家樂氏 (K) 2009 Q1 法說會逐字稿

Good morning.

Welcome to the Kellogg Company 2009 first quarter earnings call.

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

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

(Operator Instructions) Thank you.

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

Mr.

Wittenberg, you may begin your conference.

Thanks, Christina, and good morning, everyone.

And thank you for joining us for a review of our first quarter results.

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, tax rate, cash flow, cost savings, brand building, up front costs, impact of the recalls, 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 our 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 888-632-8973 in the U.S., and 201-499-0429 international from international locations.

The pass code is 43296486.

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 are pleased to report that our first quarter results were ahead of our expectations driven by broad based internal sales growth of over 4%.

As we discussed previously, the first quarter was expected to be one of our more challenging quarters.

But by continuing to continuing to execute against our strategy and business model we performed well despite the tough economic conditions, the peanut-related product recalls and the impact of some challenging European retail negotiations which have now been resolved.

Internal net sales, which excludes the impact of foreign exchange, acquisitions and shipping days, rose 4% versus last year's 5% comparable.

Internal operating profit rose 7% driven by our solid sales growth as well as a relentless focus on cost saving initiatives and efficiency.

In addition, we faced a difficult quarter of commodity cost pressures and absorbed costs related to the recalls.

Earnings per share were $0.84, a 4% increase on a reported basis and a 14% increase on a currency neutral basis.

EPS was also significantly above our target.

With our solid momentum we are now even more confident we will achieve our most recent full year guidance of 3% to 4% internal sales growth, mid-single-digit internal operating profit growth and a high-single-digit currency neutral earnings per share growth.

We will reinvest advertising savings and strive to increase our consumer impressions at a lower cost.

In addition, in this difficult economic environment, we are focused on driving a strong value message to consumers.

We now plan to significantly increase our investments and up front cost saving initiatives from our original expectation of $0.14 per share to approximately $0.22 per share, and we expect this heightened level to continue in 2010.

These investments keep us on track to achieve $1 billion of annual cost savings by the end of 2011.

The annual savings which will be achieved over three years combined with our business momentum gives us increased visibility into our future earnings.

Last we will continue to return cash to shareholders during 2009.

We have confidence in our long-term business model as evidenced by the board of directors' decision to increase the dividend by 10% starting in the third quarter.

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

Thanks, David, and good morning, everyone.

Slide 4 highlights our financial performance for the first quarter.

During our last call, we discussed the significant challenges we faced during the quarter including a tough competitive landscape, a weak economy, the impact of the peanut-related recalls and tough comps.

Despite these headwinds, we exceeded our targets of low-single-digit internal sales growth, mid-single-digit Internal operating profit growth and high-single-digit currency neutral EPS growth.

Reported sales declined by 3% during the first quarter driven by an 8% negative impact from foreign exchange.

Internal sales, which excludes the effect of foreign exchange and our recent acquisitions, were up 4% building on last year 5% growth.

While reported operating profit declined by 3%, driven by foreign exchange and lapping last year's strong 9% growth, internal operating profit rose 7% driven by our sales performance and productivity initiatives and offset by cost pressures.

In addition, the recalls reduced operating profit by approximately 5% and reduced earnings per share by about $0.05 per share.

Up front costs during the first quarter were $0.03, roughly in line with last year.

Reported earnings per share rose to $0.84, a 4% increase on a reported basis and a 14% increase on a currency neutral basis.

Let's turn to slide 5 to discuss our first quarter net sales growth components in more detail.

First quarter reported sales declined by 2.7% due to a 7.7% decline from currency.

Internal sales rose 4.2% as our pricing and mix initiatives continue to flow through with solid 5.8% growth.

Tonnage declined by 1.6% in the quarter.

However, it is important to note that our global cereal volume was up approximately 1% in the quarter.

Our consolidated decline in volume was driven by snacks which was impacted by discrete items including the impact of the peanut-related recalls, select cracker box size adjustments and a shift from lower margin bulk products to higher value added products in Russia, where volume declined 16%, the net sales grew 9%.

In addition, our recent acquisitions added 80 basis points to sales growth.

Let's turn to slide 6 to discuss our gross profit performance.

Our reported gross profit for the first quarter was $1.3 billion, a decline of 5% driven by recall costs and an 8% foreign exchange impact.

On an internal basis gross profit rose 3%.

Gross profit margin declined from 2008 by about 80 basis points due to the peanut-related recalls and acquisitions.

In the quarter, we incurred approximately 5% cost inflation driven primarily by $77 million in additional commodity costs which we offset with pricing.

For 2009, we continue to anticipate gross margin to be approximately unchanged from 2008.

Now let's turn to slide 7 to discuss cost pressures.

2009 cost pressure is forecast at approximately 4% of cost of goods.

The increases are primarily driven by rice, packaging, and factory inflation skewed to Europe and Latin America.

