Kellogg Co. Reports 6 Percent Decline In Third Quarter Earnings

Kellogg Co. reported soft third quarter 2010 earnings per share, internal net sales and internal operating profit, consistent with the company's Oct. 21, 2010 announcement. Third quarter softness was due to weaker performance in some of the company's core cereal markets, continued competitive intensity, and the impact of the cereal recall.

Third quarter reported net earnings were $338 million, a 6 percent decrease over the same quarter a year ago. Third quarter reported earnings per diluted share declined 4 percent to $0.90, and 2 percent on a currency-neutral basis.

Reported net sales declined 4 percent to $3.2 billion in the third quarter. Internal net sales, excluding the effect of foreign currency translation, decreased 2 percent year-over-year. Total reported operating profit in the quarter decreased 5 percent to $541 million driven primarily by lower net sales and increased advertising investment. Internal operating profit decreased 3 percent. Reported gross margin contracted by 50 basis points to 43.4 percent in the quarter because of higher than expected cost pressures and lower volume levels.

"We are disappointed with our third quarter performance which was due to softness in our businesses as well as a tough operating and deflationary environment driven by intense competition," said David Mackay, Kellogg Co.'s chief executive officer in a prepared statement. "2010 has been a challenging year, and as a result, two weeks ago, we lowered our full-year guidance to reflect the operating challenges."

Kellogg North America posted a third quarter net sales decline of 3 percent on both a reported and internal basis. A 6 percent decrease in North America Retail Cereal internal net sales drove the majority of this decline, reflecting the weaker performance in the cereal category driven by the continuation of heavy promotional pricing in the category. Retail Snacks posted roughly flat internal net sales as strength in the wholesome snacks business helped mitigate the impact of a decline in cookie sales. The North America frozen and specialty channels businesses posted an internal net sales decline of 5 percent due to the slower than projected rebuild of the Eggo waffle business.

North America operating profit decreased 3 percent on both a reported and internal basis. Lower sales and volume as well as higher manufacturing costs and advertising investments were the primary contributors to the decline in operating performance.

Kellogg International posted a 6 percent decline in third quarter reported net sales. On an internal basis, excluding the effects of currency translation, net sales for Kellogg International were down 2 percent. Weaker European cereal and Russian snack performance drove this decline and resulted in a 5 percent decrease in third quarter internal net sales in Europe. Latin America internal net sales rose 5 percent, and Asia Pacific internal net sales grew 2 percent.

Kellogg International operating profit declined 11 percent on a reported basis and 5 percent on an internal basis. While Europe's operating profit grew modestly, operating profit in Latin America and Asia Pacific were both lower year-over-year.

Interest and Tax
In the third quarter 2010, Kellogg's interest expense totaled $62 million, an improvement over the same quarter in 2009 as a result of more favorable interest rates. The third quarter effective tax rate was 29.8 percent.

Cash flow, defined as cash from operating activities less capital expenditures, was $827 million year-to-date. Year-to-date, Kellogg repurchased $907 million of shares under its $2.5 billion three-year share repurchase authorization.

On Oct. 21, 2010, the Kellogg Co. lowered full-year 2010 guidance. Internal net sales are expected to be down approximately one percent. Internal operating profit is anticipated to be approximately flat, which includes the benefit from lower 2010 compensation costs. Full-year currency-neutral earnings per share is expected to grow 4 to 5 percent. Given these current business results, cash flow is expected to be in the $950 million to $1 billion range. However, in the fourth quarter, we expect to make a voluntary contribution of approximately $500 million net of tax to the Company's pension and post-retirement benefit plans. Reflecting this contribution, cash flow for full-year 2010 is expected to be in the $450 million to $500 million range.

Given the challenges of 2010, Kellogg is approaching 2011 as a year of strengthening the business. For 2011, the company expects internal net sales growth to be low single-digits, in-line with long-term growth targets. Internal operating profit is expected to be flat to down 2 percent reflecting the need to reset incentive compensation levels. Earnings per share on a currency-neutral basis are expected to grow at a low single-digit rate.

CEO Mackay concluded, "2010 has been extremely difficult and our softer performance is reflected in our current 2010 outlook. We are addressing the current business challenges. As we enter 2011, we feel positive about our strong commercial plans and higher levels of innovation, yet we are also pragmatic and realistic in our 2011 forecasts. We are confident that we are doing the right things for our business and are positioning ourselves to deliver on our long-term growth targets."

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