億滋國際 (MDLZ) 2008 Q3 法說會逐字稿

Good day and welcome to Kraft Foods Third Quarter 2008 earnings Conference Call. Today's call is scheduled to last about one hour, including remarks by Kraft Management and a 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 are Irene Rosenfeld, our Chairman and CEO. and Tim McLevish , our Chief Financial Officer. Our earnings release was sent out earlier today and is available on our website at Kraft.Com. Also available on our website are slides that we will refer to during our prepared remarks.

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 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 reconciliation within our news release. They are also available on our website.

Irene will first provide her perspective on our results and outlook today, and then Tim will highlight our financials and review the results for each of our business segments. After that, Irene will take your questions and open up for questions. So with that I'll hand it off

Thanks, Chris. Good morning everyone. At the risk of stating the obvious, the world has changed quite dramatically since our last business update, but within that environment, I'm very pleased that we've just reported strong Third quarter results. Taken together, our revenue, market share and profit are all trending in the right direction despite a very challenging environment, and so while the global economy has worsened I feel even more confident about our business prospects. Specifically, our Q3 results have again shown that we're able to build our business momentum despite significant headwinds, and although we face some new macroeconomic challenges, I am confident we can successfully navigate through them and that Kraft will emerge from the present environment even stronger.

Why do I feel that way? Well, in terms of our business momentum, we're continuing to see a good payback from our investments in quality, marketing and innovation across our major categories and markets around the world, and we're seeing benefits on both the top and bottom lines. We've invested to improve product quality and rebuild brand equity since 2007 and that has given us renewed pricing power. As a result, 2008 represents an important landmark. It will be the first year in many that Kraft will fully offset input cost inflation through a combination of pricing and productivity. Going forward, I'm very comfortable that our pricing at current levels and our strength in brand equities leave us well positioned to continue to manage changes in input costs either up or down.

At the same time, our volume has held up better than expected despite significant cost driven price increases and an increasingly unsettled economic environment. As consumers have traded into food at home and traded down to value oriented meal offerings, we've given them many reasons to come home to Kraft. We're driving solid growth in a number of high margin businesses, like Mac and Cheese, Kool-Aid, Jell-O, and Di Giorno by emphasizing our value oriented positioning versus higher cost alternatives. We've successfully innovated into new segments with products like Oreo and Nilla Cakesters, upper mainstream Milka dark and Milka filled chocolates, Bagel-fulls and microwavable Di Giorno and California Pizza Kitchen, pizzas for one. Our restaging efforts are paying off in other categories like mainstream coffee and salad dressings in which we're beginning to reverse years of share declines.

As a result of our stronger than expected volume performance, we are raising our guidance for 2008 organic revenue growth to 7%, up from at least 6%. Overall, our revenue fundamentals have improved significantly. In fact the next two slides put this improvement into perspective. Slide 6 shows that on a year-to-date basis our mix is up 80 basis points and we've achieved that growth despite unprecedented pricing up almost 700 basis points. Slide 7 shows our US market share. In Q2, the temporary dislocation from our pricing actions affected both our 13 week and our 52 week market shares. As competitors appear to be catching up to market costs and consumers continue to respond favorably to our investments, we are pleased to see our shares rebounding from 42 to 47%. Not surprisingly, our performance in value oriented non- measured channels has been particularly strong reflecting our successful focus on value meals. Going forward we'll continue to invest in our brand equities and the value positioning of key brands. We'll benefit further from product news in core categories like crackers. and as a result, we expect to see market shares continue to improve.

We also feel good about the sustainability of our business momentum because we're taking advantage of our unique strengths. First, we're leveraging the scale of our broad portfolio. Our growth is now sufficiently broad based to enable us to disproportionately allocate our resources behind the biggest opportunities. We're seeing results from the highest margin, highest growth categories in North America, and from our 5-10-10 strategy in Kraft International, where our focus on five categories, 10 brands and 10 Markets is paying off nicely.

Second, our decentralized structure is leading to better, faster decisions that are driving profitable growth. Our business leaders are focused on their largest most profitable brands and looking at them holistically. In some cases, they're trading volume for profit. This includes optimizing trade spending, cutting less productive SKUs, and exiting certain product lines. In fact more than half of our Q3 volume decline was due to conscience decisions to sacrifice less profitable volume. And third, we continue to generate significant cost savings and we see considerably more savings opportunities ahead of us. As we outlined in September we now expect $1.4 billion in restructuring savings, well in excess of our original plans, and we have a strong pipeline of cost reduction initiatives beyond our restructuring program which will be implemented in the normal course of business over the next few years. Net-net, I feel quite good about our business performance in a very challenging environment.

Having said that, the world has changed considerably since our update only one month ago. Obviously, there are a number of moving parts, and the recent turmoil in the financial markets has reduced our upside potential. We will continue to pursue opportunities to backstop our plans and to offset those variables outside of our control, but from an operating perspective, we remain confident that we will deliver at least $2 GAAP EPS in 2009.

Why do I say that? Three reasons. First, we're well positioned to navigate through the current financial crisis. Yes, credit markets are tight, but we have ample liquidity. Our Balance Sheet and cash flow remain strong. Our investment credit rating is serving us well. And we've maintained regular access to the commercial paper market. Second, we've adjusted our plans for the possibility of weaker near term volumes. That's covered within our guidance. We've done this because tight credit may lead to some retailer inventory liquidation that could impact our fourth quarter shipments and because changes in consumer sentiment and consumer spending remain a concern. And third, we are well positioned in the current environment because we have strong, underlying operating momentum as we head into 2009.

Our year-to-date volume, operating income, and taxes are all better than expected and so we will continue to invest in quality, marketing and innovation to build our competitive advantage. We have a strong pipeline of cost savings both from our restructuring program and from future initiatives, and in 2009, we will realize significantly more synergies from our LU Biscuit acquisition. In some, despite some significant headwinds I believe the investments we've made over the past two years will enable Kraft to emerge from this environment even stronger.

