家樂氏 (K) 2010 Q2 法說會逐字稿

Good morning.

Welcome to the Kellogg Company 2010 second quarter earnings call.

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

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

(Operator Instructions)

At this time, I will turn the call over to Kathryn Koessel, Kellogg Company VP 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 second quarter results.

Joining me are David Mackay, President and CEO; 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 www.KelloggCompany.com.

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

Actual results could be materially different from those projected.

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

As a reminder, a replay of today's conference call will be available by phone through Monday, August 3rd.

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

Now, let me turn it over to David.

Thanks, Kathryn, and good morning, everyone.

Our second quarter results were lower than expected, reflecting weakness in the cereal category, combined with the impact of our voluntary cereal recall at the end of June, and softness in our Eggo business.

The weakness in the cereal category had the greatest bearing on our Q2 results.

Throughout the first half of the year, we talked about the challenging cereal category and deflation.

Our results, and others of other cereal manufacturers, reflected these trends.

Although we anticipated a difficult quarter, the severity of the impact to our business was greater than we expected.

Our lower cereal sales resulted from difficult year-on-year comparables, the cereal recall, and inventory reductions.

John will talk about these in greater detail.

We continue to feel confident in the cereal category, and believe trends will begin to improve in the back half of the year.

Let me talk briefly about the voluntary cereal recall, which was due to an odor that came from the liner.

While we had relatively few complaints at the time of the recall, we knew that removing the product from store shelves was the right thing to do for our consumers.

The cost was high; the total anticipated earnings per share impact for the year, including lost sales, is approximately $0.12.

And we are currently pursuing all legal recourse to recoup the cost.

Over the past 18 months, we've experienced two events that have adversely affected our business; the peanut-related recalls at the end of 2008, and the recent cereal liner recall.

We are frustrated by these business disruptions, both supply-related, but I can confidentially say that they were unrelated to one another and unrelated to our cost savings programs.

And when it comes to quality and food safety, over the last few years we've actually increased our vigilance and ramped up our investment across the Company.

What these issues do have in common is the pressure that they place on our resources, both time and money.

While we are working to minimize the impact, they will cause disruption to our business, our employees, our customers and our consumers, and in this quarter to our total Company results.

The weakness in our cereal business in Q2, combined with the size of the cereal recall, drove our decision to call down our 2010 guidance.

It has always been our intent to take a realistic, open and pragmatic approach to running our business for the long-term.

This call down, while disappointing, will ensure that we can continue to the right things for the long-term health of the business.

As we said at the beginning of this year, we expect a stronger back half, as we anticipate category trends will gradually improve.

Of course, this will not happen overnight.

We also expect to have stronger innovation in the second half of the year.

We just introduced Fiber Plus cereal at the end of June, with strong initial results, and our snacks business has launched a strong lineup as well, and we will continue to invest in our business through increased advertising.

John will review the business in more detail shortly.

Even though we had a tough quarter, we feel good about the underlying health of our business, and the remainder of the year.

With that, I'd like to turn it over to Ron to discuss our financials.

Thanks, David.

Good morning, everyone.

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

As we have mentioned, we expected to have some tough comparisons in the first half, as well as some challenging operating conditions across our business.

What we did not anticipate was the degree of weakness in the cereal category and, of course, the voluntary cereal recall in June that directly impacted our results.

For the quarter, net sales declined 5% on a reported basis and 4% on an internal basis.

Approximately one point of the sales decline was attributable to the recall.

The softness in the Eggo business also contributed roughly one point to the decline in sales.

The remainder was primarily due to weakness in our US and UK cereal businesses, and the reduction of cereal inventory levels in the US.

Operating profit for the quarter also fell as a result of lower net sales, the recall, and an increased investment in advertising.

Operating profit was down 13% on a reported basis, and down 11% on an internal basis.

Earnings per share declined 14% on a reported basis, and 11% on a currency neutral basis.

The recall reduced operating profit by approximately 10%, and earnings per share by $0.10, including lost sales in the quarter.

As we looked at recent consensus estimates, we recognize that it was difficult to estimate the impact of the recall, given that we provided no guidance until today.

The accounting rules required us to book the majority of the impact in the second quarter.

We also expect a small impact in the third quarter.

For the first half, internal net sales declined 1%.

However, year-to-date internal operating profit was up 3%, and currency neutral earnings per share grew 7%.

Excluding the impact of the recall, internal net sales would have been flat; internal operating profit would have increased approximately 8%; and earnings per share would have increased approximately 12% on a currency neutral basis.

While sales were softer than expected, without the recall, year-to-date operating profit and earnings per share would have been in line with our previous full year guidance.

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

On a reported basis, our second quarter net sales declined by 5.2% year-over-year.

Internal net sales declined 3.9%.

The following components contributed to the overall change.

Overall volume reduced our internal net sales by 4.5 points.

Our lower volume performance was impacted by three different factors.

