家樂氏 (K) 2009 Q2 法說會逐字稿

Good morning.

Welcome to the Kellogg Company 2009 second quarter earnings call.

All lines are placed on mute to prevent background noise.

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

(Operator Instructions).

Thank you.

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

Mr.

Wittenberg, you may begin your conference.

Thanks, Doug and good morning, everyone.

Thank you for joining us for a review of our second quarter results.

With me here in Battle Creek are David MacKay, President and CEO, John Bryant, CFO and Gary Pilnick, General Counsel.

We must point out that certain statements made today such as projections for Kellogg Company's future performance including earning per share, net sales, margin, operating profit, interest expense, tax rate, cash flow, cost savings, brand building, upfront costs, impact of 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 this presentation as well as our public SEC filings.

A replay of today's conference call will be available by phone through Monday evening by dialing 888-632-8973.

The pass code is pound-208-08846.

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

Now let me turn it over to David.

Thank you, Joel.

Good morning, everyone.

The second quarter was strong one for Kellogg Company.

A double digit EPS growth was higher than expected driven by strong operating profit delivery, favorability below the line and offset by higher upfront costs.

And for the second half of the year, we are increasing our investment back into the business through higher upfront costs and expected double digit increase second half internal advertising spending.

Furthermore, we enter the second half with even better visibility into the year and even stronger confidence that we will deliver another year of sustainable and dependable growth.

There is no doubt the current economic environment is difficult.

However, our business approach is designed it achieve positive results even during challenging economic conditions.

The second quarter results illustrated continued resilience and relevance of the focused strategy and business model.

Internal net sales, which excludes impact of foreign exchange, acquisitions and shipping days, grew 3% during the quarter, consistent with our expectation of 3% to 4% sales growth for the full year.

Our categories are performing well during the recession and cereal is an especially strong category to be right now as consumers seek to maximize the value received from every third dollar spent.

Gross margin exceeded our expectations and we saw solid margin expansion in the quarter.

Excellent delivery from our billion dollar challenge enabled us to deliver gross margin expansion.

And while commodity costs have fallen as we expected, we are still seeing overall cost of goods inflation versus last year.

The double digit internal operating profit growth we posted exceeded our long term annual target of mid-single digit growth as momentum continues behind productivity and cost saving initiatives.

We also benefited in Q2 from the timing of advertising spend, which will be reinvested in the second half.

And we've executed well across categories and regions gaining share in most of the major markets.

We are on track to achieve our goal of delivering $1 billion in annual savings by year end 2011.

And importantly despite increasing our investments in the second half, we are also raising a currency neutral earning per share guidance to a range of 8% to 10% growth for full year 2009, from our original guidance of high single digit growth.

As you can see, we remain committed to continue to deliver sustainable and dependable growth for our share owners in 2009 and going forward.

And now I would like to turn it over to John to walk you through the financials.

Thanks, David and good morning, everyone.

The head winds we discussed during our first quarter call have continued.

Despite the challenges of a tough competitive landscape, a weak economy and tough comps., we met or exceeded our long term annual targets of low single digit internal sales net growth, mid-single digit internal operating growth and high single digit currency neutral EPS growth.

Reported net sales declined 3% for the quarter including a negative foreign exchange impact.

Internal net sales growth, which excludes the effect of foreign exchange, acquisitions and shipping days, was 3%, building on last year's strong 6% internal sales growth.

We continue to project 3% to 4% internal net sales growth for the full year 2009.

Reported operating profit increased by 4% despite year on year inflation for the quarter of 4%.

Internal operating profit grew by strong 14%.

This result was driven by excellent delivery from our billion dollar challenge and lower advertising expenditures due to timing.

We invested approximately $0.07 of EPS into upfront costs this quarter ahead of last year's $0.04 per share.

Reported earnings per share rose ahead of expectations to $0.92, a 12% increase on a reported basis and a 23% increase on a currency neutral basis.

This result was driven by strong operating profit growth and favorability from below the line items such as lower interest expense, lower tax and timing on other income expense.

Second quarter reported sales declined 3.4% driven by 6.4% impact from currency.

Internal net sales in the second quarter rose 2.6% as our pricing initiatives continue to flow through.

While tonnage was down 0.5% in the quarter, our global cereal volume was up approximately 2% in the quarter.

The overall volume decline was driven by snacks impacted by two items; the expected shift from lower margin bulk products to higher value added products in Russia where volume declined significantly but net sales grew by high single digits, as well as by the peanut related recalls in North America.

In addition, our recent acquisitions added 40 basis points to sales growth in the second quarter.

