Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Kellogg Company (NYSE:K)

2014 CAGNY Presentation

February 19, 2014 8:00 AM ET

Executives

John Bryant - President and CEO

Michael Allen - President, U.S. Morning Foods

Ronald Dissinger - CFO

Analysts

Unidentified Analyst

Okay. So thank you for coming this morning, and I want to thank Kellogg for coming and presenting and also for sponsoring for today's breakfast. Here with me on the dais is John Bryant, CEO; Michael Allen, President of Morning Foods; and Ron Dissinger, CFO.

I would say the hard part of being a CEO at a 100-year company with a blue chip brand, is that it's hard to institute change. But under John's leadership, Kellogg is now moving in a new direction to prepare for the future. He has made snacks a bigger part of the portfolio, with the acquisition of Pringles, and he has initiated a major restructuring of the organization, with the initiation of Project K.

Here to tell us more about what's changing at Kellogg and what will stay the same, is John Bryant.

John Bryant

Good morning everyone. Hope you enjoyed breakfast this morning. If I could start by turning your attention to the forward-looking statements and then for this morning's discussion, I really have three agenda items, I am going to give you a sense of the overview and strategy of the company. And as obviously, we have Michael Allen here. Michael is our President of the U.S. Morning Foods business, which includes cereal, which I know is the topic of keen interest amongst investors. Michael has a track record of success, joining our Frozen Foods business, and holding senior roles, in both U.S. snacks, as well as, U.S. cereal and international cereal businesses, and is a long term Kellogg executive. And of course, you have Ron Dissinger, our CFO, to go through the financial model.

As we are stepping back and looking at how the Kellogg Company has changed over the years. To Rob's point, the company has continued to change and evolve. If we go back to the year 2000, we were a $6 billion company with around 70% of our sales in cereal and we had around 20% of our sales in business we called convenience foods, which was essentially affordable cereal, products like Nutri-Grain bars etcetera.

We overcame [indiscernible] in 2013-2014 supporting, we have $15 billion of sales, with two global categories. 40% to 45% of our sales are in cereal, 40% to 45% of our sales are in snacks, and we continue to have a large and successful frozen foods business here in North America. So the company has changed considerably over the last decade and a half, becoming both a global snacks and a global cereal player.

Not only has the category changed, but the geographic split has also continued to evolve. Now obviously, when we acquired Keebler about a decade ago, that put more business within the developed markets. But the recent acquisition of Pringles has given us significantly more scale in the emerging markets. It has doubled or tripled some of the scale that Kellogg Company has in some of those markets.

Pringles has really changed the nature of the game for Kellogg within the emerging markets, I will come back and talk more about that shortly. It has given us both more scale, but also an additional platform for growth to set ourselves up for long term growth in those markets.

If you look back over the last decade, the company has had a track record of success, particularly through the 2000s. We had our sustainable growth model work incredibly well. We were growing gross margin to the neighboring [indiscernible] back our brands, drive innovation, good cost discipline, all the way to continued sales growth, and a reinforcing virtuous cycle, that we are tracking along incredibly well with. And our goal, our intent is to absolutely get back on the sustainable growth model, that's what we are about as a company.

Unfortunately, a few things happened at the end of 2000s to take us off this model. One was when the recession came along, like a number of other major companies, major food companies, we increased our investment on trade spend, rather than brand building, and we know at other time, trade spend does not really drive the categories that we operate in.

The second one, which we put a bit too much focus on, renovation versus innovation. Both are important, but keeping the balance is very important; and as you all are aware, we had some issues in our supply chain. The combination of those events took us off that sustainable growth model, and our goal is very much to get back on to that sustainable growth model.

So how are we going to do that? There is a few things we have achieved and a few things we are still working on. Firstly, we have strengthened the supply chain. We have made the investments that we needed to make, and I feel extremely good -- about to say that our supply chain at the Kellogg Company.

The second is, we have made the second largest acquisition in the company's history, being Pringles, and integrated it flawlessly. The business is doing incredibly well, I will talk more about that shortly; and we have strengthened the leadership team of the company, through a combination of great internal promotions, as well as external hires.

But there is more we need to do. We have announced the largest restructuring program in the company's history. A four year program, which will generate about $425 million to $475 million in savings a year, to enable us to reinvest back in the business and drive for long term success of the company, to get back on that sustainable growth model.

How we do that depends on how we execute our strategy, and I will take you through our key growth platforms as a company.

Let me just touch briefly on what we have done. In 2011, the company took a position, that we are going to make whatever investments are required, to ensure that we have a high performing supply chain, and we have absolutely done that, and we are seeing that come through. It could be hard from outside the company, to see the progress that we have made. But just to give you one example, in 2013 we had the best record in the company's history on people safety within the supply chain, and the improvement from 2012 to 2013 was also one of the best we have ever seen, in terms of rate of change.

People safety is a leading indicator for how well your supply chain is working. If people are looking after themselves, they are looking after the plants, they are looking after the food stream. So we really feel very good about the strength of our supply chain, and what we have done to get ourselves to where we are today.

The second big change is the acquisition of Pringles. Now as you know, when we acquired Pringles, we were a little cautious on our top line expectations, it had gone through a difficult transition from P&G, Diamond, then to ourselves. I am very happy to say, since we are acquiring the Pringles business, we have been growing at high singles digit, and we are selling every can we can make in this business. So we have more capacity coming online in 2014 and 2015, and we believe we are barely scratching the surface in terms of the potential this business has. Not only the top line there, we are also delivering the synergies we expected and of course, exceeding our expectations on accretion from the acquisition. This is a tremendous business, and it has multiple impacts, not just the obvious piece of having a wonderful growing business in the portfolio, but also as I said, impacting the emerging markets, and have brought new talent into the company.

