億滋國際 (MDLZ) 2008 Q1 法說會逐字稿

Good day and welcome to the Kraft Foods first quarter 2008 earnings conference call. Today's call is scheduled to last about one hour, including remarks by Kraft Management, and the question and answer session. (OPERATOR INSTRUCTIONS)

I'd now like to turn the call over to Mr. Chris Jakubik, Vice President, 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 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. Also available on our website are slides that we will refer to during our opening 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 reper 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 the GAAP to non-GAAP reconciliations within our news release. They're also available on our website. Also please refer to the Form 8-K that we filed on April 11, for a discussion of the changes we've made to our reportable business segment.

We'll begin the call today with Irene providing her perspective on our first quarter and outlook for 2008. Then Tim will highlight our financials and 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. Good morning, everyone. In February, at CAGNY, I said that our turnaround plan would allow us to deal with the near term input cost environment while continuing to lay the foundation for reliable, long term growth. Our first quarter results represent further tangible evidence that we're on track. Our brands got stronger, our market share increased, our investments continue to pay off, and our margins improved sequentially from the fourth quarter. As a result, I'm even more confident that we will deliver our 2008 EPS committments.

In terms of brand strength, we said that in 2008, our growing brand equity would enable greater pricing power and it has. In the first quarter, pricing contributed more than 4 points of revenue growth versus only 2 points in the fourth quarter and 1.6 points for all of 2007. As the year unfolds we expect the pricing component of our organic growth to increase further, as we take additional pricing actions across our categories to cover rising input costs. As a result, we've raised our guidance for 2008 organic revenue growth to at least 5% from at least 4%.

More importantly, we continue to gain market share in categories where we have increased prices, which is is a testament to the improved strengths of our brands. On a 13 week basis we saw continued progress with 56% of of our business growing or holding share. That's up from 50% in Q4. Indeed our ability to increase prices and gain market share is proof positive that our investments are paying off. In the past, I've talked about the impact of our investments in quality, innovation, and marketing on the improved share performance of key products. These include Oscar Meyer Deli Fresh cold cuts, DiGiorno pizza, Kraft mac and cheese, Jello, Oreo, Milka chocolate and Jacob's coffee. I'm delighted to add some new businesses to that list. In Q1, our quality and marketing investments to restage Maxwell House led to our first quarterly market share gains in mainstream coffee in more than two years. In processed cheese, the introduction of single select helped to turnaround our market share and Planters gained share in snack nuts fueled by more effective marketing and a higher level of support.

Going forward we'll continue to invest behind key brands and as the year progresss, we expect to add two other large U.S. businesses, pourable salad dressings and crackers, to our list of categories gaining share. When this happens we will have invested to improve the performance of our largest North American businesses and set the stage for the portfolio to deliver reliable, profitable growth.

In a addition to our strong share performance, our biscuit acquisition from Danone is paying off as well. The integration is on track. Financial performance is on plan. We're successfully launching new better for you products like [bique dejone] with active yogurt cultures and we've expandeded Oreo distribution into Greece and the UK, which will act as a springboard to launch our broader biscuit portfolio in those markets later in the year. As a result, we are even more confident that biscuits will be a significant platform for the future growth and profitability of our international business. So overall, our top line and market share trends are strong and getting stronger, and that brings me to margins.

In January, we told you that our margins would improve sequentially from Q4 And they have. In Q1, we did a much better job of covering higher input costs through pricing and productivity. Gross margin improved sequentially from Q4 from 31.2 to 33.7% and operating margin improved sequentially as well highlighted by a solid rebound in our U.S. cheese margin, which was up 6 percentage points to 13%. But we also said that our first half margin and earnings comparisons with the prior year would be difficult and they were. That's because the full effect of our price increases lagged higher input costs, particularly in the EU and in our cheese and our snacks businesses in the U.S. Going forward, while year-over-year comparisons will remain difficult in Q2, we expect further sequential improvement in both gross and operating income margins. That's because price increases and productivity improvements wil fully cover commodity costs, and will drive further gains from a more efficient cost structure. Most importantly, we expect improved margins to be driven by sequential gains in the hardest hit businesses, the EU, U.S. cheese and U.S. snacks.

In sum, I'm encouraged that in the first quarter, we saw further evidence that our turnaround plan is working. It's offsetting near term input cost increases while continuing to lay the foundation for reliable, long term growth. As we enter Q2, we have taken and will be taking additional pricing actions to offset continued increases in input costs. Consequently, volume comparisons will remain difficult and possibly worsen, but we expect to see continued strong revenue growth and the combination of four things, improved price realization, better manufacturing productivity, increased investments in marketing and innovation, and overhead cost leverage will ensure delivery of our 2008 financial targets. 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 items affecting comparability that were highlighted in our press release. I'll start by picking up on Irene's comments that our business fundamentals are strengthening despite this challenging input cost environment. We're getting better price realization and it will improve further. Our investments are paying off and while our near term volumes may soften in a number of businesses, we have seen and expect to see further sequential improvement in our profit margin. Now let's look at Q1 results starting with revenues.

Our Q1 net revenues increased 8% on an organic basis. Net pricing made a larger contribution as we began to recover a greater portion of input cost increases. It was up 4.3 percentage points versus 2% in Q4 last year, as the impact of pricing taken over the past six months is realized. Despite significant pricing, we are encouraged by our overall volume performance as it reflects our investments in quality, innovation, and marketing. In Q1 this is particularly true in key businesses like convenient meals, mainstream coffee and mac and cheese. However, as anticipated our first quarter volume comparison were difficult. This is particularly evident in ready to drink beverages, cheese, and our dressings and enhanceers businesses as we significantly raised prices to offset cost inflation.

Looking forward, in the near term, price increases will continue to drive revenue growth and volume comparison will remain difficult. However, we have a strong pipeline of innovations and investments that should translate into improving volume performance in the second half of the year.

