家樂氏 (K) 2008 Q1 法說會逐字稿

Good morning and welcome to the Kellogg Company 2008 first quarter earnings call.

All lines have been placed on mute to prevent any background noise, and after the speakers' remarks there will be a question-and-answer period.

(OPERATOR INSTRUCTIONS)

At this time I would like it turn the call over to Mr.

Joel Wittenberg, Kellogg Company Vice President of investor relations.

Mr.

Wittenberg, you may begin your conference.

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

With me here in Battle Creek are 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, up-front costs 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 our 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 Monday evening by dialing 888-203-1112 in the U.S.

and 719-457-0820 from international locations.

The pass code for both numbers is #2412355, and the call will also be available by webcast, which will be archived for 90 days.

Now let me turn it over to

Thank you, Joel, and good morning, everyone.

We're pleased to announce strong first quarter results with solid broad-based performance across all our regions.

Last year's business momentum continued into the first quarter and our reported sales increased 10% and 5% on an internal basis.

We achieved our goal of mid single-digit operating profit growth while absorbing significantly more cost inflation versus last year.

As we said in our fourth quarter conference call, first half earnings comparisons would be difficult, and you can see why we're pleased to achieved -- have achieved earnings per share of $0.81, which was slightly above last year's very strong first quarter when we had the benefit of a significantly lower tax rate.

For the remainder of this year we now anticipate incremental commodity, energy, fuel and benefit costs of approximately $0.80 per share versus our year-end estimated of more than $0.65.

However, despite these inflation headwinds we remain confident we will achieve our full-year guidance of mid single-digit sales and operating profit growth and earnings per share of between $2.92 to $2.97.

We'll invest back into our brands to achieve sustainable and dependable growth, and we continue to return cash to our shareholders.

We took advantage of our lower share price in the first quarter to complete our full-year share repurchases at very attract attractive levels.

And we're pleased to advise you that our board of directors plans to increase the dividend by 10% starting in the third quarter.

Now I'd like to turn it over to John to take you through the financials.

Thanks, David, and good morning, everyone.

Reported sales increased by a strong 10% in the first quarter and internal sales growth, which excludes the effect of foreign exchange and our recent acquisitions, was 5%, building on last year's strong 7% growth.

Reported operating profit rose by 9% and internal growth was 6%.

As David mentioned, we achieved this despite significantly higher commodity prices versus last year.

We also continued to identify up-front investment opportunities.

This quarter we continued to implement our European restructuring program, and we completed a new program in Latin America.

Up-front charges for these investments were about $0.04 per share versus last year's $0.01.

The higher up-front investments reduced our internal operating profit growth by about three points to 6%.

Our first quarter earnings per share rose $0.01 to $0.81 compared to last year's strong $0.80 performance.

You may remember that last year's results were driven by a lower tax rate due to some discreet items.

Cash flow was $181 million for the quarter, and we still anticipate full-year cash flow to be between $1 billion and $1.075 billion.

Let's look at the results in more detail starting on slide five.

Slide five shows our net sales growth.

For the first quarter net sales growth was a strong 10%.

Internal sales growth was 5.4%.

Tonnage and price mix were driven by our strong advertising and innovation, as well as our recent price increases.

Tonnage rose 1%, and price mix was a solid 4.4%.

Of our 4.4% price mix, 2.7% was from price, roughly twice what we saw across 2007.

Foreign exchange had a 3.2% impact on sales.

As we indicated at [CAGNE], our acquisitions of United Bakers in Russia and BareNaked and Gardenburger in the U.S.

had a positive impact on sales.

In fact, during the first quarter they added 1.4% to sales.

Let's turn to slide six to discuss our advertising spending.

As you can see we continue to increase our investment in advertising, with first quarter growth at mid single-digits on top of last year's double-digit first quarter growth and ahead of our long-term sales growth target.

We remain committed to both advertising and promotions to help drive sustainable and dependable growth.

While spending more in absolute terms, we are also driving a series of initiatives across brand building further improving the efficiency and effectiveness of our investments.

Let's turn to slide seven to discuss gross profit.

Our gross margin for the quarter declined by 80 basis points to 41.9%.