Now I'll turn the call over to Tim.

Thanks, Irene and good morning. Please keep in mind unless otherwise noted my comments will exclude the items affecting comparability that were highlighted in our press release.

I'll begin my comments by starting at the top line. Our Q3 net revenues increased 7% on an organic basis. As we had expected, the balance of organic growth in Q3 shifted to pricing. We've acted decisively this year, taking a series of cost driven price increases in virtually every category and every market around the world, and the cumulative effect of our actions is playing out over successive quarters. The 8.4 percentage point increase in Q3 compares to about seven points in Q2, four points in Q1, and less than two points in all of 2007 and this trend should continue into Q4.

At the same time, we remain encouraged by our overall volume and mix performance. It held up better than expected, reflecting the benefits of our investments in quality, marketing and innovation. In fact, as Irene mentioned, more than half of our Q3 volume decline was due to a conscience decision to sacrifice less profitable volume. This is most evident in three areas. Natural cheese and foodservices, service in the US, roasting and ground coffee in parts of the EU, and ready to drink beverages in Asia. As a result ,we've raised our organic revenue growth guidance to 7%.

Turning to the drivers of Q3 earnings per share, we delivered strong gains from our operations in the quarter. As you can see in the chart, our operating gains in the third quarter accelerated versus the first half of the year, consistent with the guidance we provided in January. This reflects the fact that the benefits of pricing and productivity are now catching up to the increase in our input costs. I'd also note that the Q3 operational improvement reflects $0.02 of negative timing impact due to commodity hedging gains that were recognized earlier in the year. Additionally, the quarter was negatively impacted by $0.06 related to the mark-to-market on our commodity hedging activity. We largely anticipated this as we flagged our significant mark-to-market gains in Q2. So if we're to adjust for the timing impact of our hedging activity in the same manner we did in Q2, our ex-items EPS would have been about $.52. This is a good place to stop and discuss our input cost situation.

This chart shores prices by year versus the 10 year average for our key commodity inputs. Despite recent declines from all-time highs, prices of key inputs remain well above prior year and historical levels. Put this in context for Kraft. In Q3, our input costs were up about $700 million over last year. Year-to-date our input costs are up about $1.5 billion and for the full year, we continue to expect input cost inflation of about $2 billion or up about 13% over 2007. Going forward, we're comfortable that our pricing levels are appropriate for the current input cost environment.

Back to Q3 earnings. The strong contribution for Operations just discussed was offset by two factors below the line. One was higher interest expense, a $0.06 headwind versus the prior year. For the full year, we expect interest expense to be at the higher end of our 1.2 to $1.3 billion range. That's slightly more than we anticipated and reflects higher borrowing costs including the higher rates we're currently paying for commercial paper. Second was the $0.05 negative impact due to lower earnings from discontinued operations. The negative impact was slightly more than anticipated due to certain adjustments associated with the closing of our Post transaction. While not a significant contributor year-over-year, our tax rate is worth mentioning. Excluding items, our Q3 effective tax rate was lower than expected.

It's due to three things: A shift in our geographic mix of earnings this year, recent tax legislation, and a favorable resolution of several discrete items. These changes have lowered our expected average effective tax rate to 31.5% for all of 2008 down from the 33% we had previously forecasted. About half of the reduction comes from our geographic mix and the remainder is split about evenly between legislative changes and discrete items. As it relates to our 2008 EPS guidance, favorable taxes will help to cover the negative impact from currency and interest expense. So we remain comfortable with our 2008 EPS guidance of at least $1.88 despite headwinds from the current macroeconomic environment.

I'll take a few minutes now to share some highlights of our business segment results. I'll start with North America where our second wave of investments, better execution at retail from wall to wall and our new organization structure are all having a significant impact. Our results are benefiting from a focus on our highest margin, highest growth categories. Our programs to highlight the value proposition of our brand s are gaining traction across a number of businesses. In fact, half our North American reporting segment posted positive volume in the third quarter. Looking at individual segments, in US beverages, organic net revenues grew 7.4% behind solid gains in both volume and pricing. Ready to drink, powdered beverages and coffee all contributed to growth, and ready to drink beverages our investments in quality and Marketing behind Capri Sun and Kool-Aid lead to volume growth. This is a significant turnaround from the price related volume declines we saw earlier in the year.

In coffee, our investments to restage of the business continued to have a positive impact. We posted double digit growth in Maxwell House and more than 40% growth in Tassimo. In fact Maxwell House drove a market share gain in the mainstream segment for the fourth quarter in a row. Powdered beverages also delivered solid growth. This was driven by continued strong volume gains in Kool-Aid and Country Time as we have improved our value Marketing to consumers. However, at the profit line beverages operating income was down slightly. Here, the benefits from cost driven price increases and volume growth were offset by higher input costs and to a lesser extent, unfavorable product mix. In US cheese, organic net revenues were up 7%. This reflected double digit cost driven price increases and war partly offset by related decline in volume.

Four factors are worth noting here: First, even considering a recent price decline in September, list prices versus a year ago remain up between 5 and 20% across our cheese categories. Second, we made a conscience decision to not chase un profitable volume during the quarter particularly in the natural cheese business. In the near term, as absolute price points remain at historic highs we would expect volume pressure and difficult comparison to persist. On the other hand, innovation such as bagel-fulls continue to deliver solid benefits and more importantly, we're benefiting from new advertising that highlights the great value of Kraft singles and Velveeta, two of our highest margin cheese products. Most importantly, this played through to operating income. It was up strongly versus Q3 2007 as the multiple pricing actions we've taken have caught up with the input cost increases we've seen over the past year. Going forward, we expect margins to be in the mid to upper teens on a normalized basis. There will be some variation quarter to quarter but it will be within a much tighter band than we have experienced in the past as a result of our decision to price closer to market.

