家樂氏 (K) 2010 Q1 法說會逐字稿

Good morning.

Welcome to the Kellogg Company 2010 first quarter earnings call.

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

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

(Operator Instructions) Thank you.

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

Ms.

Koessel, you may begin your conference.

Thank you, Christina, and good morning.

Thank you for joining us today, and welcome to the review of our 2010 first quarter results.

Joining me are David MacKay, President and Chief Executive Officer, John Bryant, Chief Operating Officer and Ron Dissinger, Chief Financial Officer.

The press release and slides that support our remarks this morning are posted on our website at wwwkelloggcompany.com.

As you are aware, certain statements made today, such as projections for Kellogg Company's future performance, including earnings per share, net sales and margin, operating profit, interest expense, tax rate, cash flow, brand building, up-front costs and inflation are forward-looking statements.

Actual results could be materially different from those projected.

For further information concerning factors that could cause these results to differ, please refer to the second slide of this presentation as well as our public SEC filings.

As a reminder, a replay of today's conference call will be viable by phone through Monday May 3.

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

And with that, let me turn it over to David.

Thanks, Kathryn, and good morning, everyone.

I'm pleased to report a good start to 2010.

Solid top-line growth and robust operating profit led to healthy 27% earnings per share growth on a currency neutral basis.

These results were delivered against a backdrop of challenging macroeconomics.

Consumers are still feeling uncertain and are looking to be more frugal, buying more on promotion and shifting channels to get the best deal.

However, none of these short-term challenges alter our current agenda or our long-term strategy.

We are confident that by adhering to our focused strategy and business approach, we will continue to deliver sustainable, dependable results.

Our business faced various pressures this quarter and delivered solid top-line growth.

We remain excited about our brands and our categories as we continue to focus on building our business through innovation and renovation.

As we enter the second year of our three-year $1 billion plus cost savings plan, we continue to look for opportunities to reduce costs and increase efficiencies.

As we have said before, the goal of these programs is not a one time benefit, but a sustainable drive for visibility well into the future.

The positive ongoing impact to our gross margin performance is evident.

Moderating cost inflation combined with cost savings initiatives contributed to the improvement in our gross profit margin of 190 basis points in the quarter.

Gross profit improvement combined with the timing of advertising expenses contributed to our strong internal operating profit growth.

Our advertising spending was down in the first quarter due to the absence of EGGO spending and is not reflective of our commitment to reinvest in the business and the importance of brand building.

As we discussed at CAGNY we expect to increase our advertising investments in the mid single digit range for the full year.

We delivered earnings per share growth well ahead of expectations supported by increased operating profit and discreet tax benefits.

Our focus has been and will continue to be to sustainably grow the top line, drive investment in our brands, build an effective and cost efficient infrastructure and consistently deliver solid results for the long term.

And with that, I'd now like to turn it over to our CFO, Ron Dissinger for a review of our financials.

Ron?

Thanks, David, and good morning, everyone.

Let me begin with a summary of our first quarter results on slide four.

As we mentioned on the fourth quarter call and at CAGNY, we expected to have some difficult top-line comparisons in the first half but still grow earnings per share.

We delivered solid sales growth this quarter, and our earnings exceeded expectations.

For the quarter, reported net sales grew 5%, and internal net sales grew 2%, in line with our full-year 2010 guidance of 2% to 3% internal net sales growth and our long-term guidance of low single digit net sales growth.

The first quarter top line reflected the continuing impact of the EGGO supply disruption.

In addition, supply disruptions in Brazil and Venezuela impacted our results.

Also remember that we were lapping the impact of the peanut butter related recalls in first quarter of last year.

The impact of these items on net sales year-over-year was relatively offsetting.

As David mentioned, our advertising spend decreased during the quarter as a result of the absence of EGGO advertising and timing of investments from Q1 to the balance of the year.

Our solid sales performance combined with our continuing cost savings and productivity initiatives, as well as moderating cost inflation, drove internal operating profit growth of 17% for the quarter.

Also in the first quarter, we recorded discrete favorable tax benefits which reduced our tax rate to 27% and contributed approximately $0.05 to our earnings per share.

Looking forward to the remainder of the year, we now expect to have a full-year tax rate of 29% to 30% .

Our strong operating profit performance and these discrete tax benefits resulted in a 30% increase in our reported earnings per share and a 27% increase in earnings per share on a currency neutral basis.

On slide five, we'll walk through the components of our net sales growth.

On a reported basis, our first quarter net sales grew by 4.7% year-over-year.

On an internal basis, net sales increased 1.8%.

The following components contributed to the overall growth rate.

Our total company tonnage increased by half a point, primarily driven by strong cereal volume growth, up approximately 2 points.

This was partially offset by the impact of the transition from bulk to packaged formats in Russia and by the shift away from low-margin business in China .

As we discussed on our fourth quarter call, we expected the impact of these items to continue through the first half of 2010.

