MANAGEMENT DISCUSSION SECTION

Transcription

1 Sanford Bernstein Strategic Company Participants MANAGEMENT DISCUSSION SECTION All right, good morning, everyone. Wanted to introduce to you Dave Mackay, the CEO of the Kellogg Company. Dave, thanks ever so much for joining me this morning. We're going to be doing a fireside chat format. And as we get started here, I wanted to start with some broader industry questions before we jump into Kellogg's specifically. And as I was thinking about how to kick things off, I realize that you're wearing two hats these days. We know you as the CEO of the Kellogg Company, but more recently you've become the CEO of the Healthy Weight Commitment Foundation. And as I think about what's going on in the industry today, I'd like to ask you what role the industry has to play in childhood obesity and general health trends here in the U.S., and are there models in place in Europe that could be adopted here in the U.S.? Yes, good morning, everyone. Thanks, Alexia. And I think I'm actually Chairman of the Healthy Weight Commitment Foundation. So it's a non-paying role, just to be clear. I think as we look at what's going on in Europe, I think, they have a stronger pre-disposition towards regulation. I think in the U.S. the food companies have taken a very proactive role in saying we believe that childhood obesity is a big concern for us. We're all parents, grandparents, we work in an industry where we can make a difference, and a number of the companies all of the companies who are part of the Healthy Weight Commitment Foundation have made commitments to lower calories, a fairly significant number. And I think as we have talked about the issue, it comes down to an energy balance: calories in, calories out. So it's not just that kids are eating too much today because they are eating a little bit more, but if you go back over the last 30 years, caloric intake amongst kids is only up 6%, which is about 100 calories. That can still put weight on, but today kids are leading very, very sedentary lifestyles. So I think the First Lady's initiative Let's Move, which really just by its name indicates that we've got to get our kids today going and leading healthier lifestyles and moving is great. I think the industry wants to be an active and positive part of helping fight the issue, bringing healthier choices to the table, working on things like communication at the front of pack. And I think what the Healthy Weight Commitment Foundation is doing is hopefully going to generate more activity across the broader food and beverage industry. Just moving on to another industry theme here, a number of investors and indeed a lot of the manufacturing companies are saying that the time is right for consolidation in the food sector. We've seen it in other sectors that the food industry in the U.S. is still pretty fragmented. We've got a situation now where we've got improving cash flows, relatively cheap financing, the importance of negotiating leverage with retailers seems to paramount, and yet we don't really see that much activity. What do you think is going on there and do you anticipate that there could be further consolidation in the sector? Page 1 of 16

2 From Kellogg's perspective we're very, very happy with our portfolio. As we look at it, clearly with financing the way it is, the opportunity to make bolt-ons for us in the snacks or cereal remain good. We'd have to say that prices are a little depressed, so that may be causing some potential smaller companies that could be acquired to resist that. But I think it probably is a good time to buy and we're looking actively at what we might be able to add. And I think you may see more consolidation as we go through the balance of this year and next but very hard to know. As you think about the sort of you mentioned bolt-on as being something that you're considering. Is there particular regions or particular categories that you're looking at more closely? Well, really it's focused on cereal and snacks. That makes up over 90% of our portfolio, so and we think one of our key strategic strengths is the fact that we've got a very concentrated portfolio. We're looking everywhere in the world and if the right opportunity comes up, clearly we'd be very interested. But in the cereal space there just aren't that many opportunities. There are more in snacks, but we're going to be highly selective in that area too, so it's more global but we'll just see what opportunities might arise. Okay. Let's talk a little bit about Kellogg's specifically. As I think about what you've been focused on over the last few years, recently it seems as though the focus has been a bit more renovation, reformulating existing products rather than bringing brand new products to the market because the economy has been tough, and it looks as though new products as a percent of sales introduced in the last three years have tapered away a little bit from the 15% that you target. What do you see as the biggest broad area of focus for innovation either by product category, consumer segment, region and so on? Yeah. I think the focus has moved a little probably in the last 12 months, particularly when we look at cereal and U.S.cereal. And we'd admit that our innovation in U.S cereal certainly if we look at the first quarter this year, we got I think it was about 7/10's of a share from new products this year. We got 1.3 in the first quarter of a year ago. So that's a 6/10's reduction or delta. We've got good innovation coming in the back half. But really as you look at renovation, reduction of negatives, addition of positives, we think it was absolutely the right thing to do. It will play out well for the portfolio over the long-term. If you think about the trends on health and wellness, the focus on things like obesity, people really trying to balance their diets and have healthier choices, we think our innovation has actually put us in a good position in that regard. And as we go forward, I think, innovation stays a very critical and important part of what we do as a company. You'll see more, I think, innovation. So it was more wasn't a lull if you like, a bit more focus on getting some of the renovation we thought was important done. Adding fiber to kids' cereals I think is going to be over the long-term a big plus for us. 90% of adults and kids in the U.S. don't get enough fiber in their diets, and to be quite frank, a lot of whole grains don't contain much fiber, if any at all. So I think those things are going to work well for us, not that we're seeing or expecting a massive boost in the short-term. And I think you will see FiberPlus cereal launching in June. We've got a lot of great snacks innovation. So I Page 2 of 16

