億滋國際 (MDLZ) 2003 Q3 法說會逐字稿

Good afternoon ladies and gentlemen. Welcome to the Kraft Foods 2003 third quarter conference call. At this time, all participants have been placed on a listen-only mode and the floor will be open for questions following the presentation. It is now my pleasure to turn the floor over to your host, Senior Vice President of Investor Relations, and Financial planning and analysis, Ms. Marla Gottschalk. Ma'am, you may begin.

Thank you. Good afternoon and thank you for joining us for the Kraft Foods third quarter 2003 earnings conference call. I'm Marla Gottschalk, Senior Vice President of finance and Investor Relations and on the call with me today are Kraft's co-CEO's, Betsy Holden and Roger Deromedi, and CFO, Jim Dollive. I will take you through some prepared remarks on the third quarter results, our outlook for the remainder of 2003 and the review of some of the items that will impact us in 2004. After those remarks, Betsy, Roger,Jim, and I, will take your questions.

For those of you listening on our website, you are in a listen-only mode. Earlier today, we issued our third quarter earnings release which is available on our website. I remind you that our comments today contain projections of future results and are made only as of today's date. Please refer to the Safe Harbor Statement at the end of our release for review of some of the factors that could cause actual results to differ from projections. With those details behind us, I will now turn to the specifics of the third quarter results. Overall, Kraft's third quarter reflects the continuation of the challenges we experienced in the second quarter. Although we did begin to see some improvement in consumption in September as a result of our investment spending. As we indicated during our July call, our investment to address challenges in our focus categories will be skewed to the latter part of the year. And therefore we expect the third quarter to remain fairly soft.

For the quarter our reported volume was essentially flat to prior year. Volume from ongoing businesses which excludes the impact of businesses sold was up 1%. The investitures that comprised this difference are the 2002 sales of the small U.S. confections business and the Latin American bake free ingredients business, and the 2003 sale of the rice businesses in Europe. While we expected a soft third quarter, the volume growth from ongoing businesses was below our expectations, due to lower results in two areas. First, our U.S. cookie businesses posted weak results as the cookie category declined in the third quarter and an accelerated pace. We will discuss the dynamics of this category in more detail in a few minutes as we go through each focus category in the U.S. The second driver of lower than expected results was our European chocolate and coffee businesses which were significantly impacted by this summer's heat wave. Across virtually every affected country, both the chocolate and coffee markets were down.

For perspective, let me give you a couple of A.C. Neilson market statistics for August. In France, the overall chocolate market was down 20% and coffee was down 8%. In Germany, chocolate was down 13% and coffee was down 5%. We estimate that the market softness associated with the heat wave in Europe impacted our EMEA segment volume growth in the third quarter by over 3 percentage points and impacted our total company growth by about 1/2 percentage point. Together we estimate that the softness in these businesses, U.S. cookies, and the Euripean chocolate and coffee impacted our third quarter volume growth by a full percentage point versus prior year. Volume for the remainder of our North American business met our expectations driven by continued momentum in ready to drink beverages, and solid shipments in our Hansen's businesses, Oscar Mayer meats, Planters nuts and food service. Our third quarter share trends improved versus the first half with pound share increasing or flat in categories representing about 50% of the OCI from our top 25 North American categories.

Outside of the weakness in our European chocolate and coffee businesses, our international volume growth was fairly solid as developing markets grew over 6%. Growth was particularly robust in the large developing markets of Russia which was up 8% and China up 13%. In fact the Asian Pacific region turned in strong results broadly, with the overall region growth in the high single digits. Our Catcon acquisition contributed 0.6 points to third quarter volume which is relatively consistent with our long term trend. The family nutrition biscuit business in Egypt was the primary contributor. The integration of this business which substantially improved our scale in Egypt is progressing well. Additionally while in the early stages, the integration of the back to nature serial business in the U.S. is also progressing as planned. Finally, trade inventories in the U.S. continue to decline in the third quarter in line with our expectations.

Looking briefly at revenues, reported net revenues grew 3.7%. About 4 points faster than volume. Of this differential, 3 points were attributable to currency favorability with a another 1.3 points due to pricing and of promotional spending. Now turning to a discussion of operating income, on the quarter we were down 9.6% versus prior year with several items impacting growth. First, commodity costs were up. Cheese was the most significant with barrel cheese in the U.S. averaging $1.54 per pound in the third quarter-- up 40% versus last year. Meat and oil costs were also up significantly versus last year. Higher commodity costs were the primary driver of the decrease in gross profit as the cost of sales increase of 7.4% outpaced our revenue growth of 3.7%. The second driver of lower operating income was higher benefit costs, including pension and post-retirement costs. Third, our marketing spending increased due to the previously announced investment program. With most spending occuring in September. And finally, product mix was negative. Primarily due to volume softness on our higher margin U.S. biscuit and European coffee and confectionary businesses.