These are the leaders of some of our key businesses; Chris Hood runs our European business. Chris Hood came to us from the Pringles organization. As you look at some of our key leaders here, we have a handful from companies other than Kellogg, who have bought a new thinking, new learnings, and pushed how we run the business, as well as great Kellogg legacy executives, with a tremendous track record of success, such as Michael and Brian etcetera. So we feel very good about the state of the leadership team of the company.

As I said, there is more than we need to do. So now with Project K, this is a major restructuring program, which will give us the fuel for growth. Within Project K, there is both capability building elements, as well as fuel for growth elements. The first two, in terms of capability building; one is, we are creating global category teams. So what we are saying is, there is opportunities out there around the world, such as next generation packaging, that makes no sense to each individual regional business units that the Kellogg Company work on, to rather take that idea, centralize it, put the right resourcing against it, do the right work and then roll out from there. That will be an example of how some of these executives from other companies have pushed their operating model and challenged us, for how we can run the business even more effectively over the long term.

Both global categories team report to our new Chief Growth Officer, Paul Norman, and his primary objective is to provide long term innovation and growth visibility for the company.

In addition to that, within Project K, we are building key capabilities as a company. And obvious ones in the area of trade spend effectiveness, and other one would be in the area of, what we call Kellogg Work Systems. When we had our issues in supply chain, we looked at what was best in class for running supply chain in the food industry, and we identify the Jackson Pringles facility, as a best in class facility. This is before we had any intention of buying Pringles. Within that facility, we have something called Integrated Work Systems, that P&G has done a tremendous job of driving across along their manufacturing footprint. Now that we own Jackson, we can take that operating model, make it Kellogg specific and then roll it out across our plants around the world, and we are in the process of doing that.

But of course, within Project K, there is also some major moves within the cost structure, both in our supply chain, and what we call, in Global Business Services. Looking at on our supply chain today, we want to ensure that we have the right capacity in the right locations at the right cost structure. And like a lot of companies, we have a supply chain that was created for the business that we used to have, as opposed to the business that we do have, but unfortunately, we have some facilities that do not have the right cost structure, not the right location, not the right capacity. As a result, we have announced the intention to close facilities in markets like the U.S., Canada and Australia across this year.

We are also adding new facility, where our business is growing, so we are adding Pringles capacity in Eastern Europe and in Asia Pacific. We are adding cereal capacity in markets like India, or even adding Kellogg Snacks capacity in markets like Asia Pacific. But we are absolutely focused on assuring that we have the leanest possible supply chain to enable us to invest back in the business.

Then we have Global Business Services; this is really about simplifying, standardizing and automating key processes within the company, key processes such as oil the cash [ph] and Hire to Retire. A number of other companies have already gone through these Global Business Services approaches with great success, and we are very confident that we can see our way to make things work at the Kellogg Company. Its still early days, we are going to make some announcements, such as our regional service center in Grand Rapids, Michigan, that will start to enable us to get after these opportunities.

So you can see, the company is committed to a four-year program. We are going to do it the right way. We are going to pace ourselves. But we are absolutely going to go after these benefits, and realize them as a company.

Now I get asked a lot, how we are going to reinvest the Project K savings back into the company? The first thing is to recognize, we have $1.5 billion of brand building today. We will have one of the highest percentages of brand building of any food company in the industry. And probably number one, is to make sure that money is driving our business as effectively as it possibly can.

As we get the additional savings from Project K we reinvest back in the business, we look across a spectrum of Desire, Decide and Delight. It would be wrong to think of it as just going back into advertising, just really go into the various elements of the path of purchase model.

In cereal, we believe we primarily have a Desire opportunity. We have an opportunity to reframe the discussion of the benefits of cereal. It’s a healthy, nutritious breakfast alternative, and Michael will talk more about that later. So you could see us investing more in advertising in that particular category.

When it comes to the snacks business, we believe we have an opportunity to reinvest in our direct store delivery system in the U.S., and that's what we are looking to do there.

On Delight, there are some elements about food that we think we need to improve the food performance, to better meet the promise of the brand, and you will see us doing some of that as well. So we will be reinvesting across the key drivers that drive the consumers' behavior.

The Project K is going to give us the funds to invest back into our strategy, so its worth walking through the company's global growth strategy. We have four global growth platforms; firstly, win in breakfast, become a global snacks leader, grow our U.S. frozen foods business, and win in emerging markets.

Firstly, Win in Breakfast; this is where there has been a bit of a change in the terminology that we use. In the past, you have seen a slide from Kellogg Company that said Win in Cereal. The opportunity we have with our cereal business, is to win against other categories at the break fast occasion. So we now see this strategic challenge as winning in breakfast with cereal. So when we are talking about winning in breakfast, it doesn't mean we are going to go into frozen bagels or into orange juice or coffee, we are going to win in breakfast with cereal by talking about the benefits of cereal relative to the other categories around the cereal occasion. Again, Mike will talk more about this.

