億滋國際 (MDLZ) 2005 Q1 法說會逐字稿

Good afternoon and welcome to the Kraft Foods first-quarter 2005 earnings conference call. [OPERATOR INSTRUCTIONS] I would now like to turn the call over to Mr. Mark Magnesen, Vice President of Investor Relations for Kraft. Please go ahead, sir.

Good afternoon. And thanks for joining us for Kraft Foods's first quarter earnings conference call. On the call with me today is Kraft's Chief Financial Officer Jim Dollive. Jim and I will start today's call with some prepared remarks that will reference slides that are available on our website at www.kraft.com. About an hour ago we issued a press release with our first-quarter results and 2005 outlook and this release is available on our website. I remind you that our release and comments today contain projections of future results and are made only as of today's date. Both the release and presentation contain our Safe Harbor statement which reviews some of the factors that could cause actual results to differ materially from projections.

Our agenda this afternoon starts with comments from Jim on Kraft's progress against our Sustainable Growth Plan. I'll take you through the details of our first-quarter financial results and updated 2005 guidance and then we will open it up for questions. Please note that we will be discussing our results today on a continuing operations basis, which excludes the results for the sugar confectionery business that we agreed to sell last November. The divestiture process for this business is progressing as planned and we expect the sale to be completed sometime during the second quarter. At this point, I will turn it over to Jim.

Thank you, Mark. And good afternoon, everyone. In this recent quarter, we continued to make good progress against our Sustainable Growth Plan. As with the case last year, we made Brand Value improvements across much of our portfolio through effective price GAAP management, to increased marketing spending, and through new product activities. Our ability to manage price gaps well was particularly important this quarter as several of our key commodities, including coffee, cheese, nuts, and meats remained higher than year ago. On the marketing side, our end market consumer spending was up about $50 million in the quarter, the majority of which was advertising. And these efforts continued to pay off for us.

We maintained our top line momentum from the second half of last year driving ongoing comps and currency revenues of 4.5% versus last year, following growth of 4.4 and 4.9% in the previous two quarters with pricing, mix, and acquisition as the key drivers. We also generated improved market shares in the U.S., with dollar market share in our top 25 OCI categories up three-tenths of a point on a weighted average basis. This gain continues the positive trend we began in the second half of last year. Also consistent with last year, our new product results were strong in the first quarter.

Looking first at those items that we launched in the second half of last year, Nabisco 100 Calorie Packs continued to perform well and we have added new items to the line this year. Capri Sun Fruit Waves ready to drink pouches performed well and have helped us source volume from the adjacent juice category. Lunchables Chicken Dunks, now the fastest-turning product in our Lunchables line is tracking to be a $50 million business for us this year. Our innovative DiGiorno Microwave Rising Crust Pizza helped drive our pizza business to strong revenue growth and share gains in the quarter and Milka M-joy chocolate tablets have moved into new geographies in Europe including Romania and Bulgaria and are now available in 15 countries.

We also have some exciting new items launched in the first quarter. The retail sell-in of our South Beach Diet product line has gone very well both in terms of customer authorizations and the average number of items carried. This 27-item line addresses every eating occasion, breakfast, lunch, snacks, and dinners, and is now available all across the country. In our Oscar Mayer business we are building on the success of ready-to-serve bacon by introducing ready to serve pork sausage and canadian bacon products. And the sell-in for these items has also gone very well. We added a second flavor to our Crystal Light Sunrise line, Ruby Red grapefruit. Last year's introduction of the orange flavor quickly became our fastest-turning Crystal Light SKU and we expect the Ruby Red grapefruit line to me nicely incremental as well.

Internationally in our lead market in France, initial sales of our Tassimo brewing machines are strong. We began the sell-in of Tassimo into the next two expansion markets, the UK and Switzerland with strong authorizations from retail customers. In a few minutes we will talk more about our geographic expansion plans for this exciting hot beverage system. Within our Sustainable Growth Plan, we also made good progress on our external development efforts. The previously announced sales of the U.S. yogurt business and the UK dessert businesses were completed. The sale of the sugar confectionery business remains on track for completion in the second quarter, and we recently announced an agreement to sell our Fruit Snacks business, which was about $80 million in revenues last year. We expect this deal will also close in the second quarter. These moves are all consistent with our portfolio transformation strategy, and we continued to evaluate other potential divestitures primarily Pale brands where we do not have a competitive advantage or benefit from scale. In aggregate, these Pale brands represent a low to mid single-digit percentage of our total revenue.

Looking quickly at our International business, we delivered improved growth despite difficult retail and competitive environments in many markets around the world. In developing markets, our ongoing cost and currency revenues were up 15% versus last year, driven by particularly strong growth in Eastern Europe. Although the results benefited in part by a soft year-ago comparison in certain countries like Russia, the growth was strong across many markets. Revenues in our big four developing markets of Brazil, Mexico, Russia, and China were up approximately 20%, and we continued to invest to build our brands and scale in key developing markets.

In key western and central European markets, our results were more mixed. In the United Kingdom, our Philadelphia and Dairylea cheese businesses performed very well helping drive growth in both revenue and volume. The Dairylea Tri-bites cheese snacks that we launched last year continued to perform well, leveraging a healthier snacking position. In France, our confectionery and coffee volumes were up; however, revenues in France declined slightly because of increases in promotional spending begun last year to improve our price gaps. And in Germany, revenues and volume were down in the quarter with coffee the key driver. We took a price increase on coffee early in the quarter, and most competitors delayed similar pricing moves resulting in a negative volume impact. While our results in Germany are disappointing on an absolute basis, they were largely in line with our expectations and key coffee competitors have now announced increases to coffee prices.

Finally, our restructuring efforts remain on track. We announced two additional plant closures bringing the total amounts of site closures to 15 against our original plan of up to 20. Additionally, we continued our efforts to prune lower volume SKUs this year on top of the 11% reduction last year. And under our business process simplification initiative, we have established our core team and are identifying target areas where we can get some quick wins from simplification. So to reiterate my opening comments, we feel very good about what we've done in the first quarter with solid progress against our Sustainable Growth Plan. Now I will turn it back to Mark to take you through the details of our first-quarter results and our 2005 outlook.

Thank you, Jim. Turning now to our first-quarter 2005 financial results. Net revenues were up 6.4% on the quarter. 2.1 points that which came from favorable currency primarily from the weaker dollar versus the euro. Ongoing constant currency revenue growth, which is our guidance measure, was 4.5% driven by volume mix of 2.3 points, net pricing of 1.6 points, and acquisitions of 0.6 points. Importantly, the total volume mixed growth impact of 2.3 points reflects a strong positive mix component. Our ongoing volume growth which includes acquisitions and excludes divestitures was 2.5% in the quarter, but excluding the Veryfine acquisition it was down 0.3%.

Several factors are driving this combination of strong mix results along with lower volume growth. First, we continue to focus our resources and efforts against higher margin products to proactively manage mix. Second, as expected, our SKU reduction initiative is having a more significant impact on pounds than it does revenues. And finally, with the price increases we have taken over the past six months or so, we are beginning to see some volume impact on category growth rates. In most categories, our consumption growth rates remain solid as we have gained share.

Looking forward, while we do not expect mix favorability to continue at the 2-plus point level we saw in the first quarter we do expect mix to remain positive with volume growth on the year running about 1% on a comparable 52-week basis. In the second quarter, pricing actions and the Easter shift should make volume growth excluding acquisitions similar to the first quarter, with our drive for positive mix again benefiting revenue. Looking at our segment performance, revenue growth was broad-based with six of seven reporting segments up. North America was up 4.4% with solid growth in all segments except U.S. grocery which faced competitive issues in a few categories. And International revenue was up 4.6% with solid growth in both segments. As Jim previously indicated, our developing markets posted particularly strong growth in the quarter up 15%.

