Margins, strong sales spur 13% growth at Kellogg

by Eric Schroeder
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BATTLE CREEK, MICH. — Effective innovation and brand building proved more than enough to offset continued inflation and a difficult competitive environment at The Kellogg Co. as net income in the second quarter rose 13%.

Net income in the second quarter ended June 30 was $301 million, equal to 76c per share on the common stock, up from $267 million, or 68c per share, in the second quarter of fiscal 2006. Net sales were $3,015 million, up 9% from $2,773 million a year ago.

For the first half of fiscal 2007, net income was $622 million, or $1.56 per share, up 15% from $541 million, or $1.36 per share. Net sales were $5,978 million, up 9% from $5,500 million.

"We have remained committed to our business model, operating principles and strategy," said David Mackay, chief executive officer. "This focus continued to provide strong returns in the second quarter and we now enter the second half of the year with additional confidence and the flexibility to increase our investment in future growth."

Operating profit at Kellogg North America rose 12% to $365 million buoyed by a 7% gain in net sales to $1,980 million.

Retail Cereal posted internal sales growth of 3%, driven by innovation and strong brand building. Leading the charge was Rice Krispies, Smart Start and Special K, the company said.

The North America Retail Snacks business also posted good results, as internal sales grew 9% behind growth in cookies, crackers and wholesome snacks.

North America Frozen and Specialty Channels posted internal net sales growth of 8% driven by frozen food, food service and vending, and convenience and drug stores.

At Kellogg International, net sales grew approximately 13%, with 6% internal sales growth. Strong cereal and snacks sales boosted growth within the company’s Latin American region, which posted internal sales growth of 8% during the second quarter. In Europe, internal sales rose 7%, while the Asia Pacific region experienced a sales decline of 1% during the quarter.

Operating profit at Kellogg in the second quarter rose 12% to $518 million, up from $461 million in the same period a year ago.

"The company achieved these results despite a significant increase in cost inflation and a double-digit increase in its advertising investment, which supported both new and existing brands," the company said. "The company now expects that up-front costs for the full year will equate to approximately 17c of earnings per share. Up-front costs in the second quarter totaled approximately 8c of earnings per share, significantly higher than the investment in the second quarter of 2006; this increased investment lowered internal operating profit by almost 5%."

Looking forward, Kellogg reiterated its full-year earnings forecast of $2.71 to $2.74 per share. The company said it expects to achieve the growth despite increased investment in brand building as well as an increased estimate for full-year cost inflation of 26c to 30c per share.

"Our momentum continued in the second quarter and the good results through the first half of the year have provided us with increased levels of confidence that 2007 will be another year of dependable, sustainable growth," Mr. Mackay said. "Most important, though, is the fact that we will post this growth while continuing to make significant and increased investment in future growth."

In addition to its financials, Kellogg also announced it is reorganizing its direct store-door delivery operations in the Southeast United States and will be exiting about 517 distribution route franchise agreements with independent contractors.

Kris Charles, Kellogg spokesperson, said the company is taking the action to simplify the company’s sales network for customers and to create cost efficiencies. She said the company will integrate the independent distributors in the Southeast U.S. with the rest of the company’s D.S.D. network. As a part of the initiative, the company will be closing its Augusta, Ga., distribution center at the end of September.

The company expects the entire initiative to result in $75 million to $85 million in total project costs, and the company expects to complete the reorganization by the end of 2007, according to a Form 8-K filed with the Securities and Exchange Commission.

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