億滋國際 (MDLZ) 2004 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Kraft Foods third quarter 2004 earnings conference call. My name is Marisha and I'm your conference call operator. Today's call is scheduled to last about 1 hour, including remarks by Kraft Foods' management and a question-and-answer session. In order to ask a question or make a comment please press star followed by 1 on your touchtone phone at any time. I'll now turn the meeting over to your host, Mr. Mark Magnesen. Please go ahead, sir.

Thank you. Good afternoon and thank you for joining us for Kraft Foods third quarter 2004 earnings conference call. On the call with me today is James Dollive, Kraft Foods' Chief Financial Officer. I'll first take you through some prepared remarks on our third quarter results. Then Jim will provide a few thoughts on our outlook for the remainder of 2004. After that we'll open it up for questions. For those of you listening in via webcast, you are in a listen-only mode. About an hour ago we issued a press release with our results and this release is available on our website at www.kraft.com. Our release and comments today contain projections of future results and are made only as of today's date. Included in today's release is a Safe Harbor statement, which contains a review of some of the factors that could cause actual results to differ from projections. Turning now to our results for the quarter.

Overall, we made good progress on the key elements of our sustainable growth plan, particularly in the area of building brand value. Our top line showed sequential improvement behind increased marketing spending and new products, particularly in North America. Our U.S. market share results continued to improve. And our cost restructuring program remains on plan. In short, our third quarter results keep us on track to deliver full year revenues, earnings, and cash flow in line with our guidance.

Looking first at our top line. Net revenues were up 4.7%. Adjusting this revenue growth for the benefit from currency of 1.2 points and the negative impact from divestitures of a half a point our ongoing, constant currency revenue growth, which is our guidance measure, was up 4.0%. This growth was broad based with all 6 segments up versus prior year. Of this 4% growth, net pricing represented 0.8 points, tack on acquisitions contributed 0.5 points and the remaining 2 .7 points were driven by volume growth and favorable mix. This quarter's 4% growth reflects the solid sequential improvement from the first quarter which was 0.8% and the second quarter at 2.0%. As we expected we are beginning to see our increased marketing spending and new products translate into improved top line results.

In North America, our top line performance was particularly solid with ongoing constant currency revenue growth of 5.1%. Again, this reflects sequential improvement from the first quarter at 1.2% and the second quarter at 3.0%. Of this 5.1% growth, 2.9 points were driven by volume and mix, excluding acquisitions, tack on acquisitions added another 0.7 points and net pricing to reflect higher commodity costs represented 1.5 points of growth. We sustained momentum in key businesses that performed well in the first half, including cheese, meat, and snack nuts. We're especially pleased with the job our cheese team has done, managing prices and promotional spending, given the volatile commodity market this year. In the quarter, our cheese business delivered double digit revenue growth supported by a mid single digit volume increase. Importantly, our efforts to restore brand value in our cheese business are paying off with improved results in the marketplace.

Since beginning our reinvestment program last September, we have gained share in all key cheese segments in all 4 quarters. In addition to continuing the first half momentum on these businesses, we also delivered much improved results in 3 businesses that faced challenges in the first half, biscuit, pizza and cereal. Biscuits and pizza delivered strong growth in the third quarter despite a continuing headwind from low carbohydrate diets. And our cereal business stabilized behind recent new product introductions and more competitive promotional support.

In biscuits, several of our new items are off to good starts, including the Nabisco 100 calorie pack and Honey Maid Oatmeal Cookies. After only 4 months in market, Honey Maid already has the number 1 and number 2 oatmeal cookie SKU's in the category. Although it has begun to lap it's introduction last year, Rich Chips momentum continues and we're pleased that this business is fast approaching $100 million in annual net revenues. Also, our tracking indicates that increased and improved Oreo cookie advertising is translating into better top line growth for that icon brand. Biscuit shares are generally improving as well with cookie dollar share up 1.3 points in the latest 12 week period while crackers were down about a half a point in the same time frame.

In frozen pizza, DiGiorno thin crispy crust is performing well after its launch earlier this year and has already achieved a 3.5% share of the category. DiGiorno microwavable rising crust pizza is getting off to a strong start and is quickly making progress toward full national distribution. These new pizza items have been supported by increased and improved marketing and the business has responded, growing revenues by almost 10% in the quarter on mid single digit volume growth. We're also pleased with our pizza share performance with dollar shares up 0.8 points in the latest 12 weeks.

In cereals revenue and volume were flat compared to prior year, but this represents a solid improvement from the double digit decline in the first half. The competitive environment in cereal continued with significant new product activity. Among our new products, Post CarbWell bars have gained traction. In the two new varieties of Honey Bunches of Oats cereals with bananas and peaches have also helped stabilize this business.

In coffee, revenue, volume and share were all up in the quarter. Our quality improvement on Maxwell House Roast and Ground coffee has benefited the brand value equation on that business. In the super premium segment, we are just beginning to realize the impact of our expanded distribution arrangement with Starbucks coffee. And recently we began selling in our new Maxwell House coffee pots for use in many on demand coffee systems that are being launched in the U.S.

While most of our businesses in North America turned in strong results, our confection's business continued to be challenged, posting a double digit decline in third quarter revenues. While the combination of low carbohydrate diets and competitive activity made the environment a challenge, our Altoid gum line performed well and consumption on several other key brands remain solid. Our near-term priority in confections is to stabilize this business by focusing on our faster growing, sugar free, CremeSavers and Life Savers product line. Increasing marketing support for key brands and leveraging Altoid gum to source volume from an adjacent category.

Looking briefly at third quarter market share results in our North America business, in our top 25 categories based on OCI, market shares according to AC Nielsen, including Wal-Mart, were up in 16 of the 25 categories. And these categories represented 58% of the OCI. This figure represents solid improvement from our second quarter results, when we were up in categories representing 52% of the OCI. We continue to feel good about our progress on shares and particularly about the breadth of our gains across categories.

So, to summarize our North America results, overall, we are clearly making progress against our priority to build brand value, and we are seeing the sequential improvement in revenue growth and shares that we expected.

Turning now to our international business. Ongoing constant currency revenues from up 1.6%. While this is not as robust was we would have liked, it represents improvement from the first two quarters of the year, which were essentially flat. Several key countries delivered solid result this quarter, including Germany, Russia and Brazil. In Germany, revenues were up, shares generally improved across our categories and new products such as Milka M-joy chocolate tablets contributed to growth. We also benefited from a cooler summer this year across Germany and northern Europe, which was a positive for both our coffee and chocolate businesses.

In Russia revenues from up double digit with solid growth in both confectionary and coffee. Our results in Russia reflect a nice rebound from the first half of the year when trade inventory reductions constrained growth. And in Brazil revenues were up mid single digit, driven by very strong growth in our confectionary business.

However, we faced continued challenges in a few other countries. Trade inventory reductions significantly impacted our businesses in both France and Venezuela. In France, the positive impact of a cooler summer on our coffee business was more than offset by both increased price competition and significant trade inventory reductions, as retailers delayed ordering product until the new lower prices encouraged by the government went into effect in late September, early October. The general retail environment in Europe also remained difficult, as discount retailers continued to expand and compete aggressively on price. And traditional retailers responded by more aggressively promoting their own private label products. We continue to respond to this challenge by adjusting our prices and promotions, country by country, category by category, while accelerating our pace of innovations to keep our brand value competitive.

