家樂氏 (K) 2015 Q3 法說會逐字稿

Good morning, and welcome to the Kellogg Company third-quarter 2015 earnings conference call.

(Operator Instructions)

After today's presentation, there will be an opportunity to ask questions.

Please note, this event is being recorded.

I would now like to turn the conference over to Simon Burton of Investor Relations.

Please go ahead.

Thanks, Gary, and good morning, everyone.

Thank you for joining us today for a review of our third-quarter 2015 results.

I'm joined here by John Bryant, Chairman and CEO; and Ron Dissinger, Chief Financial Officer.

The press release and slides that support our remarks are posted on our website at www.kelloggcompany.com.

As you're aware, certain statements made today, such as projections for Kellogg Company's future performance, include earnings per share, net sales, margin, operating profit, interest expense, tax rate, cash flow, brand building, up-front costs, investment, 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 Friday, November 6, and the call will also be available via webcast, which will be archived for at least 90 days.

I will now turn it over to John.

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

We are pleased that the momentum we have seen so far this year has continued to build through the third quarter.

Total currency-neutral comparable revenue growth of 1% was above our top-line guidance for the full year, and it builds on the flat growth we posted in the first half of the year.

We saw sales respond to investment we've made, continued stabilization in many of our businesses in the quarter, and growth in the US specialty channels, Canadian, Latin American, and Asia-Pacific businesses.

In addition, we continue to make great progress with our productivity initiatives.

Our overall currency-neutral comparable operating profit was in line with our expectations, and included a significant impact from this year's re-basing of incentive compensation.

Ron will discuss this in more detail, but excluding this impact, currency-neutral comparable operating profit growth would have been approximately 6% in the quarter.

We are raising our guidance for cash flow to $1.1 billion in 2015.

We are on track to meet our guidance for currency-neutral comparable sales, operating profit, and earnings per share in 2015; and we will achieve these results while setting up an even better year in 2016.

The momentum we are building in our aggressive productivity programs give us confidence that we will meet our long-term targets for currency-neutral comparable net sales and operating profit growth in 2016 and beyond.

We'll give you more color regarding our overall business at our Investor Day in a few weeks, but we are excited about the plans we have for each of our businesses, and the performance we expect as a result.

With that, I will send it over to Ron for a discussion of our financial results.

Thanks, John, and good morning.

Slide 4 shows the financial results for the third quarter.

Currency-neutral comparable net sales increased by 1%, greater than our full-year guidance for growth.

We saw strong growth across many of our emerging and developing markets in Latin America, Asia-Pacific, and Europe.

We are pleased with the performance of our US cereal business, US snacks improved sequentially, and we grew in the US specialty channel and Canadian businesses.

Pringles posted increased sales growth in each of our regions.

Reported net sales declined by 8.5% due to foreign currency translation.

Comparable operating profit declined by 2.3%.

However, as John mentioned, that decline includes a headwind from the re-basing of incentive compensation this year.

Without this impact, comparable operating profit would have been 8 points higher, and would have shown growth of approximately 6%.

This reinforces our previous comments on the operating leverage in our business.

Reported operating profit was $334 million in the third quarter, including items affecting comparability, as detailed in the appendices to our presentation.

Comparable earnings per share were $0.85 in the quarter.

These results include $0.11 of currency headwind.

Currency-neutral comparable earnings per share were $0.96, an increase of 2.1% from the third quarter of last year.

Slide 5 shows the components of the quarter's sales growth.

We had good price mix realization despite some adverse country mix in Europe and Asia-Pacific.

Overall volume declined by 1.6%.

While volume declined in our US cereal and snacks businesses, we continue to see signs of stabilization.

The Asia-Pacific region posted good volume growth, as did Mexico, the Mediterranean, and Middle East regions, and specialty channels in the US.

We continue to see strong volume performance from Pringles across the globe.

The impact of foreign exchange lowered reported net sales by almost 10%, driven by a wide basket of currencies.

Note that our devaluation of the Venezuelan bolivar at mid-year represents almost half of the 10-point impact to sales.

Slide 6 shows details regarding our third-quarter currency-neutral comparable gross profit and gross margin.

Gross margin in the third quarter improved by 20 basis points.

Year-to-date gross margin remained unchanged from last year.

Overall, commodity and packaging costs are deflationary, and our strong productivity initiatives, combined with Project K savings, are benefiting our supply chain costs.

However, we are seeing continued higher transportation costs.

In addition, we are investing more money in our foods.

Examples include our launch of granolas and mueslis across the globe, and renovation of existing foods such as Special K. The combination of these factors has resulted in relatively flat gross margins year to date.

Slide 7 shows the third quarter operating profit performance for each of the regions.

North America's currency neutral comparable operating profit decreased by 3%.

This was due to the slight decline in sales, and a significant impact of re-basing incentive compensation.

The re-basing reduced operating profit by eight points in the quarter.

We expect further improvement in North America's currency-neutral comparable operating growth in the fourth quarter.

Europe's operating profit increased by 3% in the third quarter.

This growth was the result of deflation in commodities, and strong productivity in cost of goods sold.

It also included an increase in brand building in the quarter.

Operating profit in Latin America increased by 15% as a result of strong sales growth in the region, including the impact from Venezuela.

While we did see some adverse shift in the timing of sales in certain parts of the region impacting our third quarter, we are growing volume and sales year to date.

Operating profit decreased by 20% in the Asia-Pacific region.

We are investing some Project K savings in this region to drive growth, so the result includes investment in our brands and capabilities.

