家樂氏 (K) 2007 Q3 法說會逐字稿

Good day, and welcome to the Kellogg Company 2007 third 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).

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

Thank you.

At this time I will turn the conference over to Mr.

Joel Wittenberg, Kellogg Company Vice President of Investor Relations.

Mr.

Wittenberg, please begin.

Thank you, Andrea and good morning everyone, and thank you for joining us for a review of our third quarter results and for some discussion regarding our 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, brand building, upfront cost and inflation 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 third slide of this presentation, as well as our public SEC filings.

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

The passcode for both numbers is 3113843.

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

Now let me turn it over to David.

Thank you Joel and good morning everyone.

Just as a reminder, Simon Burton has moved into the business and Joel Wittenberg has stepped in to take on this role as Vice President of Treasury and Investor Relations.

We're pleased to report a solid Q3, even with two to three discrete items slightly impacting top line growth.

With strong EPS growth from Q3 and year-to-date, and with Q4 off to a strong start, we have increased confidence that we'll deliver another year of sustainable growth.

Through Q3, we benefited from some discrete tax items which have allowed us to make further investments in our business to support our goal of sustainable, dependable performance.

Our momentum year-to-date has allowed us to invest more against cost saving initiatives, to continue our strong advertising investment through Q4, to absorb higher cost inflation than anticipated, while raising our full year EPS guidance to $2.72 to $2.75 per share.

During Q3, we reinvested back into the business with double-digit increases in advertising, and funding of a major efficiency project within our DSD system.

We're confident that our consistent operating performance will continue into the fourth quarter, providing a strong foundation for another year of sustainable and dependable performance in 2008.

Now I would like to turn it over John to onto take you through the financials.

Thanks, David and good morning everyone.

Reported net sales increased by 6%, lapping a strong 8% sales growth in the third quarter of last year.

Internal sales growth, which excludes the effect of foreign exchange, was 4%, building on a 6% comparison last year.

Reported operating profit rose by 1%, and internal declined by 2%.

This was primarily the result of higher investment in year on year upfront cost savings initiatives, which reduced operating profit growth by 5 percentage points in the quarter.

These results also reflect double-digit growth in advertising investment as well as higher commodity inflation.

Earnings per share grew by 9% versus last year, helped in part by a lower tax rate due to several discrete items in the quarter.

And cash flow in the first three quarters was $961 million, exceeding last year by $111 million.

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

Slide 5 shows our net sales growth.

Reported net sales growth in the quarter was 6.4%.

Price mix was 3.1% higher, due to the price increases we put into place over the past year, as well as improved mix.

Tonnage added 0.7% and currency contributed 2.6%.

This solid internal sales growth came despite a couple of items which dampened the quarter's sales.

First, in U.S.

cereal, elevated levels of customer inventories in last year's third quarter resulted in a difficult inventory comparison and our U.S.

cereal shipments were flat in this year's Q3.

The good news is that we continued to deliver strong consumption growth and we continue to gain share demonstrating strong underlying momentum.

Second, our snacks DSD reorganization including the repurchase of third party routes resulted in some inventory repurchases that reduced sales in the quarter.

Despite these issues, we were still able to report a solid sales performance giving us continued confidence as we go into Q4.

Now let's turn to advertising spending on slide 6.

We increased our advertising investment at a double-digit rate for the third quarter as well as year-to-date.

Brand building investment is an essential part of our business model and we have significantly increased spending in the fourth quarter to support both new and existing products.

Let's turn to slide 7 to review our gross profit performance.

Third quarter gross profit was $1.3 billion, a 5% increase over last year.

For the year-to-date period, gross profit is almost $280 million above last year, an increase of 7%.

This increased gross profit funds our advertising and innovation growth.

Third quarter gross profit margin declined 40 basis points and year-to-date has declined by 20 basis points.

For both periods, this decrease was driven primarily by higher commodities inflation.

Now let's turn to slide 8 and a discussion of operating profit by region.

Operating profit declined by 2% as a result of strong ongoing investments in advertising and additional upfront costs.

In fact, the year-over-year increase in upfront costs adversely impacted operating profit by 5%.

We indicated last quarter that commodity cost pressures are more concentrated in the second half of the year and that was certainly the case in Q3 and will be even more so in Q4.

In North America, operating profit declined 4% due to higher upfront and advertising investments.

Most of the Q3 upfront charges occurred in North America and reduced operating profit by about 7%.

Even with these higher upfront costs in advertising investments, year-to-date operating profit is up 3% in North America.

In Europe, operating profit declined 2%, versus a tough year ago comparable of 20%.

Here again, we continued to make higher investments in advertising.

Results were also impacted by a voluntary product recall in the U.K.

Year-to-date operating profit is up a strong 11%.

