Kraft Foods Inc. Q4 2009 Earnings Call Transcript

Kraft Foods Inc. (KFT) Q4 2009 Earnings Call February 16, 2010 10:30 AM ET


Irene Rosenfeld – CEO

Timothy McLevish – EVP & CFO

Chris Jakubik – VP IR


Unspecified Analysts



Good morning everybody. With us today are Chairman and CEO, Irene Rosenfeld; CFO, Timothy McLevish; as well as Chris Jakubik who all of you know well. Now as analysts and a very curious bunch of people, we of course want all the answers yesterday. But given Kraft is still in the midst of closing on the Cadbury acquisition, the company is still subject to some extraordinary disclosure rules that among other things, limit their ability to provide earnings guidance.

Today we hear specifically more about 4Q results, which can provide us a bit more perspective on the progress of the core Kraft business, certainly very important going into a sizable integration process for Cadbury. Irene, Tim, and Chris, thanks very much for joining us and following what was obviously a most interesting and I’m sure draining few months, I’ll hand it over to Chris for a few additional comments.

Chris Jakubik

Thanks for having us today and welcome everybody. Before we get started I must deliver a bit of a legal [inaudible], as Andrew referred to. I promise this is not simply a tactic to shorten the time available for Q&A, its much more a function of the extraordinary legal requirements we’ve had to comply with of late.

So as you know, during this presentation we may make forward-looking statements about the company's performance. These statements are based on how we see things today so they contain an element of uncertainty.

Actual results may differ materially due to risks and uncertainties, so please refer to the cautionary statements and risk factors contained in our SEC filings for a more detailed explanation of the inherent limitations in such forward-looking statements.

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.

Also, in connection with our acquisition of Cadbury I would encourage everyone to read the various filings that Cadbury and we have made with the SEC because they contain important information related to this transaction.

I will also note that we continue to be restricted by the UK listing authority in terms of what we can say, particularly around financial guidance, whether in the current year or on a longer term basis.

So with that out of the way, let me turn it over to Irene.

Irene Rosenfeld

Thanks Chris, and good morning to all of you. How’s your New Year been? We’ve been a little busy. But I must say its especially nice to see so many familiar faces in the audience today. There are three things that we want to address today.

First we’re exiting the turnaround that I laid out three years ago on this very stage, with strong operating and financial momentum. I’d like to take a few minutes to review the progress we made in 2009, including some highlights from our fourth quarter results announced earlier this morning.

Second, I’ll review our combination with Cadbury and underscore again why we believe the combination of Kraft Foods and Cadbury has created a global powerhouse, one that can deliver top tier margins and growth on a sustainable basis.

And third, Timothy will provide an update on the transaction, where we are in the process including our early thoughts on integration. So let’s begin. Three years ago we laid out our plan to return Kraft Foods to long-term sustainable growth. In the first year we said we would rejuvenate top line growth and we did.

In the second year we said we would grow both the top and the bottom lines, and we did. In the third year we said we would focus on building our profit margins and market share and as we’ve done this we have a strong foundation underlying our long-term model, targeting EPS growth of 7% to 9%.

Three years ago no one could have predicted the environment we faced in the ensuing years, from record high input costs to global recession. But despite it all we did what we said we would do and we’ve emerged a much stronger company.

We began our turnaround by decentralizing and aligning our businesses and functions with common incentives. Our business unit leaders have been focused on three simple metrics; revenue growth, income growth, and cash flow.

And they’ve been the key drivers of our turnaround. Over the past three years we’ve made tremendous progress on each measure. Since 2006 on average we’ve driven 4.5% organic revenue growth per year. We’ve made significant investments in product quality, marketing, and innovation while growing operating income 10% per year on average and raising our operating income margin to 13.7% in 2009.

That’s up from 12.6% in 2008. We’ve put a greater focus on cash flow and its paid off. In 2009 we generated cash flow equal to 124% of our net earnings. That’s up from 83% in 2006. But the true measure of success for any turnaround is how well we’ve staged our business for future growth.

On that criteria I am pleased to report that we exited 2009 with strong operating and financial momentum. Since 2007 we’ve invested more than $500 million to improve our product quality. As our products have gone from good enough to truly delicious, consumers have noticed.

