家樂氏 (K) 2003 Q2 法說會逐字稿

Good morning and welcome to the Kellogg Second Quarter 2003 Earnings Results Conference Call.

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

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

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

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

Thank you.

I would now like to turn the conference over to John Renwick, Vice President of Investor Relations and Corporate Planning.

Please go ahead, sir.

Thank you, Jeff, good morning, everyone.

Thank you for joining us for a view of our second quarter results and for some 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 released the press release by e-mail or fax, and the slides that accompany today's presentation are available on-line at www.kelloggcompany.com on the Investors page.

As always, very to point out that certain statements made today, such as projections for Kellogg Company's future performance, including earnings per share, spending, growth, operating profit, costs, interest expense, investments, sales, tax rate, cash flow innovation and productivity, currencies, share repurchases, capital expenditures, 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.

In addition, the SEC's Regulation G significantly limits our ability to discuss or respond to questions about non-GAAP financial measures.

For this reason, we will post our responses to such questions, should they arise, on our web site at www.kelloggcompany.com.

Finally, a replay of this call will be available by phone through Wednesday evening by dialing 1-800-642-1687 and using passcode number 7972300.

The webcast of this call will also be archived for 90 days.

And with that, let me now turn it over to Carlos Gutierrez, Chairman and Chief Executive Officer.

Thank you, John and good morning to everyone and thank you for being on the call and your interest in the Kellogg Company.

We're pleased to announce another outstanding quarter.

EPS was 50 cents, an increase of 19% over last year's quarter.

This growth came on top of a double-digit gain in the year-ago period, as well.

Internal net sales growth, which excludes the impact of foreign currency translation and divestitures, was up a solid 3.5%, growing against the year-ago gain of more than 4%.

Importantly, we realized solid growth across our portfolio, so, very much broad-based.

U.S. cereal continued its momentum, U.S. snacks grew on the strength of brand-building and innovation in wholesome snacks and crackers and broad-based growth was posted by our other U.S. businesses.

Each of our international areas grew sales in local currency, led by core markets.

Latin America continued to post excellent results led by Mexico.

Europe recorded another solid sales gain and volume to value efforts are leading to sales in share increases in the U.K.

Our other international segments also recorded growth driven by Canada and Australia.

Along with productivity improvements, this top line growth led to increased profitability.

We were able to offset higher commodity costs and benefit costs, increase our brand building facet in sales growth, and very importantly even absorb write-offs associated with disposing biscuit production assets.

So, this was a high-quality earnings quarter.

Meanwhile, we improved our cash flow and paid down our debt.

The net result is a better-than-expected first half in what was already a front-loaded 2003 plan.

As we entered the second half, we have the opportunity to step up our reinvestment in the business, even while nudging up our EPS guidance to the high end of the previously-communicated range.

This reinvestment will include an accelerated rate of brand building as well as a launch of several cost initiatives, including a capacity rationalization in Australia and some other actions.

We will not be excluding these charges from our guidance, we will simply absorb the cost as we have been doing and still achieve our targets.

In other words, our earnings should continue to be of high quality and right in line with our ongoing growth targets.

Remember, that what we are after is not one quarter or one year of exceptional earnings growth, we are striving for sustainability and dependability.

In a moment, I will come back and discuss the health of each of our major business segments.

First, let me turn it over to John Bryant who will take you through the financial results in greater detail.

Thank you, Carlos.

Good morning, everyone.

Slide 4 gives a summary of our financial results for the second quarter of 2003.

As you can see, it was a strong quarter in all respects.

Net sales grew 6% year on year.

Excluding favorable currency translation and two divestitures, our internal sales growth was a solid 3.5%, matching our year to date internal growth.

Operating profit increased by 11% year on year, driven by sales growth and improved margins.

The margin expansion came despite higher commodity and energy costs, increased advertising and promotion as a percent of sales and the write-off of biscuit production assets.

Year to date, operating profit was up 9%.

EPS was 50 cents, which was up 19% year-over-year.

This brought our year to date EPS growth to 14% on a reported basis or 17% excluding the 2 cents of favorable legal settlements in last year's first quarter.

This performance put us ahead of our front-loaded plan, which allows to us turn to greater than anticipated reinvestment in the second half.

Cash flow, which we define as cash from operating activities minus capital expenditure, was $234 million in the quarter, up 4% against a very strong year-ago period.

Year to date, cash flow was down from the year-ago period, but that period was unusually high because of substantial working capital improvement and the timing of tax and interest payments.

This year's first half cash flow is running ahead of our forecast and is ahead of the corresponding period in 2001.

And let me walk through our financial performance in greater detail.

Slide 5 shows our reported net sales growth in the various components.

Foreign currency translation added about 3 percentage points to our sales growth in the quarter as a strengthening in the Pound Sterling, the Euro and the Canadian dollar, more than offset the impact of devalued Latin American currencies.

Obviously, these currencies, especially the Latin American currencies, are susceptible to volatility.

Based on current rates, though, we should continue to see favorability from currency translation for the year albeit less than in the first half.

During the quarter, divestitures took 0.8 percentage points out of our reported growth.

Recorded during the second quarter of 2002 we divested our bake Line private label biscuits business and earlier this year we sold another private label business.

Bake Line, the much bigger of the two, anniversaried at the beginning of May.

So, divestitures will have less of a drag on sales growth going forward.

Our internal net sales growth was 3.5% in the quarter, which is on top of a strong 4.2% gain in the year-ago period.

We continue to realize most of this growth from price mix contribution.

This was partly due to modest price increases, but is also, as a by-product of volume to value.

Our mix shift entailed more value-added products and because we're adding value to the consumer, we were able to discount less.

As reflected in a decline in trade spending as a percent of sales.

Volume, which we measure in tonnage, was down in the quarter as we continue to shift our mix toward lighter, more value-added products.

As you know, this shift is very favorable for our net sales, margins and return on investment.

Also weighing on tonnage were accelerated SKU eliminations in U.S. snacks.

The discontinuation of a custom manufacturing account and the exit from Wheat Biscuits in Australia.

We believe our momentum is enough that we can generate similar growth for the rest of the year, even despite further SKU reductions in U.S. snacks.

