家樂氏 (K) 2004 Q1 法說會逐字稿

Good morning.

My name is [Latangie] and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the Kellogg Company's first quarter 2004 earnings conference call. [OPERATOR INSTRUCTIONS] Thank you.

I would now like to turn the call over to Simon Burton, Director of Investor Relations with Kellogg Company.

Please go ahead, sir.

Thank you and good morning, everyone.

Thanks for joining us for a review of our first quarter results, and for some discussion about our strategy and outlook.

With me in Battle Creek are Carlos Gutierrez, Chairman and CEO;

John Bryant, CFO; and John Renwick, Vice President of Investor Relations and Corporate Planning.

By now you should have retrieved a press release by e-mail, and the slides for the Company's today's presentation are also available on-line at www.KelloggCompany.com on the investor's page.

We must point out that certain statements made today, such as projections for Kellogg Company's future performance including earnings per share, net sales, gross margin, operating costs, interest expense, tax rate, cash flow, share repurchases, and debt reduction are forward-looking statements.

Actual result can be materially different from those projected.

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

In addition, note that this presentation will reflect our more recent segment and product group changes.

As you know, we reorganized to bring Canada under the direct responsibility of Jeff Montie's new role as president of North American Morning Foods.

As we indicated in our 2003 third quarter 10Q filings, and in our recently released 2003 annual report and 10K, this prompted a new presentation of our operating segment with Canada's' results moving out of "all other", and moving into North America and the remaining "all other" being renamed Asia Pacific.

This also affected our supplemental product group performance, as our former U.S. product groups now include Canada.

In addition, we took the opportunity to fine-tune each of the North America product groups to better reflect the nature and management responsibility of certain businesses.

The net result is a more narrowly defined product grouping for what used to be called U.S.

Other and having all our snacking related products in one group.

Please refer to our website or 8K for March for details of this new presentation last month.

A replay of today's conference call by phone through Monday evening by dialing 1-800-, 642-1687, passcode 6854548, and by a web cast which will be our guide for 90 days.

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

Thank you, Simon, and good morning to everyone.

I appreciate your taking the time to be in our call and for your interest in the Kellogg Company.

We are pleased to report another very strong quarter, featuring a greater than anticipated 33% gain in earnings per share.

And would ask that you look beyond the earnings per share to understand just how strong of a quarter this was.

Our net sales grew by 11% and that's on top of a 4% growth last year.

And our internal sales growth, which always strips out the impact of favorable foreign exchange, acquisitions, divestures and differences in shipping days, was 6-1/2%, and that's our highest rate in five years.

Our gross margin increased despite higher benefits cost, and a continued surge in commodity costs; brand building investment again was increased at a double digit rate, and despite the brand building investment, and despite some asset writeoffs and up-front costs related to efficiency intiatives, we recorded by far our highest net income ever for a 1st quarter.

We believe that sustained reinvestment and strong execution are at the core of our 1st quarter success.

We have several successful new product launches around the world.

We continue to execute well on advertising and promotion.

Examples are our Lose a Jean Size promotion did extremely well all around the world this quarter, and sales execution continues to be strong, allowing us to fend off substantial competitive pressure.

Cash flow generation was extremely strong again.

And we are increasing our full year expectation.

So, it's very gratifiying to have such a great start to the year.

We now have a front-loaded year which should give you better confidence in our ability to deliver yet another year of dependable growth.

And as you know, we raised our full year guidance while boosting our planned reinvestment in brand building and cost savings projects--both of which can allow us to sustain this dependable growth beyond 2004.

So we're feeling very good about the quarter, very good about the business.

I'm going to stop here for the moment and turn it over to John Bryant, who will walk you through our financial results.

Thank you, Carlos and good morning everyone.

As Carlos mentioned, it truly was an exceptional 1st quarter.

Slide 4 details some key financial highlights from the quarter.

Net sales increased by 11% due to strength across our business and the favorable impact of currency exchange rates.

Our internal sales growth excluding the effective foreign exchange was 6-1/2%.

Operating profit increased by 21% with internal growth of 16%.

Remember that this excellent growth includes another double-digit increase in brand building investment, additional up-front costs and significant cost pressures.

Earnings per share grew by 33%, aided by lower interest expense and a tax rate slightly lower than the 1st quarter of 2003.

Cash flow is 211 million, also exceeded our expectations, increasing 33% over the 1st quarter of 2003, despite a modestly high contribution to our pension and post-retirement benefit fund.

So in each of our primary metrics, the quarter was hugely successful.

Slide 5 shows our net sales growth in its various components.

Currency was quite favorable to sales in the quarter, owing to the dollar's year-on-year weakening against key currencies like the British pound, the Euro, and the Canadian and Australian dollars.

Internal net sales growth was 6-1/2%, this is on top of a solid 3% growth in the 1st quarter of 2003.

Our internal sales growth was driven by strong increases in both price mix and tonnage.

Price mix increased 3.8%, mostly because of a favorable mix shift driven by innovation.

This is volume to value at work.

In addition, tonnage increased by 2.7%.

Encouragingly, strong internal growth was demonstrated across all of our major businesses, as Carlos will discuss in a moment.

Slide 6 shows our gross profit margin in first quarter increased by 60 basis points from last year's level.

Our strong sales growth created significant operating leverage--this combined with productivity savings and favorable mix to more than offset the impact of significantly higher commodity and benefit costs.

