億滋國際 (MDLZ) 2005 Q4 法說會逐字稿

Good afternoon and welcome to the Kraft Foods fourth quarter 2005 year end earnings conference call. Today's call is scheduled to last about one hour including remarks by Kraft food's management and the question and answer session. [OPERATOR INSTRUCTIONS] I will now turn the call over to Mr. Mark Magnesen, Vice President of Investor Relations for Kraft. Please go ahead, sir.

Thank you. Good afternoon and welcome to Kraft food's fourth quarter earnings call. Joining me on the call today are Kraft's Chief Executive Officer, Roger Deromedi; and Chief Financial Officer, Jim Dollive. About an hour ago we issued a press release with our fourth quarter and full year 2005 results, our review of our expanded cost structuring program and our 2006 outlook. This release is available on our website at Kraft.com. As are the slides we will reference in our comments today.

Our comments and presentation will contain projections of future results and are made only as of today's date. I encourage you to review the Safe Harbor statements in our presentation or release which review some of the factors that could cause actual results to differ materially from our projections. Roger will begin comments today with his overall perspective on our 2005 performance. Jim will take you through the details of our fourth quarter and full year 2005 results, our expanded restructuring program and 2006 outlook. After that we will open it up for questions. Now I will turn it over to Roger.

Thank you, Mark, and good afternoon, everyone. When I look back on 2005 we made good progress against our sustainable growth plan in several areas, but we also faced some significant challenges. We managed some of these challenges more effectively than others but in the end our financial results were not where we wanted them to be when we started the year. However, we are implementing an expanded cost restructuring program to address what we expect will be a continuing, difficult business environment in 2006 which will allow us to deliver improved financial results this year.

Starting first with our areas of progress we strengthened the brand value propositions across much of our portfolio last year. As you'll recall this was our top priority when we began our sustainable growth plan two years ago. While not every brand is where we want it to be we made improvements on many. We increased our marketing spending last year on top of the increase we made in 2004. We improved the quality of our marketing, making our increased spending even more effective. And we enhanced product and packaging quality across many of our brands. In the U.S. I'm pleased that these efforts have generated a turnaround in our market shares.

In our top 25 U.S. categories fourth quarter market share results represented our strongest, quarterly gain in over third years. Aggregate dollar share was up 0.4 points on a weighted average basis, building on a 0.2 gain in the fourth quarter of 2004. In these same 25 categories retailer brand share was flat and our branded competitors lost 0.4 share points. We continue to be pleased by the turnaround in our share trends that began in the middle of 2004 and we expect further progress in 2006. We've also continued to transform our portfolio. With completed the sales of our global sugar confectionery business, our yogurt, fruit snacks, Stella D'oro, and U.K. desserts brands and certain Canadian grocery assets. Together these noncore businesses and brands represented total annual revenues of approximately $1 billion.

We improved the nutritional profile of our portfolio by reformulating more than 650 products in the U.S. to eliminate or reduce transfats. We incorporated more whole grains into our biscuits and cereals in the U.S. to leverage a new USDA food pyramid and we significantly reduced the fat, sodium, and caloric content across our Lunchables line. By the end of 2005 about 25% of our U.S. products carried our sensible solutions flag and revenues on these products grew double digits last year. Finally, we continue to transform our portfolio with innovative new products with which we achieved strong results last year. New products in market for 12 months or less generated revenues of $1.5 billion in 2005, a significant increase from recent years when they were in the $1 billion range. Just as importantly we delivered this revenue through fewer, bigger and better initiatives, revenues from the top 10 new products last year were approximately $700 million, up from about 3 to $400 million in previous years.

Looking at just a few of the new items that performed well last year, the South Beach Diet product line exceeded our expectations with over $170 million in revenues. It was one of the most successful new product launches in the food industry last year. Had Oscar Meyer extensions to our deli shaved meats sign including a roast beef item drove the total platform to over $125 million in revenues last year. In frozen pizza several new items including California Pizza Kitchen thin crust and DiGiorno microwave represented over $200 million in revenues. And we rolled out our Tassimo hot beverage system to new geographies including the U.K., Switzerland, Germany, and U.S. specialty retail. Consumer response to Tassimo system has been very positive with consumers already purchasing more than 700,000 brewers worldwide. Our research with consumers in France where a machine has been available the longest indicate they are extremely satisfied with the system. While it's still early and we continue to learn in the different geographies we remain excited by this businesses growth potential. Finally, in our desserts business we reignited growth in our ready to eat putting snacks with the launches of Jell-O, sugar-free pudding snacks and Sundae Toppers. Together these items are expected to generate $70 million in revenues annually.

A third area in which we made good progress last year was an expanding our global scale. Revenue growth in developing markets was solid with full year ongoing constant currency revenues up around 8% on a comparable 52-week basis. Growth was very strong in Eastern Europe, particularly in Russia which was up about 40% versus last year. This more than offset some competitive challenges we faced in China and Latin America. We expanded our brands and adapted new ideas across geographies faster than ever. For example, in 2005 we launched Ritz Chips in Canada, Brazil, and China and introduced specially formulated Kraft processed cheeses into Russia.

We also continued to drive up cost and assets through strong execution of our restructuring and ongoing productivity programs. We delivered our targeted restructuring savings in 2005 at lower than expected costs. And we've taken up our ongoing savings target on the original program from $400 million to $450 million. Given the continuing difficult cost environment we also identified a next wave of significant cost savings opportunities and Jim will share with you more details of our expanded restructuring program in a few minutes.

Finally we strengthened our organization in several ways. Two years ago we established our global category development group and we challenged them to drive our brands and ideas around the world faster and better. This group has done a great job and the key reason we delivered record new product results. In North America we took a significant step forward in simplifying our organization by removing the division layer between the sectors and category teams; allowing us to put our senior marketing people closer to our brands and to our consumers. Also in North America we began the process of integrating the Canadian and U.S. businesses which have significant overlap in operations and brands. And finally, while I did not expect that changing our culture would happen quickly, I see signs of progress. We are stripping out excess process from our daily routines. We are making decisions and acting more quickly than we have in the past. And we are executing better overall as we leverage our scale advantages.