For the year, we are about 80% hedged.

Let's turn to slide 8 to discuss operating profit growth.

First quarter internal operating profit rose 7% driven by solid internal sales growth and cost savings offset by cost pressures and the peanut-related recalls.

While the up front cost investments are roughly unchanged from last year, they're falling in different regions year-on-year which impacts their comparability.

North America operating profit rose by 2% versus last year's tough 10% comparable.

The results were adversely impacted by higher commodity costs and up front costs as well as the recalls.

European internal operating profit rose 9% due to lower up front costs and [media] savings partially offset by higher commodity costs.

In Latin America, internal operating profit rose by 28% versus 2008 driven by high-single-digit internal net sales growth and lower up front costs.

And in Asia-Pacific internal operating profit increased by 16% driven by double-digit internal net sales growth.

Below the operating profit line we benefited from fewer shares outstanding and our interest expense declined to $67 million offset by our tax rate of about 31% which is slightly higher than last year.

Let's turn to slide 9 to review our advertising investment.

Our commitment to investing in advertising will continue to be a key to our business model and essential to achieving our goals.

During the first quarter, internal advertising spending rose by about 3%, broadly in line with internal sales.

As you can see, our spending rose mid to high-single-digits around the world except in Europe where we experienced the positive impact of efficiencies and media deflation.

Despite a lower level of spend in Europe, we believe we are achieving a higher level of consumer impressions across the region.

As you can see, we continue to invest more in advertising in other markets around the world and we are achieving increased efficiency year-on-year.

As we discussed at CAGNY, we continue to drive efficiencies in our more than $1 billion of spending which will result in an increase in consumer impressions at a lower cost.

For the full year, we expect advertising spending to grow in line with sales.

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

First quarter cash flow was $172 million in line with last year.

We are very pleased with this performance which was negatively impacted by foreign exchange and the timing of a net $82 million interest payment in the quarter.

For the full year, we anticipate another strong year of cash flow.

Our forecast for cash flow is between $1.05 billion and $1.15 billion, which still includes the impact of about a $100 million foreign exchange headwind.

Let's turn to slide 11 to review some of the key areas affecting our outlook.

We have set an ambitious goal of $1 billion of annual cost savings by the end of 2011 ramping up over a three-year period.

As we discussed at CAGNY, we continue to focus on these cost savings initiatives to help drive sustainable and dependable growth.

As a result, we expect 2009 through 2011 productivity savings to be closer to 4% of cost of goods versus our historical 3% rate.

This gives us increased future earnings visibility.

In order to achieve these ambitious goals we now plan to increase our investment in up front costs from our original expectation of $0.14 to $0.22 per share during 2009 and a similar amount in 2010.

We expect to absorb the high level of up front costs and still deliver our guidance for 2009 of high-single-digit earnings per share on a currency neutral basis.

We are on track to deliver the first year of savings through the K-LEAN initiative into our procurement and overhead discipline.

We will keep you updated on the progress of these savings initiatives going forward.

Let's turn to slide 12 to discuss the foreign exchange impact on EPS.

Since we last updated you at year end, the U.S.

dollar has weakened slightly against some of our key currencies and strengthened against some others.

Slide 12 shows our key currencies with the 2008 actual rates and recent spot rates.

Assuming current exchange rates the full year impact on EPS from translational foreign exchange will be approximately 8%.

As we discussed last quarter, our 2009 guidance of high-single-digit EPS on a local currency basis excludes this foreign exchange impact.

We will continue to update you on the impact of FX on a quarterly basis.

Let's turn to slide 13 to review our outlook for the full year.

We will continue to stick to our business model and strategy.

For 2009, our full year outlook has not changed and we remain confident in our ability to deliver another year of sustainable and dependable performance.

We continue to forecast 3% to 4% internal sales growth which is ahead of our long-term target.

Gross profit margin is expected to remain unchanged as our cost savings initiatives and price realization offset cost pressures.

We plan to significantly increase our investment in up front cost savings initiatives from our earlier expectation of $0.14 per share to approximately $0.22 per share.

These investments give us the confidence that we will achieve our target $1 billion of annual cost savings by the end of 2011.

We continue to expect mid-single-digit operating profit growth in line with our long-term target despite higher up front cost investments and approximately 4% inflation.

Finally, we expect high-single-digit earnings per share growth on a currency neutral basis.

Below the operating profit line interest expense is now expected to be between $270 million to $275 million while the full year tax rate is forecast at between 30% and 31%.

Shares outstanding are expected to decline in the back half of the year.

In summary, despite the difficult economic environment and volatile markets, we will stick to our business model and strategy and continue to reinvest back into our business for future visibility.

Now I'd like to turn it back over to David on slide 14 for the business review.

Thanks, John.

Our first quarter North American internal sales growth was a solid 4% versus last year's 5% comparable.