Turning to slide 6, operating profit increased by 11% in the quarter.

Excluding favorable currency translation and a negative impact of divestitures, our internal profit growth was a very strong 9%.

Our gross margin declined 10 basis points year-over-year which is more impressive than it looks.

Operating leverage, favorable mix, modest pricing actions and savings from various productivity initiatives were able to counter higher commodity, fuel and benefits costs.

But we also wrote off assets related to our biscuits production network.

This write-off, which equated to more than 2 cents of EPS in the quarter, was part of our ongoing efforts to rationalize our biscuit capacity.

This brought our year to date gross margin down 10 basis points from last year.

In recent months, we have identified more opportunities to increase productivity around the globe.

Most of the up front expenses for such initiatives will fall into our cost of goods sold so they will affect our gross margin during the second half.

Another key area of reinvestment, of course, is brand building.

Reported advertising and consumer promotion expense rose at a double-digit rate in the quarter and a high single digit rate for the six-month period.

So, brand building again, well outpaced net sales growth and remember, we do not consider trade spending to be part of brand building.

We expect to see a higher rate of brand building in the second half as we reinvest our current earnings momentum for sustainable growth in the coming year.

The bottom line: We're generating strong underlying profitability, that is enabling to us reinvest more than we had originally anticipated.

Slide 7 shows our operating profit growth by area.

Adjusted to exclude the impact of currency and the two private label snack divestitures.

On this basis, our profit in the U.S. increased by 3% during the quarter.

This is a solid performance given that it compared against a notably strong 10% gain in the year-ago quarter and that it faced higher commodity, energy and benefits costs this year.

In addition, this brand building investment rose as a percent of sales and it absorbed the biscuit asset write-offs I mentioned earlier.

In Europe, profit growth was 7% in local currencies, despite a double-digit increase in brand building investment.

Our Latin American business posted a 9% local currency gain, continuing to defy difficult economic conditions in those markets.

This quarter's growth was on top of a 13% increase in the year-ago period.

All other international businesses, which include Canada, Australia and Asia, collectively recorded a 59% profit gain, albeit off a relatively low year-ago level.

It is a positive sign that each of the areas are generating solid, top line driven profit growth, even as we continue to reinvest in the business.

It means that volume to value is now being executed across the entire company, which will drive sustainable growth.

Moving below the operating profit line, our interest expense was down nearly 8% during the quarter and 7% year to date, due to reduced debt and lower rates.

During the quarter, we successfully refinanced $500 million of debt at very attractive rates.

And were able to pay down debt.

We continue to expect interest expense for the full year to be slightly less than $360 million.

Our effective tax rate was 36% in the quarter, in line with the first quarter and with our full year estimate.

Average shares outstanding were down slightly in the quarter and year to date, due primarily to share buybacks, majorly in late 2002 and the first quarter of 2003.

In the second quarter, we did not make any share repurchases and we turned to debt reduction.

For the year, we expect some creeping up in our shares outstanding due to stock options activity.

Let's turn now to our cash flow.

Slide 8 indicates that we continue to reduce core working capital as a result of rolling 12-month sales.

In fact, this was the eighth consecutive quarter where we have registered sequential year-over-year improvement this key measure.

As we've told you before, we believe we can continue to improve this metric albeit more modestly than the reductions we recorded in 2001 and 2002.

Clearly we have become more efficient at turning our sales and profit into cash.

We also have continued to attain tight control over capital expenditure, through the first half, capital expenditure was running roughly even with year-ago levels as a percent of net sales.

Capital expenditures should finish the year at about 3% of net sales, similar to 2002.

Again, we are by no means starving our assets.

We are simply using greater discipline on investment decisions and we are finding ways to do more with our existing asset base.

Cash flow was up 4% in the quarter, a good performance against a difficult comparison.

The left side of slide 9 shows that our year to date cash flow is $392 million.

Because of comparisons with a notably strong working capital improvement and timing of interest and tax payments in the first quarter of 2002, we are behind last year's cash flow through the second quarter.

However, we are above our expectations and ahead of our 2001 performance.

We continue to expect cash flow to exceed $800 million for the full year.

The right side of slide 9 shows our outstanding debt, which we have reduced significantly over the past two years.

In the first quarter, we used our excess cash flow to buy back shares ahead of options exercises.

In the second quarter, we returned to paying down debt.

Debt reduction remains our priority for cash flow this year as we continue to improve our financial flexibility.

Share repurchases will largely be funded by proceeds from options exercises.

Slide 10 addresses our earnings growth outlook for the rest of this year.

In the first half, the company posted internal sales growth and operating profit growth that were above our long-term targets.

The result was strong, double-digit EPS growth, whose quality was evidenced by strong brand building and the absorption of asset write-offs.

Our previous EPS guidance of 1.86 to 1.90, reflected our ongoing target of high single digit growth.

Given the momentum our business has demonstrated as well as the favorable impact of foreign currency translation, we find ourselves in a very good situation.

We can increase our reinvestment in the business during the second half and yet still feel comfortable with the upper end of the guidance range, in other words, EPS of $1.88 to $190.

As tempting as it is to exceed our earnings guidance, we would prefer to reinvest more into the business so that we can offer investors more confidence in the sustainability of our growth.

So in the second half, we plan to up ramp brand building and cost saving initiatives.

One such initiative, the consolidation of snacks capacity in Australia is already under way.

Other projects are in earlier stages and we will be able to discuss them with you in the coming months.

These initiatives give us better visibility into 2004 and our long-term target of high single digit EPS growth.

The point is, that our P&L is strong enough that we can absorb all the costs of these programs and yet still achieve our EPS targets.

I'm sure you'll agree that the front-loaded plan, with heavy reinvestment to the future, is in the best interest of our company and our shareholders.

So, that's our financial picture.

With that, let me turn it back to Carlos.

Thanks, John.

As we turn to a higher reinvestment in the second half, it's important for you to understand that we are doing so from a position of strength.

Both Kellogg USA and Kellogg International are exhibiting strong top line momentum and high quality profit growth and we believe these trends will continue into the second half.

I'd like to begin with our U.S. business shown on slide 11.