Partially offsetting these items were the--were a $27 million currency benefit and a $23 million gain on the previously announced sale of our rice businesses. While we diluted earnings per share of 47 cents were down 6% versus prior year, due to the decrease in operating income, partly offset by lower interest expense. Looking at cash flow, discretionary cash flow which we define as operating cash flow, less capital expenditures was $2.1 billion through the third quarter up 40% versus prior year. Year to date growth was driven by higher net earnings and an improvement in working capital usage particularly in inventories. In terms of cash usage, capital spending in the third quarter was $261 million bringing our year to date total to $758 million. In August, we increased our dividend by 20% to 18 cents per common share. Additionally, we repurchased 2.4 million shares of class A common stock this quarter for $70 million.

Let's now turn to the progress we made against our investment program. As a reminder, our investment is primarily focused on four categories, cheese, cold cuts, coffee and biscuits. The programs objective is to build our brand value for the long term. The principle behind the spending is to focus both on realigning prices as well as improving the bundle of benefits we offer consumers.-- and our targeted outcome is clear. To improve share and consumption trends in the fourth quarter and next year. In the third quarter we spent approximately $45 million on this program primarily in September. In terms of our sell in, we are pleased to report that the key programs have been well received by our retail partners. As we talk about each of these businesses today, we will be referencing A.C. Neilson three outlet data excluding Wal-Mart for the five week period ending in September and contrasting that versus the year to date period ending in August. As has been our practice in cheese, cold cuts and coffee we'll be looking at volume share data. While on cookies and crackers we were shifting to lower weight and higher revenue per pound items, we'll be looking at dollar share data.

Let's start with a look at the cheese business. In the third quarter, price gap versus private label contracted as we expected. Partly driven by our spending program and partly driven by private label's reflection of higher cheese cost. Barrel cheese cost began to rise in June and as i previously indicated, were up about 40% of the third quarter versus last year. As you know, private label has historically adjusted its prices for changes in the cheese market on a lag basis and movement during the third quarter was consistent with history. With the improvement in price gaps and incremental marketing, we are seeing share and consumption trends that are encouraging. In the latest five weeks, total Kraft cheese pound consumption was up over 4% versus prior year. A 4 point improvement versus the August year to date trend.

Looking at shares across our key cheese segments, we saw improvement in each one. Our September share processed slices was up over 4 points versus an August year to date trend of about 1 point. In cream cheese, our share was up about 1 1/2 points after being down about 1 share point August year to date. And in our third key segment, natural cheese, our shares were up 0 .3 points after being down 1 share point August year to date. While we're encouraged by these initial results, I want to remind you they are only for five weeks. The story in cold cuts is similar to cheese. We reduced our price gaps in September and are encouraged by the latest consumption in share trends. Town share was down only slightly versus prior year or 0.3 points versus August year to date trend of down almost 2 points. Pound consumption turned positive up 0.8%. A significant 6 percentage point improvement versus the year to date trend. On the commodity front, meat costs have generally risen during the third quarter with lean hog prices up 9% versus prior year. These costs increases are manageable within our investment against this category.

Turning now to coffee. We have not yet seen improved share results as our marketing programs in this category did not begin until the latter part of September while competition significantly stepped up their level of marketing and promotional activity in the quarter. While our share trends remain soft, our coffee volume was on our expectations driven by particularly strong growth in non major channels. However, it's too early in the coffee investment plan to draw any conclusions. As we work through the fourth quarter, we will be carefully monitoring the impact of our merchandising and advertising programs in the face of heightened competitive spending.

Finally in biscuits, our cracker business showed improvement. But our cookie results remained weak. On crackers, initial shipments of Ritz chips are off to a good start. On a dollar basis, Kraft total cracker share was up over a share point in the latest five weeks after being down slightly August year to date. And importantly dollar consumption was up over 6% after being flat through August. On cookies, however, the category declined 5% in the third quarter after being down about 2% in the second quarter. This softness appears to have multiple drivers including: higher pricing, a difficult comparison to prior year, less impact from new items by both us and the category at large, and switching to alternate categories such as cereal bars. In September, we did see marginal improvement in our cookie dollar share trend. However, with a much softer category, our consumption trends weakened. Based on an early assessment. We believe that there will clearly be a need to continue our investment spending on cookies next year. This investment coupled with the product innovation will play an important role in rejuvenating the category.

To summarize our situation on our focus categories, we were pleased with the initial program execution and encouraged by the results in cheese, cold cuts and crackers. Consumption and share trends were improved across all three of these businesses in September. In coffee, results did not show improvement in September. Although spending began late in the quarter and there is a heightened level of competitive activity in the category. Cookies remain the most significant watchout as the share stabilization we have seen and has only been -- has been more than offset by category weakness. In all cases, the recent results are only for five weeks. And we need to see ongoing progress throughout the fourth quarter. We will continue to project the total investment of $200 million in 2003 primarily behind our focus categories.