Today about two thirds of our products are preferred to the competition versus only 44% in 2006. Putting quality back into our products and differentiating ourselves from the competition has enabled us to reestablish our pricing power.

And as a result of stronger brand equities, we’ve been able to manage higher input costs and improve the alignment of our prices and our cost structure while still investing in our franchises. This was a necessary step to restoring profit margins and it has been a key contributor of our results to date.

As a consequence going forward the ability to manage changed in input costs through pricing will allow more of our productivity gains to flow to the bottom line. Another example of our operating momentum has been our improvement in volume and product mix despite significant headwinds.

The challenging economic environment has led to weakening consumption trends around the world. In North America unemployment is higher than its been in 18 years and many of those who hold a job don’t feel secure.

In Europe unemployment continues to rise both in Western and Easter Europe and in Asia and Latin America while consumption is still growing, its well below historical levels. From a planning perspective we’re expecting a continuation of these trends until at least the back half of 2010.

But we’re certainly not sitting still in the face of these macroeconomic factors. We’ve taken some strategic actions over the past several quarters to discontinue less profitable product lines and to forgo unprofitable volume, thereby resetting our revenue base.

While this has reduced near-term volume, its clearly been the right long-term decision and enables us to grow off of a much stronger base. Despite these headwinds you can see that we delivered sequential improvement in vol/mix in every quarter of 2009.

Having said that I do want to acknowledge that our fourth quarter came in somewhat lighter than our forecast of approximately 3% growth. Why is that? Two reasons, one is lower than anticipated consumer off take for the macroeconomic reasons I just cited, particularly in North America and Europe.

The other is that we made the decision to avoid chasing certain US competitors particularly in mainstream coffee, and snack nuts. Competitors that were chasing unprofitable unsustainable volume. Instead we chose to invest in more sustainable long-term brand building by significantly increasing our fourth quarter advertising and consumer spending.

This will clearly pay dividends in 2010. Nonetheless in contrast to many of our peers, we continue to drive sequentially better volume mix in the fourth quarter delivering more than 1.2 points of growth. Looking at another measure of our momentum, we’re expanding both gross and operating margins while continuing to invest in future growth. In 2009 we increased our advertising and consumer spending to 7.2% of net revenues, that’s up from 6.7% in 2008. What’s more A&C spending increased even though advertising rates have come down considerably year over year.

Take a look at three of our newest spots from the US. [visual presentation] These spots have been extremely well received and are doing a great job of building our brand franchises. In addition to increasing our marketing investments, we were able to accelerate a number of cost savings programs, primarily related to our reorganization in Europe and our broader overhead initiatives.

We spent more than $300 million in 2009, considerably higher than the more than $200 million we had identified in early November. As this chart shows we’ve improved our operating margin year over year in every quarter of 2009.

Vol/mix continued to be a key driver of margin upside. In the fourth quarter vol/mix drove 70 basis points of margin improvement and for the full year operating margin rose to 13.7% with vol/mix driving 50 basis points of the increase.

As you can see we’ve made good progress toward our goal of restoring our profit margins to industry benchmarks while still investing significantly in productivity and brand building. Finally our momentum is broad based. To be fair we’re not pitching a perfect game. As you know that’s difficult when you’re managing a broad portfolio.

But our businesses in each region are making good progress against their objectives in a very difficult environment. Let’s take a closer look at each regions starting with North America. In the fourth quarter organic net revenue declined 2.7%. This was due entirely to a pricing decline of almost four percentage points.

Lower dairy costs and the related adjustments under our adaptive pricing model represented about two and a half percentage points of the decline. Vol/mix rose more than one percentage point fueled by growth in priority categories.

This growth was tempered by three factors, first we continued to optimize the size of our natural cheese business. This more than offset the vol/mix gains in our more profitable priority brands; Kraft Singles, Philadelphia Cream Cheese, and Velveeta.

Second we made the conscious decision not to chase unsustainable promotional activity in both mainstream coffee and snack nuts. And third we saw declines in a number of our noncore biscuit brands. This was the result of weaker trends in the biscuit category in the second half of the year due to reduced merchandising at a key customer.

Operating income margin in North America rose to 16.6% in the fourth quarter as we improved the alignment between input costs and pricing. Its also important to note that margins rose even as we made significant investments in cost savings and market initiatives.