So as we finished last year there are several aspect of our business I feel very good about. But as I said earlier 2005 also had significant challenges and there were areas where we did not make as much progress as I would have liked. The most significant challenge we faced in 2005 was a run-up in our commodity costs. Over $800 million higher than 2004. And a resulting lag in our pricing actions to cover these higher costs. While this $800 million number is large even for us the real issue was that some of our brands had not yet improved a brand value proposition sufficiently enough to allow us to increase prices to fully offset these higher costs. In addition we made strategic decisions on some brands not to price in order to improve our competitive position over the longer term. The net outcome across our business was that we incurred a decline in our operating margins. We are obviously not happy with this result, but we expect to recapture this impact over time as commodity costs normalize and our pricing actions are more fully realized. As Jim will show you later the impact to commodities net of pricing was less negative in the fourth quarter than the first three quarters of 2005 as we began to realize more pricing across our business.

A second major factor them impacted our results last year was our lack of volume growth. Ongoing volume on a comparable week basis was essentially flat on the year including a small benefit from acquisitions and was down about 2% in the fourth quarter. Several of our internal initiatives impacted volume growth, such as our increased focus on revenue and mix improvement and our SKU reduction program including the discontinuation of certain lower profit product lines. But the higher pricing also impacted volume both in North America and internationally.

In the first half of last year we saw our category growth rates slow in the U.S. as higher prices impacted consumption while growth rates in some categories improved in the second half they were still not as robust as we would have liked. And the impact of pricing was even more pronounced in Europe contributing to weaker than expected overall sales there. Two key commodities used in our European business, coffee and nuts , were both up significantly last year. In geographies where we felt our brand value propositions were strong enough we increased prices in our coffee and chocolate businesses. But in certain of those markets discounters and retailer brands either lagged our price increases or chose not to price at all and our volumes were impacted. This was particularly true in Germany where our volume was down about 10% in both the quarter and the year based on a comparable number of weeks. So while our market share results in the U.S. began to show improvement, particularly in the fourth quarter, our European shares remain more mixed.

So in summary I believe we made good progress against our sustainable growth plan in several areas in 2005. However, I am disappointed that this progress did not translate into better financial performance for the year. Looking forward, though, the combination of stronger brand value propositions and our more aggressive cost reduction efforts will drive improved results in 2006. I believe we are pursuing the right long-term strategies for the Company through our sustainable growth plan and my team and I are confident that we can deliver on our commitment to our shareholders this year and beyond. With that I will turn it over to Jim who will take you through our results and outlook in greater detail.

Thanks, Roger and hello everyone. As a reminder our fourth quarter and full year reported results include an extra shipping week this year. We estimate the benefit to our volume, revenue, and operating income growth rates is about 7 percentage points in the quarter and 2 percentage points on the year. Most of the figures we will share with you today are reported numbers including the extra week. For selected data where we think it's helpful to understand trends we will also provide estimated numbers on a comparable week basis.

Looking first at our top line growth, fourth quarter revenues were up 10% with the impacts of currency and divestitures offsetting each other. On a comparable week basis ongoing constant currency revenues were up about 3% in both the quarter and on the year. This full year growth was in line with our previous guidance.

Breaking down our ongoing constant currency revenue growth by driver, product mix contributed a strong 2.7 percentage points to growth in the quarter and 2.2 points on the year. As Roger mentioned net pricing increased in Q4 contributing two points to growth versus a full year impact of 1.4 points reflecting the benefit of pricing actions in both North America and international. Volume growth contributed 5.3 points in the quarter and 1.2 points on the year with both numbers including an extra week of shipments. There was a small carry over benefits of 0.02 of a point on the year from the VeryFine acquisition in early 2004.

Mix was positive in six of seven segments with particularly good results in Latin America as we shifted our focus to higher margin products like Tang powder beverages and Philadelphia Cream Cheese and in U.S. beverages due to strong growth in Starbucks, Seattle's Best and Javalia super premium coffees. The negative mix in U.S. grocery continued to reflect comparisons to a strong year ago period for sugar-free powdered desserts as we experienced the tail end of the low carb phenomena.

Turning to earnings per share, fully diluted EPS was $0.46 in the quarter, up 15% from 2004 and full year EPS was $1.72, up 11%. The full year EPS was slightly above the guidance we gave in October of $1.68 to $1.71 due primarily to $0.02 in lower restructuring and impairment charges than previously anticipated. These charges represented $0.10 in the quarter up from $0.08 in Q4 of last year and $0.20 on the year down from $0.27 last year. Of the $0.10 on the quarter $0.05 represented costs specifically associated with our cost restructuring program and $0.05 resulted from impairment charges on the Stella D'oro and Canadian grocery divestitures. It's important to note that within the impairment charge related to divestitures we have included a $0.02 tax benefited driven by the structure of the Stella D'oro sale. This benefit drove our effective tax rate down by about 3.5 points in the quarter.

Beyond the Stella D'Oro benefit taxes were $0.02 favorable in the quarter versus last year and $0.06 favorable on the year. The $0.02 favorability in the fourth quarter was driven by benefits from the American Jobs Creation Act and other repatriation benefits in our international operations. As we have previously indicated the operating income from the extra week represented about $0.04 benefit which makes the contribution from all other operations a positive $0.02 including $0.01 each from lower shares and from currency. For the quarter, the positive contributions from top line growth and cost reduction initiatives offset headwinds from commodities, pensions, and restricted stock costs. Overall commodity costs came in largely as we indicated in our Q3 call with fourth quarter costs up approximately $200 million versus prior year. Full year costs were up more than $800 million bringing our two-year increase to $1.7 billion.

While higher commodity costs pricing continued to impact our margin in the fourth quarter the net impact lessened from the first three quarters as our pricing realization improved. On a reported basis our operating margin was 12.4% in the quarter down 1.2 points from 13.6% last year with 0.07 of a point due to higher restructuring charges. The margin from operations of 15.6% was down 0.5 point in the quarter versus last year reflecting the negative impacts of commodities net of pricing of 0.5 points, and pensions and restricted stock costs of 1.2 points, partially offset by a 1.2 point contribution from top line growth and cost savings. Fourth quarter margin from operations of 15.6% compares to 15.2% for the first three quarters. The main area of improvement was the lessened impact of commodities net of pricing with a Q4 impact of 0.5 a point which was better than the Q3 year to date impact of 1.6 points.

