家樂氏 (K) 2008 Q2 法說會逐字稿

Welcome to the Kellogg Co.

2008 second quarter earnings call.

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

After the speaker's remarks, there will be a question and answer period.

(OPERATOR INSTRUCTIONS) Please limit yourself to one question during the Q&A session.

At this time I will turn the call over to Joel Wittenberg, Kellogg Company Vice President of Investor Relations.

Mr.

Wittenberg, please begin your conference.

Thank you, Amanda, and good morning everyone.

And thank you for joining us for a review of our second 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 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 Monday evening by dialing (888)203-1112 in the US and 719-457-0820 from international locations.

The pass codes for both numbers is #5646116.

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

Now, let me turn it over to David.

Thanks Joel, and good morning, everyone.

We're pleased to announce another strong quarter despite the impact of continued commodity price volatility.

This quarter's performance provides further evidence of the strength of our business model.

Our business momentum, along with price realization, grow a reported sales growth of 11% and earnings per share growth of 9%.

We continue to invest for the future, absorbing up front costs of $0.04 per share and increasing our advertising investments at a double digit rate.

In addition, we continued our expansion in emerging markets through the acquisition of Navigable Foods a biscuit company in China.

We're entering the back half of the year with confidence in our ability to achieve our full year goals, and we have raised our 2008 earnings guidance to $2.95 to $3 per share, versus our previous estimate of $2.92 to $2.97.

This increase in our guidance, reflects our strong underlying business momentum.

As we said previously, this year's first half performance would be measured against difficult 2007 comparables, due to the timing of commodity market increases, various tax items, and our very strong first half performance in 2007.

Given the tough comparables, we're very pleased with our Q2 performance.

As you know, we manage the business for the long-term and we will drive performance through an ongoing commitment to investing in great ideas that keep consumers engaged and aware of our brands and their benefits.

Our second half innovation pipeline looks solid and we continue to focus on maximizing the value of our advertising dollars.

Our business model and strategy continued to deliver strong results, despite unprecedented volatility in the commodity and energy markets.

To help recover some of these cost increases, we're executing additional pricings across many of our businesses.

On the cost side, we will continue to aggressively focus SG&A optimization, productivity initiatives, and longer term projects funded through upfront cost investments.

As another sign of our continued confidence, we also announced this morning that our Board of Directors approved another $500 million share repurchase authorization.

As you know, we completed our $650 million authorization during the first quarter.

We do not anticipate that the purchases will have a meaningful impact on this year's EPS, as we plan to commence the repurchase late this year using our balance sheet cash.

And now I'd like to turn it over to John to discuss the financials.

Thanks, David, and good morning, everyone.

Slide four highlights our financial performance.

Reported sales increased by 11% in the second quarter, lapping last year's strong 9% growth.

Internal sales growth, which excludes the effect of foreign exchange and our recent acquisitions, was 6% building on last year's strong 6% growth.

Both reported and internal operating profit rose 2%, against last year's tough comp of 12% reported growth and 9% internal growth.

We achieved this performance despite significantly higher commodity costs and a double digit increase in advertising, offset by lower up front project costs.

For the full year we still anticipate a mid-single digit increase in internal operating profit.

Our second quarter earnings per share rose 9% to $0.82, compared to last year's $0.75 Let's turn to page five to discuss our second quarter net sales growth components.

As you can see, our price and mix initiative, continue to flow through with solid 4.7% growth.

The price component contributed 3.4% of the total even more than the first quarter's 2.7% contribution and significantly ahead of last year.

We continue to except the price component to be higher in 2008 than prior years.

Tonnage provided 1.3% growth and foreign exchange had a 3.1% impact on our sales.

Our recent acquisitions performed well adding 1.8% sales growth in the second quarter.

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

We continue to increase our investment in advertising with double digit growth in the second quarter on top of last year's double digit growth.

Our commitment to advertising investment is a key component of our strategy and our strong execution gives us the confidence that we will continue to achieve our goals.

And as we previously discussed, we are also driving a series of initiatives across brand building to further improve the efficiency and effectiveness of these investments.

For example, we're driving cost savings through more efficient global media purchasing and production efficiencies.

We will continue to focus on other efficiencies in our advertising spending as we move forward.

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

Our gross profit for the quarter was $1.4 billion a 5% increase over Q2 of last year.

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

On a year-to-date basis, gross profit was $2.8 billion, a 6% increase over 2007.

For the full year we still anticipate gross profit dollars will rise at a mid-single digit rate.

As some of you anticipated, our gross profit margin during Q2 declined by about 250 basis points to 43.2%, versus last year's tough comparable when gross profit grows by about 120 basis points.