Shifting to earnings, we earned $0.41 per share on a continuing basis in Q1 this year, which is up $0.09 from 2004. Earnings growth versus last year reflects $0.04 in lower restructuring and impairment charges, a $0.04 gain on the sales of businesses and $0.03 in favorable taxes. As we he expected when we issued our Q1 guidance, these favorabilities were offset by a declining earnings growth from all other operations up $0.02 which include three main drivers. First, post employment benefit and restricted stock expense were up $55 million or $0.02 impact in the quarter. We continued to project $0.11 total impact from these items on the year. Second, marketing spending was up about $50 million or $0.02 as well which is consistent with our expectation to increase marketing spending by 200 million to $250 million on the year. And third, and most significantly, the benefits from our price increases lagged the related increase in commodity cost. I will elaborate more on these cost pressures in a few moments.

Favorable currency did provide a partial offset to these items representing a benefit of about $0.01 on the quarter. Versus our first quarter EPS guidance of $0.37 to $0.40, EPS from continuing operations of $0.41 was slightly above the range due to the net impact of two items. First we realized a tax benefit of $0.03 from the positive resolution of several outstanding items in the first quarter that was not in our previous guidance. Partially offsetting this $0.03 benefit were $0.02 in higher restructuring and impairment charges. We incurred $0.07 in total restructuring and impairment charges in the quarter above our expectation of $0.05. The driver of the higher cost was the $0.04 impairment charge on the Fruit Snacks divestiture which was partially offset by $0.02 in lower restructuring charges in the quarter due to timing. Excluding these items, results were generally consistent with our expectations.

One of the key factors in our quarter was commodity costs. Looking at commodities broadly, some historical perspective is helpful. The CRB index, an industry statistic which tracks 17 key commodities reached a 24-year high in the first quarter. While our mix of inputs will obviously differ from this broad index, what does become apparent is the significant cumulative impact from the rate of increases over the past three years. As we indicated last year, this is not just a one-year phenomenon. More specifically for Kraft, and for the first quarter, aggregate commodity costs were up approximately $250 million. We experienced increases across most of our key commodities.

This chart shows the percent change in the average market prices in Q1 of this year versus last year. Nuts, coffee, crude oil, and lean hogs were all up significantly. Even barrel cheese remained above prior year levels although the peak in cheese last year was in the second quarter and we don't expect to see those levels again this year. We responded to these higher cost by increasing prices across a number of product categories and geographies while also managing price gaps within targeted ranges. One of our key challenges in the remainder of the year will be to balance these higher prices and increase costs, such that impacts on consumption are minimized. As I mentioned earlier, thus far, we have seen some impacts of higher prices on category growth rates, but we have largely maintained our consumption growth through share gains.

On discretionary cash flow. Our first quarter is historically a low cash generation quarter. In Q1 2005, our discretionary cash flow was $103 million down from a very strong $346 million last year. The decline versus last year was due primarily to three items. The first was a voluntary contribution to our pension plan of $190 million this year versus $50 million in contributions last year. The second was higher cash spending on our restructuring program of about $50 million. Finally, because commodity costs were much higher across most of our portfolio, our inventory valuations were higher as well. Importantly, while our dollar investment in inventory was up, on a day's basis we improved versus the first quarter of last year. As you will see shortly, all these first-quarter impacts are accommodated within our cash flow guidance on the full year which remains unchanged.

Finishing up now with our full-year outlook for 2005. We have increased our top-line guidance which was previously 4.5% on a 53-week basis to 4.5 to 5.5%. On a comparable 52-week basis this growth would be 3 to 4%. The increase is the result of the investment in several growth initiatives which I will explain further in a few moments, along with higher pricing on several businesses.

Due to the breadth of pricing across our portfolio late last year and early this year, as well as our concerted efforts to focus on improving mix, our volume growth is expected to lag revenue growth this year. We currently project ongoing volume growth of around 2.5% on a 53-week basis or 1% on a 52-week basis. We have adjusted our earnings per share guidance on a continuing operations basis to $1.73 to $1.78 per share. This includes $0.22 in restructuring and impairment charges and $0.04 of gains on sales of businesses. Within this guidance we have not assumed any additional portfolio changes for the balance of the year.

On a reported basis, this guidance is down by $0.02 versus our previous guidance; however, it reflects $0.04 in higher-than-expected impairment charges due to the Fruit Snacks divestiture announced in the first quarter. Offsetting this $0.04 charge is a $0.02 benefit which represents a net of lower taxes, investment in key growth initiatives, and higher energy and packaging cost. On the year, the tax favorabilities projected at $0.06, and we now anticipate an effective tax rate of 31.5% below our previous guidance rate of 33.4%. The impacts of the additional investment in key growth initiatives and higher energy and packaging costs are each approximately $0.02.

Looking at the growth initiative investments, there are two items we can discuss today because they have been announced to retailers. The first is the geographic expansion of Tassimo in the U.S. and Germany in the third quarter of this year in time for the key holiday shopping season. In the U.S., we will leverage our premium Gevalia coffee brand, while in Germany we will launch under the Haakon's Coffee brand. Early feedback from retailers that will carry the machines has been very positive.

The second growth initiative is a series of investments behind chocolate-based biscuits in the U.S. These initiatives are part of an overall plan to extend our portfolio of biscuits with chocolate which have strong appeal to consumers and sources volume from adjacent categories. This initiative includes a strong shipper display program for a new single-serve Chocolate Enrobed Oreo that will reach multiple distribution channels, a Double-Stuffed Oreo with peanut butter to source volume from the large chocolate and peanut butter candy category. And an Oreo brand chocolate bar with a unique cookie and cream filling. Needless to say we plan to strongly support our biscuit business where their are growth opportunities and the initiatives we have announced thus far are only the beginning of a series of investments we plan to make.

The final elements of our 2005 full-year guidance is discretionary cash flow which remains at around $2.9 billion. As a reminder, this guidance excludes the proceeds from our planned divestitures which would add another $1.4 billion to cash flow, bringing our effective cash intake this year to approximately $4.3 billion. In terms of cash usage, our priorities remain the same, which are to fund acquisitions, return cash to shareholders through dividends and share repurchases, and lastly to reduce debt.

In summary, as Jim highlighted, we continued to make good progress against our Sustainable Growth Plan in the first quarter. We maintained our top-line momentum through positive mix, new product results, effective price gap management, increased advertising, and improved International results. Our 2005 outlook remains largely unchanged. High commodity costs, including energy and packaging were the key challenge in the first quarter and we expect that to be the case as we manage through the rest of the year. Finally, our efforts this year continue to position Kraft well for sustainable growth as we are investing both in our base business and in key growth initiatives for the future. With those comments behind us Jim and I would be happy to take your questions.

[OPERATOR INSTRUCTIONS] Our first question can coming from Eric Katzman of Deutsche Bank.

Hi, good afternoon, everybody.

Hi, Eric.

Hi, Eric.

I guess my first question is with regard to the tax rate being lower than expected, I guess I am a little bit surprised as to why half of the annual tax rate benefit is coming this quarter. Was it just kind of really a temporary adjustment and then the rest of the year is actually going to be closer to -- what was it, 33% in order to average out to be 31 or whatever you are saying now?

