Mondelez International, Inc. (MDLZ) Q2 2010 Earnings Report, Transcript and Summary

Good day, and welcome to Kraft Foods' Second Quarter 2010 Earnings Conference Call. Today's call is scheduled to last about one hour, including remarks by Kraft's management and the question and answer session. [Operator Instructions] I'd now like to turn the call over to Mr. Chris Jakubik, Vice President, Investor Relations for Kraft. Please go ahead, sir.

Good afternoon, everyone, and thanks for joining us on our conference call. 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, kraftfoodscompany.com. We've also made available on our website a set of slides that we will refer to during our prepared remarks. As you know, during this call we will be making forward-looking statements about the company's performance. These statements are based on how we see things today, so they contain an element of uncertainty. Actual results may differ materially due to risks and uncertainties. So please refer to the cautionary statement and risk factors contained in the company's 10-K and 10-Q filings for a more detailed explanation of the inherent limitations in such forward-looking statements. Also, some of today's prepared remarks will include non-GAAP financial measures. And you can find the GAAP- to non-GAAP reconciliations within our news release. We'll start today with Irene, who will provide a brief overview. Then Tim will present highlights from our second quarter results. Irene will then conclude with an update on the Cadbury integration and discuss our outlook for the year. Following that, we'll take your questions. So I'll now turn it over to Irene.

Thanks, Chris, and good afternoon. As you've heard from so many companies, the global economy is tough. And the consumer environment continues to be weak in many markets. Nonetheless, we reported strong second quarter earnings. Our bottom line was high quality, driven by gross margin expansion from volume/mix and productivity as well as overhead savings. Our top line performance, however, was mixed, primarily due to softness in the United States. Our U.S. top line continued to be affected by two things: greatly reduced merchandising support from a key customer, which we foreshadowed in the first quarter; and a significant step-up in promotional activity in a few categories. We have solid plans in place to address these issues. And that will result in sequential improvement in top line results in the second half. However, I'm very pleased with the ongoing strength in Europe and developing markets. We expect our earnings momentum to continue in the second half. This momentum will enable us to invest in the business, while still delivering at least $2 in operating EPS. These incremental investments will restore growth in North America and fuel top line momentum internationally. Let me now turn it over to Tim to discuss the second quarter results in more detail.

