家樂氏 (K) 2003 Q3 法說會逐字稿

Good morning.

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

At this time, I'd like to welcome everyone to the Kellogg's third quarter 2003 earnings results conference call.

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

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

If you would like 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, press the pound key.

Thank you.

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

Please go ahead, sir.

Thank you, Jeff and good morning, everyone.

Thanks for joining us for a review of our third 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 Simon Burton, the newest member of our IR team.

Most of you know Simon from the buy side, where he's been for the last few years and he's joined us at Kellogg to manage our day-to-day IR effort.

By now, you should have received the press release and the slides that accompany today's presentation are available online at www.kelloggcompany.com on the investor's page.

Turning to slide 2, 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, costs, cost savings, brand building, interest expense, investment sales, tax rate, cash flow, innovations in productivity, currencies, debt reduction, 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 S.E.C. filings.

In addition, the S.E.C.'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 on our web site, www.kelloggcompany.com.

A replay of this call will be available by phone through Wednesday evening by dialing 1-800-642-1687, pass code number 7972300 and via webcast which will be archived for 90 days.

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

Thank you, John and good morning, everyone and thanks to everyone for being on our call.

We're obviously very pleased to report another strong quarter, one in which we sustained our strong momentum of previous quarters.

We also had significant reinvestment into the business so that we can sustain our growth into future quarters.

We, again, reported growth on top of growth last year.

Our reported net sales growth was 6.8%, our 4.5 internal sales growth comes on top of a 5.6% gain last year.

Our 14% increase in EPS comes on top of last year's 32% gain.

So, comparisons were tough but our people delivered anyway and we're very pleased with that.

In fact, our top line growth which drove the quarter's results, was even better than the strong increase we recorded in the first half of this year.

We're equally pleased with the fact that this growth was broad-based.

It was really only one business with any notable softness in the quarter and that, of course, was the cookies segment of our U.S. snacks division.

Aside from that one business, we saw gains across our portfolio and across the globe.

This broad-based performance is an indication that our strategies are working, our financial model is working, volume to value and manage for cash continues to deliver and our people are executing extremely well.

The third quarter also featured substantial reinvestment in our business.

Brand building, which for us is strictly investment in advertising and consumer promotion and not discounting, was increased at a strong double-digit rate on top of a solid increase in the year-ago quarter and this investment, of course, is key to sustaining our growth.

We also invested in future profit margins.

During the quarter, we recorded up front costs related to capacity rationalization and cost reduction projects, the savings will allow us to continue funding brand building and earnings growth well into the future.

Again, we did not strip these costs out of our earnings.

Instead of so-called restructuring charges, we prefer to consider these as part of the ongoing challenge of managing the business and these are ongoing reinvestments and frankly, the cost of doing business.

So, we did not strip them out and we are not calling them restructuring charges, they have been absorbed in our P&L.

What we are after, as we have said many times before, is sustainable growth and we will continue to use our momentum to reinvest for future growth.

During the final quarter of the year, we will absorb more up front expenses related to cost savings projects and we will record another double-digit increase in brand building.

Nonetheless, we have increased our guidance range to $1.89 to $1.91, reflecting our continued momentum and it is this momentum in reinvestment that gives us confidence in our 2004 outlook.

So, we're already looking ahead to 2004 and we feel just as confident about 2004 as we do about our year end results for this year.

I'll be back in a moment to discuss the underlying fundamentals and performance of each of our major business suggest mane.

First, I will turn it over to John Bryant who will walk you through our financial results and then I'll be back.

Thank you, Carlos.

Good morning, everyone.

From a financial standpoint, this was an outstanding quarter.

Slide 4 gives you a summary of our key financial results.

Net sales were very strong, up 7% with an acceleration in internal growth and continued favorable currency translation.

Year to date, we are on track to exceed our low single digit net sales growth target.

Operating profit rose at a mid single digit rate, up 4%, despite a double-digit increase in brand building investment and substantial up front expenses related to capacity rationalization and cost reduction projects.

Our 14% gain in earnings per share was aided by lower interest expense as well as a reduction in our effective tax rate which offset some of these of front costs.

Cash flow exceeded last year's notably high level.

Let's take a close look at each of these metrics.

Slide 5 shows our 6.8% sales growth in the various components.

As Carlos mentioned, our growth accelerated from the first half and the reason for this was an improved internal sales growth rate.

At a strong 4.5%, this internal growth was driven by both tonnage and by price mix.

In addition, the tonnage metric understates real unit growth.

For example,our U.S. cereal business, our volume growth in cases exceeded our volume growth in tonnage by 3 percentage points.

Volume to value has us continuing to rely not on trade discounts but on the brand building and innovation that add value for the consumer while driving demand and improving our mix.

Importantly, this internal growth was broad-based, as Carlos mentioned, cookies were down in the U.S., but this is only a piece of our portfolio.

The continued momentum we realized in U.S. cereal was impressive, as was the continued growth acceleration we generated in Kellogg International.

Slide 6 shows that our gross profit margin was down slightly year-over-year.

These figures don't capture what is actually very solid underlying profitability.

Throughout 2003, we've had to contend with a surge in benefits cost and substantially higher commodity costs.

A combination of operating leverage, price mix, tonnage growth, Keebler synergies and productivity initiatives have more than offset the adverse costs.

However, we substantially increased our use of toys in the box and other value-added inserts, which are a key form of brand building and are recorded in cost of goods sold.

In addition, we absorbed those up front costs related to capacity rationalization.

In the quarter, more than $10 million of these costs, mainly in the form of asset write-offs in our U.S. biscuit network and our South American production capacity, fell into cost of goods sold.

For the full year, we expect gross margin to be down modestly due to these up front costs, which will continue into the fourth quarter.

However, we are very satisfied that we have improved our company's underlying profitability.

This improved underlying profitability is allowing to us reinvest in our brands.