The impact on volume from EGGO as well as the supply disruptions in Brazil and Venezuela, were broadly offset by the benefit of lapping the peanut butter related recalls of first quarter 2009.

Price and mix contributed 1.3 points of growth, and currency contributed 2.9 points of growth.

Acquisitions had no impact on the quarter.

All of our operating segments contributed to net sales growth for the quarter.

North America and Europe each contributed 2% to net sales growth on an internal basis.

Latin America and Asia-Pacific each increased internal net sales by 1%.

Now let me turn to slide six to discuss gross profit.

On an internal basis, gross profit rose 7% in the first quarter.

Gross margin increased 190 basis points to 43%.

There were several drivers of our gross margin improvement.

First, we had some benefit from price increases.

Second, our cost reduction initiatives were greater than the underlying rate of inflation.

And third, we were lapping the impact of the peanut butter related recall.

It is important to note, for the year, we're approximately 80% hedged on commodities, but our outlook does include commodity inflation in future quarters as we begin to lap lower costs in 2009.

For 2010, we expect cost pressures to be in the range of 3% to 4%.

Gross margin is expected to expand by approximately 100 basis points due to cost savings initiatives.

Now let's turn to slide seven to discuss advertising.

Our commitment to strengthen our brand equities through advertising remains a key facet of our business model.

However, during the quarter, internal advertising declined 3% driven primarily by timing of North American advertising campaigns shifting from the first quarter to later in the year as well as the absence of EGGO advertising.

In the US, advertising for our top eight cereal brands was up in the quarter.

Europe advertising increased and was lapping easy year-over-year comparisons due to media deflation in 2009.

Latin America also increased advertising, particularly in Mexico's cereal business, which was on top of strong growth last year.

We now expect full-year advertising to be up mid single digits with heavier investments as we progress into Q2 and Q3.

Slide eight highlights our internal operating profit growth by area.

First quarter internal operating profit rose 17%, driven by positive internal sales growth, moderating cost inflation, continued cost saving initiatives and slightly lower advertising spending.

Upfront costs are comparable to last year, at approximately $0.03 of earnings per share.

North America internal operating profit grew a healthy 22% as a result of solid sales growth, gross margin expansion and timing of advertising investment.

This compares favorably to last year's increase of 1.6% which reflected the 2009 peanut butter related recalls.

Europe's internal operating profit rose 4% due to solid sales growth and improved cost of goods, partially offset by investments in advertising.

Latin America's internal operating profit rose less than 1%.

The impact of supply disruptions in Brazil and Venezuela masked the strength of Latin America's business, especially in Mexico.

And in Asia-Pacific internal operating profit grew 10%, reflecting an improvement in gross margin and timing of advertising spending.

Now let's turn to slide nine to discuss cash flow.

Managing for cash remains a key operating principal for Kellogg.

In the first quarter, cash flow was $190 million, up $18 million over the first quarter of 2009.

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

As we said in our fourth quarter call, we expect to spend approximately $500 million in capital expenditures for 2010, and we expect our cash flow to be comparable to full-year 2009's record cash flow.

Now let's turn to slide ten to discuss the impact of foreign exchange on earnings per share.

Because our guidance is on a currency-neutral basis, we'd like to provide an estimate of foreign currency impact on our 2010 earnings.

Slide ten shows our key currencies with 2009 actual rates and current spot rates as of April 26, 2010.

Based on April 26 spot rates, we estimate full-year foreign exchange to be unfavorable $0.02 compared with our earlier estimate of flat.

So while we have good news from foreign currency in the first quarter, these current spot rates indicate we will have a negative impact over the next three quarters.

We also recognize that foreign currency has become very volatile, especially in Europe.

Over the last several days, the spot rates for the euro and the pound have declined against the US dollar.

These changes are not reflected in the April 26 spot rates.

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

Now let's turn to slide 11 to discuss our full-year outlook.

In summary, we are very pleased with our first quarter performance.

We delivered solid net sales growth and exceeded our expectations for earnings.

However, we experienced favorability in Q1 due to discrete tax benefits and timing of investments.

We expect our investments to increase as we progress through the year.

As a result, we are affirming our 2010 full-year guidance growth rates for internal net sales, internal operating profit and currency neutral earnings per share.

We expect internal net sales growth of 2% to 3%, in line with our long-term targets.

Internal operating profit is anticipated to grow 8% to 10%, which is above our long-term targets.

This includes an expectation to increase our advertising investment as we progress through the balance of the year, resulting in mid single-digit advertising growth for the full year.

We still expect gross margin to increase approximately 100 basis points and upfront costs to be approximately $0.16.

Consistent with our commitment to return cash to share owners, our board of directors authorized a new three year share buyback program totaling $2.5 billion across the years 2010 through 2012, replacing all other authorizations.

The $148 million of shares purchased in the first quarter 2010 falls under this new authorization.

