Kellogg Presentation at the 2005 CAGNY Conference
February 23, 2005
Speaking on behalf of Kellogg:
Jim Jenness, Chairman and CEO designate
David Mackay, President and COO
Jeff Boromisa, CFO
J. Jenness:Good morning, everybody. I hope you had a chance to enjoy the breakfast and sample some of our new products. I just want to say that this is very exciting for me. It is a privilege to be here at CAGNY with you all and a privilege for my colleagues sitting here with me. Lenny has introduced David. Jeff Boromisa, [CFO] maybe a new face here but he has been around the Kellogg world for over 20 years. And Simon Burton, our director of Investor Relations, is sitting out there in the audience waiting for the chance to drive some applause which I know you all are waiting to do.
First, a word from our lawyers. As you know, certain statements made today such as projections for the company’s future performance are forward- looking statements. Actually results could be materially different from those projected. For further information concerning factors that could cause the results to differ, please refer to page 2 of this presentation, as well as our public SEC filings.
Well, there’s really only one place for me to really start. And that’s to say how honored I am after 30 years with this wonderful company to actually be a Kellogg employee and now officially being able to wear a Kellogg pin which was given to me actually 15 years ago. It really is an honor for me. I also want to say right off the top here that I believe strongly in the approach that has produced such positive results for the Kellogg Company and our shareholders; and I’m going to talk a little bit more about that. Perhaps even more importantly, I believe we are just getting started in what Lenny referred to as delivering dependability.
Let’s get down to business here. Four years ago we came to you with a plan to transform the Kellogg Company. We implemented realistic targets –
something the industry has followed. We have a focused product strategy aimed right at our strengths with a very disciplined geographic strategy. We have clear operating principles in Volume to Value and Managing for Cash; operating principles that are particularly suited for our Kellogg situation. A business unit structure was put in place and we aligned all our compensation programs to this business unit structure. We added the position of president and COO and filled it with a superb talent. We added a marketing committee to the Board and put a chairman in place who had anintimate knowledge of the company. We built processes to leverage our focused businesses and our #1 and #2 share positions, all intended to drive superior execution and all intended to share ideas around the world. And when I say that I want you to think about Special K and red berries, which we have introduced around the world and it’s been successful everywhere. I want you to think about Kashi and I want you to think about Spiderman and 42 countries simultaneously introduced with a movie and all the promotion activity around it. And importantly, we committed to our shareholders that we would deliver sustainability and dependability. So my message – if there is any doubt in anyone’s mind – is that this is a track that we are going to stay on.
Let’s start with realistic targets: low single digit net sales growth, mid single digit operating profit growth, and high single digit EPS. These targets drive positive behavior to manage our company – every part of our company –
for sustainable and dependable performance year in and year out. Our strategy of focus and depth over distraction and breadth, I’m probably going to get in trouble for that, plays to our strength in our #1 and #2 brand positions.
Grow cereal. Big profitable area for us and our customers. Highly relevant for today’s consumers. Think about the new food guidelines; perfect for our business. You think about the aging population, and as all you know, the increase in per capita consumption as folks go through that aging cycle – increasing two to four pounds of per capita basis. All very positive signs for the category. You think about a serving of ready to eat cereal and skim milk, 150 calories; you put that with the fact that kids and adults who eat ready-to-eat-cereal have lower body mass indexes, and you can see why this is a great category now and a great category going forward. This is a category that responds to brand building and innovation. I remember when Special K was introduced back in 1955, actually as an alternative protein source to meat, and over the years that brand has gone up, it’s gone down, and in the last five years and the last two years in particular, it has been on fire. A great example on how these brands have tremendous relevancy and resiliency for our consumers. I would also say, and I know you all know this, ready-to-eatcereal is the lifeblood of the Kellogg Company, and it always will be.
Expand snacks. I love Kellogg with DSD. This plays to our marketing strength as brand builders and also our institutional knowledge of fruit and grains. Snacks offer us excellent geographic expansion opportunities; I’ll refer to Mexico here in a few minutes, as well expansion opportunities within existing geographies.
We are also committed to drive selected growth opportunities and a great example of this is Eggo. What a great brand and David is going to talk about that in a few minutes.
The net of all of this is our strategy is working. Five percent internal net sales growth in 2004;four years of delivering dependability on the top line. You know our Volume to Value operating principle is really a way of doing business for the company. It’s just integrated into the way we do business. An interesting point, half of the portfolio is always going to be below the average price per pound – and out of that we see only up side.