Slide 7 shows how we have continued to increase our brand building investment at a rate that is considerably faster than our rate of sales growth.

Remember, that we do not consider trade spending to be brand building.

This metric includes only advertising and consumer promotion.

It is this investment in brand building that allows to strengthen our competitive position and sustain growth momentum in into the coming quarters and years.

In the fourth quarter, we should see an even greater year-over-year increase in brand building.

We can do this because our momentum has given us the flexibility to reinvest for 2004 and beyond.

Slide 8 shows the components of our operating profit growth during the third quarter and year to date period.

Even with the substantial increase in brand building investment and significant up front expenses for cost savings initiatives, we were still able to grow our operating profit in the quarter.

At about 4%, our operating profit growth was at the low end of our ongoing mid single digit target.

However, we're up significantly more than that year to date and this is high quality growth.

It includes substantial reinvestment which should allow us to sustain our growth into the future.

All of our reporting areas posted operating profit growth in the quarter and year to date periods.

Slide 9 shows that all of our reporting areas also posted internal profit growth, which excludes the impact of currency translation.

The U.S. posted internal growth despite a double-digit increase in brand building and much of the up front costs we absorbed in the quarter.

Europe recorded an internal profit gain and solid sales growth covered increased marketing and higher raw materials cost.

Latin America's profit surged as strong top line growth more than covered up front costs related to a capacity rationalization effort in South America and a large increase in brand building.

In the all other segments, internal profit growth was significant, off a relatively small base but here too, the profit growth came despite brand building investment.

In short, our reinvestment in brand building and cost savings initiatives were significant across the company.

This is consistent with our goal of using business momentum today to reinvest for sustainable growth tomorrow.

Moving below the operating profit line, interest expense declined by 15% year-over-year due to the impact of debt reduction and lower rates.

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

Our effective tax rate was about 34% for the quarter, well below our previously targeted rate of 36%.

Tax planning initiatives and audit closures have allowed to us reduce our tax rate outlook for 2003 to between 35% and 35.5%.

During the quarter, we caught up to that rate on a year to date basis.

Average shares outstanding declined slightly year-over-year because of share buy backs and the impact of a lower share price on the calculation of diluted shares.

We expect average shares to be down slightly for the full year, as well.

Turning to cash flow, slide 10 indicates that we continue to build on our impressive record of working capital management.

The third quarter represented our ninth sequential quarterly decline in the rolling 12-month ratio of core working capital to net sales.

Importantly, year-over-year improvement was delivered by all of our reporting areas during the quarter, a reflection of the tremendous focus the organization has on our managed for cash financial model.

Meanwhile, we continue to demonstrate discipline on our capital expenditure with cap ex trending below our target of 3% of net sales both for the quarter and the year-to-date period.

The impact of our increased earnings, improved working capital efficiency and disciplined capital expenditure can be seen on slide 11.

Year to date, we have generated cash flow more than $860 million.

While this is below last year's notably strong cash flow, that period benefited from some unusually large working capital declines and the timing of tax payments.

To date, we have used the cash flow principally to reduce our debt.

Slide 11 shows our total debt has been reduced meaningfully over the last two years.

During the quarter, we paid down $200 million of debt, bringing our net year-to-date debt reduction to nearly $350 million.

Given our stronger-than-expected cash flow, we will pay down debt further and potentially make another voluntary cash contribution to our pension and post retirement benefit plans.

It is clear that our improved cash flow is leading to increased financial flexibility.

Slide 12 offers our latest guidance for EPS in 2003.

Obviously, we have posted strong momentum thus far this year and our third quarter's results were better than we had anticipated.

It was a very good quarter and we have and will continue to reinvest this momentum.

In the fourth quarter, we will increase our brand building investment at an even faster rate than the double-digit increase posted in the third quarter.

In addition, we will continue to absorb up front costs related to overhead and capacity rationalization projects.

Nonetheless, our full year EPS should be between $1.89 and $1.91.

This represents a growth rate of 9 to 10% over 2002 earnings per share of $1.73, which excludes a 2-cent benefit from legal settlements.

This is slightly above our ongoing target of high single digit EPS growth and is a slight increase over our previous guidance.

Let me emphasize our goal of continually reinvesting for future growth.

We have identified many high return projects and we will continue to reinvest our earnings upside into these brand building or cost saving initiatives, our goal of sustainable growth, not one year of exceptional gains,

Which brings us to 2004 on slide 13.

In the interest of visibility, we'd like to give you an early preview of our expectations for 2004.

We forecast low single digit internal net sales growth in line with our long-term target, though our reported sales will benefit from a 53rd week.

These extra shipping days will fall in the last week of December, a week when our sales are their lightest of the year.

In fact, most of our international operations are essentially shut down during that period, so we would expect only about a 1 percentage point of sales impact from the extra week.

We expect that our internal growth will be broadly similar across our major geographic areas, despite very tough comparisons.

So, solid top line growth is expected again for 2004.

Operating leverage, mix and the full year impact of 2003's productivity initiatives should allow us to improve our gross and operating margins in 2004 despite some very difficult headwinds.

As we have stated before, we expect to see a similar increase in our benefits costs, roughly 5 to 10 cents per share in incremental expense as we experienced in 2003.

Additionally, commodity prices have remained higher than most expected and coupled with higher energy costs, we should see an incremental 5 to 10 cents from commodity costs next year.

Meanwhile, just as in 2003, we will constantly look to reinvest in high return initiatives that can help sustain our growth into the future.

We will be launching several more cost savings initiatives in 2004, absorbing those costs along the way and, as always, we will be growing our brand building investment at a rate faster than sales.

Even despite all these factors, we project operating profit will grow at a mid single digit rate, in 2004 in line with our long-term target.

We will get some additional lift from below the operating profit line in 2004.

While our effective tax rate may be slightly higher at around 35.5%, we should continue to reduce interest expense through debt pay down.