Kellogg USA internal sales growth of over 2% in the quarter, despite challenging comparisons with the year-agos quarters internal growth of more than 4%.

As we'll see in a moment, each of our business segments reported growth.

Meanwhile, we faced higher commodity, fuel and benefit costs, Kellogg USA continued to increase its brand building.

And took steps to enhance future productivity in the form of SKU reductions and asset disposals.

And yet it was still able to grow its profit.

I'd like to take a look at a -- each business in -- in a little bit more detail, starting with the U.S. cereal business on slide 12.

Our U.S. cereal business posted 3% sales growth in the quarter, a very solid performance, especially considering that this was on top of a 6% growth in the year-ago quarter.

Innovation is so important in this category and during the second quarter we benefited from new offerings this year like Fruit Harvest, S'mores and Tony's Cinnamon Crunchers.

Kashi continues to grow at a double-digit clip, aided by new products like 7:00 in the Morning and a new organic cereal, Autumn Wheat.

Kashi's Golden Crunch is now the leading national cereal and Kashi's Organic Promise Strawberry Fields is the leading organic cereal in the gross retail.

This year's new products compared well against last year's enormous Disney launch, but we're also generating strong growth in heritage brands like Fruit Loops, Smacks, Cocoa Crispies and Rice Krispies, all targeting strong marketing programs.

Consumer promotions continue to be effective, notably a tie-in with the movie finding Nemo, featuring toy inserts and a special Nemo-themed marshmallow-blasted Fruit Loops.

In the quarter, we were able to once again grow our sales and category share year-over-year, despite extremely difficult comparisons.

These brand-building activities, which continually add value for consumers, are responsible for sustaining our momentum in the business.

Looking ahead, we will continue to add value through brand-building and innovation in the second half.

Slide 13 shows just the sampling of the kinds of new products and consumer promotions we have slated for the second half.

At the top of the slide are three line extensions that we believe will create excitement and at the bottom are selection of upcoming consumer promotions.

The point is that our U.S. cereal business is enjoying good momentum and we believe we have the plans in place to sustain that momentum into the second half.

Let's now turn to U.S. snacks and slide 14.

U.S. snacks posted an internal net sales gain of more than 1% in the quarter.

Not exceptional growth, but it did so in -- in a reasonably difficult comparison and we did lose 2% -- 2 percentage points of growth due to the discontinuation of a custom manufacturing account.

We also embarked on a new SKU rationalization program designed to create manufacturing and distribution center efficiencies.

These SKU cuts penalized U.S. snacks growth by more than 1 percentage point in the quarter.

But if there's one area of disappointment in our entire portfolio, this includes the whole global portfolio, it is cookies, where we experienced another sales decline in the second quarter.

The cookie category remains soft, feeling the effect of consumers shifting to healthier snacks.

We continue to lose some share due to relatively low levels of innovation into aggressive promotional activity by competitors.

Make no mistake, we are addressing this issue.

We have already increased innovation behind brands like Sandie's and Murray's Sugar-free and they responded well with double-digit consumption growth in the quarter.

Similarly, E.L.

Fudge continued to benefit from new products and its first media advertising in over a decade.

More of our core cookie brands will receive investments in the second half.

However, cookies will be more effective by SKU rationalization than our other snack segments.

And recent comments from competitors suggest that more, not less, promotional activity will be coming in future months.

So, we expect continued sales decline in cookies, we expect the difficult environment, even as we work to improve the performance of our core brands.

That said, we benefit from having a portfolio of snacks that goes beyond just cookies.

Cookies were down, but wholesome snacks and crackers rose enough that total U.S. snack sales were up more than 1%.

And very importantly, our DSD systems sales were up a solid 3%.

Our crackers business increased sales in category share during the second quarter.

This performance was led by the continued strength of our Cheez-it brand.

This brand is benefiting from strong advertising and the enduring impact of new products launched in 2002.

During the quarter, consumption growth for Cheez-it was 16% in measured IRI channels.

Another brand we targeted for brand-building investment was Toasted Crackers, and that also posted a double-digit consumption growth in the quarter.

Again, where we have returned to brand building and innovation, we have seen a lift.

And looking ahead, we will continue to reinvest in our cracker brands, even leveraging the promotional tie-ins we do in the cereals business.

For instance, in the second quarter, we launched Scooby-Doo crackers and Lion King animal crackers.

In wholesome snacks, our shipments and consumption grew in excess of 20% in the quarter and year to date periods.

If there is a consumer trend towards healthier snacking, we are very well positioned and benefiting from that trend.

But we're also getting a lift from DSD and some excellent new products.

Special K bars are doing extremely well.

Cereal and milk bars already achieved 90% distribution and our Froot Loops variety has already become the leading SKU in this segment.

So, despite softness in cookies, we're making progress in our effort to shift the U.S. snacks business toward an organic growth strategy, marked by brand building and innovation and moving it away from the previous "acquire and integrate" strategy.

Slide 16 shows how we have returned to brand building investment in a big way this year.

Albeit off a small base.

And remember, this is pure brand building, we don't include trade spending in this measure.

We also made good on our promise to boost innovation; new products represented 18% of our sales in the quarter, or double the 9% recorded in the year-early year period and 10% for the full year 2002.

Obviously it takes time and we're only just getting our brand-building investment up to competitive levels.

So far, we have been relatively selective in our brand building and innovation investments.

However, our 3% DSD growth in the quarter suggests that this investment is starting to take hold and that we are doing the right job on allocating our resources towards these segments.

So, amidst everything we're doing in the business, from challenging the strategy to disposing of assets to reducing SKUs, to changing management, our U.S. snacks business continues to post sales growth especially in the important DSD systems.

Based on certain competitors announcements in recent weeks, the cookie category may see more promotional activity in the near-term, but we believe we are taking the right steps for the long-term performance and health of this business.

The rest of our U.S. businesses are represented on slide 17.

Don't forget these businesses, they generate over $1 billion in annual net sales and include some very important brands that have very good growth potential.

Collectively, they posted 3% internal sales growth in the second quarter, bringing their year to date growth to over 1%.

Recall that sales were flat in the first quarter, when Pop Tarts faced unusually difficult comparisons.