3 think we're pretty comfortable about where we are on innovation and renovation. Okay. Great. I seem to remember two or three years ago there was a shift into a model of much more open innovation and using many more external sources, universities, academics and other sources for ideas for renovation. How important has that move really been to shaping your innovation pipeline and can you give any examples? Yeah. I think when we look at open innovation, and it's becoming a lot more important I think across the food and beverage industry, for us we're very strong on development. We're not as strong on the research. And actually working with the universities and some of our key suppliers to have them augment our research side is actually showing a lot of promise. Now, a lot of it is going to come more in the future. Probably the best example of where we did that in the past was when we had the issue going back two or three years with trans fatty acids. And we worked with Monsanto and then ultimately Bunge who processed what was a new soy bean variety, low linoleic soya bean oil, which meant we could get rid of trans fats in our cookies and crackers. That was very collaborative and I think that was probably the best example in the past. As we go forward, I think there a lot of opportunities and ideas we're working on where strategic partners, universities and other institutions are part of what we do as an organization. And now I think that is a much bigger area for us than it was probably two years ago. There seems to be a lot of shifting going on in terms of advertising strategy across the industry, and people are kind of scratching their heads about whether spending is going up, down or sideways and what that means for gross rating point? Could you talk a little bit about how your advertising spending has changed over time, particularly with respect to TV versus digital, and how you expect that to play out over the next five, 10 years? There's some question that maybe if everything goes towards the digital, maybe you won't be able to spend as much as you are now and we'll actually see some advertising percentage of sales decline potentially. Yeah, and let's make sure that the first quarter where we actually saw advertising decline was a bit of an anomaly and our expectation is we'll grow advertising for the year. So putting that to one side, I think if you look at our current spend, globally we're broadly just under 80% TV, 10% digital and 10% other. If you think about what's going on in the digital space, we would expect that that level of expenditure in the next five years will probably at least double, more likely at the expense of a little bit of TV and a little bit of the other. And it's very hard to predict what's going to happen on the cost base. Ideally, whatever the right mix of media is, if it lends to getting more impressions at a cheaper price, then absolutely that would be a great thing from our perspective because, if anything, our advertising expenditure mightn't go up much but we may actually be getting a much better value for the impressions we're delivering. But that's very hard to sort of predict at this point. But I do agree. The media landscape is changing. TV is still going to be a critical part as we look over the next five, 10 years, but digital and use of digital I think is going to increase each year as we go forward. Page 3 of 16

4 Right. If we start moving on to the promotional activity, which is a big source of conversation right now given the certain things going on at certain retailers, some retailers ended up cleaning up their stores a little bit in 2009 and there was a lot of commentary about what that would do to promotion-intensive categories, such as cereals as that promotional opportunity kind of disappeared. Did you see a hit from this? We've noticed that maybe the organic sales growth in U.S. cereals has slowed down a bit. Was that part of that story and is that coming back now, I guess, as some of those opportunities return? Yeah. I think the SKU rationalization across a number of our retail partners varied. Some took a very aggressive and fairly dramatic approach, others just tweaked at the edges. So it did vary across account. Cereal, really it was more about sizes. Some brands have three, four sizes, so they might have taken a size or two out. But the absolute space in cereal stayed pretty much the same. So you didn't see a degradation space. They were looking to actually re-allocate to reduce out-of-stocks by getting more inventory on shelf of the fast-selling SKUs. That was the primary driver in cereal. And the only other thing in cereal on a promotional side that you've seen is the shopping patterns in the U.S. have changed in the last 12, 8 months. You're seeing a lot more of the volume sold through the retail outlets in the first two weeks. It was always that way, but it's just skewed even more so. So if you looked at it today versus a year ago, there's a good double-digit increase in the first two week's percentage of the monthly shop than there was a year ago. So the impact that has of course from a retailer and a manufacturer perspective, you get a lot of overlap. Everyone wants to be in those first two weeks so you see more of the concentration of promotions. So where before we probably had a better chance of spreading things out, so you didn't have the competitive intensity and lower lifts from the level of promotions, today that's actually not working as well for any of us, for us, for our retail partners. On SKU adds, probably the biggest impact we saw was in cookies. Cookies probably we did see space go down. And that probably had a pretty negative impact on our business and probably on a few others. Crackers stayed fairly stable, and wholesome snacks I think shelf space went up, but they don't get that much merchandising. So it depends as you look across the mix of our portfolio. But certainly I think you're now seeing some retailers who took a much more aggressive approach recognizing that they may have dis-enfranchised some of their consumer base and they're bringing some of those SKUs back. Some who started de-prioritize promotions on some of the categories, particularly cookies and a reduction in crackers, are starting to get a little bit more positive on merchandising those. So, yeah, there's been a real sort of swing, a lot of movement, which for manufacturers isn't good, and ultimately I don't think for retailers ends up being that good either. One of the things that's actually come up this week has been very much around pricing and promotional activity, and which I know we started to touch on here. What are you seeing in terms of push back from the larger retailers on your own pricing because we're looking at measured channels and we're seeing consumer prices dip down quite alarmingly? And the assumption is it's all been pushed backed on the manufacturers and we're going to see margins compressed as commodity costs come up. Yeah. I think if you look at and we went through this a little bit in the Q1 call as we talked about Q1 and the performance and our expectation that Q2 would be tough. We started to see that in Q1 and it's clearly flowed through into Q2. And what you've got is a combination of factors. I think in a Kellogg-like cereal, it's always very, very competitive. I think it's still rational, but you've got a combination of factors. Post was out of the market because they were going Page 4 of 16