As we look at our profit outlook for 2003, we continue to project fully diluted EPS of $2 to $2.05. Generally speaking commodity costs are operating within manageable ranges. Our cost reduction efforts remain on track to deliver targeted savings. In addition, our results in Latin America continue to show improvement as they did in the third quarter as we lapped last year's devaluation driven cost increases and realized the benefit of our pricing action. Similar to past communications and consistent with our strategy of optimizing our portfolio, we continue to review our noncore businesses for potential divestitures. Our earnings guidance range does not account for any potential gain or loss in the possible future sale of any businesses. On the full year, we project volume growth on ongoing businesses of around 1.5%. A 1/2 point lower than our last guidance due to a softer than expected third quarter. We continue to project growth in discretionary cash flow of 10% plus versus 2002. Also, late in the quarter we took advantage of low long term interest rates and an improvement in our credit rating by floating $1.5 billion in long term notes to refinance maturing short term debt due to Altria group. Terming out this short term obligation, should result in higher interest expense in 2004. But in doing so we have reduced our intercompany debt with Altria to less than $200 million.

Turning to 2004 more broadly, as we indicated previously, we will be providing guidance in January. However, we wanted to reiterate two elements of our financial outlook that we know today. The first is post employment benefit costs primarily pensions which will be up significantly again next year. The second element impacting 2004 and one that is difficult for us to currently quantify is the level of investment spending behind our focus categories that will be continued into next year. As previously indicated, next year's spending level is dependent upon the responsiveness we see to spending this year, as well as the competitive and consumer environment.

To conclude, our third quarter results reflect a continuation of the challenges we experienced in the second quarter. Ongoing volume was below our expectations due primarily to softness of U.S. cookies and our European coffee and chocolate businesses. We feel good about our execution against the plan we outlined after the second quarter and are encouraged by the progress we were making in closing price gaps in our focus categories, especially cheese, cold cuts, and crackers. And the share and consumption trends that were occurring as a result of these efforts. However, as we said, it's too early to draw any conclusions or establish any new trend lines. Importantly, 2003 full year earnings and cash flow expectations remain on our previous guidance and finally we will be giving you our 2004 outlook in January. That completes our prepared comments and now Betsy, Roger, Jim and I will be happy to take your questions.

Thank you ma'am the floor is now open for questions. If you do have a question, please press the numbers 1 followed by 4 on your touch-tone phone if your question has been answered, you may remove yourself from the queue by dialing the pound sign and we do ask that while you pose your question that you please pick up the handset to provide optimum sound quality. Once again that is 1 followed by 4, please hold while I poll for questions. Thank you our first question is coming from Chris Growe of A.G. Edwards.

Good afternoon. Caught me a little off guard here being first. First question, the release as well as the comments were rather explicit about potential divestitures in gains and losses. Is that being rethought in any way? Betsy or Roger. I know there is some small ones here and there. But have you thought any more about that in terms whaf that could entail?

First of all we--on an ongoing basis continue to examine our portfolio and what we want to be in long term and what makes sense and what we see is the different things that will help us grow going forward. So there is nothing more explicit being said than what we gave you, but our ongoing process as we look at our portfolio.

Okay and then I just have two other quick ones. The first one, you know, the ongoing softness in i guess coffee which we'll still kind of wait and see what happens there but also cookie. Will this require some sort of shift in the spending at all or for that matter incremental dollars? On this $200 million dollar spending plan. Is that foreseen at all?

Chris this is Betsy. In terms of this year, we don't see spending more than that $200 million. The issues that we're seeing on cookies are as marla said it's pricing. It's a very strong year ago comparison, particularly this quarter. We had cookie bars last year and a lot of spending from Mars and ourselves as they intend to get into the whole cookie arena. So part of it is strong year ago comparison. We also--we are increasing spending--advertising spending as we go into Q4 and we are seeing some switching to other categories like cereal bars and we will need to address that through product innovation and that will come in 2004.

Okay. And then my last question then will be on the over, or this incremental spending level of $200 million this year, if we annualize that, we can all figure it out, it's $600 million. I'm trying to figure out how that will not continue into '04? Would it be better consumer trends, you know, if you gained a share from this incremental spending. Wouldn't that have to continue into '04?

Again we're not prepared to give guidance yet. But our expectation is that this is not an end of year investment. We will need to invest in 2004.

Okay, fair enough. Thank you.

Thank you.

Thank you our next question is coming from DavidNelson of Credit Suisse First Boston.

Good afternoon.

Hi, David

First maybe a point of clarification. Marla, you were talking about your market shares being up in was it 50% of your top 25 categories?

Yes.

So you are up only in half of them?

That's correct.

Okay and then just maybe more broadly, you have got in cheese meals, enhancers, beverages, desserts and then Oscar Mayer, we have got sales growth but operating income declines of near double digit in each of those places. Is most all of that due to commodities? Commodity cost increases?

Yes. We've got commodity cost increases, we do have the investment in coffee and beverages and desserts and cereal and across the board we have increases in pension and benefits.

Okay, and then maybe one for Roger. Latin America volumes were down. They were up only 1.4% last year. When might we see some improvement and what are you doing to get that going?