Well, the tax rate is -- is a combination of a couple of things, some of which get factored into the base rate. Those are the things, for example, like the manufacturing deduction associated with the -- the American Jobs Creation Act So that effectively lowers the base rate and gets the average across the year. The other impact and the one that's the more significant impact in driving the change is the resolution of some outstanding tax items. The one in the first quarter was primarily in the International business. I also expect to see a further resolution in the second quarter, which will bring that rate a little bit below the average as well. So it is a combination of a series of events.

Okay. So first half, a relatively low tax rate. Second half going back up to average to the 31.5?

Exactly.

Okay. And then second question. I guess I am a little bit surprised -- I seem to remember that, for example, last year, you took pricing up in frozen pizza because of higher cheese costs. You took some frozen, I think, snack prices up. And if you look at your consolidated revenue line, I think you said that the total -- the total net pricing benefit was 1.6%, and volume and mix were also positive. So even if you include the spending back from promotion, you still were a net positive. So why are you saying that we are not sure if we are going to get pricing and what is kind of the, I guess, the holdback? Have things gotten worse as the quarter progressed in terms of the elasticity?

Well, certainly I think the thing we are reacting to is the size of the increase in the commodity cost. As you have appropriately noted, we have taken more pricing in the last 12 months than we have seen in a significant period of time. A lot of which is to recover those commodity costs. The rate of commodity costs, however, continues to be pretty high, and we are seeing that in coffee. We are seeing that in energy and packaging costs. We are seeing that in nuts. Certainly coffee, we've gotten the pricing back -- the pricing in the market to recover some of that increase, but it is far more difficult to get that pricing recovered through the energy line, where it is sort of an insidious cost that runs across the entire businesses. It is on that piece that you are seeing the net impact of pricing net of cost, be at a little bit more of a negative.

Eric, I guess I would add what gives us some element of caution is we are beginning -- like we said in the first quarter we began to see impacts in the category. We had a very good share quarter so our consumption remained very solid because we had a good share quarter. What matters in the rest of the year is what the competitive side chooses to do in response to that. So to the extent we can sustain the share gains in weaker categories, we will be fine, and we certainly plan to do that. But that is probably what's given us some element of caution -- the categories in some of the categories have slowed down.

Then last question and I will pass it on. But your -- I mean your volume growth in the quarter, I guess, down 0.3 was somewhat disappointing given all the new product effort, and yet you are still anticipating in your assumptions -- I think you said 1.5% volume growth for the year, excluding the extra week.

Yes, about 1%.

Okay, 1%. So you are assuming that even though you are becoming a bit more concerned about the price impact and how it affects your business rather than the category, you are still expecting that volume growth lifts as the year progresses?

That's exactly what is in the forecast and that's exactly our expectations because clearly when you take a price increase, and on many of these categories, particularly in countries like Germany, where we led the price increase and others delayed the time of which they followed, we had a disproportionate impact on our volume. Everybody is subject to the same cost increases, so as the prices start to normalize, and that is the lag effect that Mark talked about earlier, we should start to see that return. The other thing I'd point out is within the volume weakness for the quarter we did have some trade inventory reductions in the U.S. particularly on our ready-to-drink business and we really don't anticipate that being a further reduction as we -- of the magnitude we saw in Q1 as we go through the balance of the year. I think your conclusion, though, is right. The things that we are looking to to drive this momentum are the investments we are making behind the businesses and certainly the new product initiatives that are out there and that is what gives us the positive outlook on that volume call.

Okay. Thank you.

Thanks.

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

Hi, Jim and Mark.

Hi, John.

Just to follow up to Eric. As you look to the tax rate which you said in January 25, would be 23.4 and now it is suddenly lower, how do you see that playing out longer term? Is this a -- what do you think the longer term tax rate is?

Well, certainly we're taking efforts and putting programs in place to manage down our tax rate with the tax strategies that we have. Obviously, when you look at the statutory rates, they are higher than that amount. Within the tax rate that we have, there is probably a couple of percentage points that are associated with some of the one-time items that are in there. I would say in the order of -- of 3 points or so, but we will continue to look for opportunities to bring the rate down below that sort of statutory rate, given the mix of businesses and countries that we have that would put us somewhere in the 36 range.

Okay. And just -- I I don't want to harp on Fruit Snacks too much, but it just -- for an $80 million business to have a 90 million some charge to sell it, can you just explain the logic of that transaction?

Well, it is not -- let me just explain the transaction. The Fruit Snacks business is one that came with the Nabisco acquisition. And within the valuation of that business it includes not only the normal assets that you would expect, it also includes a component of goodwill and a healthy slug of intangible assets associated with the trademark. Those intangible assets include a lot of the cartoon characters that are on the boxes, and that is, in fact, driven by a -- an outside contract that we have that really wasn't part of this transaction per say. So you've got a unique event in here where a lot of the value from the initial acquisition is on the intangible assets, and that's associated with the characters that we really don't own.

Okay. Cartoon characters are expensive, I guess.

The licensing associated with the cartoon characters are expensive.

On a more substantive basis than cartoons, you gave first-quarter guidance when you reported fourth-quarter earnings. You are now reporting first-quarter earnings, and you are not giving specific second-quarter guidance. Is this kind of like you are going to give guidance when you want to give guidance?

No, what we said, John, at the end of the year was because there were some unique events going on with some of the asset impairments and some of the businesses that were being sold that we wanted to be a little explicit about the first quarter. Our tactic and our objective is to give annual guidance, not to give quarterly guidance but when we know we are going to have a significant disruption like that, we want to make sure that you are aware of that.

In terms of quantifying the benefits of Easter that fell into the first quarter this year that won't fall into the second quarter. I mean normally you earn a little bit more in the second quarter than you do in the first quarter, if I can just kind of paraphrase. Is that basically where -- might some of that be lost with the timing of Easter? Or can you quantify that at all?

It would be a directional estimate. I'll ask Mark to comment on this as well, but certainly some of our businesses where we have strong confectionery business that is linked to Easter. Best example of that I can think of is in Brazil. We clearly pulled some volumes forward into the first quarter. Some of our merchandising activity that's Easter related whether it is Stove Top Stuffing or some other businesses also get pulled a little bit into the current quarter. If I had to estimate a number and it would be directional, that is probably a couple of percentage points in terms of the overall volume performance.

A couple of tenths.

Tenths, rather.

Tenths, okay.

A couple of tenths. Thanks, Mark.

Part of that is you only really had a shift of two of the three weeks. In the past when we have had this event shift. We've often shifted it entirely up from one quarter to the next. Here you have got really two weeks of the three-week merchandising period that shifted.

Got it. And listen, I think the price -- I think the price realization that you got in this quarter -- the price mix, I mean, Kellogg had a big turn around without much or if any volume growth. I think we are all thrilled to see it. And I guess what I am trying to do is -- is question the sustainability of this -- of this trend. Do you feel like you are on something that can, you know can drive the pricing realization for a long period of time?

Well, I certainly do think we are going to see it for the balance of this year and it's obviously built into our number, and I think it is more sustainable than just one year. What we are really talking about is the positive mix that we have seen in Q1 and that we saw through most of last year. And what's driving that -- certainly it is not any one single event I can put my finger on, but it is a whole series of events built around the whole strategy within the sustainable growth program. It gets into things like the change in our selling focus where we have put more of a revenue emphasis rather than a volume emphasis and with that the move to get more of the consumption-based trade spending tactics. Clearly the new product activity is more towards the higher contribution items, particularly those where we have a technological benefit and with it comes greater incrementally. I'd point to the SKU pruning exercise whereas we are eliminating last year 11% of our SKUs and we hope to have another 10% or so this year.

