億滋國際 (MDLZ) 2007 Q3 法說會逐字稿

Good morning and welcome to the Kraft Foods third quarter 2007 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 morning. Thanks for joining us on our conference call. I'm Chris Jakubik, Vice President of Investor Relations. With me are Irene Rosenfeld, our Chairman and CEO; and Tim McLevish, our Chief Financial Officer.

Our earnings release was sent out earlier today and is available on our website, Kraft.com. 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 and uncertainty. Please refer to the cautionary statements and risk factors contained in the Company's 10-K and 10-Q filings for a more detailed explanation of the inherent limitations in such forward-looking statements. Some of today's prepared remarks will exclude those items that affect comparability. These excluded items are captured in our GAAP to non-GAAP reconciliations within our news release and they are also available on our website. We'll begin today's call with Irene's perspective on our third quarter. Then Tim will provide an overview of our financials and results of operations. After that, we'll take your questions. With that, I'll hand it to Irene.

Thanks, Chris. Good morning. As we reported in this morning's press release, we posted organic revenue growth of just over 6% in Q3 and EPS X items that were $0.02 lower than the prior year. Broadly speaking, our top line growth is stronger than I would have expected at this point our transformation plan. At the same time, higher input costs and the impact on our margins are a bigger challenge than I would have anticipated.

To be more specific, I'm encouraged that our top line momentum continues to build and that our businesses are responding to the growth initiatives we launched earlier this year. We had three consecutive quarters of improved organic net revenue growth and in Q3, revenue growth accelerated in every geography. I'm especially pleased that we also had solid volume gains, despite significant price increases. That's a clear sign that our brand equity is strengthening.

In businesses where our investments in quality, marketing, and new products have had time to gain traction, we generated solid volume mix gains and captured market share, despite price increases. Prime examples are mac and cheese, cold cuts, and cookies. And a number of the new products we've launched this year promise be sizable businesses and highly incremental to our base. These include Oreo Cakesters, Live Active cheeses, Easy Mac cups, ultimate pizza, and deli creation sandwiches. In fact, we expect the revenue contribution from new products in 2007 to be more than 30% higher than 2006.

Our growth initiatives in our focus categories are also beginning to generate share gains. In Q3 we gained share in 47% of our North American business. Versus only 38% for the trailing 52 weeks. That's not yet where we need to be. We expect to have over 50% of our revenues growing share in the near term, and at least two-thirds longer term. But we're moving in the right direction and you should see further improvements as more programs hit the market in the fourth quarter.

Highlights include new campaigns for Maxwell House, behind our advantage product and package and Planters, capitalizing on the natured goodness of this iconic snack brand. We'll also have a further step-up in spending on our international growth initiatives. As our wave one investments gain traction in the marketplace, I remain confident that this will set the stage for continued top line momentum and share gains into 2008 and beyond.

Despite our progress on the top line and in market share, we still have some significant challenges. The biggest is our margin performance. We're in a much tougher input cost environment than we had expected. In the quarter, gross margins declined 240 basis points, even after pricing actions and manufacturing productivity. Frankly, we haven't yet rebuilt the brand equity of our portfolio to the point where we can fully recover input cost inflation through a combination of pricing and productivity. This has been particularly true in our North American cheese business where dairy costs in the third quarter were up 40% versus prior year and current spot prices are not reflecting their historical seasonal decline, leading to record high average barrel cheese costs for 2007.

The easy thing to do would be to cut our investments in growth to improve our near term profit margins. But as I said last quarter, the input cost environment will not change our plans to make the necessary investments to improve the quality of our products and to rebuild the equity of our brands. These investments are essential to adding value to our products and therefore to our ability to manage input cost inflation over the long-term. Our investments are also key to driving the accelerated volume growth and stronger product mix that will leverage our overhead costs, lead to higher operating margins, and restore Kraft to reliable growth.

In the face of these extraordinary cost increases, we're also taking more aggressive actions to reduce our overhead costs. To date we've been able to achieve savings at a faster rate while incurring less expense. Cumulative savings under our restructuring program are now expected to reach $775 million this year, versus our expectation of $700 million at the start of the year. And there's more to come. Looking at our total restructuring program, we expect to come in at the same cost and reach higher savings than the $1 billion originally expected.

If you recall in September, as part of our strategy to rewire the organization for growth, I announced a new organizational structure to replace key resources closer to the market, increase accountability, speed decision making, and streamline headquarters. We have now defined the structure, identified the accountable business units and named the leaders of those units. Based on the work to date, I'm even more convinced that our new structure and new leadership team will simplify our operations and increase our agility and competitiveness in the marketplace.

As you might have seen on Monday, we named Mary Beth West as our new Chief Marketing Officer. As head of North American beverages, Mary Beth helped develop our successful go to market strategy for Tassimo in the U.S. and engineered the reawakening of our Maxwell House brand that has just hit the market. She brings a strong consumer centric approach to business challenges and will play a key role in helping to upgrade the capabilities of our marketing teams and improve the effectiveness of our programs. We still have a few more personnel holes to fill, including a new leader for our North American cheese business and we'll be in a better position to quantify the incremental savings from these actions as we exit the year and put the new structure in place in early 2008.

Finally, we continue to take the necessary steps to strengthen our portfolio. To exit businesses where we do not have a clear competitive advantage so that we may allocate our capital and management resources to those businesses that can grow and generate attractive returns for our shareholders. Specifically, we've just closed the sale of our Fruit2O and Veryfine bottled beverage assets we're on track to close the acquisition of Danone biscuits by year end.

In sum, I'm encouraged by the continued progress in the early stages of our transformation plan. We're doing what we said we would do and we are seeing signs that our efforts and investments are paying off. We still have a number of challenges but we are addressing them. And I remain confident that we are on-track to restore Kraft to reliable growth. And now I'll turn the call over to Tim.

