億滋國際 (MDLZ) 2004 Q2 法說會逐字稿

We're going to go ahead and get started. Good morning. Great to have all of you with us here at Kraft Food worldwide headquarters in Northfield. And we also welcome also to those of you joining us by our phone conference call and Web cast. We've got a full agenda planned for you today. Our goal is for you to leave with a better understanding of where we are today and the actions we're taking to position Kraft for sustainable growth. In the first hour or so Roger Deromedi, Kraft Foods CEO, will present our second quarter results, and then Roger and Jim Dollive, our CFO, will take questions from our live audience. Those of you on our conference call and Web cast are in a listen-only mode. We'll then break for an hour for lunch, lunch will be outside and feature many Kraft products including the new Tastimo (ph) systems, which I know many of you are interested in seeing. After lunch beginning at 1:00 Central time we'll take you through a series of presentations that will give more detail on the actions we're taking and the progress we're making on our sustainable growth plan.

Each of these sessions will also be followed by a Q&A session. So in some cases we may give a top-line response this morning to a question if we feel that we'll be answering it in more detail later this afternoon. The entire day's presentations are Q&A sessions are available live on our conference call and Web cast and will also be archived on our Web cam -- on our Website. Now, just a few housekeeping items before I turn it over to Roger. If you need to leave the meeting for any reason please feel free to do so. The restrooms are out the door on your right, down the hall into the conference center where phones and fax machines are also available. I'd ask that you now turn off your cell phones or put them in a manner mode. At the end of today's sessions at around 5:00 a bus will be heading to O'Hare airport for those of you with a flight home tonight. On your way out be sure to take a bag containing some of our new products as a token of our appreciation.

Early this morning we issued a press release with our results and this release is available in your binders sphere and on our Web site. I remind you that our comments today will 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 presentation or our press release, for review of some of the factors that could cause actual results to differ materially from projections. Also during our presentation today we'll make reference to non-GAAP measures which we believe provide you a better view of our business performance. You'll find a reconciliation of those nonGAAP measures to report our results in the press release and presentation which are on our website at www.Kraft.com. With those details behind us I now turn it over to Roger.

Thank you Mark. Let me also personally welcome you to our worldwide headquarters. Today my management team and I are looking really forward to sharing a lot of information with you about the second quarter and about the remainder of 2004, but most importantly about our strategies and plans to deliver sustainable growth. Our second quarter reflected significant activity and overall our sustainable growth plan remains on track. Through our focus on building brand value, consumption of shares improved in North America with very good results in the categories with increased spending. In terms of portfolio transformation we're successfully integrating the Veryfine acquisition and are now ready to expand that business into new geographies, We signed two strategic licensing arrangements in the quarter, one with Starbucks to distribute Tazo Teas and the other with Dr. Arthur Agatston to utilize the South Beach Science trademark on our packages and in promotions. In our efforts to expand global scale we continue to grow our business in developing markets despite challenges in several large geographies and we're driving out costs and assets with a restructuring program that continues on track as we announced the closure of seven more manufacturing facilities in the second quarter.

And finally and most important for the long term we executed all these activities while putting a new organization in place. I'm particularly pleased to report that the new organization is working well. While there are many reasons for to us feel good about Quarter 2 we did encounter an environment that was more difficult than we anticipated in three areas. First, costs for several key commodities, most notably dairy, were up significantly in the quarter. Second low carb diet trends continued resulting in soft results in several key categories that offset solid growth in other businesses. And third, price competition intensified in western Europe particularly from discount retailers and private label brands impacting our coffee and confectionery businesses. So with half the year behind us and a better view of our internal initiatives and external environment we've updated our outlook for the year.

Top-line growth remains on our original expectations reflecting acceleration in growth in the second half versus what we've delivered in the first half. Our marketing spending plans are being maintained. And we're revising down our EPS guidance by eight cents on the year to $1.55 to a $1.62 reflecting the higher commodity costs that we will be unable to recover through pricing this year. We're certainly disappointed by the need to take down our guidance. However, given the unusual commodity situation, in particular dairy, we believe we're making the right strategic pricing and spending decisions that are in the best interest of our brand's health, both for the second half of 2004 and more importantly for the long term. With that as a quick overview let me now turn to the specifics of the quarter.

Second quarter revenues were up 4.6% with three points of growth coming from currency and offset slightly by the impact of divestitures. That results in 2% growth on a constant currency basis excluding the impact of divestitures which is a measure we use for our top-line guidance. This growth was a result of pricing actions and adjustments to our price management trade spending which contributed 0.6 points and volume mix of 1.4 points. Revenue growth was strongest in the U.S. cheese, Canada, North American food service segment due to both volume growth and pricing and in Europe, Middle East, and Africa segment due to currency. While the U.S. snack segment was down 1.4% this was largely due to soft results in confections as we're continuing to see sequential improvements in our biscuits business. Our second quarter volume was up 3.6% with reported growth slightly offset by the divestitures of our Invernizzi cheese business in Italy and our German rice business last year. About three points of this growth came from acquisitions largely reflecting the Veryfine acquisition and 0.8 points came from the base business. Volume growth excluding divestitures was up in five of six segments with U.S. snacks down just slightly.

