家樂氏 (K) 2006 Q1 法說會逐字稿

Good morning, everyone, and welcome to the Kellogg Company 2006 first-quarter earnings call. (Operator Instructions).

At this time, I would like to turn the conference over to Mr. Simon Burton, Kellogg Company Director of Investor Relations.

Mr. Burton, you may begin your conference.

Thank you for joining us for a review of our first-quarter results and for some discussion regarding our strategy and outlook.

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

David Mackay, President and COO;

Jeff Boromisa, CFO;

Gary Pilnick, General Counsel;

Neal Goldner, new Director of Investor Relations.

Neal, who many of you already know from his years on the buy side, has recently joined our IR team.

We must point out that certain statements made today, such as projections for Kellogg Company's future performance -- including net sales, operating profit, cash flow, earnings per share, margin, and dividends -- 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.

In addition, beginning in the first quarter of 2006, the Company adopted SFAS 123R and began to recognize expense related to employee stock option grants and reported results.

To help investors understand comparable performance, we will consequently be using certain non-GAAP measures, such as internal operating profit growth, to discuss 2006 results.

Please refer to the appendix reconciliation to US GAAP results at the end of this presentation.

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

The passcode for both numbers is 3783244.

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

Now, I will turn it over to Jim.

Thanks, Simon, and good morning, everybody.

We expressed confidence that 2006 would be an excellent year of sustainable and dependable performance during our January call.

We strongly reaffirmed our confidence at CAGNY in February.

Our first-quarter results against high comps and the positive start to our second quarter further strengthens our confidence in 2006 performance.

We expect to once again deliver our full-year guidance and long-term targets.

This guidance includes expanding our gross profit margin; brand building investment ahead of sales growth; absorbing significantly more than our previous estimate of $0.23 of EPS in fuel, energy, commodity and benefit cost inflation; investing $0.15 of EPS in high-return cost savings initiatives where we have good visibility to help future performance; and growing operating profit with or ahead of net sales growth for positive operating leverage, a critical deliverable for us.

The strength and visibility of our innovation in brand-building programs are strong.

The pricing actions we have taken are contributing.

Our market share positions across categories and regions continue to strengthen, and Dave will provide more details on this.

As we also discussed at CAGNY, we are addressing the obvious imbalance of first half versus second half operating profit delivery.

This is 100% consistent with our overarching approach to deliver long-term sustainability and not get caught in quarter-by-quarter performance comparisons.

To support our strengthening confidence, we are raising our earnings guidance for 2006 to a range between $2.45 and $2.49 per share, including an increase of $0.01 more than we originally presented for the costs associated with stock compensation.

Our confidence that cash flow delivery is reflected in our tighter range of delivery between 900 million and $975 million.

And lastly, we just announced a 5% dividend increase.

Slide 4 highlights our financial performance this quarter.

Reported net sales increased by 6%; this built on strong 8% reported sales growth in the first quarter of last year.

Internal sales growth, which excludes the effect of foreign exchange, was 7% and built on more than 6% internal growth last year.

Reported operating profit increased by 1%, and internal growth, which excludes the effect of foreign exchange and stock option expense, was 6%.

This result benefited from lower upfront costs -- reported growth built on strong 11% comps and internal growth built on 10% comps.

So, this was strong performance, given we absorbed significant fuel, energy, commodity, and benefit cost inflation.

We have been saying that in the first half of the year, we would see significant investment in brand building and the first quarter was no exception.

EPS increased by 11%, which was greater than our long-term target, primarily due to strong sales and fewer shares outstanding.

This includes expensed options of $0.03 per share and upfront costs from cost reduction initiatives that were $0.03 per share lower than last year.

Finally, cash flow in the quarter was $101 million.

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

Slide 5 shows the first-quarter sales growth.

As I said, reported sales growth was 6%, and internal sales growth was a very strong 7.4%.

This was driven by gains in price mix and tonnage, just like in previous quarters.

The internal growth built on very strong growth of 6.3% in the first quarter of last year.

This start to the year only increases our confidence that we will continue to deliver through the rest of the year.

As we mentioned when we gave initial guidance for 2006, we planned for a significant increase in brand building in the first half.

You can see the scale of this increase on slide 6.

It is worth noting that we will continue to expect that we will increase investment in brand building at a rate greater than sales growth for the full year, as we did in the first quarter, despite sales growth being so strong.

The increase in the first quarter and the increase that we expect for the first half is intended to support both base products and innovation around the world.

We're focused on properly supporting new ideas without taking our eye off our core business.

For us, brand-building investment includes only advertising and consumer promotion, not trade spending or any activity that cuts the price of our brands.

We recognize the importance of our brands and providing the necessary support, particularly advertising.

We remain committed to this investment.

In a moment, David will review each of our businesses.

But, first, let me turn it over to Jeff, who will walk you through our financial results.

Thanks, Jim.

Good morning, everyone.

In the first quarter, gross profit margin was 43.9%.

Even though this was 30 basis points less than 2005, we are 60 basis points better than 2004.