5 through the integration, are back and back very, very aggressively. And then all of the cereal players, ourselves, Mills, Quaker and Post, are all promoting. We have seen commodities come down. All of us are putting a little bit back in there I think because consumers are under pressure. You've got retailers actually potentially exacerbating that by wanting to draw traffic into the stores, and they're using cereal, which actually typically builds the basket, as a key way to draw consumers in. You've got the phenomenon of the concentration in the month with promotions coming into effect. All of which has led to a level of deflation that probably is going to go on for another three plus months. And then ultimately over the medium to long-term is not sustainable for any of us. I think everyone recognizes that it's a quite unusual phenomenon that we're seeing and one that we're seeing not only in our own categories, but we look at RI data, it's fairly common across a lot of categories. So the way we look at it is, okay, it's not a great thing, we think it's more short term. We're still making money because we've got great visibility in our cost savings, our commodity inflation isn't as high as it had been. But not a sustainable sort of environment and one which ultimately I think most of the manufacturers and the retailers will recognize is not helping any of us. Right. If we move on to commodities at this point how do you see grain prices playing out as we look out through 2011? I can give you a much clearer view on 2010, 2011's so far out. We will have a good sense of 2011 when we do our Q3 conference call because the way we look at 2011, and we're on a calendar year, so come Q3, so the end of October, November, we'll have concluded our 2011 budgets. We'll have a view as to what we think our key commodities will be. And if those commodities we can hedge at that point, at that level or below, then we'll hedge them. As I look out to 2011 I think commodity prices have come back a long way, although if you look at historical norms they're not that low. In fact, corn is higher than historical norms by a big margin. There seems to be plenty of availability. I think the level of speculation has moderated because you're not seeing the huge windfalls that some of the speculators were making. So I think on the basis of where prices are today, our view would be modest inflation for 2011, but the fundamentals are pretty good from our perspective, such that we don't think there'll be any run away. Now, all of that's caveated with weather conditions and all that sort of stuff. So I think next year we'll see inflation, but we don't think it will be huge. It will just be modest. Right. We've talked a lot about grains I guess over the last two or three years because of the commodity spike. Are there other inputs that we should be keeping an eye on and how do you source those? Yeah. I think probably the most volatile as we look at it today will be packaging. What you've seen in the packaging space is a huge amount of consolidation and rationalization to the point where they have closed enough plants such that capacity and supply and demand are pretty well balanced. So that means that if there is a big growth or surge then you could see inflationary pressures come in packaging. And then transportation and energy, clearly the volatility in energy -and transportation went through a huge period of inflation. It's moderated as the economy really slowed down. If there's a pick-up in the economy you could see transportation and energy prices also become quite volatile. So I think you're going to see more skewing up and down in those two spaces than probably basic food input costs. Page 5 of 16

