億滋國際 (MDLZ) 2017 Q4 法說會逐字稿

Good day, and welcome to the Mondelez International Fourth Quarter 2017 Year End Earnings Conference Call. Today's call is scheduled to last about 1 hour, including remarks by Mondelez management and the question-and-answer session. (Operator Instructions)

I would now like to turn the call over to Mr. Shep Dunlap, Vice President, Investor Relations for Mondelez. Please go ahead, sir.

Thank you. Good afternoon and thanks for joining us. With me today are Dirk Van de Put, our CEO; and Brian Gladden, our CFO.

Earlier today, we sent out our press release and presentation slides, which are available on our website, mondelezinternational.com/investors. During this call, we'll make forward-looking statements about the company's performance. These statements are based on how we see things today. Actual results may differ materially due to risks and uncertainties. Please refer to the cautionary statements and risk factors contained in our 10-K and 10-Q filings for more details on our forward-looking statements.

Some of today's prepared remarks include non-GAAP financial measures. Today, we will be referencing our non-GAAP financial measures unless otherwise noted. You can find the GAAP to non-GAAP reconciliations within our earnings release and at the back of the slide presentation.

And with that, I'll now turn the call over to Dirk.

Thank you, Shep. Good afternoon and thank you for joining us. This is an important moment, at least for me, since this is my first earnings call as CEO. I am honored to lead Mondelez and I am excited to be with you today. Mondelez is a great company with iconic brands, many competitive advantages and a very strong team. We have a simple yet powerful purpose and vision for the company, which is to create more moments of joy by building the best snacking company in the world. And I look forward to make that happen for the benefit of all our stakeholders, consumers, customers, communities, colleagues and you, our shareholders.

Today, I'll share my thoughts on our performance in 2017, some of my early impressions and the priorities I have been focused on during my first 60 days. I'll also share some perspective on our outlook for 2018 before I turn it over to Brian.

Overall, I would call 2017 a solid year. We delivered another strong year on the bottom line. Our adjusted operating income grew by 130 basis points and adjusted EPS was up by 15%. This was achieved largely through our strong operating performance. On the top line, our organic net revenue grew 0.9%. And while that was in line with our latest outlook, we know we can do better. 3 of our 4 regions, Europe, Asia, Middle East and Africa and Latin America each delivered solid profitable growth. Our emerging markets are improving and we exited 2017 with the BRIC countries gaining some momentum.

In North America, the June malware incident had a significant negative effect on our results for the year. Going forward, we remain focused on improving our performance in this region.

Our Power Brands continue to deliver strong results. Our biscuits business is solid and our chocolate franchise is growing well around the world. We also returned $3.4 billion to shareholders through dividends and share repurchases. So all in all, it was a solid year for us given the environment.

But we are not satisfied and we know we still have a lot of work to do to get to a stronger path of sustainable growth on both the top and bottom lines. It's encouraging to see that we exited the year with an increasing momentum as our organic revenue grew 2.4% in the fourth quarter. So we are cautiously optimistic we can carry some of that momentum forward in 2018. That, given the strength of our global portfolio, our focus on execution, improving currency and also commodity market trends.

So let me turn to my priorities and the opportunities ahead of us. When I became CEO in November, I established 3 immediate priorities: the first, pretty obvious, get to know our business, our consumers, our clients and my colleagues; the second, we have to execute our 2018 business plan with excellence. It's the last year of our current strategic plan and so we want to finish the job; and third, lead a comprehensive review to develop a new strategic framework for the next 3 to 5 years.

As a consequence, during the past 2 months, I've traveled the world, meeting with customers, colleagues, suppliers and investors. I've visited all 4 of our regions, 8 of our 10 biggest markets and I plan to continue to visit critical markets in the months to come. I've spent that time mainly listening and observing to be able to lead this business with knowledge and to drive that new strategic plan. I've been very impressed by the power of our brands in so many local markets and how committed our colleagues are to winning in the marketplace. My visits have confirmed my belief that our company is uniquely positioned to differentiate itself based on our brand leadership across major snacking categories.

Through our attractive geographical exposures, especially in emerging markets, our strong innovation capabilities and a continued renovation of our assets, we will be able to drive solid growth, both on the bottom and the top line.

As you know, we have made excellent progress on margins. We have delivered an improvement of 600 basis points since 2013. Going forward, we're well positioned to benefit from improving market dynamics. We will leverage our competitive advantage to also accelerate our top line growth. It's early but we are seeing some signs of category improvements in some markets. However, we do have a lot of work to do. We must continue to evolve to meet today's fast-changing consumer expectations. We have to be more innovative, forward-looking and fast-moving than ever before and we'll have to combine that with excellent execution in each of our markets. And all of that must be done while remaining obsessed with our cost structure in order to stay competitive. Therefore, we're thoroughly evaluating our business to refresh and evolve our growth framework. For me, this deep dive is an essential step to develop the right plan that drives sustainable growth and shareholder value.