Moving on to US convenient meals, our investments in quality, base marketing and new products drove 8.6% organic revenue growth. We had strong gains from cost driven pricing and one point from improved mix. In Oscar Meyer, the strength of our Deli Fresh Cold Cuts platform continued. It delivered strong double digit revenue growth and about a point of share gain in the overall Cold Cuts category. Our Deli Creations sandwiches also grew strongly in Q3, driven by the new flatbreads line. This continues to be highly incremental to our base Oscar Meyer business and it's on its way to see the $100 million mark as consumers continue to see significant value compared to take out sandwiches. Finally, strong volume growth in pizza continued. Not only from our base Di Giorno and California Pizza Kitchen offerings but also from the rollout of our new line of single served offerings under the 4-1 banner. This drove more than a point of market share gain in frozen pizza during the quarter. Operating income in this segment declined about 6% versus the prior year. Here, our pricing actions did not fully cover the combination of a steep recent escalation in input costs specifically in beef and pork used in Oscar Meyer products as well as higher marketing and overhead costs. As we move forward we expect our year-over-year profit performance to improve as pricing catches up with the input costs.

On to US grocery. Organic net revenues were up about 6% and operating income grew 5%. Jell-O and Mac and Cheese again delivered a combination of pricing, market share gains and higher profit margins in the quarter. Both categories continue to benefit from the current economic environment as consumers search for value oriented meal solutions. These gains were partially offset by declines in other parts of the business such as spoonable dressings where pricing actions lead to volume declines. Our Kraft Pure salad dressing rollout remains on track with cost price increases and slowed volume growth in this category as well. Overall we're encouraged by the progress we're making in growing our high margin grocery portfolio and we expect more to come.

Looking at US snacks, organic net revenues were up 4% in Q3, entirely due to pricing. At the category level, solid gains in biscuit were partially offset by two things. A decline in snack bars due in part to product pruning, and pricing related volume declines in snack nuts as a number of competitors have taken pricing actions later in the quarter. In biscuits our focus on our largest brands is paying off. Our top five brands grew 16% in Q3 and are up 10% year-to-date. The addition of Nilla Cakesters and the ongoing strength of Oreo Cakesters pushed this platform further towards the $100 million mark and resulted in double digit growth for both the Oreo and Nilla brands. Overall revenue performance in crackers improved versus last year with double digit gains in Triscuit and strong growth in Ritz due to successful marketing investments and terrific consumer response to our new Kraft Mac and Cheese crackers.

Going forward, we expect our cracker performance to improve further. Beyond new products and improved Q4 marketing programs. This should lead to an even stronger biscuit performance in the Fourth Quarter. At the operating income line, profit grew about 4%; however, Q3's results were negatively impacted by approximately $25 million or about 15 percentage points of growth. This is due to the benefits of commodity hedging activities that were recognized in the Second Quarter rather than offsetting the related input costs in Q3. So on an adjusted basis, profit for the snack segment would have been up about 19%.

Turning to Canada and North America foodservice, organic revenue growth was up 4.5% versus last year. We had another solid quarter in Canada driven by pricing, strong volume, and share growth. The ongoing success is due to increased investments in Marketing and 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 growth came from a combination of pricing and innovation in the form of new menu items and quick service channels and it's worth noting that our foodservice volume was down only about 1% in the quarter despite a significant slowdown in restaurant traffic and the effect of exiting a low margin, unbranded supply contract. At the operating income line, strong growth was driven by gains in both Canada and foodservice. Top line growth, manufacturing efficiencies and overhead cost leverage more than offset higher input costs. Volumes will continue to be a challenge in the near term but given the base business gains from Marketing and innovation, we expect solid year-over-year margin improvement to continue.

Now I'll turn to our international business. Our 5-10-10 strategy, five categories, 10 brands and 10 Markets is clearly paying off across Kraft international. We continued to show very good organic growth especially in developing Markets. And with the balance of growth now shifting to pricing, we're beginning to catch up to cost increases especially in the EU. In the EU, organic revenue growth was driven by about five points of cost driven pricing. That was partially offset by nearly three points of volume decline; however, the volume decline is primarily due to pruning lower margin products and pruning will continue to play a role in our volume growth profile for the next three quarters. Growth in our focused areas, however remain solid.

In chocolate, we continued to deliver strong growth from the ongoing success of our Marketing and innovation investments particularly behind our billion dollar Milka Brand. Cheese also driven in the quarter from investments behind our leading Philadelphia brand. In coffee, revenue declined slightly as gains in Tassimo were offset by planned volume losses and less profitable brands. At the profit line, the EU operating margins improved 170 basis points versus last year, and they continued to improve sequentially from prior quarters. The biscuit business added substantially to operating results this year but even excluding the acquisition, EU operating profit was up strong double digits as higher pricing and favorable product mix more than offset higher input costs. As we continue to integrate the Lou biscuit business still in its first year, we'll deliver more revenue and cost synergies which will drive improved top and bottom line performance.

In developing Markets, we saw continued strength with organic growth of 19% driven by solid mix gains and 13 points of pricing. Volume was down slightly in the quarter entirely due to lower volume in Asia. In Asia, volume declines were primarily due to pruning activities and a timing shift due to a distributer consolidation between Kraft and the Lou biscuit business. Beyond these factors, we're continuing to see strong growth across our developing Markets due to our focus on and investment in core categories, core brands, and key Markets. Operating profit growth was very strong, up more than 50%, even excluding the profit impact from the Lou acquisition and we delivered solid growth in every region.

Finally, a few notes on cash flow. In addition to our solid earnings base, we're making good progress on working capital. Our improvement program delivered a six day reduction in our cash conversion cycle with inventory being the main contributor. CapEx through nine months was $900 million and we remain on pace to spend just over 3% of net revenue for the year. As a result, we've generated about $1.6 billion of discretionary cash flow through nine months and are on track to beat last years level of 2.3 billion. With that, I'll hand it back to Irene for some closing comments.

