億滋國際 (MDLZ) 2006 Q1 法說會逐字稿

Good afternoon, and welcome to the Kraft Foods first quarter 2006 earnings conference call. Today's call is scheduled to last about one hour, including remarks by Kraft Foods' management and the question and answer session. (OPERATOR INSTRUCTIONS). I will now turn the call over to Mr. Chris Jakubik, Vice President of Investor Relations for Kraft. Please go ahead, sir.

Thank you, and good afternoon. Thanks for joining us on the Kraft Foods first quarter earnings call. Also joining me on the call today is Jim Dollive, our Chief Financial Officer.

During our opening remarks today we will reference sides that are available on our website at www.Kraft.com. Additionally, as you know, during this call we may make forward-looking statements about the Company's performance. These statements are based on how we see things today, so they contain an element of uncertainty. Actual results may differ materially due to risks or uncertainties. Please refer to the cautionary statements and risk factors contained in the Company's 10-K and 10-Q filing for a more detailed explanation of the inherent limitations in such forward-looking statements.

Before we get started, I would like to note two things regarding our earnings release and our comments today. First, presentation of our Q1 financials reflects our new reporting segments. And we restated historical result for these new segments in an 8-K filing on March 27. Second, is a comment regarding our market share data. Due to the earlier timing of our Q1 earnings release, we have not yet received complete Q1 consumer purchase data, and are therefore unable to discus full quarter market share trends.

With that out of the way, let's take a look at the quarter and what we see ahead for the year. Before I hand it over to Jim, let me review several items that impact the year to year comparability of our results.

Q1 results had three types of items that affected the comparability of results versus the first quarter of 2005. First was the impact of asset impairment exit and implementation costs. During Q1 of this year we booked $215 million pretax, or $0.09 per diluted share, for costs related to our restructuring program, as well as asset impairment charges. This included an asset write-down related to the announced sale of [Melsof]. Last year we booked 169 million of such costs, or $0.07 per diluted share.

Second are gains and losses related to the sale of businesses. This year we recorded a $3 million pretax loss as closing adjustments to previously announced divestitures, but with no meaningful impact to earnings. Last year we recorded a $116 million gain, or $0.04 per diluted share, mainly related to the sale of a desserts business in the UK.

And third, in March we announced the favorable resolution of Altria Group Inc.'s 1996 to 1999 IRS tax audit. Kraft realized the total after-tax benefit of $405 million, or $0.24 of incremental diluted earnings per share, from the resolution. As we go through our discussion of Q1 earnings drivers, our comments will exclude the impact of these items.

With that as a backdrop, I will turn it over to Jim Dollive, who will provide some further insights into our first quarter results, and discuss the outlook for the rest of 2006. We will then open it up for questions.

Good afternoon everyone. Let me start by saying that we are pleased with our first quarter results and our start to the year. World-class execution against our three guiding principles, which were reviewed at CAGNY is beginning to show through in our results. On our first principle to put consumers first, we continued to strengthen our brand value proposition. New product introductions remain strong, and we are seeing the benefit of those initiatives in better organic net revenue growth.

(indiscernible) simply enacted quickly, our restructuring and cost reduction programs are on track. In the first quarter this translated into lower overhead cost and a better operating income margin. We also continued to prune SKUs in discontinue product lines. While this had an adverse impact on our volume growth in Q1, and will continue to do so in the months ahead, we are seeing the benefits of a richer product mix in our results.

Finally in Play to Win, with an emphasis on transforming our portfolio both geographically and with greater category focus, we posted strong Q1 growth in developing markets. We also continued to divest noncore businesses, including our recent announcement to divest Milk-Bone Pet Snacks.

Turning to our first quarter results, our reported revenues grew .8 of a percent. Included in that amount was the impact of divestitures, which were a 1.6 percentage point drag. This was mainly due to the divestitures of our Canadian Grocery and U.S. Fruit Snacks assets. Currency was an additional unfavorability of 1.2 percentage points, primarily reflecting a weakening of the euro relative to the U.S. dollar, which was partially offset by strength in the Canadian dollar and the Brazilian real. Excluding the divestiture and currency impacts, we delivered 3.6% organic revenue growth in the quarter.

You'll notice that beginning this quarter we moved our revenue metric from ongoing constant currency to organic. Aside from being easier to say, organic net revenue excludes the impact of acquisitions, which we had previously included. We made this move because we believe that organic net revenue is a better measure of our progress in building the business. Given the mix of the categories and geographies that make up our portfolio, we are confident we can deliver organic net revenue growth of 3% consistently over time.

Applying our new revenue growth metric against our history, our organic net revenue growth has consistently improved over the last three years. That said, 2005 was the first year where organic net revenue growth reached our long-term growth target, and we have built on that progress in the first quarter this year with 3.6% growth.

Turning to our performance by segments. While our organic net revenue growth was broad-based across our segments, three segments stood out. In North America Convenient Meals we saw excellent performance, particularly in Oscar Mayer Cold Cuts and Lunchables. In North American Snacks and Cereals, growth was driven by cookies and breakfast bars, as well as Planters Nuts. And in developing markets Oceanic and North Asia, growth was led by double-digit gains in Russia, the Ukraine and the Middle East, along with strong performance in Latin America.

Two of our segments, North America Cheese and Foodservice and North America Grocery were more significantly impacted by Easter-related merchandising shifts that affected year-over-year growth comparisons. I will talk more about this in a moment.

Looking at the components of our Q1 organic net revenue growth, volume was down 1.1%, including the impacts of pruning and pricing actions. The effects of SKU pruning and the discontinuation of certain product lines represented approximately 2% of our volumes in the first quarter of 2005. In the first quarter of 2006 this activity impacted all segments, but was skewed to productline discontinuations on some ready to drink items in Canada, the U.S. and Mexico. This activity resulted in unfavorable volume comparisons in North American Beverage segment in certain developing markets.