On a year-to-date basis, internal net growth was solid 3% and was delivered by North America contributing 4% growth, Latin America 8%, Asian Pacific 7% and Europe was flat.

Gross margin for the quarter was up 30 basis points over last year's second quarter.

Internal gross margin dollars grew a solid 4% for the quarter ahead of internal expectations.

The margin expansion was driven by pricing and delivery of our cost savings programs despite continued inflation year on year and higher upfront costs.

Year to date gross margin of 42.3% reflects a slight decline year on year.

However, we now expect gross margin for full year 2009 to be up approximately 50 basis points versus our prior estimate of flat gross margin for the year.

As we expected, commodity prices have continued to decline and our full year outlook for cost ratios remains approximately 4% of cost of goods.

We are now approximately 90% hedged on commodities for 2009 on a global basis.

Second quarter internal operating profit rose 14% driven by solid internal sales growth, cost savings initiatives and timing of advertising spending, offset by cost pressures and higher upfront costs.

North America internal operating profit rose a strong 14% versus last year's 5% comparable, driven by top line growth, timing of advertising spending and cost savings.

In addition, increased upfront costs reduced internal operating profit by more than 7%.

European internal operating profit grew approximately 4%.

Lowest sales growth and a difficult environment were offset by media deflation and productivity savings.

Higher up front costs and investments reduced internal operating profit by approximately 6% in the quarter.

Latin America continues to deliver solid internal operating profit growth.

Second quarter internal operating profit rose by 12% over the second quarter of 2008, driven by high single digit internal net sales growth and cost savings.

And in Asia/Pacific, internal operating profit increased by a strong 36%, driven by effective cost discipline and timing of advertising spend.

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

During the second quarter, internal advertising spending declined versus last year's strong 10% comp.

and due to the timing of various advertising programs, media deflation and production efficiencies.

However, we achieved a significant increase in impressions as we continue to strongly invest in our brands by reinvesting the savings back into advertising.

For the second half of the year, we expect a double digit increase in internal advertising expense.

We will also continue to drive efficiencies in our more than $1 billion of annual advertising spend.

The combination of efficiencies, deflation and higher spending will result in a significant increase in consumer impressions in the back half.

Our reliable cash flow delivery continues in the second quarter.

Cash flow for the quarter of $363 million outpaces last year's strong delivery for this period.

We are very pleased with this performance, which was negatively impacted by foreign exchange.

Cash flow remains solid on a year to year-to-year basis as well.

The $535 million of cash flow generated in the first half is again ahead of last year's strong performance.

We are very focused on this important metric and continue to have confidence that will deliver cash flow for the full year of 2009 up to $1.050 billion and $1.150 billion, which includes the impact of foreign exchange headwinds.

Now let's turn to our full year guidance on the next slide.

We have good momentum entering the second half of the year, which gives us even greater visibility and confidence in achieving our full year goals.

We continue to anticipate 3% to 4% internal net sales growth.

We now expect gross profit margin to rise approximately 50 basis points for the full year.

We are also raising our full year 2009 guidance for internal operating profit growth to the high end of our previously guided mid-single digit range.

Despite significantly increasing upfront costs investments from our initial estimate of $0.14 per share to approximately $0.26 per share, we are raising our full year earnings per share guidance to a range of 8% to 10% growth on a currency neutral basis, from my original guidance of high single digit growth.

Below the operating profit line, interest expense is expected to be approximately $270 million and full year tax rate is forecast at approximately 30%.

We expect average shares outstanding to be relatively flat year on year.

We now have even greater visibility into the year and even more confident in our ability to achieve our short term and long term goals.

And finally looking at the impact of foreign exchange on the P&L, the US dollar has weakened since our first quarter earnings call.

Assuming current exchange rates, the full year impact on EPS from translational foreign exchange will be approximately 6% instead of the previously forecast 9% impact.

I will turn it back over to David for business review.

Thanks.

In the second quarter, North America produced 3% internal sales growth on top of last year's strong 6% growth.

As you can see, we posted growth in each of the North American businesses in the quarter.

In the second quarter of North American cereal business delivered a strong 4% internal net sales growth on top of last year's 5% growth.

The cereal category is robust, and by our estimate, grew about 4% during the quarter and our consumption for Q2 across all channels was up between 6% to 7%.

We saw inventories drop versus last year so shipments were up 4%.

We increased our US ready to eat cereal category share more than one point during the second quarter.

The cereal category remains a great category to be in.

Our focus strategy of investing behind our top aid brands plus Kashi is a key contributor to this success.

Our spring Special K challenge promotion was our strongest yet.

