家樂氏 (K) 2002 Q4 法說會逐字稿

Good morning.

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

At this time, I would like to welcome everyone to the Kellogg's fourth quarter, 2002 earnings results conference call.

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

After the speaker's remarks, there will be a question and answer period.

If you would like to ask a question during that time, simply press star, then the number 1 on your telephone keypad.

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

I would like to turn today's conference over now to John Renwick.

Good morning, everyone.

Thank you for joining us for a review of our fourth quarter and full year 2002 results as well as a discussion about 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 of Corporate Development and General Counsel.

By now, you should have received our press release, by e-mail or by fax, and the slides that accompany today's presentation are available on line at www.kelloggs.com on the investor's page.

Before we start, just a few words on how our results are presented.

The press release provided will give you are income statement, balance sheet, and cash flow figures on a reported basis.

For analytical purposes, during this call we will often refer to comparable basis growth which adjusts the year-ago results for the following factors.

First of all, they assume we own Keebler for the first 12 weeks of 2001, they also exclude the 2001 sales and profit impact of the Keebler integration activities.

They exclude the 2001 restructuring charge credit, loss on debt extinguishment and accounting change.

And they assume the 2002 FAS 142 elimination of amortization had been in effect in 2001.

And that our bakeline private label divestiture had been done in May of 2001.

In addition, for net sales and operating profit growth comparisons for the fourth quarter, we adjusted the year ago figures to exclude the impact of having one extra shipping week.

As we've stated in previous calls, for 2002 we changed the number of weeks in each each quarter for certain business, notably snacks.

This means that those business units had an additional week in the fourth quarter, but remember, there is no impact pact on our full-year result.

For complexity reasons, comparable basis EPS and cash flow growth figures do not adjust for the change in the reporting weeks.

But I will point out that EPS does exclude the notably large favorable legal settlements we had in the first quarter of this year -- of 2002, I should say.

Because of these adjustments, our comparable growth rates will be lower than our reported growth rates, but we believe this method is a more useful way to analyze our results.

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

Actual results could be materially different from those projected.

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

A replay of this call will be available by phone through Monday evening by dialing 800-642-1687 and using the passcode 7468253.

It will also be available by webcast, which will be archived for 90 days.

Our next public presentation will be at the Cagney Food Industry conference on the morning of February 18th, and that will be webcast.

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

Thank you, John.

And good morning, everyone.

I want to thank everyone for being on the call and for your interest in the Kellogg Company.

It's my pleasure to announce our 2002 results.

We finished the year with EPS of $1.73, excluding favorable legal settlements in the first quarter.

On a comparable basis, this represents 12% growth, which is better, as you know, than our long term target of high-single digit EPS growth.

It was delivered the way we want to continue deliver our numbers.

Accelerated sales growth and that means revenue growth, not necessarily volume, expanded gross margin, increased brand-building investment and significant cash flow.

Our fourth quarter earnings were in line with expectations at 47 cents per share.

Despite our most difficult comparisons of the year, we grew our net sales, and we continue to expand our gross margins, increase our brand-building investment and drive strong cash flow before a year end benefit plan contribution.

Our goal in 2002, as you know is, is to accelerate our growth and give us the momentum to embark on a path of steady, dependable growth in 2003 and beyond that.

Throughout the year, we benefited from the structural changes we made to our company in 2001, and we kept very focused on our simple strategy, and we worked extremely hard to implement two elements of our financial models shown on slide 3, that we've talked quite often about.

The first is volume to value.

The whole idea here is that we're focused on the dollars that we get for what we sell, and not how much tonnage we move through our system.

This requires a focus on adding value to our brands, while we relying less on price discounting.

This approached helped to accelerate our sales growth through mix and higher average pricing and it boosted our growth profit margins so we could reinvest significantly in brand-building and innovation.

Management cash refers to our intense focus on cash.

And for the second year in a row, we have exceeded our cash flow targets, hitting the $1 billion mark for the first time before making voluntary year end contributions to our pension plans.

This cash flow allowed us to pay more than $500 million of debt, and greatly improving our financial flexibility.

So meanwhile, we remain committed to improving our execution in all areas of the business.

And this improved execution is reflected in our financial performance.

Best of all, we delivered, again, outstanding return to our shareholders, taking into account our stock price appreciation, plus our dividends in 2002.

So I'm going to pass it on to John Bryant.

He will walk you through the fourth quarter and the full year results, showing how volume of [INAUDIBLE] manage for cash works in our business.

And then I'll come back and give you some examples of how we're executing better.

John?

Thank you, Carlos.

And good morning, everyone.

Slide 4 summarizes our results for the fourth quarter and full year 2002.

I am pleased to say that we not only hit all of our financial goals for the year, but did so in a manner that was healthy for the long-term sustainability of the business.

For the quarter, net sales are up 4% on a reported basis.

But recall this quarter includes an extra shipping week for several business units, notably our snack business.

On a comparable basis, sales are up 2% over the year ago period.

For the full year, sales are up 4% on a comparable basis, outpacing our ongoing target of low single digit sales growth.

