Kellogg Co.                  K          Q4 2007 Earnings Call         Jan. 30, 2008
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Kellogg Co.                  K          Q4 2007 Earnings Call         Jan. 30, 2008
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Kellogg Co.                  K          Q4 2007 Earnings Call         Jan. 30, 2008
                                      ...
Kellogg Co.                  K          Q4 2007 Earnings Call         Jan. 30, 2008
                                      ...
Kellogg Co.                  K          Q4 2007 Earnings Call         Jan. 30, 2008
                                      ...
Kellogg Co.                  K          Q4 2007 Earnings Call         Jan. 30, 2008
                                      ...
Kellogg Co.                  K          Q4 2007 Earnings Call         Jan. 30, 2008
                                      ...
Kellogg Co.                  K          Q4 2007 Earnings Call         Jan. 30, 2008
                                      ...
Kellogg Co.                  K          Q4 2007 Earnings Call         Jan. 30, 2008
                                      ...
Kellogg Co.                  K          Q4 2007 Earnings Call         Jan. 30, 2008
                                      ...
Kellogg Co.                  K          Q4 2007 Earnings Call         Jan. 30, 2008
                                      ...
Kellogg Co.                  K          Q4 2007 Earnings Call         Jan. 30, 2008
                                      ...
Kellogg Co.                  K           Q4 2007 Earnings Call        Jan. 30, 2008
                                      ...
Kellogg Co.                  K          Q4 2007 Earnings Call         Jan. 30, 2008
                                      ...
Kellogg Co.                  K          Q4 2007 Earnings Call         Jan. 30, 2008
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Kellogg Co.                                K                     Q4 2007 Earnings Call                           Jan. 30, ...
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Q4 2007 Earnings kellogg

  1. 1. Kellogg Co. K Q4 2007 Earnings Call Jan. 30, 2008 Company▲ Ticker▲ Event Type▲ Date▲ MANAGEMENT DISCUSSION SECTION Operator: Good day and welcome to the Kellogg Company 2007 Fourth Quarter and Full Year Earnings Call. [Operator Instructions] Thank you. At this time, I would like to turn the call over to Joel Wittenberg, Kellogg Company Vice President of Investor Relations. Mr. Wittenberg, you may begin your conference. Joel R. Wittenberg, Vice President of Investor Relations Thank you, Lisa, and good morning, everyone. And thank you for joining us for a review of our fourth quarter results and for some discussion regarding our strategy and outlook. With me here in Battle Creek are David Mackay, President and CEO; John Bryant, CFO; and Gary Pilnick, General Counsel. We must point out that 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 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 filing. A replay of today’s conference call will be available by phone through Monday evening by dialing 888-203-1112 in the US and 719-457-0820 from international locations. The passcode for both numbers is #6083848. The call will also be available via webcast which will be archived for 90 days. corrected transcript Now let me turn it over to David. A. D. David Mackay, President and Chief Executive Officer Thank you, Joel, and good morning, everyone. We’re pleased to report another year of strong performance by Kellogg Company. Highlights include reported sales grew 8% and internal sales rose more than 5%, in line with our 2007 guidance, and above our long-term guidance driven by both price mix and volume growth. Reported operating profit rose 6% and internal operating profit rose 3%. For the first time, cash flow rose above $1 billion and earnings per share rose 10% above our long-term growth target of high single-digits. We achieved these results by sticking to our business model and focusing on sustainable performance despite absorbing very high levels of commodity, fuel, energy and benefit inflation. We continued to invest in the long-term health of the business. In fact, our advertising rose at double digits to more than $1 billion. We also benefited from a lower tax rate due to some discrete items and we reinvested that benefit back into the business. Our upfront cost investments totaled $0.18. Given our investments and excellent execution and despite a volatile commodity environment, we entered 2008 with confidence in our ability to continue to deliver strong results. Therefore, we are affirming our 2008 guidance. Now I would like to turn it over to John to take you through the financials. 1 w w w .Ca ll St r eet . com • 21 2- 84 9- 40 7 0 • C op yr i g ht © 20 0 1- 2 00 8 C a ll S tr ee t
  2. 2. Kellogg Co. K Q4 2007 Earnings Call Jan. 30, 2008 Company▲ Ticker▲ Event Type▲ Date▲ John A. Bryant, Executive Vice President, Chief Financial Officer, Kellogg Company President, Kellogg North America Thanks, David, and good morning, everyone. For the full year, reported sales grew 8% and 5% on an internal basis consistent with our most recent guidance. Reported operating profit rose by 6% and internal operating profit rose by 3% and full-year upfront costs were $0.18 per share versus $0.14 in 2006. In addition, full-year incremental commodity, fuel, energy, and benefits inflation was $0.32 per share, in line with our prior estimate. As we anticipated, fourth quarter earnings were slightly lower at $0.44 as our tax rate rose to about 34%. For the full year, earnings per share grew by 10% to $2.76, ahead of our initial and most recent guidance. This was driven by our strong operating performance, a full-year 29% effective tax rate and share repurchases. And cash flow was $1.031 billion. Let’s look at these results in more detail. Slide 5 shows our net sales growth. For the full year, net sales growth was a strong 8%. Price mix was 3.3% higher due to pricing actions, continued trade spend efficiency and improved mix. Tonnage added about 2.1% and currency contributed 2.6%. For the fourth quarter net sales growth was 8.1% and 4.7% on an internal basis. Now let’s turn to our advertising spending on slide 6. As you can see, we significantly increased our advertising this year. In fact our advertising rose above $1 billion for the first time to end the year at $1.063 billion. Not only are we spending more; we are doing it more efficiently. We have increased our presence with more targeted communications at a lower cost allowing us to invest more into our best ideas. Going forward we will continue to review our spending for further efficiencies. Advertising is an essential part of our business model and we have even more investment planned for 2008. Let’s turn to slide 7 to review our gross profit performance. 