Turning now to cash flow. Our full year discretionary cash flow plus divestiture proceeds was $4 billion up approximately $1 billion from 2004. The increase was due to $1.3 billion in after tax proceeds from divestitures. Excluding the net cash benefit from divestitures, discretionary cash flow was down about $300 million from last year driven primarily by higher capital and restructuring spending. We continued to aggressively manage our working capital highlighted by a six-day reduction in our cash conversion cycle from 57 days last year to 51 days this year. Inventory was the key driver of this improvement with days inventory on hand down three days. About two-thirds of our cash flow was returned to shareholders last year through dividends of $1.4 billion and share repurchases of $1.2 billion. The remaining $1.4 billion was primarily used to reduce debt.

That completes our comments on 2005 results. I will now turn to the details of the expanded restructuring program we announced today. Through year two our restructuring program is on track. Our original plan was to exit up to 20 plants by 2006 and we've announced the closure of 19. We plan to eliminate about 6,000 positions and to date we have announced the elimination of about 5,500. Our savings target by the end of 2005 was 260 to $280 million annually and thus far we have captured $260 million. Further we now project that these initiatives will deliver $450 million in ongoing annual savings, $50 million above our original projection. On the cost side we expected to incur $1.1 billion due two years. However our pace of spending has moderated versus our original plan with $940 million incurred thus far. We continued to project a total of $1.2 billion in charges on this original program.

In addition to leveraging our original restructuring program we have also been changing the Company to enable further cost reduction opportunities. These enablers include organizational changes that impacted our global functions and our North American commercial units. We've simplified our businesses through SKU reductions. We eliminated lower margin product lines, and we divested noncore businesses and brands. In addition we changed several internal processes to drive efficiency without sacrificing effectiveness. These changes enabled us to identify additional savings opportunities which have led to the expanded cost restructure program we announced today.

This expanded program includes further organizational streamlining such as the reorganization of our European Union management structure. This will allow us to improve our operating effectiveness and coordination within the EU while also reducing overhead costs. We will close additional facilities by simplifying our operations further including an additional 10% SKU reduction in 2006. This comes on top of the 20% reduction we have achieved since the beginning of 2004. The program anticipates the closure of up to an additional 20 production facilities and the elimination of about 8,000 additional positions. This represents about 8% of our work force with the reductions coming from all levels of the organization. Decisions to close facilities and eliminate positions are never easy. However, further cost reduction is a necessity in the current operating environment so that we can continue to support our brands and remain competitive.

The expanded program adds about $700 million in annual pretax savings to the $450 million from the original initiatives for a total of more than $1.1 billion in savings. All but about $50 million of these savings are cash. The expanded initiatives add $2.5 billion in charges to the program, bringing the total program to $3.7 billion. Of this total about $2.3 billion will be cash based. In terms of timing, the charges will largely occur up front, including total 2006 charges of approximately $1.3 billion. We project $850 million in charges in 2007 and about $600 million in 2008. Annual savings will build over time with approximately $560 million in cumulative savings by 2006, a year over year increase of $300 million and reach more than $1 billion annually by 2008.

Which brings me to our overall outlook for this year. We will leverage several key business drivers in 2006 while also managing through some challenges and uncertainties. We expect solid top line growth this year driven by stronger brand value propositions and increased price realization. Additionally we will deliver cost savings through both ongoing productivity and the expanded restructuring program. Key challenges are expected to include higher energy and packaging costs, particularly in the first half of the year in a difficult European environment. While we will closely manage our price gaps to discounter and retailer store brands we will leverage innovations such as Tassimo to strengthen our competitive position.

Pension costs will be higher in 2006 for the fourth consecutive year due primarily to a lower discount rate. And we face the year over year impacts of one time events including significant one time tax favorabilities in 2005 and one less shipping week in 2006. Two key uncertainties as we enter 2006 are overall commodities and currency. On commodities excluding energy and packaging we expect more stable prices this year with prices on some key commodities up while others will be down. On currency, the impact will obviously depend on exchange rates around the world especially the euro although at current market rates it would be a slight head wind for us. One factor we will not face this year is higher stock compensation costs as we already absorbed these costs in our income statement.

Looking at our guidance. On the top line we expect ongoing constant currency revenue growth of 3% or greater on a comparable week basis. When you account for the extra week in 2005 that translates to 1% or greater on a reported constant currency basis. We expect growth this year to be driven by new products, continued positive mix, better price realization, the impact of higher consumer marketing spending, and developing markets. Our projected earnings per share for the year is $1.38 to $1.43 per share including $0.50 impact from restructuring and impairment charges. This guidance does not assume any portfolio changes in 2006.

Bridging from 2005 EPS to our 2006 guidance range restructuring charges will have a net $0.30 unfavorable impact with $0.50 in charges in 2006 compared to $0.20 last year. Our 2005 results also include a $0.04 first time net gain related to divestitures. The significant one time tax benefits in 2005 results in a $0.09 year-over-year impact. Our 2006 effective tax rate is projected at around 33% compared to 29.4% in 2005. Our tax -- our 2006 tax rate does not assume the resolution of any outstanding audits which did reduce 2000 -- our effective rate in 2005.

As previously indicated the operating income from the extra week in 2005 represents about $0.04 of EPS. That leaves growth in EPS from all other operations of $0.13 to $0.18, included in this range are positive contributions from top line growth, productivity and restructuring savings. The restructuring savings are projected at approximately $300 million pretax or the after tax equivalent of $0.12 per share. Particularly offsetting these drivers will be increased pension cost of about $0.03 and dilution from divestitures of $0.01. The underlying business growth implied by our guidance is fairly strong. And we believe it is justified by the improved brand fair value propositions across our portfolio and our aggressive cost reduction programs. Discretionary cash flow plus divestiture proceeds is projected at $2.7 billion in 2006, down from $4 billion in 2005. The decrease primarily reflects divestitures as we expect after tax divestiture proceeds of about $100 million from the announced divestitures in 2006 versus the $1.3 billion last year. Additionally we expect cash spending on the restructuring program to increase by approximately $400 million. Providing a positive benefit we expect to continue to improve our working capital position. Capital spending in 2006 is projected at $1.2 billion, flat to 2005.

Finally, our priorities for the use of cash are unchanged. We will look to make strategic acquisitions, to return cash to shareholders through dividends, and share repurchases, and to reduce debt. That completes our prepared comments this afternoon. Now we will open it up for your questions.

[OPERATOR INSTRUCTIONS] Our first question is coming from David Adelman of Morgan Stanley. Please go ahead.