We also recognize that the breakfast occasion continues to evolve and change around the world, and we will continue to change the offering to provide more alternatives to consumers. So for example, in South Africa, we have the corn flake porridge here, because hot cereals are a big category within the South African market. We see the successful growth of Porridge-like breakfast beverages in markets like Australia, so we've launched that in Australia and in the U.S., and of course, we have seen the continued growth of other breakfast consumption of cereal, in products like Krave, that we [indiscernible] those sorts of opportunities. Again, Mike will talk more about these shortly.

The second growth driver for the company, is our snacks business. Again, to go back to 1990s, it was more about portable cereals, the acquisition of Keebler in the early 2000s, gave us a DSD system, tremendous cookie cracker brands, and drove a lot of growth from the company across the 2000s.

The Keebler business was transformational for our U.S. organization, but really did not impact our international business. The duty of the Pringles acquisition was a great bolt-on to our U.S. business and is a transformational business, transformational acquisition for our international operations. Now we have dedicated snacks teams in Europe, Latin America and Asia Pacific, as opposed to cereal teams trying to do snacks on the side.

So we are well positioned with this platform, to drive an exciting decade of growth across snacks. We expect to do that both with our cookie cracker business in the U.S., as well as our global Pringles business, and our snacks that leverage the Kellogg's total [ph] equities.

The third platform for growth is really a North America platform, our frozen foods business. This is about $1 billion business, has been growing high single digits over most of the last decade. It includes the Eggo waffle business; Eggo is the second strongest brand the Kellogg Company has, second only to the Kellogg brand itself. Clearly, the leading brand in the waffle category. We also have an exciting business in MorningStar Farms in Garden Burger, and Veggie Burgers are growing at double digits across the back half of last year. We had also success leveraging cereal equities into the frozen foods business, such as Special K fiber breakfast sandwiches as well as Kashi frozen entrees. So we see frozen foods as an ongoing growth driver for the company.

Then there are the emerging markets. The emerging markets will be the defining event of our careers, our time in the food industry. Today, a company like Kellogg has 80% of our sales being sold to 20% of the world's population. As the emerging market evolves and develops in these countries, we want to have the platform that enables us to participate in that growth and to win in these markets. We are going to do that both through organic growth and through working with third parties, in order to make sure we have that platform in place.

So let me go through a couple markets and give you a sense of how our emerging market platform is evolving and changing, particularly the impact of Pringles on our emerging markets business.

Let me start with India; we have had five years of 30% of growth in cereal in the Indian business. We are opening a new facility this year, to continue to supply that market. This is market which we believe is very much on trend for the cereal category. There is availability of fresh milk on about every street corner. There is a grain based diet orientation for the Indian consumer, and we have already achieved 18% household penetration. So still relatively early days, with great growth potential. We have a good opportunity to keep driving household penetration by getting lower priced products in the marketplace. So we are launching INR5 sachets of cereal through high frequency stores across India, and we are seeing good response from that.

So we are very excited about India. We believe we have a strong cereal platform there, very strong brands, heavy level of brand building investment in that market. Pringles is relatively small. We believe we have the opportunity to leverage our Kellogg infrastructure to help drive the Pringles business over time as well.

Well I then go to Kellogg Brazil; we have been in Brazil since 1960s. We have a very strong market share position. The business has been growing high single digits over the last several years. It is again, a very strong cereal platform. In this business, Pringles adds about a third to the business in Brazil. Again, Pringles is small, but we can leverage the scale of the Kellogg Company in Brazil, to help drive the Pringles business over time as well; and then we have also launched a range of breakfast cookies, breakfast biscuits with a local Brazilian company, using their distribution system and their capabilities as well. So a combination of organic growth, as well as working with local partners in Brazil, to keep driving this business over time.

And if I go to the Middle East; the Middle East, this is a case where Pringles has had a significant impact on our emerging market structure. Essentially, Pringles and Kellogg together have doubled the size of our business there. It’s a case of one plus one equals three; because the combination of Pringles and Kellogg together, gives us enough scale to invest in the infrastructure, and to invest back in the business. This is a business that has been growing. We have had very good growth in cereal, double digit growth. We have had good growth in Pringles, mid-single digit growth type range, and we think the combination of two businesses gives us enough scale to invest back and to keep driving this business, over time.

A different business again would be Russia. In Russia, the Kellogg business has historically been relatively small. We acquired a cookie cracker business several years ago. It was a bit more a commodity business, that was a bulk business that we are driving into a truly branded packaged business, that has been a tough transition over the last several years. We have been making good progress, and we are in a much stronger position today. But again, Pringles comes in here and gives us a whole new source of growth in Russia, a very profitable business and a combination, drives us to having a much stronger platform within Russia over time.

Then finally, China would be an example of the market, where neither Pringles nor Kellogg have historically been very strong. We have a very exciting joint venture with Wilmar, the third largest food CPG company within China; excellent distribution capabilities, very strong business, very strong partner. We are in a test market, in a couple of cities within China for both cereal and for Pringles. Test market is going incredibly well, and as we prove out the test model, we will then expand city by city across China. So we have a long term trajectory for growth within China, we have a game plan and we are operating against that game plan.

Interestingly, within China, as we drive our cereal business, we are actually doing it with the Kellogg Masterbrand, similar to what we have been talking about here in the U.S., talking about the benefits of cereal versus other categories, and that's often how we go back to the very core of the category, and how we created in the first place.

We are making progress as a company. Go back over the last three or four years. We have made the investments in our supply chain, we have a very strong supply chain.