The 10% volume growth in the U.S. beverages and grocery was driven by the Veryfine acquisition worth 8.5 points of growth. With this heavy ready to drink beverage business having much more impact on volume than on revenues. Our U.S. market shares continued to show improvement in the quarter. Last year shares were up in categories representing only 38% of our operating company's income. And in the first quarter shares were up in 39%. The trend improved considerably in Quarter 2 with shares up in categories representing more than half of our OCI. While this measure still isn't where we'd like it to be we're making progress. Our International top line results were soft overall and below our expectations. The results were mixed country by country. With strong results in Italy and Benelux in the developed market and China and Argentina in the developing markets and the results are on track with our expectations in Germany, U.K. and Ireland, Brazil and Poland. However, we experienced soft results in several important markets.

In France. price competition in coffee and confections continued we realigned prices earlier this year and are taking even more aggressive actions in the second half. In the Nordic region, overall soft results were impacted by the transportation strikes in Norway where volumes were down 9%. In Mexico both our ready to drink and powder beverage businesses were caught in the intense price competition between the major carbonated soft drink players. Our Mexican beverage business is the largest portion of our portfolio there and Mexico is one of our most important developing markets. So soft results in Mexico impacted our overall international growth rate. Finally in Russia we continue to work through some softer than expected consumption and continuing distributor inventory reductions. Looking at new products launched in the first half we remain on track. In snacks Golden OREO and Uh Oh Oreo, have gained strong distribution and are moving off the shelf very well. We introduced Honey Maid oatmeal cookies bringing a well-known brand into a large segment of the cookie category. It's still early but initial results are very promising.

Also in snacks Milka M-joy chocolate tablets, or what we call chocolate bars here in the U.S., have performed very well in Germany and Austria delivering over $10 million in revenue in the first half. In convenient meals we launched DiGiorno thin, crispy crust pizza in March, in Cincinnati as a lead market and followed this up with a national launch in May. Our product testing indicated that this product was preferred over the competition and in Cincinnati it has already surpassed competitive items in terms of velocity per point of distributions. And we've got more pizza innovation coming in the second half that you'll hear about more about later today. We launched a CarbWell sub brand in several sectors to meet the demand for consumers looking for lower carb alternatives of their favorite brands. This sub line has over 20 items under our major trademarks including Kraft salad dressings and barbecue sauce, Snackwll cookies, Balance energy bars, Post cereals, and A.1. steak sauce. The parent brands give the product their taste credentials, while the CarbWell sub brand clearly communicates the sub lines benefits. Pricing is at parity to the existing brand and initial take-away has been very good.

While the number of people on carb counting diets may decline in the coming years we believe that there will remain a segment of the population that will continue to look for these types of product just as there remain sugar free, low fat, and fat free segments in many other food categories. The key is to have the taste and price right. And I'm particularly excited about our recent expansion of Back to Nature natural and organic products into several new categories. In less than eight months since we acquired the Back to Nature trademark last September we have launched organic cheese slices and cream cheese, macaroni and cheese with organic cheese sauce, cookies and crackers with no trans fats and new varieties of cereal and granola. The launch of this line has gone extremely well with both major natural retailers, whole foods and wild oats, authorizing items in all seven categories so that's a quick look at our Quarter 2 new product launches and you'll see a lot more new products in Dave, Pepsi's, Hugh's's presentations later today.

Turning now to our profit results operating income was down 23.7% and EPS was down 25.5% with about 9 points of the EPS decline attributable to restructuring costs. There are several key first half and quarter two EPS drivers. Restructuring charges in quarter two came in at 5 cents per share after incurring 12 cents in quarter one. And we began to realize some savings in quarter two, the equivalent of a penny a share. We made good progress on our restructuring program in the quarter. As I said earlier we announced the closure of 7 more facilities bringing our year to date total to 12. We finalized the reduction in our North American salaried work force and we wrote off unneeded assets. We continue to project restructuring costs of 30 cents for the year which leaves us with 13 cents to be incurred in the second half. Full year savings for the program are still projected at 120 to $140 million. Or 5 cents per share with four cents being delivered in the second half. We are very confident we'll be able to deliver and achieve these targeted savings. As I indicated earlier commodity costs are really the big story for us in this quarter. Impacting operating income by over $250 million or the equivalent of 10 cents per share. There are two reasons that the impact was so great in the second quarter.

First, most of our largest commodities were up, and those that were up increased significantly. Second, our largest commodity, barrel cheese, was up the most averaging 70% higher in the second quarter of 2004 versus the same time period in 2003. These significant increases were only partially offset by more modest declines in some less important commodities for us such as peanuts, sugar, and cocoa. Let's take a closer look at cheese, which had such a big impact on us in the second quarter. This graph shows the barrel cheese cost for the most recent five-year average and for 2003. As we've talked about before the market typically operates with a fairly predictable bell-shaped seasonal pattern. Costs are typically higher in the third quarter when milk supplies are weakest due to the hot summer weather and demand is strongest because of the summer ice cream season and back to school fluid milk needs.

But in early 2004 the barrel cheese market took an unprecedented turn rising in April to the highest level in history. Reaching $2.17 per pound. Throughout most of the second quarter the cheese market held at significantly higher than historical levels. Since its peak in April the cheese market has returned to more historical price levels declining to $1.43 per pound as of last Friday. Very importantly, though, the second quarter higher cost impact will carry over into the third quarter due to the effect of inventory values. We'll talk more in a minute about our pricing approach on cheese and why we believe we manage this difficult situation in the best interest of the business despite absorbing an earnings hit in the quarter and on the year. Next, our end market spending was up an equivalent of six cents in the second quarter after being up three cents in the first quarter. This spending was a key driver of operational growth. Which represented 7 cents in the second quarter after providing three cents in the first quarter.