We expect benefit costs to be about 3 cents per share higher than in 2003, but now believe that commodity costs will penalize earnings by 12 to 15 cents per share.

Cost of goods sold also reflected approximately half of the 1 to 2 cents per share we realized in asset vials and up front costs relating to cost-saving projects in the quarter.

Cost of goods sold in the 1st quarter also included a rise in consumer promotion expense.

Remember, toys in the box and other inserts are a critical form of value added brand building and are in accounted for in cost of goods sold.

Our outlook for the year is still for only slight gross margin expansion.

We cannot count on the same rate of sales growth throughout the year, and therefore we can't expect the same benefit from operating leverage.

In addition, we face continued pressure from commodity prices, and greater investment in up front costs, most of which will impact cost of goods sold.

Still, we are very encouraged by our first quarter performance on this metric.

We continue to invest strongly behind our brands, with brand building increasing at a double-digit rate once again in the 4th quarter - in the 1st quarter.

Slide 7 shows that this investment continued to outpace our net sales growth - consistent with with our volume to value strategy.

Interestingly, while growth was strong, it was slightly less than we anticipated due mainly to the timing of certain programs.

Therefore, operating income benefited modestly this quarter, and we should expect coming quarters to include more brand investment than previously expected.

I'll remind you that this spending does not include trade promotion--just advertising and consumer promotion.

Slide 8, details the internal operating profit growth posted by each of our geographic reporting areas in the 1st quarter.

This internal growth excludes the benefit of currency translation.

Impressively, strong operating profit growth was turned in by each region--despite substantial investment in brand building and cost-saving projects.

In North America, internal profit growth was over 10% even as brand building rose as double digit rate, and as we incurred modest up front costs related to an efficiency initiative in North American cereal.

Europe recorded 22% internal profit growth, even as we invested in up front costs related to the roll-out of SAP.

In Latin America, we increased our investment of brand building at a double digit rate, and yet still posted internal profit growth of more than 17%.

And in Asia Pacific we increased our brand building investment and our profit climbed almost 23% in local currencies.

This quarter we delivered not only high growth, but high quality growth.

Looking below the operating profit line, interest expense declined by 15% as a result of reduced and refinanced debt.

We continue to expect interest expense for the full year to be approximately 320 million dollars.

Our tax rate for the quarter was 35-1/2%, modestly lower than the rate in the 1st quarter of 2003.

We continue to expect that the full year tax rate will be around 35%.

Turning to the balance sheet, we again reduced coworking capital as of percent of net sales, as showing in slide 9.

This was our 11th consecutive quarter of improvement in this important metric.

We also remained disciplined on capital expenditure, and expect it to be approximately 3% of net sales again this year.

This is impressive because it means on top of all the progress we have made over the last three years, we continue to be even more efficient generators of cash flow.

Our strong earnings, in combination with disciplined capital expenditures and improved working capital management, enabled us to deliver another strong quarter of cash flow.

The result, a sizable 33% increase versus the year ago quarter, this is pictured in slide 10.

As a result of this strong start to the year, we are increasing our guidance for full year cash flow to be between 925 million and $1 billion.

This cash flow continues to add to our financial flexibility.

We made a small voluntary cash contribution to our benefit plans at the very beginning of the quarter, and we also continued to pay down debt.

Slide 11 highlights the progress we have made in reducing our debt, which remains a top priority for cash flow and still expect the total debt reduction in 2004 to exceed $300 million.

As we said at the beginning of the year, we intend to repurchase up to $300 million of shares in 2004.

During the 1st quarter, we did repurchase $82 million worth of shares, though this was funded entirely by option exercise proceeds.

While we improved our financial flexibility, we also increased our return on invested capital as shown on slide 12.

Volume to value and manage for cash implicitly focus us on return on invested capital.

Volume to value improves our returns, while manage for cash creates discipline on invested capital.

We've had success in proving this metric, and are confident that we'll continue to improve our return invested capital over time.

Slide 13 shows our current outlook for the remainder of the year.

You'll recall that we recently raised our full year EPS guidance by a couple of cents to $2.07 to $2.11 per share.

Note from the slide that the strength of the 1st quarter has changed the shape of our expected EPS growth over the course of this year.

We now expect low to mid-single digit EPS growth in each period, including the 4th quarter, when we now expect to have some meaningful up front costs.

Let me give you some more color on our 2004 expectations.

We do not build our plans on the kind on of mid to high single digit internal sales growth we experienced in the 1st quarter.

We'll continue to target low single-digit growth with the possibility that we could slightly exceed that in the 2nd and 3rd quarters despite tougher comparisons.

Commodity costs have remained high and have even increased, which will continue to pressure our margins.

We've identified cost savings projects that we expect to complete through the remainder of the year.

During the 1st quarter, most of the up front costs were related to our SAP implementation in Europe as well as an efficiency initiative in the North American cereal business.

These initiatives, as well as several others, will add up to the 10 to 12 cents per share of costs that we expect to absorb in 2004.

Timing can be difficult to predict as we saw in the 1st quarter.

For now, we anticipate up front costs of between 2 to 3 cents in the 2nd quarter and between 6 to 8 cents across the back half.

In addition, we will continue to invest significantly in brand building.

As I said, we expect our full year investment in brand building to increase faster than net sales growth.