2007 gross profit was $5.2 billion, a corrected transcript $350 million or 7% increase over the last year. This increased gross profit in dollars helps fund our advertising and innovation growth. As expected, our full year gross margin percent declined 44%. This was driven by significantly higher commodity inflation, which was mostly offset by cost savings initiatives, pricing, mix, lower up-front costs and operating leverage. Now, let’s turn to slide 8 and a discussion of operating profit by region. Total operating profit rose 3.1% as a result of strong sales offset by a double digit increase in advertising and higher up-front investments. In North America, operating profit was flat due to higher input, advertising and up-front investments. These additional up-front charges reduced our operating profit growth by 2.3%. 2007 was another great year for our European business unit. Full year operating profit rose 14.2% as results were positively impacted by this year’s lower upfront investments. The lower upfront cost in 2007 increased the operating profit growth by about 3%. In Latin America, full-year internal operating profit fell 4.7% reflecting increased investment in advertising as well as high commodity inflation. Sales in Latin America continued to be strong, up 9% for the year. Finally, in Asia Pacific, full-year internal operating profit decreased by 9.5% or $9 million due primarily to the continued challenges in the Australian market. The rest of our Asian business units performed very well in both Cereal and Snacks with net sales and operating profit growing at double digits. We indicated last quarter that about 40% of the year’s inflation would be concentrated in the fourth quarter, and that was certainly the case. Below the operating profit line, net interest was approximately unchanged, and our full year tax rate was about 29%. Our Manage for Cash operating principle continued to drive cash flow. Kellogg employees around the world know the importance of focusing on cash flow and for 2007 they delivered more than $1 billion. Core working capital was relatively flat as a percent of sales as favorable payables were offset by an increase in inventories due to higher input prices. 2 w w w .Ca ll St r eet . com • 21 2- 84 9- 40 7 0 • C op yr i g ht © 20 0 1- 2 00 8 C a ll S tr ee t
  3. 3. Kellogg Co. K Q4 2007 Earnings Call Jan. 30, 2008 Company▲ Ticker▲ Event Type▲ Date▲ As you can see on slide 10, we also put this cash to good use. We continued to utilize our cash flow for dividends and share repurchases. Over the last three years, we have returned more than $3.3 billion of cash to shareholders. We have increased our dividend per share by more than 20% since 2005, repurchased almost $2 billion of our stock and invested significantly in future growth initiatives. As you know, our Board of Directors has authorized a share repurchase program of another $650 million for 2008. Slide 11 summarizes our strong 2007 performance. In 2007, we absorbed another year of even greater cost inflation. We made higher upfront investments in cost savings initiatives and increased our advertising at double-digit rates. We were able to make these investments while achieving earnings per share growth of 10%. Now let’s turn to our 2008 outlook on slide 12. We remain confident in our business model. And despite even higher cost pressures, we have not changed our sales, operating profit or earnings per share guidance. This is a result of operating the business for long-term sustainable growth. We forecast mid-single digit revenue and operating profit growth given our business momentum and the recently announced price increases as well as our efficiency in upfront investment initiatives. Our guidance now includes significantly higher incremental commodity, energy, fuel and benefits inflation of more than $0.65 per share versus our earlier estimate of more than $0.40 per share. While gross profit dollars will rise, gross profit margin is expected to decline by about 100 basis points as a result of incremental input costs, a higher amount of upfront charges recorded in cost of goods and the investments in our recent acquisitions. As we discussed last quarter, total upfront investments will decline from $0.18 per share in 2007 to about $0.14 in 2008 which is more consistent with historical levels. In 2007, our tax rate fell due to some discrete items allowing us to offset the higher upfront cost. However, for 2008, we expect the tax rate to be approximately 31%. A 53rd week would have added about $0.05 to EPS, but these earnings will be reinvested back into the business. corrected transcript Below the operating profit line, we expect net interest expense to be flat at just below $300 million. We expect to deliver another year of sustainable, dependable performance with high single-digit earnings per share growth of between 2.92 and 2.97 per share. While we do not give quarterly guidance, we want to provide some insight into the shape of the year. We expect a difficult comparison for the first half of 2008 given last year’s timing of various tax events, commodity price increases and our strong first half performance, as well as this year’s fifty-third week. This should however result in a stronger back half. So, to summarize, despite the difficult and volatile commodity markets, we will continue to invest back into the business for long-term sustainable growth. And now, I would like to turn it back over to David. A.D. David Mackay, President and Chief Executive Officer Thanks John. It’s important to view 2008 against the complex backdrop of unprecedented commodity volatility and an uncertain US economic outlook. The magnitude of the commodity volatility we are experiencing is significant. In the last few months alone, since our Q3 update, our estimate of 2008 commodity and energy inflation increased from more than $0.40 to in excess of $0.65. We still anticipate that second half commodities will retrench from their current level, but we believe that commodities will generally remain on an upward trend. Despite the volatility, we remain confident in our ability to deliver another year of sustainable dependable growth. Accordingly, we’ve worked aggressively to proactively manage our risk including pricing actions taken across our global portfolio, stepping up our focus on cost saving initiatives, productivity gains, and SG&A optimization across our business. With these actions already in full swing, we feel confident about 3 w w w .Ca ll St r eet . com • 21 2- 84 9- 40 7 0 • C op yr i g ht © 20 0 1- 2 00 8 C a ll S tr ee t
