家樂氏 (K) 2007 Q1 法說會逐字稿

Good morning and welcome to the Kellogg Company 2007 first quarter earnings call.

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

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

(OPERATOR INSTRUCTIONS)

At this time, I would like to turn the call over to Simon Burton, Kellogg Vice President of Investor Relations.

Mr.

Burton, you may begin your conference.

Thank you, Sara, and good morning, everyone, and thanks for joining us for a review of our first quarter results and for some discussion regarding or strategy and outlook.

With me here in Battle Creek are David Mackay, President and 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 earnings per share, net sales, margin, operating profit, interest expense, tax rate, cash flow and debt reduction are forward-looking statements.

Actual results could be materially different from those projected.

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

A replay of today's conference call will be available by phone through Thursday evening by dialing 888-203-112 in the U.S.

and 719-457-0820 from international locations.

The pass code for both numbers is 6714942.

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

And now let me turn it over to David.

Thank you, Simon, and good morning, everyone.

We're obviously pleased to announce our first quarter results and an increased level of confidence for the year that comes from such a strong start in Q1.

As you can see, last year's momentum continued into the first quarter and sales growth increased faster than our target.

We exceeded our expectations for operating profit growth and we did this while absorbing significant cost inflation and while making investment in the business to drive growth.

Both our net sales and operating profit results were achieved against tough year ago comps and reported earnings per share growth was greater than our high single-digit target.

Results across the P&L was strong and we delivered sales and operating profit growth across most of our global businesses.

This shows the strength of our operating principals and the benefit of our commitment to invest in future growth through brand building and innovation.

We're entering the second quarter with greater confidence that we will meet our long-term targets in 2007.

Given this great start to the year and our continued business momentum, we're raising our guidance to mid single-digit revenue growth and we're also raising earnings guidance again to a range between $2.70 and $2.74 per share.

Slide 4 highlights our financial performance this quarter.

Reported net sales increased by 9% building on 6% growth in the first quarter of last year.

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

Reported operating profit increased by 6% and internal growth was 3%.

As you'll remember, we're budgeted for internal operating profit to be down in the first quarter so we're pleased with this better than expected performance.

Earnings per share increased by 18%, due to the strong sales and operating profit growth, lower interest expense, and a lower tax rate.

This was timing related, which John will discuss later.

Note, too, that EPS included up front costs of $0.01 in line with last year's first quarter.

And finally, cash flow in the first quarter was $289 million, an increase of $188 million from the first quarter of last year.

Let's look at each of these results in more detail and Slide 5 shows our net sales growth.

Internal net sales growth in the first quarter was 7% and as with previous quarters, this was driven by a relatively balanced contribution from price mix and tonnage growth.

Clearly, the sales momentum we carried through 2006 continued into the first quarter, which is why we've raised our guidance for full-year internal net sales to mid single-digit growth.

Tonnage and price mix were both driven by strong innovation and excellent brand-building programs.

In fact, I'm sure you've all seen the strong pricing benefits that are showing through in recent U.S.

measured channel category data.

And finally, as you can see, the effective foreign currency translation had an impact of less than 2% on the first quarter's reported results.

We remain committed to our realistic targets and believe they provide us the basis for our strong performance.

We want to provide you, our shareowners, with consistent, dependable rates of growth.

We know that constant reinvestment and strong execution are essential to our continued success.

Now let's turn to Slide 6, which provides detail regarding our increase in investment in advertising.

The slide shows the significant increase we made in this investment during the first quarter of 2007 and for the full-year 2006, and the double-digit growth posted in the first quarter built on mid single-digit growth in the first quarter of last year.

Remember that we said previously that we expected brand building support to be strong in the first quarter as we continue to invest in the growth of our current brands and support our new introductions.

We had a significant amount of new product activity in the first quarter and as you can see, we certainly invested as we had planned behind these initiatives.

We remain committed to both advertising and consumer promotions as a means of building our brands and driving profitable sales growth.

We'll continue to leverage our scale across our different regions and businesses throughout 2007 with programs such as Shrek 3, Pirates of the Caribbean 3, and XBOX.

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 7 shows our first quarter gross margin performance.

Gross margin was lower in the first quarter, in line with our budget and the guidance we gave you.

The decrease resulted from the impact of incremental commodity cost inflation, which accounted for the majority of the decline.

As you know, we've seen a lot of volatility from commodity, fuel, benefits, and energy costs over the last few years, and as we told you last quarter, 2007 is forecast to be no exception.

In fact, we continue to expect that these incremental costs will be between 18 and $0.22 of EPS in 2007, which could lead to a gross margin decline of approximately 50 basis points for the full-year.

The year-on-year increase is somewhat front loaded as lap higher costs in the back half of 2006.

In Q1 we incurred approximately $0.06 of additional commodity, fuel, benefits, and energy inflation versus the first quarter of 2006.