Contributors to the decline were our recent acquisition, which reduced gross margin by about 70 basis points, as well as incremental commodity, fuel, energy, and benefits inflation.

Offsetting these, were the benefits of price, mix, productivity initiatives and operating leverage.

We now anticipate gross margin will decline by it will 200 basis points for full year, up from our prior estimate of 150 basis points, driven largely by our increased inflation estimate, which I will come back in a moment, as well as our recent acquisition in China.

About half of the full year growth margin decline, was due to our recent acquisitions, as well as higher up front costs in cost of goods, while the remaining decline is driven by commodity inflation.

As you know, even though we have tried to offset inflation, the math leads to a lower gross profit margin as a percent of sales.

Let's turn to slide eight for further discussion on our inflation outlook.

Our full your outlook now includes approximately $0.90 of incremental commodity, fuel, energy, and benefits inflation, versus our prior estimate of $0.80.

If we consider all cost pressures, the full impact of inflation of cost of goods is estimated to be approximately 9% for the full year.

While we anticipate continued volatility in the commodity markets, our business model and strategy give us the ability to manage through this volatility.

On the cost side we've met the challenges through our continued drive for productivity savings and a focus on managing SG&A costs.

On the revenue side, we're focused on strong innovation backed by advertising support as well as price realization.

These proactive actions have allowed us to meet or exceed our original targets despite significant cost volatility.

Let's turn to slide nine to discuss our operating profit.

As expected, total internal operating profit rose by 2% versus last year's strong 9% growth.

The quarter was helped by our strong sales execution, price mix, and productivity initiatives and was offset by significantly higher commodity inflation as well as a double digit increase in advertising.

Our North American business reported an internal operating profit increase of 5.3% building on last year's 11% growth.

This resulted from a mid-single digit increase in sales as well as productivity savings and lower up front cost investments and was partially offset by significant cost inflation.

Our European internal operating profit declined 4% versus last year's difficult 19% comparison.

Performance was driven by higher commodity costs and a strong increase in advertising investment.

In Latin America, operating profit rose by 2.1% including the impact of commodity cost increases and higher advertising spending.

And in Asia Pacific internal operating profits increased by 1.4% despite a double digit increase in advertising.

Up front costs for the quarter, totaled $0.04 per share including a $0.03 charge in corporate SG&A to eliminate the reload feature that was a part of our employee stock option program grant until 2004.

The elimination of this feature from those grants will result in a lower option expense going forward.

Below the operating profit line, interest expense was $77 million in line with last year and other income expense was an $8 million expense.

The tax rate declined to 29.9% and we benefited from fewer shares outstanding.

Let's turn to slide 10 to review cash flow.

Through Q2, cash flow was $329 million versus last year's 280 million.

Year to date cash flow is above our expectations at $510 million versus last year's $569 million.

Cash flow benefited from higher operating profit and another strong improvement in core working capital.

In fact, our cash conversion cycle improved by three days over last year to an impressive 22 days.

For the full year, we continue to expect cash flow of $1billion to $1.075 billion.

Now, let's turn to page 11.

For the full year, we continue to expect mid-single digit revenue growth driven by both strong execution and price realization.

Operating profit is also expected to rise at a mid-single digit rate driven by revenue growth, productivity initiatives, operating leverage and lower up front costs.

We now expect earnings between $2.95 and $3 per share.

We anticipate full year up front costs of about $0.14 per share in 2008, while we have determined that at $0.03 of the 53rd weeks profits are being invested in the new acquisitions, we are still evaluating alternatives for the remaining $0.02.

Below the operating profit line, we expect interest expense to be slightly lower compared with last year and other income and expense is forecast to be a $0.02 to $0.03 expense for the full year.

Our full year tax rate is still expected to be approximately 31%.

Finally, our additional $500 million share repurchase is not expected to materially impact our 2008 EPS.

Although we generally do not provide quarterly guidance we want to give you a feel for the shape of the second half outlook.

During the third quarter we will once again face tough comparables due to 2007's lower tax rate, which was driven by discrete items.

We expect to post the year's highest EPS growth in the fourth quarter due to last year's high Q4 tax rate and the 53rd week.

The strength of our business model and strategy give us the confidence that we can meet our goals, despite the volatile commodity and economic environment that we're experiencing today.

We will continue to invest for the future to deliver sustainable and dependable long-term performance.

I'll now like to turn it back to David on slide 12.

Thanks, John.

If we start in North America where we posted solid growth verse last year's strong 6% of 6%.

Growth was broad based because all the business units and we'll discuss each business unit in more detail starting with slide 13.

North American cereal sales grew 5% during Q2 building on last year's growth.

The ready to eat cereal category growth remains strong and we're very pleased with our performance in the current competitive environment.