Thanks, Irene and good morning. Before I begin, please keep in mind that unless otherwise noted, my comments will exclude the items affecting comparability that were highlighted in our press release. In the third quarter, our organic net revenues increased a strong 6.2%. That's up from 3.9% organic growth in the first six months of the year. Volume and mix accounted for about two-thirds of the Q3 growth as many of our wave one investments in quality, new products, and marketing began to hit the market. Net pricing was up 2.3 percentage points versus 1% in the first six months of the year as we have begun to see the realization of price increases taken earlier this year. Overall, we had a great improvement on the top line.

Turning to the drivers of profit and earnings, there are three factors to highlight. First, although our price realization improved in Q3, our gross margin was down 240 basis points versus Q3 last year. Higher input costs and our investments in product quality more than offset pricing and productivity gains. For the year, we expect our input costs will be up about 9% versus 2006. We expect gross margin pressures to continue in Q4, and into 2008 as well. Second, because of the decline in gross margin, our operating increment margin was down 210 basis points. On the positive side, I would note that our overhead costs declined as a percentage of sales, meaning our cost savings are coming through and we began to generate some operating leverage due to a combination of volume mix, growth from our investments, and restructuring savings.

Looking forward, we expect operating income margins to continue to be pressured over the next several months, due to higher input costs. However, in 2008 we will leverage improved price realization, volume growth, and improved product mix while driving down our overhead cost to achieve higher operating margins versus 2007. Third, below the line we benefited by approximately $0.02 from a combination of a lower effective tax rate and our share repurchase activity. In the quarter, our effective tax rate was 31.3%, reflecting one-time adjustments from the impact of various foreign tax law changes. As a result our guidance for the year is now 32.5%, versus our earlier forecast of 33.5%.

On the share repurchase front, during the quarter we repurchased another $1 billion of our stock. And in the first six months, since the spin-off, we've repurchased $3 billion or 5.6% of our shares outstanding, at an average price of $33.02. If you recall, in September we raised our guidance to $1.80 to $1.82, reflecting strong revenue growth, lower taxes, and further share repurchase. Our Q3 results came in very much as we had expected and therefore we remain confident in our guidance, despite the continued cost pressures. I'll take a few minutes now to share some highlights of our business segment results.

We'll start with North America, where Q3 results reflected the launch of most of our wave one growth investments. In North America beverages, organic net revenues grew 5.3%. Our focus on health and wellness and premium offerings is paying off. Capri Sun ready to drink pouches were up strongly from the addition of anti-oxidants, and functional benefits, as well as from teaming up with Nabisco for a back to school promotion. And in coffee, Starbucks premium coffees continued to grow strongly, combined with another quarter of 70% growth from Tassimo as our revised strategy continues to gain traction.

Our market share in coffee was still down in the quarter as gains in the premium segment were offset by main stream weakness. However, October 1, marked the beginning of our Maxwell House reawakening ad campaign in support of our improved offering. Customer and consumer reaction to both the package and the new 100% Aravica blend has been enthusiastic and we expect positive results from the program to begin in Q4 and continue into 2008.

At the profit line, beverages operating margin increased 260 basis points. Volume growth, favorable product mix, pricing and the benefits of our new Tassimo strategy more than offset higher input costs. We expect a similar profile in the fourth quarter.

In North America cheese and foodservice, results were impacted by unprecedented barrel cheese prices. Organic net revenues were up 5.6%, mainly due to price increases reflecting higher dairy costs but operating income margins fell over 6 percentage points as we chose not to price to peak input costs and continued to fund our growth initiatives to lay the necessary foundation for long-term growth of this business. Dairy prices have remained uncharacteristically high throughout 2007, likely leading to record high average barrel cheese prices.

Three major factors have combined to break the historical cyclicality of the cheese curve. Australia continues to suffer from its severe -- from a second year of severe drought. A weak U.S. dollar is making U.S. dairy exports attractive and demand for milk powders has grown globally, particularly in Asia and North Africa. In the face of this, we've taken significant action. About 80% of our cheese portfolio has been priced at least once in 2007. And pricing actions have ranged from 2% to 13% for an average 7% increase overall. However, absolute price levels are causing weak category volumes and driving more consumers to trade down to private label versus historical normals.

As a result, both our volumes and market share of total cheese are down year-to-date. Clearly our pricing and innovation have not been enough to manage this input cost volatility. However, our new initiatives are beginning to move us in the right direction. Live Active, prebiotic, and probiotic cottage cheeses are off to a good start. To date, Live Active cottage cheese has captured a 1.6% share of cottage cheese and is more than 85% incremental. And Live Active natural cheese has a 2.6% share of the natural cheese snacking category. Also, Kraft Singles Select has already gained 1 share point of the processed slices category one month after introduction. Fixing our cheese business will take time and continued investment. As a result, we expect operating income margins in this business to be under pressure for the balance of 2007 and into the beginning of 2008.

Moving on to North America Convenient Meals where revenue momentum has been building with each successive quarter in 2007. The investments we have been making in marketing, quality and new products drove strong volume and mix gains while we've increased pricing across most of the business. The introduction of Ultimate Pizza is helping to turn around our share of frozen pizza. Ultimate share of the category was about 3% in Q3 and all four Ultimate SKUs are in the top 5% of category dollar sales in Q3. Mac and Cheese is also gaining share, up over 0.5 point in the latest 52 weeks, driven by our investments in quality and new products. Easy Mac Cups have been more than 50% incremental to our business year-to-date, and have been a key driver of the double-digit growth of our Mac and Cheese business.