  4. 4. Kellogg Co. K Q4 2007 Earnings Call Jan. 30, 2008 Company▲ Ticker▲ Event Type▲ Date▲ the year ahead. History suggests that even if the economy should weaken, our business should continue to do well as it tends to be less cyclical. Let’s turn to slide 14 to discuss our recent acquisitions. We’ve been very active, but selective in our acquisitions over the last year. Although our three recent transactions are relatively small, each one provides us with an opportunity for expansion within our current portfolio, or expansion into higher-growth geographic areas. We’ve added another growth engine to our Natural and Organic business with the acquisition of Bear Naked, makers of premium all-natural granolas, hot cereal and trail mixes, a solid strategic fit with Kashi. We also acquired Gardenburger maker, maker of a variety of vegetarian and vegan products and meat substitutes. Having Gardenburger will position our frozen foods business to further grow our presence in the frozen meals category. The Gardenburger business also provides another manufacturing facility enabling us to continue to expand our frozen veggie business. Our emerging markets growth strategy has also moved forward significantly. In Russia, we recently announced the purchase of the United Bakers Group, one of Russia’s largest cracker, biscuit, and breakfast cereal producers. The company has manufacturing facilities as well as a strong sales and distribution system. Combined with Kellogg’s innovation brand-building and R&D infrastructure, UB provides us with a tremendous platform in the fast growing Russian market. We’d also like to extend a warm welcome to our new employees from these exciting acquisitions. If you can turn to slide 15, we’ll discuss our 2008 innovation. In 2008, we will have sales of about $2 billion from products launched in the last three years. We strive for our new products to improve the economics of our portfolio. Some of the key drivers of our innovation include portion control, healthier options, and natural alternatives. corrected transcript Now let’s turn to slide 16 and the internal sales growth posted by our North American businesses in the quarter. For the full year North American sales were 5% higher versus last year’s tough 8% comp. Starting on slide 17, we will review each business in more detail. We had a great quarter in North American Ready-To-Eat Cereal. Importantly, most of our 8% growth in this quarter came from growth in base sale. Our full-year sales growth was 3% and our measured channel share grew again ending above 34%. This year’s innovation was strong with good Q4 performance from Rice Krispies with Strawberries and Mini-Wheat Cinnamon Streusel. We saw a strong performance from Rice Krispies, Raisin Bran Crunch and Special K in the quarter due to effective advertising campaigns. 2008 innovations are even stronger than in 2007 including Special K Cinnamon Pecan and Frosted Flakes Gold. Also, a new All-Bran Strawberry Medley was introduced with a new ten-day challenge advertising campaign. Once again Kashi posted another great quarter with double-digit sales growth. This year’s innovation continued to perform well with particularly good performance from two varieties of Kashi granolas. We have now raised prices across much of the portfolio of Kellogg and Kashi cereal products effective January. And our Canadian business also grew full-year sales at mid single-digits with this year’s innovation of Special K Fruit & Yogurt and Rice Krispies Vanilla doing well. Slide 18 shows our full-year Snacks sales rose 7%, well above our guidance and a tough year-ago comparison of 11%. Fourth quarter sales growth was 2%, and as anticipated, was adversely impacted by the DSD equity route repurchases and the transition of Kashi Snack Bars and Kellogg Fruit Snacks into the DSD system at year-end. Also this quarter’s growth was against last year’s tough comp of 12%. Moving Kashi Snacks and Kellogg Fruit Snacks into DSD will provide further growth opportunities in 2008. However, we 4 w w w .Ca ll St r eet . com • 21 2- 84 9- 40 7 0 • C op yr i g ht © 20 0 1- 2 00 8 C a ll S tr ee t
  5. 5. Kellogg Co. K Q4 2007 Earnings Call Jan. 30, 2008 Company▲ Ticker▲ Event Type▲ Date▲ expect some modest disruption in Q1. Across the Snacks business, we see continued opportunities coming from portion control and on-the-go packaging innovations. In addition, we have raised prices across much of the Pop-Tarts, Crackers, Cookies and Wholesome Snacks portfolios over the past month. Let’s look at more detail on slide 19, our Pop-Tarts business posted another year of sales growth with share gains for the fourth quarter. For 2008, we have introduced whole grain varieties as well as new printed Pop-Tarts. Our Cracker business had another solid year with mid single-digit sales growth and share gains during Q4. We posted strong sales from recent innovations like All-Bran Crackers and double-digit growth from Wheatables, Club and Cheez-It. Our new 2008 innovations includes Flipsides pretzel crackers, and Cheez-It Duals. Our Cookie business was strong in 2007 and full-year sales rose at mid single-digits as we gained share. For 2008, our new innovation includes introduction of Chips Deluxe and Sandies Pecan take-along packs. These innovative break-apart packs stay fresh and make the product portable. Our Wholesome Snack business continued to do well this year with double-digit sales growth for the fourth quarter and full year. Our 2008 Wholesome Snacks innovation includes our new Special K Bliss Bars. Now let’s turn to our Frozen and Specialty Channels business on slide 20. Frozen and Specialty Sales were up 6% for the full year versus a strong 8% comp last year. We achieved solid growth across our Frozen and Specialty Business. Our Frozen business continued to perform very well with full-year sales rising at high single-digits and consumption growing ahead of sales. We grew Frozen Breakfast share in the fourth quarter with solid growth from Waffles and double-digit growth in Pancakes and French Toasts. With strong results in Veggie Foods for the quarter and full year, like Frozen Breakfast, our consumption has been running ahead of sales. And again in Q4, our Kashi All-Natural frozen entrées and frozen pizzas performed ahead of our expectations. Specialty corrected transcript Channels contributed solid growth again with mid-single-digit performance for the fourth quarter and full year. Slide 21 shows that Kellogg International posted another solid year with 5% growth. Our international growth has been broad based with solid results in Europe, Asia and Latin America as you can see on slide 22. In Europe, we posted a 5% internal sales increase. We achieved solid mid-single-digit growth in Cereal and double-digit sales increases in Snacks. In addition, we had market share gains in both Cereal and Snacks categories in our important UK market. In Cereal, Special K, Optivita and Rice Krispies all performed well. Sales were also solid in Ireland, France, Benelux, Spain and Italy. In Latin America, we posted 9% full-year sales growth versus last year’s strong 9% growth. For the full year, we achieved high single-digit growth in both Cereal and Snacks, and for Q4 Venezuela, Colombia, Brazil and the Caribbean all posted double-digit sales growth. Asia-Pacific internal sales were about flat for the full year reflecting the difficult conditions in Australia. Excluding Australia, we achieved double-digit growth in the fourth quarter and full year across our Asia business unit. In Australia, difficult conditions continue in the Snacks category and Cereal remains highly competitive. For 2008, we have strong advertising and innovation plans to ensure continued international growth. In summary, we entered 2008 with momentum and exciting commercial plans. Innovation is strong globally and our focus on driving our brands remains steadfast. We remain confident and positive given the stable nature of our food portfolio and the fact that we have taken proactive steps to manage commodity inflation and mitigate risk. Initiatives include the pricing actions taken across our global portfolio, stepping up our focus on cost saving initiatives and productivity gains and tighter SG&A management across our global business. 5 w w w .Ca ll St r eet . com • 21 2- 84 9- 40 7 0 • C op yr i g ht © 20 0 1- 2 00 8 C a ll S tr ee t
