 15% year over year, and are now at a very healthy historical low.

Yet, we continue to generate solid sales growth.

The best evidence of our progress is our dollar share to category.

Once again, we increased our share year over year in the quarter, continuing a trend that dates back to early 2000.

Last year, we prioritized resources for U.S. cereal.

This was also the first business in which we rolled out our volume to value effort.

We are focusing more than ever on list prices, promoted prices, and the specialty mix.

In the second quarter, we saw impressive progress on this front, both in our reported sales, and in our in-market performance.

The category data on slide 5 show that our average price per pound during the quarter was up more than twice the rate of the overall category.

Shifting our mix toward lighter but higher price-per-pound items has a negative impact on pounds, but a relatively neutral effect on units, and a very favorable lift to our average pricing.

Meanwhile, we continue to move away from a reliance on price promotion.

In fact, we have been working to raise our promotional price points as we focus on competing on the basis of advertising, innovation, and value-added promotions.

Market data reflect these efforts, showing a double-digit rise in average price on quality merchandising during the quarter.

We're focusing on adding value and not on dropping price.

This is best captured in the market data by base sales, which attempts to measure sales that were not made on the basis of price promotion.

Slide 5 indicates that during the second quarter, our base sales growth remained very impressive, significantly outpacing the overall category.

Base sales are the most profitable kind of sales we can make, and an excellent measure of underlying competitiveness.

As expected, we lost promoted volume, referred to in the market data as incremental volume.

But this represents a profit-margin tradeoff, that we will gladly make.

In summary, we are exhibiting good momentum in U.S. cereal, and we are generating that momentum the right way.

Through brand building, through innovation, and through sales execution.

As we said previously, brand building works in this category.

In the past, the category suffered during periods of reduced brand building investment, much like other categories.

In fact, brand building investment is already having a very positive impact -- a very positive impact on the category.

Slide 6 shows how the category has returned to growth in 2002, representing a significant swing from last year's trend.

Volume has stabilized, and price and mix have improved.

And remember, this data does not cover all retailers or channels suggesting growth is even better than what is displayed here.

While our internal forecasts are based on realistic assumptions for the category, we have seen that brand building lifts growth.

I'd like to turn now to U.S. snacks, which can now begin to be a growth engine for us, following last year's transition efforts.

It's critical to understand that we consider our snacks division to be a portfolio of brands and categories.

As we enter 2002, our priority was to invest behind Rice Krispies treats and Nutri-Grain bars.

As we will see in a minute, that investment is paying off.

In crackers, we have invested opportunistically, focusing on our Star brand.

As a result, our [INAUDIBLE] cracker sales were up at a low single-digit rate in the quarter, similar to their year to date trend.

This was led by double-digit gains in Star brands like Cheez-It, Club and Wheatables.

The continued growth in Cheez-It is especially impressive, given substantial competitor pressures.

Holding down cracker growth were our commodity-like Saltine brands, and major reductions in SKUs.

Last year, we told you that we planned to resume investment behind cookies in the second half of 2002, and our plans have not changed.

Slide 7 shows how the innovation activity accelerated for cookies late in the quarter.

And cookies, more than other snack categories, rely on innovation for growth.

The good news is that while we only resumed our innovation activity in the late second quarter, the latest IRI data are already showing growth in cookies.

Pulling down our reported DSD sales in the quarter were eliminated SKUs in certain brands that we simply did not invest behind.

As slide number seven shows, we have plenty of innovation to go along with promotional programs lined up for cookies and crackers in the second half.

Importantly, our alliance with Disney begins with the biscuit category in late 3rd quarter, with the launch of Rumbly brands cookies.

We believe that resumed innovation in these segments will yield better results for us as the year progresses.

Rice Krispies treats and Nutri-Grain bars have posted the strongest growth in the division, with stong double digit growth in the quarter.

To be sure, we are comparing against a year-ago period, where we had little or no marketing or innovation activity.

However, we have also cut a high number of SKUs since then.

The retail performance can be seen in the IRI data shown in slide 8.

Year-to-date retail sales of our Nutri-Grain and Rice Krispies treats products are up a combined 22%.

Their collective consumption in the quarter was even higher.

DSD is giving us greater display activity, and it is allowing us to economically launch new products.

During the quarter, our Nutri-Grain yogurt product reached national distribution.

Late in the quarter we launched Nutri-Grain minies, which showed solid initial demand, and early in the 3rd quarter we rolled out our new Special-K bar into DSD.

In summary, while we are sticking with our previous guidance of low single-digit sales growth for the overall snacks division, we feel very good about its growth prospects.

The integration is behind us.

The division is being run effectively as a portfolio of brands and categories.

DSD is listing the growth and profitability of Rice Krispies treats and Nutri-Grain.

And cookies and crackers are already showing early response to renewed investment and brand building and innovation.

We have even increased our focus on brands by divesting a private label operation.

So it is against this favorable backdrop that we're announcing today a management change for the snacks division.