Roger, can you talk about the realism of the level of underlying organic operating profit growing you are projecting for '06, particularly in the context of not only recent performance but the fact that obviously results the last couple of years have come in shy of where you had envisioned them entering the year.

Well, David I think as you look at 2006 and where we are going to be going there the cost restructuring, expanded cost restructuring program plays a key part there in terms that we do expect $0.12 coming from that but importantly that helps offset some considerable headwinds that Jim was mentioning, whether it be on the tax rate increase of $0.09, the 53rd week of $0.04, but importantly the stepped up cost reductions are allowing us to continue to invest in our brand value propositions which is what I feel best about in terms of our ability to drive the top line and get to that 0.4 share point increase in the U.S. in quarter four.

Roger, just on that point can you reconcile what was going on in the categories because it's great to see the composite market share trends improve but I think your prepared remarks talked about volume in the U.S. being flat in the quarter.

Yes, volume was flat in there is because we one, discontinued a lot of items and SKUs, slower moving items as we focused the organization more on revenue versus volume. As we have mentioned we took out 10% of our SKUs globally and did the same within the United States. Very importantly, though, we did see some volume softness as we took pricing. A good example, staying in the coffee category where volumes were less robust but obviously revenue is strong given the pricing that we took. As you note within the release and as Jim mentioned pricing did contribute 2 points of our overall revenue growth on a global basis. So there was an impact on volume, but again most importantly we feel good on our higher pricing realization.

One last thing, can you quantify your expectations of the incremental commodity costs that you think you will face in '06?

No, we are not trying to get an exact number on that but I think the key thing you should keep in mind is the biggest driver will be petroleum and packaging costs. Obviously dairy costs have been coming down, in fact today they are at $1.21 a barrel, but again we are seeing higher meat prices and obviously higher coffee prices. As Jim mentioned there will be ups and downs across the portfolio, but the overall driver of higher commodity costs is energy and packaging.

Our next question is coming from David Nelson of Credit Suisse.

Maybe first one for Jim, on tax rate. You are talking about 33 for next year now and in the past we've talked about that eventually rising to 36. Do you still expect it to rise to 36 eventually?

Eventually we will get there but I am going to try to keep it as low for as long I can. Obviously we need to be putting those tax strategies in place to take advantage of the program so that we can manage that rate down, but what our target for next year as I said is 33% excluding any resolution of any outstanding items.

And maybe onto the bigger picture. I guess you've talked in the past about considering yourself to be a 6 to 9% earnings grower. With this guidance assuming you meet that, do you consider that to be within that goal? And then secondly on operating margins I still have operating margins down this last quarter. Do you expect those to staring rising again in '06? Is that partly how you will make this '06 number?

The answer really to both questions is yes. As we look at 2006, it is an improvement in operating earnings as you take away the restructuring charges of $0.50 and strip away thing like the tax rate and the 53rd and so forth. So I think we are feeling good about the progress we are making, a key contributor of that being the cost restructuring program that allows us to offset the higher commodity costs. Also though, as you do look at margins our expectation is margins will improve as we see pricing realization and the effect of our cost savings program offsetting higher commodity costs.

One last if I may, I thought you had talked about, on consumer spending it being up $200 million in '05. I saw on the release only up 130 million. Why did it not rise as much as you thought?

Our marketing spending was up year over year as you said to 130. We did shift some spending, to respond to price competition in Europe and also in some cases we waited to spend until we had some better programs on some brands and we are going to be spending even more aggressively against those brands in 2006.

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

Did you happen to mention what you thought your incremental marketing spending would be going into 2006? I know you said some of the productivity savings and such would be spent back on additional marketing.

No, David, we actually didn't quote that number per se. And as we look at 2006, I guess we looked at sustainable growth and have been providing that number the first couple of years. As we look at 2006 we expect to be rising greater than our rate of sales increase in revenues but it won't be as dramatic as it has in the years past.

And then with respect to pricing, it seems that you are starting to get obviously more of a price realization but I guess by my math it still seems that the amount of pricing you've taken on average across the portfolio, I guess still lags where your overall costs have gone. And so I'm trying to get a sense of whether you've taken pricing kind of to the max in the categories where you think you can or whether there is an opportunity or a need perhaps to do more in other categories going forward.

Well, this is back to as we continue to strengthen our brand value propositions we will look to take further pricing if that's what's justified in the category. But again we've been very, I will call cautious in terms of wanting to make sure we're driving the top line and make sure that our brand is within their price gap targets. But as we have been strengthened, our brand value propositions, which I feel probably best about in terms of what happened last year, I think we are finding that the pricing we have taken is working and if we find we need to take more we will do so. Importantly some of the pricing that we took, for instance, in many categories was back in November in frozen pizza and biscuits as of the beginning of this year and the cheese pricing, is just effective the beginning of February. Some of this is still coming as we speak.

I guess I would add, Andrew, that in the fourth quarter we actually had the offsetting negative impact of a price decline within cheese that was taken sort of in October.

Right. Thanks very much.

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

On pricing, Roger, just want to get a better outlook for this year. You alluded to the pretty low barrel price. It looks like class three futures are trading down as well. And I guess this kind of gets back to Andrew's question. With cheese being such a big chunk of the business isn't it likely that you will have to bring some pricing down there and thus maybe offset some of the net pricing you may have reached otherwise?

Well, this is where, as you know we've managed the pricing of cheese very tightly and if cheese prices go down sufficiently, yes, we'll do some price declines but importantly there are other costs that have to be offset, importantly is packaging costs driven by higher energy costs? And so there are some other costs besides just that and also we want to continue to invest in our brand value propositions and as we do so I think we will have more opportunities to maintain higher prices.

Well, with prices drifting down to the $1.20 range I won't ask you to predict dairy prices but it seems like we are kind of at least pointed at the direction of that $1.10 pricing that caused such problems a couple of years ago. Do you think there's any chance that we repeat that or do you think you have a better handle now in your price gaps with the private label guys?

I think the group has done a very good job of managing price gaps in cheese. As demonstrated by our share increases we've had over the past couple of years. Also the dynamics of the cheese market are, I'll call less driven not only by the United States but what happens on a global basis. As we talked about the end of last year, Terry, as you know so much is driven by what happened in Asia, it's also a lack of supply from Australia and also the stronger demand out China and other Asian markets. So I think the dynamics are milk production is strong as you mentioned, but I think that one, the group has proved they can manage it well, and two, I think we've strengthened the brand proposition such that it will continue to drive improved results.

