家樂氏 (K) 2010 Q3 法說會逐字稿

Good morning.

Welcome to the Kellogg Company 2010 third 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)

Please limit yourself to one question during the Q&A session, 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 third 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 web site 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, margin, operating profit, interest expense, tax rate, cash flow, brand building, up-front costs, and inflation are forward-looking statements.

Actual results can 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 Friday, November 12.

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.

2010 has been a difficult, disappointing year for the Company.

I know there are many questions about what has happened to Kellogg, and why, and when we expect better performance.

We're confident that we can regain momentum as a Company, and this confidence comes from an understanding of what has happened in our business over the last two years, and a conviction that we're well positioned for the future.

To understand our confidence in the future, it is fist necessary to recognize what has taken us off course in 2010, and there are four major issues.

First, we've had significant issues in our supply chain.

We've weathered the two largest recalls in our history during the past two years.

We've also been impacted by production challenges in our Eggo facility.

We have a long-standing commitment to food quality, and the recent voluntary recalls have demonstrated our commitment to putting consumers first.

We've taken steps in our supply chain to mitigate similar potential risks.

This includes additional operating expense across 2010 and 2011, as well as slightly elevated levels of capital spending in 2011 and 2012.

It is difficult to quantify the true impact of these supply disruptions.

There are the clearly-defined costs associated with the recalls, and the softer costs associated with lost sales.

To put the impact of these issues into context, we estimate that the various supply disruptions adversely impacted operating expense by $200 million to $300 million over the last two years, and impacted capital expenditures by $150 million to $200 million, for a total impact approaching $0.5 billion.

In addition, there is also the organizational impact of focusing large numbers of internal resources on proactively identifying and resolving the issues to mitigate risk going forward.

I believe that these supply disruptions clearly distinguish the last two years from the preceding eight years.

Second, we've had significantly less innovation during 2009 and 2010.

As we entered the recession, we pulled back on innovation and drove increased renovation across the portfolio, such as adding fiber to our kids cereals.

The renovation has set-up our portfolio for the future, but did not drive short-term sales performance.

The lower level of innovation, combined with the SKU rationalization has weighed on our top-line growth.

It's always difficult to quantify the impact of reduced innovation, but as a guide, we launched about $800 million worth of innovation in 2008.

In 2009 and 2010, our innovation was roughly 25% lower than in 2008.

The good news is that we are moving forward into 2011 with a weight of innovation that is going to increase significantly.

Third, we have some tough comparisons in 2010.

Both in the overall strong 2009 cereal category growth globally, and in the non-measured channels.

In 2009, we had abnormally high growth from the non-measured channels as we work closely with some large customers in that group.

However, in 2010, our competitors picked-up more of the activity that we had enjoyed in 2009.

To give you a sense of the impact, we estimate that this has resulted in an approximate two-point drag on our top-line in the US cereal business.

I think the last two years have reinforced several key truths regarding the US cereal category.

For most retailers to do well in the category, the key branded players need to excite consumers and, most importantly, the category is driven by health news, innovation, and brand building.

Promotional activity has not proven to grow the category over time.

Fourth and finally, deflation has been an issue in our core cereal categories around the world.

Managing through this deflationary cycle has been much more difficult than we had anticipated.

Heading into 2011, we anticipate cost inflation at much greater levels than in 2010.

Historically, retailers have accepted price increases to offset cost inflation of this magnitude, and we believe that a combination of pricing, mix, and trade spend could yield 200 to 300 basis points of net price realization for 2011.

It is also worth stating what has not impacted Kellogg in 2010.

One thing we have not done is cut back on brand building.

Instead, we have continued to invest back into our brands at industry-leading levels.

So, there are several specific issues which differentiate 2010 from the prior eight years.

As we head into 2011, we're confident that we can succeed by playing our game; continuing to invest in brand building and driving sustainable innovation in the market place.

Despite our long-term confidence, we need to remain pragmatic.

It will take time, focus, and effort to regain out momentum.

We will stabilize our supply chain and mitigate the risk of future disruption.

We will ramp-up our innovation.

We will keep our people focused on the key drivers of our business, and we will add value back into our categories.

We believe that we can achieve all of this, but it will not be done overnight.

It is not as simple as lapping soft comparisons.

Hence, we're providing realistic guidance for 2011 to enable us to regain momentum and get back on-track with our long-term sustainable growth model.

Now, let me turn it over to Ron and John to discuss 2010 and 2011 in more detail.

Thanks, David.

Good morning, everyone.

Slide five summarizes our third quarter and year-to-date financial results.

For the quarter, net sales declined 4% on a reported basis and 2% on an internal basis.

The key contributor to the decline was softness in our US cereal business, including continued aggressive competitor price discounting, and the impact from the cereal recall.

In addition, the challenging economic environment in Europe, combined with difficult year-over-year comparisons and a deflationary category in the UK, contributed to third quarter sales decline.

Operating profit declined 5% on a reported basis and 3% on an internal basis.