Kashi continued to deliver positive results in sales growth in the quarter by outpacing the natural and organic cereal segment.

Kellogg Canada recorded another solid quarter of mid-single digit net sales growth and category share gains.

Ready to eat cereal drove the growth posting another share gain on the strength of innovations like Special K Five Grains, continued momentum in Kashi, equity advertising behind Mini Wheats and strong in-store activity.

I would like to highlight another exciting new development for our ready to eat cereal business in regard to strengthening the nutritional credentials of our cereal portfolio.

Recognizing that fiber is an important nutrient that fewer than one in ten children and adults get enough of, we recently announced we will add fiber to many of our ready to eat cereals in the US and Canada.

For the second half, we will introduce renovations of Fruit Loops and Apple Jack cereals that provide three grams of fiber with the same great taste.

These introductions are another step in our renovation initiatives to continually improve the nutrition profile of our products, without compromising taste or quality.

As it builds in the Company's 100 plus year committment to meeting consumer health and nutrition needs, we expect this initiative to contribute to the long-term health of the ready to eat cereal business.

In the second quarter and North American snacks business posted 3% internal net sales growth over the last year's solid 6% growth.

There was a challenging quarter as warehouse sales from negatively impacted by the peanut related recall.

However, our direct store delivery business continued to perform well, growing internal net sales was solid 4% of last year's difficult comparable of 10% growth.

We are committed to expanding our snacks business and pulled all labor that is available in this very competitive environment.

During the second quarter, we invested heavily in brand building within our snacks business.

We are strong campaigns behind snacks innovations such as Fiber Plus bars and Special K crackers, as well as behind our core cracker brand Cheese It and our 100-calorie Right Bites.

Our Pop Tarts brand delivered low single digit internal net sales growth in Q2 and underlying blue box business is performing extremely well.

Store door cracker sales rose low single digits versus last year's strong growth driven by solid performance from Cheese It, Townhouse and Club.

In addition, our new Special K crackers performed ahead of expectations.

If we adjust it for the peanut related recalls, our cracker share would have been essentially flat.

For to the second half we are some exciting innovations including Cheese It Wholegrain, Kashi Heart to Heart and Flip Side Garlic crackers.

Store door cookie sales grew solid mid-single digits in Q2, with strong performance from Sandies and Murray cookies.

In addition, our reintroduction of 13 Mothers Brand cookies into the market during the quarter is off to a strong start.

Including Mothers as a new business for us, we grew our store door cookie category share during the quarter.

Store door sales of wholesome snacks were solid and grew more than a point of category share during the quarter.

A new Fiber Plus bars continue to perform ahead of expectations and we also saw solid performance from Kashi GOLEAN bars and Nutrigrain bars.

Our frozen and specialty channels businesses continue to drive excellent results through a combination of effective of innovation and great execution in the second quarter, delivering 5% internal net sales growth on top of last year's difficult comparable of 10% growth.

This performance is especially strong given the extremely difficult operating environment that the food away from home channel is currently operating in across the U.S.

Food away from home business declined in Q2 but still continues to perform above general channel trends.

Frozen business, which operates in strong categories, delivered double digit internal net sales growth during the quarter.

Big O continues to perform well and gain share in Q2.

Veggie food business delivered almost two points of share growth this year driven by continued solid base sales growth in meal solutions.

Gardenburger is doing well and Kashi Frozen meals saw a strong top line growth during the quarter.

Internal net sales for our international business grew 2% on top of last year's strong 6% growth.

Europe continues to present a very tough operating environment with a high level of competitive activity.

Internal net sales for Europe declined 1% for the quarter versus last year's top 5% comparable.

we discussed during Q1 earnings call, challenging negotiations with some retailers will now result negatively impacted sales for the second quarter.

We continue to expect a European business to deliver second half internal net sales growth of low single digits.

Volume in the region declined mid-single digits with approximately half of the decline driven by Russia as we move from a bulk snacks business to a branded business.

In the UK we achieved, 4% internal net sales growth as well as category share growth for the quarter driven by solid mid-single digit growth in base sales.

Our Crunchy Nut, Rice Crispies and Frosty cereal brands all performed well in the quarter.

And growth in the UK was offset by weakness in the continent.

In Latin America, we delivered 8% internal sales growth.

In Mexico, we gained category share in the quarter and delivered mid-single digit growth as core brands such as [inaudible], Corn Flakes and Choco Crispies continue to perform above our expectations.

We plan strong support behind our new All Bran cereal introduction that adds yogurt and fiber, which we will launch in Mexico during Q2 and then in Venezuela, Colombia, Central America and Brazil we posted good internal sales growth in the quarter.