We will share a little bit more of our approach to the strategic review at CAGNY in a few weeks. But please keep in mind that we're still in the initial phase of that review. We expect to complete this highly important work by the end of the summer and we'll provide more detail at that stage. In the meantime, we remain very focused on executing our 2018 plan.

As we think about our outlook, I want to make a few points before I hand it over to Brian. Overall, we expect our top line trajectory in 2018 to improve over 2017. Our categories improved in the second half but we're taking a balanced approach to our outlook this year. As such, we expect our organic net revenue to grow between 1% to 2%. As I mentioned before, the only region that hasn't been performing in line with our expectations is North America. They have a dynamic and competitive retail environment. So solid execution is key. And since the malware incident last summer, our supply chain execution has been challenged. While we are making progress, returning to normal service levels is taking longer than anticipated. We do know what needs to be done. And as such, our performance is gradually improving. But we do expect it will take a few quarters to see consistent improvement in this business.

On the margin front, we remain committed to further expansion and expect to deliver an adjusted OI margin of approximately 17% in 2018, including the impact of pension accounting changes. We do expect that 2018 will be another year of double-digit EPS growth at constant currency, which sets us apart from others in the industry.

And before I turn it over to Brian, I want to make a couple of comments on the Keurig-Dr Pepper transaction that was announced this Monday. We are excited to participate in this opportunity as we are significant shareholders in this new company. And we are pleased with our ongoing partnership with JAB. We see this as a compelling, new platform with a potential for significant additional value creation for us.

Brian will take you through the details in his remarks. And with that, I'll turn it over to Brian.

Thanks, Dirk, and good afternoon. We're pleased that we delivered another strong year of margin expansion and double-digit adjusted earnings growth, but we're not satisfied with our top line growth.

Let's start with our revenue performance. Organic net revenue growth for the year was 0.9%, which included a negative 40 basis points impact from the June malware incident. Second half growth was more than 2% as our Power Brands, emerging markets and overall category growth rates have picked up. Power Brands' performance continued to be a key driver of our growth, delivering more than 2% for the year. Emerging markets' revenue increased 3.6% as we see improving fundamentals across an increasing number of markets such as India, Russia, Southeast Asia and Mexico. In addition, our e-commerce business continued to perform well as we drove net revenue growth of more than 40% for the year. Our progress in 2017 supports our commitment to have a $1 billion e-commerce business by 2020.

In the fourth quarter, we grew 2.4% as we moved beyond the impact of the malware incident and we lapped the prior year impact of demonetization in India. For the quarter, our results were driven by continued growth in our Power Brands and emerging markets of 3.7% and 6.3%, respectively, with positive volume growth for both.

On a regional basis for the year, Europe revenue increased 1.3%, driven by growing volume and good results in both chocolate and biscuits. AMEA revenue grew 2.7% with exceptionally strong growth in India as well as solid results in Southeast Asia and Australia. Latin America grew 3.5%, behind mid-single digit growth in Mexico, strength in Brazil chocolate and currency-driven pricing in Argentina. Our North America revenue declined 2.4% as we saw challenges in our biscuits business resulting from malware-related losses, a tough operating environment and mixed execution.

While we've seen some areas of positive progress in our DSD share gain plans, our service challenges have kept us from realizing all the gains we expected in the U.S. biscuits business during the year. That said, we are addressing our service challenges and we continue to believe our DSD system is a competitive advantage.

Now let's review our margin performance. We executed well during another year of adjusted OI margin expansion, growing 130 basis points to 16.3%. We've now delivered 600 basis points of margin growth over the past 4 years. Our 2017 results were driven by strong net productivity and lower SG&A. As we've delivered this margin improvement, we've continued investing in growth programs, funding our white space launches and with total A&C spending of approximately 9% for the year. This is down slightly in aggregate but up in several priority markets.

Gross margins were down slightly for the year as commodity pressure and select trade investments offset strong productivity. We're still expecting gross margin expansion will be a contributor to our 2018 OI margin growth, which I'll discuss in our outlook.

On a regional basis, strong net productivity and cost execution drove margin improvements in 3 of 4 regions. Europe delivered a strong year of margin expansion posting an increase of 160 basis points to 19.7%. AMEA increased by 140 basis points to 13.1%. Latin America increased 260 basis points to 15.5%. And North America was down 10 basis points to 20.1% as select trade investments and lower revenues limited margin growth.