Lower net sales, increased advertising investment, and a decrease in operating leverage due to reduced volume in our manufacturing plants as well as increased costs, contributed to the decline.

These items were offset by a significant reduction in our estimated 2010 incentive compensation expense.

I'll discuss this in more detail along with the implications for 2011 shortly.

Earnings per share declined 4% on a reported basis and 2% on a currency-neutral basis.

Earnings per share benefited from lower average shares outstanding due to our share repurchases.

Slide 6 highlights the components of our net sales performance.

Third quarter reported net sales fell 3.6%.

Internal net sales declined 2.5%, driven by lower volume.

The 3.4% decline in volume was partially attributable to the US cereal business, including the impact of the cereal recall, and in Europe due primarily to the Russia snacks business.

Partially offsetting the volume decline, price and mix improved by 0.9 points, primarily as a result of better mix in our US snacks business and pricing in Latin America.

Currency adversely impacted net sales by 1.1 points.

Now, let me turn to slide seven to discuss gross profit.

Gross profit declined by 5% on a reported basis in the third quarter and 4% on an internal basis.

Internal gross margin contracted by 50 basis points to 43.4%.

Higher commodity costs and lower operating leverage were the primary contributors to the margin decline.

Slide eight shows our trend in advertising investment during 2010.

As planned, we continue to invest behind our brands in the third quarter.

Our internal advertising expenditures increased 9%, primarily driven by US cereal and snacks, but we also invested behind new product launches in Asia-Pacific, and the relaunch of Special K in Latin America.

Slide nine shows our internal operating profit growth by area.

Third quarter internal operating profit decreased by 3% against a strong 11% increase last year.

We had expected stronger performance as we progressed through the back half, but our business has been softer than planned.

As a result, we adjusted our incentive compensation costs sharply downward versus target.

We estimate that the benefit was approximately 10 points in the third quarter and includes adjustments for our first-half accruals.

For the full year, incentive compensation costs will be reduced significantly.

So, restoring them back to target levels in 2011 will create a significant headwind.

In North America, internal operating profit declined 3% against a strong 10% increase a year ago.

Lower sales, as a result of increased promotional pricing activity in the cereal category, the impact of a cereal recall, and a slower rebound in the Eggo business drove the decline.

In addition, higher supply chain costs and increased advertising contributed to the decrease.

Lower up-front and incentive compensation costs partially offset the decline.

Europe's internal operating profit grew by 2% against a 7% growth a year earlier.

A mid-single-digit decline in net sales was more than offset by cost of goods savings, lower overhead expenses due to incentive compensation costs, and a reduction in up-front costs.

In Latin America, internal operating profit declined 18% as a result of increased commodity costs, and in Mexico, incremental operating and distribution costs.

In addition, SG&A expenses were higher due to several discrete investments in overhead, inflation in Venezuela, and a modest increase in advertising.

These items more than offset the mid-single-digit increase in internal net sales growth and slightly lower up-front costs.

Internal operating profit declined 17% in Asia-Pacific in the quarter, compared to a 9% increase in 2009.

In the quarter, we invested heavily in advertising to support new product launches across the region.

Now, let's turn to slide 10 to discuss cash flow.

Our year-to-date cash flow was $827 million, $151 million lower than last year, primarily as a result of lower than expected profits.

Slide 11 displays our guidance for 2010.

On October 21, we lowered our guidance for 2010.

The third quarter was softer than we originally projected, and we expect the fourth quarter to be softer as well.

For 2010, we expect internal net sales to be down approximately 1%, primarily driven by the continued competitive environment in US cereal, and the challenging environment in Europe.

We expect 2010 cost pressures to be approximately 5%, reflecting increased operating costs from lower operating leverage.

As a result, gross margin will be flat to down slightly for the year.

We expect approximately $0.13 of up-front costs, including costs associated with the implementation of SAP.

We still expect to invest in advertising to support our brands at a mid-single-digit growth rate for the year.

Our internal operating profit is expected to be approximately flat due to lower sales growth and higher cost pressures.

Our guidance also includes the benefit of significantly lower incentive compensation costs.

We expect full-year interest expense to be approximately $250 million, and we estimate our tax rate to be approximately 29%.

We have historically targeted a 90% funding level for our pension plans.

While asset returns have improved this year, lower interest rates have reduced our funding status.

To return to our targeted funding levels, we plan to take advantage of a low interest rate environment, and make a voluntary contribution of approximately $500 million, net of tax, to our benefit plans before the end of the year.

This contribution will also significantly reduce the need for required contributions for the foreseeable future.

While the contribution provides a positive P&L benefit for 2011, our net benefits expense is still estimated to increase next year.

Year-to-date, we have purchased $907 million in shares, and we expect that we will reduce average shares outstanding by approximately 2% for the year.

Given our current business outlook, cash flow is expected to be in the $950 million to $1 billion range before the net $500 million voluntary benefit plan contribution.

Capital spending is expected to be approximately $470 million for the year, slightly lower than our previous guidance.

We expect our currency-neutral earnings per share growth to be in the 4% to 5% range.

This includes slight improvements in average shares outstanding and our tax rate.