Thanks, Tim. So to summit up, we've continued to build momentum, despite significant headwinds. Our investments in the business are paying off in stronger top and bottom line performance in all geographies. Obviously, it's a new world and there are a number of external factors whose impact on 2009 will be clearer as the New Year begins. So certainly keep you posted but I am confident that within this challenging environment, Kraft is well positioned to win. Now, we would be happy to take your questions.

(OPERATOR INSTRUCTIONS). Your first question comes from Jonathan Feeney with Wachovia.

Thank you. Tim, I wanted to ask about, just wanted to see if I think about this right. So the $180 million in commodity hedging activity, those are non-cash hedging adjustments and if you added that back to operating margin, you'd get to sort of an apples-to-apples type number? Am I thinking about that right?

Yes, that's correct Jonathan. If you think about it in Q2 at the end of the quarter we had some hedges for accounting purposes were considered non- effective and we had to mark them to market.

Sure.

During this quarter, essentially, the sourcing that we did for the related input costs was unprotected by those hedges and not cash but earnings reductions.

Maybe this is too nit picking but was there any kind of similar impact in '07 to think about as I try to figure out what the year-over-year, apples-to-apples is?

It was very minimal if anything.

Good. Thank you. And just Irene, you mentioned specifically I guess trade deloading as a potential phenomenon. I've heard reports of that as well. Could you talk about, is that a retailer driven thing? Is it a consumer driven thing and what regions will be most impacted and if you could put a little bit more color around that I'd appreciate it.

Let me start you out in saying I'm not making a forecast. I was just trying to really characterize our guidance and be clear to you that we believe we have taken an appropriate planning stance but the kind of potential inventory impact is that the retailer level as they are struggling with some of the same economic issues that our industry is suffering from.

And is that mainly in Europe where I've heard about that it's a big factor in Europe. You said the factor also in the US you believe?

Absolutely. I think if you look at the earnings profile of the number of our key customers this is a tough environment for them.

Okay. Thank you very much.

You're welcome.

Your next question comes from Todd Duvick with Banc of America Securities.

Yes, good morning.

Good morning, Todd.

Appreciate your comments on the liquidity situation and I just had a question with respect to potential refinancing. You had a note that matured on October 1 and it looks like you must have refinanced that with commercial paper in the short-term. Can you confirm that and also tell us if you have plans to tap the debt capital markets at any point in the near term?

Well, let me just first say that yeah, our balance sheet remains strong. We do have, Kraft is a strong name and we have good access to commercial paper markets. We did have the bonds that you identified that matured on October 1 and we did refinance that with short-term commercial paper and we'll just have to consider the market conditions as to whether we would come out with any of our commercial paper in the next several months.

Okay, and do you have any target level with which you're comfortable having short-term debt versus long term debt? Is there like an average commercial paper balance that you have on the balance sheet for flexibility?

Yeah. I think we think we're well served by having an active commercial paper program. You can estimate approximately what that would have been considering the balances at the end of the quarter and the refinancing of the $700 million. Remember, we have a $4.5 billion back up facility that remains undrawn and that was reduced by a small amount as Lehman withdrew from that credit line but we have ample liquidity as Irene mentioned and we feel good about our position.

All right, thank you very much.

Your next question comes from Judy Hong with Goldman Sachs.

Thanks, good morning everyone. Irene, I was hoping to get your perspective on your market share trend. Obviously, it improved in the third quarter versus your second quarter but it's still down versus the first quarter and I'm just wondering how you feel about sort of the direction of the overall market share trend in the US and as it relates to that and you've talked about food at home sales getting benefits and trading down the value oriented offering, to what extent is the private label more concerning going forward?

Well, Judy, I feel very good about the progress we're making on market share. There's no question that the investments that we've made over the last couple of years are serving us well. It's strengthen our brand equity and it's giving us the ability to take the pricing while having less impact on our volumes than we had expected going into it. We do see as we look out as the marketplace continues to catch up to some of the cost profiles in a variety of categories, we do see that a number of our price gaps are narrowing and as we look ahead, we do expect to see continued progress as I mentioned in our market share. The other thing I'd mention to you with respect specifically to share is that we're seeing an increasing disconnect between free outlet shares and total market performance as consumers are increasingly value conscience and they are doing some channel shifting, so in some respects you don't have full visibility to our total share performance. That said, I think we are well positioned in the current environment.

Our categories are clearly consumer staples and are definitely part of the general consumption patterns. Our increasingly broad geographic footprint particularly with the addition of LU Biscuit is serving us well. A number of our brands provide very strong value proposition s at any time but especially in the current environment brands like Jell-O, Kool-Aid, Mac and Cheese, for example. We've got even within categories very good coverage across price points so if you look at a given category like pizza for example, we're covering the spectrum of pricing from Tombstone all the way up to California Pizza Kitchen and importantly, I think the most overriding trend that's impacting and helping our business is that we are benefiting as more consumers eat at home and we have offerings that compare quite favorably, things like Deli Creations or even frozen Di Giorno frozen pizza so net-net I feel good about the progress we are making on share in large measure as we suggested to you in the past. There was some temporary dislocation in the Second Quarter which we can now see beginning to correct itself and I'm Quite optimistic about our prospects going forward.

Okay, and then just one question for you Tim. If you look at our Year 2009 guidance that at least $2 per share that hasn't changed I guess since September, I'm just wondering how much of the currency fluctuations recently that you're factoring into your '09 guidance at this point.

Yeah. Well obviously as Irene mentioned the world has changed since September. We still remain committed to our $2 earnings per share in 2009. There are a variety of factors that go into that, the exchange rate certainly is an element of that but all things considered, as we look forward in our anticipation of 2009 we remain committed to our 2009 EPS guidance.

