家樂氏 (K) 2013 Q2 法說會逐字稿

Welcome to the Kellogg Company second quarter 2013 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)

We please ask about yourself to one question during the Q&A session.

Please note, this event is being recorded, thank you.

At this time I will turn the call over to Mr. Simon Burton, Kellogg Company VP of Investor Relations.

Mr. Burton, you may begin your conference, sir.

Thank you, Mike.

Good morning and thank you everyone for joining us today for a review of our second quarter 2013 results.

I'm joined here today by John Bryant, President and CEO; Ron Dissinger, Chief Financial Officer; and Paul Norman, President of Kellogg International, who has been primarily focused on stabilizing and turning around our European business over the last year.

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, margin, operating profit, interest expense, tax rate, cash flow, brand building, up front costs, investments 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 5. The call will also be available via webcast which will be archived for 90 days.

Now, I will turn it over to John.

Thank you, Simon, and thank you, everyone, for joining us.

As you have seen, today we announced results for the second quarter which is the final quarter that we will be affected by comparisons to periods before we owned Pringles.

Results made our expectations for both operating profit and earnings in the quarter.

Underlying reported operating profit increased by 11%, and underlying internal operating profit increased by 3.4%.

However, sales growth was slower than we expected.

As you've seen in recent public consumption data, some of the larger categories in which we compete, particularly in the US, saw lower rates of growth in the quarter.

We continue to expect good rates of long term growth in our categories, but we recognize the short term weakness that we've seen and have taken a pragmatic approach with guidance.

We have just launched increased levels of innovation that will add to results in the second half and we are increasing rates of advertising, particularly in the third quarter.

We expect improvement but realize that it could be at a slower process through the balance of the year than we originally expected.

We are on track to achieve our guidance for currency neutral earnings-per-share as a result of continued good performance from Pringles and the work we've doing on our cost base.

This will allow us to cover the impact of the sales outlook, while continuing to invest in the future growth of the business.

This is important as we continue to focus on our margins and plan for further investment in the future.

Let's turn to Slide 4 and a quick update on the Pringles acquisition.

As you know, we have now owned Pringles for more than a year.

Our third quarter 2013 results will be lapping the fourth and first quarter of ownership last year.

We have made great progress with the integration.

The transition services agreement that we had with Procter & Gamble have now all ended and the business is operating on Kellogg systems.

This was a major initiative as this acquisition was a carve out which required us to quickly integrate the business into our structure.

The entire organization, including the Kellogg business units, the new employees that joined us from Pringles, and the transition team, have all done a great job.

Thanks too to P&G for all their help throughout the transition.

Reported global sales increased in a low-single-digit rate in Q2, reflecting a difficult comparison to pre-close adjustments in the second quarter of last year.

However, we saw good underlying rates of consumption growth.

For example, consumption in the US increased by approximately 7% in the quarter.

As you know, the business has continued to run smoothly all year.

Our sales and marketing execution has been good and the sales growth we have seen has exceeded our expectations.

We saw more accretion than we originally anticipated in the first half and we are tracking to the higher end of our synergy range for the full year.

This is a great brand with untapped potential.

We are increasing innovation and investing in capacity and we have visibility into improving margins over time.

I'd just like to thank everyone involved in the acquisition and the transition for all their hard work.

Now I'll turn it over to Ron for a discussion of our financial results.

Thanks, John, and good morning, everyone.

Slide 5 is a recap of our performance for the quarter and year-to-date.

Reported sales growth was 6.9%, and internal sales declined by 0.5 point.

We have owned Pringles from June 1, 2012, so Pringles adds the benefit of two months of sales and profits to our reported results.

We saw some weakness in several segments in the US and trade inventory declined in several regions around the world.

We have solid results in Latin America, Asia-Pacific, and in frozen foods and specialty in the US.

Underlying reported operating profit increased by 10.9%, which included a benefit from lower Pringles integration costs.

Underlying internal operating profit, which excludes the impact of the acquisition of Pringles, increased by 3.4% as we expected and included the impact of cost inflation net of productivity in our supply chain, as well as effective management of costs and some timing in SG&A.

Finally, comparable earnings-per-share, which excludes integration costs, was $1, in line with our expectations.

Comparable growth was 5.3% and this included a $0.02 adverse impact from currencies.

Slide 6 shows the components of the quarter's 6.9% reported sales growth.

Internal volume declined 1.6% with nearly 50% of the decline being driven by trade inventory reductions in the US, France and Mexico.

It is worth noting that we saw good volume growth in our Asia-Pacific region and we did see price mix improvement in the quarter across most of the regions.

Of course, Pringles is a primary driver of the 7.9 points of growth related to acquisitions in the second quarter.

While we expect that our renovation will contribute to results in the second half of the year, we do expect that sales growth will continue to be a bit slower for the balance of the year than we originally anticipated.

I'll provide more detail regarding our outlook later.

Finally, currency translation reduced sales growth by 0.5 point in the quarter.

Slide 7 shows the shape of the net inflation we will see this year and is a slide that we showed you last quarter.

You will remember that we recognize net cost inflation in the first half of the year and, as you can see in the chart, we continue to expect net deflation in the second half of the year which should provide a benefit to our gross margins.