Our Asia/Pacific business delivered 3% internal net sales growth buildings upon last year's strong 9% growth.

Oru businesses in South Africa, South Korea and India delivered strong internal net sales growth.

In Australia, we were negatively impacted by challenging negotiation with a retail partner.

However, the rest of the trade is supporting Kellogg and was successfully holding our position in the Australian market.

So in summary, we are pleased with the results we posted in the second quarter and the first half of 2009.

We are seeing even better momentum this year than we anticipated.

Strong brand building programs and cost saving initiatives continue to drive these results and we've continued to execute well around the world.

We are off to a great start with our billion dollar challenge and we have confidence we will achieve our goal.

We have significantly increased our investment in upfront costs, which will help drive efficiency gains and help offset commodity and energy inflation in future periods and provide the fuel to sustain our momentum.

We also plan to increase our investment in advertising at a double digit rate in the balance of the year.

All of these elements support our increased confidence we can deliver our target rates of growth again in 2009 and demonstrate our commitment to manage the business for long term sustainable, dependable performance.

And increased EPS guidance for 2009 shows how resilient our business remains in these tough times.

Finally, I'd like to thank Kellogg employees around the world for their continuing committment to excellence and dedicated work.

And now, I'd like to open it up for questions.

(Operator Instructions).

And we have our first question coming in from Robert Moskow from Credit Suisse.

Please go ahead.

I had a question about the sales growth.

It came in a little lighter than with a we had hoped.

The Nielson data for the US showed that you had pretty strong retail consumption.

But you mentioned inventory reductions.

Can you give us more color on those inventory reductions?

Is it just a Kellogg specific situation?

Or is it a category situation?

I think it's more specific to Kellogg as we look at it.

We are always very pleased with inventories drop and they did drop in Q2 for us in the cereal category.

As we look at our growth it was very strong.

Consumption was up 6% to 7%.

Shipments up 4%.

The biggest differential between the two was inventories coming down in Q2.

So they are at a lower level than we saw them Q2 last year.

So we are very pleased with that.

And really if you look around the world, we feel good about Q2 and the year to date growth.

It's in line with our target.

The few factors that impacted it are what we mentioned on the difference in consumption versus shipments in Q2 cereal, we mentioned some customers in Europe and one in Australia.

Small impact from the snacks recall.

We did see a couple of inventory reductions in Q2.

In Italy and the UK, nothing significant.

Meaningful for those two markets.

In general terms we are happy with the performance in the quarter.

In the US , if I could focus on that, there is no evidence that you were shipping ahead of consumption over the last couple of quarters and this is a

I don't believe so.

As we looked at the inventory levels as we finished Q2 this year versus last year it was down significantly and it wasn't anything that I'm toward a year ago.

It might have been a tad higher but nothing significant.

I think this is a Kellogg issue and we are constantly working with our retail partners to try to reduce inventory across the board, particularly in the current environment.

Don't think it was category specific.

It was more Kellogg specific and to be quite frank a shipment is lower than you expected, we did grow one point of share in the category and we are very, very happy with the performance.

I will get back in the queue.

Thanks.

We have our next question coming in from Terry Bivens from JPMorgan.

Please go ahead.

Good morning, everyone.

Good morning.

Dave, I know talking about the data always includes a certain amount of risk but the thing missing from Rob's question might have been this.

According to the data at least you guys were a bit more promotional than you had been in the second quarter.

I guess my look at it is this.

I would avoid the term loading inventory but you may have shipped robustly in the first quarter in advance knowing you were going to promote a bit more heavily in the second quarter and then going forward I would expect pretty close to that 4% kind of consumption number you mentioned, which is very consistent with a data.

Is that reasonable way to look at it?

Unfortunately not.

We don't preship in anticipation of promotions.

Occasionally that will happen if we've got something right at the end of the quarter that started at the beginning of the next quarter.

We didn't deliberately build inventories Q1 to Q2.

Really, we think the category is very strong.

If you look at the category at four, that was against the toughest comp.

we had in 2008 for category growth.

Q2, 2008, was the strongest growth in the category.

So we are up against a tough category growth from a year ago.

That's 4% in that context and it is very good.

And if you think about what's going on in the general market, we are happy that our consumption was up so strongly and we gained share.

We continue to try to offer consumers value wherever we can and in this market, we think that's a very pragmatic we can and this market we think that's a very pragmatic approach.

Just one quick follow.

As you look into the second half, you obviously singled advising is going to be up quite a bit.

Can you give us some flavor for what you are going to put that behind in the cereal category?

Cereal, snacks and frozen is right across the business and it's not only in North America but globally.