Okay, thanks.

Your next question comes from Christine McCracken with Cleveland Research.

I apologize. I was on mute. Just in terms of your outlook on commodity prices and as it relates to the price increases that you've taken already, I'm wondering we're hearing a little bit about the retailers pushing back and that the pass through of those cost reductions that deflation and how quickly do you think at this point you'll have to pass through some of those reductions? I think you've done it in coffee already. Maybe you could comment on that.

Well, Christine obviously, our pricing strategies are competitively sensitive. What I will tell you is that I feel very good that the focus that we've had over these last couple of years on brand equity has clearly paid dividends and the ability to price, we've certainly been able to price our brands much more so than we've been able to in the past and at this point as we've said we're substantially priced to the current market environment.

Having said that, I think we are well positioned to deal with market conditions. We do see some costs declining but in most cases we're still looking at costs that are above a year ago and in a couple of cases like for example, wheat and soy beans, we're seeing prices from the chart we showed you in our deck that were up actually 150% to a 10 year average, so we're still looking at some fairly significant prices. Now that said I need to remind you that our long term growth algorithm assumes that we're simply going to use pricing and productivity to cover costs. Our margin expansion actually comes from the leverage of our volume and mix performance and we remain focused on driving our brands and adding value to our brands to enable us to expand our margins through our mix.

All right I'll leave it there. Thanks.

Your next question comes from Terry Bivens with JPMorgan.

Good morning, everyone.

Good morning Terry.

Irene, one thing I get a lot of questions about these days is kind of the calculus between what appears to be some commodity help next year versus the currency headwind. One of your competitors in fact mentioned that for roughly every dollar they've received recently in foreign exchange they've paid out about five in commodities. I know clearly a lot has changed and probably will change as we go into 09 but can you give us some indication of how you're thinking about that trade off as we go into next year ?

Well, Terry, as we've said we feel very good about the operating momentum as we head into 2009. Clearly the investments that we've made in our brand equity and our product quality is paying off well. We're seeing good performance in all of our geographies around the world. We've got a very solid pipeline of cost savings initiatives and as we look into 2009, we have the added benefit of incremental synergies from our LU Biscuit business so our underlying operating momentum is quite strong and as we continue to see the opportunity to invest in the business, we will do so and I feel quite good about that. Obviously though, the world has changed and we certainly expected more upside in September than we might see today but and as we look at current market-rates, we see that there are some significant non-operating headwinds but we're spending our time working to offset them. Clearly, we'll have a stronger perspective as we head into next year, but net-net, I feel very good that within a very challenging environment we are well positioned to succeed.

Okay. And just one more quick thing. I mean, in line with your comments about a channel shift, if you look at the Nielsen numbers for what basically covers your quarter in North America, sales are indicated down 1% yet your revenues reported are up six. Do you think that kind of, I mean clearly there's a lot of growth going on in the non-measured channels whether it's price or volume. Do you expect that to be sustainable?

Simple answer is " Yes". As consumers increasingly are looking for value, I think we provide a unique set of offering, brands like Kool-Aid, like Mac and Cheese, like Jell-O are fairing particularly well in the current environment and I see no sign that that will stop in the future. So, we feel very good about the ability to holdup across all channels as well as our future prospects look quite good.

Okay, thank you.

Thanks Terry.

Your next question comes from Alexia Howard with Sanford Bernstein.

Hello there.

Hello.

Hi. Since we've got a lot of moving pieces in terms of drivers of EBIT growth in 2009 and I was just wondering if you could give us a little information on I'm thinking about the --

Operator? I think we're getting somebody cutting in on the line here.

Yes, sir, we're researching that now and trying to find out where it's coming from, I apologize. We've got the problem fixed. I apologize.

You hear me okay?

Yes.

Okay, so EBIT growth next year, I remember when you made the cookies acquisition late last year you were talking about $200 million in cost synergies from that acquisition. Can you confirm roughly how far through that process you're at at the moment and how much of that we could expect to see coming through in '09 and is that part of the $1.4 billion of the restructuring program? I don't believe it is but just to confirm that we should have a lot of those savings coming through plus the extra $300 million of the restructuring program that's due to come through beyond the end of 2008, so really just trying to get a handle on productivity savings next year, and then in terms of some of the additional things that you have to put into the pot next year it seems as though pensions are likely to be something of a head wind next year depending on the market and finally advertising spending. I'm not sure where you expect to be in terms of advertising as a percent of sales by the end of 2008. Maybe you could give some color on that and where you expect to be perhaps by the end of 2009.

Well let me help you with that one because I can write faster.

Let's start with LU. The 1.4 billion does not include any synergies from the LU acquisition and we remain confident that we see our way clear to delivering those savings. We did, the synergies that we laid out at the time of the acquisition were over a two to three year period and we will , you could assume those will come, those are more back end loaded but as I mentioned in my remarks, we certainly see some incremental opportunity year-over-year both in terms of revenue and in terms of cost as a consequence of our integration of that business in selected regions, so net-net , we see not only our base restructuring opportunities and fundamental base cost savings initiatives but we also have incremental opportunity as a result of the LU integration. Let's talk, let me turn it over to Tim

Yeah, Alexia, as you perhaps know, we maintain a balance, an asset allocation of about 70/30 equity to fixed income in our pension plan and you can assume that the plan is performing just about as the rest of the market is, so obviously that puts some downward pressure on our asset value and the pension plan. On the flip side with interest rates spiking the discount rate on our pension liabilities is also increasing. On balance, there's a fairly significant offset in that and we'll have to see how those things play out at the end of the year to determine on our measurement base exactly what impact that will have from our pension expense in the next year. I think it's important to note that our plans remain well funded and that we don't anticipate any required cash contributions this year or going into next year.

