家樂氏 (K) 2005 Q4 法說會逐字稿

Good morning.

Welcome to the Kellogg Co. 2005 fourth quarter earnings call.[OPERATOR INSTRUCTIONS] After the speakers' remarks, there will a question-and-answer period. [OPERATOR INSTRUCTIONS] Also, please limit yourself to one question during the Q&A session.

Thank you, and at this time I will turn the conference over to Mr. Simon Burton, Kellogg Co., Director of Investor Relations.

Mr. Burton, you may now begin your conference.

Thanks, Amy.

Good morning, everyone.

Thank you for joining us for a review of our fourth quarter and full year results, and for some discussion regarding our strategy and outlook.

With me in Battle Creek are Jim Jenness, Chairman and CEO;

David Mackay, President and COO;

Jeff Boromisa, CFO; and Gary Pilnick, General Counsel.

We must point out that certain statements made today, such as projections for Kellogg Co.'s future performance, including earnings per share, net sales, margin, brand building, operating profit, innovation, costs, interest expense, tax rate, cash flow, working capital, share repurchases, and is 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 filings.

A replay of today's conference call will be available by phone through Friday evening by dialing 888-203-1112 in the U.S. and 719-457-0820 from international locations.

The pass code for both numbers is 3185746.

The call will also be available via webcast which will be archived for 90 days.

Now, let me turn it over to Jim Jenness, Chairman and Chief Executive Officer.

Good morning, 2006 marks the 100th anniversary of the Kellogg Co. We have every confidence that it will be another excellent year of sustainable and dependable performance, but more on that later.

My message at the start of last year was all about staying on track.

Staying on track with our overarching focus on sustainable performance defined by our long-term targets with our growth cereal, expand snacks, and pursue selected growth opportunity strategy with our volume to value and manage for cash operating principles; staying on track to increase effective brand building at a rate greater than sales growth, executing cost savings initiatives, and driving visibility beyond 2005 for innovation, brand building, pricing actions and cost savings initiatives.

While staying on track is exactly what Kellogg Company did, 2005 was our strongest performance since we implemented our focused strategy.

Strong results were delivered across business units and geographies and we invested to set up a winning 2006.

The same operating team that implemented the focus strategy remained in place and delivered again.

David as President and COO;

John Bryant running Kellogg International;

Jeff Montie, running Kellogg North America; and Alan Harris in Global Marketing.

In the U.S., our ready-to-eat cereal market share increased in measured channels for the sixth year in a row.

Our 52-week leadership position more than doubled in 2005.

The quality of this share performance dramatized our commitment to sustainable growth and doing the right things for the long-term.

Our 2005 ready-to-eat cereal base business grew as a result of effective brand building and a very strong share of innovation, well above our total category share.

Outside the U.S., we grew or held share in nine out of our 10 of our top 10 businesses including the U.K., Canada, and Mexico.

These nine countries account for over 90%, excuse me, 80% of our net sales and operating profit and these are regions in which we have an average 50 share.

Our internal net sales growth of 6.4% is a fourth year in a row of strong increases.

This increase is the fastest growth we've seen since the adoption of our focused strategy.

Price mix and volume all contributed to the increase.

Gross profit margin was strong in 2005.

Significant headwinds were offset which totaled more than 70 basis points of margin for the year, and don't forget in COGS we also had an additional 45 basis points of incremental upfront cost initiatives.

Our internal operating profit growth was 5%, right in line with our long-term guidance, and are pleased with the quality of this growth as it would have been much higher had we not have absorbed significant inflationary costs, and significantly increased our investment in volume to value to brand building and invasion for the long-term.

Our tax initiatives worked and generated millions of dollars in savings in 2005 alone.

This is a result of our continued investment in cost savings initiatives that helped drive sustainable growth.

Earnings per share increased at a double digit rate for the fourth consecutive year, remained focused on manage for cash, lowered our industry leading level of working capital, and again generated strong cash flow.

We then used this cash wisely.

We completed a significant share repurchase that benefited our shareholders and drove additional value.

And all of this led to our fourth consecutive year of improvement in return on invested capital, and we increased the dividend for the first time in four years.

Once again, our approach to planning using realistic goals set up this continued strong performance while driving the right behaviors for sustainable growth into the future.

Now let's look at our results in more detail.

Slide 4 gives you a summary of our key financials.

Reported net sales increased by 6% due to very strong internal growth of 6%, a slight favorable impact from foreign exchange was more than offset by the fact that we had a 53rd week in 2004.

Internal net sales growth in the fourth quarter was also a strong 6%.

Internal operating profit growth was 5% in 2005, reported operating profit increased by 4%.

We're pleased with this given the significantly higher investment we made for sustainability and a dramatically higher fuel, energy and benefit costs which affected the entire industry.

This is the power of volume to value and managed for cash in action.

Earnings per share for the full year increased by 10%, driven by strong sales growth and helped by lower interest expense which resulted from our focus on manage for cash.

We also had a lower tax rate due to tax planning initiatives and fewer shares outstanding as a result of our more aggressive share repurchase program.

EPS for the fourth quarter was $0.47, or 4.4% growth despite the effect of the 53rd week.

We delivered this performance and still made a contribution to our Corporate Citizenship Fund of $0.02 a share.

