2004 4th Quarter Earnings Release
January 31, 2005
Speaking on behalf of Kellogg:
Jim Jenness, Chairman and CEO designate
David Mackay, President and COO
Jeff Boromisa, CFO
Simon Burton, Director, Investor Relations
Operator: Good morning and welcome to the Kellogg Company 2004 Fourth Quarter Earnings Call. This call is being recorded. All lines have been placed on mute to prevent background noise. After the speaker’s remarks there will be a question and answer period. If you would like to ask a question during this time, simply press * and the number 1 on your telephone keypad. If you would like to withdraw your question, please press the # key. Also, please limit yourself to one question during the Q&A session. Thank you. At this time I would like to turn the conference over to Mr. Simon Burton, Kellogg Company Director of Investor Relations. Mr. Burton you may begin your conference.
S. Burton: Good morning, everyone. Thank you for joining us for a review of our fourth quarter and full-year results, and for our continued discussion about our strategy and outlook. With me here in Battle Creek are Jim Jenness, our chairman and CEO-designate, David Mackay, president and COO, Jeff Boromisa, CFO, and Gary Pilnick, general counsel. By now you should have received the press release by e-mail, and the slides that accompany today’s presentation are available on-line at www.kelloggcompany.com, on the investors page.
We must point out that certain statements made today, such as projections for Kellogg Company’s future performance, including earnings per share, net sales, gross margin, brand building, operating profit, innovation, costs, interest expense, tax rate, cash flow, working capital, share repurchases, and debt reduction are forward-looking statements. Actual results could be materially different from those projected. For further information concerning factors that could cause these results to differ, please refer to the second slide of this presentation, as well as to our public SEC filings. A replay of today’s conference call will be available by ‘phone through Friday evening, by dialing 888-203-1112 in the U.S. and 719-457-2687 from international locations; the passcode for both numbers is #7124897. The call will also be available via webcast, which will be archived for 90 days. Now let me turn it over to Jim Jenness, chairman and chief executive officer-designate.
J. Jenness: Thank you, Simon, and good morning, everyone. To start, I’d just like to say how happy I am to be here and what an honor it is to be the CEO-designate of this wonderful company. This appointment will become official in a week or so as Carlos is sworn in. My wife and I have purchased a home and have just about completed our move. I have been actively involved in the business over the last several weeks… and, as many of you know, for the last 30 years, I’ve had a very close professional relationship with the Kellogg Company. My transition is going well. It is also my privilege to work with the excellent management team we have in place.
If Mr. Kellogg were here, I know he would be immensely proud of Carlos Gutierrez for all he has done for our company and for all he will do for our country. Carlos has led Kellogg through a remarkable transition with tremendous vision and courage. Our entire Kellogg family, worldwide, wish him all the best as Commerce Secretary of the U.S. Now, let’s get to our performance.
We are pleased to report excellent results. We have posted strong sales growth throughout the year, and the fourth quarter was no exception. In fact, in the fourth quarter we managed to increase sales in each of our businesses despite some very difficult comparisons during 2003.
Mix improvement again drove much of our sales growth in 2004. As you know, mix is a very important part of our Volume to Value strategy and we continually focus on its improvement. This enables investment in brand building and innovation in all of our businesses.
Our gross margin expanded by 50 basis points, both in 2004 and in the fourth quarter; the gross margin for both periods was 44.9 percent. This is a positive result given the cost pressures faced by the entire industry over the last couple of years. Margin improvement helped fund increased investment in brand building and innovation and increased investment in up-front costs for cost-reduction initiatives. In fact, as Jeff will discuss in a minute, we recognised a significant amount of these costs in the fourth quarter, and throughout the year, all of which we absorbed in our guidance. We continue to show improvement in reducing working capital, driving cash flow, and reducing our debt.
In 2004, we stayed focused on our goals of growing our cereal business and expanding our snacks business; we delivered the third consecutive year of results which equaled or exceeded our long-term growth targets. We concentrated on our Volume to Value and Manage for Cash strategies and made progress on each. These strategies are the right way to run our business. We will continue to innovate and invest in brand-building and efficiency initiatives. The company will continue to be run targeting realistic goals that enable us to deliver dependability and sustainability.
David will review each of our businesses in a minute. But first, I’ll turn it over to Jeff Boromisa who will walk us through the financial results.
J. Boromisa: Thank you, Jim. Good morning everyone. Slide 4 details our key financial highlights for the full year and fourth quarter. Net sales increased by 9% for the full year, due to both excellent growth throughout the company and because of the favorable effect of foreign exchange. In addition, internal sales growth, which excludes the effect of foreign exchange and the 53rd week, was a strong 5%, significantly above our long-term target of low single-digit growth. Sales growth in the fourth quarter was 12%, or 4% on an internal basis.
Operating profit increased by 9% for the full year; internal growth was more than 4 percent. We increased our investment in innovation and brand building for both the full year and the fourth quarter. In fact, brand-building investment increased at a double-digit rate for the full year. We also invested in up-front costs for cost reduction projects which added to slightly more than 6¢ in the quarter. For the full year, these costs equaled approximately 17¢, or right in the middle of our guidance range. Importantly, more than two-thirds of these costs were recognized in SG&A in the fourth quarter; for the full year, approximately 60% were recognized in SG&A. We also recognized approximately 1.5¢ of CEO retirement and transitional costs; despite this, operating profit grew an impressive 9 percent in 2004.