Now let me provide some category highlights. Snacking category growth finished the year at 2.1%, with the second half performing better than the first, while our overall share results were mixed. Our biscuits business grew 0.8% for the year, with strength in the U.K., Germany and Southeast Asia. This was offset by weakness in the U.S. Approximately 30% of our year-to-date revenue grew or held share in this category. And excluding North America biscuits, about 80% of our revenue grew or held share. In chocolate, our global business was strong, growing 5%. Highlights included exceptional growth in India as well as solid results across Europe and Brazil. In addition, the impact of the first full year of our chocolate expansions in China and the U.S. was an important contributor to growth. Approximately 65% of our revenue grew or held share in this category. Gum and candy declined mid-single digits as the gum category continued to face headwinds. About 15% of our year-to-date revenue in this business gained or held share.

Turning to earnings per share. We delivered full year adjusted EPS of $2.14, up 15% on a constant-currency basis, primarily driven by strong operating performance as well as good results from our coffee JVs.

2017 was another year of substantial return of capital to our shareholders. We returned $3.4 billion in total as we repurchased 2.2 billion of shares, in part from proceeds related to several non-core divestitures. In addition, we significantly raised our dividend in July while announcing our commitment to grow our dividend faster than earnings going forward.

Let me also spend a moment on free cash flow. For the year, we delivered $1.6 billion, which was below our outlook, primarily due to the timing of year-end customer collections and the impact of divestitures. We remain confident in improving cash flow performance in 2018 and beyond as CapEx spending is now below 4% of revenue, our restructuring spend is coming down and our working capital performance continues to improve with a best-in-class cash conversion cycle of negative 32 days for the year.

Now I'd like to give you an update on the impact of U.S. tax reform as it relates to our 2017 reported results. We recorded 2 significant entries in the fourth quarter relating to the implementation of the new tax law and we adjusted these one-time impacts out of our non-GAAP results. First, we remeasured our U.S. deferred tax liability, driven by the reduction of the U.S. tax rate from 35% to 21%, resulting in a $1.3 billion noncash one-time benefit to the P&L. Second, we're recording a $1.3 billion tax liability due on our historical foreign accumulated earnings. This liability results in a cash tax payout which we'll need to pay through 2026. As you know, we have limited accumulated cash overseas and are not repatriating any material amounts of cash as a result of the tax change.

Please see our upcoming 10-K filing for more information on these items.

Before I move to the outlook, I want to provide a few comments on the current Dr Pepper transaction announced earlier this week. As we've said in the past, we've been very pleased with the performance of our equity investments that resulted from the July 2015 divestiture of our coffee business. With the take-private of Keurig Green Mountain in March 2016 and under the leadership of Bob Gamgort and the team, we've seen significant appreciation in the value of our 24% stake. This is confirmed by the strong financial results you've seen at Keurig.

Similarly, our investment in JDE has also done very well. We think the financial and strategic rationale of this transaction is strong. We believe there's significant value to be created in the near term through the compelling synergies and long term as these 2 strong platforms and their brands are brought together. We're very impressed with the Keurig management team and see them as well positioned to run this new entity. In terms of key details, we'll roll our 24.2% stake in Keurig into a 13% to 14% stake in the new company and we'll continue to play an active role in the new entity with 2 board seats.

In terms of financial impact, we expect this to be accretive in year 1 for us while also providing a significant increase in cash dividends. We'll continue to account for this investment through the equity method and have no plans to exit. We also continue to be invested in JDE and see additional value creation from that platform as well. Overall, we're very pleased with how the July 2015 coffee transaction has evolved in less than 3 years and the value that it brings to our company.

Let me now provide some more details on our outlook for 2018, which we think is a balanced plan based on the environment we see today. We expect organic net revenue growth in the 1% to 2% range versus the 0.9% growth we delivered in 2017. This includes a return to modest growth in North America. And if global category growth continues to improve, we could see some improvement in this revenue outlook. Our first quarter is likely to have revenue growth at the low end of our total year outlook as we continue to work to stabilize our North America performance. We expect to deliver adjusted OI margin of approximately 17%. We're planning for continued strong net productivity and trade spend management as a key focus area. In addition, this will be another year of significant supply chain reinvention as we move more production to our new Lines of the Future. In 2018, we'll reflect the impact of the new pension accounting rules, which effectively move about $50 million of OI margin to below the OI line with no impact on earnings or cash flow. This is about a 20 basis point reduction in our adjusted OI margin.

We're expecting to deliver another year of double-digit earnings growth, driven primarily by continued margin expansion as well as JV earnings growth and share repurchases. In addition, I would note our expectations for lower interest expense due to our ongoing efforts to optimize our debt structure.

Our outlook for free cash flow is approximately $2.8 billion, which now represents a significant step-up from the past 2 years. This outlook does include the additional cash taxes relating to the U.S. tax reform.