We posted exceptional growth of 90 basis points in the first quarter of last year.

So, comps were very difficult.

In addition, we also faced the significant fuel and energy cost increases that we had expected.

In fact, higher input cost inflation decreased gross margin by 140 basis points in the quarter.

This unprecedented inflation has had a major effect on the margins for the entire industry.

So, we're very pleased with our gross margin performance and our ability to at least partially offset these increases.

Upfront costs recognized in cost of goods sold were $7 million or more than $0.01 per share.

However, this was less than the $0.04 per share of upfront costs that were recognized in the first quarter of last year and equaled 70 basis points of gross margin.

In addition, there was some margin impact from the exceptional growth that we have seen in certain new North American products in recent months.

For example, fruit snacks and Kashi bars are co-manufactured, which obviously decreases our margin.

However, these arrangements allow us to introduce innovative new product and test their popularity without initially committing capital.

In-house production of various fruit snacks and certain Kashi bars will begin later this year.

So, we expect margins to increase over the course of the year, as we continue to improve the economics.

Most importantly though, we continue to expect that gross margin will expand for the full year due to pricing taken in 2005 and early 2006 and additional savings from cost reduction initiatives.

And we expect that the total upfront costs will be approximately equal to last year's investment of around $0.15 per share.

Now, let's turn to operating profit growth by business.

Slide 8 shows the growth and internal operating profit in each of our reporting areas for the first quarter.

In North America, internal operating profit growth was 8.1%.

This builds on 11.6% growth in the first quarter of 2005 and included a significant increase in investment in R&D and brand building.

North America's operating profit growth also benefited from having fewer upfront costs in the quarter.

In Europe, operating profit growth increased by 0.6%, lapping very strong 9.2% growth.

This year's growth also included an increase in brand-building investment.

In Latin America, internal operating profit growth was a strong 12.7%, even including a double-digit increase in brand building.

And, in Asia-Pacific, internal operating profit declined by 19.3%, as a result of higher brand building, R&D and higher manufacturing costs related to production timing.

We expect gross margin in Asia-Pacific to be approximately flat for the year.

Total internal operating profit growth was 6% and included a companywide increase in investment in brand building that Jim mentioned.

Our strong operating model allows us to invest in brand building and innovation and still post operating profit growth.

In fact, we haven't cut any investments -- gives us additional confidence that we will reach our full-year targets.

Interest expense was lower in the quarter due primarily to the mix of debt and the tax rate was 32%, just within our guidance range for the full year.

We expect that full-year interest expense will be approximately equal to last year's level, as interest rates have increased recently.

And, we continue to expect the full-year tax rate will be between 31 and 32%.

Slide 9 shows our best-in-class working capital measured as a percentage of sales.

We have made a lot of progress on this measure over recent years and will continue to focus on improvement.

While we expect working capital as a percentage of sales will continue to improve, we don't expect that working capital will be a significant source of cash as sales continue to increase.

Now, let's turn to slide 10 and the discussion of cash flow.

Cash flow in the first quarter was $101 million versus 169 million last year as a result of expected timing.

The improvement made in trade payables as a percentage of sales in the first quarter of the year was less than last year's improvement.

This difference was the result of an unusually low payable debt balance at the start of 2005.

We're constantly focused on the generation of cash flow through our managed-for-cash operating principle.

As a result of performing better in the first quarter than planned, we now expect full-year cash flow to be in a range between 900 and 975 million, up from the 875 million to 975 million range we expected previously.

A major component of managed for cash is increasing financial flexibility.

We made considerable progress with this and paid down a significant amount of debt in recent years and will continue to focus on financial flexibility.

So, we are now in a position where we can consider other uses of cash, as you can tell from the significant increase in share repurchases made over the last 2 years.

Slide 11 details this progress.

As you can see, sales -- shares outstanding have declined more than 15 million shares since the first quarter of 2005.

As you will remember, our Board of Directors authorized a share repurchase program of 650 million for 2006.

We repurchased 550 million worth of shares from the WK Kellogg Foundation Trust in February.

At the end of the first quarter, we had completed a total of 580 million of the authorization.

We also recently announced that we increased our dividend for the second consecutive years.

We recognize that the dividend is important to our investors and plan to keep our payout ratio between 40% and 50% of reported earnings.

Slide 12 shows our return on invested capital over the past 5 years.

This improvement has been driven by growth in earnings and our managed-for-cash operating principle.

The flat results in the first quarter is due to this quarter's share repurchase being only partially recognized in the calculation.

We will see the full benefit next quarter and should see a corresponding increase in ROIC.

Again, we recognize the importance of improvement in this metric and expect continued gain.

Now, let's look at slide 13 and our financial outlook for 2006.

In the first half, we expect to post internal sales growth above our long-term target of low single-digit growth.

We expect operating profit to grow at a low single-digit rate in the first half, as we make significant increases in investment and brand building and lap very difficult comps.

Remember that we posted 8.1% internal operating profit growth in the first half of last year.

We also expect to post very strong high single-digit EPS growth as a result of good performance below operating profit.