Turning to margin performance, our gross margin was down 190 basis points versus Q1 last year; however, it was up 250 basis points over Q4 as the effects of improved pricing realization began to show. As our price realization improves further and productivity gains continue, we expect to see sequential improvement in our gross margin in Q2. Below gross margin our cost reduction programs drove lower overhead as a percentage of sales. Looking forward we anticipate that operating income margins will improve from first quarter levels. And we will continue to invest in our growth. We expect ANC will be up double digits in 2008. As a result while Q2 operating margin and earnings comparisons versus the prior year will again be under pressure they will continue to improve sequentially.

Now I'd like to spend a few minutes on input costs and the magnitude of increases we're facing in 2008. This chart shows commodity prices and each year versus the 10 year average for each of our 11 largest commodity inputs. Compared to numbers as recently as January you can see that the prices of many commodities have increased further. To put this in context for Kraft, for the quarter our input costs were up about $460 million over last year and we now expect them to be up almost $1.7 billion or about 12% for the year. As higher than we anticipated in January and greater than the $1.3 billion increase we saw in 2007. Because of this, we have taken and are taking additional pricing actions. This pricing together with further overhead leverage will deliver operating margin expansion in 2008 although more modestly than we had originally anticipated. Said another way, we expect our actions to deliver our expected earnings dollars but there will be greater pressure on margins as we take additional pricing actions to cover these costs.

Turning to Q1 earnings per share, having discussed the contribution from operations already, just a few comments on what happened below the line. Higher interest expense was a $0.06 headwind versus the prior year but this is partially offset by $0.03 from lower shares outstanding and $0.01 from a lower tax rate. Our effective tax rate excluding items was 30.4% in the quarter. This is lower than our full year rate due to the timing of several discrete items. We continue to expect an average rate of 33.5% for all of 2008 with some variation quarter to quarter depending upon when the anticipated discrete items fall.

I'll now take a few minute ts share some highlights of our business segments. I'll start with U.S. beverages where organic net revenues grew 2.4%. Two factors drove revenue results in the quarter. The first was coffee where investments to restage the business are paying off nicely. Maxwell House volume grew double digits and we gained share in the mainstream segment for the first time in many years. Also our new Starbucks branded tea disc drove strong double digit revenue growth of our Tassimo platform.

The second big factor in the quarter was our ready to drink beverage business. In Q1 we significantly reduced trade spending on Capri Sun to cover higher input cost. We accomplished our goal, and profitability improved while revenue declined in the mid single digit range as we had anticipated. However, I would note that the effect of this action on our volume and product mix was amplified. Amplified because our volumetric is pound based and the fact that our ready to drink product is six times heavier per revenue dollar than the rest of our U.S. Portfolio. As a result our ready to drink beverages literally weighed in the volume performance of the entire U.S. beverage business due to the tune of about 17 percentage points. Excluding ready to drink, our beverage volume was up more than 4%.

At the same time, the volume impact was largely offset by an upgrade to product mix for the beverage segment. While this will remain a feature in our second quarter results we expect the impact to be less pronounced. That's because we back stopped the pricing with the reformulated product containing 25% less sugar and a new advertising campaign. At the profit line, beverages operating income grew 7% and margin increased 140 basis points. Here are the benefits from our improved price realization particularly in ready to drink beverages more than offset higher input costs. In U.S. cheese, organic revenues were up 8.8% due entirely to price increases in response to higher dairy costs. Compared to a year ago these prices are up 6% to 25% across our cheese segments, with the largest in natural cheese. Overall, (inaudible) mix in cheese was essentially flat versus the prior year. Innovations such as LiveActive and Singles Select continued to drive solid mix improvement; however this was offset by volume weakness particularly in natural cheese as consumers adjust to higher absolute price points.

Going forward, solid revenue growth will continue. In February and March we announced further pricing actions covering two-thirds of the business. We expect this pricing will continue to pressure volume comparison in the near term. However, our innovation, activity will accelerate. We'll see the full rollout of bagel full cream cheese filled bagels, the launch of our 2% RBST free cheese protects and in June the national expansion of Deli Fresh natural cheese slices.

Turning to operating income margin it was down 5.5 percentage points versus Q1 2007. Price increases were more than offset by record high commodity costs and a strong double digit increase in Marketing; however, consistent with our guidance in January, our cheese margin was up significantly, 6 percentage points versus Q4 of 2007. And as gains from innovation and price realization continue, we expect further sequential improvement in operating margins and market share as the year unfolds.

Moving on to U.S. convenient meals, our team delivered another quarter of strong performance. Our investments in quality, base marketing support and new products drove 7.5% organic revenue growth with 5.6 points due to volume and mix gains. In Oscar Mayer the strength of our Deli Fresh cold cuts platform continued, with strong double digit revenue growth and about 2 points of share gain in the overall cold cuts category, and in late Q1, we built on our success by rolling out the new deli shaved singles, deli carved and family sized packs.

Revenue from our Deli Creations sandwiches more than doubled from Q1 2007. This was driven by our new flat breads line which is proving to be highly incremental to our base business. Finally, pizza continued its double digit organic growth, not only from our premium DiGiorno ultimate and California Pizza Kitchen offerings but also from our base DiGiorno and Tombstone brands as we've invested to improve quality. This drove more than 2 points of market share gain in frozen pizza during the quarter. At the operating income line margin was down 60 basis points versus prior year but up 250 basis points from Q4. As we move forward, we expect our year-over-year margin performance to improve as well.

On to U.S. grocery where organic net revenues were up 1.4 % and operating income margin grew 30 basis points. Here, our investments to contemporize the portfolio are beginning to pay off. For instance, two of our early investments, Jell-O and Mac and Cheese delivered a combination of pricing, market share gains, and higher operating income margins in quarter. More specifically, despite significant price increases, our Mac and Cheese cups are grabbing meaningful volume growth and mix gains. These gains were partially offset by declines in other parts of the business including Ready-to-Eat deserts, barbecue sauce and portable and slimable dressings. We'll take time to turn the entire grocery portfolio but the high margins and strong cash flow of these businesses will lead to a substantial benefit. In particular, we've begun the process of restaging our portable salad dressings business. By the end of March, we we're fully national with our new line of Kraft Pure salad dressings with no additional artificial preservatives supported by incremental marketing. While it's too early to claim victory, we're encouraged by the fact that our March market share grew for the first time in a very long time.