And finally, Oscar Meyer continued to post strong growth behind both deli creation sandwiches and deli shaved meats. In fact, deli shaved meats now have nearly a 10% share of the total cold cuts category. The result, 8% organic net revenue growth for Convenient Meals in the third quarter. However, operating income margins fell in the quarter, negatively impacted by three factors. The impact of divested operations, higher input costs including investments in quality and new capacity, and incremental marketing investments. Going forward we expect profit margins in Convenient Meals to improve as we see continued momentum from our growth initiatives.

On to North American grocery where organic net revenues were essentially flat. We are at the early stages of contemporizing these highly profitable brands. Jell-O is the first and earliest of our efforts. The total Jell-O franchise is up about 5% year-to-date and it was up 7% in Q3 behind strong momentum from new, better for you products. We'll be launching an integrated marketing campaign to rejuvenate dry packaged Jell-O in Q4. Pourable salad dressings will be next as we look to reverse many years of weakness in this franchise. We're upgrading the quality of the packaging and product and we'll be fully national with incremental marketing support in the first quarter of 2008. Some of the costs associated with these activities will weigh in our grocery margins in the fourth quarter.

Looking at North American snacks and cereals, organic net revenues were up 4.6%, led by growth of 5.5% in snacks. Several successful platforms are driving our snacks growth and serve as good examples of the impact of reframing our categories. For instance, revenue growths of our higher margin Nabisco 100-calorie packs was up 51% in Q3. Second, during the third quarter, the introduction of Oreo Cakesters captured a 6 share of the $1 billion snack cake segment with two of the category's top 10 SKUs and a 3 share of total cookies. Considering that we only launched the product in late July, we're expecting even better things to come. Third, our toasted chips platform grew 18% in Q3, versus the prior year and is now over a three share of the cracker category. Our new Garden Harvest chips have captured 1 share point since being introduced with velocities well ahead of competitive products. Despite some promising success our market share performance in snacks remains mixed. While our cookie share is up, we still have areas that need to be fixed, namely Planters and our broader cracker business.

Going forward, we expect our strong new product line-up and better marketing support across the snacks business to accelerate organic growth and improve market share trends. Operating income margins in the quarter fell 230 basis points as solid volume and product mix gains were offset by higher input costs, spending behind our growth initiatives, and dilution from the sale of Cream of Wheat. Clearly, given the high cost of grains, our input costs are on the rise in our snacks business, placing increased emphasis on improving net price realization. As a result, we're considering a combination of list price increases, targeted reductions in trade spending and productivity in order to manage these costs going forward. Nonetheless, we'll continue to invest in the growth of this business and in 2007 we'll have a solid base from which to drive growth.

Now I'll turn to our international business which continued to post solid organic growth as we focus on our investments on our core brands. The EU continued its return to moderate growth, increasing organic net revenues by 4.9 percentage points. In fact, EU organic revenue is up 3.3% year-to-date, its best performance in the last three years. Our two largest growth categories, chocolate and coffee, have been the main drivers. Chocolate delivered double-digit growth this quarter. There are two key reasons. A combination of new product launches and a double digit increase in marketing behind core brands like Milka and Toblerone. And secondly, cooler weather across the EU. Coffee growth was driven by two factors also. Category growth and market share gains from the successful restaging of our Tassimo on demand coffees and new product activity under our core Jacob's brand.

EU operating margins declined 220 basis points. There are two major reasons. First, 2007 is a year of investment to revitalize our core brand equities, through marketing and promotion. In fact, A&C spending ex Tassimo will be at its highest level in three years. The second is higher input costs. Coffee and dairy costs have been on the rise and as mentioned earlier, these businesses, especially in Germany, are not yet strong enough to enable us to fully recover these costs. In fact, with dairy costs now on the rise in Europe, input cost pressure is likely to get worse in the EU before it gets better. Looking ahead, although we'll continue to make the necessary investments to strengthen our core equities in coffee, chocolate, and biscuits, we are actively pursuing additional ways to reduce costs and improve margins.

Moving on to developing markets where we delivered another quarter of solid growth, with organic net revenues up double digits. All regions posted better growth in in the third quarter than in the first half of the year. Our focus on key brands and key products is paying off in each region. This included Jacob's coffee as well as Milka and Alpen Gold chocolate in our EMA region, Oreo and Club Sociale biscuits, Lacta chocolate, and Tang beverages in Latin America and Oreo and Tang in Asia-Pacific. At the operating income line margins was up slightly. The benefits of higher pricing and volume growth were offset by higher input costs and higher investments in marketing and distribution. Going forward, we expect continued strong top line performance from developing markets. However, we expect continued margin pressures as we step up our investment and marketing support and expanded distribution.

Finally, I would like to comment on our restructuring program. Annualized savings from the program are up to $720 million. And we now expect them to reach $775 million by year-end, up from the $700 million level we expected at the start of the year. On the cost side, we have incurred $326 million year-to-date and we now expect total cost of $500 million for the year, down from an expectation of $625 million at the beginning of the year.

As Irene mentioned earlier, we do expect to generate better savings than originally planned over the life of the program and we'll close out the program by the end of 2008. Obviously, the actions we will take to implement our new organization structure are part of our restructuring program, so we would be in a better position to update you as we exit the year. And from 2009 onward, we expect to maintain a normalized level of spending and cost savings initiatives each year, which will be part of our ongoing results.

Thanks, Tim. In sum, from an overall perspective, I feel good about our business momentum and the early returns from our growth initiatives. We can see that our investments in quality, marketing, and new products are driving improved organic growth. We're generating solid volume and mix gains despite significant price increases and we're beginning to leverage our cost savings. We still have challenges, particularly in the face of higher input costs, but we're making the necessary investments for long term growth and have maintained our full year EPS guidance of $1.80 to $1.82. I remain confident that our transformation plan will maintain our top line momentum and deliver improved margins in 2008. We'd now be happy to take your questions.