In the second half, we expect mid single-digit sales growth, ahead of our long-term targets again.

We anticipate strong, double-digit operating profit and a high single-digit EPS growth with continued investment in brand building at a rate greater than sales growth.

So, the result in the second half of the year will be very high quality, which will all lead to full-year performance right in line with our long-term target, including a high level of investment in our business and operating profit growth in line with or slightly ahead of our sales growth.

We were very pleased with our previous EPS guidance of $2.43 to $2.48, as it met our long ongoing target of high single-digit growth in a year of unusually high input costs.

However, our strong first quarter and our confidence in the second half of the year provide us with financial momentum.

We will be able to invest in the business, and as Jim said, still raise full-year guidance to a range between $2.45 to $2.49 per share, which also includes a $0.01 increase in the forecasted impact of stock compensation.

We now expect this impact to be $0.10 per share.

Notably, our higher full year EPS estimate also includes a significant increase in our estimate for incremental fuel, energy and commodity costs.

We are raising our estimate for these costs from $0.13 to $0.16 per share, up to $0.20 per share for the full year.

So, as you can see on slide 14, 2006 will provide absolute operating profit delivery that is balanced across the first and second half of the year.

After 2 years of operating profit deliveries significantly skewed toward the first half of the year, importantly, operating profit delivery will now more closely resemble the shape of revenue deliveries.

As you can tell, we always expect that the second quarter to be challenging.

However, the strength and the momentum we saw in the first quarter make us more optimistic.

It will still be a challenging quarter, but we suspect that results will be stronger than our budget and we will be in a better position to deliver our full-year guidance for sales, operating profit and earnings.

So, to recap -- for the full year, number one, we expect strong EPS growth in line with our long-term target and have increased our guidance for the full year, even with higher input costs and stock option expense.

Two, we expect gross margin expansion.

Three, we expect operating profit leverage.

Four, we expect strong cash flow in line with our new guidance.

So, now I will turn it over to David.

Thanks, Jeff.

Let's now take a look at our results by business segment.

If you will look at slide 15, it shows the quarterly internal sales growth posted by our North American businesses.

As you can see, this was an excellent growth across the businesses.

We're very pleased with this broad-based performance.

In addition, these businesses are lapping difficult comps, which make these results even more impressive.

But, let's now look at Q1 results in a little bit more detail.

Starting with North American retail cereal, which posted the strong growth in the first quarter, as you can see on slide 16.

The 6% internal sales growth built on 4% growth in the first quarter of last year and regained category share again in the quarter, building on six consecutive years of share gains.

In the US, for the 12 weeks ending March 19, we have 34.3% category share in measured channel data, up 1.3 points from the same period last year.

Importantly, our base pricing increased and we increased our levels of merchandising.

This growth was partially due to strong innovation in recent months.

That's Smart Start Maple Brand Sugar, Mini-Wheats Strawberry, Berry Krispies, Eggo Maple, and All-Bran Yogurt Bites were all introduced in Q1.

These products in aggregate had a stronger sales performance than last year's introductions, and last year's sales were very good as well.

So, all in [theory], the initial share numbers have been good and repeat rates have been improving each week.

In addition to innovation, many of our core brands demonstrated strong growth -- among them, Special K, Bite Size Mini-Wheats, Crunch, and Rice Krispies.

Kashi had an excellent quarter, posting very strong double-digit sales and increased share.

The Canadian business also posted sales and category share growth in the quarter.

We introduced Two Scoops Cranberry Crunch, Mini-Wheats Vanilla, and products introduced last year, including Special K Vanilla Almond, Mini-Wheats Maple, Extra, and Tony's Turbos also continued to do very well.

We also gained share in Canada in the first quarter, up 0.3 points after a strong full year in 2005.

We recently announced the price increase, which will be effective in the second quarter.

We increased investment in brand building in North America behind programs to support the products that we've recently launched along with existing brands and our Special K two-week challenge.

In fact, sales of Special K increased at a strong double-digit rate in the quarter.

We also have more innovation planned for late in the second quarter, including new versions of Eggo, Crunch and Swirls, as well as three new Kellogg organic versions of Mini-Wheats, Rice Krispies, and Raisin Bran, which will make us the first major manufacturer to introduce organic versions of its favorite brands.

Our North American retail snack business posted exceptional 12% growth in the quarters, as you can see on slide 17.

That built on very strong 7% growth in the first quarter of 2005 and continues the excellent performance seen all last year.

Importantly, each of the businesses within the segment posted increased sales and gained category share in major channels.

Slide 18 shows some of the year-to-date sales growth in measured channels.

Now, Pop-Tarts brand posted increased sales and now holds more than 87% category share.

We introduced two varieties of Pop-Tarts in the first quarter, Apple Strudel and Double Berry flavors.

We also introduced Go-Tarts, and advertising behind this brand began in April.

The game is early with all of these products, but we are encouraged by the initial results.

Our crackers business posted mid single-digit sales growth and increased category share by 1.4 points in the first quarter.