David Vermillan will be moving on to pursue his entrepreneurial interests, And Paul Lustig, an industry veteran who I think many of you know, will replace David as the President of our Snacks division.

When we acquired Keebler late last March, a priority was retaining David Vermillan so that he could oversee the integration of our snacks business, drawing from his considerable experience in this area.

Recognizing his entrepreneurial longings, we signed him on for a three years so we could be absolutely sure he would see the integration to it's completion.

Well, the integration has proceeded faster and more smoothly than we could have anticipated.

David leaves, having helped build a stronger, more diversified snack business.

He has more than held up his end of the bargain, and the time is right for him and the company to make this transition.

So we wish him extremely well, and we know we will be in touch.

And we will continue to be friends and business colleagues.

The timing was also perfect in that Paul Lustig was available to come to work at Kellogg.

Many of you will remember Paul from his various general management and strategy development positions at Sarah Lee Corporation.

He not only headed up that company's world wide apparel division, he also led Sara Lee's bakery business.

Prior to working for Sara Lee, he ran the personal care and food divisions for Dial Corporation.

In short, he has spent his career managing and growing packaged foods and other consumer products.

As our snacks division is moving from an acquire and integrate strategy to one of sustainable organic growth, Paul's experience and leadership skills for ideal.

Hopefully you'll all have the chance to meet Paul in the coming month.

I'd like to turn now to Kellogg International.

As you all know, in 2001, we had to ask Kellogg International to manage more for profitability and cash flow, so that resources could be freed up to invest in U.S. cereal.

As we entered 2002, certain key international markets began to receive increased resources.

To be sure, 2002 is something of a rebuilding year for Kellogg International.

But increased brand building investment and a heavy emphasis on volume to value are already starting to show early signs of progress.

Just as in the U.S. last year, signs of our progress will first turn up in the market data.

Slide number 9 shows that our share of key cereal markets are getting some lift from these efforts.

Some examples of key initiatives that drove growth in the quarter were our footbowls promotion in the U.K., an [INAUDIBLE]CD rom promotion in continental Europe, and a weight challenge promotion on Special-K and All-Bran in Mexico.

Fruit winders fruit snacks continue to grow in the UK.

Special K bars are generating good growth in Europe.

And the launch of Disney cereals was very well received in Mexico.

Pricing and mix were up strongly in Europe, Latin America, Canada, Australia, and Asia during the second quarter, reflecting the rollout of volume to value.

Importantly, we are seeing category growth in these markets.

For example, in the UK and Australia, the cereal category was up at a low to midsingle-digit rate.

While in Mexico and Canada, the category was up double digits.

Kellogg International sales may be recovering a little bit faster than we expected.

Local currency net sales rose 4% year over year in the quarter, and sales grew in markets representing over 3/4 of our international business.

We expect Kellogg International's local currency sales to increase for the full year as well, behind renewed brand building investment.

In summary, we feel good about our strategy and its execution.

The results show that they are working.

And the best evidence in that, is that in our largest businesses, U.S. cereal and snacks and Kellogg International, we posted solid sales growth in the quarter.

So we're very pleased with that performance.

With that, I will now turn it over to John Bryant to discuss the second quarter results in more detail.

Thank you, Carlos.

Slide 10 shows our key performance metrics for the quarter.

The first two columns show our reported results in absolute terms.

The third column, to the far right, shows growth on a comparable basis.

In the quarter, our reported net sales were up 7%.

On a comparable basis, sales were up over 4%, or twice the rate of the first quarter's comparable growth.

As we'll see in a moment, broad-based price mix gains drove this acceleration.

Year-to-date, comparable growth is 3%, at the high end of our low single-digit guidance for 2002.

Reported operating profit was up 24% or 4% on a comparable basis.

This was driven by strong gross margin expansion, which financed a double-digit increase in brand-building investment.

Profit also overcame integration costs and an asset writeoff.

Year-to-date, operating profit is up 5% on a comparable basis, right in line with our midsingle digit guidance.

Our EPS came in with 42 cents, which is right in line with our guidance, and puts us on track to meet our full year target of $1.73.

Finally, cash flow in the quarter is down year over year due to the timing of interest payments.

Excluding an extra $150 million interest payment in the quarter, cash flow is up significantly.

Year-to-date, cash flow is up 40%.

Let's visit each of these metrics in more detail.

While most of our discussion will focus on comparable basis growth, I want to briefly talk about reported net sales growth on slide 11.

This shows you the components of our sales growth the way we show it every quarter, without adjusting the year-to-date period.

As in the previous two quarters, our reported year-over-year internal net sales growth in Q2 came in around 4%.

This better-than-industry trend is being driven by the factors that Carlos mentioned.

Increased brand investment, a focus on value instead of volume ,and improved overall execution.

Volume to value is evident in yet another quarter of strong price mix contribution.

But volume to value is also evident in our flatish volume, as we shifted towards lighter, but more profitable products.

In fact, while our pound volume was only up slightly, our units were up more.

