家樂氏 (K) 2008 Q3 法說會逐字稿

Good morning.

Welcome to the Kellogg Company 2008 third quarter earnings call.

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

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

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

Thank you.

At this time, I will turn the call over to Mr.

Joel Wittenberg, Kellogg Company's Vice President of Investor Relations.

Mr.

Wittenberg, you may begin your conference.

Thank you.

Good morning, everyone.

Thank you for joining us for a review of our third quarter results and for some discussion regarding our strategy and outlook.

With me here in Battle Creek are David MacKay, President and CEO; John Bryant, Chief Operating and Financial Officer; 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, liquidity, foreign exchange, 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 800-964-4463 for both U.S.

and International locations.

The pass code is pound 5355644.

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.

Good morning, everyone.

We're pleased to report another strong performance for the third quarter.

We achieved 9% reported sales growth and 7% growth on an internal basis.

Our highest quarterly internal growth rate in more than two years.

Our success was driven by price realization, effective advertising and continued business momentum.

Our growth was broad-based, despite some weakness in several international markets.

Earnings per share grew 17% to $0.89 versus last year's $0.76 due to our operating performance, lower up-front costs and fewer shares outstanding.

We achieved these solid Q3 results which were above our long-term targets despite the economic slowdown, commodity inflation and a higher tax rate.

Our continued momentum adds to our confidence that we will achieve another year of sustainable and dependable growth and demonstrates our ability to manage through volatile cost inflation.

With our strong operating performance, we now anticipate full year earnings per share at the high end of the $2.95 to $3.00 range.

Now, I would like to turn it over to John to discuss the financials.

Thanks, David.

Good morning, everyone.

Slide four highlights our financial performance.

As you can see, we exceeded our targets of mid single digit internal sales and mid single digit operating profit growth as well as high single digits earnings per share growth.

Reported sales increased by 9% in the third quarter lapping last year's strong 6% growth.

Internal sales growth which excludes the effect of foreign exchange and our recent acquisitions was 7% building on last year's 4% growth.

Both reported and internal operating profit rose 9% driven by our sales performance and this year's lower up-front cost investments offset by the highest quarterly inflation experienced in our history.

Our third quarter earnings per share rose 17% to $0.89 compared to last year's $0.76 due to our strong operating performance, lower up-front costs and fewer shares outstanding.

Partially offset by a higher tax rate.

Let's turn to slide five to discuss our third quarter net sales growth components.

Reported sales increased by 9.5% in the third quarter lapping last year's 6% growth.

Internal sales growth which excludes the effect of foreign exchange and our recent acquisitions was 6.9% building on last year's 3.8% growth.

This represents our highest quarterly internal sales growth since the second quarter of 2006.

Tonnage contributed 2.3% of sales growth while our price and mixed initiatives continue to flow through with solid 4.6% growth.

Throughout 2008, we have demonstrated our ability to price to offset inflation pressures.

For Q3, the price component contributed approximately 3 points of net sales which is ahead of last year's 1.5 points.

Foreign exchange had less than a 1% impact on sales and our recent acquisitions added 2 points to sales growth in the third quarter.

Overall, we are very pleased with this year's sales performance.

On a year-to-date basis, reported sales increased more than 10% and internal sales grew more than 6%.

Let's turn to slide six to discuss our gross profit performance.

Our gross profit for the quarter was $1.4 billion, a 5% increase on a reported basis over the third quarter of last year.

As you know, our focus is on gross profit dollars.

As this is what allows us to continue to reinvest in our business.

On a year-to-date basis, gross profit was $4.2 billion, a 6% increase over 2007.

Year-to-date gross profit margin declined by about 170 basis points to 42.6% consistent with our expectations.

About half of the decline is due to our recent acquisitions and higher up-front investments in cost of goods.

While remaining decline is driven by commodity inflation, partially offset by additional pricing.

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

Internal operating profit rose 9% driven by 7% internal sales growth, cost savings and lower up-front costs offset by significantly higher commodity costs.

Our North American business reported internal operating growth of 15% with lower up-front costs having a 9% impact.

We are very pleased with this performance which was driven by solid 9% sales growth and offset by significant cost inflation.

Our European internal profit rose 3% versus last year as higher up-front costs reduced operating profit growth by more than 1%.

In addition, higher commodity inflation had a negative impact on performance.

In Latin America, the combination of softness in our top line, higher commodity costs and cost increases caused by Venezuelan import restrictions resulted in a 10% decline in total operating profit.

And in Asia Pacific, internal operating profit increased by 55%, driven by 10% sales growth and a very strong performance in Australia, partially helped by an advertising shift from Q3 to Q4.

Below the operating profit line, we benefited from fewer shares outstanding and our tax rate was about 28% due to several discreet items in the quarter.