Thanks, Irene, and good afternoon. Let me start by discussing our top line, which as Irene mentioned, was a somewhat mixed performance from our perspective. Organic net revenue growth of the combined business was 2.2%. The Kraft Foods base business grew 2%. Continued focus on investments in priority brands, categories and markets drove 2.2 points of all mixed gains, while pricing was slightly negative. In Europe and developing markets, we delivered strong volume/mix, but in the U.S, we continue to have headwinds, including a weak consumer environment, significantly lower merchandising levels and aggressive promotional activity in a few categories, mainly within our Cheese, Grocery and Snacks businesses. There were some bright spots, however. Investments in priority brands drove solid growth in our Beverage, Convenient Meals and Canadian businesses. Our growth model leverages volume/mix as a key driver in expanding margins over time. This next slide shows the increased contribution of volume/mix to the Kraft Foods base business over the past five quarters. Our Q2 vol/mix was somewhat below Q1, but we're not satisfied with that performance. But at the same time, I'd make three observations that make us optimistic about the future: First, our brand equity investments in quality, marketing and innovation continued to drive meaningful gains versus last year. This came despite a very difficult environment in many markets. Second, we feel good about the expanding geographic footprint of our portfolio over the past several years even before the Cadbury acquisition. In fact, through the first six months of the year, the strength of our international operations drove overall vol/mix gain of 2.6 points, despite a vol/mix decline of 30 basis points in North America. And third, the majority of our key North American programs are back half-weighted. So even though we expect economic conditions to remain challenging, we're confident in our ability to continue to drive vol/mix gains for the remainder of the year. Picking back up on Q2 revenue growth. Our Cadbury business reported organic growth of 3.3%. It was driven by very strong Gum performance in the Americas, fueled by the success of new products. Chocolate gains in the U.K. and India also contributed to the growth. Top line growth was tempered two factors: a negative impact of about 0.5 percentage point from the shift of Easter-related shipments into the first quarter, and weak economic conditions affecting the Gum category in several markets including southern Europe, Japan and South Africa. Turning to profit. On a combined basis, our operating income margin, excluding acquisition integration costs, was 15.2%. In our Kraft Foods base business, volume growth and improved product mix contributed 70 basis points of margin improvement. In addition, our productivity- and overhead cost savings initiatives are starting to contribute in a more significant way. Despite rising costs, we delivered gross margin gains in all geographic regions. This enabled a double-digit increase in A&C. And as a result of this virtuous circle, our base Kraft operating income margin rose by 110 basis points to 16%. Our Cadbury business also made a solid contribution to profit in the quarter. Product mix, productivity gains and the timing of marketing spending drove the improvement. Turning to EPS, our second quarter earnings reflect continued financial momentum as we integrate Cadbury. Starting at the top, we earned $0.56 in Q2 of 2009 with $0.03 of that coming from the divested Pizza business. So from a year ago base of $0.53, our operating EPS was up more than 13% to $0.60. This was primarily driven by $0.08 of operating gains from the Kraft base business. The $0.11 of operating earnings from Cadbury were offset by $0.14 of higher interest expense and the change in shares outstanding primarily related to the acquisition. I'd also note that certain discrete tax items, including the settlement of audits, benefited operating EPS this quarter by $0.03 on a year-over-year basis. Below the operating EPS line, we incurred $0.06 of integration costs and $0.01 in acquisition-related costs, resulting in our reported EPS of $0.53. On a year-to-date basis, earnings are also running ahead of expectations. For the first half, we generated $0.16 of operating gains from the Kraft Foods base business. That's roughly 17 percentage points of EPS growth from base operations. So we've had a very strong start to the year on the earnings front. Given that strength, we've made the strategic decision to reinvest the upside this year. This will ensure that we're doing the right things to strengthen our business in this difficult market and to stage the business for faster growth in the future. As a result, even though the first half came in stronger than expected, we're holding our full-year operating EPS guidance to at least $2. I'll take a few minutes now to share highlights of our business results by geography. At Kraft Foods North America, organic net revenues on a combined basis fell by 1.3%. Our base business results came in weaker than expected, declining by 1.9%. So what happened? Our performance was driven by four factors: a continued weak consumer environment; lower sales growth at a key U.S. customer due to changes in their merchandising that affected us disproportionately; aggressive promotional activity in a few U.S. categories, especially Biscuits, Cheese and Salad Dressings; and about a 50 basis point impact from the Easter shift. Despite these headwinds, we've continued to invest in brand-building activities. In fact, several of our key brands posted revenue growth behind great new advertising. For sample, Capri Sun and Kool-Aid ready to drink beverages and Maxwell House coffee were up double digit. And Oscar Mayer Bacon and Hotdogs, Kraft Mac and Cheese and Planters Nuts posted strong growth. And as we look ahead, we expect solid growth behind key programming initiatives and improved merchandising support in the second half of the year. In our Cadbury business, we produced strong growth of 7.5%. This was a driven by the success of several Gum products including Trident Layers, Stride Shift and Dentyne Pure. Now in light of that excellent performance, I'd be remiss if I didn't mention that we will lap the highly successful launch of Trident Layers beginning in Q3. Now let's look at profitability. In our base business, OI margin improved by 70 basis points to 19.1%. This reflected strong productivity gains, but they were partially offset by incremental investments at A&C and, to a lesser extent, the impact of lower volume. Our Cadbury business also posted solid profit performance. It delivered productivity gains and improved product mix that was partially offset by higher spending behind new products. As a result, our operating income margin for the combined company in North America grew to 19.4%. In Europe, combined organic net revenues increased 3.9%. In our base business, organic revenues grew 5.2%. Included in this number was a 2.5 point benefit from harmonizing the accounting calendar in some of our European Biscuit operations as we completed the integration of the LU Biscuit business. This is partially offset by 70 basis points from the Easter shift. Adjusting for these small impacts, the revenue in our base business was still strong and exceeded expectations. Our priority brands collectively grew 8% as increased focus and marketing support drove volume and mix gains. What's more? The strong performance was broad-based with growth in every category. Chocolate grew behind strength in Milka, Toblerone, Freia and Marabou, and we also posted share gains in several key markets including Germany and France. Coffee grew behind the Jacobs in Germany and a double-digit increase in Tassimo. Cheese grew behind the continuing success of new packaging and marketing of Philadelphia. It was up strongly in key markets such as the U.K. and Italy. And Biscuits grew double digits behind the successful launch of Cote d'Or in Belgium and Oreo in France. In fact, Oreo grew 45% overall across Europe. In our Cadbury business, organic net revenues were flat. Modest base growth was offset by a negative impact of about one percentage point due to the Easter shift. We generated solid growth in core markets such as the U.K. and France, but this was offset by a soft consumer environment in southern Europe, particularly in Spain and Greece. Operating income margin in Europe rose to 13.2% on a combined basis. In our base business, OI margin improved by 220 basis points to 12.2%. This reflected strong volume/mix gains and overhead leverage that was partially offset by the effect of lower price levels and an increase in advertising. Our Cadbury business also made a solid profit contribution in the quarter. Product mix improved and we began to realize the benefits of supply chain efficiencies. Turning now to developing markets, where combined organic net revenue increased 8.1%. In our base business, organic revenues grew again at a double-digit rate of 10.4%. The driver was volume/mix gains as we continued to invest in priority brands across the region. Plus a roughly one half point benefit from an accounting calendar change for certain operations in Asia-Pacific. Collectively, our priority brands grew more than 17%. Specifically, in Asia-Pacific priority brands grew nearly 30%, lead by Tang powdered beverages and Oreo cookies. In China, for example, Oreo grew by more than 70%. In Latin America, priority brands grew nearly 20%. They were again led by Oreo and Tang, plus strong gains from Lacta chocolate. And in CEEMA, despite a very weak consumer environment, priority brands grew 9% led by Jacobs coffee. Organic revenues in our Cadbury business grew 4% in developing markets. New products and improved distribution drove high single-digit growth in Latin America. We also generated double-digit chocolate gains in India. Growth was tempered, however, by weak Gum category trends in Mexico, Japan and South Africa. Our operating income margin in developing markets was about 14%. Our base business profit margins improved by 50 basis points. This was driven primarily by strong gains in vol/mix and overhead leverage. Margin upside was dampened somewhat by higher input costs and a double-digit increase in A&C. Profit performance in our Cadbury business was also solid. It reflected a better alignment of pricing and costs, as well as improved product mix. Now I'd like to turn the call back to Irene.