Thank you. Just one more quick one for Jim, maybe. Looking at the tax rate it looks to me like it perhaps had added about $0.05 in this quarter. How should allot that? Is it basically $0.02 Stella D'oro and the rest the tax rebate?

Well, yes, you are right on the $0.02 for the Stella D'oro piece and when we did our bridge in the press release we did not show that in the tax rate. Versus prior year we had an additional $0.02 which was essentially some of the benefits coming out of the American Jobs Creation Act as we got the full impact of our cash repatriation programs and we just continue to look for ways to drive down that tax rate, Terry. We will take every opportunity we can to manage our rate down.

I'm still not sure I get that but I will follow-up off-line. Thank you very much.

Our next question is coming from Eric Katzman of Deutsche Bank. Please go ahead.

I guess my first question, Roger, is two years ago you came in front of us and I think it was two years ago with the first restructuring and this next one is double the size and I am just I guess surprised at the size of it relative to what I thought was a pretty big initiative and I'm kind of wondering does that argue, how inefficient is the structure and the business if you are able to kind of move forward and take so much out versus the first charge?

Actually, Eric, it's a very good question. I guess a couple of things that drove us to do the expanded restructuring program. Obviously when you see the cost in the retail environment remaining very challenging there is a high need for us to move with urgency to deal with that. But second and probably more importantly we had such success with the first program in terms of delivering as we say now 450 versus the 400. And getting to where we are as quickly as we did. But what happened was as we continued to simplify the organization, as we eliminated SKUs and eliminated 20% of our SKUs in 2004 and 2005 we will take out another 10% this year and importantly as we simplified our processes and harmonized many of our packaging forms there were significant additional opportunities that we found that I'll be honest two years ago we didn't think we could get at, but now as we two years later have done the right things on the business in fixing the business we were able to find these opportunities. So it's just greater opportunities that we've found are very critical in this time of higher commodity costs.

Then in terms of the impact from a cash perspective it looks like, I mean it's not significant but it looks like the second charge Jim is a little bit more cash in terms of a cash cost. So I'm wondering are we looking here at I think you said 2.7 billion in operating cash flow. Does the impact of the charge in '06 mean that cash flow is likely to be down again?

Well, the answer is yes when you take into account both the divestiture implications as well as the increased cash spending against the restructure program. We spent this year, cumulatively we spent about just over $200 million of cash spending against the restructure program. Next year we are going to spend about $600 million so the year over year change is 400 million and that is captured in the 2.7 billion guidance that we've given.

So -- and how much did you do in '05 in terms of same including the cash cost?

That's the 4 billion including the restructure program but you take out the restructure net of taxes we are at 2.7 billion.

You take out the divestitures.

Excuse me the divestitures.

So the 2.7 billion, you are saying that '06 cash flow--?

Would compare to a 2.6 if we take out the divestiture net of taxes in both years. And the biggest difference drive that is an increase of $400 million of cash spending against the cost restructure program.

And then, I guess the last question I have is again, on the, I'm trying to figure out all these numbers, but you said in terms of the delta, in terms of earnings, not cash but in terms of earnings from '05 to '06, you said roughly $0.13 $0.18 swing due to operations, $0.12 positive from the benefits of the restructuring in the first year offset by $0.03 pension and $0.01 of divestiture dilution, right?

That's right.

So excluding the savings, the pension, and dilution, you are basically saying that the momentum I guess, or the sales is going to drive $0.05 to $0.10 benefit?

That's correct.

So that's rough -- if I give you the midpoint of that that's like 4% off of the base, so you are just basically talking, trying to see through all the one time items, tax, et cetera, it's 4% earnings growth and on a cash basis down. Is that right?

Yes, with the head wind of the tax rate of $0.09, and the 53rd week of $0.04.

Okay. All right. Thank you.

Thank you. Our next question, is coming from Rob Campagnino of Prudential.

Roger, I don't want to put words in your mouth but my interpretation of one of your answers to the prior question was that the basket of commodities represented excluding petroleum is basically going to be flattish year-over-year. Is that the right interpretation?

Yes. It's flat to maybe slightly negative but it's again, it depends where cheese has actually come down a little bit even as we thought about it a month ago, but obviously coffee has gone up. It's now in the $1.20 to $1.25 range and so again, there's ups and downs in both, but it's maybe slightly unfavorable, but the big driver is oil and the impact on packaging from oil.

Just a little bit of a longer term strategic question.

Sure.

And I'm not asking you for timing or anything like that. If your largest shareholder were no longer your largest shareholder, what's different here? Is there anything that you have been saying that I would love to do but for Altria?

No, actually, I guess, Rob, as I think, but we've been managing Kraft for the good of all of our shareholders and importantly as you think about what we've been focused on is fixing the business and I think we feel very good on the progress we are doing to fix the business and I think the long-term potential in our brand portfolio which is very strong is the strength of our brand value proposition is excellent. So again I don't think anything strategically will change and again, if and when Altria were to decide to spin us that's something we will deal with when that comes.

Okay. Thanks very much.

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

Just two quick questions. The first one was -- and sort of working off some of the earlier questions on the restructuring initiative. I'm just curious to what extent this will more heavily favor Europe versus the rest of the Company and is this the solution if you will to the more challenging environment in Europe, is it just getting your costs lower, is that what we are hoping for here?

No, I think it's, again it's a global initiative, obviously focused in our more developed countries because we continue to invest in growth in the developing countries, but these stepped up cost reductions will help us fund increased brand support, very importantly to drive the strengthening of our brand value propositions, and yes, it will help us deal with strength in brand value propositions in Europe but also in the United States and around the world.

Is it therefore that you think it' more aggressive in your marketing, if you will, or promotion in Europe to help stem the declining volume trend there? I know part of that is driven by pricing but it was a little -- still a very negative again this quarter?

No, we continue to have significant ongoing price based competition in Europe, as you know the economy is not where we want to be particularly how the consumer headset is and so this does allow us to resize our cost base in Europe, but more importantly get to an organization that we think will be more effective and able to drive innovations across our brand, across the entire European Union.