These factors should turn our mid single digit profit growth into high single digit EPS growth, which right in line with our long-term target.

When you consider your quarterly estimates for next year, keep in mind that the absorption of up front costs will be its heaviest in the first half of the year with the second half benefiting from the result of savings and from comparisons to the majority of 2003's up front costs.

We think these targets give us the flexibility to deliver dependable performance and, if possible, to step up our reinvestment for growth in 2005 and beyond.

With that, let me turn it back to Carlos.

Thanks, John.

I am going to walk you through each of the key business segments starting with Kellogg USA, that's on slide 14.

Obviously the big story in the U.S. is in Q3, was the outstanding performance of our cereal business but we also experienced very good collective growth in our frozen foods, Pop-Tarts® and our alternate channel businesses.

These gains more than offset a decline in the cookies segment of our U.S. snacks business.

So, I'd like to take a closer look at each and start, of course, with our U.S. retail snacks business, which I know is on many of your minds as it is on ours.

As slide 15 shows, this business posted a 4% sales decline in the quarter and was flat year to date.

Keep in mind though, that more than a point of growth was lost to the discontinuation of a custom manufacturing account where we produce cookies for a third party.

That contract was discontinued in May, so we will continue to feel its impact on growth through the second quarter of next year.

Next, please recall that last quarter we launched an aggressive round of SKU eliminations as we seek to simplify the portfolio and create efficiencies in both our manufacturing and distribution center networks.

So, SKU cuts clipped nearly 2 points of growth from this business in the third quarter and will continue to do so through mid-2004.

So, about three-quarters of the decline can be explained by these factors and this quarter also faced the most difficult comparisons of the year with last year's third quarter performing at about a 5% growth.

Now, let me just be clear, we're disappointed with this performance, we want to give you some context as to the magnitude of the quarter sale's decline but you can be absolutely sure that we are addressing these issues.

Let me give you a little bit more context as it relates to the overall U.S. snacks portfolio.

The decline in U.S. snacks was limited to the cookies portion of the portfolio.

The data on slide 16 highlights this, showing that we have experienced consumption declines in our cookies business but gains in our crackers and our wholesome snacks businesses and this is mirrors our shipment sales performance.

There are several factors appear to be responsible for the cookies decline which worsened in the quarter.

First, the category is down slightly a negative, a reflection of relatively low levels of brand building and innovation.

The impulse-driven cookies category, even more so than other categories, relies on news, on innovation, on sales execution, on brand building to drive consumption and, as you all know, there has been some negative publicity around cookies over the past couple of months.

There has also been some price promotion activity, very strong price promotion activity by competitors and by not aggressively matching those price promotions, we lost out on some display activity.

The scanner data support this, showing a significant 20% decline in our incremental or promoted sales during the quarter.

Next, we have noticed retailers' desire to push their store brands and their value brands and finally, while we have boosted our brand building investment and innovation activity, it has been limited to only a handful of brands.

So, we understand the issue and we are on that and that is the one part of our total business that under performed for the quarter and make no mistake, we are not satisfied with our cookies performance.

I do want to emphasize, though, that where we have invested we have seen results and we have experienced growth.

Slide 17 shows a few examples of that.

Even in cookies, we've posted strong growth in brands like E.L.

Fudge®, Sandies® and Murray's Sugar Free®.

Each of these brands has responded to brand building and innovation efforts.

Another, Chips Deluxe®, showed immediate response to quality improvements and related consumer promotions at the end of the quarter.

So, remember that cookies only account for a little more than a third of our U.S. snacks sales and they carry the division's lowest margin.

So, please don't let your softness in cookies overshadow the strength of wholesome snacks and crackers both businesses face intense competitive pressure and yet, both registered sales gains in the quarter and the year to date period.

In wholesome snacks, Special K® Bars has been a great success, continuing to post strong growth, despite comparing against their year-ago launch.

Our Cereal & Milk Bars have done extremely well and we have launched a new Nutri-Grain® Granola line in the third quarter.

In crackers, the main driver has been Cheez-its®.

The brand has responded to the best advertising in years and new products have added to the brand's growth.

During the quarter, we added 2 more varieties, Chili-Cheese and Sour Cream and Onion.

So, we're growing selected cookie brands, we're growing our overall wholesome snacks and crackers business, excluding SKUs that were cut, our store door sales were up in the quarter.

We expect another decline in cookies during the fourth quarter, largely because of the SKU cuts, the discontinued custom manufacturing account, price promotion and softness in the category.

However, fundamentals remain very sound for wholesome snacks and crackers and their performance could well offset the cookies decline in the quarter.

We also expect similar performance in 2004 as we believe that innovation and enhanced in-store merchandising and sales execution will drive enough growth in crackers and wholesome snacks to offset the continuing impact of SKU eliminations and discontinued contract manufacturing, as well as the overall weakness that we've talked about in the cookie categories.

So, we do expect that in 2004, the growth in wholesome snacks and the growth in crackers will offset the weakness in cookies.

Let me turn now to U.S. cereal, as shown on slide 18, this business continues to show remarkably strong momentum.

With net sales growth of 11% in the third quarter, our U.S. retail business has now generated 6% growth year-to-date and note that these growth rates come on top of extremely difficult comparisons.

Year-ago growth rates were 6% for the quarter and 7% for the year to date period.

So, we are showing strong growth on top of strong growth.

All sales growth components contribute to the quarter's gain.

On one hand, we had favorable mix, we had the impact of last February's modest 2% list price increase and also higher tonnage.

In driving this growth is effective advertising, consumer promotion, innovations, great sales executions, all of these things lifted our share of the ready-to-eat cereal category by 1 full point for the quarter year-over-year.

Just some examples of what's driving this strong advertising campaigns for Fruit Loops® and Rice Krispies®.

We had a great Apple Jacks® program where kids were able to vote for their favorite ingredients and we actually added some blue carrots to the cereal.