Operating profit for the fourth quarter increased 26% on a reported basis, helped by the elimination of goodwill amortization and year-ago integration costs.

On a comparable basis, operating profit was up 6% despite a significant increase in brand building.

For the year, operating profit was up 8% on a comparable basis, ahead of our ongoing target of mid single-digit profit growth.

As Carlos mentioned, earnings per share were in line with expectations at 47 cents.

Allowing us to close the year with a double-digit gain on a comparable basis.

Exceeding our ongoing target of high single digit EPS growth.

Cash flow, before making a year-end voluntary cash contribution to our pension and health care plan, came in higher than expected for the quarter.

On the same basis, our cash flow for the year was $1 billion.

This represents a 17% increase over last year's record performance.

While our fourth quarter net sales growth was a bit lighter than in previous quarters, note that comparisons were the toughest of the entire year.

In addition, we continue to improve on our key underlying metrics for volume to value and manage for cash.

Slide 5 depicts the volume to value model that Carlos mentioned.

Achieving the metric shown on this chart allows us to sustain a cycle of profitable growth.

In the fourth quarter and full year 2002, we were able to meet or exceed each of the volume to value metrics, putting us in solid financial position, as we enter 2003.

Let me walk you through these metrics in turn.

Critical to the volume to value cycle is gross margin expansion.

Slide 6 shows our gross margin, excluding the consumer promotion, such as inserts, that are now accounted for in cost of goods sold.

On this basis, our gross margin in 2002, expanded by 110 basis points.

Driven by operating leverage and favorable mix shift and cost savings, related to the Keebler acquisition.

In the fourth quarter, we experienced rising commodity costs and yet still posted a 40-basis point increase.

I'd like to point out that we did recognize in cost of goods sold, a favorable change in certain retiree health care plan.

But this was largely offset by asset impairment losses as well as costs and asset writeoffs related to supply chain efficiency initiatives.

Importantly, we experienced this comparable basis gross margin expansion in both Kellogg USA and Kellogg International in 2002 and the fourth quarter.

With the improved gross profit margin, we can afford to increase our brand-building investment.

Slide 7 shows that on a comparable basis, we boosted our brand building investment by 9% in 2002, with a similarly robust 8% increase in the fourth quarter.

As mentioned in the past, we are not simply spending more behind our brands, we are focusing this investment behind proven advertising and promotion.

We are improving its effectiveness and we are targeting the brands, categories, and markets, in which we can generate the best returns on investments.

Slide 8 shows our reported net sales growth in its various components.

Recall that we owned Keebler for one additional quarter in 2002, partially offset by the bakeline divestiture during the second quarter.

A change in our reporting calendar had no impact on the full-year sales growth, but it did result in an extra shipping week in Q4 for some of our businesses.

It may surprise you that currency translation had only a modest impact on our sales report quarter and full year, despite the U.S. dollar weakening in the second half of the year.

This gives you an idea of the magnitude of Venezuela's devaluation as well as that of other Latin American currencies.

Excluding these items, our internal sales growth in 2002 was a strong 4%.

In the quarter, it was 1%.

And remember that this compared against a 4% gain in the year-ago period.

Our toughest comparison of the year.

Note the sizable contribution from price mix in both the quarter and full year.

By focusing our brand-building and product innovation behind value-added brands that carry higher price per pound and higher gross margins, we were able to improve our mix throughout the year.

Again, I point out that while our volume of [INAUDIBLE] was flat in 2002.

Remember, this is pound volume, shifting our mix away from heavy, less differentiated products to lighter, value-added products has the effect of reducing our total pounds sold.

In businesses where this mix shift is occurring, however, our volume in units is increasing.

U.S. [INAUDIBLE] is a great example, market data will show you that throughout 2002, there was a 2 percentage point difference between our unit growth and our pound growth.

Internal sales growth was lighter in Q4 than it had been in the previous three quarter principally because of two businesses.

U.S.

Cereal faced an extremely difficult comparison with the year ago period which held it to modest growth.

And the biscuit segment of our snacks division posted a sales decline.

Carlos will give more details of each of our businesses momentarily.

In summary, our well-balanced volume to value cycle is producing sustainable profitable growth.

Slide 9 shows our local currency currency [INAUDIBLE] profit growth by area on a comparable basis.

Each of these areas reported expanded gross profit margins and operating profit growth during the fourth quarter.

For the year, only Europe and the "all other" area, which includes Canada, Australia, and Asia, recorded modest profit declines.

However, these declines were attributable to double-digit increases in brand building investments.

Most of our EPS growth in 2002 was attributable to our internally generated profit growth.

Moving down the income statement, interest expense increased by 11% in 2002, owing to a full year of the borrowings used to acquire Keebler.

However, by significantly reducing our debt, we're able to pull down interest expense by more than 5% year over year in the fourth quarter .

Our effective tax rate was 37% for the quarter and the year .

Our average diluted shares outstanding increased by 1% in 2002 due to the impact of exercised stock options and the effect of the higher stock price on [INAUDIBLE] dilution.

