家樂氏 (K) 2004 Q2 法說會逐字稿

Good morning, my name is Kiela, and I will be your conference facilitator today.

At this time, I would like to welcome everyone to the Kellogg Company second quarter earnings call.

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

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

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

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

Please limit yourself to one question during the Q&A session.

Thank you.

You may begin your conference.

Thank you, Kiela and good morning, everyone.

Thank you for joining us for a review of our second quarter results and for some discussion about our strategy and outlook.

With me here in Battle Creek are Carlos Gutierrez, Chairman and CEO, Jeff Boromisa, CFO, and Gary Pilnick, General Counsel.

By now you should have released a press release by e-mail and the slides that accompany today's presentation are available on-line at www.kelloggcompany.com on the investor 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, brand building, operating profit, costs, interest expense, tax rate, cash flow, share repurchases and debt reduction are forward-looking statements.

Actual results could be materially different from those projected.

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

A replay of today's conference call will be available by phone through Thursday evening by dialing 1-800-642-1687 pass code 6854548 and via Webcast, which will be archived for 90 days.

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

Thanks, Simon and good morning to everyone.

Appreciate your time and your interest in the Kellogg Company.

We're pleased to report another excellent quarter.

Earnings per share grew 14%, importantly our strong business momentum continued in the second quarter.

Our net sales increased by 6%, which was on top of a similarly strong 6% growth last year.

Internal sales growth, which excludes the impact of favorable foreign exchange, acquisitions, divestitures, and differences in shipping days was up 4.6%.

And that's on top of 3.5% internal growth a year ago.

So, our momentum continued from the first quarter.

Our gross profit margin remained essentially flat despite commodity costs which continued to increase and higher costs for increased levels of package-related consumer promotion.

Our operating profit grew by 6% despite much higher brand building investment and higher up-front costs.

So, we continue to invest aggressively for the future.

We again increased our brand building at a double-digit rate.

We continue to invest in R&D, which has driven innovation in all of our markets and we are identifying and beginning additional cost savings projects.

All of this activity, as we've mentioned in the past, is investment for sustainable, dependable growth through 2004 and beyond.

And we're continuing to execute our proven strategy.

We're improving our mix, we're growing our sales, our operating income, our earnings and in addition our core working capital measured as a percent of sales continues to improve.

In fact, these strong results provide us with the flexibility to significantly invest for the future and they give us earnings visibility and they should give you additional confidence in our forecast for the full year.

In a moment, I will review each of our businesses but first as you know, John Bryant, recently our CFO, just took on a major operating role as president of Kellogg International.

So, I'd like to introduce our new CFO, Jeff Boromisa.

Jeff is a 23-year veteran of the Kellogg Company who has served in leadership positions in our internal auditing group, corporate finance and treasury functions, North American and corporate planning and as controller at one point of Kellogg Mexico.

He has been Vice President of Kellogg North American procurement and most recently Vice President, Corporate Controller and CFO Kellogg International.

Jeff has been instrumental in driving our volume to value and manage for cash strategies and I have every confidence in his ability to help drive our continued success.

So now I'll turn it over to our new CFO, Jeff Boromisa to walk us through the financial results.

Thank you, Carlos.

Thanks.

And good morning to everyone.

As Carlos highlighted, this is another outstanding quarter and it follows a very strong first quarter.

Slide 4 details some of the quarter's key financial highlights.

Net sales increased by 6% due to continued strength across most of our businesses from a favorable impact from exchange rates.

Our internal sales growth, which excludes the effect of foreign exchange, was 4.6%.

As Carlos said, this growth is more impressive given the strong comparison posted in the second quarter of 2003 and the strong start we had for the year.

Operating profit also increased by 6% with internal growth of 4.4%.

This growth includes higher spending on R&D and up front costs related to cost reduction initiatives and a strong increase in investment and brand building.

Earnings per share grew 14% with the help of lower interest expense and a lower tax rate.

Cash flow for the quarter was $177 million, which brings our year-to-date cash flow to $388 million.

This is in line with 2003 year to date total and we remain on track to meet our target.

We are all very pleased with these results.

Looking at slide 5, it shows our net sales growth and various -- and its various components.

Our net sales growth rate benefited once again from the dollars year-over-year weakness against the British pound, the euro and the Canadian dollar.

Importantly, though, internal net sales growth was 4.6%, resulting from improved price, mix, and tonnage growth.

This growth is on top of a solid 3.5% growth in the second quarter of last year and continues at a more sustainable pace from the momentum we had in the first quarter of this year.

As was the case in the first quarter, sales growth was broad-based across most of our business units.

We will discuss each of these businesses in more detail later.

Slide 6 shows our gross profit margin for the second quarter and year-to-date.

As you can see, our gross margin for the second quarter was in line with last year.

We feel very good about the result given the significant increase in commodity costs.

In fact, we now expect that the full-year impact of this increase in commodity costs will be at the high end of the 12 to 15-cent range that we discussed last quarter.

Benefits from operating leverage, productivity savings and mix improvement all helped to offset these increased commodity costs, up front costs and a significant increase in package-related consumer promotions.

Toys in the box and other inserts are an essential part of brand building and are accounted for in our cost of goods sold.

The increase we saw in the second quarter was largely due to the timing of our global "Spider-Man" promotions.

