家樂氏 (K) 2003 Q4 法說會逐字稿

Good morning, my name is Luwanna (ph) and I will be your conference facilitator for today.

At this time I would like welcome every one to the Kellogg's fourth quarter 2003 earnings results conference call. [OPERATOR INSTRUCTIONS] Mr. Renwick, you may begin the conference.

Thanks Luwanna and good morning every one.

Thank you for joining us for a review of our fourth quarter and full year 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, Director of Investor Relations.

By now you should have received the press release by e-mail and the slides that accompany today's presentation are available online at www.kelloggcompany.com on the Investors page.

As you know, certain statements made today such as projections for Kellogg Company's future performance are forward-looking statements.

Actual results could be materially different from those projected.

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

In addition 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 on our Web site at www.kelloggcompany.com.

A replay of this call will be available by phone through Monday evening.

You can dial 800-642-1687 and use Pass Code Number 797-2300.

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

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

Thanks John and good morning to everyone and thanks to everyone for being on the call and for your interest in the Kellogg Company.

We are pleased to report the results of another strong quarter and full year.

As we indicated in our press release of December, our business momentum continued throughout the quarter and allowed us to accelerate our rate of re-investment.

It is this momentum and reinvestment that gives us confidence that we can sustain our growth in 2004 and beyond.

Slide 3 shows how I would categorize the actions that we took in 2003.

First of all, we delivered results.

Our $1.92 EPS is a 10 percent gain over the previous year would actually be an 11 percent if you exclude a notably large legal settlement in the first quarter of 2002.

This EPS was better than we originally expected and at the high end of our most recent forecast.

Actually we exceeded our budget on virtually all measures, net sales, Earnings Per Share in cash flow.

We did this despite enormous cost pressures such as commodities, fuel, health care, benefits and despite intense competitive pressure.

To perform this well in this tough environment, it is truly a testament to the focus and commitment of our 25,000 employees.

It should also give you confidence that we have the portfolio, the strategy, the financial model and the people to deliver sustainable growth.

Next, we took steps to create the future by re-investing in our business.

Our brand building investment was increased significantly in 2003 was it's largest growth in the fourth quarter.

This investment strengthens our brands and sustains our growth well into the future.

We also launched several capacity rationalizations and cost reduction programs incurring asset write-offs and upfront costs.

They held down gross margin and operating profit in 2003 but their future savings are well worth it.

In fact, we increase these cost savings projects in the fourth quarter.

So, brand building and cost savings will help us sustain our sales and earnings growth and they give us visibility into the future.

Meanwhile, we paid down $550 million of debt and contribute to our benefit plans and this will also improve our financial flexibility in the future.

Finally, we strengthened our organization.

We have got a portfolio, a strategy and a franchise model and we know they are only as good as the people executing them and during 2003, we promoted several executives, expanded responsibilities for others and move some into new positions.

And I strongly believe that we have the right people and the right jobs and we are developing a great organization not just for today, but also a future and next generation of leaders.

So all these initiatives have helped build a stronger Kellogg Company, positioning us to continue our success into 2004 and beyond.

I will be back to review all of our businesses but first let me turn it over to John Bryant, our CFO who will walk you through the financial results.

Thank you Carlos.

Good morning everyone.

From a financial standpoint, this was an outstanding year.

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

For the year, net sales increased by a very strong 6 percent due to continued internal sales growth and a favorable impact from currency translation.

For the quarter, net sales growth was 8 percent.

For the year, operating profit increased by 2 percent.

Growth was limited by re-investment, which was even higher in the fourth quarter.

These 10 percent gain in EPS was aided by lower interest expense as well as a significant reduction in our effective tax rate.

Full year cash flow reached 961 million before $37 million of year-end voluntary contributions to our benefit plans.

This compares to a record $1 billion last year before $250 million of UN contributions.

Cash flow exceeded our net earnings again in 2003.

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

Slide 5 shows our full-year net sales growth of 6 percent in its various components.

Our internal net sales growth, which excludes the favorable impact of currency and the adverse impact of divestitures, was nearly 4 percent in 2003.

This was on top of a 4 percent gain in 2002.

In the fourth quarter, our internal sales growth also was about 4 percent and was driven by a 3 percent gain in price mix and an increase in tonnage.

Again, I remind you that by measuring in tonnage, we are understating our true volume growth since we are shifting our mix toward lighter, higher-priced products.

For example, during the fourth quarter, our U.S. morning foods business unit posted cereal volume growth measured in cases that was three percentage points higher than its growth in tonnage.

We're trading tonnage for higher unit volume and price mix, a far more profitable combination.

As Carlos mentioned, our growth was broad-based in the quarter and the full year.

Our U.S. cookie business was our only area of softness.

In 2004, we expect low single-digit internal sales growth excluding the effect of a 53rd week.

This is in line with our long-term target although we did exceed this target in 2003.

Excluding the 53rd week in the fourth quarter, the sales growth should be evenly spread across the four quarters.

Slide six shows our full year and fourth quarter gross profit margin decreased from last year's level.

However, like most of the industry, we have faced increases in both benefit and commodity costs.

These headwinds have been significant, but we have offset them through a combination of underlying sales growth, improvements in price mix, key synergies and new cost savings.

Our gross margin was also pressured by investing in greater consumer oriented promotional activity through value-added inserts.

These are effective brand-building activities that are accounted for in cost of goods sold.

But the largest negative impact on our gross margin was our absorption of significant asset write-offs, impairments and upfront costs associated with cost savings projects during the year and especially in the fourth quarter.

Most of these costs were reflected in costs of goods sold.