In the fourth quarter, average shares are up only slightly year over year, thanks to using stock option exercised proceeds to repurchase about $100 million worth of shares during the second half of the year.

Again, the net result was increased earnings per share that, on a comparable basis, exceeded our long-term target of high-single-digit growth.

Let's turn to manage for cash on slide 10.

Ever since we created business integrated business units, gave them full ownership of their own cash flow, and made cash flow one of our bonus metrics, our organization has been intensely focused on driving cash flow.

On each of the metrics of the manage for cash cycle, we made outstanding progress in 2002.

Both in the fourth quarter and full year.

Let me take you through them.

Slide 11 highlights the remarkable progress we have made on two of these metrics.

In 2002, we again reduced average coworking [ph] capital as a percentage of sales, with a strong, 110-basis point decline.

We believe we can achieve improvement again in 2003, albeit a more modest improvement.

Meanwhile, we continue to work our assets harder with our capital expenditure decreasing toward our target of 3% net sales.

At work here is greater prioritization of resources.

Focusing on projects with rapid cash paybacks and improved utilization and productivity.

We are not starving our asset base, we are simply using capital more effectively.

We project capital expenditures to be around 3% of net sales again in 2003.

Slide 12 shows that these efforts produce more cash flow than ever in 2002.

Reaching the $1 billion mark for the first time before making a year-end voluntary cash contribution to our pension and health care funds.

This represented a 17% increase over the prior year's record cash flow and exceeded our aggressive expectations.

The 2002 cash impact of contributions to our benefits plan was approximately $250 million, net of tax.

Again, this was a voluntary contribution.

Our strong cash flow gave us the financial flexibility to partially offset a substantial benefits expense increase in 2003 and delay any future mandatory contributions.

Recall that weak stock market returns and our decision to reduce our discount rate and asset return assumptions, as well as increase our health care cost inflation assumption will result in higher benefits expense in 2003.

This cash contribution will partially offset this higher expense.

The cash contribution also helped to reduce the balance sheet adjustment required when our pension plans swung from a net asset position to a net liability on the balance sheet.

This amounted to about $306 million net of taxes.

But I should point out that this is purely a balance sheet adjustment to book equity.

It has no impact on our earnings or cash flow and it does not affect our debt covenant.

Slide 13 shows that we have dramatically reduced our debt in the two years since the acquisition of Keebler.

In 2002, we reduced our debt by more than $500 million, exceeding our projections.

Debt reduction continues to be a priority for us for the foreseeable future as we continue to improve our financial flexibility.

As you can see on slide 14, we continue to look at the high single-digit EPS growth in 2003.

This is in line with our long-term growth target in the range of $1.86 to $1.90 we announced on our previous quarterly conference call.

Net sales growth should increase at a low single-digit rate and should be fairly consistent across most of our businesses.

In U.S.

Cereal, we do face very difficult comparisons.

And competitive [INAUDIBLE] hoping to regain share.

However, we feel good about our brand building and innovation plans in that business.

In U.S.

Snacks, we will be investing in brand building as we move to an organic growth strategy.

And this should generate low single-digit growth, excluding our recent divestitures.

Internationally, we project low single digit sales growth as well.

While the US dollar weakens significantly against the euro and sterling, we remain exposed enough to weakening Latin America currencies that we do not expect a significant impact from foreign exchange in 2003 versus 2002.

We anticipate midsingle digit operating profit growth, driven by modest gross margin expansion that will allow us to again increase brand building at a rate [INAUDIBLE].

This margin expansion won't come easily.

We'll need to manage our economic and currency volatilities in Latin America, especially in Venezuela.

Benefits costs will rise at a double-digit rate.

Even after making the cash contribution to the plans.

Commodity costs remain high.

We believe a combination of mix, productivity initiatives, and recently-implemented price increases, all of which were contemplated in our guidance, can help to offset these cost pressures.

We are forecasting interest expense of about $360 million and an effective tax rate of 36%.

Generally speaking our EPS growth should be meaningfully higher in the first half than the second half.

While our operating profit growth should be fairly even throughout the year, we do face easier comparisons in the first half on below the line items like interest expense, tax rates, and shares outstanding.

Our first quarter EPS guidance is 38 to 40 cents a share.

This means we start the year with a double-digit increase, excluding the favorable legal settlements of the year-ago period.

In summary, our goals for 2002 were to improve our financial position and create momentum in 2003.

And we did that in the form of better sales growth, higher margin, increased brand building, greater cash flow and reduced debt.

Now I'd like to turn it back over to Carlos.

Thanks, John.

I'd like to take you through a review of our various businesses, emphasizing our improved execution in 2002.

Each of our businesses is at a different stage of implementing volume to value and manage for cash and strict prioritization has left some businesses with more resources in capital than others.

But in virtually all of our businesses, there are signs of increased competitiveness and better execution.

Slide 15 shows our comparable basis sales growth for Kellogg USA.

Clearly, U.S.

Cereal had a big year, and so did all other segments led by Kashi's noncereal products and our food away from home business.

