家樂氏 (K) 2016 Q2 法說會逐字稿

Good morning. Welcome to the Kellogg Company second-quarter 2016 earnings call.

(Operator Instructions)

Please note that today's call is being recorded. Thank you.

At this time, I will turn the call over to John Renwick, Vice President of Investor Relations for Kellogg Company. Mr. Renwick, you may begin your conference call.

Thank you, Gary. Good morning, everyone, and thank you for joining us today for a review of our second-quarter 2016 results. I'm joined here by John Bryant, Chairman and CEO; Ron Dissinger, Chief Financial Officer; and Deanie Elsner, President of US Snacks. The press release and the 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, upfront 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 will be available by phone through Thursday, August 11. The call will also be available via webcast, which will be archived for at least 90 days.

And now, I will turn it over to John Bryant.

Thanks, John, and thank you, everyone, for joining us. We are pleased report another quarter of operating profit margin expansion. Obviously, we are still challenges after that top-line growth. Part of this is an industrywide dynamic, as you all know, and part of this is our exposure to a shift in weight management trends that affected one of our biggest brands, Special K.

That is why it is important that we continue to make progress on four key priorities we have been updating you on over the past several months. First, investment in food and packaging, which was evident in Kashi, where we completed the conversion of the entire portfolio to non-GMO, in Frozen Foods, where we completed a packaging transition, and in Special K, cereal and bars, in several markets, as we reframe the brand to inner strength. All of these investments have the consumer in mind, and all require near-term investment and transition. But all will bring back growth in the future.

Second, expansion of Pringles, which was reflected in continued growth worldwide [to be] because of adding distribution, expanding new platforms like Tortilla, or accelerating single-serve offerings. Our [Latin's co] brand is growing at a solid mid-single-digit rate.

Third, enhancing our sales capabilities, which continued as we launched broader revenue growth metric capabilities in certain business units. This moves us beyond trade optimization and analytics, toward priced-backed architecture and other ways to ensure that we have the right price on the right pack for the right occasion.

We completed the reorganization of our DSD selling and merchandising organization, which will offer improved effectiveness. We continued to expand distribution in high-frequency stores, particularly in emerging markets. This investment in execution will benefit us going forward.

Finally, but perhaps most important in today's industry environment, we made notable progress in increasing our earnings visibility based on our strong productivity programs. Not only did we record a higher operating profit margin in the quarter, we also made good progress launching and executing initiatives that will improve our margins for the rest of the year and beyond.

We continue to be on track with Project K. We continue to deliver on zero-based budgeting in North America, while rolling it out internationally. And our guidance for 2016 now incorporates higher zero-based budgeting savings, with more of it pointing to earnings. This is a key driver behind our more positive stance towards our 2016 earnings guidance.

As we stated at our Day at K Investor Day, we recognize that margin expansion is a major opportunity in the food industry, and we are committed to making significant progress against this objective. Today we are announcing an expansion and acceleration of our margin expansion plans.

As slide 4 indicates, we now have a plan that can realize approximately 350 basis points of improvement at a currency-neutral comparable OP margin through the year 2018. This is a bit more and two years earlier than previously communicated. The chart shows you the key drivers of our margin expansion. The first bucket is productivity. We will continue to generate our ongoing 3% to 4% productivity to offset inflation, and we are expanding zero-based budgeting in the US, while rolling it out internationally. Also we will continue to look for additional Project K initiatives that will help us achieve this 350-basis point improvement, with the potential for further savings beyond 2018.

We also will be looking into ways to improve our price realization. We are now establishing more formal revenue growth management disciplines around the world, an extension of the trade analytics we have always done to help us get better at price realization.

The next area of focus is investing for impact. Our investment model has to change with today's consumer and technology, and we have been re-thinking how we support and build our brands to the highest possible return on investment on every dollar we invest. This could mean less reinvestment going forward, and more productivity savings flowing to profit margin.

The last bucket has to do with making sure our foods are on-trend. This involves a more impactful approach to renovation and innovation. We are moderating our net sales growth outlook for the next couple of years to roughly flat. This reflects the current industry dynamics, but also affects some of these margin expansion efforts, particularly where they touch upon price elasticity and portfolio optimization. The net is a stronger portfolio and stronger earnings strength. We will provide more detail in the coming months.

With that, let me turn it over to Ron to walk you through the financials for Q2 and 2016.

Thanks, John, and good morning.

Slide 5 shows highlights of the financial results for the second quarter. Keep in mind that when describing our results and outlook, we will be referring to them on a currency-neutral comparable basis unless otherwise noted. And in many cases, we will also give you the same metrics excluding Venezuela. We do this because we know you prefer this basis for analyzing our underlying business performance. And of course, the appendices to our presentation provide you with the detail on both our GAAP and non-GAAP performance.

Second-quarter net sales increased by 8.6%, and like last quarter, these results included the impact of pricing actions in Venezuela. Net sales excluding the impact of Venezuela declined by 2%. Our operating profit increased by 10.6%, driven by savings from Project K and zero-based budgeting in North America, as well as by price increases in Venezuela. Excluding the impact of Venezuela, operating profit increased by 5.3% and exceeded our expectations.

On a comparable basis, earnings per share were $0.91 in the quarter, due to operating profit performance. This included $0.09 of currency headwind, $0.06 of which was due to the mid-2015 currency re-measurement in Venezuela. As a result, currency-neutral comparable earnings were $1 per share for the quarter, which represented a year-over-year increase of 8.7%.