We also had some discrete items in cos of goods which negatively impacted gross margin by 40 basis points.

This included items such as a $5 million lease termination charge.

As I mentioned at CAGNY, however, we banked all [as] not margin and we generated almost $70 million of incremental gross profit in the first quarter.

This in turn helped fund our increased investment in the business.

If you look at Slide 8, you'll see a slide we showed you at CAGNY.

This shows the effect of the introduction of higher priced products can sometimes have.

For example, in our international business our snacks have a sales price per kilo that is 152% of international average.

Gross dollars that are 141% of the average, but gross margin is 92% of the average.

So margin is down while the absolute gross dollars generated are up dramatically.

Obviously, gross margin is important to us, but as I said, dollars are what we invest in future growth.

Now, let's turn to Slide 9 and a discussion of operating profit.

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

In North America, first quarter internal operating profit growth increased by 3% despite a significant increase in investment in advertising.

In Europe, 6% internal net sales growth drove 18% profit growth.

We do not have the same kind of commodity issues in Europe.

We have the benefit of significant cost saving programs and you can see the leverage in our P&L when we do not face unusual inflation pressure.

In Latin America, quarterly internal operating profit declined by 15%, resulting from cost inflation and the timing of expenses, including investment in brand building.

Obviously, we will continue to invest heavily in this excellent business throughout the year and we expect that inflation will remain high.

Consequently, we expect approximately flat operating profit from our Latin American business for the full-year.

And finally, in Asia Pacific internal operating profit increased by 4% in line with our long-term targets.

For the quarter, consolidated internal operating profit growth was 3%, which as David said earlier, was greater than our expectations.

This resulted from relatively broad-based sales growth across our businesses and was achieved despite strong investment and continued cost pressures.

Below the operating profit line, interest expense increased for the quarter by $3 million and the tax rate was lower at 24%.

While the timing was uncertain, you'll remember that we said previously that our expectations for the full-year tax rate would include the effect of certain discrete items, and as you can see, these flowed through in the first quarter.

This effect was simply one of timing.

Now, let's turn to Slide 10 and a more detailed discussion of cash flow.

You can see that we posted strong cash flow of $289 million in the first quarter of 2007, which was largely driven by better working capital management.

Both inventories and payables made significant contributions to cash flow in the quarter and obviously we will remain very focused on this important metric in the future.

We continue to expect that full-year cash flow will be between $950 million and $1.25 billion.

Now finally, I'd like to discuss guidance for the remainder of the year on Slide 11.

You can see that we now expect mid single-digit internal revenue growth, an increase from the guidance we gave you last quarter and at CAGNY.

We still expect that operating profit will increase at a mid single-digit rate but we now expect that earnings will be in a range between $2.70 to $2.74 per share.

Remember, too, that our previous guidance was an increase of $0.01 from our initial guidance.

New guidance includes our estimate for total incremental fuel, energy, benefits, and commodity costs of between 18 and $0.22 per share unchanged from last quarter.

This inflation remains a considerable headwind so we are very pleased to be able to absorb these costs and still increase our earnings guidance.

And we continue to expect that up front costs for the full-year will total $0.14 of EPS, approximately equal to last year's level of investment.

Obviously we expect some leverage below the operating profit line in 2007.

For the year, we expect approximately flat net interest expense and we expect that the tax rate could be between 30 and 31%, slightly lower than our recent guidance.

I'm sure that many of you are wondering why, given our stronger than expected first quarter performance, we have not raised our EPS guidance even more for the full-year.

While we significantly increased investment in advertising the first quarter, there was a benefit to operating income from the timing of programs and, in addition, we will continue to invest in the business given our increased flexibility.

So you can see we have momentum and our goals haven't changed.

So we should post another year of dependable results in 2007 while following our operating principles and investing in long-term sustainable growth.

Now I'll turn it back over to David for a revue of our business.

Thanks, John.

Some of the themes you'll be seeing throughout the remainder of the presentation are outlined on Slide 12.

We continue to invest aggressively behind innovation.

We have a balance between line extensions such as Special K Chocolate, usage occasions such as Right Bites cookies and new platforms such as Special K beverages.

We also continue to reinvest behind our brands to drive long-term sustainable growth.

We leverage our global scale to quickly share ideas around the world and it is our strong execution that allows us to fully leverage our innovation programs, brand building initiatives, and price mix gains to help us deliver dependable sales growth.

Now let's turn to Slide 13, which shows the internal growth posted by our North America businesses in the first quarter and we're pleased with the performance as sales growth continued to be strong across these businesses.

Let's look at each of them in a bit more detail, and if you look at Slide 14, it shows the sales growth we're posted in North American cereal in recent quarters.

As you can see, the first quarter's strong 4% growth builds on 6% growth posted in the first quarter of 2006, the year's most difficult comp.

Our base sales increased by 4% in measured channels in the quarter and price per pound increased by 5%.