We have enhanced the leadership team of the company, through a combination of promoting some great talent from within, as well as recruiting from the outside. We have acquired and flawlessly integrated the Pringles business into the Kellogg company, they have done a tremendous job. And we have launched Project K, which gives us visibility over the next four years, but even additional fuel for growth, to drive that business even higher over time.

So what to look for on the Kellogg Company in the future? Firstly, we are going to flawlessly execute Project K. This is a major undertaking, it’s a four year program. We are going to do it the right way, and we got to do it in the right sequencing and the right timing. We are going to reinvest and grow our developed cereal businesses. There is absolutely no question we can do that, and Michael will give you a sense of why. Now our expectations from markets like U.S. cereal would be low single digit growth, and we will try to drive these businesses into mid or high single digit growth, and across the 2000s, we achieved those sorts of growth rates in these markets.

We will fully leverage the Pringles business and create a truly global snacks platform, and generate the same sorts of growth we saw; out of snacks the next decade, as we saw in last decade in the U.S. business, and we will expand and drive our emerging markets business.

That's what to look forward from the Kellogg Company going forward. I am confident that we are doing the right things, we are taking the right actions and we are on the right track in order to achieve our objectives and getting back on a sustainable growth model.

Now let me turn it over to Michael, who will take you through our U.S. morning foods and cereal specifically.

Michael Allen

Thank you, John. I am glad to have the opportunity to come here today and talk to you about the Morning Foods business at Kellogg. So let's begin by just going through a couple of things. We will give you a brief overview on our business, talk about the category, not only breakfast as an occasion, but also the category in which we compete, which is Ready-to-Eat cereal. Our strategy and then the model which John referred to, which is about Decide, Desire, Delight, and really how we motivate consumers into the category through a variety of different ways.

So to begin with, the Morning Foods business at Kellogg is about $3.5 billion in net sales. As you can see, the majority of our business is Ready-to-Eat cereal, which makes some sense. There is also our Pop Tarts business, which we will talk about a little bit later. Very-very strong business for us, that has grown for many-many years, and then some other business, which have really come to the fruition in the last 12 months or so.

If you look at some of those other businesses I referred to, very specifically, when we look at the breakfast occasion, we have Kellogg's To Go, which is our drinkable breakfast proposition, which was new from last August. We also have Special K Nourish, which was our entry into cereal on single serve. We also have our health and wellness business, which is Special K protein, which is in a different section of the store that includes our protein bars, as well as our protein shakes. So that's sort of the composition of the Morning Foods business.

I'd like to turn now and spend a few minutes and talk about breakfast as an occasion. I have talked a lot and heard a lot of questions and discussions about breakfast and cereal on the roll. Interesting to know, that breakfast as an occasion continues to grow. It has grown every year for the last three years. The three year CAGR on this is 5%, and consumers recognize that breakfast is a key meal of the day. They understand the importance of getting a good start in the morning. They understand the importance of getting the appropriate nutrients in the morning. So when you look at cereal and breakfast, important to know that breakfast is not only a strong occasion, but a growing occasion.

However, when you look at that also, you also say breakfast is evolving, and the chart here, I will just take a moment to sort of walk you through this. This is some research which we undertook globally to say, how breakfast needs have been changing. Not just with cereal, but across the world. And so on one side of your screen, you see what we describe as the pre-breakfast routine, which could be anything from a quick cup of coffee, while you are going in the morning, to what we call the breakfast two step, which is later in the day, where depending on your schedule, you may be in your second meal, all prior to lunch.

So the point is, the traditional breakfast of sitting down, having something, taking that time, has completely evolved over the last several years, much like other occasions; and so we see breakfast occasion and eating opportunities over the course of the morning could be two, three and four items and in fact, you see just under two number of occasions in the morning, but three to four items being consumed, everything from a beverage to sitting down at work and eating something different. So the whole landscape of breakfast in the morning is growing and its evolving.

So at Kellogg's, across all of our businesses, we have a very-very strong breakfast portfolio. So not just cereal, although that's the majority of it, when you look at our Eggo business, very strong and growing business. Pop-Tarts, large consumption in the morning day part; our flat bread sandwich is amongst the others. So a very-very broad way to access breakfast as a mainstay [ph] through the Kellogg Company, through a number of different offerings. But clearly, cereal is a priority.

So lets talk a little bit about cereal for a minute. Lots of impacts upon the category over the last 12 to 24 months. Consumers broadly in the United States, and in fact, in many developed markets, are seeking protein. You are seeing the growth of Greek yogurt, you are seeing traditional protein sources in breakfast, such as eggs, breakfast sandwiches and breakfast meats growing. Breakfast meat consumption is growing, Greek yogurt consumption is growing. So that's an impact of the source of protein for breakfast in the morning.

The other is less milk in the household. So milk consumption is dropping, and milk consumption is also dropping in younger family households. So there is an opportunity again to look at that combination between milk consumption and cereal consumption.

And lastly, just expanded options which are available to consumers, which perhaps weren't available five, 10 years ago, a number of different options and variety convenient to meet those needs as we talked about, which are evolving between sun-up and lunch time.