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

Slide 12 shows our key currencies with 2009 actual rates and current spot rates as of October 26, 2010.

Based on these spot rates, we estimate full-year 2010 foreign exchange to have a $0.02 unfavorable impact to our reported earnings per share.

Now, let's turn to slide 13 to discuss our outlook for 2011.

We recognize that 2011 will be a year of regaining our momentum to put us back on the path of sustainable growth.

As a result, we've developed a realistic outlook for the year.

We expect internal net sales to grow low-single-digits.

Based on our growth algorithm and estimated cost inflation, the Company's sales growth is estimated to be more price-driven with some contribution from mix.

The expected volume may be flat to down slightly.

Internal operating profit is expected to be flat to down 2%, or down slightly.

Let me explain our operating profit outlook in more detail.

As previously discussed, we have a significant headwind to reestablish our employee incentive compensation plans back to target levels.

This adversely impacts 2011 operating profit growth by approximately six points.

On the positive side, we do expect operating profit to benefit approximately two points from lapping the hard costs of the cereal recall.

The net impact of these two items is a four-point headwind.

The continued rebuild of our Eggo business will contribute modestly to sales growth, but the impact to operating profit is not significant due to the reinstatement of marketing investments.

We expect cost pressures to be approximately 6%.

Our cost pressures are partially offset by approximately 4% from cost savings programs.

We anticipate gross margin to be up slightly year-over-year, and we are approximately 40% hedged on commodities for 2011.

We anticipate $0.12 of up-front costs, including costs associated with the re-implementation of SAP, and we expect internal advertising to grow in-line with sales.

Below operating profit, interest expense is anticipated to be similar to 2010; approximately $250 million, and the full-year tax rate is forecasted to be approximately 30%.

We are planning to give 2011 cash flow guidance next quarter.

However, we do expect cash flow to be greater than the $1 billion.

We expect cash -- capital spending to be approximately 4% in 2011, at the high-end of our 3% to 4% range.

We plan to continue to execute the $2.5 billion three-year share repurchase authorization.

Average shares outstanding are expected to decline by approximately 4% in 2011.

We expect earnings per share to grow low-single-digits on a currency-neutral basis.

In terms of the foreign currency impact, the latest spot rates, as shown on slide 12, are estimated to benefit full-year 2011 earnings per share by $0.08.

Now, let me turn it over to John to discuss our North America and international business.

Thanks, Ron.

Slide 14 shows our top-line results for North America.

Internal net sales declined 3% in the third quarter and were down 2% year-to-date.

The decline was primarily driven by retail cereal and the slower than expected recovery of our Eggo waffle business.

Turning first to North America cereal.

Internal net sales for the North American retail cereal business decreased by 6% in the third quarter.

The decline in the third quarter can be explained in-part by the following factors.

First, the cereal category remained soft in the quarter.

We estimate that cereal category sales were down 3%.

Our shipments were down 6%, in line with our consumption.

Second, roughly 75% of our decrease in consumption was due to the recall.

The recall hit us at the worst possible time as the three brands impacted by the recall; Fruit Loops, Corn Pops, and Apple Jacks were the cornerstone of our back-to-school program.

Following the recall, we tried to rework our promotional plans; however, competitors were more aggressive than we expected.

Our share declined by approximately one point in the third quarter, all of which was a result of the recall-impacted brands.

Finally, as David mentioned in his opening remarks, we have also been adversely impacted by less support from non-measured channels in this year.

The impact of the recall is masking some underlying strength in our business.

The Special K franchise remains healthy, and recent second quarter innovation continues to perform well.

FiberPlus and Cinnabon cereals, introduced at the end of June, gained 0.5 share points and 0.3 share points, respectively, during the third quarter.

Kashi and BearNaked continue to gain strength with a 0.3 share point gain, driven by GOLEAN and BearNaked granola.

Our Canadian business was another bright spot in the quarter.

The cereal category was up approximately 2%, and Kellogg grew 4%, resulting in a one-point share gain.

Driving this growth was the success of Mini-Wheats Mini Bites, which gained a share point in the quarter.

We are excited about our 2011 innovation calendar.

We are leveraging proven ideas from around the world.

Beginning in January, we plan to launch Crunchy Nut in the US.

This brand is our second largest brand in the UK with nearly an [eight] share of market.

We will also launch the very successful Special K Oats and Honey line extension, which has already achieved over a share point in the UK, and we will continue to bring news to our Mini-Wheats franchise.

This represents the strongest innovation pipeline for North America cereal in the last five years.

It also reflects our belief that the only sustainable way to grow the cereal business is by exciting the consumer through innovation, health news, and strong brand building.

Turning to slide 16, you can see that North America retail snacks posted flat internal net sales growth for the third quarter, and 2% growth year-to-date.

On slide 17, you can see that we achieved broad-based growth across the snacks portfolio, with the exception of cookies.

Pop-Tarts were up in the quarter and continue to gain nearly a point in share, despite lapping aggressive promotions a year ago.