Remember that we have a 53rd week this year which will fall in the 4th quarter.

We expect that this will only add about 1% of sales growth in 2004, as some of our operations are essentially closed that week.

Remember too that your estimates for 2005 should take this comparison into effect.

So in summary, the 1st quarter of 2004 was an excellent one.

It gives us increased confidence that we can again achieve our targeted EPS growth this year, even while benefit and commodity costs continue to increase and we aggressively reinvest in our business.

Remember we manage the business for the long-term, for dependability and sustainability and growth.

With that, let me turn it back to Carlos.

Thanks John.

I'd like to now take a look at our results by business segment .

And, beginning with slide 14.

As you can see Kellogg North America posted internal net sales growth of 5% in the quarter, and this is terrific performance, all the more so because it was broad-based.

Slide 15 shows that we continue to grow on top of growth in North American cereal.

True, even tougher comparison lie ahead, but this quarter's 4 % growth was a solid performance--especially if you consider that it comes on top of a similar 4% growth last year .

Importantly, we experience solid sales growth, both in the U.S. and Canada, and we gained share in both markets as well.

Slide 16 gives you an idea of how we've been able to continue to gain share in these countries.

It's been about brand building, innovation and great execution.

During the 1st quarter we launched a few more products as shown on the slide.

These items came on top of other new products launched over the past 12 months that continue to add to our growth, such as special K, Vanilla Almond, Frosted Miniwheats, Maple and Brown Sugar, and Cinnamon Krunchers, each garnered about half a share point in the quarter, and a new Peach Strawberry version of Fruit Harvest has been incremental to that line's share.

We have more exciting innovations just reaching retailers in the 2nd quarter.

Special K for low carb diets, and a one-third less sugar version of Frosted Flakes and Fruit Loops.

These are value-added products intended to give the consumer a choice.

It's early, but we're encouraged by the retailer acceptance so far.

Our brand building was again strong as evidenced by the success of our Lose a Pant Size promotion on Special K and we were also awarded three FE's including one for our campaign on Fruit Loops.

We will continue to innovate and invest in our brands and manage for dollars instead of tonnage.

We're going to stick to that basic formula.

And while we face difficult comparisons later in the year, we are confident that we can grow our North American cereal business again this year.

Turning to slide 17, our North American snacks business had a strong performance led by the launch of fruit snacks in the U.S.

Remember that this product grouping has been changed to include not only Canada, but also other snack products like Pop Tarts and the new fruit snacks initiative.

So let me discuss them first.

Though a relatively small piece of North American snacks group, Canada posted good growth in the quarter driven by new products such as Frosted Flakes and Fruit Loops Cereal and Milk Bars, Kellogg's Cadbury Rice Crispy Squares and two new varieties of special K bars.

In the U.S., sales of Pop Tarts increased modestly in the 1st quarter and even regained share following last year's entry by a new competitor.

Innovation like new French Toast Pop Tarts and effective brand building drove this gain.

Fruit snacks represent a new category for us, and one that leverages the Kellogg's brand, our expertise in fruit, our strength and innovation, our sales force and even our alliance with Disney.

The initial response to this product line has been outstanding.

And there is little chance that it will be a bigger - there is chance that it will be a bigger contributor to this year than we had originally envisioned.

The rest of North American snacks, essentially the previous way we reported it grew a respectable 2% in the quarter.

I say respectable because it faced very tough comparisons, and because we continued to endure the adverse sales impact of aggressive sku rationalization, and of course not to mention category softness in the U.S., cookies and crackers.

Slide 18 shows that within our North American snacks portfolio, only cookies posted a decline in the 1st quarter.

Is sku cuts we made last year obviously contributed to this decline, but so did category softness.

As expected, the cookies category continued to decline amidst a lack of category-wide innovation, and consumer shift towards low carb alternatives--but the competitive environment has been made even more difficult by aggressive price promotion activity by our competition.

As we've mentioned several times before, we are riding out the storm by making internal improvements to our business and focusing our resources behind key brands.

We launched Sandy's Fruit Delights in the 1st quarter, and we will have further innovation activity as year progresses including a low carb version of Chips Deluxe in the 2nd quarter.

We believe firmly that the cookie category softness is cyclical, and a category-wide return to brand building and innovation will eventually return cookies to growth.

In crackers we did experience sku cuts and category softness as well; however, we announced new Cheez-it Twisters, which was the only significant innovation in the category--and I can tell you it is off to a tremendous start.

Retailer acceptance has been strong--and so far, consumer trial has been extremely strong.

We already discussed the outstanding contribution from fruit snacks, but even excluding them, our wholesome snacks business recorded growth in the quarter.

While we and the rest of the wholesome snacks category face very difficult comparisons - with the innovation-heavy year ago period, we continue to see growth in our Special K Bars and we expanded our cereal and milk line to include two other popular cereal brands, Tony Cinnamon Crunchers and Cocoa Krispies.

We continue to expect relatively modest growth from North Amercian Snack in 2004, but we are certainly encouraged by our 1st quarter performance.

Results for our North America frozen and alternative channels group is shown on slide 19.

We called it - previously we reported a U.S.

Other group, which really was a collection of disparate businesses.

Our new group is far more focused, and therefore more useful, we believe, for analytical purposes.

Sales for North American Frozen, an Alternative Channels grew at a sturdy 4% rate in the 1st quarter, on top of 4% growth in the year ago quarter.

