億滋國際 (MDLZ) 2007 Q4 法說會逐字稿

Good morning and welcome to the Kraft Foods fourth quarter 2007 and year-end 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.

Good morning and 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 Web site, kraft.com. Also available on our Web site are slides that we will refer to during our prepared comments.

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 uncertainties, so please refer to the cautionary statement 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 Web site.

Today's agenda is as follows: We'll begin the call with Irene providing her perspective on our 2007 results and the outlook for 2008, then Tim will highlight our financials then review the results for each of our business segments. After that, we'll take your questions.

With that, I'll hand it off to Irene.

Thanks, Chris, and good morning, everyone.

Turn to Slide 4. As you saw in our press release, 2007 represented a solid start to our three-year plan and more importantly, established good momentum for 2008. Our organic revenue growth of 6% in Q4 and 5% for the full-year was even better than we had expected and it was quality growth.

We had solid gains from product mix throughout the year and volume growth improved as the year progressed. That reflects the payback from the investments with we made in the course of the year. Where we have improved quality, invested in base brand support and/or innovated, we've seen good results and so I remain confident that our plan will return Kraft to reliable growth.

Turning to Slide 5. We continue to see this model at work in the wave one investment areas I discussed in September. In our mac and cheese business, we invested in quality upgrades to our base products and rolled out Easy Mac Cups.

The result, we posted double-digit organic growth and gained a half point of market share in 2007. This followed three years of essentially no growth and more than point of share loss.

Our pizza business finished the year absolutely on fire. It posted double-digit volume growth and gained over 4 market share points in the fourth quarter.

And our back to basics approach in the EU focused on our two iconic brands, Jacobs coffee and Milka chocolate, delivered a fourth consecutive quarter of solid organic revenue growth. For a business that had been flat to down for the past four years, the 3.5% organic growth in 2007 is no small feat.

I'm also encouraged by the early results in three core categories where our programming hit late last year. Coffee where we're adding to our success in the premium segment by beginning to stem our long-standing decline in mainstream coffee. The reason, our recent relaunch of Maxwell House with quality upgrades in product and packaging.

In biscuits where our market share performance improved in the fourth quarter from several new product platforms and in cheese, where despite record high dairy costs in the second half of 2007, we increased our marketing more than 50% in processed slices and introduced Singles Select. That helped to reverse our share declines on processed cheese from the first half of the year.

We also delivered double-digit growth and market share gains in snacking cheese and our new LiveActive cheeses are proving to be highly incremental both to Kraft and to the category. There's still much more to be done in cheese but I feel we're off to a good start.

Turning to Slide 6. More broadly across North America as our investments hit the market our market share trends have begun to improve. On a trailing 52-week basis, we finished the year with businesses representing 47% of our revenue, gaining or holding share, not yet where we want to be but that's up from only 38% three months earlier.

And in the fourth quarter, we gained or held share in businesses representing 50% of our revenue. Over the course of 2008 we'll continue to improve on that trend. We are finally on our way to our longer-term goal of growing share in at least two-thirds of our revenue base.

Turning to Slide 7. Also in 2007, we put strong new leadership in place. Four of the nine members of my executive team are new to the Company or to their jobs and we've replaced half of our key business leaders around the world.

We changed our incentive systems to more directly tie executive rewards to shareholder value creation and we're now executing a reorganization to give more accountability to our business leaders while significantly reducing overhead costs.

We've also strengthened our portfolio. We're exiting businesses that don't fit our long-term growth plan like Fruit 2.0 and Post cereals. And we're enhancing our future growth prospects, profitability and international footprint with the acquisition of the Danone biscuit business.

Finally, I'm pleased to say we delivered at the high end of our increased EPS guidance. Yes, we did benefit from a lower tax rate but this was on top of better top line momentum from our investments in brand equity. At the same time, higher than expected input costs negatively impacted our margins and put pressure on the bottom line and so in response, we took more aggressive actions to reduce our overhead costs.

Turning to Slide 8. As you saw in our press release this morning, in 2008 we'll spend less and save more on our restructuring program than originally anticipated.

We now expect $200 million more in savings and our cost to deliver those savings will be $200 million less. Our spending on the program will end in 2008, but incremental savings will continue beyond that.

Clearly, we made significant progress on many fronts in 2007. Turning to Slide 9. However, not everything went our way. The biggest surprise was the unprecedented high dairy costs and the fact that they remained at these high levels through year-end.

As you can see from this chart, the 2007 price curve broke significantly from historical normals. As a matter of practice given historical cyclicality, we typically price to the expected average, not the peak dairy costs, in any given year. As a result, when cheese costs stayed high late into the year, our pricing actions did not keep pace with costs, therefore, we're taking additional pricing actions now.

We do expect some moderation in average cheese costs later this year. Nevertheless, as you can see, we're likely to face difficult cost comparisons through the first half of the year, which brings me to our 2008 guidance.

Please turn to Slide 10. Since this is the second year of a three-year plan, let me start with the expectations I laid out last February at CAGNY. At that time, I said in 2008 our operational turnaround will continue to gain momentum as we get growing again on both the top and bottom lines, our top line will grow 3 to 4% organically and operating income growth will exceed revenue growth.