This is not to underplay some of the volume challenges we continue to address in areas like U.S. Mac & Cheese category and in the EU. However, it was pruning that was the major offset to solid base volume growth in established products like Oscar Mayer Meats and Lunchables and Oreo and Chips Ahoy Cookies.

Also, the effects of our pruning initiatives will continue throughout 2006 as we target a 10% net reduction in SKUs during the year, building on the progress of the last two years.

As I mentioned earlier, the timing of Easter did have an impact on our Q1 results. However, the 53rd week at the end of last year shifted the start of Kraft's first quarter by one week, which resulted in a slight benefit that offset the Easter impact. On the year the calendar shift is not expected to materially impact results. However, certain categories that are heavily merchandised for Easter were affected in the first quarter. As I mentioned, this came through in the form of lower volumes in our North America Cheese and Foodservice and Grocery segments.

Finally, price increases of select categories negatively impacted category growth. This was particularly evident in categories like biscuits, pizza, and ready to drink Beverages where prices were up 3 to 4%, while category pounds declined by a similar percentage.

Continuing to look at the components of our revenue growth, mix was the most significant driver of our organic net revenue growth in the quarter. Several factors combined to drive broad-based mix gains, including the benefits of our emphasis on revenue growth, the impact of our new product initiatives, and the elimination of low price per pound SKUs and product lines. Our mix gains were r broad-based with every segment of the Company generating improved product mix. The developing markets, Oceanic Oceania and North Asia segment and North America Beverages segment in particular benefited from pruning initiatives. Additionally new product in the first quarter with their higher revenues per pound contributed to this performance.

Regarding new products, we continued to see strong momentum in Q1. We expanded our offerings in our South Beach Diet line with new items such as 100 calorie bars, salad dressings, and refrigerated breakfast wraps. Since its introduction 12 months ago, South Beach Diet has generated approximately $250 million in revenue, making it one of our most significant new product introductions ever.

Our pizza business also continues to benefit from new items, including DiGiorno Harvest Wheats and California Pizza Kitchen Crispy Thin Crust, as consumers continue to trade up to these more premium offerings.

With a similar transition to more premium offerings, our Oscar Mayer Deli Shave business is benefiting from both new items and the strong growth of the entire Deli Shave line. Our Deli Shave line is now 6% of the U.S. cold market, doubling its share since last year.

On Tassimo we are supporting our recent expansions into U.S. specialty outlets and Germany, while continuing to learn from our lead market in France. Germany in particular is off to a good start as our portfolio of hot beverages, ease of consumer use, and marketing programs are all working together to win consumers.

France has been a tougher market, given the broad competitive arena, and we continue to refine our product offerings to match our consumer learnings from this initial market. Our U.S. Tassimo experience through specialty channels is also building and helping to refine our marketing tactics. But the real thrust for the U.S. will be our broader market launch later this year.

Other new items this quarter, including Grape-Nuts Trail Mix Crunch, the expansion of Choco Sticks Biscuits in several Asia-Pacific markets, as well as other regional expansions continued our strong new product success.

Returning to revenue, net pricing contributed 1.7 percentage points to revenue growth. The price increases we put in place over the last year have been well accepted, and are resulting in solid price realizations despite short-term volume impacts. Overall, our price gaps remained in line with our expectations, maintaining the level of improvement in price gaps that we have worked so hard to achieve over the past two years. In addition, we have taken actions to improve price gaps in U.S. pourable salad dressings, and coffee in Germany, which tempered some of the positive price realization achieved in the quarter.

On U.S. Cheese we increased prices in Q1 to recover higher packaging costs. However, we have also increased the level of trade spending to reflect the lower commodity costs, such that price gaps are managed effectively.

Regarding actual pricing actions, our major pricing actions in 2005 were relatively broad-based across both categories and geographies. For the first quarter of 2006 we have continued to take selective pricing in additional categories, such as biscuit and frozen toppings, where both rising costs and the strength of our brand value proposition justify an increase.

Moving down the income statement, gross margins declined in the first quarter by approximately .7 of a percentage point. As I just mentioned, price realization, our ability to recover increasing costs, improved in many of our businesses. However, the aggregate benefit of our price increases and productivity gains did not fully offset our higher cost of goods. Importantly, this reflects the fact that we continue to invest in managing our price gaps in select categories as discussed.

The biggest component of higher cost of goods continued to be commodity costs. Looking at specific commodities, trends are highly mixed. For instance, market prices for world sugar led all of our major commodities with a 91% increase. However, the impact on Kraft in Q1 was limited due to our long-term coverage. Coffee also showed a large gain and was a significant portion of our higher costs. And as you would expect, energy and its implications on packaging materials had a large move to the upsides versus last year. Conversely, hazelnuts, cheese and meats turned favorable in the quarter, with U.S. barrel cheese costs falling to $1.14 per pound by quarter end.

Looking at the overall impact from commodities in the first quarter, commodity costs increased $100 million versus prior year. While this was the smallest such increase over the past two years, commodities remain a headwind in 2006. And we remain cautious on our outlook for commodities for the balance of the year, particularly on energy.

Operating income as reported declined 12%, but when adjusted for asset impairments, exit and implementation costs and gains and losses on the sale of businesses, it grew 2.1%, yielding a 20 basis point increase in margin.

The highlight here is that the benefits of our overhead cost reduction and process simplification efforts are showing through in the form of an improved margin trend. In addition, we delivered the margin gain while maintaining the higher level of consumer marketing investment established last year. I should also note that stock compensation expense was not a factor in our year-to-year comparisons as it was previously fully expensed.

Our reported earnings per share were up 45% to $0.61, primarily driven by the benefit of the IRS tax audit resolution. Excluding this benefit, as well as asset impairment exit and implementation costs, gains in sale on the loss of business -- on the sale of businesses, and earnings from discontinued operations, EPS was $0.45, up 2.3% versus last year, matching the growth rate of our operating income.