These gains were reported across this group, including food away from home, which continues to execute well, and in both of our frozen businesses.

The only decline came in the low margin custom manufacturing business.

Eggo reported a strong gain in the quarter led by the continued success of Eggo French Toaster Sticks which were launched late last year.

Innovation in effective advertising also drove growth in our Morning Star Farms veggie foods business.

Turning now to slide 20 and Kellogg International--reported net sales growth was 24% in the quarter.

Even without favorable currency translation, our growth was an exceptional 10%.

Again, not only was this growth on top of growth, but it represented an acceleration from previous quarters.

Importantly, this acceleration was driven by all of our geographic areas--and I'd like to take you through that.

Slide 21 shows the internal net sales growth of each of our major international areas in the 1st quarter.

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

Europe posted internal net sales growth of 7% in the quarter, continuing at strong momentum.

The growth was driven largely by exceptional new products in the UK, where brand building and innovation continue to lead share gains in category growth.

Importantly, we gained almost two full share points in the UK during the quarter, and in our second largest European market, which is France, we gained also two share points.

We're very pleased with that.

New products - such as Banana Crunch Cornflakes and Crunchy Nut Clusters contributed to this UK performance, as did an enormously successful Drop a Jean Size promotion on Special K and Crunchy Nut.

That promotion was also run in several countries across Continental Europe with similar success.

Sales of special K in Europe as a whole increased by 45% during the quarter.

And this is on top of gross last year and the year before--so a very, very strong brand in our portfolio.

And it just gives you an idea of how extendable our brands and our promotions can be.

Snacks were also a very good story for Europe in the quarter generating sales growth of more than 20%--led by Special K Bars across the region, and by [inaudible] cereal milk bars in the U.K.

Latin America delivered exceptional internal net sales growth of 17%, driven by Mexico, where brand building lifted our core brands.

Importantly, our Latin American business grew 20% in U.S. dollars.

Both [inaudible] and Choco Krispies posted double-digit growth.

These are two largest brands in Mexico, aided by effective advertising campaigns.

We also ran a Disney inserts campaign and launched a Lion King theme cereal.

Our snacks business posted impressive growth even after almost doubling sales in 2003.

Nutra-grain, All Bran, and Choco Krispies Bars all did very, very well.

So, we're extremely pleased and I can tell you Mexico and most of Latin America is literally or symbolically on fire.

Asia Pacific reported an internal net sales growth of 11%.

In Japan, strong sales growth was driven by our adult brands--especially All Bran and Bran Flakes-- which experienced double digit gains behind effective brand building.

In Australia, we reported strong sales growth.

We ran a challenge program on our uniquely positioned Nutragrain cereal--highlighting the nutritional benefits of the brand .

We also launched our health oriented sustained brand, and launched and Apple Cinnamon variety of Special K. Our snacks business also did extremely well behind the strength of K time.

Our international business will continue to boost brand building and innovation activity to drive growth in the coming quarters.

Examples include new Special K variance in the UK and Australia, a Spiderman promotion will run across numerous countries, an example of a truly global campaign and one that we believe few companies beside Kellogg could execute.

This is probably the broadest scope of any activity that we've done simultaneously around the world, and we're building a very strong capability to be able to do this on an ongoing basis.

So in summary -- each of our businesses is in very good shape, and off to a good start in 2004.

In fact, our 1st quarter performance gives us even greater confidence in our ability to achieve targeted growth in 2004 and importantly, sustain that growth beyond this year.

First, our 1st quarter indicated that we have better business momentum than we even had expected.

This means our brand building and innovation investment is paying off, it means all of our people are executing well, and we gain share in - cereal category again this quarter.

Second, we continue to reinvest in the business.

Obviously this includes brand building and innovation that will drive our top line in the future and it also includes the absorption of costs and writeoffs related to efficiency initiatives and cost reduction projects that will improve profitability over time.

We are raising our estimate for the costs associated with this reinvestment in 2004, adding to what was already outstanding earnings quality.

Finally, we increased our EPS target and we are also increasing our cash flow targets for the full year.

Remember, our goal is not one single year of exceptional growth, but rather, a dependable multi-year track record of consistent growth for our investors.

I want to express my thanks to our company's 25,000 employees for continuing to earn their stripes every day.

It is thanks to them that we're able to report these types of numbers, and I'd like to thank all of you on the call for your confidence in us.

So with that, I'll open it up for questions.

[OPERATOR INSTRUCTIONS] We'll pause for a moment for a moment to compile the way Q&A roster.

The first question, is from [David Driscoll] with Smith Barney.

Hi, good morning everyone.

Good Morning.

Well, congratulations on a wonderful quarter.

Thank you.

I'd like to talk to you a little bit about raw material costs.

You know, certainly we've been watching the commodity markets and listening to what the other players have been saying, and everybody out there - so far to my sense has been surprised by the strength of the commodity markets, yet in your guidance, it seems like you guys were not surprised that it was still within the top end of the range.

If I remember correctly, John, you gave us guidance earlier of about 10 to 15 cents and today you tightened it up to about 12 to 15 cents of higher commodity costs.

First off, I guess the question here is: do you see the need to raise prices related to commodity cost, you know, given where prices are, and I ask this because obviously you've raised your guidance and things seem to be going extremely well, but at the same time I think a lot of investors out there are asking is there some money on the table for you, i.e., could you take a price increase broadly across your portfolio and improve your results even more, or would you rather seek to keep prices stable and perhaps gain market share.