Excluding the effect of these write-offs and costs, our gross margin actually increased in the fourth quarter and the full year.

So while our gross margin decreased on a reported basis for the quarter and year, our underlying profitability has actually improved in 2003, putting us in a good position to offset cost inflation and improve gross margin in 2004.

This will be a significant accomplishment as commodity and benefit costs will increase further in 2004 and because we will absorb additional upfront costs associated with cost reduction projects.

Our improved underlying profitability has allowed us to continue to increase our investment behind our brand.

Slide 7 shows how we have increased our investment and brand building at a rate that was significantly greater than our rate of sales growth in 2003.

The increase was even greater during '04.

Please remember that we do not include trade spending in our definition of brand building only advertising and consumer promotion.

We will continue to increase the spending at a rate greater than our net sales growth in 2004 and beyond.

After all this investment is critical to sustaining our top-line momentum.

Slide 8 details the internal operating profit growth posted by each of that geographic reporting areas in the fourth quarter and full year of 2003.

This internal growth excludes the benefit of currency translation and the effective acquisitions and divestitures.

We reinvested in every area in 2004 especially during the fourth quarter.

In the US, brand building increased at a double-digit rate for the full year in the quarter and we absorbed asset vitals and upfront costs mainly in the snacks and cereal businesses.

Europe absorbed significant upfront costs as well as increased marketing in both periods as a result of crewing initiatives at our Manchester plant in the UK and over head initiatives elsewhere.

Latin America's profit was up with a double-digit rate for the full year with an increase in brand building investment and upfront costs associated with capacity rationalization in Argentina during the fourth quarter.

The all other segment also dramatically increased investment and brand building while absorbing costs related to the plant closure in Australia during the fourth quarter.

In short, our reinvestment of brand building and cost savings initiatives was significant across the globe.

This is consistent with our goal of using business momentum today to reinvest with sustainable check in the future.

In 2004, we expect to achieve our ongoing target of mid-single digit operating profit growth.

A modestly higher gross margin should fund another strong increase in brand building.

All areas should be up even though Europe's profit may be dampened by accelerated depreciation related to implementation of SAP in that market as well as increased brand building investment.

Looking below the operating profit line, our interest expense declined by 5 percent in 2003 due to our continued repayment of debt and lower interest rates.

It increased in the fourth quarter due to the repurchase of bonds.

We expect 2004 interest expense to be approximately $320 million.

Tax planning initiatives and order closures brought our effective tax rate down to 32.7 percent.

We expect the ongoing growth rate for 2004 to be around 35 percent.

Average shares outstanding increased slightly year over year for the quarter and decreased slightly for the full year.

This is largely due to dilution from the exercise of options and share buybacks.

Ultimately, we create value for shareowners by generating cash flow.

Slide 9 shows our steady improvement in cash flow in recent years.

In 2003, our reported cash flow increased strongly, but this was partly due to a low voluntary cash contribution to benefits plan.

That said, our cash flow in 2003 exceeded our expectations and we nearly matched 2002's record $1 billion, excluding these voluntary contributions.

Helping to drive this cash flow has been our impressive core working capital management, which continued into the fourth quarter.

This is shown on slide 10.

We have now posted 10 consecutive quarters of improving revolving 12-month ratio of core working capital to net sales.

Our managed for cash model continually focuses our organization on improving all the components of core working capital.

While we're doing a very good job on inventories and AR, we believe we have further to go on the payables metric.

We also remain disciplined on Capex prioritizing high return projects and using existing capacity whenever possible.

Consequently, capital expenditure was slightly below our long time target of 3 percent of sales.

So, we have clearly become a more efficient generator of cash flow.

This strong cash flow was used primarily for paying down debt in 2003 as we continue to improve our financial flexibility.

Slide 11 shows our debt levels for the past several quarters.

We paid down debt faster than we expected.

In 2003, we reduced our debt by more than $550 million with 200 million of that coming in the fourth quarter alone.

We have now paid down $1.6 billion of debt since the date of the Keebler acquisition.

In 2004, we will continue to pay down debt.

Even as we improve our financial flexibility we are also increasing our return on invested capital.

Slide 12 shows that we improved this measure in 2003.

Volume-to-value and manage for cash affects all of the components of return on invested capital.

Volume-to-value focuses on the generation of sustainable profit growth while manage for cash ensures, we have tight control on invested capital.

We are confident that our return on invested capital would continue to improve over time.

Slide 13 shows an outlook for 2004.

We remain comfortable at the high end of our 205, 209 EPS guidance range.

We have momentum in our business.

Last year's productivity initiatives should begin to generate savings and debt reduction should yield lower interest expense.

However, keeping a check on earnings growth should be five factors.

First, higher benefits costs.

A lower discount rate in 2004 will result in higher benefits costs of approximately 5 cents of EPS.

Second, higher commodity in fuel costs.

These costs have only gone higher since the last time we provided guidance in the 5-10 cent impact in 2004.

We now believe the impact will be 10-15 cents for 2004.

Third, increased brand building.

We will continue to increase brand-building investment at a rate faster than net sales growth in 2004.

Fourth, upfront costs, additional cost reduction projects now lead us to estimate about 5 cents worth of new upfront cost in 2004, a little more than the 3-4 cents that we discussed last fall.

And finally, a high effective tax rate.

We expect an effective tax rate of 35 percent in 2004.

As far as the shape of the quarters, we expect low to mid-single digit EPS growth in the first, second, and third quarters and a strong double-digit gain in the fourth quarter reflecting the 53rd week and lower upfront costs.

Again, this is purely a function of comparisons.