So, we think the second quarter's performance is more indicative of these businesses going -- ongoing rate going forward.

As in the rest of the company, these businesses are growing by adding value to the consumer, through brand building and through innovation.

In the second quarter, Pop Tarts benefited from a new Yogurt Blasts product line and Eggo sales growth was aided by new Fruit Loops waffles as well as Scooby-Doo waffles late in the quarter.

Our Worthington Veggie Foods business was helped by the first quarter launch of Morning Star Farms Parmesan Ranch Chick Patties.

And Kashi's noncereal business continued its strong growth, thanks in part to its new TLC's or tasty little crackers.

Despite softness in the foodservice channel, our food away from home business posted growth in the quarter as it continued to grain share in cookies and crackers and in cereal.

Innovation is helping this business but so is our increased scale and unique focus on a few strong grain-based categories.

We've touched on cereal innovation for the second half, let me now briefly discuss some innovations that are coming elsewhere in the portfolio.

In the last couple of years, our innovation has been focused almost solely on existing categories, however, one of our distinct competitive advantages is -- is the fact that we can extend our brands and the ability to extend them into different product lines.

In the very -- in the second half, we intend to launch nationally products in categories or category segments that are very close-in to categories or segments in which we compete.

Each of these leverages our brands and each of these is in a category that is literally what we call in our aisle.

In June, we began to launch Crave bars nationally.

Many of you have tried these delicious energy snack bars.

We've had them in test markets for about two years, allowing to us study their economics and get the packaging and advertising right.

Crave is a relatively safe bet for us.

It is in our aisle.

It's cannibalization is likely to be very modest and we have invested relatively little capital.

So we're excited about this national launch.

Our Eggo brand will also be extended.

Eggo syrups are a logical extension to the leading frozen waffle brand.

Our syrups not only benefit from cross promotions with Eggo waffles, but they feature a unique no-drip spout that differentiates it from other products in that category.

Again, incremental sales on -- will be -- will be achieved with very little invested capital.

So, this is not a -- a big financial bet, it makes natural sense for us to -- to extend the brand but it's not a -- a big financial bet for us.

In September, Eggo French toaster sticks will be rolled out, bringing this brand into another segment of the frozen breakfast foods category.

In September, we will take the powerful Nutri-Grain brand into the granola bars segment with Nutri-Grain Granola bars and bites.

Our product is differentiated.

The brand is already synonymous with healthy breakfast and snacking and we have the advantage of the DSD system.

All of these are smart bets because they can create incremental sales growth with very little incremental capital.

They will require product launch costs and marketing investments in the second half but they should augment Kellogg USA sales growth in 2004 and beyond.

I'd like to turn now to our international business on slide 11 -- 19, excuse me.

As these businesses have implemented volume to value, and as more of the company's resources have been shifted to core international markets, we've seen an acceleration in external sales growth.

Slide 19 shows of the acceleration began in the second quarter of 2002 and continued through the first half of 2003.

In the second quarter of 2003, Kellogg international posted local currency growth of 5% in line with a -- with its first quarter growth.

In U.S. dollars, this gain was 15% in the second quarter and over 13% year to date.

Importantly, we realized growth in both cereal and snacks and we realized growth across all major areas and core markets.

And we continue to make progress on improving our underlying profitability which, in turn, allowed us to increase our brand-building investment.

Let's take a closer look at the major areas of Kellogg International.

Sales growth by areas highlighted on slide 20.

As you can see, all of our major areas posted local currency sales gains as did each of our core markets within this area -- these areas.

So, this suggests that volume to value is working and that we are executing a lot better every day in each of these markets.

In Europe, for example, our currency adjusted growth was over 4%.

Gains were reported in most markets, including France, Spain and Benelux.

But most encouraging performance, I'd say, is that we turned our UK business back into solid growth.

Sales in this core market were up about 5% with good sales growth in both cereal and snacks.

Evident through Europe was the implementation of volume to value and its focus on new products and favorable mix.

We ran another two-week weight challenge on Special K and Crunchy Nut in the UK.

In Benelux, we had a hand-towel promotion and the Bey-Blades promotion in France.

And late in the quarter, Bobbleheads inserts across key European markets.

So, we had a lot of promotion, a lot of -- of very effective advertising that drove the business profitably across a number of countries.

We also launched a foil pack inside Corn Flakes in the UK, highlighting the freshness of this brand.

Again, this is volume to value at work and it resulted in favorable mix, strong sales and category share gains at important markets like the UK, France and Spain.

Meanwhile, we continue to expand our snacks business in Europe, launching Nutri-Grain Minis into the UK and rolling out Special K Bars into continental Europe.

In Latin America, our currency-adjusted growth was 9%.

Representing continued strong momentum in both cereal and snacks.

In Mexico, we gained a full percentage point this year in a category that continues to grow strongly.

Our growth in the second quarter was led by Corn Flakes, interestingly, which has been revitalized by a new advertising campaign and Special K, both the flagship brand and Red Berries version.

Mexico's snack growth w as again outstanding, this time driven by our new all-brand bars.

But Mexico wasn't the only market in Latin America to perform well.

We gained share in the Caribbean, led by Special K and Special K Red Berries and we posted very good local currency growth in Venezuela and Columbia, as well.

Our all-other international segments posted a collective sales gain of 5% in local currencies, led by good growth in Canada and Australia.

Both of these core markets generated good growth in cereal and in snacks.

This growth was aided by favorable mix and better trades, two fundamental elements of volume to value.

Asia also posted local currency growth on increased cereal sales.

So, as we look to the second half, we should continue to see the kind of brand-building and innovation that have revitalized our international businesses; slide 21 shows just a sampling of the initiatives but also gives you a sense of how active we plan to be.

As always, we will improve our odds of success by sharing our best ideas.

For example, Cocoa Pops Crunchers, which have done extremely well in the UK are being launched in Australia.

Promotional properties that have been successful in the U.S., including Cartoon Network and the Simpsons, are being leveraged by the UK and Canada.

Tie-ins with movies, like finding Nemo and Piglet's Big Movie, are being used in markets like Australia and Canada.