Also, Cartoon Network toys in the box helped drive growth in Frosted Flakes® and snacks.

In addition, I'd like to emphasize this great execution in the sales field is helping us drive these results.

New products continue to drive revenue and drive mix.

Fruit Harvest and two new Kashi offerings, including the Organic Autumn Wheat cereal continued to contribute to growth and early in the third quarter, we launched a maple and brown sugar version of Frosted Mini Wheats®.

At the very end of the quarter, we started shipping a new Fruit Harvest® variety, which is peaches and strawberry, as well as new Special K® Vanilla Almond and also a promotional cereal tied to the upcoming "Cat In The Hat" movie.

These are all examples of bringing excitement to the category, bringing news to the category, adding value for the consumer and contributing positively to our volume to value metrics.

We expect continued growth in the fourth quarter, even as our consumption catches up to the late quarter shipments of those new cereals.

U.S. cereal has a strong lineup of innovation and brand building programs planned for 2004 and while we can't realistically project, you know, the similar growth rates as we've had year to date and over the past year, I think it's plain to see that we have this business back in growth and we are executing extremely well.

Our other U.S. businesses are also performing well, slide 19 shows that these businesses collectively posted a second consecutive 3% sales gain in the third quarter after coming up against unusually difficult comparisons in the first quarter and like most of our portfolio, the growth in these businesses was led by appealing to consumers through brand building, through innovation.

Pop-Tarts® net sales increased in the quarter partially due to new product introductions such as Yogurt Blasted, we also launched a "Cat In The Hat" promotional Pop-Tart®, although that came very late in the quarter.

The national rollout of Krave® Bars has gone extremely well, as has the launch of new Eggo® Syrups.

We continue to generate strong double-digit sales growth in the non-cereal products of Kashi, including GoLean® snack bars and TLC Crackers.

Our food away from home business, some call this foodservice, continues to post growth at a time when most companies have cited declines in their foodservice channel and this is thanks to innovation.

We've gained share in cereal, in crackers and cookies in the foodservice channel and we also continue to expand our presence in the military channel but it's a great credit to the foodservice sales force that has continued to post growth in a very difficult environment at a time when others are finding it difficult to grow their business.

Slide 20 shows a reported and internal sales growth for Kellogg International recorded during 2003.

As you can see, our internal growth, which is adjusted for acquisitions and the effect of currency translation, has actually improved sequentially throughout the year.

So, during the quarter, our 7% internal growth was driven by price, mix growth, by tonnage, both of which reflected investment in innovation, in brand building, in sales execution.

In other words, this quarter provided further evidence that volume to value continues to work as we roll it on the and continues to drive momentum.

Let me just walk you through some of the regions of Kellogg International.

Slide No. 21 shows that each of our major areas posted local currency sales gains.

In fact, each of our core markets within these areas posted local currency growth, as well.

Before I get into this, to the examples here, let me just say that I will be noting some examples from around the world and I hope that you note the similarities of the examples, the fact that we're doing very similar things in Latin America as we may be doing in Europe and the reason for that is that we are moving successful ideas very quickly across countries.

So, for that reason we hope that you'll see that as we talk about what is really driving the business, you'll note that it's very similar ideas.

In Europe, for example, our sales jumped 15% with currency adjusted growth of about 4% and the U.K. is a notable success story.

After implementing volume to value and building up an impressive pipeline of innovations, consumer promotions and great sales execution, our cereal business in that core market has picked up momentum and for the first time years, it is gaining category share.

Meanwhile, we continue to generate strong growth in markets like France, Spain and Italy and in each case, the growth has been driven by better brand building initiatives, more differentiated innovation, greater customer focus, greater sales execution, so we're working all of the levers and our people are executing them extremely well.

Examples of brand building and innovation in Europe abound.

The successful rollout of Special K® Bars in new markets and the successful launch of a new Special K® variety like with chocolate.

So, it's a Special K® with chocolate and I should note that that innovation was started in France where we also begun the development of Special K with Red Berries®.

We've also launched Special K® with Peach and Apricots.

So, reformulations, line extensions and really good marking and advertising have driven our country nut cereal and extra brands across the U.K. and continental Europe, respectively.

In Latin America, sales increased by 10% and I want to emphasize this is 10% in U.S. dollars, in Latin America.

With currency adjusted growth, that would be 17%.

This performance featured double-digit gains in cereal and snacks.

This growth was led by our business in Mexico, which, once again, reported record sales in cereal and very, very strong growth in snacks.

Again, this growth was led by brand building, by innovation, by sales execution, by really going after the basics, having the ideas and going after the basics and executing.

Sucaritas® which is our Frosted Flakes® brand in Mexico was lifted by strong advertising and promotional campaign and this is a very, very large brand in that country.

So, to show strong growth behind a brand that size is a great feat.

Special K® rose strongly amidst another challenge campaign.

All Bran® bars continued their very strong growth and we launched a handful of Disney snack products.

Our all-other international segments posted a collective sales gain of 20% or 5% measured in local currencies.

This was led by good growth in Canada and Australia, both of which generated growth in cereal and in snacks.

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

For example, in Canada, cereal growth was led by an effective advertising campaign for all All Bran® and a Simpsons "toy in the box" promotion.

Our snacks business there was also helped by the launch late in the quarter of Rice Krispy Squares® with Cadbury® Chocolate and Nutri-Grain® Granola Bites.

In the quarter, Australia launched Special K® Peach and Apricot and a Simpsons-themed cereal as well as successful programs on big brands like nut Nutri-Grain® and Soltana® brand.

It's a great testament to what we're doing in Australia, the fact that we're growing such large brands and doing it through brand building and innovation.

Our snacks business in Australia continued to post exceptional results.

Asia also posted local currency growth on increased cereal sales and Japan growth was driven by All Bran® behind an effective advertising campaign and by a new Disney cereal.

