家樂氏 (K) 2006 Q4 法說會逐字稿

Good day, everyone and welcome to today's full year 2006 year-end earnings review conference call.

For opening remarks and introductions, I'd like to turn things over to your host, Mr. Simon Burton.

Please go ahead, sir.

Thanks, Jason, good morning, everyone.

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

With me here in Battle Creek are David Mackay, CEO, John Bryant, CFO, and Gary Pilnick, General Counsel.

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, up front costs, brand building and share repurchases 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.

Beginning with the first quarter of 2006, the Company adopted SFAS-123(R) and began to recognize expense related to employee stock option grants in 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 U.S.

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 U.S.

And 719-457-0820 from international locations.

The passcode for both numbers is 4244212.

The call will also be available via webcast at www.KelloggCompany.Com which will be archived for 90 days.

Now I'd like to turn the call over to David.

Thank you, Simon, and good morning, everyone.

It's great to be here and to be able to report such strong results in my first quarter as CEO.

We had strong sales momentum all year and it continued through the fourth quarter.

This growth was driven by successful product innovation and brand building programs.

The fourth quarter was strong with high single digit sales growth and strong internal operating profit growth adjusting for the significantly greater investment in cost reduction initiatives in the quarter.

We posted high single digit internal revenue growth for the full year.

In fact, we're pleased that this is another year of greater than targeted growth.

This revenue growth was driven by a positive combination of price mix and volume growth, all of which resulted from the success of our innovation, brand building efforts, and in store execution.

Excluding the effect of expensing stock options, we generated double digit earnings per share growth, and we also continued to make significant investments in cost reduction initiatives.

While these contributed to lower growth and operating profit margin than we would otherwise realized, the investment provides a good return and helps us provide sustainable rates of growth.

So, by almost any measure, this was a successful year.

We met, or in most cases, exceeded our long term target while investing in the future growth and while facing dramatically increased costs.

In fact, it's the excellent execution by our team that will help us navigate through another year of cost inflation and again deliver strong results in 2007.

Now let's look at our results in more detail and if you turn to slide four, it shows a summary of our key financial results.

Net sales increased by 7% in 2006 as a result of strong, internal growth of 7% and a slightly favorable impact from foreign exchange.

Reported net sales growth of 8% in the fourth quarter was also strong as was internal growth of 6%.

Internal operating profit increased by 4% in 2006 and reported operating profit increased by 1%.

The difference stems mainly from the expensing of stock options which began in 2006.

Internal operating profit growth was in line with our long term targets and we're very pleased to deliver these results given the dramatically higher fuel, energy, benefits and commodity costs we again saw this year. 2006 was a solid year where we met our goal for operating profit growth and it's also the fourth consecutive year that we face significant incremental increases in costs.

Internal operating profit in the fourth quarter also increased by 4% and included 27 million more in up front costs than in the fourth quarter of last year.

Reported operating profits for the quarter was approximately unchanged.

Earnings per share for the full year, excluding the effect of expensing stock options, increased by 11%.

This growth resulted from strong sales growth and fewer shares outstanding as a result of our continued share repurchase program.

EPS was $0.45 in the fourth quarter and included a small charitable contribution.

You'll note that full year EPS of $2.51 exceeded initial guidance for the year of $2.42 to $2.47 per share.

In addition, up front costs for the full year totaled $0.14 per share or $0.01 than our initial guidance.

Full year cash flow reached $957 million in line with our guidance.

Slide five shows our net sales growth and for the full year internal net sales growth was 6.8%.

For the fourth quarter, internal sales growth was 6.1%, and we're very pleased with these results as both a significantly greater than our long term targets and as you can see, price mix and tonnage growth were balanced contributors to internal sales growth for the full year.

Our goal is to drive sustainable rates of profitable revenue growth and we're pleased by tonnage and price mix continued to contribute.

In the full year and for the quarter, we benefited from increased demand, mix improvement, and increased pricing that you've seen in measured channel data.

The effect of foreign currency translation had a relatively small impact on full year results.

Now let's turn to slide six which provides detail regarding advertising.

As you can see, during the year, we said we're going to undertake a major project to drive cost efficiency and effectiveness in the consumer promotion area and in media buying.

We saw major efficiency benefits and consumer promotions in Q4 and we will see a continued benefit in 2007 due to efficiency gains and optimization.

So while investment in brand building will increase in 2007, investment in advertising will increase significantly.

We haven't changed our long term approach to increase brand building at a rate greater than sales growth, but obviously because of this initiative, 2007 will be different.

As a result, we'll show you investment and advertising on this chart during 2007, and as you can see, this investment has increased at a rate greater than sales growth even though sales growth significantly exceeded our long term target, and as I said, we continue to benefit from a disciplined review of our media planning and buying.

As a result, we've increased our presence, developed more targeted communication, and lowered the cost.

We established best practices in terms of the global purchasing of premiums and are focusing on fewer, stronger, and more effective promotional programs.

We continue to leverage our bigger properties across our different businesses as we will in 2007 with Shrek 3 and the game's supplier, Electronic Arts.

Our committment to building brands through our advertising and consumer promotion remains absolute.