As we review the balance of 2010, we now expect average shares outstanding to be relatively flat compared to the end of 2009.

We remain confident in our visibility to achieve currency neutral earnings per share growth of 11% to 13%, which is above our long-term annual targets.

And now I'd like to turn it over to John Bryant to cover our North America and

Thanks, Ron, and good morning, everyone.

I'd like to give you some more color on our business performance in the first quarter.

Starting with North America, which delivered solid internal net sales growth of 2% compared to 4% growth last year.

Let me discuss each business in greater detail, beginning with cereal on slide 13.

The US and Canadian cereal categories continue to operate in a competitive environment and lap tough growth comparisons from a year ago where category growth was 6% to 7% in the US and 8% in Canada.

While the North American category is down slightly in the quarter, we expect improvement through the back half of the year.

Our North America cereal sales were up slightly in the first quarter against tough comparisons.

Taking a close look at the US, our core brands continue to do well, growing 4% across all channels.

If you look across all channels, our share was slightly down, roughly 20 basis points.

Within alternate channels, particularly club and dollar, our gains were strong.

First quarter innovation included the well received Special K granola, and we have strong innovation in the second half, including Fiber Plus cereal.

As we said in the fourth quarter call, we built cereal trade inventory at the end of 2009.

However, given the timing of both Easter and several April promotions, we continued to hold slightly elevated trade inventory at the end of the first quarter.

We anticipate that this inventory will be reduced across the second and third quarters.

Our Canadian cereal business delivered a good quarter with half a point share gain and good sales growth against tough comparisons a year ago.

Let's turn to slide 14 to discuss the North American snack performance.

We posted first quarter internal net sales growth of 5% compared to 2% a year earlier.

The strong results reflected broad-based growth across Pop Tarts, crackers, cookies and wholesome snacks.

Our Pop Tarts business posted another strong quarter with mid single digit internal net sales growth and over a 3 point increase in market share.

Our store door cracker sales were up a robust 4% against strong first quarter 2009 comparisons of 11%.

Our sales growth was driven by our three big brands and introduction of Italian Four Cheese Cheez-Its and Wheatables Nut Crisps in the quarter.

Cookie sales were also up for the quarter, and we gained 60 basis points of share.

The Fudge Shop Cheesecake Middles introduction, Mother's brand and strong growth in Kashi cookies contributed to the performance in the quarter.

Sustained momentum in our wholesome snacks business resulted in a greater than 3-point increase in share and widened our share leadership in this growing category.

We are very pleased with the successful introduction of Special K Fruit Crisps at the end of 2009 and strong performance of Fiber Plus bars.

Turning to our frozen and specialty channels business, frozen and specialty channel's first quarter sales declined 3% compared to last year's increase of 6%.

Over the past several months, we have made significant progress in increasing EGGO production levels, and we have nearly reached previous capacity levels.

We continue to build our inventory and our customers' inventory.

The impact on the top line will continue through the first half of 2010, and is included in our 2010 guidance.

Morningstar Farms' veggie foods continue to perform well, growing internal net sales 5% in the quarter, and Kashi frozen meals also delivered healthy growth.

The pressure on our food way from home business is moderating.

The business posted flat sales this quarter, reflecting improving trends in the food service industry.

Please turn to slide 17 for a discussion of the international business.

Outside North America, our international business continued to perform well, delivering 2% internal net sales growth for the quarter.

European internal net sales grew 2% during the first quarter, driven by cereal share gains in the UK, France and Italy and an inventory build at the end of the quarter in preparation for April promotions in the UK.

The healthy mid single digit growth in cereal sales and volume was driven by strong innovation.

The introduction of Crave in the UK as well as solid performance of Triple and Extra on the continent.

We were pleased with our European performance given that in the first quarter of 2009, the cereal category in the UK, our largest European market, was up 6%.

However, the continued migration from bulk to packaged snacks in Russia distorted Europe's overall volume performance.

We expect this impact to continue throughout the first half of 2010.

Latin America internal net sales rose 1% during Q1 on top of 8% growth last year.

A highlight of the quarter was the high single-digit sales growth in Mexico driven by cereal.

Mexico's strength was offset by a sales decline in Brazil due to the excessive rains, which resulted in water damage and temporary closure of our Brazilian manufacturing facility.

While the plant is now up and running, it will take some time to return to full capacity.

Lower inventory levels will continue to impact results through the second quarter.

In addition, Venezuela's performance was impacted by intermittent supply disruptions driven by various government policies.

We continue to expect internal net sales growth for the Latin American region to be in the mid single-digit range for the full year.

In Asia-Pacific, first quarter internal net sales grew 1% on top of strong growth in the first quarter of last year of 11% and was driven by strong cereal sales in the region.

However, as mentioned on the fourth quarter call, we continue to transition our Chinese business from a low margin business to a branded model.

This will result in volume loss through the first half of the year.