Either way you look at it, volume actually exceeded our internal expectations.

Note also that this growth excludes the year over year benefit of an extra shipping week for Keebler, as well as the comparison with a year ago period's integration impact attributable to trade inventory reductions at our snack products.

In short, we're trying to show you this internal growth in the cleanest way possible.

Now, let's sensor our discussion of sales and profit on a comparable growth basis.

Not only did our comparable sales growth accelerate, it was also broad based.

Slide 12 shows that each of Kellogg USA's major product groupings posted solid comparable growth in the quarter.

Cereal sales to the retail channel increased 6% year over year, continuing on the impressive high-single-digit gains of the previous two quarters.

Our retail consumption outpaced our shipment sales, resulting in a continued reduction of trade inventory.

Volume to value limited our volume growth, as I said before, but our pricing mix was up strongly.

Carlos already touched on the success of our new products and consumer promotions.

I would add that Kashi continued its strong growth, and our overall cereal sales grew at a double digit clip in the club store channel.

Year-to-date, our retail cereal sales are up about 8% on a comparable basis.

Though we face more difficult comparisons in the second half, particularly given the price increase and success of Special-K Red Berries last year.

Snack sales to the retail channel increased 3% year over year on a comparable basis.

Rice Krispie treats, and especially Nutri-Grain bars, posted strong gains as they benefited from increased display activity in DSD, resumed marketing, and exciting innovation.

SKU rationalization, and a relative lack of innovation activity,y at least until late in the quarter, contributed to a low single-digit decline in cookies, while cracker sales were able to post solid, low single-digit growth.

Once again, we point out that these performances are consistent with our plans for allocating brand-building resources in the first half of this year.

We did return to growth and biscuits in the quarter, and expect biscuit sales to improve modestly in the second half.

The other segment includes our Pop-Tart, Eggo, Worthington, and Food Away from Home businesses.

Collectively, these operations posted 4% comparable growth in the quarter, led by Worthington and Kashi's noncereal products.

Slide 13 shows that Kellogg International also posted solid sales growth in the quarter, with a 4% gain in local currencies.

Europe posted its best internal growth in several years, led by reinvestment in key markets like the U.K., France, and Spain, the growth was attributable to the brand-building efforts and innovations that Carlos discussed earlier.

It was also attributable to a strong increase in pricing and mix, suggesting that volume to value is starting to bear fruit.

In Latin America, a 7% comparable gain in local currencies was driven by higher pricing, and by a favorable mix shift towards premium brands, especially in Mexico..

This is a good performance, considering that economic weakness hampered our important Venezuelan business, as well as our much smaller business in Argentina.

The all other area posted a sales decline of nearly 2% on a local currency basis.

The decline was principally attributable to declines in Asia, as part of our focus on [INAUDIBLE] strategy.

Sales were flat in Canada and in Australia, which faced difficult comparisons.

But in both countries, renewed brand building efforts revitalizing our consumption growth, volume to value has lifted price mix.

So our net sales growth was broad based in the quarter, with all three major U.S. segments showing growth, as well as many of our important international areas this.

This is a very positive sign.

Turning our discussion to profitability, slide 14 shows that we continue to strongly improve our gross profit margin.

This is critical for funding our increased brand building investment.

During the quarter and year-to-date, this gross margin expansion has been driven by higher average pricing, improved mix, operating leverage, and cost synergies related to the Keebler acquisition.

Slide 14 shows this expansion on a comparable basis, with gross margin climbing 110 basis points on the quarter, and 140 basis points year-to-date.

Our gross margin would have been even higher had it not been for an asset writeoff in China, and an increase in value added promotions such as inserts.

The letter is a key brand building activity that is now accounted for in cost of goods sold under an EITF accounting change.

Excluding this value-added promotions from cost of goods, gross margin would have been up an additional 40 basis points for the quarter, and 30 points year-to-date.

Slide 15 shows that we have made good on our promise to reinvest significantly in brand building.

During the quarter, the total company's brand building investment rose a strong double-digit rate over last year.

This reinvestment began in the U.S. in 2001, and yet Kellogg USA's improved gross margin has allowed it to continue to invest heavily again in 2002.

This high investment comes despite lower media rates, and the ability of the combined Kellogg and Keebler organization to leverage value added promotions.

Coupling this marketing with strong innovation, we were able to get a better return on our brand building investment.

Kellogg International began to resume brand building reinvestment late last year, and it has increased it's brand building at a strong double digit clip so far in 2002.

Our net sales performance in several key markets during Q2 suggest some early effectiveness of these brand building efforts after prioritizing resources for the U.S. last year.

Importantly, our gross margin expansion has been more than sufficient to both fund this heavy worldwide brand building investment, and post operating profit for the overall company.

Slide 16 indicates that comparable growth in U.S. profit was 9e% during the second quarter.

Showing an ability to grow both sales and profits amidst significant reinvestment.

As we predicted, our International's market profit growth is down slightly, because it's their turn to step up reinvestment.