We've got inserts planned like color-changing spoons in fruit loops in Australia, and in-and-out products like holiday versions of Rice Crispies and Fruit Loops in Canada.

We will also continue to expand our snack businesses in core international markets.

Building on a success of all-brand bars in Mexico, we will be rolling out All Bran Bites in that market.

In the UK, we're extending our Kellogg's Screaming Fruit brand of fruit snacks beyond the Fruit Winders line, to an innovative new product called Squidgers, an all-fruit refreshment snack.

So, volume to value's evidenced in all of these moves and they should allow Kellogg international to sustain momentum in the second half.

In summary, we had an exceptional second quarter with good momentum exhibited across our portfolio and an EPS gain of 19%.

Importantly this was high-quality earnings growth and as we continue to invest in our brands for future growth and we continue to invest in productivity initiatives that can create future savings.

We now enter the second half of 2003 in solid financial shape.

We're generating good top line growth.

Our underlying profitability is strong and our cash flow continues to improve our financial flexibility.

Simply put: We have momentum.

In the first half, the business momentum flowed through our better-than-expected earnings but in the second half, we plan to use our momentum to accelerate our reinvestment.

We will increase our brand-building investment at a faster rate and we will launch new cost-savings initiatives.

So, our momentum in profitability is strong enough that we can afford to make these investments and incur these costs without changing our EPS targets.

The reason we set realistic targets and the reasons we insist on reinvesting in the business is because what we are after, as we have said so many times before, is sustainability.

Not one spectacular quarter or one -- or one year that maxes out the whole business.

We are delighted that we can offer you a front-loaded 2003 earnings plan and that we can absorb costs related to productivity initiatives, all without veering off our EPS guidance.

In the meantime, we continue with our very deliberate and focused strategy.

Grow cereal, expand snacks and pursue selective growth opportunities.

And to follow our simple financial models of volume to value and manage for cash.

This is the best way to achieve dependable, sustainable growth that will translate into value for our shareholders.

So, a very solid second quarter and I should say that this is a tribute to over 25,000 people working extremely hard in the company to make the numbers come in.

And I think the second quarter is a good example of that tremendous work everyone's doing.

So, we appreciate your interest and we'll now open it Q&A.

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

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

Your first question comes from David Adelman of Morgan Stanley.

Good morning, everyone.

Good morning, David.

Carlos, you quantitified -- or maybe John -- the second quarter one-off costs in terms of the cost savings efforts that you absorbed at 2 cents.

Can you quantify what it's likely to be in the remainder of the year?

David, as you know, over the last roughly six quarters, we've generally taken a variety of charges through our normal operating P&L and this quarter, as you said, it's around 2 to 3 cents of EPS impact.

In the back half of the year, I expect a similar rate of cost, if you like, going through, no more operating P&L that than what we saw in the second quarter.

And secondly, as it relates to the U.S. cookie business, do you think it's being affected by the price increase you took?

And that your competitors followed?

David, I -- I think there are a number of reasons -- I would hesitate to make that -- the number one reason for the softness.

I think there's been less innovation, there's been less brand-building, there's been less attention on the category and then we've seen migration toward healthier snacks and I think that can also be impacting the category.

And as you know, the, you know, the publicity that the -- that the cookie category has received in recent times hasn't been great.

So, I think all of those things are adding up together to cause a -- a temporary slowdown in that business.

Thank you.

Thank you.

Your next question comes from Romitha Mally of Goldman Sachs.

Good morning.

Good morning, Romitha.

Congratulations on a great quarter.

Thank you.

I just wanted to understand a little bit more about the back half of the year because on the -- on the surface it seems like the expectations are being tempered a bit and some of us expect EPS to, you know, $1.04 in the back half of the year.

So John, if I understand correctly, you're saying 0 to 6 cents of that is coming from the cost saving initiatives, the costs associated with that.

Without getting too precise, that's in the ballpark in terms of the impact of various initiatives.

And also, we intend to have double-digit brand-building growth in the back half of the year.

So, reinvesting in brand building and long-term productivity initiatives.

Okay, so, in terms of business momentum it seems like it may be better than we're expecting, but then there's incremental costs being incurred?

Yes, and to given you confidence, we expect our top line growth in the back half of the year to be similar to the front half of the year.

We're not expecting any sort of a slow down, we're just reinvesting the money back in the business.

Okay.

And in terms of the commodity cost, I think initially at the beginning of the year, you said 10 to 12 cents in higher costs this year.

How is that tracking?

As you said, we started the year with 10 to 12 cents.

A lot of grain costs have come down, but they came down pretty much in line with that expectation.

What we didn't expect was the big increase in natural gas costs.

If I look at where we stand now it looks looks more like if anything 12 to 15 cents of higher costs this year relative to 2002.

All of which we're absorbing within our outlook for the year.

Can you tell me how much of that was absorbed in the first half?

Roughly 7 to 8 cents cents in the first half.

Okay.

And one final question.

Why was corporate expense down so much?

Corporate expense is tied in between the first and second quarter.

Do you remember in the first quarter, actually the other way.

And on a year to date basis we're right in line with a year ago.

Great, thank you.

Thank you.

Your next question comes from Christine McCracken of Midwest Research.

Good morning.

Good morning, Christine.

Just another question, if you could, on cookies.

You know, given the outlook there for somewhat weaker trends, I'm wondering how do you balance your new product efforts, your brand-building initiatives behind a category that you don't see really taking a turn here in the second half?

Is it your intention to -- to keep putting the same level of spending behind that category?

Given the outlook.

Christine, that's a good question because that's -- it really comes down to how we're allocating our resources across the portfolio.

You know, we're fortunate enough to have crackers, cookies and wholesome snacks.

Crackers are growing at low single digit, wholesome snacks are growing at very solid double-digit.

So, we are allocating our resources towards the areas that give us the greatest growth, without -- without, you know, taking our eye off the ball as it refers cookies.

The other thing to say about this portfolio, which gives us the -- you know, the ability to allocate across it, is that the highest margins are in crackers and wholesome snacks.

So, while we don't like the softness in cookies, we believe that we have the type of portfolio that enables us to allocate resources across it so that we can grow the whole portfolio.