Let me take the pricing part of that and then I'm going to ask John to walk you through commodities.

You know, we've been saying for a while that cost inflation is meaningful and we've been seeing inflation in commodities and other parts of the business for quite a while.

Pricing is one way of doing it, but of course we've productivity which we've been working on quite a bit and then mix is the big contributor to helping us defend our business from inflation.

nd then of course, there is pricing.

We've taken modest price increases, I believe, this year in the UK, Mexico, Canada, and Korea, and that's all I want to say about that.

Obviously, pricing is an opportunity, it is an alternative, but I really don't want to talk about pricing plans or anything specific, but I appreciate the point.

And I guess on pricing, we said 10 to 15 cents back in January for the year.

Commodities - sorry - We're hoping to be posted to the 10 cents, obviously now we're closer to 15 cents, and now in a range of 12 to 15 cents for the full year on commodities.

And then, Carlos, if I could follow up just one more question, this is an overall question, I've heard from a number of other companies that they are really focused on -- and this is one company's particular term, health and wellness, new product trends going forward, but when I listen to all the things that you're telling us, obviously you guys are doing a great job, but yet I feel like it's not -- you're in a lot of different areas.

You know some of your products are - you know - heavy in sugar and good tasting products, and they're doing very well, and some of them are health and wellness.

Can you kind of give us - would you characterize it differently, do you think that going forward, you know, over the next year that the product - that the new product focus really needs to be in health and wellness and that's where the consumers are going and, specifically, I'm talking about the United States?

Yeah, I think - yeah obviously health and wellness is a trend, and it's - I don't think health and wellness has ever gone away.

I think it tends to take on a different shape, and take on different topics and different areas of focus.

And then our whole company was built out of the whole idea of health and wellness.

I think there's a bit of a trap if you put all your new products and all your activity and all your focus on one area of the market, you are going to be missing consumers who do want choice-- so what we're doing is giving consumers choice.

We have cereals that are high in fiber, we have cereals that are great tasting, we now have a cereal that is for low carb diets, we have wholesome snacks, but we also very indulgent snacks.

And I think the key is to be aware of consumer trends, to have your finger on the pulse of the consumer and understand that ultimately what consumers want is choice.

Not everyone wants the same thing, and we've got to stay very close to that.

Okay, great.

Thanks a lot guys.

Thank you.

Your next question comes from the line of Chris Growe with A.G. Edwards.

Good morning.

Good morning.

My first question for you is, in terms of your marketing investment, and I think you've taken that up for the year with the better results, is it too broad to say that you have more of an international or U.S. focus this year with your marketing or - could you talk about where your real emphasis is this year on the marketing side?

We're really looking to invest back in marketing at a rate faster than sales growth across the portfolio as a whole.

So, there's no one region or one area that's going to get a greater focus this year?

Well, we've got - depending on the size of the area and ideas and growth rates, and you know, obviously we're continuing to invest in Latin America and other parts of the world, I think what you're seeing is that because we started volume and value a little better later in international.

We're beginning to see the same sorts of -- the same sort of pickup that we saw in the U.S., but we are spending across categories and investing across regions.

Obviously we invest when we have the idea, so it's not giving everyone a pot of money, but at this point, we've got ideas, we've got ideas that we can transfer around the world, and pretty much everyone will get investments this year.

Okay, now the - on the product mix, if you will, price and mix front, you seem to be pretty reliant this year on improved product mix--and it's coming through well so far this year.

Is - the international side seems to be a very big contributor.

Is that part of the main piece of the product mix improvement for the year for the overall Company is international?

It's really both.

Okay.

It's international and the U.S.

And again, International, as you know, just - they started volume and value a little later, so they're getting the initial benefits from it, but we're getting price mixed improvement in just about every business we have, it's something we're driving very hard, and you know, just to give you a sense of that, Chris, we've had 11 consecutive quarters of positive price mix improvements, so there's rhythm and it's becoming part of the way we do business.

Okay. nd then my last question is on the category - the cereal category in the U.S., you look to have a pretty nice contribution from alternate channels, and that's been an ongoing trend I realize, but did that seem to pick up in your eyes in this quarter relative to past quarters?

No, it's pretty much sustained what we had in previous quarters.

And as you know, we were growing at a time when the - especially the food service business was going through a tough time so we continue to see that growth and we continue to drive that.

Thank you.

Thank you.

Your next question comes from the line of David Adelman with Morgan Stanley.

Good morning.

Good morning.

The - I was curious, 6-1/2% organic sales growth resulting in a 16-1/2% operating profit gain, is there anything unusual in the results during the quarter or is that the kind of leverage that's inherent in the business?

That's really just the impact of operating leverage.

It's nothing unusual to the one time benefit nature in there.

It's going through the P&L, we have good productivity, we have positive mix, we have strong overhead control, and then even below operating profit we have good interest in tax .

And then -- then internationally, the three major segments having such strong local currency - local currency operating profit growth, you highlighted certain specific things that were going on in the markets, but are there any broad generalizations, it the build-up of volume to value that's driving business broadly ?

Yeah, it's essentially a combination of the rollout of volume to value, a very strong pipeline of new products, the ability to share our best ideas across the world, the ability to extend our brands, so we have a very integrated business worldwide and people are taking the best ideas from the world and implementing them all within the context of volume to value.