During the quarter our IRI major channel share declined by about one point driven by significant increase in our largest competitor's incremental or trade driven sales.

However, when we include the impact of retailers in the non major channels, we achieved a significantly better performance.

In addition, price realization was strong and our price per pound in measured channels rose 4%.

Our solid price mix performance resulted from the realization of our price increases and innovation like Special K Cinnamon Pecan.

In addition, Corn Pops sales showed strong growth for the quarter.

As we discussed last quarter, our cereal box size adjustments have now been completed.

Kashi was again posted another double-digit sales increase, driven by GoLean Crunch and Organic Promise.

And our second half innovation includes introductions from our Mini-Wheats, Smart Start, and Kashi franchises.

Our Canadian sales also rose by mid-single digits driven by innovation like Special K Satisfaction and the accelerated expansion of Kashi, where we saw strong cereal growth.

Let's turn to slide 14 to discuss our snacks performance.

Snack sales rose a strong 6% in Q2 on top of last year's exceptional 9% comp.

As we discussed during the Q1 call, the transition of Kashi cookies, crackers, and bars, as well as fruit snacks to DSD continues to deliver solid results.

Sales of Kashi snacks are up sharply due to significant increases in distribution and quality merchandising.

Our snacks business will continue to be driven by innovation and our recently announced second round of pricing.

Let's turn to slide 15 to look at more detail on the quarter.

Our Pop-Tarts business posted a slight sales decline versus last year's growth.

While we achieved mid-single digit growth from our core Pop-Tarts, we were still lapping last year's Go-Tarts sales, which are now declining.

Our cracker business continues to post strong results with sales rising double digits during the quarter and we gained one point of market share.

Innovation performed well ahead of expectations with products like Cheez-It Duoz and Town House Flip Sides driving all of our share gains.

Our cookie business also achieved low-single digit sales growth in Q2, as the category showed good growth and we achieved IRI share gains.

We had strong performance from brands like Chips Deluxe, Fudge Shoppe, and Rite Bites portion control packs.

Second half innovation is strong with the return of Hydrox by popular demand.

Growth in our wholesome snacks business was driven by products like Rice Krispies Treats and Kashi TLC chewy granola bars

If we turn to slide 16, we can discuss our frozen and specialty channels performance.

Frozen and specialty channels had another great quarter with sales rising 10% verse last year's 7% comp.

Our frozen sales grew at double digits which drove share gains across the business.

Key to our growth, was great innovation, supported by strong advertising and promotion.

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

In addition new innovation performed well including new Eggo Mini Muffin Tops.

Resulting in frozen breakfast IRI share gains of more than two points during the quarter.

The Morningstar Farms veggie foods business also turned in another solid quarter as our healthy lifestyle message draws strong consumption.

Once again our Kashi all natural frozen entries and pizzas performed very well and ahead of expectations.

We drove strong IRI market share gains and we've just recently launched some new Kashi pocket bread sandwiches.

Our specialty business also achieved strong mid-single digit growth in food service and vending channels during Q2.

If we turn to slide 17, we can review our international business performance.

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

Sales growth was broad based around the world.

Let's turn to slide 18 to discuss this in further detail.

In Europe we achieved solid 5% internal sales growth on top of last year's strong 7% increase.

Our solid UK performance was above expectations driven by category growth and strong execution in both our cereal and snacks business.

We also achieved growth in Italy as well as the Nordics, Benelux and the Middle East regions.

In addition, our European snacks business achieved double-digit sales growth driven by solid performance across the region.

And we're also pleased to report that the integration and development plan for United Bakers acquisition in Russia is progressing well.

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

Growth was broad based with mid-single digit increases in both cereal and snacks.

We saw solid growth in Mexico behind our core brands.

And in addition, we saw good growth in Central America, Venezuela, and Brazil.

Our Asia Pacific business unit posted solid 9% internal sales growth.

In the very competitive Australian market, our cereal business grew mid-single digits, driven by brands like Nutra Grain, Special K, and All Bran.

Our South Africa, India, and South Korea business, once again achieved double digit growth, largely driven by per capita growth in ready to eat cereal.

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

Let's turn to slide 19 talk about our second half innovation.

Our innovation plans give us additional confidence in our sales and price mix contribution.

While this is only a sample of the new products we're introducing, you can see that the variety spans geographic regions and categories.

Our long term goal is for innovation introduced in the prior three years to account for roughly 15% of current year's sales.

As you know, we've exceeded this goal in recent years and it's the contribution from this innovation that has helped drive our mixed performance.

If we turn to slide 20 for a summary.

We're very pleased with our 2008 year to date performance.