The efficiency gained in Q4 and throughout 2007 and our consumer promotion activities are a great example of our committment to drive efficiency and effectiveness in all that we do, and now I'd like to turn it over to John for an overview of our financial performance.

Thanks, David, and good morning, everyone.

Slide seven shows our performance over the past two years.

Gross margin was significantly effected by increased up front costs in the fourth quarter.

In fact, without this effect, gross margin would have increased by 40 basis points.

Increased cost inflation, which began in the second half of 2005, has been a significant headwind in 2006, and we are happy to have weathered the increases as well as we have.

The impact of cost inflation from commodities, fuel, energy, and benefits decreased gross margin by 150 basis points for the full year and by 160 basis points in the fourth quarter.

In fact, in 2006, we incurred incremental commodity benefits , fuel, and energy inflation equal to approximately $0.28 of EPS.

Also, we continued to experience some margin impact from growth in certain new co-manufactured products this year.

These arrangements have allowed us to introduce popular new products without initially committing capital.

Partially offsetting inflation were the benefits that came from our cost efficiency projects, productivity initiatives and the benefits from pricing actions taken in many of our major businesses in the last 12 months.

Given the volatility we see resulting from alternative energy and its impact on grains and fuel in the U.S, we see even more cost inflation in 2007 than we originally expected.

In fact, our estimate for incremental benefit, commodity fuel and energy costs is now between $0.18 and $0.22 of EPS, a significant increase from initial estimates of between $0.10 and $0.16, We expect that this will lead to a gross margin decline of up to 50 basis points for the full year.

Now let's turn to slide eight and look at operating profit.

This slide shows the growth in the internal operating profit in each of our geographic reporting areas.

In North America, full year internal operating profit growth was 7%.

This result was driven by strong sales growth and was achieved despite significantly increased input cost inflation, although it benefited from lower up front costs.

In Europe, full year internal operating profit growth increased by 1%, also achieved despite double digit increases in advertising and increased input costs.

Significantly higher up front costs lowered full year operating profit growth by 8% so the growth we saw in Europe for the full year was excellent.

In Latin America, full year internal operating profit growth was now standing 9%, driven by strong sales growth and despite a double digit increase in investment and advertising.

And in Asia Pacific, we posted a full year internal operating profit decline of 9%, which resulted from a difficult operating environment in Australia and significant investment in Asia.

Consolidated operating profit growth was solid for the full year, in line with with our long term targets.

The fourth quarter's results were also in line with our long term targets, despite a significant increase in investment and up front costs, and keep in mind that we delivered these results in a period of significant cost inflation and while continuing to invest in our business.

Below the operating profit line, interest expense increased for the full year by $7 million and the tax rate for the full year was 31.7%, in line with our previous guidance.

Now let's turn slide nine which shows the history of our core working capital, measured as a percentage of sales.

As you can see, our improvement in this important metric continued in 2006 and 12 month rolling core working capital as a percentage of sales is 6.8%, which is industry-leading performance.

While the rolling month result remains strong, you'll notice on the balance sheet at year-end 2006 that we saw increases in inventory balances versus year-end 2005.

These were due primarily to input cost increases and an increase in the amount of inventories in preparation for new product launches.

Despite this, our inventory is also at industry leading levels.

Now let's turn to slide ten and the more detailed discussion of cash flow.

Our measures for cash operating principal has helped drive the improvement in working capital seen on the previous slide.

Also it keeps us focused on the generation of cash flow.

Cash flow for the full year was was $957 million, toward the high end of our guidance range.

Looking forward to 2007, we expect that full year cash flow will be between $950 million and $1.025 billion.

Having strong cash flow is one thing, but we've also put this cash to good use as you can see on slide 11.

Over the last three years, we've repurchased approximately $1.6 billion of our own shares and have paid more than $1.3 billion in dividends.

That's almost $3 billion returned to shareholders over the last three years.

We remain committed to a balanced use of our cash flow.

We will continue to assess our dividend.

We will continue to repurchase our stock.

We will continue to focus on decreasing net debt, and we will continue to invest in future growth initiatives.

As you know, our Board of Directors has authorized a share repurchase program of $650 million for 2007.

Now let's turn to slide 12 which details our outlook for 2007.

This slide is very similar to the one we showed you last quarter; however, we now expect that internal revenue growth could be as high as 4% and that earnings will be between $2.68 to $2.73 per share, an increase of $0.01 from prior guidance.

We continue to expect mid single digit operating profit growth.

Built into this guidance is our revised estimate for total incremental fuel, energy, benefits and commodity costs of between $0.18 and $0.22 per share, which adds to the dramatic incremental increases in each of the last four years.

Obviously, this is a considerable headwind, so we are pleased to still be able to provide earnings guidance in line with our long term targets despite these additional costs.

We have budgeted for cost saving projects in 2007 of $ 0.14, which will approximately equal the amount invested in 2006.

These projects are a very important part of our approach to business and contribute to gross and operating profit margins and help provide the flexibility when needed in recent years to overcome cost pressures and we also continue to expect some leverage below the operating profit line.

While we expect higher interest expense for the year, we expect that all of this will be offset by higher interest income and finally, we expect the tax rate to be around 31%, in line with recent guidance.