Europe's profit decline is advertising promotion expenses significantly outpace sales.

This is a reinvestment period for key markets in this region, And we're encouraged to see top line impact even this soon.

In Latin America, strong price mix contribution boosted our gross profit margin, which more than funded a double digit increase in local currency marketing.

The all other experienced a low gross profit margin due to an asset writeoff in China, and heavy brand building investment pulled down profit meaningfully against a noticeably strong profit gain in the year ago period.

This area should see much-improved profit performance in the second half, as we get passed some unusual costs, and sales get some traction from increased marketing investment.

Moving below the operating profit line on the income statement, you will see that we experienced a favorable swing in other income.

This is mainly attributable to comparison against notable foreign exchange losses on intercompany transactions in the year ago period.

Our tax rate came in around our target rate of 37%.

Let's turn to cash flow, a key priority for us.

Cash flow in the second quarter was again a good story for us.

It declined from a year-ago level because of an additional $150 million interest payment that we did not have last year.

If you exclude the after-tax impact of that item, cash flow was up over 11% versus last year.

The organizations continues to manage for cash.

One way it does this is by prioritizing capital expenditures for higher return on investment projects.

For the first half, we were on track to hit our forecast of declining capital expenditure in 2002.

Equally important is our continuing improvement in working capital, shown on the left-hand side of slide 17.

Our core working capital reached an all-time low as a percent of net sales.

The result is a year-to-date cash flow that is significantly ahead of last year's.

There is some timing involved in this improvement, and we continue to expect that 2002 cash flow ends up less than that of 2001.

This forecast is based on the additional interest payment, and on an unusually strong working capital reduction in late 2001.

Clearly, our first half 2002 performance gives us good confidence in our cash flow outlook.

We have been using this cash flow to pay down debt.

Slide 18 shows the dramatic reduction in our total debt outstanding over the past five quarters.

Clearly our financial flexibility has improved.

This debt reduction, along with lower short-term rates, helped to lower our interest rates by 9% year over year in the 2nd quarter.

We continue to look for full year interest expense of just under $400 million for the year.

Average diluted shares outstanding [INAUDIBLE] roughly 2% year over year, and probably more than many of you anticipated.

This increase was principally due to a rising share price that placed more [INAUDIBLE] stock options in the [INAUDIBLE], and a large number of options exercised in the quarter.

Incidentally, we have decided to use proceeds from options exercises to repurchase shares.

This will hope to contain the diluted effect of recent options activity.

Slide 19 indicates that we are affirming our 2002 EPS guidance of $1.73.

Through the first half, we are right on track toward this target, and we have managed to stay on target while absorbing integration costs and some unusual writeoffs and charges.

None of those items had been in our original guidance.

Obviously, we continue to have hurdles ahead of us.

I already mentioned the rise in diluted shares outstanding.

But we also have to absorb dilution from the bake line divestiture.

We're also weary of the wear Venezuelan currency, and possible commodity cost inflation due to weather conditions in the Mid-Western United States.

But knowing what we know now, we are comfortable with $1.73.

For the third quarter, we are comfortable with the consensus forecast, which implies flatish earnings per share. [INAUDIBLE] recall that the unusual shape of our quarterly earnings per share growth, as shown on slide 19, has to do with the change in number of shipping weeks per quarter.

The third quarter has three fewer weeks, while the fourth quarter has one additional week and an easier tax rate comparison.

There may be some slight shifting between Q3 and Q4, depending on the timing of marketing programs and synergies realization, but the shape of our year should look like that on the slide.

In summary, we feel good about our financial performance in the 2nd quarter, and first 6 months of 2002.

We are right on track to achieve our earnings forecast, and we have considerably improved our sales growth, underlying profitability, and financial flexibility.

With that, let me turn it back over to Carlos.

Thanks, John.

As we said repeatedly, 2001 was a year of transition, with 2002 being our year of acceleration.

We've done the things we said we'd do, and our results are showing this acceleration.

Our internal net sales growth is improved, led by better pricing and mix, and a return to brand building.

The second quarter saw sales gains that were more broad-based than we expected in this early juncture, with sales growing in businesses representing over 90% of our worldwide sales.

Our gross margin is rising quickly, thanks to more attention to mix, and to the realization of cost savings related to the Keebler acquisition.

That improved gross margin is funding increased brand building investment.

We're not just talking about investment in our brands.

We're increasing marketing at a rate that exceeds our sales.

And our brands are reacting.

Last year we began investing in U.S. cereal, and the results speak for themselves.

This year, resources are shifting toward U.S. snacks and International, even as we continue to reinvest in U.S. cereal.

Overall, brand building was increased at a double digit rate during the 2nd quarter.

And most importantly, we are generating more cash flow.

We set a company record for cash flow last year, and we continue to reduce working capital and capital expenditures as a percent of sales in 2002.

It is allowing us to reduce our debt, restore financial flexibility, and improve our return on invested capital.

These are the financial measures that best track our progress on turning around our company.

Our strategy is clearly working.