Slide 8 shows our year-to-date cash flow.

Year-to-date operating cash flow after capital expenditure was $580 million.

This result includes year-to-date investment in Project K of approximately $260 million.

As I mentioned last quarter, cash cost for Project K in 2015 we'll be approximately $350 million, the most in any year of the project.

As you can see on the chart, we now expect full-year cash flow of approximately $1.1 billion, an increase of $100 million from our original estimate.

This increase is due to accelerated performance of our supplier financing initiative in the fourth quarter.

In fact, we expect that this initiative will offset the approximately $350 million in full-year cash costs for Project K.

Slide 9 shows our core working capital as a percentage of net sales.

In the past we have discussed our focus on working capital improvements and our supplier financing initiatives in particular.

Over the first nine months of this year, we have reduced our core working capital as a percentage of sales by more than 1 point.

As I said, we expect accelerated progress on supplier financing in the fourth quarter, and we are also evaluating new initiatives to unlock even more cash from our working capital.

Slide 10 shows our guidance for 2015.

We continue to expect that net sales will be approximately flat for the year.

We now expect gross margin for the year to be relatively flat also.

We continue to expect that operating profit will decline by between 2% and 4% and we also still expect that currency-neutral comparable earnings per share will be in a range between flat to down 2%.

Results for both currency-neutral comparable operating profit and earnings per share still include a negative impact of 3 to 4 points from the resetting of incentive compensation.

The expectations for sales, operating profit, and earnings per share do exclude the impact of items affecting comparability.

Our expectation for the impact of foreign exchange translation is now approximately $0.31 per share, an increase from the $0.29 per share we expected last quarter.

This change is due to the Canadian dollar, the pound sterling, and the Australian dollar.

Our expectations for net interest expense have increased to between $225 million and $230 million, driven by slightly higher levels of debt associated with our acquisitions in Nigeria and Egypt.

We now expect that the full-year tax rate will be between 26% and 27%, which will cover the impact of higher interest cost and other below-the-line items.

Guidance for total capital spending remains in a range between 4% and 5% of sales, including approximately 1 point to sales for incremental capital to execute Project K. We still expect share repurchases of approximately $700 million to $750 million for this year.

Slide 11 shows our full-year earnings per share walk.

Costs for the integration of acquisitions are still expected to be between $0.04 and $0.06 per share, although they could be to the high end of that range, given the recent acquisitions in Egypt and Nigeria.

We now anticipate that Project K's pre-tax profit and loss statement costs will be between $350 million and $400 million, or approximately $0.70 to $0.80 per share for the year.

We expect that 2/3 of these costs will be in cost of goods sold.

A change in the expected cost is simply due to the timing of projects between years.

Project K remains on track, and our estimate for savings in 2015 and 2016 has not changed.

Slide 12 shows our guidance for 2016.

As we communicated on our Q2 call, we expect our currency-neutral comparable sales to be in our long-term guidance range for low single-digit growth.

We also expect 4% to 6% growth in currency-neutral comparable operating profit.

As we mentioned last quarter, if current sales growth trends continue, it could put us at the lower end of our long-term sales targets; but even if this happens, we will still meet our goals for operating profit growth, due to the significant productivity programs we have under way.

We expect currency-neutral comparable earnings per share growth of between 6% and 8%.

Our outlook assumes a similar amount of share repurchases to the $700 million to $750 million we expect in 2015.

With that, I will turn it back over to John for a discussion of operating performance by segment.

Thanks, Ron.

Now let's turn to slide 13 and the US morning foods business.

Results for the third quarter came in as we expected.

The Kellogg brand gained share in the quarter, and saw continued sequential improvement in consumption.

In fact, our total consumption was essentially flat, and we gained share.

Importantly, category base sales were up in the quarter, and we out-paced the category.

Our six core cereals grew in combination and gained share.

Raisin Bran posted double-digit growth due to great advertising, and the popular cranberry innovation.

Overall, Mini-Wheats did well, as core bite-size posted growth in both base and incremental sales.

Our second-half innovation did well, including Pumpkin Spice Mini-Wheats, which were a big hit.

As you can see on the chart, Special K continued to benefit from activity that began in the second quarter.

The brand posted increased sales, and share gains again, just as it did last quarter.

Our adult cereals in total, which had been an area of softness, returned to growth.

Finally, for morning foods, we've had a great reception for the innovation we have planned for the first quarter.

For example, we are launching Special K Nourish, which is a cereal with positive nutrition, and ingredients the consumer can see in the food.

There are two SKUs in the US, cranberry coconut almond and apple raspberry almond, and both are made with a multi-grain quinoa flake.

The food includes fruits, nuts, and on-trends grains like quinoa.

You'll remember that this ready-to-eat cereal has been very popular in other parts of the world, and retailer acceptance in the US has been encouraging.

We've got a lot of activity planned for the launch, and we're excited about the potential.

Let's turn to slide 14 and our US snacks business.

Overall, we saw sequential improvement in the cracker, cookie, wholesome snack, and Pringles businesses in the third quarter.

In all channels, overall consumption of our crackers was essentially flat in the quarter, and our big three brands posted low-single-digit consumption growth in measured channels.

The Cheez-It brand posted consumption growth of 3%, driven by increased display and the success of two new products -- Cheez-It Grooves and Extra Toasty.

In addition, Cheez-It also grew base sales at a mid-single-digit rate, much faster than the category average.