Sure David, one of the things that we have seen in Latin America, one of the things that we have saw in our last results the earnings are improving as we are lapping against the devaluation driven cost increase last year, and as the pricings come through this year. What's downs been some of the performance of Latin America in quarter three, in particular was in Brazil, where we had the impact of the inflation then the impact that the government did to deal with that and then the lower consumer spending. Keep in mind also in Latin America as you compare to a year ago if you compare on a reported basis that with the sale of the yeast and baking ingredients business which had a major impact on--if you look at the reported results on volume, keep that in mind, as well. The challenge we had is Brazil. Very happily to see that actually, Argentina, had a much better in performance again, coming off the difficult times a year ago and feel very good about the actions taken across all the markets-- doing a lot of resizing and getting smaller unit sizes at lower pickup prices for consumers and it seems to be working well for us in Argentina, we're doing similar things in Brazil, as well. And lastly, all I'll say is Venezuela continues to be a challenge for us but the group is doing a superb job managing through it. As you know there is currency controls and, you know, working hard to make sure to get the raw materials and make the products. But the group has done a great job there in managing through that one but that one is always a watchout as we go forward.

Let me just one last maybe quicky on -- a map to confirm please, if I walk through some of the numbers in your release, I get a net pricing being down 1.8%. Does that sound right?

No. Dave. Again, if you look in quarter 3, overall--reported logs are down 0.2 -- revenues are up 3.7. Currency is worth about 3 points. Pricing net of trade is roughly worth about 1 1/2 points and then the remainder is mixed.

Okay, I was doing it after dispositions. Thank you.

Okay thanks David, good bye.

Thank you our next question is coming from David Adelman of Morgan Stanley.

Good evening, everyone.

Hi, David.

Betsy and Roger could you talk about your business algorithm if you step back. You look at the results that you are seeing now. If pricing gaps were within your targeted ranges, do you think this company is still capable of delivering 8 to 10% EPS growth excluding the higher pension costs?

Yeah, David this goes back to earlier in the year in our business model, we'll give you a better sense of that when we get to our January guidance. Importantly, I think, as we get the brand value equation rights on our brands, which is what we're doing, we do feel that we can get the top line and again keep in mind when we talk to the top line guidance of--in that around 3% include that Capcon acquisition as you saw this quarter in that same sort of range. But we do think that the model can work overt ime and when you get that-- the impacts of the pensions and other benefit costs that we have and get the equation right on and the brand values.

And secondly, are you looking at any potential major restructurings? In other words a substantial head count reduction or looking at the capability in a more difficult environment of closing some major manufacturing facilities?

David we always continue to look at ways to grow our business and ways to reduce our costs and I think we are clearly seeing in this environment that the value is important so we are looking at every item to look at how do we aggressively reduce costs.

More aggressively than you might have a year or two ago?

Again, we continue to be--I think you know productivity is a major hallmark and we will continue to very aggressively look at all costs.

Thank you.

Thank you our next question is coming from Eric Katzman of Deutsche Banc.

Hello, everybody.

Hi, Eric.

I guess the first question I had just in terms of, I realize everybody is kind of--focuses on 2004, but I'm not -- I guess I'm not really sure how you are still kind of getting to the high end of a 205, 2 to 205 range. Because if I look back at the numbers that you provided on a quarterly basis, it seems like every year from third to fourth quarter operating margins have declined just due to whatever seasonalities in the business is. So I kind of have a difficult time unless you're really assuming some huge benefit in volumes from your incremental A and P spending as to how, you know, if you still have a 35% tax rate and $150- $160 million in interest expense how you--you don't end up disappointing again. Maybe you can walk through a little bit in terms of the fourth quarter of what I'm missing.

Sure. Be happy to Eric and give you some sense of--again, we've left the range as it is, we think that's appropriate. To your comments, the top end of the range is probably a stretch as you look at the numbers. Year to date as you look at it, I believe it's $1.51, so if you do the difference in quarter 4, for the $2 to $2.05 you're at 49 to 54 cents. Once again you look at that and that's down 9% to flat. And then keep in mind in the year ago when we earned 54 cents there was a 3 cent gain from the sale of the yeast business bakery and ingredient business down in Latin America. But then you also would have the impact of the higher benefit that we've had in every quarter going throughout the year. So we do expect that we'd have to have operational earnings improvement. The key thing that will be driving that will be improved volume and mix as we are spending our focus money against the focus categories and that will improve our mix and we also look at it in terms of as the costs are flowing through we'll see improvement on our price net of cost as well. So it gives you some dimensionalization as we look at the full year and where we are year to date and quarter 4.

Okay and then kind of following up on David Adelman's question, I realize you can't talk specifics but obviously a target that you talked about is 3 1/2% of cost of goods as a kind of ongoing productivity target within the company and that has to be if you continue to spend at this rate on promotion that has got to be a pretty important offset. So I guess the question is, if you got to spend money on promotion, which nowadays because of the way it's accounted for is a direct hit to gross margins, can you really get that much leverage out of the productivity when promotion is being accounted for a little differentlyl than the last time you talked about 3 1/2% of cost of goods.

Again, the trade promotion comes off the revenue line, not off the cost of goods sold line. So the cost of goods sold line would be the same target we had before. We agree with you. We need to clearly aggressively go at every line and item to make sure we improve our earnings performance.