If you look at 2004, brand building was up a double digit, innovation was strong, price mix improved, net sales grew, and gross margin increased by 50 basis points. This is a virtuous cycle we intend to continue driving. A high quality internal net sales growth is key to Volume to Value. In 2004, price/mix and tonnage growth both were strong. These are positive outcomes driven by realistic targets and clear operating principles.
Each of our businesses in North America contributed to the overall North America internal growth of 5 percent. Retail cereals are up 2% and remember that is against a comp of 6% in 2003. Retail snacks up a strong 8% and our frozen and specialty channels up 4 percent. Eggo was up a double digit – this is a great brand. And our Food Away from Home business also grew and this is in an industry where many of the players were having trouble.
Kellogg International internal revenue growth was also 5% and we increased in all areas. Europe was up 4 percent; this is the highest growth we have had in Europe in 10 years. But we are also executing two very significant efficiency and effectiveness moves while we are growing the business 4 percent.
Latin America, I wish all of our regions wereLatin America. Eleven percent growth and continues to be very strong, driven by our Mexican operation. Both cereal and snackswere up in Mexico and remember our snacks business in Mexicois lapping a 100% growth in 2003.
Asia-Pacific grew 2% despite some category issues in Korea and some increased competitive activity in Australia.
You know despite the significant increases in commodity costs, we still increased our gross profit margin by 50 basis points. As you can see this was driven by our operating leverage, productivity savings and a strong contribution from mix. At just under 45%, we see continued room for improvement on this measure. In fact our long-term goal is to continue to increase gross profit margin by 50 basis points. Our compounded EPS growth of 10% between 2000 and 2004 is all about one thing; it’s about delivering dependability. In line with our long-term targets, we see 2005 EPS growth at high single digit.
Our cash flow compounded annual growth rate was also 10% for this period. Cash flow exceeded net earnings by $59 million in 2004. We are committed to drive improvement in cash flow as it reflects the true value and health of our company and the absolute right mindset for each and every one of our employees. The Manage for Cash operating principle, like Volume to Value, is just a way of doing business for us. Our 2004 performance, if we could write it down, write a book about it, we would write it this way: The net of all of it was that it all added up to a 60 basis point improvement in our return on invested capital.
You know core working capital is an absolute key part of Managing for Cash. We view it as receivables+ inventory – traditional payables. And as you can see here, we have had 14 consecutive quarters of improvement in core working capital. If there is a measure that shows the impact of discipline around Managing for Cash and the commitment of every one of our folks to drive and improve our efficiency, this is it. And more importantly, we see room to continue to improve our core working capital.
You know when it comes to capital expenditures, we think of ourselves as a marketing company and a brand building company. We pegged our capital expenditures around 3% of net sales; 2004 we spent about $279 million here. We’re going to stay pretty much on that target of 3 percent.
What all of this has lead up was the ability to pay down a significant amount of the leverage we took up when we bought Keebler. Over the last couple of years, we have paid downover $2 billion dollars of debt. This is a discipline we intend to maintain. This is an important use of our cash, and continuing to develop financial flexibility is something that is very important to us.
You know hundreds of Kellogg folks around the world delivered superior execution of some efficiency and effectiveness measures. We consolidated our Worthington, Ohio Plant into our Zanesville Plant. We moved our Snacks business from Elmhurst, Illinois to Battle Creek. We implemented two European initiatives while growing our business 4 percent: we implemented SAP across 16 countries and we strengthened our European structure by moving our Headquarters to Dublin, which involved moving a lot of our management out of Manchester. I would just like to mention Tim Mobsby, who is our regional head for Europe, who did just a fabulous job in this regard.
So we’veaccomplished a lot in the last four years, there’s no doubt about it. But I really believe that we are just getting started. If you think about it, we have leading brands, we have a global infrastructure that has been put in place over decades, we have a focused strategy and we have a sustainable business model anchored in some very clear operating principles of Volume to Value and Managing for Cash. So now with that I would like to turn it over to David [Mackay] for a little closer look at our business.
D. Mackay:Thank you, Jim. It is good to be back at CAGNY, especially after Kellogg has had such a great year in 2004. And it wasn’t just that we achieved strong results. We also executed, as Jim said, some major moves that actually will give us visibility into the future. As you can see on this slide, Tony [the Tiger] is demonstrating that in today’s environment to stay on track you’ve got to run and you got to keep moving. To stay on track for us as a business, we need to grow and the way we grow is through innovation, through advertising and through great execution.
What I would like to do is take you through some of the first half 2005 innovation. Look at some of our advertising for 2005 and look at some of our consumer promotions for 2005. Starting with cereal.