Our sales growth should be fairly consistent throughout the year.

We are projecting cash flow of $900 million in 2004, which is higher than net income.

This strong cash flow will allow us to reduce debt and buy back shares, which we intend to do beyond the normal use of option proceeds.

In summary, 2003 was an excellent year.

We entered 2004 in strong financial condition, and with underlying momentum in our business.

Our realistic targets and strong cash flow should provide us with the flexibility to invest for continued growth into 2005 and beyond.

With that, let me turn it back to Carlos.

Thanks, John.

Let me now walk you through our key business segments starting with slide 14.

Kellogg USA posted 4 percent internal net sales growth in the 4th quarter finishing a very solid 2003.

Once again, growth was led by outstanding performance in our ready-to-eat cereal business.

We also had very strong growth in our other U.S. businesses, which is comprised primarily of Pop Tarts alternate channels and frozen foods.

The only softness in our portfolio in 2003, as you know, was our U.S. snacks business due specifically to cookies.

So let me start there.

Slide 15 shows the internal net sales growth of our retail snacks business for 2003.

As you know, our sales began to decline the second half of this year primarily due to three factors.

One is the discontinuation of a low margin, custom manufacturing agreement.

Had about a 1-2 percent impact on sales growth in the third and fourth quarters.

This is consistent with our branded focus, but it will result in adverse comparisons through the second quarter of 2004.

Next, the elimination of SKUs also lowered both third and fourth quarter sales by 1-2 percent.

This is part of our effort to reduce complexity in this business and it should allow us to generate supply chain efficiencies and to concentrate our resources behind core brands.

Third and very importantly, cookie category declines accelerated in the second half and we lost feature and display activity amidst very aggressive price promotion by competitors.

Cookies demand, as you can imagine, has likely been hurt by obesity concerns and by the prevalence of low-carb diets, and I would like to say we're taking this very seriously and we have seen categories, low-carb products and categories growing.

Also over the years, cookie sales, we know, have risen and fallen on the basis of intensity of sales execution, brand building and innovation by the leading branded players and frankly, in the past couple of years, there simply has not been enough.

I'm not pleased with our cookies performance, needless to say, but I believe that we are doing the right thing to weather this current storm, we are preparing our portfolio, we've got the right team in place, we have the right plans, and we're putting the right pieces in place to make sure that this business grows in the future.

We're managing our U.S. snacks business as a portfolio of categories and brands.

In 2003, we did focus resources on our wholesome snacks business, which is now about 20 percent of our U.S. snacks portfolio of sales.

Slide 16 indicates this business posted very strong growth for us in 2003, and we added to our DSD systems new products like Special K bars, Cereal and milk bars and Nutri-Grain Granola.

While it would be unrealistic to expect the double-digit gains we enjoyed in 2003, we do believe our wholesome snacks business can generate mid-single digit sales growth in 2004, which would be better than our overall company average.

We're also focusing on our core brands.

We did not invest strongly in our core brands in 2003 and most of them declined as a result.

However, the several core brands did react well to our investment.

Cheez-it is a power brand, by far the largest in our U.S. snacks portfolio.

Improved and increased advertising along with continued innovation led to a double-digit gain with Cheez-it in 2003.

Likewise, our Toasted cracker brand received additional focus and it, too had a strong year.

Even on the cookie side, despite the overall category softness, we are able to grow key brands like Eol Fudge, Murray sugar free and Sandies all on the strength of great sales execution, brand building and innovation.

Finally, we're making important behind-the-scenes improvements to our business.

We have eliminated SKU's.

I mentioned before, we have closed four distribution centers, strengthened and reorganized our sales force, put in place a better forecasting process and enhanced our information systems and all of these actions will lead to a stronger business in the future.

We also have more realistic expectations for the near term, which will allow us to compete more effectively.

As we have stated previously, we expect continued category softness and competitor price promotion in cookies, which along with SKU cuts will result in a decline of our cookie sales in 2004.

We're not banking on a turnaround in cookies in order to make our numbers.

If cookies do better, that's great.

But at this point, we have assumed that cookies will continue to decline.

And we believe that stable cracker sales and good wholesome snacks growth can offset that decline.

I'd like to turn now to our US cereal business.

As you can see on slide 17, this business continues to show remarkably strong momentum.

It's good growth on top of good growth.

It generated full year internal net sales growth of 7 percent on top of 6 percent growth last year.

In the fourth quarter, this business increased sales by 9 percent and its comparison was tougher than it looks since two years ago, our growth in the fourth quarter was 10 percent.

Importantly, consumption was strong enough to allow us to post the strong fourth quarter growth while reducing trade inventories from the end of the third quarter and actually keeping them flat versus where we ended last year.

It comes down to execution and we executed extremely well in brand building, innovation, and merchandising and we plan to continue to do that.

I'd like to say too, impressively, we increased our dollar share of the category by 40 basis points in 2003 and this represented our third consecutive year of value share gain as shown in slide 18.

As you know, we had a strong innovation program in 2003.

Early in the year, we launched Fruit Harvest, Smores and Cinnamon Crunchers and then later in the year, we launched Special K Vanilla Almond, a new fruit harvest variety, peaches and strawberry and a maple and brown sugar version of Mini Wheats.

We launched promotional cereals including one tide to the "Cat in the Hat" movie in the late and the third quarter.

Our Kaschi brand continued its excellent growth aided by new products like 7:00 in the morning and organic autumn wheat.

We drove growth in established brands through more and better advertising, brand building and innovation.

For instance, Fruit Loops recorded sales and share growth on the strengths of its new advertising campaign, and brands like Cocoa Krispies and Smacks also posted good gains from advertising and from consumer promotions like inserts.