Net, on the international side, our third quarter ongoing constant currency revenue growth was better than the first half and solid in several key countries. However, the improvement this quarter was not as strong as we had hoped and we continue to adjust the various elements of our brand value equations in several markets to improve results.

Shifting now to earnings in the quarter. Reported diluted EPS was 46 cents, down 1 cent or 2.1% versus last year. However, current year EPS includes 2 cents in costs associated with our restructuring program, while the prior year contains a 1 cent benefit from the net impact of the sales of businesses. Breaking down the 1 cent decline in EPS further, negative impacts included 9 cents from increased commodity costs, 6 cents from higher end market spending, 2 cents from restructuring program cost, 1 cent from restricted stock expense and post employment benefits, and a penny from the net impact of the sales of businesses. These were largely offset by the positive impacts of 4 cents from lower taxes, 2 cents from restructuring savings, 1 cent from fewer shares outstanding, and 11 cents from all other operations, including the benefit from volume growth, favorable mix and productivity. Currency was not a significant driver in the quarter contributing less than half a penny. Looking at a few of these drivers in more detail. First, our end market spending was up about $160 million on a constant currency basis versus last year and is now up around $400 million through the first 3 quarters. While both trade and consumer spending were up, given our priority of maintaining targeted price gaps, the increase in spending was primarily in trade promotions. The spending increase also continued to be focused on our North America business, which had more than 90% of the increase.

In the businesses with higher spending, the increase marketing is having its intended effects and driving better performance. Year-to-date, on businesses in North America that have increased marketing spending by 10% or more, aggregate revenues are up over 6%. We are encouraged by this improvement and look for that momentum to continue in the fourth quarter.

Commodity costs were up approximately $225 million in the quarter, with dairy the largest driver. As we indicated in the second quarter, the spike in dairy costs that occurred in the spring would have a carryover effect into the third quarter as the higher costs flow through inventory. We did experience higher costs beyond cheese, however, as coffee, meat, packaging and energy were all up from last year. Post employment costs including pensions and restricted stock expense were up $34 million pretax this quarter. This impact includes a $12 million benefit from the adoption this quarter of a new accounting standard for the Medicare Prescription Drug Act. We've continued to expect that this accounting change will provide about $20 million in benefit this year, which has been built into our earnings guidance. Asset impairment charges and costs for our restructuring program were $61 million in the quarter and our activities netted us $43 million in savings. Our restructuring efforts in this quarter were focused on implementing the plans to close and exit 12 facilities announced in the first half. Our tax rate in the third quarter was 28.4%, lower than our second half tax rate guidance of 32%, due to the positive resolution of a net $76 million tax item this quarter. In our July earnings call, we indicated that we expected this event to occur in the second half but we were unable to tell you in which quarter it would be finalized. Versus our second half average tax rate guidance of 32%, this quarter's favorability represents 2 cents EPS on the quarter. Given that we are not changing our second half tax rate guidance of 32%, we expect this 2 cents favorability will be offset by 2 cents unfavorability in the fourth quarter.

In summary, on the earnings side, our third quarter results were in line with our expectations and keep us on track to achieve our full year guidance. Looking briefly at cash flow, through three quarters, our discretionary cash flow, which we define as net cash from operating activities less capital spending, was $1.9 billion, down about $150 million from last year. The decline is due primarily to $320 million in voluntary pension contribution and lower earnings partly offset by decreased capital spending. Our full year expectation for discretionary cash flow remains at $2.6 billion. Capital spending is projected in the 1.0 to $1.1 billion range, down about $50 million from our previous guidance. In terms of cash flow usage, we expect to return over 70% of our discretionary cash flow to shareholders in the form of dividends or share repurchases this year. In the third quarter, our board increased our dividend by 14% to an annualized rate of 82 cents per share and we repurchased 5.2 million shares at a cost of $162 million. That completes my comments on the third quarter results and now I'll turn it over to Jim who will take you through our outlook for the remainder of 2004. Jim?

Thanks, Mark, and hello, everyone. As you look at the final quarter of the year, we have narrowed our full year EPS guidance range to $1.56 to $1.60 per share. This guidance assumes no change to our portfolio and continues to include 30 cents per share in costs associated with our restructuring program. To date, we have taken charges equal to 19 cents per share so we expect a fair amount of restructuring activity in the fourth quarter. Our projections for increase marketing spending on the year are now 525 to $575 million, a narrowed range relative to our previous guidance of 500 to $600 million. Commodities are expected to be up over $750 million on the year, which is about $75 million higher than previous projections. Cheese has moderated as we expected but we continue to see high prices in coffee, meats, energy and packaging. These higher commodity costs represent about 3 cents per share impact and have been offset by operational gains. Estimated restructuring program savings are 5 cents per share on the year, consistent with past guidance. And finally, we continue to project the full year tax rate of 33%, which implies a fourth quarter tax rate of 35.5%. On the top line, we are maintaining our guidance for 3% growth in ongoing cost and currency revenues, giving year to date growth of 2.3%, this guidance clearly implies that we expect a sequential improvement delivered in the third quarter to build in the fourth quarter and this is due to a few factors.

First, our new products are gaining traction. Just 2 examples of third quarter launches that should impact fourth quarter results are DiGiorno microwave pizza in the U.S. and our Tassimo on demand coffee system in France, both of which have been well received by the trade.

Second, we expect our increase marketing spending to continue to build momentum. Our full year spending guidance implies a fourth quarter spending increase of 125 to $175 million, which is on top of the similar increase made in the fourth quarter of last year.

Third, our recent acquisitions in trademark licensing agreements will contribute more fully to growth in the final quarter. The Veryfine integration has gone very well and we are now in a position to more aggressively expand that business. Similarly, we will get a full quarter benefit from our expanded Starbucks Coffee arrangement and Tazo Tea licensing.

And fourth, we will realize a full impact on revenues of pricing actions we took earlier this year in response to higher commodity costs. These include increases on meat, cheese, pizza, cereal and our food service businesses. We feel good about the factors that will drive fourth quarter improvement. We also recognize that we are on a tough competitive environment where incremental brand support is required to drive share performance. We certainly recognize since the start of the year when we initiated our sustainable growth program. We are encouraged by the gains we have seen to date and remain committed to restoring momentum across our businesses.

Let me turn briefly to 2005. We are not in the position to provide specific guidance at this time, but there are certain items that will impact our expectations. These include commodities which remain a wild card, given the high cheese market this year, we certainly expect lower cheese costs next year. However, energy and packaging are obviously up and the outlooks for other commodities, such as coffee and meat, remains uncertain. Also, in the fourth quarter of this year we will reassess the impacts from our increased marketing spending, our new product pipeline and any new competitive initiatives and these will be key inputs into our 2005 investment program.