Cheez-It continued to perform very well, and we grew sales of both the Club and Town House brands.

We launched Cheez-It Crisps and a new flavor of Fiesta Cheez-It in the first quarter as well as a Multigrain Club and a new gram cracker, and there is more to come in the second quarter, including Town House Toppers with good brand-building programs, which drove the base business in the quarter for crackers and also for wholesome snacks and cookies.

We are also active in cookies in the first quarter, and we increased our share by 8.5 points.

We introduced two varieties of Chips Deluxe, new Fudge Shoppe and Murray Sugar Free Cookies.

As you can see on the chart, some of the sales gains reported in measured channels were very, very good.

In fact, cookies also posted mid single-digit sales growth in the quarter.

In wholesome snacks, our sales grew to double-digit rate in the quarter, and category share increased by a strong 1.1 points.

This continues to be a strong signal of the business, and we are well-positioned to benefit.

Fruit snacks continued to grow very strongly, and we again increased our category share.

Munch'Ems Granola Snacks, introduced in the first quarter, are doing well, as our Special K bars, which continue to be on trend.

The results for these have been exceptional.

We supported the brand in the first quarter with strong on-air ads and the introduction of new Special K Snack Bites, which have been incredibly well-received.

We're introducing new Crunchy Nut Sweet and Salty Bars in peanut and almond varieties and Smart Start bars both late in the second quarter.

So, as you can see, this was another excellent quarter for our retail snacks business.

Very importantly for us, our DSD execution continues to be outstanding and gives us great confidence in the year ahead.

Slide 19 shows the results posted by our North American frozen and specialty channels businesses in the first quarter.

Internal sales growth was 5% and built on a 12% comp, the most difficult of last year.

Eggo posted strong mid single-digit sales growth and launched various new products, including Eggo Waffles with a Lego theme, Lego my Eggo;

Nutri-Grain Waffles; and new Eggo Pancakes.

Morningstar introduced new Veggie Bites and continued to support the new [Mills Status] products, introduced in the second half of last year.

We're also having some exciting introductions planned for our frozen business in the second half of the year, including the extension of the Kashi brand into the frozen entrees category.

And our specialty channels businesses continued last year's success, posting strong sales growth in the first quarter.

Food service and vending, convenience and drugs all posted good growth and continued the excellent execution in product packaging innovations that drove such strong results last year.

We continue to anticipate strong results from our frozen and specialty channels businesses through the remainder of the year, despite the difficult comps we had last year.

Our plans and momentum give us confidence that these businesses will meet their full-year targets.

Slide 20 shows reported and internal sales growth for Kellogg International during 2005.

Internal sales growth was 5% in the first quarter, and it was relatively broad-based.

In fact, we posted sales increases in most of our international businesses, even though the competitive environment remained a challenge.

Europe and Latin America posted excellent growth, and Australia continued the recovery we saw beginning late last year.

We also took pricing at the end of last year and in the first quarter of this year in the UK, in France, and various other countries internationally.

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

Slide 21 details the internal net sales growth posted by each of our international areas in the first quarter.

Our European business posted 5% internal sales growth, and each business within the region posted growth.

Notably, we grew cereal category share in our important UK business by more than 1 point in the quarter.

We also grew category share in France by 2.7 points and in Italy by 1.4 points.

In the UK, we introduced Special K Medley, Coco Pops Straws in the first quarter, and we have more innovation and brand-building programs planned for Q2, including a new variety of Special K in the UK, All-Bran Chocolate and Special K bars in France, and All-Bran Chocolate and a new variety of Coco Pops in Italy.

In addition, we posted increased sales in both Germany and the Nordics.

You remember, these two areas faced a very challenging business environment in 2005.

In Latin America, we also posted sales growth in every business in the region.

In Mexico, our largest business in the region, we've gained over 2 percentage points of category share year to date and the category has grown at a double-digit rate.

Specifically, Special K, Froot Loops, and All-Bran [Whittle and Nasa] -- as they are product valued for its health benefits -- all added to that share growth.

In the first quarter, we launched a number of new products across the region, including Nutri-Grain Cereal and All-Bran Chocolate Bars in Mexico;

Smart Start in the Caribbean, [Musely] with Cranberries in Venezuela and two versions of All-Bran in Colombia.

And of course, we have more activity planned for the second quarter.

Our recent launches of snacks in Colombia, Venezuela and Central America are also doing very well.

Our Asia-Pacific business posted 1% lower sales due to difficult competitive conditions and a distribution restructuring in Asia.

In Australia, the improvement in our cereal business that began late in the fourth quarter continued and we believe that the business has stabilized.

We introduced 6 new cereal products late in the first quarter, including Mini-Wheat Strawberry, Special K Forest Berries, Just Right Berries and Apple and All-Bran Tropical.

And we are very pleased with the initial results, and the advertising is only just beginning.

In conclusion, globally, our first quarter exceeded our internal expectations and we've built momentum as we start 2006.

While our expectations were for a tough first half, given our operating profit comparisons last year, we have finished Q1 very well.