We had some programs that were due to run in Q2 that slipped into Q3.

We saw probably slightly more media deflation through the first half and we are expecting.

We have some great opportunities to add some incremental programming in the back half that we think will give us great momentum as we get on to 2010.

It's a combination of factors.

We have our next question coming from in Alexia Howard from Sanford Bernstein.

Good morning, everyone.

Good morning.

I want to focus on the margin [inaudible].

On the commodity cost side, could you talk about the outlook.

Think you mentioned the commodities were beginning to come down but the total COGS are continuing to go up.

Could you maybe give us a bit of color on what it is within the COGS line that is still causing you pressure?

I mean, Alexia when we gave the forecast of around 4% I think it was originally were a little higher but 4% is where we are seeing it.

And in that forecast, we had an anticipation of commodities coming down this year and that's proven to be the case.

You have pension costs and wages in there, factory expenses.

Some of the other things that are going up around the world for us is things in rise in packaging elements.

In general terms when you look at 4% inflation, that's the best we are seeing in four or five years.

That's consistent with the 3% to 4% we were seeing from the early part of 2000.

It really is pretty much where we expected.

Maybe slightly lower because we saw benefit from fuel that may or may not stick for the year.

Okay.

And I guess just really quickly.

Bolton acquisitions.

Can you tell us how much they reduced margin -- gross margins by this quarter and we sort of [anniversarying] that at this point?

About a 20 basis point for the quarter and I think we were close at [anniversarying] that for the year.

Thank you.

I will pass it on.

Thanks.

We have our next question coming in from Vincent Andrews from Morgan Stanley.

Thank you.

Good morning.

Dave, could you give us sequential commentary on how you are seeing consumer behavior change, maybe more specifically in the US , but also anywhere else in the world that you think would

Really, I think nothing dramatic.

What you are seeing in the general marketplace is a very tough economy.

Unemployment is still rising.

People looking for value.

I think one of the issues that investors have had is a concern about the growth in private label.

The one thing on that is we started to see its growth moderate in many categories not only in the US but around the world.

We would call it a sequentially flat whether looking at cereal, crackers, waffles, you go to the UK, Australia, Canada private label is down.

While it did have a very strong spurt of share growth, it's now leveling off a little bit I think consumers will nab mind set of looking for value and trying to extract as much value they can out of every dollar they spend.

We were pleased to being in categories like cereals and snacks where we can offer great value.

And with people I think stilling a little nervous about moving their expenditure back from in home to out of home, I think the trend towards more in-home consumption is probably going to prevail for awhile whenever we see unemployment high and not coming down.

Thanks.

John, you quickly remind us what your transactional exposure to foreign exchange is?

We have transactional exposure.

It's not that significant because we hedge that thoroughly so the transaction exposure will be raw materials coming from the US and Mexico and going from the UK to the continent.

Part of the normal operating model.

And even if I wanted to I'm not sure I could sum up and tell you what it is.

It's largely hedged.

Thanks so much.

We have our next question from David Driscoll from Citigroup Investment Research.

Please go ahead.

Thanks a lot.

Good morning, everyone.

Good morning.

Just two relatively brief questions.

First one is on nonmeasured channels in the United States.

David, could you come on those channels in specifically it looks to me by looking at your reported results versus the food drug in mass data that we received that the nonmeasures weren't as positive this quarter as we had seen them in past quarters.

So can you just comment on what you're seeing in those channels and my observation correct?

I would say the trends are consistent in the nonmeasured channels.

If you look at Club dollar and some other retailers, they are all doing pretty well.

And as you expect in an economy where people are looking for value, I think they are train held pretty constant to be honest.

I look at your data for the quarter and our data was indicating 4.7% and you reported at 4% and historically what I have been watching at a number of companies including Kellogg is a substantially higher reported number from the companies when you take into account the nonmeasured of.

That's where my confusion is coming from.

I think you have to get back to what our consumption was in the quarter which was 6% to 7% probably towards the high end of 6% to 7%.

Our shipments were 4%.

As I mentioned on the call and previous question we did see inventories here on the year come down significantly.

More at Kellogg issue or opportunity than I think category things.

I think if it you look at consumption versus shipment, I think then you will find the data is consistent with what you normally expect.

Just a final one.

Can you comment on the competitive environment in US cookies and crackers a bit further?

It's intense.

But we did see a pretty big step out there through the second quarter.

I would expect that to continue.

This sort of environment I think most branded manufacturers are quite pragmatic.

They are looking to offer consumers value during the recession.

We see that continuing.

Thanks for the comments.

Congratulations on the quarter.