Over two points of the total Company volume decline was attributable to our US cereal business, which included approximately one point from the recall.

Softness in the Eggo business contributed one point; and the continued transition from bulk to packaged products in our Russia snacks business contributed another point to the decline.

Volume across the remainder of the our business was relatively flat.

Price and mix were positive and contributed 0.6 points of growth, and currency negatively impacted growth by 1.3 points.

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

On a reported basis, gross profit declined 7% in the second quarter, and gross margin contracted by 90 basis points to 42.6%.

The impact of the recall contributed 120 basis points to this year-over-year decline.

So without the recall, our gross margin would have expanded modestly.

As a result of the recall, and an expectation of higher commodity costs, we now expect gross margin to increase approximately 50 basis points for the year, in line with our year-to-date results.

We now expect cost pressures to be in the range of 4% to 5%, up from our prior estimate of 3% to 4%.

For the remainder of the year, we are approximately 90% hedged on commodities.

As we said in our first quarter call, our outlook includes commodity inflation in future quarters, as we begin to lap lower costs in 2009.

We plan to share our outlook for 2011 on our third quarter earnings call.

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

As David stated, we are committed to reinvesting in our business.

The categories in which we participate respond well to investment, and we believe it is important for the long-term health of these categories and our business.

As a result, we have not pulled back on advertising.

Instead, we have continued to invest.

Internal advertising increased 4% in the second quarter.

The US retail cereal, Europe, Latin America and Asia Pacific all increased advertising expenditures by at least mid-single digits this quarter.

Advertising was up 1% on an internal basis for the first half.

And, as we said last quarter, we expect our advertising investment for the full year 2010 to grow in the mid-single-digit range.

Slide eight reviews our internal operating profit growth by area.

Total Company internal operating profit declined 11%.

In North America, internal operating profit declined 16%, with the recall contributing 13 points to the decline.

In addition, the cereal pricing environment, trade inventory reductions at key customers, and softness in the Eggo business, contributed to the decline, and were partially offset by lower up-front costs in the quarter.

Europe realized a 6% increase in operating profit, as a result of lower commodity costs, cost savings and lower up-front costs.

These more than offset the softer sales and increased advertising spending.

The 10% decline in Latin America was a result of commodity inflation, increased advertising, the difficult operating environment in Venezuela, and, to a lesser extent, the residual impact from the temporary closure of our Brazil plant in the first quarter.

These items more than offset a mid-single-digit increase in sales.

While sales also increased in Asia Pacific, increased cost pressures and advertising investment contributed to a 10% decline in operating profit.

Note that Latin America and Asia Pacific are lapping strong double-digit operating profit growth in the second quarter 2009.

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

We remain committed to generating cash and returning it to share owners.

Year-to-date cash flow was $446 million, $89 million lower when compared to last year.

Lower cash flow was primarily due to the timing of cash tax payments.

We now expect our cash flow to be in the $1.15 billion to $1.2 billion range for the year, in line with our revised business outlook, which I will discuss shortly.

Now let's turn to slide 10 to discuss the impact of foreign exchange on earnings per share.

Since our guidance is on a currency neutral basis, each quarter we provide an estimate of the foreign currency impact on our full year earnings per share.

Slide 10 shows our key currencies for 2009 actual rates, and current spot rates as of July 26, 2010.

Based on these spot rates, we estimate full year 2010 foreign exchange to be unfavorable $0.04.

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 adjustments to our full year 2010 outlook.

As David mentioned, we are lowering our guidance for 2010.

This change reflects the weaker business performance in the second quarter, and the voluntary cereal recall.

We still expect to have a stronger back half based on the comps, coupled with increased innovation and advertising.

But remember that we have more difficult sales and earnings comps in the third quarter, and easier sales and earnings comps in the fourth quarter.

We expect internal net sales growth to be flat to up 1%.

Internal operating profit growth is now expected to be in the 4% to 6% range.

As you recall, we had strong operating profit growth in Q1, and for the first half, we were up 3%.

This guidance also includes our intent to grow advertising in the mid-single-digit range.

We will continue to execute our three-year, $1 billion-plus, cost savings challenge, and expect that gross profit margins will expand approximately 50 basis points for the year.

With this outlook on internal operating profit and slightly lower average shares outstanding, we expect our currency neutral earnings per share growth to be in the range of 8% to 10%.

On the next slide, we have laid out the key changes to our 2010 earnings per share guidance.

The primary driver to our lower earnings per share guidance is the voluntary cereal recall, which is expected to have a negative 4% impact.

In addition, the softer business performance reflects another 1% to 2% decline.

However, embedded in this guidance is up front costs of $0.12 per share for 2010, compared to our prior guidance of $0.16.

This contributes a positive 1% to the earnings per share guidance.

Note that lower up front costs were driven by reduced costs of the initiatives, not the number of initiatives.

In addition, we remain on track to achieve our three-year, $1 billion-plus cost challenge.