Our ongoing tax rate was approximately 31%, about 3 percentage points higher than last year, as the prior year benefited from the resolution of certain international tax items. The $0.02 EPS impact from the higher tax rate was essentially offset by the reduction in shares outstanding due to our stock repurchase program, and lower interest expense reflecting both reduced debt levels and the redemption of higher coupon Nabisco bonds.

Turning to our outlook for the balance of the year, we expect 3% plus organic net revenue growth on a 52-week basis. In terms of EPS, on March 16 we increased our 2006 guidance by $0.17 per share to a range of $1.55 to $1.60. The increase included $0.24 per share for the IRS tax audit resolution, partially offset by $0.07 per share for the Pet Snacks divestiture. And our guidance continues to include $0.50 per share of costs related to the Company's restructuring program and other impairment charges.

Finally, we expect our cash flow in 2006 to remain strong, approximately $3.4 billion in discretionary cash flow and divestiture proceeds, including the refund from Altria Group for the tax audit resolution.

To briefly sum up before moving to questions, the first quarter was a good start to the year. We strengthened our brand value propositions, posting solid organic net revenue growth. Our cost savings initiatives are starting to show through in our reported results, and we expect momentum to build more broadly as 2006 progresses.

With that, Chris and I will open it up to your questions.

(OPERATOR INSTRUCTIONS). David Adelman for Morgan Stanley.

A couple of things. I know you don't provide quarterly guidance, but were the first quarter results above your internal expectations?

As you said, we really don't get into guidance by quarter, but clearly we felt good about the quarter. We are seeing the kind of momentum we would like to see in the business, and hopefully we're going to build on that.

Were you surprised by the essentially neutral effect of Easter? In other words coming into the quarter had you envisioned it having a more significant net negative effect?

Easter did have a negative effect, and that met that our expectations. I think where we saw a little bit of a benefit was on the calendar shift where we picked up the offsets due to this year's first quarter beginning with the first week in January, whereas last year's first quarter began with the last week in December.

Two other quick things. You had talked as the number one priority usage of cash flow to make strategic acquisition. You obviously haven't been active there for some time. Can you address the absence of closing deals?

It is getting the right value. That is the right priority for us to reinvest our cash to grow the business. But it is not investing or acquiring businesses for the sake of doing an acquisition. It is doing it to support the overall business, to support the longer-term growth, and to deliver the right kind of shareholder value. We will continue to look for those opportunities. That continues to be the right kind of priority for our cash.

Lastly, 96 million in interest expense on page 11 of the release, that is reflecting, am I correct, the benefit of the interest income component of the refund you received from Altria? Is that correct?

That is correct. That has the $46 million of interest recovery in it.

David Nelson of Credit Suisse.

Three months ago when you talked about full year guidance, you talked about tough first-half challenges. Obviously you talked about the higher input costs, but also on that call a tough European operating environment. Has anything changed in the macro?

The macroenvironment really hasn't changed dramatically. Europe continues to be a tough operating environment. I think what we're feeling good about is the progress we're making against our brand -- our business investment initiatives and our brand propositions.

That is really starting to come through. You are seeing it -- if you look at the type of results that we had this quarter, the fact that we are taking pricing across multiple categories, our price gaps are generally in line with our own expectations. And then you've got the new product success coming through. It is much more I would say business specific as opposed to changes in the macroenvironment.

Got you. I think that is reflected in the organic net revenue growth, especially in Snacks and Cereals, which was a big surprise to me. But the operating profit decline in Cheese, and you talked about the input costs there being down, but I guess the issue there is you're having to promote back against that giving you a net negative margin?

It is managing the price gaps appropriately. The other thing that affected that category more so than most of the others was that Easter shift, because cheese is a heavily merchandised item around the Easter time, particularly our cream cheese business.

David, if you are following the line on the chart of cheese prices, cheese prices started to coming down more towards the end of the quarter. So you still do have some issues around timing of cost versus pricing.

Cheese looks a lot better for the balance of the year?

(multiple speakers) I am not going to give you a forecast, but yes, we're feeling good about where we are with our price gaps, our programs behind the business, and where we stand overall.

Jon Feeney of Wachovia.

Jim, you talked about SKU pruning. I know this isn't the first you have mentioned of it. But can you just refresh my memory about that 10% number -- that target. What is the framework used to reach that kind of goal? And what sort of things are you looking at when you plan to prune certain SKUs?

Our objective, and this is year three of the program, is 10% reduction in net SKUs. We really looking at it not just taking out the items we have, but net of the new product that are going in. It is a reasonably aggressive target. And that has a benefit across the entire value chain -- the operations organization. It helps drive further productivity initiatives. It really gets the organization to focus on those products that will make a difference longer-term. Now the group will look at which items are the ones that have the most complexity, that have the least value in terms of overall value to the franchise, and put the emphasis on the faster moving, more important SKUs.

It sounds like it is a lot of different things. Are you --?

It is across the entire Company.

It was very heavily concentrated it looks like this quarter in Beverages. Are there any areas of concentration in those SKU reductions to look out for, for the rest of the year?

We will continue to look at all of the items. I'm not sure I can point to a specific category or business where it is going to be more SKU. I think in this case because the Beverage products tend to be more heavy, and we took out some particular productline, such as the one liter size in Canada and one liter size in Mexico, that is where you saw the actual SKU because it was the whole line that was being eliminated.

Moving now to Europe, I'm surprised to see that currency has such a big impact at the operating margin line. Are there some dollar costs in there that are causing that?

You do procure certain commodities like New York coffee on a dollar basis. That does have an impact, and that is a large business for us in Europe. But it really gets into the fundamental strength of the dollar relative to the euro, where last year Q1 was on the order of $1.30, and it has been averaging more in the $1.20 range for this year.