Given we deliver as expected in Q2, our confidence for another above target year will be strong.

Currently, the trends in Q2 suggests we will exceed our internal forecast.

And now, I will turn it over to Jim for a summary.

Thanks, Dave.

Our message is one of increasing confidence -- to deliver another year of sustainable, dependable, high-quality performance, while investing in our brands and future cost savings initiatives and while identifying future innovation in marketing programs.

The commitment to our overarching driver of sustainable and dependable performance based on realistic goals continues.

Our focused strategies continue to provide growth visibility, and our operating principles are driving the right behavior.

And with that, we will open it up for questions.

(Operator Instructions).

Eric Katzman, Deutsche Bank.

Can I just ask a specific just kind of a detailed question?

I thought a year ago, your upfront costs were $0.05 a share, not $0.04 and a pretax of 24.5 million.

Did I just have that wrong or--?

Eric, this is Jeff.

It's just slightly more than $0.04.

It didn't round to $0.05.

It probably was a tax rate assumption; it's something to look at that.

But it's $0.04 last year.

And then I guess more importantly, I guess you said you did very well in the UK.

But, reports that we've been hearing is that Wal-Mart/ASD is kind of looking at global pricing and coming down very hard on manufacturers that may be pricing differently across regions or giving different deals to other players.

Since you have such a big UK business, I was kind of wondering I guess, Dave, if you could kind of answer that?

Yes, we don't typically talk about specific retail partners.

I think just on the UK, it remains as it has been for many years, a highly competitive market, with Tesco, Sainsbury, and ASDA are off slugging it out.

You know, we are working effectively with all of our trading partners to grow our business and their business.

We did well there in the first quarter in relatively tough and highly competitive conditions.

So, I would just say that we continue to grow share.

We've got some great new products that launched in the first quarter.

We've got more coming midyear.

Our focus is going to be working to better meet consumer needs and do everything we can to grow our business in the right way.

While I'm sure the market will remain tough, we are performing well and we expect to continue to perform well, even though there are some challenges there.

But, in terms of pricing, you feel pretty comfortable that your products are kind of harmonized and there isn't really a potential issue there?

Well, we have a very clear policy at the Kellogg Company to deal with all of our retail partners fairly and squarely.

So, these aren't concerns that we typically have to run up against.

Otherwise excellent results, thank you.

Andrew Lazar, Lehman Brothers.

I guess we've heard during the first quarter specifically of some of the players in the industry and cereal players included, kind of stepping up their distributions to some of the more sort of value-oriented customers, such as say Aldi or Save-a-Lot.

Without getting into sort of specific customers, I'm just trying to gauge if this is something that also took place in your business and whether -- if it did, whether this acceleration might have been part of a longer-term strategy or it's something you think drove it specifically in the quarter?

I think for us, while we like most other players in the US are looking at all of the channels of distribution and trying to drive all of them equally hard, I wouldn't say that there was any disproportionate gain or benefit coming from the channels that you mentioned.

Ed Roesch, Banc of America Securities.

I want to understand a little bit more the expansion of some of your brands into organic offerings.

I was very interested in that.

Could you give us a few more details on what brands you are going to expand that offering into and then what other brands might see this potential?

I believe Dave mentioned in the call, it was Raisin Brand and Mini-Wheat and Rice Krispies are the three.

You know, one of the things that we feel very good about is just the strength of our brands and the value we have been bringing to these over time.

This is just a continuing process about the stretch we see in them, very much on trend area.

We are all about giving choices to our consumers.

So, this is growing out of the investment.

We're making the strength of the value added, and we are really excited about these items.

Just a follow-up on that, I mean, could you talk about the trade reaction to that and you would expect in terms of the channel distribution of these products?

It's a little early yet on just the reaction, other than just a positive sense that the idea makes sense and all that.

So we're a little early in the game to be commenting on that.

One more question please, broadly speaking, some consumer packaged goods companies have seen an impact from inventory changes at the retail level.

Was there any impact at all in the first quarter?

Broadly speaking, now, I think we've said in the last couple of calls -- yes, we are working actively with a number of our trading partners through the end of managed inventory to try and reduce the amount of inventory that they have.

It helps them; it helps us get clear visibility on inventories.

We did that through the first quarter.

It's all part of their ongoing business.

You know, we're very pleased with where we are as far as inventories go.

[Michael Avery], Citigroup.

This is Michael on behalf of David Driscoll.

You mentioned the declines in Asia-Pacific, and I believe you said some of that was from a distribution restructuring.

Could you give us an idea of what we should expect from there going forward?

Is that a permanent adjustment that you have lost distribution, or is that something where it is a hiccup from a transition or how should we think about that?

Michael, that was simply in one of the markets in Asia, where we were working through a distributor.

And we have gone direct, so we were buying back the inventory.

It's onetime --

Onetime in the --

It's done in the quarter.

Not a big deal but did have an impact on Asia for the [third] quarter.

Okay, great.

And then, just one other thing, you mentioned that there obviously wasn't a severe impact from trade deloading in the quarter.