  6. 6. Kellogg Co. K Q4 2007 Earnings Call Jan. 30, 2008 Company▲ Ticker▲ Event Type▲ Date▲ Our focus remains on delivering sustainable and dependable growth, clearly an approach that should resonate more today than ever. Our recent acquisitions and positive progress toward geographic expansion are also a clear signal of our focus on building a stronger business for the future. We feel well positioned to continue our goal of sustainable, dependable growth. Our business model remains on track, and we remain firmly committed to our company operating principles of Manage for Cash and Sustainable Growth. Finally, I would like to again welcome the new Kellogg employees and thank all Kellogg employees for their great work throughout 2007. And, with that, I would like to open it up for questions. corrected transcript 6 w w w .Ca ll St r eet . com • 21 2- 84 9- 40 7 0 • C op yr i g ht © 20 0 1- 2 00 8 C a ll S tr ee t
  7. 7. Kellogg Co. K Q4 2007 Earnings Call Jan. 30, 2008 Company▲ Ticker▲ Event Type▲ Date▲ QUESTION AND ANSWER SECTION Operator: Thank you sir. [Operator Instructions]. And we will start with our first question Alexia Howard with Sanford Bernstein. Please go ahead. <Q – Alexia Howard>: Hello, John. <A – John Bryant>: Hi, Alexia. <Q – Alexia Howard>: Hi, quick question on marketing spending. It seems as though we now operate with advertising, particularly as a percent of sales up at about 9%, and that’s obviously been increasing I guess over the last few years. What is – philosophically I guess, what is your plan for, over the next couple of years, is the intention that it will continue to increase as a percent of sales, or are you pretty comfortable with the level you are at given that you are now well ahead of the rest of the packaged food group. <A – David Mackay>: Alexia, if you look at our consumer support, advertising and consumer promotion, we are around the 12% mark which is very strong for our business, but as we think about it, we will continue to increase certainly at a rate consistent with sales growth. And if we find more opportunities and have the flexibility and great ideas to invest behind, to strengthen our brand equities then we will look to do that as well. <Q – Alexia Howard>: Great, thank you very much. Operator: And our next question comes from Chris Growe with Stifel Nicolaus. Please go ahead. <Q – Christopher Growe>: Hi, good morning. corrected transcript <A – David Mackay>: Good morning, Chris. <Q – Christopher Growe>: Hi. I have a question for you regarding sort of the upfront costs and the cost savings. Clearly, you are in a sort of a new paradigm here for input cost. So, could you talk about, I’m not sure you’ve really ever given us sort of, in some general numbers, kind of – what kind of, what level of cost savings you are going to have coming through this year in 2008 to help kind of blunt the effect of these input cost increases? <A – John Bryant>: Chris, if you look at the upfront costs, our long term guidance is to get a payback within five years off of those upfront costs. And we’ve been executing them now for some years. So clearly, there is a flow-on benefit coming through the P&L. The issue of course is the size of those savings is relatively modest compared to the size of the inflation that we are facing. So, it’s not having a cumulative impact, it is just helping us each year as part our boarder productivity initiatives, as part of the mix to help offset that inflation. <Q – Christopher Growe>: So, it’s not actually stepping up this year, given this environment? <A – John Bryant>: No. I think what we said is we had about $0.14 stock cost in this year, $0.18 last year obviously will help us in the 2008 year. <Q – Christopher Growe>: And I just want to ask one other question that’s just relative to the Cereal category. In measuring it through IRI, it looks like the merchandising activity has been down a little bit and there has been little surges here and there. But do you anticipate that for 2008 I guess as a means of getting the price increases through, we’ll see overall merchandising activity down? 7 w w w .Ca ll St r eet . com • 21 2- 84 9- 40 7 0 • C op yr i g ht © 20 0 1- 2 00 8 C a ll S tr ee t
  8. 8. Kellogg Co. K Q4 2007 Earnings Call Jan. 30, 2008 Company▲ Ticker▲ Event Type▲ Date▲ <A – David Mackay>: Chris, if you look at the merchandizing in the latest quarter or year-to-date, it’s actually up slightly. And it’s a category that I think is a bit of a destination category for our trading partners. So I think merchandising will play an ongoing and positive component of how we and others drive consumers to the category, and innovation clearly plays a very big role in that. So I would expect it to stay positive. Whether it will increase dramatically is very hard to say. <Q – Christopher Growe>: Okay. Thank you. <A – David Mackay>: Okay. Operator: And our next question comes from Terry Bivens with Bear Stearns. <Q – Terry Bivens>: Good morning everyone. <A>: Good morning Terry. <Q – Terry Bivens>: Couple of quick things on Cereal. Dave, could you give us kind of the number for what the price increase was on US Cereal across the line? <A – David Mackay>: Your low single-digits Terry, I mean really we took broad based global processing across the portfolio. And it was anywhere from low to mid-single-digits globally, and in US Cereal, it was low single-digit, and that’s been announced and I think is in play in January. <Q – Terry Bivens>: Okay. Did you ship any of your ‘08 Cereal innovation in the fourth quarter or have you been able to more or less keep all of that in the first quarter? <A – David Mackay>: We -- I think we started shipping Special K Cinnamon Pecan the last week of the year. The interesting thing though is as we’ve tracked inventories Q4 to Q1, we’re actually corrected transcript coming into 2008 with a lower inventory level than we’ve had for the last 2 or 3 years. So, we feel very positive about that. <Q – Terry Bivens>: Okay. And just lastly, I guess, General Mills, according to them they’re pretty much through with the right size, right price. What’s your evaluation on that? It seems to have been pretty much of a positive for the category, but it, from my perspective, is that the way you’re looking at it? <A – David Mackay>: Well, I mean you’d have to ask them specifically how they feel, but I mean as we look at our performance in Cereal in the fourth quarter, we grew in IRI 4%. The category was actually up 1.2, but the category number is probably, in our view about 4% if you take in all channels. So, the Cereal category had the strongest growth for the year in the fourth quarter comparable to 2006. And we grew significantly above the category and actually gained nine-tenths of a share. So, certainly, we are very happy with our performance. I think the category is doing very well. I wouldn’t like to comment on anything else. <Q – Terry Bivens>: Understood. Thanks a lot. <A – David Mackay>: Okay. Operator: And we’ll take our next question from David Driscoll with Citi. Please go ahead. <Q – David Driscoll>: Great, thanks a lot. Good morning everyone. <A>: Hi David. <A – David Mackay>: Hi David. 8 w w w .Ca ll St r eet . com • 21 2- 84 9- 40 7 0 • C op yr i g ht © 20 0 1- 2 00 8 C a ll S tr ee t