In Latin America, quarterly internal operating profit rose by 1%, reflecting increased investment in advertising as well as high commodity inflation.

And finally, in Asia-Pacific, internal operating profit decreased by 26%, or $6 million, due primarily to the continued challenges in The Australian market.

Part of the decline was due to a charge in Australia for additional efficiency initiatives.

In Asia, our cereal and snacks businesses are performing well.

Below the operating profit line, net interest was approximately unchanged and our tax rate was about 27%.

Meanwhile, our average shares outstanding continued to decline because of share buybacks.

We purchased $153 million of shares for the quarter, bringing our year-to-date repurchases to $417 million.

On slide 9 you can see a summary of our 2007 year-to-date performance.

I won't review each point of the sustainable growth wheel, but the net take-away is that we expect 2007 will be our sixth consecutive year of dependable, sustainable growth.

Let's turn to slide 10 for a review of our cash flow.

Year-to-date, we have generated $961 million of cash.

This growth has been achieved through our strong earnings growth.

The cash flow metric is very important to us and we will remain focused on further improvement in the future.

For the full year, we now have even greater confidence that our cash flow will be approximately $1 billion.

As you know, the fourth quarter tends to generate the seasonally lowest cash flow of the year, and we are also considering voluntary retirement plan contributions in Q4.

Let's turn to slide 11 to look at our full year 2007 guidance.

Our guidance for mid single digit internal net sales growth for the full year hasn't changed.

But we now forecast earnings to come in between $2.72 and $2.75 per share, $0.01 higher than our earlier guidance.

Remember, this includes the extra investment we have discussed for Q3, additional investment planned for Q4, as well as significantly increased input costs in both periods.

We now expect total incremental commodity, fuel, energy and benefit costs of approximately $0.32 per share, or $0.04 above the midpoint of our most recent guidance and $0.16 to $0.19 more than our initial guidance for the year.

And we've increased our estimate for upfront investments.

We now expect that this investment will total approximately $0.19 of EPS or $0.05 more than our original estimate.

Obviously, this will reduce our internal operating profit growth.

In fact, excluding upfront costs, operating profit would rise at mid single digits.

These projects provide greater visibility for 2008 and beyond.

Given the significant inflation costs and increased investments, we continue to expect that full year gross margin will decline by approximately 50 basis points.

As we discussed previously, our commodity inflation is heavily weighted to the second half of the year with the largest impact in the fourth quarter.

We continue to get good leverage below the operating profit line.

We expect essentially flat full year net interest and the tax rate will be about 29%.

In summary, we are very pleased that we have the ability to absorb high input costs while raising guidance in a difficult environment.

The fact that we can also increase investment in future growth at the same time demonstrates the flexibility of our business model, the strength of our current momentum and our desire to drive sustainable and dependable results.

Now let's turn to slide 12 and a preliminary guidance for next year.

For 2008 we expect to deliver another year of sustainable growth.

Once again, we are forecasting and planning for high single digit earnings per share growth.

Our forecast calls for mid single digit revenue growth, reflecting our momentum into 2008 and broad pricing actions across our portfolio to help offset significantly higher cost inflation.

We anticipate advertising will once again rise at or ahead of sales.

We currently forecast the incremental commodity, fuel, energy and benefits cost inflation to increase by more than $0.40 per share in 2008.

This builds on the 2007 increase estimated at $0.32 and the 2006 inflation of $0.28.

We expect mid single digit operating profit growth and high single digit earnings per share growth.

As you can see, we're anticipating earnings of between $2.92 and $2.97 per share in 2008.

We also expect to see continued investments in upfront costs in 2008.

Over recent years, our upfront costs have been running at about $0.14.

However, the in 2007, we had had the benefit of a lower tax rate, which enabled us to increase our upfront investments to about $0.19.

As we go into next year, we would expect our upfront costs to return to approximately $0.14.

However, we have the benefit of a 53rd week in 2008 which adds roughly $0.05 to EPS.

At this stage we are reviewing our ability to invest the benefit of the 53rd week into either additional upfront costs and/or investments to accelerate our growth in emerging markets.

We will provide more clarity on how we will reinvest the 53rd week in future conference calls.

Either way, it is all about driving sustain ability.

In addition, we expect essentially flat net interest expense and our tax rate will move back to approximately 31%.

Some of the tax benefits we saw in 2007 were one-time in nature, which obviously will not be repeated next year.

Also, we plan to complete our $650 million 2007 share repurchase in the fourth quarter and we are pleased to announce that our board has approved an additional $650 million share buyback for 2008.

While we do not give quarterly guidance, the shape of the year might be a little bit different from 2007, due to some unique circumstances.

We will have significant commodity inflation, particularly in the first half of the year and tough tax comparisons in Q1 and Q3.