Australia was also down modestly as it lapped high single digit comps from a year ago, and we had no promotional activity with one of our largest retailers during the quarter.

Although Australia is facing challenges similar to other developed markets, we anticipate seeing stronger sales growth for the remainder of the year.

In Asia-Pacific, we still expect to deliver mid single digit internal sales growth for the region in 2010.

Now let me turn it back over to David.

Thanks, John.

In summary, we're pleased with our first quarter performance.

We expect that the pressure on our top line this quarter will continue during Q2 and then improve in the back half of the year.

The top line is expected to be in line with our 2010 and long-term guidance of 2% to 3%.

We're focused on leveraging the current environment to our advantage to build Kellogg into an even stronger company in the future.

We will continue to renovate our current products and drive new innovation to address consumers' growing and evolving needs while differentiating and enhancing our portfolio.

We're optimizing our global organization and striving for enhanced effectiveness in many areas of our business.

And as we have said, we'll continue to invest in brand building and in other areas of the business to make Kellogg's stronger.

Our 2010 financial performance will be driven by moderate top line growth coupled with our cost savings, productivity momentum and continued investments.

We've almost reached the halfway point of our three year $1 billion plus cost challenge.

We're on track, and these savings will help us drive efficiency gains, offset future commodity and energy inflation and provide the fuel to sustain our momentum.

All of these elements, combined with excellent financial visibility support our increased confidence that we're on track to deliver on our 2010 guidance.

While we feel good about the future, we're also pragmatic about the current consumer, customer and competitive dynamics and the impact on our business during 2010.

And we believe that we're addressing and reflecting this environment in our outlook.

Our business model and strategy remain relevant and resilient.

We remain committed to managing our business for cash and long-term sustainable and dependable growth.

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

Gentlemen, the floor is now open for questions.

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

Thank you.

Our first question comes from Alexia Howard from Sanford Bernstein.

Please state your question.

Good morning, everyone.

Good morning, Alexia.

Okay.

I guess the broad question is really, what came through better than expected?

I'm just thinking back to your commentary at CAGNY talking about being up against really tough comps on EPS growth in the first half.

It seems as though, with this kind of EPS growth this time around, something must have gone very right in March.

And as you think going forward, given that you haven't raised guidance for the rest of the year, are there things that are looming that concern you?

Well, I think, Alexia, a few things -- and there's a lot of factors in that.

As we mentioned in the prepared remarks, our advertising expenditure was down in Q1.

That will come back and increase through Q2, Q3 for the rest of the year.

We had some discrete tax benefits.

Our sales were probably a little bit stronger than we thought, as was our gross margin.

And when you think about the sales gross margin areas, a couple of things are likely to happen there.

We thought inventories would come down in US cereal, and because of the timing of Easter and April promotions, that did not occur, so that will probably come out in Q2, Q3.

We also saw in the UK, probably about a 1-point impact on our performance across Europe because of strong inventory builds for promotions in April, and the timing of Easter there as well.

But we're off to a great start for the year.

We plan to invest back to build the Company to make ourselves stronger in this environment, and we remain very confident in hitting our numbers.

That's great.

Thank you very much.

I'll pass it on.

Thank you.

Thank you.

And our next question comes from Andrew Lazar of Barclays Capital.

Please state your question.

Morning.

Good morning, Andrew.

I think I had heard you say that the category in cereal overall was down a bit this quarter, and that's -- obviously, the category has been decelerating a bit from a pretty high rate of growth over the last two years.

First time I think I've heard it down a bit.

Does that -- how much does that concern you in light of the comment in the release around a more competitive cereal environment?

Maybe you can give us a little bit of additional color there, and why do we think the categories should get a little better as we go through the year?

Yes.

I think the category remains, long term, very strong.

If you look at the first quarter in the US, and if you take the major markets around the world, the category in the first quarter a year ago was up anywhere from 5% to 8%.

So, significantly stronger.

So in the US, we're up against tough comps that grew 6 to 7.

You're seeing a lot of retailers driving traffic through the category, consumers buying more on deal and channel shifting, people looking to get the best value they can.

So our expectation was, we'll see a little bit of softness in Q2, a bit of second half.

But long-term, we don't see any issues for the category whatsoever.

It remains -- it will remain vibrant, and we'd expect that in the second half to return to more normal growth rates.

Okay.

And one little thing that caught my eye in the North American cereal slide, there was a picture of a box of Raisin Bran with a flag on it, 15% more cereal in the box.

I'm just wondering, what's behind that?

Is that-- I guess it's weight in on -- is it just on that brand alone?

And if so, why is it just that brand, and perhaps you can try to give us some sense of that.

Yes, I think it was Raisin Brand Extra, which is an innovation, was probably just another way of driving a little bit of value on the short term in and out.

We occasionally do those.

It's not signaling anything of any significance.

So hopefully, the picture didn't send you a message that was unintended.