We now expect the full year tax rate to be approximately 30%.

In addition, other income and expense resulted in income of $13 million and Q3 interest expense declined to $71 million.

Let's turn to slide eight to review our advertising spending.

At close to 9% of sales, our advertising investment remains significantly higher than the food group average of about 5%.

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

As previously discussed, we are also driving a series of initiatives across brand building to further improve the efficiency and effectiveness of these investments in the new media environment.

We began to see the benefits of these initiatives during the third quarter.

While spending declined slightly against last year's double digit comparable growth, the effectiveness increased as evidenced by our strong sales performance.

This slight decline in spend was driven by three items.

First, a tough comparable.

Second, timing in Australia as mentioned earlier.

And finally, some initial efficiency gains.

As we move forward, we will keep you updated on the progress of our efficiency and effectiveness initiatives.

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

The third quarter's cash flow was $383 million, about even with last year's $392 million.

Year-to-date cash flow was $893 million, versus last year's $961 million.

We continue to improve our core working capital through the quarter.

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

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

Given the recent volatility in the financial markets, I also want to update you on our liquidity.

We currently have about $1.5 billion of outstanding commercial paper which is offset by approximately $700 million of cash on the balance sheet and backed by $2 billion of bank lines that mature in 2011.

We have maintained good access to the commercial paper markets throughout the recent market disruptions and our next term debt maturity is not until another two and a half years.

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

Thanks, John.

Continuing with slide ten, you can see our North American sales growth was a very strong 9% versus last year's 3% comparable.

This growth was broad-based across all of our business units.

If we turn to slide 11, we can discuss each business unit in more detail and if we look at our North American cereal, internal sales growth was 7% during the third quarter.

Which included strong growth in non-major channels.

We're obviously very pleased with the strength of the category and our performance this quarter despite a higher level of competitive trade activity.

We achieved strong price realization once again in Q3 and our price per pound in measured channels rose by mid single digits during the quarter in line with the category.

Our solid performance came from innovations like mini-wheats blueberry muffin and we saw good performance from Special K cinnamon pecan, Raisin Bran Crunch and Corn Pops.

For the quarter, Kashi sales rose double digits driven by GoLean Crunch honey almond flax and organic pumice.

Our Canadian business continues to perform well despite competitive conditions similar to the U.S.

During Q3, we achieved solid growth from Kashi innovations, Mini Wheat cinnamon and the Guitar Hero promotion.

We're pleased to have achieved this strong third quarter although it was against the relatively weak trump, and conversely in the fourth quarter, we face a tough 8% comparable and we expect shipments to be relatively flat versus last year.

Let's turn to slide 12 to discuss the North American snacks performance.

As you can see, our snacks business posted a very strong quarter with 10% sales growth versus last year's 5% comparable.

Our success was driven by innovation, a second round of price increases and robust category growth.

Let's turn to slide 13 to look at more detail on the quarter.

Our Pop-Tarts business posted a solid quarter with high single digit sales growth driven by higher Blue Box sales and price realization.

This year's strong credit performance resulted in ROI market share gains and we delivered double digit growth in Q3 driven by innovations like Cheez-It (inaudible) and Townhouse Flip Sides.

In addition, we continue to see good growth from both cracker and cookie portion control packs.

Cookie innovation remains strong as we achieved low single digit sales growth and gained ROI market share during the quarter.

Also snack sales grew at mid single digits during Q3.

And we achieved solid sales from Nutri-Grain as well as innovations like Kashi, TLC Chewy Granola Bars and Special K Bliss bars.

We turn now to slide 14 to discuss our frozen and specialty channel performance.

Frozen and specialty channels had another great quarter with sales rising 11% versus last year's 5% comparable.

Third quarter sales included a slight trade inventory benefit due to the frozen foods price increase taken light in Q3.

We achieved double digit frozen food sales growth due to the trend toward in-home food consumption as well as strong innovation and advertising.

Sales grew at double digits driven by strong price realization and innovations like Bakeshop swirls and Bakeshop mini muffin tops.

These success resulted in more than a one point of ROI market share gain.

Our Morningstar family veggie burgers and veggie country products posted strong sales for the grilling season as well as our new Asian veggie patties which are exceeding expectations and our frozen Kashi meals, once again, grew at double digits, driven by rising distribution of Kashi frozen entrees and pizzas.

Given the difficult away from home environment, we're particularly pleased with our food service business which achieved high single digit sales growth.

You can see on slide 15 that our International sales grew 3% during the quarter versus last year's 5% growth.

During Q3, the economic environment had a greater impact on the International business than on our North American business.

If we turn to slide 16, we can discuss this in further detail.

In Europe, we posted 3% internal sales growth for the quarter.