In the fourth quarter, mini wheats responded to a new campaign highlighting fiber and Special K benefitted from a lose a pant size promotion launched in the third quarter.

Finally, we, again, strengthened our sales organization in 2003, increasing the number of in-store sales representatives.

In short, we created excitement for consumers and for our customers and we focused on value instead of volume.

We certainly would not budget 7 percent cereal sales growth again in 2004.

Having said that, we are executing well.

We have good plans in place, and we believe we will continue to post growth in this very important category for us.

Our other U.S. businesses also performed well in 2003, as slide 19 shows.

They collectively posted 3 percent net sales growth in 2003, including a strong 6 percent gain in the fourth quarter.

This growth was the result of innovation and brand building across the portfolio.

Pop Tarts showed its strength in overcoming tough fourth quarter comparisons and new entrance into the category to post yet another year of net sales growth.

During the year, innovations like Yogurt blasts and Hot fudge sundae helped to drive growth as did advertising, such as the chill campaign and the successful sponsorship of "American Idol".

Fourth quarter sales growth was helped by the launch of a "Cat in the Hat" theme Pop Tart as part of the promotional campaign.

Our Eggo brand posted strong sales growth in the fourth quarter and full year, thanks to second half introduction of French Toaster Sticks, and a promotional Scooby-Doo themed waffle as well as the continued success of such products as Froot Loops Waffles.

Interestingly, our frozen Eggo products are getting lift from the launch of new Eggo syrups and the advertising we're doing behind Eggo syrups.

So this underscores the extendibility and cross-promotional opportunities of our brands.

In specifically in this case, the Eggo brand.

Many of the non-cereal products like Kashi continue to post strong sales growth and also as a result of innovation, the Kashi tasty little crackers line has done well, as has Kashi frozen waffles and new varieties of Kashi go lean bars.

In addition, 2003 was another good year for our food away from home business, which posted internal sales growth at a time when, as you know, many companies endured softness in these channels.

This growth was led by innovation and very solid execution by our sales force.

In all of these businesses, we expect innovation, good brand building to sustain our growth in 2004.

I'd like to turn now to slide 20 in Kellogg International.

The chart shows a strong sales growth we realized in this division during each quarter of 2003.

In the fourth quarter, we posted a 17 percent sales gain largely because of weakening in the U.S. dollar.

Our internal net sales growth, however, which includes currency, was up a very solid 4 percent in the fourth quarter.

These figures were roughly in line with our full-year results of 15 percent reported sales growth and a 5 percent internal sales gain.

No matter how you look at it, this was the second year of accelerated growth in Kellogg International, and we believe that we're just getting started.

You will recall that in mid-2002, we began to implement volume-to-value in our key international markets and since that time, we have seen dramatic improvements in many of our largest markets.

Slide 21 shows the internal net sales growth of each of our major international areas in the fourth quarter and the full-year 2003.

Each of these areas and each of our core markets within these areas posted internal sales growth.

In Europe, our report of sales increase by 18 percent for the year, currency adjusted net sales growth of 3 percent despite the most difficult retailer environment in the world.

Growth was experienced throughout most of the region and our small gain in the fourth quarter represented the eighth successive quarter of internal sales growth for Europe and that's growth on top of solid growth.

At the beginning of 2003, we told you we needed to improve in the UK, and we did.

That market was a notable success story this year.

We gained a full share point in the cereal category and posted sales growth.

The Special K brand continues to be a success across Europe and sales increased at a very strong double-digit rate.

But both cereal and bars grew sales behind continued innovation and successful two-week challenges.

We plan to continue this activity in 2004 and have some significant brand building and innovation plan for that reason.

Reported sales in Latin America increased by 2 percent in 2003 with currency-adjusted growth of 13 percent.

Ready-to-eat cereal is growing in most markets in Latin America and in conjunction with our booming snack business led to high levels of growth in 2003.

Growth was even better in the fourth quarter when Mexico posted double-digit sales growth in cereal and doubled its snack sales year-over-year.

This business has shown high levels of innovation and brand building and has also grown sales of existing brands, such as Sukaritas (ph), which is our version of Frosted Flakes in Mexico and Kellogg's corn flakes.

So, needless to say, both these brands increased their shares.

We introduced the cocoa Crispix bar during the year, which is doing very well, and we have seen instances of outer stock due to its popularity.

So very pleased with our Mexican business and our Mexican organization important country for us.

Our all other international segments reported sales gains of 18 percent for the year and 25 percent for the quarter and internal sales growth was 4 percent for both periods.

Canada, Australia, and Asia had a good year.

In Australia, we expanded our food service presence during the quarter and have generated excellent growth from our snacks business albeit from a relatively low base.

Asia also posted low currency sales growth as a result of gains in every major market.

Japan posted strong sales as a result of good execution and effective marketing campaigns for adult brands as well as strong contributions from our Disney products.

Three years ago, we came to you and we presented a plan to transform our company and put us on track for more dependable growth.

We have exceeded expectations at each stage of this transformation and we believe that 2003 was no exception.

We sustained top-line momentum.

We overcame higher benefits, commodities, and fuel costs.

We invested in our brands for future sales growth.

We launched cost savings projects to help fund future investment in our business and importantly, we absorb those costs and did not isolate them or want, you know, attempt to clear some kind of a restructuring charge.

We use our strong cash flow to pay down debt and improve financial flexibility.

All of this puts us in a strong position to sustain our growth in 2004, even in spite of heightened costs inflation and of course, ever-present competitive pressures.