If you turn to slide 15 we'll discuss each business unit in a bit more detail.

We continue to be very pleased with the Ready-to-Eat Cereal category which we estimate grew roughly 6% to 7% during the quarter.

Our North American Ready-to-Eat Cereal internal net sales growth was 6% during the first quarter, a strong performance against the fairly tough year ago comparable.

As mentioned at CAGNY, our first quarter IRI category share comparables will be the most difficult of the year and while our IRI share declined, strength in non-measured channels resulted in only a modest overall share decline year-on-year.

Sales growth was broad based with solid performance from our core nine brands as well as innovations like Jumbo Rice Krispies, Special K Blueberry and Frosted Mini-Wheats Little Bites.

As discussed before, we are also reviewing our power brands for efficiency opportunities.

Our Kashi business grew at a mid-single-digits during the quarter and we are pleased with the performance of BareNaked which delivered strong base sales growth.

Our Canadian business also grew internal net sales by mid-single-digits for the first quarter despite aggressive competitive pricing with a highly success resolution promotion which drove strong Special K and All Bran sales.

Our Kashi business, still in its early stages in Canada, continues to show strong momentum in both cereal and snacks.

Let's turn to slide 16 to discuss the North American Snacks performance.

North American Snacks internal net sales grew 2% on top of last year's 5% growth.

Sales were negatively impacted by about 4% due to the recalled product much of which is not solved through our DSD system.

We continue to be pleased with our DSD business which grew about 6% during the quarter.

If you turn to slide 17 we'll look at more detail about our Snacks business performance.

Our Pop-Tarts business posted a solid quarter with mid-single-digit internal sales growth.

We achieved solid performance across both measured and non-measured channels.

This quarter's cracker store-door sales grew double-digits and we gained IRI our category share.

We achieved solid performance from our new Special K Crackers which performed ahead of expectations.

In addition, we continued to drive double-digit Cheez-It growth.

Cookies store-door sales grew low-single-digits in a competitive category with solid performance from Sandies, Chips Deluxe and Rite Bites on-the-go packs.

Wholesome Snacks store-door sales achieved mid-single-digit growth and our IRI category share grew with strong performance from Kashi TLC bars and Rice Krispies Treats, and our new FiberPlus bars are off to a very good start.

If we turn to slide 18 to discuss our Frozen and Specialty channels performance.

Our Frozen and Specialty channels Q1 sales rose 6% versus last year's 10% comparable.

We continue to achieve strong performance from Eggo waffles and pancakes.

In addition, our premium priced Nutri-Grain and Special K waffles, as well as our bake shop innovations, continue to perform well.

Morningstar Farms veggie foods continue to perform well driven by solid base sales growth in meal solutions.

Kashi frozen meals continue to grow IRI share driven by increased distribution and strong base sales.

On slide 19, you see international internal mid sales grew 4% versus last year's strong 6% growth.

We achieved these results despite the headwinds of a weak global economy.

European internal sales grew 1% during the first quarter.

Sales were impacted by challenging negotiations with some retailers which, while have now been resolved, will also impact our Q2 results.

We achieved mid-single-digit sales growth in the UK driven by strong performance from Frosties, Crunchy Nut and Snacks.

This was partially offset by significantly lower sales in Ireland due to the downward price adjustments caused by exchange rate movements between the Euro and the British Pound.

As we discussed last quarter, we anticipate Europe's full year internal net sales growth at low-single-digits and we expect softer first half sales followed by a stronger second half.

In Latin America, internal sales rose a solid 8% during Q1 on top of last year's 7% growth.

We achieved high-single-digit Ready-to-Eat Cereal sales growth and mid-single-digit Snacks sales growth.

Core brands like Zucaritas, Corn Flakes, and Choco Krispies performed well in a difficult economic climate.

In Asia-Pacific, Q1 internal sales grew 11% driven by strong performance in Australia, South Korea, India and South Africa.

In Australia, we continued to grow ahead of a very strong cereal category and gain share.

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

And if you can turn to slide 20 for a summary.

We remain confident in our ability to deliver sustainable and dependable performance in 2009 and beyond.

The current economic environment, while challenging and difficult for our consumer base, gives us even greater incentive to focus on cost control and continuous improvement so we can strengthen our business while driving future visibility.

Our strong first quarter performance provides early momentum and gives us the ability to significantly increase this year's up front investments from $0.14 to $0.22 to drive our $1 billion cost savings initiatives.

These savings give us increased confidence in our ability to deliver future growth.

We will continue to focus on reinvesting in our brand through strong advertising.

We've identified efficiencies and areas for improved effectiveness and we will continue to invest in strong consumer engagement so our consumer impressions increase at a rate faster than sales.

In addition, as we discussed at CAGNY we are driving fewer, bigger and better innovations and renovations to meet consumers' needs in this environment and to further differentiate and enhance our portfolio.