In Korea, we had a great Lion King on pack CD and a launch of a new almond flake, which is driving good growth in that country.

So, clearly it is, you know, gratifying to see that Kellogg International is making the kind of progress that it has this year and how well we are moving successful ideas across markets and you can see that as we talk about what's driving the business.

In many cases, it's the same idea we're using in other countries and our people throughout the world are getting very, very good at finding ideas that work and executing them quickly in their markets.

In 2004, our international business will continue to implement and focus on volume to value and manage for cash.

In the U.K. and other key markets in Europe, our pipeline of innovations and consumer promotions is impressive and we'll continue to expand our snacks presence.

In Latin America, we should, again, be able to counter the recent inherent volatility with relentless brand building and innovation led by Mexico.

In our all-other region, our innovation pipelines are still gathering momentum and coupled with a solid calendar of marketing programs, we should continue to see growth in Australia, Canada and Asia, all of this supported by great sales and supply chain execution.

With that, we'll return to a familiar graphic on slide 22, which I've shown in the past.

In our view, the third quarter provided further evidence that a combination of a focused strategy, realistic targets, a clear, understandable financial model and substantial reinvestment can lead to strong sustainable growth.

The third quarter featured accelerated top-line growth with broad-based gains as well as improved underlying profitability and financial flexibility.

The result was a surge in earnings per share.

The quarter was so strong in fact, that we again were able to reinvest some of our momentum back into the business and we will do even more of that kind of reinvestment during the fourth quarter.

While it's tempting to allow upside to flow through to earnings, we believe and are convinced that it is better for the long-term health of our business, our stock, our owners, our employees, to reinvest it with an eye toward delivering more dependable growth in the future and very importantly, growth into the future as far as we can see and beyond.

This is all about dependability, reliability but also very important, it's about the longevity of the business model.

So, I hope you can see that in spite of these great results, within our numbers we have a strong, embedded earnings power that will help us in 2004 and 2005 and even beyond that.

It's because of this year's reinvestment and because of the momentum our business is demonstrating that we feel confident about achieving our high single digit EPS growth target again in 2004, despite several headwinds in the form of benefit costs, commodity costs and, of course, an increasingly competitive environment.

I'd like to thank you all for being on the call and for your interest in our company and your confidence and I would now like to open it up for any questions you may have.

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

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

Your first question comes from John McMillin of Prudential Equity Group.

Good morning, everybody.

Hi, John.

Congratulations to you.

Thank you.

You mentioned up front expenses in the quarter a number of times and I do see the $13 million increase in corporate expense.

John, is that what the incremental up front expenses were in the quarter?

The, in the quarter we had 2 to 3 cents of EPS.

We had about over $10 million go through cost of goods and then we had a small amount go into the corporate expense line but only about $3 million or so.

So, most of the up front costs actually fell into the cost of goods line.

What was the pretax number in terms of this total up front expense, would you calculate?

Well, 2 or 3 cents, you are going to be around the 13, $14 million range, John.

Okay and just in terms of the tax rate, can you say again why it came down in this quarter and why it won't be at this rate for next year?

Well, it came down to, our full-year estimate for the year has come down to about 35.3, in that sort of range and for a variety of reasons, including some tax planning initiatives as well as closing out some orders.

As we look to 2004, we're actually projecting to keep the rate around 35.5 so, it has come down on a permanent sustainable basis.

And Carlos, just in terms of the fourth quarter guidance, I mean it's obviously been a terrific year and you probably, if you want to keep this thing going, you don't want to, you know, set the bar too high but are you looking in this guidance for similar 2 to 3-cent up front expenses, is that the kind of number or might it be even be higher?

Let me say, John, I will ask John to give you more color on the numbers but the thing about the fourth quarter is that we expect to see the same type of sales momentum that we have seen for the first three quarters and that we just saw in the third quarter.

So, it's not like we are, you know, taking a break, we expect strong mid single digit sales growth on an as-reported basis.

Our brand building will be up very strongly, actually it will be up more than it has been all year, so, those are two factors that we're using to reinvest in our business and to take advantage of the fact that we have the momentum.

So, you know, what we're doing is using the momentum to reinvest in the business and to build continued earnings power because, once again, as we've mentioned before, the goal is sustainability, dependability.

Let me just ask John to give you a little bit of color on the numbers that, you know, at this point are very tentative for the fourth quarter, but --

John, just to clarify, if we go back to the second quarter conference call, we said in Q2 we had 2 to 3cents of up front costs in the back half of the year, we would have 4 to 6 cents.

So, the Q2 conference call we said we'd have around 6 to 8 cents of up front costs for the full year.

Now, what we're saying is we're more likely to have 8 to 10 cents of costs in the full year with 2 to 3 cents in the second quarter and the third quarter and as high as 4 cents in the fourth quarter.

And Carlos, you know, it's very early for next year but you're talking about these type of run rates continuing in up front expenses?

It depends, John.

You know, it's hard to pinpoint that one year will be exactly the same as the other but the overall philosophy of running a business and getting charges out of the way and making investments as you go along and absorbing them into our P&L and reinvesting in the P&L, that will continue.

The exact amounts are, you know, are still to be seen.

That's one way to be dependable by saying "it depends".

Yep, that's...

Thanks a lot and congratulations.

Thanks, John.

Your next question comes from Jonathan Feeney of Wachovia Securities.

Good morning.

Great quarter, everybody.

Thank you.

Good morning.

I had one question for Carlos and one for John.

For Carlos, you know, gaining a full point in cereal, who do you think you're gaining share from, from what you can see?

Well, as you look through the most recent data, basically we are, you know, we're gaining share at the expense of most players, I don't have a specific switching analysis as to where the business is coming from or where it's going, but we have gained more share than the other players and even if you look at the price segment, where you have bags and store brands, that's pretty much flat.

So, I would say pretty much from everywhere.

Okay and John, just on capital expenditures, only $121 million, year to date.