And while we're pleased with our Q3 performance, the economic conditions across Continental European in particular have become more challenging.

As strong U.K.

growth was driven by pricing, innovation and category diverse.

In France, a trade inventory reduction resulted in Q3 shipment weakness, however, this year's end market consumption has grown faster than the category resulting in market share gains in both cereals and snacks.

European brands like Extra, Cocoa Pops, [Trizole] performed well.

Our European snacks business posted double digit growth during the quarter with solid performance from special K Mini Breaks and Rice Krispie Squares.

We achieved solid growth in Germany, Austria, Switzerland the Nordics and Benelux.

In Latin America, internal sales declined slightly this quarter versus last year's very strong 12% growth.

Sales in Mexico declined primarily due to the weaker economy and aggressive pricing by our largest competitor.

Sales growth was strong in Brazil, Ecuador, Venezuela, Argentina and Central America.

Due to the weaker economic environment we anticipate 2009 sales growth at closer to mid single digits than Latin America.

In Asia Pacific, internal sales grew 10%, our Israeli ready to eat cereal business grew mid single digits, driven by strong category growth and our focus on core brands.

In addition, our recent Special K Advantage and contact check innovations performed well.

We also achieved double digit internal sales growth in South Korea, India, and South Africa.

Before I turn it back over to John to review 2008 and 2009 preliminary guidance, I would like to say a few words on slide 17 about the year ahead and how we plan to adjust to the tough consumer environment and the slowing global economy.

Clearly, there remains a high degree of uncertainty about what lies ahead in this turbulent economy.

It is important to continue to manage costs to help offset inflation and fund reinvestment in the business.

We're doing so through agressive cost saving initiatives across three areas, supply chain, overhead and brand building.

First, we have a major new program focused on our manufacturing facilities under the banner of Kellogg LEAN which stands for lean, efficient, agile network.

This program will ensure we're optimizing our manufacturing utilization, reducing waste and developing best practices across many of our global facilities.

You'll hear more about Kellogg LEAN as we progress through 2009 and we anticipate it will be our largest up-front cost saving initiative for the year.

Secondly, we'll continue to keep our overhead as low as possible.

And finally, as mentioned earlier, our efforts to optimize our advertising and promotion efficiency and effectiveness are starting to bear fruit and should be near full implementation during the first half of next year.

Ensuring we continue to build our brand recognition through quality and added value, is particularly critical in these tough economic times when private label is likely to grow.

Not only will we continue our drive to greater brand building efficiency, we also expect our advertising spending will grow in line with sales for 2009.

Now, I would like to turn it back to John on slide 18 to discuss our full year 2008 and 2009 outlook.

Thanks, David.

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

Operating profit is still expected to grow at mid single digits including cost of goods, cost pressure of 9% as well as up-front cost savings investments of $0.14 per share.

In addition, we anticipate foreign exchange headwind starting in Q4 which will be largely mitigated by translational hedges in the fourth quarter.

Despite a difficult trading environment, we're maintaining our full year earnings guidance of $2.95 to $3 per share and we now have additional confidence that earnings will be at the high end of this range.

Last, we want to update you on a few housekeeping items.

First, we've now finalized how we'll use our fourth quarter's 53rd weeks's profits.

We plan to use these profits to largely reinvest back into our recent acquisitions in Russia, China, Australia, and the U.S.

Second, we expect our full year net interest expense to be unchanged from 2007.

Third, our full year tax rate is now expected to be approximately 30% versus our earlier expectation of approximately 31%.

And finally, we do not plan to repurchase any shares during the fourth quarter.

To summarize, we expect to continue to achieve our goals, deliver our targets and reinvest in the business despite high inflation.

Let's turn to slide 19 to discuss our outlook for inflation.

This slide highlights the high level of inflation we have experienced in recent years.

Based on recent market declines in many commodity prices, some of you may be anticipating a decline in our costs.

Thanks to our aggressive hedging program in 2008, we avoided the full impact of commodity cost increases.

Without these hedges, our inflation rate would have been even higher than the 9% shown on this chart.

As hedges roll off in 2009, we anticipate another step up of cost pressure inflation at approximately 5% of cost of goods.

The commodities component of this inflation is skewed to Europe and Latin America for 2009.

We've recently announced or executed pricing actions to cover this additional inflation.

We have demonstrated an an ability to manage our way through both high inflation and volatility.

We expect to do this in 2009, through expanded savings programs as David mentioned earlier.

Let's turn to slide 20 for our 2009 outlook.

We expect 2009 will be another year of sustainable and dependable performance.

We'll enter the year with momentum, fueled by our business model and strategy.

We have invested in our long-term growth through innovation, advertising, cost savings, initiatives and acquisitions.

Our forecast calls for internal sales to increase by mid single digits.

As we discussed, cost pressures will remain significant.