In the second quarter more of our investments will hit the in market. As these gain traction we expect to see improved year-over-year performance in the second half of the year. Looking at the U.S. snacks and cereals performance was very much a mixed bag. Organic net revenues were up 2.7% in Q1. Biscuits showed solid mid single digit gains, but these were partially offset by a decline in snacks bars. In biscuits, 100 Calorie Packs were up strong double digits again as the momentum of that platform continues. Our Oreo franchise demonstrated solid growth behind improved marketing, the rollout of our proprietary snack and seal packaging and the continued success of the Cakesters platform and Ritz delivered strong growth resulting from investments in product quality and marketing.

On the other hand our snacks bar business was down in the quarter. This is mainly due to a lack of new product news as well as our decision to rationalize SKUs. At the operating income line, margin eroded 4 percentage points, this was due to escalating commodity costs particularly wheat, that were only partially offset by price realization and productivity during the quarter. Coming into the year, we expected soft margins in the first quarter. That's because we made a conscious decision to reduce trade activity in biscuits instead of increasing list prices to improve the long term health of that business. The benefits of this change in trade strategy are more back end weighted and will unfold over the course of the year. At the same time during the quarter commodity costs particularly wheat increased more than anticipated. Since then, we've announced an 8% list price increase effective this week. Going forward, the benefits of this latest price increase will combine with the impact of our trade efficiency efforts. We'll continue to invest in innovation and base brand support and as a result, we expect sequentially improving operating margins for the remainder of the year.

Finally, I would note that our cereal business grew both at its top line and operating margins during the quarter. This reflected continued improvement in the kids cereal business as well as February price increase. As grain costs have risen further we recently announced another price increase that takes effect this month. I'm sorry, in May. We remain on track to complete the transaction to exit our Post cereal business in mid 2008.

Turning to Canada and North America foodservice, organic revenue growth was up strongly, 6.4% versus last year. In Canada, solid Q1 organic growth was driven by strong category and share growth, increased investment in marketing innovation across all categories and the implementation of improved customer plans as we leveraged our scale with the reestablishment of Canada as a standalone business. In North America foodservice, high single digit growth came from a combination of strong customer response to quality improvements and innovation and to a lesser extent, customer buy ins ahead of price increases.

At the operating income line, margins up 200 basis points as pricing, manufacturing efficiencies and overhead cost leverage more than offset higher input costs. Going forward, both Canada and foodservice will be executing price increases to cover significant commodity cost increases. And while volumes may soften in the near term, given the base business gains from marketing and innovation, we expect further margin improvement in the second quarter. Now I'll turn to our international business, which now represents 40% of our total. We continue to post solid organic growth as we focused our investments on our core brands. In the EU, this resulted in 9.5% organic revenue growth marking the third consecutive quarter of solid volume and mix gains. We delivered double digit growth in chocolate, from investments in Milka, Toblerone and Cote d'Or. Cheese also grew double digits from improved marketing behind Philadelphia. And coffee demonstrated solid organic growth again behind gains from Jacobs and Tassimo.

At the profit line as we anticipated EU operating margins declined 50 basis points as pricing lagged input cost increases, with only a partial offset from overhead leverage. As our price realization improves in Q2 we expect sequential improvement in our EU margins from Q1 levels. As Irene mentioned the integration of the Lou biscuit business is on track and will enhance our EU margins over the course of 2008. In developing markets, organic growth of more than 21% was driven by volume and mix gains of more than 12%. Our focus on and investment in core categories, brands, and markets has continued to pay off. Q1 growth was driven by Jacobs coffee, Milka, chocolate and Kraft Cheese in our EMEA region, further gains in biscuit and confectionary in Latin America as well as consumption and distribution gains in our Asia Pacific region particularly in China. At the operating income line, margin was up 90 basis points. This resulted from a combination of strong top line growth and the acquisition of the biscuit business. And it more than offset higher input costs and investments in marketing and distribution infrastructure. Looking forward, while organic revenue growth may not remain as high, as consumers adjust to higher prices, our profit margins should remain stable.

Finally, before we take your questions a few notes on cash flow. Capital expenditures were $271 million in Q1, up from $180 million in Q1 last year but on a pace to spend just over 3% of net revenues for the year. I would also note that we continued to make solid progress in our working capital program despite the rise in input costs. And our numbers on cash conversion cycle were further enhanced by our newly acquired international biscuit business. So, to summarize, we've had an excellent start to 2008. We remain confident that our strengthening brand equity, our investments and cost reductions will maintain our operating momentum, increased margins and deliver at least $1.90 of EPS ex items in 2008. That's all for opening remarks. Now I'll be happy to take your questions.

Thank you. (OPERATOR INSTRUCTIONS) Your first question is from Chris Growe with Stifel Nicolaus. Please go ahead.

Good morning. I just had a couple questions for you. The first one I wanted to maybe get into a little bit perhaps for Irene, is in this quarter you had a very strong product mix benefit coming through and obviously some very strong pricing as well. Obviously I guess because the margins were a little weaker particularly in North America that did not fully overcome the input cost pressures, so I thought the mix benefit would have been more beneficial to your earnings. Do you have a broad statement about that and can we expect this level of mix improvement throughout the year?

Yes, Chris. Overall Q1 was generally in line with our expectations. As we had said in January, we knew that the first half was going to be difficult because of the timing of a number of our pricing actions as well as the fact that costs continued to escalate on a couple of core items but I would tell you that we needed to price protect a number of our key franchises that were relevant to the Super Bowl like pizza and biscuits and Easter coffee and cheese, for example, and as a result, that's part of why we didn't see as much of the flow through of our pricing actions in Q1. We will see as we said sequential improvement as the year progresss and for the full year, we expect to fully recover input costs through a combination of pricing and productivity.