Our restructuring program remains on track and we expect pretax costs for this program in the $330 to $360 million range next year or in the after-tax equivalent of about 13 cents per share, down from the 30 cents per share that we anticipate spending this year. Incremental savings from the restructuring program in 2005 should be 130 to 150 million or about 5 cents per share, which we will reinvest in the business to build brand value. Pensions and other post employment benefit costs will continue to rise in 2005. Our current projections for these costs are an incremental 5 to 7 cents impact on year to year EPS due in large part to lower than plan returns on our pension assets in recent years, including this year, where our U.S. pension asset returns were around 3% through 9 months. The negative impact from lower returns have been partially offset by the discretionary cash contributions we made to our plans last year and this year. The upper end of this pension range reflects potential non cash earnings impact of changes to our pension accounting assumptions for 2005. As a reminder, our current long-term return on assets assumption is 9% and our discount rate is 6.25%. Next year will also be the last year for the step-up in amortization associated with our switch to restricted stock from options 2 years ago. In 2005 this amortization will result in 3 cents per share impact.

And finally, as we mentioned in Q2's webcast we continue to review our portfolio for opportunities to gain more focus with our business. As is our practice, we will not comment on any specific business but obviously changes to our portfolio can impact current year expectations as well as year-to-year comparisons. In closing, let me reiterate 3 key points. First, the third quarter was a good one for us as we made strong progress on the key elements of our sustainable growth plan especially in the areas of building our brand value. We've begun to restore growth on the top line and improve our market share results while delivering our targeted cost reductions from the restructuring program. Second, in the fourth quarter we fully expect to continue this sequential improvement we've delivered in the third quarter behind effective marketing spending increases and strong new product activity. And finally, our third quarter results keep us on track to deliver full year revenues, earnings and cash flow in line with our guidance. With that, Mark and I would be pleased to answer your questions.

Thank you. The floor is now open for questions. If have you have a question, please press star, 1 on your touchtone phone. If at any point your question has been answered, you may remove yourself from the cue by pressing the pound key. Questions will be taken in the order they are received. We do ask that while you pose your question, that you pick up your handset to ensure the best possible sound quality. Once again that's star, 1 for any questions at this time. Our first question is coming from David Nelson of Credit Suisse First Boston.

Good afternoon.

Hi, David.

Net pricing was negative, I guess, as we expected earlier this year, but we're starting to see net pricing be negative for a lot of your competitors now. Do you see the environment in North America getting a lot more competitive? You mentioned cereal.

Yes, well, the impact of the negative net pricing is mostly through the price gap management. For us during a quarter when Mark went through it, we did in fact see a positive on net pricing and our revenue growth and that really is a function of some of the commodity increases being passed through to consumers.

Yeah, North America, David, net pricing was 1.5 points of positive contribution to the top line. That's the net of pricing on a lot of the commodity oriented businesses offset by some promotional spending as part of the growth plan.

Okay, I was excluding -- I was taking away some marketing, I guess, which I shouldn't have. But I was calling it the same thing. Anyway, price gaps in some of the Nielsen data that came out at least to me last Friday seem to be getting bigger. Is that something I should be concerned about? You're telling me qualitatively that it's getting smaller still. But the Nielsen in some categories seemed to show an expansion.

Well, in the categories that we -- we track very closely all of our categories, but in the ones that we've been focused on to drive down the areas where the gap has been large, I think for the most part, we've gotten those into the ranges that we targeted at the beginning of the year and they've been there for the last couple of quarters.

Expansions were mainly in, you know, center of the store, shelf stable products.

Sure. Now we have seen, to your point, some areas where we have put more support behind certain businesses, like the cereal business, like our ready to drink beverage business and that is an area where we have seen increased competition and therefore we felt it appropriate to get our price gaps back in line.

All right. If I can ask one last question. What happened more in Latin America, does Latin America ever get better?

Well, Latin America this time was actually an issue in Venezuela for us more so than anyplace else. It was a matter of the customers holding too much inventory as a way to hedge inflation and with the elections they had down there, they actually took their inventories pretty far down and we saw that flow through into our business and quite honestly, we would like to see them keep those inventories relatively low, rather than rebuild them.

Okay. Thank you very much.

Thanks, David.

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

Good afternoon, everyone.

Hi, David.

Hello, David.

Jim, first on the total level of marketing spending, incrementally, not just in the fourth quarter but going forward, given the performance generally outside the United States this quarter and earlier in the year, do you feel the need to ramp that up substantially to get those businesses growing?

Well, we did in this year, we certainly did have some of the investment we made go towards the international businesses, particularly in Europe. We have seen the competitive environment change quite a bit and I think everybody who competes in Europe these days is seeing the impact of the hard discounters moving across the continent. And that certainly will have an effect. So the answer basically is yes, that we're going to continue to keep our prices competitive in those markets. Now, I will say that we've been at this a lot longer in Germany than we have in other countries, and the results we have gotten in Germany in the last couple of quarters have actually been quite encouraging because our shares have been up in those categories. The hard discounter private label group actually has had a slight share decline. So we know we can do this.

And David, just a point of reference, that the international business has gotten about a quarter of the increased spending year-to-date. But, it's not that disproportionate relative to it's size of the business.

Okay. Secondly, I'm not -- I don't want you to -- I'm not asking you to disclose what businesses you're contemplating selling but could you give us a scale of the magnitude of the profit dilution that could occur or a range because clearly you're looking at a number of businesses. You don't know precisely what the proceeds would be, but can you give us a range of the lost profit or of the dilutive impact from those transactions?

I really can't because it would depend on what the businesses -- what the business is or businesses are. And it really will depend also on whether or not there are any substantive gains or losses that are associated with those sales.

Okay. And lastly, can you talk about retail take away within the United States? Because clearly your results benefited from some extent by a more rapid rate of new product activity this quarter than the year ago. So can you talk a little bit about U.S. retail take away trends to the extent that you have them as you look at the universe?

Sure, I'll let Mark run through some of the particulars but overall, we have seen a nice increase in the North America portfolio.

Yeah, it tracks just below -- actually it tracks very much with our volume take away, David, the consumption with Wal-Mart.

Okay.

So it's a case where there wasn't a significant load that occurred as part of a new product activity, no, whatsoever. In fact the one businesses where -- business where we had a deload was Aseptic Beverages. It was pretty significant to that business in terms of shipment take away. So, consumption generally tracked very well with shipments.

Okay. Thank you very much.

Great.

Thank you. Our next question is coming from Eric Katzman of Deutsche Bank.

Hi, good morning, everybody -- good afternoon, sorry about that.

Hi, Eric.

It's already been a long day.

Where are you?

I guess one thing I'm -- I don't understand, if I just look at volumes, I exclude acquisitions, I exclude price, I exclude mix, your volumes in the quarter were up 0.8 and that was versus only up 0.4 consolidated. That doesn't seem to me to be all that successful and yet you're kind of playing it up as if, you know, this spending is really having a lot of momentum. Are my numbers wrong?

In aggregate your numbers are not wrong, but the piece that's helping us quite a bit is the mix implication on here, because we are seeing the good volume growth on some fairly high contribution businesses. So it's the mix piece that's giving us that oomph, if you will, in that revenue growth 'cause the volume mix component for total Kraft is up 2.7 percentage points on the revenue line.

Right. So, North America, Eric, as an example, our volume growth ex-acquisitions was 1%. The contribution of that volume growth ex-acquisitions to revenues was almost 3 percentage points.