The other term and thing that's really affecting the category overall, is this notion, which we talked about in the fourth quarter call, of unconscious migration. And this is this notion, that consumers don't necessarily realize they are eating cereal, but perhaps they are eating one less bowl a week, as an example. They are eating less cereal. The good news about that is, there is no specific one reason. So when we have conversations and say, what's going on with the cereal categories, one thing driving impact on the category? The answer is no, there is several things going on, and this comes back to an earlier comment about reminding consumers of the relevance of cereal, how it began, long-long time ago in terms of nutrition, simplicity, value, convenience, a great way to get nutrition into your family first thing in the morning, and a valuable proposition. So there is no specific drift, it's just that unconscious migration, which is going on, which we have a responsibility to reinforce the benefits of cereal.

However, across that, even though there is some of these impacts on cereal, when you look across cereal as a category over years, and this chart shows back to 2002, annual eatings per capita have not changed significantly. Its really a stable category, over in this case, 11 years. So you see consumption per capita in 2013 pretty much the same as 2002. There are some ups and downs and some impacts based on economic conditions and other factors, but largely, it’s a very-very stable category over time.

Additionally, cereal still has far-far more the number of servings into the home, relative to other breakfast items. So in this case you can see, cereal on the left, fruit, eggs, bread, hot cereal and grains as things that make up breakfast occasion, and cereal category is still two time the occasion of fruit. Cereal is still a very high penetration category over 90%, and as an example there, cereal has about three times the household penetration as a Greek yogurt does. So very-very high penetration product, already in the home, understood the benefits, is back to the relevance discussion, and we also know that the category responds extremely well to brand building, to innovation, to the benefits of nutrition, and of course, merchandising.

When you look at the demographics across cereal -- another factor to consider is two real groups, if you look to the left and the right. On the left side, you obviously have younger families and on the right side, you have the ageing boomers. So two key demographic areas that make up large segments of the population, that are core users of cereal. So we have a demographic that's in the favor of the category. We have penetration that's in the favor of the category, and we have a consumption opportunity, which is in favor of the category as well.

So what we realized, when we look at the evolution of the breakfast occasion and all the needs that are desired and the scale that cereal brings to that, as well as the household penetration, is we need to win in breakfast, and we are going to do that with cereal. Cereal still is the majority of that breakfast occasion.

So how are we going to do that? The Kellogg's approach and our model on the path to purchase is about Desire, Decide and Delight, and desire to the early discussion is very much about brand building, and looking at that opportunity to give consumers the relevance of cereal, the relevance of our brands, the needs they play in the life, in terms of positive nutrition and other messaging. Decide is more about in the cart. So that's in the in-store environment, scale events, promotional opportunities, providing good value, and providing consumers a destination, when they see that cereal purchase.

Then Delight is always about the food, always great food, and also loyalty programs that will encourage that behavior that we are seeing.

So let's spend a minute and talk a little bit about Desire. We have very large core brands at the Kellogg Company which you are aware of, the Special K's, Mini-Wheats, Frosted Flakes of the world. We will continue to support those brands with brand building efforts, at a very large scale.

The difference now, is when we talk about the Masterbrand and the opportunity to grow the category through Kellogg brands is activating Kellogg as a brand. So when you look at Kellogg as a brand versus a sub-brand, like a Special K or Mini-Wheats, Kellogg is a brand that's synonymous with U.S. consumers, as breakfast, it's synonymous as cereal.

We are also the number one U.S. food brand is ranked by Interbrand and CPG. Very powerful equity, the Kellogg brand. So we are going to activate some of our messaging to drive the category behind Kellogg as a brand, and a couple of ways we are going to do that. We are going to look at the benefits of nutrition as we talked about before, cereal and milk as a combination, which gives great nutrition into consumers, and also provides a very-very strong protein benefit. And then alternative consumption, the opportunity to consume cereal outside of the morning day part.

Benefits, a number of them. Again, that relevance and remining consumers that's important. The cereal category was developed over 100 years ago as a simple nutrition sway, to get a great meal in the morning; nutrient dense, low in fat, balanced, well balanced product, and also not rooted in one occasion, and we have talked about that 3% of the consumption is outside of the morning day part. About 10% of that is used for recipes. So it’s a simple and delicious way to get children the protein that they need; and when you think about that as an example, one bowl of Mini-Wheats, with a coupled low-fat milk, actually has more protein than Greek yogurt. These are the kinds of things that we need to make sure consumers understand the benefits of cereal as a category.

Want to take a minute and give you an example of Desire, really as a framework for brand building and how we drive at the Kellogg Company and many of you are familiar, that we are involved with the Olympics, the United States Olympic Committee, and this is a great example of taking a belief of starting and how you start and perform, consistent with our values of breakfast and the importance of strong nutrition, and driving that messaging, not only through brand building, but all the way through the line. So this is a program that has been activated mobily, it has been activated in the digital world from how we interact with our athletes on the United States Olympic Team, and also how we drive that messaging through , as an important part of nutrition, not only in performance, but also in your values and representing your country.

So let me show a couple of spots, so you can get a perspective of how we have activated the Olympics. If you could roll the spots please?

So a great example of how we activate a property, we look at the Desire. We look at that in the context of a great start and the benefits of breakfast, and we do that across our Masterbrand, as you saw with Kellogg's See You at Breakfast.

Another opportunity, our ability to be flexible and to get close to the consumer in a lot of different ways in non-traditional media, is always important as well in activating properties. This is an example of where we have the Untied States Olympics Team win several medals very-very quickly with the slopestyle ski team, and this was an example where we went from a victory, to a limited edition promotional package within 24 hours, and you can see the results of that. If you could play the video please?