Okay. And then was there much of an Easter benefit? Like sales or volume in the quarter? Is that something you can quantify?

It's not significant enough for us to quantify, Chris.

And then last question would just be relative to your volumes in the U.S. they were weaker than I expect, I into there was one business dragging that down. I guess as we look through the year especially the first quarter I expected that to be a little better given your promotional programs were a little heavier so you talked about cutting back on promotion throughout 2008. Are you still, I think it was $200 million was the number you gave. Is that still something you expect to do or could we see that adjust a little bit based on some weakness in volume we saw in North America?

Let me clarify the issue on volume as Tim mentioned, the ready to drink business where we made a very concerted decision to reduce our trade spending and get our future prices higher on that business in response to the escalating input cost, that business weighed quite dramatically not only on beverages but in North America and in turn on total Kraft. Actually, the volume, organic volume that we reported was essentially flat, ex ready to drink, it would have been up about 2.5% so net-net, we actually felt reasonably good with the volume performance in the first quarter. We are though, as part of our effort to increase prices, we will see higher promotional price points throughout the year, but most importantly, I feel much more confident given the investment that we have made in brand strength that we will be able to deliver volume mix improvement sequentially over time despite the fact that we've taken these increases.

Okay. Thank you.

Thank you. Your next question is from Christine McCracken with Cleveland Research.

Good morning.

Good morning, Christine.

When I look at your commodity costs obviously you're facing a very inflationary environment and you're taking pricing to offset that but when you have very volatile commodity or swings in commodity prices, like you've seen in cheese and a number of other areas, how do you constantly readjust pricing and how does the retailer react to that? Is it that you stick pricing or that you're forced to go back and reevaluate the pricing strategy?

Well, Christine I think the first thing we are doing is getting our merchandising pricing closer to the marketplace, and so that that takes a lot of the pressure off of our forecasting and over time we've talked a lot, particularly in cheese about our desire to move in that direction and I think you'll see that play out in the course of the year. The reality is the world is changing. I think we're all learning how to forecast better in the current environment. We're pretty good on the supply side but even there as we see more of the food cropping diverted to biofuel use, we are seeing some unanticipated consequences which I think is impacting pricing. So in the face of it though I feel very good about the fact that we have been pricing quite aggressively to recover those costs and once again, I feel good that the investments that we have made are increasing our brand strength and our ability to price and as a result, we expect that we will continue to improve our margins sequentially despite the input cost situation.

Are you seeing demand impact as you raise prices? It seems like your portfolio is actually fairly well positioned in this environment.

Well quite frankly we feel -- our first the quarter came in essentially the way we thought. We will continue to see some of these pricing actions play through in the second quarter which is why we've been somewhat cautionary with respect to our volume forecast for the second quarter but as the consumers adjust to these higher prices, we believe that the strength of our brands and our marketing efforts will be able to allow us to continue to improve volume mix in despite the pricing.

All right, thanks.

You're welcome.

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

Good morning, Todd.

Your line is live. Please unmute and proceed with your question.

Yes, can you hear me now?

We can hear you now.

I feel like a cell phone commercial. Had a couple questions for you on the international front, specifically with respect to your chocolate segment. Obviously the Mars and Wrigley transaction made a lot of news on Monday and I'm just wanting to know from your standpoint if you continue to consider the chocolate business in Europe to be core to your overall business?

Well, Todd, as we've said we're continuing to evaluate our portfolio and determine the long term prospects for each of our businesses. The reality is that Mars is already a significant competitor and I feel that the strategies that we've got in place will enable us to compete quite effectively in the face of that new combination.

Okay. And just one follow-up question. With respect to your acquisition appetite, I mean you've talked a lot about the operations that you have today. Can you just talk a little bit about your acquisition appetite and Irene, I think you've said in the past that one of the things that you might consider doing were you to make a sizeable acquisition is that you'd be willing to use equity to help fund a portion of an acquisition. Can you just comment on that?

Well, let me underscore again, Todd, our plan is predicated on organic growth and with the continued improvement in our businesses, our turnaround is clearly gaining momentum and therefore I continue to be confident that we will deliver the committments that we've made. We have said that we would acquire to, in particular to build scale in international geographies and that will continue to be very much on our plate.

Okay, and can you just comment about your appetite or willingness to use equity should you come up with a large acquisition opportunity?

I'm not going to comment on that, obviously any decisions that we would make have everything to do with the circumstances.

Okay, thank you.

You're welcome.

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

Good morning. Wondering whether you could comment on what impact the deliberate changes in your merchandising and promotional strategy for ready to drink beverages had on the overall Kraft consolidated mix contribution and how sustainable you expect the first quarter level of mix contribution to be for the remainder of the year?

Well, ready to drink as I've pointed out in my comments had a significant impact on the volume as we measure it, but again, ready to drink is six times the impact for every dollar of revenue due to the weight of the product. Overall, the volume and the mix impact on the beverage business was very, relatively small net impact, about 2% and had a much lesser impact on the entirety of the Company, so we do expect to see some of the same in Q2 although as I've pointed out that will be mitigated because we have, we reformulated the product with 25% less sugar and we're putting some marketing behind promoting that product and think that will mitigate some of the volume impact. So we're encouraged by, as we look into the second quarter.

So do you think that a 3 to 3.5% kind of mix contribution is sustainable for the remainder of the year or are there other factors that we're not talking about that should cause that to either accelerate or decelerate?

Really, Eric, we don't want to go into the specifics. Q1 was in line with our expectations and we've given guidance for the full year. We expect to see continuing sequential improvement in our brand strength and therefore in our pricing and our ability to pass through the cost increases and we expect to see margin increases.

Okay, and finally, was the 4.3 percentage point total contribution from price largely in line with your expectations considering that you protected price points on some key items as Irene mentioned? It seems like a pretty strong price number considering you were protecting price points on cheese and pizza.