Thank you. (OPERATOR INSTRUCTIONS) Your first question is from Alexia Howard with Sanford Bernstein. Please go ahead.

Hello, there.

Hello.

Good morning.

Hi. Couple of quick ones. Marketing spending. I know that we've got this incremental 300 million to $400 million this year that costs marketing, SAP, R&D, and better ingredients. Could you tell us how much of that went into the third quarter and how much is left I guess for the rest of the year?

We haven't actually quantified the pieces that went into each of the quarters, Alexia, but as I said, our spending is back half loaded and it will be a combination of Q3, Q4 with more of it skewing to Q4, which is why we're anticipating continued progress on our share growth in Q4.

Thank you. And then just another quick one about the differential between pricing and input costs, obviously very negative this quarter. I'm not sure whether you can quantify that. But going forward, do you see that differential closing in Q4 or are we likely to have to wait until next year for that gap to start to close?

Well, as we said, we're covering only about half of our costs at this point. It's primarily an issue related to dairy and it has a lot to do with the strength of our brand equity and that's why we continue to make the necessary investments. As we look forward to the fourth quarter, I think it's going to look a lot like the third quarter. We should continue to see strong top line momentum and continued pressure on margins. But as we exit this year, as we've discussed, I believe we have programs in place that will allow us to make the kind of gains in our operating margins that we had given in our guidance.

Great. Thank you very much and welcome on board, Tim.

Thank you, Alexia.

Thank you. Your next question is from Terry Bivens with Bear Stearns. Please go ahead.

Good morning, everyone and Happy Halloween.

Good morning, same to you.

Just a couple of things. I know you probably won't get into guidance until the fourth quarter, but Tim, is there any way we get kind of an advanced look at what you're thinking about in terms of the tax rate? That's a pretty big swing factor here. You've given us one for this year, obviously but any comment there, looking into '08?

Yes, well, first of all, as you saw, our rate has progressively come down over the course of the year as we identify opportunities that fall within discrete category within the year. We're now anticipating the 32.5% for full year as opposed to previous guidance of 33.5. Clearly, as we think about the tax rate and as I get more engaged in better understanding where we've been and what the opportunities are, first thing we'll be more thoughtful about how we plan the rate, rather than start out the year with a high rate and then progressively bring it down, we'll be a bit more realistic and thoughtful about what the ultimate opportunities and the full year effective rate will be. And secondly, as I engage in looking at opportunities, I am confident that we will find ways to overall better manage the tax rates, but at this point I'm not prepared to commit to a number.

Okay. And just lastly, on commodities, Kellogg I'm sure you're aware talked about some pretty significant input inflation going into next year, be it energy or food ingredients. What is your preliminary view on where that might go, '08 over '07?

Well, again, we're not going to get into specific guidance on 2008 but certainly commodity costs are putting pressure across many of our categories and our businesses. It is particularly exacerbating the dairy situation, where dairy costs are, they're unprecedented levels and despite fundamental okay markets in the U.S., we're seeing the prices are holding up there more so than we would anticipate. No question, this is going to provide a headwind in 2008 and certainly in the earlier part of the year.

Okay. Thanks.

Thank you. Your next question is from Steven Kron with Goldman Sachs. Please go ahead.

Thanks. Good morning.

Good morning, Steven.

Couple questions. I guess just following up on the marketing initiatives, the 300 million to $400 million. I guess I was a little surprised that the marketing and administration line was a little bit favorable on the year-over-year basis, so clearly the trade-off of some of the cost benefits that you're seeing, whether it be overhead or other initiatives, it's offsetting the incremental spending. Can you maybe talk a little bit about how you expect that line to trend going forward?

Well, again, Steven as we said, our focus is going to be to continue to make the necessary investments in the business and you're seeing that going through. We are continuing to work, though, to offset some of the other input costs. Some of the input cost with continued focus on overheads and so that what you're beginning to see in this quarter is indicative of what we're going to continue to push on going forward. If you remember our fundamental growth formula, it is for pricing and productivity over time to offset input cost and to use volume growth and mix together with a continued focus on overhead cost savings to increase operating margins. So we're seeing some of the early benefit of that. We expect that we'll continue to benefit more from the overhead opportunity in 2008.

We continue to drive opportunities to manage the overhead piece of it. We want to continue to invest in the advertising consumer and as Irene mentioned, we want to continue invest in the advertising, consumer and as Irene mentioned, we want to continue investing in building our brand. Right now, we're not able to offset the commodity increase costs with pricing. But as we build our brands we'll be even better positioned to do that.

Okay. And then I guess secondly, I think this is the first time I think in like four or five years where cost to the consumer on products that are eaten at home, food at home products is out-pacing that of food away from home. I was just wondering, given your size and diversity of product and customer, whether you could just provide some comments. Clearly the cheese category is feeling the price sensitivity. Trade down to private label as you indicated. What about costs to your other categories, your other brands? Are you seeing the price realization a lot more difficult to achieve and maybe you could talk little bit about how you're thinking about pricing in some of those other categories going forward.

I would argue that we're actually seeing better pricing realization as we have come out of the third quarter than we've seen in quite some time and I've been particularly pleased by the fact that our volume and mix have held up in the face of that. As we exit the year, we will continue to see the impact of pricing as it plays through on a number of our categories. But there is no question that we are in somewhat unchartered water on a number of these categories as we reflect the impact of input costs through the P&L.

Thanks.

Thank you. Your next question is from Eric Serotta with Merrill Lynch. Please go ahead.

Good morning.

Good morning, Eric.