We have better visibility into our cost structure for the balance of the year and now expect a small amount of net inflation in the third quarter, and then net deflation in the fourth quarter.

The slower sales growth we've seen so far this year has led to reduced operating leverage.

We saw the impact of this in the second quarter and expect it to have an impact on margins in the second half of the year, particularly in the third quarter.

In the second quarter, our underlying reported gross margin declined by 140 basis points.

Of this, approximately 50 basis points was due to the impact of the Pringles acquisition and approximately 90 basis points was due to the impact of net inflation, operating leverage, and some country and product mix.

Slide 8 highlights some of the brand building activity we have planned for the second half of the year.

Obviously this is just a small sample but it highlights the breadth of activity we expect in the business.

As you know, we launched a significant amount of innovation around mid-year and we will support these products over the balance of 2013 with strong support planned for the third quarter.

As we've mentioned a few times over the past year, we have been doing a lot of work increasing the efficiency of our investment in brand building.

This work continued in the second quarter and we have seen encouraging results.

This work included savings in working media through mix improvements, digital purchasing, negotiations, and moves to pan regional purchasing.

We have also realized savings in non-working media by leveraging copy across multiple markets where practical.

And in addition, we have done a lot of work with consumer promotions around the world.

As a result, we expect that advertising will be up in the second half and flat to up for the full year despite the savings that I had mentioned.

Let's turn to Slide 9 which shows quarterly internal operating profit performance for each of the regions.

Overall, total Company underlying internal operating profit growth of 3.4% was broadly in line with our expectations.

Underlying operating margins were solid at 15.5%, up more than 50 basis points from last year.

North America's internal operating profit increased by 3.2%, a sequential improvement from the first quarter.

We saw good cost discipline and we benefited from Pringles synergies.

The morning foods, specialty and North America other segment, which includes frozen foods and Canada, all posted operating profit growth.

Operating profit in the snacks business was flat due to sales performance.

We have a stronger innovation pipeline and increased advertising planned for the second half of the year in North America, although we do expect the environment to remain challenging.

Internal operating profit grew by 1.8% in Europe and included a mid-single-digit increase in advertising.

The restaging of Special K across Europe that was spoken about before began in the UK and northern Europe at the end of the second quarter, and we have seen early signs of improvement.

Internal operating profit in Latin America decreased by 8.3% in the quarter due to significant commodity inflation and the impact from reductions and retailer inventories.

Much of this is behind us so we expect improved performance in Latin America across the second half of the year.

In Asia-Pacific we saw an increase in internal operating profit of 11.3%.

Growth was driven by solid sales across key businesses and included increased levels of advertising.

Slide 10 provides detail of our year-to-date cash flow performance.

Cash flow from operations before capital spending was $705 million in the first half of the year.

This was an increase of $25 million from the first half of last year.

Remember, we benefited last year from the structure of the Pringles transaction with the addition of approximately $100 million of cash flow in the second quarter of 2012.

Capital spending was $238 million, an increase of $83 million over the first half of last year, and in line with our plan.

We still expect to spend slightly more than 4% of sales for the full year.

We have now repurchased more than $500 million in shares so far this year.

We still expect to repurchase shares in line with proceeds from options for the full year.

Our share repurchases in the first quarter were well below options proceeds and while we are currently tracking ahead of proceeds for the year-to-date period, we expect that this will balance out as we progress through the second half.

Now let's look at Slide 11 which shows our guidance for 2013.

Due to the slower sales growth we saw in the second quarter, expectations for the remainder of the year and increased currency headwinds, we now expect reported sales growth will be approximately 5%, two points lower than our original guidance.

The decline in sales growth is split evenly, one point from currency and one point from internal growth expectations.

While our underlying reported earnings per share has come down by two points, our currency neutral earnings-per-share is consistent with original guidance.

We have been able to manage the one point internal sales shortfall through improved performance from Pringles and disciplined cost management.

We haven't changed our estimate for full-year cost inflation at approximately 5% and cost savings of around 4%, but inflation is a little lower and savings are slightly higher.

As I mentioned, we still expect to see net deflation in the second half as a result of lower cost pressures and slightly higher cost savings.

We now expect that gross margin for the for year will be down 75 to 100 basis points, a change from our original guidance of down 50 basis points.

Pringles is still contributing approximately 50 basis points to the decline, due to the lower margin structure.

Slide 12 shows more detail regarding our full-year earnings-per-share guidance.

Previously we gave guidance for underlying earnings-per-share growth of between 5% and 7%.

This included a $0.02 negative impact from currency.

We always expected currency neutral earnings-per-share growth, excluding integration costs, to be between 6% and 9%, or $3.84 to $3.93 per share, and that has not changed.

However, over the course of the last quarter, currencies have moved against us more significantly.

This means that instead of a full year negative impact of $0.02, we now expect the impact to be $0.09.

Our guidance for reported earnings per share has gone from 5% to 7% growth to 3% to 5% growth.

This change is completely due to the $0.07 extra headwind in currencies.

Obviously currency translation will remain volatile so I will update you regarding the effect as the year progresses.