Okay. Well, thanks for all of that.

Thanks, John

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

Good morning -- or afternoon, I guess.

Hi, Christine.

Just wondering -- not to focus too much on the tax rate, but another company in the group talked about changing a tax law in several of their International businesses earlier today. I am wondering, are you seeing differences in the tax rates in other countries that could affect that long-term rate?

Well, the changes we are seeing on the International side are really tax strategies right now that we are doing to manage down our tax rate. I'm not --?

But not specifically tax law change?

Not that I am familiar with right now.

Okay.

Certainly not in some the major countries that we are in.

Sure. And -- from my understanding it was primarily in South America where I assume you would probably see similar changes over time.

Okay.

Effectively. Then just, if you could, talk a little bit more about the delays you are seeing in your ability to pass through, again, packaging and fuel costs. Specifically, are you looking to take up pricing and able to offset some of that over the longer term? And do you think you will be successful later this year in doing that?

Well, the challenge -- certainly when we are looking at commodities like coffee or meat or nuts, where it is a high component of the cost of goods, we are able to pass those through pretty quickly. It is far more difficult when you get into energy-related costs for two reasons. One, there is a direct component which is pretty small. There is an indirect component that gets into the packaging material and that tends also to be a small increase, but it is an increase across everything, and then all of our suppliers in turn have some component of their cost structure that is influenced by energy. The difficulty is trying to take pricing specifically for that kind of cost increase, so what we typically try to do is look for a cumulative effect of not just the energy and packaging cost but the other components of cost to reach more of a trigger point where it is appropriate to then take a -- take a normal type price increase. Because normally you price these businesses in some sort of increment like a dime or $0.20 or whatever. And that's what we're looking for, is when can we reach an appropriate trigger point where we can execute a price increase.

At this point, though, after you have already taken pretty hefty increases over the past year to compensate for some of these other commodity price pressures, is it reasonable to assume that you could pass through additional pricing?

Well, certainly if the macro underlying commodity continues to change, i.e. coffee, and coffee has been fairly volatile recently, we would look for that change and then we'd bundle the other cost implications on as well.

But your premise is right, Christine. And that's why, of the $0.06 in tax favorability, 2 of it went to offset packaging and energy cost because they are more difficult to specifically price for.

That's reasonable. You'd also mentioned specifically one area in the center of the store where you are spacing a lot of competitive activity. You guys have really stepped up advertising and marketing trying to differentiate your products. How do you combat I guess that type of -- of, I guess, cost based competition in your new strategy?

Well, you are getting right at the heart of the whole Sustainable Growth Plan, and that is ensuring that we can drive Brand Value through not just the appropriate price gaps but by the investments we make, whether it is through quality, through marketing, or other initiatives. And then you get into the whole new product arena, and lately where we have been leaning into the technology aspect as a way to differentiate our products and create a sustainable point of difference versus the competitive environment. And it's those pieces that have been working well for us in the -- certainly last year and the start of this year, and those are the levers that we are going to continue to pull.

But generally are those also areas that you might consider, I guess, exiting over the near term -- noncore businesses?

Well, as we mentioned, there are certain Pale business where we will look to divest those businesses if it makes sense to do so, and that includes whether or not we are going to get appropriate value for those businesses. And that's a fairly small percentage that I indicated of our total revenue base.

Great, thanks.

Thanks, Christine.

Thank you. Our next question is coming from David Nelson of CFSB.

Good afternoon.

Hello, David.

Hi, David.

Well, you are talking a lot about commodity cost again. Certainly some are up, but some are down. Could you talk about what your experience is in commodity -- where the commodity input cost is actually going down, maybe soybean oil affecting salad dressing and mayonnaise. Are you having to give back in pricing as much or more than the commodity input is down?

Well, certainly we have seen some commodities like oil and the grains in particular showing more favorable trend this quarter versus what we were looking at last year at this time. But that's just one component of that cost structure. The packaging, and this is one of the ways you offset some of those other cost implications like packaging and like energy where the total bundle of the cost are not down as much. The thing we have to watch, though, is to make sure price gaps stay within the targeted ranges so that if -- if we are -- if somebody else is changing the competitive dynamic by using that commodity change, we want to make sure that we either have our benefit side increased to the point we can justify a larger price gap or we are going to have to use some promotional programs to maintain our relative value.

So it varies by business category.

It absolutely varies by category.

You want to avoid a cheese like a couple of years ago.

Exactly. You don't want to get yourself in a position where you have to take a quantum leap because it's very hard and very expensive to gain back share once you've lost it.

When you talk about moving up the mix, and we are seeing you make some progress here. Are you implementing any new systems to help you with that? I know lots of your domestic competitors have installed SAP or -- to help you with marketing mix modeling. Are you putting in any new technologies to help you with that?

Well, we are certainly looking at technologies, and we do have within the whole area of business process simplification a look at what we can do, not only to improve the information flow but also to simplify the process around which all of that activity occurs. Clearly we've put in new systems throughout all of Europe with a -- with a common SAP infrastructure. We've got new systems going in right now to help us on the financial side in terms of the tracking and the reporting at a fairly low level of detail, and we think that will help us from a -- from the global category management group that has been set up so we can start to manage the information on the businesses on a global category basis. So all of those are activities in process, and we continue to look at the other opportunities where we can make investments in systems as a way to drive the overall business capabilities.

One of the keys to that is the information flow to the sales force, who are the ones helping make lots of day-to-day decisions. So there is an increase in information flow to help them manage mix to the sales organization as well.

If I could get micro for a second. I realize this is not a big part of your business or maybe a huge priority, but I noticed in the release, cereal was up solidly, and we hear some others out there complaining about private label and so forth. What are you doing right in cereal?

Well, it is a comparison to last year. A couple of things I would point out. First, the pricing on cereal is reasonably good for us right now. We certainly took a price increase last year when -- in the third quarter and we continue to promote reasonably well on that business, so we are seeing some pretty good price points. That's not the big driver though. The big driver really is the new product activity compared to last year. Last year we just didn't have a lot of new items going into market. This year, we are seeing a couple of new items. We introduced late last -- second half of last year, some line extensions on Honey Bunches of Oats, and they are still doing quite well for us. We also introduced some new Items in the bars category, particularly on Honey Bunches of Oats and on CarbWell and those are nicely incremental for us. So those are a couple of the big drivers in terms of the year-to-year comparison on Post.

What tends to happen, David, when you don't have new items and this was the case for us a year ago in the first quarter was you literally get shut out of entire events in terms of merchandising. And those are the ones had that really hurt you in terms of your volume performance. So with the new items that we launched in the second half of last year, we were back in the game on the -- from the first-quarter perspective in terms of events themselves and that really benefited us.

Then lastly, if I could get big picture. This was a quotation over the wires, I think it was Reuters about a month ago, as acquisitions have remain your top cash reinvestment priority. Roger was quoted as talking about western Europe being an attractive area. If that quotation is correct, what is attractive about western Europe. Why would you want to get bigger there?

Well, what we have said is we have global core businesses, and within our global core businesses of which there are four, it's -- it's coffee, it's biscuits, it's certain of our cheese businesses, cream cheese, and processed cheese in particular, it's certain of our refreshment beverage businesses such as powder and fruit-flavored ready-to-drink. As we look across the world, there are certain white spaces in terms of where we have presence in -- in those global core categories. So just filling out our global course is an opportunity. So that's -- that's one area that -- that would be of -- of interest to us.

It becomes a bit of a scale leverage play in those markets as well.

Well, good luck. Thank you.

Okay.

Bye-bye.

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

Hey, Jim and Mark.