Just wanted to circle back on Alexia's question regarding the marketing and other quality investment and investment spending in the third quarter. I guess last quarter, Irene, you made the comment that about 75% of the end market activity would occur in the second half. Could you give us some sort of -- I realize you don't want to get into specifics of dollars spent, but could you give us some sort of feeling as to percentage left to go for the fourth quarter?

No, we're not prepared to provide that number at this time, Eric, but again, I'll tell you that particularly as we look at some of the launches that are pending, our Maxwell House reawakening program, our Planters campaign launch, a number of other programs on both cheese and biscuits, we are looking to see a continued increase in our spending in the fourth quarter.

And Tim, is it fair to say that your accruals for this type of -- for this investment spending is more evenly weighted through the year than the actual end market activity or benefits that you are likely to see?

No, I think we are expensing as we incur the cost.

Eric, as we have discussed on some of these programs, some of it is allocated throughout the year based on volume. But when you have new products come out that are entirely new to the product, you have to -- you incur the cost as you launch.

Sure. But things like the Maxwell House three stage, have the costs from that been accrued throughout the year in anticipation of it or is that an example of something that is -- that you're expensing as incurred?

Eric, I think the important take-away here, and I don't want to get into every individual brand, but the important take-away, is as Irene said, about three-quarters of the spend was going to come in the second half of the year and as we look at the third quarter, we certainly had a significant step-up. We're going to have another significant step-up in the fourth quarter as well.

Okay. Thank you.

Thank you. Your next question is from David Palmer with UBS. Please go ahead.

Great. Thank you very much. Good morning.

Good morning, David.

Just a question about your product improvements and reformulations. I know you were making some changes there. Are those substantial? Is there any way for you to give us a sense of how much of an expense this is, versus the other marketing and pure commodity cost inflation?

It's a little bit hard to quantify. Certainly, it is a piece of the impact on our gross margins. It's probably about a quarter of our $400 million incremental cost. But the end result here is the fact that as I mentioned, we're seeing a considerable step-up in the percent of our products that are rated superior to competition. As we go forward, that will continue to be a key driver of our performance and we're seeing the benefit in select categories like Mac and Cheese, where we have made those kinds of investments, we're seeing the impact of that investment in the marketplace.

So a quarter of the $400 million is really something that's flows through the COGS line.

That's correct.

The wall to wall initiative, I might have missed it in your opening remarks, could you perhaps give us an update there, how you're feeling about the progress, I think by mid-'08 you were expecting to have things largely rolled out?

We continue to feel good about the program. We are learning, continuing to learn about how best to train our sales reps but we expect to be national by mid-2008 and we are on track.

I'll leave it there. Thanks very much.

Thank you. Your next question is from Eric Katzman with Deutsche Bank. Please go ahead.

Good morning.

Good morning, Eric.

A few questions. The first one, the beverage charge of -- the charge within beverages of $120 million, I mean, that seems like a lot. I just don't remember Fruit2O and Veryfine being that big a business. Why is that such a high charge?

It all has to do with the sales price and the value, vis-a-vis, when we bought it. Unlike a lot of our other brands, it was rather new. Wasn't terribly depreciated in terms of the assets as well as the brand value. So that was -- I mean, you can you do the math. That's pretty much the end result.

Okay. And then I guess Irene, you mentioned that this, we're kind of at unprecedented levels, vis-a-vis pricing and potential demand elasticity but you've been there for 20 years or so, there were periods of inflation back in the late '80s, early '90s. What kind of of experience did the Company have at that point vis-a-vis tradedown by the consumer and is that applicable to today?

I think certainly, Eric, some of the past history is applicable and we are seeing in selected categories again, particularly cheese, where the costs are most extreme, we are seeing some tradedown and it comes back to our need to continue to make the necessary investments in brand equity to be able to add enough value to be able to justify our price premium. But having said that, there are a number of factors, despite the fact that as we look at the dairy market, we see some of the traditional metrics all going in the right direction, number of cows, milk production, milk per cow, all of those traditional metrics that we look at that would lead to declining dairy prices at this time of year, we're not seeing that happening. That reflects the fact that there really are some changes happening in the marketplace, as Tim mentioned. So as we move forward here, some of the impacts are somewhat unchartered and we just need to continue to be prepared to address them, which is why we are so focused on continuing to build brand equity, while driving down costs.

Then my last question, thank you for that. My last question, I think you mentioned that you expect EBIT margins to be up in 2008. But can you quantify how much incremental savings you expect from the restructuring efforts, because if you have a continuation of input costs up, and you are also expecting advertising to be up, I assume at a greater percentage than sales, that means that the savings have got to be pretty significant. Can you quantify what dollar amount that should be?

Well, as you might expect, it's a little early for us to give a firm number on 2008. We obviously will do that in our fourth quarter call. But as Tim said, we expect to grow margins in 2008 as we committed in February, despite the input costs and it's really going to come from the fact that we're going to see the benefits of our wave one investments, plus some of the beginning of the wave two investments that we're now making as well as the impact of the accelerated restructuring savings. So that's what will contribute to our operating leverage in 2008.

I'll let it go after this. So the restructuring savings, do they really start ramping up in '08? Is that -- have you -- in terms of incremental, is it much more significant in '08 versus what you got in '07 versus '06?

If you think about it, we're anticipating being at an annualized level of $775 million at the end of 2007. So there will be incremental. We said that the overall savings will exceed $1billion, so there will clearly be incremental year on year. The 775 is a run rate level. So clearly, 2008 we'll see more benefits from restructuring savings.

Okay. Thank you. I'll pass it on.

Thank you. Your next question is from Andrew Lazar with Lehman Brothers. Please go ahead.

Good morning, everyone.

Good morning, Andrew.

In looking at the volume gain that you had, that's certainly a better organic number than we've seen in a couple years maybe, since '05 or so, just trying to get a sense of, with all the new products that you're launching, is there a way to quantify perhaps how much of that was impacted by shipping at a whole bunch of new products that hopefully will start moving off the shelf in the fourth quarter versus just ongoing volume improvements.