Full year cash flow reached $769 million including strong contributions to benefit plans of approximately $400 million, or $200 million more than in 2004.

Slide 5 is our volume to value wheel.

We achieved strong performance across this sustainable growth model, maintained gross profit margin despite significant inflationary headwinds and funded incremental up front cost initiatives, invested in double digit increases in brand building, improved price mix, delivered excellent innovation sales performance in a very strong top line.

Let's look at each of these metrics in more detail.

Slide 6 shows our net sales growth.

For the full year internal net sales growth was 6.4%.

Price mix and tonnage growth, again, contributed to our internal sales growth result.

Those of you familiar with volume to value recognizes that it is all about generating profitable and sustainable revenue growth.

We are not driving tonnage growth through price cuts.

You can see this in our price mix improvement in these results, and public category data.

Rather, tonnage growth is being driven by consumer pull as a result of effective brand building programs and successful innovation.

Tonnage growth in our more profitable brands, along with price mix improvement is good, and our revenue growth momentum continued right through the fourth quarter.

Foreign currency translation in 2004's 53rd week impacted both fourth quarter and full year results.

Let's now turn to slide 7.

Our long-term target is to increase investment in brand building at a rate faster than sales growth each year.

We achieved this in recent years, and, again, posted double digit growth in 2005.

Investment in brand building is a principal driver of the profitable and sustainable revenue growth that is the goal of volume to value.

Heavy trade discounting provides temporary rented share gains, but it doesn't build brands.

In 2005, we delivered operating profit growth in line with our long-term target of mid-single digit growth and make no mistake, we made significant investment in brand building and innovation during the fourth quarter and full year.

We will not under invest in the business, and we certainly didn't do this in 2005.

In 2006 we will continue to target dependable rates of sales growth and we'll invest to achieve them over the long-term.

Now, Jeff will walk you through more of our financial results.

Thanks, Jim, let's turn to slide 8.

We maintained our gross profit margin for the full year of 2005 at 44.9%.

The performance in 2005 was primarily the result of uncontrollable weather-related increases in fuel and energy costs of $60 million, and a $12 million charge for the conclusion of a collective bargaining agreement in the fourth quarter.

These factors reduced full year gross margin by 70 basis points alone.

In addition, incremental upfront costs for costs savings initiatives reduced gross margin by another 45 basis points in 2005 versus 2004.

Remember, all of the $0.15 of upfront costs were in cost to goods sold for 2005.

Gross margin for the quarter declined by 130 basis points.

Due to the headwinds having a proportionately greater effect in the fourth quarter the Company expects its gross profit margin to expand in 2006 as a result of price increases taken in 2005, and cost savings from prior investments.

So our gross profit margin performance was strong given the serious headwinds.

Fuel and energy costs increased in 2005 on top of commodity inflation of approximately $0.15 of EPS in both 2003 and 2004.

Our cost savings projects have helped us overcome these headwinds and we plan to overcome them again in 2006.

This is exactly what sustainability is all about.

Slide 9 shows our internal operating profit growth for the full year and fourth quarter by region.

This internal growth excludes the benefit of currency translation and 2004's 53rd week.

Internal operating profit growth was 5.2% for the full year, right in line with our long-term target.

Internal operating profit increased by 3.5% in the fourth quarter even with the increased investment in brand building and cost pressures on gross profit that I just mentioned.

In North America, internal operating profit increased by 2.4% for the full year and decreased by 11.1% in the fourth quarter.

North American results included all $90 million of this year's upfront costs and significant increases in brand building.

Both of these items had a significant effect on the fourth quarter results, as well.

Remember, though, these are investments for the future.

Internal operating profit in Europe increased by 14.9% for the full year and 284% in the fourth quarter.

We also made significant investment in brand building, as full year investment increased at a strong double digit rate.

Remember, too, that most of the upfront costs in the fourth quarter of 2004 were in Europe which resulted in this year's large profit gain.

In Latin America, internal operating profit growth was 6.6% for the full year and 18.5% in the fourth quarter.

We achieved this excellent full year result despite an increase in investment in brand building of more than 25%.

And internal operating profit in Asia Pacific increased by 7.4% for the full year and declined by 11.7% in the fourth quarter.

We achieved this excellent full year result even with the increased investment in brand building.

The fourth quarter result was affected by comparisons to the fourth quarter of 2004 when operating profit more than doubled.

Our full year tax rate was 31.2% which was broadly in line about our expectations.

Slide 10 shows our improvement in working capital that we made in recent years.

This is core working capital measured as receivables, plus inventories, less trade payables divided by our last twelve months sales.

As we mentioned before, this does not include customer trade liabilities which would artificially improve this measure.

We believe that there is room to improve further, as we demonstrated again in the fourth quarter of 2005.

We will continue to spread best practices around the world, even from our industry leading position.

We remain focused on the generation of cash flow as you can see on slide 11.

As you know, cash flow of $769 million in 2005 was in line with our expectations and included total contributions to benefit plans of approximately $400 million, and including a $300 million contribution in the fourth quarter alone.

These contributions totaled approximately $200 million greater than 2004's total.

CapEx was 3.7% of sales in 2005, and as we previously announced, it should be about 4% in 2006, right in line with the peer group average.