I mean, you know, we penalized you in the past for not having a positive price mix and now it's maybe swinging the other way so you deserve the credit, but just looking on the volume part of it, it wasn't all that impressive. Okay. Second --

But you also need to go down and look at the various categories because, you know, the ready to drink business was in fact down for us ex-acquisitions this quarter and that's part of what's driving the mix.

Okay. And then the second question, I guess, is that, you know, you raised, you know, wholesale prices in a number of categories a little bit earlier than others, I think, in kind of like the April/June time frame and you're saying that you're starting to see some of that sticking or that benefit flowing through. A lot of the other companies have kind of -- that have raised prices have said, you know, wait 6 months before we see the benefit. Do you think that your price increases and when that's expected to benefit is consistent with what the other companies are saying in terms of a 6 month kind of lag?

I'm not sure I can link into a 6 month kind of lag because when we do price, we are always sensitive to how we execute and transition from the old price to the new price from a consumer perspective. And that means at times we'll deal back some of that price increase and then over time peel back on the amount of that increase merchandising and dealing activity. 6 months is probably a reasonable time frame within which to get that back on track. Obviously, it will depend on the competitive nature if we can do it sooner rather than later, we prefer to do that.

Okay. And then last question. You know, I think it's fair for you to kind of comment that you know what it's like to compete with hard discounters in terms of Germany, and you're, you know, I guess success there, but it took you an awful long time. I think it's been several years for Germany to turn around. I mean, should we kind of conclude the same thing in terms of France and some of these other countries that are now being buffeted by the hard discounters and that it will take as long?

Well, I'm not sure I would declare success on this in any particular market at any particular time. This is how business is done in those markets and it requires us to do the fundamentals right to keep the price gaps in line, to support the business with the appropriate amount of consumer advertising and consumer promotional support, and then to continue to leverage the innovation activities there we think will make a difference longer term. And it's really that simple formula that is so hard to execute effectively and to do it consistently.

And, Eric, I just add, I guess, you know, one of the encouraging signs we see is that the growth of soft discounters in many markets has begun to exceed the growth of hard discounters and we typically have very good presence in a soft discounter such as Leial, et cetera. So the trends in many markets aren't following necessarily the German model and I think it could turn out to be quite positive for us in some marketplaces.

Okay. Thank you.

Thanks, Eric.

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

Good afternoon, everyone.

Hi, Terry.

On commodity costs, Jim, you mentioned they were up 225 in the quarter. Now, I assume there that we're basically talking 2 months of the elevated cheese prices and 1 month of the more normalized prices, is that the right way to look at it?

It's directionally but not necessarily that way because depending -- there are lots of different cheeses we have and some of those cheeses we hold for a fairly long period of time, so you know, it will be a longer tail in terms of working those through the inventory system.

Okay. But it's probably fair to say you're working off much cheaper inventory as we exited September than you were in July? , right?

The -- on a 3 month basis, yes.

Okay.

I guess maybe, Terry, to make it somewhat clear. If you look at what we've said, our guidance on the year is to be about 750 million higher in commodity costs.

Which is plus 75, you said?

Yeah. So the 750 million, if you look at what we've incurred to date we are in sort of the 625 range.

Okay.

So we've got another 125 that we're projecting in the fourth quarter.

Right.

And cheese will be a part of that. So, you know, there is a lag and -- but it's more than sort of 1 quarter, as Jim referenced to you, you have a fair amount of aged cheese that's making its way through the system.

Man, it must be pretty moldy by now.

To be fair, to be fair, on the positive side, when this thing goes the other direction, we shouldn't be impacted as quickly.

Okay. But you're saying then, Mark, I think, that of that additional 125 cheese will be a positive contributor to that additional higher commodity costs, is that correct?

It will be higher, correct.

It will be a component of it.

Exactly.

Okay. Then as we look into '05, I know, Jim, you know, you're not prepared -- by the way, when do you think you will give guidance for '05, while we're on the subject?

We'll do that with our fourth quarter full year earnings release in January.

Okay . And as we look into next year, obviously cheese shapes up as being cheaper for you. Is there anyway we can kind of directionally decide whether your food ingredient cost, lower cost there are going to be, you know, offset and then some to, I think, what everyone would look at as higher energy and packaging? I mean, it -- can we make that kind of determination or is too early?

It's a little bit early to do that. Cheese is obviously our largest single commodity cost and it did have -- it's unique run up in the second quarter, so we are expecting a pretty decent benefit coming back from that. But we're also seeing the -- a lot of other commodities that were at historical lows, like coffee and some of the meat products, pushed back up. Energy is going to affect everybody and to your point, it's not just the direct cost of energy, but it's the indirect cost of the packaging line and it affects virtually every other component of the cost structure because every one of our suppliers is also subject to those same kinds of increases in energy costs. Okay. So right now it's hard to put a handle on exactly where it's going to shake out.

Okay. Just more broadly, do you think your operating margins, you know, basically this will be the trough year and I think at one point you were feeling pretty good that '05 would be a margin expansion year. Is that still a reasonable way to look at next year?

I would say that is reasonable.

Okay. And last question, did I hear you correctly when you said 70% of your discretionary cash is going to go to either share repurchase or dividends?

That's correct.

Okay. All right. Well, thank you very much. Appreciate it.

Thanks, Terry.

Thank you. Our next question is coming from John McMillin of Prudential equity.

Good afternoon. Lucky I'm -- lucky I'm not a Red Sox or Yankee fan. Just in terms of the '05 initial -- I mean, just looks like you're not guiding officially but you're guiding somewhat unofficially to get us to look at an '05 scenario where the base is -- I mean, you’re basically saying the 5 cent tax saving you're going to spend and you're then kind of pointing out 8 to 10 cents of incremental cost that might make a 190 base a 180 base. You know, I'm saying that out loud. Am I thinking correctly?

Well, we -- there are certain things we know about that we can give guidance that will impact next year. The real key for next year is going to be the whole sustainable growth program into year 2. You know, and we do have some good momentum from the marketing spending we have from the new product initiatives and that is the focus for our business to continue that momentum into '05.

Well, you know, you're in a quarter where your operating margins, and you can calculate it as well as I can, according to me I have your operating margins down from 193 to 166 in the quarter. I mean, hopefully we are at a point where these margins can now, you know, sustain and start to grow.

There are two things that are driving those margins down, one is the marketing investment we're making and the other is the cost of the commodities that we're not fully recovering through the pricing line. And while we will have some increases in marketing spending year-to-year, certainly we do expect to see the top line momentum accelerate in '05 relative to this year and to the comment we had -- the discussion we had with Terry, on the commodity side, we should see at least the cheese piece go more normal and then we'll have to deal with the other components for the course of the year.

And just responding to David's question, I know it was difficult for you, but, you know, General Mills has kind of the same situation and they at least have kind of come out and said we think we can make divestitures in a very tax efficient way, you know, using these capital losses. Do you think as you approach divestitures, you know, are there any up-front tax benefits that you can talk about or can you just kind of led us -- led us to believe that these things can be done in a tax efficient way because I don't know what the cost base of things like Life Savers are? My sense is they're probably pretty low on Altoids. Can you just talk about tax efficiency in selling.