Thanks, Tim. As we look back over a very eventful first half of 2010, we're beginning to realize the benefits of several things. Our improved portfolio mix, our broader geographic footprint, our significant brand investments and our cost savings initiatives. This is creating a virtuous circle that will enable us to accelerate volume and mix gains, leverage our scale and drive down overhead costs, and generate additional earnings that can be reinvested in the business. Our businesses in Europe and developing markets delivered exceptional performance through the first six months of the year. We posted both strong vol/mix and market share gains. In North America, despite some headwinds, our investments generated solid base consumption growth for a number of our priority brands. And across the portfolio, volume/mix gains and cost savings expanded both gross- and operating margins. This in turn is enabling incremental investments behind our priority brands around the world. On the bottom-line, operating EPS rose 18%, driven by strong operating gains in the Kraft Foods base business. Turning to Cadbury, the integration continues to progress extremely well. The acquisition has provided a great infusion of new talent. In fact as we've named the business unit-, country- and functional leaders around the world, about a third of our four hundred most senior leaders come from Cadbury. We've also made excellent progress in identifying synergies. We now expect to deliver greater cost savings and to do so even faster than we had originally planned. Specifically, we expect to generate at least $750 million in annual savings. And we'll deliver about 15% of the savings in 2010 versus a prior estimate of 10%. The total cost to generate these savings will be slightly higher, about $1.5 billion versus our prior estimate of $1.3 billion. But the pacing of costs should be about the same. Although there have been very few surprises during the integration, there are two areas worth mentioning. First, we've seen some baseline weakness in a few core markets as the businesses were pushed hard in the heat of battle last year. We anticipated this and had begun to reinvest in these markets. We expect they will begin to recover as we exit the year. Second, we discovered that Cadbury distributors carried fairly high trade inventories in a few markets. We intend to normalize those levels. This will result in lower revenue growth in the second half of the year, but it will provide us with a more efficient supply chain going forward and stage the business for future growth. Turning now to our 2010 outlook. In terms of organic revenue growth, we've adjusted our target to 3% to 4% growth from at least 4%. This reflects the slower than anticipated start in the first half, the impact of aggressive promotional activity and the normalizing of Cadbury trade inventory in select markets. Where we ultimately fall within that range will depend on the consumer environment globally, as well as whether or not merchandising changes are implemented by a key U.S. customer. If these mutually beneficial merchandising opportunities occur, we'll be higher in the range. If not, we'll be lower. Regardless, our objective is to build a solid revenue base from which we will generate profitable top-tier growth. On the bottom line, as we've said, we expect to deliver operating EPS of at least $2.00, while funding the initiatives we've mentioned. This will enable us to build an even stronger foundation for 2011. So to sum up, we've continued to make progress toward our goal of building a global powerhouse. Our integration is on track and we 're delivering greater synergies faster than expected. We're beginning to reap the benefits of a more diverse global portfolio. We're delivering strong, high-quality base business earnings growth, and most importantly, we're reinvesting our upside this year to further strengthen our brands and lay the foundation for top-tier performance in 2011. We'd now be happy to take your questions.

[Operator Instructions] Your first question comes from the line of Chris Growe of Stifel, Nicolaus. Christopher Growe - Stifel, Nicolaus & Co., Inc.: I guess the first, and one that is on top of mind I think for a lot of investors these days is the promotional environment, which obviously came through in your U.S. results. I just had a question in relation to, you talked about some plans for the second half of the year. Does that entail being more promotional? Is that kind of what your goal is? I guess I'd be also curious, how much was promotion up in the quarter in North America for you as well?

Well first of all, Chris, our focus has been and will continue to be on advertising and marketing investments that will build our brands for the long term. That will remain unchanged. We still expect our second half revenue growth to be volume/mix-driven with very little contribution, if any, from pricing. We'll remain disciplined as we move forward here, but I will say that as category leader, we will not continue to tolerate share gains being driven by aggressive promotional pricing. So you will see some increase in our promotional spending in select U.S. categories in the second half. But that is reflected in our guidance, and as I said, we expect that our second half revenue will be primarily driven by vol/mix. With respect to the question about the contribution, as you saw, pricing contributed very little to our overall performance in aggregate or in North America. Our results were primarily driven by vol/mix. Christopher Growe - Stifel, Nicolaus & Co., Inc.: And then I guess in relation to that, I was surprised by the gross margin strength in the quarter. Is that the vol/mix that's driving that? Or were there cost savings coming through? Maybe perhaps you can give a little more detail around that?

Well, it's actually both of them, Chris. It's a combination of the focus on vol/mix, particularly our focus on priority brands, which around the world tend to have higher margins, as well as cost savings. And those will continue to be key drivers of our margins going forward.

I'd like to take all the credit, Chris, for the significant increase. You need to recognize that Cadbury brings in a starting point of a higher gross margin than traditional Kraft is, so when you look at almost 200 basis points of improvement, a lot of that is driven by the mix of Cadbury coming in. Still very solid from the Kraft standpoint. We increased 60 or so basis points in the base business but we were aided by the Cadbury integration.

Next question comes from Alexia Howard of Sanford Bernstein.

Can I ask about the acceleration in organic sales growth that you're expecting to see in the second half? I think you alluded to a couple of factors there, primarily the step-up in new product launches or merchandising activity and marketing spending in the second half. Could you talk a little bit about how much the consumer marketing spending is going to increase maybe for the full year. I think it was at around 7% of sales in 2009. Given this step-up in market expanding, how high do you expect it to hit in 2010? And secondly, just in terms of the external environment, you talked about the step-up or the changes in the merchandising activity at the key customer. Are you seeing any improvement in that dynamic that would give you confidence that the second half of the year's going to be a little easier on that front?