Dave, it's just - I want to make a comment on the leverage.

You know, when you think about most people think about operating leverage in terms of volume or tonnage--and what we're seeing is the power of operating leverage coming from dollars and that's where we see our leverage in the business within the 11% top line, or 6-1/2% internal sales.

There is tremendous leverage when you get it through dollars more so than when you get it through just tonnage.

Right, and then lastly Carlos, the - could you comment on your sense that the low carb phenomena is having on the U.S. ready-to-eat cereal business, and what your sense of overall category dynamics when you include alternate channels?

David, we've calculated -- and this is a calculation, and, you know, that the low carb diet has taken about 1% growth of the cereal category.

And that is -- that's an estimate.

My sense is that -- and some of the numbers we've seen and just the calls that we get in from consumers is that low carb is - it is for real, there's no question about it, we believe that it has peaked.

The question is how long will that last?

But I do believe that it has peaked, and I think we're going to find a little bit more moderation as opposed to people looking for one carb product, I think there's moderation, people may be counting carbs, but something like a 9 carb or 10 carb will be part of a low carb diet.

I think we've seen very, very large extremes when it comes to low carb, and we typically see that at the beginning of a trend.

But, I do believe it has peaked, and you know, we'll have to see how long - how long that lasts.

Thank you.

Thank you.

Your next question, comes from the line of Terry Bivens from Bear, Stearns.

Good morning, everyone.

Good morning, Terry.

Carlos, let me first of all say it was really nice to read that your involvement with a certain Atlanta company extends only to its diets, so that was good to hear.

Just quickly, I know you've got a new segment reporting system there, but is it possible to give us some indication of what your U.S. cereal sales were?

Hey, Terry it's about 4% in U.S.

Okay, roughly the same as Canada then?

Well Canada would have been a little bit faster, but it's a smaller piece of the overall pie there.

Okay.

Is it also possible, I think John Bryant mentioned that you did alter the timing slightly on one of your marketing programs, is it possible to quantify what that may have done to the quarter?

You know, we expect it to have more brand building in the quarter.

UK raw materials around two to three pennies worth of more brand building, that actually moved out of the quarter at the timing of the events and will now be in the - probably the Q2, Q3 time line.

Okay, split pretty much - incorporated in your estimates there I guess.

That's right.

And lastly, I guess you did suggest that of the up front capital projects, we have about 10 to 12 cents I think is now the current estimate, but you did seem to indicate that that would probably expand as we go through the year.

Is there any estimate of what sort of magnitude we may see there?

Terry, it's a 10 to 12 cents is our best estimate for the up front costs in the year.

We're always looking for additional projects, but there's a physical limit to what we can execute.

At this stage we're comfortable with that 10 to 12 cent estimate.

Thanks very much.

Thank you Terry.

Your next question comes from the line of Eric Katzman with Deutsche Bank.

Hi, good morning everybody.

Hi Eric.

A few questions, one, what were the trends like or what have the trends been like so far in April, and how would you categorize the end of March, because if we listen to the projections for the full year, we would have to assume a pretty dramatic slowdown .

Why don't I just give you some - let me start with the end of the 1st quarter, Eric.

That's - a good question.

Our trade inventories actually are down -- at the end of the 1st quarter they were down sequentially versus the 4th quarter of last year, and down versus the same - down versus the first quarter of last year as well, so we don't -- you know, we don't have a - an inventory situation, and to your comment or your question about how is the 2nd quarter doing, I would say fine.

It's not as eye popping or as explosive as perhaps the 1st quarter, but we're very pleased about how we've started the 2nd quarter.

Okay.

And then, so if we're to believe - which I'm having a tough time believing - the 211 in earnings, that basically means that the rest of the year earnings growth is basically flat.

Is that really -- I mean, how likely is that given the momentum you have in the business?

I find that as about believable as your comments at Cagny that things are just on track which they clearly were not.

They are well above expectations.

Well, let me ask you a couple of things in there.

I think at Cagny we said we were coming in strongly, we were off to a strong start for the quarter.

So, I think we were pretty up front in terms of how we were doing at Cagny.

But also as you look at the back three-quarters, we are projecting approximately 3/4 low to mid-single digit EPS growth, remember, we do have a very tough tax comparison in the 4th quarter versus this year and we will continue to reinvest aggressively in brand building as well as up front costs--so I think we have a very high quality of earnings in the back three-quarters of the year, and are very comfortable with the progress we have out there and numbers we're putting out.

Hey Eric, just to go back to your comment on Cagny and I can understand your frustration, but I do recall that that we mentioned that our business was off to a very strong start, it was early in the year, and the business continued to be strong throughout February and March.

I can, you know, I can just imagine if we would have said in Cagny that we were expecting 11% growth a quarter, so I understand your frustration, but we said at Cagny as much as we knew about the quarter, which was we were off to a very strong start.

Okay.

And then last - I guess last question is based on your annual, your free cash flow in '03 was like 900 plus million, and now you're saying cash flow will be, you know, somewhere between 900 and a billion.

So even though you're still having, you know, what is at least at the start a great year, you're still seeing free cash flow is basically going to be flat.

Well, last year was around 924, we're now saying free cash flow will be 925 to a billion this year so that means we'll be up year-on-year.