I said we'd continue to invest a portion of our growth back into the business as we launch the next wave of trajectory changing initiatives, and we'd further accelerate our advertising and consumer spending toward our long-term target of 8 to 9% of net revenue.

I also said that by 2009 we'd hit our stride. We'd fully realized the financial benefits of our investments and deliver our long-term targets of at least 4% organic net revenue growth and 7 to 9% EPS growth.

So, how do I feel about those statements today? Turn to Slide 11. I stand firmly behind them. I feel good about our momentum and I'm even more bullish as we enter year two of our three-year plan.

Looking at the numbers, our top line will grow faster than we had expected, at least 4% organically. And remember, that's before the addition of approximately $2.8 billion in revenue from the Danone biscuit acquisition.

In 2007, although pricing was higher than in the past, it represented less than one-third of our organic revenue growth. In 2008 it's likely that pricing will be a much more significant factor as we offset higher input costs. The investments we've made and will continue to make are strengthening our brand equity and enabling improved pricing power.

As a result, we are far better able to recover input cost increases through pricing and productivity, however, we do expect that near-term category volumes will be negatively impacted as consumers adjust to new price levels. Through it all, I remain confident that our continued investments in marketing and innovation will drive further share gains across more of our portfolio, despite our pricing actions.

Now let's look at operating income. While Danone will have a modest dampening effect on margins in its first year, we expect that operating income ex items will grow faster than revenue in 2008.

We also expect that Q4 2007 represented the low point in our margins and they will progressively improve as 2008 unfolds. We will continue to invest in the next wave of trajectory changing initiatives and we'll further accelerate our advertising and consumer spending toward our long-term target of 8 to 9% of revenue.

Turning to earnings per share. Ex items our EPS guidance is at least $1.90. This reflects a 3 point headwind to earnings growth from the increase in our effective tax rate from 31.2% in 2007 to 33.5% in 2008 as we become a fully independent tax filer. If we were to normalize for taxes, our EPS guidance would represent an increase of almost 8% year-over-year.

Turning to Slide 12. To summarize, we've had a solid start to our plan to restore Kraft to reliable growth.

We continue to invest in our growth initiatives. They're paying dividends and at the same time they're strengthening our brand equity and pricing power in the face of unprecedented input costs.

We're successfully reducing costs and overheads to provide additional funding for investment and our strategic actions are strengthening our portfolio and future growth prospects. I remain confident that by 2009 we'll be well positioned to reliably deliver our long-term targets of at least 4% organic net revenue growth and 7 to 9% EPS growth.

And now I'll turn the call over to Tim.

Thanks, Irene, and good morning.

Please turn to Slide 13. I'll begin my comments by providing some perspective on our financials, both for 2007 and how we see 2008 unfolding. 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.

(Missing audio) 2% for the second consecutive quarter. That's up from 3.9% organic growth in the first half of the year. Volume and mix accounted for about two-thirds of Q4 growth as our wave one investments in quality, innovation and marketing hit the market.

Net pricing was up 2 percentage points versus 1% in the first six months of the year, as we begin to see the realization of price increases taken during the year. Overall, we had steady improvement and established a solid momentum on the top line in 2007.

As Irene mentioned, in 2008 we expect pricing to make a greater contribution to top line growth as a result of improved price realization. At the same time, our first quarter and first half volume comparisons will be difficult as we implement the significant pricing necessary to offset cost inflation.

Nonetheless, during this time of unprecedented price increases, we expect to build market share over the course of the year, which is a testament to the improving strength of our brands.

Please turn to Slide 15. And turning to operating income, our Q4 results were significantly impacted by input costs, particularly dairy.

Although our price realization improved in Q4, our gross margin was down 410 basis points versus Q4 last year. This was primarily due to higher dairy costs. Our pricing and productivity gains were simply overwhelmed by higher input costs and by our investments in product quality.

For the year, our input costs were up about $1.3 billion over 2006. At the same time, our cost reduction programs drove a reduction in overhead costs as a percentage of sales.

This enabled us to fund a double-digit increase in marketing and as a result operating income margin was down less than gross margin. Looking forward, we anticipate that margins will get progressively better as the year unfolds from the low point in the fourth quarter of 2007.

We will continue to spend on our growth investments. We spent $375 million in 2007 and we'll spend incrementally on top of that base in 2008. As a result of our planned investments, together with the addition of the Danone biscuit business, we expect A&C as a percent of net revenue to be in the mid 7% range in 2008.

That said, first half margins and earnings comparison with the prior year will be difficult. Difficult for two reasons. First is the fact that the full effect of our price increases will lag higher input costs at the beginning of the year, and second is our expectation that input cost comparisons should ease as the year progresses.

I think it's instructive if we turn to Slide 16, I think it's instructive to take a minute to take a look at the magnitude of input cost increases we face coming into 2008. This chart shows commodity prices in each year versus the 10-year average price for each of our 11 largest commodity inputs.

With the exception of almonds and lean hogs, we're starting the year at record cost levels and in the cases of cocoa, wheat and soybean oil, we're starting 2008 at significantly higher levels than the average 2007 costs. Because of this, we have taken and are taking pricing actions as well as focusing on overhead costs to ensure the expansion of operating margins in 2008.

Now, if you'll turn to Slide 17. Turning to earnings per share, we've discussed operating results already so let's look at what happened below the line.