We came into 2008 anticipating earnings of $2.92 to $2.97 per share, including more than $0.65 of incremental commodity, fuel, energy and benefits inflation.

And despite our current expectation of approximately $0.90 of inflation, we've increased our earnings expectation to $2.95 to $3 per share.

We've responded to these challenging times by continuing to make the right decisions for the long term.

We will achieve our increased targets while countering then cost headwinds by driving price realization, as well as increased cost and productivity savings.

This is strength of our consistent business model and strategy.

We also expanded our geographic footprint with the addition of United Bakers in Russia and Navigable Foods in China.

Both acquisitions represent exciting opportunities to help build sustainable and dependable growth in the future.

Overcoming the volatility we're experiencing today, requires a strong and dedicated work force and Kellogg employees have met the current challenges, executing our business plans with excellence.

They continue to drive cost savings, innovation, and strong marketing execution.

Our long term growth will be driven by our commitment to investing in great ideas and keeping consumers engaged with our brands and their unique benefits.

Our focus remains steadfast on continuing our consistent track record of delivering sustainable and dependable growth.

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

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

Thank you.

(OPERATOR INSTRUCTIONS) We'll pause momentarily to allow everyone to signal for questions.

And we'll take our first question from Alex Paterson of RCM.

Yes, good morning.

On your cost of goods 9% increase I just wanted to get a sense of that.

That's inclusive of all the hedging that you put in place at the beginning of the year?

Yes, that's correct.

And I believe you said you were probably on the order of 80, 85% covered at that point?

That's correct.

And that number still pretty much holds?

That number is now higher.

We're probably about 90% hedged where we can hedge.

There are clearly some items that you can't hedge.

But we have taken as much hedging for this year as we can.

And I think for in a reason we feel very confident about that even though volatility and commodities and energy remains high.

Okay.

Great.

Thank you.

Thank you.

And we'll take our next question from Andrew Lazar of Lehman Brothers.

Good morning.

Good morning Andrew.

I guess you had mentioned that ex-acquisitions and higher up front spending that are flowing through cost of goods this year.

Your gross margin would be down about 100 basis points for full year and I guess 200 including all that.

I guess that's not dramatically out of line with kind of what we've seen from a lot of other food companies, maybe a bit at the lower end.

I guess it's just I thought with your sort of productivity plan both the base productivity and all the upfront projects that you've been doing, perhaps you'd be even maybe better equipped than some of your peers to deal with some of this.

So, I'm just curious if there are any -- what some of the differences might be?

Is it in the way you're hedged verse others do you think?

Is it, the way some of the commodity costs have hit your verse others?

Or is there something around operating leverage that perhaps you're not seeing that you want to.?

I'm just trying to get a sense of that, because I would think you'd be frankly better equipped than many others.

No, I think Andrew, we're in pretty good shape with broadly offsetting inflation with pricing and what when you do that the math, clearly drive down your gross profit margin percent.

As we've said before, we're very much focused on gross margin dollars.

They're going to be up mid-single digit for year.

That enables us to invest back in the business to drive sustainable and dependable performance.

I think what you're seeing in our current moment, our strong first half is all of the investments we've made and the continuing focus on cost reductions and efficiency gains, actually enabling us to weather what is a fairly volatile environment.

Still continued to perform and to have a degree of confidence about the future.

So, I think we're in pretty good shape.

Others are doing a variety of things on hedging.

I don't really want to get into that.

We have a fairly conservative approach where we're trying to take volatility out.

Because, I think while you can hedge, those things roll off eventually.

And you do need to price for the market and the way you view it.

So we feel very good about where we are and where we're going.

Thanks, Dave.

We'll move to our next question from Eric Serotta, Merrill Lynch.

Good morning.

A couple of quick questions here.

First, John, you mentioned with respect to the 53rd week, I think that $0.03 would be attributable to reinvestment towards acquisitions and $0.02 of it would be to be determined.

From that I took that the full $0.05 would be reinvested.

But then later on when you were talking about year-over-year growth on the breakout between the third and fourth quarter you mentioned the extra week as being a factor in the fourth quarter.

Is that just a timing difference or could you explain that to me a bit?

That's right Eric.

The 53rd week will be reinvested back in the business, but we'll reinvest that back in the business across the year.

In fact, we've already started to do some of the reinvestment in Q1 and Q2, as we make those acquisitions.

But then all the recorded benefit of the 53rd week comes in the fourth quarter.

Okay.

At this stage, we've invested $0.03 and $0.02 has yet to be determined.

Okay.

Thanks.

And to pick up on David's comment about the reality of hedges continually rolling off.

I know it's early -- it's about a quarter earlier than you give an outlook for the following year.