This capacity was made necessary by the success of volume to value, our sustainable growth model.

Our value added innovation and brand building programs have been so successful that we need to add the capacity to meet sales demand.

Just to put this into perspective, since 2002 our sales have grown $1.9 billion, essentially the size of our European business.

Mini-Wheats, alone, posted measured channel growth of approximately 18% last year, and our Eggo business posted double digit sales growth in each of the last two years.

We remained as careful and disciplined about CapEx as ever while serving our customers and driving incremental mix and returns.

Looking now at slide 12 and our debt level.

Our debt remained at about the same level as last year.

Debt increased in the last quarter, primarily as a result of share repurchase of approximately $400 million and benefit plan contributions completed in the fourth quarter.

We remain committed to the continued long-term repayment of net debt, or reducing total debt less cash and the financial flexibility it brings.

As we mentioned, we repurchased $400 million worth of shares in the fourth quarter from the W.K.

Kellogg Foundation Trust, and repurchased a total of $664 million over the course of the year.

We have a $650 million authorization for 2006 and expect to complete the full amount by year end.

Return on invested capital improved significantly in 2005 after three years of strong growth as shown in slide 13.

Our 70 basis point improvement is the result of our focus on volume to value and managed for cash.

You can see, based on the slide, the effect this focus has had in recent years.

Slide 14 details our outlook for 2006.

We continue to expect low single digit internal revenue growth, mid-single digit operating profit growth, and earnings per share of $2.43 to $2.48 per share, which includes the impact of expensing employee stock options.

We now expect that the impact of options will total $0.09 per share, in line with 2005, rather than the $0.08 we told you last quarter.

This increase is largely due to the share repurchase activity late in 2005.

The earnings guidance range of $2.52 to $2.57, without the effect of the options, is an increase from previous guidance of $0.02 per share.

Included in our guidance is the expectation that benefit costs will increase by between $0.03 to $0.07 for the full year, and that total fuel and energy costs will increase between $0.13 and $0.16 per share.

Changes in fuel and energy prices in the fourth quarter confirmed that the estimates we gave you last quarter appear reasonable for 2006.

However, this still represents a significant amount of cost inflation after two years of $0.15 per share in incremental commodity costs.

We have also included in our guidance cost savings projects that will total $0.15 this year.

These projects have a high return which we will use in future periods to increase our investment in brand building and R&D.

Remember, this investment is part of volume to value, our sustainable growth model, and helps us provide sustainable, consistent rate of growth for the long-term as we have demonstrated.

As a result, we have also included in our guidance an increase in brand building investment greater than our expected sales growth rate.

We expect gross profit margin expansion in 2006 and that some operating margin expansion will provide mid-single digit operating profit growth right in line with our long-term target.

We also continue to expect some leverage below the operating profit line, interest expense will be lower than 2005 and the tax rate should be between 31% and 32%.

So the lower interest expense, tax rate, and fewer shares outstanding should lead to a high single-digit earnings per share growth for the full year.

While we don't give quarterly guidance, I do want to give you a sense of the shape of the year.

As you remember, the operating profit in the first half of 2005 was very strong.

Brand building investment will certainly be significant in the first half of 2006, effectively balancing out operating profit delivery across the year.

We continue to have confidence in our full year guidance and the dependability of our business model.

We again expect to meet our long-term targets in 2006.

It is because the strength of our operating principals and how we run our business for sustainability that we can achieve this result in this environment, while continuing to increase our investment in brand building and future sales growth.

Now I will turn it over to David for a review of our operations.

Thanks, Jeff, and if you look at slide 15 it shows our North American internal sales growth for the full year and the fourth quarter.

Full year growth of 8% built on strong growth of 5% in 2004, and fourth quarter growth of 8% also built on 5% growth in 2004.

This is comparable growth as it excludes the effect of currency translation and the 53rd week, which fell in the fourth quarter of 2004.

This growth was a result of price mix and volume improvement and we're carrying good momentum into 2006.

While each of the components of revenue growth should remain strong this year, we're budgeting for price mix to contribute about half of that 2006 top line growth.

Let's look at North American retail cereal in more detail on slide 16, which shows the quarterly growth and full year results for 2005.

A strong momentum continued in the fourth quarter as we posted 8% internal growth.

Consequently, full year growth was also 8% and this is an outstanding performance resulting from increased category share and growth in non-measured channels.

In the U.S., new products introduced during the year, some of which are pictured on the slide, performed very well and helped drive this growth.

As we discussed last quarter, we're maintaining the pressure in 2006 with significant new product introductions and brand building programs.

Very strong brand building programs also aided to 2005's results.

We had effective advertising behind many of our brands, including the healthier [INAUDIBLE] messaging behind Smart Start Healthy Heart, the Mini-Wheats fiber messaging, and the popular Raisin Bran Crunch programs.

Kashi posted another year of double digit growth.

Kashi is a highly credible brand in the important in the natural and organic channel.

In addition to our strong results in the U.S., our Canadian business also had an excellent 2005 after a difficult start to the year.

After no growth in the first quarter, as a result of a very competitive and promotional environment, we posted internal sales growth of more than 6% for the year and we also grew category share.