We continue to expect slight gross profit margin expansion for the full year.

Commodity prices will continue to be a factor and we will make even greater investment in up front costs for cost savings projects.

As in prior quarters, much of these investments will affect cost of goods sold.

We are very pleased that we've been able to maintain our gross profit margin and even increase it over the year-to-date period in such a difficult environment.

Slide 7 shows our level of brand building.

We again increased brand building at a double-digit rate.

For the quarter and the year-to-date period, we have increased this investment at a rate significantly greater than net sales growth.

This is another important component of our volume to value model.

We intend to increase our investment in brand building at a rate greater than net sales growth for the full year, as well.

Slide 8 details the internal operating profit growth of each of our geographic reporting areas in the second quarter.

As always, this internal growth excludes the benefit of currency translation.

We saw strong operating profit growth in all the regions except one and achieved this while investing aggressively in brand building.

In North America, internal operating profit growth was 5.4%.

And we increased brand building investment at a double-digit rate and absorbed additional up front costs.

In Europe, we continue to invest in up front costs related to the rollout of SAP as well as a new initiative designed to improve that area's organizational effectiveness.

Despite this, we still posted 7.2% internal operating profit growth.

Latin America posted internal operating profit growth of more than 14%.

And we also increased our brand building investment at a double-digit rate.

Internal operating profit growth in Asia-Pacific, which actually represents less than 5% of our total operating income decreased by 22%.

While we increased our brand-building investment in this area, we also experienced weakness in Korea as a result of a soft category and low sales growth in Australia, which was due to increased competition from a new entry in the cereal category.

This weakness was partially offset by strength in Japan from our adult oriented brands.

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

We expect interest expense for the full year to be approximately $315 million.

Our tax rate for the quarter was 33.5%.

Bringing us to a 34.5% for the year-to-date period, which is in line with our guidance for approximately 35%.

This increase -- this decrease was due to changes in our projection of mix of earnings.

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

Slide 9 shows that we once again improved the balance sheet.

This was our 12th consecutive quarter of improvement in working capital measured as a percent of net sales.

This quarter's improvement was significant and we remain very focused on this important metric.

We have made considerable progress since 2001 and now generate cash much more efficiently.

In addition, we have managed all of this while improving our levels of customer service.

Slide 10 details cash flow for the second quarter.

At $388 million, the first half cash flow was in line with last year's strong results.

It is worth noting that year-to-date contributions to benefit plans in 2004 were 127 million or almost $70 million more than we had contributed by this point in 2003.

We also were impacted unfavorably by the timing of tax payments, which will benefit us in the second half of the year.

Cash flow has benefited from a very disappointing capital expenditure and excellent working capital management.

We are very pleased with our cash flow performance by overcoming the contributions to benefit plans and the timing of tax payments and still will be in line with last year's performance.

This quarter's strong results give us added confidence in our previous guidance for full-year cash flow to be between 925 million and $1 billion.

Slide 11 shows that we also continued to pay down debt.

Debt reduction remains a very important priority for our cash flow.

Debt outstanding decreased in the quarter to approximately $5 billion.

We continue to expect that the total amount of debt reduction in 2004 will exceed $300 million.

In addition, we've repurchased approximately $80 million worth of shares during the second quarter.

All of which was funded by option exercised proceeds.

Turning to slide 12, we see the improvement that we continue to make in return on invested capital.

Buying to value and managed for cash focuses our entire organization on the components of return on invested capital and we expect continued improvement in this metric as we continue to execute our strategy.

Slide 13 shows our outlook for the remainder of 2004.

The continued strength of our business in the second quarter has reinforced the shape of our earnings for the full year. 2004 will be a front-end loaded year and importantly we now have even more financial flexibility.

We've identified and begun various cost reduction projects that we expect to complete in 2004.

In the second quarter we absorbed up-front costs of more than 3 cents per share.

These costs were largely related to the implementation of SAP in Europe and a new initiative in Europe aimed at improving organizations effectiveness.

In addition, we began the relocation of our snacks business to Battle Creek from Elmhurst.

Also, various manufacturing network initiatives are continuing.

As we mentioned last quarter, we continue to identify additional projects and as a result we now expect full year up-front costs to fall in a range of 14 to 16 cents per share.

Or 4 cents higher than the previous expectations.

It is difficult to predict with certainty in which quarter they will hit but we currently expect that approximately 40% of the remaining costs will fall in the third quarter.

This means that the third quarter will be a down quarter and the fourth quarter will show good growth.

Make no mistake, we expect strong top line growth in the third and fourth quarter of this year.

The variability in earnings is solely due to the timing of up-front costs both this year and in 2003.

In 2005, we will continue to reinvest our cost savings into more projects that will provide visibility for future earnings.

We will continue to invest aggressively in brand building.

This investment is an important component of our buying to value strategy and for the full year we will increase spending on brand building at a rate greater than the growth of net sales.

Commodity costs have continued to increase throughout the year.

While there is no one commodity that's solely to blame, costs are generally higher and we now expect that the full year impact of these increases will be at the high end of the 12 to 15-cent range we previously expected.

As you may know, we took a cereal price increase earlier this month.

We do not anticipate that this increase will have a material affect on earnings in 2004 due to the phasing of the increase and the continued impact of commodities and transportation cost increases.