This should all lead to high single digit EPS growth for the year, despite the pressure faced by the entire industry.

Our approach to business and the flexibility provided by our operating principles make it possible for us to expect to meet our long term targets again in 2007.

Finally, while we don't give guidance on a quarterly basis, I'd like to say a word on the first quarter.

Gross margin will be down more than our full year target in the quarter due to the timing of commodity cost increases, and as we told you in October, we are expecting operating profit to be down in Q1 as a result of the continued commodity inflation, significantly increased investment in advertising and extremely difficult comps.

Importantly though, the key is that we continue to expect that full year operating profit will increase in line with our long term target of mid single digit growth.

And with that, I'll turn it back over to David for a review of our operations.

Thanks, John.

If we could turn now to slide 13 which shows internal growth posted by each of our North American businesses in 2006, and for the fourth quarter.

We posted good rates of growth despite the difficult comparison set in 2005 and if we look at our North American business in more detail, slide 14 shows North American retail cereal growth for the fourth quarter and for the full year.

Full year growth was 3% which built on 8% growth in 2005.

The fourth quarter sales declined by 2% on an 8% comp, even though end market consumption grew roughly 3% across all channels in Q4.

This all channel consumption growth was in line with full year growth and the difference between shipments and consumption in the fourth quarter is a result of the decrease in inventory level at some of our retail partners in the fourth quarter.

In addition, we had difficult comps and faced very competitive activity in the category during the quarter.

Our base sales, those not on promotion, grew 4% and our price per pound increased 5% in measured channel data.

Sales growth for the full year was driven by strong results from Special K, Mini Wheats, Smart Start and All Bran, specifically new products such as Mini Wheats Strawberry Delight and Special K Fruit and Yogurt contributed, and our Rice Krispies brand also posted a good year as a result of innovation.

As you might imagine, we recently introduced some great new products including Special K chocolate, Rice Krispies with strawberries, Smart Start Cinnamon Raisin, and a new version of Cocoa Krispies.

Kashi posted strong fourth quarter and full year results, also as the result of innovation and successful advertising support.

Golean Honey Almond Flax, these, and Organic Promise all posted strong growth and with more new products to come in 2007, and finally in Canada, we posted low single digit sales growth in the fourth quarter and full year.

We launched All Bran Guardian in Q4, and while it's early, acceptance has been good and the brand is doing well.

In addition, we've got great promotions planned and new products being introduced including Mini Wheats Strawberry Delight and Special K Chocolate.

You can see on slide 15, the increase we've posted in the U.S. measured channel ready to eat cereal category shared since 2000.

The chart shows 52-week comparable data and we gained category share again in 2006.

This was driven by excellent innovation and brand building programs throughout the year.

Even in Q4, with significant tactical activity in the category, our measured channel category share declined only ten basis points through the latest 13 week period.

Let's now turn to slide 16 and our North American snacks business.

Snacks posted strong 12% growth in the fourth quarter.

These results again were considerably greater than our long term targets and built on strong comparisons in 2005.

Full year growth was 11% and we saw strong growth across the businesses and in store execution was excellent, and you can see more detail on slide 17, which shows our toaster pastries business posted another year of share gains for the full year.

With some good innovation in 2006, and some new 2007 innovation for each of the categories is shown on the slide.

Our cracker business also posted excellent growth for the full year and in the fourth quarter.

We posted strong growth in both our Town House and Club brands in 2006.

Cheez-It also had a strong year as did portion control packs such as cracker packs, caddy packs and grips.

We've got some great new innovation coming including Cheez-It sticks and All Bran crackers.

We saw good growth in the cookies business and also gained share for the full year and fourth quarter.

Chips Deluxe, Fudge Shoppe, Sugar Free all posted strong full year sales growth, and recent innovation include new variations of our 100 Calorie pack Right Bites.

The wholesome snack business also gained shore and posted very strong double digit sales growth in both the fourth quarter and full year.

Great new innovations include Nutri-Grain Fruit and Nut Bars, new Special K Honey Nut bars, and various new fruit snacks, and in Canada, we saw good sales growth, and in the fourth quarter, our Canadian business is introducing two versions of Sweet and Salty bars, similar to the ones available in the U.S.

And two versions of All Bran Bite Size Snacks.

Slide 18 shows that our Frozen and Speciality Channels businesses posted very strong internal sales growth of 8% in the fourth quarter and for the full year.

Again, our two main frozen brands, Eggo and Morning Star, and the Speciality Channels businesses all posted very good results.

The Eggo business performed very well with innovations such as Choconilla waffles and pancakes drove results, and the Morning Star and Kashi entrees businesses also posted strong results behind successful new products including meal starters and meal solutions, veggie bites, and the Kashi entrees we told you about last year.

Our Speciality Channels businesses posted high single digit internal net sales growth in the fourth quarter and for the full year.

Both foodservice and vending and convenience and drug contributed to this growth.

Pricing and innovation contributed to sales growth and we're very pleased with the performance of all of these businesses this year.

Slide 19 shows the internal sales growth posted by our international businesses over the past couple of years.

This growth while strong all year actually increased in the fourth quarter.