Snacks growth was modest, and that was principally due to a soft fourth quarter, which I'll get into in a second.

Slide 16 shows our U.S.

Cereal sales growth in the fourth quarter and full year 2002.

In the fourth quarter, we faced enormously difficult comparisons.

So recall that in the year-ago period, our U.S.

Cereal sales jumped 13% after restating for EITS despite a reduction in trade inventories.

So, to achieve a 1% gain against that kind of a comparison, we believe is quite impressive, especially given the considerable amount of promotional activities by competitors during the month of December.

So a very good quarter and very good year for cereal.

For the year, cereal sales were up 6% on the heels of a 2% gain in 2001.

These are outstanding results and equally important is that we are achieving these results in a sustainable way.

Cereal was the first U.S. business to implement volume to value and is furthest along in improving it's execution.

In 2002 it targeted specific consumer segments, enhanced its advertising effectiveness and ran better value-added promotions.

And our innovation, frankly, led the category.

Slide 17 uses IRI data show to highlight this execution in 2002.

The data show that we truly did focus on adding value and price discounting less.

Our base sales, which attempt to measure products sold without any form of promotion, increased by 6% in 2002.

While the rest of the category was down 1%.

Our incremental sales, which reflects products sold on some form of price promotion were down 4%.

This tradeoff of base sales instead of incremental sales is one, as you know, we will gladly make because of its favorable impact on profitability.

Our average price on quality merchandising was up 8%.

This means we are discounting far less.

And our overall average price was up 5%, compared to the categories' 1% rise.

This is principally because of the mix-shift toward value-added brands, like Special K Red Berries, and the Disney cereals as well as reduced discounts.

Most important, we realized our third consecutive year of dollar-share growth, adding 80 bases point and we helped lift the category.

Clearly, we're committed to brand-building and we are executing so much better.

We will share more of our U.S. marketing and innovation plans for 2003 at the Cagney conference next month.

Slide 18 shows the year-over-year net sales growth of our U.S.

Snacks business by quarter in 2002.

Remember, that we face usually difficult comparisons during the first quarter of the year.

Then sales growth in this business picked up in the second quarter and the third quarter as wholesome snacks grew rapidly behind innovation and DSD and selective investments helped keep biscuits relatively stable.

However, a 4% decline in the fourth quarter brought the full-year growth rate down to 1%.

Our shipment decline in the fourth quarter resulted from three primary factors.

The first was the discontinuation of certain custom manufacturing businesses.

The second, frankly, a disappointing December cracker season.

For our company and for the category and then, importantly for us, was the cancellation of a quarterly sales incentive.

Let me just take you through each of these points.

You'll recall that we have been discontinuing our low-margin custom manufacturing business as we move our towards focus toward higher-margin branded business.

This created a loss of revenue year-over-year.

Next, we had a disappointing cracker season.

Our consumption at retail was down 3% year over year on crackers in the fourth quarter.

The decline was driven by lower sales and reduced display activity as we pulled back on trade spending in December, while our competitors were extremely aggressive.

But make no mistake.

We're not happy about this performance.

And we are all over this business.

We will continue to strike the right balance between trade and consumer spend.

As we move our snack business to more of an organic growth strategy.

And it is fair to say that we pulled back a little bit too much trade in December.

Finally, we canceled the quarterly sales incentive programs that Keebler has had in place for many years.

These are special incentives above and beyond the normal commissions.

And while they are effective in driving shipments, they can also lead to inefficiencies in periods of high inventories and product returns.

So cancelling the sales incentive caused some temporary pain in the form of year-over-year shipment declines.

However, our cookies and cracker consumption was relatively soft, as shown on slide 19.

Even though it did not decline as much as our shipments.

This correction should be largely behind us.

And we expect our biscuit shipment and our consumption to track more closely going forward.

Innovation and brand building efforts are under way in biscuits and where we have invested, we have seen growth.

For example, in cookies, our Keebler, E.L.

Fudge, Keebler Sandies and Marie Sugar Free all posted growth at retail in the fourth quarter, driven by recent innovations.

In crackers, advertising and new varieties helped Cheez-It and Club continue to grow in the fourth quarter, finishing with full year dollar sales consumption gains of 10% and 8% respectively.

The slide also indicates that, despite these factors in biscuits, our total snack consumption continued to grow in the quarter.

Our wholesome snacks continued to grow impressively in DSD, posting growth of over 20% in the quarter and nearly twice that rate for the full year.

With DSD providing display activity and favorable product launch economics, the Nutri-Grain franchise was expanded with several new products, each of which experienced impressive growth.

Our new Special K bar launched in the third quarter has been a great success, indicating the opportunity for new brands.

This launch has posted the highest initial velocity of any previously launched wholesome snacks.

We're very pleased with that.

In 2003, we'll be active in innovation and brand building in both biscuits and wholesome snacks segments.

And importantly, our snack sales are off to a very strong start in January.

We'll have more details for you next month at Cagney.

Slide 20 shows quarterly sales growth rates for our other U.S. businesses in 2002.

As the slide indicates, this portion of Kellogg USA put up strong numbers all year.