This was impacted by our recent acquisitions, which lowered gross margin by 40 basis points, and by the quarter's up-front charges, which reduced our gross profit margin by another 40 basis points.

Our focus, however, is on gross profit dollars, as this is what allows us to continue to grow our investments in advertising, and innovation.

Our gross profit for the quarter was $1.4 billion, a $100 million, or 8% increase over the first quarter of last year.

For the full year we anticipate that gross profit dollars will grow at mid single digits.

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

Total operating profit rose by 6% as a result of the quarter's strong sales.

This was impacted by higher commodity inflation, as well as higher investments in advertising and up-front charges.

This quarter's higher up-front charges reduced our operating profit growth by 3%.

Our North American business turned in a strong quarter, with internal operating profit rising by 10%, driven by 5% sales growth.

Our European internal operating profit declined slightly versus last year.

This was a result of higher up-front investments this year, which lowered our operating profit growth by more than three points.

We are very pleased with this performance when compared to last year's 18% first-quarter growth.

In Latin America operating profited declined by almost 7%.

However, about half of our first quarter's up-front charges were taken in Latin America, reducing operating profit by almost 22 points.

And finally, in Asia-Pacific internal operating profit rose by almost 4% on top of last year's 4% growth.

Let's turn to slide nine to review cash flow.

You can see that cash flow for the first quarter was a strong $181 million, but below last year's unusually high $289 million.

We continue to drive underlying improvement in core working capital as a percent of sales.

For the full year we continue to expect cash flow between $1billion and $1.075 billion..

Now let's turn to page ten to discuss our full-year outlook.

Our expectation for full-year incremental commodity, energy, fuel, and benefits inflation has grown from more than $0.65 per share last quarter to approximately $0.80.

The first quarter's results included about $0.15 per share of the full-year's expectation leaving about $0.65 of incremental inflation that we expect to be realized for the remainder of the year.

We are confident we will offset the higher inflation estimate with our underlying business momentum, strong cost and mix programs, our solid first quarter performance, and fewer shares outstanding.

We now expect gross margin will be down approximately 150 basis points year over year for the full year, reflecting our increased impact from commodities.

The expected decline for the full year is due to several factors.

First, gross margin will be impacted by about 60 basis points due to our recent acquisitions.

Secondly, higher levels of up-front costs recorded in cost of goods this year will have a 30 basis points impact.

And finally, we had also expected productivity initiatives and our recent pricing to more than offset commodity inflation.

However, the increase in the expected inflation obviously results in some additional margin pressure.

We remain confident in our business model, and despite even higher cost pressures and volatility we have not changed our sales, operating profit, and earnings guidance and still expect to achieve a full-year mid single-digit sales and operating profit growth, as well as earnings per share of $2.92 to $2.97.

We still anticipate total up-front costs of about $0.14 per share in 2008, consistent with our historical levels.

In addition, as we indicated, we are continuing to evaluate our options for the 53rd week's profits.

We currently expect about half of the benefit to be invested in new acquisitions with remaining portion yet to be determined.

Below the operating profit line we expect net interest expense to be unchanged compared with the last year and our full-year tax rate is still expected to be approximately 31%.

So to summarize, despite the volatile cost environment we will continue to reinvest back into the business for sustainable and dependable growth.

This is the right way to run the business for the long term.

And now I would like to turn it back over to David on slide 11.

Thanks, John.

Moving now into the business results, you can see that our sales growth was broad based around the world, despite the difficult economic environment.

As we mentioned at CAGNE, our businesses generally perform well during recessionary periods, and the long-term growth of the business will continue to be driven by our commitment to investing in great ideas and keeping consumers engaged and aware of our brands and their unique benefits.

In addition, we're aggressively taking actions across our global portfolio and stepping up our focus on cost-saving initiatives, productivity gain and SG&A optimization.

Despite the difficult costs and economic environment, we remain confident in our ability to deliver.

Now let's turn to slide 12, which shows the internal growth posted by our North American businesses during the first quarter.

We posted solid 5% growth on top of last year's strong 7% comp.

Our growth was broad based across all the business units.

Let's discuss each business unit in more detail -- if we can start with slide 13 -- and as you can see this quarter's 4% North American cereal sales growth builds on last year's 4% growth.

We continue to be pleased with the strength of our North American cereal business and are committed to its future success.