We're very pleased with 6% internal growth in the fourth quarter and excellent 5% growth for the whole year.

Now, if you'll turn to slide 20, you'll see internal growth highlighted by area.

In Europe, we posted full year internal sales growth of 5% as a result of strong growth in most of the countries in the region.

This is the strongest internal growth we've posted in the region since the early 1990s, and we're very pleased to have achieved this result in the current difficult environment in Western Europe.

We executed some very strong innovation in brand building programs across the region which led to excellent levels of growth in both cereal and snacks.

In the UK, our largest business in the region, we posted mid single digit sales growth in both cereal and snacks and gained share in both categories.

We introduced new versions of All Bran, Special K Bliss, and Cocoa Pops cereals which all contributed to the growth.

As did Nutri-Grain, Special K Bars and Rice Krispie Squares.

And with more to come including Crunchy Nut Sweet and Salty bars in the first quarter.

Our businesses in the rest of Europe also did very well in the year and fourth quarter.

We saw strong full year cereal and snacks growth in France, Benelux, Spain, Italy, the Mediterranean, South Africa, and Ireland.

In Latin America, we again posted high single digit growth in both our cereal and snacks businesses.

In Mexico, where we gained measured channel cereal category share, we launched Special K with chocolate and a multigrain cereal version of our new NutriDia brand.

Across the rest of the region, we saw strong growth in most of the businesses for the full year.

This extended across both the cereal and snacks categories.

Our Venezuelan business, where All Bran continues to do very well, saw exceptional growth, as did Colombia as a result of strength in adult brands, and our introduction of wholesome snacks during 2006.

Finally in our Asia Pacific business, we saw solid sales growth in our cereal businesses in the fourth quarter.

Kellogg Australia posted on target cereal sales growth in Q4 driven by Just Right, Corn Flakes, Sultana Bran, Special K and Mini Wheats.

The snacks category continues to be challenging, but we expect this to shake out over time.

Sales growth in Korea was driven by Frosties and Chex, and in Japan, the new wholesome snacks business appears to have started well and the category continues to grow.

So in summary, we're pleased to report another strong quarter and another excellent year.

We face significant cost inflation and difficult operating conditions in many of our businesses during the year.

The volatility in commodity costs continues and will remain a challenge for the foreseeable future.despite all these pressures, which affected the entire industry, we managed to meet, or in many cases beat, our long term targets in 2006.

We delivered above target internal revenue growth and excluding the impact of expensing stock options, we delivered another year of double digit earnings per share growth and we did it all without sacrificing the integrity of our business plan.

In fact we continued to significantly increase investment in the future growth through advertising and R & D, price mix and volume increased as a result of our successful new products and brand building support.

We generated significant cash flow through continued focus on manage for cash and we returned an increased amount to shareholders through major share repurchases and an increased dividend.

Our continued focus on our operating principles is unchanged and, as you've seen, we have strong innovation, advertising, and promotional programs planned for this year.

With the right people in place across the Kellogg world, strong plans in place, and with the ability of our employees to continue to execute with excellence, we look forward with confidence to another year of growth in 2007, and with that, I'd like to open it up for questions.

Thank you, everyone. [OPERATOR INSTRUCTIONS].

We go first to David Adelman with Morgan Stanley.

Good morning, everyone.

Good morning, David.

David, I wanted to ask you if you could put the inventory reduction among the customers in the U.S. ready-to-eat cereal business into context.

Was that simply working out some of the inventory build at the end of Q3?

Are levels now at the trade below where they were entering '05?

And so fourth.

Yes, sure, David.

I think the key as we looked at Q4 was consumption in our cereal business across all channels was up around 3% which was consistent for the year.

Shipments were down due to trade inventories.

We flagged it in Q3.

To be honest it was slightly greater than we had thought when we flagged it in Q3, and the great thing is we took the right actions.

We finished the year with our inventory position at the end of Q4 '06, slightly below where it was at the end of Q4 '05, so we did the right things. the great thing also I think when you look at cereal because that was a big difference between consumption and shipments was our base performance in the quarter was very strong, up 4, our price per pound was up 5% so it was a very good performance I thought and we basically put that inventory issue behind us, David.

As a follow-up, David are you surprised by the level of overall competitive activity in the category in the second half of '06 in light of the input cost inflation that obviously all of your competitors are absorbing as well?

Yes, well, I guess we did see heightened technical activity principally in Q4 but I mean the key from our perspective is we're going to continue to play our game.

I think brand building and innovation are really what drives the category and drives long term share performance and growth and Q4 was quite strong, and we'll just keep doing what we need to do and I think everything will take care of itself, David.

Okay, thank you.

Good luck.

[OPERATOR INSTRUCTIONS].

We move to Terry Bivens with Bear Stearns.

Good morning, everyone.

Good morning, Terry.

By the way, I think this is the first all Aussie conference call that certainly I can recall, so congrats on that.

Just on the commodity side, pretty significant revision there.

Could you touch on what elements in particular caused you to raise your estimate of the input inflation for '07?

Yeah.

I think the biggest driver, Terry was what's happening in grains and edible oils.