Operational growth primarily reflects our volume growth, pricing, and ongoing productivity efforts. In terms of total dollars, second quarter end market spending was up about $170 million concentrated in North America. Just over two-thirds of the spending went to our price gap management. This increase was up almost $100 million from the first quarter and was concentrated in the month of June as we began spending and support of second quarter new product launches. To better understand our top line results in North America and the impact of our increased spending we split our businesses into three groups. First are the businesses on which we increased end market spending by 10% or more in the second quarter. These businesses represented about three-fourths of the total increase in spending. Many of these such as cheese, meat, and coffee reflect the continuation of reinvestment spending we began in the latter part of last year. While others like Snack Nuts and salad dressing became more of a focus in the first half of this year. Overall our results for these categories were strong with aggregate volume up 4% and revenues up 7% with the higher revenue growth driven by pricing in cheese.

The second group comprises categories that did not receive significant increases in spending but drove growth overall due to effective marketing and price gap management. This group includes key categories like bacon, dinners, and ready to drink beverages. Overall this group experienced solid volume growth of 3% and revenue growth of 4%. The third group comprises categories in which we face competitive challenges or the category was impacted by low carb diet trends. Additionally, in some cases our new product timing has been shifted to the second half as compared to the first half when new product launches occurred more in the first half. The key categories included here are biscuits, cereal, confectionery, and pizza. Collectively these businesses were down 4% in volumes and 5% in revenues and were the primary reason our overall North American top-line growth was not more robust. In this afternoon's session Dave Johnson, President of our North American commercial unit, will give more details both on the categories that did well and what drove their performance as well as discuss the weaker categories and our plans for improvement in the second half.

While Dave will expand on these categories results I did want to address the impact we believe low-carb diets are having on our business. As I know this topic is one of much interest and debate these days. This chart shows the data for the last nine quarters and shows consistent growth for categories commonly considered low-carb and also shows defines for categories commonly considered high carb. This data indicates these trends began accelerating back in quarter one of 2003. While the trends generally continued in the latest quarter you can see that the rate of growth of low-carb categories versus prior year has slowed for the first time. Like many in the industry, we believe this rate of growth will moderate later this year as it lapsed high-growth year ago periods. Top-line growth in the quarter also came from pricing actions we took in the first half to address the higher commodities. Inn North America we increased prices on cheese, frozen pizza, bacon, and several food service lines. In Latin America we increased prices on biscuits, powdered soft drinks in Venezuela and confectionery in Brazil as a result of inflationary pressures in these developing markets. However, due to fixed competitive challenges we did decrease prices on confectionery and coffee in France to address price gap issues more aggressively.

As I indicated earlier these pricing actions were not sufficient to offset the higher commodity costs in the quarter or for the year, particularly in cheese. We believe the approach we took on cheese which was to price our product more in line with our full-year commodity expectations rather than the short-term spike that turned out to be the right one given that the dairy commodity cost has moved down significantly from the peak. As a result the first-half impact of the spike in cheese costs will not be recovered during the remainder of the year. We also did not increase prices in a few other categories that experienced higher commodity costs. In coffee we held our prices due to the challenges we're facing from branded competition. In biscuits the category as you know has been weak and we made a strategic decision to hold prices to help revive category growth. Similarly in cereal, the category has been relatively soft and despite higher grain costs our competitors have not increased prices. And in meat excluding bacon we are managing price gaps versus regional competitors that have been aggressive on price points despite higher costs. Each of these decisions has been made within the overall context of our sustainable growth plan and we believe each is the right one given our competitive situation.

Returning to other EPS, drivers pensions and restricted stock expense were a two-cent negative impact in the quarter and we continue to project 7 cents impact for these items on the year. Below operating income, taxes and interest had no impact versus prior year, and slightly lower interest expense was offset by a higher tax rate. And finally as was the case in the first quarter favorable currencies drove a 1-cent benefit in quarter two. In total for the quarter we were down 14 cents to 41 cents per share with 5 cents of that coming from restructuring costs. In the first half, discretionary cash flow was down versus prior year by around $100 million as lower earnings and $320 million in voluntary and tax deductible contributions to our pension plan were partly offset by lower capital spending.

Turning now to our updated guidance for the year. We continue to expect constant currency revenue growth excluding divestitures to be around 3% but we've increased our volume guidance from 2 to 3% to be around 3.5% reflecting the significant impact that the Veryfine acquisition will have on our pound shipments. This top-line guidance projects a step-up in our second half growth rate versus the first half. Our first half constant currency revenue growth excluding divestitures was 1.4% or 1% excluding acquisitions. To achieve our full-year target of 3% we must drive total growth of 4.5% in the second half or 4% excluding a half-point benefit from acquisitions. And volume performance is also expected to improve in the second half. First half volume growth excluding divestitures was 2.4% with just under two points coming from acquisition. We project a total volume increase of 4.5% in the second half.

There are several factors that will drive our second half growth. Our new product launches are timed later in 2004 versus 2003. We also expect our marketing spending to build momentum and continue to drive the trend improvements we saw in the first half. We spent around $240 more in marketing in the first half of the year and with a full-year targeted increase of 500 to $600 million we've got a significant amount of spending to come in the second half and much of that in support of new products. Third you may recall that the European heat-wave last summer had a significant impact on our coffee and chocolate businesses and we do not expect a repeat of that issue this year. And finally on revenues, we will realize the full impact of the price increases we took in the first half of the year. In summary we believe we have the right plans in place to achieve the second half growth target.