Well, we certainly will look at that. Typically that's tracked around some sort of restructure initiative where you have some capital loss that can you offset those gains. We've looked at those and we continue to look at those as opportunities to mitigate the tax implications. Remember, we file our taxes as part of a consolidated US federal tax is part of a consolidation with Altria so we've got that entire bundle within which to look at these opportunities.

[indiscernible] Now, when you gave this second half guidance in July, you certainly acknowledged that there would be a lower tax rate. Was I wrong in thinking -- I mean, this one quarter at 28, the other at 35, was that in line with what you initially thought or wasn't it supposed to just be a little less volatile, the tax rate, quarter-to-quarter?

Well, what we said was there was an event that was going to happen. And we didn't know which quarter it was going to happen in. I -- this was a -- essentially had to go through a joint committee of Congress for approval and I didn't think the government could move as fast as they did, but we were able to get it into the third quarter.

Yeah, I was just thought -- I was thinking the quarterly impact would be 2 cents, not 4 cents but if you didn't say it.

Well, it's 4 cents on the year-to-year basis but relative to the guidance that we had given on the average tax rate for the quarter, it's a 2 cents impact.

And getting, you know, getting to a fourth quarter range of 48 to 52, which is almost in line with last year, but your tax rate will be higher, you know, assumes that basically you can get your volume growth maybe a little less expensive than you just got it in the last quarter but you're basically -- I mean, this is a little more aggressive guidance for the fourth quarter using that tax rate. I mean, a lot us had these estimates for the fourth quarter with a lower tax rate.

Uh-huh.

Okay. Well, thanks a lot.

Thanks, John.

Thank you. Our next question is coming from David Driscoll of Smith Barney.

Hi, thanks a lot. Good evening everyone.

Hi, David.

Jim, can you walk me through your thinking on marketing spending for 2005? If a $5 to $600 million increase has taken market share up in 58% of your relevant categories based upon the OCI metric, that leaves a sizeable chunk, something, I guess that would be 42% left over that's not improving. How then does Kraft arrive at, I think it was $130 to $140 million increase in '05, which is equal to the cost savings associated with the restructuring program. How do you get to that 130, 140? Why shouldn't it be a much bigger number?

Well, the 130 to 140 that we talked about in terms of those savings, we are specifically saying is going to be ear marked to go back against building brand value. That doesn't necessarily mean that's the only money that will go back to building brand value. If we think it's appropriate or see an opportunity to spend more against the business, just as we did this year, we will in fact do that.

Well, given the fact that we're at that 58% level, maybe I should be asking what are the targets. What do you want to get that metric to?

We've typically said we want about two-thirds of our shares to be growing. You know, because there 's always going to be some competitive scenario or some situation that it may not be economic or effective to go chase, but about two-thirds of our shares are what we're targeting for growth.

Okay. How much was the net commodity cost impact projected to be for the year? So, I think you identified that 750 million was the gross commodity impact. Net of all the pricing actions, can you give us, you know, what's embedded in the guidance here for effectively the net commodity impact for '04?

Yeah, I -- I would be hard pressed to say exactly how much 'cause what you're asking is how much have we offset through pricing?

Yep.

And that's a tougher one to answer because while we've certainly taking pricings where we could, particularly on things like meat, cheese and a few others, a lot of this has also been figuring out where the price gaps need to be and then adjusting both our trade spending and the amount of pricing we don't take so that we can make sure our price gaps stay within that range. Clearly we haven't fully recovered the increase in commodities through the pricing actions nor do we want to do that because we didn't expect cheese, which was the biggest increase of all, to stay up at those stratospheric levels.

Can you give me the -- so, what did cheese represent of the 750, half?

It will be on the order of the equivalent of about 16 cents in total.

About $450 million. That's our latest view.

Then essentially what -- Jim, where I'm trying to go with this is commodity costs have been an enormous impact here but I -- it's tempting to want to say that if commodity costs are down next year, all that money flows into -- you know, is a positive but that's not true because of the price gap management. What I don't really have a sense is how much of the number was -- you know, is it possible that we actually see captured in a favorable way on the '05 P&L?

Yeah, we do expect to see some recovery of those in the '05 because we clearly took a hit this year, so we should see some recovery of those commodity impacts that we saw this year. Separately we'll have to deal with whatever new commodity impacts come along in '05.

Okay. Last question I had was back to the '05 margins. So, I think a number of callers have already asked on this. But, you know, essentially when I calculate my margins, you know, as John just said, 16.6% in third quarter, but this is sequentially down from second quarter and down from the first quarter. I think you answered Terry's question that you thought there could be margin expansion but it doesn't look like we're headed that direction and if we have an unknown amount of marketing expenses that we have to put in there, as well as all those other costs that you identified for '05, is this a meaningful increase in margins in '05 in your opinion or are you just giving a direction and just saying --

No, we have said we expect to grow margins over time and what we've said longer term is we expect to see about a half a point margin growth over time.

Yeah. And in the quarter and as well as year-to-date commodities as a net impact to us is about 1.6 points impact on our operating margin. So that's something we would expect to sort of come back at us, in addition to the restructuring charges that won't be permanent as well. But the marketing spending is the part that's sort of is the permanent step-down in the operating margin.

The current year marketing is certainly a step-down in the margin profile. And then I would hope that as we continue to grow the top line revenue, that gives us the fuel, if you will, to invest back against the business. And then the piece that we're ignoring in this is all of the initiatives we've done to take cost out of the business. Because that will in fact be part of this equation as well and help over time to drive margin profile.

Super, I appreciate it. Thanks a lot, fellows.

Thanks, David.

Thanks, David.

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

Hi, guys. Thank you.

Hi, John.

Just sorry to beat a dead horse. One detailed question. When you answered Terry's question about operating margins and this being a trough, were you speaking after charges or before charges?

Well, it would certainly be a case with those charges included but even excluding the charges, we do expect to see the margin start to improve on a go forward basis.

Understood. It's the end of it, I promise. But other -- only other question is you mentioned the continued impact of low carb in the press release and in your narrative this afternoon. You know, we've had a couple of other companies go on record as saying they think low carb is passing. I know you've made some pretty high profile investments in the Carb Well line and some other low carb product line extensions. I mean, how are you feeling about the consumer's reaction to low carb right now, how are those, you know, low carb product launches doing across the board and what do you see in 2005?

Well, we -- we actually track a baskets of both high carb and low carb products and what we've seen is the rate of growth in the high carb basket come down but it is still a positive number.

Low carb.

That's a low carb rather, the low carb -- I'm sorry, the low carb number, you know, was -- it would have been more in the 9, 10% range in the [very] first half of this year and now it's running more in the 4% range but it's still a -- an increasing trend on low carbs. Conversely, the high-carb items which would have been down in the 3% range we're now seeing down in the 1% range. So clearly it's not as acute as it was but it is still headed in that trend. The more important part of the question is where do we think this is all going to settle? And I think we've now had an impact due to carbs such that there will always be some level of concern, some group of consumers who will be looking at carbs, counting carbs and focusing on that piece of their diet.