Now let's turn to slide 6 and the components of the second-quarter sales. Volume declined by 1.6%, and roughly the same as Venezuela. We will discuss some of the markets where we saw declines a little later. Price mix contributed more than 10 percentage points to sales growth, due to the impact of pricing in Venezuela. The price mix excluding the impact of Venezuela declined by 0.5% percentage point, held down by category channel and SKU mix in various markets.

And finally, you can see on the chart that the impact of foreign exchange lowered reported sales growth by 15 points, with almost all of it coming from Venezuela. Now, in the second half, we will have lapped the Venezuelan re-measurement, so this impact will be much smaller.

Slide 7 shows our currency-neutral comparable gross profit margin for the quarter. Venezuela's inflation and currency re-measurement can be a bit distorted, but you can see that excluding Venezuela, our gross profit margin was flat in the quarter and very close to flat for the year-to-date period.

Our productivity, Project K and zero-based budgeting initiatives all delivered as planned in the quarter. This was most evident in North America, where our gross profit margin increased meaningfully, in spite of investments (technical difficulty) included Kashi, adverse transactional currency impacting Canada, and some adverse mix in Morning Foods and Snacks. Offsetting this strong North America performance for gross margin declines across our international businesses. These declines were primarily driven by the adverse transitional currency impacts on dollar-based commodities and other inputs and a deflationary retailer environment in Europe.

Slide 8 shows the currency-neutral comparable operating profit margin, excluding Venezuela, for the quarter. And on that basis, operating margin increased by 110 basis points in the second quarter. It was led by North America, which is where we rolled out ZBB. Operating margin was up internationally as well, though expansion was a bit more modest, owing to the gross margin pressures described previously and to the fact that zero-based budgeting is just starting up in these regions.

Slide 9 summarizes the regional financial performance for the second quarter on a currency-neutral comparable basis. I will focus on the profit and margin performance, and then Deanie and John will follow with more color around the top line. The first thing that you'll notice is that, excluding Venezuela for Latin America, every region posted profit growth and margin expansion in the quarter.

In North America, operating profit increased by 5%, as savings programs more than offset a decline in sales. Operating margin improved by 1.4 points, driven by Project K savings, the ZBB initiative and lower net input costs. In Europe, operating profit increased by 4% on flat sales, with an operating margin that increased by 0.5%, largely on efficiencies and timing of brand building, as well as savings [in full bread].

In Latin America, operating profit increased substantially because of inflationary Venezuela. Excluding Venezuela, operating profit also increased by 4%. Operating margin excluding Venezuela improved by nearly a full point, led by price realization and cost management programs.

Asia Pacific's operating profit jumped by a little more than 17% in the quarter, partially driven by sales growth. Operating margin increased by nearly a full point as the timing of investments more than offset unfavorable transactional currency impacts.

Slide 10 shows our cash flow for the first half of the year. You may recall that our first-quarter cash flow included the impact of a bond tender offer, which lowered cash flow by approximately $145 million. Related to that, we did get a cash tax benefit in the second quarter. So the net after-tax cash impact of the tender, year to date, is approximately $97 million. And still, our year-to-date cash flow through the second quarter was $399 million, which is about $76 million better than that of the year-ago period.

And importantly, we continued to reduce our core working capital as a percentage of sales, both sequentially and year on year. This improvement was again led by the accounts payable initiative that has been benefiting working capital over the last year. We are still on track to deliver our targeted $1.1 billion of full-year operating cash flow after capital expenditure. Full-year capital spending should still be in a range between 4% and 5% of sales, including investment for Pringles growth and Project K. We bought back shares worth approximately $176 million in the second quarter, bringing our year-to-date total to $386 million -- all this under our current $1.5 billion authorization.

Slide 11 shows our latest guidance for the year, again, on a currency-neutral comparable basis. Our net sales guidance does not change, but we believe we will come in at the low end of the 0% to 2% range that excludes Venezuela. Our operating profit guidance moves higher because of Venezuela's profit performance in the first half. And excluding Venezuela, we are not changing our guidance range, but we expect to achieve the high end of the 4% to 6% range. This is related to zero-based budgeting, which is now projected to deliver roughly $150 million to $180 million of savings in this year.

North America has confirmed more savings than anticipated, and our international regions now have savings commencing in the second half. We are allowing more of our projected savings to flow through the bottom line, more than offsetting the impact of sales, coming in toward the lower end of our guidance range. Between this higher ZBB savings and the performance of our Venezuela business, we expect are currency-neutral comparable earnings per share to be about $0.11 higher than the range we gave previously. I will point out that on a comparable basis, including currency, our earnings per share outlook range actually comes down $0.06, owing to further devaluation of currencies against the US dollar.

Our increased outlook for operating profit has been offset by a higher average share count, due to increase in share price and dilution from [offs rejected]. This $0.06 of additional negative currency translation is from the British pound, primarily, following the vote to exit the European Union. From a phasing standpoint, the additional $0.06 of impact from currencies is evenly spread across Q3 and Q4. Remember, the impact of Venezuela is immaterial in our second half, as we have lapped the year-ago we measured. The Q3 our earnings per share will be a little lighter than Q4, owing to the timing of investments, particularly around the Olympics, and to media campaigns that were shifted first half into third quarter.