Got it.

Thank you.

Thanks.

And our next question comes from Vincent Andrews with Morgan Stanley.

Please state your question.

Thanks.

I actually have two quick cash-flow questions.

The first is, on cash flow in the quarter, I don't think you gave an explanation for why it was flat.

You talked about the full year being flat.

But you had much higher net income in the quarter, and then it looks like there was some sort of working capital build.

Can you give a little color on that?

Yes, of course.

Cash flow was driven by strong earnings growth.

Partially offsetting that, we did have a large tax refund in the first quarter of 2009 that had an adverse impact on this year's cash flow.

That would really be the key item.

We did have some settlement on some hedging contracts as well in the first quarter, and those are really the drivers of our cash flow position.

A follow-up would just be on the share repurchases, it sounds like -- correct me if I'm wrong, you're talking about the shares now being flat year over year.

So are you going to be buying back less stock in 2010 now than you thought before> Or do you still think you'll do the 1.3 in 2010?

We're more likely to buy back less shares and to see that share repurchase back-end loaded.

I should point out, we are committed to returning cash to shareholders as evidenced by the recent approval from our board of directors on the $2.5 billion share repurchase.

We did increase our dividend by a strong 8% as well.

You'll still do the 1.3 billion in 2010, is that correct?

Share repurchases are likely to be a little bit less.

At this point in time, we're taking a position to maintain a very strong financial flexibility position, strong liquidity position given that the financial markets remain volatile.

For instance, look at what's going on over in Europe.

Even if we buy back less shares this year, we're quite confident in hitting our 11% to 13% earnings neutral earnings per share.

Okay, that's what I was getting at.

Thanks very much.

I'll pass it along.

Thank you.

And our next question comes from Jonathan Feeney of Janney, Montgomery & Scott.

Please state your question.

Good morning.

Thank you very much.

I specifically want to dig in on some of the disruption -- a little more on the disruption in the marketing calendar for one of your major competitors in the spring and summer last year.

Can you talk about the performance, particularly in incremental sales in both measured and non-measured channels in Q2 and Q3?

And what steps, if any, are being taken to make up for what locks like, on the face of it any way, a fairly daunting comparable?

Can you be a little more specific, Jonathan?

Sure, David.

Seemed like Post last year in the transition lost quite a bit of incremental sales, promotional sales momentum with key retails.

And it seemed from the data at the time that Kellogg was, laudably so, the benefactor of a lot of that interruption.

It was very opportunistic.

And I guess, I'm wondering if, A, is that true and B, if so, does that create difficult comparables, and how does that look in the cereal business for the spring and summer period now?

Yes.

Without wanting to get too specific on what a competitor might do, there's no question that they did appear to trail off in their activities, and I think we saw a significant ramp up in Q1.

We'd expect them to do that, probably in Q2.

I don't know what will happen in the back half, but while their incremental is up significantly, and there is a degree of interaction, more specifically with Kellogg, than maybe others.

Their share, I think was flat for the quarter.

So I think you'd have to direct that to them, really.

But I guess -- let me ask it this way, David, if you don't mind.

Sorry to keep pushing on it.

But if you had excellent -- what's the typical for promotional sales?

What's the typical salient period?

Because if you had excellent promotional sales numbers, in let's just say theoretically, July or August, when would that have shipped?

You're saying, when is the peak for the cereal category?

No, I'm asking what's the total sort of sale end period for promotional sales in the cereal category on average?

How long -- what is it from revenue recognition at Kellogg to sale at the retail register?

Jonathan, it's John here.

It normally takes us about three or four months to negotiate trade activity with a customer, and then we'll ship a week or so before the actual deal.

Perfect.

Thank you very much

Okay.

And our next question comes from Judy Hong with Goldman Sachs.

Please state your question.

Thanks.

Just following up on the cereal question here as well.

David, you alluded to your share performance, I think was down 20 beats in all channels, but alternative channels, I think you did better.

So can you walk us through what you're doing better in terms of alternative and what's going on in the, maybe more traditional channels that you're not doing as well from a share perspective.

And then, as inflation picks up in the back half, can you give us some broad perspective on your ability to take another round of pricing, maybe not this year, but 2011 and on.

Yes, I think on the alternative channels, you are seeing, as I mentioned, some channels shifting.

I think club in general terms is growing very fast and so is dollar is relative to the retail environment, an we, likewise, did pretty well in those channels.

I think that's not just a Kellogg phenomenon, I think that's relatively consistent probably for most companies.

And I think as we've looked at it, it's an indication of consumers looking for deals, watching the absolute dollar amounts they spend.

And we saw that in the first quarter in the cereal category for ourselves, but it was pretty consistent, I think, probably for those sectors to run above dollar and club in particular, the growth rate for the retail.

As far as the second question, Judy, on inflation and pricing, it's way too early to be commenting on any of that.