In the fourth quarter, higher interest expense costs us roughly $0.04 of earnings versus the prior year. This is partially offset by $0.02 from lower shares outstanding.

We invested another $500 million in our stock repurchase plan during the quarter and in the first nine months since the spin-off we repurchased $3.5 billion, or 6.5% of our shares outstanding at an average price of $33.13 per share.

Looking forward we expect interest expense to be between 1.2 and $1.3 billion in 2008. This is primarily the result of higher debt levels related to our acquisition of Danone biscuit business and activity under our share repurchase program. And finally, as Irene mentioned, our effective tax rate excluding items will increase from 31.2% in 2007 to 33.5% in 2008.

I'll take a few minutes now to share some highlights of our business segment results. If you turn to Slide 18. We'll start with North American Beverages where organic net revenues grew 6.7%.

Volume and mix were up strongly from new Better for You offerings in powdered and ready to drink beverages. In fact, Crystal Light was functional benefits extended the success of our stick platform. It drove double-digit powdered beverage growth in the quarter.

In coffee we saw continued strong growth in premium coffee from both Starbucks and Tassimo. I'd also note here that since the November introduction Starbucks T-discs for our Tassimo machine are the most successful T-disc launch ever with three times historical customer demand.

In mainstream coffee, Maxwell House trends are improving. As Irene mentioned earlier, we've had an excellent consumer reaction to both the preferred plastic packaging and the new 100% Arabica blend. While it will take time to reverse years of decline, we expect to see further improvement in the months ahead.

At the profit line, beverages' operating income doubled and margin increased 480 basis points. This upside was delivered by the strong growth of higher margin powdered beverages and premium coffee as well as our more targeted marketing strategy for Tassimo.

Please turn to Slide 19. In North America Cheese and Foodservice results were significantly impacted by persistently high barrel cheese prices. Organic net revenues were up 8.4% almost entirely due to price increases in response to higher dairy costs.

While there was some volume growth in the quarter this was primarily due to buying ahead of our price increases and this will adversely affect Q1 volumes. It's important to note, however, that where we have invested, we're seeing results. For instance, our efforts to revitalize processed cheese slices with better marketing and the introduction of Single Select helped to reverse our share declines in that segment.

We delivered double-digit revenue grow and share gains in snacking cheeses in the quarter and our sales of LiveActive cottage cheese are proving to be over 80% incremental to Kraft and about 35% incremental to the category. It's not enough but it's a start to what will be a big focus area for us in 2008.

Turning to operating income margin, it fell 9.9 percentage points as dairy costs rose over 40%, well above our pricing. Despite that, we continue to fund our growth initiatives to stage this critical business for the future. Our 2008 outlook calls for significant margin improvement from our Q4 performance as we recover higher input costs through pricing.

We'll also continue to bring more innovation to market and make further investments in building our brand equity for the long-term. As a result, we expect to show successive improvement in operating margins and share from Q4 levels as the year unfolds.

Now if you turn to Slide 20. Moving on to North American Convenient Meals. The investments we've been making in quality, base marketing support and new products drove 6.8% organic revenue growth, almost entirely due to volume and mix gains and our market share is up in categories representing 90% of the segment revenues.

This growth was driven by such investments as Ultimate Pizza, mac and cheese, Deli Creation sandwiches and deli fresh meats. The benefits of volume leverage, favorable product mix and cost savings led to a 100 basis point increase in operating income margin and that was despite higher input costs.

The success we've seen here in 2007 has provided solid momentum going into 2008 including further benefits from volume growth and favorable mix as well as price increases taken in December to cover higher input costs.

Now turn to Slide 21 and on to North American Grocery where organic net revenues were down 3.5%. Our investments to contemporized Jell-O are driving solid revenue and market share growth in desserts, however, this was offset by continuing weakness in salad dressings.

As we've mentioned before, reversing many years of decline in our pourable salad dressings business is a priority for the grocery management team in 2008. We've upgraded the quality of the packaging and product and by the end of the first quarter will be fully national with incremental marketing support.

Some of the costs associated with these upgrades impacted our Q4 grocery margins and together with our inability to aggressively price into the weak brand equity, our margin was down 3.7 percentage points for the quarter. Going forward, while grocery margins in Q1 will be under pressure from the stepped up level of investment in pourable salad dressings, we expect margin trends to progressively improve over the course of the year.

Now to Slide 22. Looking at North American Snacks & Cereals. Organic net revenues were up 4.7% in Q4 behind strong gains from new product platforms. 100 Calorie Packs were up strong double-digit again in the quarter and ended the year with $230 million in revenue.

Cakesters, after only a half year, has captured over 5% of the billion dollar snack cake market and is on its way to becoming a $100 million product. Our bars business was again up double-digits and Garden Harvest chips helped further fuel the growth of our toasted chip platform.

Marketing investments during the quarter led to improved performance in crackers and snack nuts and we expect to see continued strength in 2008. And finally, solid, ready to eat cereal growth was driven by Honey Bunches of Oats and a continued recovery in our kid's cereal business.

Operating income margins were up 50 basis points. Solid volume growth and productivity offset higher input costs and spending behind our growth initiatives. Going forward, we'll continue to invest in the growth of this business with more innovation and base brand support.