Let's take a quick look at some of the items we've launched late in quarter two or will launch in quarter three that will drive that second half top-line. You'll hear more about these and others this afternoon. First, in snacks we've just launched Nabisco 100-calorie packs. This line has been very well received by the trade as one of the many new items that makes weight management even easier. In beverages we'll be expanding distribution of our Veryfine fruit flavored waters to new geographies. Those of you from the northeast where our distribution is the strongest are probably very familiar with these products. Those of you from other areas of the country will begin to see these products in the coming quarters. If you haven't tried them before I encourage you to try them at lunch or during the break later today. I'll tell you I personally drink four or five a day.

Also in beverages we began shipping Tazo Tea products to grocery clubs and convenience and mass merchandising stores around the country in the third quarter. We're very excited about this line as we have a small percentage in the adult refreshment beverages. And it's a good example of sourcing from adjacent categories to improve our new product incrementality. And as we revealed earlier this year we're launching our Tastimo coffee business in France this year as a lead market.. The machine will be in stores in France in time for the holiday shopping season and we began shipping the coffee, tea, and hot chocolate tea disk this month. We've received excellent feedback from our retail customers on this product and have gotten strong distribution in all channels. And again if you've not had a chance to try a hot beverage from these machines I encourage you to do so in the tents today. We continue to be very excited about this opportunity because it's a highly unique and proprietary system and we are currently developing our global expansion plans.

In the U.S. grocery sector our cereal business struggled in the first half as our competitors launched a significant number of new items. At the end of the second quarter we launched two new fruit added varieties of Honey Bunches of Oats, one with real peaches and the other with real bananas. In the past we've found these fruit added extensions to be very incremental to the Honey Bunches of Oats line and we look to continue to grow this powerful cereal brand. In convenient meals Lunchables had a weak performance in the first half and to improve we're launching chicken dunks. Our research indicates that this extension should be one of our best and most incremental items in the line. Here again we're sourcing volume from adjacent categories in this case a large restaurant chicken nugget business to increase our incrementality. Also in convenient meals we're very excited about our latest innovation in frozen pizza, DiGiorno microwave rising crust pizza. This product uses new microwaveable dough technology to deliver the same great rising crust quality consumers expect from DiGiorno, but reduces the overall prep time from over 20 minutes to just 5 to 6 minutes. This product will begin rolling out later this quarter and will also be available for you to taste during our break later this afternoon. So this is just sample of our new products.

As I indicated before, the timing of our new product launches is skewed to the second half relative to last year. To put this in perspective first half new product revenues in North America were only about 60% of last year's level while the second half will be about two times last year's revenue. More important than gross revenues, however, is the incremental impact. And we're confident that the new items are more incremental than we've delivered in the past. Turning now to the full year earnings we expect EPS of $1.55 to $1.62 including around 30 cents from restructuring costs. This range covers the current street estimate of $1.90 if you exclude the restructuring cost. This new EPS guidance range reflects an 8-cent reduction from our original guidance in January although we had guided our EPS projections to the lower end of our previous range during our first quarter call. The main driver of this 8-cent reduction is a net 11-cent impact of higher commodity costs that we do not expect to recover fully through pricing. Dairy represents a majority of this. This impact was partially offset by a lower expected annual tax rate of around 33% which will yield three cents of benefit. Additionally volume mix unfavorability due primarily to the soft first half international results will be offset by currency favorability.

Finally we've updated our full-year target for discretionary cash flow, which we define as net cash provided by operating activities less capital expenditures. Our new discretionary cash flow projection is $2.6 billion including about $200 million cash impact from the restructuring. This discretionary cash flow guidance is down $200 million from our original guidance of 2.8 billion. The key drivers of the reduction are lower earnings and the after-tax impact of the voluntary contributions we made to our pension plans. These negative impacts will be partially offset by reduced capital spending and working capital improvements. While we're clearly not in the position to talk about specifics for 2005 we felt it was important to give you an early outlook on some key issues and business drivers for next year. Key positives may include continued top-line momentum from the cumulative effect of our marketing spending. Increased incrementality from our new markets which Betsy Holden will talk about later this afternoon. Lower restructuring costs and higher restructuring savings and portfolio transformation.

However, these portfolio transformations could obviously also include divestitures which could reduce our EPS. Key potential negatives may include higher pension costs although the incremental impact continues to diminish, incremental restricted stock expense, and continued growth in discount retailers and private label in Europe a topic that Hugh Roberts will address further this afternoon. Additionally there are a few key unknowns for next year. Currency has been a benefit for us this year, primarily due to the euro, and it's uncertain where currencies will be next year. And while we don't expect a repeat of the significant run-up in commodity cost next year, especially in dairy, it is too early to project costs for our key commodities. So in summary there are three key messages today coming out of our second quarter results. First, the many initiatives accomplished in the quarter are a good indication that our sustainable growth plan is on track. Second, we recognize that the environment, especially commodities has been more challenging than we anticipated and we're taking steps to address these challenges. And third, we've updated our outlook for the year with top-line guidance on our previous expectations but earnings revised down to account for the higher cost environment. While the earnings reduction is disappointing we firmly believe our actions this year are consistent with priorities we laid out in our sustainable growth plan. And we're acting in our brands and our shareholders' best interest for the long term.

And finally, on a personal note I want to thank all of you for your well wishes and support when I was out earlier this year. I received many calls and cards and messages and they're all very much appreciated. So thank you very much and Jim, Mark, and I would be very happy to take your questions at this point in time.