Is that something you still think you may have to work through or that you feel good about not being a big issue?

As I said, we constantly are working with all of our retail partners through the end of managed inventory to try and reduce inventory, where it makes sense for them and sense for us.

We think that's a positive thing for us to do.

We will keep doing that.

You know, you do get ups and downs in the quarter.

But, that's all part of just managing the business effectively.

David Palmer, UBS.

A quick one -- I was hoping to get some more color on your cookie business.

The share gains there in one sense are striking.

I mean it seems like you may be turning the corner -- I was wondering if you had that sort of confidence that perhaps that means that that business is at least stabilizing and the execution internally is somehow better in the legacy Keebler business.

Secondly, on inventory, I noticed you are a couple days higher year over year.

Is that a result of some of the upcoming innovation you mentioned?

Thanks.

Dave, first of all, on the cookie, you know, we've been -- in previous calls, we talked about the need for us in our cookie business in particular to get our innovation really lined up, particularly against the core brands.

I think what we are seeing here is that paying off for us.

The execution, as Dave mentioned just during our script here, we continue to see outstanding execution of our DSD system.

So, you put those together and I think that is it.

As far as the inventory, we're not having any inventory issues.

I just had a point in terms of performance of our business right now.

In the DSD system, Dave, our inventory is actually as we look at it broadly in the first quarter are down because our sales are actually above our initial expectations.

So, no issues there.

David Adelman, Morgan Stanley.

In Europe, the improved underlying overall sales trends -- do you attribute that -- I know your innovation efforts have been accelerating.

But, some other consumer products companies have seen somewhat better overall consumer operating environment.

To what do you attribute your improved performance?

Well, as we said last year -- and our approach in Europe is similar to what we do globally -- I think we've continued to increase our investment in brand building.

We have ratcheted it up to an extent, our innovation.

We expect that to continue.

So, in France, Italy, Spain -- right across Europe, including the UK, which many of these markets remain highly competitive, we just believe we are exciting consumers with new products.

We are working collaboratively with our trading partners.

So the approach that works for us works for them.

We are going to stick with it, and we think it's going to stand us in good stead over many, many years to come.

Yet, importantly, the thing in Europe was sales growth in Europe was broad-based.

Every country in Europe actually grew.

Now, I'm not sure we can say that too often.

That's why we mention it.

Because there are a lot of them, but they are very, very strong performance by European market.

David, as a practical matter, given the cost pressures, do you think that the Company essentially needs to over-deliver on the long-term sales target over the intermediate term to be able to deliver the earnings growth expectations of high single digits?

Well, we did mention that we have taken some pricing in some of the markets in Europe and other parts of the world.

And we're constantly working to optimize our supply chain.

I think that's really -- that's really critical for us as we look at it.

So, cost savings come into play as well.

If we hadn't done all the work we have done over the last 3 to 4 years, I'm sure we wouldn't be in this sort of position we are, given what Jeff said on the big increases we've seen.

Some of those have clearly flowed into Europe.

So I think all it says is that our model of constantly reinforcing and reducing our cost base and investing back in the business is working.

On the pricing, David, are there any markets of concern vis-à-vis what competition did after you?

No.

Terry Bivens, Bear Stearns.

Welcome Neal, wherever you are out there.

Just on cereal, first of all, what was category growth in the quarter as you guys look at it?

If you looked at ROI, Terry, it looked quite weak.

But I think as we do an internal analysis with all channels, we think it was broadly flat.

You know, the ROI dialer showed down sort of 2.9%.

But, as we look at all of the channels, we think the category in total across the US was broadly flat.

Just on the cereal subject, clearly, you have some tougher comps as you look into Q2, Q3, and Q4.

My assumption is that you will attempt to improve on those in the ways you've always done -- innovation marketing, merchandising.

But the question is really as you look at that innovation, obviously, you guys have a lot of new stuff that's already there -- some nice new stuff for the second half.

Are you gaining shelf space?

Or as you put these things in, are you trimming out some of the less profitable family-sized things?

I guess what I'm trying to get to is to what extent is your shelf set evolving as we look through this year and into next?

Terry, it's nice to have you ask a question that is not related to upfront costs and we applaud that.

You have a good point.

I mean, underneath our model, the drivers that you identified that we're going to stay on is around our marketing programs and innovation.

We -- having said that, and that is a key part of our model -- where we're using innovation to help drive mix, which is a key part of our model -- but as well as very aggressive programs to basically call out SKUs that are not selling and to continue to drive our mix within the shelf.

But, strong improving share, strong aggressive programs certainly can help us in terms of shelf space and our brands.

Would you say that that effect is accelerating this year?

It looks to me as though it is, but I want to get your opinion on it.

It's hard to say, whether just relative to prior accelerating.

But we're certainly seeing some positive move in it.

We continue to expect that as we bring out more innovation.

Chris Growe, A.G. Edwards.

Somebody has to ask an upfront cost question, so I will be the one I guess.

Just a quick question for you on -- just I guess really for Jeff sort of about the timing of those.