6 Do you pass that straight on to customers or is there hedging in there that would smooth that out or is it? A lot of those things are very hard for us to hedge. Packaging, we will sometimes do contracts with suppliers on a medium to long-term basis, so that gives us some protection. But energy costs are pretty difficult and transportation pretty much moves with supply. Okay. One of the big things that's driving, I guess, the margin recovery right now is your $1 billion plus program on productivity. Could you talk a little bit about the biggest chunks, so what you're seeing in there in terms of what's giving you the biggest benefit in there? Yeah, I think the billion plus, we said in Q1 we're very comfortable with that. We've got great visibility. We're in year 2. As you look at it, the Lean process in our manufacturing areas probably makes up close to 40% of the returns. And then the next biggest one is the indirect procurement we call it internally Project Silver, where we've taken a lot of the things that we weren't buying through the purchasing group, consolidated those and actually gone back and negotiated better contracts on those things. And that particular indirect procurement initiative is going to save us probably in excess of $150 million. So over 10% of that billion plus will come through the indirect procurements. So those two probably make up half. Great. And just coming back to the retailer dynamic because it's such an important topic right now. You mentioned earlier that you expect that there'll be a correction in promotional intensity three to six months out. What actually causes that to happen, I mean, or gives you the confidence that we won't return to the very competitive dynamics that we had in 1990s in cereal? Yeah, I think while there's a little more promotion going on, I think, the category still remains rational. I mean, it's like everyone's doing a bit more, it's not like and Post is doing a bit more than everyone else, but a year ago they weren't doing that much. So if you balance that out there's a bit more in the short-term, but remember that most of us have got cost saving initiatives, we've seen costs come down a little bit even though they're up versus last year and a little bit more is going back from most manufacturers because of the consumer environment. I think the tougher one is the retailers because at the moment what they are seeing is areas of deflation across their store, they're selling more volume, they'll probably have lower rings so the dollars going through the till aren't as high and their costs are going up. And they're not buying as directly as we are, so they're not seeing some of the cost savings initiatives. So for us our attitude has been how do we work more closely with our retail partners to try and reduce costs wherever we can, facilitate lower inventories et cetera because ultimately that's going to help them and that's going to help us. Page 6 of 16

7 I think as category captain, a lot of times, we'll go in and we'll talk to retailers about the dynamics in the market and what those dynamics are actually doing to all of us. And I think you'll see that in three to six months though I do think you'll see a more rational, balanced approach to how they manage the business because what's going on in the current environment isn't sustainable, particularly for our retail partners. You mentioned the role of category captain and I think conceptually we all understand what that badge means, but in cereals you've got two players that are fairly similar in size. Is there a material difference in the role that a category captain would play versus a lieutenant or is it? It's a little different. I think the category captain is appointed by the retailers, so they become by default a slightly closer strategic partner and the demands on a category captain are a little bit higher. But in a category like cereal where if we're the category captain and Mills is a close number two, they have a very strong voice at the table, they'll be giving their perspectives, those perspectives will be listened to. And the process is supposed to be rational. So if you're a category captain and all you're trying to do is benefit yourself at the expense of the category, you won't be category captain for long. So you are supposed to take a more strategic, independent view of what's right for that retail partner and managing that category so you can grow it. Okay. Actually sticking with your portfolio versus key competitors here, it seems as though Kellogg's portfolio has a number of different brands that are targeting specific health needs individually whereas your key competitor had one very, very large brand and a number of others, but that brand seems to cut across a number of different health benefits. As you think about that difference in the portfolio, how's that played out during the recession, has there been a difference? And if you think about future product launches and emerging consumer needs, would you plan to launch new brands or would you always sort of tuck those new needs within the existing brand portfolio that you have? Yeah. I think if you look at Cheerios in a down economy when consumers are really trying to watch every penny they spend, the size of the brand and the breadth of its appeal means that it has a great utility value. So more people in the household are going to eat it so it's probably going to do better in this sort of an environment by default. Having said that, as you look at the long-term, the demographics in most of the major cereal markets favor an adult portfolio and specific, I think, targeting of needs to adult consumers because we are going to see a greater proportion of growth come in the U.S. and Canada, Australia, the UK from that aging of the consumer base. So we think our portfolio over the long-term is extremely well placed. As far as new brands versus doing it under existing brands, clearly you have a synergy and a cost effect benefit if you can tuck it under an existing brand. But if doesn't fit well and you try and tuck something under there with a specific need you're trying to address, you potentially doom it to failure. So FiberPlus is a good example. We launched the bars a year ago. It's been a huge success. We launched the cereal June this year. We think it will do extremely well. And that one's we pushed All Bran for a couple of years. All Bran is probably the best fiber alternative in the market. It's wheat bran based which is clinically proved as the most efficacious form of fiber you can get. So FiberPlus is a better tasting form of fiber. It just doesn't deliver quite the same dietary benefit that you would get from a wheat brand-based cereal, but consumers are trading off some of the help Page 7 of 16