Finally, do not forget that we have a 53rd week in the fourth quarter of this year.

We have said that we expect that this will add only about 1% to sales growth, as many of our operations around the world are essentially closed that week.

So,summary, we continue to face a difficult cost environment in the second quarter and still managed to post excellent results.

Cost increase, we recognized additional up front costs yet we still maintained our gross profit margin and grew operating profit in earnings per share.

This demonstrates our embedded earnings power and our commitment to dependable and sustainable growth.

With that, let me turn it back to Carlos.

Thanks, Jeff, nice job.

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

Slide 14 shows the solid growth we've seen across our North American business.

Sales growth was 5% for the quarter and year-to-date period.

This is a -- an excellent result and spanned all of our businesses.

I will start with the North American cereal business.

Slide 15 shows that the North American cereal business continues to post solid results.

This performance is even more impressive given the category weakness suggested by measured channels sales data.

We continue to innovate, run successful brand-building programs and execute very effectively throughout the organization.

In the U.S., this is slide 16 now, in the U.S. we continued to increase our share.

In fact, this is the fifth year in a row that we've increased our share of the U.S. cereal category.

Slide 17 provides additional detail on North American cereals, innovation, and promotion programs.

In the U.S. during the second quarter we introduced Special K for a low carb lifestyle.

And one-third less sugar versions of Frosted Flakes and Fruit Loops.

While they've not been on the shelf long enough, we are pleased with the early results.

We also introduced a special "Spider-Man"-themed cereal and this is part of our global "Spider-Man" promotion which will reach 42 countries in 2004.

So as you can see on the slide, we have more innovation and additional programs coming in the third and fourth quarters, as well.

These are only examples of the investment that we believe is essential for volume to value and to growing our cereal business.

Obviously we face difficult comparisons in this business in the third and fourth quarters still.

I remain convinced that our North American cereal business is on track for another very successful year.

If you turn to slide 18 in our North American snacks business, first let me point out that this product grouping was changed earlier in the year to include Canada and also other snack products such as Pop Tarts and our new fruit snacks.

So, the results detailed on this slide have been restated to be comparable.

Sales growth in the snacks business was again very strong during the second quarter, posting a 7% increase.

This follows 6% growth in the first quarter of 2004 so our momentum continued and even accelerated in the quarter.

Our new fruit snacks were a contributor to this growth.

In fact, they alone added 2% to the segment's growth.

This is a category in which we can use our key capabilities and our strong execution and we continue to be very pleased with the early success of these products.

Our Canadian snacks business, again, posted good growth in the quarter, also driven by the success of new products, such as fruit snacks, and Cereal and Milk Bars.

Pop Tarts continued to perform very well in the U.S., as a result of effective brand building and innovation.

Notably both the core business and new products, such as French toast Pop Tarts, added to the growth.

The rest of the North American snack segment, cookies, crackers and wholesome snacks, also did well in the quarter, despite category softness both cookies and crackers showed some sales growth as the results of new product introductions.

Slide 19 shows that each part of our North American snacks portfolio increased in the second quarter.

This came despite the negative effect of the discontinuation of contract manufacturing agreement and the SKU cuts we made last year.

This is essentially the last quarter that these two changes will affect our sales growth.

The cookies category continued to be a difficult one as there has been too little category-wide innovation and brand building.

Our focus and improved new product and promotional programs led to a modest increase in sales during the quarter.

We believe that the cookies category will improve over time as brand building and innovation improve and we are well-positioned to benefit when this happens.

The crackers category also experienced some weakness.

However, the success of our new Sponge Bob Cheez-it and Cheez-it Twisters crackers is very notable.

These are examples of how these businesses respond to innovation and proves we must continue to focus on doing more in the quarters to come.

Wholesome snacks continues to do well.

Our new fruit snacks helped to drive strong growth in the business in the second quarter and our Twistables product benefited from excellent brand building support and the Disney-themed products continued to exceed our expectations.

We have some good innovation planned for the second half of the year and we continue to expect growth in North American snacks for the full year.

It is very encouraging to see this broad-based growth in this segment and to see excellent results from our sales execution, our innovation and our brand building.

Results for our North American frozen and specialty channels group is shown on slide 20.

Sales increased by 4% in the second quarter on top of 5% growth last year.

This is growth on growth and came across the -- the whole segment.

Our Food Away From Home organization continues to execute extremely well and our Eggo business posted very strong double-digit growth.

Both Eggo and Morningstar Farm's benefited from innovation and brand building and we have more of each planned throughout the remainder of the year.

If you turn to slide 21, we will go to Kellogg international.

Reported sales growth for the quarter was 9%.

Internal growth was 5% and that's on top of 5% growth last year, so we continue to drive very strong results in our international business.

And I'd like to just look at these briefly by area.

Slide 22 shows the internal net sales growth of each of our major international areas in the quarter.

I'll begin with Europe.

Europe posted internal sales growth of 3% in the second quarter and 5% for the year-to-date period.

This performance came despite increased levels of price discounting by competitors in the U.K.

Our businesses in Spain, Benelux, and Mediterranean all posted exceptional growth and we again increase increased our investment in brand-building across the region.