So, in theory you could hold back some of your new product initiatives until the market looks a little stronger

Yeah, and -- and a lot of that will depend on how much we would have to invest behind it.

And whether we have other alternatives, whether it be in crackers or snacks that we believe could generate a -- a higher return.

So, you're right, we do have those types of options.

Great, thanks.

Thank you.

Your next question comes from David Nelson of Credit Suisse First Boston.

Congratulations.

Thank you, David.

I think John mentioned that trade spending was down, how much did that boost sales?

Trade spending was not a significant impact on net sales.

You know, look at our price mix, it's roughly half-priced, half-mix, with a modest impact from trade spending.

It's maybe too early, but last October you did sort of lower the boom on '03 expectations on employee benefits.

Is there any outlook you can make at this juncture for '04?

Or do you just maintain the high single digit EPS growth despite whatever happens out there?

It's a bit early to talk about '04 at this stage.

We would normally give guidance on '04 at our third quarter conference call.

What I think we have said is you can expect to see ongoing, higher benefits costs.

Obviously we have good momentum going into '04.

At this stage, I think we're comfortable with the high single digit EPS guidance.

Great, thank you very much.

Thank you, David.

Your next question comes from Leonard Teitelbaum of Merrill Lynch.

Good morning and excellent operations.

Let me ask a question, really on your reconciliation, if you will, on the -- the slides you presented, your contributions of post retirement and benefit plans are actually down.

Is that a timing issue?

Or is there something -- or is this the result of the extra contributions last year?

The -- the contributions is just a timing issue, Lenny.

Because I think -- if you look at year to date, it's up much it's just an issue in the quarter.

Okay.

Thanks.

As we take a look at how you're going manage the business, Carlos, I congratulate you by saying you're not going to take special charges for the asset rationalizations, you don't believe in them.

But are there other plans?

Do you have the thing right-sized now?

Or are you still going to have to look at fixed assets that might be maybe measurable and significant in the second half of this year?

Well, as -- as we've mentioned before, Lenny, we still have -- we're in the midst of looking at all of our snack network and that -- that is a -- it could be a longer term project than just simply the second half.

So, we also have projects that we've taken in Australia, where we've collapsed to for snack plants into one.

We've got some, you know, overhead opportunities elsewhere around the world.

So, the important thing is to get at these on a quarterly basis, to get some of these out of the way to absorb them instead of letting them accumulate and then having to come to you with a massive charge.

It just works against everything we're trying to do to manage this business.

We take a look at a return on investment versus at the snack area, what is the goal there, if you can break it down divisionally as opposed to cereal versus let's say the Keebler operation.

What kind of a -- of a -- either a return on assets or cash return on investment are you looking for out of that business?

Ultimately?

Well, we're looking for similar earnings growth across the portfolio and remember, we're not that capital-intensive of a business, Lenny, so, the return on assets, was in the snack business, we bordered on the assets, got a large goodwill component, so they will be naturally pulled down by that.

Whereas the cereal, being organically grown will have a higher return on the assets.

As you know, Lenny, we took the hit on return on investment capital with the Keebler acquisition.

Right.

And over time, we don't see why, you know, the snacks business should be delivering the similar sort of return as -- as -- as we were as a company before.

And, you know, we're talking about the kind of low 20s.

So, we're -- we're growing that and that's -- that's the good part about it.

Last question, do you have your inventories now pretty well right sized for where you think you have to be?

I know a lot of companies are working on it very diligently and it's a continuing process, but realistically, have you got the pipeline where you need it going into the September to December period?

Yeah, on trade we've actually seen -- we've actually seen a flattening out of inventories and as you know, we -- we keep close tabs on this and we -- we manage it very carefully.

We don't want -- we don't want high -- high-lows or high stocks at the end of a quarter.

And we've actually seen them quite -- quite flat, they've moderated over the last few -- few quarters.

But that isn't to say that they're not going to continue to decline and I -- I believe that customers will continue to look for working capital improvements the way we are.

So, we're ready for that and -- and as we've mentioned before, we're trying to help them do that.

On the company side, our inventory is well below our peer group average, the way we've managed our inventories, the way we've focused on sales forecasting, all of those things have helped keep our inventories down.

We continue to find ways to reduce them even more, even though, you know, today we are pretty low levels.

I'd attribute that to just a great amount of work on sales forecasting, planning and on logistics.

Good answer.

Thank you very much.

Thank you.

Your next question comes from Tim Ramey of D.A. Davidson.

Good morning, congratulations on a terrific quarter.

Thank you, Tim.

On the first quarter, you mentioned that the percentage of sales from new products in the DSD channel rose from 10 to 19, I believe was the number.

And unless I missed it, I didn't hear a similar metric on this quarter.

Can you tell us how new products as a percent of mix worked through DSD?

Yeah, it's about the same, about -- we said 8 -- 9 -- 9% last time versus 18%, it's about 18% now.

So, that same -- that same number is continuing.

And, you know, Tim, if you look at those new products, many of those new products have been successful, they just haven't had enough time to generate the mass to -- to, you know, to build business, but the 18% is -- is about right for the second quarter.

And as we look -- I was pleased that you gave us the margin kind of breakdown between cookies, crackers and wholesome snacks.

As we look at that internal mix shift that's going on between, I guess out of cookies and into wholesome snacks, what's the order of magnitude of that?

Can you talk a little bit about how much of the truck is being devoted to, you know, on an incremental basis?

Well, just to give you an idea, the -- our wholesome snacks are growing in the stock double-digit and crackers are growing in kind a low single digit whereas cookies are declining.

So, if you just take that pie and project that out you will find a very different -- a very different mix across the three categories.

Okay.

And finally, are -- the syrups, the Crave bars and the granola bars, I assume all of those are contract manufactured by others?

That's correct.

Okay.

Granola bars --

It's -- two out of the three.

Okay.

And, you know, finally, somebody's got to congratulate and recognize Janet Kelly, I think, for pulling out the only, you know, DSD acquisition that shows revenue synergies.

Let me be willing to do that.

Thank you.

Would you like to say something?

Thanks, Tim.

Your next question comes from Eric Larson of Piper Jaffrey.

Hi, everyone.

Nice quarter.

Thank you.