Brand building in the quarter included the excitement surrounding the opening of a Times Square store in New York City.

Our store-door cracker sales were up low-single-digit in the quarter.

Our share gain of 0.2 points in the quarter was driven by strength in our Cheez-It, Wheatables, and Town House brands.

Town House Flatbread Crisps, launched in late June, continue to perform well.

We are excited about our 2011 innovation, which includes Special K cracker chips.

We believe healthier snacking alternatives represent a significant growth opportunity for the Company.

The strong performance across our snacks business was masked by a weaker performance in cookies in the quarter.

This business has been adversely impacted by several retailers rationalizing assortment.

We are starting to see a reverse in this trend, as it has not helped the category.

Also, while our cookie sales were down in the quarter, this was largely due to lower incremental sales; our base sales were relatively flat.

Our wholesome snacks business continued to deliver solid results in the quarter, led by the strengths of Nutri-Grain bars, FiberPlus bars, and Special K Fruit Crisps, we delivered mid-single-digit internal net sales growth and gained 0.4 share points.

We are actively working to add capacity across our wholesome snacks portfolio to improve service levels, better supply the market, and further accelerate our top-line growth.

Our Frozen and Specialty business posted an overall decline of 5% in internal net sales for the quarter, and a 6% decline year-to-date.

Third quarter top-line growth for North America Frozen reflected the slower than anticipated rebound of our Eggo business.

Customers are not resetting their shelves as quickly as we had expected, and the pace of consumers' response is slower than projected.

We are confident that the business will return to previous sales levels over time.

We are accelerating our growth with an exciting innovation calendar of new products.

Our recent introduction of Cinnabon pancakes continues to perform well, and we plan to launch Eggo thick and fluffy original and cinnamon brown sugar waffles, as well as several SKUs of FiberPlus Eggo waffles in mid-December.

In addition, our Veggie Foods business performed well, and we have strong innovation programs for 2011, including two varieties of Morningstar biscuits.

Our Food Away From Home business also grew modestly year-over-year.

Turning to our international business, our total international internal net sales decreased 2% in the quarter against a 6% increase a year ago.

On a year-to-date basis, international internal sales were flat, masking cereal growth of 2%.

Snack sales were down, largely driven by Russia and Venezuela.

Our business in Europe continues to have good share performance despite an internal net sales decline of 5%.

In the UK, our consumption was down 5% against a tough 9% growth year ago.

Despite lower consumption, we held share in the category, which is suffering significant price discounting similar to the US.

We have an exciting range of innovation in the UK for 2011, including Special K clusters and milk chocolate Krave, which will help drive the category.

In France, our second largest European market, our consumption remains strong with solid share growth.

However, in the third quarter, changes made by the trade resulted in a reduction of a week of inventory, which contributed to a 6% decline in net sales.

Similar to last quarter, Russia experienced strong growth in cereal, up 38%, and snacks while improving, were still down over 20%.

For 2011, we expect Europe internal net sales to grow modestly as the region remains a difficult operating environment.

In Latin America, our top-line increased 5%, compared to a 9% increase a year ago.

There was strong cereal growth across the region with cereal sales up 8%, mitigating a decline in the snacks business.

Our decline in snacks is largely driven by Venezuela, where we import products from Mexico and have been impacted by changes in exchange rates.

Note also that in the quarter, our business in Puerto Rico was impacted by the US cereal recall, which dampened our growth.

In August, we relaunched Special K in Mexico, Central America, and Columbia.

The Special K franchise is responding well; improved food, price points, and media support.

For 2010 and 2011, we expect to deliver mid-single-digit internal net sales growth in Latin America, driven by strong underlying cereal growth.

Asia-Pacific delivered internal net sales growth of 2% with strong performance across Asia and South Africa.

In Australia, we gained share behind the successful launch of Sultana Bran Buds, which achieved in excess of a share point in the quarter.

For Asia-Pacific, we expect low- to mid-single-digit internal sales growth in 2011, as we continue to see strong category growth across most of Asia and South Africa, offset by slower growth in Australia and Japan.

On slide 20, I'd like to make one final point.

We expect 2011 to be one of our strongest innovation years ever, with estimated net sales from innovation up at least 25% over 2010.

Now, let me turn it back to David.

Thanks, John.

While 2010 has been a difficult and disappointing year for the Company and our shareholders, we remain confident in our long-term future.

We are addressing the major issues that took us off-course in 2010.

We're stabilizing our supply chain and mitigating the risk of future disruptions.

We're ramping-up our innovation, and we're adding value back into our categories.

We are also fully aware of the tough consumer and economic environment in which we are competing and operating, and the degree of volatility that this environment can create.

However, we remain positive about 2011 and the future.

We expect our core serial markets to see category growth with a combination of innovation, price, mix, and trade.

All of our products offer a strong value proposition, and our heritage as a health and wellness company, is aligned with current consumer needs and demographic trends.

Regaining our momentum will take time, so we're providing pragmatic guidance for 2011.

Our outlook reflects our intent to do what is necessary to get Kellogg's back on-track.