8 benefits for some of the taste benefits. Okay. I understand that one of the larger retailers has been approaching suppliers with a view to taking over the distribution functions this was an article I think came out a couple of weeks ago. It's something that's come up from time to time in the industry. I think there was a concern about that about three or four years ago. For the larger players with DSD systems, as you have, is that a concern? I mean is that playing out? It seems as though it's actually happening, but how are they doing that? You'd probably have to talk to whichever retailer you're mentioning and ask them specifically, but I think our approach when we have requests for collaboration on things like logistics, we always embrace it. If there's a better way, there's a lower cost way, if there's a benefit to be had that one party can get that doesn't disadvantage the other, then we remain very open to that. And I think that's true for most manufacturers. We have a lot of our customers today actually they have freight collect. So they'll pick up from our warehouses. Because they have trucks going out, dropping at their stores, coming back empty, they can pick from our warehouse and actually fill that truck, they get a benefit and we pass on what it would have cost us normally to get that delivery to them and they end up winning and it really doesn't negatively impact us at all. So that's a win-win. And there are number of examples of those types of things going on across the industry today. They vary by retailer, they vary by supplier. But in general terms I think if the request from a customer is one where it's cost neutral and they see a benefit and it doesn't impact on customer service, then we'd work effectively with whoever it was to try and work that through. So you're not worried about operational de-leveraging as this plays out on your DSD system? I don't think there's an effective way that you could see a customer do it from a DSD perspective. But if someone came to us on DSD with an idea, as I said, we'd talk to them. But I think DSD is so specific and the benefit to the retailer of DSD is most of the costs are borne by the manufacturers, so I can't imagine why a retailer would want to take on what is a relatively high-cost logistics distribution method. Okay. As you look at your different product categories, cereal, cookies, crackers, wholesome snacks, and the breakfast area, could you talk a little bit about how retailing strategies differ? What characterizes each of those different categories in terms of how you go to market in them? Yeah. I think if you look at cereal, it is a category that typically has been proven to if someone's buying cereal in a particular retailer, they typically have a higher shop, a bigger basket size. So we'd say a traffic builder for the retailer. Page 8 of 16

9 So it gets normally a little bit more merchandising, a little bit more promotion than most of the segments in which we compete. Crackers and cookies typically are displayed or quite often displayed together. Normally you'll see a higher discount on those because the frequency of display isn't as high as in cereals, so when they're on, the retailer is looking to give a better deal. And then wholesome snacks is not merchandised that heavily but gets good shelf space. So does that get at your question? I think it Yeah. Alexia Howard, It's getting at. I was trying yes. I guess so cereals is the most marketing promotion-intensive category and maybe. Yes. There's more display probably in the cereal category than any of the other categories in which we compete in. Frozen, because of the cost of the freezer space, it's very difficult to get mass displays on frozen. Even though the end cabinets can be used, that's much tougher. Okay. Sticking with the cereal category, it seems as though there's concerns now that the category growth has slowed down a bit. This time last year it was humming along quite nicely and now we seem to have hit a bit of a dry spell. Are there opportunities to continue to grow the market here in the U.S. and is it going to be mainly in the adult versus the kids' segment? How do you see that playing out? Yeah, I think firstly when you look at the first quarter and what we said in the first quarter about our view on the second quarter and having a stronger back half versus the first half, that's based on looking at how did the category do a year ago. What are the comps? You remember last year, in the U.S., for example, I think the cereal category grew, call it, round 7 it was between six and 8. So it was probably around 7%. Typically our expectation would be a category growth of two or 3% on an on-going basis. So the first quarter of this year was broadly flat might have been down a little bit, but let's call it broadly flat. So if you balance the two years out, it was probably slightly above the growth. Second quarter wasn't a bad quarter year ago. With what we saw in the first quarter and our expectation of how tough the second quarter was going to be because of the promotional dynamics and what was going on with some of our retail partners, our expectation is you're seeing some deflation. So second quarter is going to be a tough quarter. But if you think about the category on a long-term basis, the demographic trends are very, very positive. Consumption is going to continue, while population growth is probably relatively modest. In most of the developed markets it's still growing a little bit in the U.S. The Hispanic consumer is probably going to be one of the bigger areas of opportunity Page 9 of 16