In summary, our business model and strategy remain relevant and we are committed to our operating principles of manage for cash and sustainable growth.

We are making the right investments in our business to drive visibility and flexibility and are well positioned to continue delivering long-term, sustainable and dependable growth.

And now let's open it up for questions.

Thank you.

(Operator Instructions) Please hold while we poll for questions.

Thank you.

Our first question comes from Judy Hong of Goldman Sachs.

Please state your question.

Thanks.

Good morning, everyone.

Good morning, Judy.

David, looking at the cereal in North America, up 6% internal sales growth in the quarter looked pretty encouraging.

I was wondering if you can strip out how much pricing and mix added to that growth?

And as you think about your commitment to gain share again in the cereal category whether the pricing improvement in that part of the segment can be sustained over the period of time?

Yes.

I think when you look at our performance the great thing about -- in the U.S.

cereal category was the growth overall up 6% to 7%.

So very strong performance from the category and to be frank, we're seeing that from a lot of the larger cereal markets around the world.

Price mix, given we took some pricing early in the first quarter and we lapped an increase from 2008 where we are price protected was probably a little higher than we'd expect it to be for the balance of the year.

And our volume also grew 1%.

So we saw a good combination of volume growth, probably higher price mix in the first quarter than we would expect for the balance of the year.

So overall while we never like to lose share, if you look at the total market performance we did lose probably a few tenths of share.

Very strong performance from the category and a very solid performance from Kellogg in what is our toughest comparative for the year.

Okay.

And if I can follow up.

In terms of your guidance, you are now expecting $0.08 of higher up front costs, but you are basically sticking with the full year guidance so that implies that the underlying momentum is actually stronger.

Where do you think there's upside in terms of the underlying momentum that gives you comfort that you can offset the $0.08 increase?

I think the whole K-LEAN initiative and the billion dollar challenge that we laid out at CAGNY, we started that on 2008.

We've got great traction across the business, not only in North America, but in many markets around the world, and that's going extremely well for us.

We mentioned the indirect procurement work is going on.

That is playing out extremely well for us and the overall process we have looking to simplify and standardize all we do, I think, is going to give us great visibility and benefits as we go through the course of 2009.

So I think that probably is the primary reasons why we are seeing greater visibility and increased confidence in a very, very difficult market where consumers are clearly looking for value.

Okay.

Thank you.

Thanks.

Our next question comes from Chris Growe from Stifel Nicolaus.

Please state your question.

Hi, good morning.

Good morning, Chris.

Hi.

I wanted to ask you first on the increase in the up front costs that you had initially talked about this K-LEAN initiative and how you can absorb that within the $0.14.

I am trying to get a feel for, are the expenses to achieve the billion dollars in cost savings greater than you thought or is it just a matter of kind of pulling those forward?

I think as we've got into all of the aspects of the billion-dollar challenge and started to quantify some of the costs, we have seen that to actually achieve that we will have some expense in 2009 and certainly through 2010.

We are fortunate to be able to absorb that and stay with our guidance for this year, and we think that is the right thing for the business for the long term, particularly in these tough economic times where, I think, most shareholders will appreciate the fact that we are going to drive future visibility and the ability to have the confidence to sustain dependable performance over the medium term.

Okay, that's great.

The last question I had for you.

The Kellogg model has been heavily reliant on mix and I'm just curious in this kind of environment you talked about bringing more of a value message to the consumer.

Does that complicate that strategy in terms of achieving mix improvements in the business?

You obviously have good pricing coming through and we should see better volumes throughout the year.

I'm just curious on the mix side, any change in your thoughts there?

I think certainly mix is still important to us.

Our expectation would be at that there would be a little bit of mix, probably more predominantly price, of the price mix in the first quarter, but as we mentioned that will abate a little bit as we go through the year given we are lapping price protected first quarter increase from last year.

So we won't see that at high level.

So I'd expect to see some mix, a little more price, not as much as Q1, and volume to be solid in this environment.

Okay.

Thank you.

Thanks.

Our next question comes from Bryan Spillane of Banc of America-Merrill Lynch.

Please state your question.

Good morning.

Just a question on gross margins.

It looks like you got a little bit better price realization in the first quarter.

It looks like your outlook for the year, your expectation on cost inflation is a little bit, or at least a low end of that range.

So curious as to why the gross margin expectation for the full year won't be better than expected?

Is it because some of the up front costs are running through there?

Or is there something else I'm missing?

It's a great question Bryan and certainly you are right.

We have lowered some of our inflation expectation.

At CAGNY, we said 4% to 5%.

We are now around 4% cost pressures for the year, and as you've seen the first quarter, we are seeing good performance from price and mix.

We are saying flat for the year on gross margin.

The higher up front costs for the year, some of that will flow through cost of goods and as we said at CAGNY our guidance will be flat.

We certainly have the opportunity to potentially do a little bit better than that.

Okay.