Let me just follow-up on your advertising and marketing spending question. I feel very good about the investments that we've made over the past two years and I think they've given us an exceptionally strong base from which to build. You'll see our AUC will be up again in 2008 despite the challenging cost environment, we should come in at about 7% of net revenue and I feel particularly good about that as we watched some of our peers take their spending down, so net- net, we will continue to invest in the business and build on the equities we have been creating and I feel very good about our prospects going forward.

I think important to note, at the beginning of the year we had indicated that we anticipated 7.5% as a percentage of revenue. We will spend the same number of dollars that we had anticipated at that time, however the percentage of revenue will come down to a little over 7% as Irene identified purely as a result of the denominator impact of the significant growth.

Great. Thanks ever so much.

Your next question comes from David Driscoll with Citi Investment.

Great. Thank you. Good morning everyone.

Good morning David.

Wanted to talk to you a little bit more about the market share issue. So Irene it seems that you're interested the sequential improvement but maybe you could talk a little bit about the year on year declines on the 13 week data, specifically what I want to understand is these numbers are still negative and when we look at volume data that we can see in food, drug and mass data, the volume data is concerning to me. In cheese, for instance your top category in the United States, Kraft equivalent volumes were down 19% in FDM data while private label was up 11. It was a 30 point gap between the two and I've never seen a gap that large so the question really is, with market shares declining, and with volumes declining at least in the data that I can see in the measured channels, what's your outlook here for the sustainability of your pricing and really, why shouldn't we be concerned about this a bit more than I think you guys were in the prepared comments?

Well, David, let me just remind you again, we are seeing tremendous channel shifting in the current environment so for starters it's increasingly difficult for you to look at IRI data for example, and forecast our total market share performance and I think as you look at our shipments and certainly recognizing nobody is building inventory right now , as you look at our shipment profile it is clear that we are consuming more than you can see in the traditional channel so there's clearly some channel shifting going on. We knew that there would be some temporary dislocations. We were quite active and aggressive in our pricing in relation to the cost situation earlier in the year. We knew that there would be some temporary dislocation and we talked about that quite a bit at our Second Quarter call.

But if you look at categories like cheese for example, and there's no question we are not freezed with our cheese share performance if you look at the relative segments what we are consciously sacrificing some volume in less profitable segments like natural cheese which is the bulk of our share decline relative to segments like processed cheese and cream cheese and so we are looking and Velveeta in particular if you look at that business is exceptionally well positioned in the current economic environment so we're making some very conscious tradeoffs, category by category, segment by segment within our category, and we remain confident that our outlook going forward is that we will see more than half of our shares growing on a sustainable basis. So I come back to the fact that it's been temporary dislocation as a consequence of our pricing and response to the cost environment but we are clearly seeing that begin to recover and I have great confidence that it will continue to recover in the

Great. Thank you.

You're welcome.

Your next question comes from Eric Katzman with Deutsche Bank.

Good morning everybody.

Good morning Eric.

My first question has to do with the international and EU results excluding both acquisition and currency. Maybe, Tim, you could talk a little bit about what those numbers look like because we've been hearing very distressing things about what's coming out of Europe and I want to try to judge how you're doing on the core business with the understanding that you now own Donone and that's going relatively well.

Yeah, well we're quite pleased with all of the progress we've made in the international business and particularly the EU has shown good progress from levels that it has in the past. We've shown solid organic revenue growth and we showed a significant improvement in OI margin. Obviously LU was a contributor to the reported numbers but even in absence of that we showed a nice profit improvement in the EU. Clearly, there are signs that the EU is slowing and we'll be monitoring that as we go forward. The good news is is that even as the market softens, we're in the consumer staple business and we think we can deliver growth within the guidance we've laid out.

So you can't give me a number as to what profits were ex- acquisition, each-currency?

We're not going to give, we'll have to follow-up with Chris after the call as to the specifics. We layout an EU number but I can't give you a sub-break out of that.

Okay. And then Irene, I've heard from a number of companies that are competitors of yours or just in the food space and watching from afar and it sounds like your efforts at Wal-Mart in particular spending something like $120 million on a promotional program, trying to maybe have your own aisle, I know it's difficult to talk about a specific retailer but it seems like I guess from your numbers that that's been a correct decision but can you talk a little bit more about your willingness to spend so much on promotion in that channel?

Well, let me be clear. We are not spending so much in promotion in that channel. I clearly, the information you're getting is coming from other companies and it's an interesting thought but we are spending proportionately in the marketplace and I feel particularly good about our performance with a customer like Wal-Mart because they are growing retailer. They are well positioned in the current economic environment and our value positioning is working quite well together with them, but I feel particularly good as we move forward here that as we see the success of some of those value meal programs, other of our customers are jumping on Board and particularly with the wall to wall capability that we now have at retail I am quite comfortable that we will see continued progress with other key customers as well so I feel very good about the program that we've had with Wal-Mart. We look forward to continuing to build on that success but going forward we have some very exciting programming across the marketplace, really driven by the fact that we have so many products and brands that really are fitting uniquely well into the current value space.

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

Your next question comes from Chris Growe with Stifel Nicolaus.

Yes, good morning.

Good morning, Chris.

Hi. I have two questions for you. The first one is that you had anticipated, this is a follow on to Eric's question. Anticipated cutting back on your trade promotion spending this year. Has that changed throughout the year whether it be the pricing environment or the competitive environment to where you actually had to increase that level of promotion? You're not giving me specific numbers with respect to the mix of our spending but we remain committed to the opportunity as I mentioned in my remarks of continuing to refine our trade spending to make sure that it is much more performance based, that it's serving the businesses that get the most impact for that spending and as a consequence of that we've been able to make some terrific progress in building our brand equities while still maintaining our volume so I think that will be a program that will continue as we go forward and we are committed to making that shift over time. Earlier in the year you talked about reducing trade promotion $200 million for this year. Is that something you can confirm?