Because of all these factors and the timing of the 53rd week in Q4, we expect EPS growth to be back-end loaded.

As you can see, our model is working.

We have been and will continue to invest back into the business for long-term sustainable and dependable results, which will enable us to offset this unprecedented cost environment while investing in innovation and brand building.

And now I would like to turn it back over to David for the business review.

Thanks, John.

If you can turn to slide 13, and the internal sales growth posted by our North American businesses in the quarter, North American sales were 3% higher versus last year's 7% growth.

Slide 14 looks at each business in more detail.

Third quarter cereal sales were flat versus last year, as we lapped last year's heightened Q3 inventory levels driven by our September 2006 price increase.

We're pleased to have achieved very strong underlying consumption growth in Q3 of 3 to 4% across all channels, and are expecting a stronger fourth quarter shipment performance.

In addition, our price per pound rose by more than 4% during the quarter.

Innovation was strong with the launch of Fruit Loops Smoothie and Cinnamon Streusel Mini Wheats.

We also saw a strong performance from Rice Krispies, Raisin Bran Crunch and Smart Start in the quarter behind good advertising campaigns.

Once again Kashi posted another great quarter with double-digit sales growth.

Innovation was strong with two new varieties of Kashi ga know had as well as continued momentum from Go Lean honey almond flax cereal.

Our Canadian business also posted a solid quarter.

We continued to benefit from this year's innovation with Mini Wheats strawberry, Special K Fruit and Yogurt and Vanilla Rice Krispies among others.

Slide 15 shows our snack sales were up a strong 5% for the third quarter.

This exceeded our long-term target, despite last year's 11% comparable.

The DSD route reorganization had an adverse impact on sales growth as we realigned the system and bought back inventory from the equity route owners.

DSD is a great asset for the Kellogg Company and we're going to further leverage the asset by taking Kashi snacks and true snacks into DSD at the end of this year.

While this will provide further growth opportunities in 2008, we expect modest disruption in Q4 and Q1 as we reduce inventory in the warehouse system.

Both of these moves are steps for the future of retail snacks.

Overall, year-to-date sales are up a strong 8%.

You can see more detail on slide 16, which shows our Pop-Tarts business posted solid sales growth in the third quarter, while lapping last year's introduction of Go-Tarts.

The crackers business also posted solid quarterly growth, versus a difficult double-digit comparison as Cheez-It and All Bran crackers both performed well.

In addition, we also saw double digit growth from Club and Wheatables.

We gained cracker share in the category in the quarter, and new innovation including Club Puffed, Cheez-It sticks and [Caro Cheese Melts] gives us confidence we'll finish the year well.

Our cookie innovation and brand building have been strong and we're seeing the benefits.

We saw solid sales growth and measured channel share gains in our cookie business and we are again lapping good growth in the third quarter of last year.

New RightBites Grasshoppers and Dipping Delights innovations were ahead of expectations and Famous Amos posted strong growth for the quarter.

The wholesome snack business continued to do well in the quarter.

We saw solid growth from Rice Krispies Squares, Special K bars and Nutri-Grain fruit and nut bars.

And finally, we're delighted that Kellogg's snacks was recently rated the number one DSD manufacturer among all consumer group companies by Vantage Group Performance Monitor.

This award is a great recognition for the entire DSD team.

Now let's turn to our frozen and specialty channels business on slide 17.

Frozen and specialty sales were up 6% for the quarter.

We achieved solid growth from Eggo Pancakes, French Toaster Sticks and our new Special K waffles.

And our Kashi all natural frozen entrees and pizzas continued to perform ahead of our expectations.

We're finding that for many consumers, Kashi frozen entrees are their first experience with the brand and they're now purchases additional Kashi items.

Specialty channels contributed solid growth again with good performance across club, convenience, and drug channels.

Slide 18 shows that Kellogg International posted another solid quarter with 5% internal sales growth in Q3, lapping last year's 5% comparison.

Our international growth has been broad based with solid results in both Europe and Latin America, as you can see on slide 19.

In Europe, we posted 3% internal sales growth with good growth in both cereal and snacks.

In cereals, Special K, Coco Pops and Rice Krispies all performed well.

We saw solid performance with recent cereal innovation from Optivita and Chocos.

Sales were strong in Ireland, Spain, Italy and Benelux, and the U.K.

achieved serial growth even with the adverse impact of a product recall in Q3.

In Latin America, we posted 12% internal sales growth as a result of growth in both cereal and snacks across the region.

Venezuela, Colombia, Brazil and the Caribbean all posted good internal sales growth in the quarter and achieved double-digit growth with strong performances from Zuckeraters and Special K control, and our market share also rose during the third quarter.

Asia-Pacific sales declined by 1% or less than $2 million.

We saw solid ready to eat cereal sales growth in Japan, South Korea, India and South Africa.