The Club brand also posted increased consumption and share gains, as the core business performed well, and the new Town House Focaccia also gained share, and now holds 0.6 share of the overall category.

Our Special K cracker and popcorn chips, which have been an adverse headwind, continue to impact results.

While we'll continue to be impacted by past losses in distribution, the products we re-staged earlier this year posted slight consumption growth in the quarter.

In the cookie category, the Fudge Shop, Chips Deluxe, Famous Amos, Fudge Stripes, and Mother's brands all posted consumption growth in the quarter.

We have some strong brands which respond well to activity, and we are encouraged by recent performance.

We're pleased that we're seeing sequential improvement in the business, although we have been impacted by a decline in 100-calorie packs this year, as we've discussed before.

The wholesome snack business posted a low-single-digit decline in consumption in measured channels, plus the Club channel.

The Special K brand posted an increase in consumption of almost 3% across the same channels, driven by new Special K chewy nut bars.

The Pringles business posted low-single-digit sales growth, building on high-single-digit growth last year.

Across all channels, including Club and convenience combined, Pringles posted mid-single-digit growth in the quarter.

The team has been doing a lot of work in each of the categories, and we're seeing sequential improvement as a result.

There is a lot more to come, as well, and we will hear more about some of those plans at the Investor Day scheduled later in the month.

Slide 15 shows highlights regarding the US specialty segment.

Comparable net sales in the specialty channels increased by 6% in the quarter.

The food service, convenience, and vending channels all posted growth.

The food service performance was driven by the growth of whole grain offerings in the K-12 school business.

The convenience business had an easier comp last year due to a customer lowering their inventory.

In addition, we also saw excellent broad-based growth across the categories in the convenience channel.

Year to date, we're growing share in the cereal, cracker, wholesome snack, and cookie categories.

Finally for specialty, the Pringles business also continues to do well.

As you can see on the slide, our new Zip Dips product, Pringles and dip together, won the Retailer Choice Award for best new product in the convenience channel, and helped the overall Pringles business post double-digit growth and gain share in Q3.

The team continues to expect a strong fourth quarter for both sales and operating profit, and we're excited about our prospect for 2016.

Slide 16 highlights the performance of the North America Other segment, including the US frozen foods, Kashi, and Canadian businesses.

In the frozen food business, our Eggo hand-held sandwiches continued to perform well in the quarter.

As you've seen in public data, the consumption increased at a strong double-digit rate, and we gained share.

Elsewhere in the business, a number of items affected performance, including egg prices, network improvements, the timing of activity, and the drawing down of inventories in anticipation of an exciting change to packaging.

We ended the third quarter with low levels of retail inventory, and we expect a continued impact in the fourth quarter, with improvement in 2016.

The Kashi business is seeing stabilized distribution and sequential improvement in cereal consumption and share performance, although sales still declined.

In cereal, our Sweet Potato Sunshine and Sprouted Grains cereals are doing well.

In fact, overall consumption trends improved significantly as the year has progressed.

In the latest data, year-to-date cereal consumption was down 13%, 12-week consumption was down 7%, and four-week consumption was down only 3%.

The team has done a great job, and we're on track to return the business to growth in 2016.

We are increasingly confident about next year.

We're focused on progressive nutrition and have some great introductions planned.

In fact, our total weight of innovation in 2016 is twice what it has been in 2015.

Finally, net sales for the Canadian business increased in the quarter due to growth in wholesome snacks, Pringles, and frozen foods, and we grew share in the cereal category.

Unfortunately the combination of the performance in the frozen food and Kashi businesses led to a quarterly sales decline in the segment.

Let's turn to slide 17 and our European business.

The Pringles business in Europe posted strong double-digit net sales growth in the quarter.

The base business posted growth, and the launch of Pringles Tortilla in the UK and Germany also contributed to the overall performance.

In addition, we had strong commercial initiatives across the region, and we expect continued group performance in the fourth quarter, traditionally the quarter of the year with the highest level of sales.

We have exciting plans for the region's wholesome snack business in the fourth quarter and into 2016.

As in many parts of the world, we are making significant investment in our food in Europe.

This includes the re-launch of Special K bars, and extensive innovation that will include completely new foods with fruits, nuts, and seeds.

The cereal business declined in the quarter as a result of continued difficult environment in the UK and parts of the continent.

The focus for the team is to strengthen the overall plan and improve performance.

With this in mind, we have included additional activity in the UK, focused on Crunchy Nut, Krave, our porridge products, a tie-in with Star Wars, and increased levels of holiday promotions.

In addition, there's exciting activity coming in the first quarter.

We are taking lessons learned from the US and applying them in the region.

We're adding more red berries in Special K, and we're launching new products, including cereals, mueslis, and granolas.

We're also launching Special K Nourish cereal.

Slide 18 shows highlights for our Latin American business.

Total currency-neutral comparable net sales increased at a double-digit rate.

Cereal sales in the region increased significantly, and we're seeing good volume growth, and have held or increased year-to-date share in strategic businesses like Mexico, Columbia, and Brazil.

These share gains have been driven by children's and family brands, and the introduction of Kellogg's-branded granolas and mueslis.

Sales in the snack business also increased in the quarter, driven by innovation and go-to-market activity; and we've gained year-to-date share in the wholesome snack businesses in Brazil and Columbia.

The Pringles business continued to perform well, and we've launched Pringles Tortilla in the region.

Our initiative to drive sales in high-frequency stores continues to go well.

We have gained year-to-date share in this channel in Mexico, Columbia, and Brazil; and have increased the number of stores we're reaching at a double-digit rate.