Great.

I want a clarification on Chris Growe's question.

Is K-LEAN or the up front costs more, higher because it's just more expensive or is it because you are pulling costs forward?

I guess I was a little unclear on the answer to that.

When we laid out the billion-dollar challenge at CAGNY we didn't have complete visibility on how we are going to do that.

Over the last couple of months, we've actually driven substantially higher visibility on how we are actually go get that billion dollars.

These are additional new projects as opposed to increase in spend on prior projects.

Got it.

Thank you.

Our next question comes from David Palmer of UBS.

Please state your question.

Thanks.

Hi, guys.

Question on, just looking at some of the scanner data, maybe you can give some color behind, maybe the market dynamics behind two categories.

Cereal, to what you attribute, aside from the simple comparisons and maybe it's just that simple, with regard to cereal your last three months share trends have certainly improved versus the category, and are you at all alarmed that the category, at least in the measured channels, is not doing better up until lately or do you just see that as channel migration?

And then separately on cookies it does look like that category while it's not been one of your best categories in recent years, it seems to be getting to fairly alarming trends.

Is that just the peanut butter issue or do you think there's something else competitively?

Thanks.

David, firstly, on cereal the category IRI for the first quarter shot up 3.5% and typically we'd add anywhere between 2.5% to 3.5% to get a true picture of what is going on in the market.

That's why our view is the total category all segments grew 6% to 7%.

So a very strong performance.

And I think if you look at that 3.5% even on IRI year ago in the same quarter it was up 1.5%.

So a significant acceleration even on IRI data in the category.

So I think that is a great performance.

We saw that, the category start to accelerate in the back half of the last year and I think this is really related to the fact that cereal remains a great value.

It's versatile, convenient, nutritious.

So the category is growing strongly.

Hard to know whether that will grow for the balance of the year but we would certainly expect it to grow well.

On cookies, when you look at, again, all channel performance, we did grow.

I think the category is still growing, low-single-digits, and would expect it to continue to probably grow low-single-digits for the balance of the year.

So we are not seeing anything that you must be seeing to draw another conclusion to that belief.

And within cereal is it just simply comparisons because it doesn't seem like there's any sort of mega introduction behind the Special K trademark or whatever to be helping your case so to speak.

Is there any sort of shining star within the cereal business that is helping your trend lately?

The Kellogg in particular?

Yes.

When you look at the core eight to nine brands that we are focusing on, we grew share in those even on an IRI basis.

Our base was up strongly.

So I think that really is the key for us as we continue to focus on driving the category.

The performance was very good, and while we did lose a few tenths of share, even taking all channels into account, David, I think it was our toughest comparison for the year.

So we feel pretty good about the rest of the year.

I'd also say outside of the U.S.

that the cereal category globally in most of the major markets has shown a similar resilience in growth, both through Mexico, Australia, Canada the UK and the U.S.

we are seeing anywhere from 5% to 8% growth.

So I think this is a great category to be in and one that in tough economic times consumers are figuring out who represents great value.

Thanks, David.

Thanks.

Our next question comes from Eric Katzman of Deutsche Bank.

Please state your question.

Hi.

Good morning, everybody.

I guess my first, let's say, more detailed question has to do with the increase in the up front charges and kind of where you see those hitting.

Is that mostly going to be North America for K-LEAN?

The up front cost charges, Eric, are going to probably fall across North America and international.

So we are not in a position to give guidance as to exactly how they are going to fall by geography or even by line between cost of goods and overhead.

What I will say is the $0.22, we saw about $0.03 in the first quarter.

We expect a similar amount in the fourth quarter.

So most of these up front costs will come through in Q2 and Q3, but until we disclose publicly what the projects are I'm not in the position to tell you which geographies.

Okay.

And then just to clarify, David, did you mention BareNaked in terms of the internal sales growth in North American cereal?

And was that even material to the growth?

Because I guess I kind of viewed that as more of a snack business than a cereal business.

Well, it's primarily cereal, and what I mentioned in the prepared remarks was that the base sales were up strongly and we're very pleased with it.

Okay.

And last thing.

I guess I'm just a little bit surprised that your view of global cereal is so positive, whereas Cereal Partners Worldwide, their public comments have been that the category is slowing.

And you can talk, obviously, individually about performance and market share, but I'm just surprised the two biggest players in global cereal are viewing the market differently?

I think, Eric, you've really got to look at where they skew versus us.

We skew very much to the mature Anglo markets making up over 70% of our global cereal performance.

They are very strong in Central and Eastern Europe and have some pockets of strength in other parts of the world where we are not.

Those areas are typically slowing from the fast rates that we are seeing.

Whereas we are seeing somewhat the inverse in the more mature markets where the categories are actually picking up a little bit.

So that might explain the difference.

Okay.

I'll pass it on.

Thank you.

Thanks.

Our next question comes from Eric Serotta of Consumer Edge Research.