Now let's go to Slide 13 and some additional detail on our guidance.

As we mentioned last quarter, we expected that estimates for the full-year tax rate might improve, and that has been the case.

We now expect that the full-year tax rate will be between 29% and 30%.

We continue to expect that interest expense will be between $230 million and $240 million.

We still expect annual cash flow to be between $1.1 billion and $1.2 billion and total capital spending to be slightly more than 4% of sales.

In the second half we have increased innovation, more advertising, and Pringles will be included in the base.

As for the phasing of earnings over the remainder of the year, we expect reported earnings-per-share, including the impact of currency but excluding integration costs, to be roughly equal in the third and fourth quarters.

Our current expectations are that integration costs and the impact of currencies will be approximately balanced between the third and fourth quarters.

As has been the case all year, our guidance for comparable operating profit and earnings-per-share excludes the impact of adjustments from market to market.

Finally on Pringles, we continue to expect that integration cost will be between $0.12 and $0.14 per share, but synergies will be toward the high-end of our $50 million to $75 million range for the year.

Now I'll turn it back over to John for a discussion of our segments.

Thanks, Ron.

Slide 14 shows the internal net sales growth posted by Kellogg North America.

As we've mentioned, performance was mixed in the quarter.

Let's look at the segments in more detail, starting with Slide 15 and the US Morning Foods business.

Growth in the cereal category in the second quarter was disappointing, although we did expect it to be challenging given the timing of innovation scheduled for launch at media and the need for additional activity.

Special K saw consumption growth of approximately 2% in the quarter as a results of growth posted by Special K Protein, which we relaunched in the second half of last year, and Special K chocolate strawberry, which launched this year.

Frosted Flakes continue to perform well, as did Raisin Bran.

We saw high-single-digit consumption growth as a result of our recent healthy dividends campaign.

Healthy dividends is targeted at adult health-conscious consumers and focuses on bringing boomers into the cereal category.

For example, the campaign highlights the benefits that come from a balanced diet, including cereal and a healthy lifestyle.

As I mentioned last quarter, we are seeing some weakness in the adult cereal segment.

In addition to the healthy dividends campaign, we also have innovation that will help to address this including Raisin Bran containing omega-3, Kashi Chia Heart to Heart, and multi-grain Special K. Special K is a great brand that travels well around the world.

In addition to all the activity I mentioned, we have also just launched Special K Nourish hot cereals in the US.

As you will hear from Paul, we are also launching hot cereals in Europe.

In the US, we have launched three varieties which are a healthy blend of oats and grains, including quinoa.

They also include inclusions such as cranberries which you add after preparation.

We have only just introduced these cereals but acceptance has been good and we have activity planned for the fall.

We have also launched Kellogg's breakfast beverages and are off to an encouraging start.

ECV is good and brand building has started.

Obviously it is early but we are optimistic that these will be successful and will generate a meaningful amount of incremental sales growth.

Finally, Pop-Tarts had an excellent quarter.

Consumption increased at a mid-single-digit rate.

We introduced two kinds of peanut butter Pop-Tarts in May and again, although it is early, both are exceeding our expectations.

Now let's turn to Slide 16 which shows the internal net sales performance of the US Snack segment.

The segment posted an internal sales decline on the most difficult comparison of the year.

Internal sales in the cracker business were down slightly, partially because we were lapping very strong growth in Special K cracker chips last year.

However, we've seen improvement in distribution and quality of merchandising in the business in recent weeks, and the innovation we launched around mid-year is off to a good start.

Cheez-It Zings and Town House Pita are both getting good rates of trial and we are selling all the crackers in our new cup packaging that we can make.

The cookie business also declined in the quarter.

Again, the innovations we've just launched, including Keebler simply made cookies, Jumbo Fudge Shoppe, and cookies in a cup are all off to a good start.

The decline we saw in the wholesome snacks business was at least partially due to the strong 7% sales growth posted last year.

We did see some good growth this quarter from Special K pastry crisps and new Nutri-Grain crunch bars also contributed.

Our Pringles business saw good consumption growth of approximately 7% in the quarter, which outpaced the category's growth and we gained share as a result.

The core grew and our Pringles Stix innovation also added to the results.

We have good activity planned for the second half and more innovation planned for introduction toward the end of the year.

We always knew the second quarter would be a difficult one for the snacks business.

We have innovations that just launched and more coming.

This, in combination with additional support and Pringles now being included in internal sales growth, should help results in the second half.

Of course, it will continue to be a difficult environment and we continue to expect that improvement will take some time.

Slide 17 shows the net sales performance of the US Specialty segment.

We posted internal net sales growth of 1.9% in the second quarter.

We posted good results in the convenience channel, driven by cereal in cup and our five SKUs of Special K cracker chips and single serve packs, which are doing very well.

We've just launched Special K nourish bars in this channel and have more innovation planned for later in the year.

In addition, our food service business has good plans for the second half of the year and we are optimistic that the specialty channels business as a whole will improve over the balance of the year.

Finally, Pringles, which has done very well in these channels since the acquisition, continued to post growth in the quarter and our expectations are for continued good performance in the second half.