For the first quarter the category grew about 3%, and we gained IRI share through solid innovation and growth in our core brands.

In fact, our share grew to more than 35% this quarter, driven by an increase in share performance and a half-point increase due to our acquisition of BareNaked.

Both base and incremental sales growth was strong this quarter.

We achieved solid price mix performance as a result of recent price increases and great innovation, including Frosted Flakes Gold and All-Bran Strawberry Medley.

In addition, our overall Special K line performed well behind the January resolution event and the introduction of Special K Cinnamon Pecan.

As we announced last year we are proactively reformulating some of the products marketed to children to meet our global nutrition criteria.

We're committed to delivering the same great taste consumers' enjoy and expect from our brand.

and this effort will be accompanied by continued strong advertising and marketing programs and selected box size adjustments.

Turning to Kashi we posted another great quarter with double-digit sales increases.

Recent innovations, like GOLEAN Honey Almond Crunch, continue to perform very well and we have more innovation in the pipeline.

For the second quarter we'll run a trial event around our two new Kashi Granolas, and our new innovation includes Kashi U for adults and Honey Sunshine cereal for the entire family.

Also, our Canadian business continued its solid performance, with mid single-digit internal growth against tough 2007 comps.

This performance was driven by innovations like Special K Satisfaction and Mini-Wheats Cinnamon Streusel, as well as double-digit increases in our Kashi business.

Let's turn to slide 14 to discuss snacks.

Snack sales rose 4% in Q1 on top of last year's very strong 11% comp.

We've now completed the move of Kashi snacks and Fruit Snack into the DSD system.

As we mentioned previously, the move resulted in some anticipated sales disruption that affected first quarter sales.

However, now that the transition is behind us, we're seeing a positive impact.

For example, Kashi cookie sales are up sharply due to a 20-point increase in distribution.

We're also seeing significant increases in distribution, quality merchandising, and resulting sales for Kashi crackers and wholesome snacks.

Obviously we continue to be positive about these moves and the state of our overall snacks business.

If we turn to slide 15 we can see more detail on the quarter, starting with our Pop-Tarts business, which posted sales in line with last year.

We continue to see good growth behind our core Pop-Tarts.

however, we're lapping last year's Go-Tarts performance.

Our cracker business posted double-digit sales growth in the first quarter, resulting in another quarter of IRI reported share growth.

Innovation performed well ahead of expectations, with products like Cheez-It DUOZ and Town House FflipSides pretzel crackers doing very well.

Our cookie business achieved low single-digit sales growth during the first quarter in a tough competitive environment.

We had strong performance from focused brands like Fudge Shoppe, as well as on-the-go packs like Grips variety packs and Right Bites 100-calorie packs.

We introduced our new Chips Deluxe and Pecan Sandies take-along packs during the first quarter, and they're off to a good start.

Our whole\ some snacks business grew at mid single-digits against tough 2007 comps, driven by our Special K Bliss and Nutri-Grain Innovations.

And during the quarter base sales rose as well.

For the second half of the year we have even more exciting snacks innovation, including Special K Cinnamon Pecan Bars, Sandies Dark Chocolate cookies and White Cheddar Reduced Fat Cheez-It.

Now if you turn to slide 16 we can discuss our frozen and specialty performance.

Frozen and specialty channels had a great quarter, with sales rising 10% above last year's 5% comp.

Our frozen sales grew at double digits, driving share gains across the business.

Eggo Waffles, Pancakes and French Toast varieties achieved solid base and incremental sales growth.

In addition, new innovation performed well including Eggo French Toast Waffles and our new Eggo Muffin Tops, resulting in frozen breakfast IRI share gains of more than a point during the quarter.

During the second half we'll introduce new Eggo Bake Shop Swirls.

The Morningstar Farms veggie foods business also performed well.

Innovation continues to be strong, with breakfast bites and Asian veggie burgers.

Our Kashi all-natural frozen entrees continue to perform ahead of our expectations.

Over the past year the success of our entrees and pizzas have led to double digit IRI share gains.

We'll continue to expand the frozen Kashi business in the second half with introduction of Kashi handheld sandwiches.

In addition, our food service, convenience, and drug businesses achieved broad based first quarter growth in these competitive channels.