In the fourth quarter, it posted sales growth of 4%.

And for the full year grew 5%.

Worthington and Agwire [ph] frozen foods business each recorded solid midsingle digit net sales growth in 2002.

Our food away from home business, which benefited from new products in an intense focus, delivered 3% growth in a sluggish food service environment, which we believe is a great accomplishment.

Kashi's noncereal business expanded beyond Go Lean snack bars and into crackers and even waffles.

And growth was outstanding in 2002.

And Kellogg's Pop-Tarts, our largest single brand in the U.S. posted sales growth of 5% in 2002.

This brand has now posted over 20 consecutive years of growth.

These businesses contribute to good profitable growth.

They offer considerable opportunity for innovation and margin expansion.

Better execution in volume to value also beginning to yield improved results in Kellogg International.

Slide 21 shows how Kellogg International finished 2002 with over 3% comparable basis, local currency sales gain for the full year and 4% for the quarter.

This growth would be even stronger in reported U.S. dollars.

Impressively, this division showed sequential acceleration throughout the year.

It began the year with a 1% comparable basis growth in the first quarter, building up to 4% in the second, 5% in the third, and 4% increase in the fourth quarter.

Behind this growth was a 13% increase in brand building and local currencies, as well as improved price mix, as the various markets implemented volume to value.

Slide 22 shows us this international sales growth was broad-based, with each area contributing.

In Europe, sales and local currency increase said 1% for the fourth quarter and 2% for the full year.

These same growth rates applied to U.K. business, whose growth we expect to accelerate in 2003.

France and Spain showed notably solid growth in the quarter and the year.

In U.S. dollars of course our sales in Europe were up 13% in the fourth quarter.

And 8% for the full year.

In Latin America, sales and local currencies increase was a very strong, 9% for the fourth quarter and 7% for the full year.

Mexico continues to execute extremely well, driving impressive net sales growth in local currencies.

Elsewhere in Latin America, we experience solid growth in both the quarter and the year, in key markets like central America and the Caribbean, more than offsetting declines in Venezuela.

A very important market for us.

And smaller markets like Argentina and Brazil.

In U.S. dollars, our sales in Latin America declined 6% in the fourth quarter and 3% for the full year.

In all other sales and local currency increased 6% for the fourth quarter and 2% for the full year.

Canada posted modest local currency sales growth in the fourth quarter and full year, as it worked to implement volume to value and boost profitability.

Australia's performance improved as the year progressed, finishing 2002 with a high, single-digit local currency sales gain in the fourth quarter and a strong midsingle digit increase for the full year.

In Asia our local currency sales were off slightly for the year.

But we began to show a pickup in growth in the second half and in the fourth quarter, this region posted a midsingle digit sales gain.

In U.S. dollars, the "all-other" area reported a sales increase of 11% in the fourth quarter and 5% for the full year.

We've shown you slide 23 several times before.

It outlines our three-year plan, and we have kept to that plan.

As we look ahead to 2003, we clearly have challenges, as we mentioned before.

However, our recent results, both for the quarter and the year, confirm that we're turning Kellogg into a more dependable, competitive, and profitable company.

We finished 2002 in strong form.

Achieving our goal of accelerating our growth.

We expanded our gross margin, and we increased our brand-building investment.

We improved our execution in the last bits of our business, including innovation, marketing and sales.

We improved our mix.

And as a result, we accelerated our net sales growth in 2002.

Meanwhile, we're generating more cash flow than we have ever generated in our past, allowing us to pay down debt and improve our financial flexibility.

But, you know, we are by no means done.

Volume to value is still at early stages.

This is a journey and execution can always be improved.

Our strong performance in 2002 gives me great confidence that we've got the people, the plans, and the capabilities to execute well in 2003 and continue to achieve our long-term targets of low single-digit net sales growth, midsingle digit operating profit growth and high single digit EPS growth.

We believe we can do that reliably and dependably.

And that's how we believe we can do the best job we can for the owners of our stock.

I'll stop there and turn it over to John so you can --

Sure.

Kind of enter into the Q&A.

Before we start, operator, I'd like to ask everyone to please limit yourself to one question at a time so we can get more people on the call with their questions.

In order to ask a question, please press star and then the number 1 on your attach keypad.

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

Your first question comes from John Feeney with Sun Trust.

Good morning.

Great quarter, everybody.

Thank you, John.

Just a couple of questions.

I'll limit myself to one question, actually.

Start us off right.

What is your position with respect to corn, wheat and other commodities in 2003?

Are you comfortable based on forward buying, even if it has some negative effect that there's not going to be a lot of volatility there?

That's a good question, John.

As we said in our last conference call, we largely hedged on those commodities.

And just a reminder, wheat's up 29%, corn 22%, soy's up 47.

Also we have seen cocoa with some of the new highs and sugar and natural gas come up as well.

We think we have the commodity risk covered within our forecasted $1.86 to $1.90.

But obviously it is a significant increase in 2003 over 2002.

Okay.

Thank you.

Thank you, John.