Now let me talk briefly about the 2018 impact of the recently enacted U.S. tax reform. As you know, we're a very global company. Our geographic footprint and operating models have given us a low tax rate in the past with most of our earnings generated outside of the U.S. in jurisdictions with significantly lower tax rates. Aside from the 2 one-time items that we recorded in Q4 that I've already discussed, there are several elements of the new law that impact our ongoing overall effective tax rate. The impact of these items on our effective tax rate in 2018 is basically 0 based on what we know now. As you would expect, we're actively reviewing all opportunities to ensure we're structured as efficiently as possible from a tax standpoint.

In this outlook, we expect our 2018 adjusted effective tax rate to be in the low to mid-20s and likely very close to our 2017 rate. We'll provide longer-term guidance on tax when we update our strategy later in the year.

Now let me turn it back to Dirk for a few concluding remarks.

Thank you, Brian. So in summary, we have strong foundational pillars in place and we enter the year with momentum in several areas of our business. Our 2018 plan reflects an emphasis on execution, ongoing improvements in top line growth and continued actions to expand our margins. And as we develop our strategic plan for sustainable growth, we focus on how we can optimize and accelerate our strength to create more value for all our stakeholders.

As a leader, my philosophy has always been to set thoughtful goals and deliver against them. And as I look ahead, I am very excited about the opportunities to create value at Mondelez. Similar to my attention to consumers, customers and colleagues, I look forward to engaging with the investment community over the coming months and quarters.

And with that, let's open the line for questions.

(Operator Instructions) Your first question comes from the line of Bryan Spillman (sic) [Spillane] with Bank of America.

So I guess, we've got a few questions this afternoon just related to the guidance. And I think, generally, people are kind of looking at it and kind of looking at the second half organic sales growth that accelerated. And so the guidance sort of implies that maybe that acceleration doesn't continue. And also, maybe even on the operating profit margins, there might have been some expectation there would have been a bit a little bit more. So maybe could you start, Dirk, just talk a little bit philosophically how you think about planning and maybe how conservative or how much flexibility you're trying to put into your plans for maybe things that are unforeseen or things that might go awry?

Yes, yes, Bryan. Well, first of all, I arrived mid-November. I'm 60 days on board. Secondly, my approach to planning has always been that I try to set very thoughtful targets that I believe we can deliver. So with that, we are saying that we are going to have a top line improvement in 2018 versus 2017. We're saying 1% to 2% top line and expect about 17% adjusted OI margins. It is correct that the categories are growing faster in the fourth quarter. But if you look at the whole of 2017, we had the first half which was pretty low growth and then the second half was a lot better. So we've taken a balanced approach. We don't think we can already bet on the categories accelerating. And we also want to deliver on those margin expansion targets. So that's, overall, what I would say my philosophy is. And I think that maybe, Brian, do you want to add a few things to that?

Yes. Bryan, I would just say we're being thoughtful, as Dirk says, and I think careful with the top line. I would admit that there should be some upside. And as we look at the dynamics, we want to see a couple of things. First, North America stabilizing; and second, laying out really these global category trends. They have recently improved, but I'm not sure that it's fully sustainable and we want to see that. If the categories continue to improve, there should be revenue growth that's above what we've talked about here. We feel good about the margin expansion. It's in the range of 70 basis points. There's a good supply chain plan for the year. There would be smaller impacts that we've seen over the last few years in overheads as ZBB and shared services play out and, as you know, an improved commodity and currency environment. So we do have more runway on cost in both COGS and overheads as we look at the plans and we'll work through this as we get through the year. We do want to invest for the long term. So we'll continue to fuel and land investment around white spaces, innovation, renovation of our product portfolio as well as funding appropriate levels of advertising and promotional spend. And then on double-digit EPS, look, we feel good about that too. It's driven by margin expansion. The coffee JVs will continue to contribute. We'll have buybacks obviously and then lower interest expense. So overall, as Dirk said, thoughtful and I'd say a balanced plan.

That's -- thank you for that perspective. And if I could just have one follow-up. On the margin guidance, is that inclusive of FX? So is there some sort of -- because currency is going to have a much more impact -- be more impactful this year. So I'm just curious, is there any effect from margin -- or from FX in that margin guidance?

Yes, there's clearly a benefit for us of a weaker dollar. I'd say, as you look at transactional impacts, we haven't really factored in specific opportunities there. I think we have hedges in place for the majority of our exposures. We're trying to balance that with pricing actions. So I don't see transactionally a big lever in terms of the margins. I think you'll see it in translation. We gave you those numbers for '18. But in general, there will be some benefits associated with currency that flow through margins. But we're not necessarily capturing those in how we build the plan.

Your next question comes from the line of Andrew Lazar with Barclays.