You can see on slide 17 that our international business posted another solid quarter, with internal sales growth rising 6% above last year's 5% growth.

Sales growth was broad based around the world, and if we turn to slide 18, we can discuss that in further detail.

In Europe we achieved 5% internal sales growth on top of 6% growth last year.

The strong performance was driven by growth in both cereal and snacks.

We saw good growth from the UK, France, and Italy, as well as the Mediterranean, Nordic and Benelux region.

In the UK we achieved share gains behind our Special K slimmer jeans challenge and the introduction of Special K Oats and Honey.

In addition, our strong snacks performance resulted in share gains in the UK, France, and Ireland.

In Latin America we posted 7% internal sales growth above last year's strong 8% increase.

We saw solid growth in Mexico behind our core brands.

In addition, we saw good growth in Central America, the Caribbean, and Brazil.

Our Asia-Pacific business unit posted solid 5% internal sales growth.

In the very competitive Australian market our cereal business grew, driven by our core brands and innovation like Cocoa Pops Chex and Special K Advantage.

In Japan we launched Special K Red Berries in cereal and snack bars, and both are off to a good start.

Our India business once again achieved double-digit growth, as did our cereal business in South Africa.

For the rest of 2008 we'll continue to invest in advertising and innovation to drive further growth in these markets.

We're pleased with our broad-based growth across our business around the world.

We executed on every level, growing sales, operating profits, and earnings per share, despite the impact of higher inflation and a higher tax rate.

Focusing on sustainable and dependable performance is even more important in the current economic environment of volatile energy and commodity markets.

We remain confident in our ability to deliver our goals and we will continue to demonstrate an ability to manage through this tough environment.

Our employees' commitment to the success of the Kellogg business model is steadfast.

This year's innovation is strong and we'll continue to invest in the business through strong advertising.

We feel well positioned to deliver another year of sustainable, dependable growth.

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

Thank you, sir.

(OPERATOR INSTRUCTIONS) We'll take our first question from David Driscoll with Citi.

Great, thanks a lot.

Good morning, everyone.

Good morning, David.

I'm going to try to sneak two in, because hopefully they're pretty straight forward.

When you talked about the guidance and you talked about the increase to your commodity costs, what the message that I got with John's comment with gross margins going down because of the incremental commodity hit, it sounds to me like you're not planning additional price increases, given the incremental res in commodity costs thus the gross margin guidance.

Does this then -- when we put it all together, does this reduce some of the -- I don't know a better word here, some of the cushion in the guidance you previously had and that's how you're maintaining the number today?

Second question just relates on private label pressures if you'd make a comment on that.

Firstly we don't comment on future pricing, and I think everyone has seen the volatility in commodities and we've reflected that in our guidance and feel very confident about the year.

On your second question relating to the private label, we're seeing no consistent trends in the categories in which we compete.

Our business was very strong across the board in the first quarter in every category and every geography around the world, and as we said in the last conference call, we've executed pricing in almost every market and every category in which we compete.

John, do you want to talk about margin a little?

Just going back, David, to your comment on guidance, the way I think about it is the $0.15 of commodity increase, we're probably covering about $0.05 of that from lower shares outstanding and foreign exchange, good versus where we were probably three or four months ago and the remaining $0.10 we're going to cover through underlying business momentum, which includes all range activities such as cost saving initiatives, margin improvements and pricing.

That's great.

Thanks a lot.

Our next question is from Chris Growe with Stifel Nicolaus.

Hi, good morning.

Good morning, Chris.

Hi.

I just wanted to ask you a bit following up on David's question there but on the price realization, I guess if you'd start with how much -- how well hedged you are on your input cost inflation for the year?

And I guess related to that, it's just that you saw this unusual spike in the first quarter,and you just can't keep up.

I know you don't want to concentrate on future pricing trends, but there's a lot of companies, including one this morning, that talked about having to take another round of pricing.

If you could commend on that, that'd be great.

Thank you.

I think on the commodities, while we had an increase in the first quarter, we did say on the call that there was about $0.15 and that means we've got $0.65 left to go, so we're going to see more through the balance of the year, and John just, I think, explained how we're covering that with the shares outstanding effects and just productivity and momentum in the business.