And both were driven by successful innovation and strong brand building programs.

Special K Chocolate, Rice Krispies with Strawberries and Kashi GOLEAN Honey Almond Flax, all of which were introduced within the last year, are doing very well and all contributed to our strong results.

We're constantly looking for creative ways to bring innovative food to consumers and as you'd imagine we've got more introductions planned including our Cereal Straws product and Mini-Wheats Cinnamon Streusel.

Kashi posted strong sales and share growth in the quarter as GOLEAN and Organic Promise did well.

And we're launching two versions of Kashi granola, which are great-tasting additions to the Kashi franchise.

Our Canadian business posted mid single-digit sales growth as a result of All Bran Guardian and Buds, Mini-Wheats Strawberry and Special K Chocolate all performing well.

Slide 15 shows our snacks business and the strong 11% growth posted in the first quarter.

This continues the strong momentum that these businesses built up in 2006 and builds on a 12% comp.

Let's look at more detail on Slide 16.

Our Pop-Tart toaster pastries business posted essentially flat sales on a difficult comp from the introduction of Go Tarts last year.

Despite this, category share in measured channels was 86% in the quarter and we continue to expect another solid year from this great brand.

Our cracker business posted high single-digit sales growth and strong consumption growth in measured channels.

Cheez-It, Club and Townhouse all had a good quarter and portable snacks continued to do well.

And we've got great new innovation about to launch with Club Puffed crackers.

We also saw high single-digit sales growth in the [store] dough cookies business and posted increased consumption gains and share gains.

Our portable products such as Right Bites and Grips had a greater quarter.

We're about to introduce a new variety of Sandies in the second half after a strong lineup of innovation in the first half.

Our wholesome snack business also had an excellent quarter posting double digits sales growth behind innovation and continued growth in Special K bars, Rice Krispies's Treats, Nutri-Grain, and Sweet and Salty bars.

And our fruits snacks business continued to post excellent sales growth, consumption growth, and share gains.

Yogo's is doing well and we've got more products planned for introduction in the month to come.

And finally, in Canada, we also saw high single-digit sales growth as a result of innovation, including All Bran Snack Bites, Nutri-Grain Sweet and Salty bars, Munch'Ems, and Froot Loop Yogos.

If you'll turn to Slide 17, you'll see that our frozen and specialty channels businesses posted 5% growth on 5% growth last year.

Our two frozen brands, Eggo and Morningstar, both contributed and both gained share in the quarter.

The Eggo business saw continued growth [through innovation].

Pancakes continued to do well and we've got new Blueberry Eggo pancakes launching in a couple of months.

Morningstar posted high single-digit sales growth, also as a result of good innovation.

Products such as Veggie Bites posted significant growth.

Our Kashi frozen entrees have six of the top 10 natural and organic entrees ranked by sales.

Kashi entrees have also grown the category and are doing very well to date and, as you may know, we're introducing three versions of Kashi frozen pizza in the second half.

Finally, our specialty channels businesses had another good quarter.

Our execution in these channels has been excellent, and we expect another strong year from this very important business.

Now, if you'll turn to Slide 18, you can see some of the innovation planned by the North American businesses in the second half of the year.

As you'd expect, this is a lot of activity and we're excited about the continued strong quality of the ideas.

Importantly though, the innovation is broad-based across the categories, as cereal, cookies, crackers, toaster pastries, fruit snacks, frozen foods and specialty channels are all represented.

Most of these products will be shipping in the next couple of months.

You can see on Slide 19 that we posted very strong internal sales growth in Kellogg international in 2006 and we began 2007 well, also with strong growth of 5% and this growth was relatively widespread.

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

In Europe, we posted quarterly internal sales growth of 6% as a result of strong growth in both our cereal and snacks business.

The U.K.

posted mid single-digit growth also as a result of both growing the cereal and snacks businesses.

Both Special K and Rice Krispies did very well as did Nutri-Grain Oat Baked bars and Special K bars and we've got more innovation planned, including two varieties of crunchy nut bars.

Our businesses in Spain, Italy, and France all posted high single-digit or low double-digit internal sales growth and we have Special K two-week challenges and Shrek theme promotions planned across Europe in Q2.

We also have good pan European innovation planned, including Special K Sustained with Fiber and Protein, Corn Flakes Multi-grain, and Special K snacks.

In Latin America, we posted growth in both cereal and snacks.

In Mexico, our largest business in the region, cereal posted strong growth and we continued to gain share.

We ran a number of promotions in the first quarter which were well received and innovation continued to contribute.

In the second quarter we have a Shrek 3 promotion and we'll introduce Guardian cereal.

Outside Mexico, we also saw double-digit growth from our businesses in Venezuela, Ecuador, Columbia and Brazil.

Finally, in Asia-Pacific, we poster lower internal sales, primarily as a result of continued weakness in the Australian snacks business and category.