But given the commodity volatility and what was still a significant benefit from hedging this year, could you give us some sort of feeling as to how you're looking at the commodity picture for next year?

Do you have any coverage in place yet?

Should we expect any kind of a step change as the coverage from this year rolls off?

Eric, it's a bit early to give too much on 2009.

Our expectation for 2009 is that we'll see cost inflation again, not in our view at this point to the levels of 2008.

But likely above what we saw in 2007.

That's the current basis on which we're planning for future.

At this early stage we feel that's appropriate.

We have taken some coverage, but it's not dramatic at this point.

And as you're seeing the markets remain extremely volatile.

But our belief is, as we've said to investors over the last 18 to 24 months, we are in a new upward cycle in commodity inflation and that's our view that we'll see a further increase in 2009.

Okay, thanks.

I'll pass it on.

We'll take our next question from Chris Growe, of Stifel Nicolaus.

Good morning.

Hi, Chris.

Hi.

I wanted to ask you a question, just relative to -- kind of along the same lines.

There's been seemingly a lot of shifting to the alternative channels, the non measured channels.

I wonder if you could speak to that for Kellogg?

And particularly, I think you sighted it in cereal for example.

And then related to that, just your view of the kind of the private label trade down.

Maybe you can give some feel for what happens to cereal in the second quarter, if that's become more of an issue or problem for the business?

I think what you're seeing is I think growth is pretty strong on the non measured and many of the measured channels also doing very well.

We did pretty well in the non measured, we did okay in the measured channels.

I think what we are seeing is in general a belief that center sales are actually benefiting from a consumer trade or reduction in out of home consumption.

I think casual dining is declining.

I think people are buying more through their grocery stores.

And us and many others are benefiting from that.

We would expect that trend to probably continue.

So I think that's why we're seeing as we look at cereal for example the growth in the category for the second quarter was probably the strongest we've seen in a number of years.

By our estimation while we grew five, the category was up anywhere from five to up to 6%.

We haven't seen that level of growth in quite a while.

So that's a very positive indication that we are seeing people actually move to the grocery store, so we and many others are benefiting from that.

And I think while consumers are under a lot of pressure and private label is in aggregate doing pretty well, our view is that we're seeing the benefit from out of home, drop.

We've got strong brands, we've got strong innovation.

As the number one or number two in the categories in which we compete, we don't think it's going to have a massive impact on us.

Okay.

And then could your just clarify one comment from John before and that's on the $0.03 charge that's in SG&A this quarter.

But then does it just sort of reverse in the second half?

The $0.03 charge in the second quarter is the charge of eliminating the reload feature on the options that we have outstanding.

So what will happen is we'll have lower option expense going forward, there will be some of that in the back half of this year.

And we'll have a full run rate for 2009.

Is it a $0.03 benefit in '09 then?

It is.

Okay.

Okay, great.

Thank you.

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

Good morning.

Good morning, Jonathan.

Wanted to ask a couple of questions if you don't mind.

The first is a big picture question.

David, with all the discussions you've had with retailers and activity you've had taking prices, what do you think would happen second half of this year, first half of next year, if commodities, particularly wheat, corn, soy, continued their current relatively precipitous declines?

Do you think it would change the pricing dynamic in a meaningful way?

Well I think Jonathan, we've said that we price typically behind inflation.

We took a round of pricing at the beginning of this year that we thought would offset inflation in 2008.

We're taking incremental pricing across a lot of the business in the second half because inflation as we said exceeded our expectations.

We typically do price behind inflation.

And the reasons for that is, the one you're mentioning, we don't want to have priced and then see commodities and costs drops precipitously.

I have to tell you that's not our view.

And some of the reductions we're seeing while they might look dramatic, when you think of where those come from and even where they are today, most of the major commodities are more than double what we would have seen two or three years ago.

We are in a very different environment from a commodity and energy perspective.

And our view is that that will persist.

Some things could drop.

Others could continue to go up.

IN aggregate, we think we're going to continue to see inflation as we go forward.

Okay.

Thanks.

And just one other.

On United Bakers, it seems to me there could be a huge opportunity here.

I know it's an unorthodox way of looking at it.

Kellogg has -- looks like has about $440,000 in sales per employee.

And this company you just bought in Russian, fast , big fast growing market, has about $25,000 in sales per employee.

Seems like, I know there's some differences there, but it's probably not 90% difference.

Is there a huge opportunity to leverage distribution there and how soon can we seen new Kellogg products sort of going through that distribution

I think, Jonathan, that acquisition is going to prove a great one for us in the medium to long term.

We're looking at the opportunities.

Russia is a market that continues to grow rapidly.

I think we've bought a fantastic platform for cookies, crackers, and cereal.

Of which, we've no doubt that we can expand and grow into the future.