As we have discussed, the Australian business posted lower sales as difficult category conditions continued in the snacks category.

We expect that the situation will shake out in the next 12 months, much as it has in other parts of the world.

And finally, a thank you to all 26,000 Kellogg employees for their great work in strengthening our company.

As we look towards 2008, it's clear that cost inflation is likely to remain high and volatile.

Accordingly, we'll be looking to employ all the levers to help offset these costs including mix, trade efficiencies, cost savings initiatives and pricing.

Our focus on strong innovation and increased advertising support remain highly relevant and our operating principles remain in place.

Finally, we have talked frequently about our intention to explore small bolt-on acquisitions and opportunities for geographic expansion that support our focused strategy.

We're pleased to share that over the next few months, we expect to close several small acquisitions in several areas around the world.

These transactions are subject to regulatory approval and standard closing conditions so we're not in a position to share any additional details at this time.

As John mentioned earlier, in our 2008 guidance we have the flexibility to invest in new geographic market expansion.

We remain confident that with strong investments in Q4, we'll maintain our momentum into 2008 and deliver another year of sustainable dependable performance, in what is shaping up to be a challenging environment.

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

Thank you.

(OPERATOR INSTRUCTIONS).

We'll pause for just a moment.

You'll hear first from Terry Bivens with Bear Stearns.

Good morning, everyone.

Good morning, Terry.

Dave, I wanted to get just a little bit more clarity on the cereal business, make sure I understand it.

I think last year in Q3 you mentioned the base business in RTE was pretty good in North America, it was the incremental that didn't quite get the take-away you thought.

Inventories built up a little bit.

As we move now into this quarter, where do you think your inventory levels are, first of all.

Remember last year, we had a price increase in September and as we finished the quarter, we said we thought we got about 1% incremental shipments in that quarter.

Okay.

And the inventories were higher.

We pulled them down and that's why you saw in Q4 last year actual shipments were down, even though consumption during the two quarters was relatively even, up 2, 3%, I believe.

Okay.

This year, consumption was very strong.

We're up 3 or 4% across all channels.

We actually gained share.

But our inventory levels clearly on last year had to come down and we pulled them down so shipments were flat.

What I can tell you is as you would expect is that through October, our shipments have been strong because last year in October we were actually going through the process of pulling them down.

So it's all about comps year on year.

That issue is now behind us.

The great news is that through all of that inventory movement, our consumption remained very strong.

We gained share.

And we're off to a strong start to Q4.

Do you have to take trade spending up at all in the third quarter, perhaps to -- in reaction to some of the things Mills is doing?

Really, I think as we look at our position, our consumption was strong, we gained share.

We're very happy with the business.

We continue to play our own game and focus on strong innovation and brand building.

Okay.

Thanks very much.

Thanks.

We'll take our next question from Mariann Montagne with Thrivent.

Good morning.

Couple of detailed questions here.

On the U.K.

recall, what are you -- how much are you attributing to that in dollar terms.

Probably about $5 million,.

And the snack realignment?

For snacks, it was less than a couple of percent.

But probably 1 to 2% for the quarter for the snack shipments.

And Australia, what kind of a write-down is that in dollar terms?

It was just a couple of million dollars, $2 million.

On the Latin America side, 1% profit growth, that's due to your mix toward the corn products; is that right?

Yeah, that's right.

I think that portfolio is very corn-based, so the commodity issue from corn has really hit them very hard this year.

Also, in the quarter, advertising was up double digits before we're very, very happy with the strong growth we saw in the market during the quarter and we're going to continue to invest there because it remains one of our strongest growth regions.

And is that also an area you're targeting for greater snack growth?

It is, yes.

Okay.

Thank you.

Thank you.

We'll take our next question from Robert Moskow with Credit Suisse.

Thank you.

Can you guys tell me, you say that Montagne increased your investment in advertising this year.

Could you give us a sense of how much you're increasing it?

And then also, I don't think I quite got you're increasing your upfront charge by another $0.02 for the year.

Is that a new project or is the existing DSD project just costing more?

And that's it.

Robert, on the advertising, we're up double-digit.

John, you want to take the --

On the upfront cost, Robert, we actually executed the DSD buyback ahead of schedule and if anything, it's -- the total cost of that program was a little bit less than what we had had anticipated.

The additional $0.02 is for another project in the fourth quarter that we have not as yet announced.

Okay.

And you say the advertising is up double-digit.

But is that a stronger double-digit than you thought at the end of second quarter?

Yes, it is, yep.

Okay.

Okay.

Thank you very much.

Thanks.

Our next question will come from David Palmer with UBS.

Hey, guys.