But will moderate from 2008 levels to about 5% of cost of goods.

We expect inflation to have a proportionally larger impact in Europe and Latin America.

Overall, we expect gross profit margin to be about flat resulting in mid single digit internal gross profit and mid single digit internal operating profit growth year on year.

We're realistic about the headwinds we face in 2009 including additional inflation and a weaker economy.

While the unprecedented strengthening of the U.S.

dollar is also likely to impact reported earnings per share, we are confident in our ability to deliver high single digit EPS growth on a currency neutral basis next year.

The recent volatility of the foreign exchange markets, however, makes it difficult to forecast reported earnings per share.

We plan to update you regarding foreign change on future calls.

Our guidance includes an assumed tax rate of approximately 30% to 31% and fewer shares outstanding.

A key driver of our confidence in our sustainable and dependable growth is an intensified focus on delivering cost savings from productivity and efficiency initiatives.

In addition, we will invest back into the business with up-front cost saving investments.

Consistent with prior years, our 2009 forecast includes upfront costs of $0.14 per share.

Our largest up-front investment for the year will be the Kellogg LEAN manufacturing program.

Along with that continued focus on overhead cost control, these initiatives will help offset the headwinds we face in 2009.

Despite these challenges, our business model and strategy continue to give us the confidence that we will once again deliver another year of sustainable and dependable performance.

Now, I'll turn it over to Dave.

Thanks, John.

As we move into 2009, the pressure of the weak global economy on consumers and the additional volatility from an unprecedented depreciation of the U.S.

dollar are adding up to another challenging year.

We'll stick to our business model and strategy, reinvesting back into the business for future growth.

This gives us continued confidence in our ability to deliver another year of sustainable and dependable growth.

We'll continue to aggressively manage risks by stepping up our focus on cost saving initiatives, productivity gains, and SG&A optimization.

In particular, our focus on the Kellogg LEAN manufacturing initiative will provide savings at our manufacturing costs and processes.

This project just kicked off and will run through 2009.

We'll continue to invest in great innovation and effective advertising programs to keep consumers engaged and aware of our brands and their benefits.

In addition, we'll drive our advertising programs across the globe to our costs while delivering even more effective consumer brand building.

All of these moves, making the right investments, achieving price realization, focusing on cost saving initiatives and investing in future growth, provide us with the confidence that 2009 will be another year of sustainable and dependable performance.

As we move into the new year, we'll continue to address the issues we face and give you another update on our Q4 call and now, I would like to open it up to questions.

Thank you.

We will now conduct a question-and-answer session.

(OPERATOR INSTRUCTIONS) Our first question comes from David Palmer with UBS.

Please proceed with your question.

Hey, guys.

Just one simple question.

And that is about currency and the interconnection with commodities.

I think this is the first time you're giving a constant currency guidance but I'm wondering how we should think about how that connects -- I would assume with commodities and the outlook for that, in other words, a stronger dollar would coincide with year over year declines or a more benign outlook for commodities than perhaps you would assume if we had a weaker dollar environment.

How should we think about that?

On the face of it, I would assume you would choose to have a firm dollar and less inflation but perhaps there's some other timing things going on here where you haven't done certain hedges on currency but you have on commodities that might be shaping your outlook for '09.

Thanks.

David, I'll let John take the FX then I'll come back and talk a little bit about commodities.

Just to clarify on foreign exchange, step back and look at our business.

Certainly, the internal mid single digit sales growth and profit forecast gives you a sense that our business is doing well.

But there has been some unprecedented moves in foreign exchange.

If we think about those in two buckets, there is a transactional and a translational impact of foreign exchange.

Transactional, I'll just give you an example of export product from the U.S.

to Canada, the Canadian dollar is devalued by 20%.

Obviously product going to Canada will cost more.

That sort of impact of foreign exchange we can price away in the marketplace.

The translational impact, the profits in Canada now are translated at 20% less than U.S.

dollars.

That's something that we can't price away.

If you think about the size of the translational issue that we have, we'll look at the operating profit from our International business plus Canada, it is about 40% to 45% of the Company's total operating profit and quite frankly, we have a lower tax rate outside the U.S.

than inside the U.S.

It is more in the ballpark of 50% of net income.

And if we've had a 10% to 20% move in foreign exchange, you can see a 5 to 10 point impact on EPS.

So, the size and magnitude of the movement is quite substantial.

Just before I tackle commodities, something else on FX.

If FX were currently 1% to 2% EPS impact, we wouldn't be having this conversation.

We would simply absorb it into our guidance.

It is clear, the volatility in FX is unprecedented.

To be quite frank, we have got no clue what the impact will be come January 2009.

Just yesterday, in one day, the U.S.

dollar weakened roughly 3% against most global currencies.