10 because that population is actually growing quite rapidly. An older consumer is typically a big consumers of cereal. So as we see the aging of the population, that's going to give a boost to the cereal category. Kids is probably a slightly more intensive promotional area because the variety seekers and people are looking for value there. But I think demographics is going to help the category. I think long-term you're going to see health and wellness continue to play a positive role in the cereal category and cereal category growth. And clearly innovation and bringing the relevant innovation to market remains a pretty critical component for us. Okay. The Hispanic group seems to be a really big opportunity here in the U.S. market, which is unusual. Do you think the cereal category is doing enough to target that group, and how do you feel you're doing versus some of your competitors? Yeah. I think yeah, you look at Hispanics, it's a very big group, it's growing. We think there's a real opportunity there for us. I'd have to say that we've probably in the last couple of years haven't been doing as much as we should. We're going to redress that, probably, focus and lack of investment in the second half of the year. And we think we can pretty quickly re-build anything we might have lost in the last couple of years because of, in my view, not adequate investment in the Hispanic market. Particularly when you think of the influence of Mexican Hispanics, our share in Mexico is over 70. They're very familiar with our products. I think for that reason we may have just assumed that we didn't need to directly communicate and influence them in the U.S. and we're making sure that as we go forward we more specifically communicate with them and re-build a stronger presence with them as we go forward. Because I think if you look at the population trends, I think can't remember the data specifically, but certainly Hispanics are going to be a bigger percentage of the population in five years than they are today. Great. As you think about the portfolio as a whole, there's been some commentary that investors spend too much time thinking about the U.S. cereal category and not actually looking at the growth opportunities that Kellogg has in other categories, other markets. How do you think about that? Is there an over-focus in the investment community on the cereal? Well, there's no question. I mean, it's sort of like if we have a bad cereal quarter in the U.S., it's like the company is about to collapse. If you look at the U.S. cereal category and by default, I said earlier, our innovation is not where we'd like it to be, and there are some short-term issues impacting on the category, but it's 25% of our business. U.S. snacks is 30% of our business. We get a 5:1 ratio of questions on U.S. cereal versus U.S. snacks. In the first quarter I think our share was flat to down one point or something. We grew three points in Pop-Tarts, we grew three points of share in wholesome snacks, we grew in cookies and we held share in crackers. I'm not sure I even got a question on any of those, so. But I think there's a presumption that it's a zero-sum game if Kellogg loses, Mills wins, if Mills wins, Kellogg loses. And in reality I think both of us are looking at it and saying the way we grow our business and make the category healthy is through innovation and communicating to consumers. Both of us can do that effectively and appropriately. Page 10 of 16

11 Both of us can still garner reasonable growth. And a disproportionate amount of our growth is going to continue to come from snacks and from some other markets around the world. But I don't think that's going to change. I mean me saying that's not going to change and people are still critically interested in the cereal category in the U.S. and I think that's just a fact of life. Okay. Let's talk about frozen then. I guess you've gone into Kashi frozen entrées recently. How is that going? Do you see that as a major new platform, or is it really getting too far away from your core on the snacking side? It's done very well. When you look at the Kashi entrées, the great thing is they are very consistent with the brand, natural, very healthy relative to some of the other entrées you get. They don't compete with the mainstream entrées clearly that typically are sold very heavily on discount. So when you look at the Kashi frozen entrées, they compete more with Amy's than anything. They have drawn new consumers into the Kashi franchise. They're not going to be a massive part of the portfolio. We've been spending a little bit of time ensuring that the margin and return from those products is where we want it to be, and we're getting close to getting them there. But I think they'll be a positive, small but healthy part of Kashi as we go forward. Sticking with the frozen side, there's obviously going to be Eggo waffle plant disruption that's hit over the last year or so. I don't know whether I'll get an answer for this, but a lot of people are curious about it. That second plant that didn't come back to life again, what exactly happened there? Are there more details that you can give us? So I think they call it self-inflicted wounds. We took Rossville which is our biggest plant it's half of our network down and we're doing massive restorations on all sorts of parts of it. A good, sensible work to do. When we tried to bring the plant back up, we'd inflicted a bit more damage on ourselves than we had ever intended, and it took us a long time to actually rectify and fix those. So that plant is now getting back to where close to where it was six to nine months ago. So, you just go, well, sometimes bad things happen. It's unfortunate when it's sort of a little bit self-inflected. But that's life. We said in the first quarter Eggo was going to be a drag in the second quarter. But we have started to promote a little bit. Our customer service levels are back to a level where I think our retail partners are happy and hopefully as we head into the back half we won't see that being a drag on our top line as we go forward. But over and above that what it has taught us is we were probably running a little bit tight on capacity. So if anything went wrong, we had nowhere to go. So we are planning to look at the potential to add more capacity as we head towards the end of this year and next year. Great. On a brighter note, Bear Naked, can that become the new Kashi having seen Kashi sky rocket the way that it has? Page 11 of 16