Well, remember, I mean we saw significant price increases in the latter half of last year and into the fourth quarter so some of the price increases we've put in effect during that time as we mentioned in our fourth quarter call, the full effect of that benefited us in the quarter. So that contributed to some of the pricing improvement we saw in this quarter and again, as commodities continued to escalate and perhaps beyond our expectation in some of the categories , we've put during the quarter additional pricing. Some of it we protected as Irene mentioned, but overall it was generally in line with our

Okay, thank you.

Yes.

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

Good morning, everyone.

Good morning.

A couple of questions. Irene in the current environment with a weaker consumer, do you find that it is more difficult for people to trade up and I say that because in some of your products, people are paying a premium because of the, obviously the increased run equity or you're moving them to a branded premium product or in other cases you're paying extra for convenience or for a better quality product, I understand that's a strategy and that's why you want to move but do you find that that strategy is more difficult to implement in the current economic environment?

No, actually, in fact I think we will continue to do just fine in the current environment. There will be some puts and takes but I am confident that the investments that we've made to strengthen our brands will help us to continue to make progress despite the higher pricing and I think although it varies by category, the numbers I referred to earlier are quite encouraging to us. There are 13 weeks and for the past 13 weeks, 56% of our U.S. revenue is growing share up from 50% in the fourth quarter so I think that it's really proof positive that we're able to continue to grow share in the face of very aggressive pricing. The key remains our ability to differentiate our products in the consumers eyes and to make sure that we've adequate support behind those businesses and as we've told you we are planning to invest at a double digit increase in ANC this year and that together with a very strong innovation pipeline and our base marketing efforts I'm confident will continue to allow us to grow share.

Now related to that would you say that compared to past year being now assertive in terms of price increases, compared to private label or the competition or I mean in the past I think you had lagged on cheese. Would you say that the portfolio now you're moving quicker than the competition and if so, has the competition begun to catch up with your price increases or are they lagging now? Can you comment on that?

I can't speak specifically to the competition. I would say as we look across our categories the entire market has responded in to the higher input cost but there is no question that we are more aggressive in pricing today as a result of the stronger brand strength that we have been able to develop because of the investments that we've made in quality, in marketing and in innovation.

And just two quick follow-ups. When I see a 4% price increase on your revenue base, last year of 37 billion, that's about $1.4 billion just from pricing, which is pretty much the number that you're giving us on commodity so if you can can maintain a 4% increase obviously you should be able to cover the higher dollar cost increase. Is that the right way to think about that or am I missing something there?

No, I think that's right. That's what we've said that the additional pricing we expect will cover our commodities and generally on a dollar per dollar basis, that as you know if you think through the math of it will put some pressure on the margin improvement, although we still expect that we're going to continue to drive and deliver margin improvement over the course of the year, it may be a little bit less than we had originally anticipated as a result of the denominator effect from the equation.

One last one, Irene. I understand you can't comment too much on M&A, but just remind us, chocolate in the past, you have mentioned and highlighted as a core category in your international business and I want to ask a question whether , is that still the case? And given that your chocolate form is mostly what I would call center of the aisle overseas, do you see a need to grow in the front end of the store with your chocolate platform? And if that's the case, I guess we can make our own assumptions about how you could pursue that type of -- how you would pursue that through acquisitions? And the same question would apply to U.S. I mean, your snack business is not doing well but I could make the argument that all your snacks can be sold in single serve format but your distribution in seas stores in the front end of the store is more limited so I'm just wondering whether an acquisition would make sense in that regard to help you grow in that part of the store or that's not a priority in terms of growing in that part of the

A lot of hypotheticals in that question, Pablo, what I will tell you is that we had a very strong quarter on our chocolate in the EU. We have been very focused on rebuilding the core equity on some of our iconic brands like Milka, Toblerone, and Cote d'Or. We are seeing progressive margin improvement on that business and as long as it continues to contribute it will be an important part of our portfolio.

All right, thanks.

You're welcome.

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

Hello there.

Hello.

A question on Europe margins in general. It seems to me you've just bought the Danone cookie business and from memory in 2006 at least the margins on that business were about 16%. Margins in Europe have been stuck in the sort of very low double digits now high single digits for quite some time. Historically I guess they were up in the sort of midteens kind of level. As I look at your peer group, many of the other companies have much higher margins sort of mid to high teen kind of levels in Europe. Is there something structural around the portfolio that just makes it very hard to get the margins up over there or how do you see those developing over time?

Well, I don't want to make any excuses for our performance. We are not happy with our margin performance in the EU. We had a very strong top line performance, another very strong quarter of strong volume mix gains and we are expecting to see sequential improvement in margins over the course of the year, particularly as the price increases start to flow through. We needed to price protect a number of our core businesses in the first quarter. That said, we have a fairly significant business in Germany, which does weigh somewhat on our overall margin performance, but we are committed to increasing our EU margins over time and there's no question that the acquisition of the Lou biscuit business will be very much an enabler to that end.

Great, thank you. And one other the follow-up on the restructuring that you implemented during the reorganization I guess into the new sort of independent business unit to improve accountabilities I guess that's now complete. Could you speak a little bit to what changes you're seeing, what is that enabling you to do now that those, that new structure has been put in place?

Well, the new structure came in place the beginning of this year and we have business units responsible for their full P&L's and balance sheet as opposed to the past where we tended to be much more functionally oriented and we're seeing that the businesses are stepping up and they're making decisions much closer to the consumer. We have full responsibility for their brands and as I said the P&L and balance sheet we're seeing much better decision-making and we're seeing much improvement in the decisions that are being made.

Thank you very much.

Sure.

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

Good morning, thank you.

Good morning, Jonathan.

Tim, you mentioned a buy in on the foodservice side of the business having an impact. Could you possibly quantify that with a little bit more granularity?

Well, it's hard to say specifically how much impact there really was. I mean there was some impact. We don't think it is a material amount. That's as much as I can give you.