We saw strength once again in the Special K and Crunchy Nut brands behind strong marketing campaigns earlier in the year.

We also ran a pre-summer two-week weight loss challenge campaign in most countries in the area, which helped increase sales of Special K by 30%.

This growth in cereal and in snacks came pretty much across-the-board.

In fact, the snacks business across Europe continues to grow at a very strong double-digit rate and we have new innovation and powerful marketing programs planned for the back half of the year.

We're introducing a three-layer bars in four varieties in France, Spain, and Benelux and anticipate that this will help fuel future sales growth in those countries.

Internal net sales growth in Latin America was 16% during the quarter.

We also increased our investment in brand building across this area to double-digit rates.

This impressive growth was achieved despite weaknesses in many food categories in Mexico.

The area's largest business unit.

We launched a "Spider-Man" cereal and bars during the second quarter, along with very successful Yu-Gi-Oh! version of our Choco Krispies brand.

We also ran another successful campaign with All Bran.

This innovation and promotion in marketing drove impressive mix improvements and we have much more planned for the third and fourth quarters, including new products and health-oriented marketing campaigns.

As we continue to be very, very pleased with our Latin American business.

The Asia Pacific region posted an internal sales decline of 6% in the second quarter.

Year-to-date, internal sales have increased by 2%.

The decline in net sales resulted from marked category weakness in the Korean market and a new competitive entry into the cereal category in Australia.

This weakness was partially offset by strength in Japan, where our momentum of our adult-oriented brands continued.

And we're very pleased with our business in Japan.

Our international businesses continue to execute volume to value and our focused on innovation and brand-building and improving our mix.

We're leveraging our international scale in ways that we believe few companies can.

We very quickly introduce successful products into new markets and as I mentioned earlier we are currently running our first truly global marketing program by using the "Spider-Man" equity, timed with the release of the movie in 42 different countries.

And we're going to be doing a lot more of that in the future.

So, in summary this was another excellent quarter.

And we're very confident that we can achieve our targets for the full year.

Our organization continues to execute volume to value, manage for cash, driving innovation, driving brand building, spreading ideas throughout the world, and executing our -- our proven strategy.

The -- the important thing and the thing that we are extremely proud of is that we managed this while reinvesting in our business at a time when we know commodity costs are -- are increasing.

Competitive spending is increasing.

And we are able to continue to drive our business.

So, we've again raised our estimates for investments that we will make in 2004, which increases our earnings quality and should give you added confidence that we have the earnings power and visibility not just in 2004 but in 2005 and into the future.

Our approach to the business has not changed.

We strive for dependable and sustainable growth over the long term, and I remain as confident as ever the Company's 25,000 employees will continue to deliver the excellent results expected by all of our owners.

So thank you again, and with that we'll open it up for questions.

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

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

Your first question comes from Jon Feeney of Wachovia.

Good morning, guys.

Good morning, John.

Very strong performance, particularly in -- in U.S. retail cereal and I know you got into it a little bit in the presentation, but, you know, that stands in stark contrast to -- to -- to some of your competitors.

Can you -- I mean do you feel like you have a new product pipeline?

Or marketing programs, or whatever kind of magic you have going on right now, to sustain these kind of market share gains?

And if so, I mean, you know, do you -- do you think they're coming more at the expense of your -- your branded competitors or more at the expense of private label over the next 12 months?

Well, you know, our people continue to provide the -- the programs, the innovation, the mix improvements and the sales executions.

So, you know, as we increase these programs and as we execute we just, you know, we believe we're getting better and better at it.

So, yes, we -- we're going to stay on course and we're going to continue doing -- doing what we've been doing all along.

You know, in the future it's hard to forecast where our share will come from.

We have been gaining share in a category that has been, you know, flat to slightly up and interestingly in the quarter, private label was about an 8-3 share, which is pretty much in line with what it's been and then if you add up all of the price-led segments it was actually down about 1/10.

So, that could be reflective of what could happen in the future as we continue to drive value-added programs as opposed to relying on -- on discounts, but you can be sure, John, that, you know, we're on track, we're on course, our people are executing extremely well.

We're driving ideas, driving innovation and we're going to keep it going.

And just one follow-up, Carlos, on the last call you made what proved to be a pretty impressioned comment about the slowdown of low-carb and you believed, looking a couple months out that things, you know, were peaking in that arena.

What area -- have you seen any follow-through in areas of your business or signs, at least, of follow-through that maybe some of the categories that have been hurt to devastated by consumers trends, towards lower-carb products are, you know, at least going to recover in the next six months?

Well, what we have seen is on -- on one hand a tremendous amount of new product introductions going into say the wholesome snack area with low-carb claims.

I think somebody mentioned 65 new SKUs over the last quarter.

The interesting thing is that we're hearing that there's a bit a glut of -- of low-carb products in the marketplace and inventories are extremely high.

So, while we're -- we're clearly seeing that the -- the low-carb trend has -- or fad has peaked and -- and it looks like it is taking a bit of a dive in the supermarkets, we have yet to see the recovery of those categories that were impacted by low carb.

I would hope to see that in the future but we're just seeing one half of the equation at this point.

Okay.

Thank you.

Thank you, Jon.

Your next question comes from Leonard Teitelbaum of Merrill Lynch.

Good morning.

Good morning, Lenny.