However in Asia, we saw growth in our cereal business and in our snacks business.

We introduced snacks in Japan, which are off to a good start.

We also posted good results in Korea, Thailand, Taiwan, and double-digit growth in India as a result of innovation and brand-building programs.

We are anticipating that the Asia Pacific business as a whole will return to growth in the remaining three quarters of the year and that full-year growth will be in line with our long-term targets.

In summary, our message for 2007 remains unchanged.

Our strong start to the year simply enhances our confidence and gives us more opportunities to build momentum for the future.

2007 will be another year in which we meet our long-term realistic growth targets in a difficult competitive environment.

More importantly, though, we plan to achieve these goals while continuing our investment in sustainability and future growth.

We recognize that this investment will build stronger momentum and visibility into 2008 and 2009.

We will continue to focus on executing well and pursuing continuous improvements in all that we do.

Our commitment to our business model, operating principles, and our strategy remains strong and our confidence in the future has only been enhanced by a positive start to 2007.

And with that, I'd like to open it up for questions.

Thank you.

(OPERATOR INSTRUCTIONS) We'll go first to Andrew Lazar of Lehman Brothers.

Good morning.

Morning, Andrew.

I guess I'm thinking about the operating leverage that you saw in Europe versus North America on the margin line.

And I know you'd mention you're not facing the same inflationary pressures, I guess, there that you are here.

Perhaps you could provide a little bit more color on that.

I guess in the context of, would it be a fair characterization to sat that all of your projects and up front costs over the last couple of years, are they generating [per] activity savings ongoing that are as of now equal to what you spend, let's say, this year whether it's $0.14 or so in costs or have we not reached that inflection point yet?

I think, Andrew, firstly on Europe, as you're aware, per the EU has fairly tight controls on the cost of many commodities and imports, and therefore, we don't see the levels of volatility in Europe that we will see in other markets that may be a little bit more open to immediate shifts.

So that's certainly true.

As far as our investment in up front costs, I think the reason why we continue to be able to invest in the business and drive growth and succeed in driving the top and the bottom line has been ongoing process of constantly looking for ways to improve our cost base to try and offset these movements in commodities and other cost volatility.

So hopefully, we'll continue to do that as we go forward and we'll continue to see strong results.

John anything you want to add?

I think to Andrew's question on whether we've seen an inflection point, as David said, we invest in the up front costs to offset inflation and so if you want to take a multiple year look at the savings programs you have take a multiple year look at the inflation, as well.

And the two being -- have been offsetting each other.

That's why you don't see a net benefit in our P&L.

Although in Europe, as you said in this quarter, we had both operating leverage as well as the benefits of prior up front cost programs coming through because we don't see the big commodity cost increases in Europe.

Thanks very much.

We'll go next to John McMillin of Prudential Equity Group.

Good morning, everybody.

Hey, John.

Congratulations on the quarter.

The tax rate guidance for the year is now 30, 31.

And prior, it was what?

Prior guidance was 31% even.

Okay.

So, and that's, and obviously the first quarter rate was well below that, and you're just simply going to spend this back?

Is that the message you're getting across today?

I guess see the tax rate coming down a little bit and I didn't see that in the press release or anywhere else.

In terms of not passing that on, it's just your decision to spend it offensively?

Well, I think when you look at the tax in the first quarter, that was really in our full-year guidance.

It's just really timing in nature, John, and we do believe there could be a slight benefit in tax for the year, but it's nothing that significant at this point.

It is early and clearly taxes are the forecast, but we feel pretty good about the latest call of 30 to 31.

Okay.

Thank you.

Thanks, John.

Moving on, we'll hear from Eric Serotta of Merrill Lynch.

Morning.

Following-up on Andrew's question on operating leverage, it looks like your volume growth in U.S.

cereal was pretty flat or perhaps negative.

Was an absence of volume growth in cereal, I know you're focused on value over volume, but was perhaps a lack of volume growth a factor in the lack of operating leverage in North America?

Well, I think, Eric if you look at our U.S.

cereal business, there's a great performance in the quarter.

We grew 4%, the category was actually quite strong, as well.

We actually gained a tenth of a share and it was driven by base sales and also our price per pound being up about 5%, but also our price on deal being up even higher than that.

I think that is specific to the way we're driving the business, innovating, so I wouldn't draw any conclusions apart from a very strong first quarter in U.S.

cereal.

What was the other part of the question?

Basically, yes, I realize it was a very strong quarter from a dollar perspective in cereal.

Was an absence of volume growth a factor and the absence of operating leverage in the quarter?

Eric, I think the primary issue in North America on operating leverage is really the increase in commodity benefits and fuel cost year-on-year.

That's really more of a North American, or an America's driven issue between North America and Latin America.

And that's affecting both of those businesses predominantly within our portfolio.

Okay.

Thank you very much.

We'll move next to David Driscoll of Citigroup.