I think, as John mentioned for this year, or Ron did, we're 80% hedged for 2010.

We'll see what happens in the back half of the year and when and if we decide to do something, then we'll notify the market.

Okay.

David, just going back to the channel question, maybe I missed this, but you said your share in cereal was down 20 beats, but you gained share in alternative, or you just said you did better in alternative?

Judy, it's John here.

We -- looking at the IRI data, it looks like we lost about 30 basis points a share.

If you look across all channels, it looks like we lost about 20 basis points.

So we did gain some slight share in the alternative channels, and that was primarily in club and drug.

And I think a part of that is some softer year-ago comparisons in those channels.

And as Davis said, those channels themselves are going because the consumer is shifting more into those channels.

Got it.

Thank you.

And our next question comes from Bryan Spillane from Bank of America.

Good morning.

Good morning.

If you could just give us a little bit more color on the EGGO rebuild.

First, in terms of, if I heard it right, you've got production capacity pretty much back to where it was before the disruption happened.

So that's the case, are you going to be shipping ahead of consumption for the next quarter or two as you rebuild inventories?

And then also, have you lost any shelf space?

Are you basically going back into the same amount of shelf space you were in before the disruption?

And then also, maybe if you could just talk about what you're going to do to sort of reengage consumers?

Will you price promote or advertise more?

Just trying to get a sense for what the plan is to get people back into the brand.

If you look at EGGO, our production is getting back nearly to where it was.

We have been focused on rebuilding our customers' inventories, and we need to continue to build our own internal inventories, so I don't think we're going to be shipping that much ahead of consumption going forward.

As you look into the back half of the year, we are now turning on more of our demand plan to try and drive demand.

And to do that, obviously, we'll have the whole range of our normal demand planning, demand driving initiatives, advertising, et cetera to try to bring that market back to its more normal level.

In terms of shelf size or shelf space, we'll say that we've been operating around 15 SKUs, it's going to go up to probably 19 SKUs.

We're well below the 40 plus that we had before the event.

So the good news is that the core is very strong and that the brand is very strong.

We're very confident the business is going to come back aggressively because we've seen consumers really hold in there with us, and I do expect a much better back half than front half.

Yes.

I'd also add that our customers have been very understanding through this difficult period, and I think that they'll be very supportive as we start to improve their service levels and really start to reengage with consumer activity in the back half.

And then, is the restoring of your capacity, is that all -- have you basically reinstalled or installed all of the equipment you needed to install, or is it because you've procured more co-packing?

We're still working on the capacity solution, so we have go additional capacity coming online later on.

Not -- probably towards end of the year.

Okay, alright.

Thank you.

Our next question comes from Terry Bivens of JPMorgan.

Please state your question.

Good morning, everyone.

Good morning, Terry.

Good morning.

Just in terms of the SKU rationalization, which you kind of surprised us with a bit last year, did that play any part in your volume performance, anything we should look at that there particularly going forward?

Yes.

I think Terry -- it did, and and it played into our share performance.

If you look at the impact of the SKU rates in the first quarter, it was about eight-tenths of a share.

That will be fairly consistent probably through Q2, and then will start to dissipate pretty significantly in the second half.

But we're not using that as an excuse, it was something that we needed to do.

I think it will end up being a positive for us, but as another factor why we're actually looking at the second half being somewhat stronger than the first half.

Okay.

And just one other quick thing.

Obviously the cut in advertising has something to do with your innovation calendar in cereal, I would think as well as the EGGO.

Is there anything, as we look forward and you're on your way to get to the increase in advertising you spoke of, is there going to be any particular quarter we should be alert to as being kind of a bulge on the upside in your advertising?

I think Q2, Q3 you'll see pretty strong increases.

The reason the first quarter was as much EGGO as anything.

We didn't have support for the EGGO brand in Q1 versus a year ago.

And then all it takes is for a campaign or initiative to slip from one quarter to the next, then you can have a point or two shift in your advertising spend.

So hopefully we've made it clear that there is nothing fundamentally change in our approach to advertising.

It's purely timing, driven by EGGO in Q2, Q3, you'll see stronger support and stronger activity for the rest of the year.

Okay.

Thanks very much.

Thanks.

Thank you.

And our next question comes from Todd Duvick of Bank of America.

Please state your question.

Hello, Todd.

Are you on the line?

Okay.

Our next question comes from Eric Katzman of Deutsche Bank.

Please state your question.

Hi, good morning, everybody.

Good morning, Eric.

I've got a bunch of questions.

Let's start with the share count.

I don't understand the math here.

Unless there is a ton of common stock equivalents that you think are coming due, even if you spend your normal $600 million, $650 million at roughly $55 a share, that's enough on a weighed basis to have a 1% reduction in your share count.

And it seems to me that based on what you've been saying, you're going to spend at least $600 million.

So can you till me why the share count shouldn't be down?