A number of questions, now, you may have said this already, did the entire one-time charge go through your cost of goods sold?

The 2 to 3 cents in this quarter was all through cost of goods sold, yes.

So, if we adjust for that, you had a 40 to 50 basis point improvement in your gross margin year-over-year?

The impact on gross margin was about 60 basis points.

Okay.

The -- the second question and this is one probably for Carlos, but if you're running, Carlos, 18% of our sales from new products, what do you envision as the right number for that when you're fully up to speed and you're more in a maintenance mode of innovation?

Well, you know, we've -- we've taken that number to similar levels on the cereal side and I -- I would say that that is pretty much a going rate.

Maybe not exactly 18, maybe 15, but, you know, in the double-digit range.

I think that's the kind of innovation we need to support our business strategy and to continue to drive mix and to continue to drive higher margin products.

So, the -- the 18 is not -- the 18 is not -- is not out of the question.

Especially snacks, where we're in impulse category, we need innovation we need news.

That's where you will be able to see a lot of the, you know, a lot of the new products.

Okay, great.

Two other quick questions.

What did you see through category growth in cereal in the quarter?

Was it around 2 to 3% as well?

Well, we have obviously, the data, which does not include the whole market.

Right.

It declined by 1.9%.

That would be a volume growth?

No, that's dollars.

Okay.

And then finally, last question, can you -- some of the other larger package food companies said that the inventory reduction at Fleming in the last three months penalized their volumes.

Did you see an impact to your business in your warehouse-delivered business this quarter?

No, we didn't, Eric.

Okay, thank you.

Thank you very much.

We have eight more questions.

Your next question comes from Philippe Dussen of Credit Suisse First Boston.

Yes, sir, good morning, gentlemen.

A couple of questions for John.

John, on the balance sheet, you have about $1 billion of short-term debt.

I know that you came to the market recently but with the rates backing up, any sort of plans to perhaps tap the market again?

I think we acquired Counsel with the level of commercial paper we have right now.

We turned out $500 million of debt during the quarter, the commercial payment balances are down to quite a nice level now.

Okay.

When was the last time John, you met with the rating agencies?

I don't want to go into specifics of our discussions with the rating agencies.

We have regular contact with them and as you'd expect, we keep them apprised of how the business is performing.

Okay.

And my last question, any more divestitures that we should be looking at for the next 12 months or so?

We're always looking at the portfolio.

I can't say there's anything significant out there, but it's always -- we're always looking at opportunities for more acquisitions and always looking at around the -- around the periphery of the portfolio.

Okay, thanks so much, John.

Thank you.

Your next question is from Terry Bivens of Bear Stearns.

Good morning, everyone.

Hi, Terry.

Carlos, you addressed the category growth there on Eric's question as being down about 1.9.

I think that was measured, though.

Obviously you're getting a pickup from other channels.

Do you folks have a general category estimate for how you felt the category fared all channels during the second quarter?

It's hard to say, but if you look at our measured sales, we're down 3% but we're up 3% in shipments.

I think that gives you a sense of how much growth is coming out of the measured channels.

Which is about the same as Q1, as I recall.

Right.

Yes.

And, Terry, I'm glad you asked that.

I'm not sure that we had totally answered Eric's question, but if you take those three components, the measured data, which we know is not complete and doesn't measure the whole market, show the category down 1.9% in dollars.

Our shipments were up over 3%.

And our inventory levels with our customers are flat.

So, that would suggest that we are getting growth in the non-measured channels.

Okay.

And just one more, if I may.

Given the fact that Red Berries came out of Europe and did quite well for you, is there anything in the UK, you mentioned results have perked up there nicely.

Is there anything in terms of new products there that you feel may be especially promising in terms of bringing it over to this side of the pond?

Well, you know, right now what -- what seems to be working well in the UK is all of the -- the volumes to value principles that they've applied.

They've got some products that are scheduled to be launched.

As I mentioned before in the script, they've done a very nice job with fruit snacks, but I would hate to get into what they're going to launch.

But we're very pleased with what we see and very pleased with the continued innovation and just the mindset coming out of Europe.

Okay, very good.

Thank you.

Thank you.

Operator, because there's so many in queue, we will extend for another 10 minutes, if you don't mind.

Your next question is John McMillin with Prudential Equity.

Thank you for including me and congratulations.

Thanks, John.

The currency benefit, John was $9 million?

Can you quantify just the currency benefit in the quarter?

The currency benefit to EPS was around 1 cent.

In the quarter.

Which about is about 8 or 9 million --

Do the math there, John.

Why is that?

Has it helped sales by $66 million --

Yeah.

You see, if you just assume the normal margin to that, what am I doing wrong?

It's a good question, John, what happens there is we've had a devaluation on some of the higher margin businesses.

I got it.

In Latin America.

It's a country mix.

And yet we've -- we've got good appreciation in Europe.

Okay.

And the charge amount was $13.4 million pre-tax for the --

It was 2 to 3 cents of EPS, John.

Why don't you -- can you give us the number on your web site?

Is that how you have to do it?

We're not stripping it out of our results.

Okay.

Well, Janet is not going to win any more legal awards unless I think if you talk about it, you have to tell us what the number is or put it somewhere that we can figure it out.

I guess new rules.

We'll have it in our 10Q, John.

Okay.

And just, you know, I know how tempting you were, you know, to maybe raise guidance completely rather than just go to the upper end.

To what extent was the competitors' actions a couple of weeks ago, reasons you didn't do it?

Actually, John, we had planned to invest in brand-building and to invest in w some cost savings.

The announcements that were made last week just make us feel better about the decision we were going to make anyway.

So, I wouldn't see this as a reaction to anything that was made, we've got our game plan, we know what we want to do with our business and -- and we're moving forward with that.

You know, you got almost 5 points of sales growth from price mix.

You know, it just seems clear that domestically, you know, that's -- that's going to be much more difficult if -- if -- particularly if, you know, Kraft picks up spending in two of your core areas.

Do you think those kind of price mix gains are sustainable?

We believe that price mix as a whole and in individual businesses is definitely sustainable.

And John, you know, it's one of the things that we can control.

So.