Just following along on the top line guidance for a minute for '18. The global snacking category growth looks like, as you noted in the slides, it accelerated maybe even closer to 3% in the fourth quarter. And so if we take the 1% to 2% organic forecast for '18, I'm trying to get a sense of whether this is just, as you stated, not being certain about how sustainable that better category growth is or is it just suggesting that you see continued market share losses as we move in -- through '18? And the reason I asked is I'm assuming you need a lot less pricing to offset negative foreign exchange. And I was hopeful I guess that, that could lead to a -- more of a stabilization in market shares, particularly in emerging markets.

Maybe just, Andrew, I'll reset a little bit the numbers. So snacking is up 2.1%. I see your point, the fourth quarter was a bit better than that. When you look at the total business, it was in the mid-1s, right? So you got the cheese business -- cheese and grocery plus beverages that dragged that down a bit. This is roughly a share -- a flat share plan as we lay it out. And if -- again, if that category growth is better than that, again we would expect to see some upside there.

Okay, okay. And then, just I think you basically intimated in some of your prepared remarks that we should start to see a bit of a better balance in terms of where you get the operating income margin improvement from this year between gross margin and the SG&A line. Is it more a matter of just hopefully not seeing the type of volume deleverage that you've had the last couple of years such that some of the work you're doing around the supply chain footprint and the Lines of the Future and such can just more fully flow through on gross margin? Or are there other things at play there?

Leverage will clearly help, Andrew, I think, as we stabilize volumes. They've gotten a bit better. But I'd also say that commodity currency pressures, as we talked about a little bit, are not there. We're not -- as you see cocoa pricing has come down, I mean, we do have other areas where we're seeing commodities up. But net-net, it's not like what we've seen over the last couple of years. So we think that will help. We'll continue to execute on a pretty robust productivity plan for '18, roughly in the range of what we've been seeing over the last couple of years. And we think we'll be able to drop some of that through.

Your next question comes from the line of Ken Goldman with JPMorgan.

I guess, my question is on DSD. You talked about your desire to sort of stick with it. But I guess I would ask, why? Just given a few things, right. We have the malware incident I guess exposing some of the unexpected vulnerabilities of the system. Your biggest competitor in U.S. biscuits is probably doing better than some feared. I mean, it's hard to tell exactly how much of that is unique because of your challenges, right. We have the higher cost of transportation and then some of your bigger customers are demanding much better fill rates. They're trying to get trucks out of their parking lots. So I guess I'm curious, where's the evidence that we can see on the outside any way that DSD is really worth the what I guess would be hundreds of basis points to that segment's operating income?

Yes. Well, first of all, I'm just arriving -- and to make the decision on DSD is a pretty important decision. And on top, it's difficult to read what exactly is going on with the issues that we've been having. Overall, I think it's a powerful asset for our U.S. biscuits business. And so I do want to take some time to go through this and study and see what the cost-benefit declaration is for -- or keeping it or getting out of it. So it's part of our strategic review. We hope to have clarity near the middle of the year. But from my perspective, at least, it's a bit early to make a decision on that.

Yes, Ken, I would just say, I mean, we, clearly, given the malware incident and then the supply chain challenges that followed that, with the product availability challenges, I mean, we underdelivered here versus what we expected. There's no question. We have seen nice progress in capturing shelf space, increase displays. And in some channels, we've seen share gains. And -- but not to what we expected. We're still tracking it. There's likely some opportunities as the spring shelf resets play out and our case fill rates improve. And we'll see the progress as we work through that over the next few months. But we'll look at this as part of the strategic review, as Dirk said.

Your next question comes from the line of David Palmer with RBC Capital Markets.

First, just a follow-up on DSD and the malware issue. I think you said those issues were going to be an ongoing drag through the first half of 2018. Could you just give us some color as to why those fill rates would be such a persistent issue? And maybe any color, and I have a follow-up.

David, it's really -- I mean, the malware incident and the specific issues related to that were cleared up as we worked through the -- into the fourth quarter. It's just the supply chain really catching up. We've had some specific products where we were unable to build the inventory levels we needed to, to move through the year-end and the surge of demand we saw. We've seen good overall consumption trends in that business that have put more pressure on the supply chain. And to be honest, we just have to catch up and rebuild some of those stock levels. That's really the priority for us.

And then -- and just looking ahead to 2018 and looking back to how your innovation did in 2017, you had some big bets like Véa, the Milka Oreo chocolate in the U.S., Milka chocolate in China, how would you grade the performance of your innovation last year? What product should be building into 2018? And how does your pipeline look for this year?

Yes, David. I would say, in general, we feel pretty good about it. U.S. chocolate had a very good year. We're pleased with the momentum there. Velocity is good. Repeat rates have been good. Display activity is up. More to do there as we invest and bring some new products to market. Some of the other products that are more renovations and updating of our product lines in North America have also done well. And as expected, Véa is generally in line with expectations. As you know, it's a new brand. It takes a little bit of time to build brand awareness and consumer trial has been an important focus for us. It's highly incremental and I think we feel pretty good about it. But these things take a bit of time to get scale. But in general, the innovation pipeline is pretty good. For '18, continued focus on renovation. There will be some more innovations as we move through the summer across the biscuits portfolio. There will be a couple of things we'll do in gum this year. But continues to be a focus area for us and we're investing to keep the innovation pipeline going.