But what I'm saying, Betsy, is that years ago the promotion deduction hit your SG&A line and didn't affect gross margins. But now when you have got a deduction between gross and net it directly affects your gross margin.

I understand what you are saying in terms of gross margin. But in terms of the productivity and the pool of productivity to go after. I think one of our other goals here is to drive the volume also on some of our higher margin items that have been some of the ones that have been under share pressure which will help the main margin in a mix standpoint.

Okay and for the last question, I was jsut kind of wondering with all of this spending going on, I don't know if you kind of let investors know whether some of the products that you have coming out in the various categories where you are seeing challenges -- I mean, is there another Lunchables lines coming out in meat? Is there, I don't know an upgrade to the cheese business like calcium and -- can we look forward to some differentiated product in addition to a price reduction given strategy.

Well and again, I think what we tried to communicate at Prudential our goal is A, to get the pricing right, it's to get the spending right (INAUDIBLE)on our core brands and it's through smart innovation behind the same brand. So yes, you should see news and you should see and or product and package improvements or spending against differentiation in all of the categories we are investing behind. It's not just price driven, but I think we have clearly learned if you don't have the pricing right, it's hard to grow.

Is it the first, like in terms of timing for us? Is it the first roughly -- I don't know, three to six months promotion driven and then the new products start to flow? What's kind of the timing of how these things hit?

Well and again, I'm not going to give you specifics and in each category it's a little bit different. But clearly the first short term is to make sure we have got the pricing right and the spending right and then we will all see these innovations appropriately.

You are exactly right and that's why we didn't talk about building brand value. Consumers end up buying brands that have value, that have benefits at a price and we have got to make sure that both sides of that balances is correct. So you will see us taking actions on both sides. Have to get the price right and you'll see benefits coming on a continuous basis going forward.

Thank you.

Thank you. Our next question is coming from Romitha Mally of Goldman Sachs.

Hi everyone. Can you update me on just the whole trade inventory picture right now and then specifically how you feel about your inventories as you head into the fourth quarter?

Well in terms of U.S., we as we talked about at the last call, we've been expecting the accelerated declines in inventory for the rest of this year really driven by some of the customer issues in particular Fleming and that's our inventories in Q3 were very consistent with what we thought and you know frankly was not a point of growth.

Okay, any specific categories?

We have seen more -- we saw some impact on cheese. We've seen some impact on some of the enhancers products, more so. And I think what we have seen is our products that are skewed more to the center of the country which really where Fleming supplied. Those products seem to have been hurt a little bit more than some of the others. But we have seen it across the board and we have seen as expected all of our customers continuing to look to take a day or so out, of everybody trying to improve their working capital.

Would that be -- 1% a good forecast for the fourth quarter as well?

Yes. And then just following up -- Again that would be our estimate right now. Yes.

And one comment outside of the U.S., again, we've seen continued trade and stock. But no massive acceleration except we did see in quarter 3 in Brazil significant trade destocking basically as the President (INAUDIBLE) tried to get inflationary curl he raise interest rates considerably so the trade did a very logical thing in reducing their trade stocks. And then what we do when you have to pay, you know 20% rate. So yeah we did see some impact in quarter three but pretty much the same continued trend in other markets.

I had a follow-up question on just new products. As you look out into your pipeline for '04, how good to you feel about the pipeline and then have you taken any measures to make sure that the '04 products are more successful than what you experienced in '03?

I will start and then let Roger jump in. I think importantly Romy is that the key is we are not going to bat 1,000 in new products. If you go through our track record we have a long history of success even with some of the -- we had a couple this year that have clearly not met our expectation. But we should still do about a billion dollars in new products and we do feel good about the people in the process and any time something doesn't work, we take a hard look to say what can we learn, what can we do better? We do feel good about the products that we have in the pipeline for next year. If we look at some of the timing, some of them are a little bit more back half skewed and it's a good combination of both closer end and some things that we are pushing that will be more incremental.

One final question on the cookie category, is it specific brands that seem to be weaker, is it Oreo or is it pretty much across your cookie brand? Are you seeing any pockets of strength. SnackWells, one thing that I heard recently is that sugar-free seems to be doing well.

It is really -- it is Oreo has been the biggest driver of cookies and that's where also a lot of the-- and Chips Ahoy where we had Cremewhiches last year we had cookie bars, Chips Ahoy and on Oreo and we had strong Double Delights. Oreo and Chips Ahoy that are most affected. We are seeing some nice growth onTeddy grahams, on Fig Newtons, our Snackable desserts have done very well. Our honey grahams have done very well. We are seeing some nice pockets of growth.

What kind of competitive response have you seen in cookies? To your spending.

From a spending standpoint, we have seen Keebler increase some of their spending behind Chips deluxe and we have seen Pepperidge Farm with their minis put some more emphasis behind cookies. I would say overall from our reinvestment program, we haven't seen a significant increase. Competition has been very aggressive but we have not seen a significant increase. The bigger impact on cookies has been the barrage of new products in the cereal bar area and all the spending there. And that's probably been had a bigger impact on cookies than some of the stuff going on within the cookie category.