Questions? David, you were quickest. Also as we go through we're not going to ask you to stand up and state your name and all that. We're all in here together and having a conversation and there will be microphones on each side so wait for the microphone to come. David.

-- big picture, given the top line guidance almost seems conservative in the second half given the pricing you've taken, given commodity costs, maybe some of that is give-back if commodity costs go back down, but others out there, Wal-Mart namely, have talked about the consumer getting squeezed because of gas prices, milk prices. What are you seeing out there in terms of consumer behavior that's changing and what are you doing about it?

Again, I recently put in a chart for first half second half so you can really look at what our expectations are and as you can guess I and my management team spend a lot of time talking about that first half, second half and many debate that it's too low many debate that it's fairly aggressive. And this is where, when you weigh the factors together, what makes us feel good is the action that we're taking. We are seeing that consumers continue to be sensitive on their purchases as you've heard from the large retailers. But as we look at our categories we see in the continued categories growth in the ones that -- where we put in the innovations in the pricing and if that price value equation is right and Dave will take you through many examples of where we think when we talk about those equations but we're not envisioning a massive slow down in the second half of consumption by consumers but it's not going to be taking off like a rocket like many had expected. Over there, then we'll swing over here. All right. That's good enough. And we'll move to Terry next. All right. He's back.

Well, it's good to see you back, Roger.

Thanks.

You could advertise Fruit 20 as preventing dehydration. I've seen a lot of companies go through restructuring but few of them have kind of missed numbers so quickly after announcing a restructuring. I think what you're saying is that's totally due to commodities and as they reverse maybe we can expect more but are you just going to take that more and spend it back in the market would be my first question.

Oh, okay. You're doing your question in parts or do you want to hit me all at once?

Well, and then, you know, I kind of applaud the lower working capital and the capital spending that you've done in the quarter. You're taking it down for the year. I guess a lot of other companies have kind of really focused on this, and I just wonder how much more might there be in terms of declines in cap spending and improvements in working capital.

Okay. Let's start with the first I'm not going to give you a projection for 2005. But those who know the market and do their own projections on commodity costs could say that there was, you know, a one-time negative impact this year from the high cheese cost and presuming we don't have a repeat next year we won't be seeing those higher costs next year, obviously, we need to see where pricing comes out and competitive actions come out. And then your question is will we spend it back or not. Again we're spending the 5 to 600 million that had planned this year despite the fact that we had environment run up and we have a game plan for 2005 and what we want to spend behind our brands. I think we'll stay on that game plan. So we'll have to see how the environment turns out but if you do your analysis you could argue that there's costs next year that won't occur that are occurring this year. To your question on working capital and CapEx, I think Jim this afternoon will actually go through a detailed analysis on our cash conversion cycle and actually give you all the pieces of that and we'll give you some perspective on it, where we see the opportunities and what we're doing to continue to improve that cash conversion cycle. So we do see it improving -- continuing to improve going forward and Franz-Josef Vogelsang will touch on some of the programs that we're doing and what we see are the levers to get out some of the working capital in our system as well, so we'll go into that in great detail this afternoon. Terry and then over here.

Thank you. Roger, I guess given the way cheese has moved most of us can see how that's going to improve as we get out of this year and then go into next year but I guess relative to my expectations the western Europe situation seems to be a lot worse than I thought it might be. You and I talked a little bit about all the coming into France but could you kind of give us a road map for how you think that situation can improve as we go forward?

Sure. I'll give you some perspective now as I don't want to steal Roberts entire presentation this afternoon.. But what we see and you've seen the growth of what we call hard discounters and I'll separate hard discounters from what we call soft discounters, or you can call them all together discounters in totality. Hard discounters like Alby (ph) typically sell nearly only private label. They may have a small percentage of some branded product.s Soft discounters on the other hand have about half and half of branded versus store brands and here would be a good examples would be Lito, which is one of the fastest or actually the fastest growing chain of stores in Europe right now. What we've seen is actually in Germany in our categories at least Alby actually declined, and that they did not gain shares as they typically have in every previous quarter. But we do see them coming into France but what's encouraging for us is the growth that we're seeing with the soft discounters who carry their private label and also carry number one brands.

We've now put together, I think, terrific programs with the soft discounters who are helping, that's actually why our business actually is right on track in Germany right now, because of that successful effort we're doing with soft discounters. Hugh will take you through our exact strategies, what we're doing to deal with that including things like even taking some of our old trademarks and selling them exclusively to some of these soft discounters. So some very unique things that we're doing to deal with that channel in the different ways.. So you'll hear more but I -- it is a concern but I think we have the right actions and in the end it always comes down to you need to have strong number one or number two brands because that's whats going to be carrying these soft discounters going forward. Move over here. We'll go all the way over, whoops, I just pointed over here, Eric. Then we'll get back.

I guess the first question has to do with kind of the efficacy of your promotional spending. I mean it seems like .8% volume growth ex acquisitions, even though it did increase share I guess in half of your categories, was pretty light, and I'm wondering how much of that was due to new products and the pipeline fill, then I'll follow up with the second.

Okay. All right. Well, Eric, as you look at it one of the things, and Dave will talk at great length about this afternoon, is we've been in an executing in the category executing quarter 2 was in our dairy category, cheese category, is a consumption-based trade semiprogram, CBM as we call it. We have been seeing from that program reductions in our trade inventories, as we execute that program and we started just over two years ago and now we've just finished off in all our categories. We are seeing on some impact from that program offset by some other increases in other categories. As we look at it customers like Wal-Mart who are driving a lot of our consumption growth also are, you know, staying very tight on their inventories as well.. So you do see some of that in the numbers. Interesting the way we really just broke out the numbers the way we did is we feel very good about that group of the first thing where we increased -- first categories we increased our spending in that middle group of categories.