I think everyone is seeing corn, driven by ethanol, it's impacted on all grains.

Wheat is currently very high due to drought and the global finishing stocks on wheat are quite low.

Rice is up significantly, and ultimately, it will affect barley and oats and everything because a lot of these grains are interchangeable when you look at various segments in the market.

In the grain prices and the high volatility in our view is unlikely to change in the foreseeable future so from our perspective, we're pleased that we absorbed much higher costs and yet, we can still hit our long term targets.

Was there any element in there perhaps some of your hedges rolling off at maybe a less than propitious time?

We don't really get into a great level of detail on hedges.

There were some areas that we hedged in '06 that I suspect you believed we hadn't hedged, so some of the benefit I think people thought may be coming through in '07.

We didn't really have that as a cost in 06 and the other area which is on energy which you look at what's happened to the price of a barrel of oil, it's down about 20, 25% from $70 to the $50, $55.

The price of diesel is actually down about 10%, so you've seen a disaggregation in the price of oil and the price of diesel so diesel is is effectively up nearly 15% relative to the price of oil.

So, those two things have drifted apart which also is a factor in what's going on in energy costs.

Okay, thank you very much.

Thanks, Terry.

We'll move next to Eric Katzman with Deutsche Bank.

Good morning, everybody.

Good morning.

Congratulations on your new titles.

Thank you.

I guess my first question, what should we make, Dave, of the fact that your tonnage in the fourth quarter was only up 0.7% and based on my records, that's the slowest rate of growth since the third quarter of '04?

Well, I think, I mean looking at the overall performance, price mix was up.

Volume was up a little bit, so I don't think it was a bad performance.

You're of talking across the business?

Yes.

On a consolidated basis, coming out of the Keebler deal, right?

It was a lot of volume to value, so we saw the price mix component move up and then volume started to accelerate as you kind of, I guess, got done with some of the SKU cuts, so I was a little bit surprised to see, I mean, I guess my point is that in the last few years that the price mix versus tonnage balance has been much more equal?

Yes.

Whereas in this quarter it was very skewed to price mix and I'm just kind of wondering how we should think about that?

Yeah.

I think if you look at the full year, it's where we think it should be, very balanced year.

Remember we did take a fair amount of cereal inventory out in Q4 which would have had an impact on it so I haven't actually calculated what that would be so I can't tell you but it would have had an impact, but I think the full year is more the trend would expect going forward.

Okay.

And then what was the components of corporate expense that was up so much versus a year ago?

Eric, the corporate expense that's up is primarily the stock option expense that's going through the center line there.

Yes, I mean, but it seems like it just accelerated a bit in the fourth quarter versus kind of the comps that you've had during the rest of the year.

I think you got about about 65 million in the full year, about $19 million in the fourth quarter and there's also some timing of incentive programs in that fourth quarter balance as well.

Okay, and then lastly, I guess you've been fairly conservative in your outlook for the last, for most of this decade actually, and then exceeded the forecast over time, but like how should we put in context like currency going into '07?

What have you kind of assumed there because that should be a tail wind, and kind of what happens if we get a decoupling of say corn versus wheat because I think the sub soil moisture levels are quite good.

Maybe we get a better crop out of Eastern Europe so maybe we could see wheat rollover versus corn that kind of is subject to its own dynamics and related to energy.

Okay, well let me take the easy currency question and I'll throw it to David to forecast future grain prices and answer the guidance question but on currency, Eric, what we're looking at for 2007 is similar to what we saw for 2006 full year.

We saw about 40 basis points of improvement on net sales from currency and a little bit of benefit on the bottom line so we see that again in 2007.

And Eric, our view would be that wheat should come down.

I mean, it's basically drought related.

The actual correlation between corn and wheat historically has been quite strong but given how far corn has run up, I think that correlation should disaggregate as we go forward, but our view is that wheat will come down as the new crop goes in and as the global picture actually looks better.

That's why we've got a range in our inflation of $0.18 to $0.22 because at this point, who knows?

We do know that I think grains are going to remain more volatile and at the high end of the range is from our view going forward, so we have got a fair degree of hedging for 2007.

On the things we can hedge we're about 70% plus covered so we're taking probably a more conservative view on this given the volatility and that will be our approach going forward.

Okay, thank you.

See you at Cagney.

[OPERATOR INSTRUCTIONS].

We move next to David Palmer with UBS.

Hi, guys.

Hi.

Congrats as well.

You said during the call that you're going to talk more exclusively about the advertising portion of your overall brand building as you previously described it, and from that it sounds like some other areas of brand building spending, again away from advertising, are not going to grow as fast.

Could you perhaps give more detail about perhaps the evolution in your thinking about brand building dollars, the return on investment of different types and why there may be a shift here?

Yes.

I think we started flagging this at Cagney last year, that on the consumer promotions aspect of our brand building, we were going to do a global analysis to see how we drive efficiency and effectiveness on the inserts and the promotional programs we use.

That program is being completed very successfully.

We saw a benefit in Q4.

We're going to see an ongoing benefit through 2007, but once we've got that benefit then going forward, it won't alter much, and that's really just us going, okay, our level of brand building has been high.

