By Lyle Niedens

BridgeNews

KANSAS CITY (B)--Kellogg Co., the cereal marketer struggling to please shareholders while reforming its business, will lower annual profit growth targets and increase marketing spending on its biggest brands upon completing its $3.7 billion purchase of Keebler Foods early next year.

Carlos Gutierrez, Kellogg's chief executive, told analysts gathered Nov. 28 in New York City that the company must undergo a fundamental change in its business model in order to boost stagnant revenue growth.

"You know and we know our challenge is to deliver top-line growth," Gutierrez said.

Buying Keebler, the nation's second-biggest cookie and cracker marketer, is one way to do that, he said. Kellogg announced in late October plans to purchase Keebler for $42 per share in a deal the companies expect will close in late February.

"We believe this is the right thing to do--to reinvest in cereal--and that Keebler gives us the ability to reinvest in cereal," Gutierrez said.

However, he said the company must lower its profit-growth targets to more realistic levels while raising the profile of its best brands. Doing so, he acknowledged, forces him to renege on several forecasts he previously made to investors and analysts.

After closing a portion of Kellogg's famous cereal plant in Battle Creek, Mich., last year, Gutierrez said throughout much of 2000 that the company would incur no more restructuring costs.

But Nov. 28, Kellogg said the next phase in its growth strategy, including melding Keebler's operations into its own, will cost $50 million to $70 million in pre-tax charges in its current fourth quarter.

On Oct. 26, the day it announced the Keebler deal, Kellogg said its fourth-quarter profits would suffer from increased marketing spending on U.S. cereals. While the company still expects a modest quarterly profit gain, excluding restructuring charges, Gutierrez said the need to continue boosting consumer marketing programs has forced the company to reassess its annual profit growth targets for the next several years.

As a result, Gutierrez said Kellogg's realistic targets, in percentage terms, now stand in the mid-single digit range.

The adjusted targets come just one year after Gutierrez assured those attending Kellogg's 1999 analysts' meeting that the company's existing businesses could support annual earnings-per-share growth of 10% to 12%. But he admitted that focusing on such growth rendered Kellogg ineffective in boosting its revenue.

"Our marketing division has been constrained by budgets focusing on double-digit EPS growth," he said.

Now, Kellogg will spend more money on consumer marketing programs designed to restore the glory of Kellogg's Frosted Flakes, Froot Loops, Pop-Tarts and other famous brands.

John O'Neil, a food industry analyst with PaineWebber, said Kellogg needed to make the changes.

"They are in the middle of a long turnaround," O'Neil said. "They have appropriately decided not to focus on short-term profits. They are doing the right thing.

"They have starved the business for resources, and they are trying to get the business back on track. But there is a cost to that."

Kellogg lost its longtime lead in the U.S. cereal market to General Mills in late 1999. As it focused on acquiring non-cereal businesses, such as soy food marketer Worthington Foods, and expanding worldwide, the company did not keep pace with competitors in marketing its U.S. cereal brands after heavy advertising in the first half of the year.

In the meantime, Kellogg's shares continued dropping. After trading as high as $50.38 in December 1997, the company's operational woes pushed the stock as low as $20.75 by February.

Gutierrez acknowledged the company's mistakes Nov. 28. "We probably tried to do too much too soon," he said.

Looking ahead, he said Kellogg instead would focus on its biggest, highest-growth markets and revamp its sales and marketing team while continuing to acquire additional revenue and profit "streams."

"We need to refuel and regenerate our growth, and we need more realistic profit targets to do so," said Gutierrez, adding that double-digit, per-share targets are unrealistic for most food companies, particularly one dependent on a declining product category such as ready-to-eat cereal.

Kellogg's reliance U.S cereal revenues as a part of its total sales will decline to 27% from 37% once it closes the Keebler deal, though. Keebler's cookie and snack businesses will account for 43% of the company's $10 billion in annual sales.

"This is clearly a transforming event for Kellogg," said Sam Reed, Keebler's chief executive, who has accepted a role as vice chairman at Kellogg. "These two companies have great complementary strengths."

But Kellogg will spend 2001 incorporating those strengths, and doing so will crimp profits.

Before gaining access to Keebler's renowned direct-store delivery system, Kellogg must reduce inventory in its warehousing distribution system, said Tom Webb, Kellogg's chief financial officer. An additional $60 million in lost revenue will occur because Kellogg's Pop-Tart co-packing arrangement with Keebler essentially will turn into an in-house operation.

Consequently, operating profit growth in 2001 will increase less than 5% from 2000, Webb said.

But Webb also said the company's strong cash flow and profit margins can handle the fourth-quarter restructuring charge, financing the Keebler deal through debt and higher marketing spending next year.

Most of that spending increase will occur in consumer advertising instead of coupons and other trade-oriented programs, Webb said.

"We trying to focus on brand building, not reverting to trade promotion warfare," he said.

Kellogg's shares fell 6%, or $1.63, to $25.13 early Nov. 28 before rebounding to $25.69 by midday.

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