We estimate that the reduction in average shares outstanding should contribute another 1% to 2% to our earnings per share.

As I mentioned earlier, we now expect full year 2010 cash flow to be in the range of $1.15 billion to $1.2 billion.

We will continue to return cash to share owners under our current three-year, $2.5 billion share repurchase authorization.

Year-to-date, we have repurchased $356 million worth of shares.

We currently assume that we will decrease average diluted shares outstanding by approximately 1% to 2% in 2010.

We will update you on the third quarter call on our progress.

And now I will turn it over to John Bryant, to cover our North America and international results.

Thanks, Ron.

Let me begin with North America.

Internal net sales declined 6% in the second quarter, and were down 2% for the first half of 2010.

In the second quarter, net sales for the North America ready-to-eat cereal business decreased by 13% versus last year.

While disappointing, the 13% decline can be explained in part by three factors.

The first factor is weak consumption against tough comps.

Second is the cereal recall at the end of the quarter.

And, finally, the correction of elevated trade inventory, which we flagged at the end of the first quarter.

First, looking at consumption, we estimate that the category declined by 2% to 3% in value during the quarter.

We believe that our total channel consumption was down around 5%, leading to a loss of approximately one share point.

A large part of the decline in the category and in our consumption can be explained by the comparables.

In the second quarter last year, the category grew around 4% in value, and our total channel consumption was up approximately 6% to 7%, resulting in approximately one share point of growth.

Our share gain last year was largely due to Post going through some integration issues; as we lapped last year, Post has regained some share.

It is also worth noting that the SKU rationalization last year adversely impacted our second quarter results by 1% to 2%.

In addition, our innovation this year is more back-end loaded.

The second factor, as David has already talked about at length, was the voluntary cereal recall.

While this occurred at the end of the quarter, we were required to reverse the sales of all products which were subsequently returned.

The net impact was a reduction in sales of 5% in the second quarter in North America retail cereal sales.

Finally, we flagged at both the end of last year and the first quarter that we had higher retail inventory than we were comfortable with; and we saw this reverse out in the second quarter, resulting in an estimated 3% adverse impact on shipments.

So contributing to the 13% net sales decline is a 5% impact from weak consumption, largely due to a tough year-ago comparison, a 5% decline from the recall, and approximately 3% from a retail inventory correction.

While these three factors help explain the results, we do not pretend to be satisfied with the performance of our cereal business.

On a more positive note, we gained cereal share in Canada in the quarter, and have seem some very promising early results from innovation in the US.

Both Fiber Plus and Cinnabon cereals have shown strong early performance, with an 0.4 share and 0.3 share respectively.

As we look at the remainder of the year, we expect to have weak consumption in the third quarter, as the impact of the recall will show up on shelf, but expect better performance in the fourth quarter.

We will have more advertising pressure and more innovation in the back half, and we remain excited about our long-term prospects in this important category.

North America retail snacks posted internal net sales growth of 1% for the second quarter and 3% for the first half, reflecting strength in the Pop Tarts and Wholesome Snacks businesses.

The Pop Tarts business delivered another strong quarter, with net sales up mid-single-digit, and gained two points of share.

Innovation and strong brand-building supported this iconic brand's continued growth.

[Store door] cracker sales were down slightly in the quarter.

Our overall share was flat, as we decreased our promotion activity in the second quarter in order to return to more balanced levels.

Late in the second quarter, we launched a range of new products, including two variety of Townhouse Flatbread Crisps, Club Minis, and Cheez-It double cheese snack mix.

Our cookie business declined in the quarter against a tough year ago comparable, when we launched the Mother's business.

Recent innovations, including Fudge Shoppe Coconut Dreams, and 100 Calorie Right Bites Mini Brownies, are performing well.

We expect cookies to continue to be a tough category for the remainder of the year.

Momentum in our Wholesome Snacks business continued into the second quarter, delivering strong sales growth and maintaining our share leadership in this growing category.

The successful introduction of Special K Fruit Crisps at the end of 2009, and the strong performance of Fiber Plus bars, continue to drive growth.

We also launch stood new SKUs in NutriGrain bars in the quarter.

For the remainder of the year, we anticipate continued growth in Wholesome Snacks and Pop Tarts, combined with a slight improvement in crackers and flat performance in cookies.

We feel good about our strong innovation throughout the back half of 2010, much of which was introduced at the end of the second quarter.

Turning to the frozen and specialty channels business.

North America frozen and specialty channels' second quarter sales declined 9% versus last year.

This was driven by the softness in our Eggo business, which was adversely impacted by our supply constraints and a tough double-digit growth rate comparison in the prior year.

It is also worth noting that the performance in the second quarter was weaker year-on-year compared to the first quarter, due to a higher trade inventory rebuild in the first quarter.

Towards the end of the second quarter, we had enough capacity in our network to return to demand-driving activities such as advertising and trade promotion.