There's a lot of opportunity in these channels in both the Latin American and Asia regions, and that will continue to be a focus for us next year.

The team in Latin America is expecting strong fourth-quarter results due to the high-frequency store program, the continued impact of granolas and mueslis, new bars launching in Brazil, new Special K Protein in Mexico, and some significant brand-building events across the region.

Plans for 2016 include more great innovation and brand-building events.

However, as you know, a number of countries are facing a slow-down in their economies.

While we have plans to deal with this and the impact of transactional foreign exchange, it will remain a headwind in 2016.

Let's turn to slide 19 and our Asia-Pacific business.

We saw strong double-digit growth in the Asian business in the third quarter.

The Indian business posted double-digit growth, driven by single-serve packs and strong results from the core brands.

The Japanese business grew at a double-digit rate as the result of continued popularity of granola and packaging innovation.

The Korean business also grew at a double-digit rate.

The business in sub-Saharan Africa and the Pringles business both posted high-single-digit sales growth.

On Pringles specifically, we continue to see great results in the region, and our activity and investment have gained traction.

In addition, our new Pringles plant in Malaysia is performing well.

The overall Asia-Pacific segment posted currency-neutral comparable sales growth of 2% in the quarter.

The Australian business continues to be difficult, and we also faced the impact of differences in the year-on-year timing of promotions in the quarter.

We expect declines in Australia to moderate in the fourth quarter, and we have plans for further improvement in 2016.

Let's turn to slide 20 and comment on our JVs in Asia.

Although they're not reported in Asia-Pacific's results, both the Chinese and Nigerian businesses posted very strong growth in the quarter.

In China, both cereal and snacks grew at a double-digit rate, and we gained share in the cereal category.

As you know, we announced in September our investment in West Africa.

Specifically, we announced the acquisition of a 50% stake in Multipro, a premier sales and distribution company in Nigeria and Ghana.

We announced the creation of a snacks and breakfast joint venture across West Africa with Tolaram Africa, one of the largest food companies in the region.

We're very excited about the investment that this region is experiencing explosive gross for the growing middle class.

Nigeria alone has the largest population and economy in all of Africa.

At the time of the transaction, we announced that the total Company sales from Multipro were expected to be approximately $750 million in 2015.

Just to put that into perspective, our Asia-Pacific business posted total sales of slightly less than $1 billion last year.

You can see the transformational impact this acquisition has on the region, and why we're so excited about its potential.

Amit Banati, our Head of Asia-Pacific, will discuss both partnerships in more detail at the Investor Day; but I will say that we are very pleased to have these great relationships in place, and we're confident that they will be significant contributors to total corporate results in the years to come.

Let's turn to the summary on page 21.

Results for net sales growth and operating profit were in line with our expectations, and we continue to build momentum.

Currency-neutral comparable net sales increased by 1%, and currency-neutral comparable operating profit, excluding the impact of rescinding incentive compensation, increased by approximately 6%.

We also increased guidance for full-year cash flow.

In the quarter, we saw improving trends in our US cereal business.

We saw sequential improvement in our US snacks business.

The Kashi brand continued to improve, as we expected.

Our international business continued to perform well; and importantly, our productivity programs continue to generate significant savings.

We're on track with both Project K and our zero-based budgeting initiatives.

These two cost savings programs, in conjunction with our underlying productivity programs, give us a significant amount of visibility into future results.

As I said, we are building momentum.

The group performance in the third quarter and our visibility into increased efficiency give us confidence that we will meet our targets for 2015, 2016, and beyond.

We recognize that we have a lot to do, but we have a plan, and we know we can achieve our targets.

Our employees around the world are doing great work.

As always I would like to end by thanking them all.

Now, I'll open up for questions.

We will now begin the question-and-answer session.

(Operator Instructions)

David Palmer, RBC Capital Markets

Thanks.

A question about the promotional activity.

It seems that as measured by Nielsen, the in-store promotional activity has been declining in cereal, as it has been for many categories.

Why do you think that is?

Do you see promotion spending continuing to come out of the category?

Is there perhaps a shift away from traditional in-store promotions towards other stuff like consumer marketing and digital?

Thanks.

We continue to see good merchandising performance behind our categories in store.

We have categories that do respond to merchandising activity.

I think you have seen on an aggregate basis some merchandising reduction.

That actually is more tailored to what a small number of customers are doing in the area of specific clean-store policies.

In fact, we're lapping one of those larger customers -- lapping that initiative in the middle of this year, so that should have less of an impact as we go forward.

We are ultimately, though, focused on winning with the consumer through brand building, through innovation, through engaging the consumer directly; but we feel good about our in-store merchandising performance.

Just a follow-up on your innovation comments.

You said that you will have double the innovation, or have doubled the innovation activity heading into 2016 than you had in 2015.

In food, we're never really sure if more means better when it comes to innovation.

Are there reasons why you feel like your innovation will be more incremental, or the ways that you're changing your innovation process to make it more incremental?

Thanks.

Great question, David.

Let me just clarify, the double the weight of innovation is actually a comment only for Kashi in 2016 here in the US.

We've done a lot to invest back into our innovation processes as a Company to improve the performance of our innovation.

We established our global category teams, so we would have the longer-term innovation pipeline coming out of those global category teams.

In the case of Kashi, specifically, pulling the team back in La Jolla, back in California, and allowing them to focus on the longer-term innovation to move at a faster pace as is required in that particular segment of the market, is showing dividends.