And despite rising grain costs, these investments will enable improved net price realization and lead to market share gains. Finally, the divestiture of our Post cereal business continues to be on track for a mid-2008 closing.

If you turn to Slide 23 and I'll turn to our international business. It continued to post solid organic growth as we focused our investments on our core brands.

In the EU this resulted in a 4.4% organic revenue growth and a fourth consecutive quarter of solid volume and mix gains. Growth from Milka chocolates, Jacobs and Tassimo coffee and Philadelphia cheese were partially offset by continued declines in local categories.

The EU operating income margins declined 170 points. The reason, top line momentum and productivity were insufficient to recover higher input costs, primarily dairy and cocoa.

With dairy and cocoa costs now on the rise in Europe, input cost pressure is expected to worsen in the near-term. In response, we're increasing prices across almost half of portfolio in Q1. As a result we expect to see difficult near-term year-over-year volume and margin comparisons.

At the same time, the integration of the Danone biscuit business is on schedule. It will enhance both our growth prospects and our margin in the EU over the course of 2008 and well into the future.

Now on to Slide 24. Finally, let's look at developing markets. Here again, our focus on core categories and brands delivered another quarter of double-digit organic net revenue growth. Q4 growth was driven by Jacobs coffee and Milka chocolates in our EMEA region and Oreo and Tang in both Latin America and Asia-Pacific.

At the operating income line margin was down 4.5 percentage points. This resulted from a combination of investments in marketing and distribution infrastructure and higher input costs ahead of pricing. Looking forward, Q1 will see soft volumes and a lower profit margins versus a year ago.

This is because of significant price increases related to input costs and a one-time volume reduction in 2008 due a shift to local sourcing with the opening of a new cheese and powdered soft drink plant in Bahrain. However, we expect both these actions together with the integration of the Danone biscuit business to improve our developing market results as the year unfolds.

If you turn to Slide 25. Just a few notes on cash flow before we go to questions. Our full-year discretionary cash flow was $2.3 billion, down approximately $200 million from 2006. The entire decrease was due to the decline in operating income with some offsetting changes on the balance sheet.

Capital expenditures were flat versus 2006, at $1.2 billion. But I would note that we continue to aggressively manage our working capital.

After adjusting for the Danone biscuit acquisition we reduced our cash conversion cycle by four days from 51 days last year to 47 days this year. We had solid improvement in inventory and payables but we see further opportunities going forward.

So to summarize on Page 26, I would echo Irene's earlier comments. We've had a solid start to our three-year plan to return Kraft to reliable growth. We remain confident that our investments and cost reductions will maintain our operating momentum and deliver at least $1.90 of EPS ex items in 2008.

Our strategic actions are strengthening our portfolio and future growth prospects. And by 2009 we'll be well positioned to reliably deliver our long-term targets of at least 4% organic net revenue growth and 7 to 9% EPS growth.

That's it for our prepared comments. Now we'd be happy to take your questions.

Thank you. We will now conduct the question-and-answer portion of the conference. (OPERATOR INSTRUCTIONS) Our first question is from Eric Katzman with Deutsche Bank.

Hi, everybody.

Good morning, Eric.

I'll keep it to one question.

I guess, it sounds like you're anticipating in 2008 some moderation in input costs, particularly in the second half, and I guess I'm wondering, one, kind of how prudent is that in this type of volatile market, or is that really a function of dairy with the other inputs kind of still expected to be up?

Well, Eric, I think as Tim said, we certainly expect to see input costs up at about the same rate as we saw in 2007. The reality, though, it'll be a mirror image of what we saw in 2007, so the moderation comes from the fact that we'll be lapping the spike year ago but we do expect to see input costs up at about the same rate. The good news, though, is that our brands are strengthening and we're able to recover those input costs as a result.

Okay. Thank you.

Thank you. Your next question is from Todd Duvick with Banc of America.

Good morning.

Good morning, Todd.

Good morning, Todd.

I had a couple of questions for you and, Tim, I guess this probably falls in your camp.

Jim [Dalla] had previously indicated it was important for Kraft to maintain its Tier 2 commercial paper rating and I was wanting to know if you can tell us if your CP rating continues to be a guidepost in your financial policy?

(Inaudible) talked a little bit more broadly about capital structure and as we see it today.

As you know, when we first became independent we were under utilizing our balance sheet. Over the course of this past year, we've repurchased about $3.5 billion of stock and borrowed $7 billion to buy Danone biscuit. Today I would say the leverage on our balance sheet is pretty appropriate.

I think the leverage metrics are currently in pretty good position which supports our BBB credit profile. I do believe that Kraft is well served to maintain investment grade and I think access to CP markets provides operating flexibility that is a value to us.

Our focus, there may be some mix changes in our leverage structure, maybe we switch some between fixed and floating, maybe it moved the maturity schedules and put in the right currencies and so forth, but overall the levels are pretty appropriate for us. Our focus now is expanding our capacity by improving our cash flows.

Okay. Very good. And just one follow-up question on that.

You've already termed out a portion of the debt related to the Danone acquisition. Can you tell us anything about the timing and the markets that you're considering to term out the remainder?

Yes, Todd, I mean, we did go to market for about half of it late last year and we still have the other half of it to go but I can't talk specifically about when and where.