Eric, the exact amount that we intend to spend this year, I don't think we necessarily communicated that.

We did buy back some shares, as we discussed in the first quarter.

We do have options exercises that partially offset any share repurchases that we make.

And as I communicated earlier, we expect any share repurchases to be very back end weighted at this point in time.

It's more of a timing matter, though, than anything, Eric.

We can discuss it offline, but I just -- your cash flow is about as visible as -- it's better than a lot of countries.

(laughter) Why wouldn't you be buying back now if you're so confident?

I don't get it.

The idea that the financial markets have tightened up?

Not for you.

We remain very, very positive about our business and really, I think the timing of the buyback, the increase to demonstrate that we are returning cash to shareholders, both by the increase in the three year to $2.5 billion plus the 8% dividend hopefully sends that message clearly.

The timing of the buyback just gives us a little bit more flexibility.

But we remain very positive about the Kellogg stock.

Okay.

Second thing, on a more fundamental basis.

I don't understand how Mills, a month ago, kind of indicates that the cereal category, all outlets in the US is up 3 %.

And now you're saying it's down?

There's only basically been a month between the two of you.

So unless the cereal category fell off a cliff, which is just not possible, why is there such difference between the two kind of quotes for the category?

You'd have to ask them, but if we just you look at IRI data, whether you look at the four-week, the eight-week or the twelve-week, you're seeing IRI, which understates the category performance, down 5, down 3, down 2.5.

So even if you add back at least a couple of points for that, it would indicate that in the first month of the year, the second month of the year and the third month of the year to round out the quarter, the category was showing a degree of softness relative to a year ago.

And I think our view on that is primarily that relates to, as we said, the comps versus a year ago when the category grew 6% to 7%, which to be quite frank, I think was a demonstration of the shift we've seen in consumer patents, more people eating at home, more people actually buying cereal because it was great value.

The category got a significant bump this year, not that that has necessarily turned around That comp makes it difficult.

You have got retailers driving traffic to the stores, consumers being a lot more sensitive to value, buying on deal, channel shifting.

All of those things in combination meant that the category was down slightly.

But as we said, we think that may be the case in second quarter.

But as we get through the second half, we think the category is going to come back to more normal levels.

Okay.

Last question.

I'm not exactly clear -- not that it's the biggest thing in the world, but in answer to Bryan's question, John, I don't understand the EGGO waffle stuff.

I think he said that your production is now back to pre-disruption levels.

You've got 15 SKUs in the market.

You're going to 19, and you normally have 40.

So how can you be back to pre-disruption levels if you're only shipping back half of your SKUs?

That's unclear to me.

To be clear, Eric, we're not back to pre-production levels.

We're nearly back to pre-production levels.

So we are a little bit shy of where we were.

And the -- like any business, the 80/20 rule applies to the SKUs that we have, and most of the volume was going through those core SKUs.

I'm not sure when or if we'll get back to 40 SKUs, because some of those SKUs just weren't turning at the rate that that we probably should have had them turning at.

So I think we've got our core in place.

It's well served, and I think we can grow from this core.

Okay.

I'll pass it on.

Thank you.

Our next question comes from Chris Growe of Stifel Nicolaus.

Please state your question.

Good morning.

Good morning, Chris.

Hi, I just wanted to ask a question.

Earlier on, I think it was in your commentary, Ron.

You talked about overall tonnage being up about 0.5%, and I think you said cereal up 2%.

Is that a global cereal number you gave?

Yes, that is a global cereal number.

And that cereal being up 2%, global cereal, I think you said it was offset by Russia, China and some of the continuing activity there.

I think you also mentioned Brazil and Venezuela.

So is that -- to better qualify the Russia, the China, the Brazil, the Venezuela, was that about a 1.5 percentage point hit to volume in the quarter?

Could you give a little more color on that?

Yes.

If you sum all of those items up, Russia, China, they would be a big factor contributing to bringing us down to roughly a half a point of increase.

And I also mentioned that the peanut butter related recalls, EGGO, Venezuela, Brazil, those were virtually offsetting if you take those and wrap them together.

Okay, I got you.

And then I just wanted to ask about the promotional -- really, looking at your price mix component in the quarter, it was up a little over 1%.

Would that be -- or could you give me a little better feel for how promotional spending was in the quarter as well as your product mix?

Was mix positive and was commercial (inaudible)?

The benefit we had in gross margin from pricing was as a result of lapping some of the earlier in 2009 price increases that we excused.

So we got some benefit that, quite frankly, as we look to the future quarters, likely won't be there.

We did see a little bit of positive improvement from a mix standpoint as well.

Sir, does that complete your question?

Sorry.

We're having difficulty hearing on this end.

Okay.

We'll move on.

Our next question comes from David Palmer of UBS.

Please state your question.

Thanks.

Hi, guys.

Hello, David.

A question on base trends and material.

I know you're a fan of that metric, as am I.