Hi there.

When you look at -- when I look at some of your key segments like beverages, convenient males, snacks, and cereals, you have got some nice constant currency revenue increases, nice decent price mix factor, but declining operating income, and I guess -- I know a lot of that is commodity prices, and I purposely chose three segments that apparently exclude much change in restructuring costs. A lot of companies might control for a difficult commodity environment or maybe where some competitors weren't taking pricing through marketing dollars. And you alluded to that earlier, Jim. I'm wondering, what do you look at in terms of marketing dollars per category. Do you have any specific metrics, payback times in terms of variable operating profit for investing marketing dollars? Because it looks like you are kind of spending an awful lot right now.

Well, I don't know if I would say we are spending an awful lot. We are certainly taking it up. We do have modeling programs that we use -- mixed modeling -- to help us understand by category, where's that point of inflexion where the last dollar doesn't really drive as much gain as the previous dollar. And -- and that will also help us, not only in terms of the absolute level of spending but also the mix of spending in terms of what is the right vehicle to use to drive those -- those categories. We clearly are investing more, and this year we are emphasizing the advertising component of that as a way to drive the overall business performance. That's what we said we had to do to build our share in those categories, and -- and to build our Brand Value, and we think that is the right way to be approaching a business right now.

I guess when you look at the first quarter specifically in businesses where we saw the most significant increases in advertising, they were in things like crackers, pizza, cereal, all of which had -- and even our Miracle Whip and Mayo business in the U.S. all of which had very good first-quarter results. If you look at where we put our dollars and look at our results there is an alignment and it's a nice impact from some of the spending.

The other thing I would point out on that are those kind of investments help change the trajectory on some of those businesses and that has a very long-term cumulative impact.

Right. Okay. Thanks. And one other question I had was just -- when you look at your -- your -- these volumes right now. I mean you are -- you are expecting a pickup second half of the year. The price mix has been very nice. You seem to be doing the right things around -- I guess half the equation, which is taking up the pricing, extracting the value from the -- from the businesses. On the other side of that eventually is cash flow. Specifically, I know there are some things you can't control or you want to be opportunistic about restructuring, laying out cash for restructuring cash flow -- restructuring events; however, capital expenditures with the moderate volumes, here, flattish volumes, is there any way that we could see reductions or flattish CapEx -- I am just looking out two or three years.

Well, we have brought down our capital spending in the last couple of years I think in this quarter the capital number -- was, Mark, correct if I'm wrong, was 139 million.

That's right.

Which is down about $10 million from where we were prior year. So we have, in fact, gotten the capital level down as -- as the Nabisco integration has gotten behind us. More capital right now is going into some of these restructuring initiatives, but they tend to have a pretty strong payback for us.

Sure.

The place where I would expect to see us step up capital as I look to the future are some of the new product initiatives particularly as we look to things like Tassimo or some of the other initiatives that are technology based, and those have a whole different dynamic in terms of the kind of change in the -- in the nature of that whole category.

Yes, we often look at CapEx as a percentage of sales. Last year we were just above 3% which is a good comparison relative to our peer set and ongoing we looked to remain below that 3.5% threshold. So relative to our history, we have brought it down and feel pretty good about the absolute number at this point.

Percent of sales is more or less how would you look at it?

That's one of the metrics we look at, correct.

That as well as the relative depreciation.

All right, guys, thank you very much.

Thanks.

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

Hi, good afternoon, everyone.

Hi, Terry.

Just a couple of things. The trade deload, Jim, you said was still continuing a bit on the beverage side.

Specifically the rate of the drink beverages and it was mostly through alternate channels where we saw the step-down in some of the -- of that. And that had a disproportionate impact on volumes than it did on revenue.

Well, that's what I wanted to get to. Is there any way to kind of make an adjustment for the -- I know the pounds there are very high in relation with some of your other products.

I think our estimate in North America alone, the trade deload was a little less than a point impact on the volume growth.

Okay. All right, so the volume doesn't look quite as bad as might be otherwise.

I guess the one thing I would add on the volume side, is actually on a consumption basis, the first quarter, on a pound basis, was very similar in the U.S. to what we experienced in the third and fourth quarters last year.

Okay.

So when you look at a consumption basis, it was a similar quarter. We had several anomalies going on, Jim made reference to, the trade inventory deload, and the SKU pruning impacting things as well and then obviously the impact of higher prices on the category growth. But to take away on a pounds basis was consistent with what we had in the second half of last year. At least in North America and where we can see the data.

Okay. And can you quantify as you look at your SKU pruning program, Hershey, for example used to walk through the numbers pretty carefully. Could you make a similar adjustment, what would the top line have looked like X the SKU rationalization?

I would be very hesitant to do that because the whole objective in taking out the SKUs is to drive -- to eliminate complexity in the overall process. The assumption we are making and the thing we are driving for is that we get a lot of that back through faster turning items, and that would mean I would have to make a guess --.

Yes an offset to it --.

As to how much was incremental and how much they met. I can tell you that the amount that was pruned in terms of certain markets is -- and this is a directional estimate, because I think the number is still being refined is probably in the 35, 45 million pound range.

Okay.

But I wouldn't want to be held to that in terms of what is pruned. And then the question becomes how much of that did you get back.

Understood.

More importantly you get the efficiencies of having less items clogging up your network.

Okay. And I guess lastly, always hesitant to get too much into the puts and takes of guidance here this late in the day, but if we started out the day with guidance of $1.90 to $1.95, excluding any contribution from businesses sold and excluding all restructuring and impairment items, it would look to me that you've basically raised it then on a reported basis by $0.02 given the fact that you now anticipate a $0.06 gain from the tax rate offset by -- you are going to spend two pennies more in marketing and commodities are hitting you to the extent of two pennies. Would that be the right way to look at it?

That would be exactly the way to look at it although the marketing spend is more new product growth initiatives than it is pumping more against existing business margins.

I understand. I should have expressed it that way.

If you choose to exclude the $0.04 impairment charge on Fruit Snacks which generally, I know, Terry, you do in your numbers your guidance effectively has gone up $0.02 from your perspective.

Understood

Thank you, our next question comes from Judy Hong of Goldman Sachs.

Hey, Jim and Mark.

Hi, Judy.

Can you talk a little bit about the chocolate-based biscuit products and I am just wondering if this is in response to the evolving competitive landscape in the broader snack category where you are seeing blurring of the category definitions and companies looking at outside of their core categories to expand their sales and I am just wondering if this is sort of looking at the broader snack category and identifying where there is opportunity, whether it is going after new consumers or going after a new user occasionally?

Well, I think you kind of answered the question yourself, but you are absolutely right. The whole objective is to drive further growth in that area, source from a broader snacking occasion, and it also recognizes that we have some competitors who are seeking to do exactly the same thing, coming into our categories. And where we are targeting a lot of this activity right now in the U.S. is on what we would call our Choco-bakery area. We think the products we are putting out there have some pretty good legs in terms of potential for those businesses. Mark went through and I think identified the specific items. The other thing I should say we've done is we've also invested in our DSD capabilities so that we have the conditioned storage to be able to distribute the pure milk chocolate products to retail using -- using that infrastructure as well. So we see this as a -- as a two-edged opportunity, both in terms of defending our business, but more importantly building the growth opportunity.

What about looking outside of the biscuits and looking at some of the adjacent categories where you don't have presence in or have very little presence in. Is that more initiatives to -- are there more initiatives that you are likely to focus there or are you right now limiting to the core biscuit category?