Ask just more along -- I guess along the line of a housekeeping question.

The amount of money that you're spending now on ad and promotion, how much has that gone up in the first half of the year?

Have you reset that budget at all?

Well, as we mentioned it's gone up at a double-digit rate, if you're talking about brand building.

Well, yes, sir, I am, but what I mean is I know you had managed -- you had budgeted in some increase I just want to know if you're increasing it as your earnings come in perhaps better than you thought.

You're taking some of that overage and increasing the budget as you go through the year.

Yeah, yeah.

I get it.

Let me ask Jeff --

Yeah, you know, year-to-date, Lenny, we're up a strong double-digit and when we go forward for the year, you know, certainly the -- the up front cost initiative is one thing that we look towards but -- but brand building is the other one that certainly can increase with more earnings potential.

But to answer your question, are we investing more than what we planned to invest in the first half when we put together our budget?

The answer is yes.

I don't want to get into how much and -- but yes, we've been able to reinvest more than we had planned, which -- which is good for us and that obviously is what we try to do when we put together our plans.

Okay.

Now, as we get into the third quarter, where we're obviously going to have perhaps a more extent, you made a conscious effort to move some of the expense that you expected over the second half here, maybe up 4 cents and maybe more into the third quarter.

Was that a decision that -- on when when it fell was within the -- within the planning process you had?

Or had you always expected to put it into the third quarter?

Well, you know, Leonard it wasn't in the planning process.

We do have a lot of a cost savings initiatives that we have on paper and we do execute them when we do have the earnings potential to absorb those into our earnings.

So, we did increase it -- I think our original guidance was around 5 cents, I think at the end of the first quarter that was raised to 10 to 12 and now it's at the the 14 to 16-cent level.

All right.

Obviously what I'm trying to get to here is whether or not your, you know, we know we had actual monies so we increased the ad budget and we shared some with the street and put some behind the brand-building.

I was just wondering about the costs, as well.

So, the way it stands now, all of the extraordinary items are all identified and the bulks going to fall in the third quarter and the fourth quarter should be -- should be pretty clean, is that -- is that the way to look at this?

You know, Lenny, about 40% of the remaining up-front costs will fall in Q3. 60% in Q4.

So, both quarters are impacted by the up front initiatives.

All right.

Yeah, the reason we have a -- we're calling the fourth quarter up is we do have some pretty favorable comparisons versus last year.

Okay.

Thank you very much.

Thank you, Lenny.

Your next question comes from David Nelson of CSFB.

Good morning.

Good morning, David.

With commodities, you talk about commodities being on the high end of the 12 to 15 cents.

But you've talked about that before.

But, now, markets such as futures for soybean oil have really rolled over, could we possibly expect a positive of some nature, perhaps that nature of when we look into '05?

No, David, you know, I think recent -- in the recent weeks, you will see that corn pricing, wheat, have come down a little bit in the futures market.

But, you know, one thing about Kellogg's, about 80% of our raw materials, packaging materials, are non hedgeable items, so, less than 20 is actually on the futures exchange.

The things that are not hedgeable like rice, packaging material, we see those costs at -- as we -- as we have given guidance here, in the conference call, at the high end of the 15 cents.

So, even though there's been some slight easing that's not going to impact the 15-cent guidance that we're giving you.

I was thinking for '05, though?

Well, it's kind of early for '05.

You know, usually at the end of the third quarter we give guidance for next year.

If I had to call it now, because of these items not being on the futures exchange and non hedgeable, we would pretty much be in line with what we see this year.

Okay, thank you very much.

Thanks, David.

Your next question comes from Eric Larson of Piper Jaffray.

Yes, good morning, everyone.

Good quarter.

Thank you.

The first question, what were your first half one-time expenses?

It was 3 cents in the second quarter.

Do you have the first half available?

Yeah, in total it's about 5 cents.

So, 5 cents for your first half.

Right.

And then talk about pricing for a minute.

Your cereal pricing you took up, oh, I think about five weeks ago.

What was the average price of that domestically?

And did you do it across the globe or no?

It was -- in the U.S., the one you're talking about was in the U.S. and we announced it, I believe on July 11.

It's about a 4.5% increase on average, different brands have different increases but the average is about 4.5%.

Okay.

And have you -- have you taken any pricing on any other products elsewhere?

Given the current competitive environment in cookies and crackers, I suppose that's pretty doubtful.

At this time it's still -- in addition to the cereal price increase, pie crusts were also part of that.

Yeah, that was in the U.S. and that's -- that's not going to make that big of a difference.

Around the world, you know, we -- we take pricing based on local conditions, local inflation.

Different timing, depending on the plans.

So, we have taken pricing say in Mexico, where -- where inflation is is a little bit higher.

But that all depends on local circumstances and local conditions but we don't -- we don't take global price increases.

Okay.

Thank you.

Thank you.

Your next question comes from Tim Ramey of DA Davidson.

Good morning, congratulations.

Thank you, Tim.

The price increase comes on top of a pretty strong price mix performance that you've been able to do year-to-date.

How should we think about that going forward?

It's probably not additive, but give us some color on that, if you could?

Well, you know, in this quarter, you know --

This quarter I think our price mix was around 3.2%.

That's essentially all mix-driven.