12 We wish. I think Bare Naked's about a half a share, so I think it can continue to grow and be positive. It targets a slightly younger consumer than the Kashi franchise, and we think it's got real prospects for growth as we go forward. But we wouldn't assume it will be the next Kashi. We just think it will be a very positive part of our portfolio. I think you mentioned just sticking with some commentary from the first quarter, but you did mention that inventory is likely to be a bit of a headwind or inventories reductions are likely to be a bit of a headwind in the second and third quarters. How are you beginning to see that play out? Is it likely to impact you significantly or what are you seeing? Yeah. I think well, we'll give greater clarity when we complete Q2. But as we said in Q1, inventories in the U.S. we were expecting in cereal to come down. Our desire and hope would be we can pull them down in Q2, but given the timing of the end of the quarter and some of the new product launches, we'll have to see how good a job we can do in that. And then we had a situation in the UK where we had a lot of promotion starting the beginning of Q2. Our inventories at the end of Q1 in the UK were actually higher than we'd like, so it flattered our growth in Europe. And that's why we said in the Q1 call, if we looked at our Q2, we think it's going to be a very tough quarter because you've got those potential inventory issues, you've got the issues of a more intense competitive environment across a number of our categories, you've got some of the retail issues playing out. But what we also said in first quarter was with that expectation we're still comfortable with our 11 to 13% EPS, mainly because we've got great visibility on cost savings, there's great momentum there. So in the short-term we could have some challenges and just weather them and get on with life. If you think about the longer term, emerging markets, and particularly Latin America, how important is that area in your expansion plans over the long-term, or is it more we want to build in France and Italy, sort of developed markets where? Latin America's probably I mean, it's interesting when you look at the world, the U.S. and Europe are not where any of us would like them to be. Latin America is doing pretty well. Venezuela's got it's challenges, but apart from that, Latin America is doing pretty well and Asia Pacific is doing well. So I think Latin America for us continues to be a strong area for growth. Mexico's our biggest market there; most of the other markets per capita consumption is low. We have opportunities with adult consumption. So we'd see Latin America continuing to be a strong growth platform. If you look at the rest of our business, we have six markets make up 90% of our sales: the U.S., Canada, Australia, the UK, Mexico and France. So if you take those other markets, we have to grow those markets in the cereal category. And you take one market like France, the big opportunity there is adult consumption. While kids eat a lot of cereal in France, adults don't eat a lot of cereal. We haven't done the sort of job we believe we need to do and can do in getting adult consumption in a market like France. So that remains a real opportunity as does per capita consumptions in markets like Italy and Spain long-term because in the short term, I think, when you look at Europe, Spain's clearly struggling with unemployment above 20%, Italy's Page 12 of 16

13 struggling not as much. But I think in the short-term our expectations out of markets like Europe are going to be relatively modest. I'm going to run through some of the questions from the audience here and then we'll come back to some broader ones right at the end. On the consumer dynamics that you're seeing today and retailer dynamics that you're seeing today, are you seeing any acceleration in consumer discretionary spending? And on the retailer side, is Wal-Mart, the rollbacks that they're doing over there, are they taking a lot more share and pressuring measured channels substantially? So consumers and retailers. I think from our perspective the consumer dynamics are a lot harder to assess. I think if you look at other categories, car sales are up and all of these other things. Food and bev really is not discretionary. So while we didn't see, if anything, we saw a bit of an up tick last year as people ate more at home and there was more conservatism about out-of-home expenditure. This year we're not seeing as consumers potentially come back that much benefit. If anything, if out-of-home consumption goes up just marginally, which I think it is through incremental promotions, it's not going to help us. I don't think it will hurt us. My view on the consumer is that until unemployment drops, there is a high degree of concern about levels of debt and people are going to be very, very careful. People have looked at it and talked about have we entered a new age of thrift, are consumers going to be frugal now going forward? And I think potentially that's absolutely right. People are much more careful about what they're spending. Coupon redemptions and usage has gone up dramatically in the last 12 months and people have a greater propensity to shop on deal and buy on promotion. So all of those factors in the near-term are going to stay with us and probably in the near term for at least the next year or so. As far as talking about any particular retailer, you'd have to go direct and talk to them. We'd not like to comment on it. It's a competitive market out there, and we are probably seeing retailers struggling, and as I said earlier, we're going to help them in any way we can because if they can manage their costs, that probably helps them in the short-term. Sticking with a similar theme, could you talk about what you're seeing in Europe right now in terms of the macroeconomic environment and the impact on your business? Yeah. Europe, high levels of unemployment, it's mixed. People are nervous there, as you can imagine. I think, again, the dynamics are not that different to here. Until jobs are created, it's going to stay a fairly challenged and difficult market. We're actually not seeing growth in private label to the extent that you might expect and maybe that's again to the point that branded manufacturers recognize it's a tough environment and there's probably a little bit more promotion as we're all trying to ensure that we keep ever loyal to our brands. And private label's probably not growing as a result of that phenomenon. But I think Europe's going to stay challenged in the medium term at least, and, again, across Europe and the U.S., until jobs are created I think consumers are going to feel very nervous and probably remain conservative. Page 13 of 16