Just finally, could you talk a little bit about the competitive landscape in cereal? Specifically you mentioned that certain declines in kids' serials offset strength at Honey Bunches of Oats. Could you give me a sense of the order of magnitude? Are we talking mid single digit declines for the rest of the portfolio?

In terms of cereal portfolio, we're more balanced in the overall cereal -- our cereal business in Post. What we have is on our kids' cereals where we have made a conscious decision not to advertise those products under our Advertising to Children initiative, such that we have been off air, and we're only recently have gotten on air with reformulated products that meet our Sensible Solution Criterion. It is those businesses where we have suffered some share loss, where as we have seen terrific momentum on our adult cereals, including the new entry on Grape-Nuts. But adult cereals overall for us are running somewhere on the order of a plus 10%.

And kids' cereals are down by about that much?

Actually they are down a little bit more than that, but yes they pretty much offset.

Excellent. Thank you very much.

Terry Bivens of Bear Stearns.

Just a couple of nuts and bolts things. Jim, given your remarks on the trade spending, could you give us a little bit better idea of the whole marketing picture there? I think you indicated that it was up. I assume there you are talking consumer marketing?

Are you talking about a specific part of our business or Kraft overall?

I am talking about the overall P&L. I would like to get a better idea of what kind of drag trade spending was. Apparently that was up versus -- I think I heard Jim say.

What I said was the trade spending was up on cheese, and that was indicative of the lower commodity cost. In aggregate, our trade spending was -- when looked across the entire U.S. business in particular -- I'm not going to get into items on the P&L, but our trade spending did not have a dramatic change. It pretty much tracked with the overall growth in revenue.

How would you describe then consumer marketing? Would that be up, down, flat?

Consumer marketing was essentially flat versus prior year. But remember prior year had a step up, and what we did was maintain that level of investment. Now as we see the momentum behind the business, we will look for opportunities to do more to continue to build our brand value proposition.

Just in terms of the incremental input cost, I think you tagged a number of 100 million. Would it be a safe bet on our part to multiply that by 4 to get through the year?

First of all, that was 100 million just in commodities. We've got other costs that are going up as well.

How would you -- I took the commodities to include food ingredients, energy and packaging. Is that how you're defining it?

Yes. That is how we are defining (multiple speakers).

On that basis then would it be a safe bet to say roughly four times that is your expectation?

I think in the last call we gave a directional testament estimate on commodity costs in aggregate, but --.

That is what I'm forgetting, if you did.

We will have to check on that.

What I would say is just look at the individual commodities. In the case of cheese and meat where the commodity costs have come down, those are going to -- the milk supply right now is relatively strong, so there's not a lot of upward pressure on that commodity. It is the energy and packaging I think all of us remain cautious on, particularly given what we are seeing in the marketplace. I really don't want to get into a forecast of the entire basket.

And quite frankly commodities are one issue, but the broader issue isn't commodities, it is our brand value proposition. As we look at it, I think as Jim had mentioned, you expect momentum to build as we go through the year, I think what we are expecting is that we will get more momentum behind our brand value propositions. So whatever way the commodities tend to play out, we will be in a much better position to handle it going forward.

Pablo Zuanic of JP Morgan.

I am just trying to work (indiscernible) algorithm, when I'm looking at your gross margin and SG&A. You're saying for the first quarter gross margins were down 20 basis points. SG&A apparently as a percentage of sales was down 90 basis points. [It came up to] 70 basis points increasing margins. There is two questions related to that. But the first question is, how should we think of that over the next nine months? That the gross margin piece should be (indiscernible) through, and that the magnitude of savings on the SG&A front are sustained for most of the year. Can you answer that for us?

Given the kind of guidance we've got, both on the revenue and earnings, that does imply margin improvement on the year. As Chris just said, given the improving brand value propositions and our ability to recover those kinds of commodity cost increase, you would expect that gross margin line to improve over time.

And the SG&A line to be sustained?

On the SG&A line, what is happening there is we are seeing the cost reduction savings come through. And that -- I think we are going to continue to build on that momentum, given the magnitude of the investments we're making in our cost restructuring program.

The follow up to that is that when I see the gap in terms of your results for the quarter, in terms of gross margins and SG&A, and then I look at the divisional breakdown where you had significant margin improvement in terms of EBIT -- margin improvements in Convenient Meals, Snacks and Cereals and so on -- when we had a company that most of the savings for quarter or the margin expansion is being driven by the SG&A line, I wouldn't expect to see -- and there has been a little change in those margins -- I wouldn't expect to see so much divergence at gross divisions. Can you help me out to understand that? The SG&A cost savings I suppose are applicable at (indiscernible) divisions, right?

I think what you have to keep in mind is they are different businesses and there are different issues going on in each business. Some of the areas where you're seeing perhaps some EBIT or ROCI margin softness you've got other issues going on in terms of things like making investments to build brand value propositions going forward, and different commodities that are coming in that we need to deal with. I don't think you can really make one blanket statement. All the divisions are experience -- the cost savings. However, there are different points in terms of getting brand value propositions right. And as we say, momentum will build as 2006 progresses. I think you'll see a bit more uniformity in terms of the breadth of that momentum.

But on that point, could you -- for example your examples on the SG&A front, which was the additions that really saw significant savings in terms of overhead and process simplification that were not made out by the higher margin (multiple speakers)?

Aside from the fact that -- to target just a few, where we are seeing some of the big savings are showing up in the Snacks Group, and that is related to some of the activities we're doing within the selling activity on the distribution side.

We also, if you remember back in Q4, announced a reorganization in the EU, which was an emphasis on moving the focus of that management to a more category across the entire structures to leverage some of the capability. I think those things are starting to show through, as well as the overall emphasis of managing down the overhead profile. I think the more important point, as Chris just mentioned, is we are seeing the kind of improvements we have been targeting and making investments to deliver against the brand value proposition, and that is going to have happen at different paces across each of these businesses. I think that is probably the primary factor that is driving the difference you're seeing by some of the regional components and some of the category differences.