I'd like to thank all Kellogg employees for their hard work and dedication.

I'm confident that by working together, we will effectively execute our plans to grow the business and get back to our long-term growth model.

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

Thank you.

(Operator Instructions).

And our first question comes from Judy Hong of Goldman Sachs.

Please state your question.

Thanks.

Good morning.

Good morning, Judy.

David, just in terms of the issues that you've talked about, and obviously you've talked about in terms of the timing perspective, that the recovery may take some time before we really see the visibility, and the underlying business getting better.

But maybe you can elaborate a little bit just in terms of when you think about the four buckets of the issues, is there one bucket or the other that may take a quicker, in terms of course, correcting?

And then as you think about the milestones that we should monitor going forward, is it first just innovation really driving better top-line improvement, and then over time as some of these investments in the supply chain goes away, then you ultimately see margin expansion over time?

Yes, I think if you talk about the four key issues, the supply chain related to the recalls, et cetera, clearly that's going to take some time.

We're already on it.

And through 2011, we believe we'll have everything we need done behind us.

The innovation, we're coming into 2011 with a very, very strong list of innovations.

I think, as we start the year, you'll see that kick in very strongly.

The comparatives, clearly they're going to be easier next year, given the tough year we've had this year.

And I think the learnings we and our trading partners have had across these will help both of us as we go through 2011.

So, I think that will be relatively fast.

And then the deflationary environment, harder for us to truly predict what will happen there, but clearly with inflation coming back fairly significantly as we speak, we do expect that we will see a fair amount of net price realization, 200 basis points to 300 basis points.

So, most of these we're already working on, or have in play, will start in 2011.

Some will take its time through 2011 to fully complete.

Okay.

And just if I can follow up quickly, on innovation, it sounds like you're really excited about the pipeline that you're looking at 2011.

Yet when you think about the volume outlook, it sounds like you're still looking for flattish volume performance in 2011.

So, given sort of the robust pipeline of innovation that you have in the market, or you are planning in the market place, what's kind of holding you back in terms of seeing more of the volume improvement in 2011?

Is it the consumer?

Is it just take some time for you to just get back into some of the merchandising programs at retail and others?

Judy, it's John.

I think it's a great question, and we are excited about our 2011 innovation plan.

I think it takes it back to the levels we were doing back in the 2007 and 2008 time period, and we have demonstrated over the years, innovation can absolutely drive our top line and drive volume.

I think we're trying to be pragmatic, though, going into a year where we're planning to have 200 basis points to 300 basis points of price realization as a Company, clearly that is going to weigh a little bit on volume going the other direction.

So, as we give our guidance for 2011, we're trying to be pragmatic.

Okay.

Thank you.

Thank you.

And our next question comes from Diane Geissler of CLSA.

Please state your question.

Good morning.

Good morning, Diane.

Just, I guess, when I look at your guidance, and I appreciate your previous answer, so maybe this is a little bit redundant, but can you tell me how pragmatic is pragmatic?

Because it seems like what you're highlighting here in terms of your innovation is significantly better than what we've seen in the last couple of years, and I guess, I sort of look at that as that's really kind of what's going to turn things around.

Is it just the retail environment is still so competitive, or you're coming off a really tough year, so you want to be as conservative as possible?

I think it's fair to say that 2010 was a pretty tough year for the Company.

We had to work through a variety of issues, as David went through in the opening remarks.

I think we do have confidence in our ability to get back on our long-term growth targets over time, and return the business to long-term growth.

I think that there are -- as we go through the issues in 2010, we understand what they are.

We're addressing them.

We're confident in the future.

2011 is about stabilizing and reinvesting back in our business, and regaining momentum.

So, I think it's -- given the issues we've had in 2010, we're just being very realistic on the 2011 outlook.

I think, Diane, I would just add that the consumer environment with unemployment at the levels it's at, both here and in Europe, has been very tough through 2010.

We're not anticipating a massive change as we look at 2011 at this point.

Okay.

So, to the extent we see any bit of recovery, then that would be, I guess, sort of upside to what your current viewpoint is?

Yes, it may help, yes.

All right.

Terrific.

Thank you.

Thank you.

Thank you.

Our next question comes from Robert Moskow of Credit Suisse.

Please state your question.

Hi, thank you.

David, I think it makes sense to be very conservative in guidance for next year, but I have a couple of questions.

One is, a lot of these decisions about being cautious on innovation for two years, and then also just in the management of the supply chain, there's people behind those issues.

And I'm just wondering, are you satisfied with the team that you have in place, and the processes you have in place, or do you think there needs to be some kind of a shake-up in order to get back on track?

And then secondly, I get a lot of calls, I'm sure a lot of people do, about the selling of stock that you're doing, of Kellogg stock.

I'm just wondering maybe you could put us at ease and say, is this part of a normal estate planning that you do every year, and is it kind of out of your control, or how much control do you have of that selling?

Thank you.

Yes, I think firstly, on the general management issues, we've had nine years of great performance, and 2010 clearly is a disappointment for us all.