Okay. Very good. Thank you.

Thank you. Your next question is from Tim Ramey with D.A. Davidson.

Good morning.

I'm just continue to wonder about the baseline level of earnings. You always talk about comparability but, really, you know, the best level of comparability is the GAAP earnings and others in the sector have gone to looking at GAAP.

These charges have been with us since you came public. Why do we continue to think that they are non-recurring?

Tim, as you know, we laid out a restructuring plan in 2004 that we then updated in 2006. We are finishing up that restructuring plan and we expect to end that as we exist 2008. Our plans then as we go forward and we hit our stride in 2009 will be to report on a GAAP basis and we've made that commitment and we're underscoring it again today.

It isn't to suggest that we will stop restructuring and spend in further improving our cost structure and improving our brand but just that it will be, as you suggested, reported through GAAP earnings without identifying ex items.

Terrific.

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

Just wanted to follow-up on the dairy side. So you've indicated that, I think, that the front half will be the tough part on dairy comparisons but, Irene, I'd really like you to talk to us a little bit more on the strategy on how you repair the cheese margins and why the price increases haven't come at a much faster rate and been much more significant. A 53.8% decline in operating profits is just an absolutely astounding number and I would think that a commodotized category, or one that has much more of a commodity feel to it, would be much more receptive to prices that were predicated on the underlying commodity.

Also in your answer could you just overlay this with the mix improvements from some of the new products that you've launched within that particular business?

First of all, David, I think the issue of recovering the input costs has everything to do with our brand equity and our pricing power. So although we actually took some very significant actions on our cheese business, our pricing realization was not as strong as we'd like it to be because we don't yet have suitable brand equity.

As I mentioned, we're starting to see some encouragement on our singles business as we have made some investments in base marketing as well as in new products like Singles Select. But the key to our future in cheese, as it is in so many of our businesses, is continuing to ensure that we have invested appropriately in quality, in marketing support and in innovation, to be able to realize those price opportunities.

Having said that, I think if you look at our results for 2007, you can see that there's already more pricing power. We already have more pricing power across the portfolio than we've had in quite some time and our plan in 2008 is to be able to recover more of those costs.

But it has everything to do with our ability to build our brand equities and to build our innovation pipeline and we still have some work to do on cheese but I think we are at least -- we've made a good start.

So you would say the key here is watching market shares and that would be the linchpin before you would want to go much more aggressively on price to prevent margin declines like we saw in the quarter? Is that a fair statement?

I would say, let me just talk a little bit about 2007 fourth quarter and what happened with raw cheese prices. Traditionally, we see a spike before the holidays in barrel cheese prices and we tend to price to an average and don't hit the peak.

In 2007, which was very uncharacteristic, barrel cheese prices stayed up at that peak level for a prolonged period. They've started to come down now but they stayed up at that level. We didn't price to the peak, we priced to what we expected to be an average and we kind of got caught.

By the time we realized that, it was too late to price as we had already put in place our holiday promotions and so forth. So as we go forward we're going to revisit our pricing paradigm and look at being more precise to raw material input costs as opposed to kind of anticipating what historical patterns have been. So we will more closely price with the barrel cheese prices.

That's helpful. Thanks for the color.

Thank you. Your next question is from Jonathan Feeney with Wachovia Securities.

Good morning. Thank you.

Good morning, Jonathan.

I guess also in that vein, I guess, Irene, you said you didn't get the realization, I guess, because you took some pricing in cheese and foodservice but didn't -- could you talk about the mechanics of that? I mean, what would be, I guess, let me ask it this way. What would be the downside to taking more aggressive, much more aggressive price increases and perhaps not protecting some of your holiday promotions and, you know, suffering the volume penalty?

And in answering that, if be you wouldn't mind commenting, I don't know, Tim, if you'd rather do that, about private label price gaps. Because it's clear to me in this category and a lot of others that some of these store brand and, say, deli cheese manufacturers, are much more under the gun than you are to take pricing. And so, I guess, if you maintain those price gaps I would think that you would be looking at a much softer sort of landing here in terms of operating profit.

Jonathan, I think Tim's comment helps to understand the impact on the fourth quarter, which was simply that the curve stayed up and we were priced to a lower level. And we did not react fast enough because historically we would have expected that curve to come down in the back half of the year.

Going forward we will be pricing much more aggressively and we will in some cases be sacrificing, at least in the early months, as the consumers adjust to new higher price points, we will sacrifice some volume. We believe, though, that it will be an industry phenomenon and we will be able to continue to grow share in the face of those pricing actions.

And I'm sorry, Irene, are private label price gaps about where you want them right now? Are they wide? Are they narrow?

They're about where we'd like them to be. And, again, this is an industry phenomenon and we expect that all of the players in the industry are dealing with the same challenges on input costs.

Thank you.

Thank you. Your next question is from Alexia Howard with Sanford Bernstein.

Good morning, Alexia.

Can I ask about marketing spending and where things stand at the moment? There was obviously the big step up in overall investment in the business in 2007 and I understand that a lot of that was focused on the fourth quarter.

Can you tell us how much that step-up was in the fourth quarter? And perhaps more importantly, for the whole of 2007, did the consumer marketing as a percent of sales hit that sort of 7, maybe slightly higher than 7% level and where do you anticipate it being during the course of 2008?