We are beginning to see the business respond to these drivers, and expect it return to modest growth in the back half of the year.

We also introduced new products with Eggo Cinnabon Pancakes and Eggo Real Fruit Breakfast Pizzas launching at the end of the second quarter.

We continue to work with our customers to help reset freezers, to regain space that we lost when we were unable to maintain supply.

The combination of new products, improved freezer space, and increased advertising pressure, should help drive improved performance in the back half of the year.

In addition, the Veggie Foods business continued to perform well in the quarter, and our Food Away From Home business also showed positive growth.

Turning to our international business.

Our Latin America and Asia Pacific businesses continue to deliver solid sales growth, while weakness in Europe muted the growth of our overall international business.

Europe internal net sales declined 3% in the second quarter, driven primarily by two factors; a weaker UK cereal category, and continued volume declines in the Russia snack business.

Similar to the US, many food categories across Europe experienced deflation.

In the UK, our largest European market, we gained share in the quarter but our sales were down, reflecting a 4% decline in the category, which was up against a very tough 7% growth in the second quarter last year.

At the end of the first quarter, trade inventory in the UK was increased in preparation for Easter promotions.

The UK ended the second quarter with inventory levels similar to a year ago.

In Russia, the migration from bulk to packaged snacks drove lower volumes, and contributed to Europe's lower topline results.

With a weak local economy, the transition has taken longer than we originally anticipated.

To stem the short-term volume declines, we are protecting our bulk business, while pushing harder to gain more trade support for our packaged snacks.

We expect to see less of a negative impact from Russia in the back half.

And while we were disappointed in the performance of our Russia snacks business, our cereal business in Russia had strong growth during the quarter.

Latin America's internal net sales rose 5% in the second quarter, on top of last year's healthy 8% growth.

Internal net sales were driven by price increases in Venezuela and strong cereal growth, particularly in Mexico.

Double-digit consumption growth in Mexico was not fully reflected in our net sales performance, as retailers reduced inventory in the quarter, and we lapped an inventory build last year due to the H1N1 virus scare.

We continue to expect Latin America to deliver mid-single-digit internal net sales growth for 2010.

Asia Pacific delivered internal net sales growth of 3%, driven by strong topline performance in Australia, South Korea and India.

Both Australia and South Korea saw strong second quarter category cereal growth.

We are currently launching a new Sultana Bran product, which will increase our healthy offerings in Australia, and Heart-to-Heart Oat cereal in India.

For the year, we continue to expect mid-single-digit internal net sales growth from our Asia Pacific businesses.

Now let me turn it back over to David.

Thank you, John.

We are committed to continuing our track record of sustainable and dependable performance, and while we believe that our second quarter is not indicative of the potential of our Company, it is never positive to have such a weak quarter of performance.

We feel it is essential to face the issues that created this weakness, and reflect them as accurately as possible; hence the lower guidance.

Our view, and we believe the view of our shareholders and investors, has always been to be open and transparent, and to ensure we do what is right for our business over the long-term.

While we expect the tough environment to persist, we continue to invest in our business to drive future results.

We have confidence in the long-term health of our business, and remain focused on managing the business for sustainable and dependable performance.

I'd like to thank all the Kellogg employees for their dedication and hard work, and before I conclude I'd like to congratulate John on his election to our Board of Directors.

Those of you who have had the pleasure of interacting with John know that he has a great breadth of knowledge about our financial and business operations ,and we are pleased to have him join the Board.

And now I would like to open it up to your questions.

(Operator Instructions)

Our first question comes from Eric Katzman of Deutsche Bank.

Please state your question.

Hi, good morning everyone.

I guess my question has to do with -- we've talked a lot in the past about the advertising efficacy, and it looks like excluding the recall and maybe even the Eggo waffle problems, your volume on the business is still I guess about flat, and yet you continue to raise advertising.

You are one of the highest, percentage of sales.

I guess I will follow-up, but what do you think is the issue, is it the new products, is it just the macro environment?

Maybe you can touch on that, Dave?

I think, Eric, when you look at it, because really when you look at the quarter, the US cereal category and our performance within it, to a lesser extent the UK cereal category, and the recall, are the major issues that we've tried to lay out as we went through the Q2 results.

If you look at the category, as John said when he went through, it's -- deflation exists in the category.

We saw it.

We talked about it at Q1.

It's actually a little bit worse than we expected.

But as we've reflected on it and did the analysis, no question that Post, and the fact that the year-on-year comps, when they were out of the market last year and have come back this year, have had an impact.

I think retailers pushing and using the category to draw traffic in has exacerbated in the short term the situation, and no doubt consumers are continuing to look for and buy on deal.

So I think all manufacturers in the short term have seen some of their costs come down, which has probably meant their activity has gone up a little bit.

Our view and our outlook, as we look to the back half and going forward is, the cereal category is a great category.

We think once Post laps Q3, that the level of investment tactically should moderate as costs go up.