With regard to General Mills' moves with its right sized right price initiative, has that become more of a competitive intrusion in the EDLP accounts where perhaps their lower shelf price has provided a bit of a boost to them and perhaps at the expense to Kellogg?

David, I think you would be best posing that question to them.

I think from our perspective, as you saw in the quarter, we did expect we could have some disturbance there but our consumption was strong.

We gained share.

Very happy with our business and really the key for us in the third quarter was to fix the year on year inventory issue that we had last year which is now behind us and we started Q4

Okay.

And then just a second question, having to do with the health news benefit in the cereal category.

The Americans want to maintain their health, obviously and they're saying they want to add things like dietary fiber, whole grain, antioxidants, probiotics and the like.

I'm wondering to what degree to do you think some of the growth we've seen in the last couple years, having to do with some of this increase in demand for these attributes may wane, or perhaps, do you see some of these concerns in the immediate future being addressed better by the industry and the cereal category perhaps picking up momentum as some of the cereal category players get better at addressing these concerns?

I think, David, that our belief is that cereal is on trend, certainly as you look at the demographics in the market and a number of -- including Kellogg's, playing toward the slightly older demographic where there's a greater propensity to look for health benefits.

We would think that that will be a positive for the category for many years to come.

And last question, just I know this is out there, but is there any possibility that you guys will get -- do anything on the packaging side in cereal?

It seems like if anything, from a consumer standpoint, the industry has not done anything in packaging, except perhaps go backwards with pillow packs for decades.

Is that something that could be in the horizon in the cereal category?

We are constantly looking at how we can improve our environmental footprint and we have taken a lot of packaging out.

It may not be obvious to you but there's a huge amount of work that goes into.

By the whole industry and it's an area we'll continue to focus on.

Given how fragile cereal is, it's not as easy as you'd think to make a dramatic move but there's constant work going on, trying to reduce the amount of carton and use recycled board, et cetera.

And you'll probably see more of that in the years to come.

All right.

Thank you very much.

Thanks.

We'll take our next question from Andrew Lazar from Lehman Brothers.

One quick one.

On U.S.

cereal, I think you said that sales were flat and shipments were flat as well.

If I have that right, was the fact that not a lot of pricing came through more due to -- more just tactical items that you had to do promotionally in the quarter as opposed to anything that structural that pricing isn't coming through for some reason?

Our shipments were flat because of the inventory reduction year on year, in comparison to last year.

Our consumption was up 3 to 4% across all channels.

Our price per pound was up 4% during the quarter.

It was a very strong quarter and really the shipment issue is now behind us and as I mentioned earlier, October is off to a strong start as you would expect.

The last thing is just on -- you've always leaned heavily on reinvestment, so nothing overly new there and I certainly understand the cost environment.

You guys try to be anticipatory in your business as well.

perhaps are not only about future growth, but also in anticipation of maybe some structural shifts in whether it be in the North American cereal category, whether it be box size changes from competitors or even potential shifting around of brands ultimately to new owners.

I'm trying to get some sense of how you think about that, looking forward?

We're really focusing on our own game and I think most of these investments to ensure we've got strong brands, we're supporting and driving innovation hard, we're trying to maintain momentum and on the cost side clearly, we're looking to do as much as we can wherever possible to reduce cost so that we can offset some of the inflation.

And as we mentioned in the call, clearly with the sort of inflation environment we're seeing, broad based and global pricing is likely.

Thank you.

Just a little bit of commentary to that as well.

When we look at these upfront costs, we do look for sort of the four, five year payback and where the costs occurred depends on where the project are.

This year, it was in SG&A, largely because of the DSD buyback.

To give you a bit color on 2008, we've given guidance of $0.14.

About half of that we've already committed to an ongoing European manufacturing project.

The other half we will announce as we firm up the projects.

Got it.

Thank you.

Thanks.

Our next question comes from Vincent Andrews with Morgan Stanley.

Good morning everyone.

Could you just help me understand the 53rd week, is that essentially -- is it smaller or the same size as any other week?

I assume it's in the fourth quarter.

53rd week is the last week of the year.

It's a bit of a strange week, in that it's -- some of our international markets don't even ship in that week.

So it's a little bit small firefighter the sales perspective, but also it tends to be a smaller brand building week.

When we sit back and look at it, we estimate that it's worth about $0.05 of EPS.

The decline of gross margin of 40 basis points, that included upfront costs to some extent; correct?

That's correct.

That's reported gross margin.

My last question is just, why is this year the share repurchase, it seems to be a little more skewed toward the back half of the year, in particular the fourth quarter.

Any reasoning behind that?

If you look at the third quarter, it's pretty proportional from a share buyback perspective.

I think we got off to a slower start in the year, but with $417 million of $650 million year to date, so we're tracking reasonably well.

Okay.

Thanks very much.