So, certainly, you know, we have a lot of focus on moving our mix every quarter.

So that should, you know, remain in place as we go on and certainly the pricing element here will help that metric.

Yeah, so, -- so Tim, if this quarter, the -- the pricing added may be 8/10 to our overall sales, you know of the 3.2, 8/10 was pricing now with the price increase, we're not going to stop improving mix.

That continues to be part of our strategy.

So, as -- as the price increase gets -- gets into the marketplace and it will take some time, you know, we've got -- we've got programs on the street and it doesn't happen over night.

But as you look to 2005, you will probably see a higher contribution within that on -- on pricing but you -- you'll still see mix.

And -- that's terrific.

And could you give a little bit more detail on what you plan to do with these cost initiatives, you know, you've given turnouts in big numbers, but there isn't particularly color on -- on what exactly the steps might be?

Well, you know, just to give a little background on the cost initiative, you know, the -- we have an FAP implementation that's going on globally.

Also our Worthington manufacturing consolidation project is -- is in place, or starting to be -- to be worked on.

Our snacks move from Elmhurst to Battle Creek.

And also we have an initiative in Europe that's going to improve our organization effectiveness, but all of that is to generate, you know, future visibility for the Company, future earnings potential.

And what we've typically done is taken the cost savings that these projects generate and invest those into more projects down the road and to execute those and absorb those into our, you know, GAAP earnings.

Thank you.

Thank you.

Your next question comes from John Mcmillin of Prudential.

Good morning and congratulations.

Thank you, John.

One comment and then one question.

You know, my comment, Carlos, is by keeping the earnings target in tact and I recognize it's reported earnings, you know, the bar for '05 and '06 is not being raised and you can, you know, you can do your targeted level of earnings growth just by having, you know, less project costs, so that would be my comment and I -- I would like my question to kind of focus on Europe.

Which might have been, you know, the only weaker spot in -- other than Australia in a very good quarter.

Can you talk a little bit more about the U.K., I understand there's some articles this morning, kind of highlighting that the sugar and salt you use in Corn Flakes is less than the amount of sugar and salt in Corn Flakes in the U.S. and just kind of what's going on in -- in the U.K. market, specifically in cereal?

Let me address the first point, John.

You know, we're going to give you some -- we'll give you guidance for 2005 after our third quarter and during our third quarter release.

You're right, we could -- we could have fewer up front costs or charges in 2005 and increase our earnings.

Because we have this, as I mentioned, this, what we call embedded earnings in our profit and loss statement.

We continue to look for cost savings.

We know we can invest more in brand building.

And the important thing is that we've got the earnings power and the visibility to -- to, you know, to achieve the -- what we have called dependable, sustainable growth.

And that's what we're after.

So your point on Europe and the U.K., you know, we saw category growth of close to 4%.

This is year-to-date now, U.K.

We're growing ahead of that so we're growing share once again in the U.K. and we're seeing that market, you know, react and be a bit more vibrant than what we had seen in previous -- in previous years.

In terms of formulations of products, there, you know, there could be slight differences in formulations, depending on local tastes, depending on local consumer preferences.

But there's nothing, you know, nothing significant to report or nothing -- nothing big in terms of a program to reformulate our product.

Thank you.

Thanks, John.

Your next question comes from Eric Katzman of Deutsche Banc.

A few questions, details.

First of all, on the one-time costs this quarter, can you break those out between cost of goods and SG&A and also by region?

You know, it will be in our filings, but on the cost initiatives incurred, about half of that is cost of goods sold and the other 50% is in our SG&A line.

Okay.

And is that also fair by region, between North America and Europe?

Yes, that's pretty close, I would suspect.

SAP and the European project going on there versus the snacks move and Worthington, it's probably fairly equal.

Okay.

And then also on the top line, you didn't disclose whether promotion was a -- a addition or deduction to net sales.

Can you go into that a bit more?

Yeah, you know, it's -- you know, our trade spending, certainly like all companies, is above net sales.

It's I would say slightly up for the quarter versus last year, but very marginal.

Okay.

And then, Carlos, I guess, you know, I recently had conversations with Pepsi Co and they kind of eluded to a, you know, real kind of change in the snack, in particular snack and Granola bar environment in the June quarter mentioned that both General Mills and Kellogg both put out new products at lower price points than they've been -- been at historically.

Lots of competition in the category.

I mean I realize it's, you know, an important but -- but, you know, relatively small part of the business.

Maybe you could comment a bit on the category health and how you see your business within that -- within that framework?

Yes, Eric, what we're seeing and I talked a little bit about this, was a lot of new product introductions of the -- the number I've got in my head is 65 SKUs, in for that wholesome snack section.

So, you know, a lot of products being thrown into that section.

I think there will be a point where it shakes out and what -- what really survives are big brands that have, you know, longevity and that will stick for the long-term.

This quarter, for example, our Special K bars were up about 7%, our Nutri-Grain business was up about 8%.

So, in spite of all these small SKUs coming in, our big brands did -- did well.

And I think in the future what you'll see is, you know, these -- all these small new products and a lot of these SKUs will eventually fall off and what you'll have is big, stable brands that -- that will stick in that section.

But right now we are seeing a tremendous amount of competition and people trying to get into that game.

Okay.