As you'll see on the year, our aggregate spending hit about 6.9%. So we're making some good progress as we exited 2007 and made the necessary investments in our wave one initiatives.

As I mentioned in 2008, we are going to continue to make progress toward our longer-term target of 8 to 9% revenue and we expect that the aggregate spending including Danone will be in the mid 7% range.

Okay. Thank you very much.

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

This is actually Andy Keller with (inaudible) Consulting.

A couple of things, Irene. As we head into a very challenging environment in the (inaudible) arena, what are going to be your operating improvement initiatives regarding lean manufacturing, TPN, Six Sigma and what metrics are you using to measure your benefits?

Eric, we've got a whole host of manufacturing objectives and initiatives. Clearly, to the extent that we are expecting to see continued record high input costs, and we are expecting that our pricing and productivity together will offset those, we have a whole host of productivity initiatives designed to improve our performance. So I don't want to talk about any specific ones today but I assure you that productivity is a critical piece of our program in 2008 as it has been historically.

What metrics are you guys using to measure manufacturing process? Are you looking at OE, RONA, what's the (inaudible)?

We look at ROA, we look at OE, we look at a whole variety of other metrics but the end in mind is to lower our cost per pound on a conversion basis year-over-year.

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

Good morning, everyone.

Good morning, Terry.

Good morning, Terry.

Going back to cheese, Irene, I understand your comments there about why it will be a second half phenomenon there. That's kind of what we're looking at with cheese prices as well. But I'm wondering if it could be a really good second half under the following scenario.

If some of your innovation indeed allows you to kind of keep more pricing than you might ordinarily have, maybe a better contribution from mix, as pricing begins to fall what would prevent the second half from being significantly better? Would it be private label competition since that seems to be kind of stubborn even at the high price levels?

Terry, you know, I don't want to get into hypotheticals on our guidance. We're starting the second year of our three-year plan. If in fact we start to see that the market reacts better than we expect to the pricing actions, we will continue to invest in our franchises.

So I hope the optimistic forecasts are accurate. I think we're planning prudently. But if in fact we do see some upside and in fact the volume impact recovers, the volume recovers faster than anticipated, we will be able to continue to make some investments in our franchises.

Great. Thank you.

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

Thanks.

Irene, this question's on innovation. At CAGNY, I remember we talked about the innovation pipeline which needed some serious rebuilding and so far this year you've had some market share traction in some categories and you've had some hits.

But I'm wondering given to the changes that you've been making and in management incentives and the organizational changes that you think might help you become more of a focused organization per division on innovation, I'm wondering if you could give us a sense about maybe the real inflection point on your innovation effectiveness? When that might happen in '08, perhaps and what the innovation coupler really looks like today? Thanks.

David, I feel much better about our innovation pipeline today than I did a year ago. We're going to share a lot of -- give you a lot more visibility of that at CAGNY.

But just a couple of the items that I talked about are not just new items that we launched in 2007, they're platforms. So Oreo Cakesters, for example, is our entry into a $1 billion snack cake category. We've got a whole pipeline that comes behind that.

Ultimate Pizza is our entry into the upper mainstream pizza segment and you'll see some new items coming in there. LiveActive cheeses is our entry into the $500 million pre and probiotic category. You'll see some additional items there.

So as you look across the portfolio, in addition to some of the actions we're taking on core businesses like our Maxwell House coffee, 100% Arabica product, as well as our pourables items, which have been significantly upgraded, I think you'll see a much more robust pipeline than we had a year ago and that's what gives me the confidence that we can maintain our top line momentum even as we're taking the pricing that we've indicated.

Okay. Thank you very much.

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

Good morning, Andrew.

Irene, it's been interesting to see the industry and the way they're going about pricing. And obviously the whole industry's been playing catch-up because no one expected costs to rise as quickly as they did.

But I'm wondering if some of the price initiatives you're taking now, do you feel good enough about sort of the quality initiatives and where your portfolio is across the board that you can take pricing now, that is more of anticipatory of what may or may not but could happen from an input cost standpoint as we go through the year and even into '09 and beyond?

In other words, will '08 be another year where hopefully you're kind of still catching up but maybe getting closer or is there a potential to really be ahead of it based on what you're trying to do with pricing, like, in the fourth quarter?

Look, Andrew, I think there's no question that our pricing power has improved. If you look at the 5% revenue growth that we turned in in 2007, we've got 2 points of pricing in that growth together with 3 points of [all] mix which I think is a stronger performance than you've seen from us in quite some time.

2008, we're going to get a lot closer to recovering input cost. Given the high levels, though, I'm not expecting we're going to go much ahead of that. But I think as Tim said, particularly as we look at markets like dairy, we're looking to get much closer to the marketplace so that we don't find ourselves caught behind.

Thank you.

You're welcome.

Thank you. Your next question is from Chris Growe with Stifel Nicolaus.

I just have two questions for you. The first one, I'm just curious relative to your developing markets business, are there ongoing investments there that will continue to kind of constrain the operating margin progress in that division given the strong revenue growth?

Well, we're going to continue to make investment, Chris, in the developing markets. We've seen double-digit growth from that geography and we expect that that will continue going forward.