Any changes to 2003?

And is it too early to talk about 2004 in terms of your cap ex plans?

We normally talk at around 3% of sales in cap ex and it's seasonally high in the fourth quarter, so, it could be that this year we come in slightly below that 3% and next year we might be slightly above that 3%, but on average across the three years, we'd be at 3% of sales.

And same for 2004?

Yes.

Okay.

Excellent.

Great quarter.

Thank you.

Thank you.

Thank you.

Thank you.

Your next question comes from Eric Katzman of Deutsche Banc.

Hi, good morning, everybody.

Good morning, Eric.

John, can you say what went into the other income line in terms of the swing from a year ago?

Well, the other income line includes interest income, foreign exchange gains and losses and a variety of other items.

On a full year basis, we would expect that line to come in around zero and on a year to date basis, it is $2.2 million of income.

So, it's largely in line with where we expected to be because of the volatility of those items though, you can get some swings from year-to-year so it's no one major item.

In fact, last year we were around $8 million of income.

This year it's $7.6 million of income in the third quarter, so, the numbers are fairly similar.

Okay and then I think you kind of noted that the fourth quarter next year, the last week is seasonally a small week I am guess normally we'd figure that's about 2% of a year's worth of earnings.

Should it be 1 to 2%, is that what you're saying, so, 2 to 3 cents benefit?

I'd say it's around 1 to 2% at the most because what's happening, it is the week of Christmas and New Year's, it's literally the week ending the first of January, 2005, very few shipping days in there.

The impact of net sales is about a point, obviously we pick up a whole nother week of fixed costs, salaries, interest expense and so on, so really, it affects operating profit net sales EPS all about equivalently, around 1-point impact.

Okay, so maybe two cents a share, then?

Yes.

Okay and then I guess you,I mean to,I congratulate you for giving us such an early outlook on 2004.

I guess the one number I'm wondering about is the EBIT growth for '04.

I mean I think you mentioned sales and you mentioned the bottom line, but you have lower interest expense and a lower, slightly lower tax rate?

Eric, we're basically still on the guidance that we've been giving I think now for two or three years and our operating profit, our EBIT growth is, you know, mid single digits and that's what we'll stay with for next year.

The way to model it, that should be second-half weighted because of the charges that you're taking through the P&L?

Yes, our growth, our operating profit or EBIT growth will be slightly stronger in the back half of the year as we lap this year's up front costs and it will sort of shape how this year's panned out.

Okay and then last question, I guess to what extent, you know, some of the bigger players that you're going up against, like Kraft and Frito-Lay, have really only, I mean certainly with Kraft, they've really only started to open up the spigot.

I mean, how conservative do you think you're being seeing as you really haven't yet assumed seeing the impacts since that spending hasn't really started and Frito-Lay is just starting in terms of rolling out some of their grain-based snacks?

Well, you know, clearly it is a very intense competitive environment and we've got some very aggressive competitors and some very capable competitors but, you know, the competition has been heating up for a while now and it's not something that is totally new.

We believe that the profile of our business because we are focused on several big categories and we'd have fewer things to get integrated and fewer things to get fixed, that that is a key advantage for us and frankly, what has worked so far is our game plan and we are going to stick to our game plan and if anything, we're just going to intensify what we've been doing.

Okay and then last question for John, I guess, you know, last year you had, you know, your cash flow growth because of the working capital improvement was much, much stronger than your reported earnings growth and I'm kind of wondering now that while you're still making improvements and those are very, very good, would you expect going forward now that cash flow growth should be more in line with earnings growth?

Yes, I think our cash flow will continue to exceed our net income in absolute dollars because depreciation exceeds our capital expenditure but going forward, I expect our cash flow to broadly grow in line with net income.

Okay, all right, good quarter.

Thank you.

Thanks.

Your next question comes from Christine McCracken of Midwest Research.

Good morning, Christine.

You had obviously mentioned your guidance here for fourth quarter and going back to John's question, you know, this quarter you beat our estimates by 5 cents, it looks like next quarter, your expectations are relatively modest and you'd mentioned some of this up front spending but are you seeing any impact from the strikes out here in California, obviously on being local, it seems a little bit disruptive from our perspective?

Maybe you can talk about how that is affecting your business and if it's factored into your fourth quarter guidance?

Yes, Christine, we saw some impact of late last month, not something that would be of a material impact and we don't expect it to be something that could derail the quarter.

In fact, we do have it in our guidance.

So, you are actually expecting some disruption are or is it a function. are some of your products being picked up in other channels that might be offsetting some that that impact because, as I understand it, it's 20% of grocery sales for Kroger's, Albertson's and things?

We have seen some impact but we're also seeing that people are, you know, buying buying groceries at stores that are open.

So, in that regard it is being offset.

Again, as I said before, our call for the fourth quarter is mids single digit sales growth and all of that has been factored in and we feel very comfortable that we're going deliver that.

All right.

Thanks.

Thank you, Christine.

Your next question comes from Terry Bivens of Bear Stearns.

Good morning, everyone.

Good morning, Terry.

Just a little bit more on Q4, as we were looking before, John, I know you'd mentioned about 2 cents would be the likely up front cost, I guess most of us were looking, you know, somewhere in the 50 cent range.

Would it be fair to say that of that kind of 5-cent swing there, a couple of pennies is more up front if you look at the remainder, if we're assuming kind of a 5-cent swing, would that be a combination, I guess brand building, you mentioned and following up Christine's question, is there a point or so in there for the grocery strike, if you could give just a little more color on that?

As Carlos said, we're looking at mid single digit net sales growth in the fourth quarter, which is what we've done so far this year and we are expecting 4 cents of up front costs in the fourth quarter.

Okay.

As well as very heavy brand-building growth, so, that's really the factors that are affecting our fourth quarter performance.

Okay, so the very heavy would be a capitalized "V" then?

Well, it would be heavier than the third quarter and the third quarter was double-digit.