14 Just coming back to the volume challenges that you or the deliberate volume mix shift that you've put in place in China and Russia, moving into more packaged products, away from bulk. When do you expect that that will stop being a headwind? Is that in the next quarter or a couple of quarters? We'd love it to be in the next quarter or a couple of quarters. It's evolving. As you go and you make changes in these markets and as you learn we'll understand more over the next quarter or two. In neither instance are either of those businesses going to have that material an impact. If anything, as we look at Russia where we have more of a scale play than China which is very, very small, we see opportunities to invest a little bit more in the short-term for hopefully long-term gain. China really is just a work in progress, we're learning off it. But neither of them in the scheme of the company are going to really make that much difference. Okay. Changing gear now to financial strategy. I think people were a little surprised that you pulled back on the share repurchases. I can tell this hasn't come up before. Why aren't you buying stocks back now given that you've got the cash flow coming through and so on? What was your thinking in terms of deferring that? Well, what we said in Q1 was we're relatively comfortable hitting our 11 to 13% EPS without the need for a rapid or early share buyback; that remains the case. And I think we'll look at it and we'll buy back shares at some point, but we are likely to skew them to the back part of the year. And it's really not a reflection on anything except in this sort of market we still are conservative. We think that's the right approach for us to take. But there's really not much more to it than that. Okay. In terms of other uses of cash, how do you prioritize those, and in particular, are there capacity constraints that you're coming up against that might require any sort of step up in capital expenditure over the next few years? Yeah, the only one we'd mentioned is if we add capacity in our frozen network that could be a reasonable size for cap expenditure. But we'll continue to review the network and our needs there, and as and when we see anything of any significant note, we'll let the market know. But nothing dramatic at this point. Margin trajectory from here, I guess that you've got guidance of low single-digit top-line growth, mid single-digit EBIT growth over the long-term, which tends to imply an improvement in margins. What's the upper limit in your view on operating margins and, yes, how do you think about what that constraint is? Page 14 of 16

15 Yeah. Well, we typically are more focused on gross margin than operating margin because if you can get a good gap between gross and operating that means you've got enough money to invest to drive the business for the long-term. If you look over the last sort of five or 10 years, our operating margins have been within a fairly tight, range probably 16 to 18-ish. And they were at the high end when we had a fairly benign commodity environment. As we went through the last three or four years before 2009 we saw heightened commodity and inflation; we always price behind that. So you saw the margins come down. Now you're seeing them start to graduate back up as commodities have gone the other way. So we don't really look to manage from an operating profit margin perspective, we're more focused on gross and ensuring we've got enough money to invest in the business to drive sustainable, dependable performance. Okay. Just a couple of quick ones as we wrap this up here. What broad industry lessons have you learned from the UK or the European markets that you could apply to the U.S. over time given that they may be a little bit more advanced in terms of retailer consolidation? I think the lessons really if you look at private label development is there's a role for private label. The key to ensuring that your business is strong is strong innovation, strong investment behind the brands. And we've seen that really play out for us as we have stabilized and even seen in some of the developed markets private label actually flat or in some markets reducing. The U.S., the performance here is lower, in the low double digits, versus in the high teens in Europe. So I think that's the key, is innovation, strong brand building, making sure that the quality of your foods and the value of what you offer is representative of the price differential. Had this come in from a few people over the years: If the right offer were on the table, could the Kellogg Company be sold, or are there impediments there? Well, I think that would be up to the shareholders and the board. We're very happy with our business. We think we're in a great position. Long-term cereal and snacks I think are great categories. I think the demographics are going to help us. Our approach is to drive sustainable, dependable performance for the long-term. We think that gives investors a degree of comfort, particularly in these volatile times. And that's going to be our approach. And I really couldn't respond to that. Okay. It's more down to the Foundation, or? Really, that would be down to shareholders and to our board. Page 15 of 16

16 Okay, got it. And then finally, if you think about Kellogg versus other packaged food companies that maybe have more exposure to emerging markets, why should investors choose Kellogg when there may be other companies that have perhaps higher top-line growth potential over time? Well, really, I think I've covered in part most of them. I mean, the concentration of the portfolio. Cereal I think long-term remains a very strong category to be in, I think, snacks also. They're big, they're relevant; they have real growth potential. I think our focus and modus operandi, trying to drive sustainable, dependable performance, looking to return cash to shareholders, over the long-term means that those who want more stable long-term holds in their portfolio, Kellogg is a great option. Great. I'm going to wrap it up there. Thanks ever so much to Dave. I really appreciate you taking the time to do this this kind of format as well, the opportunity to. Great. Maybe dig behind some of the things that have been coming up is incredibly helpful. So thank you so much. Thanks, Alexia. Cheers. This transcript may not be 100 percent accurate and may contain misspellings and other inaccuracies. This transcript is provided "as is", without express or implied warranties of any kind. Bloomberg retains all rights to this transcript and provides it solely for your personal, non-commercial use. Bloomberg, its suppliers and third-party agents shall have no liability for errors in this transcript or for lost profits, losses, or direct, indirect, incidental, consequential, special or punitive damages in connection with the furnishing, performance or use of such transcript. Neither the information nor any opinion expressed in this transcript constitutes a solicitation of the purchase or sale of securities or commodities. Any opinion expressed in the transcript does not necessarily reflect the views of Bloomberg LP. COPYRIGHT 2010, BLOOMBERG LP. All rights reserved. Any reproduction, redistribution or retransmission is expressly prohibited. Page 16 of 16