I would tell you -- we haven't quantified that, Andrew, but I would tell you this is not about pipeline. This is about take-away and the contribution of some of these core businesses that I mentioned in my earlier remarks to our overall performance. I feel very comfortable that the volume gains that we'er seeing are sustainable and real and in fact will continue to build into 2008.

Then mix has been for a couple years now a really great driver on the top line. It was again in this quarter. Accelerated a little bit from where we've seen, but obviously the comparisons are tough. I know that's something you're expecting to help out again from a contribution standpoint in '08. Does the way you get that mix start to become more difficult, in other words, does it -- now seems like it has to come from a lot of the higher value added new products that you're putting out, versus maybe before where it was one off, SKU reductions, selling less, heavy beverage versus light powder. Things that you shifted by perhaps changing compensation of the sales force, things like that. Does it get harder to do now or is the visibility on the mix part still pretty high in your view.

I think the visibility is still pretty high. I feel good about the progress that we've made. As you rightly say, over the last couple of years we benefited from cleaning out some of the less profitable pipes of the portfolio. We've got most of that behind us, though at this point. And so the mix that we're looking at is about the higher margin that comes from competitively advantaged concepts like Cakesters, like Live Active cheeses, for example, that will allow us to realize higher margins in our snacks business, these 100-calorie packs and our toasted chips have very attractive margins.

The very last thing is just, Tim, I know you said you started to see perhaps some signs of operating leverage in the business, even though we don't see it coming through in totality at given costs and such. Can you just expand on that a little bit? That becomes obviously a lot more critical as we go into '08 and it's tougher for us to see underneath given the impact on margins for cost and investment spending.

Sure. Clearly we're leveraging -- we're providing some leverage from the increased volume. And it's our cost savings initiatives, it's the restructuring program and the benefits associated with that that is helping to contain those costs.

Thanks very much.

You may recall that at the gross margin line, we're down 240 basis points but on the operating line we're down 210 basis points, so that 30 delta as a result of that volume leverage and the savings initiatives.

Thanks.

Thank you. Your next question is from David Driscoll with Citi Investment Research. Please go ahead.

Thank you, good morning everyone.

Good morning, David.

The gross profit margin was down 240 basis points. Can you give us the split between the raw material inflation and the product quality improvements. This is, I kind of think of this as the so-called self inflicted hit. So what's the difference between things that are out of your control versus things that were in your control on that 240?

I don't mean to be cute here, but 100% of those was driven by input costs. Another third of it was attributable to the investments we're making in new products and so forth. And we made up that one-third back from other productivity initiatives. So it's all from input cost.

That's helpful. On the commodity cost side, somebody else was asking about this, but can I just ask you if you would be kind enough to give us what percentage of your commodity costs are hedged for the balance of the year. Other companies are willing to provide that level of hedge for 2008 just to give us the ballpark of what kind of exposure do you have. Will you give us some level of guidance on that?

I'm sorry, we can't give that kind of guidance. We've got -- certainly, we have some of our input cost hedged and that is a dynamic process, as we use it over the course of the year and going into 2008, clearly we're hedging some ahead but that's not a level of specificity we're prepared to talk about.

Irene, one final question. Status on divestitures. There's lots of discussion around Post and Oscar. I think in your prepared comments I wrote this down that you said that you would exit businesses that did not provide a competitive advantage. Can you talk about those two big businesses and whether or not they provide a competitive advantage. How do you think about them?

David, as I laid out the strategies in February, I made it clear that they were not meant to be a Safe Harbor for all of our businesses and we've given each of our businesses the charge in the face of those four strategies to take a look at what the long term growth prospects look like. We've been very clear to say that the three criteria we are looking at in terms of the potential divestiture is growth potential, relative market share, and overall profitability and we will continue to use those as our screens. Certain of our categories are better positioned to be able to -- with this new framework, to be able to make progress and be accretive over the long-term. Obviously, as we have news to announce on that front, we will give it to you.

Okay. Very good. Thank you.

Thank you. Your next question is from Pablo Zuanic with JPMorgan. Please go ahead.

Good morning, everyone.

Good morning.

I'm just trying to understand the cheese strategy, at a recent investor conference you talked about five products that you want to focus on and one of them was cheese. Why would the industry leader, with all these marketing innovation, probiotic cheese want to lag into the price increases. I feel there's opportunity here, even all the innovation and brand support that you are putting through of leaving. That's one question. I have a hard time understanding that, this persistent focus on market share where perhaps profitability would be more important in this environment. You would think private label is being more squeezed. And related to that, when I think of the cheese business, I would assume that given your scale, you have to have some cost advantages over your competitors, so you also should have room there to increase prices in this environment. Can you comment on that, please?

Yes. Well, as we mentioned, Pablo, we've been quite aggressive in our price increases on our cheese business. We've priced over 80% of the portfolio anywhere between 2 and 13%. We continue to have a premium on virtually every form that we make. So it's not about our shyness as the market leader in terms of a willingness to take pricing. Having said that we're also well aware of the fact that we need to make sure that we are justifying the prices that we're charging and we haven't, across the portfolio yet added enough value to be able to be even more aggressive in those price increases. I think we're beginning to see some of the impact in the kinds of items that we have launched, the Live Active cheeses, our single select product, and some of the marketing actions that we've taken on our base businesses. But bottom line, quite frankly, we need some new thinking on our cheese business and we've been making some key leadership changes over the course of these last few months in an effort to help that business realize the potential that I know it has.

Okay. Just to follow-up on that, can you walk us through briefly, in terms of your five North American divisions, in terms of what are the leadership changes, somebody came back from Hershey, you have to look for someone for cheese, just briefly if you can give us some color, please?