Again, what we are after is sustainability, consistent growth year after year as a company and importantly as an investment for you.

We believe we are doing all the right things to achieve that sustainability.

So with that, I would like to thank you for your interest and confidence in our company and we'd like to open it up for a Q&A.

Thank you.

[OPERATOR INSTRUCTIONS] Your first question comes from Jonathan Feeney of Wachovia.

Gentlemen, not much to quibble with as far as the fundamentals go.

The one question I would have is the use of cash flow, and I know at the risk, sounds like a broken record, and I know there's some example of company - consumer products out there with limited volume growth profiles that maintain excellent p/e multiples by accelerating their EPS growth through share re-purchase.

Clearly with rates, you're in that situation.

Is there any talk and have you talked about it and can you be more specific about any plans to buy back shares more aggressively in 2004?

Yes, as you say, we have been paying down debt for the last three years following the Keebler acquisition.

As we go forward, here we said in 2004, would have a more balanced use of cash and we continue to pay down some additional debt probably about $300 million.

We currently have a board resolution that enables us to buy back up to $300 million worth of shares.

So, for 2004, it's the first year since the Keebler acquisition that we will buy back shares in excess of just the proceeds from option exercise.

OK.

Thank you.

Thanks, John.

Your next question comes from Terry Bivens of Bear Stearns.

Good morning everyone.

Two quick ones.

This is for John Bryant, I guess.

John, did I understand you to say your quarterly progression will be low single-digit growth over the first three quarters and then much better in the fourth quarter?

Yes.

It's low to mid-single digit EPS growth over the first three quarters and then double digits in the fourth quarter.

That reflects the lapping of our upfront costs in 2003.

The 5 cents of upfront cost we spoke about in 2004 will be largely in the first half of the year.

Also, we'll have some strong brand building reinvestment in the first three quarters of the year.

OK.

As I understand it as well, the revised and I think it was the commodity.

You brought one of the estimates down from 5 cents to 10 cents and I'm looking quickly to benefit costs.

I believe we had before talked about 5 to 10 cents and now it seems more fixed at 5, is that correct?

Yes.

It's more in the line of 5 cents.

What's happening there is we're dropping the discount rate in the assumption in the U.S., 6.9 percent down to 6 percent which reflects lower interest rates, and that's driving that 5 cent increase in benefits costs.

At one stage, we were concerned we would have higher level of inflation.

We made a small contribution at the end of last year that helped offset that as well as a very strong on our pension assets across 2003, which helped us in the plans for 2004.

OK, and then finally, I guess if my calculations are correct, currency added somewhere between 250, 300 million to your results this year.

I would assume that most of that went back into brand building book, could you give us a little bit more color around how you reinvested the currency?

The currency benefit for the year, if you look on the operating profit line is about 2 points of growth year on year from foreign exchange, and that translates to around 5 cents of EPS benefit from operating profit.

We do have offsets and other income expenses the net EPS benefit was around 3 cents in 2003, and as they go back into brand building or go back into upfront costs, you know, basically went back into reinvestment for business.

OK.

Very good.

Thank you.

Thank you, sir.

Your next question comes from Eric Katzman of Deutsche Banc.

Hi.

Good morning everybody.

Good morning, Eric.

I guess, John, I have a few questions on the cash flow.

It seems like and I think you noted in that the year-over-year improvement was mostly tied to the lower pension contribution.

Is that fair description?

On the reported basis, yes.

How much of the one-time charges and upfront costs, you know, hurt cash as opposed to reported earnings?

The upfront costs largely non-cash.

Only about a third of it was cash in nature.

One-third was cash?

Yes.

And then I think in the press in the slides, you indicated that cash flow based on how you define it was going to be 900-950 million.

I think this year you said, it was 924 or something.

So you are saying that cash flow year over year should be flat.

But I thought when I asked the question at the November meeting that you said cash flow is likely to increase in line with earnings for the foreseeable future.

What's the difference between those two things?

Part of that, Eric, we significantly adhere with our expectations to cash flow in 2003.

If you look at cash flow in 2003 our net income is around 787 million.

The difference between depreciation and capital expenditure is about 110 and 115 million.

As we drove $60 million of cash flow off the balance sheet in other areas to get to us 961 million, which is a number before the pension health care contribution.

So you know, our ability to continue to drive cash flow in excess of net income, it's still there, but we can't necessarily grow on profits such as strong performance in 2003.

So you kind of look at 2004 as maybe like a reverse catch-up and then afterward, it kind of grows with earnings?

Basically, yes.

Our 2004 cash flow is broadly in line with our net income expectation and difference between depreciation and capital expenditure.

Last question for Carlos, you know, obviously a lot of the other, I guess, companies in the industry have started to talk about the changing consumer diets and the low-carb impact, and I mean, it seems like, you know, it's like cookies and crackers.

We're not sure whether, it doesn't seem to be hitting snack and granola bars or cereal and maybe or maybe not salty snacks;

I guess we'll find that out soon.

But are you seeing any, you know impact or creeping impact in some of the other areas that so far haven't, at least from our perspective, seen a hit?

Well, fortunately, we've been able to offset any impact from the low-carb diet specifically on, you know, cereal and wholesome snacks by investing, by having the right programs, by gaining share.

We have seen low-carb products, and we have talked to customers.

We're seeing an increase in low-carb products.

I think the issue is concerned about obesity and that is one of the solutions, so, you know, we're looking at it very closely.

We're taking it very seriously, and we do see a trend.

Whether it's going to be long term or not, we've got to wait and see, and we have seen a lot of trends in the food industry, but clearly, low-carb products seem to be picking up.