Yes, we did inherent with the acquisition lot of employees.

We intend to utilize them to continue to grow that business into the future.

And can you give us any sense what products would be first and how soon we'd see new products in there?

We'll roll that up for you when everything is finalized and we're close and talking to the market participants.

But there's a lot of work going on as we speak to ensure that we have the opportunity to maximize that business as we go forward.

Great.

Thanks very much.

(OPERATOR INSTRUCTIONS) We'll take our next question from Vincent Andrews of Morgan Stanley.

Good morning everyone.

If I could just ask a question on Europe.

I understand you had a difficult comparison with last year.

But the first quarter did as well, and the top line grew substantially in the second quarter.

So I'm just wondering what the difference was between 1Q where you grew operating profit and 2Q where it declined?

I think as we said on the call in the second quarter last year, our operating profit grew 19%.

This year it was down 4%.

So we had a very, very tough comp.

Commodities as we said in the last couple of calls, while it was predominantly a Latin America, US issue has now spread to the EU over the last 12 months.

That impacted us and also United Bakers, the acquisition in Russia had an impact on our profits.

We feel good about Europe.

It's a challenging market, but we're doing pretty well at the moment.

Okay, and then the other question that I had was just to make sure.

And I think this is the case.

Some companies have been reporting different types of hedging gains or losses within their results and I assume nothing material for you in that regard?

There's nothing significant.

Most of our hedges get hedge accounting treatment.

Within other income expense, you'll see we are in a slight expense position.

A part of that is because we are expensing some premiums on commodity options through that line.

Okay.

I'll pass it long.

Thanks so much.

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

Hi, thank you.

A big part of the story for Kellogg over the years has been the mix to higher dollar per pound items.

I'm just wondering as you see a consumer that's weakening whether you have reassessed your portfolio or at least taken another look at whether it's possible that consumers could trade down to lower dollar per pound items.

Are there any parts of your portfolio that you think you might want to emphasize as value offerings to consumers?

Thank you.

Vincent, we'll see and we're watching that closely.

If you look at mix year to date for this year we're at about 1.6.

If you look at the prior three years, we're around two, so it's pretty similar.

We could see a mix within our portfolio where people go to more basic foods within the Kellogg portfolio.

We're fortunate in that most of our portfolio, the operating margins and returns are pretty good.

So we don't -- it's a concern and watch out.

But at this point we're not seeing it.

And who knows what the future holds?

But at this stage we feel very good about our business and our portfolio and aggregate.

Okay.

Thank you.

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

Hi, good morning, everybody.

Good morning, Eric.

One question, 14 parts.

In all seriousness, gross profit dollars, I think getting back to I think it was Andrew's question, but the gross profit dollars up mid-single digit.

John can you dice and slice that to the extent that we exclude M&A and we exclude 53rd week?

I mean are gross profit dollars for the full year expected to be flat if we exclude some of these items?

The M&A does not have a significant impact on it, because of the margin structure of some of the businesses we're acquiring.

The 53rd week also is not a significant driver of that.

It would be probably around that mid-single digits maybe a little bit lower than that.

There's a bit of foreign exchange in that.

Okay and then just as a follow up.

We've been hearing some companies getting more concerned about the European consumer.

I guess there's also some concerns in a merging markets as to whether the consumer holds in there.

Dave, prehaps you can kind of take us on a little bit of a tour around the world as to what Kellogg is seeing from the consumer outside the US.

Yes, sure Eric.

I think when you go to Europe there are a couple of market that is for a variety of reasons demonstrating a little bit of weakness.

Spain has a particularly tough economic environment at the moment.

And while our business is doing okay there, I think in general terms consumers are under pressure.

That's true in France.

If you speak to most companies, I think 75% of the grocery categories in France are down due to economic conditions.

And retailers there have actually cut inventories pretty significantly.

So we're seeing a little bit of weakness there.

Whether that persist depends on whether the inventory cap is one-time as we'd expect.

But in aggregate, we grew 5%.

So even with a couple of markets showing a little bit of weakness, our business in totality continues to do well.

We do track what's going on with private label and hard discounters.

There's always the concern there.

But that's still growing, but we haven't seen a massive acceleration.

You go to markets like Latin America, we saw pretty good growth.

There are a couple of markets there a little bit weaker than normal.

Venezuela while grew double digits it was significantly lower than we'd see for a while.

And the key reason was there was an issue with milk and the price of milk and there was no milk available in Venezuela for probably the first three or four months of this year.

And as you can imagine, in the cereal business that can be a little problematic.

So our growth there was significantly slower than it had been in the prior year.

And the Colombia the economy is a little weak there.

Not sure you can draw any aggregate conclusions from any of that because it's all isolated.