Yeah, I can confirm that that in fact is in the numbers we've given you today. Okay, all right and then the second question SR there any other categories where you anticipate price increases whether you want to discuss which ones they are or not, are there any areas where you are still looking to take a little bit of pricing given your current cost environment? Well, Chris, as I said earlier, obviously our pricing strategies are competitively sensitive. I feel terrific about the brand equities of our core brands as a result of the investments that we've made. We are substantially priced to current market prices today and but importantly, I think we're well positioned as we go forward here to respond to market conditions either up or down. Okay and then the last question I have relative to your wall to wall program, do you have any, can you give any numbers around what that's adding to sales growth as best you can define that?

Well, I guess the best at this point we've essentially rolled wall to wall out to all the Markets that we intend to. We believe it is a key reason that our volumes in North America have held up better than expected. If you look at our North American volume it was down about 1.5% against 6.5% pricing so I feel awfully good that the merchandising capability that we have at retail is a key driver of that and I truly believe it will continue to be a source of competitive advantage for us.

Okay, great. Thank you.

Your next question comes from Ken Zaslow with BMO Capital Markets.

Good morning everyone.

Good morning Ken.

My first question is when you talk about volume and pricing, is there and I see what you're saying that the volume wasn't down as much as you anticipated but is there a balance that you want to have where you can get like 2-3% volume and 3-4% pricing? How do you maximize that and where do you think that stands right now?

Well again, we're in a little bit of a dislocation right now. I think we all understand that the cost environment has been disproportionately high over the course of the last year and a half, but I want to remind you, our long term growth algorithm is that we will rebuild our brand equities to the point where pricing and productivity will cover cost and we will rely on volume growth and mix to essentially expand margin so clearly, volume growth in the range that you've laid out is part of our long term algorithm. As you said in the short-term, pricing is contributing disproportionately to our revenue growth.

And there's no difference in the margin, like I guess what I think about is if you have less volume, does that increase your fixed cost in that operation and then does the pricing fully offset that in margin? I guess that's what I was trying to get at. I don't know if you can comment on that?

Well first of all, it's pricing together with productivity that is meant to offset input costs and the answer is as we looked to at market pricing, we feel very good about our profile. It seems for us going forward is to insure that we continue to drive, fill our brand equities and drive the growth of our categories.

Okay, my next question is with the channel shifting, this is part A, and part B, to this and they aren't that long. One SR there any channels that you're underindexed that you think there might be extra growth opportunities there and the second part to it is is there any in terms of channel shifting is there any margin compression based on bigger sizes or anything like that we should be aware of?

Simple answer is we're well represented across all channels and that's why I think we are uniquely well positioned to win in the current environment. To the extent that there are different margin profiles from one channel to another, that's something that we continue to work on over time so that as the consumer moves, from channel to channel, we are and that's not impacting our margins but to date that has not been an issue.

Great. I appreciate it.

Your next question comes from Eric Serotta with Merrill Lynch.

Good morning.

Good morning Eric.

Just to pick up on one of Ken's questions, in terms of pricing versus volume, clearly, as you mentioned this year, as expected, top line organic top line was driven primarily by pricing with a much smaller contribution from volume. As we look to calendar 2009 I think it's fair to assume that absent the tremendous cost pressures or looking at more moderate cost pressures, or even cost relief, you aren't going to be able to lien on that pricing lever so much so it seems that volume has to play a much larger role in the overall top line, organic top line growth mix. I'm wondering whether you could sort of dimensionalize for us qualitatively at least what some of the drivers that you expect volume growth to be between on the one hand you have a softer consumer environment and on the other hand that could play well into some of your category growth, your internal efforts in terms of rebuilding your brand equities and other factors behind that, if you could talk about what some of the drivers you're looking at for volume growth next year would be.

Well Eric, one of the reasons I feel particularly confident that within this very challenging environment we're well positioned to win is the nature of our portfolio. We've got a number of categories that are consumer staples and will be relatively consistent regardless of the economic environment. Our geographic footprint is increasingly broad, particularly with the addition of the Lou Biscuit business and we have a very strong value proposition across our portfolio, with brands like Kool-Aid and macaroni and cheese and Jell-O, and we've got very good coverage within categories on key price points as we look at individual categories so we cover Maxwell House up to Tassimo, and all the way up to Oreo, so we've got very good price coverage within categories to address the fact that we do see some consumers trading down, and importantly, we are clearly benefiting as more consumers come home to Kraft, they're eating at home and businesses like Di Giorno, like Deli Creations have very strong value propositions in terms of relative to away from home alternatives. The other point is that as our wall to wall capability continues to improve and we learn more and more about what we need to do to train this Army of ours, we are an increasingly valued partner to our customers and I think that opportunity will continue to drive our volume particularly in North America. So net-net I think there's a number of characteristics about our portfolio as well as our sales capabilities that will enable us to continue to grow within the current environment and as you rightly point out as we look forward, the contribution of volume mix to our revenue performance is likely to improve as we exit the exceptionally high input cost environment that we've been dealing with.

Thank you for that and a quick follow-up question on that. At the level of volume growth that you're looking at for next year, is it reasonable to expect to see some material improvement in your operating leverage or fixed cost leverage versus what we've been seeing in 2008?

Eric, I'll remind you, we have guided to a 4% organic revenue growth in2009 and we would expect to see a much better distribution back to our normal long term distribution between volume mix and pricing as we go into next year. So obviously, with more volume contribution from it we would expect more leverage contribution to the bottom line from that.

Okay, great. And just one final question here. A lot of people seem to be focused on the three outlets indicated data which you've pointed out and the results clearly show there's a real disconnect between that and the all outlook data. Do you have any numbers that you could share with us in terms of sort of a composite category growth or growth in some of your key categories in all outlets?