Earnings per share grew by 11% for the full year, helped again by lower interest expense. EPS decreased by 2% in the fourth quarter, primarily as a result of a one-time increase in taxes that led to a tax rate of 35.9 percent. I’ll discuss this in more detail in a minute. However, despite these unanticipated expenses, and the focus required to execute the cost-saving initiatives, we were still able to over-deliver EPS in the quarter. Cash flow for the full year was $950 million, driven by increased earnings and core working capital improvements. We are pleased with each of these results. Let’s look at them in more detail.
Slide 5 shows our net sales growth in its various components.
For the full year, internal net sales growth was 5.0 percent. This resulted from both price/mix improvement and tonnage growth. This is growth on growth as it builds on strong internal sales growth of 3.8% in 2003. Foreign currency translation again contributed to reported sales growth, adding 2.8% for the full year and 2.4% for the fourth quarter. This year’s 53rd week added approximately 1% to annual sales, as we expected. In the fourth quarter it added 5.3% to our sales growth over last year. Importantly, our sales growth continues to be broad-based across our businesses.
Slide 6 shows our gross profit margin for the full year and the fourth quarter. Our gross margin increased by an impressive 50 basis points for both the full year and fourth quarter. This increase was driven by improvement in mix, increased productivity as a result of our cost-saving initiatives, and operating leverage which resulted from the sales growth. Importantly, we achieved this growth despite continued high commodity and benefit costs. The impact of these higher commodity costs on full-year earnings was 14-15¢ per share, which built on a similar increase in 2003. We are very pleased with these results given that commodities have added an incremental 30¢ per share to cost of goods sold since 2002.
Remember that gross margin expansion is a very important part of our Volume to Value strategy, as it provides us the flexibility to increase investment in innovation and brand-building programs and drive improved mix. In addition, as we said, our gross margin was affected by up-front costs in the fourth quarter and full year. As always, we absorb these costs in our communicated results as we believe it is just a part of our ongoing business.
Turning now to slide 7, which shows our investment in brand building. We aim to increase our investment in brand building at a rate greater than sales growth each year. We exceeded this target for the full year, although we fell short in the fourth quarter simply because of the greater than expected sales growth and very significant growth in investment during the fourth quarter of last year. As you can see in the chart, brand building increased at a strong double-digit rate during 2004 as we continue to invest in our brands and future sales growth.
Along with investment in innovation, investment in brand building comprises the core of our Volume to Value strategy and we are committed to meeting our targets for this spending in 2005, and over the long-term. Our goal is dependable, sustainable growth, and we will not sacrifice that trend for one or two quarters of unsustainable operating profit growth.
Slide 8 shows internal operating profit growth for the full year and fourth quarter by reporting area. Remember that this internal growth excludes the benefit of currency translation and the effect of the 53rd week. Internal operating profit growth was 4.5% for the full year. It decreased by 5.6% in the fourth quarter, due primarily to an increase in investment in brand building, up-front costs related to our cost-saving initiatives, CEO transition costs, and commodities.
Internal operating profit growth in North America increased by 6.5% for the full year and 10.0% in the fourth quarter. These results included up-front costs primarily related to the consolidation of the Worthington plant and the costs related to the relocation of our Snacks business to Battle Creek. We are very pleased that operating income increased so strongly despite these costs and a significant increase in commodity costs.
In Europe, operating profit decreased by 7.4% for the full year and by 76% in the fourth quarter. While we invested heavily in brand building in this area, the decrease is largely attributable to up-front costs for cost-saving initiatives. We essentially finished the implementation of SAP in the region and we continued an initiative during the fourth quarter designed to improve Europe’s organizational effectiveness; our European headquarters is now located in Dublin.
In Latin America, internal operating profit growth was 14% for the full year, although it decreased by 4.5% in the fourth quarter. We achieved this excellent full-year result despite a double-digit increase in investment in brand building in 2004. Fourth quarter growth was adversely affected by the repurchase of a few weeks of inventory in Latin America, which was done to improve our warehousing efficiencies and which had a material impact on the area.
And in Asia/Pacific internal operating profit increased by 13.8% for the full year and by 108% in the fourth quarter. We have been active in this region, increasing our brand-building investment at a double-digit rate to address weakness in the Korean market and an increasingly competitive environment in Australia. The unusual growth in the fourth quarter was caused by strong sales growth and comparisons to the fourth quarter of 2003, which, you’ll remember, included up-front costs associated with a plant closure in Australia.
Our tax rate of 35.9% in the quarter was significantly higher than normal due to a provision for the future repatriation of foreign earnings as a result of the passage of the American Jobs Creation Act. This also brought our full-year rate to 34.8 percent. We anticipate that, with the finalization of certain regulatory details, we will repatriate approximately $1 billion.
Slide 9 shows continued improvement in working capital. This is core working capital measured as receivables plus inventories, less traditional trade payables, which excludes customer trade liabilities, divided by our last 12-month sales. This was our fourteenth consecutive quarter of improvement in core working capital. We are very proud of this achievement, but believe that we have an opportunity to improve further, even from our industry-leading position. Obviously, we have businesses which are better than the average and we are constantly spreading their best practices throughout the organization and are remaining focused on the right metrics. We intend to do all this while continuing to improve the quality of our customer service, as we have in the past.