But again, in Latin America our business grew 7% and while we're watching it, Eric, at this point we feel fairly comfortable with the future for our business and the strength of our brands and I think continued focus and innovation should hold us in pretty good stead.

Okay, I'll pass it on.

And we will move now to our next question.

This question comes from Terry Bivens, of JPMorgan.

Hi, good morning everyone.

David, just back on the cereal topic for a second.

Certainly a good growth rate.

That's not what we see in Nielsen, I know which only gives us part of the picture.

Can you kind of parse what you're seeing in terms of a growth rate in the measured channels versus Wal-Mart?

And -- or unmeasured I should say in the aggregate.

And also if you could giver us an update on market share now that we're kind of nearing the end of General Mills strategy?

I think on the category as I said earlier, we believe the category across all channels grew anywhere at a low from five to a high of about 6%.

If you look at the IRI data through the third end weeks ending 29th of June, it was up 3.6.

So typically anywhere between two and 3% to that to get to the overall market.

You can see the while IRI is 3.6 the category is going significantly better in aggregate, at let's call it 5.5%

We grew 5%, so we did lose share in measured channels.

We lost one share point.

And I think one of our competitors was aggressive there, they were probably lapping a weak comp, because of their right size right price, initiative last year.

But to have incrementals up 42% for the third end week period, was a lone time.

And we'll probably see in the third quarter with our lapping weakness again, they'll probably do well in a business model.

Looks are, but we're very comfortable with the way our cereal is going.

I have to tell you, we've started well, as we've go into Q3.

The cereal category does appear to be benefiting from this overall change in consumer behavior.

Where out of home consumption and casual dining looks to be down at least double-digits.

And center store in aggregate does appear to be picking a lot of that up as consumers buy more and eat more at home.

So I think that's reflected not only in cereal but across a number of the categories in which we compete, where we're seeing relatively strong and maybe even marginally stronger growth than we're seeing over the last couple of years.

Does that get at your question, Terry?

I think it does.

I would just add that I continue to eat cereal in the evenings so I'm doing my part.

Thanks a lot.

We appreciate that.

Thank you.

Our next question comes from David Driscoll of Citi.

Thanks a lot.

Good morning, everyone.

Gentleman, on the last two calls, you highlighted that the first half earnings would face very difficult earnings comparisons.

Second quarter earnings of up 9% very solid number.

So David I'd just like to ask you what specifically came in better versus your plan in the second quarter?

Can you call out a couple factors?

I think our top line was strong.

While we got impacted by higher commodities in the quarter, and we had tough comps, and we had a tax benefit last year that we didn't have this year, our tax rate actually was positive too in the quarter.

I think it was more the momentum and strength of the top line in the quarter across almost all of the markets.

We saw broad based growth almost everywhere.

And typically we'll have a pocket of weakness somewhere, but in aggregate.

Pretty hard to come up with one in the second quarter as far as top line goes.

If I could sneak in one more in the US cracker business it looks like competitive activity is picking up there.

Can you talk to us a little bit about trends for Kellogg and your new product plans for coming?

I did notice one new product on the slides.

But just curious if there was any other announcements on new products and crackers.

Yes.

We've got a few things coming up.

Our innovation that we kicked off in the first half of the year continues to actually grow and that's really the Cheez-It DUOZ and the Town House Flip Sides.

And I think we are going to see a further momentum and upside from that.

We've got a low fat white cheddar Cheez-It coming out and a couple of innovations.

But our innovation through the first half I still think has legs as we get out of the second half, and we're going to enhance on those as we go forward.

And the whole category in crackers and cookies, again, very strong.

We saw strong growth.

And even though we priced early in the year, we have announced a second price increase for the back part of the year.

Because probably if you look at snacks, it's probably one of the most negatively impacted from a commodities inflation perspective as we look across our portfolio.

I think the category is going to continue to do well, and I think all players can continue to grow and succeed.

Great.

Thank you very much.

Thank you.

We'll take our next question from the line of Alexia Howard, Sanford Bernstein.

Hello, there.

Hello, Alexia.

A question on commodity costs.

I know that you said last quarter it was $0.15 a share that you were facing.

Could you let us know what it was for this quarter?

And give than outlook for commodities, what are the primary drivers of the better EBIT growth that you're expecting in the second half of '08?

I know that you mentioned some of them earlier, but could you quarter them?

Is it mostly pricing?

Is it a slowdown in the upfront costs?

Is it better productivity improvements coming through, is it a slowdown in marketing money?

An idea of which of those factors are the most important.

I'll let John take the commodity inflation in Q2.

I think we have got the number.

In the back half, as John said, the third quarter is going to be challenged.