Your next question comes from the line of Chris Growe with Stifel.

Just had 2 questions if I could. I wanted to understand, in relation to the North American division, do you believe you can grow the margin in that division this year? And related to that, should we expect that the malware sales are, say, fully recovered this year including some of the loss sales or these supply chain issues kind of impede that?

Yes. On the first part, Chris, I mean, we continue to have margin opportunity in North America. It was -- we underdelivered on our commitments this year in terms of margin expansion for North America. However, it's still our highest margin business for the year as you look at comparable OI margins across the regions. Malware was the biggest driver, frankly, of some of that execution, not only around the top line but around cost. And it was a distraction to the team as the work in the supply chain had to move off of some of the cost programs and into getting case fill rates back to where they needed to be. We did have negative volume leverage in the year and that was a bit of a pressure. So it's still -- yes, the answer is yes. We'll still see margin expansion in North America. But we have a robust productivity opportunity there. Volume leverage again will help as we get that business back to growth. So yes, I think it's still an opportunity to do better, even in the rates we have today.

Okay. And I just had one follow-up, which was, do you expect any SKU rationalization activity of any size? And then also related to the Kraft licenses, going back to Kraft, does that -- what effect did that have on, say, the 1% to 2% sales growth for the year?

There's really no Kraft license impact in '18. There's a tiny one, it's relatively small later in the year. We're down, as you know, with a couple of the transactions that we've executed. We're down in the range of a little more than $200 million of revenue from these long-term licenses that ultimately go back. The majority of that goes back in the 2020 time frame. And the broader question around SKU rationalization. There's still some of that work going on. I'd say it's a smaller focus now. We've made great progress there and feel pretty good about where we are. We're down in the range of less than 23,000 SKUs. We started over close to 75,000. So not much in the way of impact in the '18 numbers.

Your next question comes from the line of Jason English with Goldman Sachs.

I actually have 2. First, and I want to come back and revisit a couple of points made already. First, on North America, and I don't want this to sort of overshadow the momentum you have outside of North America, which obviously matters more. But with the comments in terms of the service level, it's a bit hard to (inaudible) with the retail offtake data that we see, which has looked rather strong. It's hard to understand how retail offtake data would be, so strong if you're not able to fill the shelves. So is this really an out-of-stock situation at retail? Or has the service level effectively resulted in you being destocked? Is that why the retail offtake looks so much better than the sell-in numbers that you have?

Yes, Jason. It's been a bit of a mix. I mean, we've had some specific SKUs where we've had shortages. We've clearly had to do a fair amount of expediting, which is one of the challenges, as I said, in the margins. But as you look at some of the more recent data, I would just say we're catching up in some of that. So again, feeling better. I think it will take a little while to get back completely to normal and we're having to still invest in some cost to expedite. But that's really the story.

Okay, that's helpful. And I guess you segued into my other question, which is to come back to gross margin. You mentioned that commodities and currency are maybe the biggest swing factors. I was hoping you could put some teeth on that and give us a bead in terms of what commodities may have looked like to you last year in terms of pressure, what you're expecting this year. And then as we try to decompose your margin drivers and bridge us to kind of how we got here, there looks like there's a big mix line kind of leaking out from here. And I guess my question is, A, is that true, and B, is there anything that you think could help us turn that as we pivot into '18? Is gum -- like, do we need gum to turn? Or what are the drivers that could cause abatement of that pressure?

Yes. Maybe the second part first. I think, gum is the biggest. I don't think -- it's not a new issue. I mean, we've been fighting that negative trend as you look at the last couple, even probably a couple of years, maybe even longer. So we're planning the business in a way that doesn't expect a miracle to happen on gum. I think as you look at where we're investing and trying to drive mix, we've got a priority focus in the regions around more effectively managing that and making sure we invest to drive improved mix. So yes, I don't expect the environment to change a lot and that dynamic to change. But again, it's something we're counting on as we build the plans. In terms of commodity trends, we all talk about cocoa and the fact that, that's down over the last 6 to 9 months. But as you would expect, we haven't necessarily seen that help given hedging and inventory positions in cocoa. So that will begin to play out really not even in the first quarter, but after that we'll start to see some favorability. That's obviously a discussion with customers. It's a big part of our chocolate dialogue around pricing as we have negotiations. So we won't necessarily pocket all of that. And then, for us, remember that other commodities have moved in the opposite direction. Dairy has been a big headwind for us this year. So both cocoa and dairy were negative and hurt us in 2017. And dairy is even a bigger buy for us now than cocoa. Packaging, transportation are other areas where there's pressure. So I would say in aggregate as you look at '18, I don't see commodity deflation as a net positive. But it's not a big negative. It was a negative in 2017 and we had to price for that, we had to cover that. And we didn't quite do that everywhere.