Slide 17 shows the increase we're seeing in U.S. ready-to-eat cereal category share in recent years.

This is comparable year-over-year growth, and we're very pleased that we increased category share by 40 basis points, again, in 2005 after after a similar increase in 2004.

In fact, this is our sixth consecutive year of category share gains.

Our fourth quarter was strong with 12 weeks share growing 90 basis points, primarily as a result of strong growth in our base business.

Slide 18 shows continued growth in the North American snacks business, which had another excellent year.

Our growth of 7% was above our long-term target, and we remain confident that our investment behind core brands like Cheez-It and Special K bars, along with our outstanding innovation plans will continue to drive growth in this business.

And, as many of you might know, we increased our prices on cookies and crackers late in the fourth quarter of last year to help offset some of the cost inflation we've seen.

Let's turn to slide 19 which details the North American retail snack results by category.

For the year, Toaster Pastries, Crackers and Wholesome Snacks all posted internal net sales growth.

Pop-Tarts had another very good year, posting category share growth of 1.8 points.

Pop-Tarts is a powerful brand, and we continued successful invasion in 2005 and we have more exciting products planned for introduction in 2006.

Our Cracker business also had another very good year with high single-digit sales growth.

Club Sticks has been a very successful introduction which also helped the base brand post high single-digit it sales growth, and Cheez-It, our largest brand, posted exceptional growth.

Even the Cheez-It base business was up at a strong double-digit rate.

We also have a lot of innovation being introduced right now in Crackers, including Cheez-It Crisps and Club Multi-grain.

Cookie internal net sales increased significantly in the fourth quarter as a result of strong innovation.

As expected, total net internal cookie sales were down slightly for the year.

We proved that it's innovation that drives this category, and our core brands posted solid single-digit net sales growth.

New products in 2006 include new Fudge Shoppe fill varieties and new Murray sugar free cookies.

Finally, our Wholesome Snacks business had another exceptional year with double-digit growth.

Base Nutri-Grain and Rice Krispies Treats performed well, as did Special K Bars and All-Bran Bars.

Fruit snacks continued to do well as a result of invasion, and we now have close to 25% category share after two years.

Wholesome Snacks will continue to be a focus for us, and with some great new products hitting the shelves right now, including Special K Snack Bites and Granola Munch Em's.

Our snacks business posted excellent results over the last three years, and we have confidence that we can continue to grow in 2006.

Slide 20 shows the results posted by our North American Frozen and Specialty Channels product group over the course of the year.

Internal sales increased by an exceptional 8% for the year, and by 8% in the fourth quarter.

This above-target growth continued all year long and resulted from strong performance across the businesses.

Eggo had an excellent year posting double-digit internal sales growth, building on double-digit growth in 2004, and share of the waffle category increased by 2.1 points.

Our new pancakes are doing extremely well, as are French Toast Sticks and Flip Flop Waffles.

Morningstar posted good mid-single digit internal sales growth for both the quarter and the full year, and our Specialty Channels businesses had an excellent year.

Food service, vending, convenience, and drugs all post the strong growth and we saw very good share performance, as well.

This strong performance continued into the fourth quarter as did our excellent execution, which you all know is of primary importance in these channels.

We have excellent visibility into new product introductions and brand building programs for 2006, and we're confident that our Frozen and Specialty Channels businesses will continue to post very good results.

Slide 21 shows reported and internal sales growth for Kellogg International during 2005.

Internal and reported sales growth was 4% for the year.

In fact, internal growth was solid all year despite competitive conditions in certain regions.

For the fourth quarter, internal growth was 3% and reported growth was minus 4% due to the stronger U.S. dollar and the impact of last year's 53rd week.

Importantly, Europe, Latin America and Asia Pacific all posted internal growth for the year and much of the growth came from their core brands and innovation within those core brands.

Special K, Cocoa Pops and All-Bran were all significant contributors.

Now let's look at each of these areas in a little more detail.

If you look at slide 22, it shows the full year and fourth quarter internal net sales growth of each of our three international areas.

In Europe, both cereal and snacks posted growth for the full year and the fourth quarter.

We're very pleased with this industry leading performance given the difficult environment experienced in Europe this year.

Across Europe, Special K gained posted solid sales growth in the fourth quarter, and both Cocoa Pops and Nutri-Grain saw double-digit growth.

In the U.K., where we'd seen some weakness earlier in the year, we also posted good growth in both cereal and snacks, and we increased our share of the ready-to-eat cereal category in both the 12-week and the 52-week periods.

As you remember, our innovation was timed to be introduced in the third quarter of the year and we've started to see the benefits.

We also increased share in Spain and France, Benelux for the year.

Latin America posted internal growth of 14% in the fourth quarter, and 11% for the full year, and we grew share in both Mexico and the Caribbean.

In Mexico, Corn Pops, Froot Loops, Zucaritas, and Special K cereal all posted high single or low double-digit sales growth as a result of strong brand building.

Innovation launched in the fourth quarter included two new varieties of All-Bran, Raisin Bran Crunch, NutriDia Amaranto Bars and NutriDia Flexi Bars.

Other markets in our Latin America region, Columbia, Venezuela, Brazil, Argentina, the Caribbean, and Central America all posted double digit internal sales growth in the fourth quarter.