It's within cereal, we believe we have further price mix gains and then as we launch snacks they represent a price mix benefit versus cereal.

So, that -- that's at the heart of our strategy and that's what we're executing against and has what we're doing.

You know, will it always be 5%?

Maybe not.

But -- but we do see continued price mix improvements going forward.

And I'll tell you, again, John, as you think about our business model, we are not relentlessly pursuing tonnage.

And I believe that that is one of the principles that has enabled us to deliver the kind of numbers that we've got and just the kind of business structure that we have today.

So, yes, we -- we will continue to improve price mix.

And just my last question, just in terms of, you know, your performance in the quarter being broad based, you know, 2% domestic, even if you get the advantage of -- it really was an international-driven quarter.

Do you agree with that?

If anything, you look at the domestic numbers and say they're kind of so-so.

Well, there's no question about it.

International had an excellent quarter.

But U.S. ready to eat cereal, we had 3% sales growth on top of 6% growth last year.

I mean I would say that that was -- that was pretty, you know, pretty spectacular considering numbers in that business.

Total USA was up 3%.

Last quarter, second quarter 2002 was up 4%.

So, you know, --

Yep, I see.

International was an excellent quarter, but U.S. also had a solid quarter.

And again, that 3% U.S. cereal gain was without any kind of inventory build that you can see?

That's correct.

The inventories remain flat as we measure them.

Thanks a lot and congratulations.

Thank you, John.

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

Good morning, everyone.

Good morning, Bill.

Good morning, Bill.

It seems like the surprise in the quarter really came in the SG&A line -- it was only up 2% and given your currency differential it would probably be flat or even down in local currency.

Could you just elaborate on what's going on there and why it wouldn't continue to help you in the second half?

Well, within the SG&A line, including the brand building, as you say, brand building is up double digits in the quarter.

Despite that, the SG&A is favorable as a percent of sales.

What's driving that is low overhead costs.

We have lowered integration costs year on year since they're now behind us.

We've completed implementation of SAP in North America.

So, that's now behind us.

We have very strong discipline and control around overhead, as well so we're really driving -- that SG&A line, I would expect to continue to -- before we get a little bit higher in the back half, given the significant increase in brand building, but SG&A line as a whole is not coming up because of savings and overhead.

Okay, and in terms of back half guidance, do you expect similar gains in the third and fourth quarters?

Guidance on SG&A?

No, on -- on EPS, you're guiding to like a 3% gain on EPS for the rest of the year.

Do you expect both quarters to be up modestly?

At this stage we expect those back quarters to be similar growth.

Okay.

Thanks a lot.

Thank you.

Your next question comes from Eric Katzman of Deutsche Banc.

Hey, good morning.

Good morning, Eric.

A few questions which haven't been touched on, although it's difficult to come up with a few.

Pop Tarts, can you talk about that vis-a-vis the competition from Pepsico?

Yeah, we had, as as I mentioned in the script, Eric, we had a -- a pretty slow first quarter because of some difficult comparisons.

Second quarter we launched our Yogurt Blasts.

We have a wonderful tie-in with American Idol in 41 different cities where we're promoting Pop Tarts, the product that can be eaten, refrigerated.

A lot of stuff going on in marketing.

So, our business is up for the quarter and, you know, you probably are better off getting the numbers from -- from our competitors but from what we see, I believe their market share is about 4 and that's pretty much where it's stayed, about half of what it was before our other competitor entered -- sorry, exited the market.

So, we're pleased with Pop Tarts and we continue to do what that brand responds to and we will continue to push it on ahead.

Okay.

And then with regard to Latin America, I guess you have, you know, now the benefit of appreciated currencies there and so I assume that the cost structure there should be better so, should we assume that it unless there's something competitive going on there that the second half profitability in Latin America should increase year-over-year?

Well, you -- you mean that currencies will remain flat and therefore not.

Well, isn't -- the currencies year-over-year there are up and your right -- you're buying dollar cost of these products?

No, at this stage, we're seeing the -- at least the markets that we participate most heavily in in Latin America, we're seeing a devaluation of those currencies relative to the U.S. dollar and we're buying raw material obviously -- quite often in U.S. dollar denominated contracts.

So, the result is actually negative to our profitability in Latin America.

So, you're still seeing a drag there?

Yes.

All right, and last question I can't remember if you give this out, but you talked about for a consolidated, the volumes were down slightly and core sales were up 3.5, what were units?

Good question.

We generally don't track units, however, what you can see in our cereal business is that unit growth is generally about 1 to 2 points higher than our volume growth.

So, you know, our units would be better than our volume performance.

Okay.

All right, thank you.

Thanks, Eric.

Your next question comes from Chris Gaulin of JP Morgan.

Good morning.

Hey, Chris.

I think one of the other things Kraft mentioned as part of its problem in the Nabisco business was overburdening the DSD system with new productivity.

That hasn't happened to you.

I'm curious, how do you manage with some of the new productivity that you're coming out with as well as some of the line extensions, how do you manage the system such that you don't have a similar-type issue.

You know, it's difficult to talk about what we believe a competitor did and I'd rather stay away from that.

But one of the things that helps us, Chris, is our -- our focus on revenue and not a focus on tonnage.

And a focus on tonnage could strain the business and it could make you do things that you -- you really don't want to do at the end of a quarter.

We're also taking out SKUs and rationalizing our SKUs which gives our DSD system better -- better leverage by carrying products that are higher-priced and higher margins.

But really that's -- that would be the difference I see.

We have not seen a build-up in trade inventories for -- for our brands.

It could just be a difference of between how the businesses are managed.

Okay.

And then just separately, I guess CPW is going to make another go of the Australian cereal market.

Any change in your operating philosophy, where you have to spend to defend the business there in the second half?

We have -- our business in Australia is actually doing quite well this year.

And we've got some plans in place, we've got volume to value in place.

We have a great team of people down there, so I -- you know, we're not -- we're not turning everything upside down and changing our plans.

We believe we've got good plans in place.

Okay, great, thanks.

Thank you very much.

Operator, it seems we've now run out of time.

I apologize for those of you who didn't get in.

But please give me a call if you have any other questions at 269-961-6365.

This concludes today's conference call, you may now disconnect.