Okay, but I mean, still up just slightly.

I mean, you're talking a few % and yet earnings growth is going to be up, you know, close to double digit.

Eric, recognize the cash flow significantly exceeds income, so it's going to be tough for us to continue to grow cash flow significantly faster with it exceeding net income by over $100 million a year for the last three years.

Oh yeah, and then of the 10 to 12 cents in one time costs, is half of that cash?

We'll give you a better estimate as we go through, but last year we said it was around a third with cash, probably be similar to this year.

Okay, thank you.

Thank you.

Your next question comes from the line of John McMillin with Prudential Equity Group.

John?

Sir, your line is open to ask a question.

Can you hear me now?

I can hear you.

You sure the extra week wasn't in this first quarter, John?

I'm pretty sure it's in the 4th quarter, John.

Well, with the leap year, the extra selling - you still have the same amount of shipping days?

I believe we do, yes.

And the - identified costs in this 1st quarter, of the 10 to 12 cents, I guess you might have said it, but was it one to two cents in this quarter of the identified costs?

That's right.

You don't know which one or it's right between there?

It was $9 million, John.

Okay.

I'm sorry, I didn't get that.

And you know, that international improvement was startling.

I'm just trying to gage, Carlos, how sustainable it is.

Somebody sent me a copy of the daily mail on April 1st that talked about unhealthy cereals and sugar contents and so forth.

And I know that's just one rag in the UK, but you feel that this international turn around, maybe not to this extent of plus 10, but has legs to it?

Yeah, what - what has really happened that would make it any different would be that Europe, which as you recall, a couple years ago, we talked about Europe being our key challenge and something we needed to address.

Europe has really picked up behind volume to value, behind programs we're doing, behind innovation, as I mentioned before, we've gained share in the UK and in France, but then, you know, Latin America has always been on and it continues to be on a roll.

I mentioned Japan in the text of the conference call.

Japan is really picking up for us and I think it's the combination of programs as always, execution, local management and that has lifted Asia-Pacific.

So that's - we continue to execute very well n Europe, we continue to see that the European business is driving with momentum and Latin America continues to grow extremely fast.

I would say that - the only other change is that Europe has become a very significant contributor of growth.

And John - the $9 million, what areas was it localized, these items?

We'll give you more information in the 10-Q, John, but it's going to be roughly half U.S. and half Europe.

Okay, and Carlos, thanks for not drinking the Minute Maid.

Thank you, John.

Your next question is from Christine McCracken with Midwest Research.

Good morning.

Good morning.

Just a couple more commodity questions, and explain a little more in the pricing, your pricing strategy obviously you're not going to reveal that, but in the past you've fallen in a trap of taking weight out of products.

And I'm wondering, are you considering that at all, and would that hurt the price value relationship over time, or is that something that just isn't in the solution set at this point?

Hey, Christine, listen, as far as I can remember, unless -- unless you remember a specific circumstance, we've never taken product out of a package to make lighter and have a - what they call a disguised price increase.

I just don't remember doing that.

It's not one of our -- one of our typical tactics.

We are well aware of commodities, we are - we look at this every single day, we talk about it every single day, and we will take the appropriate action to continue to deliver our numbers and absorb the commodity costs.

That's fair.

I guess I was referring to more the industry has certainly had that as an issue.

But, secondly looking I guess at commodity costs in general it looks to us as though commodity prices specifically on the oil side and corn are probably going to come down in the second half of the year.

Have you factored that into your outlook at this point, or could that provide incremental upside?

Well, you know, we have hedging out there through Q2 and Q3, we're a bit exposed in the 4th quarter.

It's very hard to predict where these commodity prices are going.

If anything, they could go up as much as come down.

So, at this stage we'll just see how numbers come in.

Finally, on cookies, clearly, you know, it's been an issue with lack of innovation, but I'm also wondering if you've explored at all, is this more a second change, have you seen people shifting to other snacks, have you done any kind of analysis to see whether or not mothers, instead of, I guess, providing cookies in the school lunch for example, are giving a healthier alternative with the obesity kind of debate--and could that lead to a more difficult time, I guess, restarting in that piece of the business?

Well, there are a couple of things that are - that are impacting cookies.

One is, as we've always said, is health inflicted which is - we can do more, we can do more innovation, we can always execute better, but we do have a category dynamic which is, as you mentioned, I would say, low carb as opposed to just a broad obesity.

And there has been.

We know that cookies is one of the categories that has been impacted the most by low carb dieting.

So, if we're right about low carb having peaked and consumers being a little bit more balanced in their approach, that should help the category.

Now having said that, and I don't want to minimize the importance of cookies because it's a very important business for us, cookies are well less than 10% of our sales.

So we could have a softening category and continue to deliver the kind of numbers that we plan to deliver.

We've seen that, certainly.

But, I guess I'm curious, if you look at your portfolio of cookies, is it skewed toward a kid or an adult base, and how many kids are actually on a low carb diet?

I mean, have you seen any numbers that show that, or is it?

The numbers we've seen and the information we've received is that children are not on the low carb diet or at least the parents do not want their children to be on low carb diets.

So what you have is a combination of adults, you have a combination of, you know, the bad publicity about three, four months ago was all about cookies.

It almost seemed like cookies was the reason for the -- for all the health problems.

So I think it's a combination of the publicity, combination of -- adults eat quite a bit of cookies as well.