Please state your question.

Thanks.

It's Consumer Edge Research.

Good morning.

Last year you guys were pretty vocal about the competitive dynamic going on in the cereal category with your largest competitor having a higher percentage of their growth coming from incrementals, in your view at least.

It looked like according to the Nielsen data for the latest quarter and the latest four weeks a significant portion of your growth came from incrementals.

I guess Nielsen shows that your baseline sales dollars for the quarter and latest four weeks were down.

I'm just wondering whether you could provide some color as far all outlets, how your baseline versus incrementals in U.S.

cereal did and whether it's fair to read into your results that promotional activity increased at least on a sequential basis?

If you look at the first quarter, the total categories I mentioned, our estimate is it grew 6% to 7%.

We are up to about 6%.

If you look at our top eight or nine brands we grew share.

Their base was up with or above the category.

That's over 80% of our business.

We do have two issues if you are looking at base, some [field] innovation, straws being one of those, and brands that either aren't working or that we've deemphasized year-on-year, brands like All-Bran and Smart Start are still strong parts of our portfolio, but a heavy investment in the first half of last year, not as much investment this year.

So I think overall a strong business.

Nothing unusual.

So that would be my conclusion on our first quarter.

The IRI incremental, the category grew about 80-ish%.

I think we were up 10%.

So we were slightly above the category.

The most market increase in incremental has been in private label where, I think, retailers are clearly jumping on the current economic conditions and pushing it very, very hard.

Okay.

And then to circle back on some of the, I guess, non-core brands and your strategy there, can you talk a little bit about sort of the strategy to either, is the strategy there to fix them and to increase investment over the next couple of quarters, behind them, or is it to just continue to gradually deemphasize things like Smart Start and, I forgot the other one that you just mentioned, All-Bran, I believe.

I realize cereal straws, innovation is hit or miss, but for some of those other brands that had been some strong contributors in the past, can you talk a little bit about the strategy going forward and what should we expect to see in the baseline data as you start to cycle these comparisons?

This is a natural thing for all players in the category with innovation sometimes not working.

It's not big in the scheme of things with the top eight, nine brands making up in excess of 80% of our portfolio.

You are going to see some natural gravitation there.

I don't think it will be dramatic if you take a brand like All-Bran.

It's been around since 1916, it's going to be around a long, long time.

It may come down from a 1 share to a 0.8, but long term I think it will be a very vital brand.

So nothing major, but we did believe in our own reviews, Eric, that some of our innovation needed to be cleaned up and we are doing that proactively and we'll probably lap the bulk of that, anything over and above what would be typical or normal through the first half.

Great.

Thanks a lot.

I'll pass it on.

Thanks.

Our next question comes from Ed Roesch from Soleil Securities.

Please state your question.

Good morning.

I just want to check in on retail inventory levels.

Was there any impact in the quarter?

In the U.S., nothing noticeable.

A couple of international markets we did see a little bit of reduction in Mexico being one.

But nothing dramatic.

Okay.

And then thanks for the color on the European business.

I wanted to get a little bit more, if you could, on Latin America.

I know the up front costs were down.

But margins there were particularly strong.

Was there anything that surprised you there?

No.

It was actually a little bit above our expectations, 8%, we had said mid-single-digits for the year.

I think there's a lot of concern that as the U.S.

economy has slowed, the impact on Mexico could be dramatic.

We didn't see that to the extent that we had expected in the first quarter.

Latin America actually grew pretty strongly.

We are watching it.

I think there's a general sense that there could be a degree of volatility in Latin America through the course of the year.

I think also Latin America had the benefit of lapping some up front costs from last year.

That was a good portion of the year-on-year growth.

Great.

Thank you.

Our next question comes from Alexia Howard of Sanford C.

Bernstein.

Please state your question.

Good morning.

Good morning.

I wanted to follow up on the other questions on productivity improvements.

By my calculations I guess 4% of COGS this year translates into about $300 million of savings or about a little bit over $0.50 a share.

Can you talk about how that is likely to phase in through the course of the year?

Have we already hit the run rate and it will come in fairly evenly through the quarters, or is it something that will ramp-up during the course of the year as the increase in up front investments phases in Q2 and Q3?

Alexia, the productivity is relatively smooth.

It might increase a little bit towards the back part of the year, but it's not a step change, it's more of a -- reasonably smooth allocation throughout the year.

Okay.

Great.

Thank you very much.

I'll pass it on.

Thank you.

Our next question comes from Jonathan Feeney from Janney Montgomery Scott.

Please state your question.

Good morning.

Thank you.

I wanted to dig in a little bit on Europe.

Your performance and outlook has been a little bit more bullish than some others doing business in Europe yet there still is that difference there.

Maybe just a big picture question.

What is it -- David, you mentioned in your prepared remarks a difficult negotiation you had with a couple of retailers there.