  9. 9. Kellogg Co. K Q4 2007 Earnings Call Jan. 30, 2008 Company▲ Ticker▲ Event Type▲ Date▲ <Q – David Driscoll>: David I wanted to ask your opinion on the big macro environment here. There is always concerns about economic slowdown. Do you expect to see a volume pickup from people changing their behavior from food-away-from-home to food-at-home? Have you seen anything in the fourth quarter, would you expect to see anything in 2008? And then just on the whole volume picture, of the mid single-digit, I would assume that volume embedded in that particular guidance is relatively small and that most of it’s pricing. Is that correct? <A – David Mackay>: David, first on the last. I think mix of price mix to volume will skew more to price mix than it did in ‘07 because of the levels of pricing. We’ll still have some volume growth, but it will be predominantly price mix. On the economy, speaking specifically to our business, because there is a lot of other things going on that are in the press that probably won’t have an impact on us. We look at the company and the categories we’re in, we’re less cyclical. We’ve looked back in history at when we’ve had slowdowns or recessions in the US and really our business has performed pretty well through those periods. The business is currently very strong, we have strong momentum and we have great confident as we look at the future. And, very hard to really read, what will happen but, so we always done as look at history and we feel pretty good about where we are. <Q – David Driscoll>: Great thanks a lot. <A – David Mackay>: Thanks. Operator: And our next question comes from Jonathan Feeney with Wachovia Securities. <Q – Jonathan Feeney>: Good morning and thank you. <A>: Hi Jonathan. corrected transcript <Q – Jonathan Feeney>: Here once again you’ve maintained guidance, while absorbing another $0.25 upward revision in commodity cost pressure, and clearly I think productivity and savings are helping you do that. So, does that mean without all this commodity pressure, if we ever get a break on that, you’d be in a position to raise numbers? And as part of that I mean do we ever get to a point where cost inflation is so pervasive with your competitors in private label that you just ask retailers and consumers to absorb all these cost increases as opposed to maybe dipping in to your own productivity to do it. <A – David Mackay>: Jonathon, I’d love to be in a situation where we have that problem. We are currently not, but.... <Q – Jonathan Feeney>: And there is always hope for the future. <A – David Mackay>: Yeah, there is hope for the, I mean we have taken broad-based pricing actions. We’re driving efficiency. We’re driving mix. We’re driving productivity. And that’s really helped us with the $0.65 plus commodity impact for 2008. When you look at our pricing, it is broadly offsetting the bulk of the inflation for 2008. So – and we feel pretty good about that given the strength of our brand equities, the level of our innovation and the support we intend to continue putting behind our brands as we go forward. <Q – Jonathan Feeney>: And is there any, I mean, let me simplify it then, has the pricing environment among your competitors, and just from what you’re hearing from the trade about not just your category, but others, improved, maintained itself or gotten tougher over the past quarter? <A – David Mackay>: I think everyone is feeling these inflationary pressures. It may not be exactly equal across businesses depending on the segments you’re in, but I think everyone is feeling a lot 9 w w w .Ca ll St r eet . com • 21 2- 84 9- 40 7 0 • C op yr i g ht © 20 0 1- 2 00 8 C a ll S tr ee t
  10. 10. Kellogg Co. K Q4 2007 Earnings Call Jan. 30, 2008 Company▲ Ticker▲ Event Type▲ Date▲ of inflationary pressure as we go forward. Most – a lot of categories have taken price. I can’t really speak for exactly what’s happened outside of our own categories, where we have broadly taken price across every category in which we compete globally. <Q – Jonathan Feeney>: Okay, thank you very much. <A>: Thank you. Operator: [Operator Instructions]. And we will take our next question from David Palmer with UBS. <Q – David Palmer>: Thanks. A follow up on this issue of pricing and the difference perhaps between retailer pushback and how you monitor consumer decisions, the duration and the magnitude of inflation I guess has reached new extremes. And it seems like the retailers are accepting the pricing from what we’ve heard and competitors and even retailer brands are going up with you guys in certain key categories. But how are you going to think about and how concerned are you about the consumer trade-down? For instance, I think retailer brands maybe gained a little share in ‘07, something like 30 basis points in the measure that I saw for ‘07. Maybe you have a different number. But is there a risk that becomes more pronounced, and even within your portfolio that people might trade down from your better margin products to perhaps something of a lesser margin? Thanks. <A – David Mackay>: Yeah, David, I think we do look at all of our competitors. If you look at 2007 in private-label performance, as we saw in 2005, in the fourth quarter and for the full year, in fourth quarter 72% and for the full year 68% of the growth that was achieved in private-label came from two retailers. And typically, what we have seen is that if retailers want to push that particular part of their business, then we could see disproportionate growth. In the current environment, we don’t think that that’s going to be excessive. And we feel pretty good about where we are given the strength of our brand equities and the level of investment we can continue to put behind them. corrected transcript <Q – David Palmer>: Okay. Thanks very much. <A>: Thanks. Our next question comes from Tim Ramey with D.A. Davidson. <Q – Timothy Ramey>: Good morning. Just wanted to get a little more color on the $0.65, and also the view that that moderates some in the second half of the year. Can you give us any breakdown in