Well, we certainly have tried to do some of that with things like Ritz Chips in terms of looking at how we can expand that product and we will continue to look for opportunities. Obviously I don't want to get into things that are on the drawing board because it would be too speculative at this time, but that is certainly an area of highly incremental growth that we'll continue to pursue aggressively.

Okay. And then the second question is on Western Europe. I'm just wondering if you could talk about the progress that you are making with some of the soft discounters in those regions. Maybe if you could give some specific examples of what -- of what you are doing to increase your penetration with those soft discounters, and how that may be impacting your profitability there.

Well, certainly, what you are referring to, I guess, is the situation we are seeing primarily in France and Germany these days, and we continue to work with both the hard discounters and the soft discounters although the hard discounters usually only carry their own private label products to get our leading brands into those accounts and there have been some initiatives to tailor some particular products exactly for those customers so that we can have strong presence and share in the growth of those categories. The real fundamental challenge, though, with those markets is to make sure we continue to build our core businesses, whether it is in coffee, chocolate, or some of the other areas, by getting -- by doing what we have done elsewhere in terms of getting the price gaps to where it is appropriate, investing behind the marketing initiatives, using technology where we can with initiatives like Tassimo to create a sustainable point of difference, and driving that in those -- in those markets.

Now clearly, we had some challenges in France toward the end of last year, and we've had to invest more in France with the promotive price initiatives to get the coffee business back in line. Germany as I mentioned earlier was a bit of a challenge for us in Q1 because of the run-up in commodities and we led to the price increase in that market. The message is on discounters, they are part of the landscape. We have to learn how to, and we are, I think, learning how to live effectively with them and leverage that opportunity.

Okay, thanks.

Okay, Judy.

Thank you, our next question is coming from Phillipe Goosens of Credit Suisse First Boston.

Good afternoon. First housekeeping. Do you have the number for depreciation amortization?

I think it was 215 on depreciation and 3 on amortization. A year ago number I think was --.

209 in total it was up to 218 in total G&A.

Because you need the year-ago number since it has been restated for the -- for the ongoing business.

Okay. Great. Then with regard to your pension plan. Am I correct to assume that all of these plans are single company plans that you do not participate in any multiemployer plan (INAUDIBLE)?

That -- that's correct. There might be an instance or two in some minor International location where we might have a multiemployer plan but that would be a rare exception.

Then can you provide us with an update in terms of what progress you are making in terms of setting up systems, as well as operational sanctions for an eventual separation from Altria?

Well, we are certainly looking at the possibility of that event. What are the implications to us if, in fact, that happens, and we have taken some positive steps to position ourselves to operate independently if and when Altria ever chooses to restructure a change. Some of the things we have done, for example. We've created more capacity in terms of our European operations in the treasury function and how we manage cash on a global basis. We have put some systems in place to allow us to track our businesses I think a little more carefully and consolidate the activities, specifically within Kraft. We are looking at what we need to do from insurance purposes and have created some insurance capabilities on the International side that are purely for Kraft's benefit without -- without leveraging the benefit of being part of -- of a broader Altria organization.

So we are clearly taking the steps we think are necessary to put things in place, and obviously if you have seen the -- the proxy statement that came out, there is an item in there as well that deals with the potential implications of -- of options, Altria options held by Kraft employees to give our compensation committee of our board the ability to manage through that if and when Altria ever chooses to make a change.

Then my final question today. The new food pyramid as published. How are you positioned to take advantage of that.

Sorry, can you say -- you cut out a little bit.

I think today they published the new food pyramid or pyramids as they are called right now and how are you positioned to take advantage of that?

Well, clearly that falls into the health and wellness initiative, and we have had a fairly extensive program in place to leverage our health and wellness -- wellness programs, not the least of which is the South Beach Diet initiative that we talked about earlier. Certainly -- and I haven't gone through the new structure entirely, so it would be hard for me to react personally to that, but I can assure that we'll be very much linked into the entire health and wellness initiative that we have.

Our Sensible Solutions approach has been very well received by consumers. We get a lot of consumer feedback, positive. And it's no surprise that the products that had that tag last year were up double digits in terms of top-line growth. So it is very much -- consumers are looking to this trend and looking for companies to help solve their health and wellness needs and the Sensible Solutions is turning out to be a very good way to do that.

Great, thank you so much, gentlemen.

Thanks.

Thank you.

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

Good evening. I will try to keep this quick I know it is getting on a little bit. Just two things. One would be getting back to mix just briefly. Seeing some of your emerging market business, or developing market business rebound a bit this quarter, I realize typically that has a, I guess somewhat lower revenue per pound, kind of characteristic which has typically been a drag on the mix component. And with that being better in the quarter, and you still having very positive mix, I mean, is that what is giving you more of the feeling of confidence there and what's driving it? Or was a lot of it just given the ready-to-drink beverages also has a much, I guess, lower revenue per pound, and that had some inventory reductions. I am trying to get a sense of -- again, getting back to John's question earlier on -- the sustainability --.

It's a combination of all of the above because clearly the ready-to-drink changes some of the mix implications. But when you look at the segments within which we report you will see positive mix in virtually every one of the segments including the International components and many of them do not have any ready-to-drink in their profile. So it's a much broader gain than just looking at their ready-to-drink piece. A couple of things that are help driving that. When you look at, like our International businesses where powdered soft drinks are a big component of that, and that is a very attractive category for us. We have saw mixed gains in some major International places like Russia, like Brazil, and in the Middle East we saw some -- some gains as well. So developing markets had a nice contribution in terms of the mix impact and it is not just looking at ready-to-drink.

I guess I will add to Jim's comment. I think in six of the seven reporting segments, we had positive mix with grocery being the only one that did not.

And I would then go back and talk to those specific items we think that are helping drive it in terms of the selling focus, in terms of the new product activity, in terms of the SKU pruning program and the sustainability of those initiatives.

And then the last thing, you talked a little bit about the enhanced kind of DSD process here, which will allow you, I guess, to be more effective in kind of the alternative channels, because I guess typically Nabisco has kind of made some of these efforts before, even before it was owned by Kraft, and -- I guess was not overly successful in that regard. Trying to get a little more color on exactly how will this be sold in. Is it going through Kraft's current sales force or is it kind of a third-party merchandising agency? Are there just more feet on the street? Is it going to be dropped by the --?

Are you referring to some of the chocolate bakery items.

Correct, the ones that are really targeted --.

It's a combination depending upon the channel where it is going into the channels where our DSD organization typically goes and is very effective, they will handle the distribution on those and have the infrastructure now to be able to do that.

Like the big box.

Also down-the-street sales organization that we'll use to get to those other locations, the instant consumption channel in particular, so we've got sales organizations that are tailored to those channels and we'll leverage these products through those capabilities.

Have there been changes to -- I guess the down the street one is the one I am particularly interested in because that is the one that's not -- or that has not given Kraft the advantage or Nabisco I should say, the advantage over time or even Kraft when it comes to Altoids and Life Savers. I'm trying to get a sense of if something's changed there.

We have moved to some brokers in terms of using them to expand our -- our internal organization, and so we are -- we do recognize that in some of those kinds of areas, some of those capabilities it is better to go and leverage their infrastructure than it is to try and create our own.

I think what you were referring to earlier when we talked about enhanced distribution capabilities. Jim was specifically referring to our ability to do condition distribution to be able to handle real milk chocolate products. So that's the extent we are going to take our -- our biscuits and chocolate line and extend it, we have the need to be able to handle real milk chocolate within our distribution capabilities and we have added the capability to do that.