The Keebler acquisition is clearly working.

And our results are on track.

Best of all, we believe that we are only, as we've said a couple times before, that we are only in the early inning of a very long game.

Volume to value is only just starting to take hold with the organization and with our customers.

There is much more to do in returning to brand building and sales growth in international markets.

We are just starting to realize the power of DSD for our snacks business.

We have only begun to realize cross promotional and innovation opportunities with the acquired Keebler business.

Mixed synergies and operating efficiencies should continue to improve our profitability.

The conversion to SAP is just starting to yield efficiencies in our U.S. business.

These are just some examples of early stage initiatives that should lead to consistent growth going forward.

Return on invested capital is a good way of showing this.

As we improve our earnings and we focus on cash flow and on our capital base, our return on invested capital will improve.

Slide 21 shows how our return on invested capital was pulled down in 2001, as you would expect in the year of a major acquisition.

The stabilization and sequential rise that you see for the first two quarters of 2002 suggest that we are only just getting started on ROIC improvement.

Again, we're in the early innings of a very long game.

The important thing to remember is that we are seeking consistency, reliability, dependability in our sales and earnings.

We are right on track for our 2002 EPS guidance, with even greater earnings quality than we had previously anticipated.

And we're doing what is best for the long-term health of our business.

We'd now be happy to answer any questions you'd have.

John, if you'd want to just --

Elizabeth, can we open it up for questions?

At this time, I would like to remind everyone, in order to ask a question, please press star and then the number 1 on your telephone keypad.

We'll pause for just a moment to compile the Q&A roster.

Your first question comes from David Nielsen of CSFB.

Good morning.

Congratulations on a good quarter.

Thank you David.

I guess David Vermillan's departure was perhaps inevitable in a matter of time.

It came a little faster than I might have expected.

I guess could you comment on the timing?

And did you look at internal candidates?

I think those of us have met Paul like and respect him, but comment on the process there, please?

Yeah.

We've -- as you know, Dave, we signed up David Vermillan for a three-year period.

And we wanted to be able to ensure he'd be with us for the integration period.

The integration happened quicker, it happened smoother.

We always knew we wouldn't have David indefinitely, so we have been planning ahead for this for a while.

And David has been planning the succession with us.

So we've actually strengthened the leadership team under David Vermillon.

Several weeks ago, we promoted Rich Robertson to a sales and marketing job.

As you know, Rich is the key leader in the DSD organization.

So we have been working up to this moment.

What may have skewed the timing a couple of months here and there was the fact that Paul Lustig was available to come to Kellogg.

So we're sort of in a win-win situation.

David did a great job in guaranteeing a smooth integration.

And we were able to recruit a world-class executive like Paul Lustig.

But we have been working on this for a while.

Uh-huh.

And in another matter, someone else in the food industry has said that they want to [INAUDIBLE] said that they want to diversify their portfolio.

Obviously Kellogg has a trust.

Any comment you could make on the Kellogg's trust situation?

Not really, David.

I'm talking on behalf of the Kellogg Company, not as a trustees of the Kellogg Foundation.

I would just say that I would just hope that investors are buying our stock on the basis of fundamentals, and not on any speculation that is taking place because of the Hershey matter.

If I could ask one more question, do you have any projections for year-end debt level?

You want to take that?

At this stage, what we see is the debt continuing to come down for the balance of the year.

We are looking at some potential refinancing or moving of debt around in our international operations, that could change the [INAUDIBLE] of that debt.

But with strong cash flow still in the back half of the year, we'll see the debt probably coming down by another couple hundred million dollars from where it stands today.

What interest expense might there imply for the year?

The interest expense would be about 6.5% for the year.

Most of our interest expense --

I'm sorry.

In dollars.

Slightly less than $400 million.

Great.

Thank you very much.

Thanks, David.

Your next question comes from David Adelman of Morgan Stanley.

Good morning, everyone.

Good morning David.

Carlos, could you talk about the outlook for price mix improvement in the second half of the year as you lap the U.S. cereal price increase, and then as you go into next year?

You've obviously had substantial price mix improvement throughout the company over the last four quarters.

Is that pace sustainable as we go forward now?

You know, we do believe it's sustainable.

It's -- you may not see the same rates, and we have had some opportunity to take important price mix improvements.

But that is going to be an ongoing effort.

So what you haven't seen is some new products that will be coming out in the third and fourth quarter.

New initiatives for first quarter of next year.

But there's still a lot to do in the area of price mix.

Still a lot to do -- As you know, we have a big chunk of our P&L in price promotion, which also helps mix.

So as I've mentioned in the script, the -- we're very much in the early stages of what we think is a long-term process.

And there is -- there is always work to be done on improving mix.

And again, it's something that has not taken place for a long time in is this business, so there's plenty of room.

Okay.

Thank you.

Thank you.

Your next question comes from Terry Bivens of Bear Stearns.

Good morning, everyone.

Good morning, Terry.

Just in case I missed it, did you give the volume number on U.S. cereal at retail?