We've got the advantage, Eric, that, you know, we have a portfolio that is, on one hand, about 55 percent of the portfolio due to low-fat or fat-free, so on the trans-fatty acids, we don't have that much of an impact to the portfolio, but right now, we are watching the low-carb trend and the good thing is we've been able to offset it in each of our categories.

I think what's happening; too, Eric is that there are different segments out there.

Some people have chosen low-carbs.

Some people are sticking to low fat.

We continue to believe that, you know, low-fat diets and high complex carbohydrates with grains and fruits and vegetables are the way to go, but there are consumers who clearly are looking for low-carb, so we're staying very close to it.

Thank you.

Congrats on a good '03.

Thank you, Eric.

your next question comes from John McMillin of Prudential.

Good morning, everybody.

Good morning, John.

I almost feel like it's the second time I heard you this week.

I guess imitation is the highest form of flattery, as they say.

Just the quarters have top-line trends, but it is so messy, you know, below that with all these things coming and going, and I know there's a reluctance to get into GAAP, but let's first deal with the tax rate and I guess this is to John.

If your tax rate were at the first nine-month rate, it would be about a $30 million hit.

Is that correct?

Well, the benefit to us in the lower tax rate in the fourth quarter was around 7 cents of EPS, and that's broadly correct.

OK, and in the press release, you say that 7-cent benefit is more than offset.

I think that's the term that basically you have.

Was more than offset by a bond redemption, which I guess might have been around 15 million, and I guess to get gross margins up, you need some kind of $40, $50 million asset write-off.

Is my math correct?

Well, let me walk you through a little bit of it, John.

Just taking the hints you gave and following up on them.

As we look back at the third quarter conference call, we said that we had 8-10 cents of upfront cost across the year.

Now we're saying if you include the early extinguishment of the debt, we have in total 15-17 cents of upfront costs through the year.

And in addition to that, our brand building was up very strongly in the fourth quarter and we haven't quantified by how much.

So some of that tax benefit went into funding upfront costs and some went into brand building.

But I can't -- brand building is -- when you say that in the press release that these tax benefits were offset, you're including brand building in that?

Well, John, even if I take the 8-10 cents that we're going to do now and compare it to the 15-17 cents we did do.

That's a 7 cents differential, which is equal to the size of the tax benefits.

And you're talking about the quarter not for the year?

I'm talking about the full year.

Can we go to the quarter?

OK.

Well, in the fourth quarter alone, we have around 10-12 cents of upfront cost in the fourth quarter including 2-3 cents from the early extinguishment of debt.

OK.

So you're basically talking about a total of 10-12 cents?

Yes.

And then a 7-cent tax benefit?

Correct.

So if you would look at an operating basis, it would be a 3-4 addition to the reported number.

Right, which is basically what we indicated back with the third.

And those upfront costs do not include brand building?

Correct.

Great.

Just in terms of, you know, the outlook for U.S. snacks, Carlos, in '04, did you say that you two--did you give a specific number for the or a range of sales that you expect for that segment this year?

I didn't, John.

What I mentioned was that we're planning for a continued decline in cookies so that we're not banking on a turnaround.

We're looking at crackers maintaining relatively flat and then about a mid-single digit growth in wholesome snacks.

That should get us either flattish or a slight increase.

Obviously, we're looking for a slight increase.

So that's basically the outlook for snacks.

The key would be is how much we could drive wholesome snacks and then obviously, on the other side, is how much we can contain cookies.

Just in terms of the European slowdown in the fourth quarter, could you just go through what happened there a little bit in more detail.

Yes, we had some specific localized trade-related issues in two countries.

Not very, very large, but enough to impact the region.

One was Germany, one was Scandinavia, so it was very localized, very specific, and the good thing is countries like the UK continue to grow in the fourth quarter.

So it was just those two.

John, you gave, I think, the currency benefit for the year at 3 cents to Terry, can you give the currency benefit in the fourth quarter?

Fourth quarter would be around probably about 1-2 cents of that, a lot of it was at the back half of the year.

Thank you.

Thank you, John.

your next question comes from David Nelson of CSFB.

Good morning.

Good morning, David.

Congratulations and also congratulations on Bake Line, getting out before it went under.

You certainly highlighted some headwinds you've got over the coming years, so we're generating operating profit growth is going to be pretty important.

So you may be towards that end give us an update on what traction acceptance you are seeing from some of the many new products you talked to us about last November, you know, the improved quality of chip deluxe, the drink and crunch, K with vanilla element, Corn flakes with bananas, things like that, please.

Yes.

Let me walk you through the things we have done.

We had a very good year for innovation for cereal.

Our Fruit Harvest is doing quite well.

We just launched a new variety in that added with Special K Berries.

It's put us in the lead for this whole fruit variety and fruit segment that's emerging.

Cinnamon Crunchers has done quite well.

Maple Brown Sugar, Mini Wheats has been a pleasant surprise.

I think it's hanging in there at a 0.5, 0.6, and then Special K Almond has done well in its initial stage.

We had, David, a dieting event, sort of a resolution event in January, and the whole Special K brand is just doing extremely well.

Fruit snacks, we have just launched and I can tell you that at least the customer reception and the initial shipments are very solid, and you mentioned drink and crunch.

That is in a test.

It's only a test.

We want to look at that look for a while because that would be a big bet on a national level.

Corn Flakes Banana still too early, and then on Crave, very good distribution and we're seeing pretty much a repetition of the test market where we've got a very slow build or a very solid build with very solid repeat rate.

So overall, I'd say our innovation is doing well.