Thank you.

Our next question is coming from Andrew Lazar of Lehman Brothers.

Good evening.

Hi, Andrew.

Some additional marketing spending is putting pressure on the margin structure. In looking at some of your key categories that you highlighted, there seems to be perhaps too much industrywide manufacturing capacity. And I'm trying to get a sense of how you think about the balance between the two options of either closing some of this capacity more aggressively or perhaps absorbing some of it perhaps even with store brand activity as many of the household and personal care companies do. Or is there some other option that you think about or can talk about?

I think from a capacity standpoint our first priority is to look to reduce some of that capacity. We have tended to not do a lot of private label manufacturing. With our agressive productivity, if you look at our track record, we really tended to close the capacity and close the plants versus doing private label producing.

One other one, have there been any changes of note in kind of the sales organization just given sort of new management structure there? Perhaps more organizationally or structurally that are worth talking about? Or no?

Well, I think we have been pretty open about we were a leader in going to a customer focused organization and we have -- we are looking to even more broadly go to more of a national customer focus and that's something that we have implemented in our southern area and something that we will continue to expand across the country. That's really been the biggest difference.

As opposed to?

And again it's an evolution not a revolution. We've always been customer focused. But as a number of our customers are really organizing themselves more nationally we are looking to organize our structure in that same way.

Thanks, very much.

Thank you.

Thank you our next question is coming from Evan Morris of UBS.

Good afternoon. Can you just--just a few questions can you first update us on the key categories that the spending behind, what the current price gaps are versus private label relative to what the historical price gaps have run. How much lower are they right now and how much further do you have to promote them now?

Well, let me -- I'm not going to give you the specific gap by every individual product and every individual item. I will just say that we--our price gaps are moving within target. We just implemented this and have started to see things coming through in the middle of September. By the time we get to fourth quarter we are on target for the past as we expected. We are seeing gaps close which is why we are seeing shares improve and our expectation by early to mid October we should be fully there.

Now when you say the gaps are close, are they closing back to historical levels or are they less than historical levels.

They are getting back into our target ranges.

Okay that is back to historical levels?

Yes, historical levels or historical price points.

Okay just another question here, are you starting to see now that in some categories you essentially forced some people to try the private label version of the branded products such as cheese and the product quality in private label is improved a lot. Are you seeing in any other categories consumers saying, well you know what, this private label version is actually pretty good in this product that we are trying. Why not try it elsewhere. Are you seeing private label share pickup in any other category unexpectedly because of this?

Again, I think we have seen across the industry over the last couple of years with the softer economy we have seen private label growth across a variety of categories. One of our keys is to make sure that we have the pricing right and we continually test our products versus both retailer brands and versus competitors to make sure that we're superior and we continue to improve the product and package to make sure we were delivering a superior product.

Right, but have you seen a pickup in terms of share gains in private labels in these other categories that typically don't have a high level of private label penetration or categories that you weren't expecting. I know private label as a whole has been gaining share. More specifically to your business, have you seen any incremental pick up recently?

I think the whole industry we have seen it pretty much across the board in most categories as retailers are filling in other categories where they haven't had distribution or haven't had an item. But there is not like a category that sort of sticks out and say wow it has really picked up in that individual category. It's been more pretty much across the board retailers are looking to fill in categories where they may not have an offer.

Thank you.

Our next question is coming from Terry Bivens of Bear Stearns.

Good afternoon, everyone. Just a couple of things. I guess as we sit here today in somewhat lateish October, I'm a bit surprised you can't narrow the range a little bit more in the fourth quarter. What would be the reason for that? It seems like a pretty wide range with only basically two months and change left.

I talked about that a little bit before. We think the range is appropriate. We did say that--I did say the top end of the range is probably a stretch as I went through some of those numbers before. Again, given what we are waiting to see how the competitors respond to the marketing activities we're doing, Betsy gave you some sense of that and want to see how that all works out and will they work better or worse than we said. We think we have it calibrated correctly. We want to make sure we see that. Something that will be outstanding, a trade customer inventory goes and how that one plays out. And always a little bit of a wild card in certain economies. I mentioned Brazil and how that's having a little bit more challenging time as we're in the second half. There's always some variability here so we left it there. As you play it through the top end of the range, it's probably a little bit more of a stretch.

Okay. And Betsy, this one is for you. As I look at the cheese meals and enhancers, the volume was up in the third quarter, but it was less than I was looking for and it also represented a deceleration from the quarter before it. I'm a little puzzled by that. It seems as though with the addressing of the price gaps of the month of September, that perhaps we should have seen some better volume there and I guess you guys cite the inventory.

I would give you two things. One is that we have seen some inventory and inventories impacting us about a point and the other thing is included in that segment is Canada and Canadian grocer which is a very low margin business for us and we did see some declines and it's really more of a timing thing in the Canadian grocery business which did impact the segment, too.

Okay, just to be clear then, that 1% reduction would be specific to the cheese meals and enhancers division.