No.

We have -- do you need volume numbers, Terry?

I could get them offline if they aren't readily available.

The -- our retail -- if you look at IRI data, our volume at retail was down a little less than 2%.

Okay.

And sales, as we mentioned, was up 6 -- very close to how we're tracking on IRI.

Okay.

Carlos, as you look at the overseas market, where you're reinvesting, and your shifting to volume to value, could you just touch on the key markets there.

I noticed, for example, that Canada was flat this quarter, I think.

I know you had a price increase in March.

But if you could kind of touch briefly on those key markets of UK, Canada, Australia, and I guess Mexico as well.

Sure.

In Canada, we're facing a reduction in retail stocks, which we're managing along with our customers.

And I think it's just part of the process as we go from volume to value that you start seeing a very healthy reduction in trade stocks.

So that's what we're seeing in Canada.

We had a very solid quarter in the UK.

Very pleased.

Our business is up kind of a solid single digit, low single-digit.

Australia was flat, about flatish, slightly up.

And that's just the function of some of our programs that we have going as we make our shifts as well.

Mexico was up.

High single digit.

But the interesting thing about our international business, Terry, is as you look across the spectrum, there is basically growth across the board, whether it is UK, Italy, Spain, France, Mexico, Central America, Caribbean, just very good, broad-based growth.

And as I mentioned in the script, 75% of our international businesses showed good growth for the quarter.

Okay.

Thanks.

And one last one.

And I'll yield the floor.

Have you guys given any thought to expensing stock options?

Is that something you're looking at?

I'll tell you, Terry, I think it's something that can work.

But before we jump into anything like that, we would like to see someone establish some standards, and try to get some uniformity and consistency across companies, across businesses.

And unless that's done, I think there's a tremendous risk for confusing financial statements instead of clarifying them.

So we think it can work.

We'd like to -- we'd like to see some standards and some uniformity in the approach.

Okay.

Great.

Let me add my congrats on a real solid quarter.

Thank you very much.

Thank you Terry.

We appreciate it.

Your next question comes from [Phillipa Guses] of CSFB.

Good morning.

I am a researcher.

Also my congratulations for a great quarter.

A couple of questions this morning.

You continue to make good progress with regard to debt reduction, based on my own forecast here, now we're around at 3.3 times debt over EBITDA.

Based on your conversations with the rating agencies, have they given you specific metrics in terms of where you need to be before they will consider you for an upgrade?

No.

We continue to discuss with the rating agencies.

I think they're pleased as we are with our performance, and bringing down that debt by over a billion dollars in the first quarter of last year.

But we do not have a specific ratio that we need to get to for the rating agency will give us an upgrade.

That's a process the rating agency goes through, they look at numerous factors to come to that conclusion.

Maybe, if you could just refresh for us what your target rating is over time.

Do you plan to achieve, let's say, low single A rating?

Is that kind of where you would feel most comfortable with?

What I would say first off is we're not managing to see the business for a rating agency target in terms of A or A-minus.

But what we would like to see over time is moving back towards that sort of a-minus rating.

But if something else came up along the way, and took us off that path, then that's something we have to look at.

But that's sort of that approach.

And finally, you talked about some potential refinancing later on in this year.

As you probably know, your largest competitor, during their conference call, spoke about them looking at potentially some structured finance product in order to get the best funding.

Is that something you might be looking at as well?

Or are you going to just keep it a little more simpler, and just use traditional financing?

Well, refinancing might have been a little more than what we're talking about here.

We do have some cash overseas that we need to find a way to repatriate back to the U.S.

We do have a bond that matures April 1 next year of about $1 billion.

In terms of restructured financing, we'll look at every opportunity out there to find an effective way to keep our interest expense and our tax rate as low as we can.

Okay.

Thanks very much.

Your next question comes from Bill Leach of Banc of America Securities.

Good morning.

Good morning, Bill.

I was just wondering.

Could you give us the volume for U.S. biscuits in total and international cereal in total for the quarter?

Yeah.

I'll give you overall volume for -- You want biscuits and what, international?

Total international cereal.

Biscuits volume was up about -- and we're talking snacks here.

So that includes wholesome snacks, crackers and cookies -- up around 3%.

And International cereal?

International cereal was up -- about flat.

Flat?

Yeah.

And the 3% gain that you said before that, that includes Rice Krispie bars, not just Keebler?

Yeah.

The 3% gain on sales on Keebler is a combination of snacks, cookies, and crackers.

So with the basic --

Our crackers were up about 4%.

Cookies were down slightly.

So if you strip out snacks, our total biscuits were up about 2%.

Okay.

And just to clarify.

The full-year guidance of $1.73, that continues to exclude the 2-cent legal gain of the first quarter?

That's correct.

So that implies a fourth quarter of 48 cents, a 20% gain?

It implies a fairly strong 4th quarter EPS gain, yes.

And, that was a pretty strong quarter a year ago.

Why would you expect such a large gain this year?