Okay, when you look more broadly across your business, both foodservice and retail particularly in the United States where it seems like the commodity prices have and therefore retail pricing has been much more aggressive, has there been a change in strategy on the retailer standpoint to try to maybe anticipate price increases by buying in and maybe seeing a little bit more pairing a little bit higher levels of inventory?

Actually, we don't allow that. We have some fairly strict policies with respect to buy in against price increases so the loading behavior of the past is really not a factor here. One of the reasons we called out the impact on our foodservice businesses of the pricing actions was just because we had a very strong quarter in foodservice, I'm not sure that's entirely indicative of the market. I think we're all feeling that although we haven't been able to fully quantify the impact of the economic conditions on food away from home, we're all feeling that there is some impact and it's one of the reasons we feel comfortable that as consumers eat home more often, they will come home to Kraft, but we purposely called that out because we do believe some of our strength in foodservice in the first quarter was in response to the pricing actions.

Thank you. And just one final one. Irene, you've been talking about, very consistently about your acquisition strategy for awhile and I guess I just wonder now that Master Foods and Warren Buffet sort of broken the ice here, does it make it more likely in your view that yourself and others will look more aggressively towards filling those acquisition needs maybe just because financing is good and other folks are likely to follow?

Well, Jonathan, obviously I don't want to speculate on any industry trends or what others may do. What I will tell you is that we are not changing how we go to market. I feel very good about the strategic direction that we've laid out. It is clearly -- our turnaround is clearly gaining momentum. It's serving us well and we're going to stick to our game plan.

Okay. Thanks very much.

You're welcome.

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

Thanks, hi.

Hi, David.

Good morning. I was looking at some data recently about the number of new Kraft products that are being introduced under Kraft in general, not the brand and it appears like the pace of innovation is not really accelerating. Is that something that you see too that -- and perhaps you can describe how you're seeing he pace and incrementality of innovation, how is that played out and relatedly, how, when you look at the pipeline in the next few quarters, how do you see the pace and the effectiveness of your innovation progressing? Thanks.

David, I feel terrific about our innovation pipeline. It's quite full, it's fuller than it's been in a long time and actually, we have more ideas than we are actually able to fund at the moment. What we have tried to do is to stage those innovations and make sure that they are big enough so for example, Cakesters we just, we launched the soft cake idea last year under the Oreo trademark, we just came out with a Nilla version. It's been a tremendous item for us, in fact it's contributed to over 3.5 point swing in the growth of the category so we're seeing a lot more incrementality to the ideas that we're doing. We are working to expand them and make them bigger so for example, a number of our innovations this year are behind our 100 Calorie Packs which just continue to be a stand out performer, so many of the ideas when you see Deli Creations, flatbread, that may not look as innovative to you because you've already seen Deli Creation Sandwiches but frankly that's the point. We have terrific opportunity to build on the equities that we're creating and to be able to amortize them in the marketing investments.

I mean and just to clarify, when you get more decentralized as you are, one by-product would perhaps you could get little ideas up to the top better and I would expect it to be manifest in more ideas being introduced, more products. Is that really, I mean do you literally see more products coming to market from Kraft in the coming quarters?

No. Once again, the value of the decentralization is to enable speed and to make sure that these, each of our managers is fully focused on the marketplace and on their competition. What I expect as a result of that is higher quality ideas, bigger ideas but I am actually not looking for more ideas. Our whole focus over the last two years has been to narrow focus on those areas of opportunity across the Company that we think have the greatest promise and so most of our innovation is focused on health and wellness, on premium products, on convenient products and on snacks and each of our businesses is focused in those areas. Where possible we are looking for synergies on platforms that cut across, so for example, we're building our Deli Fresh cheese launch is building on our learning in deli fresh meat. Our LiveActive stick are building on the experience that we had with Active sticks and bars are building on the experience that the we had in LiveActive cheese, and so we're trying to take some of those platforms, obviously 100 Calorie Packs have had impact across a number of our categories. Mac and Cheese crackers builds on the equities that we have in our base Mac and Cheese business so we don't expect to see a larger number of items. We do expect to see a larger contribution from a smaller set of items and I feel very comfortable that the pipeline that we've got can deliver on the ambitious goals that we've set.

Just one more question. On the wall to wall sales structure initiative, how is that helping you as you kind of get to the final stages in that rollout, how is that helping you whether it be the top line or maybe through maybe in store marketing, out of stocks, or maybe it's a cost benefit, any specifics there? And if there's been any negatives that have come out whether they be short-term from the rollout itself, could you perhaps discuss that? Thanks.

No, actually, David, we feel terrific about wall to wall. The rollout is now complete as we had told you it would be and our focus continues to be on execution and training. We truly believe that better execution on wall to wall is going to help us to improve our display support, help us to reduce out of stocks, get our new items to market faster and the proof of that is that we're seeing about a, since we've begun the initiative, we've seen about a 1 point incremental revenue contribution and in fact that's almost 180 basis points for the last eight weeks, so as our organization continues to understand what their new responsibilities are and we set the agenda in a way that is easy for them to execute, we are very comfortable that this will continue to make an important contribution and give us a source of competitive advantage.

Thank you very much.

You're welcome.

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

Hi, thanks. We get a lot of questions on the demand side for food and whether it's food at home is rising or falling and how people are reacting to higher prices. I'm curious if you have any visibility on the supply side. In this high cost environment, have you seen any signs that smaller competitors or private label manufacturers co-packing manufacturers are closing up shop or feeling such an impact from the cost pressure that maybe they have to relook at how they do their business models and would that have a positive impact for you?

Well, Robert, I don't think I can comment specifically on what impact this might have on smaller companies. There's no question that we are continuing to learn to forecast in the wake of the current environment. We believe that our scale will continue to be a competitive advantage for us both in procurement and in sales execution and once again, the good news is that as a result of the investments that we've made in our brand, we feel much more confident that we have the ability to price and as a result, we will continue to expand margins.