Well, basically, we just, as Mary Beth West moved into our CMO role, we have back filled Mary Beth with Bob Levi, who is a beverage veteran, been with the Company over 20 years and has made some significant contributions and he will pick up that business as we move forward. As you say, we -- Chris Baldwin has joined us on our snacks business and I am quite confident that he will help us to access what we believe to be terrific opportunity on the snacks front. Our cheese leadership is open right now. We have been public in terms of looking on the outside. I really do want to get some new thinking on that business and in the meantime, [Nick Maragioli], who has been running our Convenient Meals business, has stepped in to serve as the interim leader there. Cheese is really at this moment the only one of our businesses that is open. Ronda Jordan is still very -- managing our grocery business quite effectively and we're beginning to see good progress as we improve the relevant and the contemporariness of that business.

One last one, if I may. Again, going back to Back to School conference, you talked about those five products that you want to focus on and then you also mentioned I believe nuts, salad dressings, and other product there, and Convenience Meals, Oscar Meyer meat. That was about 70% of sales. How should we think about 30%. The experience we have at companies is that when there's not enough investment on those other products they begin to fall off a cliff in terms of sales. Should we think that that other 30% will eventually be sold? How do we thing about that, Irene?

The way you should think about that, Pablo, is that we are sequencing our investments. As I said at Back to School, we have chosen to focus on the categories that matter most and the five categories that I laid out there were about 50% of our revenue. As we continued to make improvements in pourables, for example, that will further add to our overall investment. But the reality is, we can sequence these investments and start to get the impact while we then make the next range met phase of investment. So with investments in these five core categories, we have seen a significant step-up in our revenue growth, our organic revenue as we said is up over 6% in this quarter. And so I am confident that by focusing our investments on the areas that can have the greatest leverage, we will be able to make progress but we will eventually get to all of the businesses in the portfolio that need support.

One last one. I understand that by November 14, if you want to make changes to the Board of Directors, that has to be proposed before November 14. Is that true and do you plan to make any -- are there plans for new Directors to be proposed?

It is true that November 14, is the filing date. We continue to look at the opportunity to add Directors, qualified Directors to our Board and that will be an ongoing process independent of the November date.

All right. Thank you.

Thank you. Your next question is from Kenneth Zaslow with BMO Capital Markets. Please go ahead.

Good morning, everyone. Just had some follow-up questions from the previous questions. Commodities for the quarter, I think you said were up 9%. What is your expectation for the full year? I don't know if you said that.

Nine is the number for the full year, Ken.

And then in terms of, on the cheese side, can you discuss Kraft's Premium relative to private label and is there -- is the Premium relative to private label one of the reasons that you're having a more challenging time pricing through?

No, we've been very diligent in managing our price gaps and I feel very comfortable that we're in a much stronger position with respect to our gaps than we have been historically and we are not going to allow ourselves to get out of the proper range, which is why we need to continue to ensure that we've added enough value to the portfolio and that is the focus of the investments that we're making.

You said something very interesting, you said you're looking for new thinking on the cheese. What are you looking for in terms of the thinking? Are you talking about new product innovation? Are you talking about how to execute? What is the -- what would you be looking for in that division when you're looking for a person to head that out -- head that up?

I think it's the opportunity to approach the category from a consumer perspective as I laid out in February. I continue to feel very strongly that cheese is a growth opportunity for Kraft. As we look around the world, consumers are eating cheese. It's growing at a very healthy rate. And our opportunity is to ensure that our offerings within the category are preferred and I think the key to that is to take a more consumer centric approach to the category and both through our marketing efforts as well as our new product innovation.

And my last question is you didn't discuss at all cereal or the -- at all in the discussion, in the discussion. Is there something we should interpret from that? Is there something wrong with the business? Is there -- was it just an oversight? How do we look at that? There was no commentary on the cereal business?

It just wasn't -- you should interpret nothing. It simply was not a significant contributor to the overall results of our snacks segment and that's why we didn't mention it.

Okay. Great. Thank you.

Thank you. Your next question is from [Vincent Andrews] with Morgan Stanley, please go ahead.

I had to step off the call for a moment so if this has already been asked, please let me know. Irene, I'm just wondering if you could give your view of what businesses are operating at an acceptable level of performance right now?

A number of our businesses, frankly, on the top line are performing at an acceptable level. As we look across the portfolio I'm quite pleased by the performance of most of our categories, both in North America and around the world. As we mentioned we have seen accelerated revenue growth in all geographies. So I feel very good about that. I would say within North America, our Convenient Meals business was up 8% and if you look at under the covers and look at the contributors to that growth, it's about quality, it's about marketing investment, it's about new product innovation and that is the formula for our future. So I believe that is our model and as we move through the various parts of the portfolio, that is the formula that we're looking for.

And would you still stand by the idea that in 2009 you're going to hit your stride and you'll fully realize the financial benefits of your investments and you'll deliver your long term targets?

Absolutely.

Thank you very much.

Your next question is from Jonathan Feeney with Wachovia. Please go ahead.

Good morning and thank you.

Good morning, Jonathan.

I guess I'm sorry to beat a dead horse here, but private label tradedown, what is it about the cheese category that it seems like you held the line maybe a little bit more there, if anything absorbed a little more of those commodity costs, yet it seems like that's the only really place you've called out where you are losing to private label. Is that a fair characterization? What is it specifically about this category that made it such that private label won't raise prices?