Pretty much across the board. We saw pretty much that impact across the board. But that segment also does include as I said Canada and Canadian grocery. Volume was down in that segment.

All right, very good. Thank you.

Thank you, our next question is coming from Leonard Teitelbaum of Merrill Lynch.

Good evening. A couple of things. You are spending at the rate on average of $200 million over $50 million a month, you are $45 million into it. Are you getting -- can you give us some degree of what kind of lift you are expecting from this $200 million spend first of all? Should we see a 3 point -- we are talking on average now, not specific product, but how can we judge the effectiveness of your spend in terms of volume? Do you have internal plans for that you could share with us?

I think as we said on the last call, we were spending 6 cents and expected a trend improvement of about 2 cents. If we look at it, we are seeing -- we are seeing consumption share improvement pretty much across the board and that's the goal.

Are you seeing any disruption with the closing in California? I know people are going to shop some place. But are you seeing that as a factor in the quarter coming up? Or is that something you expect to even out?

You know what, it's too early to tell. It really depends on how long the strike goes. I think it depends on how consumers react and whether they shop at other stores or whether they decide to eat out or whatever.

Or skip a purchase cycle I guess.

Yeah, exactly. -- When we were talking about the investment, it's 8 cents in investment and it's 2 -- we said about a 2 cent improvement.

Okay, thank you. We talked about commodities. And are you-- when I tried to work it out I assumed your prices would have to come down at least 10% and maybe even more percent because the gaps had seemed so wide versus private label, at least in the store checks we did. Are you starting to see private label and other brands increase, and therefore your price reductions are certainly below what I thought they would be and you are going to try to meet in the middle? Or is there another round of price reductions that you are going to take as part of your strategy?

Well number one we are seeing private label increase their price as we would expect with commodities going up. So that was one of the questions. What will they do and their price has gone up as expected. And our approach was really two tier. It was to hold prices as a way to help narrow the gap on a number of items and then on some items where we were out of line we have taken the price down and we are not planning at this point to take them down any further

The price reduction is over then?

Yeah and again, I'm not sure everythings been totally-- again we are moving through, a lot of it has been reflected by mid October and it all should be reflected, yes.

Thank you. Say oils, and other veg oils for your portable dressing line are certainly higher than I know I thought about a month or so ago. Where is it in regards to what you have budgeted for and is that going to cause either a margin squeeze or are you going to have to take prices up in that area?

We're covered through this year.

This year meaning December?

Yes.

If it rolls off into next year, do we see a price increase or some impact on margins, is that safe to say?

I'm not going to talk about the specifics until we see how everything totally shakes out and what happens to some of the products around the world but we will manage the margin through, again either through cost reductions or through trade reductions.

Thank you very much. Go cubs!

Thank you our next question is coming from Ann Gurkin of Davenport and Company.

Good afternoon. You all recently made an acquisition, I think, back to Nature cereal was the name of it. Could you talk about that segment where you see your business going and what you project for sales for that business for the whole natural business, maybe looking out a couple of years.

I'm not going to give you specific projections. But I will tell you that we believe that the natural organic area looks to be a very nice growth opportunity and we think it's a terrific name. And we think there is good opportunity in the cereal category and potentially some of our other categories to expand the name.

If you lump all that together like with Boca and et cetera, where do you see that segment of your business groing?

Again, I'm not going to give specific numbers. We see a lot of good growth opportunity in that area and I think importantly it's incremental.

That area of additional acquisition for you.

Well, I think we said the whole area of snack meals, beverages and health and wellness and I would put that in the health and wellness camp. That will continue to be an area that we would be interested in.

And returning to the discussion of your products and recent introductions. Is there anything out there that's not meeting expectations to the levels that we saw with a Nabisco cookie pullback? Anything missing at that level?

No. Anything else has been managed very tightly so that there would not be an issue. The other things are performance consistent with our expectations or where we've taken action of course.

Right thank you very much.

Thank you.

Thank you our next question is coming from Christine McCracken of Midwest Research.

Good afternoon. Touching on Lenny's questions on commodity exposure and particularly in the confectionary segment, is that cocoa that's hitting you, or is it oil relative to your biscuit business?

Cocoa is up versus a year ago so we are having a significant impact from cocoa for instance in the international markets we did take pricing at the beginning of the year. But it's now sort of settled back down again. If you take the barometer of key 1 for our European business on the London market in pounds Sterling, it's actually up -- coming down 26% versus the year ago when it was very, very high. So we had a runnup in last year and took the pricing for the beginning of the year but we are seeing cocoa cost come down. And again, key variable there is if you look at the crop in particularly in the Ivory coast and it's a stronger crop this year but there is always uncertainty in terms of the political stability in the Ivory coast.

Looking at the big picture, at your commodity exposure, you guys have a ton of exposure obviously to some commodities that you can't manage as well like cheese. But others like oil or flour that possibly you could hedge a little better. Is it your strategy mabe to be a little bit more conservative in that area and that's why we're starting to see some new commodities flow through and hit the margins? Or are you just possibly seeing an unusually or unpredicted move in commodities?