terms of which commodities are driving that, and also why you would view the second half relief as possible? <A – David Mackay>: I think we are not going to get into specifics, but we do believe that we will see some commodity costs retrench in the second half. Two reasons for that, one is comp comparisons to the second half of ‘06, and the second is while we can’t control the weather or the crops, most experts expect some reductions in some crops versus their current highs. We have taken I think a very pragmatic view on commodities and tried to reflect what we think they will do, and we have baked higher numbers, much higher numbers as you can see into that expectation, but the markets remain very volatile. I think most importantly, on this is, we have demonstrated our ability to manage this volatility should it occur, and that’s why we feel very comfortable in affirming our guidance for 2008. <Q – Timothy Ramey>: David, could you break it between at least energy and food, or is there any more detail you can offer there? <A – David Mackay>: Not at this point, no. 10 w w w .Ca ll St r eet . com • 21 2- 84 9- 40 7 0 • C op yr i g ht © 20 0 1- 2 00 8 C a ll S tr ee t
  11. 11. Kellogg Co. K Q4 2007 Earnings Call Jan. 30, 2008 Company▲ Ticker▲ Event Type▲ Date▲ Operator: [Operator Instructions]. Our next question comes from Pablo Zuanic with J.P. Morgan. <Q – Pablo Zuanic>: Good morning everyone. <A>: Hi Pablo. <A>: Good morning. <Q – Pablo Zuanic>: Again David, I want to go back to, on your view of resizing, I mean based on our stock surveys, and which are obviously limited in size, but I calculated General Mills has about 47-50% of their Cereal SKUs or boxes below $2.50. And then, I look at your portfolio, and I only found about 5% of your boxes that are $2.50. Do those numbers ring a bell, do they seem correct, and is that an issue? <A – David Mackay>: No, they don’t ring a bell. The numbers we’ve got would indicate on averages that we are around mid-3s, and they are slightly above us. But I am not sure what stores you went to. I mean all I’d do is, again reiterate that I think that we’re through that big initiative through the fourth quarter, and in IRI, we grew 4%. We gained nine-tenths of a share. Our base business was actually up very strongly and the category actually had the strongest quarter it’s had for 2007. So it’s a very, very good situation for the category, for us, and hopefully for our competitors. <Q – Pablo Zuanic>: Okay, and just a follow-up. When I look at Crackers and Cookies, and again here again perhaps oversimplifying, but I see from the Kraft side an apparent ramp up, in terms of advertising on their brands, Oreo Cookies and on the Crackers side. And your side, I don’t necessarily see the ramp-up on advertising on biscuit, but definitely a lot of innovation around packaging formats. Obviously, you think that’s the right way to go, but can you explain why? I mean it seems that they are a lot more aggressive on advertising, and you are just more focused corrected transcript on product innovation and formats around Clubs and Town House? <A – David Mackay>: Well, I think again if you look at the results we delivered in Cookies and Crackers, we did very, very well in the fourth quarter and for the year. Our innovation seems to be working, on the go, not only for ourselves, but for the whole category has been a huge positive and is driving a big chunk of the growth. We think that will continue as we go forward, and we’re trying to capitalize on that. And our levels of brand building support remain relatively consistent year-on- year. So, I don’t know how else to react, but we are very comfortable with where we are. We continue to grow share, and we continue to perform pretty well across both Cookies and Crackers. <Q – Pablo Zuanic>: And one last one if I may, just regarding Russia, can you give us some color in terms of how the category there has been growing for Cereal and Biscuits in the past few years? And whatever market share, does the company -- you both have there? <A – David Mackay>: The company we bought – United Bakers is about 100 million in sales. And I think it’s a market leader in two of the three. The categories there in general terms have been growing high single or low double-digit. We think while there is a lot of opportunity for us to improve that business there is huge upside and has a platform for growth in an exciting market, we’re just delighted with that acquisition and you will hear more about it as we go forward. <Q – Pablo Zuanic>: And before that, you were exporting your products there, did you have a distributor, or how was your business there? <A – John Bryant>: Pablo we were tiny. <Q – Pablo Zuanic>: Okay. Thank you. 11 w w w .Ca ll St r eet . com • 21 2- 84 9- 40 7 0 • C op yr i g ht © 20 0 1- 2 00 8 C a ll S tr ee t
  12. 12. Kellogg Co. K Q4 2007 Earnings Call Jan. 30, 2008 Company▲ Ticker▲ Event Type▲ Date▲ <A>: Thank you. Operator: And our next question comes from Eric Katzman with Deutsche Banc. <Q – Eric Katzman>: Hi good morning everybody. <A>: Hi Eric. <Q – Eric Katzman>: I am going to switch focus here a little bit to kind of capital structure and cash flow. You guys have done just a fabulous job in terms of generating cash flow. I think you have one of the highest free cash flow yields, the debt markets are right now given what the Fed has been doing, very cheap especially for a credit like yours. The Board authorizes 650 million in share repo which is equal to the last few years, yet earnings are much higher. The stock has been under pressure. Why wouldn’t you give a little bit more -- assuming that our DCF work suggests that the stock is undervalued, I mean and I am sure yours does. Why wouldn’t you be pushing the Board to put more money into share repo? <A – John Bryant>: Eric, great question. I think the – certainly the cash flow for the company was very strong in 2007 and we continue to see improvement in things like conversion cycles and so on from a working capital perspective. And as we go forward, the $650 million authorization is still in place. If you look back over the last three years Eric, almost all the cash the company has generated has gone back to shareholders, whether it be in the form of a dividend or a share buyback. Our net debt position has been flat and in fact absolute debt has been growing a little bit over the last couple of years. So, I feel pretty good about the capital structure. I think it’s a balanced use of cash. I certainly think the share price is attractive, but I think that where we are from a capital structure, is a good place to be. <Q – Eric Katzman>: Okay. If I could just ask one – just quick follow-up. Just I don’t want to pin corrected transcript you down too much, but how much on the top line this coming year should come from acquisitions roughly with all the three that you’ve named so far? I mean, is that – is it just 1%? Is it more like two plus, just to kind of get a sense? <A – John Bryant>: It’s a good question, Eric. What we