Slide 12 shows other elements of our guidance. And first, you can see the currency impacts we just talked about. Interest expense should come in at around $400 million, which includes roughly $150 million from the bond tender, which has been excluded from our comparable results. Our comparable tax rate will be approximately 27%. Share buybacks are expected to be approximately $700 million to $750 million, though as I said, a higher share price and increased options exercises will translate into a higher average shares outstanding.

Full-year upfront costs remain consistent with our original guidance of between $200 million and $250 million, or approximately $0.40 to $0.50 per share net of tax, about half of which should be in cost of goods. And full-year integration costs are still anticipated between $0.02 and $0.03 per share, net of tax. For both the upfront costs and integration costs, we are showing on this slide, post-tax values, as well as our new disclosure rules.

And with that, we will now discuss the performance and outlook of each of our business units. We will start with our largest business, US Snacks. And with us today is Deanie Elsner, President of US Snacks.

Thanks, Ron, and hello, everybody. Let's go to slide 13. Before we jump into our Q2 results, let me quickly reground you on what I told you back at November's Day at K investor presentation. First, we are a big business, with good profitability. We compete in five different categories, each with their own dynamics, and in different aisles of the store.

Second, we have a strong portfolio of great brands, which participate in the mega consumer trend toward snacking. This slide points out the size of some of our key brands. Third and importantly, I laid out the opportunities that exist to get this business back to growth again, and I shared with you the key priorities we are focused on this year.

Among those were the following: First, expand our margins. Next, shift investment to our growth brands, the brands most aligned to today's consumer. Next, expand on-the-go formats to reach consumers across occasions and channels. And finally, stabilize Special K.

Today I want to give you a progress report on each of these priorities. Let's start with how we are improving our profit margins, on slide 14. As you know, we are driving significant productivity through Project K and ZBB. I'm happy to say that we are on track with these savings.

We are also institutionalizing a broader, more disciplined approach to revenue growth management. We have started with Cheez-It, where we evaluated the price point of our offerings across channels, from large sizes to on-the-go and single-serve. And we are assessing how we invest our trade dollars. In-market for Cheez-It demonstrates the early impact of this effort. Year-to-date consumption is up 5%, led by volume and strong price mix. Base sales, up 7.6%. And we have increased distribution more than 7% behind an expansion of our price pack architecture. The brand also posted improved profit margin.

Across our portfolio, our efforts on productivity, cost savings and revenue management are paying off. Our currency-neutral comparable operating margin is up year on year, both in Q2 and Q1. In fact, year to date, that margin is up 120 basis points. So good progress on margin expansion in snacks, with more to come.

Our second priority was to shift our investment to brands that could give us the strongest growth. This is represented on slide 15. To optimize our return on investment, we concentrated our spend behind our best brands. In crackers, we are invested behind our big three -- Cheez-It, Club and Town House. All three of these brands grew consumption in Q2 and year to date. Collectively, they are also gaining share in Q2 and year to date.

Pringles grew consumption nearly 3% year to date. Our core four flavors where we are putting the most emphasis on the shelf increased consumption 9% year to date. And our single-serve offerings have grown at a double-digit rate. So as we get past some phased out, non-core items in the second half, you will see accelerated growth thrusts in salty snacks.

In cookies, we have turned on media for the first time in years on the Keebler brand, introducing a whole new generation to the elves in the hollow tree. It's early days, but the Keebler brand turned to consumption growth in Q2.

In wholesome snacks, Rice Krispies Treats grew consumption by 4.5% in the quarter, and Nutri-Grain grew consumption by more than 5%. This means two-thirds of our wholesome portfolio delivered healthy growth in Q2. Focusing on investment of our growth brands is a key element of our plan this year, and we are seeing the results.

Slide 16 talks about our third priority: expanding our on-the-go offerings and distribution. We know consumers are snacking more and on more occasions, but we have been missing out on many of these occasions by not having the right pack format in the right channel. This has been a key area of focus for us in 2016.

We are expanding formats or pack types across channels to better meet consumer needs. We've expanded our line of smaller-size and single-serve offerings. We have gained distribution. And we have even added capacity where needed, as with Pringles Snack Stacks and small cans. An example of this is our crackers and cookies caddies, or our multi-pack of single-serve items. They have grown consumption year to date by 10%, accelerating in the latest four weeks. Similarly, our Pringles on-the-go products are up double-digits.

As we launch these new formats, we are swapping out less-relevant SKUs to ensure a more proactive approach to portfolio management. This will result in the in-market data looking a bit mixed today, but improving in the second half. This is a big growth opportunity for us, and we are encouraged by the results.

The final priority we discussed with you at Day at K is stabilizing Special K, represented on slide 17. We discussed how the shift in weight management trends have had a negative impact on Special K, and how that more than anything else has pulled down our sales over the past few years. So taking a page from the cereal playbook, we are overhauling Special K's snacks portfolio to drive consumer relevance and reconsideration.

We have done a lot of work over the last year, renovating some of the Special K SKUs, and launching on-trend foods like Special K Nourish Chewy Nut Bars. And we are seeing positive results. Our Nourish bars are 80% incremental to the Special K bars line. And importantly, their velocities in Q2 were 3 times greater than the rest of the Special K bar portfolio. So when we get the food right, this brand can grow.