On price mix we're up 4.4%.

2.7% of that came from price, which was twice what we saw in the 2007 year, so we are seeing very strong price come through.

We feel, as we said on the call, very excited about the year.

Commodities remain volatile.

We think we're over 80% hedged.

There clearly are some things you can't hedge, so we feel in pretty good shape for the year, Chris.

That's great.

Thanks a lot.

Thanks.

We'll take our next question from Jonathan Feeney with Wachovia.

Good morning.

Thank you.

Good morning, Jonathan.

John, you mentioned in your comments that the movement of Kashi cookies into the DSD network and seems like there's a number of movement -- moves you made like that over the past few years, which clearly have a positive impact in terms of operating profit per unit.

I guess I just wondered, how much more is less as far as optimizing that DSD network?

Can you give us a sense of are there other products in your portfolio you could move through DSD at a higher profit per unit, like this Kashi, and what inning are you in in terms of optimizing that if we look over the past, say, five years of improving that network?

Jonathan, it is David.

I think all I'd say there, our DSD team has done an outstanding job over the last three, four years in optimizing across all of the levels you can pull in DSD.

The recent move came on top of our in-sourcing the independent routes that we talked about last year.

That was a big initiative, and then to bring Kashi and Fruit Snacks onto DSD, to change all of the routes, to go through all that reconfiguration, a lot of work and effort, they did a great job.

And I mentioned on the call the 20 point increase we saw in Kashi cookies.

We also saw nine points of incremental distribution on crackers and six points of incremental distribution on the Kashi bars.

And if you look at the IRI data against those three Kashi cookies, crackers and bars, they're up anywhere between 26% to 80% in the first quarter, so the results are starting to come through.

I think if you were speaking to that team, they'd tell you that they can continue to improve, and they're always looking for opportunities to optimized what they do.

We're probably just going to absorb and focus on all of the work we've done in the last six months this year, and then any new initiatives we'll communicate as we go forward.

Okay.

Thanks very much.

Thank you.

Our next question comes from Alexia Howard with Sanford Bernstein.

Hello, there.

Good morning, Alexia.

Question on advertising spending.

It seems as though that was up slightly less -- well, a bit less than sales growth this quarter.

How do you see that developing going forward as we go through the rest of the year, and how is that linked to the timing of new product launches during 2008?

I think looking at the year we're targeting to be up with sales around mid single-digit growth, as we told you before.

When you look at our budgeted spend, over $1 billion, we'd always anticipate to be within a point or two of that as far as the year goes.

The first quarter, the only thing of major significance there was we're still up mid single digits on a very strong double-digit growth last year.

If you remember we launched the Special K bars and protein beverage last year, so we were lapping that, so that had a couple of points impact on advertising in the first quarter versus year ago.

So we still have a very strong commitment to advertising, and investing behind our brands and talking to consumers.

We've also said, and importantly when you're spending $1 billion, that we are looking at any ways that we can drive efficiency gains and effectiveness in all that we do so we can optimized the returns that we get on that investment, and there are some programs going on during the course of this year that we feel very good about.

Okay.

And the timing of the new product launches this year, what kind of pace, it's not going to speed up or slow down as we go forward?

Fairly consistent, very steady through the first quarter, and we'll see more around mid year, and we feel very good about our innovations, very strong.

It'll be strongly support, so not a dramatic change, but a very strong slate of innovation for 2008.

Great, thank you.

Thank you.

Our next question comes from Ken Zaslow with BMO capital markets.

Good morning, everyone.

Hi, Ken.

The Kashi brand, you talk about it in little pieces here and there.

Can you just give us a feeling because it seems like that is one brand that continues to be able to expand beyond its current categories.

Can you give us a view on what other categories you think it can go to, how large you think that the brand can be, and do you think it'll go geog -- it'll expand geographically?

I think, Ken, just on Kashi, I think we did say, I think at CAGNE, that over the last five or six years we've seen 40% compound annual growth in that brand.

It has been a strong growing brand for us,.

Not sure we've actually given exact size, but it is over $0.5 billion as a brand, well over,.

Continues to grow very strongly.

We're cognizant that we've moved into some new categories.