Just going back to clarify one piece on the 53rd week, one thing I want to keep -- sort of reinforce, is that we're not using that 53rd week to hit our guidance for next year.

The guidance we've given is effectively a 52 week guidance.

What we're saying is the 53rd week, that's $0.05, will be reinvested back into the business, either in additional upfront costs, growing above the $0.14 that we've given guidance on or into selected emerging market investments, which we'll give you more commentary on when we get there..

Give you more commentary on when we get there.

Thank you very much.

That's very helpful.

Our next question comes from Kenneth Zaslow with BMO Capital Markets.

Good morning, everyone.

I was going to ask a question about North American retail snacks.

Your business is -- has been hitting about double-digit top line growth, net sales growth for probably almost two years.

You had a little slowdown into 5%.

Is there a competitive dynamic that's changing?

Is it tough comparisons?

Is it a timing of your products?

Is this something that we should start to see more of this lower mid single digit growth in the net North American sales.

We gained share in cookies.

We gained share in crackers.

They both grew about mid-single digits.

We grew our wholesome snack high single digits, even though the category grew slightly faster than that.

Our fruit snacks was down.

Part of that was as we discontinued items in preparation to move those into DSD.

The DSD route buyback impacted snacks just short of a couple of percent in the quarter.

Net we had a strong quarter.

There was nothing from a competitive or slowdown perspective.

We have continually said that the prior quarters at greater than 10% in our view weren't sustainable.

What we would expect is roughly mid single digit Q4 and through 2008.

And the only thing that could impact that is we've got to allow that in Q4, end of Q1 next year, there will be some disruption as we move Kashi snacks and fruit snacks into our DSD system.

I think as we talk about DSD, you've got to remember that our DSD snacks group was recently recognized by Vantage Group as the best DSD organization in the USA.

This is a great asset for us, they're performing fantastically well, we continue to want to drive it hard.

Okay.

Thanks.

I'm going to limit my questions to one.

Thanks.

Thanks.

Our next question will come from Bill Leach with Neuberger Berman.

I just had a question about your implied four quarter guidance.

If I back out all the numbers, seems to me you're implying EPS in the fourth quarter before upfront costs of about $0.48, down from $0.53 from last year, so down 9%.

I'm just wondering is that really what you're trying to say are you assuming for the tax rate in the fourth quarter.

That's a good question.

We do have 40% of our full year commodity inflation is actually hitting us in Q4 so it's abnormally heavy quarter.

We also have a significant investment in advertising in the quarter.

And as you go below the line, there are several items which will be a drag on the fourth quarter.

One in particular I call out of the tax line.

We are looking at a tax rate in the mid-30s, much higher than what we've seen year-to-date.

That is certainly impacting the outlook for Q4.

Okay.

Thanks a lot.

Thank you.

We'll hear next from Jonathan Feeney with Wachovia.

Good morning, thank you.

Good morning.

We've got a couple of mixed sort of trends here and I guess what I want to get a feeling, you've got pricing across the portfolio but snacks have grown faster than cereal.

Could you give us an update as to what maybe direction, roughly, the negative mix between snacks and cereal is doing to your gross margin line right now?

In fact, in the quarter there was no negative mix from snacks and cereal.

It was pretty much a wash.

Is that just because the snacks margin is up so much?

I think if you're looking -- we have pointed out before that there's a lower gross margin in some markets in snacks relative to cereal.

That's a very good gross margin business.

Thanks very much for that.

If I could just follow up on a comment you made at the very end of your prepared commentary David about it being a tough environment out there.

I guess if you could maybe -- you've achieved 310 basis points it looks like of price mix across the portfolio to offset these commodity costs.

You've been doing very well in this high-commodity cost environment.

It seems like the supply chain in North America is pretty inflationary.

Would you say that's a fair characterization, so when you say it's a tough environment out there, do you feel like retailers and wholesalers starting to push back on the pricing they're letting through?

Is there something new there, or is it just kind of a tough environment on the cost side, and let's continue to hope for the best on the pricing side.

Yes, I think, Jonathan, when you look at it, the current forecast that I've seen on food inflation for next year is 4 to 5%.

That's not our forecast.

That's the forecast that's out there and I think with the volatility in commodities that exist today, our view is that they'll move to a higher level and while they could stabilize over the next few years for a year or so, they do appear to be on an upward trend and that's what I'm talking about.

It's a tough business environment when costs are going up, we're taking a lot of moves to try and reduce our own costs and drive mix and trade efficiency.

But we also are looking at broad-based and global pricing and I think if you look at our track record over the last two, three years, we've demonstrated our ability to offset inflation and I think we go into next year with a high degree of confidence.

We're reinvesting this year to make sure that we have momentum going into next year, so we think we're pretty well-positioned.