Well, let me answer your first question, on our spending levels. We continue to move our business toward our ultimate endpoint of 8% to 9% of revenue in A&C. We're making very good progress there and as you heard, we made significant investments in the first half of the year, we're up double digits, which takes us to about 7.5% or so of revenue on a base Kraft; the total company's actually closer to 8% because Cadbury comes in at a somewhat higher spending level. And we expect to continue to see that relationship continue in the back half. As we mentioned, we had fairly significant back half loading in our base Kraft programming, or actually in our planned programming, and now that we are now anticipating spending some additional monies in the back half, you will see even more of a contribution on the marketing side. That is what gives us great confidence that we will be able to see sequential improvement in our top line. With respect to the questions as to how our merchandising plan's progressing, we obviously have seen this. Our major U.S. customer has been quite public in suggesting that perhaps they went a little bit too far in a changing their merchandising philosophy. We have a very strong set of consumer programs, plans for the back half of the year, and we will work together to realize those opportunities. And as I said, that in some respects accounts for the range that we've given in our top line guidance.

Your next question comes from Terry Bivens of JP Morgan. Terry Bivens - JP Morgan Chase & Co: Irene, if I can just zero in on the Cheese business for a second. It looks to us like the costs are still reasonably high on a historical basis; they should come down, we think, a little bit in the back half of the year. But I guess the worry there is, do you believe that if they do come down the promotional environment in Cheese will actually accelerate instead of get better? What's your view on that?

Well what I'd say, Terry, is we haven't seen a very tight relationship between cost and pricing in the Cheese business and in fact, as we shared with you in the first quarter, we saw a number of our customers very aggressively promoting natural cheese in particular, and that's been a key part of our volume decline in Cheese. I think as we move forward here, we have made some programming changes on our own business that I think we're starting to see pay some dividends and we certainly are starting to see, as you suggest, prices come back up a little bit. So I think we'll see things in better balance in the back half, and we certainly do expect to see sequential improvement in our overall Cheese business as a result. Most of that, though, is about natural cheese. We continued to make good progress in our focus businesses where we make most of our money and we've had successively strong share performance on our cream cheese, our single's business and in Velveeta. Terry Bivens - JP Morgan Chase & Co: More broadly, if you look at some of the intense promotion across categories, it does look like as though it's reached the point where it's not really affecting foot traffic that much and maybe some of the retailers are beginning to realize that 'at this point, all I'm doing is taking the profit pool down'? We're hearing also signs that kind of point to that but it seems to be more talk than action at present. Are you getting any, without mentioning a specific retailer, are you getting more signals that maybe as we progress through the year -- and especially now that it looks like commodities might go up a bit -- that there may be possibly some reflation coming as we exit the year and go into next?

That's a new term, reflation. Terry Bivens - JP Morgan Chase & Co: It's probably not even a word, but I heard it once and it sounded cool.

What I think, Terry -- I can't speak for the retailers, what I can tell you -- is we certainly saw more tactical trade-driven activity in the second quarter. We chose not to participate, we chose to invest in our brands because we do believe that is the proper way to stage our brands for the long-term. And I would say that our assessment is pretty much what you just suggested, that it has proven to be the right strategy. We did not see category growth; in fact, many of our categories continued to [indiscernible] (43:43) experience some weakness and it certainly has not appeared to drive traffic, so I am hopeful that everyone is looking at that same profile and will realize that the right way to run these businesses for the long term is by investing in equity spending. But again, we're going to stay on our game.

Next question comes from Bryan Spillane of Bank of America.

In the first quarter, if I remember it right, in the press release you had a comment about 2011 and expectation for mid-teen EPS growth off if $2.00-plus base and $2.10. I didn't see it in the prepared rumors today so has that changed at all? Is that still your expectation?

Yes, it absolutely is, Brian. We have held our guidance for this year and are unchanged with regard to our expectations from margin and growth in EPS in 2011.

And then just a follow-up on the Gum business. Some of the work that we've done suggests that Wrigley has cut investments to help service its debt and its dividends, and it seems like there's an opportunity there. So one is you've got to get into – you've looked at Cadbury's gum business further, is it true? What are your market share trends recently? And then has that adjusted at all, maybe, the way you're thinking about investment and maybe spending more in Gum over the next year or so?

Well, I will say we have certainly seen good share performance on our Gum business around the world. And that is one of those categories that we believe can benefit from increased investment. And so we are making those investments in key markets around the world, and I think it will pay good dividends for us.

Your next question comes from Jonathan Feeney of Janney Montgomery Scott.

First question, Tim, when I think the $160 million out of the income statement for integration costs, I'm assuming that comes from marketing-administration line, not from COGS? Is there some split there?

Large majority of it will come out of the overhead line just because the large majority so far of spending has been head office. We're working our way through the regional offices and down into manufacturing, et cetera, so we'll see some hit the COGS line in the future but the large majority of it will come from overhead currently.

And John, I could follow up with you after the call on that and get you a bit better breakdown.