Your base trends have been weak, we see it since the middle of last year.

Could you perhaps give an assessment as to why do you think consumer pull for Kellogg's portfolio perhaps started to weaken in that time, aside from the discontinuance of certain things like toast snacks.

And as we look ahead, obviously you have the benefit of comparisons you're pushing on some new health news with fiber.

But how do you see base trends and consumer pull perhaps rolling through the year and hopefully improving in 2010?

Thanks.

Yes, I think if you look at the soft base David, part of it is consumers volume more on deal.

If you look at our base of our core, for the quarter it's down in line with the category.

Our base has also been hurt by the SKU rationalizations.

Long-term, we'd like to see more base, and we hope to see that as we get into the second half.

And we're very pleased that overall, our profit was still very solid.

Dave, you don't see any sort of specific portfolio reason for that?

Obviously, their base trends haven't been uniform across the cereal world, but is there something that you thought that you were missing last year?

Is that the rationale for this fiber thing?

You just didn't have the wellness news to go to battle?

No, no.

The fiber additions and the number of our kids' products are all about our trying to strengthen and differentiate our foods and address specific nutritional needs in the populations we serve, and 90% plus of kids an adults in the US don't get enough fiber in their diet.

We try to add it in a way that doesn't impact the taste of the product so we can actually help address that deficiency.

But really, I think the basis is one of the causes.

There are a couple of other brands that on a year versus year basis, like Special K and All-Bran where we had very strong support in our year-ago, wasn't working and we pulled.

That's also impacted the base.

But in general terms, we'd like to see our base get stronger.

We're hoping that will happen in the second half.

Okay.

Thanks very much.

Thanks.

Our next question comes from Robert Moskow with Credit Suisse.

Please state your question.

Thank you.

Just a couple of things.

Can you give us a sense of energy costs rising?

That seemed to be the big factor in why you raised your cost inflation guidance for the year.

I think you were at 3%, and now you're at 4%.

So is that really a function of your direct store delivery and your expectation for cost there?

And then secondly, advertising expense.

Spot rates are rising quite a bit.

I've heard as much as 20% You're probably locked in for the most part;, but are you going to have to use the spot markets at all in the back half due to the shift in advertising that you're planning for the year?

Let me comment first on the cost pressures.

I believe we've previously told you approximately 3% expected increase, and now we're suggesting 3% to 4%.

We do have better visibility now that we've gotten through the first quarter.

We are seeing slightly higher increases in our factory costs.

Not necessarily related to energy, though fuel is ticking up a little bit.

I wouldn't say it's monumental.

We are spending a little bit of money in Brazil and Venezuela as a result of the disruptions that we saw there.

Remember, I mentioned also the commodities turn around a little bit on us, though it's included in our guidance.

We do still feel quite comfortable at hitting that 100 basis point improvement in gross margin, however.

I think, Robert, on the advertising question, we feel pretty okay for 2010.

We are noticing, as you're seeing, some spot increases maybe in the back part of the year.

So that may be something we are going to have to think about as we get more data and we look to 2011.

But the other area, of course, in the whole advertising mix is the increase to focus on digital and what we're doing to manage cost and drive efficiency will help offset and mitigate some of that as we go through this year and into next.

Great.

Thank you.

Thanks.

Our next question comes from Alec Patterson of RCM.

Please state your question.

Yes, good morning.

Just wanted to see, is there a figure you guys usually provide for the cost of goods per ton, ex-productivity, sort of your internal measure of what it was in the quarter?

I don't think we've given anything that specific.

No, we haven't .

Maybe the closest we've come to that is probably giving a sales estimate of around talk about 4% to 5%.

4% to 5%.

So we've talked about cost pressures being roughly 3% to 4% increase, savings are expected to be more in the range of 4% to 5% contributing to us getting to the 100 basis points of margin

Does that help?

?

Yes, that's fine.

And just -- I do have to, maybe it's just a comment, but circle back to Eric Katzman's comments about share repurchase.

Money back to shareholders, in effect, the dividend increase is basically in line, and the amount you were talking about for this year has been materially reduced on the share repurchase basis, so net-net, it's down.

So I guess, is there something on the cash flow outlook that's changed?

Can you give a sense of why the net amount here is being reduced?

What we have said is that we don't think that our shares outstanding are going to change much.

We haven't said exactly what we're going to buy back, when we're going to buy back.

We said that we don't think shares outstanding are going to change much this year.

But we've also said that regardless of where we end on share repurchases in 2010, we're very confident about hitting our 11% to 13% currency neutral EPS guidance.

Yes, I got that.

Okay, alright.

Thank you.

Thanks.

Alright, operator, I think that our hour is up, and I want to thank everybody for joining us today; and if you have any follow-up questions, please feel free to to call me.

Thanks a lot.

Thank you.

Again, ladies and gentlemen, does conclude today's teleconference.

We thank you for your participation.

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