So another example of activating that desire and doing that through the Masterbrand at Kellogg's. The second piece of the model is Decide or getting in the cart, and this is about scale events. And you can see a couple of examples here, where we take that Olympic property and we drive that through in store display, merchandising. We also look at opportunities to reward the consumer and help to make that decision in the store environment, through packaging as well, giving consumers a need to have the package, the way the want, which is flexible, and the example here is our Special K Nourish, worth a single serve container. It has very easy instructions to follow, and you can have the benefits of the hot cereal, with very-very positive nutrition and you can do that very quickly and conveniently. So that's what Decide is about.

Lastly Delight, always about great food. We always need to build food, that is consistent with what consumers want and have a nutritional benefit, and in addition to that, there is opportunities to rebuild that loyalties through our Kellogg family rewards program which has been very successful for us, as well as opportunities to provide value to the consumer, after they make the decision to purchase and to be part of the Kellogg brand.

Innovation, couple of examples here, very consistent with our conversation, the quality of food and delighting consumers. So Go-Lean Crunch, which is non-GMO project verified. We now have four of those products in the market. Bear Naked brand which was acquired a few years ago now, very-very positive granola, a segment of cereal which is continuing to grow. And in this case, Special K Chocolate Almond, which is all about giving consumers and weight managers different ways to access the benefit of weight management through a variety of foods, and in this case, almonds.

So moving on for a moment, I would be remiss if we didn't spend a couple of minutes on celebrating Pop-Tarts, which is 50 years old, which I understand so is CAGNY, so happy birthday to both. 50 years for Pop-Tarts, just an incredible brand. We will talk a little bit about that performance, but first, I'd like to also extend that direction of Olympic activation and brand building and desire as a phase, and how we have done that with Pop-Tarts. If you could roll the video please?

[Indiscernible] what you always wanted to see from a media opportunity and building that Desire phase is, doing that in context relevant environment. So of course, that commercial aired during the U.S. bobsled runs the other night, during the Olympics.

So Pop-Tarts, to summarize; over 32 years of growth, grew consumption last year, grew share last year, and continued to be very-very strong brand, and of course, we have innovation that launched this through the peanut better SKUs which are performing very-very well. So we feel good about the positioning of that brand and the direction of that brand, long term.

So just to summarize our future, as we talk about the category, and cereal very specifically. Breakfast has a need, [indiscernible] and an occasion of consumption in the morning is strong, and continuing to grow. At Kellogg's, we have a very well balanced portfolio as you saw earlier, from cereal to our frozen foods to offerings to our snack bars to a number of different ways to access breakfast through the Kellogg Company. That being said, we realized that cereal is the largest segment, and that's where we have to drive our growth, and we are going to do that through activating the Kellogg Masterbrand, and clearly making consumers understand the benefits of cereal, and how that's the best way to start your day, with the Kellogg breakfast. We are committed to the cereal category, we are committed to growing this category, and a large part of what Project K allows us to do, is to provide incremental investment, to continue to grow the cereal category, which we started over 100 years ago.

Thank you for your time. Ron Dissinger.

Ronald Dissinger

Thanks everyone. Thanks Michael and good morning everyone. So let me take you through a financial overview of our company. First, starting with our long term growth targets, and then our operating principles as well, and many of you are familiar with them, and I will turn to Project K, and help you understand how Project K may impact our quality of earnings over time, and we will touch on capital structure, returning cash to shareowners, and last, I will land on our 2014 guidance. By the way, our 2014 guidance, and what we will communicate today, very consistent with what we just told you on our fourth quarter earnings call.

So first, in terms of our long term targets; we are committed to our long term growth targets, and we have been able to demonstrate performance consistent with these targets over the last decade. We are taking the right actions, we are executing against our strategy, investing in our brands, with the goal to get back on to these long term targets, and sustainable growth over time.

We participate in great centers to our categories around the globe, that are very important to our consumers and to our customers as well. Our operating principles are foundational and fundamental to the way that we run and think about the business. Sustainable growth is about making sure that we are disciplined and cost of goods sold and driving productivity initiatives and in overhead as well. Project K is a great complement to these areas for us as well.

We do that right, we can invest back in our brands, and in innovation as well, to drive the top line and create a virtuous cycle of growth. Through effective tax cost management and interest cost management, we can grow our net earnings mid single digits. On working capital, we already have low levels of working capital as a percent of sales, and we are doing work now to further improve upon that; prioritize our capital expenditures, and we tend to work interest he 3% to 4% range on our capital spending, and we will come back to those levels in a couple of years after Project K.

Maintain our financial flexibility, manage our debt, put those two together, sustainable growth and manage for cash, we should be able to improve our return on invested capital over time.

Now let me turn to Project K, and what we communicated when we initiated the project on our third quarter call. Our financial expectations are very consistent with what we communicated there. About $1.2 billion to $1.4 billion pre-tax charges, with the non-cash component of that, essentially asset write-offs being in the range of $275 million to $325 million. We expect to invest capital -- over the next two years, 2014 and 2015, at an incremental 1% of sales. So think of that as around $300 million of cash associated with the initiative, and ultimately we will achieve a run-rate on a cash basis of $425 million to $475 million wroth of savings. Now when we launched the initiative, we communicated that we expected a solid 30% return on the initiative. So, good, strong return in terms of this project.

Project K has a number of initiatives under its umbrella, each of those, as we get prepared for execution, comes up for review, and what we make sure of it, is that we have a financial discipline and the operational execution to deliver the projects well, and we are pushing on that financial model all the time.