said, what we’ve given guidance on here is internal sales growth at mid single-digits, you’d probably add just under two points to that to get to the impact of acquisitions. <Q – Eric Katzman>: Okay, thank you. Operator: Our next question comes from Andrew Lazar with Lehman Brothers. <Q – Andrew Lazar>: Good morning. <A>: Good morning. <A>: Good morning, Andrew. <Q – Andrew Lazar>: I guess in looking at the contribution over the last couple of quarters or more to your top line from price mix, it sort of seems like it’s been decelerating as we’ve gone sort of through the year, including the quarter you just reported. And I know you just started with your pricing effective January, but I’m trying to get a sense why wouldn’t I be seeing more of that come through even in the last couple of quarters? <A – John Bryant>: I think a part of that Andrew has to do with the pricing of 2006. If you go back look at 2006, our price mix ramped up through the back half of the year. So, Q4 2006 was actually 12 w w w .Ca ll St r eet . com • 21 2- 84 9- 40 7 0 • C op yr i g ht © 20 0 1- 2 00 8 C a ll S tr ee t
  13. 13. Kellogg Co. K Q4 2007 Earnings Call Jan. 30, 2008 Company▲ Ticker▲ Event Type▲ Date▲ a highest price mix of 5.4% for the quarter. So part of it is just the comparative across ‘07 versus ‘06. <Q – Andrew Lazar>: Okay. And then is it fair to say that you and obviously a lot of others have been kind of behind the curve more dramatically, the cost curve that is, with respect to pricing. Is the -- are some of the initiatives that you’ve taken in pricing around January across the portfolio designed to get you a lot closer to covering and/or maybe completely covering some of the cost increases that you see going through the year and you’re obviously being pretty conservative in your assumptions on costs? <A – David Mackay>: Yeah Andrew, I think it would be fair to say that we were probably lagging, if you look at ‘06 and ‘07. A lot of that is because of the volatility and uncertainties, were commodities actually going to stay high and stay on that potential high or upward trajectory. I think our view is and has been probably for the last year that that’s the case and when you look at 2008, with that higher level of commodity inflation, we have been able to offset the bulk of it with broad based global pricing across the portfolio of about low to mid-single-digits. So, we didn’t offset it all, but we offset the bulk of it. So, I think your point is we -- yes we have replaced price more to reflect where commodities are, because we don’t believe that they are going to suddenly drop when we go into the out years. <Q – Andrew Lazar>: Thank you. <A>: Thanks. Operator: Our next question comes from Ken Zaslow of BMO Capital Markets. <Q – Kenneth Zaslow>: Hi good morning everyone. corrected transcript <A>: Hi Ken. <Q – Kenneth Zaslow>: In terms of just following on, on that question, when you think about your recovery rates from the pricing increase relative to the commodity costs, are there certain regions or products where you feel like you are getting a greater recovery rate, and what products would you think that you are not getting as high a recovery rate. Can you just kind of span the world as well as the products? <A – David Mackay>: All I’d say Ken is we don’t price just to recover in a particular business unit. And some of the commodities may impact on a particular area of business unit, to a greater extent than the globe, but we did take broad based pricing and, I think what we have done, is probably the right approach to try and recoup a lot of those costs but, like last year in Latin America when corn went through the roof and that portfolio is more corn based, our pricing was relatively consistent, maybe a tad higher. And we got through that, you saw the impact on profit in Latin America but we are going into a New Year now where that’s more stable at a higher level, but it’s more stable, so... <Q – Kenneth Zaslow>: Yeah. And maybe your just rephrasing a little bit is, are you finding that your ability to pass on costs in Europe versus the US is any different or they’re similar, just, are there regions, besides Latin America, the consumers either accepting it or not accepting as well, or is it just globally, the exact same reaction across consumers? <A – David Mackay>: I think certainly we are seeing inflation globally, and I think Europe is seeing theirs ramp-up as we look at 2008. But, that’s been true globally, I think pricing is being taken by many, many companies across the board and in all sorts of markets. And we have seen in Europe even in the hard discounted markets like Germany where private label has gone up 10% for the first time in a number of years. The consumer reaction – no one likes high prices, but I think the only 13 w w w .Ca ll St r eet . com • 21 2- 84 9- 40 7 0 • C op yr i g ht © 20 0 1- 2 00 8 C a ll S tr ee t
  14. 14. Kellogg Co. K Q4 2007 Earnings Call Jan. 30, 2008 Company▲ Ticker▲ Event Type▲ Date▲ way to manage your business effectively given these high commodity prices is to regain some of it to go forward. <Q – Kenneth Zaslow>: Great, I appreciate it. <A – David Mackay>: Thank you. Operator: Our next question comes from Robert Moskow with Credit Suisse. <Q – Robert Moskow>: Hi, thank you. I wanted to know, you mentioned cost savings from your upfront charges but, aren’t there other layers of cost savings and other projects that you have internally that go beyond those upfront charges and is there any way to help us quantify what those savings could be? And then secondly, I wanted to ask you about pension expense because in our modeling we saw a pretty big pickup in pension expense starting in 2009. Are you making a contribution to your pension fund and is that helping you offset 2009 increases? Thank you. <A – John Bryant>: Okay, great. On both of those questions, firstly on productivity you’re absolutely right, there is much more to our productivity program than the upfront costs. And, I’d say that we target around a 3% productivity improvement. So, that helps to offset the commodity inflation that we’re seeing out there. And, then on benefits expense to your point, benefits expense will actually be down 2008 versus 2007. So, when we give guidance that commodity benefits, energy, et cetera are up in excess of $0.65, that’s actually netting-off within there, the good news on benefits expense. So, benefits will be down $0.06 or $0.07 because of the higher discount rate that’s out there. So that $0.65 is net of that good news. On pension contributions, we did make a small pension contribution at the end of 2007, but as a company, we are pretty well funded across our various plans. <Q – Robert Moskow>: Well John, have you modeled out 2009? I mean maybe this is just the corrected transcript intricacies of pension forecasting and my models don’t match yours, but have you taken a look at it, whether those benefits continue in ‘09? <A – John Bryant>: It’s hard to get there because you have got to see where the 2008 market returns versus your actual return assumption and so on. So, there is quite a bit of volatility in there. But if I can have a forecast of 2009 discount rates, maybe I can get there, but that’s a very hard thing to forecast from where we are today. <Q – Robert Moskow>: Okay, thank you. <A>: Thanks. Operator: Our next question comes from Linda Donnelly with Franklin Management. <Q>: Thank you. Could you give us some guidance on what you anticipate for capital expenditures in ‘08 and depreciation and amortization? <A – John Bryant>: I would expect capital expenditure to be around 4% of sales, which is sort of ballpark around $500 million, and then on depreciation and amortization similar to this year, around $380 million. <Q>: Okay. And if I could, do you have a number yet you can give us for your R&D expense for ‘07? <A – John Bryant>: No, I think we will have that in the 10-K. I think it will be in the same sort of ballpark, maybe up slightly from 2006. 