But the big question that I had was, when I think about this environment right now with retailers and consumers, whoever it is driving that, sort of screaming for promotions and value, it seems like Kraft's ability, seemingly unique ability to provide lowest delivered cost given the scale here would be just a huge advantage, and yet when I look at either the level of sort of that overhead line, which I guess in the [ph] fund (47:11) is going to be like in the high 22% or something like that just looking at it, that doesn't compare super-favorably with other companies with much, much lower revenues. I guess my question, Irene, would be, we talked about wall-to-wall maybe a couple years ago and now that you have another big slug of revenues in there, is there like a 2.0 where you can take more costs out and get those numbers down given the scale here?

Well, I will tell you I think, John, we're in the midst of 2.0 coming from two places. First of all, the programming we've got on base Kraft where we are looking at costs across the entire value chain, and in particular, we've laid out for you last September our focus on managing overhead in each of the regions around the world. So we've got zero overhead in North America, negative overhead in Europe and overhead growth at half the rate of revenue in our developing markets. That's obviously beginning to play through very nicely in our base Kraft results. Obviously, the larger overhead you're looking at right now for the combined company has a lot of Cadbury overhead in it and of course, that's a big part of our synergy. So I think you will see that number inherently come down as we deliver against our synergies. But I will tell you, the 2.0 opportunity that you refer too is very much under way and you will continue to see that play through our numbers in both this year and into 2011.

Our next question comes from Andrew Lazar, Barclays Capital.

A big part of your ability to get to your targeted mid-teen margin structure on the base business by I guess 2011 or so, probably has a lot to do with the improvement in margin structure in Europe where it was really subpar relative to peers, as margins in North America are already pretty good, although obviously there's still some room there. And this is the second quarter in a row where I guess we've seen some very nice base business, gross and margin, operating margin improvement in Europe. So I'm trying to get a sense of your comfort level with the sustainability of that? In other words, is this really now starting to move in Europe for real after obviously a whole bunch of years where that just couldn't get moving in the right direction? And then more importantly, how quickly does that operating margin in Europe get closer to your peer group from the larger European-oriented food companies, where you still have a long way to go there.

Andrew, as you rightly say, a big part of the margin improvement that we have committed to for the total company depends upon our improvement in Europe and we are making terrific progress in that regard. As you saw, we're up about 200 basis points on our base Kraft business this quarter. And it's very much for real. I think Mike Clark shared with you and others last Fall, the plan that we've laid out. It's a combination of continuing to push more profitable volume, continuing to make some significant reductions in overhead and we have the benefit of integration both of the LU business, as well as now the Cadbury business as a further opportunity, as well as the broader opportunities that we have across the company in procurement and conversion. So they are very much real margin improvements. I feel very confident that they will continue, and I feel very confident that the targets that we've laid out both for Europe and within the total Kraft portfolio are achievable.

If we look at the second quarter for Kraft and then, let's call it, for a lot of the calendar second quarter companies that have already reported, as you noted obviously, the promotional environment ramped up fairly substantially, broadly speaking. Is it your sense that we will look back on this second quarter and say, that was really the peak in sort of promotional activity for this group? Not that the second half's going to lighten up dramatically or what have you, but do you think as a group, we moved at least sequentially in the right direction from a promotional standpoint? And if so, why? And is there any evidence yet that would suggest we should be confident that that will happen?

Well we sure would like to hope so. I mean, again, as we look at the results of the very significant promoting that we saw certainly in a number of our core categories, it did not really impact store traffic and it certainly did not help category growth. And I think that those results are clear. And so I do think that everybody looking at those results has to come to their own conclusions. Again, our intent is to stay on our game plan, which is to continue to invest in the longer-term brand building activities, but as I said, we will selectively look at some activity in a select number of categories in the U.S. because we're just not going to continue to tolerate share losses due to aggressive promotional activity. But I think it is quite possible that this could be the beginning of an inflection. It could be an infection point.

Next question comes from Vincent Andrews of Morgan Stanley.

If there's an inflection point on promotional spending and that gets ratcheted down I guess there's sort of a fork in the road in my view. One is that, that means gross price points go higher which means price gaps with private label probably widen and the conversation to date on the call really hasn't included private label, so to what extent are you concerned that if the promotional environment calms down, gross price points go back up, we get back into a situation where private label starts to gain share again at an accelerated pace and that's what we wind up talking about on these calls.

Yes, well let me say first of all, without a doubt private label share has stabilized, that's been true over the last couple of quarters, and in fact in some cases we're seeing it begin to decline. So I don't expect a dramatic change there and I think, again, the investments that we are making in our brand franchises, in our brand equities as well as in our innovation pipeline, are, we believe, the way to set ourselves apart over the long term. And so I think we're going to be well positioned to be able to address our market position in the future as a consequence of that investment.

So your view would be that private label share gains have decelerated, but this doesn't have to do with branded promotional spending going up, is that correct?

I would say that's correct because we basically saw that private label share seems to have a water level, we actually saw it reach that water level a couple of quarters ago, and we haven't seen really much change since that time. But again, our approach to dealing with private label, as well as any of our comp competitors in any of our categories, is to continue to differentiate our brands by investing in equity and investing in the innovation pipeline. And so far, that seems to be serving us well in most markets around the world.

On input costs, what's your outlook for input cost inflation for the balance of the year? There obviously have been some movements recently in cocoa, and sugar's back up, and multi-grains and so forth? So how should we be thinking about that in terms of your guidance?