Your next question comes from the line of Alexia Howard with Bernstein.

Could you give us a quick rundown on progress in the emerging markets, going through maybe the BRIC countries for example? It looks as though it was a nice acceleration in the second half. And I'd just be curious to know where China and India and Russia and Brazil are. And then I have a quick follow-up.

Okay. Maybe I'll start with Brazil. Brazil has been challenged for us but it's showing some improving dynamics. I was there about 3 weeks ago. The currency, as you probably know, was stabilizing and the GDP has turned positive. So our Q4 revenue growth was mid-single digits, about 5%. In chocolate, the category trends are pretty strong. We had 9% year-to-date. We had some share loss in Q4 because of aggressive pricing from one competitor. And in biscuits, we launched chocobakery with the Lacta and Milka cookies line, so that helped us to recover some of the share. So I would say, in Brazil, we are cautiously optimistic. The GDP growth is improving and the currency is stabilized. There's still some uncertainty in Brazil, I would say. Russia, we are feeling very good about. So it grew sort of mid-single digits in the quarter, 8.4%. The economy is showing clearly signs of progress with falling inflation. Our team is executing well. The year-to-date category growth in biscuits is 7%, it's 5% in chocolates. We are now the #1 player in chocolate. We did launch our chocobakery in Q2 -- Q3, sorry, and we're off to a very strong start. So we're encouraged in Russia because of the signs of the economic improvement and the higher oil prices, better GDP and the ruble strengthening. India, India very strong. We had a 27% growth in Q4, but that's of course lapping the demonetization. Still, we grew double digits without that. And overall for the year, India is up 12%. The category growth for chocolate and biscuits continues to be very strong with double-digit growth for the year. The team, I think, is executing very well. India, I was there 2 weeks ago and we had some good share gain. We gained about 1 point, a full point in chocolate over the past quarter. And so we have very strong performance in Cadbury Dairy Milk, Silk and a bunch of new launches. India, for me, is a very important market for us as the demographics are very strong. We see a growing middle class. We still have a very low per capita consumption of chocolate, about 0.1 kilogram. And the U.S. is 4.5, Germany is 8, the U.K. is 10. So we also see that we have significant room for distribution in the traditional trade and that is something we are actively pursuing. And the GDP growth rates are pretty strong. So overall, very bullish on India. And then China was a little bit off for us in the last years. But they had a solid quarter. They had 1.5% growth. But that was also due to the late timing of the Chinese New Year. I think we will continue to see some good news coming out of China for us. We have a number of opportunities. We launched the Milka magic cup, which is a new offering in our chocolate portfolio. E-commerce is quite big for us. We had a very successful Singles Day and we grew at twice the rate of the market in e-commerce. So the e-commerce was up 30% for us. With respect to -- sorry -- so on China, I would say we are feeling good and I think we will see some acceleration of the growth rate there in the first quarter.

Great. And a really super quick follow-up. I was surprised to see a bit of a slowdown in the share repurchase guidance for 2018. Does that mean you're planning to use the cash -- the improvement in free cash flow that you're anticipating this year for something else? Thank you, and I'll pass it on.

Yes, Alexia. We're -- we'll continue to reevaluate that. I mean, we've -- as you know, we did a bit extra in '17. It was driven by the availability of cash from some of the divestitures that we did. We'll continue to look at it over the course of the year. And as you know, we've done more than we would have said in the outlooks for the last few years. So...

Your next question comes from the line of David Driscoll with Citi.

Great. I wanted just to -- Brian, just a quick follow-up on the inflation execution for '18. I apologize, did you say '18 would be deflationary in aggregate for your basket of inputs?

You know what, I'd say it's about flat, David. There's puts and takes. Cocoa is obviously going to help. Dairy is still up, packaging is up, transportation is up. When you put it all together, it's about flat.

Okay, perfect. That leads into kind of the bigger picture question on your revenue guidance and pricing. So in years past, 2014, 2015, you guys are hit with very heavy foreign exchange headwinds. And as a result, we saw a lot of pricing from the company in various markets when there was a lot of foreign exchange headwinds. If 2018 is going to have foreign exchange tailwinds, and if there's really not much in the way of commodity inflation, what does pricing do? Is pricing actually down in 2018? How do you guys think about it?

Yes, I -- over the last, I'd say, 5 or 6 quarters, David, it's been more about pricing has been driven by the hyperinflationary emerging markets. And I'd say developing -- or developed markets for us, pricing net-net has been relatively benign. It's been relatively flat. And there are places where we put some more promotional spend or trade spend in play and we've talked about that from time to time. But as you say, commodities and currency in those markets have been relatively uneventful and then pricing has been relatively flattish. So I expect more of that. I think we'll see pricing, in general, be positive. But it's driven by hyperinflation as we look at '18.