I think you've seen that in the Kashi business performance improving, and also in that greater innovation coming through next year.

Also, as you think about innovation, I think you can see more from us in the area of packaging, as we try to hit the right package-price product offering by channel by market.

I think as you look at our innovation pipeline going forward, it's both a stronger pipeline, and since we have a longer-term pipeline with our global category teams.

It's a more diverse pipeline, in that it's not just more food.

It's food, it's packaging, it's in the core parts of the business, as well as in the leading segments of the business, as well.

Thank you.

Robert Moskow, Credit Suisse.

Hi, thank you.

My question is maybe you can give us a little more color on how you are progressing on zero-based budgeting.

You mentioned that you have better visibility into next year, and I would imagine that the ZBB efforts are starting to gain some momentum.

Can you give us some updates on what areas of your cost structure you're focusing it on, and where you expect to see the biggest benefits?

Sure, Rob.

Our initiative is progressing well in North America.

As we said earlier, we would be rolling that out across the globe, as well.

We have not started that work yet, but that should be beginning in 2016.

We continue to have very good visibility to the $100 million of savings that we communicated on zero-based budgeting, and that's specifically in North America.

You may recall we said we're interrogating around $2 billion worth of discretionary spend.

That is just $2 billion within North America.

So far we've identified a number of things.

We're looking across supply chain costs, supply chain overhead, distribution costs, and SG&A as well.

We've noted a number of areas around our policies and practices, based on benchmarks that we have from this process.

An example is travel and people-related costs.

We've found that we're investing or spending more money in some of those areas, and there's a great opportunity to pull back.

We've interrogated professional services, as well.

We're looking into brand building, as well, and dissecting our brand building investment, both from a working perspective and a non-working perspective.

One other thing that I do want to point out, as well.

As we get into 2016, and we provide more information on our guidance, we are unlikely to provide guidance around our gross margin percent and our brand-building percent to sales, as well.

Let me assure you, both of these are absolutely critical to our business.

We remain focused on investing behind our brands and building our brands, and maintaining a strong gross margin.

But the advent of zero-based budgeting and how that may change the complexion of our profit and loss statement, as well as the changing landscape -- how you build brands the shift of TV media to digital media, as well, and the investments we're putting back in our food, make it difficult for us to provide specifics on those items.

I'm sorry, Ron.

You said it's going to be more difficult to provide gross margin guidance going forward?

What I'm saying is we won't be providing those details going forward.

Obviously we have a plan and understand where our gross margin and our brand building are going, but we won't be providing those details, because of the shifting landscape as a result of our zero-based budgeting initiative.

All right.

I'll get back in the queue.

Eric Katzman, Deutsche Bank

Good morning, everybody.

I guess a couple of questions, with the understanding you're going to have the Analyst Day shortly.

First, I guess this is after the quarter close; but one of your competitors had a pretty big recall with their biggest brand.

I'm wondering if you were seeing a benefit to that, or has the category overall been hurt by that.

Maybe you could just go a little bit into that, and I have some follow-ups.

Well, Eric, I think we're seeing a very strong performance from the US cereal category.

It's improve significantly over the last couple of years.

Total consumption is relatively flat.

Within our business, we're seeing a significant improvement within our core brands.

Also in the two brands we've struggled with over the last few years, Special K and Kashi, seeing significantly better performance from those brands as we go forward.

I don't think that particular event that you're pointing to has had a meaningful impact on the category or our business.

I think it's good for us all to get past those sorts of events.

I think we're seeing a better longer-term build in the performance of the category over time.

Okay, thank you.

Then Ron, in answer to Rob's question, maybe can you quantify at least this year how much more you are spending in terms of the quality food initiatives, like the higher-cost ingredients.

How much is that let's say limiting your gross margins?

We haven't quantified that specifically, Eric.

But it's probably 20 or 30 basis points of impact that we're seeing within our business, depending upon which quarter you're looking at, based on the roll-out of granolas and mueslis across the globe, the renovation we're doing around Special K, and some of our other foods, as well.

Okay.

Then last thing, I know this is small, but I noticed in the release that you re-stated $3 million of sales due to restructuring and other items.

Why would sales be re-stated as a function of a restructuring?

In some cases, Eric, we are having to change our foods.

It's requiring us to pull current products from shelf and re-slot new product in its place.

These are listing fees, in some cases, associated with them.

You felt that was part of a --

It is specifically related to the Project K network initiatives that we are conducting.

Okay.

All right, I'll pass it on.

Thanks.

Andrew Lazar, Barclays

Good morning, everybody.

Good morning, Andrew.

I know that you've talked about continuing to expect your sales and the EBIT growth in line with your long-term algorithm in 2016.

For the first time you provided the EPS part of that for next year, which I guess at 6% to 8% is maybe slightly below what the long-algorithm has been.

Maybe it's just splitting hairs and conservatism, or maybe it's a higher tax rate, but trying to get a sense of why you wouldn't be getting maybe the typical below-the-line benefit that you would expect?

If you could provide some perspective on that, that would be helpful?

Absolutely, Andrew.

We do have an expectation for slightly higher interest costs with the potential for rates moving higher into next year.

In addition, we're seeing a lower than normal tax rate this year as a result of tax planning initiatives that we have undertaken.

We communicated a 26% to 27% rate for 2015.

We do expect that rate to tick up slightly.

Then offsetting that are the normal share repurchases that we'll conduct over the course of the year.

Okay, thanks for that.