We have a tax rate comparative advantage in the fourth quarter.

As well as the -- we have the movement of the extra Keebler shipping weeks as well going around the back half of the year.

So, we feel good about the numbers for the fourth quarter in terms of it's laid out on the slide and in the shape of the year.

And we see some pretty strong operating profit growth in the fourth quarter as well.

Okay.

Hey, Bill, I want to go back and make a comment on volume.

And I know I do this on every call.

But we're measuring our success in revenue, and volume is only one component, not the end goal.

I would suggest that now with the advents of EITF, that we should all be looking at revenue a little bit closer then just volume.

I agree.

But we like to know the volume and the mix.

Sure, of course.

Anyway, congratulations on a good quarter.

Thank you Bill.

Thanks.

Your next question comes from John McMillan of Prudential Securities.

Good morning, everybody.

Good morning John.

I guess I'm getting a little slow on the switch.

Just to finish Bill's point.

If volume was up 0.3%, you said on a units basis it was higher than that, I think, John.

Do you have that number?

We have it for the U.S. --

If you look at U.S. cereal, and you look at your IRI data, you'll see that our --

1.3.

-- our unit volume is up 1.3 in IRI for the 12-week period ending June 16th, whereas our pounds, I think, are down about one-sixth.

So there's a --

I got you.

There's about a three-point swing between the two.

Got it.

And just on an overall basis.

If you're -- and I know you don't want to do this.

We all have databases.

If your total company volumes in the quarter were up 0.3%, can you break that down by segment?

I've give you just general numbers.

U.S. volume was up about 1.

Europe was close to 2%.

We had slight decline in Latin America given the, you know, Brazil, Argentina, Venezuela situation.

And then a slight decline in all other, which includes everything from Asia, Australia, Canada.

So the .3 was actually driven down by businesses outside of the U.S. and Europe.

And to some extent in Latin America, you have to manage the devaluations, you know, by pricing --

Absolutely.

When something like that happens and you get a crash like we've had, the important thing is to protect your margins so that when you come out of the crash, you're still healthy.

So we would expect the volume decline.

You know, watching the Hershey, and this follows on the Dave Nelson question.

Just watching the Hershey move, and the desire for diversification on the part of the trust.

And maybe the desire to put Hershey in a more diversified environment.

Can you talk overall about your Kellogg structure?

You're much more of a focused company.

Can you talk about the benefit of focus and your feeling in that regard towards greater diversification?

We're seeing the benefits of focus in our results.

We've got a very simple business.

Simple to understand.

We have generally, you know, small set of raw materials that we're focused on.

Our technology is similar across categories.

We do business in a -- in really one or two aisles of the supermarket, which tend to be very close to each other.

That means we can transfer ideas very quickly.

We have scale in those businesses.

We have got category presence, and in most cases leadership.

In other cases a strong number two.

So I would say in that model, just as strong as having to be in 20 or 25 categories and not having that kind of clarity and simplicity.

Will you look to buy back any of the stock in your buy-back program from the foundation directly?

No.

When we execute the share buy-back, we'll just go back in the general market and buy back shares.

Okay.

Thanks.

Thanks, John.

Your next question comes from Jane Merring of Soloman Smith Barney.

Good morning.

Good morning Jane.

So the numbers do look good, but I can barely see the slides threw my elfan tears that are being shed.

I just wanted to go back to this David Vermillan issue, if I may.

Keebler has a very unique culture, which I think is part of why you purchased it.

So nothing against Paul, but could you really clarify a little more why you didn't seek to bring someone up internally from that Keebler organization and, you know, how you were going to manage this, what I think, is going to be a huge cultural issue for the Keebler folks in the ranks?

Jane, we have very strong -- a very strong organization at Keebler.

We have made a number of very significant promotions from Keebler Heritage folks since the acquisition.

Some of the elves are today Kellogg company corporate officers.

Many of them have a bigger job within Keebler than they had before.

So we have done quite a bit of succession planning and quite a bit of promoting Keebler executives.

Many Keebler executives run larger businesses today than they did before.

So I -- I don't -- I mean, it's something we to manage through.

But I think with someone like Paul, who -- frankly, an advantage here is that Paul doesn't have the Keebler background or the Kellogg background.

So in that regard, I think he'll be very good in building a bridge.

When you meet Paul, I think you'll see that he will be very effective in that transition.

We have still retained many, many Keebler executives.

So I understand, being in New York and just hearing it for the first time, that it may surprise you, but it's not -- it's not something you should worry about, Jane.

You know me.

My job is to worry.

I know.

So is mine.

But it was a surprise, because you characterized it as sort of being a difference of a couple of months.

But in the press release, it said you were hoping to have him originally for three years.

I guess processes develop.

Second question, on a broader, strategic basis.

Towards the end of your comments, Carlos, you described the Kellogg story as being in the early inning of a long game.

And perhaps you're referring to this 12-inning Yankees-Red Sox game.

And there are a lot of improvements to be made.