I think the hardest thing for a management team and a company to do, when faced with a disappointing year is to step back, understand and confront the issues that have taken them off track.

The team has done that.

We understand what the issues are.

We're in the process of fixing them, and moving forward to address them.

We're going to stabilize the business.

We're reinvesting in innovation, we are going to keep our brand building going.

So, we do believe we'll regain momentum through 2011.

Hopefully, that will get us back to our long-term targets as soon as possible.

Really I think the confidence in the Company is very strong.

If you asked about, I exercised some options.

I have a lot of stock.

The bulk of my personal wealth is clearly tied up in Kellogg.

I remain very committed to the Company.

I don't think anyone should take anything away from that at all.

Thank you for addressing that, David.

Thank you.

Our next question comes from Bryan Spillane of BofA Merrill Lynch.

Please state your question.

Hi, good morning.

Good morning, Bryan.

David and John, I'd like to get your perspectives on -- as you went into the planning cycle for 2011, was there any consideration about maybe adjusting or changing the long-term growth objectives?

The reason why I ask that is, you look at some of the things that have dragged your business over the last two years, some of it is cyclical.

In a good economy, sales are better; but in a lousy economy, sales are actually weaker, so maybe there's more of a cyclical element to your business than we all appreciated, and maybe you did.

Secondly, part of the SKU rationalization, I guess, is tied to some of the -- that has occurred, has been tied to maybe some of the new product innovation that you've done in the past that didn't stick as well, and also the supply chain issues maybe suggest that you have to spend a little bit more on supply chain than you were.

So, just curious in terms of whether there was a serious debate about changing the long-term objectives, and your confidence level in that that may not have to be adjusted in the future.

Bryan, I wouldn't call our category cyclical.

I think, if anything, what we saw in 2009 was a significant increase in the category growth.

To the extent that when we came into 2010, we probably looking backwards, underestimated the benefits of that in 2009, and therefore, the impact as the category readjusted in 2010.

The deflationary environment that we're seeing this year is not typical for the category, and we believe that that will reverse.

I don't think there is anything fundamental about the category.

We feel great about our brands and the categories.

The most important thing is we do have a clear understanding of what we need to do to succeed going forward.

It will involve some investment in our supply chain.

We think that's appropriate.

But I don't think it really changes our desire to get back onto our long term guidance.

We have the confidence that if we do the right things with the business, which is why we're calling it pragmatically for 2011, that we can, over time, hopefully as soon as possible, get back on our long-term guidance.

Thank you.

Thanks.

And our next question comes from Edward Aaron of RBC Capital Markets.

Please state your question.

Thanks for taking the question.

Just was hoping to maybe get some comments on the pricing environment, relative to where you had expected it to be.

90 days ago, I think you talked a lot about on the last call about starting to see some improvement in the fourth quarter.

Seems like that's starting to happen.

But curious to know where that's shaping up relative to what you had expected.

Also as a follow-up to that, the disruption in your promotional programs that you discussed with back to school.

Has that caused you to turn around and promote back a bit more aggressively in the near term than you might have thought on your last conference call?

No, I think really we underestimated the impact of the recall on our back to school.

That really did hurt us in Q3.

I think John went through that.

As far as the pricing in the category, I think it's remained deflationary a little bit longer than we had anticipated.

I'd have to say we're being as rational as we believe we need to be going forward.

And on the pricing environment, we can't comment on specific pricing actions, but I think experience has shown us that the deflationary environment hasn't helped the category.

I think John mentioned, we believe the best sustainable way to grow the category is to excite consumers.

I think our innovation is going to do that.

Some health news is going to do that.

Strong brand building is going to do that.

We're going to pull all those levers, and we did mention we expect 200 points to 300 points of net price realization from a variety of factors, including innovation, price mix and trade.

We feel good about 2011.

The deflationary environment went a bit little longer than we thought in Q4.

Thank you.

Thank you.

And our next question comes from Robert Dickerson of Consumer Edge Research.

Please state your question.

Thanks, guys.

I had a quick question around the volume growth.

I know, when you refer to the 200 basis points to 300 basis points of price next year, I guess the assumption is that there will be some volume weakness, and I know we've gone over this a little bit already on the call.

But just all-in, what's happening, I guess, at retail?

So, if you have so much innovation coming, you would expect, all things being equal, with essentially just a base volume or just a standard volume base, that the volume should still just be growing.

Are there other products that would be coming off?

Is there continued SKU rationalization, or are there lower margin products that are being cut as you add the new products?

I think, as we add the new products into the categories, I don't think the retailers are necessarily going to increase the shelf size because there is new innovation coming in.

I think what the retailers will do is take some of the slower turning items off, and swap these in.

Some of those might be ours.

Some of those might be competitors.

So, I think that trade inventory shift, if you like, is going to be some in, some out.

Okay, great, that's perfect.

Thanks.

Another quick one.

It looks like in the quarter, there was about $640 million in share buyback, of which, I believe according to my math, there was about $250 million of that went to option exercises.