As we look ahead, though, we will continue to take aggressive pricing actions as part of that so I think we will continue to see improvement in our overall margins. There's, in some of our individual markets, there are some one-times in the base that might map that a little bit but in aggregate, we are looking for improved margin expansion from our developing markets as we are from the EU.

Okay.

And my second question was just relative to North America. You've obviously spent a lot of money on sort of the quality upgrades, the marketing, the R&D, the new products. And throughout the year we saw product mix weakening, product mix benefits to the Company weakening from North America itself.

Is that due to a certain category? Usually beverages can kind of shift there, or is that just related to the new products, we're seeing less of an incremental benefit there?

No, actually, I think it was just a mathematical impact and the fact that volumes started to become a bigger part of the equation. So I think you're going to continue to see in 2008, as I mentioned, pricing will play a bigger part in our overall revenue growth and mix will continue to be important.

As we look at the new items in our pipeline, they are generally higher margin than their base counterparts and we expect that trend to continue, as well as the impact that we're seeing on our base business as we migrate some of our base products like Ultimate Pizza, like Jacobs Symphony to the upper mainstream end.

Did you say where marketing as you defined it ended the year sort of as a percentage of sales, you're talking, like, mid 7s in 2008? Where did it end 2007?

6.9.

Okay. Thank you.

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

Good morning, everyone.

Good morning, Pablo.

Irene, I guess I'm very (inaudible) on profit margin expansion and I want to go back to a question in the past (inaudible) in two year margins were at 21% of the consolidated level this year around 14%. I know you said you cannot go back to 21%, but in that long-term (inaudible) of 7 to 9% EPS growth, what are you thinking about margin expansion?

And if I can, and hat's really a question but I want to expand a little bit on a point here. If I'm not wrong, your marketing expense was 6.9% at CAGNY. That's what you said in 2006. As a percentage of sales it did not increase. So I'm trying to think is that good or bad.

We may (inaudible) because we've seen your volume grow, we've seen your mix, your innovation, but I'm kind of thinking you're going to go from 6.9 to 8 to 10% that's going to be a drag on margins for a while. So help me think that and combine with that, of course, the idea of the long-term upside on profit margins. Thank you.

Let me see if I can help you through that, Pablo. Our 2006 marketing A&C investment was about 6.8% and we took it up to 6.9% so we not only saw a 10 basis point increase but more importantly it was in the face of these unprecedented commodity costs. So I feel very good about that.

As we enter 2008, as I mentioned, we're targeting to be more in the mid 7 range with the addition of Danone and we'll continue to be making some investments but not quite at the same rate as we were making in the past.

The question with respect to margin expansion, let me see if I can help you through that. Clearly, our strategy is working and we will continue to execute that strategy in 2008. We will see margin expansion, as Tim and I said, but it will not come quite as rapidly as we had hoped because of the fact that higher costs are going to necessitate price increases and we will see some dampening impact in the near-term on volume as the market adjusts.

The good news is we clearly are seeing brand strength, our brands strengthening as a result of the investments that we've made and so we expect that over time we'll continue to be able to benefit, we will be able to benefit from the operating leverage that we laid out in our growth algorithm.

If I just follow-up there, if I may.

You know, your operating margins are 10%. I mean, Heinz and Kellogg, maybe different markets, different products, they have 17, 18% margins. There's a huge gap there.

Are we looking at 20, 30 basis points a year only? (Inaudible) your comps in North America and Europe your margins are way below peers and I don't know, is that an issue, you think, of your product mix, your markets or is there room for faster margin expansion?

Pablo, there's no question that our EU margins need to expand and we're in the process of taking a number of actions there. We had a very strong performance this past year on the top line in the EU after many years of decline and I think we've got our base business moving in the right direction.

Our focus in 2008 will be to begin to expand margins and we've got a number of initiatives in place to allow us to do that over the next few years. So we're not satisfied with our margins in the EU, but again, I believe that the investments that we've made in our core brands like Jacobs and like Milka will serve us well as we move forward and we start to recover more of the input costs.

Thank you.

Thank you. Your next question is from Ken Zaslow with BMO Capital Markets.

Hello?

You indicated that European commodity costs have now started to increase. The question I have around that is why the delay relative to the U.S.? What has changed and is your pricing ability in Europe better or worse than that in the U.S.?

Let me say there's a couple differences. Europe, we tend to use more powdered dairy input products and that has lagged a little bit general dairy in North America.

The other thing is we're much more -- cocoa is a much more important input cost in Europe for our chocolate business. So that's the lag.

And I would say, again, it was we continued to execute our strategy in Europe as we do globally to build our brands. We think that it'll give us more pricing power and we'll be better able to withstand the input cost increases.

Is the consumer in Europe more willing to take on the price increase than the U.S. or different? Is there any, can you just talk about the consumer acceptance of higher prices?

I don't think consumers ever like to have higher prices, but I think that there is a general recognition that across all categories, the consumer is going to be facing globally increasing prices as a result of the run-up in commodities. So we'll just keep having to push at it.

Great. Thank you.

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

Thank you.

My question is, you know, consumer staples investors have more and more been looking at companies with high exposure internationally thinking that North America is under a lot of pressure from a top line perspective and their growth is international. In your forecast for '08 I thought I heard some negative outlook on commodity costs in the EU and volume in emerging markets.