So we remain confident in our business model ability to deliver sustainable and dependable results.

We'll keep you updated on this with another review in January and February.

But on the commodity side, David, to your question there, as you're aware, when you look at COGS inflation and cost inflation, it is very complex.

A lot of puts and takes.

We've said for the next year, we expect our cost of goods to rise 5%.

Of that, roughly half is factory expense, wages and benefits.

That's relatively consistent with what we've had over the last five or ten years.

The balance is a combination of packaging energy and commodity inflation.

As we said on the call, we had some positive allied hedges that roll off in '09 and while spot prices are down in some commodities, if you look at spot prices on things like sugar and rice, 2009 versus 2008 they're up an aggregate of between 40% and 50%.

You have got packaging inflation which is highly energy sensitive.

It tends to lag the market by anything up to 6 months.

So, we'll not see the benefits of reduced energy input costs there for probably six months until the second half and as we've told you in the past, Kellogg's, like most other FMCG companies tends to lag out pricing versus inflation.

To an extent, we're still catching up to the allied cost.

Net net costs will be up year on year in 2009 when you look across the entire basket.

I'll stop there.

Thank you.

Our next question comes from Judy Hong with Goldman Sachs.

Please proceed with your question.

Thanks, good morning, everyone.

Just a follow-up on currency.

When you said the fourth quarter, you had translational hedges in place.

That's not impacting the fourth quarter outlook.

Do you have any hedges in place for '09 at this point?

The problem we have with translational hedging, is we don't get hedge accounting for that so we actually have to mark that to market each month.

You might notice in our third quarter results and our other income expense is about $13 million of other income.

The reason for that, one of the reasons for that is within the third quarter, we had the mark to market our fourth quarter translational hedges.

There's actually $0.02 of good news sitting in Q3 because of those hedges.

That will actually mean that we won't get those benefits in Q4.

If we were to hedge out the 2009, then we would just be bringing even more volatility into our 2008 P&L.

That's all translational.

Obviously on transactional, we do have hedging in place to different degrees in different markets around the world already for 2009.

Okay.

And then David, as we think about your efforts to optimize your marketing spend efficiencies, I'm just trying to get a better perspective on your confidence level in maintaining your sales or share momentum.

We've seen some of your competitors taking advertising up.

As you think about your total marketing spending bucket and as you optimize the level of the spending, just in terms of how you think about that in an absolute basis and then as you think about optimizing that relative to your competitors that may be taking it up on an absolute basis?

Judy, let's make sure no one is confused.

We are still planning to take the number of impressions that we have against our brand up year on year.

For 2009.

We've said that next year we'll be taking our spend up mid single digit.

And remember if we drive these efficiency gains, then we'll be getting more impressions for a lower cost but yet we're taking our investment up mid single digit to 2009.

Anyone who makes the wrong assumption that we're trimming our brand building support is not getting the message.

The message is pretty clear.

We're one of the highest spenders on advertising and promotion in the food category.

Around 9% of net sales.

We think that gives us a strategic advantage versus our competitors who are trying to catch up.

But it also is important for us as a Company to recognize there was broadly $1 billion in spend there, that there are opportunities to improve the efficiencies and effectiveness of that spend to make sure that our brands remain vital and strong.

That's exactly what we intend to do going forward.

Okay.

Thank you.

Our next question comes from Andrew Lazar with Barclays Capital.

Good morning, everyone.

Good morning, Andrew.

Just a quick one.

It is a little out of the scope of the quarter itself.

I guess you've heard that Kellogg is leading a charge to change sort of the core cereal box size and configuration to sort of change on packaging and shipping and such.

I guess it is maybe a shorter, squatter box, I guess a compaction maybe in laundry detergent.

I'm just curious if this is accurate?

And if it is, is it meant to put Kellogg at a competitive advantage, or by changing the price per ounce or the unit in profit metrics or does all of that stay the same and it is really more about the efficiency side and does the consumer's perception of value change if the box size configuration changes?

Yes, Andrew, what you're poking out is something that we're playing around very much as part of our environmental sustainability drive.

As a Company, we've always had a strong history of trying to leave a positive footprint wherever we compete.

We think we need to step that up.

We have a number of initiatives going on.

Looking at how we can make positive changes in what we do to improve our footprint and to drive efficiency and effectiveness.

It is too early to say any more than that.

And hopefully, once we have more consumer learning, we'll see where that takes us.

Okay.

And then is pricing that you got to take more overseas now, given that's where all the inflation is coming from, is that a tougher charge than we have seen in the U.S.

where it has obviously gone through quite successfully for you and for the industry?

I think to the credit of our retail partners, they always like to understand is pricing that we're taking justified.

We work very closely with them both in North America and Internationally to explain what's going on because quite often, they don't necessarily have as clear a picture as we would like them to have.