For us, as we look at the performance of Kellogg specifically, and take the 5% decline in the US, we had a small impact from the SKU [charge], it was probably about 1% or 2%.

So if you look at that relative to the category, while we are not happy with the performance, we can understand it.

John mentioned our innovation in the back half is much stronger.

We are seeing very good performance out of Fiber Plus and a couple other innovations we've launched.

And on your question specifically on advertising investment, our belief is that while we are one of the highest spenders, if you look specifically in the category, it tends to be a fairly high investment category, and we have real opportunity to build stronger capabilities in digital.

We have real opportunities to increase the level of communication with Hispanics; and those plus other opportunities on new products, and investments around the world, will see our advertising grow.

I think mid-single-digits is a very good level for us, and we feel very comfortable that over the medium to long-term we will get a good investment return for that.

If I could just follow-up on the recall specifically, I think it was probably a lot greater than most people were expecting, and I'm just kind of worried to the extent that the recall has a brand equity impact.

I mean, sometimes these things are short term and the consumer comes right back, but are you seeing -- you mentioned some new products performing well, but are you seeing any lingering impact in terms of consumption on some of the core brands where the recall was greatest?

Our view would be that while in Q3, for the three or four weeks of the quarter, mainly through July, we will see an impact, because in some retailers we pulled all of the stock, and it's going back in.

There just wasn't the availability.

So we've seen that in the first week of data through July on those affected brands.

But because we acted so responsibly, I believe, in voluntarily withdrawing all of the product, I don't believe there will be a long-term impact on that very strong equity.

I will pass it on.

Thank you.

Thanks.

Our next question comes from Chris Growe of Stifel Nicolaus.

Please state your question.

Hi, good morning, guys.

I just had a two questions for you.

The first was, it's been made clear by some of your competitors in the category, but how would you characterize your returns of your promotional investments?

Was the nature of the competition in the quarter that made it to where you were promoting more heavily but not seeing the return, or was it the consumer?

And just curious if you think that any of that kind of lingers into the second half of the year?

I think if you look at the return on promotions, with everyone being a little bit more active, there is a sort of offsetting effect where no ones promotions are really working as well, because there's just too many offers in the market.

So I think that reduces the benefit and return from promotional activity.

Our view would be as we look at our back half, certainly we are going to be watching our level of promotions very carefully.

And I think at some point in time, we will see the level of deflation in the category abate and go away, particularly as cost pressures start to increase.

Is that this year you think, or more next year in 2011?

I would say it's probably going to be towards the end of this year and going into next year.

Okay.

And just one follow-up, and I guess a question for Ron or for John.

In relation to your earnings growth, your EPS growth guidance, we know the clear effect from the recall; that seems to account for the majority of the decline.

Even if you take into account up front costs being down, I mean, your guidance really hasn't changed much for the year; so is there a degree of real improvement for the second half of the year that you see?

It is going to require that, it would seem like, in 3Q and 4Q to really make that full guidance; or am I looking at that the wrong way?

We do expect, as we said, a bit better performance in the back part of the year.

You can see that our sales were down 1% in the first half, and we are calling our sales up flat to 1% for the second half; so there is a bit of business performance improvement, as well as a benefit from lower average shares outstanding as well.

Okay.

Thank you.

Our next question comes from Robert Moskow of Credit Suisse.

Please state your question.

Thank you.

I guess my question is about the innovation that you do have for the seconds half, David and John.

If -- Fiber Plus feels a little bit like a "me, too" kind of product.

I was kind of hoping that you would talk a little bit about the pipeline for 2011 and maybe some -- start getting us excited about things like that.

I know Post is planning a lot of new products for January, and they've already showed it to the trade.

Is there anything that you can kind of hint to, in case the second half and Fiber Plus doesn't quite achieve what you thought?

Robert, if you look at our innovation here in the back half, I think we are doing very well with Fiber Plus and with Cinnabon, and I guess 0.4 and 0.3 share respectively in the latest 12 weeks -- in fact, the latest couple weeks, Fiber Plus has been over 0.5 a share point in terms of performance.

So I think we are getting good momentum behind that innovation.

We have a stronger innovation lineup for the first half of 2011 than we had in the first half of 2010.

We have not shared that with our retail partners yet, so we can't talk about that on this call, but we do -- we are excited about the upcoming innovation pipeline in US cereal.

Okay.

Do you feel though that Fiber Plus and Cinnabon, did they -- have you done any kind of work on whether it cannibalized your existing lines?

Because those shares were up, but others must have been down.

Do you know where those products took share from?

No.

We look at the switching analysis, the [turf] analysis for all new products, and actually we are quite comfortable with the incrementality to our portfolio.

You think about Cinnabon, we don't have a heavy cinnamon portfolio, and then Fiber Plus, good tasty fiber is quite healthy for our portfolio.

Okay.

Lastly, a lot of people have raised some questions here about product quality and the recalls.