Your next question comes from David Nelson with CS First Boston.

Congratulations.

Thanks.

I guess as analysts, we're trying to look for soft spots and obviously biscuits were weak in the fourth quarter.

It does come right after you've had a change in top management there.

Are you managing this business differently?

Or in that transition, did you take your eye off the ball?

Well, we are transitioning the business from, you know, one that has been integrating acquisitions for the last five years to one that is growing through organic initiatives, advertising, innovation and sales execution.

And that is a big shift.

And so we're still going through that shift.

And if anything, David, that is proving to be a task that is going to take some time because it is a big shift.

I wouldn't say that the management changes have disrupted our business.

As we mentioned in the script, we pulled back on that sales incentive at the end of the quarter.

We saw some incredibly high competitive activity.

We did divest some businesses, which have also impacted our top line.

But you know, if you had to point to one part of the business in the quarter, where we are absolutely focused and the one part where we are not totally happy, it's what you pointed at, it's biscuits.

And the good thing is we got through December.

We didn't need to push.

We didn't need the incentives to make our year.

So we're starting the year with very healthy inventories and off to a really good start in January.

Great.

Thank you very much.

Thank you.

Your next question comes from David Adelman with Morgan Stanley.

Good morning, David.

Good morning.

I had a question about cash flow.

I mean, clearly it's gotten substantially stronger over the last several years.

You've indicated that in the near term, an interest in continuing to reduce debt.

But what about on a longer-term basis?

Could you give us a sense about how you've prioritized the use of cash flow, and with respect to acquisitions, you know, how would you prioritize those, domestically, internationally, and so forth?

Let me talk to cash flow, first, and what we've seen going forward.

Last couple of years, we've had tremendous performance on cash flow and our cash flow has exceeded our net income significantly.

As we look to the future, we expect our cash flow to come more in line with that net income, plus the difference between depreciation and capital expenditure.

Our depreciation is about $80 million higher than our capital expenditures.

We're expecting cash flow somewhere in the low 800 its, 850 sort of range going forward.

In terms of how we use that debt reduction going forward remains our number one priority for the next few years.

We've mentioned we wanted to get to a target rating of a single A. And that's the path we're on and what we've done the past couple of years.

Carlos, do you want to add any comments on the acquisitions?

Well, we're always looking for ways to allocate our cash to give us the highest returns.

The important thing that we saw this year is when we have high cash flow, as we do, we have options, and we have the ability to look at options.

And we have the ability to reallocate that capital for the best returns.

And in this case, we were able to fund our pension plans.

So cash flow for us is going to continue to be at the heart of how we manage the business.

We have had a tremendous increase over the last several years.

As John mentioned, we'll probably need a year of correction.

But after that, you should expect cash to grow pretty much in line with earnings.

But for us, it's a very important objective.

Okay.

Thank you.

Your next questions from -- comes from Terry Bivens.

Good morning.

Looking at Latin America, which as you know caused a big problem with another one of the peer companies.

As you look at the peso now, Carlos, I know you've always been enthusiastic on the Mexican business but it is bumping around record lows at this point.

Certainly it has come down sharply from April.

And we have the Venezuelan situation as well.

Give us your outlook there.

I mean, the worry is that it might hold a potential to spoil some of the things you have looked at.

Yeah.

Let me just tell you how we approach it, and our sense of Latin America and then I'll ask John to talk a little bit about the exchange rates and where he sees them going.

Okay.

You know, we have been in Latin America, Terry, for quite a while.

I think this is 51 years in Mexico.

And several decades in most other markets.

So we have been through quite a few of these bumps.

What we have found is that when a crisis strikes, the best thing we can do is protect margins, hunker down, manage our balance sheet.

And come out of the crisis with a stronger business.

That's what we're doing in Venezuela.

And if something were to happen of that magnitude in Mexico, which we don't believe it will, you know, we sort of go into a plan "b" mode because we've done it before.

And I'm very confident that we've got the people and the experience to manage through those crises.

You want to talk about Mexican exchange rates?

Sure.

Just to put it in context, Terry.

If you look from January last year to this year, the peso is down about 16%.

Colombian peso is down 23.

And so on with Argentina peso and the Brazilian real.

It's a pretty widespread devaluation.

As we look across 2003, we see foreign exchange as not being a big impact on our total business, and that we have some strengthening in the European currencies, although quite frankly, I don't expect the euro to stay at 1.08 or the sterling to stay at 1.65.

But looking to Latin America specifically, we are expecting our U.S. dollars operating profit and sales to be down probably in 2003 relative to 2002.

And have significant gross margin pressure as we U.S. dollar denominated input costs going into the Latin America cost of goods line.

But again, in totality across the business we don't see a big impact from foreign exchange in '03 relative to '02.

So your input costs are denominated there?

Thanks.

Yes.

Thank you.

Your next question comes from John McMillin with Prudential Securities.

Good morning, everybody.

Good morning, John.

How about one question for each executive?

Anyway.

You know, the U.S.

Cereal price increase -- and you've taken a price increase for both your base and your major U.S. businesses.