Well, the first thing I would say is that, again, with the investment we're making in our brand equities we feel that we can manage any input cost changes within the P&L. We think we have some pricing power as a result. We're holding to our guidance and think that any inflation that we may see going forward is reflected. We have taken some selective actions in a number of categories where we have seen some input cost changes and, again, that's consistent with our approach to managing the business and within the guidance that we've given.

But you don't have a percentage increase for this year?

I'm not going to offer a percentage now. I mean obviously you see a couple select ones, cocoa and sugar have increased materially. But on the balance, other ones have actually come down. We saw modest increase in the first half of this year, balanced across categories.

Next question comes from Robert Moskow of Credit Suisse. Robert Moskow - Crédit Suisse AG: Irene, can you elaborate a little bit on what you mean by more programming occurring in the second half of the year and how it's kind of back half-weighted? Do you mean specifically that advertising will be higher year-over-year in the second half than it was in the first? Are there more new products and then what kind of products can we look forward to? And then also just merchandising activity, what kind of programs and what kind of customer activity do you have in the back half that you didn't have the prior year?

Well actually, Rob, it's all three of those, so our advertising will in fact be higher in the back half. We have planned it that way in our base plan, and certainly a portion of the money that we're reinvesting will be against A&C so you will see advertising even stronger in the back half. We got a fairly robust innovation pipeline that was always back half-loaded. Again, we were concerned about the consumer environment and we chose to keep our powder a little bit dry there and so we have a pretty good roster of new products as we look into the back half and we can talk a little bit about that. And then the third piece is simply that we will lack the merchandising change in the back half of the year as well as, as we've seen, there's been some rethinking of that merchandising strategy. So all of that together is what, first of all, makes our programming back half-weighted, and what gives us great confidence that we will see sequential improvement in the back half of the year. Robert Moskow - Crédit Suisse AG: A quick follow-up. On Slide 13, this is the only one that kind of stood out for me as being a little off versus expectations, is that Cadbury's growth in developing markets only up 4%, Kraft's base business up 10.4%. Most people think of Cadbury as being very incremental to your business in terms of having developing market exposure. But you mentioned Southeast Europe and Japan as being kind of a drag and those aren't really emerging market kind of markets. So what's going on there? What's the real run rate for developing market growth for that business for Cadbury?

Well let me say, first of all, that I expect that as we bring a few companies together we will certainly be stepping up that growth rate as we bring kind of the best of both together. But I would say the profile of the Cadbury business is much more heavily weighted to markets like Australia, New Zealand and Japan. And as we've shared with you, those are markets that happen to be for a number of reasons, primarily macroeconomic, seem to be disproportionally hit by the economic condition. So as a consequence, their growth in those markets was relatively lower.

Your next question comes from David Palmer of UBS.

First, could you talk about potential margin pressure you might experience, sort of net margin pressure versus what you might have had in the first half of the year. And I mean this in the base business from input costs. Even if it's just timing of pricing versus some of the input cost inflation that we're seeing, one example category that I would worry about would perhaps be chocolate in Europe. Tough market to get pricing, we're seeing the cocoa inflation out there, but any thoughts would be welcome about maybe some timings of net margin pressure.

Well, from an input cost standpoint, as we've said before, we have a pretty active hedging program so we're managing our input costs on a regular basis. And to the extent that we see material again, I believe that we have the pricing power to make sure that we've covered that. So from an input cost standpoint, I don't see a lot of margin pressure. We do, as we've said, plan on spending some additional investment in A&C in the back half of the year and naturally that's going to put some pressure on margins relative to the very strong first half and second quarter. But again, we're going to manage that within our guidance and within the P&L.

You noted that marketing and innovation helped drive solid base trends in some of your cookies and crackers and beverage brands, and in the past you talked about potentially touching more and more your portfolio of your portfolio with the step-ups. Where do you see Kraft sort of moving, where do you see the ROI from here in terms of incremental spending and perhaps that includes some of the Cadbury brands and regions?

Well I think our first priority will be on the brands that we've identified as our priority brands, and we're getting a very good return on those investments both in terms of base marketing investment as well as innovation. I mean I look at markets like our developing markets. As Tim mentioned, we're looking at 30%, 40% growth on Tang and Oreo without doing anything but invest in those base franchises. So we're using a different metric market-by-market with the end result of focusing on profitable volume/mix driven growth, [ph] that's (1:01:31) profitable sustainable growth, and so far we feel quite good about how that's playing out.

We will, as we've targeted a little bit higher A&C as a percentage of revenue, and we will continue to invest until we get to those ranges. Cadbury brings in normally with our categories a little bit higher percentage. The other thing I would point out is we have an Analyst Day coming up in a month are so and we'll be a little bit more clear on our overall strategy and how we manage the strategic brands and the broader portfolio.

Next question comes from Eric Katzman of Deutsche Bank.

I guess a few specific questions on Cadbury. I think if my understanding of the table on Slide 8 is correct, you've had about $0.03 of dilution from the deal so far, Tim, is that right?

Yes, that's correct.

And you had said last quarter that you had expected the full year to be $0.16 dilutive. Is that $0.16 going up with the inventory cost that you're absorbing, given the levels were too high.

No. Actually, it's really a seasonality timing within the year. In the first half, a number of things happened. First of all, there is naturally within Cadbury -- about 2/3 of their profitability falls in the second half of the year. In the first half, we also stage over the first quarter the share issuance for their business and also the interest on the bonds. So we don't have the full effect from the share dilution in the first half, the second half it about doubles. Interest almost doubles and we did have some additional back-end weighting of A&C investment based in their base plan. So that $0.16 still holds, it was about $0.03 in the first half, about $0.13 in the second half as a result of those factors.