Okay. I guess it's just because you start to obviously compete more aggressively with those that are quite tailored and obviously very focused and aggressive in the fee store and some of these alternatives up in the street where it is really their core focus. I am trying to get a sense again, of what's perhaps changed that allows you or gives you more confidence to get that done.

I think we view it as opportunistic, Andrew. This is not a core, go full guns to all channels, there's going to be an opportunistic element for growth to pick the right channels in the right areas where we can take this and expand it into the adjacent categories.

Thanks a lot.

Thanks, Andrew

Thank you. Our next question is coming from Pablo Zuanic of JP Morgan.

Hello, everyone.

Hi.

I want to touch on the price mix argument. Here the way I look at it, the price mix is not really helping you from a profit margin point of view. On a like for like basis, your margins at the consolidated level OCI terms fell 200 basis points. If price mix is coming from new products or for price increases that are sustainable, I would expect to see margin expansion. If margins are down, it probably means that there has been some price increase on the commodity-type products and as you have said those price increases were not enough to offset the higher commodity cost. Can you just comment on that view, on the bottom line?

You are exactly right in terms of your assessment on that. That when I look at the price mix contribution, it is, in fact, positive. And when you look at the margin profile and aggregate, it is a couple of things that have affected that, one of which is -- we didn't fully recover all the commodity increases through pricing. The second piece that effects that gets into some of the spending initiatives, both in terms of pension restricted stock, as well as the ANC investment that Mark mentioned earlier that had a negative impact on the margin profile as well.

When you do the analytics from our perspective, mix itself was a positive to our margin on the -- on the quarter. So it is hard to see, I know, because there are so many moving parts going on but mix in fact was a positive for us.

It's a positive on the top line but not on the margin side.

On the margin side as well, Pablo.

Right.

What you are seeing is being mapped by the -- commodity pricing impact that we have got within the quarter.

And what I would expect is as pricing builds over time as that lag effect gets behind us as the commodity cost moderates to a more normal level, I would expect to recoup much of that pricing commodity profile.

Okay. And the $250 million number you are talking the price increase, is that net after the price increase or before the price increase?

That is the aggregate commodity cost impact before any adjustments, before any pricing.

Do you have a sense of what the net impact would have been?

Well, not -- not one that I am willing to put out there and as a hard number, but, we are -- what happens when do you a price increase is there is a period of time where you protect some of the merchandising programs that are out there. So you don't see the effect of the pricing immediately. We may have some trade commitments we have made to customers for a second feature point and we honor those commitments at the prices, at the feature prices we agreed to so it's a lag effect that goes on with it. Eventually I would expect the pricing to get up to the commodity level unless we have an unique situation like we had on cheese last year where it ran -- in the U.S. where it ran so high that we knew it is inappropriate to try and price to that level because it was not sustainable.

Thanks. Just a follow-up, just a question on the coffee side. I just understand experiencing France and we weren't expecting in Germany and the U.S. What is happening with pods? You are also selling pods for alternative coffee systems. What percentage of your sales, for example, in France right now are coming from pods that you tell from Tassimo or that you sell for other alternative machines?

Well, the Tassimo is still in its introductory phase in France, and we are still building the inventory -- the consumers are still building the inventory machines that are in our retail so it's a fairly, fairly low number in terms of overall revenue on our pot business. Excuse me, on our T-Discs. In terms of the pods. I don't have that number on the top of my head, but we do track the share numbers, and our share within the pods which are a growing segment tends to be indicative and parallel right now with our share of the overall market.

That's true in North America as well at this point.

In fact I think we have the leading share of pods in the U.S. today.

All right, that's good. Thank you very much.

Thanks, Pablo

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

Good afternoon.

Hi.

I just made the cut here. Just a couple quick ones. Just so I am clear on the pricing side. I know that you've talked about pricing in coffee, cheese, nuts and meat, and there's a number of different costs, I'm sorry, price increases that you are putting in place in other categories whether it is cereal or beverage or obviously cheese up year-over-year, pizza, whatever. If we look to the second quarter will that list of categories expand? Is that the intent at least? Did you just not mention all the -- in the release the categories taking pricing in?

Well, we can't preview pricing for obvious reasons.

I understand that, sure.

But clearly it's going to track with the commodities where you are seeing the commodity pressure increase, that would be the first place to go look in terms of where you would expect us to do a -- any subsequent pricing if, in fact, we think it is appropriate to do. Conversely, if we see some of these commodities come crashing down, we'd have to look at whether or not that has any inverse implications as well.

Sure, sure.

We have taken an already announced pricing in France in the second quarter on coffee, and most major competitors have also announced pricing there as well.

Okay. And then, just a quick question for you on western Europe. Should we expect sort of this price deflationary environment for the remainder of the year? Is that the intent behind the increase promotion and really the function of deep discounters?

Well, certainly where we have said we have had to reinvest in our price gaps in France on coffee, that's part of a -- a permanent affect on that business. It is not the intent to bring down prices any more than we need to. It is the intent to stay competitive, and I think for the most part, we have gotten a lot of our prices in line competitively, and then the big wild card on this is going to be whether or not we need to take subsequent pricing to recover these commodity costs and then how long does it take for everybody else to move to that sustainable level.

Okay. And then have you given, like, a total estimate for your commodity cost inflation for the year on a gross level like you have done the past couple of years for '05.

We have not, and that would require us to give some forecast on some of these commodities, but in general, the places where we are going to see the most pressure on the commodity side should be pretty obvious. It is going to be coffee, it is going to be nuts, it is going to be energy and packaging. Conversely, the cheese which ran up latter part of Q1 last year and stayed high for most of last year, we should be seeing the -- the inverse situation where that should hopefully be less onerous, particularly since the -- the milk market had good growth in the month of March. I think they were up 2.8% in terms of the milk supply.

That's right.

In the U.S. So hopefully that will keep -- keep pressure off of the cheese market.

Okay. My last one then was just on the -- growth initiatives, the chocolate-based biscuit and the Tassimo. Are those initiatives that sort of sprung up that you decided you needed to spend incrementally more than you thought initially. Were they not planned as part of the marketing endeavors for the year?

Well, in some of those initiatives it was incremental programming compared to what we had planned, and certainly when we look at things like Tassimo going into Germany, that is a complete -- that was planned to be at a later time, and we have accelerated the speed with which we hope to roll that out. So versus our previous plans, a lot of this is funding new initiatives.

And aligned as bit with one of our guiding principles to act more quickly when we see the opportunity there.

Okay.

So I think an instance of a bodes faster in some cases than we may have gone otherwise and bigger in some other instances.

Okay. Thank you.

Thanks.

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

Good afternoon.

Hi, Evan.

Couple of questions. Couple questions. Profits were down operationally in almost every segment and margins obviously took a big hit. I know you saw it in commodities and pension and some impact from pricing, but that has been hitting everyone. Why do you think Kraft took such a big hit across the board compared to some of your peers, particularly in light of the fact that you had favorable price mix?

Well, it is a matter of magnitude on some of these things, particularly on -- on the net commodity impact. So I -- it's -- it's that coupled with the 55 million that we quoted on the -- on the pension restricted stock implication, this was the last year, a big step-up in the restricted stocks and we should have that one behind us. And hopefully, we will see the kind of changes in the pension program going forward that we saw -- that we got built in for this year. And -- I don't know how I can compare myself to the competitive, I don't know their profiles as well.

Okay. Last question. As you look ahead to the balance of the year, is the margin recovery primarily going to be based on a volume rebound or spending levels coming down, and I guess given the commodity environment why should we assume higher profits in the second quarter and third quarter or for the full year might your EPS growth just come from the extra week. How should we look at the balance of the year?