Great.

Good morning, everyone.

Hey, David.

Well certainly congratulations on the quarter and a good start for the year.

Just to follow-up on the tax rate question.

Am I right to assume that in '05 and '06 you had similar quote unquote discrete events the difference being is that those events were more evenly spread throughout the year?

Hence, I don't remember seeing a tax rate this low in any one particular quarter.

But first off, is that correct that we're just seeing a lower tax rate because you guys have had a number of these discreet events for the last couple of years?

There have been discreet items in the past and they have fallen across the years.

In the first quarter of this year, the discrete item is particularly large and it's the main discrete items that we expect in the year.

So as we look at full-year guidance of 30 to 31%, we do have roughly 24% in the first quarter and then more like a 32, 33 in the back three quarters of the year.

John, I believe that I'm correct in remembering that the 10-K indicates a 33% number in the absence of the discrete events.

So really, I come up with the question then is how long of a sustainability do you really see out there for these discrete events which I don't know that any of us can have any real clarity on?

How much further?

How many years forward would you see the tax rate remaining at the 31% level?

Can you give us any guidance here?

You might say that our sustainable rate in the 10-K is about 33%.

We do have a variety of initiatives underway to try to drive that sustainable rate over time down to 31%.

So then you would give guidance at 31% for the foreseeable future?

It's a bit early to be giving guidance for 2008-2009, but that's certainly what we're trying to drive the rate to.

Okay.

Thank you.

Thanks.

Moving on, we'll hear from Chris Growe of A.G.

Edwards.

Good morning.

Morning, Chris.

Good morning.

I just wanted to ask a couple quick questions here.

Just a bit of a follow-up on North American cereal, were there any kind of following on from last quarter, any inventory kind of adjustments that occurred at retail this quarter?

Are we pretty much in the clear there, if you will?

I think basically our inventories were broadly aligned with where they were last year.

I think what we saw was the fourth quarter of '06 was a bit of a hiccup and the performance in the first quarter at around 4% growth was very strong.

And the category itself actually grew, probably if you add in non-measured channels, probably grew 3.5 to 4%.

So it performed strongly, as well.

So we're very pleased with that.

I don't see any real issues on inventory, Chris.

Okay.

And then just a quick follow-up, there, a quick question on the kind of SG&A and advertising side.

You had talked about some savings coming through from kind of the consumer marketing side.

Were those in effect just reinvested back into advertising this quarter or was there some kind of benefit there to SG&A in the quarter?

No, we reinvested back.

We did on the consumer promotions line, that was a little less than last year, but our advertising was up, so we reinvested those benefits back to advertising.

That's great.

Thanks a lot.

Thanks.

[OPERATOR INSTRUCTIONS] We'll go next to David Driscoll with Citigroup.

Oh, I appreciate being able to get back in so quickly.

Just a question.

You guys had launched, and I forget the name of it, I think you just simply called it your wholesome snacks or you really, you were trying to open up a division that was going to be your big push into getting healthier snacks out there.

Again, forgive me, I don't remember the name, healthy, it was wholesome snacks I think you called it.

Bottom line, David, can you give us an update as to where this is going and how do you see future product innovations coming out?

Should we be expecting a lot more innovation this year or is this something that really stages rather slowly over the course of the next few years?

No, I think you're talking about wholesome portable breakfast snacks, WPBS, which is part of, now, our snacks business unit.

I think that area has always been, you know, a very high innovation segment for us.

It's doing well, it's growing, probably mid single digits over the longer term.

We saw a lot more growth, certainly, in the first quarter and we were up double digits.

But I'd hate to give any predictions on the future, except we've got a strong pipeline.

We feel very good about our approach to innovation and advertising, David.

We'll go next to Steven Kron of Goldman Sachs.

Great.

Thanks.

Good morning.

Two questions if I might.

On the cost reduction programs, the up front spending, $0.01 this quarter.

Do you have any color as to kind of the pacing of that as we move through the year?

I think, Steve, you're going to see it back loaded as it has been, certainly, in the last couple of years with a fair amount in fourth quarter and a little bit in third.

But that's been consistent over the last couple of years, I think.

Okay.

And then, David, can you give us an update on some of your health and wellness initiatives?

Kind of the Special K expansion if you will?

And then also whether the organic Kellogg's cereals, or what kind of traction you're seeing there?

Yes, I think the Special K protein beverage and the mineral replacement bars, it's relatively early.

Launched the advertising in January, so probably another three, six months before we get a very clear read, but we do now have the number one selling meal replacement bar in the market.

At this early stage, that's promising.

And I think the protein beverage is doing well, but like all of these things, it's a relatively new concept.

It'll be a while before we see whether we've got the level of trial and repeat that we need to make a long-term success.

But the initial indication's are positive.

And on the organic Kellogg's cereals?

Sorry.

The organic cereals, tracking probably around a tenth of a point.