As we do that, clearly, they are understanding, I think in this tough economic time, there's no doubt people would rather there wasn't any inflation but unfortunately, even though things have moderated and you look at some of the commodities out there coming down.

As we've said in the call, our COGS for next year are going to be up 5.

On pricing, we're taking actions we need.

We think our brands are strong enough.

We think it is necessary to offset the inflation that we have.

Thanks very much.

Thanks.

Our next question comes from David Driscoll with Citi Investment Research.

Good morning, everyone.

Good morning, David.

Two items on my mind here.

First one is back on the commodity side.

John or David, can you guys comment on how your competitors and/or private label, maybe most importantly, is positioned just kind of historically within the commodities?

What I'm really trying to drive at, a lot of folks are looking at these commodity prices and expecting them to be down.

If you guys were benefiting in 2008 from lower than spot price numbers because of good hedging you put on in '07, then the question is is that's a benefit in '08 but of course it turns out to be a negative in '09 as inflation catches up with you and hedges roll off.

Does the competitive position of Kellogg, is it at a disadvantage in '09 because you have competitors who are on a spot basis?

David, it is virtually impossible for us to comment on what competitors are doing.

I think it is probably very much a mixed bag.

As we look at 2009 and we look at the 2009 hedges, we believe we're currently slightly favorable to the current spot prices.

As we have talked about hedges to investors, there is always good news and bad news.

You don't want too much of either because it can have a dramatic impact year to year.

I think we're pretty well placed.

As I said, our hedges, we believe, are currently slightly favorable to current spot prices as we look at 2009.

Final question is what comments can you make to us about the effects of Wal-Mart's efforts to increase private label penetration?

How significant is this for Kellogg in 2009?

Certainly in light of the fact that nonmeasured channels have been such a strong component of the growth here in '08.

I think the first thing to remember when you're thinking about private label is that from a Kellogg perspective, we're in categories.

And we have products that represent great value.

Private label typically has lower relative shares because of the strength of our brands and the value proposition that we demonstrate.

Across the world, the categories in which we compete are growing and growing strongly.

Our position at number one and number two also helps.

And I think if -- we remain very positive about our ability to grow the business going forward.

If you look at Q3, I think it is a solid example of that with 7% internal growth.

Our best defense against private label is to play our game.

Strong innovation and brand building.

If you're being pragmatic as we sit on the call, private label growth in a recessionary environment is likely as some consumers are going to have little choice but to trade down.

But again, our categories are growing.

We feel our brands are strong.

We're going to keep playing our game.

As you might have seen, we had a campaign starting in October that tried to help consumers understand the great value that ready to eat cereal represents on a per serving basis.

Great.

Thanks for the comments.

Thanks.

Our next question comes from Chris Growe with Stifel Nicolaus.

Please proceed with your question.

Thank you, good morning.

I have a question first just in relation to your price increase.

You mentioned Europe and Latin America being two areas where you've taken pricing.

This is one of the rare quarters where Latin America has been a leader in the competitive dynamics, that maybe challenged you.

So, is the price increase out of sync with the category in Latin America?

Is that going to be a more challenging environment for you in 2009?

You mention he sales growth for the year.

When you look at growth for Q3 in Latin America, and we mentioned Mexico was actually down, we did have a tough comp across all of Latin America.

That was true for Mexico as well.

We are seeing the Mexican economy slowing a little.

But the key issue for us in Q3 on the top line was a very aggressive competitive activity that caught us a little off-guard.

As we look at Q4, would expect to be back around mid single digits and we did reflect that for 2009, with more pressure across the number of the Latin American markets, our forecast would be that sales would be around mid single digits.

They have been historically a little higher.

That's just a pragmatic view reflecting that some consumers across those markets will be under a little pressure.

Okay.

I had just one more question.

Just in relation to -- we're seeing significant growth in alternate channels, obviously, ROIs becoming less predictive of your business.

I wonder if you could comment on your success in the quarter in alternate channels and related to that, is there any trade inventory reductions that you're seeing or feeling or you are concerned about in the fourth quarter just given the environment we're in here today?

So on alternate channels, I think it is true, you're seeing strong growth there across the whole retail category.

Our categories are growing.

If you look at our ROI share performance it probably does understate how we're doing if you look at all channels.

In all channels, we probably grew 3% or 4%.

The category for cereal for example grew probably 5 or 6%.

So we did lose about a few tenths of a share, but the category is growing strongly.

So, I think you're seeing a number of the alt channels actually do well but I don't think you're seeing a significant degradation in the normal retail business.

The second part of the question, Chris?

Trade inventory declines, any concern with that and just in the environment we're in today?

As we look at the trade inventory, relatively consistent year on year.