Our next question comes from Edward Aaron from RBC Capital Markets.

Good morning and nice job on the quarter.

Good morning.

Just a follow up quickly my main question is about the media opportunity.

I wanted to follow up on the inventory issue.

Is that a function you think of your competitors being more aggressive on trade promotions or more of a conscious effort on your part to work down inventory?

I think we are always aiming to pull inventories down wherever we can because that's a positive not only for our trading partners but for us.

I'm sure part of it was that there could have been other elements.

We looked at inventories year on year that it had significant impact on the 6% to 7% consumption data down to the 4% shipment data.

It was there overwhelming differential between the two.

And to be honest as we look at it, we feel great about that because our inventories as we finish Q2 and go on to Q3 and US cereal are lower than we'd normally expect, which is a positive place to be.

Thanks for the clarity.

Then on the media deflation opportunity, is the back half waiting of your ad spending this year, is that related to your expectation for cost to come down the back half you might have seen in Q2 for maybe more opportunistic with that?

I know you don't have perfect visibility yet.

How would you characterize how you seen so far and the upfront negotiations in the upfront market for the TV advertising?

It's nothing opportunistic in it.

I think media deflation is relatively consistent.

In the US, as you know will probably come later in the year because we were in the upfront and we have commitment that are locked in.

For us part of it is as I mention, timing of programs and some of the things we plan to do in Q2 have slipped into Q3.

So that gave us a benefit on the quarter we will spend that money back.

Is it an opportunity in a recessionary environment to continually ensure the consumers of seeing our brands and we are able to get the quality and value perception up in this environment.

As far as the upfront, I think just starting, I couldn't give you any specifics on that.

I don't think we were far enough in.

Thank you.

Thanks.

We have our next question coming in from Jonathan Feeney from Janney Montgomery Scott.

Good morning.

Thank you very much.

Good morning.

If you look at this earning season for food retailer versus the earning season food had so far there is a stark disconnect.

And I think talking about the US companies here and I know you mentioned European retailers as far as tough negotiations.

How do you -- you seeing the tone of your confirmations or conversations you had with people internally who touch your food retailer customer's change in the past three or four months as it seems times are tougher and at the margin what can Kellogg do to -- what's the message Kellogg is sending to food retailers how you can help them grow their business in the next 12 months?

Anything we can do to work with all of our retail partners to reduce inventory to take cost out of the system, we will do and continue to do wherever we can.

Driving value and offering great opportunities for all of our retail partners to attract consumers into the stores and working collaboratively with them on that.

Ensuring that we are investing heavily against our brands so we can keep category growth going is also essential for us.

And things like renovating our products.

Some the work we are doing on adding fiber to our products we think is going to be a very positive thing from an overall category consumer perspective.

A combination of a number of factors.

But probably most importantly listening to what specifically they want to do in their particular retailer outlet and trying to channel their support so that we meet their needs and our needs for mutual benefit.

Okay, thank you very much.

Thanks.

Next question comes in from David Palmer from UBS.

Thanks.

Good morning, guys.

You mentioned specific reasons for weakness in Europe and still expect some revenue growth there for the year.

Several players in Europe and many consumer companies have noted that trends are slipping on the continent but you say things are unchanged.

Are you really seeing things slip at all there due to economic drag or perhaps any market share issues?

Then separately why do you think your trends through the second quarter were stronger in the UK than in continental Europe?

Thanks.

When you look at Europe in totality there are differential by market and the Continent is clearly tougher.

Markets like Italy and Spain and France have struggled.

Spain struggling with an unemployment rate around or over 20%.

But certainly it's close to that level, so its very hard to talk just about Europe without getting into some of the market differences.

Europe last year slowed dramatically around July and August.

That's when they really some of the markets really started to slow.

Part of the reason for our confidence to do low single digit in the back half even though we were flat through the first half is the fact that the comps.

for us and I think for many companies get easier in the back half because when lapping those slowdowns and of course, in the first half as we mentioned with while we resolved some of the retailer issues we are not fully back into promotional swing with all of them.

That's broadly behind us at the end of the second quarter.

That's really it.

The general belief is that when you look at our categories, they are doing pretty well.

The UK is probably being the most solid.

But in general terms we feel confident about doing low single digit in the back half and in Europe.

And it is not one of those trends right now through even the quarter it looks like it's slipping.

It seems like it's stable enough on almost a two year basis such that you should enjoy a reacceleration with easing comparisons in the second half.

Certainly as we look at our categories and the trends.

We are not saying sort of quarter to quarter deterioration.

Some of the dropoffs that we saw July, August of last year, once we lap those, the comparisons are going to be significantly easier.