Probably not doing as well as we would like.

It's very much dependent on the area in which it sells.

It's got some pockets of strengths, but the overall market reaction at around a tenth for those SKUs as being okay, but probably slightly below what people thought it might have been.

Okay.

Thanks.

Moving on to Alexia Howard of Sanford Bernstein.

Hi.

Question on the SG&A as a percent of sales.

It seems as though you got very decent leverage this time around despite the increase in media spending.

Could you give us a little bit more color on what that was?

Was it to do with pension expenditures or some other ongoing cutbacks and is that likely to be sustainable for the rest of the year?

Alexia, I think the key reason now SG&A margin -- SG&A sales went down is because the sales growth was so high.

So we spent the money we expected to spend, we had good increases, a double-digit increase in advertising as a company.

And there's nothing unusual on the cost line so much as such a high level growth at the top line.

Okay.

Great.

Thank you very much.

Okay.

We'll go next to David Adelman of Morgan Stanley.

Good morning, everyone.

David.

David, is there any major business unit or major geography you'd flag where you're increasingly anxious about the competitive dynamics?

No, I don't think so.

I mean, you know, from time to time we have, you know, we have more intense competitive activity, but generally most of the markets in which we compete are highly competitive and that remains the case, there's not one that stands out.

We feel pretty good about our business approach.

It seems to be working so we're going to stay focused on driving the business through innovation and brand building, David.

Okay.

And then, David, also a question on the capital structure.

What's your response to the reaction that the Company's balance sheet is becoming increasingly lazy that you could increase returns to shareholders and returns on capital and accelerate growth going forward by taking on more debt like in the post-Keebler environment?

Whether it's through a buyback or a one off dividend and so forth?

I'll let John add a little bit of color to that, but you know we have an authorization for share buyback, it's $650 million, and we think we're actually managing our balance sheet pretty well.

John, any thoughts?

I think at that level, given the size of the Company, it's about in line with the food industry peer group if not slightly higher.

I think we've got a pretty good position there, it gives us flexibility as a company to operate.

What we've started to do is to continue to try to improve our ratings position by growing into the ratings rather than, say, paying down additional debt.

So we are, as David said, we have a large share buyback in this year.

We also have the dividend increase we recently announced at 6.5%.

So I think we're at a pretty good balance there amongst the many uses of cash.

Okay.

Thank you.

We'll go next to David Palmer.

Hi, guys.

Just one big picture question on cereal.

Clearly, that growing 55 and over population in the U.S.

and you've been doing some nice things with Kashi and recently some weight management innovation under Special K, but I can't help but think that internally you think you could be doing more and maybe you are working on doing more to appeal to this age group, which could be kind of a long curve of demand growth in the future, particularly in the cereal category.

Could you perhaps give us a sense of how you view, what you've done to date with this age group and the remaining opportunity?

Well, I think you've seen a number of initiatives over time.

Special K continues to do very well.

Smart Start Healthy Heart and [Up-to-Date] are in the U.K., very much targeting the sort of over 40s, 50s.

Kashi continues to really appeal to all of these people.

All-Bran around the world is doing extremely well.

A tougher challenge in the U.S., but nevertheless starting to get some traction.

So we have, I think, a fairly broad array of products that appeal to a number of the needs of the demographic population that's going to continue to probably be a bigger part of our business which is the other 40s over 50s.

And that's true in the U.S.

but around many of the markets globally for us.

So we feel very good about it, there is more going on and when and if we're ready to go to market, we'll let you know.

Okay.

I'll leave it at that.

Thanks.

Thanks.

We'll go next to Terry Bivens of Bear Stearns

Good morning, everyone.

Hey, Terry.

Pardon me.

Going back to the cereal category, clearly you guys been successful in getting some price mix in there, and I'm referring North America.

Your chief rival has been kind of going the other way in some of the recent data.

The question would be, Dave, as you look forward, what would you expect Mills to do in terms of pricing on the cereal line?

They seem to be signaling that it's coming, but have you seen anything or what would your expectation be?

Well, I think, Terry, we don't like to make any conjecture on what other competitors in the market will or won't do.

We manage the business to ensure that we believe we're driving it in the right way.

We've taken pricing, it's coming through.

Our price per pound is up even higher than our base consumption growth and even our sales price on deal, those prices are rising.

We're managing the category we think in the right way given the cost pressures that we're under and continuing to drive the category through innovation and brand building, we believe is absolutely right for the long-term.

So I really wouldn't like to get into any discussion about what someone else in the category might or might not do.

Well, just on visible evidence, though, has there been anything you've noticed over the short-term of late that would suggest they're more likely to try to get some pricing?

Well, you could probably refer to the IRI data and they do stand out in a couple of regards, but rather than comment on that, I'd suggest you go back and look at the data.

Okay.

Thanks very much.

Thanks, Terry.