Okay. And then one last one for me. Originally, Brian, I believe the guidance for the 2018 operating margin was a range of between 17% and 18%. You're giving us the 17% number today. But maybe, could you just kind of give us some thoughts as to why the top end of the range that you guys had set out some time ago why that's not really achievable in 2018? And I'm not trying to push too hard on this. I'm just trying to get a sense as to what's going on the gross margin, volume leverage, those kinds of factors as the game has actually been played out, kind of what influenced it so much to come down to the 17% level.

Yes, David. I would just say continued to try to strike a balance, making sure we're making appropriate investments in the business around growth. At the same time, we have the headwind associated with the pension accounting change. We also have the headwind that volume growth and leverage in the P&L has not been as good as we would expect with slower category growth. So again, with the progress that we've made with another approximately 70 basis points of margin expansion, while we invest to get more balance in the P&L and drive some top line improvement, I think we feel like that's exactly the right plan for where we are.

Your next question comes from the line of Rob Moskow with Crédit Suisse.

Brian, just a couple of quick things. Did you lower the operating margin kind of run rate going backwards also? I looked at your fourth quarter presentation a year ago and everything is 30 basis points lower. Is that because of the pension accounting change only? Or is there something there related to divestitures too? And then secondly, a question on free cash flow. I think you said that there was some year-end kind of positioning by customers that hurt your year-end cash flow. But shouldn't that help you in 2018 when that cash comes back to you? And if so, did you consider raising your guidance for free cash flow above $2.8 billion? Because I guess you've had $2.8 billion before and now it's still $2.8 billion. Sorry for the length there.

Yes, I'd say on cash flow, you're right. Clearly, there is some timing. We had collections that really were due on the 30th and 31st of December, which was a Saturday and Sunday, and the majority of that showed up in the next week. So we should have a good start and I can validate that we've seen that cash come in. The reality is we've got an incremental cash tax payment related to the U.S. tax reform that partially offsets that. We've got another one-time VAT-related tax payment that we have to take. So net-net, I think it puts us about at the $2.8 billion, and we feel good with that number. Your first question related to the backward-looking OI margin. And the one thing I would call out we did have is the divestitures, which had about a 20 basis point impact in the margin rates if you take that back and adjust for that. So that's the only...

So ex those 2 things, you would been at 17.5% here for 2018, I guess.

That's right. I mean, 17.4%, 17.5%. Yes, that's right.

And we have time for our final question. Our final question comes from the line of Matthew Grainger with Morgan Stanley.

Great. I guess, first question, Brian, could you elaborate a bit more on the benefit you expect from better utilizing the Lines of the Future and sort of where we are in the process? Are we just right now at the point of seeing some early improvement in category trends and being able to get better utilization rates there? And at what point would you actually be in a position to start thinking about reaccelerating some of the deferred CapEx that you might have put on hold previously?

Yes, I think we've made good progress. We've talked about getting to 70% of our volumes for Power Brands on advantage assets. We're in the range of about 60% now as we exit '17 and then '18 is we'll continue to make progress towards that goal. It really is the key for us is getting the volume leverage on those lines. And that comes from growing the business obviously. And we've got some volume growth that we're starting to see in some parts of the business. And then we'll continue to take actions across the supply chain to move more production from other lines onto those Lines of the Future. And that will be a focus that plays out. And I mentioned the fact that it continues to be -- '18 will be a year where we have some significant supply chain actions to do that, moving more production there. So still a lot of runway in terms of capacity on those Lines of the Future and that will create nice net productivity. That's one of the drivers of net productivity in 2018 that I talked about.

Okay, great, thanks, Brian. And Dirk, I guess, just a high-level question about reinvestment. I know you want to make sure that the company is taking full advantage of its differentiated position in emerging markets and the scale of the business there and sort of reaching your full potential from a top line perspective. Given some of the service issues in North America and the need to continue to stabilize that business, is this a year where we may continue to see a bit more of the near-term reinvestment flowing back into developed markets than may ultimately be the case once we get through your initial assessment and the multiyear strategic plan that we'll hear about later in the year?

I would say that, certainly, we'll have a look at it. We'll need to see how much leeway we have to do that because we do have to stabilize our North America situation first, and that's priority #1. We are going through an analysis where we are looking at what we think the opportunities are that we have in emerging markets and how we could capture those, what type of investments would it need. We're trying to do that as fast as we can. But if anything, I wouldn't expect us to make big moves in the beginning of the year here. Maybe towards the end, we will have more clarity on what is possible for us.

Ladies and gentlemen, this concludes today's call. You may now disconnect.