So does that mean that the inventory that's coming down, are you taking that as a one-time or that's not affecting the full-year dilution because maybe the first half is better?

Yes, to the extent that we take inventory down, it will affect that. That actually would take that $0.16 a little bit higher.

Second, and maybe this follows up on Rob's question, Irene, but it sounds like there's – granted you've only owned it for five or six months, but obviously the deal was partly predicated on Gum and Confection being a very strong category. How much do we need to worry about the fact that the category leader is seemingly struggling? I think you said the EU Kraft business was flat in the quarter. I think you said in the first quarter, the category was actually down. So is there something that we need to worry about in terms of the category not growing as fast as you had hoped when you originally bought it?

No. Everything we've seen, Eric, continues to confirm that this business will be transformational for Kraft. I would tell you that there are some markets that we talked about, Southern Europe, South Africa and Japan where we certainly are seeing some of the macroeconomic impact but that's a select number of markets. The bigger issue is just that in the heat of battle, we knew that Cadbury has perhaps pushed some of their businesses. We also understood that we've got a challenging first half-second half comparison when we put the plans together. So we expected to reinvest in those businesses. We already have made a number of investments in Europe, in the U.S. and elsewhere. We now have the earnings flexibility to go beyond that and we are making selected investments in the best opportunities that we see around the world. So we continue to feel terrific about the portfolio, about the opportunity for Gum, and we've certainly -- given that we will continue to invest in the franchises around the world -- I think we will continue to see share gains as a result.

Last question again on the transaction. You raised the cost of it from $1.3 billion to $1.5 billion. Is that all cash? And the savings rate, I guess is now $75 million higher?

That's correct. We went from $675 million to $750 million, and increased $200 million from $1.3 billion to $1.5 billion. The same proportion of cash to essentially write-offs would pertain to that as well. The predominance of it is cash.

And is the additional spending, the additional cost, is that what gives you the confidence in the extra $75 million? Or are they completely unrelated?

I wouldn't connect them in that fashion, Eric. I mean as we've looked through the program, we carefully built up the details and in the last several months as we've really gotten under the covers and refined all of our analysis, it's not that we necessarily have found new synergies but we've just confirmed what we've seen and as we are finding more there that it's costing us a little bit more to get it.

Next question comes from Ed Aaron of RBC Capital Markets.

On the distributor destocking that you talked about, did that start at all in the second quarter or is it entirely back half? And then can you give us a sense of what the magnitude of that might be?

Yes, a little bit of it we did. Again, you may note that in the first quarter, we had believed that we didn't find the higher levels that we anticipated, but when we got particularly into some of the developing market economy, there is a multi-tier distribution network. And as we dug down into the network further, we found that they were higher than we would normally expect. As we're rationalizing that into the Kraft distribution system, we think it's prudent to bring them together; and are bringing them down commensurately. A little bit of it in the second quarter but the large majority of it is still ahead of us in the second half of the year. I would say it's somewhere between $100 million and $150 million is what we would expect.

And Tim, I think you mentioned in your prepared remarks that Cadbury margins might have benefited a little bit from low advertising spending? I was a little bit surprised to hear that just given that Cadbury wasn't spending quite as much during the takeover process, and so wondering why this wouldn't have been a quarter where maybe you might have stepped up that level of spending on that business?

That was [ph] win-win (1:08:33) in one market and I mean it was the timing between first half and second half, it's just a matter of how the programming fell.

And then one last one. That accounting calendar shift that you talked about for Biscuits, is there a reversal of that that needs to happen or is that just a one-time deal?

It's a one-time. What actually happened is, LU was reported on a lag basis and as we brought them, as we said, we'd integrate them into the Kraft business and as we've done so, we've put them on concurrent closed schedule. Again, so it's a one-time thing and it's part of our guidance, our expectation for the year when we originally gave guidance.

Next question comes from David Driscoll of Citi Investment Research.

I wanted to start off with just going back to the brand building. So it's great to hear that you're increasing it. If you said this, I apologize, what is the magnitude of the increase and really, I'm just trying to get, what's the change in the guidance from last call to this call?

Well, I think what we've said is we've got some upside as the result of the momentum that we have on the business, and we are planning to make some investments. It's probably about $0.10 and we expect about half of that is going to go toward increased A&C on top of the increases that we already had in the base plan.

So it's $0.10 of upside that you've had so far and you're saying half of that goes into A&C? And where does the other half go?

The other half is that inventory [indiscernible] (1:10:15) stock in Cadbury that we just talked about. And the other one is anticipating, as Irene mentioned a bit earlier, that we do expect in the second half, we will respond to the promotional activity in select categories particularly across North America. And so we're anticipating some set-aside for that.

Can you comment on what your hedging coverage is for the balance of the year? And then specifically, can you comment on what is what as a percent of COGS just given all the tremendous news flow on wheat in the past few days?

Yes, we don't comment for good reason because we don't want to share with perhaps speculators what we're doing with our hedge positions. So we can't comment. We carry hedge positions on commodities as prudent and as consistent with past practices. And with respect to wheat, it's a very small portion of our total input cost.

And Tim, I wasn't actually trying to ask what your hedge was on wheat itself. I was just trying to ask, can you tell us if you're 90% hedged for the balance of the year? Kellogg and Mills give metrics like that and I was hoping you might.