Well, without a doubt, of all the categories in which we compete, private label is a bigger factor in cheese than it is in our other categories. So you start there. The reality is that to the extent that some of our offerings within the category are not well-differentiated. It puts pressure on our ability to price at a very significant premium. We're still at considerable premiums within each of our forms today but the issue will be can we command an even higher premium. I come back to the fact that products like Live Active have about a 13% margin advantage to our base product. And it's the opportunity to leverage some proprietary technology that goes into the making of that product, together with our marketing opportunities, that then allow us to be able to command higher prices going forward.

But the reality is absolute price points do matter as well. So part of the challenge in cheese is that the entire category is down as the consumer absorbs some of the extraordinary impact of these input costs.

We have an unusual situation also with regard to dairy prices, whereas typically at this time of the year, we would have seen them started to come off the seasonal peak and in fact they've held up much more than we would ever have experienced in the past. Usually with the spike in the season, we don't typically, the industry typically doesn't price to that peak. As we're seeing it behave a bit differently, we're going to have to kind of rethink that.

Thanks for that. And just, I guess maybe to ask the converse implication of the squeezed, cash-strapped consumer. If we go back to the late '80s, early 90s, last really consumer recession, are there any parts of your portfolio you would expect to receive some of those consumers who maybe are eating out a little bit less? And are you seeing any of that kind of lift today do you feel like?

Actually, I think one of the benefits of the breadth of our portfolio is that we expect that that can benefit virtually all of our products. As we continue to think about a consumer centric approach to them and what we need to do to help to make them more relevant to today's consumer. Virtually every one of our segments can benefit from that move from away from home to at home consumption.

Thank you very much.

Thank you. Your next question is from Robert Moskow with Credit Suisse. Please go ahead.

Thank you. My question has to do with the guidance for '07. If I look at the implication for fourth quarter, maybe it is just my model, but it looks like it's something like a 12 to 13% EBIT decline and you've been tracking around a 5% EBIT decline for the year. Am I looking at that correctly, Tim?

I know we've given our full year guidance and I'll let you kind of sort out the analysis in between it.

But is there anything about fourth quarter that's exceptionally worse than the first three quarters of the year?

I'd say fourth quarter, you see what's happening coming out of the third quarter, I would expect it probably to look a lot like the third quarter. We continue to expect to have top line momentum. As we've talked about with the input cost, we continue to expect pressure there.

Okay. And then secondly, for 2008, the Danone acquisition is hanging out there. You've said to expect I think it was about $0.01. Commodity costs are a lot higher than they were when you first negotiated the deal. Is there anything -- do you have any visibility as to whether margins in that business have held up and when do you think you'll be able to update us on your guidance for how accretive or dilutive that business could be?

We'll update you as part of our 2008 guidance but we are on track for our year-end closing. They continue to report strong performance on their biscuit business. As you know, their Q3 growth was almost 7%. So it's a healthy business. Clearly the impact of grains will have some impact. But there are some very strong productivity programs in place and I'm pretty confident that we will be able to continue to benefit from the accretion that we have laid out for you.

To help us think about that a little bit more, is there anything you can tell us about your snacks business in Europe in the quarter and how much of a commodity hit it took and maybe we could extrapolate that into the Danone business?

I think the better indication is what happened to our snack business domestically. Without a doubt it did take a hit in margin. As we mentioned though, we are looking at a variety of actions, including pricing, trade spending, and productivity to help to manage that going forward and I'm confident that we will be able to do that.

Lastly, has the transition to wall to wall in the U.S., has that at all compromised your ability to get baked goods distribution like you had been in the crackers business or do you think that it's more a function of the marketing program that's causing the weakness in crackers?

I feel very confident that it is about the marketing programs. One of the key metrics that we look at as we are rolling out wall to wall is the performance of our base biscuit program versus the performance of the warehouse products. And we've continued to see strong incremental growth in the wall to wall markets, and as we look at the base businesses, I'm confident that this has not had an impact on -- adverse impact on the biscuit business. That's one of our most important criteria as we roll this thing out.

Thank you very much.

We'll take the last question.

Thank you. Your final question is from Edgar Roesch with Banc of America Securities.

Good morning.

Good morning, Edgar.

Irene, when you talked about '08 costs being up, is that just a continuation of what we're seeing on the ag side, the agricultural side or is the increase in -- this is kind of a specific question, but has the increase in energy started to factor into your outlook as well and maybe spill into packaging?

Yes. When we talked about input costs it's not just the raw material input cost. It's the knock on effect on resins and packaging costs as a consequence of the high energy prices. So it's an aggregate assessment.

Okay. Thank you. And then could you just give me or give us the changes to the Tassimo program, what kind of benefit that provided the beverage segment?

Well, as you are aware, one of the most significant changes we made this year was to focus our Tassimo marketing efforts to a more targeted audience and to look at more targeted marketing approaches to that audience and so we are seeing the benefits of that. Our Tassimo business is up almost 70% and at a considerably lower cost than we had year -- than we had a year ago.

One last kind of bigger picture question. '07 is clearly a year of investment. I would just like to know if you expect to exit the year with a lot of that heavy lifting done and the reinvestment is largely behind you or whether there is further investment in next -- into 2008 as well.

Well, as we said when we laid out the plan in February, this is a three-year plan. Our target in terms of our overall A&C investment is to get to us the competitive levels of 8 to 9% over time and we are committed to making progress against that objective and so as we exit 2007, we will have made progress. We will make continued progress in 2008. And we are looking to then drive our other aspects of the P&L, particularly overhead cost, as our means, together with volume growth, and mix improvement to drive our overall operating margins. So you will see continued investment in the business in 2008 but we are committed to making margin improvement as we said.

Very good. Thank you.

Thank you. I would now like to turn the floor over to Mr. Chris Jakubik for any further or closing remarks.

Thanks everybody for joining us this morning. If any of the analysts have further follow-up questions we'll be around all day. Thanks very much.

Thank you. This does conclude today's Kraft Foods conference call. You may now disconnect.