The challenge is that there are food forms in this brand that are simply not as well-aligned to how our consumers are eating today. That is why in Q2, consumption for certain lines of Special K declined at a double-digit rate. Stabilizing Special K is mission-critical for us. In 2017, we will make a more aggressive portfolio change to the Special K brand, but we expect to continue experiencing some drag from Special K in the second half of 2016.

So I will use our Q2 and rest-of-year outlook as a summary of everything we've discussed, and that is on slide 18. We are improving our profit margins in this business. We saw that in our Q2 results, and we should continue to see profitability improvement in the second half. Our most important brands are growing, and we will continue to invest in these brands in the second half.

We still have drags on our top line, most notably, Special K, but we anticipate less of a drag in the second half. In Q2, we also felt the impact of some timing-related factors from shifting promotion, in addition to the completion of our DSD reorganization. But that is behind us, and we have already started to see signs of improved effectiveness.

So we have a lot of work going on in US Snacks. In the first half of this year, we have improved our profit margin and grown our focused brands, even as we address the drags from Special K and our non-core portions of this portfolio. This gives us the confidence that we will see improved results in the second half.

And with that, I will turn it back over to John.

Thanks, Deanie. Let's turn to slide 19 and walk through our business segments, Q2 performance and full-year outlook. In US Morning Foods, like Snacks, our margin expansion efforts are clearly going through. Project K savings and ZBB efficiencies contributed to an expansion in operating profit margin of nearly 4 points, an acceleration from Q1's strong performance.

In cereal, the category came back to flat after down Q1, which is encouraging. As [shares grew] slightly in the quarter, mainly due to the timing of promotional activity. But our core six brands held firm and retained market share year to date.

Fruits and pastries, meanwhile, continued to perform well, growing consumption by 5%, with good contribution from the new soda flavors. As we move to the second half of the year, we continue to expect improvement in top-line performance, particularly with timing of promotions like the Olympics. We feel good about our business, and strong profit margin expansion should continue to drive profit growth.

US Specialty Channels is shown on slide 20. This segment posted another quarter of growth in sales profit and profit margins in Q2. In food service, we sustained strong growth in cereal, crackers, veggie and wholesome snacks -- all categories with leading shares. In convenience, we gained share in cereal, salty snacks and crackers.

Innovation continues to perform well, and we feel good about the momentum we have in our business. We also feel good about our profit margin performance, which continued in Q2, good price realization and the early benefits of zero-based budgeting resulting in improved profitability. We expect this to continue in the second half.

Rounding out North America on slide 21 is our North America Other segment. During Q2, our North America Other segment posted the lowest sales and profit, as each of its component businesses progressed through transitions. US frozen foods is an example of a portfolio in transition, as we have reshaped the portfolio for Eggo, and transitioned to new packaging across the entire MorningStar Farms line. Even as we've made these major moves, this business posted improvement in profit margins, driven by Project K and zero-based budgeting.

Kashi has also invested in a major overhaul of its portfolio. We are investing heavily in our food. During the quarter, we completed an overhaul of our portfolio, making every product non-GMO-verified. We also launched several new products. In fact, we believe this was the most innovation launched in Kashi's history. And finally, we redesigned our packaging across our Kashi portfolio.

In Canada, we [leaned] to the price realization in order to cover the transactional currency impact on our cost goods. This caused some elasticity impact on consumption in the quarter that will help us better-offset our adverse costs going forward. The good news is that we continue to see share gains in our renovated and repositioned Special K. So the North America Other segment is clearly in transition, though we expect to see gradual improvement in sales and profit margins in the second half.

Turning to slide 22 and Europe, we have been expecting sequential improvement in sales and profit in Europe, and we saw that in Q2. Sales were flat following Q1's slight decline, and our operating profit margin expansion led to better profit growth. We are extremely pleased with our Pringles business, which grew at a double-digit rate. Wholesome snacks also had another good quarter, growing at a mid-single-digit rate, led by UK's 5.5% consumption growth, and broad-based improvement in trends in most markets.

Cereal, though, was disappointing in Q2, mainly in the UK. The category there remains very soft, and is typical with economic and retail environment, and we lost share, mainly as work to reposition and renovate Special K. Our efforts to renovate Special K's food and new inner-strength positioning are ongoing. And while the new Nourish is doing well, this recovery may take some time.

The good news is that in our other cereal markets -- including France, Benelux, southern Europe and northern Europe -- we did see sequential improvement. And we continue to generate double-growth in Russia. As we look to the second half, we continue to expect sequential improvement in Europe in sales and profit, which will require progress in stabilizing UK cereal. We have plans in place to address this, including an exciting Olympics program, and the inner-strength campaign for Special K in the UK, and big back-to-school insert programs across the region. And of course, we will continue to improve our profit margins across Europe.

Slide 23 highlights the performance of our Latin American business in the second quarter. We continued to manage well through a difficult business environment. Obviously, Venezuela presents a unique set of challenges, and we are managing that well. But we are also operating in a challenging economic environment throughout the region.

We're working through these challenges, and in Q2, we realized sequential improvement in sales and profit. Our consumption performance, particularly in cereal, remains solid, with good growth in Mexico and share gains in key markets like Brazil and Colombia. Our [cupper] America soccer promotion did well, and innovations like Special K Protein cereal are helping us stabilize that key brand.