We did mention in the call that we took a price increase on frozen late Q3.

So, our anticipation would be that we've got some incremental shipments in Q3 that will come out in Q4 as inventories readjust.

I think retailers are being very cautious on inventory levels.

We also have vendor managed inventory with well over 50% of our customers.

We've been working very closely to keep our inventories relatively tight so while it could be a little bit of an issue, I don't see it as being significant.

That's great.

Thanks for your time.

Thanks.

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

Just to (inaudible) for a second.

Would you say that the overarching environment for packaged food and for Kellogg is better or worse than it would be last year?

I think it's not changed dramatically.

The only issue is the one I mentioned earlier.

If you take a pragmatic view on where we are from a economic strength/weakness perspective, there will be some consumers who, by default, may have no choice but to trade down.

That's the view as we look at 2009, as we take that view, we're also looking at what programs and steps we can make to keep our brands front and center and to make sure that we're demonstrating the value of everything we do.

The great news is if you look at Q3 because I believe the U.S.

economy has been weak through the bulk of Q3, we had very strong growth, our categories were strong.

We did pretty well in most of those categories, some very well.

Some, not so well but still well.

So, I don't actually think that the dynamic has changed, and the one benefit I think all of us will get if we don't have a massive food service business dependent on main meal is that out-of-home consumption is declining, has declined through I think the last three or four months and our anticipation would be that we'll see a continuation of that through 2009.

So, you've got some is slight negatives with the negative impact on consumers and their ability to buy all branded goods and you have some slide positives with a probably greater propensity for in-home consumption which would certainly help our business.

Net net, we would see the two sort of balancing off.

We don't see a massive change.

Okay.

And if commodities were to fall off, would you be able to keep whatever price increases you have passed through?

Or did you price -- did you price ahead or behind -- I'm assuming you priced behind inflation, not ahead.

It should be pretty sticky, is that fair?

Then I'll let it go.

As we've said, consistently and I think we're not the only Company, we typically lag inflation in our pricing and especially when it is volatile as it's been because you make a forecast, you price to try and cover that and we've been wrong for the last eight plus months and even as we look at 2009, our COGS inflation is forecast to be around 5%.

Albeit, half of that is really pension, wages, expense which is really consistent so the other half is a mismatch of commodities and energy and packaging and various inflation hitting us at different levels around the world.

We did say on the call that in Europe and Latin America, we are seeing a disproportionately large percentage of our commodity inflation coming in those two areas.

For a variety of reasons.

So, we shouldn't expect to see lower cookie or cereal or cracker prices at my home grocer?

I would think not on an ongoing basis although I'm sure we'll find a way to entice you to buy.

Great.

Thank you.

Our next question comes from Eric Katzman from Deutsche Bank.

Good morning, everybody.

Good morning.

I guess I have a question on the why inflation and input lag in the EU and Latin America?

Seems in this time, with information moving so quickly, I don't understand why there would be such a lag there.

And then doesn't that put your forecast more at risk that you're taking pricing in those markets because of that lag into what appears to be a much weaker consumer in the EU and I suppose Latin America as well?

Eric, I think that's why we've called our 2009 view on Europe at low single digits.

And Latin America around mid single digits.

So, we're anticipating a little bit of a tightening there.

You do have some situations, for example, rice, is up dramatically year on year.

And in the EU in particular, there always has been a lag effect and given the volatility and what's been going on in the commodity markets, some of that is still flowing through in Europe in particular.

As you look at the forecast, we all understand how much stuff is moving around because we're experiencing that every day, too.

Yes.

Is that the greatest in terms of your view, risk to your forecast in terms of how the consumers behave in EU and Latin America, vis-a-vis this price move?

We hope we're reflected it in the way we've given guidance for 2009.

As we've said, if our view changes as we get into Jan, Feb.

we move into Q4, we'll give you an update.

At this point, we think we've taken a pragmatic view that across Continental Europe in particular, things will slow a little bit just because of what's going on in markets like Spain and Italy.

And same in Latin America.

If we get any greater intelligence than we currently have, we will update our forecast and give you a bit of visibility.

But that's -- as we look at it going forward, that's our current view, Eric.

Okay.

I'll pass it on.

Thank you.

Thanks.

Our next question comes from Brian Spillane with Banc of America.

Please proceed with your question.

Hi, good morning.

Just a quick clarification.

In the outlook for '09, you mentioned fewer shares outstanding.

Is that predicated on starting share repurchases again in '09 or is that just based on what's been done in the past?

That is a great question.

If you step back and look at our potential uses of cash in 2009, obviously, we're going through a fairly volatile period right now in the financial markets.

So, we want to be quite flexible in how we think about this.

And there are a couple of different options for us.

One is that we can continue to pay down debt.