And the performance in the back half, we feel pretty good about.

Thanks.

Thanks.

We have our next question coming in from Eric Katzman from Deutsche Bank.

Please go ahead.

Good morning, everybody.

Good morning, Eric.

Follow up with David's question with regards to international.

I'm wondering specifically in Mexico if there was any quote-unquote benefit to the business because of the H1N1 virus alert down there and then also in Australia I think, David, you mentioned that the other retailers were kind of supporting you.

You guys know Australia better than I do.

I thought there were only basically two retailers there.

Could you clarify those two issues and I have a follow-up?

Sure.

In Mexico we had a strong quarter and very strong in cereal in particular.

We saw when H1N1 first came out that earlier in the quarter we saw what we assumed was a bit of a spike in shipments because people may have been loading up the pantries that probably worked itself out during the balance of the quarter.

I'm not sure it had any material impact in the quarter.

It was positive in the first part of the quarter.

That did die down as you went through the back half of Q2.

I'm not sure that was meaningful.

So I think Mexico was a strong performance and we still are a little cautious on the back half.

But things are going pretty well there.

Australia, yes, you are right.

There are two major retailers and a third player who is a retailer wholesaler.

We have an issue with one of the major retailers and we are working our way through that and we are getting very positive support from the other retailer.

So while it's challenging, I'm sure we will resolve it in due course.

And then John, if I could ask -- as you noted you moved upfront spending from $0.14 expected up to now $0.26 for this year.

Can you kind of frame that in terms of your I guess comfort left with the billion dollar cost savings target?

Is that basically a signal that you're that much more confident and therefore are willing to spend more upfront to deliver on those targets just to maybe a little more clarification?

Thanks.

Sure, Eric.

We have great visibility into the billion dollars.

When we first mentioned the billion dollar back at [CAGNY], we didn't have the same visibility as to how we were going about getting it.

We didn't have general sense and without the details.

We are further along.

We have a better sense where we will go to get the savings.

As we have done that we identified additional upfront costs associated to get that billion dollars.

I would say as we look at this year, we were well on track and are getting a good component of those savings this year and those $0.26 in upfront costs in all related to getting that billion dollar cost saving.

Thank you.

I will pass it on.

We have our next question comes in from Ken Zaslow from BMO Capital Markets.

Good morning, everyone.

Good morning, Ken.

I know you mentioned on the call you were 90% hedged on the commodities.

Have you begun to think about 2010 on the commodities particularly given they are lower.

How you started to be more aggressive or is it typical what you are doing for 2010?

We certainly looking at '10 and we are taking some actions.

What we will do, Ken, is give you an update on that as we do the third quarter and give you a guidance next year.

We will give you a sense where we are and what we are doing.

Okay.

Can you talk a little bit about your strategy with Kashi, how big is it now and how broad do you think it can it get?

You talk a little bit about that brand because it seems to be one of those -- I wouldn't say hidden gems but not something you talk as much about.

Can you broaden out on the strategy on Kashi?

Kashi is a very strong brand equity continues to do well, well in excess of half a billion dollars.

And growing -- I mean, it came up through the natural organic channel and that channel as you probably should be aware is struggling at the moment.

We are doing better than the channel is, but it slowed a little.

We continue to see Kashi growing.

Maybe the growth will slow a little bit in this tough environment potentially people coming in and out of that particular natural and organic segment.

A strong equity for us in the long term.

And my last question is, how long will it take before sales and take away will be more aligned?

Are we done with the inventory?

And so going forward the duration part of it.

That was really a specific and probably noticeable impact in US cereal only.

Only because I think investors watch dramatically that we drew that out.

Growing 6% or 7% in consumption and gaining a share is inconsistent with 4% shipment.

We normally don't see that big a swing in a given quarter.

I think it's a positive as we get on to Q3 inventories are lowers.

But I don't think it's more than a bit of an aberration to be quite honest.

The third quarter going forward we don't need to be worried about that issue?

No, I would think not.

If anything happens in the third quarter, it's material, we will tell you.

Thank you.

We have our next question comes in from Bryan Spillane from Banc of America, Merrill Lynch.

Please go ahead.

Good morning.

Just a couple of points of clarification on the outlook for the year.

First, on share repurchases, are you expecting -- is an expectation for share repurchases for the second half built into the guidance.

We do have authorization for $65 million for the share buyback.

In putting together our guidance we have little benefit.

To the extent that we execute that authorization will be back end loaded.

Okay.

And then if I remembered it right at one point there was an expectation for interest expense for the year, net interest expense to be about $270 million to $275 million.