Slide 18 shows detail regarding the North America Other segment, which includes the Canadian and US frozen food businesses.

The segment posted 3.9% internal sales growth in the quarter.

In Canada, we are seeing some good results from innovation including share gains in the frozen category as a result of the launch of Special K flatbread sandwiches and Eggo mini waffles, growth in crackers due to the introduction of Special K cracker chips and good early performance from breakfast beverages.

We saw high-single-digit internal sales growth in the frozen foods business in the quarter.

We saw good volume growth in the frozen breakfast business and also posted gains in price mix.

Growth in the frozen breakfast business was driven by the continued success of the Special K flatbread sandwiches, and we've got a new version being introduced later this year.

Now let's move to the international business.

As you know, we've had a difficult start to 2012 in Europe.

We have been doing a lot of work over the last year to stabilize the business and we saw growth at the end of last year and early this year.

Now I'd like to turn it over to Paul Norman to provide more color regarding our plans for the European business.

Thanks, John.

Good morning, everyone.

Back in November at Day at K, we discussed some of the issues affecting performance in Europe over the past few years and we shared our strategy to change all that highlighting three key where to play choices.

One, sustainably grow cereal in and beyond the bowl.

Two, explosively grow snacks.

Three, accelerate growth in select emerging markets.

To win, we said we would need to operate differently by designing for scale, by developing and executing ideas at a pan-European level.

Finally to enable this we needed to reorganize the way we worked.

The acquisition of Pringles provided the catalyst for us to do so.

Several months on and Pringles is now integrated.

The region is organized around two category hubs, namely cereal and snacks, and we are bringing pan-European ideas to market in cereal, in and beyond the bowl, and in snacks, as well as increasing levels of investment in key emerging markets.

Our overall rate of innovation will increase significantly in 2013 and we have good visibility to 2014 and beyond.

I would like to run quickly through a few slides on key initiatives coming in the back half of 2013.

Let's start with cereal on Slide 20.

In the second half we will be looking to drive momentum behind key adult brands.

On Crunchy Nut cornflakes, our leading taste brand in the UK, we will accelerate momentum via new advertising from the proven, the trouble is they taste too good campaign, as well as with innovation in the form of the recently launched glorious oat granola and soon-to-be launched chocolate curls variety.

In France and Italy, the Extra brand will benefit from an all new advertising campaign backed by significant year on year increases in investment.

Finally in the UK, Spain, and the Nordic region, we will be launching the five day challenge on All-Bran, offering consumers faster, more effective relief from digestive discomfort.

Moving onto Slide 21, we will also continue to reinvigorate our largest brand, Special K. As you know, we launched renovated base food including whole grain and fiber in recent quarters.

This rollout continues in more countries as we speak.

We are expanding our presence within the cereal category to hot cereal with the launch of Special K multi-grain porridge coming to selected countries in September.

A differentiated food offering in three varieties and two different packaging formats, we feel confident that we will attract new users to the Special K brand over the coming months.

As 2014 comes, we will be expanding further into additional formats in various parts of the region with the Special K brand.

More to come on this soon.

Moving to Slide 22, our aim is also to complete more broadly in breakfast beyond the bowl.

As a result, we are just launching on the continent a full range of new Nutri-Grain hand-held breakfast solutions.

We recognize that sometimes consumers don't have time for a bowl of cereal and milk.

That is why we develop foods that provide the benefits of cereal in a portable and convenient format that better meets their needs.

These are delicious, toastable and dunkable whole-grain foods designed to better fit the local breakfast occasion.

The range will include breakfast biscuits but also unique new to market propositions too, including toastable pastries.

Now, let's talk snacks on Slide 23.

First of up is Pringles, where things continue to go well.

Following another quarter of mid single-digit consumption growth, driven by some great in-store focus from our local sales teams, selected innovations like the extra sub line and continued geographic expansion in emerging markets, we feel good about the future.

We are adding capacity in 2014 to further fuel the brand in terms of growth in existing geographies and in new ones, and to enable a strong pipeline of innovation that you will hear more about in the coming months.

Moving to Slide 24 and Special K snacks, and an update on a couple of key pan-European initiatives.

Firstly, Biscuit Moments which we launched in the UK last year, and now can be found across the region in 2013.

This is a great example of an idea designed and delivered consistently across the region.

And it is an idea that has worked in other regions too.

For example, this idea was launched in the US under the Special K pastry crisps brand and has been doing very well.

Another example is Special K cracker crisps which are shown on Slide 25 and which will roll out across the region later this year.

These are similar to the Special K cracker chips you will know in the US.

This idea has obviously been successful and has now travelled to Europe, but has also now been launched in Canada, Mexico, and soon in Australia too.

When you pull it all together on Slide 26, you'll see a good cross-section of activity in and beyond the bowl at breakfast and an exciting set of initiatives across snacks to accelerate growth.

All of this is being done with the benefits of scale, both in development and delivery.

To close, I pulled back my summary slide from Day at K last year in November.

We continue to transform our company in Europe into cereal and a snacking company, leveraging ideas with scale across the region by operating differently.

Change takes time and effort and I would like to recognize the entire team in Europe for what they are doing to make it happen and bring our strategy to life.