We are realizing price across the region, particularly as we cope with adverse transactional foreign exchange. And while we saw initial price elasticity impact our volumes in Q2, we should hold sales and profit in the second half. It is never easy in Latin America, but our team there is managing through the volatility, and we should see sales and profit growth in the second half.

Let's look at slide 24 at our Asia Pacific business. Our Q2 net sales growth accelerated from Q1, and increased our operating profit margin as well. Our Australia business continued to improve, posting slight sales growth in cereal in the quarter. Of note has been a turnaround in our biggest cereal brand in Australia, Nutri-Grain. In fact, across the entire cereal portfolio, it improved the penetration and gained share in the quarter.

In Asia, growth was led by distribution gains in southeast Asia and strong commercial activation in Korea. Our business in Sub-Saharan Africa continues to outpace the cereal category. Pringles in Asia Pacific grew at a high single-digit rate in Q2 accelerating from Q1.

It is important not to overlook our joint ventures. The results are not consolidated into our reported results, but they represent a key element to our emerging markets growth strategy. On a pro forma basis, if they were included in Asia Pacific's net sales, our growth in Q2 would have been nearly 12% year on year. We are generating double-digit growth in China, led by [Wynalda] cereals. And our West Africa JV also posted strong double-digit growth, in spite of a challenging macro economic environment. We expect continued growth in Asia Pacific in the second half with added growth from our JVs.

Now let's wrap up our prepared remarks with a quick summary on slide 25. Regarding Q2, we continue to make progress on our key priorities for this year, investing in our food, expanding Pringles, enhancing our sales capabilities, and executing our savings initiatives. And we are seeing stabilization in key cereal markets like the US, Canada and Australia. We are reflecting a greater focus on profit margins, with moving our productivity initiatives with positive earnings that were slightly better than our expectations.

As for our 2016 outlook, on a currency-neutral comparable basis, our earnings outlook improved on the strength of inflationary Venezuela. But just as importantly, our [point-of-profit] outlook, excluding Venezuela, now looks to come in at the higher end of our guidance range, reflecting the rapid expansion of our ZBB effort. And on our longer-term outlook, new initiatives and accelerated programs are giving us better visibility into how we can improve our profitability going forward.

This is going to boost our profit margins, even as we reshape our portfolios to better-align with today's consumer, as we continue to expand our footprint in growing markets around the world. We'll have more to share on this in the coming months.

I would also like to this opportunity to thank our employees around the world for their dedicated service to our Company.

And with that, let's open up the line for Q&A.

(Operator Instructions)

John Baumgartner with Wells Fargo.

Hi, good morning. Thanks for the question. John, I'd like to ask about changes underway in the DSD system. As that delivery salesforce reorganization concludes, how are you thinking, going forward, assessing the opportunities for further efficiencies in that route to market, either personnel- or overhead-related? And where can you better-leverage DSD for that increased distribution snacks that Deanie discussed?

Well, as I said, DSD obviously is a powerful go-to-market engine. It is one that we constantly look to optimize and improve. Over the years, we have taken things in and out of DSD, and we're always looking to make that system more effective and efficient. We have seen good progress. We're very excited to have the reorganization behind us. We expect to see the business be stronger in the back half of the year, and we're making good progress.

Just to add to that, John, as I talked about, the price tag, architecture, and specifically, the expansion in format -- we have the opportunity in our current grocery channels that are serviced by DSD to expand the format in those channels, as well as outside of the traditional grocery channels. And so we will be pushing those initiatives into our DSD system.

Is that more of a back-half focus, or more 2017?

You will see us expanding as early as we speak -- back-half now.

Great, thank you.

Matthew Grainger with Morgan Stanley.

Hi, good morning, everyone, thanks for the questions as well. I wanted to just ask about the revised margin targets. So you are on track to deliver $200 million-plus in incremental cost savings this year. And with the ZBB, I think you had around $550 million in total. So even if we assume some incremental savings on international ZBB, right now the formal cost savings seem to give you visibility to about half to two-thirds of the margin that you are targeting, if that flows through to the bottom line.

So can you just talk about the other factors you mentioned, like improving mix, revenue management, how those bridge the gap to get you to the 18% target? And are you comfortable that there is enough margin for error in your model and in your cost savings pipeline that you can definitely reach that target, even in the event of weaker volumes or higher inflation?

Sure, Matt. In short, yes, we are. And let me just run through some of the elements of that 350 basis points of margin expansion. Remember, that is off of a 2015 base. And it is also important to note that, that expansion is based on essentially a flat sales expectation.

So of course, we have a continuation of Project K savings. And we have talked about this before. As we look at 2017, 2018, we have in the range of $130 million to $150 million worth of savings.

Our zero-based budgeting program, we communicated for 2016, $150 million to $180 million. We now have visibility for both North America and our international businesses of savings over that period of $450 million to $500 million. So that is over a three-year period, 2016 through 2018.

The other thing, as we discussed, we are doing, is, we're putting a more concerted effort behind revenue growth management, to generate stronger price and mix improvements. We have very good line of sight to achieve that margin expansion goal on essentially a flat sales expectation. Of course, our goal would be to do a little bit better on sales. If we do, then 18% -- the 350 basis point expansion -- is not a ceiling, it is a target or goal at this point in time, and we have a strong plan and good visibility to get there.

Okay, that is helpful. Thanks, Ron.

Eric Larson with Buckingham Research Group.