Truthfully we just got hammered in about four categories in cereal, to biscuits, to frozen pizza, and confectionery. So in that you can't see we don't own them, we own them. And we have issues in those categories and Dave will take you through what we're doing to address those challenges, but as we look across our portfolio we feel good about how our marketing is biting we're see good returns on both the trade promotion spending, on the lift that we're getting with that increased spending, and again the spending is building over time. I did point out that our increased spending is 170 million we spent incrementally versus year ago in quarter 2, was primarily focused in the month of June because many of the new products are first shipping early in quarter 2 and we will obvious wait that 30, 60 days before turning the TV on and starting the promotion. And so we actually expect that carry-over effect to be kind of impacting our quarter 3. Does that give you some perspective about the quarter 2?

So of the .8% you would say a fairly small part of that is due to new products?

A fairly small part of that is due to new products, yep.

Okay. And then the second question has to do with the forecast. I think you were looking for something like 4% top-line revenue and 2.5% volume and it seems like price mix almost since I guess the second quarter after you came public has been a negative. Now, granted, you have some pricing going in there but it seems that the promotional spending is then moving up it's going to be awful difficult to have that positive spread so I'm wondering, you know, how that is and how confident of that spread is possible.

You're right. Trade spending has gone up as part of price gap management and would we had included in all our forecast as we've done that. The big difference is cheese pricing. When you take 5 to 15% pricing on cheese and given the size of that category board you have quite an impact from that cheese pricing to top line revenue. Also as we commented we have taken pricing in some of the developing markets, in particular, Latin America to offset inflationary prices in those countries. So I think that's where we have a pretty good sense what that revenue improvement is going to be net of I'll call it the lift price increases that we've taken and our increased state promotion spending. Thanks. Right here in the middle.

Roger you had flagged portfolio transformation as something that could potentially be a dilutive impact next year on the business and you flagged that earlier as a key part of the change you want to drive at the company and you want to move quickly. And obviously you haven't announced anything today along those lines but can you give us a sense sort of underneath the surface how active your efforts are there, how much time you're spending and what the potential scale of those actions could be?

Sure. I'll actually come back to it at the very end of the presentation, but again, I won't be giving you specifics. Let me give you a little bit how I'm thinking about what we've deny doing at Kraft over those past six months.. As you know, in early January we announced a new organization the first thing we had to do is get in place our new global organization. Then, you know, the end of January we announced a restructuring program to drive out costs so we can spend back against our business and then there's been an awful lot of focus, as Dave Johnson will talk about, to get our brand value occasions right, call that the blocking and tackling. Are the price gaps right? Do we have the right marketing in place on our core brands? And then Betsy Holden's group has been doing a lot of effort to get place, I'll call it the internal development side in the category strategies related to our portfolio transformation and that's really been our focus in I'll call it the first six months. Getting the basics right, getting the organization in place, and I will tell you now in the second six months I am spending a lot of time, we have, I think as you know a new head of corporate strategy, Linda Hefner who has joined us.

We're going to spend a lot is time looking at our portfolio. And as I'll mention at the end, the key is to bring greater focus to our portfolio, be in categories where we can have global scale, where we can leverage our technology on procurement wealth, but very importantly very cognizant of geographic scale as well you need both you need to have category scale and you need to have geographic scale, and so we're reviewing our entire portfolio across the five sectors that we have talked about. And we will continue to have that focus as we said on categories that will provide us faster growth and particularly those in line with consumer trends and health and wellness and I'll talk more about it at the very end, but it is a major focus of my time and energy at this point in time, now that we've got some other major pieces underway. You still have the microphone, go ahead.

On the tax rate at 33% which is helping you this year can you talk to what's bringing it down and whether that's sustainable going into next year.

As I've been answering all the questions I'll turn this one over to Jim.

I was hoping you'd answer all of them. As we indicated the tax rate year to date is 34% and we've got a 33% average for the year so obviously we're anticipating about a 32% average rate for the second half of the year. There is built in an assumption that we will have a favorable resolution of an outstanding tax item that will cause a difference between the Q3 and Q4 rate. I can't give you the timing on that simply because we just don't know. We have to get it through the process. When we do know we will tell you but for modeling purposes I would go with a 32% rate as an average for the balance of the year.

Over here. Roger you talked about the four businesses that got hammered in this last quarter. When I think about, you know, Kraft's portfolio being dominant in so many area and having that kind of scale, if you will, while they may not all be working in the same direction at the same time I sort of felt like that in some ways perhaps insulates your categories from really seeing any kind of really sharp fall-off because you do these multibrand promotions and they mean that much more across, you know, 15 different aisles I'm curious just how that really happens given the broader scale that you have. Again, if you talk about some of the categories where we had the downfalls, you can take the cereal category we're down double digits, we're in fact turning down digits, outside the impacts were so large, and yes, you know, you're very right that we do have group promotions and so forth, but it still comes down to us versus competitors in the category despite our ability to leverage our scales with the sales force. I think it's a -- you know, you're right in terms of broad portfolio. It allows us to moderate the ups and downs and, you know, come out where we are, but the magnitude of the impacts particularly in confectionery and cereals were just so large, I guess I'm actually, well we've put on that list, you know, biscuits and cookies and crackers, I'm actually encouraged on the sequential improvements on that. It was down but it's, again, it's -- the down was less than what we've seen in previous quarters and Dave will actually talk through that more this afternoon so I'm actually encouraged on that one but it was just the size of the misses in particularly in cereals and confections.