Just a follow-up on a different subject. As very specifically in the case of the coffee business, both in Europe and the U.S., can you just give us an update there in terms of what is happening with the competitive landscape? Of course raw material prices are significantly higher. As private-label and other competitors are moving prices up, how is the price gaps situation in the U.S. and Europe? Is it becoming more stabilized? Just walk us through with regarding coffee in the U.S. and Europe?

Well it is doing pretty good. But where we are in coffee in the U.S. business is doing well. We continue to see strong growth on our premium offerings with Starbucks, Seattle's Best and our Gevalia business. On a competitive side, we are saying the recovery from one of our competitors who had difficulties obviously because of the hurricane effects back in the latter part of last year. And they're doing exactly what you would expect them to do now that they are back in business. They are promoting their products.

On the European side, it continues to be a relatively tough environment. That is an environment where the retailer brands and some of the price discounter brands, that just makes it tough arena to compete in. The real message though on that part of the business and coffee in general is how we're evolving the portfolio. And that this into a discussion around things like Tassimo, where we are moving to the more premium end where we have some unique product differentiation -- a complete system. And those are the kinds of initiatives that are going to enable us not only to create installation versus the competitive front, but drive a better margin profile longer term.

Thank you. That's helpful.

David Driscoll of Citigroup.

Just a few questions. First one on cheese, did you mentioned during your prepared comments that you raised prices in cheese, that's correct, right?

We took a price increases to recover packaging materials. Yes.

Pull a couple of points together. As you mentioned, milk prices are down very significantly -- certainly sequentially. What is the story then on why you would be taking a price increase in light of the fact that we have got milk going in the opposite direction?

But we also increased some of the promotional spending, the trade support, to reflect the commodity decline. The issue here is protecting the brand value, protecting the price gaps. And we have to recover some of those higher costs, but at the same time we've got to reflect what is going on with the commodity. The net change, when you look at the price level of cheese is actually down on a year-to-year basis, but had we not taken that pricing increasing, we would have never really -- we have to recover those costs that would have been there. It really gets down to the sequence of events when you come right down to it.

My analysis of the Nielsen data for FTN would show that your shredded and your cream cheese price gaps have risen. And it would look to me like it is back to levels that I saw when you were losing share, although our data indicates that share has been okay for the moment. But I think in response to another questioners -- looking right here at the cheese [spread], you said that you think the price gaps are fine. Is that --?

The price gaps are we are we expected them to be.

Does that mean that they are in a good place? Where you expect them to be, they could have risen.

They are where we expected them to be and we're gaining share. To me that is the real important metric of whether or not we're delivering the kind of results we need to deliver. Brand value is stronger in our cheese business than it was a couple of years ago. If we can manage within the higher end of our price gap range, that is a good thing.

And key metric is our share performance. Now share is up on almost all of our cheese categories. We don't have the data that would take us into the month of March, but I know in advance, given the shift in the Easter merchandising, we are going to see -- it is going to be tough to read the share performance when that data becomes available.

Particularly in cream cheese, we have had some good experience over time as we manage the price gaps, came out with some good new products. As you say, we have to continue to monitor the price gaps.

And the brand value is stronger today than it was a couple of years ago.

On the pet snack divestiture in the press release you put that out back in March I think you indicated that there was $0.07 of negative hit in 2006 composed of minus $0.04 on the impairment and minus $0.03 on the additional tax. But then you threw in another line that said that there was minus $0.02 on an ongoing basis. When I add all those numbers up though I would get minus 9, not minus 7. What is the simple answer here? on an ongoing basis, how do you reconcile those numbers?

It really comes down to the timing of the transaction and when the transaction closes, because the $0.02 that we talked about, the clock won't start ticking on that until we actually close the transaction. It is really difficult for us to forecast the exact impact for fiscal 2006 at this point.

The only thing that you quantified for '06 was the impairment and the tax. Then there is an additional impact related to the loss of the operating income from the business.

Dilution effects.

Right. That is not included right now in your guidance?

No, it is not.

Two more quick questions. On the tax rate, 31% in the quarter. Guidance is still 33. Is there just a little pacing issue here, so all we're expecting to see then is a couple of quarters ahead we're going to see little tax rate bump up, and that evens us out?

That is exactly the situation. There are events, there are resolutions of outstanding tax items that occur throughout the world and at different stakes. And we recognize those events as they occur, and that makes it very difficult to forecast any individual quarter. On the year, the average should be about 33%, assuming no other significant changes, but it could get lumpy by quarter.

It happens when you have a global business.

That is fine. I think that everyone gets awfully precise about the consensus numbers on the quarter. And if we look at there is a 2 point change, because I'm sure everybody put, as we did, a 33% rate in our model for the quarter. But coming at out at 31, it looks like it was a penny or two positive variance. Could you give us guidance on interest expense? And then I will pass the call on.

I haven't made a -- I'm not going to give a specific forecast on the interest expense, but if you look at what we had in Q1, adding back the implication of the interest recovery for the taxes, that should be a pretty good surrogate of what to expect going forward. After adjusting and making assumptions about what is going to happen to short-term interest rates. We have got about $1 billion outstanding on short-term items, offset by cash flow implications.

That was complicated, but I will try to parse that later.

Multiplied by 4.

Tim Ramey of D.A. Davidson.

I just wanted to get a little more follow-up on what was happening in cereal there. It sounded like there were some major moving pieces. Can you give us any more detail there, or is it just all about not advertising to kids products?