We've gone back both on consumer promotions where we've seen the greatest efficiency gains but even on media last year, we pitched our media buying in many markets around the world and we've actually gained significant efficiencies so, with advertising going up at the high single digits, brand building still increasing, but given the benefits we've got in driving efficiency and consumer promotion, we just wanted to flag it.

It isn't really a change in what we're doing.

It isn't a change in approach and I think during the call I tried to give you as much clarity on that because it is something we've been talking about for over a year.

Does that help or is there something more specific you'd like?

I guess that helps a bit.

I mean, I just can't help but think that you've done some things that you identified low hanging fruit maybe three or four years ago on the consumer marketing end and that that's reaching kind of an end of the road so to speak on longer term base basis in terms of the ROI from your perspective.

Yes, I think personally in every aspect of our business including advertising and consumer promotion, trade, COGS, we're always looking at continuous improvement and how we can get efficiency gains in everything we do.

Impressions, importantly, as far as media impressions will be up year on year, significantly, versus 2006, so there is nothing negative in this from our perspective.

We see it as absolutely a net positive.

I'm going to hop off but could you just maybe give a couple insights on your extensions on that Special K brand, what categories are showing the most promise as you get into the weight management areas and what might eventually be in sourced that's being outsourced today?

Thanks.

Yes.

On the Special K, you're talking about the meal replacement bars and the protein beverage, while they've been in the market for awhile, the Marketing launch actually started mid January, so it's very early to really understand how consumers have and will respond.

It's looking promising but it would be probably a little foolish to give any predictions.

What those products do is actually enable consumers to more holistically through the day, manage their diet so that they can control weight, and we think as the advertising program continues through January-February, probably by March-April, we'll have a pretty good read on that, but its certainly started well, David.

Thanks very much.

[OPERATOR INSTRUCTIONS].

We go to John McMillin with Prudential Equity Group.

Good morning, welcome back, John.

Good morning, John.

Congratulations on these numbers.

The North American retail snacks numbers are just incredibly good.

I'm just trying to get, I don't know if Carlos would be happy to see you give a 4% sales growth target because he's just had low single digit printed on his head.

Why the change?

Is it just reflecting confidence that you wanted to be more specific than that or pricing that you're putting through or getting through, or just the significance of changing that to a 4% level?

Well as we said on the call we've changed it for this year.

Our long term targets will remain low single digit, and it's a combination of all of those factors you mentioned actually.

And just when you flag trade inventories and I must admit when I look at the supermarket I always look at the top of your boxes, and I still see stuff that's only a couple months old.

When you flag it, what kind of month levels are you looking at?

How do you flag it?

How do you know when its too high?

John, we have what's called vendor managed inventory with the bulk of our retail partners in the U.S, So we track with them of our retail partners in the U.S, So we track with them and on their behalf our inventory level so we can ensure if they go up above what we've agreed is a reasonable level, then we jointly work on how we manage those back down, and we saw that happening towards the end of Q3.

We actually had a price increase at the end of Q3 so probably exacerbated so that was a pretty significant pull-down but the great thing from that perspective was consumption for the quarter was consistent with the year and we've put that issue behind us.

And if I could just ask one Asia Pacific question, because, I mean, you talked about the challenging conditions.

Am I right to assume that the major challenges are just in the snacks area or has CPW had an impact in Australia cereal or can you just kind of give a little color in terms of the Asia Pacific challenges and the lack of growth?

Yeah, John.

Talking specifically Australia, our cereal business did grew low single digit in the fourth quarter.

It was really our snacks business and this is something we've seen in snacks categories around the world.

When you get a couple of the bigger confectionary players come into the snacks category, it tends to have somewhat of a destabilizing effect on the snacks category which typically by default are more wholesome in nature and you go through probably 12 to 18 months has been our experience where the category can swing up and down and typically go sideways and slightly backwards.

Cereal, we're doing pretty well.

The category is growing quite nicely down there.

Great.

Thank you.

Moving on we'll take a question from Todd Duvick with Banc of America Securities.

Good morning.

Wanted to ask a quick question on the fixed income side if I may.

Sure.

You definitely got solid cash flow and you've been using that for dividends and share repurchases as you have said, but I'm just trying to reconcile that with your reduction in net debt, which you have actually done.

You've got a 550 million Euro note that comes due some time in the middle of the year in May.

Is it fair to assume that you're going to refinance at least a portion of that in the capital markets some time between now and then?

Well we're still working through exactly how we're going to specifically finance it but we're probably going to have some sort of, when I look at something like a commercial paper program in Europe and then maybe turn out some debt in the U.S, Something on those sorts of lines.

Okay and would that be for the full amount or for a portion of it or have you not yet decided?

We haven't yet decided on that.

Okay.

And as it pertains to I guess your long material target, you have obviously the Keebler acquisition a number of years ago and since then, it seems like you've really been focused on organic growth and obviously doing a good job with that.

How do you view acquisition opportunities and how do you think about that with respect to your long term credit rating?

Well, I guess to answer the question at a macro level, I'm very come comfortable with the level of debt that we have today.

I believe that enables us to do small bolt-on acquisitions.

In terms of the question around the credit rating as such, we're not targeting a particular credit rating.