As we said in the prepared remarks we have about a $1.5 billion commercial paper program.

$700 million in cash backed up by a $2 billion credit facility.

We feel good about our liquidity.

If the situation doesn't improve, that's always an option for us.

Another thing we need to keep looking at is our pension status.

We've historically been very well funded against the pension as you would expect, our assets had a pretty good equity allocation and those assets have come down this year.

While I don't see any mandatory funding requirements for 2009, we would certainly historically have gotten ahead of this with voluntary contributions.

That's something else that we will look at.

Having said all of that, our long-term intent is to return cash to shareholders.

That's what we've done over the last three to four years.

That would be our long-term plan going forward.

Certainly as we've constructed our outlook for 2009, we still have that $500 million share buyback occurring in the first half of '09.

That's what's giving us that lower shares outstanding.

Having said all that, again, we'll step back from the '09 use of cash and this flag that we're going see how the markets develop over the next two to three months.

We may come back in January and provide more specific guidance in this area.

But clearly, with the current volatility, we need to stay very flexible.

Great, thank you.

Our next question is from Terry Bivens with JPMorgan.

Good morning, everyone.

Hey, Terry.

Obviously you guys are doing pretty well at Wal-Mart.

We heard kind of the same thing from Kraft this morning.

But kind of a shaggy dog question here.

We've seen some prime time ads that, basically say if you buy your Kellogg's cereal at Wal-Mart, you save, I forget the exact amount but it was quite a bit of money on a yearly basis.

I'm wondering about those.

What kind of role those play in your results at Wal-Mart.

Maybe it is too early there but also, are those classified?

Would you classify such ads as trade promotion or would that go under advertising?

Just to clear that up.

We ran a Kellogg campaign in October demonstrating the value of Kellogg's cereals at $0.50 a bowl with milk.

We paid for that Kellogg advertising.

And Wal-Mart has been constantly pushing their angle as being the retailer that gives the best value.

They paid for the advertising that I think featured an array of Kellogg products and suggested that consumers could save $900 plus a year.

That's the one I'm thinking about, Dave.

That's an ad that they ran.

We didn't pay for it.

No doubt Wal-Mart is helping our business.

We would hope so.

I'm sure they would, too.

But the campaign we ran was stressing the value of cereal at $0.50 a bowl with milk.

Okay.

But with regard to Wal-Mart, would you do anything in terms of trade promotion in connection with those ads or is that strictly them?

That's them.

We try and deal with all of our trading partners on an equal basis and they're a big, important customer.

We value everything we do together.

But that was an initiative that Wal-Mart chose to run and we thank them for the support.

Just one quick one.

What did you say the U.S.

cereal category was growing at?

If you look at all channels, our view is 5% to 6%.

If you look at ROI, for the quarter it is showing 3.4.

Typically, we would add 2% to 3%.

We're saying 5% to 6% all channels for the category.

Okay, terrific.

Okay.

Thank you.

Thanks, Terry.

Our next question comes from Alexia Howard with Sanford Bernstein.

Just a real quick one.

In terms of the -- you mentioned that the commodity pressures were at their peak this quarter.

I know that last time around, we spoke and you mentioned on the last earnings call over $0.24 in the second quarter, $0.15 in the first quarter.

Can you give a number as to how much it was this quarter and are you still expecting $0.90 to the full year?

Alexia, we're still in the ballpark of $0.90 cents for the full year.

We saw about 30% of that come through in the third quarter.

So, around the $0.27, $0.30 for the quarter.

Okay, great.

Thank you very much.

Let's take one more question, please.

Our last question comes from Vincent Andrew with Morgan Stanley.

Dave, you referenced a couple of times a high level of competitive trade activity and I think you might have mentioned it was in several geographies.

Could you just characterize that a little more for us and tell us whether you think it is continuing into the fourth quarter?

I was referencing -- two references, one was Mexico which I think has been a quarterly phenomenon and the other was U.S.

cereal.

I think again, we had a major competitor whom a year ago had gone through a major change in their box size.

So, they had weak comps when you look at this year.

They chose the opportunity to support their business strongly.

We don't believe that that's something that they'll do on an ongoing basis.

That's clearly entirely up to them.

But it certainly did have an impact as you look at the amounts on deal in the quarter.

But again, having said that, we still did pretty well and the category did very well so, not a major issue, just a variable in our results for the quarter.

Okay.

So, it sounds like the U.S.

issue was very much like it was last quarter and I guess I'll leave it there.

Thanks a lot.

Thank you.

I would like to turn the call back over to Mr.

Joel Wittenberg for closing comments.

Thanks very much.

We want to thank you for participating in today's call and for your continued interest in Kellogg's.

Have a good day.

This concludes today's teleconference.

You may disconnect your lines at this time.

Thank you for your participation.