Actually, it's interesting that if you look at the frozen entrees and pizzas, that attracted new users into the Kashi franchise.

And everything we do with that brand has to be consistent with its heritage.

It's typically always seven whole grain, more natural or organic, and -- so the opportunities have to be consistent with the overall essence of the brand.

We've got a lot on our plate.

We're very happy with it, we'll keep driving that, and anything new we'll advise as we go forward.

Can it go international?

It's gone into Canada and it is starting to really pick up momentum in Canada, a very good performance through the first quarter, and we believe it'll continue to grow strongly there.

As far as the whole natural and organic opportunities, we're exploring a variety of options there, and when and if we conclude those we'll tell you about them.

Great, I appreciate it.

Thank you.

We'll take our next question from Vincent Andrews with Morgan Stanley.

Good morning, everyone.

Good morning, Vincent.

I understand that to date you haven't seen any negative impact from consumers trading down to private label across the business,.

but there's obviously a lot of pricing still yet to go through across the industry through the balance of the year.

At what point do you think you can declare victory that the consumer isn't going to materially change his or her purchasing behavior, or is that not a realistic assumption that there won't be some sort of disruption at some point in time from all the pricing going through?

It's a hard one to answer.

I think what we'd say, Vincent, is we've got strong brands, we have heavy investments in consumer engagement.

As I said, we've seen no consistent trends in private label categories in which we compete.

Some are down.

Some are flat.

Some are up.

Our price mix was very strong through the first quarter.

The pricing was actually reflected in markets for more than half of the quarter in some areas, in some categories for the whole quarter, and we are seeing broad-based pricing across all players, both branded and nonbranded.

So given the economic environment in which we're in, could you see some trading down?

Possibly, but we believe that our business model and focus on driving our brands and engaging consumers will keep our business health I and growing.

Okay.

Just as a follow up to that, Safeway -- you probably heard the comments last week that in their particular stores they were seeing substantial trade down, almost six to one in the center of the store versus branded sales growth.

What do you think when you hear something like that?

Do you think it's just isolated to perhaps-- they're over weight in California, which one could argue is kind of the epicenter of the real estate bubble, but how do you respond to retailers speaking like that?

When we've typically looked at private label and where it has grown and why, the trends are very, very similar quarter to quarter and year to year.

It's typically two to four retailers in a given quarter that are driving the growth in private label, and that's normally is because Ithey've taken a position that they want to expand or focus on it.

When that happens, that normally goes on for two to three quarters.

They reach whatever they're target is and then they start to ease back, and then a couple of other retailers might pick it up.

But it is not -- we have not seen -- as we we track back through history.

we've looked at the last two or three recessionary periods, private label's done well in a couple and not so well in another.

We've done pretty consistently well, so very hard to answer what will happen this year, but we feel very good about our business.

Okay.

Thank you very much.

Thank you.

Our next question comes from Robert Moskow with Credit Suisse.

Hi, thanks.

Your leading competitor in biscuits specifically said that they would have to reduce their trade spending in that category, it also looks like they caught on wheat.

Have you changed any of your promoted price points already in biscuits?

Is that part of your strategy?

Have you seen any kind of unusual benefit this quarter in what the trade was willing to let you merchandise in biscuits, perhaps at the expense of competition because of the cuts that they made in their trade spending?

Well, unfortunately we didn't see any dramatic easing off in the competitive nature of the category.

We took pricing at the end of last year, early this year, our promoted price points did go up.

We grew slightly in cookies, even though in IRI data we lost a little share.

Crackers were up double digit, very strong performance.

So, again for us, we priced as we felt we had to.

We drove the business hard with some very positive innovation, Cheez-It DUOZ and FlipSides pretzel crackers did very, very well.

I think it was a competitive category through the first quarter and we performed pretty well.

Do you think that they're doing anything dramatically different from what you're doing in terms of your price strategy or your promotion -- promoted price strategy?

Nothing that I've observed.

Thank you.

Thanks.

Our next question comes from Ken Goldman with Bear, Stearns.

Good morning.

Good morning, Ken.

So it seems like a strong quarter across geographies, categories and brands, even Australia's doing a little better, so I guess this is a broad question, but, Dave, I'm wondering which specific brands in your opinion are performing below your expectation and what will it take, whether it is innovation, marketing, maybe even more rationale competition, to drive their growth to their potential?