And then last -- last question is, you know, with the balance sheet improving and cash flow continuing to be at a good level, I guess that -- that brings in the question of M&A and, you know, debt reduction isn't going to serve much purpose shortly.

So, can you just kind of refresh us on what your thoughts are bout, you know, what areas you'd like to get into in M&A, dilution and some of those other topics?

Well, you know, we're always looking at M&A opportunities, we probably looked at 20 over the past year.

As you know, we're disciplined about it.

We don't like to overpay.

But there is nothing on the horizon and we don't believe that we need something of a magnitude that would, you know, seriously impact our -- our -- our EPS or have a dilutive effect.

But we're always looking for a bolt on acquisitions and, you know, I -- I don't want to comment any more specifically but -- but we're always looking for things that we can add.

As you know we'd like to stay focused, we're not going to become a -- a total food conglomerate, so, whatever we do add will be complementary and we'll have some linkage back to our current businesses.

Okay.

Thank you.

Thank you.

Your next question comes from Terry Bivens of Bear Stearns.

Good morning, everyone.

Good morning, Terry.

I may have missed this, I think Eric Larson may have asked it.

Through the first half on up front costs we are now at a total of a nickel?

That's correct.

That's correct.

Okay.

And Carlos, as we look into the back half, I mean recognizing certainly starting with U.S. cereal, we've got some pretty tough comps there, you've got a 10% sales increase in Q3. 9% in Q4.

Do you think U.S. cereal sales will grow over the next two quarters?

Are you expecting a positive number there?

Well, as you say, I mean we've got some really, really tough comparisons.

The important thing is that the -- I would say the portfolio, without getting into our cereal numbers specifically, we expect the portfolio to be up so if -- if cereal is up against some very tough comparisons, we will make that up in other parts of the business.

And you're talking U.S. cereal specialty, we -- we just had, you know, a tremendous quarter last year.

But the important thing is that we expect our sales to grow in the third quarter and in the fourth quarter.

We're up against about a 4.5% internal growth last year in the third quarter and a little less than 4% in the fourth quarter.

So, you know, low single digit, we don't expect the kind of blowout quarters that we had last year on U.S. cereal.

Uh-huh.

But overall the portfolio will grow.

Okay.

And implicit in that, I haven't had a chance to run the numbers, but implicit in that is -- is you feel pretty good about international cereal growth, I guess, despite the fact that we've, you know, got double-digit comps to go up against there, as well.

Yes, we do.

Would that be fair?

Yes, that's correct.

Okay.

Thank you very much.

Okay.

Thank you, Terry.

Your next question comes from David Adelman of Morgan Stanley.

Hi, good morning, everyone.

Good morning, David.

Carlos, could you comment on the competitive dynamics within U.S. cereal at the moment?

It appears that competitors either have or intend to accelerate their pace of new product activity?

And the data that we see would also show some visible increase in competitive promotional spending.

Is that your read of the market, as well?

Well, what we've seen and what the data suggests is there has been an increase and an intensity in price promotions.

We have yet to see the surge in new products and, you know, consumer stimulus, but that would be very welcome because the category, the category needs that and we know that ultimately that -- that is what drives the -- the category, is consumer stimulus and new products and marketing and things like that.

And do you think that the price increase you're taking is going to hurt the category's overall trends?

Well, you know, we expect to invest back in the category and -- and we know that over time that is what -- what helps this category grow.

We may see some slight easing at the beginning, you know, the -- the initial jolt, but we don't see this as a major -- as a major deterrent for the future.

If anything, it gives us more ability to invest back, which is what we believe our business in the category needs.

And then lastly, Carlos, in France in the second half of the year, I think that's your second biggest market in Europe and there are mandated price reductions that the government put through.

Is that going to be material to your second half European results?

No, we don't believe so and we're still working through that and it's not something that will -- that we're expecting to impact our -- our European numbers.

And especially our corporate numbers.

Okay, thank you.

Thank you.

Your next question comes from David Driscoll of Smith Barney.

Thanks a lot, good morning, everyone.

Good morning.

I wanted to follow up on the questions on expected internal sales growth or reported, however you like to do it, going forward.

You know, when -- I think Terry was just asking about the cereal numbers and certainly they're very strong comparisons in 3Q and 4Q from a year ago, however, you know, 1Q '04, 2Q '04, you know, total internal sales growth is markedly above your long-term expectations and if I heard you right, and this is what I want to be crystal clear on, you're saying that the momentum that we've had here, 6.5 in the first quarter, 5% in the second quarter, should come down materially in Q3 and in Q4.

Is that correct?

Well, what I said is that, you know, going back to what our guidance has always been, is low single digit net sales growth, internal net sales growth and that's what we're expecting in the back half.

Just to give you a sense of the third quarter, and I think I can do this on this call, is our business in July suggests that that's doable.

We continue to see the momentum in July and we were up in that low single digit range.

Maybe, Carlos, if I even try the question in another direction, it just seems to me like the business has been very strong, stronger than you expect, so, to expect low single digits in the Q3, Q4, you know, -- it doesn't seem like -- it seems like I want to be higher than that because we've seen fundamentals here that were stronger than what you normally expect.

And I'm trying to almost get from you guys the expectation as to what's the variance, what brings it down to these lower numbers?

Where do we see weakness on a sequential basis?