But there are unknowns out there, even for us today as we're giving 2008, we feel pretty good that we've captured everything.

We'll update it in Q4 but at this point we certainly do appear to be in a relatively high inflationary food environment.

Okay.

Thanks very much.

Thank you.

Our next question will come from Eric Katzman with Deutsche Bank.

Good morning everybody.

Good morning, Eric.

Few questions.

I guess first on the DSD change, I mean, I don't recall a company in the industry kind of messing with their DSD and not having a problem.

So have you kind of built in some kind of let's say conservatism guidance for next year as to how, if something messes up with the DSD that you can kind of cover that?

I think what we are saying is, I mean, our DSD is performing incredibly well.

The DSD route buyback in Q3 we thought would be Q3, Q4.

They executed it so well that they actually got it completed almost in its entirety in Q3.

That was buying back over 500 routes, putting in products into our current DSD system, hiring a lot of people and they're actually up and running effective October 1.

And while you have short term impacts, they actually will be positive for the long-term and them the only other thing on Kashi snacks and fruit snacks going into DSD, as I mentioned through Q4 and Q1, you'll have the inventory levels coming down, a little bit of disruption but we see those as very positive moves for us.

So we're looking at 2008 with a very positive view on our DSD system.

Okay.

And then if I could follow up on 2008 guidance, just a few clarifications here.

One, I assume that you're not including any of those acquisitions in your guidance in terms of top line or EBIT?

No.

Okay.

And then currency, what are you assuming for currency, since that's been a pretty big tail wind for everybody in the industry?

We're sticking about $0.05 or $0.06 of good news on FX next year.

Okay.

And then when I look at some of the swing factors with currency being a benefit and lower shares being a benefit, the tax rate being a negative, upfront cost year-over-year change being a positive, I guess we'll just leave the 53rd week kind of up in the air at the moment, so I guess we're kind of left with the input cost being just this huge negative.

The $0.40, most of the other companies in the industry kind of look at it from a percentage basis, so like ConAgra is talking about 7% increase and I guess Mills has been talking about 5 and Campbell's has been talking about 5.

What's the percentage increase or are you way out of line with others?

Should that make us question kind of how you've hedged or haven't hedged successfully?

I'd say we'd be around a 5.

The $0.40, $0.42, we're saying above $0.40 is the current view.

A lot of things moving around still but we'd be around a 5, so relatively consistent with most in the industry.

It does vary, of course, depending on what's going on at the time.

But we're pretty close to most other companies.

Okay.

All right.

That's helpful.

All right.

I'll pass it on.

Thank you.

All right, thanks.

Our next question comes from Pablo Zuanic with JPMorgan.

Good morning, everyone.

Good morning.

Just a couple of accounting questions first and then the questions.

On the corporate expense line, the number was unusually low this quarter, $35 million.

Anything particular going on there?

If you'll go at a year-to-date basis, it's actually pretty similar to last year.

So it's just timing one year to the next.

Year on year corporate expense was relatively flat for the full year?

That's right.

This guidance of $0.40 of cost inflation for '08, that assumes that you're what 50% already?

You've given that ratio before.

Just to have a sense.

Probably around 50.

Okay.

And then just on the cereal side in terms of the ability to decrease prices.

I know we've touched on this before but the concern I have is when I look at your major price increase, that was mostly resizing of frosted flakes, Mini Wheats and Rice Krispies and since then, you have an $0.04 price per pound increase.

What's been the real price increase on a like-for-like basis and aren't you having an issue with price points on a per box basis now, particularly since Mills is resizing?

Welling, well, I don't think we can get into any specific on the call.

Until we -- we're not going to discuss exactly what we're doing, but we feel very comfortable going forward with what our plans are and when they hit the market we'll let you know.

John, anything you want to add?

Just to give you a sense of pricing globally for the company, we have about 3.1% I think price mix benefit.

About a third of that is price and two-thirds is mix.

We're getting some good price mix coming through in the data as well.

Just a follow-up, David, if you can talk about the crackers business.

There's a lot going on there, there's lots of innovation around Club and Townhouse and now All-Bran to whole-grain.

Just give us a little more color there.

The reason why I ask, I look at Cheez-It, you have Stix Cheez-It, Club you have Stix Club.

What's the deal there?

How are you segmenting that portfolio?

How should we think about that going forward.

When you look at the crackers market, I mean, it continues to do relatively well, even in ROI, it's up.

And then when you take all channels, you could probably add another 2 or 3%.

So its pretty well and has for the last two or three years.

We're looking at Cheez-It, the big cheesy taste and looking for other ways to bring new food forms, to bring other consumers in that may be on the outskirts of the brand.

And then with Club, the buttery taste of Club and some of the derivatives we've had there, we've seen those perform particularly well.

It's just looking and segmenting the market and finding ways to bring new consumers in by different flavors and textures.