Are you expecting profit growth specifically profit growth to lag internationally compared to the rest of your portfolio? And would you even think that despite maybe an 8% benefit here from currency that profits could actually be flat internationally in 2008?

Actually, Robert, we're looking for margin expansion across the portfolio. As I mentioned before, the first half will be a little more challenging because of the higher input costs relative to year-ago, but we expect to see margin expansion across the portfolio and around the world.

Okay. So do you -- if you look at international and North America, where do you think more of the profit growth is coming in '08?

Well there's no question in the near-term, more of the profit growth will come from North America and, of course, that's almost 80% of our portfolio so that makes you feel pretty good. In the EU, we will continue to build on our base momentum while we expand margins and it will take us a little bit longer to get there.

Okay. Thank you.

Thank you. Your next question is from Vincent Andrews with Morgan Stanley.

Good morning, everyone.

Good morning.

Just a question on, you know, the last several years, well, let me start here. It seems like your guidance and your plan for this year assumes kind of a run rate of commodity costs going forward and that hasn't been the case at the start of each of the last several years, in other words, commodity prices have continued to increase. What's the risk if that happens again this year and what can you do about it beyond just looking for further price increases?

Well, we continue to focus on productivity, reduction of overhead, certainly. We can't -- we aren't forecasting what will happen to commodities. Obviously we have taken a view to reflect our earnings guidance.

But we are expecting that we'll continue to see pressure in commodities, particularly in the first half of the year, and particularly because we have the year-on-year comparison where they were at a lower level and we saw most of the increase and most of the commodities coming in the second half.

But we will continue to invest back to build our brands. We think we've gotten good traction there. We think we have better pricing power, but of course, we're going to be continuing to focus on productivity and overhead reduction.

Okay. Thank you very much.

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

Thanks for taking the follow-up.

I guess the first question, just more of a technical question, is there, given the changes and, I guess, better performance on the restructuring, I had assumed that there was roughly 500, $550 million or so of cash cost from the restructuring in '08. Is that still accurate or should that be less given the changes?

I think the cash cost will be about the same. It may drop a little bit commensurately with the reduction in the overall program but I would say directionally that number is pretty good.

Okay. Thank you.

And then as a follow-up, I just, I mean, I'm just not clear exactly, Irene, on the kind of how all this flows in that I think Danone you said would be initially dilutive to margins. The Post deal, you know, roughly $0.07 to $0.13 annualized dilution and margin dilutive once that hits.

How does all that square at the end of the day with margins still being up and input costs being up? I just, maybe it's because I already include the divestiture of Post in our numbers, as I think most analysts have already done. Help me kind of bridge this gap.

It's actually very simple, Eric. While margins will be up, they'll be up a little less than they would have been our base business because of the addition of Danone. They've got a very attractive margin.

But as you know, international margins are a little bit lower than the Kraft average so it's just simple math. But the net of it is that the guidance that we've given you assumes margin expansion as a consequence of the pricing actions that we're taking together with our productivity and our overhead leverage.

And that doesn't include any impact of the Post divestiture?

That's correct.

And is the Post divestiture still, are those numbers, the $0.07 to $0.13, is that still a reasonable number?

Yes. Let me step back. The guidance that we have given assumes that Post is in for the full-year. We don't know when that will take place and therefore to try to anticipate an additional variable about when it may take place and what actual impact it will have for the year, we chose to keep in there and when we get close to that happening and we can better define a date, we'll update you on what impact it would have. And it's still -- we're generally looking at a mid-year type time frame.

Okay. All right. Thank you.

Thank you. Your final question is from Virginia Chambless with JPMorgan.

Thanks.

Actually, I have a question on the divestiture of Post. I think when you initially announced that you indicated that you're intending for about $950 million of sort of debt transfer, debt assumption by Ralcorp, is that still the intention so that net debt will be reduced by $950 million as part of that transaction?

Yes, that's what we're intending.

Okay.

And then another question on the short-term debt balances. I mean, clearly, pretty large at around $8 billion at the end of the year and part of that is the Danone bridge. But can you sort of give us some guidance on how much commercial paper you're comfortable sort of operating the business with?

Well, the level of commercial paper is obviously at a peak. We did try to go to market with more of the Danone bonds late last year and the markets were not conducive to going forward. We clearly want to bring the commercial paper down to more normal levels.

We do have $4.5 billion worth of backup, stand-by credit lines and so that puts some limitations on our CP ability. Part of that, obviously, is that we have a bridge loan on funding that that's not drawing on commercial paper.

Okay.

Again, AB2 ratings are quite important to us so we're maintaining our leverage consistent with that.

Would a more normalized level of CP be in maybe the $2 billion range?

I like to keep an active program and on an ongoing basis that's probably directionally correct.

Okay. Great. Thank you.

There are no further questions at this time.

Thank you.

Well thanks, everybody, for joining us.

If the analysts have any further questions, this is Chris Jakubik, I'll be around all day. For those of the media with questions, Lisa Gibbons will be available and you can reach her at 847-646-4538. Thanks very much and have a good day.

Thank you. This concludes today's Kraft Foods fourth quarter 2007 and year-end earnings conference call. You may now disconnect.