I'm not sure I fully understand the scope of your question. But let me talk about what is going on on that category -- at least what we're doing. When we made our commitment not to advertise to kids unless we had products that met our Sensible Solution criteria, that meant we basically went off air on our kids cereal products. We are now back on air in Q1 with our Honeycomb product. And we will continue to look for further initiatives to get our other products back on air as well, as they meet that Sensible Solution criteria. Our competition continued to advertise their products, and the result was our business was down and theirs was up.

As we roll forward we will continue to roll out reformulated products.

The goal is to get all those back on line?

Absolutely. The objective is to grow our business.

Are you essentially saying that coffee in Europe ex Tassimo is pretty rugged right now?

It has been (multiple speakers).

It is more a discussion around the European environment. It is a difficult consumer goods environment. There is strong discounter presence throughout Europe and that makes it a tough retail environment. It means you have to stay diligence on your price gaps. You've got to continue to build your brand value propositions, and you have to look for those points of differentiation to leverage your business.

As Jim said, you look for the points of differentiation. When you are in a situation like in Germany where coffee has been a loss leader for a lot of retailers, you have to mind your brand value propositions that much more and invest against it in order to protect your franchise.

And then the last one on your SKU reduction program, I think that is a three-year program. This is the third of the three years. How do we know when we are close? It seems like this has been somewhat never-ending.

I don't think we ever said that it was a three-year program. I think we're going to continue to look for those opportunities that simplify our overall business profile. And that is an ongoing effort. I'm not sure we're going to be able to do 10% every year. But we're going to continue to look for ways to increase the efficiency, to drive the effectiveness as part of our entire sustainable growth program.

Andrew Lazar of Lehman Brothers.

One quick thing for what it's worth. Thanks for slimming down the earnings release. It was certainly easier for me to get through, if that's helpful at all.

Secondly, in terms of -- I was wondering if there's a way you can take an estimate at about what percent of your sales portfolio at this point that you have taken some form of list price increase on? I'm asking because I think that is a good benchmark on how you really feel about the brand value equation that you have been talking about across your business.

And frankly, more importantly, how much you still feel you need to spend going forward in terms of spending back a lot the additional savings and whatnot. And on the cost side to really make sure your portfolio is in a place that is sustainable on the brand value side. In other words, there are certain categories that you have kind of highlighted where you still need more. But even on the categories where you're seeing some traction from it, is there an opportunity perhaps as the year goes on to really pound it in to make sure you're in that place, or even like the dots that Roger put up at CAGNY where you were -- I forget the numbers -- but like a 2 3 or 3 in terms of getting into like a 1?

Let me try and hit all those points, and if miss any, please remind me. As far as the pricing action goes, if we go back to when we started to take some of these increases, I think in the latter part of Q3 or early Q4, in the U.S. portfolio, both in terms of pricing as well as adjusting trade spending, we probably moved close to have our business up in terms of the revenue metric. It varies pretty broadly based upon where we've got the strength in the brand value initiative, coupled with what we're seeing on the cost side.

The real message here though is getting back to the whole brand value discussion. We have been investing in getting the price gaps right, in better marketing support, in the new product initiatives, etc., and we're starting to see some of the fruits of that profile. We're going to continue those kinds of initiatives, building the momentum, building the brand value propositions, because ultimately that is what is going to sustain our long-term organic net revenue growth.

If we can continue to build that kind of strength and maintain the right kind of price gaps, we will be in a much stronger position to recover, as Chris mentioned earlier, some of these commodity cost changes.

You see where I am getting at with the pricing and the percentage to get a sense of how confident you are, and what percentage of your portfolio is at a place where you feel a lot better. It is getting back to what Roger was trying to communicate at CAGNY as well in terms of business by business where you are in that brand value piece.

Any sort of price gap or price target, it is a moving target. Because things change, and as we were talking before as we do other things to improve our offering, perhaps we can afford a larger gap. But it is a dynamic equation, not a static one.

And then the last thing is, I think Jimmy talked about some of the changes you're making on the selling activity on the distribution side. I think you were talking specifically in snacks. I'm just trying to get a sense, in case I missed it, in over the last whatever it is, couple of months, what specifically are some of the changes you're making on the distribution side in snacks? Because that has obviously been a business over time that has been somewhat more sensitive in its history to those types of changes?

We continue to look for opportunities where we can leverage the kind of capabilities that the Nabisco System, in fact with its [stored on] capabilities provides to us. We have used that in the past to merchandise certain products during seasonal windows. We refer to this as our adaptive supply chain initiative. And we continue to look for those kinds of opportunities where we've got that kind of skill base. We are looking, and we continue to look, for further opportunities for where we can go in the overall sales organization, not just in the U.S., but in all the businesses.

Is there something structural though that has changed in the kind of organizational structure, or things that one could point to that just to kind of bench mark it and sort of track the progress and make sure those changes aren't impacting the business in any way? I realize adaptive is opportunistic, so I am trying to get a sense if anything structurally or organizationally has changed that we can keep an eye on so there could be (multiple speakers).

Nothing fundamental. Nothing fundamental that I can go into at this time.

And you certainly didn't see it in our snacks results this quarter.

Chris Growe of A.G. Edwards.

I just had a couple of follow-up questions for you, and then one separate question. I guess just to be clear on the -- in terms of cost savings coming through this quarter, was there a significant amount of cost savings coming through? I know you've got roughly $300 million for the year. Were those more heavily weighted towards SG&A, or again what is driving the SG&A improvement in the quarter?

It was -- well, we said we had about a $50 million incremental cost savings. I think you're referring to the cost restructuring program. There is a $300 million incremental target for the year, so obviously that momentum is expected to build as the year progresses. We are on track with the savings profiles that we have identified.

In terms of where the savings are showing up, it was not -- it wasn't particularly skewed just to SG&A. It is showing up in both SG&A and cost of goods. What you're seeing in the SG&A line is a combination of those initiatives and just the ongoing cost reduction programs that we continue to do year in and year out.

And the way it works through the P&L, and you look at the margin improvement, it is more a function of getting solid topline growth and leveraging that against stable, flat overhead costs.