Let me -- the way -- let me ask probably a little -- the question is -- it's just a follow up on something you said. If the current trends right now if you kind of push those forward to the beginning of 2005, you know, considering -- I've kind of -- I think you said to view that is the peak of low carb adoption trial, whatever, would you see up year-over-year trends still for low carb products?

That's awfully hard to say right now because I think it's -- I think that we're going to absolutely see some level of concern about carbs. It's whether or not it starts to turn negative and decelerate as opposed to show some positive growth, too hard to predict because there's still a lot of new items and still a lot of focus going out there these days that keeps attention on low carb type diets.

Okay, that's fair. Thank you, guys.

But I will, let me just close it by saying, we clearly are seeing the trend have less growth than we saw earlier.

Right, that's clear. Thank you very much.

Thanks,Jonathan.

Thank you. Our next question is coming from Chris Growe of A.G. Edwards.

Good afternoon.

Hello, Chris

Hi, Chris

Hi. And just a couple of follow-ups here. The -- if we look at the marketing spending for the fourth quarter of coming here, you give a $50 million range for the quarter. I would assume those plans would have been mostly set and I know you can't nail down to an exact number but is there anything that would -- that could change the fourth quarter? For example, if pricing items you've put in place do not stick for some reason, if you get more promotional, is that what sort of the $50 million range is for?

Pretty much and if you -- if you've got a program out there where you're not seeing the kind of lift that you are -- you want from that program, we can read those things pretty quickly and adjust on the fly if need be or conversely, if we're seeing one where we're getting a terrific response, we'll want to feed it even more.

Okay.

Your point, advertising at this point is pretty much locked. It becomes more of your sort of feature pricing until you get to a certain price point.

That's reacting to competitive trends, et cetera?

Yeah, effectively.

Now the pricing environment sounds like you seem to be fairly confident and you've gotten some decent pricing, especially in North America. Is there more pricing to take in any categories or put it differently, do you see any other -- are there any competitive threats in the categories where you've taken pricing so far that sort of stand out right now?

Well, [what] we monitor there is the price gaps and across our major categories our price gaps are pretty much in line with where we need them to be and we'll react pretty quickly because that was one of the lessons learned, if you will, last year is the need for to us react quicker to price gaps when they start to get out of line. So we'll adjust pricing very quickly but to answer your question where we have taken pricing, where we have seen any gap at all, we’ll adjust our merchandising programs to compensate.

Okay. And my last question then was just on trade inventory reductions. I've heard that more and more throughout the year, and it was Russia at one point earlier in the year and now we're hearing France, even some here in the U.S. Is that something you can quantify? I know in the past we used to talk about, about a point per year of volume in here. Is that still a reasonable number here for 2005?

It's not quite that much. In the U.S. it was -- it wasn't down quarter on trade inventories but that was centered a lot on the ready to drink business.

It was about a half a point in our North America business this quarter.

You know, Russia was an issue with the beginning of the year. That's -- that's behind us. And we actually had a very good quarter in the CEMA group, Russia in particular, so that one you know is back on track as far as I'm concerned.

Okay. And then just my last question, a bit of a bigger picture question, just in terms of your incremental marketing and I don't want to keep talking about '05, but the fact is if you raise your marketing at least in line with your cost savings, is there a point in which you need this continual increase or incremental investment in marketing just to reach our sales growth targets? Is there ever a big enough bucket in which you don't have to keep adding to that?

Well, --

Is that a 6 or -- ?

The way to think about that is as a percentage of revenue. As long as you're growing your revenue, you can continue to put more money against your marketing programs and it becomes a self perpetuating process.

Sure.

And that doesn't hurt your margin profile as you go forward.

But still in '05 there may be some incremental investments still required and therefore we're looking at, in terms of cost savings coming through, at least funding the marketing if not more in '05?

Sure. And we have done that. As we said earlier, in the U.S. we put some additional support behind our Post cereal and our beverage businesses. Certainly in Europe we're going to be looking at a little bit of a step-up in that investment as well. But that said, you know, we are seeing some pretty good traction on the meat business, on some of the other businesses that have been getting this support for a while, so we're certainly encouraged by those kinds of results.

Okay, that's fair. Thank you.

Thanks, Chris.

Thank you. Our next question is coming from Filippe Goossens of Credit Suisse First Boston.

Yes, good afternoon, Jim and Mark.

Hi, Filippe.

One housekeeping question and then 2 kind of real questions. Jim or Mark, do you have the D&A number ready for the third quarter?

Yes. I believe it was 207, Filippe.

207, okay. I had 212.

And that includes both the depreciation and amortization.

Yep, okay. Thank you. Then my first question. Jim, as you know, you have those notes coming due, I think November, late November, I think November 26, 27, $50 million.

Correct.

Any further color on what you might do with that? Am I still right to assume that most likely you will refinance those and take advantage of the attractive rates here?

That would be a reasonably good assumption at this time.

Okay. And then my final question with regard to the Homeland Investment Act, there was an article in the Journal last week, your parent company was listed there as one of the companies. Can you give us any color in terms of whether you would have earnings that you could repatriate or you think it's more attractive to reinvest those overseas?

Well, it really depends on where your cash pools are internationally and where we have cash pools in low-tax jurisdictions, we will certainly take a look at the opportunity to repatriate that cash favorably compared to what we would do under existing circumstances, so we will absolutely look at what opportunity that affords us to get cash back in the U.S.

But you don't foresee at this moment that that would result in any incremental borrowings because the way that I understand it from our credit strategists here is that companies that may have earnings that they would like to repatriate does not mean that that's available in cash and that they may have to start borrowing at the subsidiary level.

I said -- I prefaced it by saying cash pools in low countries so we're really looking at repatriating where we do have excess cash.

Got you. Thank you very much, Jim.

Filippe, just to be precise, it's 209 million in D&A. There was a bit of amortization.

Yep.

And we frequently get questions on the capital expenditures, so I'll just tell you that number as well. It was 221 million.

221. Great. Thanks so much, gentlemen.

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

Good evening.

Hi, Andrew.

Just quickly back on volume growth for a minute. You used -- I mean, should I understand that your volume growth up 0.8%, I mean is that -- and the mix being better than you typically get, is that essentially just the shift that you had in your ready to drink business? I mean, had that been -- had you not had the issue around volume there -- I mean is it big enough to say volume would have been, you know, better and mix not nearly that significant?

Well, that's a piece of it. The international side particularly on lap is the other one where you would have had a mix impact where volume was not as strong, you know, and that's where the Venezuela impact factored in. You know, and within the international side, you know, Europe was up which favorably impacted the mix, so you've got those 2 factors going on. North America ready to drink was the issue and internationally we did see Latin America have a downturn.

All right. So I mean -- --

It certainly is part of our plan, our plan is to spend where we get good bang on good profitable businesses, so there's an element of intent here as well as an element of just sort of where the volume happened to fall.

So, I mean, I know you wouldn't necessarily predict the kind of mix impact that maybe you had this quarter, but is there -- I guess I'm getting at, are you starting to see some improvement in your, what I would consider your kind of ongoing, you know, structural mix in your business that you can sort of start to count on from quarter to quarter or is it just, you know, is that -- is it way too early to sort of suggest that?