We just launched or are about to launch a couple of new Sandies cookies, which would introduce fruit.

Also a couple of products that would be on sort of the health and wellness side of cookies, and let's see what else, syrup is hanging in there.

We feel very good about what we did in 2003 about our pipeline, and our ability to get these products out there.

I don't know if there's anything else specifically, David.

I think that's -

That was a good run down.

Was there one for John.

On the pension, was there going to be another cash contribution for this year, or was that just last year?

We made a small contribution in last year.

We may make another small contribution this year, but it will be a large use of cash.

Great thank you very much.

Our next question comes from Christine McCracken of FTN Midwest Research.

Good morning.

You didn't mention the impact of the strike out here in California, but you did mention that you had higher sales, I believe, in alternative channels and I'm wondering is there any relationship there?

Could you quantify at the strike?

You didn't mention it, so I assume it wasn't a big disruption for you, and in fact, the bump in alternative channel growth might be associated with that.

Yeah, let me just take the -- on the strike, obviously, it's difficult to quantify exactly how much of an impact there was.

We believe that there was an impact, and there is an impact continued on the strike, and the good thing is we try to manage around these things, and we've been able to offset the impact of the strike with benefits elsewhere, so I can't really say it's, you know it's brought our numbers down.

We just had to manage through it.

Do you want to take the other one?

I'm sorry, what was the second part of the question, Christine?

I guess I am wondering, you mentioned the growth in alternative channels I believe.

Certainly, you saw better growth in Pop-Tarts and Frozen, but part of that other segment seems to be alternative channels, and I'm wondering, did you see any improvement there?

Is that a function possibly of the strike, or is that largely, you know, your change in approach to those segments?

Yeah, it's very difficult to pinpoint it to the strike.

We have seen growth in alternative channels.

You know, we've seen a relatively good growth in food service.

Our vending machine business is not what we'd like it to be.

Convenience stores are doing well.

We're seeing a bit of a good growth on these dollar stores, which we also focused on, so I think those are normal trends that are happening.

I wouldn't relate it directly to the strike in California.

The important thing is we've been able to manage through it and offset it.

And just with the Kraft's acquisition of back to nature, and Kaschi has been a home run for you guys, the platform in general.

As you get more competition in this area, are you expecting growths at Kaschi to kind of continue, or do you expect it to slow over time given the larger base?

You know, we had some exceptional growth at Kaschi.

As you know it went like 25 million in 2004 up to almost 150 million.

And we expect solid growth to continue at Kaschi.

New competition, I mean, it's already a very competitive marketplace.

Organic products are very competitive, natural products very competitive; the natural channel is very competitive.

So we just see this as business as usual.

It's more competition, and that's what we're used to.

So the environment will get tougher competitively in every single business in which we compete, so it doesn't surprise us that other companies are looking at the natural channel or organic cereal.

Sure.

Well, good quarter.

Thanks.

Thank you.

Your next question comes from David Adelman of Morgan Stanley.

Good morning, everyone.

Good morning, David.

It wasn't clear from your earlier response to a question about asking.

Do you think the low-carb phenomenon is affecting the US ready-to-eat cereal market?

David, we don't have any data to show specific switching to low-carb products.

My answer is sort of what we believe and what we're seeing and what we're hearing from customers and what we're hearing from consumers and anecdotally.

I would say that there is some impact.

And I don't -- I think it would be wrong to just discard the move towards low carb.

However, the good thing for us is that we've been able to go to consumer segments that are growing in cereal.

We've been able to gain our share in cereal, so whatever impact there has been, we've been able to offset it.

But, you know, we have heard from customers that consumers are voting with their wallet and they're not just saying low carb.

They're actually buying more low-carb products.

Let me ask you about price mix in '04.

I think your price mix in '03 was up about 3 percent.

Can you give us a general sense of the magnitude of price mix improvement you expect across the portfolio in '04?

Yeah, we're targeting, you know, -- in price mix, we usually do about 50/50, price 50 percent mix, and that's what we're sort of targeting for next year.

I would say about 2 points of mix would not be unrealistic.

OK.

Thank you very much.

Thank you.

The next question comes from Philippe Duffus (ph) of CSFB.

Yes, good morning, Carlos and John.

A few questions here, John, looking at the balance sheet, can you just provide a little bit more clarity on the two line items that deal with current maturities of long-term debt and notes payable.

The 320 that shows up in the notes payable, is that what's left from the note that's actually coming due today?

No, that would have been in the current maturities of long-term debt and the 320 would have been our commercial paper program.

OK, that's what it is.

OK.

Wonderful.

The other question and we talked about this in the best, and if I look at some of your key credit metrics, whether it's sales, leverage, margins, et cetera, I mean, if it's not even, you're actually in some cases better than some companies like Campbell's Soup or Heinz, which are all rated low single A. At the end of the day, what are the ratings agencies are looking for before giving you credit for all the things you accomplished over the last couple of years?

I mean, is it the mature nature of the industry?

Is it concern about, I mean the activity or is it just simply the passage of time they're looking for?

It's the latter.

There's not a specific issue to the company.

I think they are a little concerned about the industry in general but I think they want to see consistency in delivering what we say we will do over time.

We have a very good relationship with the rating agencies, and we're very, very comfortable, and I believe they're comfortable with our programs.

And then the final question I had perhaps for Carlos.

If you look at the allocation of free cash flow for this year, aside from share purchases as well as for the debt reduction, still no appetite for smaller back on acquisitions.

We've continued to look for small both on acquisitions and I would say we probably looked around the world, maybe a couple of dozen and we just haven't found the right one at the right price, but we continue to look, but we will continue to be disciplined on price.