Another just sort of a follow-up, if you will. There has been a lot of discussion, especially in other consumer staples companies, about trade deloading and any sort of activity that may occur this quarter. Was that unique in the quarter? Is that something you have answered already? If you have, I'm sorry, but I didn't recall hearing any discussion of that?

No, that wasn't asked before. But we have had trade destocking going on for a few years now. And while we did see a reduction in trade inventories, particularly with our largest customer Wal-Mart who has a specific initiative to bring down their inventories, but it was not a significant impact on a year to year comparative basis.

And my last question, just relative to your developing market growth -- in your new reporting structure the developing markets Oceania, North Asia, that division had pretty minimal volume growth, but a very strong overall revenue contribution. Was that by design? Has that just been aggressive pricing, or is that more mix related? I just expected more volume growth in that division.

Certain of the businesses, as we mentioned, had terrific growth, particularly in Eastern Europe. But what really affected the numbers there was some of the products pruning and discontinuation items as we exited things like the ready to drink Beverages in certain countries. They also did have pricing increases that occur in several of the markets which helped further drive the revenue momentum.

I assume that product pruning will be with you for the remainder of the year for the most part?

Yes. And keep in mind with it being in ready to drink, those are rather heavier products.

Sure, so you're looking for more of a, if you will, a sort of price mix versus a volume for that division?

No, it is more value related. And still we are getting the kind of momentum we want to see on the organic revenue growth.

Thomas Russo of Gardner Russo.

A couple of questions. On the confectionary side, can you bring us up-to-date with how business is going in South and Latin America on your confectionary side where you have some high market share markets?

South America?

Yes.

In the EU, which is our largest confectionary market, we are taking initiatives there to do things to improve the quality of our products, to build the brand value propositions. We are expanding our premium Cote d'Or product into new markets such as Germany and the EU. And it is still early in the process, but we feel pretty good about where those businesses are.

The real challenge within those markets, just as we see on coffee, is the retailer brands, the hard discounters, and the -- and our need to make sure we protect the brand value propositions to stay competitive on our chocolates portfolio. In Latin America most -- a lot of it is the Brazil business. They continue to do quite well in Brazil. They have a terrific Easter business with Lacta. And I know they were off to a good start in 2006.

On Tassimo, I wonder what steps you are taking for on-site marketing. I see product in markets. I haven't yet seen much in the way of display or third-party contract personnel helping to show the consumer how it works and to describe the product.

Actually, that is the primary mechanism for supporting Tassimo. The whole concept of the marketing behind Tassimo is to see it, to try it, because it is a relatively large purchase for somebody to procure the equipment. And our whole marketing program is targeted towards getting them to see what a wonderful proposition it is, to help stimulate that purchase.

Actually in the states it is a big part of the initiative, and that really comes off with a lot of the learnings that we have had from Europe.

And last question is, there have been some prominent personnel shifts affecting Kraft -- people leaving. I wanted to know what your experience is on recruiting in laterals or bringing up from the ranks new talent to fill spots. And just talk a bit about the team, the bench, and how you're working.

Chris here, sitting right next to me is a recent employee (multiple speakers).

I recall.

So we have got a live example on the phone with me. But clearly we have said, and Roger I think has made this clear in many of the other presentations, is we look to supplement both the strong talent we have within our own organization with new ideas, new thoughts by bringing very capable people in from the outside. Our Head of Strategy recently joined us in the last two years or so from the outside. Our Head of HR recently joined us in the last 9, 12 months or so. We not only continue to develop the terrific resources we have, but we're looking for the best people.

Christine McCracken of FTN Midwest.

I was just wondering if you could talk a little bit more about sugar. You said it didn't impact you in the quarter because you had sufficient I guess coverage. But I'm wondering asset coverage rolls off and the expectation that global markets are going to remain maybe at above historical levels, how do you manage your exposure to sugar? Is there anything you can do to move production or reduce maybe the volatility that you might see? Obviously you have pricing action that you can take, but maybe you can just comment on that.

The question on sugar, to your point the key on it is making sure you've got the brand strength to be able to recover that higher commodity cost. We were fortunate enough to have covered most of our requirements in Q1. The question becomes what is the forecast on sugar, whether it is going to continue to run at that high a level? But we will look at the options and alternatives we have to find substitutes, if that is appropriate from a formulation perspective, to drive the productivity, as well as strengthen the brand value and pass on the related commodity cost.

As a percentage of your total costs for things like maybe confectionary in parts of the world, it seems like those products would have more exposure. Is it something that you might have a squeeze for a short period time, and then follow it by your ability to price it through or would you --? I don't need you to necessarily give us your -- obviously your intentions relative to pricing -- but more if you could give us color as to if there will be kind of this lumpiness in results tied to the movements in sugar as you coverage rolls off?

Sugar is not one of our major commodities. I see your point. It can be more significant on a particular business. But it is not one of the most significant commodities we have in our portfolio. Even if it were to become disruptive on a particular business, I'm not sure that would materially affect our overall results. Now obviously that said, we will look for opportunities to manage through the situation, and to protect the business by eliminating the variability around that commodity.

Fair enough. And then just wondering, gasoline prices look like they're likely to stay high over the summer. Some of your customers, specifically channels that you sell into, started to talk about weakness expected -- that they are experiencing now and expect to see over the coming months. Is there anything in our portfolio that would have particular exposure to lower disposable income, let's say, over the balance of the year? Or could you talk to -- obviously you're going to see in impact from a distribution perspective, but maybe from a sales perspective, volume perspective, what kind of (multiple speakers).

It is an interesting question, and it really gets down to a discussion of how the consumer is going to react with the rising cost of energy in terms of their overall disposable income. I can only make guesses, as you can, as to whether or not that is going to affect purchase patterns. What I would argue is we actually are seeing some just the opposite effect on businesses like our pizza business, businesses like the Oscar Mayer Deli -- excuse me, the Deli Shaved we talked about, where consumers are moving up towards the premium end. So it is a tough one to try and get a handle on and forecast.