Moving on, from Wachovia we'll go to Jonathan Feeney.

Good morning.

Congratulations.

Hey, Jonathan.

Wanted to, and I jumped in the call a little bit late I apologize if this has been asked, but one area of confusion I think for investors has been the gross margin and the impact on it.

You're down 120 basis points, but it occurs to me that you guys have a snacks business that's grown 11% and a cereal business that's grown 4, and there's a huge, you know, gross margin differential there.

Is there any way you could sort of quantify how much of an impact that sort of, those different gross margin products might have had on your gross margin?

Well, there is an impact, as we said at CAGNY, that we are selling more products with higher priced per kilo realization, whether they be wholesome snacks or other similar products.

And that has had a positive impact on our sales growth and a positive impact on our gross profit growth in dollars, but it does have a slight negative impact on gross margin as a percentage of sales.

While we haven't historically quantified that, it was at about negative 30 basis points in the first quarter.

Okay.

Thanks very much.

Thank you.

Up next we'll go to Robert Moskow of Credit Suisse.

Good morning.

Hey, Robert.

I guess I had a question about the snacks business being up as high as it is.

I know it's a combination of better distribution and better innovation, but it seems like a lot of these items are things that might be kind of faddish in nature.

And I'm wondering, can you give me a sense of what percentage of these do you think are platforms that can last for a long period of time and what percentage of them would you consider kind of like new flavor variations that are maybe just trying to keep the news flow up?

You know, Robert, I think if you look at the growth in our snacks business, one of the biggest drivers in there has been the single-serve 100-calorie packs.

I think that's true not only for ourselves but our competitors.

I think that growth is sustainable and something that we'll see going forward because it is something consumers are looking for.

Right.

And other occasions for people who snack when they can do, would control calories or control portion size I think will continue to be a growth area for us and for all in the category.

We don't actually look at our growth and believe that we're launching stuff that's going to disappear.

Our level of innovation in snacks is probably slightly higher than the average for the Company, but that really relates to the nature of that type of category and those types of products.

The fortunate thing is when you have a DSD system as, we do in the U.S., we are able to deliver a lot of innovation cost effectively [into] the marketplace and manage it extremely well.

If it doesn't succeed, we'll delist it, now if it's working, we'll push it hard.

So we feel very good about what's going on in snacks.

Okay.

And then another question.

Kashi, it seems like whenever I turn on the TV, I see another Kashi ad, so you're clearly investing heavily this year.

Can you give us a sense about how big that brand is currently and then what do you think it could be five years down the road?

Yes, I think, I mean if you took Kashi in totality, it's in excess of $300 million but we wouldn't give anymore flavor than that.

It's doing very, very well.

It's clearly on trend and I think it's the brand that will continue to grow very, very strongly for us.

Okay.

Great.

Thanks, David.

Thanks.

We'll go next to Eric Katzman of Deutsche Bank.

Good morning, everybody.

Morning, Eric.

A few questions.

One's kind of just more of a specific follow-up on the tax issue.

John, is this a FIN 42 or whatever that number was in terms of then should we just expect more volatility from quarter-to-quarter from here on out?

FIN 48 does, will drive a little bit more volatility.

Obviously, what happened in Q1 had nothing to do with our implementation of FIN 48, because that was, for us, an immaterial implementation impact.

This had to do with this particular discrete item coming through in the quarter.

Okay.

And then on the cookies and crackers, I think Kraft mentioned a price increase in Oreo.

I don't know if that was broader, but have you taken pricing up in cookies and crackers at Keebler?

Yes, we took it up, i think, effective January.

Might have been December-January.

Effective first quarter.

Okay.

All right.

I'm on it, three months later.

Thank you.

And then last, kind of more of a comment than a question.

I talked with Simon about this, but I just don't understand why, for example in your slides, I think you gave two slides on international.

And yet, the vast part of the growth of operating profit and arguably a big part of the growth on the top line longer term is going to come from international.

And yet, I don't know, you kind of continued to guide us to focus in on the domestic business when it looks like the year-to-year kind of strength is actually, and should continue to come out of international, and yet that's -- we get less detail on that.

Yes, I think, Eric if you look at our business currently it's around the two-thirds, a third, 65-35 North America to international.

I think the growth expectations for the Company currently that will grow in most markets around the world.

I think when and if we find opportunities to potentially get into some of the developing markets, then over the longer term that may have an impact, but over the short-term, I don't see it being dramatic.

And we do try and give broad flavor on every part of our business, so maybe you could talk to Simon if you'd like us to do more.

I just think I'll let it go, but I just think you're kind of underselling yourself because, obviously, the developing markets in South America are -- you have very high share.

The markets there are quite strong and you're doing well.

Europe is finally recovering for you after a decade or so weakness in some respects.