Okay. And then my other question just is relative to again, someone on the lines earlier questions about the pricing and mix realization in the quarter and the volume decline, is that would you call that balanced as you would like it today or it seemed a little too heavily favoring the price and mix in my mind versus volume. Is that an accurate statement.

No, I think it's an accurate statement. We are very pleased again on the mix improvement. As Jim went through, we had 2.7 points of improved mix and pricing was again importantly better at 2 points of realization which is something we wanted to make sure we were getting the pricing through, but, no, in terms of volumes we are poor as we focus more on revenue as an organization versus volume and as we continue to simplify the business and fake out SKUs, the key on volume as we go for forward is continue to strengthen our brand value propositions and I think the improved share we saw in North America says we are moving on the right track.

Okay. Thanks a lot.

Our next question is coming from David Driscoll of Citigroup Investment.

I wanted to go back to Eric Katzman's question. I think Eric read something that I read a little bit differently. Your release says the -- in 2006 that you expect EPS growth ex the tax impact is like $0.13 to $0.18, however the restructuring program is expected to contribute 560. You guys in that little section just included the incremental number from the newer program. So then the total EPS impact from your restructuring that you have been doing all along and what you are going go do going forward is like $0.22.

No, that's the cumulative number, David.

You have to take the change year over year.

Right. So it's 300 million incrementally that would be benefit in '06 versus '05 which is the $0.12. Eric had that part correct.

So then the 560 million that's on page four of the release that's the cumulative savings?

Correct.

So I suppose essentially when I look at that, that number would come out to be $0.22 and it would basically say this, that if had you not instituted these restructuring programs you would not be growing at this time so I guess the point that I'm looking for here is I combine this with maybe going back to Chris' question on the volume side. Volumes are down, your net price is up just 2 points. The mix side while that's a very good sign, the price is really not up that strong and yet you are almost, you are losing 1.7 points of volume in the fourth quarter. So I look at that and I look at these restructuring programs and it seems to me that we've got a business here that is not capturing a price increase without a volume loss and at the same time you have to do these restructuring programs or the Company actually would be seeing earnings declines.

So, Roger, the takeaway that I'm getting here, an immensely complicated release you guys have out today you have got an enormous restructuring charge of $0.50 a quarter of the base number of your gross earnings base for 2006. So it's really, there just seems to be a lot here that is very concerning for a holder of this stock. What can you really tell me here about this restructuring program as it relates to the larger context of earnings growth? And I'm really trying to drive at I fundamentally I applaud an SKU reduction and so forth but new products have to be the driver of this business going forward rather than restructuring?

And, David, I agree with you 100% and that's why I will start with new products as you mention. We had the best year we've ever had in new product. We did $1.5 billion worth of new products and importantly, as Jim said and as we said in our review we did that with fewer initiatives so we were much more efficient as we did those and so I feel terrific on the success of new products and as I mentioned South Beach Diet and where we have with Tassimo and so many other ones. So the success for us going forward is driving the top line and I feel we've made progress their with our top line being at 3% plus for the second straight year and with our strength in brand value propositions and the key is that's being reflected in our improved market share in the United States.

What's offsetting that as you talk about volumes is we as an organization have focused more on revenue versus volume and we are taking out volume that is less revenue per pound in our slow-moving noncore items and that is impacting our volumes, and yes in some geographies and some categories we have seen some volume impact as we took pricing most importantly in Europe. So versus taking any as we try to deal with it we want to make sure we are aggressive in dealing with our cost structure such as we saw higher commodity costs in this environment that we can continue to invest in our brand value propositions and still deliver the earnings growth that I think this business can and will continue to grow even faster going forward. So, yes, if you want to look at it, yes, do we need restructuring at this point in time given the higher commodity costs? Yes, we do and very importantly we have taken aggressive action to deal with these higher commodity costs.

We see that with all the other companies, it's just staggering in terms of the amounts of monies here and I think, well, maybe I'm alone in this one, but it's a very large number and it almost feels like the entire kitchen sink went into this new restructuring program. So from our perspective on the outside a $0.50 change on the 2006 earnings because of the restructuring is just an enormous charge but that's more of a statement than a question. Can you tell us what capacity utilization is across Kraft's manufacturing plants?

It varies by various categories and it's not something we quote in terms of an average across everything because it does vary so dramatically by category. But, David, I guess to your previous comment, keep in mind that we were a $34 billion revenue business and so many in our space are not nearly that size and that scope so don't let the absolute size of numbers and that's what we are dealing with is stepping up our cost reductions really to help us fund the increased brand support that will drive this business in a sustainable way.

When you answered the question on brand support to one of the other analysts, was that brand support specifically, you said double -- greater than the rate of increase in sales.

Right.

Did that include trade promotion? Are you including that?

No, no, that's just what we refer to as consumer marketing.

Okay. Very good. Well, thanks a lot and good luck with 2006.

Thank you. Our next question is coming from David Palmer of UBS. Please go ahead.

You are expanding your cost reduction program obviously and you said in the release you are reinvesting again and in incremental marketing. How much in incremental marketing will there be in '06.

Again, we didn't provide any specific there other than what we just said on the call that we will be growing faster than our rate of growth and our sales.

Okay.

But again when we talk about brand value it's not just marketing it also includes a significant investment in product and package quality. You will see a lot of innovative new things happening there, but also a significant investment in more innovative new products, many new items coming out under South Beach, the continued expansion of Tassimo, a whole range of taking advantage of our new technologies we have in microwave dough and so I think you will see the investments in brand value being very broad across all the benefits and importantly the level and then quality of the marketing I think continues to improve which is improving our brand value propositions.

No, I mean you are actually kind of getting in front of the question I was going to get at, which was the nature, I guess first is the slack in the P&L that you may have just reinvest in certain things that it may be more functional, perhaps the innovation capabilities or maybe more advertising rather than some of the other types of trade oriented or pricing measures that you've taken in the past. And given that the enormity of some of the savings, the incremental savings that you are going to have and presumably maybe not early '06, but sometime beyond you are going to have the cost precious abate somewhat, I'm wondering if you have something more transformational in mind with the slack in the P&L that you would presumably have here.

This is where, again we are going to continue to invest in the benefits for our consumers and I think importantly as you mentioned in 2004, and 2005, as we began the sustainable growth plan a lot of the focus was getting the price is right for where we were, but also continue to invest in consumer, but as we go into 2006 it's going to be continued even more so and as we maintain our appropriate price gaps the investment in the consumer side and the benefit side.