Roger, I want to get a little bit of your perspective to reconcile something for me. On -- back when we heard the last conference call, I think there was a fairly clear understanding that cheese prices were going to be up substantially. In your presentation you've highlighted that commodity costs were the big issue, the big driver here. But I guess the question is really what change from the last conference call to today that really then comprises the magnitude of the change? Because I don't think it can be the full 11 cents. Some of it had to be in your number before. Then as a very much, you know, to draw another piece into this whole equation, when I look broadly across the portfolio, maybe I'll ask you the question, what is the entire U.S. retail portfolio doing on a volume share basis? So is that whole portfolio gaining share, or losing share? There's been some debate about this particular point.

Okay. Again as we reconcile back to our original guidance and show that 8-cent difference if you go to from where we were when the earnings call was done in April and we said we were going to be at that lower end of our guidance, again, call it $1.63 because that was the low end of the call, if you look at it -- without the 30 cents it would be $1.93 to $2. But, now you say where are you in that range, call it whatever, halfway between our 1.55 to 1.62, call it in between there so it's gone down maybe 4 or 5 cents. Why 4 or 5 cents now versus where we were in April? Two things. One is the cheese costs hung up higher and longer than we thought. We knew that, you know, at that point in time we knew where it had to spike. We also expected a drop more quickly. Typically we see it spike and then drop more quickly. It hung much longer. It finally has dropped in the month of June where it is today, but it hung longer than we had anticipated. And the second thing is that the international business did not perform as well as we thought in the second quarter because of the challenges we had in France. So while we thought we knew we had the currency favorability we thought we could, you know, use it to improve our earnings or do other things with it across the business but in a very sense had to use to offset the shortfall in the international business. So those are the two drivers versus that mid-April forecast.

What about the volume share across the U.S. retail portfolio? Would you have that figure collectively? You gave a metric on there that I don't know that I understand it well enough.

Yeah. Let me explain the metric as we showed it and then I'll give you a different perspective. What we do, we look at our top 25 categories which represents the bulk of our OCI. And reason we waited by the OCI, deliver by that category, because a fairly unimportant category within that top 25 shouldn't get the equal weighting that something like a cheese does. We think it's a more representative way to think about our business. Many times people will say your shares are up in X number of categories versus down this many categories. Well, I gotta tell you I'd rather be up in process slices and cheese than on, you know, Milk-Bones. So this is where -- it's called focus on the things where you make the money and where the volume is important so that's why we use that metric at what percent of the OCI of that top 25 had shares up that's why we had the metric of the 38% for all of 2003, we're up in 39% of the OCI in quarter 1, and then up over 50% in the second quarter. Is that where we want to be? No. We probably want to be roughly that two-thirds ranges of our shares being up. We're never going to expect all of them to be up because truthfully there's a trade-off. Sometimes the chase share is a margin impact you don't want to go after, there's always some trade-off and there's always a case where competitors are doing things that you have to react to at a later quarter and so forth. So being somewhere in that two-thirds of our OC on the top 25 is what we try to get to. So are we there yet? No but we're encouraged by the progress that we're seeing.

[INAUDIBLE QUESTION FROM AUDIENCE]

[INAUDIBLE ANSWER]

Weighted on the OCI basis.

No, that's.

I'm sorry, I'm sorry. Then overall if you look at this, you know, what you've said about your marketing spending is that total marketing spending is going to be that $550 million midpoint of the range. Cheese prices are actually up so in fact you didn't put price spending -- there's no trading spending in there. So collectively, because that's one of the categories, should I actually read into this your marketing spending defacto has gone up if the same $550 million is going to be there but cheese prices actually rose so clearly there was no trend spending on that side reducing that price.

Well, I think this is -- and actually this is one of the interesting things that if you look at trade spending. In some cases in some categories in cheese we took a higher lift in actually spent some back in the trade spending. And sure we protected some important feature price points or ensure we got the merchandisers to bite despite the higher prices I think the key is to look at the total spending that we had, the 170 million, and add it to the 70 million we spent in the first quarter, so you now have 240 million, versus that 550 which goes to show we have a lot to come in the second half and a lot coming in quarter 3 because remember in quarter 4 we already add a step up what you think of that year-over-year change. There's going to be an awful lot in quarter 3 and that's why a lot of new products shipped in early quarter 2 and spending was way up in the month of June and will continue into quarter 3 and early quarter 4.

Great.

Thanks. Right here.

Hey, Roger you mentioned the possibility of divestitures and I guess if you aren't prepared to highlight any areas, I wonder what areas you were looking at for potential divestitures. I understand if you're not come comfortable doing that but what criteria are you going to look at when you look at your portfolio globally? I mean I look at Kraft as a platform where a lot of the value out of the company is to add terrific brands around the world. What kind of criteria are you looking at?

