Kellogg Company (K)

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Kellogg (K)

Q3 2010 Earnings Call

November 02, 2010 9:30 am ET

Executives

Kathryn Koessel -

John Bryant - Chief Operating Officer, Executive Vice President and Director

Ronald Dissinger - Chief Financial Officer and Senior Vice President

A. D. MacKay - Chief Executive Officer, President, Director and Member of Executive Committee

Analysts

Alexia Howard - Bernstein Research

Andrew Lazar - Barclays Capital

Diane Geissler - Credit Agricole Securities (USA) Inc.

Judy Hong - Goldman Sachs Group Inc.

Vincent Andrews - Morgan Stanley

Robert Dickerson

Robert Moskow - Crédit Suisse AG

Kenneth Zaslow - BMO Capital Markets U.S.

Timothy Ramey - D.A. Davidson & Co.

Bryan Spillane - BofA Merrill Lynch

David Driscoll - Citigroup Inc

Edward Aaron - RBC Capital Markets Corporation

Presentation

Operator

Good morning. Welcome to the Kellogg Company 2010 Third Quarter Earnings Call. [Operator Instructions] At this time, I will turn the call over to Kathryn Koessel, Kellogg Company Vice President of Investor Relations. Ms. Koessel, you may begin your conference.

Kathryn Koessel

Thank you, Christina, and good morning. Thank you for joining us today, and welcome to the review of our 2010 third quarter results. Joining me are David MacKay, President and CEO; John Bryant, Chief Operating Officer; and Ron Dissinger, Chief Financial Officer. The press release and slides that support our remarks this morning are posted on our website at www.kelloggcompany.com.

As you are aware, certain statements made today, such as projections for Kellogg Company's future performance including earnings per share, net sales, margin, operating profit, interest expense, tax rate, cash flow, brand building, 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 filings.

As a reminder, a replay of today's conference call will be available by phone through Friday, November 12. The call will also be available via webcast, which will be archived for at least 90 days.

Now let me turn it over to David.

A. D. MacKay

Thanks, Kathryn, and good morning, everyone. 2010 has been a difficult, disappointing year for the company. By now there are many questions about what has happened to Kellogg and why and when we expect better performance. We're confident that we can regain momentum as a company, and this confidence comes from an understanding of what has happened in our business over the last two years and a conviction that we're well positioned for the future. To understand our confidence in this future, it is first necessary to recognize what has taken us off course in 2010. And there are four major issues.

First, we've had significant issues in our supply chain. We've weathered the two largest recalls in our history during the past two years. We've also been impacted by production challenges in our Eggo facility. We have a long-standing commitment to food quality, and the recent voluntary recalls have demonstrated our commitment to putting consumers first. We've taken steps in our supply chain to mitigate similar potential risks. This includes additional operating expense across 2010 and 2011 as well as slightly elevated levels of capital spending in 2011 and 2012.

It is difficult to quantify the true impact of these supply disruptions. There are clearly defined costs associated with the recourse and the softer costs associated with lost sales. To put the impact of these issues into context, we estimate that the various supply disruptions adversely impacted operating expense by $200 million to $300 million over the last two years and impacted capital expenditures by $150 million to $200 million for a total impact approaching $0.5 billion. In addition, there's also the organizational impact of focusing large numbers of internal resources on proactively identifying and resolving issues to mitigate risks going forward.

I believe that these supply disruptions clearly distinguish the last two years from the preceding eight years. Second, we've had significantly less innovation during 2009 and 2010. As we enter the recession, we pull back on innovation and drive increased renovation across the portfolio, such as adding fiber to our kid cereals. The renovation has set up our portfolio for the future but did not drive short-term sales performance. The lower level of innovation, combined with these key [ph] rationalization has weighed all our top line growth.

It's always difficult to quantify the impact of reduced innovation. But as a guide, we launched about $800 million worth of innovation in 2008. In 2009 and 2010, our innovation was roughly 25% lower than in 2008. The good news is that we are moving forward into 2011 with a wide of innovation that is going to increase significantly.

Third, we have some tough comparisons in 2010, both in the overall strong 2009 Cereal category growth globally and in the non-major channel. In 2009, we had abnormally high growth from the non-major channels, as we work closely with some large customers in that group. However, in 2010, I compare this picked up more of the activity that we had enjoyed in 2009.

To give you a sense of the impact, we estimate that this has resulted in an approximate 2-point drag on our top line in U.S. Cereal business. I think the last two years have reinforced several key truths regarding the U.S. Cereal category. For most retailers to do well in the category, the key branded players need to excite consumers. And most importantly, the category is driven by health news, innovation and brand building. Promotional activity has not proven to grow the category over time.

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