We don't provide specific number like that because it actually wouldn't be a very meaningful number Eric but I will tell you is the vast majority of our categories across-the-board are growing quite healthful and again I think in response to the fact that these are consumer staples that are exceptional, offer exceptional value in the current economic environment and it's one of the reasons that we are optimistic about our prospects going forward.

Great. Well good luck. I'll pass it on.

Thank you.

Your next question comes from Brian Spillane with Banc of America Securities.

Hi good morning and thanks for taking the question. Just one follow-up on just thinking about volume drivers for next year. Are you now, given what you've done in terms of pricing and productivity and thinking about that relative to your competitors and especially private label, are you now the low cost producer in many of your product categories, and if so, is that going to help maybe change the way you try to manage volume and share going forward?

Well obviously, our decisions with respect to how to best manage our revenue growth, our profit growth and our share performance is going to continue to be important to us as we go forward and we'll be making the appropriate trade autographs category by category. We feel very good about the productivity that we've turned in over the last few years. I think particularly with our new organizational structure, the decentralization is not only making our business unit Managers more accountable for productivity but it's causing them to look at their business on an end-to-end basis and that's turning up a whole host of productivity opportunities that we might not have seen in the past and it's one of the reasons I am so optimistic about our prospects going forward , so I feel very good about our cost position. We will continue to focus on that as an opportunity to make sure that we are investing, to enable us to invest appropriately in

Thanks.

Your next question comes from Robert Moskow with Credit Suisse.

Hi, thank you. A concern I get from investors is about emerging markets and whether they withstand the global credit crisis and how consumers are going to behave there. I mean, a lot of your growth this year has come, 50% run rate and profit growth in emerging markets. What are you doing in those Markets to I guess make sure that we don't have a repeat of blow ups that we've had in the past, I remember 2003 was a very bad year for Latin America and having been to Russia, I've heard that some retailers are starting to pushback and not allow price increases so can you give us a sense of what you're seeing in those markets?

Yeah, Robert, to date we're seeing a lot more indications of consumer weakness in the media headlines than we have been seeing in our own numbers but without a doubt we are concerned about the economic environment particularly in developing markets going forward. I feel very good about the focus strategy that we've implemented within our international business. This idea of focusing on the brands, the categories and the Markets where we have the highest potential and we made significant investments and will continue to do so behind the brand equities in those markets and I think that will continue to serve us well, even in the event of a slowdown, but most importantly, as you look at our performance particularly in international, we've been growing well in excess of our long term targets, and so even if these markets soften somewhat, I think we're well positioned from a portfolio standpoint and we certainly have a little bit of head room to be able to see those numbers come down a little bit and still deliver the guidance that we've laid out for you.

Okay, and then lastly, a commodity question. You've kept your guidance for commodity costs unchanged for the year, despite the fact that a lot of these commodities have come down a lot. Can I assume that that means that you were hedged for the year and therefore there's no impact and then the next question is as we look into '09, should we expect your commodity inflation headwind to be just much less severe and maybe more like a single digit number than a 13% number? Thank you.

Yeah. I think as we look at the remaining of the year, we're closing in on the end of the year and obviously we do have hedge positions on most of our major commodities and normal course according to our natural hedging program, the prices have very recently come down and most of those are either already in inventory or have short-term hedge positions. Clearly as we look out into 2009 we wouldn't anticipate the amount of increase that we saw in 2008 in our major commodities so to the degree that they will come down we just have to play that out but as of right now, we wouldn't anticipate significant increase in commodities. Given the very recent volatility in changes, it's too early to anticipate what impact 2009 or it will have on 2009.

But is it even conceivable the number could go to 0?

The increase?

Yes.

I think that's not inconceivable for it, i mean, we're not in the business of forecasting those. Obviously, we have to manage those inputs. We have to manage our hedging positions and so fourth but clearly, we're at historical 10 year highs on virtually every one of our major commodities and to assume that we're going to see significant increases past that is probably a bit of a stretch.

Okay, thank you, Tim. Thank you.

Your next question comes from Andrew Lazar with Barclays Capital.

Operator? If this could be the last question, I think we're getting past time.

Good morning.

Good morning Andrew.

Just to follow on very quickly then from Rob's question. Is there a way you can give us a sense of how much you either are or are not hedged out into 09 at this stage, because the reason I ask is it begs the question I think there's an expectation now, building in the group as a whole that as you move into '09, the year-over-year inflation is a lot less substantial, perhaps there's a case to be made for margin improvement to really snap back and in some cases maybe dramatically in the group and I'm trying to get a sense of whether this is really a reasonable expectation in your mind.

Well, let me start with the question of our hedge position. We run as we've said before an ongoing hedging program to protect our margins going out until our ability to price at the end of the day, we communicated to you our algorithm that pricing and productivity will cover cost and that volume and will provide overhead leverage and improve our margins. Our normal program would naturally be hedging out, some six to nine months on some commodities where we see that we need production and our view of the pressures on upward or downward of those individual commodities. I can't give specifics about how long and specific of the commodities but generally, we haven't made a change to our hedging program in recent months.

I guess I want to underscore again Andrew, we are not relying on our pricing for margin expansion, so we are priced, we feel very comfortable we're priced to market cost right now and we will be able to go with the market up or down, but that's not the basis for our ability to expand margin over time.

Great. Thanks very much.

Before we close, can I go back to Eric Katzman's question which was margins ex-LU and ex-currency? I've cleared with our disclosure experts here and I can say that ex-FX, which contributed about 5% of the EU operating income and ex-Lou, we would be in double digit organic or operating income in the EU in the third quarter.

Okay, great. Well thanks everybody for joining us. If you have members of media have further questions, Mike Mitchell will be available to take them after the call and for any analysts and investors who have questions, myself and Steve will be around all day so thanks very much for joining us and have a good day.

This concludes today's conference call. You may now disconnect.