Thanks for the clarity on the impact to gross margin of food quality and such.

I'm trying to get a sense, and I don't think you'll be giving guidance on this per se, next year.

But directionally from a gross margin standpoint, with the favorability around some commodity movements of late, all of the ongoing productivity you have, the Project K, the ZBB impact, which ramps up dramatically next year, shift to digital and such.

I'm trying to get a sense -- I would think gross margin directionally would accelerate quite a bit year over year versus sort of the flat result that we are likely to see this year.

Is there anything I'm missing in how I'm thinking about that?

In terms of our gross margin performance for next year, obviously we haven't quantified it yet.

You're right, we are seeing some deflation in some of the exchange-traded commodities.

Obviously, that's just the commodity aspect of that item.

We are seeing inflation, though, in other commodity elements.

For example, fruits, nuts, cocoa, rice are escalating.

We're seeing higher distribution costs and slightly higher factory costs, but we're being able to offset that with our strong productivity initiatives and Project K savings as well.

Overall at this point in time, we're expecting our input costs to be relatively neutral, offset by our productivity.

Okay, thank you.

Jonathan Feeney, Athlos Research.

Good morning, guys.

Thanks very much.

I wanted to ask about the cereal category.

John, you mentioned you had seen some improved trends there.

It's a simple question, but it touches on a lot of things.

What is allowing for improved trends in both the category and for yourself?

Is it a change in the number of occasions -- like you're using fewer occasion -- or is it a change -- and I'm talking about the category level here -- in share, meaning like are more people eating breakfast, or maybe less worse change in fewer people eating breakfast?

Or is it that Greek yogurt or other breakfast options, or maybe food service reached a high water mark, and it's ceasing to eat into breakfast's lordly share -- I mean cereal's lordly share advantage in the breakfast occasion?

Thanks very much.

Thanks, Jonathan.

What we're seeing on breakfast -- we've actually seen consumption of breakfast at home growing.

It's not really an issue around QSRs, et cetera.

It's more how we compete at that breakfast occasion at home.

If you go back to the 2000s, obviously our business in the category grew quite strongly.

What was growing our business at that time were the adult cereals.

If you look at what's happened here more recently, those adult cereals, particularly Special K and Kashi, went quite soft.

But it's in the third quarter we actually saw adult cereals return back to growth.

You're seeing Special K return to growth behind -- movement in positioning, it got caught in a little bit more of a diet positioning toward a wellness positioning now, with new foods coming out that support that.

Kashi -- pulling the team in California, ramping up the innovations, staying on trend with foods that are evolving and emerging in the market place.

You're seeing how the innovation is starting to drive that business back to a better place.

Even a business like Raisin Bran, where we have a cranberry innovation, some great advertising that's on trend, and we're seeing double-digit growth in that brand.

I think a lot of this has to do with what we're doing to drive our business.

Quite frankly the category performance is a combination of what manufacturers do, rather than a determinant of how well manufacturers do.

If all the manufacturers do better, the category does better.

Sure.

Just to follow up on your answer there, John.

You said the adult cereals came back.

I don't know how you slice and dice what's an adult cereal for a competitor, but do you get the sense that's true for your competitors, as well, that it's that adult segment that's come back, or is just better execution, do you think, at Special K?

I guess I'm more focused specifically on our business.

I'd say our businesses is doing better, and that's what's driving, certainly, our section of the adult segment.

To your point, it is difficult on some of these brands to define what's an adult brand, what's a kid brand, since roughly half the consumption in the kid brands are actually adult consumption.

When we have adult-targeted brands like this, like Raisin Bran and Special K, we're seeing those businesses come back.

Great.

Thanks very much.

Alexia Howard, Bernstein.

Good morning, everyone.

Good morning, Alexia.

A couple of quick questions.

US snacks -- we obviously read in the press that you might have been interested in a snacks acquisition recently.

That doesn't seem to be going to you, at this point.

How are you thinking about maybe building out your US snacks business to get more out of your CSD system in the US?

Then I have a follow up.

Let me step back a little bit and provide some thoughts on M&A in general, since you could have that entry point into the snacks question.

On M&A, we are obviously looking at a number of opportunities around the world.

You've seen the Company execute three transactions in just the last several months -- two acquisitions in Egypt, the largest cookie/cracker company there, and the largest cereal business there; and then our West Africa-Nigeria investment.

Now all three of those are great investments, combination of snacks, emerging markets, et cetera.

As you think about our M&A strategy, obviously the intersection of snacks in the emerging markets is an interesting place for us to play.

We also would look at M&A in a market like North America in natural and other areas that would be good bolt-ons to our business.

On snacks itself, we have an outstanding DSD platform.

It's a Company-owned DSD platform.

It's an advantage platform compared to a lot of other DSD platforms out there.

We believe we have an opportunity to keep driving that platform over time.

We're focused on improving the hit rate of innovation in this business.

We're seeing good growth in crackers behind Cheez-It.

We have opportunities in cookies.

We've got some work to do in wholesome snacks.

But we had some good progress there on the DSD business.

Then as a follow-up, can I just calibrate my expectations for what success in US cereal looks like in 2016?

I know you were feeling pressure earlier in the year to really get the US cereal business back on track by the end of the year.

It seems as though you're talking in a very positive way about that you've got a lot of innovation coming down the pipe, but the US morning foods organic sales are still down 2.6%.

Is it enough just to be gaining share in a category that's down?

What's the color, what's the description of what good looks like for next year?