What fundamentally is different about the value chain that is driving what seems to be pretty dramatic private label share growth and dramatically more value seeking among customers and more hostile relationship with retailers than you are seeing in the U.S.

or in fact other markets globally?

Any insight you can provide there on a big picture basis would be appreciated.

I think there's probably two things, Jonathan.

One is some of the more traditional larger retailers are concerned with what is happening with the hard discounters and the growth of hard discounters and the reaction to that.

We saw that with Tesco in the UK bringing in a new range of product label.

So I think that is playing out, not only in Europe but right across our entire business.

I think all of our retail partners have a heightened sensitivity to the economic conditions and the stress they are placing on consumers and we are trying to work closely with them globally to ensure that we are delivering value to consumers in a way that works for both of us.

You have some markets in Europe like Spain where unemployment is 18%.

So that is a particularly difficult economic environment and you are seeing private label there as you would expect people forced at a greater extent to trade down.

So it's a bit of a mixed bag, but as I mentioned in the prepared remarks we worked our way through those.

There were a number of them and as we actually start to reinvigorate our trade promotions we'll see the positives of that in the second half.

So I don't think there's any dramatic difference apart from the economy.

In pockets, there's probably a little worse than we are seeing across North America and some concern by traditional retailers about hard discounted growth.

Great.

Thank you very much.

Thanks.

Our next question comes from Rob Moskow of Credit Suisse.

Please state your question.

Hi, thank you.

I have a two-part question.

The Nielsen data today shows that your percent of sales sold on promotion is around 53%, it's the highest it's been in the last 15 months.

But General Mills is down sequentially quite a bit from like 45% right around CAGNY to around 34% today.

My question is at CAGNY you had a pretty negative tone and you were expressing a lot of caution.

Has anything changed, what changed since then?

Did you promote more aggressively?

Did you have more merchandising out than you had earlier in the quarter?

And then, secondly, maybe you can also wrap that in with your comment that pricing will be weaker sequentially and this is as high as it gets in the first quarter.

How should we read, why should pricing be weaker sequentially for the year?

Let me start with the last one and work backwards.

If you look at our price mix in the first quarter, up 5.8%, we don't expect that level going forward.

As I mentioned, we're lapping last year's price increase which was price protected.

Once we roll through that that will bring it down.

Also in the first quarter the recall impacted the business on mix because there was a lower margin, products coming out.

So it tended to exaggerate it somewhat, and we are seeing very high inflation in international, so more pricing there and, again, once some of that rolls over, we'll see it abate.

As far as Kellogg and the promotional environment goes, what we mentioned was that General Mills would lap a very strong increase in incremental at the end of the first quarter.

So we are probably going to see that as we go through April and on.

Kellogg is very focused on driving a strong value message to consumers in this environment, as I think are most companies.

We are working through our retail partners and through our marketing groups to stress value and quality of our brands and we think that is a focus and an orientation that is absolutely appropriate for the current global environment.

Okay.

David, to what extent is the declining sequential price mix that you are talking about?

To what extent will that be driven by this peanut butter issue?

Is that like 100 bps?

We --have we calculated that?

I know it's an impact, but I don't think we've actually calculated how much it is, Rob.

Okay.

I'll follow up later.

Thank you.

Right, thanks.

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

Please state your question.

Good morning, everyone.

Good morning, Ken.

At some point the up front costs should be somewhat self-funding.

Is that a thought that you have that it should be going forward?

Is there a point in time that you think that will happen, or is it just always that you are going, I wouldn't say manage to the mid-single-digit, high-single-digit operating profit, but how does that work through?

Ken, I guess one of our issues is we've been executing up front cost projects for several years now and the savings from those projects are coming through our P&L ever year.

So if you were to go back over the last five or six years and add up all the savings from the up front costs it probably is in excess of our normal $0.14 of up front costs in 2009.

But because those savings have been coming through each year, we've been using to offset inflation, to offset other things in the business.

It's not a case of us having an accumulated savings number that now we can somehow offset against the up front costs.

Okay.

Would you have increased the up front costs if you didn't have such strong earnings in this quarter?

I think we would have in terms of going after the billion-dollar challenge, these are up fronts that we need to execute to get to that billion-dollar challenge.

It's the right thing to do for the business.

We are fortunate to be in a position to be able to afford that and still be able to hit our prior EPS guidance.

My last question and, have you seen any anecdotal evidence that there has been a change in demand in Mexico for any of your products?

Can you just give a little color on that?

Not for the first quarter, but --

Recently.

I mean, obviously, the last couple of weeks, a week or so and, obviously, because of swine --

Yes, the last couple of days because of the, as I think it's called, the H1N1 virus now, there's been a couple of large orders come in in the last couple of days.

So that will probably play through in the second quarter.

So we are not expecting that it will have a material effect.

Great.

I appreciate it.

Thanks.