Yes, this is a question for John. In the early part of your prepared comments, you -- it is kind of a little bit of a tag-on, on the last question. Your new marketing model -- and I think that you said that it might result in less reinvestment.

Does that mean that you're advertising spending as a percent of sales -- which is running roughly about 8%. I think it is amongst the highest in the industry. Will that percentage come down over time a little bit? And will actual dollars in advertising ease as you become more efficient? How should we look at that?

It's a good question. As we think about brand-building, it is an important part of our mix. What drives our categories is strong brands, strong innovation, good end-market, in-store execution. And as we continue to have industry-leading levels of brand-building and we continue to invest in our brands, how we invest in the brands is obviously changing.

So the importance of TV versus digital, social, mobile, et cetera -- all that is changing the mix. As we do that and we apply zero-based budgeting to our principles to that work, we're finding, one, we can do some of the nonworking activity at a lower cost without impacting the amount of activity that we actually do. And secondly, by changing the mix, we can actually get a better impact, and potentially at lower cost.

So I'm not going to give you guidance over the next few years as to where brand-building will go. But I think it is fair to say that we probably can see our brand-building come down a little bit from where it is, and continue to drive very strong brands into the future.

Okay. And then just a tag-on question for Ron, and then I will pass it over. Your new margin target goal for 2018 -- does it include any additional cash investment? Or is this just a better outlook for all of the programs that you already have in place, i.e., Project K and ZBB? Is there a cash impact?

So our Project K is on track at this point in time, and it is on track both from an investment and a savings standpoint. So there are no additional cash requirements for us to achieve this margin goal.

Okay, thank you.

Yes.

Mario Contreras, Deutsche Bank.

Good morning, thanks for the question. I wanted to ask a little bit more on the revenue management initiatives that you have in place. Can you give a little bit more detail on what exactly that entails, or at least the detail you can provide now over the next couple of years? And what the volume elasticity that you're looking at relative to some of the pricing and [per to] the changes you plan on making?

Yes, we are launching a greater focus on revenue growth management in the Company. As you would expect, we have always had a focus on it. But what we have historically focused on has been trade analytics. And we are finding these opportunities in some other areas, such as price pack architecture, and of course, continue to drive our focus on mix.

And for those of you who have followed the Kellogg Company through the 2000s, we had a significant benefit in price realization, and what we called a volume-to-value model orientation. We're actually bringing that orientation back to the Company to ensure that we are focused on price mix. Our price mix realization of the Company has actually been lagging our peer group over the last few years.

So I do not view this is as a radical shift, I view this as an increased focus in this area. And I really want to see better performance from the Company going forward. To give you an example of this, we have Deanie on the call. I will let Deanie talk about one example in the snacks business.

Yes, and John is exactly right. The opportunity for Kellogg is greater price realization across all three levers of revenue growth management. So I mentioned earlier the Cheez-It example.

In Cheez-It, we assess our portfolio pricing across all of our channels. We expanded our formats to meet the needs of consumers by channel, and that included large sizes and on-the-go and smaller sizes, in addition to opening price points. The formats change by channel.

We optimized our trade, and that gets to the trade optimization that John talked about, is a towering strength of Kellogg's. And the results -- and you can see them in Q2 -- consumption is up 5.4%, we have had strong volume mix, our base sales are up, our distribution is up, and our operating margin has expanded. And so when you look at revenue growth management holistically and in totality across all three levers, there really is strong opportunity for the Kellogg Company going forward.

Okay, thank you very much.

Chris Growe with Stifel.

Hi, Good morning.

Good morning, Chris.

I just had a question, if I could, and forgive me if I missed this earlier. But have you said how much the total cost savings will be in FY16? So adding international, the ZBB -- how much more is that contributing to your available cost savings this year?

Yes, good point, Chris. So when we started the year, we said we had about $100 million worth of Project K savings. We are still on track to deliver against that. And we said from a ZBB savings standpoint, we expected about $100 million of ZBB savings.

We are now at a range of $150 million to $180 million worth of zero-based budgeting cost savings. So that has allowed us to cover sales coming down to the low end of the 0% to 2% range, and increase our operating profit guidance to the high end of the 4% to 6% range, all ex-Venezuela.

Okay, that is helpful, thank you. And just related to that, as I listen to the commentary about more savings and the focus on margin, I think that is great. I guess what I'm trying to understand is, as you have more savings coming through -- or I should say, as you better-focus on margin, does that allow you to also reinvest back into -- to generate better top-line growth?

Are there more savings coming through that are allowing you to reinvest and to pursue a top-line growth target along with the margin target? Or could you speak to that, over the next couple of years?

So we are continuing to reinvest back in our business. As you mentioned, we've invested back in our sales capabilities. Also investing back in our food. I think Kashi is an example of investing to go non-GMO is a major investment by the Company.

And so we'll continue to ensure our food and packaging is on-trend as we go forward, and so there will continue to be investments in that area. As part of our margin goal, we do have an expectation to reinvest some level of savings back into the business.

We are giving a sales guidance here over the next couple of years of flat, and that is less than what we would normally do. A couple reasons for that. One is, what we are saying is, from an economic model perspective, from an analyst perspective, if you put in flat sales and the 350 basis points of margin expansion, we think that is a good way of modeling the Company.