Okay. You know, we've always said before, you know, gee, we want to do things that are shareholder enhancing, where, you know, sales price will be better than keeping the business so forth. Those are simple financial things that of course you want to go do but more strategically we need to get greater focus in our portfolio, you know, this is where despite the fact we have a huge sales force that does very well with some greater focus on fewer categories we think we can do even a better job. So I would call getting focused on those categories that, you know, we think we can drive forward and really win with going forward. And again as I said, it's ones that we can really, you know, get scale as a category, so there is a little leverage from a technology point of view and that's where Tastimo is a very good example. You know, we develop that as a global platform for a whole new coffee system. Yes we're starting in France but we're going to be deploying that around the world, in the countries where it makes sense to go do. So being in the coffee business there's certain scale from global.

And there's also scale and commodity buying for instance in coffee. So we're going to look for those categories where, you know, relative market share and scale can really be driven on a country and category basis I also said it's important though, when you look at our portfolio to remember what's in different countries because different categories give us country scale. And you say, gee, why do you bother to be in this category. Well, it may be because it gives us terrific scale in the countries that allows us to afford the infrastructure that allows us to support other categories in that country. So it's like a matrix where you have to really think through it some of us in the company call it ar Rubix Cube in terms of how you have to think about it, because it is many dimensions having to come together to decide what are the right things to be selling so that gives you just a sense of how we're talking about. I don't want to get into specific categories or sectors at this point. Over here. I guess we have about five more minutes but don't worry, just again, to tell everyone, as everyone's presenting this afternoon there's an open Q&A and Jim and I are going to sit up there so if you want to even ask us questions during that open Q&A that's after, there will be plenty of time but we'll keep going until noon.

Thanks. In terms of private label competition with cheese in particular as dairy prices begin to come down I would expect private label to also start cutting cheese prices does that mean they're going to force, are you forced at those prices? I mean is that in your guidance because it sounds like you're planning to keep prices unchanged based on the guidance.

if you got any inference that we'd not be moving our prices in line with the commodity cost then, that's not the correct way to think of that. We will continue to manage our price GAAP versus competition in this case in cheese it is private label and then we have very good models in terms of what they do when theirs a hike too. One of the things that does happen is their prices don't actually rise as much because they do compress their margins somewhat and so if it comes down you won't see a secular drop either. But we have -- we understand those models and we do expect prices to come down for private label and you'll see our prices come down as well at the appropriate time. Much of that can sometimes be done through feature prices and already in the July 4th, we appropriately had the right, I think, target prices for our feature price in July 4th, and have been encouraged already by what we've seen in the July quarter as far as merchandising. So you will see a price adjustment relative to private label.

If I could follow up in terms of the -- the 170 million market investment program 82% of that in domestic market can you be more specific in terms of how it was distributed across the four divisions and also for the second half how it might be distributed as well?

I, you know, we're not going to get specific there, but I think you'll have a good sense from Dave's presentation this afternoon, about where the spending is going, because he'll walk through the various categories. Actually a key focus of where we're spending the money is obviously where we have great advertising, great marketing but very importantly where you see the new product innovations. So if you want a sense or a guide to where the spendings going, look at the categories where we have the new product and we'll go through those this afternoon and you'll get a pretty good sense where the spending is going.

One more question?

Okay. And again we'll be here all afternoon and available at lunchtime as well.

Roger, I was just curious, given the slide you put up about maybe the low-carb trend is moderating how is that influencing the way y'all are approaching the launch of your low-carb products? Are you changing what you're expecting from that? Are you pulling back on introductions? Any comments on that and then I'd also be curious if you break out volume projections by domestic and international business now.

Okay. Yeah, I guess as I put that chart up one of the things I wanted to -- the reason I put it up well you saw and we just had that basket of I'll call it low-carb product it was up over 10% in the first quarter and just over 9% in the second quarter, I wouldn't call that slowing, let's call it, it's not at 10, it's now at 9, so I don't think you're seeing people totally run away from carb and counting carb's in their diet. As I mentioned, we do see though if you get to the back end of this year we're going to be lapping over it for some very high periods. I think, and Dusty will talk about this later this afternoon, our focus as we did CarbWell and we'll talk about, that we want to be fast and best to market with products, yeah, we'd also like to be first to market, but if being first means not doing it best then we don't want to be first. And I think on our CarbWell's line as I comment in my presentation we've made sure, again, they're line extensions from our parent brand we've made sure that the taste is very, very good, very comparable to the existing parent brands and importantly are priced at parody to the parent brands. Just as fat-free varieties came out in that early '90s time frame, and yes, we had a run up in that and then it came down but it's still a very nice business. We see for those who are counting carbs this business being there and I think we've calibrated our expectations for the line appropriately versus what we see the interest in carbs will be, it won't go away but it will moderate some. We've built that into our expectation so that doesn't mean that we're not going to be supporting this new line aggressively. We think there's opportunity for it. We think we have the marketing bundle right in terms of that taste branding and pricing and so we'll be supporting it very well. Second part of the question?

Volume.

Oh, volume between -- you'll see actually in Jim's presentation this afternoon, he will show you, I'll call it, sort of our expectation going forward. Both in North America between, I'll call it, the traditional trade and, I'll call it, the emerging trade channels what that split is and also split out the international business. So I'll wait until this afternoon, but you'll see it this afternoon. Great. Well, again, it's lunchtime. What I would ask is that everyone go outside for lunch it's in the tent. And I think we'll be available during lunchtime and you'll find other members of my management team out there as well. Again, we have other folks from -- Betsy's global management group and technology group standing in front of the product displays in the hallways, so please take your time to ask them questions about their product categories. And I would ask that you be back in your seats a few minutes before 1:00 Central time. And for those listening on the conference call you can rejoin us again at 1:00 Central time. Well, thanks a lot and see you after lunch.