Asia posted good growth in the fourth quarter and full year as a result of strong innovation, which launched later in the year.

In the fourth quarter, our South Korean business posted double digit sales growth after last year's weakness, and Japan posted strong mid-single digit growth as a result of strength in our adult brands including 2005's launch with Special K. We also increased our category share in Japan in 2005.

India continued to grow at a double-digit rate, again, in the fourth quarter driven by category growth and innovation and we have more planned for 2006.

In Australia, we posted a slight decline in internal sales growth for the full year compared to strong mid-single digit growth in 2004.

We posted a decline in internal sales in the fourth quarter due to very difficult double digit comparisons, as well as the timing of innovation and adverse competitive activity.

Importantly, cereal share rebounded at the end of the quarter as All-Bran, Be Natural, Guardian, Just Right, and Sultana Bran all posted share gains.

Reflecting on 2005 across the Kellogg globe we're very pleased with our top line growth and share gains.

Our innovation and brand building were strong and we invested across the business globally to build sustainable results and keep our momentum.

In 2006, we'll continue our focus on driving for sustainable growth and in an environment as tough energy and commodity inflation.

Pricing actions in late 2005 in a number of markets, plus our continued driver to reduce costs and improve efficiency in our business give us great confidence that we can sustain our recent performance into 2006 and beyond.

With that I will hand it over to Jim.

Thanks, Dave.

We stayed on track in 2005.

We delivered the strongest year of performance since we embarked on our focus strategy and we invested to drive sustainable rates of growth.

We have visibility for our innovation and brand building plans, as well as additional high value cost savings initiatives.

Our confidence in delivering another strong year in 2006 is high, and reflected in the fact that we raised our EPS guidance early in the year.

We have momentum coming out of 2005 with a seasoned management team and a proven strategy.

As we enter our 100th year, I would like to take this opportunity to thank our 25,000 employees for their hard work and commitment to the Kellogg Company.

With that I will open it up for questions.

Thank you. [OPERATOR INSTRUCTIONS] We'll now take our first question from David Palmer with UBS.

One quick question.

Heading into '05, you forecasted low single-digit internal sales growth and, obviously, you beat that with a plus 6% number.

I guess the concern is that against these tough comparisons the same guidance looks tougher to beat, obviously, the U.S. led things this year.

Could you perhaps give us some general view as to where upside may be, whether it is within the U.S., and whether it is outside the U.S., even insert internally within domestic businesses if it is going to be cereal or snacks that you see taking the lead, perhaps you can give us granularity there?

Thanks.

Dave, it is Jim.

First of all, I would like to say the performance of the Company this year has really been across our geographies in the business units, and the momentum we see there in terms of where incremental growth is going to come and where we will get it for next year will come from a similar profile.

That's what we're expecting.

The plans and the budgets we've seen certainly give us ideas that we seen give us the confidence for that, and I would say our talk about sustainability is it drives our actions, and we saw the strong top line coming in, we clearly invested against the business to set up continuing with that strong performance in the 2006.

To answer your question we're seeing it across the business units where it will come from.

The plans that we have in place and the visibility around our innovation gives us confidence in that.

So we're feeling real good about 2006.

By the way, in your overall cost guidance you had energy $0.13 to $0.16, I think it was, and your overall commodity costs have been at least for two years around $0.15 incremental each year.

Is that, is that right?

Hi, David, this is Jeff.

That is correct.

The last two years we've had commodity unfavorability for us about $0.15 each year.

Next year we're seeing $0.13 to $0.16 of earnings really in the energy fuel area.

In addition to that, we also are seeing about between $0.03 and $0.07 related to benefit costs.

So that's all in our guidance, and we're still looking forward to '06.

I think the big story here is that even with those headwinds we're able to increase our gross profit margin for 2006.

The volatility within the segment operating margins we saw in the fourth quarter here, I realize, obviously, some of the charges that were in the fourth quarter of '04 were reversed for Europe, but it did seem like the North American margin swing was bigger than, you know, what some of the 12 million settlement was?

Could you perhaps give us some color as to that 400 basis points plus change there in the U.S.?

When you look at the operating profit performance of North America, particularly in the fourth quarter, we had that collective bargaining agreement charge of $12 million.

That was totally in North America.

Also the upfront costs this year were all in North America, and for the quarter that was around $0.03 of EPS.

Those two factors is what caused the operating profit delivery.

It is right in line with what we're expecting to do with the up front costs.

Thank you.

Thanks, David.

Thank you.

Once again, please limit yourself to one question.

We'll Take our next question from David Nelson with Credit Suisse First Boston.

Good morning.

Congratulations.

Good morning.

Hard to find any problems here, and so maybe I will ask about cookies, obviously, you had better performance in cookies in the fourth quarter and you have news for this year, but over the last four years your share in cookies has gone down.

Is there something in the volume to value program that cookies just don't -- your position there, or something about the cookie category where it doesn't work as well as cereal or crackers in the volume to value program?

I think, David, you probably have heard us focusing very much on crackers and wholesome snacks.

We have not in any way given up on cookies, and our performance has been relatively flat, down a little bit over the last couple of years.

We are looking at innovation as being as key driver.