Carlos, this company is a lot different than it was in the past.

And that's a tribute to you.

But one thing the previous management did too much is hit that pricing lever.

With private label recently up, what gives you the confidence you can kind of get this through without any disruption to your bigger brands, and to your bigger retailers?

Yeah.

John, a couple of things.

One is the -- the last time we took a price increase on cereal was June of 2001.

And we took about a 2 1/2% increase.

So we just announced this week about a 2% increase.

About two years later.

That is still running below the rate of inflation.

And I think the -- you know, the obligations of us in our business is to make sure that we can sell products that at least enable us to raise prices close to the rate of inflation.

We're not trying to go beyond that, but what we think our business should be able to sustain that over time.

Obviously, we do need to have a case that we take to our customers.

We have input costs.

We have raw material costs.

We have health care costs.

This is a price increase that is very, very justified.

And obviously we have to explain it, but so far, our customers have been -- have been very understanding of that.

Including the big one?

The big customer.

Well, without talking about anyone specifically, again, our customers ask that we explain to them why we're taking a price increase.

We're in the process of doing that.

And I don't foresee any issues because this is very justified.

Okay.

And the recent private label gains?

Have they come at your expense?

And are you taking pricing on, you know, the corn flakes, frosted flakes, kind of your bigger brands, that are a little bit cheaper?

Well, we're taking prices on some brands.

We're not taking prices on all brands.

You know, the interesting thing about the store brand growth, not to take anything away from the fact that they are growing, but there are several new products that they've launched that started rolling out about 18 months ago.

They're still gaining distribution.

So a lot of their gains are coming from distribution.

A couple of these products are targeted, frankly, at competitors.

So that is part of their growth.

The interesting thing is that store brands are behaving almost in a mode of volume to value.

You know, for the quarter, their prices on veal [ph] were up slightly for the year.

Private-label prices veal [ph] up 5%.

Their average price per pound is up 2%.

So we see -- it's almost like part of a similar strategy.

I'll just answer that, if I can, that most of the share gains of private label seems to be coming from the bag segment.

And you've had a rationalization of bags and some of our major customers and private labels are going more at the expense of other price lists [ph] components of category.

And John, can you just go through -- and this is my last question, your pension plan assumption changes?

Sure.

We've changed our return on asset assumption from 10.5% down to 9.3%.

And, put that this context.

Since 1976 the actual returns have been 10.4%.

On discount rates, we've taken on a worldwide basis from 6.9% down to 6.6%.

And we've increased our long-term health care inflation assumption from 4.5% to 5%.

So fairly significant long-term assumption changes.

And the net impact of that is some $40 million?

Or can you quantify?

I would say that we were facing roughly a 10 to 11-cent EPS adverse impact from that.

That's being partially mitigated by the pension health care contribution that we made.

And now we see our benefits expense in 2003, 5 cents higher in EPS than 2002.

Great.

Thank you.

Thanks, John.

Your next question comes from Bill Leach with Bank of America Securities.

Good morning.

Good morning, Bill.

For those of us with old models, I was wondering if you would mind running through your volume trends in the quarter and the year.

Your corporate volume was down two and a half.

I'll tell you what I'll do here, Bill.

You have the sales growth components on the slides.

But let me just walk you through the worldwide, U.S. and International.

Sales on a FX basis.

And if you need the volume components you can check with me later.

I just don't have them with me.

Global cereal sales for fourth quarter were up nearly 3% and for the full year were up a little more than 4%.

United States, cereal sales were up more than 1%, again, against that difficult comparison But for the full year, they were up a little more than 6%.

International sales, again on a FX adjusted basis were up about 4% in the quarter and about 3% for the full year.

So very strong international performance.

You take our other businesses, which in your old model may still be called convenience foods.

It looks a little bit like this.

Globally, our sales were off a little less than 1% in the fourth quarter, driven primarily by that biscuit performance we talked about.

But for the full year, they're up about 2 to 3%.

In the United States, the convenience foods sales were off about 1%.

But for the full year, they were up a little more than 2%.

Internationally, which is primarily in our core markets, our convenience foods sales were up about 6% for the fourth quarter, and 6% to 7% for the full year.

Okay?

That's how we look at it.

And if you need the volume components, you can call me.

You did give us a corporate volume decline of two and a half for the quarter, right?

You don't have that broken out by segment?

I don't have it done by business like that.

I can give you the volume growth by area which we usually publish in our 10Q.

But you're only getting one component of our net sales growth.

I guess I can call you later.

Yeah.

Can I ask one more question.

Your SG&A was down 8% in the fourth quarter.

You said advertising was up.

Why was it down?

The SG&A was down for a couple of reasons.

One was the elimination of amortization in the year-ago period.

And the second was the integration costs that fell into the SG&A line in the fourth quarter last year.

In fact, other components such as brand building was up significantly in the fourth quarter goes to S&GA but that was masked by those other declines.

As we look forward I would say that for 2003, 2002 SG&A in itself was a much better proxy.

Okay.

Thanks.

Thanks, Bill.