I feel very good about the level of debt that we've paid down since Keebler, and how much the business has grown so I'm very comfortable with the position we're in.

Fair enough.

Thank you very much.

Now we'll take a question from Eric Serotta with Merrill Lynch.

Just wanted to touch base on the issue of up front costs.

This was in my recollection about the third or fourth year of running in the 11-15 cent per year range for '07.

Just wondering, are you looking at diminishing returns or lower IRRs on the projects that you have planned for '07 than on the projects you've had planned for the past few years as you've maybe gotten at the low hanging fruit and I realize that you're still seeing a build of, a build from the previous year spending, but do you see the IRRs on the spending for 06, '07 and perhaps '08 being lower than what they were in the previous years or are you finding more savings potential as you peel away layers of the onion?

Eric, I think when we look at one-time costs, they really are an inherent part of that business and they will be ongoing and we'd expect to get good returns on the project that we do going forward.

John, do you have anything to add?

No.

I think that we don't see a case of diminishing returns.

We're always looking for new projects and the projects that we enter into always have a return in excess of our current return on invested capital so we feel very good about the projects we're pursuing.

Okay and if you disclose specifically what some of those projects are for '07, yet?

I know there's always sensitivity with communications to employees and the like, but have you discussed any of those specific areas?

Some carryovers from last year, so I think they're in the public domain.

Many are yet to be communicated.

Okay.

And then lastly on cash flow, you had very nice growth from '05 to '06.

Part of that was from lower pension funding.

Just wondering what your outlook is for pension funding for '07?

In '07 we're looking at pension funding probably more in line with '06 and '05 so we're not looking at a big pension contribution in '07.

Great thanks a lot.

Thank you.

We now take a question from Pablo Zuanic with with JP Morgan.

Good morning, everyone.

I guess I had a question for John Bryant on the international front.

John, can you just give us some color in terms of what you achieved in the last two years?

You're still in charge of that division.

From outside, I always thought there was a lot of potential there and the growth has been good, it's been pretty much in line with North America so the question is long term should we assume that international will grow faster than North America and number two, what were the big changes that you implemented internationally in the last two years?

Well, Pablo, I think my boss agrees with you completely in terms of growth opportunities internationally.

It's obviously an area where we're accelerating growth.

It's an area where we see very good category growth in cereal and snacks good category expansion.

As you look at Latin America you see very strong growth over many years now, Europe, strongest growth since the early 90s and we have an opportunity I think to accelerate our position in Asia Pacific, so I feel very good about the direction we're heading international.

We've ramped up our rate of innovation and still driving forward and a lot of opportunity ahead of us.

For example, in the Asian unit, it seems that your putting a lot of hope in that piece of the international division.

Can you give us a bit more color there and what's happening with mix improvement overseas if you can just expand on that ?

I think Jeff's role in Asia Pacific is an indication that for us to make the progress we would like to make not only in Asia Pacific but in Eastern Europe, we've got to dedicate some high level resources.

Jeff has just started on that journey and we're very hopeful that we'll come up with great ideas to expand and grow our business but we're going to find the right way to do that, Pablo.

Now, just moving on to domestic front, David.

I look at obviously very strong performance in snacks.

I would argue that cereal is decelerating that you're facing tougher competition and snacks has had three very good years of growth but I'd assume that Kraft is going to become more aggressive in cookies and crackers and then I look at the frozen side, waffles, Pop-Tarts, how much growth can you really get there?

Why should I expect snacks and the frozen side of the business to continue to do so well in the environment you just described and related to that, isn't there a need for Kellogg, while keeping the focus maybe trying to expand into new categories, making use of the breakfast category for example, in a broader sense, leveraging the Kellogg name?

Can you comment on that?

Yeah, Pablo, I think firstly, the forecast for 2007 indicate that we'll be going for 4% growth across the business.

I think your comment on cereal, if you look over time, we grew 3% consumption for 2006 for the full year and we're up against very tough and much stronger growth in 2005, so that was part of it.

We continue to believe we'll continue growth with our cereal business as we go forward.

Snacks, the rate of growth was very strong but our expectation is we will do that again at that level in '07, because 2006 was an exceptionally strong year.

So, I think you're right.

I think that's what you're hearing in our forecasts and projections for '07.

We feel very comfortable with them and our plan is to continue to drive the right things to sustain the performance of the business in '07 and beyond.

We try to be realistic, especially when you think about some of these cost pressures we've got.

They're impacting everyone, not just us.

Gentlemen, last one if I may.

In terms of kids cereal category, according to our numbers that's a category that's been decelerating, the growth has been mostly on the adult side.

We're hearing General Mills come out with an interesting innovation in that segment.

Can you expand in terms of what it is you are doing in terms of kids cereal and am I right in saying that piece has been decelerating?

I think the kid component of the cereal category in North America is more competitive than the adult from a pricing perspective which has had an impact on the overall growth levels.

It's always been that way, Pablo, so it isn't actually that different, and I think given where we are with our portfolio, we're fairly comfortable that we're well positioned to continue our performance.

Thank you very much.

Thanks Pablo.

Next question will come from David Nelson with Credit Suisse.