The fourth quarter is going to be very strong.

A number of factors in that.

One time costs last year.

Our increase in advertising was extremely high.

The expectation would be we'll have strong advertising it won't see the levels of increase that we saw in the fourth quarter of last year.

And in general terms, I think when you look at third quarter, the commodity impact is higher there than it is in fourth.

So those are some of the things.

John, do you want to cover -- ?

Alexia, the commodity impacts in the second quarter is about $0.24.

Great, thank you very much.

Thanks.

We have a question now from Judy Hong, Goldman Sachs.

Thanks, good morning, everyone.

Couple quick questions.

First in terms of the price gap versus private labels in cereal, has the trend changes anyway up or down?

Not dramatically.

I think we're seeing them price maybe slightly below the branded players in the category.

But typically that's a lag effect.

They get pricing through a little bit slower than the branded players.

We're up fourish, they're probably up in the low threes.

But we'd expect that they'll catch up in that.

They have cut the amount they promote too.

Because I think they're trying to make their P&L's work.

No real dramatic change in the spreads at this point.

As we see historically, we are seeing occasionally a particular retailer or two have a greater focus on private label and drive it aggressively and that could tend to skew the data until you dig into it look at it and the fundamentals of what's going on.

And we'd expect that to continue.

But in general terms, the price gaps really haven't moved.

And I think as we look at it, while given the consumer is under a fair amount of pressure, you'd expect private label to do well.

We believe we can continue to do well because of the strength of our brands, our strong innovation, and the high quality of our product offerings.

Okay and then you talked about the incremental pricing in the second half.

Can you give us the magnitude of the price increases in the second half?

Particularly if you compared that against the pricing increases that were taken in the beginning of the year.

Yes, I haven't actually done the math.

All, I'd say is that it's sort of broad across many of the businesses.

A lot of them have been announced and some are coming.

Probably in the low single digits.

But--

And not too different from what you've done earlier in the year?

Not dramatically.

Okay.

Thanks very much.

Thanks.

And our next question comes from Tim Ramey, D.A.

Davidson.

Good morning.

Wondering if you can give me a little more clarity in change in estimate to $0.90 of cost that you now adopt versus the $0.80 that you said before.

There weren't that many things that got worse in the Q2, except I suppose energy.

Was it the $0.03 from the reset options or what else might have been in there?

It was both energy and also edible oils, the two I'd point out.

In general terms, anything that's energy based also continues to rise.

So across a number of items, we did see an increase.

To clarify the $0.03 for the option expense was not part of the $0.90 estimate.

Okay and then David, you mentioned that healthy snacks were up, but I don't think you give us an order of magnitude.

Is that business doing as well as it's done in the past given a weaker consumer?

I think it's growing about mid-single digit.

It had grown historically a little higher than that and our expectation has always been in the medium to long term it would grow mid-single digits.

So it is performing as we would expect it to perform.

And we grew about with the category for the quarter.

So it was a pretty solid performance and it continues to be a category that I think will grow around that level going forward.

And just to comment.

I think it's quite commendable to get rid of that reset or reload option feature.

That's good corporate governance.

Thanks.

Thank you.

And I think that was a positive move by the board.

Amanda, we'll take one more question, please.

Okay, thank you.

Our next question comes from Ken Zaslow of BMO Capital Markets.

Hi good morning, everyone.

Thanks for squeaking me in.

Hi Ken.

Just one question.

Just going back to Europe.

What steps can you do to reverse the profit trends in Europe?

Is it more just doing the same?

Or is there something that the pricing environment can get better?

What steps can really change the profit outlook for Europe?

I think , Ken if you look at the year, when we finish the year, I think you'll look back at the year and you'll go okay the profit in Europe was pretty solid.

So I wouldn't be drawing any negatives from a quarter number, because the comparatives are the single biggest drive of why it didn't look so good.

And I think when we finish the year, we'll look at our European profit, it will be where we expect it to be and it will be relatively healthy.

So I wouldn't draw too much from the quarter number.

Because when you've got nine a year ago and you're down four and your aggregate the two, it's still pretty healthy over the two year

The only thing I will add to that is we will have more upfront costs in Europe this year, relative to last year.

So that will slightly deflate some of the reported numbers.

Were there actually up front costs in Europe this quarter or no?

There was a little bit but it wasn't significant.

Great.

I appreciate it.

Thanks.

Thanks.

That does conclude today's question and answer session.

At this time, I'd like to turn the conference back over to Mr.

Wittenberg for any final or closing remarks.

Thanks, Amanda.

We just want to thank everybody for attending our call today.

We appreciate your interest in the Kellogg Company.

That does conclude today's conference.

We thank you for your participation.

Please have a good day.