Well, we hope you're right and we would also like to see more than our low single digit, but we are up against -- we are up against some -- some very difficult comparisons and we -- we, as you know, we like to be realistic, we like to be realistic in our forecast and our expectations.

And what we ask our people to shoot for.

You know, I will say that our businesses, our internal sales growth, I've got a chart in front of me, 10 quarters in a row where we've seen solid internal sales growth and we expect to keep that up.

But at this point low single digit is what we're calling and again, we like realistic targets.

We don't like to throw out big, lofty goals.

If we hit them, that's great.

All right.

I appreciate that.

On -- can you also give us some color on the cereal price increase?

When does it really percolate into the P&L?

I mean is there a period of time in which it will take before those price increases are actually realized?

Yeah, I would say, you know, generally speaking it's probably neutral in the back half and it's the kind of thing that will -- that will give us a full year benefit in 2005 but there's a lot to work through, programs that are already on the Street and, you know, things of that nature.

So, I would just plan it to be a neutral, in this year.

And then the benefit coming in '05.

On the up front costs you guys have talked a lot about the actual costs themselves this year and -- and the quarterly breakdown, I think I'm clear on that now, but what I'm not clear on is exactly what type of benefit that we get ongoing in subsequent years.

Can you quantify, so, if we're going to take a 15-cent hit this year, what type of savings on a -- on a, you know, ongoing basis, do you expect from these programs?

Yeah, you know, typically we're looking for a four-year pay back.

A four-year pay back?

Right.

Okay and then -- and then lastly you made some comments about your debt.

You know, you're still are expecting that just greater than $300 million reduction.

Can you just talk a little bit about the -- you know, if I look I think on the second quarter balance sheet, you know, the short-term number is up a bit.

Is there any desire here to -- to take more of that and term it out?

Or can you kind of give me a sense here, I'm trying to really drive that interest expense in '05, so, trying to get a sense as to where the different pieces are going to go, fixed, floating, short-term, long-term.

Right.

You know, really the next time we have fixed debt that's due is really toward the end of 2005.

So, up until that point we'll be pretty -- pretty similar mix to what you see right now.

Super.

Thanks a lot, very good quarter.

Thank you.

Kiela, if we could take just one more question and wrap it up, please.

Our next question comes from Chris Growe of AG Edwards.

Thank you.

I just made the cut it looks like.

The -- my first question -- I think you've answered this, so, if we look at 15 cents per share in incremental commodity cost pressure this year, are higher prices in any of your categories, for example, cereal, overcoming that level of increase in costs? -- or is that sort of a net number or an absolute increase?

No.

That's an absolute increase and certainly with the pricing action that we've taken that's hoping to offset the commodity transportation costs but not entirely.

Okay.

And then the up front costs, if I recall, was 12 cents per share last year.

You had -- we're looking for somewhere close to 15, 16 cents this year.

So, you have, you know, 28 cents or so in up front costs.

We should look at that as a four-year pay back then for these incremental costs, is that right?

Yeah.

You know, last year, actually, when you look at the up front costs, they were close to 15.

Similar to this year and, yeah, we would be looking for a four-year pay back on that, but the savings that are generated from the projects are reinvested, you know, back into further cost initiatives that give us visibility or brand building.

Looking forward to a time when those are not reinvested back into the business, I assume so--

Yeah, but that's, you know, our business model really, really looks for that.

The important thing is we've got the earnings power and we've got the visibility and we're shooting for sustainable, dependable growth as we've always said.

Sure.

We're just trying to deliver on what we said we would.

Absolutely.

And then my last question, then, really regards the weakness in the Asia-Pacific division.

Is that something that will ease in the coming quarters?

Or is this a sort of a four-quarter event to sort of work through until you can get through that more difficult competitive environment?

We believe it will ease somewhat although it will be a -- it will be a tough year.

We just had a new competitor come in in Australia and we have a, you know, very high share of that category so you would expect that -- that the initial impact is up against the, you know, the Company that has the higher shelf space and the higher market share.

So we're forecasting that we'll continue to have competitive pressure in Australia throughout the year.

But we should, you know, we should get through that as we have in the past and work our way through a good 2005.

Is this requiring you spend more aggressively, promoting, for example, or advertising, any more than you have been before?

Not to the point that it would be material or, you know, or that would impact our results.

I mean we're -- we're spending, it's a matter of spending in the right places and investing in the right places, having the right new products.

So, I wouldn't see a material difference in that.

Okay.

And I just had this one other question, that's sort of the uses of cash and will we see Kellogg be more aggressive, will share repurchases of stock prices come back a little bit.

Is that something that offers an opportunity for the back half of the year?

When we look at the -- the uses of our cash flow, you know, we've been pretty consistent since, you know, 2001, that we made a commitment to our equity and bond holders to have debt repayment as our main priority.

And I think at the end of the first quarter we talked about having a more balanced approach between debt reduction and share repurchases going forward.

So, that's basically from a -- from a use of cash standpoint.

That implies it will not change in the second half of the year, is that right?

That's correct.

Okay.

Thank you.

Thank you, gentlemen, are there any closing remarks?

Thank you very much for being on the call and we're going to continue to -- to drive the business the way we have and we appreciate the support and the interest in our Company.

Thank you.

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