It seems to be two separate incidents.

Are you doubling up your efforts, though, when you talk to your suppliers to make sure that they are not cutting corners to achieve your cost reduction goals?

Robert, absolutely, particularly in an environment where a lot of businesses are under pressure, there is an increased focus in diligence in working with our suppliers to ensure that they understand that they must meet the high quality standards that Kellogg Company has set and expects of them.

Okay.

Thank you very much.

Our next question comes from David Palmer of UBS.

Please state your question.

Thanks, hi, guys.

Hi, David.

The revenue guidance of flat to up 1% we estimated implies something like a 3% currency neutral revenue growth in the second half, including maybe a one to two-point ding from currency, it would be less than that.

But 3% currency neutral revenue growth in the second half, versus about a 1% currency neutral decline in the first half; I guess my question is, does that sound about right?

And your North America cereal business, I'm assuming that's going to lead the sequential improvement, in your view?

Do you see cereal revenue going back to growth in the second half?

I think, David, the way I would look at it is more 1% to 2% in the back half, to get to our zero to 1% for the year.

And when you look at cereal, as we said in the third quarter, we are going to see the impact of the recall, so cereal is still going to be under pressure; and while we expected to have a better fourth quarter, our view would be that for the back half it's going to be more flat, or flattish.

So that's not going to be the key driver.

And that's why when we gave the forecast, we did call down our net sales to zero to 1% for the year.

Just a follow-up, I know we are going to talk a lot about cereal, but could you perhaps zero in on the state of that category today; a year ago or so and this is the epitome of rational, profitable growth as a category.

Obviously, there has been some issues with category profitability.

Folks point at consumers, the retail customers and their actions, and then the competition, notably promotional activity from Post; but could you perhaps go back and take another crack at it in terms of what's going on with this category?

Yes, I think all of the things you mentioned play into what we are seeing in the category this year.

I think when you think about the category in the first half of 2009, the four major developed markets in the world, the category grew anywhere between 4% and 8%.

I think with hindsight, we probably underestimated the difficult change that would create for 2010.

We knew it would be a challenge; that's why when with come into the year, our expectations for topline were probably more moderate than people were expecting.

Then you look specifically at what's unfolded this year.

Post really, as we dug into the data, was out, and has come back in, and are probably back to more historical levels.

I think all manufacturers, because of lower costs, are probably putting a little bit more money back into the market to reflect the consumer -- their consumers being under pressure.

Consumers clearly across all categories, I think, are buying more diligently on deals when they can get it, and using coupons.

And the retailers themselves see the cereal category as a great traffic-builder, so are actually using it in ways that may help with traffic, but may not help with the overall strength of the category.

So you put all of those things into combination, and what you see is a very stark difference this year to last year, partly because of the comps, and partly because of those competitive dynamics.

But our view would be, this is a great category.

We will see that dissipate, as we move through the back half of the year.

And as costs increases, invariably they will as we go forward, we would expect to see the category start to perform on a more normal basis.

Thanks, David.

Thanks.

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

Please state your question.

Good morning, thanks very much.

I wanted to follow up a little bit on Eric's question, just specifically -- forgetting about the customers reaction to the recall, managing changeovers in this industry, as some others have recently taught us, is logistically pretty difficult.

Are there still places right now where we speak where there's out of stocks and supply chain interruptions, and also like problems with getting back on promotional calendar type of thing?

There's certainly no question, Jonathan, when you go through something like this it disrupts the organization and our retail partners.

We are fortunate that we were able to get back into production very quickly, and start refill the pipeline.

I think most of those customers now are back.

But some of our trade activity was obviously disrupted in July and even into August, so it has had an adverse impact on us, and it is -- it does become a large focus for the organization, and so that is distracting.

But I guess I was asking at the retail level, you feel pretty good about where you are?

I think we feel good about where we are at the retail level; obviously it's the sort of thing we don't want to have to go through.

Right, completely understood.

Just one other thing.

I'm trying to understand, as you restore capacity to Eggo here, and presumably there's going to be some cost to get back on the shelves as you kind of walk capacity back up, shouldn't there be a period of time, though, that the contribution margin should be very impressive from Eggo, as you sort of releverage not only the brand investments you've made, but just capacity, distribution, et cetera, over the next 12 months?

We do expect to continue grow the Eggo business.

And as you said, we are in the process of resetting some freezers in the third quarter, getting back up to a fuller distribution level in Eggo.

And incremental volume is highly profitable for us; obviously, we are turning back on advertising and brand-building support, so that's going to mitigate the operating profit benefit from getting back into the Eggo business, but it's a big opportunity for us in the back half of the year.

And it's early days; we will see more the benefit of this I think in Q4, when we lap an easier comp.

Q3 is still a more difficult comp for us.

Great.

Well, thanks very much.

Our next question comes from David Driscoll of Citigroup.

Please state your question.

Great.

Thanks a lot.