And what about on the consumer side? Have you gone to any, I don't know, consumer testing facilities just to hear consumers and what they're saying about price inflation in food? I mean, there's a Journal article today that says that 5% price inflation for food is annoying but not necessarily something that causes alarm and panic. Would you characterize it that way?

Well, I think it's fair to say that we're certainly not seeing alarm and panic. We are definitely as I said although it's not, we can't exactly quantify it, we're certainly seeing a trend in people eating away from home less and eating at home more which we believe is a positive for our business, but don't forget, the reality is there has been essentially little to no inflation in food prices for 10 years and so the reality is we've now introduced some pricing into the marketplace. We do believe that there is going to be some short-term dislocation as consumers adjust to those higher price points but I frankly am pleased to see at the early days on a number of our core categories we're seeing that we're able to continue to perform and again, I think our share performance in the face of some very aggressive pricing is good evidence of that reality.

Thank you.

You're welcome.

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

Hi, everyone.

Good morning, Terry.

Irene, a question on your cheese business. I know there are various ways to forecast the pricing but from where we sit it looks like your cheese cost ought to be somewhat flat in the second quarter and then be down maybe in the high single digits as we go through the remainder of the second half. So my question is this. I was a little bit surprised that you took further pricing in cheese, then it occurs to me, have you done what you think is calibrating your spreads to private label to ensure maximum profitability as we go through the back half in cheese? And I should ask first of all, do you agree that it should be down on that order?

No. I'll start there.

Okay.

We're not providing a forecast here but what we will tell you is we are feeling much better about our ability to take pricing in cheese than we had in the past. The investments that we've made in innovation and marketing support are clearly playing through, but as we've also said we are committed to improving our cheese margins over time so we're going to stay pretty close to the market to ensure that we are adequately getting the right relationship between pricing and cost.

We think that our gaps relative to private label are in pretty good shape, we're finding the private label players are following our lead in pricing.

Okay, so the pricing in your mind then is more response to what you see as ongoing pretty high pricing in cheese there?

That's correct.

Okay, very good. Thanks very much.

You're welcome.

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

Good morning everyone.

Good morning, Andrew.

Irene, I know you've mentioned a couple times you're trying to price closer to the cost curve in cheese and kind of change the pricing algorithm in that business. Just two follow-ups there. One, how is that sort of thought process being received by your retail partners? Is it I guess a pretty big departure from what you've done as a Company in the past and then I guess while that might reduce a lot of the volatility going forward that you've seen in the business more recently, does it change at all the structural return of that business, perhaps is it lower just because now you don't have the ability to sort of price the way you might have previously? And then I have a follow-up for Tim.

Yes, a couple of thoughts there, Andrew. I would tell you that the work we're doing on cheese is similar of the work in process. We are looking at a number of different ideas in concert with our customers. I will tell you that they are quite receptive to the notion of their being greater transparency. One of the challenges in the category historically has been that there hasn't been very clear transparency and that I think what we're talking about doing is as we move forward will make a big difference. I think if anything, what we're talking about executing will actually help the structural returns and most importantly reduce the volatility, so we see a number of positives of getting our pricing, our merchandising pricing closer to the marketplace. I believe our customers are receptive to the idea but working through the details of exactly how we want to execute that is something that we will be doing in the course of the coming weeks and months.

We think, Andrew, the new pricing strategy as we roll it out being much closer to input costs will benefit us. Will enable us to get back to respectable margins and maintain them. Again our customers in many respects are also our competitors in private label arena and I think they will welcome the lead we're taking on that. If you think about where we had been in the past, we lost something on the way up and we probably gained a little bit on the downside, but with increased volatility that's not a good place to be.

Thanks for that and then Tim just a quick one. In thinking about your 2008 earnings base, obviously we know there will be an adjustment of some magnitude once the Post transaction is completed and you've kind of given ranges around that. I want to make sure I'm clear on as you look to absorb your up front costs going forward I guess starting in 2009, do you think there will need to be some form of adjustment to kind of the '08 earnings base beyond the Post adjustment, as you move into that sort of new model of absorbing these costs and if so, is there any way to sort of gauge what that might be at this stage?

Yes, Andrew. I'm actually going to wait until after we announce the Post divestiture and recalibrate 2008 before we give guidance. I know that's a question that is on many peoples minds. The larger majority of the heavy investment and restructuring will be behind us in -- by the end of 2008. We do expect to continue over time to continue to drive costs out. There will be some further investment but it will give an indication that we're probably $700 million some in 2008, that number should drop by probably $500 million in subsequent years on a kind of 250 million or 200 million to $300 million annual spend, a fair amount of that we think we can absorb it and still deliver the 7 to 9% but we're not at this point going to committ to exactly how we're going to recalibrate that.

Okay. Thanks very much.

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

Hi, actually I have a few questions. Irene, I guess first I'm not exactly clear as to why the EU is all of a sudden performing so much better. The fourth quarter was a real mess. You've kind of said it was going to take awhile. Is the consumer recovering over there because it doesn't sound like it's necessarily that your products are where you want them to be in that region?

No, I would say a lot of what's happening over there is very much a result of our own efforts on our coffee business. It's the redeployment of some of the money that we were spending that we had siphoned off from our base coffee businesses and we were spending on Tassimo, the redeployment and the reinvestment in our core Jacobs and Carte Noire franchises. It's the focus on our core brands, Milka, Toblerone and Cote d'Or and the combination on chocolate and coffee of that focus has had some tremendous results and dramatic improvement in our top line performance. The issue in the EU is to continue to maintain top line momentum but start to make progress on the margin front and as I've said we are committed to doing that. We have a number of programs in place. We should start to see sequential improvement in our EU margins as the year progresss and again, the addition of the Lou biscuit business will also enable us to improve our margins overall in that region.

Great. And then just a point I missed earlier, Tim, what was the new inflation number that you gave all in for '08?

Input costs inflation we're looking at probably as we view the marketplace today, we're probably talking about a 12% increase. In the first quarter we're up $460 million and we're looking at perhaps somewhere, 1.5 to 1.7 billion expected for the full year.