As we sit in the call, our core brands all grew in 2005, and our fourth quarter performance was very pleasing even though you didn't see it in the IRI data and that was a combination of things, including the fact that a non-measured channels we did very well and across both cookies, crackers, and wholesome snacks we had lower price-based spend in the fourth quarter and we also did a great job in DSD in lowering our unsaleables, which is a big factor when you have a DSD system and the team did an outstanding job of pulling unsaleables down in the fourth quarter.

Going forward on cookies, I think if we continue to innovate we're in a reasonable position.

We're going to continue to bat way and I think the strength of our execution in store is going it help us, and we feel pretty good about our position.

Okay.

Thank you.

Thanks, Dave.

Thank you.

We'll now move on to Ken Zaslow with Harris Nesbitt.

Good morning everyone.

Good morning, Ken.

Just one question.

In terms of the competitive environment in the U.S. cereal, do you think that your products continue to differentiate relative to the competition, if you think back a couple years ago when you came out with the Berries that was really something very different than what everybody had in the market.

Now, more and more companies are coming out with the yogurt chips other the other products that are a little more similar.

Can you speak to that as a product differentiation issue?

Ken, this is Jim.

The strengths of our business in the States here, and the brands, as you can see from the share improvement and the programs around innovation is outstanding, and the differentiation is what we are all about.

The investment in brand building at a rate greater than our net sales is what's behind it all.

The quality of the innovation and you think of brands like Smart Start, Healthy Heart, the positioning around that; you think about All-Bran, digestive health positioning, Special K, the positioning around weight maintenance, weight control, I think if I mentioned All-Bran, just these brands are, sit on top of extremely relevant consumer needs that are, in fact, becoming even more interesting to consumers now, and we have the power to continue to drive those, and it is to drive them with our communications, but also to drive the food, and continuously improve the food, and you look at our results and the strengths of brands, and you see a lot of our strength coming around our base businesses that we have really grown overtime.

This, I think, is an opportunity for us going forward, not only across our base brands, but you see how we performed on innovation and our share of innovation over the last three years and the last year the investment we made in this area to continue it.

This is an area of strength for the Company and an opportunity.

Thank you.

Thank you.

We'll now take a question from John Feeney with Wachovia.

Good morning, guys.

Congratulations.

Just one question on cereal.

Can you detail first, and then a strategy question, if you, when you look at the 8 percentage net sales growth, forgive me if you said it, but could you, at least approximately, break that down between pricing and volume, and then just comment on when you look at price gaps, and market share gains and the health of some of your competitors in the category, how sustainable are these continued share gains in your view?

Is it getting harder to take share away from branded, potentially private label, competitors given what it appears to be consistent dollar share gains over the past two years that are coming out of somebody's hide?

John, it's David.

Let me have a crack at that, there are a couple of questions in there.

The first one just to respond to the difference between reported internal and IRI data that you are probably looking at, fairly consistent with what we've been saying on an ongoing basis, just so you know our inventories are broadly in line with year ago and down from the third quarter.

So it wasn't inventory driven.

We had about 3% or 4% incremental growth versus IRI coming out of alternate channels, which has been relatively consistent for the last year or so, and we had greater than 2% benefit from lower Q4 price activity versus year ago from a Kellogg perspective.

I think the great thing, if we look at our business in the fourth quarter Kellogg grew total sales and we grew base sales.

We were only branded player to grow our total sales and our base sales.

Coming to your question is can we continue to gain share?

I think the bar goes up every year.

We're performers, we have been performing, but execution is critical.

As Jim mentioned innovation is going to be critical.

We continue to gain quality [murch] as our field force does an outstanding job, and I think the strength of our innovation is value added promotions continues to drive a good support from our retail partners.

The third part of your question probably poking a little at private label, I think we mentioned our expectation was private label's growth would slow in the back half.

We're seeing exactly that happen.

Private label was up over 7% for the year, just over 3% for the fourth quarter, and up 1% for the latest month of the year.

I haven't taken pricing it doesn't appear, and we feel good about what we can do going forward.

We're just going to deep driving very, very hard.

Just one other thing, David, I am sorry, could you approximately break out the 8% between price mix and volume?

If you look at IRI, it is just short of one.

If you take three to four old channels and you take more than 2% for lower trade, that's basically it and on --

I see.

Okay.

Yes.

Thank you very much.

Thanks.

[OPERATOR INSTRUCTIONS] And, once again, please limit yourself to one question.

Moving on to David Adelman with Morgan Stanley.

Good morning, everyone.

Good morning, David.

Can you comment on the outlook for the first quarter earnings?

Do you expect to have higher earnings in the first quarter, and I ask that because you've, obviously, had two dynamite consecutive first quarters in '05 and '04?

As you know, as we talked about, David, this is Jeff, for the first half we don't normally give quarter-by-quarter guidance.

But for the first half of '06, looking at our delivery of operating profit last year, which was very strong in Q1 and Q2, we see certainly a strong investment in brand building happening in 2006.

We expect our operating profit delivery to be pretty consistent by quarter.

Right now that's about all the guidance we would give on a quarter-by-quarter basis.

Okay.

Just to be clear, the $0.02 collective bargaining agreement is not included in the fourth quarter in the upfront costs you've referenced, is that correct?