Okay.

As you look into next year, you raise the possibility of another cash contribution to your pension and benefits.

Is that included in the guidance you've given or, if there is a significant contribution, does that represent some lower hit from benefits and pensions?

If we make a cash contribution, then that it included in our cash flow guidance.

Okay.

The guidance we're giving from an EPS perspective next year includes 5 to 10 cents of higher costs and there is obviously quite a large range in there because we have to wait until the end of the year to see where the discount rate comes out, obviously we have higher healthcare inflation so, there is a lot of moving pieces in there still, Terry.

I understand, but the point would be the 5 to 10-cent increment that you're talking about at present does not include any assumption of a cash contribution, is that correct?

Well, again, Terry, there are a lot of moving pieces in there, we may or may not make a cash contribution, the discount rate may or may not come down.

We could be in the range even having made a contribution.

Okay, and lastly, Carlos, you mentioned a little bit about the cereal consumption, I think you expected to pick up the in the Q, 4th Quarter after some late in the quarter shipments.

Can you just, leading me to ask you, could you briefly address cereal inventories as we move into Q4?

Sure, Terry.

The, I think I mentioned in the script that we had quite a bit of new product activity toward the end of the month, toward the end of the quarter.

We've shipped Special K® Vanilla Almond, we've shipped the new Fruit Harvest®, we have some programs in October that we also shipped.

The interesting thing is, that in spite of such a strong September, our inventories were up slightly sequentially against the second quarter of this year, but were right in line, almost just identical to what they were at the end of the third quarter of 2002.

So, we're very pleased with that and another thing I would say, of course, is that as you're looking at that data, you know, that doesn't include non-measured channels, our business is very strong in non-measured channels

And the other thing I would say, Terry, is that our business in October, our consumption in October has been very strong.

So, we are not at all concerned that we may be taking up trade stocks.

Okay, great, thanks very much.

Thank you.

Your next question comes from Bill Leach of Neuberger Berman.

Good morning.

Good morning, Bill.

Carlos, I was wondering if you could just comment on the state of the U.S. cereal market, overall?

We obviously get a limited view with the scanner data.

Where do you see the market year-to-date in pounds and dollars and how do you think everyone is doing?

I will answer in dollars because I spend less time than you thinking about pounds, Bill, but anyway.

We think that, you know, obviously you've got the measured channels, you've got the non-measured channels and then to get to a total category number, you're essentially using different methodologies.

We think the category is growing all-in, around 3% if you add measured channels which we believe is a healthy growth rate.

Now, in terms of pounds, tonnage, I'll need some help on that because frankly, it's a number that we don't track as closely as perhaps you do, Bill, but I hope that 3% gives you some color.

And how do you perceive yourself to be doing versus your competitors?

We just gained 1 full share point in the quarter.

We're gaining share in the early numbers we've seen in October and probably the biggest indicator of how we're doing in terms of the health of our business is, our sales are up 6% year to date and our trade inventories are flat.

And for the fourth quarter, you do expect your U.S. retail cereal sales to be up even though the third quarter was so strong?

Yes, yes we do.

Obviously, not at the same pace we've had before because we'll be working off some of the shipments from September but yes, our business will grow.

Okay.

Thanks very much.

Your next question comes from David Adelman of Morgan Stanley.

Good morning, everyone.

Good morning, David Adelman.

Good morning.

Can you help me understand better the contribution of the late quarter September's sales of the newer products had to be 11%, U.S., cereal sales increase in the overall quarter?

Yeah, in the month of, we don't have a quantifiable for the full quarter but in the month of September, I would say that probably two-thirds of the increase was due to new products and programs that were being shipped that start in early October.

Okay and secondly, what level of price mix benefit, approximately, have you embedded into your 2004 forecast, in other words, I think you were up 4% for the third quarter, 4% year to date, what type of price mix improvement do you expect to be able to generate for the company next year?

Well, I'll just, David, without getting into a specific number, I don't want to give another layer of guidance on that but I will just say that it will increase and it is part of our strategy to increase and we are all focused on using the price mix lever and we believe we still have a lot of room to move.

So, without giving you specific numbers, I will just say that it will continue to increase.

Okay, thank you.

Thank you, David.

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

Congratulations.

Thank you, David.

Maybe from John, at what point, given all this cash, might you think about share repurchase?

What we've said is coming out of the Keebler acquisition, we'd spend the first three years focusing on debt reduction and we have had a tremendous run at that this year and the last couple of years.

So, as we go into next year, we're likely to have a more balanced use of cash and we would consider some share repurchases next year.

Okay and then perhaps Carlos, if you could get into, you eluded to new comments on cookies and the category weakness there yet, you're picking up strong growth in wholesome snacking.

When people aren't buying and eating cookies, what are they shifting to, if you could give us your thoughts there, please?

Well, we've seen some research on where they're switching and some of the switching analyses that some of our people have done and these, of course, are estimates but obviously, wholesome snacks is one where and that benefits us directly.

The move to wholesome snacks from cookies and then there are a lot of other snacks that are growing, anything from, you know, fresh fruit to snacks that aren't perceived to be as high in fat but we believe and we know that one of the major beneficiaries of the decline in cookies has been wholesome snacks.

Okay and then you were referring to a lot of here, so-called up front costs.

Is some of that RFID?

I know Wal-Mart has a big meeting tomorrow, is there going to be a big cost there for you?

The up front costs that we're reporting are primarily around capacity rationalization and SG&A and so on.

Any costs related to RFID would be a normal operating cost.

So, you don't expect a big hit there next year?

The extent to which we have any of those costs we will just absorb as a normal part of doing business.

Gotcha.

Thank you very much.

See you tomorrow.

Thank you, David.

See you tomorrow.

Your next question is from Leonard Teitelbaum of Merrill Lynch.

Good morning.

Good morning.

First of all, Carlos, congratulations.