Those sort of external factors.

But I'll tell you, the cookie business is not going to disappear.

We are going through a cyclical time, a difficult time, but we'll get through it, and we will be able to offset it with other businesses that are growing faster.

Okay, congratulations.

Thanks.

Thank you, Christine.

Your next question comes from the line of Jonathan Feeney with Wachovia.

Hello guys.

Hello Jonathan.

Two questions.

One, you've made impressive share gains in the cereal category specifically just talking about the last 12 months.

Have you seen - you know - last quarter or even more recently than that, any change in your competitive activity--either in terms of more new product introduction, or competitive pricing activities in the cereal category?

Well, let me just give you a couple of -- a couple of data points from the 1st quarter, and I think the - you know - headline is we - the category is pretty much as competitive as ever.

I think our other companies are trying to invest in brand building, doing what is right, we see a category that is more focused on the long-term.

We gained about 1.4 share points during the quarter, and we continue to see the type of dynamic that we've been seeing for the last three to four years.

Our sales were up half a percent, our sales on -- our sales per pound were up about 3%, our prices on veal were up--so we see all the same dynamics and we continue to execute the same dynamics that made us successful over the past several years.

And, in the category, we're seeing innovation, we're seeing consumer promotions, we're seeing new products, we're seeing line extensions, so it continues to be a very competitive category .

But, sequentially, you know, not a tremendous amount of change, just you guys winning and other people losing?

I said it, not you.

Second question is, you're piling up your cash flow here.

Would you be inquisitive internationally?

I mean, it's the first time it's - I know it's really - become out of vogue as a growth vehicle, but with the kind of results that you've - put together, do you see Kellogg long-term as a debt acquirer overseas?

Yeah, we - in fact, you know, we're always looking for opportunities, especially in key markets.

So, the answer is yes, we would be interested in looking at - and we continue to look at - acquisition opportunities.

The one caution I would have, Jonathan, is we don't want to end up with a company with different brands in different markets.

Because we are so integrated, one of our strengths that we can do global promotions, we can share ideas, we can extend brands.

Our portfolios are very similar around the world.

So while yes, we would be interested in adding to our international portfolio, we are very cautious about -- extending the portfolio to the point where every market is doing its own thing.

Okay, thanks very much, great quarter.

Thanks Jonathan.

Operator, we're getting close to 10:00 and a lot of you have another conference call to get on.

Can we take one more question?

Most certainly.

Your final question comes from the line of [Pablo Zuanic] of J.P. Morgan.

Morgan.

Good morning everyone.

Good morning Pablo.

Just a question about the up front costs of 10 to 12 cents, do we understand that they don't include brand building?

And what I have seen in the past, is that when had a very strong quarter you were able to move some of those up front costs in that particular quarter.

What happened in this case that you were not able to do so?

The up-front costs, cost base activities, they do not include brand building.

Right.

In this quarter, we were hoping to get one particular project away, it was the sale of the manufacturing facility, unfortunately, we didn't get the proceeds that we thought were appropriate for that facility, so we put the project on hold and it moved up.

Right.

Okay, and now just a second question comes for the wholesome snacks category.

I find that -- the reason for that category is at the moment very biased to a morning snack and to the young segment, except for your Special K bars.

Is there room there to introduce other adult brands in wholesome snacks, and besides that, given that they have such a low price point, what's the potential to really put them in the check out counters eventually, where you know, other products there are a dollar per bar compared to say 40 or 50 cents for these products?

Those are very good questions, Pablo.

One is on the adult side, yes, we see opportunity not, you know, not just backed up by demographics, but also by current eating habits.

Special K bars of course, is an adult targeted wholesome snack.

We've had tremendous success in Mexico with an All Bran wholesome snack.

So, yes, there is a sizable opportunity to create a larger adult segment of wholesome snacks.

But do you have potential to really enter a checkout counter with such a low price point?

Well, and we - we are at some checkout counters and we are at different areas of the store.

And we are looking at that as we speak, Pablo, not just having these snacks in the -- in the aisle, but we believe we have room, and we have some brands that can go in some places like the checkout aisle or other parts of the store.

Okay, thanks.

And then just the one last question.

New prices are at about, you know, 25, 30% up year-on-year pretty much for the last three quarters.

Doesn't that ever-increasing new prices have any effect in cereal volumes based on your research?

We have never seen that.

You know, you have to go back a long time, there was a time when the price of cereal and milk were very close, so there was a little bit more - a little bit more interaction, but we haven't seen that.

There is so much milk consumed and it doesn't really -- we haven't seen any correlation.

Okay, and just a last question on international, particularly Mexico, what are you saying from Quaker, you know, they introduced an inexpensive cereal in the bag there, and they're going to introduce a wholesome snacks.

What's going on there if you can give us some more color?

We've seen their cereal, it's in bags, and it's on the shelf, I don't have any market share numbers for you, but I can tell you that we're holding our share.

I think you'd have to ask them to see how they feel about it.

Okay, are there any plans to launch Cheez-Its overseas?

We have no plans now.

We see tremendous growth and opportunity here in the U.S., and we'd like to focus on that.

And there's - we don't have any specific plans to roll at that out.

Okay, thank you very much.

Thank you Pablo.

At this time there are no questions.

Okay.

Thank you very much.

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

Thanks for being on the call .

You're welcome, sir.