1.5 to 1.7, okay. And then I guess just as a bit of a follow-up to Andrew's question, Irene, I just don't know, I mean I understand that you kind of focus on the organic revenue growth and then earnings number pre the Post split or spinoff but that isn't like, I don't know, I guess I don't think that's really accurate, I mean sales this year are going to be in total including the acquisition in currency and everything else that we have to factor in, is that a $41 billion number, 42? I mean I guess I'd like a little bit more clarity as to kind of what you're thinking in terms of the other drivers for the top line that are having a significant influence on that and then also, why not, given that you know you're going to either split or spin that business, why not give us a better picture on the bottom line as to what that means and then we can really gauge your margins as to kind of really where it looks like it's going to fall out for the year?

Yes, our expectation is, I mean we're coming up towards mid year when we expect to complete the transaction, at that time we'll give a better update when we know the specific of the timing. At this point, we still don't know specifically what the timing is which will have -- would have an impact on how we report the year. So within the next couple months we should be to the point where we'll give you better guidance on that.

And the top line?

The top line as well.

But I'll tell you, Eric, we've been working pretty hard over the course of the last two years or so to make the necessary investments in quality, in marketing support and in innovation to create sustainable growth on our top line and I think as you're seeing from our results, each of our businesses we've chosen to focus on the businesses that can have the greatest impact. The businesses that we've invested in are in fact responding and we're seeing it in revenue growth, we're seeing it in market share improvement, clearly these investments are paying off and so we have great confidence that we will continue to deliver the kind of top line growth that we have committed to. We have taken our guidance up somewhat from at least four to at least five as we said simply because in this extraordinary pricing year without a doubt, we are seeing some extraordinary impact of pricing.

Okay. I tried and then I'll ask one more. Or maybe just react to this comment, but why, Irene, shouldn't we view the new pricing mechanism to the market as opposed to an average in something like cheese as kind of recognizing that that's more of a commodity type of strategy? I mean, if the brand has equity, shouldn't you be able to just pretty much price as you kind of want as opposed to more or less having to react to the underlying commodity?

Well, I don't want to act as if we're reacting to the underlying commodity. I simply want to make sure that we are not getting left behind. You are well aware the issue that we have had on our cheese business is that we have been left behind and so our pricing strategy is designed to stay ahead of that curve and ensure that that is not a contributor to a margin decline. We are confident that as we continue to innovate, launch ideas like LiveActive, ideas like Singles Select, ideas like Bagel-fulls, that these products are going to continue to help us drive both our revenue performance as well as our mix contribution.

So is it kind of fair to say that there's like a part of the cheese business let's say that is a little bit more commodity oriented and that's going to be kind of priced to the market as opposed to, as you kind of layer in these new value add products that you hope not to have to price those to market and more to the old way of doing it which was pricing to average?

I think the key is to find those areas where we believe we can have differentiation and our focus within cheese to your point will be on the highest margin segments and so our expectation going forward is that we can significantly improve our mix performance in cheese by focusing on the higher margin products as well as pricing aggressively enough to cover, to recover any of the cost increases.

Okay. Thank you for taking all my questions.

You're welcome.

If we could take one more question?

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

Great. Thanks a lot. Good morning, everyone.

Godd morning, David.

I'll try to be quick and I do appreciate you taking the question after the hour here. U.S. Snacks and cereals, I'm surprised no one has asked any questions about this because it seems to be the most important data point in the quarter, the most surprising one to me, this division has been very consistent for many many years with very high margins. Irene, can you comment on the, an absolutely massive margin degredation here. How does the split work between snacks and cereal? Was it all cereal and so we can just forget about it because this thing is going to get sold off or was the bulk of the degradation related to the snacks portfolio?

Well, first of all let me say, David, clearly we are not pleased with the Q1 performance of our snacks and cereal business. There's no two ways about it and in particular the margin performance. The process as Tim mentioned were impacted by two factors that we do expect will reverse themselves over the course of the year. The first was our conscious decision to take our initial pricing action by reducing trade. We believe that is very definitely in the long term health of the business and, but it does take longer to see that play through and as I mentioned we did price protect some of the snacks businesses at Super Bowl time.

The second is we did have a very unexpected run up in wheat costs in particular which caused us some dislocation in the first quarter. We announced a pricing action in fact just on Monday, a second pricing action and so we are confident that as we continue to invest in those franchises and we have a significant investment in ANC planned we've got a very strong innovation pipeline as I look at some of the items coming behind in terms of 100 Calorie Packs, the Oreo Cakesters extension, some of the stuff we're doing on Ritz, all of which should lead to a sequential improvement in both the top line and the bottom line performance of our snacks business. But let me also say quite honestly, the cereals business was not the drag on the overall performance. We had a very strong biscuit business performance. We felt good about our Planters business. We saw some inventory deloading which impacted shipments but did not hurt our share, and we were actually, our cereal business, we were actually able to hold market share and we grew both top line and operating margin, so that was not a drag. I think in most, the biggest impact was the dislocation on the pricing front and that will correct as we move to the out quarters here.

Probably half the degradation was attributable to the trade as opposed to pricing, the other half was the run up in some of the wheat costs particularly and again, with the pricing action and as the course of the year rolls out, the benefits of the trade change will also improve our margins.

This is a very surprising result and I can't imagine that folks are going to be happy to see this particular business have these troubles. We all know the problems in cheese and coffee and understand the commodity side, a very branded business where you have number one brands all over the place, this is a tough one to swallow here but I do appreciate the comments and good luck with that business. Thank you.

Thank you, David.

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

Thanks very much. Thanks, everybody for joining us on the conference call. For those of you from the media who have follow-up questions, please contact Mike Mitchell at 847-646-4538 and for analysts who have follow-up questions I will be around all day. So thank you and have a good day.

Thank you. This concludes today's Kraft Foods first quarter 2008 earnings conference Call. You may now disconnect your lines.