Yes, I'll just say we are well hedged for the year. I really don't want to give a specific percentage.

Irene, just coming back to the promotional environment. I think when you were commenting to Andrew, he mentioned that, is this the inflection point? And I thought you said that you thought it was the inflection point. So if it is …

Well I think I said I hoped it was an inflection point. I don't know for sure.

What I want you to tie together for me, what I can't see is that I think you said that you're going to increase your promotions to kind of tactically respond to people who were taken share from you. So it sounds to me like from Kraft's actual actions, promotional activity steps up in the back half. So then why does it sound to you like it's going to die down?

Well, first of all, what we've been very clear about is that we will respond in selected categories if we need to. I mean we have been very disciplined and we will remain very disciplined as we go forward. So all I'm suggesting is that we are prepared to respond in selected categories. You've seen that we had some softness in a couple of core franchises, our Biscuit business, our Salad Dressing business and our Cheese business, and we will take some selected actions as appropriate. But we will certainly watch the environment. We certainly are looking at input costs as we move forward here. But our primary focus will remain on investing in longer-term brand-building, because that's what will pay the dividends for us going forward.

Tim, what's the tax rate guidance for the year? And that's it for me.

I expect it to be modestly under 30%. We were a little bit above 30% anticipated as the result of the discrete item that we recorded in the second quarter of this year. It'll drop it a little bit below 30%.

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

Can you just tell me about the progress, at least anecdotally, if you've made any progress on the revenue synergies?

It's premature to talk about that today, Ken. That will be one of the subjects we'll talk about at our Investor Day. We certainly are actively involved in beginning to identify the areas of opportunity and figuring out which ones we want to go after, first, second and third. But one of the reasons that I feel really good about having the flexibility to reinvest in our franchise is because we see all kinds of opportunities and we'll be in a position to be able to capitalize on some of them sooner than we had anticipated. But as we've said before, the real impact of revenue synergies will not begin to hit until next year.

But the investors out there I think tend to want to invest beyond also this year as well. That's why I was just trying to get into the strategy beyond this year. So we look forward, definitely, to hearing what you guys have to say at the Investor Day for sure. The other question I had was, in terms of the cost savings -- so the outperformance in the quarter, it didn't have to do with the increase in the cost savings from the integration or it did? I just didn't understand that.

We had about a penny of benefit for our cost synergies coming in a little bit higher than expected.

So I guess my real question on this is, the incremental savings that you're finding, how do you expect to spend that? Or does that give you more comfort in being able to deliver your 2011 and beyond expectations? I was just trying to figure out what your doing with that money.

Well, first, we've got about a dime in total between tax and favorable operations and the little bit of the synergies, there's about a dime, and as Irene mentioned, the large majority of that we would expect to spend back in the second half, about half of it in kind of A&C and then probably half of the remainder in responding promotional activity and then that trade destocking. So that's kind of how we think about that in the second half of the year. On an ongoing basis, we have said that probably 2/3 to 75%, we would expect to drop to the bottom line and the remainder there would be some spending back from synergies.

So going from $675 million to $750 million, 2/3 of that would drop to the bottom line?

That's correct.

So that gives you a little bit more comfort in how you can get your longer term targets? Is that not a fair way of looking at it?

That's correct.

Your final question comes from Eric Larson of Soleil Securities.

Given integration issues, one never always knows exactly what you see when you get in, and obviously, you disclosed, I think this quarter was the first time you talked about some higher inventory levels of Cadbury at the distributor level. Are there any other potential surprises? I think that at one time we heard that there may be some pension issues with Cadbury, might require some cash payments. Are there any other hidden issues that need to be addressed that could either be both dilutive to earnings and/or cash in the next 18 months?

I means we've had the business for about six months now. We've taken a pretty good look under the covers and we think, I mean we thought after the first quarter that we had viewed the inventory levels. And we found that there's a little bit more learning in the second quarter. However, with six months under our belt and we are fully in control in managing aspects of the business at this point, we think that we have a pretty good handle on where there might be any pockets of weakness, et cetera. And again, as Irene said, we're very pleased with the business. With respect to pension funding, I mean, we had been aware prior to the transaction that they have an under-funded pension plan and we are working with the trustees of the plan to address that issue. It may result in some cash payments but that's within our plans.

And did you quantify what the impact in the sales growth rate might be in the second half with Cadbury and the de-inventorying strategies that you're putting into place right now?

Well, if you think about it, I kind of gave an indication $100 million to $150 million, the impact on full-year growth would be somewhere between 20 and 30 basis points.

It hasn't been a huge concern of mine. Currency was a positive for you a little bit in the second quarter. The only thing that's hurting you right now is really the euro and pound sterling. In how you've guided for your second half, will currency be, let's say, just a modest headwind for you as you go forward?

That's right. We've picked up about $0.03 in the first half in favorable currency from a earnings standpoint. Sitting where the currencies are today, it's probably second half looking at a penny, a penny of headwind.

This concludes the question and answer session of today's call. I will now turn the conference back over to Mr. Chris Jakubik for any closing remarks.

All right. Thanks, Paula, and thanks everyone for joining us today. For those folks in the media who have additional questions, Mike Mitchell will be around to answer those for you. And for any of the analysts who have further questions, both myself and Dexter Convoy will be around today, tomorrow, et cetera, to answer any questions you have. Thanks very much and have a good evening.

Thank you. This concludes your conference. You may now disconnect.