Yes, that's a tough one as we get into specific brands and we talked about categories.

I think the broad-based nature of our was across every category in which we compete and almost every geography, so while some things are better in the given quarter than others, brands and/or segments of the business, it's not like anything is performing in such a poor fashion that I'd call it out, Ken.

It is unusual for us to see the consistency, and breadths of performance we saw in the first quarter is great, and I think it 's a reflection that strength of our brands and commitment to drive consumer interest in the categories across everything we do, but there wouldn't be anything that I'd particularly single out.

Okay, thanks.

Thanks, Ken.

Our next question comes from Eric Katzman with Deutsche Bank.

Hi, good morning, everybody.

Good morning, Eric.

Just to clarify something, John, the gross margin in the first quarter year over year, ex acquisition and ex up-front costs, you said gross margins were actually flat?

Yes, that's right.

We're down 80 basis points, but 40 basis points is because of acquisitions, another 40 basis points because of the impact of up-front costs.

That's actually very, very strong results relative to what most companies are putting up.

They're seeing gross margins actually down.

I know you focus on the dollars, but what accounts for -- even though you're raising up the input costs outlook, is it mix and leverage across your fixed assets that's allowing the margin to be flat ex those two items?

I'm just -- it's pretty good performance, the Market doesn't seem to be reflecting that, and I just -- I guess I want more clarity on what is driving that performance?

Eric, I think there's a couple of things in there.

One is, on the commodity outlook for the year we're saying about $0.80 of additional inflation, only $0.15, though, in the first quarter, so there's obviously a heavier impact in the back three quarters of the year than the first quarter.

Also, we did have a very good operating performance -- underlying operating performance in the first quarter, so we were very pleased with that.

The other big factors, as David mentioned as well, was our net price realization at about 2.7% in the first quarter was roughly twice what we saw last year and even more than that compared to 2006, so we feel very good about that performance in the first quarter.

Okay.

And then, David, if I can just follow up on just an unrelated question, but Nestle and General Mills with their CPW joint venture have really expanded that business for years.

It sounds like, based on their comments, that they're pretty comfortable with their factories or production facilities around the world, they're in the markets that they generally need to be in.

Can you characterize the non-U.S.

cereal markets and just the level of competition and given their seeming focus on bringing more profit out of that business after years of investment, what that means for you longer term and the category?

Yes.

Eric, when you look at where we compete head to head, I think both of us are growing and doing pretty well.

The categories in many markets in Europe are growing quite positively.

They're growing throughout Latin America and in Asia-Pacific.

There are a couple of geographies where they are very strong and we have currently a little or no presence, and that can skew the growth that they're seeing relative to ours, but I think overall we're both seeing good growth.

The category remains quite vibrant.

Many of the markets -- the less-developed markets, per capita consumptions are still low, so the growth potential going forward is very high.

And we've entered the Russian market through an acquisition there.

It is cookies, crackers and cereal, and we believe over time that platform gives us a great opportunity, and we are looking at some of the other markets where we don't participate and try to develop an appropriate entry strategy there.

So I think the international markets from a cereal perspective remain vibrant, relatively strong, and I think there's room for us to grow and for them to grow, too.

Okay, I'll pass it on.

Thank you.

Thank you.

Our next question comes from Andrew Lazar with Lehman Brothers.

Good morning, everyone.

Hi, Andrew.

I think you mentioned with respect to the 53rd week -- if I'm not mistaken, but correct me if I'm wrong -- in the last conference call I think you said that you'd reinvest the full amount of that 53rd week.

I think here you said not sure what you're going to do with half of it and half of it might be in acquisitions, so I didn't know if that meant additional acquisitions, and I'm trying to get a sense of why the change and what will drive your decision on what you do with the other half.

Okay, Andrew, sorry for the confusion there.

Just to clarify, our position actually hasn't changed.

The 53rd week, which is about $0.05 of good news this to year, about half of that will be spent back integrating the acquisitions that we've spoken about before, such as Gardenburger, BareNaked, Russia, and other acquisitions we may yet make this year.

The remaining half we have not decided yet how we're going to invest that back into the business.

When we make that decision we will communicate that at that time.