The best thing we could do it is, as we have been talking about the whole call, is increase our investment behind our brand value propositions to give good value for the money, and that is where consumers will go.

Ann Gurkin of Davenport.

I was wondering if you just go through the revenue change in definition one more time. You look for 3% or greater organic revenue growth. I think last time there was ongoing constant currency, which included 50 basis points from potential acquisitions. Does the 3% now exclude that 50 basis points?

That is correct.

You have kind of raised the bottom end of it.

When we changed the definition from ongoing constant currency to organic, and if you take the historic amount that we have had in our long-term forecast, which has been about .5 percentage point from acquisitions, yes.

And then secondly, corporate expense was lower than our forecast, and can you help me with that for the year?

I'm not sure I can comment to your forecast. Corporate overheads are part of our over arching overhead profile. And when we look at our productivity initiatives and our programs to reduce overhead, it affects all overhead, including corporate overhead.

So keep it at this rate for the year? (multiple speakers).

You know, we're not going to get in the habit of providing guidance on specific P&L line items. What we would tell you is that we're comfortable with the guidance for the year that we have given.

Ed Roesch of Banc of America Securities.

I am just wondering the Tassimo launch later this year in the U.S., what is the timing on that? And has spending ahead of that launch kind of peaked this quarter, or what is your thoughts on that?

We really haven't been specific I think on the exact timing of when that U.S. launch will be.

It is a more of an expansion I think.

And that is the point I'm going to get to, is we are already in the market in specialty channels, so it would be a further expansion of the marketing initiatives we're doing right now.

Okay. You mentioned in salad dressings that you invested a little bit to bring down the price gaps. I was wondering on the more positive side, if you've gotten the Good Seasons premium brands out there to a pretty good level of distribution at this point?

Yes, the Good Seasons, that is one good thing, we are going after the premium end with Good Seasons in pourables. Obviously we have some work to do with the main line Kraft, but it is very early days. I mean we just really got it out.

They've got pretty good distribution on like 6 -- 5 or 6 SKUs of those?

Yes, I think we will be able to better speak to its success in coming months as more of the advertising support starts coming through.

Sure, it makes sense. I was just wondering if the change in the segment reporting just reflects the management or the way you evaluate results, having changed in some way or just --?

As I mentioned earlier, what it really got down to is the structural change we made in the EU moving to a more category focus, the remaining three regions we manage geographically.

Steven Kron of Goldman Sachs.

Just a couple of questions. Jim, when you talked about building brand value, you talked about managing the price gaps effectively, building brand support, and I guess the third pillar to that would be new product innovation. And I know in 2005 that was a good innovation year for you guys. And I know it is still early in '06, but just wondering if you can add a little bit of caller as to the new product maybe that you guys have introduced thus far in this year, how they are tracking.

And then secondly, I was just wondering, back on the SKU reduction question, after a 20% SKU reduction in the prior two years, 10% targeted for this year, I just want to make sure I didn't misunderstand your comments earlier to a response when you talked about it is more than -- it is ongoing. Clearly the SKU reduction has had an impact on volume. I am just wondering whether we should expect something of this kind of magnitude or of scale in the future beyond '06 that could continue to keep volume depressed?

Let me try and take all of that in the sequence. As far as new items go, I did mention many of them as I went through the earnings call, with a particular emphasis on the South Beach Diet line, which continues to do exceptionally well. The Deli Shaved Oscar Mayer products, also doing exceptionally well, where that, as I said earlier, at 6% of the total cold cut business. These businesses are off to a terrific start in terms of the new product initiatives.

On the frozen pizza side, California Pizza Kitchen, new items also doing very well. And is not just the new items, it is the entire California Pizza Kitchen line is well. In aggregate we're feeling really good about where we started the year on new products. There are additional items which we didn't mention that are just starting. Things like the Kool-Aid Sticks, which is the presweetened stick product that mirrors the Crystal Light To-Go that was so successful for us last year. We also have the Easy Mac cup, also doing very well. So all of these things just contribute to the whole kind of the momentum we have within our new product portfolio. And we're feeling terrific about where that is going.

As far as the SKU pruning piece goes, as you said, 20% over the last two years, another 10% this year, and we're just on to continue to look for opportunities where we can simplify our portfolio. Now that will obviously have some drag on the overall volume performance, but we are seeing the enhancement in the mix profile. And I think that is having a net overall positive effect on the total business.

Which is actually just -- my last follow-up -- which is on the mix improvement. Are you able to kind of dissect and quantify how much of that mix improvement do you expect is coming from the pruning of some little lower priced products, and how much of it is, like you said, on some of the items trading up?

It is awfully hard to do that because you would have to make an assumption on how much of the pruning product was completely lost versus somebody moved to a different flavor or a different pack size. But given the magnitude of the mix improvement that we saw relative to the 2% impact associated with the pruning, it is obvious that the mix impact goes well beyond the pruning benefit. And you see that as well when you look broadly across all the categories, every single one of them were showing the mix gains.

Right. And simple math would tell you, you look at the combination of volume and mix, you were up very nicely year-over-year, if you put them together. That is simple back of the envelope calculation.

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

Okay. Thanks very much. I just want to mention that a replay of this call will be available. The number to call for the replay is 877-519-4471 in the U.S., or 973-341-3080 outside the U.S., with the confirmation code of 721-6502. Additionally, the replay will be available on our corporate website, Kraft.com, a few hours from now.

For members of the media who have listened to the call and have additional questions, please contact Perry Yeatman, Vice President External Affairs, at 847-646-1045. For analysts having more detailed questions involving nonmaterial information, I will be available to take your call. Thank you and have a good day.

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