Could you perhaps try to measure for us just the very specific question, but there was a disruption in your competitors supply chain boost to your beverage business, how much of a boost would that be? Or perhaps you can just give a sense of maybe if there is going to be, if that's over in the first quarter of '06.

I think you are referring to in the coffee category?

Yes.

Yes, it's, we -- our share in quarter four in the coffee category is up 1.3 share points so it was a better share trends than we had before. We've tried to do some of our rough calculations on that and it is about $20 million of incremental revenues but not that significant but it was a benefit for us in quarter four.

One last small blocking and tackling question. In Europe you obviously got a big hit from your price increases there, anything striking about the price elasticity and is there any reason to believe that you are going to -- are you going to stick with these price points and are you already seeing evidence that they will be able to stick.

This is where -- as we've seen some of the dynamics and maybe Germany being the best example we have adjusted some of our own prices in Germany and in the month of December we had very good share improvements in Germany versus our trends before. So we have done some adjustments, striking that balance between the total increases that we took and where we are today. And I think we are finding a better balance as we exited the year in terms of share in Germany.

Okay. Thank you very much.

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

Most of the questions here, forgive me, I'm simplifying things, the way I look at it with your valuable positions being out of balance on certain products, either you adjust price points or you invest in marketing and brand building and innovation and clearly you've been doing both, but it seems to me that over the last two years there's been more of a bias to adjusting price points and please give us some quarterly in terms of numbers, what percentage of that delta in the marketing program is going to adjusting price points. And the problem I have is that if indeed most of those resources have adjusting price points that's not a sustainable proposition in the long-term, right? And that's why you have to continue to come out with these cost savings. If the innovation and the ramp building had indeed been successful I would argue that you won't need to be so aggressive on cost savings right now. Can't you just elaborate on that and help us understand what is the rationale in terms of how much goes into brand building, how much goes into adjusting price points?

Again, as we, and I think you understand as we think about it the same way is brand value the benefits you get from the price that consumers pay and in many cases in the 2004 and 2005 versus what we had in the benefit side our prices were just too wide and more of the focus on what we were doing in those periods of time was either taking prices down or not taking prices when commodity costs were rising to get price gaps that were justifiable to the consumer. But as you also mentioned during that whole period of time we continued to invest and accelerate our level of innovation in what we are doing and I guess what I feel best about as you go back three years ago and as we show in our charts, new products were about $1 billion of revenues, we are now up to 1.5 billion and importantly they are even more incremental in what we are doing. So, yes, there is a shift in sort of the focus of how we are spending our funds on brand value. I think importantly as you look at the volumes, yes, it's impacted as we focused on revenue versus volume but I think that that shift is playing out very well because we are selling higher revenue per pound products and the new products very importantly are both higher revenue and profit per pound. So you are right in the shift of what we are doing and as we go back a couple of years ago our brand value propositions weren't where they needed to be and that's why we've had to invest in them.

Now what are one or two programs that you would highlight a little more what needs to be done in the U.S. market specifically?

Sure. I think on the flip side where I feel very good like Lunchables is one where a couple of years ago we were very concerned about. We have completely redone that brand value proposition and we had share up in Lunchables 2.9 and very strong growth as we reformulated that. One where we needed to do more work is in the whole area of dinners where our share has been down, but we just came out with in quarter four a Super Mac product that has great new nutritionals and we'll also come out with Easy Mac in cups and I feel very good that that will generate, and again, those are new innovations, both in the area of health and wellness and convenience that will turn around our dinners business. Another good example, maybe is in salad dressings where there's been more move to more premium type salad dressings and we've been losing share. But here again, in quarter four we came out with a good seasons premium range which is gaining in the marketplace and here again we are actually getting a new advertising agency to help us in that are of salad dressings to have, I think, some very impactful advertising with increased spending in 2006?

Thanks. And just a follow-up for Jim. Jim, is there anything in stock option expense in the 2006 guidance and just a follow-up question, also, I think in the past you have explained that Kraft benefits from consolidating their international operations with Philip Morris International for tax purposes and just trying to understand in the event of a spin-off what would be the tax, the tax losses or the tax benefits that would be lost, if you can explain that, please?

Well, first of all, we pretty much completed the absorption of the stock compensation in the '05 results so the step up from '05 to '06 is relatively minor. As far as the consolidation process we go through with Altria we benefit from the use of the excess foreign tax credits that we generate. And a lot of that gets into how we manage cash in repatriating that. One of the things should Altria choose to spin Kraft that we'll look at is how do we optimize that tax position both now while we are part of that consolidated result and in a post spin environment what is the right way to manage that process and that's something we are in fact looking at.

Thank you. Our next question is coming from Tim Ramey of D.A. Davidson. Please go ahead.

Yes, I think this question has sort of been beat on a little bit. But the question really is, as an external observer, how do we ever really get to what we think is earnings progress, because these numbers are so enormous on the restructurings and you have to be an insider with kind of a spread sheet on little projects to actually come out with a positive result. The net result to us as an external observer is it seems like every year you trade some amount of margin in for growth. And margins have been on a negative trend for many years now. Is there a point where we just kind of fess up and say, these margins had to be brought down and we will never reachieve previous levels and it's just a cost of being Kraft today?

Well, I think -- well, to the first part of your question in terms of understanding the numbers we try to be as explicit as we can in our releases and just sort of split out the parts of what is one time restructurings and so forth. I think to your point is as we look at 2006 our expectations are that margins should improve and again, will we get back to where they were in the early 2000? That's not what we've been saying in terms of -- it is a different environment. And importantly as we continue to invest for the long-term, and for the long term health of our brands and the brand value propositions we want to make sure we have a sustainable business proposition going forward which means it's driven more by top line growth than maybe what we were doing in times past and not investing our brand.

So I think will you see though going forward is improved margins and again we have, it has been difficult to see with such huge swings in commodity costs the last couple of years but I think as you go through the bridges for 2006 you will see that we are making progress in our margin and from an operations point of view and we are encouraged by that because it's being driven the right way both between the costs that we are taking out but importantly because of the contribution from higher revenue growth.

And just one definitional question. On the -- you talked about progress with new products to $2.5 billion. What do you define as a new product and has that definition been consistent over time?