Our next question comes from Terry Bivens of JPMorgan.

Please state your question.

Hi.

Good morning, everyone.

Hi, Terry.

David, as you look towards private label, we were looking at the Nielsen numbers, I guess, for the last month, March 11, and then transitioning to the ones that came out today.

Originally it looked like you may have gotten hurt in some of the brands that one would think would be pretty competitive with private label corn flakes, for example.

But it seems, it's down, but down a little bit less than some of the other brands, perhaps All-Bran.

Have you recently made a stronger push against private label?

And if you can kind of just address the trends there that seems to be a big concern with a lot of people.

The concern is Terry?

Private label.

The growth of private label?

Yes, which brands might be more vulnerable is what I'm trying to get at and what you may be doing there?

We are looking at it more generally and private label has grown strongly, but I think the key point from our perspective is the category is doing incredibly well.

If you look at the category it's up very strongly.

Private label is growing ahead of the category and I think that is clearly because consumers are under pressure and trading down.

It's also a reality that retailers are seeing that as an opportunity to push private label.

Their incrementals are up as high as I can remember it and that's why, I think, our focus is on driving a strong value message to consumers.

As far as differentiation between parts of our portfolio, there may be areas where you have stronger match-ups and that could be an area where we could see a little bit more impact.

But I think nothing too dramatic at this point, Terry, and we may see it, but in an overall sense, if we can draw any positive because private label will be an issue for all of us as we manage through the year.

If you look at their share in the U.S.

in the first quarter of this year at 10.3% and you look at their share in the fourth quarter of last year at 10.8%, it was the first time that sequential share had actually come down.

While they are growing strongly, we'll watch it carefully.

But we think we can continue to do well in this environment by driving strong branded messages and a value orientation.

Okay.

Great.

Thanks very much.

Our next question comes from Tim Ramey of D.A.

Davidson.

Please state your question.

Good morning.

You were on the topic of managing down ad spending through efficiencies last fall and Proctor was talking this morning about rates being significantly lower.

Might there be a much bigger opportunity in delivering the same or greater messaging, but at significantly lower cost this year?

Should we be thinking that way?

Certainly, there's a potential opportunity as we go through the year.

As we are seeing more mini-deflation in Europe than we have thus far in the U.S., although we will probably see some.

And some of the other efficiency measures we have taken, consolidated media buying and how we manage our commercial production, et cetera, applying through across the business.

Our intent, as we said in the prepared remarks, this is a great opportunity for us.

If you go back to the founder, W.K.

Kellogg, back in 1929, he said in a recession was a great time to increase your advertising.

We have that type of orientation, Tim.

If we get significantly more savings, our intent at this point would be to increase our impressions, to make sure that the message is getting through to consumers about value, about our brands and about our qualities are very strong and even more stronger enforced.

One area that we are seeing play through is consumer promotions where we have challenged the cost benefit of some of those, and we are seeing that benefit actually flow through.

But less so in advertising because our current orientation would be to invest back.

Just a quick one for John.

The peanut recall, if you had to split it between cost of goods and SG&A, about what percent would be?

In the first quarter, about $23 million was cost of goods and about $4 million was SG&A.

Thank you.

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

Thank you.

Our last question comes from Andrew Lazar of Barclays Capital.

Please state your question.

Good morning, everyone.

Good morning, Andrew.

I know when you started the up front cost spending projects, whatever it was, five or six years ago, I know some of the early projects had some very attractive payback periods, if I'm not mistaken.

Sort of two, three-year kind of paybacks.

Given that you've been at this a while, and even though you've identified a lot more opportunity, are the sort of projects you are looking at now sort of still that attractive from a payback period standpoint or are we pushing it out a little bit at this stage?

No, I think, Andrew, we've actually upped our focus on this area and I think almost all of the projects that we'll undertake will have, in the worst case, a four, five-year payback.

Some of them may be significantly better.

I know there's always been a belief that you eventually run out, but I think we continue to find the great projects that can really give us very good paybacks.

Great.

And then just the last thing, I'm a little surprised that the phasing of the cost inflation for the year was up 5% in the quarter and it will be up 4% for the year.

For whatever reason, I thought it would be more lopsided, meaning a lot higher earlier in the year and potentially a lot lower in the back half.

Perhaps just a little more color on that to give me a sense of why that is?

You know, I think we'd expect the first half to be a little bit worse than the second, but as we look at it, it's not going to be dramatic as you would expect, but a little bit as you are indicating.

John, anything?

There's a couple of things in there.

One is just how hedges roll on and off year-on-year.

And the second is you remember that our inflation is not just commodities, but also it's general factory inflation as well.

Some of those are much more smoothly allocated across the year.

Thanks very much.

Great.

Thank you, everybody, for joining in today.

We'll be here if you have any questions.

Thanks, again.

Bye.

Thank you.

This does conclude today's teleconference.

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