When I look at the organic business, Kashi, quite successfully going into frozen pizzas and frozen dinners.

Is there room for Kellogg to do another transaction on the organic front.

I know that there's many other brands out there.

Or is Kellogg going to stick to Kashi on its organic platform?

I'm not going to speculate on what we might or might not do going forward, but Kashi continues to strong at a strong double-digit.

We believe it can continue to perform well in all the categories it's in.

Consistent with what you're probably seeing in natural and organic, that area does continue to grow strongly, probably around double-digit.

So we are looking at how we can continue to participate in that and if we find new opportunities then, we'll let you know at that time.

Okay.

Thank you.

Our next question will come from David Driscoll with Citi Investment Research.

Good morning everyone.

Hey, David.

I've got three questions, but they're all related ton the same topic, if I can.

When is the last time Kellogg experienced commodity inflation at a 5% level?

Well, let me just clarify, the 5% inflation that we mentioned before, which I think our peer group talks about as well is all inflation, not just commodity, benefit and fuel.

So there's other elements of inflation that gets into that sort of metric.

I think the last three years we've been tracking in that broad ballpark.

This would be the highest number, would it not?

Certainly the commodity component of this is the highest number we've seen.

I think you have to go back quite a while since the company has seen this sort of inflation.

It would be -- I'm guessing to be frank, probably seven or eight years to get anything even close to this, apart from '06 and '07, which have also been quite high.

My related question is that when I look at the price mix, it's 3.1 percentage points in the quarter but it's decelerated from the year-to-date number at 3.6.

Can you guys just talk a little bit about why it would be decelerating when it looks like the commodity side is accelerating?

I'm not sure I would really call it decelerating, David.

Certainly a lower number but I would say we're still driving price mix very hard and it's our intention to continue to drive that into next year.

That's a big reason why we have a goal of mid single digit sales growth for next year.

Would you say, that's the final question I had it, what is the assumption for price mix for 2008?

Is it more than half of your expected sales growth?

I don't want to give too much guidance on that.

But clearly with the environment we're operating in, price mix will be an important part of delivering next year's numbers.

Very good.

Thanks very much.

Our next question --

We'll take one more question, Andrea.

Okay.

Our next question will come from Eric Serotta with Merrill Lynch.

Thanks for taking the question.

First of all, could you comment on brand building in aggregate for the quarter?

I know that you spoke about advertising but previously I think you had mentioned that consumer promotion expense might be down somewhat, given the efficiencies you were realizing.

And what kind of benefit did you get in the quarter and year-to-date from some of those efficiencies?

Yeah, I think we spoke about this, gee, a long time ago.

But basically through the course of 2007, and probably even in Q4 '06, we benefited from a global exercise where we looked at our consumer promotion spend, tried to drive for efficiencies, purchasing inserts on a global basis versus area to area, cutting out some of the least impactful spend.

So that has helped up us on a one-time basis through the end of '06 and through '07.

I don't know whether you've actually dimensionalized that.

Certainly for this year we've been focusing more on the advertising so it didn't distort the number.

Okay.

And just a couple of just final housekeeping items.

I know that you don't want to talk about specifics of acquisitions, but every company defines bolt-on acquisitions differently.

Can you give us a sense as to what we should expect for contribution from acquisitions in aggregate.

You mentioned you had I think several on the front burner for the next quarter or so.

What kind of contribution in terms of total -- in terms of percent of total sales do you think in aggregate these acquisitions could add?

It's a good question, good opportunity to clarify.

We are looking at several acquisitions but in aggregate, the several acquisitions will cost us between 2 and $300 million.

These are relatively small acquisitions.

All of them combined are only $200 million to $300 million from a purchase price perspective.

Relatively small acquisitions, they're strategic around the portfolio whether it be an interesting part of the world for us, or something to add to our portfolio in the U.S.

So these are not acquisitions which are going to dramatically drive our P&L or our balance sheet.

Just lastly to finally clarify on the North American cereal inventory situation, just want to clarify, did you see any customer inventory destocking on a sequential basis 2Q to 3Q or was this all attributable to the year-over-year impact of customers carrying some high inventories in the third quarter of last year and then drawing them down in the fourth quarter of last year?

I think the bulk of it, Eric, was that latter point, that last year we finished Q3 with a higher inventory level than was appropriate.

We pulled it down in Q4.

So this year, we actually made that change in Q3 and that's why consumption is 3, 4% up and shipments were flat.

So we will see a slight benefit in Q4 on the shipment side, should be stronger shipments in cereal in Q4.

Thanks a lot.

Thank you.

Okay.

Thanks very much.

Andrea, we're all set.

Thank you very much for your time.

That concludes the call.

Thank you.

That does conclude our conference for today.

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