Thank you and now I will turn it back over to John.

Thanks, Paul.

Now let's turn to Slide 28 and our other international businesses.

Internal net sales increased by 4.1% in Asia-Pacific in the second quarter, driven by strong volume growth.

The Australian business contributed to this growth as the breakfast drinks we launched last year continue to do well.

Nutri-Grain, our core cereal brand in Australia, gained category share in the quarter and we have more innovation planned for introduction in Australia including Special K cracker chips, which are similar to the ones you know in the US.

In Asia, we saw good growth in India, Southeast Asia, and South Africa.

South Africa posted double-digit net sales growth as a cornflakes brand including cornflakes porridge did very well.

We also saw double-digit growth in India due to strong growth from Chocos, Muesli and the Special K brand.

Pringles also posted mid-single-digit sales growth in the quarter, driven by both volume growth and price realization.

The Latin American business posted 5% internal sales growth, although this included some unusual items including the reduction of trade inventories, as I mentioned before.

Without these items, both sales and operating profit growth would have been much higher.

The economic environment in Mexico remains difficult but cereal consumption growth remains good.

We've had some recent gains in distribution and we've got some innovation that is working well.

We have more plans for introductions before the end of the year.

We also saw growth in Brazil, the Andean region, Venezuela, and Chile.

Pringles also did well in the quarter, exceeding our expectations.

Now let's turn to Slide 29 and the summary.

We made our goals for operating profit and earnings in the second quarter.

We have better plans for the second half including more innovation, and increased levels of advertising.

However, we recognize that the difficult environment we saw in the first half will continue through the balance of the year.

We've completed a majority of the Pringles integration and the business is performing very well.

We have reaffirmed our full year targets for earnings, excluding the impact of currency translation.

So finally, I would like to say thank you to all the Kellogg employees around the world for all their hard work and dedication.

Together we are building the plans and laying the foundation necessary for future growth.

Now I'll open it up for questions.

(Operator Instructions)

David Driscoll, Citi.

Thank you and good morning, everyone.

Would you please comment on the cereal merchandising outlook?

It seems like General Mills captured a lot of merchandising activity during your second quarter period.

Can you give us some comments on how you see the merchandising outlook in North America for the rest of the year?

It is very hard to predict how the merchandising activity will change as we go through the back half of the year.

What I will say on cereal is we are focused on driving our business the way that we have seen the business respond historically, which is through brand building, innovation, both food and packaging, as well as nutrition.

We believe that is the right way to drive the cereal business.

Obviously cereal is always an intensely comparative category, we will be competitive in that category, but I wouldn't say that there's any trends around merchandising that concern us.

Related to the cereal category on new products, how have the new products performed and would you call this out as a reason for the soft sales in any way?

Or more importantly, are the new products more of a second half event?

If you could help me out a little on that one.

David, the new products are really a second half event.

They only started shipping towards the end of the second quarter.

And the brand building won't be turned on until we get well into the third quarter and we have the right level of distribution across the US stores.

Final question for me is just a detail on advertising.

What was the advertising change during the second quarter?

David, this is Ron.

Our advertising was down just slightly in the second quarter and that was a function of the innovation, timing of innovation launches that John mentioned.

We do expect advertising growth in the third quarter.

The nice operating margin performance relative to the gross margin was not related to a giant decline in advertising, it was other factors, namely Pringles savings and-or other savings?

And-or other savings, David.

Particularly, we have been very focused and cost disciplined around overhead.

We have executed some initiatives earlier in the year knowing that we were facing high inflation in the front part of the year.

Really appreciate the comments.

I will pass it along.

Thank you.

Bryan Spillane, Bank of America.

Hi, good morning.

Just one clarification and a question.

Ron, you had mentioned in your prepared remarks that in phasing the back half of the year that third quarter earnings would be the same as the fourth quarter.

I want to make sure it was clear.

Is that the absolute or is it the year on year growth rates that you are referring to?

That is the absolute earnings per share, Bryan.

Just a question on Pringles.

It has been an important revenue growth contributer since the acquisition, and profit growth contributor since the acquisition, and still an important component as we look into the second half, especially now that becomes part of the internal calculation.

Can you talk a little bit about first, where you stand today on capacity, whether you are capacity constrained at all?

And then second, now that you are completely free from the Proctor's shared service arrangement, how effective you've been at filling in some of the white space?

So the markets where you've had to sort of find your own distribution now that you've pulled away from Proctor.

Just those two things as we look at Pringles going forward.

Thanks for the question, Bryan.

I'm going to answer at a very high level and then Paul might end up with some questions -- or some comments on Europe specifically around Pringles.

First, as you said, the Pringles acquisition has gone incredibly well for us.

The integration is largely complete.

We now have Pringles operating on our systems and that is enabling us to generate the synergies that we are seeing come through on the cost side.

Remember, a lot of the cost synergies from Pringles was unhooking the P&G shared activity, hooking it onto the Kellogg's systems and support processes, and be able to run the business without adding a lot of additional cost.

We are absolutely seeing that come through.

Also when we acquired the business, we were concerned about the top line growth of the business, given it had been through a difficult transition.