Good morning, congratulations.

Thanks David.

At this point just one last question from me.

You'd launched the Kashi into frozen dinners and entrees and organic versions of some of your year quality icons.

Could you give us a little more information on what you're seeing with those new product launches, please.

On frozen, or --

The Kashi into frozen dinners and entrees.

Well, it's early but I mean if you look at the subsegment of the meals category which was more the natural, there's one other major branded competitor there, currently, while it's early, we have, I think, six of the top ten selling meals in that natural sub segment, so while it's early and distribution is still building, we're very pleased that we have more products coming in 2007, so it started pretty well, David.

Okay.

And then organic versions in cereal?

For Kellogg or Kashi?

Kellogg, sorry.

You know, I think they're doing okay.

They're certainly doing pretty well in the natural channel.

In the mainstream, it varies account to account and we'll see how it does over time.

The hanging in there with the number of accounts and they aren't doing so well with others so mixed bag.

Okay, thank you very much.

Thanks, David.

And moving on we take a question from Alexia Howard with Sanford Bernstein.

Hello.

Hi.

Hi, a couple quick questions.

Price mix growth has obviously been very strong recently, particularly this last quarter, but over the last year as well.

Could you talk about going forward, how you expect that to play out and whether you expect it to soften a bit and maybe growing those things up, and I'm thinking specifically about the three drivers of price mix growth in terms of innovation.

Are we expecting that momentum to continue to drive mix improvements over time?

Secondly, I guess we've got on the positive side commodity cost inflation maybe allowing you to keep the pricing fairly positive, and then on the flip side, we've got perhaps increasing rates of competition particularly in the retail cereal segment in the U.S.

How do you expect that to play out during the course of 2007 and are we likely to see a bit of moderation in price mix growth going forward?

I think our expectation is that price mix going forward will be not that dissimilar to what its been in the past, maybe a little bit similar, I'd say.

When you talk about innovation, it's always to see if we have innovation that drives mix.

As far as commodities and the impact on price, we've been relatively aggressive on price globally and in many of the segments in the U.S, and in cereal in the U.S, it's always been a fairly competitive category, so I wouldn't read too much, we're not reading too much into Q4.

We're just getting on with playing our game which is to drive innovation and brand building.

Great.

And then one quick follow-up on Europe.

It seems that we're hearing from a number of companies now that the environment in Europe after several years have been quite painful is getting a little better now.

Could you elaborate on that a little bit further?

Are there particular countries where it's getting better, perhaps Germany with the hard discounters easing up?

Are you seeing private label, perhaps easing off a little bit and again, is it volume versus price mix that's really giving you the boost there?

Yes.

I think across Europe, you're probably seeing hard discount is still growing but not quite at the rates they were growing historically.

I think many retailers are finding that equilibrium and balance between what they want out of their private label and what they know they need from their branded suppliers, so I think net-net, it's marginally more positive.

It's always a little volatile, Europe, so we had a great year in 2006, the best year of top line we've had in more than ten years but I think that was because of the strength of the innovation and brand building, so there is probably a little bit more in price mix than volume coming in Europe, but relatively balanced.

Okay, great.

Thank you very much.

Thanks.

Jason if we could take one more question, that would be great.

Thank you.

Last question will come from Jonathan Feeney with Wachovia Securities.

Great.

Thanks for getting me in, guys.

Just one quick one.

On North American retail snacks, that's one heck of an acceleration at 12%.

What role did maybe a disorganized and maybe less effective competitive landscape play in that and specifically, what drivers of the business, is it shelf share, is it new products are driving that huge acceleration?

Well, when we report snacks, Jonathan, you know we've got everything in there, we've got what's going on from the DSD perspective, we've got fruit snacks, we've got Pop-Tarts, we've got the Kashi snacks, so I mean DSD had a great year across cookies, crackers and wholesome snacks, we've done incredibly well with Kashi snacks, Pop-Tarts continued to grow and fruit snacks had a very good year, so I don't think there was any slackening off from the competitive side.

In fact, I think if you look at 2006, both of the major competitors in the cookie and cracker side, innovated quite positively and well.

You know, it was a very balanced year and some of the categories, actually crackers in particular showed very strong growth for all of us, so I think that is as well as we go forward so we'll let growth rate moderate a little as we go forward.

That would be our expectation and that's what we got built into our forecast.

It was a great year but even given that, it accelerated pretty nicely third into fourth.

Is it more of the same or is there anything specific going on?

Very strong, our innovation was very strong.

I mean, crackers, Club and Town House did well.

Cheez-It continues to do well.

The portion control packs not only in crackers but also in cookies, the 100 Calorie packs are doing well as they are for our competitors, so it was really quite balanced.

In store execution remains exceptional.

The level of unsalables has come down year on year very strongly so I think that's always a good indication of how effectively a DSD organization is working when they can drive improved unsalables year on year while growth is growing at that level.

It's a great performance.

Okay, thank you very much.

Thank you.

Okay, Jason.

That will end the call for today.

Thank you very much.

Do you have any final or concluding comments?

Thank you very much for your time.

Once again, everyone, this concludes today's program and we thank you all for joining us.