That's correct.

Thank you very much.

Moving on to Eric Larson with Piper Jaffray.

Good morning.

Congratulations, everyone.

Your stock option expensing, is it fair to assume that those expenses will be spread evenly across the quarters like about $0.02 or about throughout '06?

Eric, this is Jeff.

That's a good assumption to make.

Okay, and then, Jeff, also tax rate?

You did get quite a bit of benefit in the fourth quarter.

I am assuming that's from things you put in place over the last couple of years.

Is that a sustainable tax rate for '06, as well?

That is, and we're looking at an '06 tax rate of around 31% to 32%, and we do believe that's ongoing.

We've done a lot of work with our tax planning initiatives around the world and we're seeing some good dividends coming from that.

Q4, specifically, was impacted by mix, country mix around the world and we did have some discreet items that are unexpected tax resolution items.

Okay.

Good.

Thank you.

We'll take our next question from David Driscoll with Citigroup.

Good morning.

This is Michael Avery for David.

You demonstrate about as well as anybody the value of the consumer spending and the advertising.

But you, obviously, at some point wouldn't it be fair to think that that could level off a little bit, that you're describing '06 as increases above the rate of sales.

Is that a deceleration from the double digits, double digits, obviously, would be above the rate of sales, but is that, are you reaching a point where your increases can decelerate because of the base being so big?

Michael, this is Jim.

In our long-term guidance, just all around having our brand building running ahead of our net sales, but for us it is, we're not just investing brand building against laying it on top of same programs.

We are, we have a whole menu of opportunities to invest against and whether it is line extensions to our current brands, additional innovation, and as we see business momentum going, it is absolutely critical for us and our commitment to sustainability to invest against those opportunities.

We want to keep driving our brand building, the teams are outstanding at that in terms of building brand value and getting on top of consumer benefits that are extremely relevant in today's world.

So our commitment to brand building around our long-term guidance is, as I said, above our net sales.

But if we see the opportunity to invest against incrementally as the business develops against opportunities and visibility we have we're going to do it.

I think that helps.

I think the benefit is very clear.

You really do have a lot of believers, I think, in the value of that spend, but would the increases perhaps be lessening over time, so that you're basically getting some operating leverage, maybe?

It sounds like the double-digit increases from the last couple years might not be quite the increase that we'll see going forward.

Is that fair?

I think the best way, Michael, to think about it is our long-term guidance, and we're going to invest ahead of net sales and that's in our model, and that's in our whole volume to value model and how we go about it.

Okay.

Thank you very much.

You're welcome.

We'll now take a question from Chris Growe with A.G. Edwards.

Good morning.

Good morning, Chris.

I have two questions for you.

First one, more more so from a modeling standpoint.

I know Asia had some tough comparisons year-over-year, but there was some weaker internal growth than what I expected in the quarter.

Is that expected to ease into that into 2006, we should see better growth throughout the year or is the first half going to be a little weaker, can you talk about that in more detail?

I think, if you're looking at 2006, I would expect their growth to be relatively balanced.

I don't have right at hand exactly what we did quarter-by-quarter.

No major ups or downs.

There can be some, and if there are, we will report them, but we're expecting low single-digit across the year, Chris.

Okay.

And then my last question just is a general question on pricing and volume.

You seem to show a better balance this quarter and, obviously, across the year.

Are there pricing actions that you've taken that internationally we're not aware of?

I know cookie/cracker in the U.S.

What other pricing activities have you taken that will help 2006?

We've taken a number of price increases, late in '05 that we believe will clearly have a positive impact on our price mix for 2006, and, you know, while we've taken a number, they not only help us offset some of the energy and cost inflation we've seen, and the only one we've taken that was mentioned in the U.S. has been in cookies and crackers and that was very light in 2005, as well.

So were there international markets you can mention where you took pricing, for example?

The U.K. we took pricing, Mexico, a couple of others.

And these are late in '05?

Yes.

And then, I guess, generally as you see the pricing environment here in the U.S., and I really refer to cereal, private label prices have at least been creeping up and I know it is not necessarily from a price increase, would you regard the environment for U.S. cereal pricing as positive today given private labels movement of late?

We don't comment on pricing, you know.

I think everyone recognizes the current inflation environment we're in given energy and some of the other costs, but wouldn't like to comment on that at this stage.

Thank you.

Thank you, and as a reminder please limit yourself to one question.

We'll now move on to Terry Bivens with Bear, Stearns.

Good morning everyone.

Good morning, Terry.

As you look at the P&L, we just finished the second year, I guess, where the growth of operating income is less than the growth of sales, which is not in your algorhythm, of course.

I know you project that to reverse next year and clearly there are two big drivers of that, all these commodity, before that food ingredient cost, certainly number one, but the upfront cost which is really my question.

We've had roughly $0.15 now for four, three years and projected to be the same for '06.

How long do we keep seeing that?

Isn't there a point -- I know various people have tried to take a look at the pay backs on those.

But is there a point in your mind where those begin to fall off in a significant way?

Terry, this is Jim.