I think it's too early to suggest that. I would prefer to see all of our businesses grow and not as the, you know, just the mix piece showing the improvement. I'd rather have both quite honestly.

And then with respect to trade loading, given you've kind of made the complete conversion to the more of a sort of pay by consumption type of model in North America, that in theory was something that impacted you or your trade deloading numbers more significantly than a lot of your peers for a period of time. With that at least the conversion kind of behind you, shouldn't we start to see that be less negatively impactful to your top line than it might have been over the last year?

I think that would be a fair assessment. Clearly -- .

And it's true in total. Like I said about a half a point in growth this quarter is not all that significant. It was just that it was centered in one business, sort of unfortunately.

And to that point, the other businesses didn't have as much of an inventory deload as we have seen in the past.

Okay. And then just so I can wrap this 1 point up because I'm still a little confused and I apologize. With respect to sort of your outlook on marketing spending, I realize you want to invest back the incremental restructuring savings in '05 and then perhaps hope to grow marketing perhaps more in line with what sales are growing at. Is that kind of where you're at least initially coming out or have I missed something where there may be the need or potential to spend, you know, at a much greater pace than that to sort of continue to get your business back where it needs to be?

Well, --

In other words can you safely say -- this was the transition here.

There are two pieces here. One is is there a short-term fix that's needed in a particular location or on a particular business and in some instances there may be some countries or a brand where we have to do that. Whether or not that's large enough to sway the mass of Kraft, it's not -- I doubt it is. But we'll certainly keep that in mind. I think longer term, as we go forward, I think the increases to your earlier point will be more in line with the revenue growth.

It's safe to say we won't revisit, I don't believe, the step-up we took this year.

Okay.

That is if a fair and safe statement.

Okay. As you came out in last January with kind of the more reasonable sort of bottom line growth targets, I mean, part of why you did that perhaps was to try and obviously give yourself room on the lower end for years where you needed to step it up, on the higher end where perhaps you didn't, you're not going give guidance now I realize that, but is -- you know, is next year a year where even if you're continuing to step it up incrementally that it's more a matter of just falling in a certain part of the range? You know, does your range kind of incorporate that or it that just kind of longer term in nature and you've got to do next year what you have got to do regardless?

Well, I wouldn't say it's regardless. But I say we have to do what we have to do next year tempered by everything else. You know, and obviously we would like to get into our longer term guidance range as soon as we possibly can.

And the last quick thing is just, I'm sorry if I missed this, your tax rate for the full year, is that what you think you will see going into next year or is it, you know, is that an ongoing rate, the lower rate, for the full year?

Too early to call because the tax rate this year was clearly affected by some one-time items. If you exclude those one-time items, the base tax rate would be around that 35.5%. What I cannot give you a handle on yet is what if any one-time items will affect that base tax rate in '05.

You will probably know that assuming on the fourth quarter call?

We should have an estimate of what that while be in the fourth quarter call.

Okay, thanks very much.

Thanks, Andrew.

Thank you. Our next question is coming from Timothy Ramey of DA Davidson.

Good afternoon.

Hi, David.

I just have a quick question on the restructuring costs and then the savings that you garnered from them. If I got it correctly, I think you said there was 61 million of cost and 43 million in savings in the quarter, which is a pretty large and quick pay back. Can you give us any detail on how that occurred and what specific areas were impacted.

Well, sure, but don't associate the savings with the costs during the quarter because the savings that we're seeing are a function of the costs that really were spent in Q1.

Sure.

And in Q2 more so than it was the items that were spent in Q3.

Maybe here's some numbers on a year-to-date basis, Tim, that might help you. The cost year-to-date is a little over a half a billion, 508 and our savings year-to-date are about 84 million. Okay. Now, the cash cost of the 508 only about 80 million of that is cash. So year-to-date we've spent about 80 million in cash for savings of about 84, which is mostly cash.

Got it. And can you give us any specific businesses or areas where you're taking these cost savings?

Well, the savings to a large degree, since we had the headcount restructure program in North America, that's a big driver of what we're seeing in the step-up in savings now that we're into , you know, in Q3's results. Also from a manufacturing perspective, we have announced the closure of 12 facilities and I believe as of the end of Q3, we had physically closed 4 of those facilities. So it's balanced in terms of that kind of profile . You know, we still have more to do as far as bringing this program to fruition goes.

And I think you originally announced 20 plants to be closed. Does that -- do you think you're on track to do a lot of those in the fourth quarter or is this going to, you know, spill into '05 as well?

Oh no, it will go -- there are still some in -- there's some we hope to do in the fourth quarter. There's some that we hope to do in '05. So, you know, we said up to 20 plants and that number can change depending upon circumstances and what happens with business. But that still is our expectation.

Terrific, thanks.

Okay. Thanks, Jim.

Thank you. Our next question is coming from Evan Morris of Banc of America.

Good evening, guys.

Hi, Evan.

Just a real quick one. Just looking at the price gaps, you've mentioned that they've stabilized and they're in line with your targeted range, one, those ranges seem to be at lower levels than they had been historically, and two, just trying to get a sense of really how stable they are, you're spending a lot of money in trade promotion that's going toward managing these price gaps. Is this a strategy that you're going to have to employ sort of longer term or what happens then if you pull back on trade promotion which may not be the best use of your money, do these price gaps then get out of line? How does this remain stable in a very competitive environment and what could be the impact on your margin structure

Well, certainly if we're spending the trade monies to manage the price gaps, typically we do that as a condition of earning the funds. So, you know, it's not an issue of the spending not finding -- finding it's way to the consumer. The question really is whether or not this is a permanent change in the margin and cost structure of the business and the answer to that is pretty much, yes, it is because we want to have these -- these businesses within those targeted ranges. Now, we measure those targeted ranges over time, you know, and they don't change a lot but they can change based upon what else you do with your benefit bundle. So if you've got better advertising, if you've got really super promotional programs or even new product initiatives, you can manage that range to a higher level. But, you know, the answer basically is yes, that we want to keep our prices within the appropriate gaps and then gain share based on marketing initiatives and innovations.

And typically, Evan, when we move a range, you're talking about, you know, often 2 to 3 points of a move. So perhaps instead of, you know, 17 to 20 it's 15 to 18, or something. It's not nearly as dramatic as you might imagine.

Okay. Thank you.

Thanks.

Thank you. Our next question is coming from Ann Gurkin of Davenport.

Hello.

Hi, Ann.

Hi, Ann.

A few questions. Can you just give me the category growth for cereal in the U.S. and also for confections in the U.S.

Yeah. Mark's got the numbers. I'll let him look it up real quick.

You know, what we see is basically the category for cereal is flat. And for confections it was also largely flat. Both those categories, again including a Wal-Mart projection, are essentially flat in categories.

And what are you defining as confections?

That's, you know, our sugar confections business.

That category? That category?

Non chocolate. Non chocolate sugar production.

Non chocolate. Okay. And then as you roll out Tassimo overseas, how is that going?

Well, it's a little early yet but we've had a very good sell in. The initial take away on the machine has been fairly positive. In fact, it was very positive and right now we're selling them as fast as we can make them but we're not, you know, up to full production capabilities yet so we've had very good response both from consumers and from customers. Way too early to gauge any kind of repeat on usage, but we think it's an exciting idea and we think it will be a big winner for us going forward.