We were relatively conservative in sitting out top line growth expectations.

The good news is this business has responded incredibly well to merchandising with our sales force and bringing to life those programs in store.

That is working very well for us.

As you pointed out, we have been capacity constrained in this business.

We do have new capacity coming on.

We've also been able to run the plants a little bit harder and get more capacity out of them which has also worked well in terms of supplying the market.

As we look at Pringles around the world from a consumption perspective in the second quarter, we saw 7% in the US, good growth in Asia-Pacific and Latin America, and also some very good growth in Europe.

In terms of the white spaces, there is some good Pringles opportunities in Europe as well, so why don't I let Paul talk a little bit about the Pringles experience in Europe.

Hi, Bryan.

If you think about outside of the Kellogg go to market sales people and you think further afield into emerging markets, remember, Pringles for us was pretty transformational.

In several markets it will have almost doubled the size of our business.

We find ourself today with a great opportunity.

We have Kellogg distributors and we have inherited Pringles distributors.

The process we are going through now, as you can imagine, is to consolidate given our new found scale to drive more capability to go further to grow.

Obviously there is cost to serve benefits to come.

So I don't think that business has been left exposed any where.

In fact, we've ended up with more distributors than we probably had before, and the opportunity is now, I would say, in emerging markets in Europe but also the same case in Latin America and parts of Southeast Asia, the opportunity to consolidate, build capability and hopefully improve cost to serve and invest to grow further.

Thank you.

Robert Moskow, Credit Suisse.

Hi, thank you.

I was curious about the gross margin coming down to a decline of 75 to 100 basis points and the grain cost futures markets would indicate that you, and you said yourself, that your costs are lower than you thought.

And your productivity seems to be coming in lower than you thought.

So is this an issue where it's a volume and deleveraging is causing gross margin to be lighter than you thought?

Then I had a question on Kashi consolidation.

Yes, Rob, it is really a factor of our operating leverage.

So we have very good visibility to our cost structure as we look at the back half of the year, seeing net deflation in the fourth quarter.

As I mentioned, a little bit of inflation in the third quarter, and that's because of the operating leverage impact as a result of the sales coming down and a couple of the key US businesses.

So it's nothing more than that.

Pringles is still about 50 basis points dilutive impact on the margin as well.

The underlying margin is down about 25 to 50 basis points.

Okay.

Then regarding Kashi, I heard that you've consolidated headquarters into Battle Creek.

Can you talk a little bit about the cost benefit of that?

Kashi had a very strong culture in La Jolla and sales have been weak lately.

When do you think performance will improved, and what are you doing internally to make sure that you retain what made it strong to begin with?

We think Kashi is a great opportunity for us to drive additional growth.

I think the opportunity with Kashi is to play it's role within our portfolio.

One of the benefits of having it viewed within the board of Kellogg portfolios, we can more clearly have some Kellogg brands play in some places and then Kashi play where it needs to play.

An opportunity for Kashi is really in the area of pioneering nutrition, putting the value back in the food, whether it be GMO or organic or new edge grains, et cetera.

That is the opportunity that Kashi can play and by having it viewed within that broader portfolio, we can actually more clearly define and articulate the job that we need Kashi to go out and achieve for us.

Also, Kashi now is a very large business and we can more effectively leverage the scale and benefits of the Kellogg Company by putting it into the broader context of Kellogg's.

We feel very good about the longer-term growth opportunity for Kashi and if anything, we think this gives it the better opportunity to achieve it's long-term growth potential.

Eric Katzman, Deutsche Bank.

One thing I haven't heard from you yet on Pringles is the revenue synergies that you expect a little longer-term.

I think you started to talk about it qualitatively but not quantitatively, and obviously you bought Pringles not for it's cost savings but for the revenue potential.

Perhaps we'll start with that.

Eric, I think there are significant revenue synergies coming out of the Pringles acquisition.

We have not quantified those for external purposes, but think of it in a number of ways.

The first way is the benefit of putting Pringles into the Kellogg's sales system and driving that initial growth.

That is what we are seeing come through.

The second way is a little bit dependent on broader capacity coming online for Pringles which is innovation on the Pringles business itself.

And there is a third wave out there, which we are also going after aggressively, which is leveraging the Pringles infrastructure to drive Kellogg's snacks more aggressively around the world.

I think Europe is a great example of where we are doing a lot of that today.

I'd just say, I think it would be helpful at some point, sooner versus later, if you could give some quantification on that.

Then this is a question that I think has been asked in the past, but given the poor core results out of the business versus your advertising spend relative to sales.

You've talked for a couple years about, quote unquote, optimizing your advertising spend, but the reality is, despite a lot of new products and effort, the core business volume has been pretty weak for an extended period, whether it's Europe, or US, or what have you.

I wonder what would sales at your company be like if, God forbid, your advertising spend wasn't nearly as strong as it is.

Why isn't such high spending giving a better lift to the portfolio?

It still makes me scratch my head.

Eric, we are very comfortable with the level of advertising we spend as a company and that advertising is becoming even more effective and efficient each year as we drive more into digital and we activate the brands even more effectively through those programs.