I would say, Alexia, in a market like the US, given the performance of the category in recent years, if we could stabilize the US cereal business in a stable category, I would define that as success.

In the context of the Kellogg Company portfolio and hitting our low-single-digit sales growth target next year, we don't need to see growth from the US cereal business.

Great.

Thank you very much.

I'll pass it on.

Thank you.

Kenneth Zaslow, BMO Capital Markets.

Hi, good morning everyone.

Good morning, Ken.

Just two follow-up to the questions.

One is, in the -- you did say that the environment is deflationary.

How do you think that's going to play out in the promotional environment?

Which categories are most insulated, and which are most affected by it?

My next point, I just want to make sure I got it right, is you pointed out that sales may be at the lower end of next year's guidance.

Can you talk about why you are already there before the year starts?

Thanks, Ken.

Great question.

On the potential deflationary impact on cost of goods, and how could that play out in the market place, if you look across our categories, our categories are very rational.

They compete more on the quality of brands and the quality of innovation, on ideas, in-store execution.

They are intensely competitive categories; but they're ones that tend to be fairly stable in pricing over time.

Feel good about the dynamic there, and don't see that necessarily being disruptive.

On the question of sales guidance, I think there's maybe some confusion there.

If you look at the Company, we are building momentum.

Last year our internal sales were down around 2%.

This year we're around flat.

Next year we're giving guidance of 1% to 3%.

If you drew a straight line through that trend line, you get down to flat, say up 2%.

The point we tried to make on our guidance for next year is we don't need to deliver 2%, 3% sales growth in order to deliver the 4% to 6% operating profit growth.

Our comment there was about the strength and visibility we have into our productivity programs.

We believe that if we hit even the low end of our sales guidance, or even if we were flat on our sales performance next year, we still have the visibility in those productivity programs to hit the 4% to 6% operating profit range.

If I'd add to that, if I'm thinking about our guidance for next year, and you asked me the question where is the risk within that guidance, I think the risk is more on the sales guidance than in the operating profit guidance, is another way of getting what we're trying to say.

Great.

I appreciate the clarity.

Thank you.

Bryan Spillane, Bank of America

Hi, good morning.

Good morning, Bryan.

I have just two questions.

The first one is on the FX in Latin America, and I guess in this quarter Venezuela had a pretty meaningful impact.

I think it was like a 61% adjustment to sales, and 71% adjustment to operating income.

Is that like a catch-up, one-time thing, or will we have a few quarters of meaningful negative affect from FX?

Good question, Brian.

Thanks for allowing me to clarify.

That will impact us as we go through the back half of this year.

This is the translational impact associated with re-measuring Venezuela from the VEF6.30 to the US dollar, to effectively VEF200 to the US dollar.

You'll see an impact for that translational change through the back half of 2015, and into the first half of 2016, as well.

Roughly same order of magnitude, is that right?

Will depend on the size of the business.

But yes, a little bit lower as we move into the front half of next year.

Okay.

John, the second question is around Special K. I don't know how easy this is to answer, but at the starting point in terms of rebuilding the brand, one of the things was to go after the positioning, and positioning away from a weight-loss brand to being more of a just generally healthy brand.

How much of the improvement in Special K has been that that positioning is actually occurring, so consumers are reacting to a different positioning away from weight loss?

If you could also within that, talk about how the core Special K business has done, ex the new products?

Great question.

I think we are seeing the brand make that transition to more of a wellness brand, weight-wellness brand than a diet brand.

The turnaround in Special K, of course, not just that positioning in isolation.

It's also changing the food in some cases to be consistent with our positioning.

I think where we've made changes to our food we're seen even more progress than where we had some legacy foods in place.

A lot of the food changes, though, are not just new foods in terms of innovation.

They're renovating the current foods.

When you ask the question how much is that new versus the base, take Special K Red Berries.

Adding more red berries to Special K and reinforcing the berries in there really has had a very positive impact on the Special K business in the US.

It's hard for me to tease apart what is food and what is non-food related.

But the good news is we're definitely seeing people respond to that program -- not just here in the US, but also in Canada -- and we're seeing the brand do better.

All right, thank you.

Look forward to seeing you in a couple weeks.

Great, thank you.

Matthew Grainger, Morgan Stanley

Hi, good morning.

Thanks for the questions.

Good morning.

Just two questions.

First on brand building.

I know you've called out Europe, specifically, as seeing increased spending during the quarter.

But can you just update us for Q3 and maybe year to date how brand-building overall is trending constant currency, or as a percentage of sales, and how you see this trending into 2016 as Project K savings build -- how dependent that may be on how sequential sales trends evolve from here?

It's a great question.

It's probably worth spending a little bit of time talking about brand-building.

Obviously, brand-building is critical to the long-term performance of the Kellogg Company.

The strength of our brands is something we're absolutely focused on.

You can see that in that we have industry-leading levels of brand-building, and we're committed to those brands.

At the same time, we are seeing a transformational change in how you build brands.

Think about the transformational changes we've seen in the past from print to radio to TV, and now to social, mobile, digital et cetera.

As you go through each of these transformational changes, the amount and how you spend brand-building fundamentally changes.

As we see people skipping more ads on TV, as we see people -- particularly millennials -- using their mobile devices, social media, et cetera, having a larger impact, we have to change our brand-building model.

As we do this, we have to both identify what's not working as well as it has in the past, and where should we invest more money.

Now we see very good ROIs on digital-type spend, so we're seeing more of our money migrate in that direction.