Quite frankly, we would shoot to do better than that, and actually grow the top line from an internal perspective. But we are not relying upon that to get to the operating margin expansion. The margin expansion is coming more from productivity and price mix realization, rather than, say, volume-type growth.

In addition to all of that, as we go through the next few years, you might see some elasticity as we improve the price realization. And we might see some parts of the portfolio that is lower profit, that we de-emphasize as we continue to grow other parts of our business, such as Pringles, which as been growing mid to high single-digits the last couple of years.

Okay. Thank you for that color.

Thank you.

Robert Moskow with Credit Suisse.

Hi, Ron. I was hoping you could help me on one thing that you mentioned. When you said $150 million to $180 million of ZBB this year, I think in the same breath, you also said $450 million to $500 million over three years. And I was just wondering, did I get that right? And if so, does that assume that there is no improvement in 2017 and 2018 on those ZBB savings, that it is kind of like a one-time help, and then you just hold onto it each year? Thanks.

So Rob, we have $150 million to $180 million visibility in 2016, and then that will build over 2017 and into 2018 to a run rate of $450 million to $500 million. The other thing that I would point out, so that savings in ZBB, that's on top of Project K, that is on top of our base productivity savings as well, Rob. So we have a lot of productivity savings coming through our P&L.

Okay. So it is not a cumulative number, it does build each year. Can you give us a sense of what -- this is very different from what I thought. So can you give me a sense of what gives you confidence that it can build to that degree? Is it in rolling out in different functions of the organization and geographies? And then what percent of those functions and geographies do you think it is in right now?

So it's certainly in North America, and we have a line of sight year by year. Rob, some of the things are very easy to change and to get the cost savings. There are other things within supply chain and other areas of our business that take a little bit more time to recognize the savings. So we are certainly doing it as quickly as we can.

In terms of the rollout through the international regions, certainly our Europe and our Latin America businesses are well-underway, and we're getting some of those savings end-of-2016 related to them. Asia Pacific, we'll see more of that savings coming into 2017. But international overall has a stronger cost of savings in 2017, whereas North America, their savings really was ramping up here through 2016.

Can I ask if Kashi is going to go through this process?

Kashi has been involved in the process throughout 2016 as part of the North America implementation, Rob.

Got it. Thank you.

Yes.

Dave Driscoll with Citi.

Great, thanks a lot, good morning.

Good morning, Dave.

John, I wanted to go back to this sales comment that you are making about 2017 and 2018 and the flat numbers. You know, I want to say that back at Analyst Day, there was a lot of energy about rebuilding the top-line momentum and getting the Company back on revenue growth. You made repeated comments about the operating leverage that revenue delivers to the business model. You've made a couple of comments here, but I'd just like to push it a little further.

Is it you are just trying to set up some kind of super-reasonable expectation going forward, i.e., a very achievable numbers, at this early date? Or is there something about all of the growth plans and reinvigorating cereal and Kashi, and all of those things that you just have less confidence in, and says -- hey, let's take this down to a zero-growth exhortation?

Thank you for giving the opportunity to clarify it. That is a concern out there. I feel very good about the progress we are making on the top line. If you look back over the last three or four years, we've talked about the importance of stabilizing the large four core cereal businesses. I'm happy to say that if you look at the US, Canada and Australia, you will get the measured data, you can see the categories are stable, and our share is stable across those three businesses.

The UK continually is a work in progress. That's why we're not happy with this performance, but we expect to see improving results in the back half of the year in the UK. So core cereal is looking better than what I would say a couple years ago. Special K has been a major drag. In fact, pretty much all the loss of sales the Company has had over the last few years has been Special K.

And what you're seeing in business end-markets like Canada and the US, particularly in cereal, that business has stabilized. And we've still got some work to do in some snacks extensions of Special K, but we're feeling better there. And so we do think that the growth from Pringles and so on will keep coming through.

And although while we are being cautious and saying flat sales again, is because, one, we are being, I think, prudent from a modeling perspective. And clearly if we can get sales growth, it will give us even more flexibility in the P&L. So one, I think we're trying to avoid overstating expectations -- over-cooking expectations. So [good economics].

And secondly, as we do drive for more price realization, as we do de-emphasize some [royal] profit elements of the portfolio, we might see drag on the top line. But it's a drag that I would not be concerned about, because we are building a stronger core business over time, with a better growth profile. So I think we're just giving prudent guidance at this stage.

Thank you. Could I just sneak one in for Deanie? Your largest competitor was complaining of higher trade and promo spending by the competition. Can you discuss your view on promo spending and how rational it is right now in your big categories?

Yes, I would love to, Dave. It is never productive to comment on competitors, but I will give you a perspective of how we are looking at the category. For me, the category dynamics appear pretty rational. If you look both across cookies and crackers, both categories are up in consumption, average price is up in both categories, both on a per pound basin, as well as a per unit basis. Quality merchandising is flat, features and displays are up, displays are down. So it is pretty rational of what you would expect.

It is more competitive, and I can tell you, as we look at this from a Kellogg's standpoint, our pricing is very similar to what we're seeing in the category. Our price per pound and per unit, both in cookies and crackers, are up versus a year ago in the quarter. But ultimately, in the long run, to win in this category, you have to do three things.

You've got to invest in your brands. You've got to launch innovation consumers love. And you have to drive in-store excitement. And so we are going to continue down our playbook in terms of how to go win in this category, and you will see us do that, both in cookies on Keebler, as well as a couple of our regional brands, as well as the big three in crackers.