Could you sort of help us understand what you think are some of the margin implications, longer-term, from the improvements that you're putting in place now.

I know that's a very broad question.

Yeah.

I think we still have -- in fact, I know we still have plenty of room to improve in the area of mix.

We have a lot of work to do to continue to work our brand building and to fund our brand building.

We still have a lot to do to be more efficient with the amount of money we're spending on trade.

We've got gross margin improvements still to be had.

Not just by mix, but also through continued productivity in our network of plants.

We talked about return on invested capital towards the end of the call.

You know, I mean, we've gone to 11% in the first quarter.

We went to 13% in the second quarter.

So you can see, looking out, that we -- we've got tremendous opportunities to improve our return on invested capital.

Very uniquely so.

And we're so early on in that stage as our cash flow improves, we continue to see gains in working capital.

We're managing our capital expenditures extremely disciplined.

We're just beginning to see this model play out.

Yeah.

And that's why I'm trying to get a more tangible sense over the next, say, let's say three years or so, more quantitatively, what some of this turns into.

As we've said Jane, and you know, we are managing the business with realistic goals.

And I think the worst thing we can do now, is now that we're seeing even better number than we had expected, the last thing we want to do is take up our own targets and start getting ourselves into that sort of a spiral.

So we continue to say that our, you know, long-term goal is low single digit at the top line.

And that's revenue.

We see continued annual improvement in gross profit.

And if you took 50 basis points, that's probably a good number.

Operating profit, midsingle digit, EPS, high single digit.

And our goal is to do that consistently, reliably, dependably, and we're still on that.

But as you can see, with what we've got in place -- and please look at this as a model.

The model is working.

The model has a lot of legs, and the model is at a very early stage.

Okay.

Thank you.

Thank you, Jane.

Don't worry.

Your next question comes from Chris Grelley of A.G. Edwards.

Good morning.

I have a question for you regarding foreign currency, and if the positives we have seen in the euro, for example.

Is that going to [INAUDIBLE] incremental marketing dollars?

Or will we see some of that [INAUDIBLE] bottom line?

How will that work for the remainder of the year?

If you look at the second quarter, as an example, where we're seeing strength in the European currencies, we're seeing weakness in Latin American currencies.

And so across the second quarter, it only impacted our net sales by about four-tenths of a point.

As we go into the back half of the year, if the currencies stay where they are, the Latin American currencies will broadly offset those European currencies.

There may be a little bit of favorably there.

But quite frankly at this stage, I would take that favorably and offset against a little bit of risk with the current state of commodity prices in the U.S., with weather conditions in the midwest in the United States.

So I wouldn't see any favorability falling to the bottom line.

And then, just two sort of related questions.

One would be how much dilution is from bake line that you're absorbing?

And the other one would be, with SKU rationalization.

How would is that negatively affecting the volume this year?

Let me talk to bake line first.

There are two sources of dilution from bake line.

One is if you look at the business in isolation.

And that dilution is about less than 1 cent of EPS for this year.

And that's a fair amount of business, but it's a relatively low margin business, being private label in nature.

However, the second part dilution is when we ended up selling bake line, we kept the [INAUDIBLE] plant, which is a very large plant, and sold the Marietta plant with the business.

The result of that is we kept a lot more manufacturing capacity and overhead.

And that's at about an additional two cents of EPS dilution this year.

So it's about 3 cents of dilution for this year.

But we are absorbing that in our $1.73 guidance.

Okay.

And the SKU rationalization?

The SKU rationalization, we've generally declined to try to quantify that.

It's a rather difficult thing to qualify.

We've looked the that, and eliminated the tale of SKUs, they're relatively small in size.

And I'd rather not try to do that on the call.

Okay.

I appreciate it, thank you.

Elizabeth, we have time for one more.

Your last question comes from John O'Niel of UBS Warburg.

Good morning, everyone..

Good morning John.

I snuck it in under the gun.

The quarter looked very solid.

The primary question I had was the profit drop in either Asia Pacific or Canada.

Can you address what's going on there, and whether or not the China writeoff was part of the cause, and how big was that?

Yeah.

John will take that.

The Asia, or other component, was primarily driven by China, which was an asset impairment, which was a little bit less than 1% of EPS.

That's the primary driver there.

And the rest of the international businesses had very strong double-digit growth in advertising and promotion.

And that reflects our decision -- desire to reinvest in international businesses this year.

Okay.

And then to quick questions.

Can you tell me your outlook for corporate expense for the year, and have you changed any prices during the last [INAUDIBLE]

In terms of prices -- any prices that we've changed, is -- Canada, a price increase in the first quarter of between 4% and 5%.

I don't think we've taken any other pricing elsewhere around the world since then.

And we generally don't provide guidance on lines like corporate expense within the P&L.

So I'd rather not go on that topic as well.

Sorry.

Thank you.

Thanks, John.

Okay, operator.

Thank you very much.

Thank you.

This concludes today's Kellogg company second quarter 2002 earnings call.

You may now disconnect.