It has been a consistent definition over time and yes, it's just a minor new flavor and so forth we don't include that. But significant new products coming out from a range or whole new brands we do include and it has been consistent over time. So again, I'm sure everyone in the industry may define something differently but all the numbers we've given, we've shown in these hit-o-grams for every year has always been done exactly the same way.

It does exclude sort of promotional.

Yes, all the promotional stuff and one time in and outs are not included.

But I should also mention that it's products that have been in markets for 12 months or less.

Got it.

Some company's quote three years, some quote two years. We been very focused on insuring we have a strong pipeline in getting up to that 1.5 billion every year.

Thank you.

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

Just wanted to dig a little deeper, or if you could provide a little more color around the restructuring. I'm wondering are you planning to consolidate any of the production from the facilities that you are closing into existing facilities or are these simply products that you are discontinuing in some form or another?

It's actually probably more of the former than the latter. It's a combination of both obviously but an interesting, good example, I will give you two examples, one, for instance , in Latin America we moved from selling our dry package desserts, our gelatin products and pudding products that we have sold in boxes like you see in the United States from Jell-O but it's under the Royal brand there, we moved it from a box to a pouch such that we could make it on the same production lines as our powdered beverages. Because of that we were able to take out a significant number of factories and production lines. Another good example is in Europe interestingly many of our tablets, chocolate tablets were of different lengths by about a millimeter or two, they required multiple factories by harmonizing the length and size of our tablets allowed us to consolidate production and get rid of both factories and production lines. So it's just moving lines. We've been very efficient what we've been doing. A good example is Choco sticks, a product we've come out with which I'm very excited about in the United States is that wafer product that Oreo Choco Sticks that we initially made actually using assets in Lithuania but now are starting up in Mexico using excess assets from Belgium. Yes, it's moving equipment around, it's reducing both number of facilities and where things are made in different locations.

What has been the worker reaction to this? Has morale been an issue for you thus far and do you anticipate any issues with another 8,000 workers I guess as part of this restructuring set to go?

It's always hard to make changes in the size of your organization, but I think what we have been communicating and an important part in all these things is to communicate considerably to both all levels of the organization and so we've explained to unions and work channels the key is for us to be competitive and have a cost structure that allows us to provide consumers with the brand value propositions that would drive improved results. And in a message I sent out to employees today, we explained that it's while difficult, it's important that we have a business that's successful going forward over long term and that gets us ensuring that we have the right cost structure to improve our brand value propositions.

Are you outsourcing any of this production at all? Is that part of the kind of this transformation or is it all just moving things within Kraft?

We do some outsourcing, and it's one of the strategies we do use, but I wouldn't characterize this as a major outsourcing project. There us some included in some of this restructuring but it's -- that's just being more efficient as we operate our operations with a little bit of outsourcing.

And you expect this restructuring or most of these plants to be shut within the year or have you decided about it?

It's a three-year program and you will hear announcements like we did in the last two years. We will be announcing them as we finalized what the plans will be included, and what facilities will be included, and what employees are affected. So it continues through 2008.

Our next question is coming from Jonathan Feeney of Wachovia.

I guess my first question is a strategic one, Roger, would you -- you look at, I mean I look at the successes you outlined for 2005 in a tough year and the one thing I would say, probably the biggest success was that you built, out of nothing you built $170 million brand in South Beach which tells -- reinforces I think that you have the best kind of distribution in go to market because of your scale infrastructure out there. In light of -- I think it was Rob's earlier question, about what would you do differently if you were under your completely -- your largest shareholder weren't there? Do you think you are making enough acquisitions? I mean you are in tough categories. You're gaining share in those categories, you need probably to get into better categories. Are you making enough? And would you look to get more aggressive there even in the U.S.?

As Jim said, one of our uses of cash would be to make acquisitions. We continue to look at acquisitions both within our current categories and in adjacent categories, but we are very disciplined in our approach to acquisitions and we will not make them unless they are shareholder enhancing and right now it's been hard to find good ones. We continue to look and so I wouldn't preclude them in the future.

Is that primarily a function evaluation, Roger, when you say shareholder friendly?

It's valuation and strategic fit and making sure that it will help us drive our business from a growth point of view. Importantly, acquisitions for us are not just what you can get in cost synergies but what it will do to help transform our portfolio in line with consumer needs, there's convenience, health and wellness, and demographic trends, and so finding the right ones will help us do that and the adds to right value is key.

Thanks and just a few detail questions, I guess primarily for Jim. You look at in the release it talks about -- you talk about 50 basis points of net of pricing of commodity cost hit, netting down 0.5 a percentage point. Can I take that, add the, I guess it's 2% pricing you got across the portfolio and say that you had a raw commodity cost hit of 2.5%?

Well, that's what you would imply. We give you the specific number on the commodity increase of 200 mill and the net of the two is 0.5 a point hit. So yes, you have got enough points there to figure it out.

Okay. So there's nothing else in there I guess is my question.

No, it's just pricing and commodities when we give you that net impact.

Excellent. So I guess I was just afraid there was an allocation for pricing you might have gotten anyway. Jim, do you have any idea on gross margin in '06? I'm sorry if I missed that, but did you?

No, we didn't really give a gross margin in '06 but since we do imply the revenue growth and we do give the EPS guidance range with a tax rate you can sort of back into where that would be.

I guess that would -- could you be more specific also about Q4? You talk about consumer marketing spend for the full year. Was it up year-over-year in Q4? Consumer marketing.

Yes, it was. It was up year-over-year in quarter four but again we did shift some spending to respond to price competition in Europe and in some cases we did wait to spend as we have some new programs coming for some brands but the increase was probably more in different quarters depending on when new products were coming out.

But the rate year-over-year probably declined a little bit?

Yes, it did, actually in quarter four.

I'm sorry, yes, sorry Q3 into Q4.

Right. Exactly.

Excellent. Thank you, guys.

Our final question will be coming from Judy Hong of Goldman Sachs.

Actually, all my questions are answered.

Well, come up with a new one.

Thanks so much. Take care.

Thank you. We have no further questions at this time. I now turn the floor back over to management for any closing remarks.

Thank you all for participating in our call this afternoon. We look forward to seeing many of you at the Cagney conference in Arizona next month. Our presentation is on February 21, at 10:45 in the morning and it will be webcast for those of you who cannot attend. Have a good evening everyone.

Thank you ladies and gentlemen. This does conclude today's teleconference. You may disconnect all lines at this time and have a great day.