Was the timing different than what you expected?

Should I expect maybe more of an even flow for the remainder of the year for the upfront costs?

No, actually, the timing is spot on from what we expected.

And it's primarily related to the bakery closures that we were going through last year.

I would say the more that the rest of the year, that $0.15, would be more back-end based.

Then my other question is related to the cereal category, sort of a follow-up.

It looks as if -- and this is again using IRI data that base sales growth has weakened a little bit for Kellogg of late.

It would seem to indicate an increase in promotion.

Although if I heard correctly, you said your pricing was up in the quarter.

I wonder if you could kind of put those two together for me by chance.

Sure.

I mean, I think Chris if you look at the out-based sales, the -- if you look at IRI, remembering that the whole category looks like it's down nearly 2.5, 3%, our base sales were down less than the category.

They performed better than anyone else's, and our base prices -- we were one of only two of the companies that actually had base prices rise in the first quarter.

So, we think we're doing particularly well.

You would expect that given our innovation is working, that our base would be relatively strong.

So, we're pretty happy with the performance.

Jonathan Feeney, Wachovia.

Congratulations.

Just one question -- a little bit of a follow-up too.

But in the cereal category this quarter, there appeared to be, away from the IRI data, I guess Post -- some strategic reduction in marketing and clearly some public information that there's been some double-digit declines in terms of shipments in the kid cereals part of Post.

I guess I know it's not your typical policy to comment on specifically on competitors, I am not asking you to.

But, in terms of the pricing dynamics and the amount of incremental marketing dollars coming into the category and specifically the kids' cereal, have you see more friendly trends than expected this quarter?

Do you think that's -- are you seeing signs that continues into Q2?

You know, quarter by quarter, you see different dynamics playing out, and you are right about us commenting about specific competitors.

You know, you think about what we talked about a lot about last year was what private-label was doing.

Now, you are seeing trends on private-label that are significantly different than what it was and I think favorable to the brand of players.

That's a nice way of putting it.

So, we will leave it like that.

Pablo Zuanic, J.P. Morgan.

Just a couple of questions -- first of all, can you give us an update on that lawsuit regarding Sponge Bob that came out within a couple months ago?

This is Jim.

Any kind of pending litigation, we just cannot talk about.

I'm sure you can understand that.

So, I would leave it like that.

So, related to that subject -- you know, I am going to go back to a question that I asked at CAGNY -- I know you said that brand building is growing above sales.

As you define brand building, it's advertising plus consumer promotions, not trade promotions, and I understand that.

But, your earnings report said that advertising to sales was flat year on year comparing '05 and '04.

So, that means there were more consumer promotions.

But, is really Sponge Bob, Dora the Explorer, Spiderman, how is that brand building?

I mean, I'm sure I am missing something out there.

But when I see a cereal box turn into a movie, I wonder how different is that just from a trade promotion?

I don't see it too much as brand building.

Show me how to understanding that.

You know if you follow this category in marketing for a long period of time, what you see, there are certain drivers to the business that you have in the game.

It's pulling all of those levers and having all your guns loaded against all of those kind of drivers.

In particular, the area you mention is not priced based.

Knowing that we have to compete across these things because consumers have a very strong interest, they are appealing, that's how we are going to market with all of our guns loaded and that's how we intend to continue to go to market.

Several question in terms of distribution.

Obviously, this nice performance was very impressive and hopefully sustainable.

Can you explain there, in terms of channels, is this still mostly growth in the traditional supermarket, in terms of package snacks?

Or are you making inroads in the c-store channel, in terms of single serves, which I think has been something that has been lacking in the past?

Just how does DSD play into that because I think DSD is just for your supermarkets, right?

It doesn't help you with c-stores.

So, help me understand how is the packaging mix and the channel mix evolving therefore snacks and how did that contribute to a 12% growth?

The easy answer is if broad-based we grew in DSD.

We grew snacks that go through warehouse.

We grew in food service, vend, convenience, and drug.

We have very strong business in our club channel.

So it's across the board.

You know, while one channel might be better than another for a given quarter, the trends have been relatively consistent.

Certainly, the first quarter continued very positive performance with all of the channels.

But have you done anything different in terms of approaching the single serve channels than before or pretty much the same?

Sure.

We're very organized.

We have got more focus on it from the category management perspective.

We've added people there.

We're doing a lot more on the packaging side than we did historically.

We believe we have a lot more upside there from a packaging innovation perspective.

We're trying to right size the products to fit the channel.

So, that's really it.

Also, of course, our brands work very well.

When we can get them in the right packaging into those channels, they are going to do very well.

So, it remains an opportunity.

Sure and one last question if I may.

You said Kashi, it is going to expand into the frozen entrees category.

Does that mean your traditional frozen entrees in terms of waffles?

Or are you planning to actually enter the wider frozen dinner category with Kashi?

Frozen entrees is a wider frozen main meal category.

So, that would be a new category for Kellogg, right?

That would be, yes.

[Linda Donnelly], Franklin Management Group.