Your next question comes from Eric Katzman with Deutsche Banc.

Hi.

Good morning.

Good morning, Eric.

Try to limit it to one question.

I guess with regard to the biscuit business, can you quantify how much of the impact in the fourth quarter was tied to the discontinuation of the contract business and with regard to the fourth quarter or biscuit business -- I think, Carlos, that you mentioned that the Cheez-It franchise, which accounts for a very big percentage of your cracker volume was up pretty significantly at takeaway.

So why is there such a difference?

And I suppose the stock is weak this morning, based on this problem in biscuits in the fourth quarter.

Rather than having to wait until Cagney, maybe you could give us some idea in terms of new products or what you intend to do more specifically to rejuvenate that business?

Yeah, Eric.

Just to answer the first part of the question, the custom manufacturing and some brands that we had in the previous year, such as Sesame Street is probably about 50% of the decline and/or the loss of revenue.

And then the other 50% would be sales incentives and competitor activity.

You know, it was a pretty soft cracker category.

And that also led to, you know, the efficiency of trade spending and trade activities being less than what we'd like.

In terms of what we've got going, I mean, we have a double-digit increase in advertising in the first quarter of the year.

We've got a new products rolling out.

E.L.

Fudge Blasted, which is also going to be advertised.

And for the first time in quite a while.

Sandies are coming out with some new products.

Micky's Magic coming out.

We have cereal and milk bar coming out in the next couple of weeks.

That will be advertised.

We'll be advertising Special K bars for the first time.

We have a new Nutri-Grain muffin bar coming out.

Clearly it is a new year with very enthusiastic folks who want to get out there and make up for December.

So we feel quite good.

And as I mentioned before, Eric, January was a strong month for us in snacks.

And just as a follow-up to make sure I understood it right, you did say that Club and Cheez-It takeaway was up pretty strongly, but it sounds like shipments of that were down.

Is that a fair characterization?

You know, I don't have shipments of Club and Cheez-It.

I think we said 10 and 8% up for the year.

But we've got -- we've we have other brands, such as Sesame Street and Saltines that are low, you know, lower priced, lower margins that we de-emphasize.

What is very obvious here is that we ship a lot lower than consumption.

And that, in part, is due to these sales incentives at the end of the year.

Okay.

Thank you.

Thanks, Eric.

Your next question comes from Tim Ramy with D.A. Davidson.

Good morning, Carlos.

I wanted to understand a little better about the sales incentive shift.

Was that an incentive to retailers or incentive to your sales force?

Is this a trade loading or deloading issue?

Or is it a way you pay your sales force issue?

It goes through our sales force.

And it gives you some flexibility to move shipments from one quarter to the other.

It gives you the flexibility to boost shipments when you need them quickly.

So therefore, it's not as efficient as you'd like.

So it does give you flexibility, and with DSD , you can put it in place pretty quickly.

Should we characterize this as a d-load in the fourth quarter.

Yes.

Thanks.

Thanks.

Your next question comes from Tom O'Neil with Barclay's Capital.

Good morning.

Good quarter, guys.

Thanks.

I had my commodity question answered, maybe more of a fixed-income question.

John, you said in the past you're not running the company for its yet credit rating.

You certainly moved your numbers closer to some of your higher-rated peers.

I was just wondering if you exceeded the goals in terms of debt reduction that you set with the rate agency at this point?

We certainly exceeded our internal total goals in debt reduction.

We have generated significantly more cash flow.

And I think we would expect in the time of the acquisition of Keebler.

And that has improved our financial flexibility.

And I feel good that we're ahead of our target.

Okay.

Great.

Thanks very much.

Thank you.

Operator, I think we have time for one more question.

Your last question comes from Eric Miller with Lehman Brothers.

Good morning.

I have a follow up on some of the debt reduction questions.

Is there a metric?

We look 2003 and out that we should be looking at?

Is there a target, be it debt to EBITDA?

And secondly, could you maybe elaborate why you targeted single A rating?

The credit spreads currently last to within basis points?

Why would that be a priority when your funding costs are kind of already there?

It's a good question.

Because you say we are trading more like a single-A company now from the pricing of a debt perspective.

In terms of a longer-term debt to equity ratio.

We have not provided that target.

We made some commitments when we went into the Keebler acquisition, that we would pay down our debt.

That's going to end the growth back towards a single-A rating.

And the plan there is to do that initially primarily by paying down debt.

Then after a few years of that, probably switch more towards growing into that single A rating at the time as opposed to exclusive debt reduction.

As for giving to targets or specific ratios that we wanted to go after, as Carlos said, we want to keep the flexibility in terms of excess cash flow.

But certainly for the next year or two I see continued debt reduction.

In terms of targeting single A, it's a question of having financial flexibility.

As to your comment, it doesn't affect our cost of capital significantly as we are already trading towards that sort of range already.

Great.

Thank you very much.

Thank you.

Okay.

It is 9:30.

We are out of time here.

If you have any questions, please give me a call, 269-961-6365.

Thank you.

Thank you for joining today's conference call.

You may now disconnect.