And I don't know, it just seems to me that rather than kind of getting us to focus in on the difficult, or more competitive U.S.

cereal market every single quarter, it's -- it would just be better to kind of focus in on these developing markets and the recovery in Europe to a greater extent than you kind of show us through the slides.

I'll leave it there.

Okay.

Thanks, Eric, and we'll have a look at that.

Moving on from Franklin Management Group we'll hear from Linda Donnelly.

Thank you.

I believe before you gave us guidance on Cap Ex for this year of 454, is that still approximately what you plan?

Our guidance is about 4% of sales for the year, Linda.

All right.

And could you give us a little guidance on depreciation and amortization?

Depreciation expense should be around $330 million for the year.

Thank you very much.

(OPERATOR INSTRUCTIONS) We'll go next to Pablo Zuanic of JPMorgan.

Good morning, everyone.

Morning, Pablo.

I guess have two questions if you don't mind.

But I want to follow-up on the last question on international.

I actually regard it from a different angle.

I mean I could make the argument when other companies took over selling soup in China and Russia that those countries have their dietary habit in their diet, but in the case of cereal, obviously, it's not part of those countries' dietary habits.

So I'm just wondering when I look at international, why are you not being more aggressive in selling some of your, say, biscuits, your cookies, crackers overseas.

Should I assume that most of the growth is going to come from cereal bars?

It's hard for me to picture, to be bullish on the Kellogg international growth when I believe that some countries, you know, the people that would eat cereal are limited to maybe well-to do families or people that have had exposure or live in the U.S.

Can you walk me through that rationale because I have a hard time getting comfortable with your long-term growth story on the international piece.

You know, Pablo, it's interesting.

Cereal is still our biggest part of our business.

You go to the biggest, the highest per capita consumption market in the world is Ireland.

I think it's about 8 kilos per head.

In the first quarter of this year Ireland grew 10%, the category was up 10%.

The category in many of our bigger developed markets is growing, you know, 4, 5, 6, but Ireland, 10%.

There is no limit to how far you can push and grow these categories.

Now, we are looking at the international markets and looking at our overall portfolio products and saying well, okay, if we want to expand in these, what products best fit.

And you're absolutely right.

A market like China for cereal, it's quite small.

So we'll see how we pursue that over time.

But we'll give you more color when we get there.

And one last one.

When I look at operating margins in North America I see roughly around 18% for Kellogg and then I look at General Mills and Hines, you know, 23, 24% if I'm not wrong.

Do you guys benchmark with them and why would your margins be lower and how should we think about your profit margins in North America evolving over time?

I think, Pablo, all I'd say is we had a great first quarter, our business is strong, our business model strategy and operating principles continue to work.

We're investing heavily back against innovation and brand building, which is driving, we believe, long-term sustainable growth.

We think our margins are very strong.

We think our model's working.

So we're very comfortable with where we're at.

Thank you.

Thank you.

And we'll go next to Chris Growe of A.G.

Edwards.

Thank you.

I just had a quick follow-up.

You had talked about, I believe it was (inaudible) about having a good chunk of your commodity costs hedged for the year.

Is there any way you update us on maybe kind of where you stand on the input costs that you can hedge?

Yes, we're about probably, Chris, 80-ish percent for this year.

Okay.

And just want a quick follow-up, as well.

You had mentioned, we know about pricing in cereal, we know about pricing in cookie and cracker.

Can you talk about, are there any other price increases that have hit, they've already been announced, that are hitting maybe in the international markets, for example, where you've taken pricing up?

We've taken pricing in probably every market over the last six months.

We took pricing in frozen, we took pricing in specialty channels, cereal, snacks, the U.K.

through Europe, Australia, Latin America, Canada, I can't think of a market, to be quite frank, where we haven't in the last six odd months taken pricing, Chris.

Okay.

That's all.

I want to be clear.

Thanks so much.

Sara, if we could just take one last question.

Thank you.

And that will come from David Palmer of UBS.

Mr.

Palmer, your line is open.

And hearing no response, we'll move on to John McMillin of Prudential Equity Group.

Well I got in there in the nick of time.

Hey, John, well done.

Seemed like Katzman wanted your job, Simon.

I'll talk to him about that, John.

I will only ask one question and it just deals, first of all, thank you for putting the up front charge number in the actual press release.

I assume this lease termination is in North America?

Is that right?

It is.

Okay.

I'm just trying to back it out of my numbers.

Thanks a lot.

So John, just to clarify, though, the lease termination charge is not the up front cost.

The up front cost, $0.01 in this quarter, is actually in Europe.

The lease termination charge is just a discrete item but doesn't qualify by our standards as an up front cost.

Okay.

So you have that charge plus the up front charge?

True.

Okay.

Thanks a lot.

Thanks, John.

And gentlemen, I will turn the conference back over to you for closing remarks.

Thank you very much for your time and we're looking forward to hopefully a very strong year.

Thank you.

And that concludes today's conference.

We thank you all for joining us.