Thank you.

Alexia Howard with Bernstein.

Good morning, everyone.

Good morning, Alexia.

Can I ask about the ramp-up in your cost-cutting efforts? They have obviously accelerated for the near-term here. If I compare that to the billion-dollar challenge -- where there were execution problems through that cost-cutting program, issues of morale, cultural upheaval -- what is different? How will you manage -- or how are you thinking about making sure you learned lessons from that experience, to make sure that this time, it is smooth sailing? Thank you, and I will pass it on.

This is Ron, Alexia. When you look at Project K -- and we've discussed this before with analysts and investors -- it is very different than that billion-dollar challenge. Where we took capacity out of our network, we were actually closing down facilities, that previous billion-dollar challenge, we were simply taking people out of the organization and asking the organization to do the same with less people. That was a bit harder for them to accomplish.

So we feel good about Project K and the integrity of our infrastructure as a result of the actions we are taking there. Zero-based budgeting, it's really just a refreshing way to look at our cost structure and ensure the investments that we have are prioritized and aligned with our strategy. It is nothing more than that. We are being very thoughtful on how we take costs out of our business and make sure that the investments we're making are aligned with our priorities and strategy.

Thank you very much. I will pass it on.

Gary, I think we have time for one last question.

Michael Lavery with CLSA.

Good morning, thank you.

Good morning.

You touched on Kashi and it sharing in some of the savings efforts. But obviously there is investments there too, and that other segment margins are still down. Can you give us a sense of what that trajectory looks like? And should we expect those margins to increase over the back half? Or is there a different way we should -- some other investments still to come we should be factoring in?

On Kashi, we feel very good about where we are from an investment perspective. Now we have the entire portfolio GMO-free, if we can turn the marketing program on in the back half of the year. We had a very strong slate of innovation go through here at the middle of the year. So we expect to see Kashi return to growth in the back half of the year.

Now, there are some parts of the Kashi business and frozen pizza items and some other items that we've culled out of the portfolio, so that might continue to drag on the business. But that was ultimately lower-margin segments of the portfolio anyway. So we feel good right where we are in Kashi in terms of positioning it for long-term growth.

If I could just say, on K&A Other, because that is a part of the portfolio that did drag in the second quarter, so a few quick comments more broadly on that segment. Three businesses in there. One is frozen foods.

In frozen foods, Eggo is actually doing reasonably well when you add in non-measured channels. MorningStar Farms has gone through a very difficult packaging transition that is now complete. Turning on the marketing in the back half of the business -- back half of the year for that business. And also, we did cull some SKUs on the Eggo business at the end of last year.

So when you add all that together, it's had a bit of a rough first half, but we do expect frozen foods to return to growth in the second half of the year. Canada, we have had significant transactional foreign exchange issues in Canada. We have increased our promotional price points.

That's going to lead to some disruption in the market as that sort of settles its way in. So I think Canada has a tough year. It's the right, low-term decision, but it's going to come with a little bit of short-term pain as we go through that.

And then Kashi, as I said, we do expect Kashi to return to growth in the back half of the year, and feel better about it. So in the back half of the year, we have two of the three businesses within North America Other returning to grow, and we think that the same -- we'll look better in the back half than the front half.

Okay, that is helpful. And can I just add one quick last follow-up? On the flat sales expectation, can you give any sense of what the split might be between volume and price mix?

No, we have not given that sort of guidance. I think we'll will wait until each annual discussion, when we provide more color of why it is what it is. But clearly within a flat sales guidance, you would expect volume to be down a little bit, and price mix to be providing some benefit.

And again, let me reiterate, internally we will chase better numbers than that, but we don't want to promise those numbers. Clearly we want to deliver them, though, when the time comes.

Okay, thank you very much.

Hey, Gary, that went faster. We can do one more.

Ken Zaslow with Bank of Montreal.

Good morning everyone.

Hey, Ken.

Just two quick questions. One is, when you talk about the flat line growth over long term, can you take a separate -- or segment it between how you are seeing about the US? Because it seems like there is a lot more activity in the US.

Would you expect that to be ahead of the rest of the world, just given the activity? And then my second question is, when you think about the margin expansion of the 350 basis points, that does include this year's benefit of Venezuela, or does that not?

Let me answer the sales question, and I will hand it over to Ron to answer the margin question. On sales, I'd say the heavy lifting on margin expansion is going to be more in North America and Europe, just given the size of those businesses. And I would expect those businesses to be slightly lower in growth than the portfolio average, with more growth coming from Latin America and Asia Pacific.

So I would say, again, flat is a range. Flat is not 0.0%. So I would hope that even those two big businesses can be in the flat ballpark in terms of top-line growth. But I would not point out that I expect them to grow faster, say, than the portfolio average.

Ron, do you want to talk about the margin goal?

Yes, just the way I think about the margin growth, so it is off of a 2015 base, and I have been looking at it on an ex-Venezuela basis. Venezuela is distorting mainly the 2016 results. But I think about that growth on an ex-Venezuela basis.

Okay, thank you.

All right, Gary, I think we are finally out of time.

This concludes our question-and-answer session. I would like to turn the conference back over to Management for any closing remarks.

Thanks, everyone. We appreciate the time on the call, and John and I and the team are available for follow-up calls throughout the day. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.