Good morning, everyone.

David, can you talk about your cereal promotional calendar for the second half of 2010?

Specifically, what I'm worried about is Post and their continued promotional environment.

Are they taking events that you otherwise would have had?

What's your confidence in second half 2010 promotional calendar for Kellogg's cereal?

All I can really say on that, David, is we are taking the appropriate response and attitude as the category leader in the category to manage what we do going forward to try and drive the category and our business.

Don't you have, or maybe you can say that you do have, visibility -- maybe you can't tell us or don't want to tell us, but you do have visibility on that promotional calendar for six months; that's correct, right?

That's correct, right.

Well, certainly three or four months out.

One follow-up on the Eggo business, John, I believe that you said that Eggo sales would be up just modestly in the back half of the year, Q3 and Q4.

One thing I don't understand about that is, given how weak it was in the year ago period, if you've restored the capacities and are now achieving much higher levels now, why wouldn't the expectation be for significantly better numbers, just given the weak compares?

I think you will see significant growth in the fourth quarter, when there is quite a weak comparison.

In the third quarter, though, it will be -- hopefully we will see growth in the third quarter, but it will be very modest growth.

And part of that is we do need to get back improved distribution across our key customers.

We do need to get some of these SKUs more on the shelf, and turn on our advertising and our promotional activity.

So there is a need to bring the consumer back into the business.

Thanks for the answers, and thanks for all the disclosure today.

Thanks.

Our next question comes from Terry Bivens of JPMorgan.

Please state your question.

Good morning, everyone.

Good morning, Terry.

Two things this morning.

First of all, if you look at it, and I know sometimes our figures vary a little bit from what you guys are looking at, but on a brand analysis, one thing that concerns me a bit is some of your more profitable pricier cereals, I'm looking at Smart Start, for example, Raisin Bran, Crunch, Special K, had what I would call pretty disappointing performances, certainly in the ACNielsen data.

What worries me there, David, is do you think there's an internal trade down going on in the cereal category from some of those -- you know, you guys are famous for volume to value, make sure I get that right, but I guess I would look at the data and start to worry that maybe there is a trade out of some of the pricier, higher profitability cereals?

Good question, Terry.

There's a couple of things going on there.

I think with Smart Start, was one you use das an example, we've actually reduced our investment in Smart Start and moved it elsewhere in the portfolio, and that's one of the reasons why that business is down.

I think also what you seeing a little bit in the cereal category is a drive towards utility.

All family products are doing well, highly-focused brands against (inaudible) needs [state] in general are not doing as well in this current environment; I think that's a reflection of the consumer.

Having said that, I think you can point to a couple of businesses where you are getting some good growth, and they are reasonably high-priced.

So, for example, we are seeing double-digit growth in Bear Naked, and we are seeing good growth in Kashi.

So it's hard to generalize; I think what you are seeing is some movement of money around the brands, and you are seeing a general consumer drive towards utility.

Okay.

Thanks for that.

And the other thing, you know, obviously the trade inventories were an issue here, a little bit more than I thought they would.

Where do we stand now going forward?

Are you satisfied with inventories at the trade level?

I think in US, we are in very good shape from an inventory perspective, as well as in the UK cereal business.

Okay.

Very good.

Thank you.

Our next question comes from Judy Hong of Goldman Sachs.

Please state your question.

Thanks, good morning.

I guess I just wanted to go back to cereal in the US, and just really want to understand, it seems likes there are a couple of issues.

One, at the category level, you have kind of talked about the tough comps, and a lot was really driven by pricing being pretty robust last year; obviously, now you are seeing pricing down, but it doesn't seem to be driving volume pick up, as much as the pricing down or the promotional activity being pretty intense.

So I just want to understand why that is the case, and why that should get better in the back half?

So that even if pricing doesn't necessarily get better, should we expect to see actually volume get better in the back half?

And then secondly, at the competitive level, I mean, it just seems like you've got even players like Quaker talking about spending more money in the category.

Obviously, you're raising investments both in the brand side and some of the promotional activity.

Does the competitive environment get worse before it really gets better?

Can you just help us understand how that kind of plays out, the path to getting better, I guess, in the next six to 12 months?

Judy, if you step back and look at the cereal category, one of the reasons it is such a great category it is highly responsive to brand-building and innovation; that's what drives the category over the long term.

The category from a pricing perspective is actually not all that elastic, in that the volume didn't go down significantly last year, and some of the pricing came up, and didn't go up this year and the pricing came down a little bit.

So it's not a category that you can win long-term through the pricing, really You get there through brand-building and through innovation.

I think some of the deflation we are seeing in the category this year is actually a bit of an anomaly.

If you look at 2009, and let's look at Post, they had some integration issues last year, and their price per pound last year was up about $0.25 year-on-year in the second quarter.

This year, their price per pound in the measured channels is down around $0.25.