OK.

Thanks so much, gentlemen.

Thanks Philippe.

Your next question comes from Leonard Teitelbaum of Merrill Lynch.

Good morning.

Good morning.

Good morning.

As the poster boy for the low carb diet need to go on, I don't think it's necessary in opening, I think it's for real here.

That's just my observation.

Number of in-store merchandisers, could you talk about how many you have when you close year this year, and is that a full compliment as far as you're concerned.

We're always looking at the level, so at this point; it feels that we are at the right spot.

We got about, you know, 250 plus merchandisers, but we'll always continue to look at that number and make sure that we've got enough people in stores to drive our business.

When you started that program, you talked glowingly of how much they could help the top line, et cetera, and has that been realized?

Yes.

What we've seen are things like you know, filling voids in the store, getting the display up, getting an extra display up, making sure we got the right space with the real blocking and tackling and execution that eventually has an impact on our top line.

It's hard to isolate, but we know these folks are making a real difference.

I will follow up off-line because I'm trying to get some impact of that.

Have you done your sensitivity -- I'm sure you have.

The sensitivity studies on foreign exchange that if the dollar were to go up, say 5 percent against the major currencies, what kind of delta would that be in year-over-year earnings?

Around one to two pennies, and it depends on how it goes up on every currency at the same time, it can be more than that, but generally speaking, you see it move one direction with European currencies and the Latin American Currencies.

So, 5 percent would equal 2 cents approximately if it were uniform across the board.

Could be a little bit more than that.

We do have some translational foreign exchange contracts out there in 2004, so we locked in some of the good news on foreign exchange.

Do you expect any further restructuring of debt on the balance sheet, early buy in, et cetera.

I think we're in pretty good shape now.

We want to make sure we had enough commercial paper to keep the program liquid.

I think we're in good shape

And kind of a growth rate do you see, should we look at on this new basis of tonnage going forward for next year in the cereal business in the U.S.

We don't spend a lot of time thinking about tonnage.

We're focussed on the dollars and obviously tonnage is a component of the dollars and we may see a slight increase because we're overlapping some heavier products and things of that nature.

I would just urge that you look at our revenue; our dollars and again, we're looking at low single digit growth for next year.

Very good.

Thank you very much.

Operator, I think I think we have time for two more questions if you don't mind.

OK.

Your next question comes from Romitha Nally of Goldman Sachs.

Good morning.

Good morning.

Good morning.

In terms of your innovation pipeline for '04, Carlos, I mean, you had a lot of new product activity in '03, how would you compare the pipeline if you looked across the year and you looked across the categories?

Well, we had a very strong cereal innovation plan in 2003, so while we have, you know, a solid innovation pipeline, we got a lot of work cut out force to make those products that we just launched stick and continue to grow, but we feel very good about our cereal pipeline going forward.

We also believe that our snack pipeline is stronger going forward than it has been.

I think we launched a lot of products, but ultimately, you know, there's been a little bit too much of proliferation of SKU's and we think we're - we've made an important change in the quality of the pipeline for snacks for 2004 and beyond.

In terms of the cereal gross in '03, how much of that would you attribute to new products?

: I don't know.

I don't have that number, but I'm sure we could calculate it.

Obviously because of the new products we launched and because of the success.

And interestingly and importantly Romitha, because of the success of new products launched before 2003, I would say that new products, you know, they could be about 15 percent of our total sales and we could get the growth and figure that out.

And just in terms of the cookie category, you know, the weakness that you're forecasting again and clearly the category's been weak.

Do you feel like your innovations in cookie are good for '04?

Is that still an area you're very focused on?

We are.

I mean, we're focused on the whole portfolio and obviously, we love the growth rates we're seeing on wholesome snacks and we think that's a category that is going to continue to grow, but we also have cookie innovation.

We're looking at, as I mentioned before some health ideas within cookies.

I also mentioned that we're taking the low-carb dieting very seriously, so while we are forecasting a very conservative rate, the performance of cookies next year, we are going to be very active obviously.

Great.

Thanks.

Thank you.

Your next question comes from Mitch Kaiser of Piper Jaffray.

Good morning, everyone.

Eric Larson speaking.

Carlos, regarding your kind of all the one times and lower tax rate this year, you know, it seems that when you lower the tax rate for your fourth quarter, you did take some one times against that to offset it.

So, you know, in effect, are you lowering your base or could you or should you have less one-time charges of this upcoming year to help alleviate the higher tax rate.

We will continue to look for one-time charges.

This is an ongoing-really just as the way of doing business in ongoing reductions so that we can avoid, you know, the massive turmoil every two or three years.

So it's ongoing for us and we're always looking for projects and cost reduction projects that we can take into the P&L.

On the specifics, let me pass this over to John to talk a little bit about how we would see that in '04 and the tax rate of fourth quarter.

One way of looking at it in the '03 up front costs were 15 to 17 cents and we had 7 cent tax, and you can net those against each other and say you really around 8 to 10 cents in 2003, and at this stage, we're guiding to around 5 cents in upfront costs in 2004, so while there is a little bit less in 2004, it's not that much.

OK.

And just one more follow up and thank you for the answer.

Have you quantified anything regarding what incremental brand building expenses might be for the year?

All we said so far is the brand billing will grow at a rate faster than net sales growth.

We haven't quantified beyond that.

OK Thank you.

Operator, that's all we have time for.

Ladies and gentlemen, we reached the end of the live time for questions and answers.

Mr. Renwick, are there any closing remarks sir?

No.

Just want to thank everyone for being on the call and for their interests.

Thank you.