I think the biggest impact in 2003 has been that a lot of our commodities were at historical lows as the whole industry has seen a lot of increases across board. Across the grains, across as Roger said across cocoa, across coffee, across meat, across cheese across energy. Pretty much across the board. So there really hasn't been any change. I think Lenny's question was most recently soybean oil which has been low there were issues with the crop this year and soybean oil has jumped up and as we talked about we are covered through this year and will figure out where the market settles down and what's the implications are for next year.

Looking at your press release talking about commodity cost pressure in some of your categories and certainly you've actually had some commodities rise on you recently.

Oh you know, that's what I said, in 2003, we had again those are changes versus prior year and cheese has clearly been up. Cheese is up about 40%. Meat is up. So those have been some the biggest drivers recently.

And coffee as well. From a very low price a year ago is up almost a dime. From 55 cents to 65 cents.

And cheese, and just backing up this is my final question. On your outlook for fourth quarter, typically that's a weaker pricing period, what happens with private label recently having increased prices? Do they then drop prices again and then do you see some loss of traction in the recent gains that you've made?

Well, again, there is usually a 60 to 90 day lag. So any, right now we were looking at barrel cheese in the $1.65 range. Any changes we see, we would expect cheese to come down seasonally, as we move into the end of October, November, December. And we would then expect private label to pass that through in the first quarter and as we plan for the first quarter and plan for our pricing and promoted prices that's what we planned in.

Thanks.

Thank you. Our next question is coming from Jonathan Feeney of Wachovia, Securities.

Thank you, good afternoon. Most of my questions have been answered. One question. You did $70 million in share repurchase in the quarter. Given where the stock is relative to others in the group. Have you given any thought and of course the projected handsome increase in discretionary cash flow. Have you given a thought to more share repurchases as a way to kind of express confidence that we are turning a corner here?

Hi Jonathon, Jim Dollive here, we certainly do look at that, but remember our share repurchase program is really intended as a way of offsetting the delusion from our stock comp program. We do look at the alternative of being more aggressive on that, but we need to be little bit careful given we only have about 16% of our shares to trade publicly.

Right. What are your priorities as far as cash flow currently?

Well, as we always said, there is really a couple of key areas there. First and foremost is making sure we reinvest back against the business and growing with our franchises. And we look at acquisition opportunities as a vehicle to do that as well as the internal growth aspects. In the past we put a lot of our cash flow into bringing down our debt levels. We felt that was appropriate. Where we were to split up by our credit rating. We will continue to do that but I think we have shown dividends have now become a higher priority with the 20% increase that we took recently. And the program you just mentioned which was the stock program for offsetting the stock comp is also high on the list as well.

Okay, thank you.

Thank you.

To ask a question, please dial the numbers 1, followed by 4 on your touch-tone phone at this time. Our next question is a follow-up coming from David Nelson of Credit Suisse First Boston.

Hi thanks, Betsy, when you were talking about issues in cookies being primarily in Oreo and Chips Ahoy, are those the lines with the most line extensions, do you think you may have stretched the brand equity on those too far?

I don't think it's that we stretched the brand equity. If I look at our news this year it's not as strong as the news we had last year. We had a couple of things this year that didn't play out. that well. The news this year was not as strong as it was last year. -- I think although I will say Oreo has done pretty nicely. I think one of our learnings is we had a lot of good ideas and we probably could have paced them out a little bit better. I think the other thing having read some of your materials, we do see a fall off on pretty much all products in year two because of the high trial and repeat the second year is a little bit less. But this is an area where you will see us next year continue to look at snacks are a treat, what are the treat fun extension that make sense for the brands and what are the health extensions that make sense.

We are seeing real declines. So absent new news, we actually see declines, is that the expectation?

Well, again, the key is particularly on snack products you need enough news in each year that you continue to at least exceed what you delivered in the year before.

But we are seeing declines.

Yes, and we're seeing declines because of pricing, because some of our products this year did not work as well. We don't have as much news as we did last year and we're seeing some again a lot of competition from alternative categories.

Thank you.

Thank you.

Thank you our next question is a follow-up coming from Eric Katzman of Deutsche Banc.

Hi, just a quick follow-up. The first one, Jim, can you walk through the top line component again. I based on the press release I calculated them at a little bit differently. And then how much was promotion subtraction to your top line?

What you had done that. I can pick it up. No I can--because the volumes are down or reported basis 0.2% revenues up 3.7% you get a gap of 3.9% between revenues and volumes. Currency about 3 points. Pricing--net of trade we are at about a point and a half. And then the balance of that is between that because we have those you are up 4 1/2% I'm trying to explain the difference of 3.9% and the rest is negative mix. And basically acquisition and divestitures pretty much offset each other.

Okay. All right and then-- Okay, that's good. Thank you.

Thank you.

I would like to turn the floor back over to management for additional comments or closing remarks.

Thank you. I want to thank everyone for joining us tonight and have a great evening.

This does conclude the teleconference. You may disconnect your lines at this time and have a great night.