If you look at where some of our weakness has been on the volume side, it has really been back in cereal.

As we think about cereal, this is true in the US and some of the other large developed markets we have around the world, the good news for cereal is the breakfast occasion is in general growing, particularly here in the US.

And within breakfast, cereal has the single largest share.

There is reasons to believe there is long-term growth potential in the cereal category, whether it be aging population, health and wellness or desire for value.

However, there has been some short-term pressure over the last couple of years on the cereal category form alternatives at the breakfast occasion.

So how are we addressing that as a company because this will help us get back to volume growth long term.

One is to win with cereal at breakfast.

We take adults, which is the biggest source of opportunity.

We are driving increased adult consumption around cereal in four levers, innovation, advertising, food and packaging.

At innovation as you can see year in the middle of this year, there is Special K multi-grain, Kashi chia, Raisin Bran omega-3 coming out.

On advertising, to your question about advertising effectiveness, the healthy dividends program was in place in the second quarter.

It drove strong growth in Raisin Bran which was heroed in that particular piece of advertising.

On food, as we mentioned on Kashi, our focus is on pioneering health.

We are seeing the benefits of getting the food right where we have, say Bare Naked growing double digits in the second quarter.

Then on packaging, whether it be resealable bags easy open liners, or more portable solutions like cups all helps us drive that cereal consumption.

It is more than just winning with cereal at breakfast.

It is also winning in breakfast beyond cereal.

We have a number of warm breakfast alternatives, Eggo, Pop-Tarts, the Special K breakfast sandwiches.

Now we have Special K hot cereal launching, both in the US and in the UK.

Within that as well we are looking at portability, whether it be wholesome snacks, hand-held breakfast that Paul mentioned in Europe, or breakfast beverages here in the US.

We are confident we can do both.

In the breakfast occasion we can grow cereal breakfast, as we did across the 2000s, and we can leverage our strong cereal brands into other formats to meet consumer needs at that breakfast occasion.

We believe if we do this well, we can get ourselves back to volume growth as a Company.

Andrew Lazar, Barclays

John, I think the general expectation to your earlier, the answer you just gave, by many investors is that the cereal category will ultimately bounce back to a rate of growth, whether it's the low single-digit rate that it has had historically, even though thus far that recovery has been slower than you would have liked.

If the slower cereal category growth rate continues for a bit of time or longer than planned, do Kellogg and the investment committee have to wait through perhaps a longer period of profit pressure as you launch in transition to a lot of these new outside the bowl initiatives and formats, as necessary as they maybe, but require spending and may have potentially negative mix issues given the excellent profitability of your core cereal franchise.

In other words, can Kellogg's long-term EPS growth target, 7% to 9%, be hit and sustained during a transition like I've described and as you talked about in your previous answer?

Andrew, I think it is definitely our intent over the long-term to get back on our sustainable growth model.

We are making the investments we need to make in order to get back on that model, and we recognize the need to drive our growth more aggressively in the cereal and breakfast occasion, and we are making the investments we need to make.

What I think you're seeing within that investment model is we are using cereal equities to help drive our growth in some of the non-cereal spaces, so for example leveraging the Kellogg master brands and launch the Kellogg to go beverages in the US.

That enables us to have a more efficient investment model so we don't need to add a significant amount of additional brand building in order to drive that growth as it hails back on the cereal business, as well.

At the same time, within the advertising line, we continue to move money between digital, consumer databases and so on which make that spending even more efficient, which also enables us to free up investment.

Also, we will continue to look within our company on the cost side to be more effective and efficient to identify opportunities to provide fuel for growth in our organization going forward.

I know that you switched over to using a third party broker for some of the in-store work around your Morning Foods business, maybe back in April or so.

Trying to get a sense if that transition has gone relatively smoothly.

I don't know if you've got any metrics to point to around distribution or merchandising effectiveness, but has it basically delivered on what you had hoped you'd get from it?

Andrew, I think any transition like that always has its bumps early in the process, but I feel like it's working very well today.

Chris Growe, Stifel.

I just wanted to ask you first on the revenue growth for the Business and looking out.

I think what I heard from you so far, I think we heard this has been a consistent theme, is a very heavy level of innovation marketing that is picking up in the second half of the year.

I had assumed some of that started in Q2.

It sounds like it started late in the quarter.

What I'm getting to, John, is it as simple as you need to increase your marketing even more, your advertising, or do you think these new products are what is going to help fix what are, in some cases, a category issue like in cereal or just a competitive or slower dynamic in, say, cookies and crackers in the US?

I believe the innovation we are putting in the marketplace here in the second half, as well as the commercial plans we have in the second half, will lead to better sales growth rate the second half than what we had in the first half.

I also believe it is going to take more innovation and pressure over time to get the categories fully back into the growth rates we like to see.

This is not a short-term easy fix.

This is a longer-term journey that we are on but we're absolutely doing the right things.

We have seen the ability to grow these categories over time back in the 2000s.

It's a case of engaging and exciting the consumer and bringing them back in.

Just a follow up to that.

You have had a fairly heavy level of productivity savings this year and it sounds like it's a little higher than maybe what you thought initially.

Is there anything unique that is helping drive that?