Now we have received a number of questions around the cash requirements for Project K. Top part of the chart shows you the cash investment requirements, [indiscernible] around $1.3 billion. The cash investments really are in three key buckets. First, the supply chain network of the future that we are creating, that includes a new capital, that I discussed. It also includes some equipment relocation from facilities we may be closing down to new facilities in the network, or to existing facilities in the network, and then we will start off that equipment as well. The cash requirements for this component of the initiative are in the range of $700 million to $800 million.

The next two areas, global business services, which as John mentioned is around our transaction processing, back office work, standardizing, simplifying and automating that work, and taking some of the work global as well, and then functional alignment about organizing our overhead infrastructure behind our strategy, and behind our operating model, winning in breakfast and winning in snacks as well. Those two components comprise essentially the remainder of the cash requirements.

Now, how will Project K impact our quality of earnings? Well first, about two thirds of the savings we expect to generate from the project, will come through cost of goods sold, driven by our supply chain initiatives, and we have made some announcements on things that we are already executing. We expect the savings to drive approximately 150 basis points of gross margin improvement after the four year period. So it provides just a good strong foundation to invest back in our brand an in innovation.

The remaining one third of the savings essentially comes through our overhead cost structure, and we expect that those savings will improve our percent to sales on overhead, or around 50 to 100 basis points. Now I'd point out that it does include the reinvestments that we tend to make on capability. We talked about some of those on the fourth quarter call and John referred to some. Some sales execution investment that we are making, I will talk later about some R&D investments that we are making, we created the global category teams, and there will be other investments that we will want to make to generate faster revenue growth.

So, we'd do well on those two components of managing our cost structure effectively, and then we will invest the money back in brand building and in innovation. First and foremost, in 2014, we will invest money behind our core developed cereal markets, to stabilize and return those businesses to growth. 2015 and beyond, we will invest to developing and emerging markets. I should point out, we already have $1.5 billion worth of base brand building investments across the entirety of our business. So we will work to make sure that that investment is as effective and efficient as possible as well.

In research and development, we put a satellite facility into India, so we are making some investment there. We also put some resources into our business in Russia. In addition to that, we are working on an initiative and have put resource behind design to value. Design-to-value is about increasing consumer preference for our products. Its about optimizing our food and our packaging and ensuring that that food and packaging delivers value to the consumer. I see really two key benefits that we can drive from that initiative; one, its faster revenue growth, because of the consumer preference increase. The second, is if there are items contained in our food or our packaging that don't add value to the consumer, there is an opportunity to remove that cost from our food or packaging. Quite frankly, we might put that back into the food and packaging to increase consumer value perception.

So, the efficiency we will see on our cost structure and cost of goods and in overhead. The investments we will make in brand building and in innovation and research and development area, should allow us to get back on our long term targets and grow our internal net sales 3% to 4%, with a good balance of price mix and volume growth as well. I would say also, we have a renewed focus on mix, particularly in our big developed markets, mix is an important part to driving revenue growth. An example of that is, in morning foods, we launched raisin brand with the Mega Three, has a much stronger margin than our base raisin brand product.

Now let's turn to the capital structure, and returning cash to shareowners. First, after we acquired Pringles, our debt, and this is total debt, increased to about $8.3 billion. At that time, we said we would pull back on our share repurchase program in 2012 and 2013 and pay down our debt. We did just that, and we reduced our debt by about $900 million.

At the time that we launched Project K, I communicated that potentially based on the cash requirements, we could see our debt levels increase by about $0.5 billion, but at the same time I also said, we were working on an accounts payable initiative. We are now executing that accounts payable initiative with supplier finance; and effectively what supplier financing does, is it allows you to extend your payment days with suppliers. But it does allow the suppliers access to cash to a third party, at a nominal cost of money, so they can get their cash sooner. So we believe this is a -- know, this will provide great benefits to our working capital, of about $200 million to $300 million and should reduce our debt level slightly, versus what we previously expected; and we won't stop there; there are other opportunities in working capital and driving cash flow that we will continue to pursue to manage our debt levels.

Now over the past six years, we have returned about $7 billion of cash to our shareowners, through our dividend and share repurchase program, and we recognize the importance to shareowners and getting cash back. We will continue on our dividend program to work in the 40% to 50% payout ratio. On share repurchases, we did communicate on the fourth quarter call, that we are going to resume our normal share repurchase activity, and we should reduce our average share count by about 1.5 to two points to 2014.

Next on our guidance for 2014, and again, very consistent with what we communicated. We are reaffirming, we expected gross sales of approximately 1%, underlying internal operating profit will be flat to up 2% EPS, up 1% to 3% and our cash flow will be in the range of $1 billion to $1.1 billion, including approximately $300 million to $400 million worth of incremental cash associated with Project K. so we have good underlying cash flow generation business, and that supplier financing initiative helps us to drive that improvement.

The other thing I would mention is, recall in the fourth quarter call, we talked about our expectations on the first quarter. We said that our sales can be down slightly, and operating profit would be down as well as a result of the trends we are seeing in some of our big developed businesses. We also said earnings per share would be in the range of $0.95 to $0.98, we still expect that delivery to be consistent with what we communicated on the fourth quarter call.

So, we are executing Project K, and we are making sure that we get the right operational execution and financial execution, to deliver the financial goals of the initiative. We generate strong cash flow, and we are returning that cash flow to our shareowners.