But because of this sea change, it's very hard for us to say where our brand-building is going in the future.

I certainly feel like we spend enough money on brand-building.

As we look, say, to 2016, we will have zero-based budgeting savings in brand building.

Some or all of that will get reinvested back into brand building.

But I don't think we need to continue to increase our brand building, as such.

Our brand building as a percentage of sales may be flat, may even decline slightly.

But don't take that as a lack of commitment to brand-building.

Take that as a recognition that how you build brands, how you engage with consumers as they engage with media differently, is changing at such a pace here that we have to re-evaluate our entire model and continue to push the edge on how much we need to spend to build these great brands.

Thanks, John, that's helpful.

Then secondly, I wanted to come back to the comparability issues you've been facing in the cracker category, specifically on the cracker chips.

It feels like we've been talking about it for a few quarters.

We probably should now be starting to approach the point where we could start lapping some of those distribution losses.

Is that -- how are you thinking about the ability of that dynamic to be a tail wind next year, or should we simply be looking for the head wind to moderate or normalize?

We have renovated our Special K cracker chip business, and that has resulted in vast stabilizing.

Now we're just lapping loss distribution.

There may be parts of that business that also get eliminated over time.

We come back to a stronger core number of SKUs.

It's certainly becoming less of a head wind.

It's been a pretty major head wind across this year.

It will probably be there, but to a lesser degree in 2016.

Okay, thanks.

Jason English, Goldman Sachs

Hi, good morning Folks.

Thank you for the question.

Good morning, Jason.

I wanted to come back to the question on Venezuela.

Can you give us -- first, can you quantify -- I'm not sure how Spillane got has math on this one.

I probably just haven't read in the detail he has on this one, but what the bottom-line hit was on Venezuela translation this quarter?

Also, how much the pricing in Venezuela contributed to organic sales growth?

To say differently, what would LatAm organic sales look like if Venezuela was not the base?

First of all in Venezuela, let me remind you of how that re-measurement has impacted our results, and then as well there's a translational impact.

In the second quarter, we took a significant charge as a result of our re-valuing our balance sheet.

We took a small charge as well in the third quarter, with about $0.41 of earnings per share impact.

It's more the transactional impact of re-measuring that business.

Also in the third quarter, we would've taken the translational impact of re-measuring that business to the VEF200 to the US dollar.

That's roughly around $0.04 or so of earnings-per-share impact.

As I said in terms of the sales impact, it was a little less than half that 10-point impact to sales.

As you think about what's happening in Latin America generally, there's no question that Venezuela drove the sales growth you saw in the third quarter.

On a year-to-date basis, our local currency growth ex-Venezuela would be up low single digits.

But it's worth remembering within that, that our Pringles business is a US-dollar-denominated business.

What you're seeing there is actually US dollar growth in Pringles, as opposed to true local currency growth.

Local currency Pringles is up strong double digits, but that obviously translates to a very low US-dollar performance given where the exchange rates have moved.

It's actually hard within our results to get back to a pure, local-currency ex-Venezuela for Latin America.

What I would say in Latin America is we are seeing a slow-down in economies in Latin America in general, and in our business, as well.

We are gaining share in key businesses, such as Brazil, Mexico, Columbia.

As we go into 2016, we expect this business to continue to be challenged a little bit with the macro-economic head winds of the exchange rate movements, and how that's impacting consumer demand in the region.

Gary, we have time for one more question, please?

Eric Larson, Buckingham Research.

Thanks for sneaking me in, guys.

I appreciate it.

Just a follow-up on the head winds that you're facing in the US business.

One is Kashi, which you're starting to transform and renovate.

The other obviously is in the cracker chip side, where you're up against some difficult comps, which was a previous question recently.

If you exclude the negative impact of Kashi on US morning foods, and the cracker chip business in your US snack business, what would your organic sales growth rates have been?

Eric, I don't have that math to hand, but I think it's fair to say that we have some head winds this year that in some respects masks our underlying performance.

As we go into 2016, we don't expect to have some of those head winds.

I think that's another reason why we have confidence that we are building momentum, and we will be in a better position as we go into 2016.

Okay.

Maybe we will drill down that further in your Analyst Day.

Then the next question is probably for Ron.

Ron, obviously you're generating more free cash this year.

I know that this year is your peak cash spending for Project K. You've got some more in 2016 and 2017.

But $350 million of cash costs this year, and maybe you gave this number, I don't have it -- what are your cash costs expected for Project K next year?

What would be additive to cash next year from just lower cash costs for Project K 2016?

First, Project K. After-tax cash for the entire four-year project is about $1 billion.

That includes capital spending and the other elements of cash to execute the program.

More than half of that will have occurred through 2015 business.

We were well over $200 million last year, approximately $350 million this year.

Our cash requirements are a bit less as we move into 2016 and 2017, and then closing up in 2018.

The other thing I think it's important to note, in both 2014 and 2015, we focused on our working capital improvements, and essentially we have been able to offset that impact of the increased cash for Project K through working capital improvements, and specifically the supplier financing initiative.

Okay, thank you.

This concludes our question-and-answer session.

I would like to turn the conference back over to Simon Burton for any closing remarks.

Okay, everyone.

Thanks very much for joining us.

We'll be around for the next few days to answer any questions.

Anybody who still wants to register for the Analyst Day in 2 1/2 weeks or so, please get hold of IR.

We'll take care of getting you signed up.

Thanks.

The conference is now concluded.

Thank you for attending today's presentation.

You may now disconnect.