So a lot of what you are seeing actually is a disruption in one particular competitor coming back to I guess what is more normal levels, that will be there for the second quarter and the third quarter.

I think as you go into the back half of this year and into next year, as you get cost inflation coming through, you would expect to see less deflation, and potentially return to an inflationary environment in the cereal category.

Okay.

And then if you think about -- just in terms of the promotional activity across the category amongst the major players, is the level of spending now pretty comparable across all players at this point?

I mean, I guess your point is last year Post just underspent, so now they are getting back to kind of the normalized level, and then as that happens you really shouldn't see one player kind of disrupt the category dynamics?

It's always an intensely competitive category.

There's always some gives and takes across manufacturers.

I think the share of incremental is broad; we share a base with most players.

So there's always movements from one quarter of one year to the next.

Okay.

Can you help us, how do you envision European sales playing out in the back half?

It sounds like the UK, it may continue to be challenging there, so do you expect sales to also get better in the back half, if you just exclude the inventory movement that hurt you in the second quarter?

Within our guidance, it's fairly flat-type sales for Europe in the back half, and there's a couple of reasons for that.

Certainly, the UK had a great year last year, and that continued even to the back half of the year, so we've got some pretty tough comps to lap.

We are gaining shares, as I said, in the UK, but it's just a tough marketplace.

In Continental Europe, in general the economy is pretty tough in Continental Europe.

Consumers are under pressure.

We are actually gaining some share in some big markets in Continental Europe.

Hopefully, we will see some improvement there in the back half of the year, but it's certainly a tough environment.

Then as I said, in Russia, the bulk sales within snacks, as we transition from a bulk business to more of a package business, we've seen some of the bulk sales slip a bit more than we wanted to, and the package sales take a bit longer.

Hopefully, we can get a better balance in the back half year.

The great thing on Russia is, you know, we bought that business to drive the cereal -- or to create a great cereal platform, and our cereal business in Russia, which is about a third of our business in Russia, is up 40%.

So we are seeing some good long-term potential there.

Okay.

Thank you very much.

Our next question comes from Vincent Andrews of Morgan Stanley.

Please state your question.

Hi.

Thank you.

Good morning.

A couple of questions here.

First, I guess maybe on the share repurchase, just wondering, given what your stock is doing today, and sort of the outlook for the balance of the year, why you are not being more aggressive with the existing program?

As we indicated, we did by more shares in the second quarter, and we are essentially using the available cash that we have after dividends to repurchase shares.

We think now our average diluted shares outstanding will be 1% to 2% better.

Depending upon the timing and price that we can purchase the shares at, we believe we will end up purchasing probably somewhere between $600 million and $1 billion worth of shares in total for the year.

If you think about it, that's roughly a third of the $2.5 billion authorization that we have outstanding.

I know, but just that third would account for what you should have done last year, and then sort of the run rate of this year.

So I'm just wondering, why not be a little more aggressive?

I think Vincent, in summing, we will certainly look at and be considering as we go forward, and we will give you an update in Q3.

I think the only thing we'd say is what was built into the guidance we gave you is what Ron went through, but the point you make is a very valid one.

Fair enough.

Maybe if you can just help me understand, you said the up front costs are coming down but the number of projects is flat; so what's changed that's allowed the cost of those projects to come down?

It's just the estimates that we had in previously for the year on some of those initiatives; we were able to execute those at a lower cost.

So it has nothing to do with the actual execution of the initiative, and driving our cost savings initiatives going forward.

Then lastly, you increased your input cost inflation for the year.

Could you just give us a sense what items are driving that?

Yes, the primary driver there, and I alluded to this briefly in the communication, is higher commodity costs, particularly sugar and packaging costs, and sugar primarily in the US and Mexico, and then packaging in North America.

Okay.

Thank you very much.

Christina, we are approaching 10.30, so we can take one more question.

Yes, thank you.

Our last question comes from Alexia Howard of Sanford Bernstein.

Please state your question.

Good morning, everyone.

Just coming back to the cost saving program, I guess we are now about halfway through timewise in terms of the $1 billion challenge; I think it was a three-year program ending the end of next year.

Could you talk a little bit about how far through in terms of the cost savings you are, and whether you expect that will -- I mean, you talked about a reduction in the cost of actually getting off of these initiatives this time around; is that likely to persist into next year?

So really how do you see the benefits and the costs playing out as we run through the end of the program next year?

We actually have very good visibility to our $1 billion challenge savings.

We estimate roughly $400 million, perhaps a little bit more, in 2010; and we have good visibility into 2011 to achieve those cost savings as well.

So the fact that our costs for some of the initiatives have come down has not impacted our visibility to the savings.

So you are a little more than halfway right now, in terms of the savings from the overall program?

We are a little bit more than halfway, in terms of the savings.

Great.

Thank you very much.

Yes.

Thank you very much for joining us today.

If you have any additional questions, please feel free to call me.

Thank you.

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

We thank you for your participation.

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