14 w w w .Ca ll St r eet . com • 21 2- 84 9- 40 7 0 • C op yr i g ht © 20 0 1- 2 00 8 C a ll S tr ee t
  15. 15. Kellogg Co. K Q4 2007 Earnings Call Jan. 30, 2008 Company▲ Ticker▲ Event Type▲ Date▲ <Q>: Thank you very much. Operator: And our next question comes from Vincent Andrews with Morgan Stanley. Mr. Andrews, your line is open. <Q – Vincent Andrews>: Good morning, everyone. I know it’s a small part of your business, but it’s a part of your business that isn’t performing well. Has there been any change in the margin of the issues in Australia, good or bad or indifferent? <A – David Mackay>: Yeah, I mean Australia didn’t have a good year. The Snacks category, while it continues to be down, we did see the last month or two of 2007, a slight improvement. And we would hope that through the course of 2008 that the category itself can outperform and will start to come back to more normal levels. And then the only other thing impacting us there was CPW acquired Uncle Toby’s. They have ratcheted up the level of competitive intensity there and that has had an impact on our Cereal business as well. <Q – Vincent Andrews>: Okay. Thank you very much. <A>: Thanks. Operator: Our next question comes from Todd Duvick with Banc of America. <Q – Todd Duvick>: Yes, good morning. <A>: Good morning. <Q – Todd Duvick>: I just wanted to ask a quick capital structure question. You’ve got quite a bit of short-term debt and you do have a note that is coming due I believe in this June. I was corrected transcript wondering if you could tell us if you plan to refinance any or all of that in the capital market? <A – John Bryant>: We will certainly be looking at that. As you say, we have about $1.5 billion of commercial paper. We have a credit facility of around 2.2 billion and we have a maturity of around $500 million coming in. So, depending upon the conditions in the market and how the curve looks, we’ll look at whether we refinance that or how we take that going forward. <Q – Todd Duvick>: Okay. And I guess just back on the share repurchase program, you just plan to I guess buy back shares opportunistically not considering anything like an accelerated share repurchase program? <A – John Bryant>: At this stage our plan is to buy back the $650 million which has been authorized by the Board. <Q – Todd Duvick>: Okay, very good. Thank you. <A – John Bryant>: Thank you. Operator: [Operator Instructions]. And we’ll take a follow-up question from David Driscoll with Citi. <Q – David Driscoll>: My questions have been answered. Thank you. Operator: Gentlemen there are no further questions at this time. I would like to turn the conference back over to you for any additional or closing remarks. 15 w w w .Ca ll St r eet . com • 21 2- 84 9- 40 7 0 • C op yr i g ht © 20 0 1- 2 00 8 C a ll S tr ee t
  16. 16. Kellogg Co. K Q4 2007 Earnings Call Jan. 30, 2008 Company▲ Ticker▲ Event Type▲ Date▲ Joel R. Wittenberg, Vice President of Investor Relations Great. Lisa, thank you very much. Thank you very much everybody for tuning in. And if there is any questions please call in. Operator: And that concludes today’s teleconference. Thank you for your participation and have a good day. corrected transcript Disclaimer The information herein is based on sources we believe to be reliable but is not guaranteed by us and does not purport to be a complete or error-free statement or summary of the available data. As such, we do not warrant, endorse or guarantee the completeness, accuracy, integrity, or timeliness of the information. You must evaluate, and bear all risks associated with, the use of any information provided hereunder, including any reliance on the accuracy, completeness, safety or usefulness of such information. This information is not intended to be used as the primary basis of investment decisions. It should not be construed as advice designed to meet the particular investment needs of any investor. This report is published solely for information purposes, and is not to be construed as financial or other advice or as an offer to sell or the solicitation of an offer to buy any security in any state where such an offer or solicitation would be illegal. Any information expressed herein on this date is subject to change without notice. Any opinions or assertions contained in this information do not represent the opinions or beliefs of FactSet CallStreet, LLC. FactSet CallStreet, LLC, or one or more of its employees, including the writer of this report, may have a position in any of the securities discussed herein. THE INFORMATION PROVIDED TO YOU HEREUNDER IS PROVIDED quot;AS IS,quot; AND TO THE MAXIMUM EXTENT PERMITTED BY APPLICABLE LAW, FactSet CallStreet, LLC AND ITS LICENSORS, BUSINESS ASSOCIATES AND SUPPLIERS DISCLAIM ALL WARRANTIES WITH RESPECT TO THE SAME, EXPRESS, IMPLIED AND STATUTORY, INCLUDING WITHOUT LIMITATION ANY IMPLIED WARRANTIES OF MERCHANTABILITY, FITNESS FOR A PARTICULAR PURPOSE, ACCURACY, COMPLETENESS, AND NON- INFRINGEMENT. TO THE MAXIMUM EXTENT PERMITTED BY APPLICABLE LAW, NEITHER FACTSET CALLSTREET, LLC NOR ITS OFFICERS, MEMBERS, DIRECTORS, PARTNERS, AFFILIATES, BUSINESS ASSOCIATES, LICENSORS OR SUPPLIERS WILL BE LIABLE FOR ANY INDIRECT, INCIDENTAL, SPECIAL, CONSEQUENTIAL OR PUNITIVE DAMAGES, INCLUDING WITHOUT LIMITATION DAMAGES FOR LOST PROFITS OR REVENUES, GOODWILL, WORK STOPPAGE, SECURITY BREACHES, VIRUSES, COMPUTER FAILURE OR MALFUNCTION, USE, DATA OR OTHER INTANGIBLE LOSSES OR COMMERCIAL DAMAGES, EVEN IF ANY OF SUCH PARTIES IS ADVISED OF THE POSSIBILITY OF SUCH LOSSES, ARISING UNDER OR IN CONNECTION WITH THE INFORMATION PROVIDED HEREIN OR ANY OTHER SUBJECT MATTER HEREOF. The contents and appearance of this report are Copyrighted FactSet CallStreet, LLC 2008. CallStreet and FactSet CallStreet, LLC are trademarks and service marks of FactSet CallStreet, LLC. All other trademarks mentioned are trademarks of their respective companies. All rights reserved. 16 w w w .Ca ll St r eet . com • 21 2- 84 9- 40 7 0 • C op yr i g ht © 20 0 1- 2 00 8 C a ll S tr ee t

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