A critical part of our whole sustainability model is the constant exploration and finding of high value cost savings initiatives that we can invest against that help us in future years, and so that the answer to your questions is, this is an ongoing part of how we go about doing business and I would say, Terry, if there is any dramatization about the appropriateness for the business and it is the results of 2005, given all the headwinds that we faced, and even more impressively as we look at it, is how we're setting up 2006, and it is because of the way the Company has been run around volume to value and managed for cash for the last four years and the logic underneath that that we feel we're in a position to be able to stay on our long term guidance, deliver our fourth year of top line growth, fourth year of EPS double digits, and with that very impressively and from my position seeing the strong share growth in the U.S. continuing, and the strong share growth we've had in nine out of our 10 top markets, which accounts for over 80% of our business, that is the power of all of this working.

So cost savings initiatives are critical to our model going forward and you will continue to see them.

Okay, and I didn't mean to imply anything negative by that.

I just wanted, it is a tough one for us to forecast and you have to acknowledge it is kind of a big piece.

Terry, I would just say this, and I think --

Your view is that's more or less a sustainable part of the P&L as we look forward into the foreseeable future, is that correct?

We certainly -- yes, and we certainly want to drive visibility around what those actions are.

If you think about it in the context of just the food industry, we would much prefer to be going at this on a continuing smooth basis to find these things versus having it where all of a sudden the rubber band breaks and you have to go at a major restructuring, and the reason for that has to do with the behaviors in the Company and driving the right kind of behaviors for the long-term on a continuing basis, so you don't have to disrupt the Company to do a major shot.

That's what we're really trying to work against, and we will take the heat and I certainly will take the heat for sustainability and driving it.

But that's what, of course, this Company is on and we're going to stay on it.

It is a good point and timely one.

Thank you very much.

We'll now move on to Tim Ramey with D.A. Davidson.

Good morning.

David, you mentioned innovation a couple of times and there was the press release on low linolenic soybean oil, I think a little over a year ago.

There was some news on Omega 3's.

Can you give us any more detail about how prominently good-for-you products and new health stories will be featured in 2006?

I think, Tim, the whole health and wellness trend is clearly very strong.

I think when you look at low linolenic oil, that is our response to try and remove trans fats from the products we have.

There are no trans fats in cereals, as you are aware, but where we do have them, trying to remove them, but keep the total oil at or below the current level.

You mentioned Omega 3.

Clearly, there is work out on that and at the appropriate time we'll tell you what you're doing, and you will probably hear more about health and wellness, not only from Kellogg, but from many companies.

Rather than try, over the conference call, to preview something that we may do we'll leave it to the appropriate time.

Amy?

It looks like we have time for one more question.

Thank you.

We'll take our final question from Eric Katzman with Deutsche Bank.

Slipping there under the wire.

Hi, Eric, how are you doing?

My usual modus operandi.

I guess a quick one.

The $0.15 of one-time items, Jeff, are those supposed to spread evenly across the year, as well?

For next year, for 2006, I would say probably more towards the back half of the year.

Okay.

Currently, we have the big initiative that's going on with the closure of two plants in the snacks business.

That will come into, finish up in Q1, and then you will see things pick up in the second half.

Okay, and now for the real question, I guess I have been harping on you over time about cash flow having kind of flattened out.

We can argue about the contributions to the pension fund and how that's affected the free cash flow numbers, so I guess, one is, after a $400 million payment in '05 what kind of pension contribution do you think you will have to make in '06, and correct me if I'm wrong, but regardless of that pension contribution payment, you have got, give or take a billion of net income, $400 million of depreciation amortization, offset by let's say roughly the same amount of CapEx, deferred taxes was a use so maybe that swings to being a source given the pension contribution, so it seems to me that your cash flow after, you know, kind of flat to downish the last two years off of the '05 base should swing up quite a bit.

Is there anything wrong there and can you answer the cash pension contribution?

Maybe just a little clarification there, Eric.

If you look at 2006 our guidance on cash flow is $875 million to $975 million.

On the benefit side certainly this year in '05 we did a tremendous amount, the $400 million.

We see minimal benefit contributions next year, probably more in the $50 million to $75 million range.

CapEx, as we talked about, will be about 4% of sales, and when you look at that, our absolute cash flow delivery versus income is very good.

It is, where you're off a little bit is on your assumption on depreciation versus CapEx.

There is probably a gap there of about $80 million to $100 million versus where you call them even.

You reported $392 million at D&A in '05.

In '05.

And, certainly, depreciation in '06 will be lower because of our CapEx spending over the last three or four years have been very low.

So our depreciation level is coming down and then increasing our CapEx because of our growth coming up you'll see that now more around that $80 million to $100 million gap versus where they probably were at par before.

So even including the $80 million of D&A difference and roughly, let's say, the other stuff is a wash, you're spending a little more on CapEx and then the cash -- either way, even if you get to 950, right, off of an equivalent base you're talking 23% growth in year-over-year free cash flow?

Absolutely.

Okay.

All righty.

That's what I needed to know.

Thank you.

Thanks.

Thank you.

Mr. Burton, I will turn the conference back over to you for any additional or closing remarks.

Thanks everybody for joining us for this call.

We look forward to talking to you soon and we will see you at [CAGNE.]

Thank you.

That does conclude today's presentation.

Thank you for your participation and have a great day.

You may now disconnect.