A lot of us remember back to periods where the supply chain was cut a little too far.

So, trying to understand what is driving that and how sustainable this level of savings is.

The tick-up in savings, productivity savings, is only slight, Chris, it is not significant.

We are quite comfortable with the programs that are in place and the things that the supply chain is doing to generate their savings.

Chris, on the supply chain, I feel very good about the state of our supply chain.

The investments that we've made over the last few years have enabled us to run this plant even more effectively and quite frankly, the work that we did in those plants is enabling us to run even more efficiently this year and that is a little bit of the source of some of the productivity benefits.

Jason English, Goldman Sachs.

Thanks for the question.

More innovation coming to try to rejuvenate growth, we've been hearing a lot about innovation for a number of years now.

If we look at the cereal category, which is clearly a point of weakness, TDP growth suggests it has been pretty explosive expansion of the varieties in the category.

Meanwhile velocity has fallen off a cliff.

Why shouldn't we be bracing for some SKU rationalization in that category rather than banking on innovation to turn it around?

Jason, I think in a category like cereal, which is a high repertoire category, you always have a level of innovation and a level of ongoing rationalization on the shelf.

The shelf is not growing and it's not declining, it's an element of bringing new news to the category and continuing to bring consumers in.

In some parts of the business such as say Special K, we need a high level of choices to keep people excited and interested in eating Special K each day.

There's a wider level of variety out there than we might have in some other brands.

Also, Jason, when we talk about innovation, we are not just talking about another line extension.

We are talking about beverages, we are talking about hot cereals, we are talking about breakfast sandwiches.

So I think if you compared our innovation pipeline this year to say last year or the year before, there is a greater proportion of incrementality within the innovation pipeline.

Plus, when you look at the international innovation we are ramping up from a relatively low base and within that, and some of the things that Paul talked about in Europe, that innovation is significantly more incremental than some of the historical cereal-based line extensions.

Going to come back with one more question and it is really picking up where Growe led into it with.

Your sustainable growth model, it worked for a number of years.

It hasn't really proven to drive a very sustainable growth recently.

An important pillar of that is grow brand building, continuing to increase the investment, yet over the last five years, advertising up at a 1% CAGR, well below sales, down so far this year.

So back to Chris's question, why shouldn't we think that we need just a lot more reinvestment to really get this thing going, to get you back on the sustainable growth wheel?

Within that advertising line over that last five years, there has been a pretty significant shift under the surface between traditional 30 second advertising and digital, and engaging consumers more effectively with a different media mix.

Having said that, we will constantly look for fuel for growth in the organization and say how do we continue to drive effectiveness and efficiency to enable us to invest more in the business over time.

Thank you, I will pass it on.

Ken Goldman, JPMorgan.

You're not the first company to experience some sluggishness in your legacy categories and brands at the same time that you're integrating a new one, in this case Pringles.

As you look back on some of the challenges you have faced in those legacy cookies, crackers, cereals lately, would you have done anything differently over the last year in terms of your time focused on legacy products and your whole management teams focus versus toward the integration?

Or in your view, maybe with those challenges facing those categories have taken place, whether Pringles was taken on or not?

Ken, it is a very difficult question to answer.

Certainly Pringles being the second largest acquisition in our history, and being a carve out and bolt-on was more intense integration, particularly in some parts of the world such as Europe.

I don't think some of the issues we've seen in cereal more recently were impacted by the Pringles acquisition.

Certainly it has been something that the organization has been focused on with the integration.

Quickly, Latin America, almost all of your growth over the last few years has come from price mix.

Your volumes have been down.

Can you talk a little bit about the break down between price and mix in that line and to what extent you are comfortable with volumes not really growing in a region where a lot of companies are seeing their tonnage up over the last few years?

Over time, as we go forward in Latin America, we are looking for more volume growth.

I think when you look at the second quarter, it's a little distorted by lapping the trade inventory build that happened in Q2 last year that we spoke about on the second quarter call last year.

In particular, in Mexico, where are shipments were down quite significantly and our consumption was actually (Inaudible).

I think if you are looking at a full basis, the volume performance will be much better.

Certainly our strategy going forward in Latin America is to be volume improved.

Mike, I think we have time for one more question.

Lucia von Reusner, Green Century Capital Management.

Thank you.

I was curious, as a company publicly commits to sustainability, how will Kellogg ensure that the Kellogg brand is not associated with the illegal deforestation that its partner Wilmar has been accused of?

How will you ensure that the Kellogg brand remains sustainable and all that?

Well the Kellogg Company has a very strong track record on sustainability and we have a sustainability report that I would turn your attention to.

In terms of [power more], we actually buy green certificates to counter all our power more purchases and we feel very good about our practices in that area.

We work with a number of partners and suppliers around the world, and I will leave it to you to talk to Wilmar directly if you have questions for them, but we feel very good about Kellogg Company's position on this topic.

Thank you very much.

Okay, everyone, thanks very much for dialing in and we will be available throughout the rest of the day and tomorrow for questions.

Thanks.

We thank you, sir, and to the rest of the management team for your time today.

This conference call is now included.

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Thank you and have a great day everyone.