And last, as a company we are taking the right actions to get back on track. We are executing our strategy. We acquired Pringles, which gave us better scale in our international snacks business. We successfully integrated Pringles, a big complex integration for us. We have undertaken Project K as well, and we are taking the funds from that and reinvesting back first in our core developed cereal businesses, to stabilize those businesses and return them to growth.

With that, I will turn it over for questions. Thank you.

Question-and-Answer Session

Unidentified Analyst

Thanks very much. Good morning. John and Michael I guess, lathering up your positioning to a Masterbrand as you plan to do with the Kellogg brand. I guess, countering the risk of sort of deluding the direct sort of compelling communication right, that you are looking for of product benefits to specific consumers or specific targets, and a lot of companies have had I guess varying degrees of success with this kind of process. So how do you manage that, and how do you -- I know, it's not an either/or at the end of the day, but how do you sort of manage that, so you don't lose the direct messages of the key brands?

John Bryant

Just to be clear, we are keeping the brand level advertising in place in our U.S. cereal business and lathering on top, the Kellogg Masterbrand activation. That's why it’s the Project K savings going on top of the three existing brand building activity. Over time, we will see how that Masterbrand activity works, and then we can reshape the investment over time between brand specific and Masterbrand. But to move all of our money from brands to [indiscernible] Masterband and until that program is in market and demonstrating it has got attraction, will be too risky a step. That's how we are using the Project K savings to invest back in that part of our business.

Unidentified Analyst

Thank you. Good morning. Question to Michael; two issues here on cereal, first question is, does the U.S. business, has it had sustainable adequate funding in its advertising budget, in your judgment? There is a lot of talk here about the Masterbrand, but there has also been prior talk about potentially reduced advertising within the category, specifically asking Kellogg if it has had, what it deems adequate dollars within advertising for U.S. cereal? And then second question is, how do you think about the impact of your new product innovation in 2014? John specifically cited a lack of effective innovation as one of the culprits of this cereal slowdown, so how do you see that innovation progressing in 2014?

Michael Allen

Thank you for the question David. I would suggest that we have had adequate dollars in terms of brand building support for our business for many years. We have long been committed to brand building at the Kellogg Company. I think, when you look at over time, it's pretty consistent. I think the challenge is always to get the right ideas all the time against those dollars, because at the end of the day, that will drive whether its an effective program or not. So getting great ideas against the funding is always the important part, and we have a renewed effort in doing that through the entire organization.

With respect to innovation, I believe our innovation program is strong and robust. What I would also say is, its very difficult to have strong innovation when your core is not necessarily strong. Its always best to launch an innovation off a strong brand, and a brand that is growing. So we will continue to have a robust innovation program, but job number one, is to have a strong core cereal franchise to leverage off of that.

Unidentified Analyst

Thank you. You mentioned reinvesting back in brand building. You talked about the umbrella advertising as being one big chunk. I'd imagine there is other chunks between the three different stages of engagement with the consumer. Could you maybe add some -- a little bit more detail about where that investment will be? And then also, the benefits that you mentioned a lot of benefits with cereal, which ones do you think will play nicely into your portfolio? Thank you.

John Bryant

We haven't spoken that way, that reinvestment will go beyond 2014. In 2014, we have same priority, number one, is some of that deep core businesses that we want to stabilize and return to growth. So on the Desire front in U.S. cereal, the U.K., those sorts of markets, we are investing back in advertising. As I said earlier, we are investing back in the direct store delivery system for U.S. snacks, and we are selectively investing back into specific food.

I don't want go into too much depth into exactly where we are investing, for obvious commercial reasons, but we are investing back, where we believe the opportunity is going to give us the greatest possible return.

Unidentified Analyst

Thank you. I guess, it has been a tough half decade at least for the company, so you are pushing this project and the cost savings, but what I didn't hear John, was kind of where -- in four or five years on the tail end of this project, how big will snacks be as a percentage of the portfolio? You said in the past, that margins on snacks can, on occasion though, maybe this is before Pringles, have been equal to, if not better than ready-to-eat. Will that be enhanced by the project? So I want a little more, if possible, detail on kind of what this company is going to look like on the back end, in terms of like sales and profit break down beyond the capital structure?

John Bryant

Eric, there is a lot in that question. Our intent would be to get our [indiscernible] businesses back to low single digit growth. We think our U.S. snack business can grow at a similar sort of rate, may be a little bit faster. Our international snacks business, we think we can grow low to mid single digits. So I wouldn't see if we are doing that, a big shift in the portfolio at the time. If you look at what has happened over the last 14-15 years, we have basically grown our big snacks platform as a company, partially through acquisition, and we keep looking at whether acquisitions make sense, as we go forward as well.

So I think as you look at our business, we are looking to continue to drive that; cereal business, low single digits; snacks business, maybe a little bit faster. Continued growth in frozen, continue to expand the emerging markets as well. So I wouldn't see the portfolio changing dramatically. Our goal is to get back on a sustainable growth model. It works incredibly well, it's a virtuous cycle. We believe Project K gives us the catalyst impetus to get there, along with Pringles. We are definitely making progress to get back on that model.

Unidentified Analyst

Okay. We are going to have to end it there. Thank you very much to Kellogg for breakfast.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Kellogg Company's CEO Presents at 2014 CAGNY Presentation (Transcript)

Check out Seeking Alpha’s new Earnings Center »

This Transcript
All Transcripts