I think it is a rolling kind of process because the -- the level of investment that we started to make behind the business really picked up quite a bit in last year. We will be lapping some of those activities as this year further unfolds. We are -- we are getting back on the cheese business in particular some of the margin give-up that we had last year. So it is a combination of all of those activities, and while I am not necessarily looking for a margin step-up due to the net pricing commodities situation, certainly the mix that we are seeing is having a positive benefit for us.

Okay. So you would expect then profits to be up year-over-year in the second and third quarter?

Well, if you look at the -- the forecast we have given in terms of the EPS projection, you -- you'd have to lay that out, and I think you would end up seeing that that has to be the case.

Okay. Thank you.

Okay.

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

Thanks a lot. Good afternoon, everyone.

Hi, David.

Hi, David.

Going back to the cereal side. I don't think I understood your answer to the question. You -- we've not seen any or very little price increase from Post in our -- in our Nielsen data, I think it is like 0.3% for the 12 weeks ending on March the 19th versus 1.5% for the category. And obviously Kellogg's and Mills were up much more than that. It would seem to me that private label is not going to budge until Post and Quaker make their move. Obviously you can't speak for everybody else, but are we going to see those promoted prices start to rise and then net --?

Sure. And two things. I think -- I think what is keeping our promoted price relatively flat is the new product support that is captured in that aggregate measure that you are looking at and that has an influence on the overall profile because the new product items tend to get a little heavier support than the base items. Clearly we are -- our intent is to move up those promoted prices over time, consistent with the pricing action that was taken in the third quarter of '04. Mark, I don't know --?

I was going to add. The numbers I would be looking at in terms of base prices would not be consistent with the numbers you just quoted. I would have us up on a base price basis much more similarly to what some of the peers would look to be up, low single digits.

Doesn't the promoted price really -- isn't that the price that really matters, though. Your list price can be up anything you want but if your promoted prices haven't moved, who cares.

It's a combination of both, you are exactly right. But base prices do matter. Don't sell 100% of your product on deal. So base prices do matter and our base prices were up, call it 2.50 to 3% this quarter. So we have seen the base prices increase and it's basically reflecting the increase that was taken last August, I believe, in terms of a list price change and again on the promoted side, it was much more of a comparison to the prior year as opposed to a change in strategic approach to trade spending.

Okay. On sliced lunch meats, it is the same thing. I am seeing the Company lagged increases in the category, and as a consequence, you have been gaining share in there, but I think in both the case for cereal and for sliced lunch meat, these are negative margin events because you are -- obviously -- I believe that the category is raising prices because of higher raw material costs. If you are lagging the category, than it would seem this is a contributing factor to why margins were down in the quarter. Would you agree with that?

Well, I think you have got to go look at a series of pricing actions rather than a last pricing action. Because I think we may have gotten an extra pricing action in aggregate over the last couple of years behind that business. Clearly our margin profile within our sliced meats business is as good, if not better than anybody else in the industry. So I am actually feeling pretty good about the Oscar Mayer business. And some of what is helping us in that category in the growth are these new items that we are doing particularly on the -- on the deli slices.

Said another way, David, our price gaps have not gone down dramatically. Basically, as we look at price gaps and where we were a year ago and where we are today, they have not moved dramatically.

Okay. Then this all relates then to the overall guidance here. If I understand the numbers right, excluding items, you were $0.44 -- you were -- excuse me you were $0.03 better in the quarter than your original guidance and then for the year you have taken up your guidance by two pennies so that would basically imply the final three quarters you have maybe taken it down one but maybe it's semantics. Maybe it is really unchanged and the net -- again if I understand this right, what you highlighted as the risk here was as you continue to take further pricing actions, the volume impact on those categories and/or competitive action by -- by different players out there could hurt those volumes and that -- that is the real risk as you see it. Is that a fair statement?

I -- I would agree that's -- that's what we are trying to imply is that as the commodities continue to move and we take the pricing actions, it could have a -- not necessarily in the dollar category performance but on the volume category performance a depressing effect. As far as the guidance change goes, I think, Mark, we were -- we essentially beat the range we gave by a penny. You may be quoting I think the midpoint of the range?

Well, --.

We gave a range on guidance for the first quarter as well as the full year.

No, I know that. Yes, the top end of the guidance for the quarter was $0.42 excluding items. I am sorry, so maybe it's two pennies. You beat by two pennies.

Was a penny, wasn't it.

Yes, we will work with you David and see if we can reconcile that for you.

No worries. Thanks a lot, everyone.

Thank you, we have time for one final question coming from David Adelman from Morgan Stanley.

Good evening, everyone.

Hi, David.

Let me ask you a couple of quick things. First, could you talk about the logic of electing to spend even more than you were planning on spending on promotion and brand support in an environment where you are already finding it difficult to drive profitability?

When you say "spending more than you were planning to spend," --?

The incremental $0.02.

That was right in line with the --. The incremental $0.02 that we are talking about of the total 6 from tax favorability.

Right. But leave aside the tax issue. The underlying earnings --?

What you're talking about are really driving new product activities more than it is anything else. So a lot of it is getting into this accelerated expansion of some of the Tassimo initiatives and other new business ventures. It isn't actually a step up in spending against base businesses.

Okay. But in other words, Jim. is that going to continue -- are you going to continue to feel the need to incrementally spend more against the business as you see opportunities. I am just getting to the point or the issue -- when do you see profit growth. Because you are going to go into next year and you are going to have a higher tax rate, you are going to have one fewer week, you are certainly going to have those hurdles.

And those hurdles will be there, but as what is best for growth, certainly you have got to do something up front to drive longer term sustainable performance and that's essentially what we are doing with that $0.02 for the -- that we are spending back. In fact, I am pleased that we are able to do that and not bring down our guidance number.

Although it is lower on an underlying basis, correct? X the tax benefit.

On a reported basis it is lower

Okay. You -- you both were taking pride in improved share trend and improved sales, but isn't it the case that your U.S. market share is actually on a composite basis lower than where it was two years ago?

I don't know the answer to that question, but it would not be dramatically different.

I mean it is basically flat over two years.

Yes. You are talking tens if that is the case. I don't know the numbers off the top of my head.

But that's with two years --.

That chart was in the display that shows a couple of tenths per quarter over the last year.

Certainly in terms of a trend line we feel good about the reversal of the trend line.

Building momentum.

In terms of profitability or the profit outlook on an underlying basis, Jim, for the business, I mean are you -- are you sort of tracking six months ago from the -- from the perspective of six months -- six months ago. Are you tracking today where you thought you'd be?

In terms of the general direction of some of the components, yes, because what we said would happen six months ago when we had that analyst day here is we said we would see some of -- we would -- we said we would see some of our SG&A-type investments growing faster than the rest of the profile and in fact it is. The difference I would say between where we are now and where we were then is how the commodity costs have affected the overall profile of that flow. The things that are going to drive the margin, drive that profile longer term which are getting our cost structure down, driving this productivity, and then investing for longer-term sustainable top-line performance are all happening consistent with exactly what we said we would do.

Where you said you have the greatest risk to category growth are simply the commodity-oriented category that are seeing the escalating cost pressure, correct?

Basically the sticker shock of when you have to recover those higher commodities through -- through pricing.

Okay. Thank you.

Thanks, David.

Thank you. I would like to turn the floor back over to management for closing remarks.

Okay. I appreciate you all staying on the call for us. I know it went a little longer than we expected, but we appreciate your time with us this evening. Thanks and have a good night

Thank you. And thank you callers. That does concludes today's conference. You may disconnect your lines at this time and have a wonderful day.