I think your attitude toward restructuring costs is a cause of doing business rather than strip stripping it out, it is commendable but for those of us who don't believe in a masochistic tendency, would you suggest that you've got your hands around your entire rationalization that you're going to go through here and that the numbers you gave us earlier are it for this year or are we looking at a multi year program?

Well, let me just say a couple of things, Lenny, then I will turn it over to John to give you some numbers and a little bit of color but, you know, these things are always present in any business, as you know.

We always have SKUs that we can cut, we have costs that we can cut, we have capacity that we can rationalize, we have a new product that we can reinvest in.

So, I wouldn't see this being a, you know, one-time charge or something that happens during one year, then we just go back to normal, we're always looking for these things and I believe that we will continue to find high return projects and continue to take them as part of the, you know, ordinary course of doing business.

I appreciate that.

My comment was more on plant rationalization than new product or initiatives of that sort.

Well, we're looking at plant rationalizations as well and, in fact, we've got some in our numbers.

John, you want to talk about those?

Yes, Lenny, as you've seen this year, we've taken a variety of plant rationalizations and the total cost this year is 8 to 10 cents, as we said earlier.

Right.

In addition, we're going to have projects beginning in the fourth quarter that will impact next year by 3 to 4 cents, just from the projects rolling into next year, as well.

So, we continue to identify opportunities and continue to execute against them and feel very comfortable with that.

But should is end next year or as it gets integrated and rolls on and on and we could be looking at a couple of pennies a year going forward?

I think it's an ongoing process.

If you look back at even 2002 and spent every quarter of 2002 we had some sort of event like that witness we took through our operating P&L.

Lenny, what you may not see is the same amounts that we had this year but we think it is part of the cost of doing business and I would hope that it also becomes evident that by managing the business that way we have embedded earnings power in our numbers and that's what it's all about is, you know, future sustainability.

Indeed.

Thank you very much.

If I could switch topics for a minute.

Yes.

Cereal bars, can you tell us how they're doing and how are you looking to position those with, as a, or any reformulation to make them appear more, rather than a cereal alternative, healthy snack alternative?

Well, our cereal and milk bars?

Yes, sir.

They're doing very well.

Last time I checked, I believe one of our bars, our Fruit Loops® bar was right at the top of the SKU list for that category.

So, we're very, very pleased with that.

You know, these bars are, they can be a substitute for breakfast cereal, they can be a snack, that's what make them so versatile.

We're looking at many reformulations that could help us make them better and make them healthier,but, you know, you're going so a lot of details tomorrow on plans, on new products, on what we're trying to do and I'd hate to steal the thunder from the folks who are doing all the work.

So, the rest of the question will be fully answered tomorrow, Lenny.

We appreciate that.

Now, one other thing, did your promotional team's being very aggressive, did you alter those at all when it became apparent that not only were earnings going to be good, but cash was going to build higher than you thought earlier or was it the same plan enacted around mid-year?

We reinvested in some brand activity, some programs that were working well, we put more money into them, we moved forward some new products.

So, we did reinvest and we reinvested in brand building but we did add money to marketing.

Very good.

The last, which commodities are causing you the problem and is it because you're having to hedge in at higher levels than you had than your running out of, is that why the commodities will be up next year as opposed to anything else?

It's a variety of commodities, Lenny, it's soybean oil, dairy products, egg and we also have exposure to rice and a particular version of rice is not fully hedgeable.

So, those are the main drivers of the costs going up next year.

I think, this is in response to Dave's question, this is my last one.

Clearly, the kind of the public commitments you made, not only the rating agencies but I think to the market that you're going to, you know, have these debt repayments scheduled until the end of Q3 and a more balanced approach to cash and we presume that means share repurchase, et cetera.

Are you looking to ask the Board for any type of modification for existing approvals or new plans that you might see for this year, I'm talking '04 now?

Lenny, we clearly have options and I'm sure you understand, I'd rather not get into what we will ask our Board approval for and what we will not.

We have options and we're evaluating those options.

Thank you very much and good luck tomorrow.

Thank you.

Operator, we've already extended this considerably and we only have time for one more question.

Okay, your last question comes from Eric Larson of Piper Jaffray.

Hi, guys, nice quarter.

I guess, I just got in under the bell here, just this first question is for John.

John, I believe in Carlos comments it was $10 million of asset charges in the quarter, Is that about $7 million in cost of goods and $3 million in corporate, is that how I should look at that number?

No, it was over the $10 million in cost of goods, so, let's call it 10, $11 million and around $3 million in SG&A giving you about $14 million in total.

Good and then there was there anything in the quarter prior, from a comparability point of view?

In the third quarter year-ago, yes, we had a write-off, I think it was the production line in Australia would be in about a penny.

Okay, gotcha, all right, thanks, and the final question here is for Carlos because I know the call is running long here.

If your '04 guidance, you mentioned that commodity costs could impact negatively up to 5 to 10 cents a share.

Just roughly speaking, if it's $2 of earnings next year and you hit the high end of that which is a dime, it's 5 percentage points off your growth.

It seems that that is conservative to me and that the strength of your brands, you should get some sort of pricing relief.

Can you talk a little bit about that?

Well, I hope you're right and you may well be right but we're planning conservatively and it's just an example of the kinds of headwinds that we have for next year that we have to deal with.

And that enables us to, the important thing is that we're able to stay within our guidance, we're able to stay within high single digit EPS growth,spite of the fact that we see an increase in commodity, that we see an increase in pension.

In terms of whether we can reflect that to consumers in pricing, obviously, I'd rather not get into a discussion on pricing, but I'd like to leave you with a thought that we believe we can absorb those increase in costs and still make the estimates and the guidance that we have been giving for two or three years.

Okay.

Thank you.

We'll see you tonight and tomorrow.

Thank you, look forward to it.

Thank you.

Thank you.

Operator, that concludes our call.

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

Thank you.