Growing a cereal business, as Jim has said, is a key element of our focus strategy. This slide shows some of the recent global cereal innovation or innovation that will be introduced in the near term.
If you look at North America, you’ll have tried this morning Tiger Power, a combination of protein, fiber and calcium. The advertising for that started last week, so it’s very early. Smart Start Healthy Heart also tackling a big issue within the American population, especially for people my age. We will show you a commercial for that in a minute, too. Mini Wheats Vanilla Cream and a number of others. It’s too early to give you any real update on them. They’re tracking about a 0.1 to 0.3. With the advertising of them just having started it is probably going to be a month or two before we are going to have a very good read.
If you look at Latin America and Australasia, we have a new Zucaritas packaging innovation in Latin America. We have a new version of Special K launching in Mexico, a new variety of All Bran in Japan and a number of other products. In Europe we are launching Crunchy Nut Nutty to build off the strength of that great brand. A Special K Yoghurty in Spain. The first launch of a Kashi product in the UK market will take place in the next couple of months and also an All Bran Flakes Yoghurty launch.
What I would like to do is run some commercials for you. We are going to see Tiger Power, Smart Start Healthy Heart, a Frosted Flakes ad, All Bran ad from the UK, Special K from the UK and a Mexican Frosted Flakes ad. So if we could run those, please. [commercials]
OK. Our global and domestic promotions for 2005 – this is a very important way for us to add value to our products and bring real interest. You can see we start in Q1 with Robots. It’s out there and it’s doing reasonably well; it’s a bit early to really tell. Q2 Star Wars Episode IIIis probably the biggest event for us in the year and we have a lot of positive indications from our retail trading partners that this going to be a very, very big promotion for us and for them. In Q3 we have a combination of a Disney theme park and a Cartoon Network-themedpromotion. And in Q4 Chicken Little.
Turning now to the second part of our focused strategy – expanding snacks on a global basis. On the screen you have some of the innovation going on globally. In North America, I’ll mention a few of them, there’s a new Cheez- It and Chips Deluxe Gripz, which is single served packaging that is just going out. A newFruit Streamers fruit snack, and I’ll talk a little more on fruit snacks in a minute. A new flavor of Twisterz, a new Cool Ranch and Cheddar. A new All Bran bar flavor in Canada. Two new flavors of Club Sticks and many, many others. In Latin America and Australasia, just to mention a few,All Bran bars and Nutri-Grain bars. A new Special K bar is going out in Mexico as we speak. And in Australia, a bar form of the Nutri-Graincereal that is really only sold in Australia. In Europe we have new versions of Special K bars going out across Europe. We have new Nutri-Grain Chewy in the UK, the new flavors of Nutri-Grain in the UK and a new Coco Popssnack innovation going on through Europe.
As we look at our snacks portfolio globally, we feel that we have a great opportunity with this not only to build on our current portfolios. We look at wholesome snacks; we think there’s a lot more we can do there. We think about cookies and the recent category weakness; we see real opportunities as we go forward. Crackers, likewise, we think we can build a business there. Toaster pastries continues to perform exceptionally well, but again we still think there is still more growth there. Plus, we see a real ability for us to enter new segments and I think one such example is fruit snacks. We launched fruit snacks in early 2004. We weren’t in the category. We’ve currently reached a #2 position in the category with a 13.7 share. So to Jim’s point, we’re just getting started, as far as we’re concerned,in building our global snacks portfolio.
And what I want do now is just run some commercials. We’re going to look at a Pop Tarts French Toast commercial, a Special K bar commercial, a new Keebler equity campaign for cookies namedMagic Oven, which hasn’t started airing yet so you’ll get a sneak preview. The Australian Nutri-Grain bar ad and you’ll see the cereal, if you can see it on screen, is very different there. And a Mexican ad which is a Nutri-Grain bar that’s got a very much a competitive focus up against a knock-off that was launched there. So if we can run those please. [commercials]
The final piece of our focused strategy is probably the broadest – pursuing selected growth opportunities. And currently as you think about this, the main business focus is Frozen Foods and the Eggo and the Morningstar Farms brands. Innovation for the first half of the year include two new flavors of Eggo Toasted Swirls and Morningstar Farms Honey Mustard Chicken Tenders. I think Jim mentioned, Eggo in the last two years has grown at double digit. I’ll talk a little bit more about selected growth opportunities later on, but first we’ll just run a couple of Eggo ads – Home Style and French Toaster Sticks. [commercials]