Kellogg Company (K)

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Kellogg Company (K)

Q3 2009 Earnings Call

October 29, 2009 9:30 am ET

Executives

John Bryant - CFO

David Mackay - President and CEO

Gary Pilnick - General Counsel

Analysts

Andrew Lazar - Barclays Capital

Judy Hong - Goldman Sachs

Eric Serotta - Consumer Edge

Ed Roesch - Soleil Securities

Chris Growe - Stifel Nicolaus

Bryan Spillane - Bank of America

Eric Katzman - Deutsche Bank

Terry Bivens - J P Morgan

Jonathan Feeney - Janney Montgomery Scott

Ed Aaron - RBC Capital Markets

Presentation

Operator

Welcome to the Kellogg Company 2009 Third Quarter Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (Operator Instructions).

At this time, I will turn the call over to Mr. John Bryant, Kellogg Company Chief Financial Officer. Mr. Bryant, you may begin your conference.

John Bryant

Thank you, Audrey. Good morning, everyone. Thank you for joining us for a review of our third quarter results.

With me here in Battle Creek is David Mackay, President and CEO and Gary Pilnick, General Counsel. I'm also happy to introduce [Kathryn Kessel] our new Head of Investor Relations.

We must point out that certain statements made today, such as projections of Kellogg Company's future performance, including earnings per share, net sales, margins, operating profit, interest expense, tax rate, cash flow, cost savings, brand building, up-front 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 filings.

A replay of today's conference call will be available by phone through Monday evening by dialing 888-632-8973. The passcode is 72183663. The call will also be available via webcast replay which will be archived for 90 days.

Now, let me turn it over to David.

David MacKay

Thank you, John. Good morning, everyone.

The third quarter was a strong one for Kellogg Company, continuing excellent momentum from earlier in the year and there's no doubt the current economic environment is difficult. However, our business approach is designed to achieve positive results, even during challenging economic conditions. We have sharpened our marketing and tried initiatives to reflect the pressure on our consumer, and we have been relentless in our pursuit of increased productivity through our three-year $1 billion cost reduction challenge.

The current environment also creates opportunities for us. We have seen consumers trade into some of our core categories, such as cereal, in market like the US and the UK, as consumers seek to maximize the value received from every food dollar spent.

We have also taken advantage of media deflation to significantly reinvest back into our brands. We still expect our advertising spend to be up double digits in the back half, with an even greater increase in underlying impressions. We believe that while the current economic environment is challenging, it also gives us the opportunity to build an even stronger Kellogg Company for the future.

The third quarter results illustrate the continued resilience and relevance of our focused strategy and business model. Internal net sales which exclude the impact of foreign exchange, acquisitions and shipping days grew 3% during the quarter, consistent with our expectation of 3% to 4% sales growth for the full year.

Gross margin exceeded our expectation in the quarter. Excellent delivery from our $1 billion challenge enabled us to deliver gross margin expansion and while commodity costs have fallen as we expected, we are still seeing overall cost of goods inflation versus last year. We posted double-digit internal operating profit growth, exceeding our long-term annual target of mid single-digit growth, as momentum continued behind productivity and cost saving initiatives.

Our EPS growth for the quarter was higher than expected, driven by strong internal operating profit delivery. Importantly, despite significant reinvestment in the business, we are also raising our currency neutral earnings per share guidance for 2009 and providing 2010 guidance above our long-term targets.

As you can see, we remain focused on delivering sustainable and dependable growth for our shareowners in 2009 and going forward. We continue to have excellent visibility into our future financial performance.

Now, I'd like to turn it over to John to walk you through the financials.

John Bryant

Thanks, David. Despite the challenges of a tough competitive landscape, a weak economy and tough comps, we met or exceeded our long-term annual targets of low single-digit internal net sales growth, mid single-digit internal operating profit growth, and high single-digit currency neutral EPS growth.

Reported net sales were relatively flat for the quarter, including a negative foreign exchange impact. Internal net sales growth, which excludes the effect of foreign exchange, acquisitions and shipping days, was 3%, building on last year's strong 7% internal net sales growth. We continue to project 3% to 4% internal net sales growth for full year 2009.

Reported operating profit increased by 6% despite the adverse impact of foreign exchange, significant reinvestment in advertising and higher up-front cost. Internal operating profit grew by strong 11%. This result was driven by our strong top-line performance and excellent delivery from our $1 billion challenge.

We also delivered a high quality of earnings. We took advantage of our momentum to reinvest in the long-term health of our brands by increasing advertising by 17% on an internal basis in the quarter, and we executed up-front cost projects which adversely impacted operating profit growth by 6% year-on-year.

Reported earnings per share rose ahead of expectations to $0.94, a 6% increase on a reported basis and a 12% increase on a currency neutral basis. This result was driven by strong internal operating profit growth, partially offset by unfavorability from foreign exchange. On below the line items, we had some discrete items, which reduced our tax rate to 26.8% for the quarter and lower interest expense year-on-year. However, this was more than offset by other income and expense.

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