And what you stated before, should the expectation on our end be, going forward at least for 2011, that there should be less going to option exercises, or do you just have no way to know?

Yes, it's difficult.

This is Ron.

It's difficult to know exactly how much will be executed in terms of options.

It depends upon the stock price, obviously.

And just on what we repurchased in the quarter, it's more like $550 million.

We had some repurchases at the very end of Q2 that were reported in Q2.

So, we have about $550 million in the third quarter.

We've repurchased over $900 million for the year to date.

We're likely to repurchase a bit more before the end of the year, giving us a 2% benefit to our average shares outstanding for the year.

Okay, great.

Thanks a lot.

I appreciate it.

Thank you.

And our next question comes from Tim Ramey of D.A.

Davidson.

Please state your question.

Hi, good morning.

So, the decision to emphasize renovation was probably spot-on at the time, and I'm just wondering what confidence you have to move to innovation now.

Are you going to be providing sort of innovation on the cheap to customers, and sort of not crowding them out of the market with sort of higher-priced innovation?

Tim, I think, when you reflect back when the recession started, the general consensus, as people look back at what had happened in prior recessions was that there would be a significant drop-off in consumer interest on products they weren't familiar with.

I think a lot of the food and beverage manufacturers eased back somewhat on innovation as a result of that, believing that it wouldn't be as beneficial as it had been in good times.

As we did the same thing, and we have looked at what is going on in the market place, and our category specifically, as we've discussed it with our trading partners, there has clearly been too much of a pull-back, not only by Kellogg but by many companies on innovation.

I think our trading partners want it, I think consumers want it, and we are absolutely of the firm belief that that will help grow the category and grow our business.

So, we are going to be back in full stream as we come into 2011.

Tim, just to add to that.

Across 2002, 2008 innovation was a key driver of our top line sales, and it helps the category as well.

It keeps the category vibrant, brings people back into the category.

It's not just within the category dynamic, but bringing people from outside the category back in.

What makes us excited about our 2011 program is we're taking some of the best ideas that have worked around the world, and bringing those ideas to the US for the cereal category, and we feel very confident in that program.

Terrific, thanks.

Thank you, and our next question comes from Ken Zaslow of BMO Capital Markets.

Good morning, everyone.

Good morning, Ken.

Can you talk about the promotional environment in the -- or compare the promotional environment in the traditional retailers versus the non-measured channels.

And what is it going to take for you to get back on track on the non-measured channels, because it seems that was also a weakness that you pointed out.

I'm not sure that we would necessarily highlight any major difference between the measured channels and the non-measured channels from a promotional perspective.

I think as both manufacturers and retailers have tried to keep customers loyal, or draw customers in their door, we've all had probably a slightly heightened level of price-based promotion, and I think that's really not worked very well for manufacturers or for retailers.

On non-measured channels, I think exactly the same as measured channels, they're excited to see more innovation come back.

They want to support that because they know that's going to bring consumers in the door, and grow the categories in a positive and sustainable way.

I'm just -- on a follow-up, to what extent did the retailers participate in the promotional activities versus companies specific to Kellogg, for example?

Was it shared, and is that one of the reasons why the volume next year may be a little bit more (inaudible) week flattish?

Is that the right interpretation?

Because the retailers promoted as well, and now they're not going to be promoting as well, so the volume was a little bit better, makes it harder on the volume side, or is that a misinterpretation?

Well, I think, Ken, it's clear that retailers did promote, along with companies.

I'm not sure what they're going to do next year.

Very hard to actually discern what they'll do, and what the impact on volume will be.

We're just talking from a Kellogg perspective, when we give that indication.

Great.

I appreciate it.

Thanks.

Thank you.

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

Please state your question.

Good morning.

Good morning, Andrew.

When we think about, I guess, overall marketing spending in 2011, I think you said you expect advertising to be up more or less in line with sales, potentially some trade spend benefit to a net price realization.

So, are there other sort of big buckets around either consumer spending, or that I'm missing?

I'm just trying to get a sense of overall marketing next year, or are you relatively happy with the absolute levels you're at, and just a matter of having some new products and things to spend behind that consumers actually want?

Yes, I think Andrew, as you're aware, through late 2009, 2010, we undertook a lot of work looking at how we could drive efficiency and commercial production, working with our agency partners.

We actually went through an extensive review of immediate buying practices.

You will see a significant shift toward digital in 2011, which I think will be very beneficial.

But to answer your question, as we look at the magnitude of amount of spend, we feel comfortable with it.

We believe we're supporting the innovation in our brands appropriately to ensure that our messages get through to consumers, and really it's been an optimization approach through the last 12 months that's put us in that position.

Okay, thank you.

Because I guess the reasoning behind the question is partly also from an overall category standpoint, which is, the more room or flexibility Kellogg gives itself to kind of regain momentum through spending, behind innovation and whatnot, that either has a positive effect on the overall category, or can be used to just target, hey, we have to get back share here and now because we're coming from a tougher place, and we'll worry about others in the overall category later.