They swapped debt from longer term debt is there any change in that extra expense expectation for the year.

It's around $270 million for the year.

And then gross margins at one point you are expecting gross margins to be unchanged for '09.

Is that still the expectation?

No.

I think when we gave guidance last time, we said we could do better than that and in this taken the guidance up to 50 basis points.

That would imply that gross margins for the back half of the year would be basically flat.

No.

I think we are down year to date minus 20 basis points.

That implies that back half gross margin growth is quite strong.

And then just the last part.

If you look at the internal sales goal, goal for internal sales growth for the year, it implies it accelerates in the back half of the year.

Part would be you wouldn't have any more inventory reductions.

You look at the second of the year, would you expect you will see a more volume contribute more to your revenue growth from the back half of the year relative to pricing?

Just trying to get an understanding of what's going to drive that acceleration in internal sales growth in the back half of the year.

Actually not 3.5% percentage sales growth, so we are 4% full year guidance.

Back half could be a similar rate of growth to the front half and still meet the full year outlook.

And then on price mixed volume we are seeing good price mix to the first half.

We expect that to continue to back out, volume might do better but we will see how it plays out.

You are in a range relative balance-wise in terms what we would expect in the back half of the year?

Yes.

Thanks, guys .

We have our next question coming in from Chris Growe with

Hi, good morning.

I would like to thank you for the incremental disclosure on the back of the release as well.

You are making it easy for us.

Thank you.

I had two quick questions.

First is just bit of a follow on to that.

Retailer issues you had that were disclosed in the first quarter, in terms of their effect on the business I know they had gotten better but was there a heavier effect on the second quarter?

I'm focusing more on Europe where volumes got worse.

Was it heavier hit to the volumes this quarter than maybe it was in the first quarter?

Probably similar.

I think when you look at volume for Europe, you have to remember that half of it was Russia.

Russia the volume was down 15% but net sales were up 8%.

The other half toward the enact that it resolved most of the those issues we are not fully back into the promotional swing and then in Italy and the UK we did see a little bit of inventory reduction.

Italy specifically because year ago there was a belief that in Q2 there was going to be a freight or transport strike so the trade build up inventories in anticipation of that.

And this year we didn't have that.

So they came down quarter on quarter.

Combination of factors.

But probably slightly less but Russia was really the big volume impact.

Okay.

And then I want to clarify as well on the upfront costs, $0.26 for the year.

Did that in anyway pull forward expenses from next year?

It will be one element of the question.

The other one is vis-a-vis, are those still focused on Q2 and Q3 in terms of the heaviest quarters for the upfront costs?

The upfront is $0.26, pretty evenly straight across the back half of the year.

Q3 and Q4 look similar to Q2 into facing out.

In terms of I wouldn't describe them as pull forward projects.

I think we will wait until our third quarter conference call to give you guidance on next year's upfront costs.

We are working to see what that will look like.

And you said $0.22 before.

Is that kind of the current guidance for next year?

That's right.

Last time we took the upfront costs up to $0.22 for this year we expect it be a similar number for next year but we were working on that in detail and give you better guidance on the third quarter call.

Let's take one last question.

Our next question is coming in from Andrew Lazar from Barclays Capital.

Please go ahead.

Good morning, everyone.

Just a quick one.

I realize your gross margin year over year looks a lot better when you account for some of the upfront costs that fell into cost to goods this year versus last year and I was the acquisition impact and such.

One of the questions I'm hearing a lot is for some of the food companies we have seen report over the last couple weeks seen probably much more dramatic year-over-year gross margin improvement in their quarters.

I'm trying to get a sense whether perhaps there is a difference in maybe some of the way you hedged some of your inputs or maybe a difference in some the inputs you are using versus the others.

Just I realize you're expecting gross margin improvement to accelerate a bit in the back half of the year.

I was wondering what the disconnect is with the more outsized improvement we seen versus yours.

Boy, I think you are right.

Upfront costs limiting our growth.

And in the second quarter our upfront costs impacted gross margin by 80 basis points.

I can't talk to other companies are saying.

What's driving their gross margin.

From our perspective we are seeing good price mix performance in the business as well as delivery on the billion dollar cost challenge and those in combination even though we were seeing year on year inflation and higher upfront costs are enabling us to drive positive gross margin.

Thanks very much.

All right.

Thank you everybody for listening in today.

We are here to answer any additional questions and we appreciate your interest in Kellogg Company.

I'll turn it back to Doug.

Thank you, ladies and gentlemen.

This does conclude today's teleconference.

We thank you for your participation.

You may disconnect your phone lines at this time and have a great day.