I wanted to ask -- is your specific explanation for the 17% increase in accounts receivable?

Yes, there is.

Certainly it's driven by -- Linda, this is Jeff -- but it's driven by our sales growth, particularly we had strong growth in the back half of March.

So, that's primarily -- we see very good performance on our DSO as a percentage of sales.

But, it's just skewing towards the end of March sales.

If I may, would you give us guidance for the year on your CapEx and your D&A?

Yes, you know, on CapEx, what we have indicated that the capital spending would be around 4% of net sales.

On guidance on depreciation, what we're looking at is around the 350 level.

Tim Ramey, D.A. Davidson.

Just a follow-up on the co-pack announcement that you would be moving some of that back into house.

How big a piece of business would that be?

What we're trying to do is just point out there -- we had a particularly high level of activity with our co-packers because of some of the innovation we have introduced.

The point we were trying to make is just relative to some of the pressure on the gross profit margin, that really is a great opportunity for us from two ways.

One, we were able to get some innovation out and see how it's doing with consumers before we put capital into it and then just a future impact as we do repatriate that volume -- will be the positive impact on our overall financial structure of the P&L.

So, this is not a strategic shift.

It's just a -- it's a timing difference?

It's a timing thing.

We just happened to hit a few things in particular that's a little heavier than we have hit.

But, it's ongoing.

It's a great way for us to get some innovation out and a smart way to go about it.

Second, I'm intrigued by the organic introductions in the mainstream brands.

Is that a part of the new division that you have talked about at CAGNY, the healthy division?

Or would that sort of be managed in the mainstream organization?

First of all, [Hal] and David did give more detail on it at CAGNY.

But this is all under Jeff Montie, our Head of North America.

They're working -- the folks in that division are working very closely with I guess our traditional cereal folks.

So, this one in particular just hasn't come out of that piece.

But, there will be some coming hopefully in the second half of the year.

Eric Larson, Piper Jaffray.

Just a quick follow-up.

I missed the very front-end comments about what your total input costs are going to be this year.

I think at the end -- in January, you said that you're looking for a negative cost impact -- the input cost impact of $0.13 to $0.16.

I think you said primarily energy and (multiple speakers) primarily fuel and energy.

Did I hear $0.23?

Was that the number you gave earlier in your prepared comments?

Eric, this is Jeff.

You are exactly right.

We increased it up to $0.20.

Up to $0.20?

Also, in addition to that, don't forget that we have guidance on our benefit expenses going up $0.03 to $0.07 for the year (multiple speakers) --

In that $0.20, is that primarily energy?

Does it reflect any of the higher distributor costs that we've seen, particularly outside the United States because you're tied to the world price of sugar.

It's got to have an impact.

Would that include that sugar as well, that $0.20?

Well, the $0.20 is certainly the big majority is fuel because fuel, energy not only directly impacts us but it comes through as increases on packaging material.

So, that's the bulk of it.

But, there is some commodity inflation in the up to $0.20 guidance.

You are still getting maybe some positive benefit on the grain side of the equation or no?

That's kind of mixed.

There's still been pretty high commodity costs out in the marketplace.

This is Simon.

If we could take one last question, please.

Eric Katzman, Deutsche Bank.

A follow-up -- my lucky day.

Gentlemen, I guess like one question would be -- we heard earlier from another company about kind of limited editions and kind of proliferation of SKUs.

I just was listening to all of the bars that you're putting out there.

I'm kind of wondering how you kind of keep track of so many different brands that you are using and so many different bars.

Like for example, we haven't heard about Nutri-Grain in a while, even though we're hearing about Special K -- All-Bran and I think I don't know you talked about a Munch'Ems bar.

Then Jeff, can you talk about the swing in other income from an expense to income this year?

I know you had the contribution to the foundation a year ago.

But, maybe you could just flesh that out.

Thank you.

On SKUs, I think in our snacks area, when you talk specifically about wholesome snacks, you remember over the last year or two, there has been a large number of new entries.

A number of those now have actually declined precipitously and are exiting the market.

So, we are working effectively with our category management group to try and help rationalize that, taking [Summerville] line out -- weak performers.

But when you mentioned the Granola Munch'Ems, that is actually a little snack bite; it is not a bar.

And the Special K Snack Bites are single serve packages of bite-sized snacks versus bars.

There are new bars coming in from us and from competitors, but we believe we're managing our own portfolio effectively by taking out SKUs.

There is an exit by a number of other products that are not performing in the market.

So, we're feeling pretty good about where we are.

Eric, this is Jeff.

On the other income, it's three things.

Last year, we had a write-down of a company-owned asset.

We had a charitable contribution.

This year, we had some foreign exchange gains -- all three about the same amount.

Okay, because I exclude the write-down, so we knew about the charity.

But there are some FX gains and what is that from hyperinflationary economies or something?

Well, just you know of our protection on hedging.

Okay, hedging, thank you.

Thanks everybody.

We appreciate you tuning in.

That does conclude today's conference call.

We thank you for your participation and have a great day.