And we have begun to sell it in. It's been out for the trade in the UK as well.

Okay. And we're trying -- one more time, I apologize, to the marking spending? What you've spent so far, what's been -- what has exceeded your expectations and what has missed or what has changed in the marketplace since you started this program?

Well, certainly a couple of things in terms of the business response. We had some tail winds with this on some of the early wins like on cheese, nuts and meat. More recently, the success we're seeing on pizza and biscuit, I think, are real big positives to add to that. But we've also had to step-up some of our programming, as I said earlier, in Post and in beverages. And what's nice, particularly on the biscuit side, is some of the advertising that's been out there has just been absolutely terrific, has gotten tremendous accolades in the industry and we see it actually making a difference. I think Oreo is up in double digit kind of increases driven in large measure by the quality advertising.

All right. Thank you.

Thanks, Ann.

Thanks, Ann.

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

Good afternoon.

Hi, Christine.

Hi, Christine.

Yeah, just wondering, just again to follow-up on the earlier question on commodity costs, is it your expectation that you will be able to hold pricing in a declining cost environment? I'm sorry if you kind of answered this earlier, but if you could just follow-up.

Well, I'm not sure I'd say -- certainly we'd like to hold pricing if we can, but the fundamental issue here is making sure that we don't let our price gaps get out of the targeted ranges. And that could mean we've put a little more merchandising support behind the business to keep it in the targeted range, or if it's a substantive change in the underlying commodity, we would consider a price decline if need be.

And just --

As you know on some of our businesses we tend to move sort of with the market, so on things like cheese, meat, coffee, if the market moves down substantively, we will be coming down with it. Jim's point, the overriding goal here is to maintain the price gap. And also we need to think about the efficiency of how we execute these things because in some instances if we take a price decline, we may not see a penny by penny reduction to the consumer whereas on the trade spending, we can make it a condition that it find its way to the consumer.

Fair enough. And then secondly, we're seeing a lot of new entrance into some of your categories specifically in the meats category. Companies have announced intentions to be more competitive. Is it your expectation that in these commodity based areas that you'll continue to go head to head with some of these new entrants as they become very cost competitive or is your goal to take more of the high ground and maintain pricing? I know this has been an area that you've been challenged with in the past. I'm just curious what your approach would be.

Well, certainly, the nice thing about a new competitive, branded competitive entry is they tend to grow the category and that's sort of the concept of a rising tide lifts all boats. But more importantly, whenever we have these competitive challenges, we need to make sure we execute our fundamentals well. You know, and that means we offer the right brand value. We'll certainly look to step-up innovation. And if it is, you know, in most cases it is one of our core categories, we'll defend our share within that category.

And Christine, just a couple of numbers to put it on top. You know, in cold cuts where there has been a lot of activity, on the first half our consumption was up about 10% and in the third quarter it was up 10% again. So, we've gained about a share point and a half in that business this year, in a fairly competitive environment. So, to Jim's points, good ideas are good for the category and it's driving top line growth for all of us.

Fair enough. And then finally, just wondering, you know, you spent a lot of money, certainly, on new products and launching some of these new products. Is it your expectation that some of that initial trade spend will decline over time or is it given kind of the steady stream of new products is that something that you expect to be a kind of a constant percentage of your marketing spend?

Well, when -- certainly on the launch of a new item, with the fees to do that, you'll spend a higher pace than you expect to spend on a sustaining or ongoing basis, but to your point, I would hope that we can continue to launch new items at a fairly good pace, which would say that we're going to continue to put the support behind it. The one thing I will add, though, is as we look at these new item activities, we're clearly trying to make an effort to make them far more incremental to the business so that we do get a big -- a bigger bottom line impact overall.

Great, thanks.

Thanks.

Thank you. And our final question is coming from Pablo Zuanic of J.P. Morgan.

Good afternoon, everyone.

Hi, Pablo.

I'm sorry just to follow up again on the marketing spending question. What I don't understand is that you're implying that you're going increase that number by 130 million in 2005, that's a pretty much a 20% increase over the '04 number and I don't think you're guiding for 20% revenue growth. And the reason I say I have a hard time understanding that is it goes -- from all of the cost increases next year are not so much in cheese and cold cuts, as you said, it's mostly packaging and energy which I see as more wide in terms of impact on most of your competitors. In the use of cheese and cold cuts, your price premiums were out of whack and you had to rebalance that. Now you are saying that your price gaps are pretty much in balance in general. The commodity cost pressure next year is going to be more across the board to most of your competitors, why would you need to ramp up trade spending by 20%?

Well, what your -- the 20% you're referring to is a 20% step-up in the incremental marketing support because when we look at the total in marketing support, that number is in the billions.

Right, okay.

So the increment we're talking about is relative to the mass of our spending, you know, it's probably the hardest working dollars we have but it's not, you know, just to put it in perspective, it's not that dramatic of an increase. But the key on this is making sure we drive our sustainable growth program, drive our brand value. And if we have advertising, if we have promotional programs that continue to push the business forward, we actually should look to spend more since that presumably is going to give us a positive pay back on that investment. As far as the commodity discussion goes, I mean, the cost we're referring to, you're absolutely right, they are across the board, they're affecting everybody who's in business, not just those of us in the consumer good space, so will it lead to general inflationary increases, you know, that remains to be seen but clearly it is going to push everybody. The problem with it is when you -- it's a small component of everybody's cost and we tend to price in, you know, certain increments. So it gets a little hard to pass through some of these insidious costs until they can reach a certain threshold where you can make that kind of change. Ideally what you would like to do in the interim is you back off a little bit on your trade merchandising support, which has the same net effect as a price increase, but you still have to make sure you're hitting your targeted promotional points and you're delivering the kind of merchandising you need to support your business, and that's fundamentally where you've got to end up.

Right. And just one follow-up. I mean, the mix number of 1.9%, I think that's quite good relative to the recent history. I realize it's partly distorted because of lower beverages, but can't you just expand in terms of where that came from and how sustainable is that going forward?

Well, again, we -- certain businesses like ready to drink were -- the 1.9% you're talking about is mostly a U.S. number. I think the number -- actually, it's about the same, 1.9 for a total. The key drivers that helped push that up, you know, cheese is certainly a contributor to that. The biscuit business and its return to a growth mode in the third quarter was a significant contributor to that. Pizza, coming back on as strongly as it did in the third quarter helped that. Germany, the fact that we grew a positive volumes in Germany certainly helped in that regard as well. The businesses, whenever you have a mix somebody is up, somebody is down. The businesses that were down, as we said, we had a little bit in Venezuela, we had a little bit in some other developing markets and we had the ready to drink business here. My hope is we don't have those kinds of negatives to accentuate the mix as much as it did. I would much rather deliver a broader growth across the portfolio.

Okay. Thank you very much.

Okay. Thanks, Pablo.

Thank you. I will now turn the floor back over to management for closing remarks.

Okay. Well, thank you all for your participation today and your questions. Have a good evening.

Thank you. This does conclude this afternoon's teleconference. You may disconnect your lines and enjoy your day.