Okay.

And the targets, obviously, that you talk about around full-year things, that's excluding the 53rd week anyway in terms of mid single-digit internal sales and operating profit growth?

That's right.

Okay.

And then just last thing, how's the best way to think about the base productivity that you're generating, separate from the specific projects that you do and that you call out in your up front costs.

How do we get a sense of what the -- how to quantify the base productivity?

Do you look at it as a percent of goods annually that you can take down?

Have you published anything specifically on that, because it would seem like that's got to be also a very big driver of how you're covering this extreme commodity-cost environment aside from pricing?

I think, Andrew, I'm not sure how much we've talked specifically about it, but our global supply chain and our R&D group and the purchasing group did a wonderful job of driving efficiencies.

We have about a 3% productivity target across the board as a Company, and that clearly is a critical factor ongoing and helping us offset the volatility and increases in commodities and energy is something that we are very much focused on continuing well into the future.

All right.Okay, thanks very much.

Thank you.

The next question comes from David Palmer with UBS.

Hi, most of my short-term questions have been answered, and I wanted just to ask a long-term business goal strategic question, and that is when you look at your business mix today and think about where Kellogg might be in five to ten years, is this -- are you comfortable?

And I suspect you are comfortable with your brands, categories and the productivity opportunities and even geographies, but how might once you-- would you want to shift that mix, not just organically by growing what you got, but perhaps rounding that out through M&A where other joint ventures, alliances, whatever, as you think about the Kellogg of -- again down the road?

Thanks.

David, without giving you our specific internal targets and desires, we have stated that there is a significant opportunity for us in markets like Russia and Central and Eastern Europe.

Through parts of Latin America where we have a very strong business, we still see vast growth opportunities.

And in Asia including India -- China, and India and other markets in Asia, we believe that we are a subscale, that there are opportunities for us to grow, and given the faster growth rates of some of those markets, that if we can get to where we'd like to be, that will enhance our long-term ability to drive sustainable and dependable performance, and that's something we'll be working on diligently as we go forward.

Is a lot of this going to have to happen just because of the eating patterns overseas and in the cultural norms really more in the snacking, particularly --

Yes, as --

-- away from here?

Yes, in some markets like China, for example, where cereal cold really-to-eat cereal does not really resonate.

Clearly other parts of the portfolio will be our primary focus.

Thanks.

Congrats on the quarter.

Thank you.

(OPERATOR INSTRUCTIONS) And we have a follow-up question from David Driscoll with Citi.

Great, thanks for taking the follow up.

Retail sales for the cookie portfolio in the Food Jug mass channels plus Wal-Mart, estimates were down about 7.2% for the quarter according to our data, although you guys reported, I think it was 4% North American retail snacks growth.

Can you describe what the discrepancies are?

I'm getting a lot of questions on this.

Are there parts of the snack portfolio -- or just describe what's the difference here, either is the data just completely off or is it the other pieces of the portfolio are making that retail snacks number of 4%, it's skewing it so much higher because the other pieces are so much stronger?

I think, David, really if you look at the channel mix compared to the ROI data that will explain cookies where we grew, but yet if you looked at ROI, it looked like we declined.

Crackers, we just had a very, very strong quarter, and again if you look at ROI consumption, that was broad based and we did better across the total business than just in the ROI data, which does typically tend to understate.

Likewise on wholesome snacks we said mid single digits against tough comps a year ago.

So some of it was because of the strength in non-major channels and just a general, probably understatement, of the overall growth of the categories that you typically see in ROI versus what we would see, and that's consistent across many of the categories in which we compete.

So that's really the simple answer.

All right.

So bottom line then, it's looking at this minus 7% number on cookies is just not talking about the true strength of the business across all channels, because that number was a bit concerning, but it doesn't sound like it's really indicative of the overall business?

No, and the number we're looking at is minus 6.2%, but probably the data difference.

But, no, we grew our overall shipments in cookies across all channels and all categories.

That color was really helpful.

Thank you.

Thanks.

And there are no further questions at this time.

I'd like to turn the conference back over to our speakers for any additional or closing remarks.

Great.

Thank you very much, everybody, for listening in.

That concludes today's teleconference.

Thank you for your participation.

Have a good day.