But at least from the comments around spending and levels, right, it would seem that it's more of the -- I can't remember whether it's the former or the latter, but the one around the overall category as opposed to just going back to where we were over the last couple of quarters.

I think certainly our focus is on exciting consumers through great innovation and brand building, actually try to help see the category grow, and that's really our focus.

And I think that will be more and more our customers' and retailers' focus as we go forward.

Thank you.

Thanks.

Our next question comes from Vincent Andrews of Morgan Stanley.

Please state your question.

Thank you, and good morning, everyone.

A question on the recall, and the consumers that were buying Eggo and then couldn't buy Eggo, and same thing in cereal.

Do you have a view into where they went and what they bought?

I know you mentioned some heightened level of cereal promotional spending around back to school that could suggest they went to some of your competitors brands, but do you know where they are, and how is your plan to get them back, how to deal with that?

Given we were very proactive in voluntarily recalling the products, most of our consumers, I think, when the product is back and available, will return to it.

The back to school was quite painful because that was a time when the three products most impacted by the line of quality issue would have had significant display, and we missed all of that, and our competitors opportunistically picked it up.

So, while that hurt us for the quarter, we don't see any long-term issues.

The same is true on Eggo.

We had anticipated customers' shelf resets to be complete through Q3.

Some of that has gone into Q4, but it's progressing well.

Consumers are coming back a little more slowly, and part of that is because, in many instances the number of SKUs and the availability isn't back to where we'd like it to be.

So, you add those two things together, we see Eggo also returning strongly to growth in Q4 because of weak comps, but likewise improving as we go through 2011.

Okay.

Thanks very much.

Thank you, and our next question comes from Alexia Howard of Sanford Bernstein.

Please state your question.

Good morning, everyone.

Good morning.

Want to focus in on Latin America, which does seem to come under some pressure, particularly on the profit side this quarter.

Can you talk a little bit about what's changing down there?

And whether -- I know you mentioned snacking volumes were weak.

Is it a consumer issue?

Is it a competitor issue?

And more importantly, you mentioned a number of factors that were driving the decline in profitability this quarter, commodity costs, Mexico marketing and distribution, the investment in overhead, and the inflation in Venezuela.

How long do you anticipate that each of those factors will persist, or are some of them going to go away fairly quickly?

Good question, Alexia.

If you look at the top-line drivers, the cereal business in Latin America was actually quite strong in the quarter, up 8%.

The issue that we had was more in the snacks business, particularly in Venezuela.

There the issue is we produce in Mexico, and have to import into Venezuela.

Of course, with the exchange rates and transfer of currencies, that business has gone down sharply given the pricing it had to take to maintain a positive gross profit.

So, that cereal business is doing well.

That's why we have confidence in mid single digit growth this year, and mid and single digit growth next year.

I think the issue on Latin America more broadly is where the operating margins are, and have come down over the last couple of years.

We're very comfortable with the level of operating margins that we have today in Latin America.

We think we can keep those margins going forward.

While there's some volatility from one quarter to the next because of timing and various expenses, we're very comfortable with our ability to sustain the current margin structure in Latin America.

Great.

Thank you very much.

I'll pass it on.

Christina, we have time for one more question.

Thank you, ma'am.

And our last question comes from David Driscoll of Citi Investment Research.

Please state your question.

Great, thank you for taking the question.

Wanted to go back over some of the cereal recall items.

Ron, can you talk about the cereal recall from the perspective of breaking it down into what was the cost of the recall itself, and then what's the lost amount of sales?

I'm looking for a full-year quantified impact on those two pieces.

And then also the EPS, I don't think you said it on this call.

Last call, you called it out at minus $0.12 for the year.

Can you update us on that as well?

Yes, recollect when we communicated the impact of the recall in the second quarter, we talked about $0.10 of impact from the recall.

And about $0.08 to $0.09 of that are hard costs, the actual product value, and then fees to recover the product as well.

It was about $0.01 of estimated lost sales as well.

As we look into Q3 and Q4, we said there's another $0.02, essentially $0.01 per quarter.

It's very difficult to try to alter that estimate, or quantify the impact that back to school has had just directly as a result of the recall.

So, we're still on about a $0.12 across the year with about $0.08 to $0.09 being hard costs.

My follow-up is just simply to David.

Given the magnitude of the cereal recall, I still am struggling a bit with the volume guidance.

Wouldn't that alone put the volumes up year over year because of the enormity of the recall?

I think you go back to what Ron said in terms of the impact of the recall.

The hard costs, $0.08 or $0.09 are not really volume related.

So, we do have an impact from the recall on top line because it disrupted our marketing programs.

Obviously that will help us as we go into 2011.

Again, we're trying to be pragmatic because of the level of pricing expectation across the total company of 200 basis points to 300 basis points.

That's -- in this current environment, that has a degree of volume risk to it.

So, we're trying to be realistic as we pull together our 2011 plan.

Okay.

Thank you.

Thank you all for joining us today.

Please feel free to call me with any follow-up questions.

Bye.

Thank you, again.

Ladies and gentlemen, this does conclude today's teleconference.

We thank you for your participation.

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