In fact we increased our investments in A&C at a double-digit rate versus the prior year. For the full year organic net revenue in North America declined slightly. During the year we effectively managed the transition to vol/mix driven growth from price-based growth.

In the end the contribution from pricing was a negative 50 basis points due entirely to 160 basis point impact from lower dairy costs. Priority categories fueled the gains in vol/mix. However these gains were offset by a 70 basis point impact from discontinuing less profitable product lines.

The good news is that as we exited the fourth quarter we’ve now fully lapped the major product line discontinuations and will be on an apples to apples basis going forward. Segment operating income rose to 17.3%, again better alignment of inputs costs and pricing drove the improvement despite incremental investments in cost savings and marketing.

In terms of US market share as we lapped the significant pricing actions of 2008 we’re making slow but steady progress in regaining US market share. Our 52-week trends are improving with 45% of our retail revenue gaining or holding share.

We’re not yet where we want to be but we expect this positive trend to continue in 2010. In fact according to the data we’ve just received we are gaining or holding share in well over 50% of our US retail revenue for the 52 weeks ending January.

Turning now to Europe, organic net revenues were down slightly as we continued to take the necessary actions to improve margins. The discontinuation of product lines and our decision to forego unprofitable volume resulted in a two-percentage headwind to vol/mix.

In addition the economic slowdown has continued to negatively impact consumption with particular weakness in Spain, Portugal, and France. And given the strong position of the LU biscuit brands in these markets it caused a modest revenue decline on our overall European biscuit business as well.

Despite the difficult economic conditions we posted solid market share in most categories due to continued investments in our focus brands. At the profit line fourth quarter operating margins were 8.2%. Improved product mix contributed 90 basis points of the margin improvement. But this was offset by significant investments in cost savings initiatives and a strong increase in marketing investments to support our priority brands.

For the full year our European business posted solid results in a very eventful year. We shifted to a category led operating structure and integrated the LU biscuit business, all while managing through a very tough recession. On the top line organic revenue in Europe declined by one percent as vol/mix was negatively effected by the discontinuation of products lines and our decision to forego on profitable volume.

At the same time market share performance was good, particularly in chocolate, coffee, and cheese. On the bottom line, our operating income margin rose to 9%. Vol/mix improved margins by 90 basis points while we continued to make major investments in cost savings initiatives and marketing.

Turing to developing markets, organic revenues grew by more than 10% in the fourth quarter. Our priority brands drove strong revenue gains across the board. In Asia priority brands grew about 30%. In Latin America, up 25% and in CEEMA, up double-digits. What’s more, we grew market share in almost every one of our key country category combinations.

Operating margin was 8.1%. This reflects improved vol/mix and cost price alignment offset by strong double-digit increases in A&C spending versus the prior year. Our full year developing market results showed that our 5-10-10 focus continues to pay off.

We posted strong revenue and share growth despite softening category trends. Overall organic revenues grew nearly 10% and our priority brands grew even faster, up 18%. Operating income margins were 11.8% and as in every region we continued to invest in additional cost savings initiatives and incremental A&C, to fuel future growth.

As a result of the improved regional operating performance we’ve got strong underlying financial momentum. In 2009 we earned $2.03 per diluted share. That represents 7% EPS growth over 2008 on a GAAP basis and 14% growth on a constant currency basis.

I’d also note that our 2009 EPS includes a negative impact of $0.04 from expenses related to the Cadbury transaction. I know that breaking the $2.00 barrier may seem like the end of an era for many of you, but rest assured its just the beginning from our perspective. In fact let’s take a closer look at the drivers of EPS growth.

As you can see on this chart operating gains were a key driver, delivering $0.15 of improvement over prior year. We’ve also made exceptional progress in terms of cash flow. In no small measure this reflects the fact that cash flow is now a key compensation metric for our managers.

We generated significant gains in 2009 from intense focus on working capital efficiency and improved earnings while ensuring we’re supporting our growth with sufficient CapEx. Looking at the numbers, free cash flow for 2009 increased 35% to $3.8 billion. I would note that we got a working capital benefit due to timing of some payables at the end of the year.

But even excluding this impact, our free cash flow still rose considerably in 2009. So, to recap the progress we’ve made we’re exiting our turnaround with our base operations in great shape in every region around the world and their solid momentum behind each line of our P&L.

The four turnaround strategies I laid out three years ago, have positioned us well to deliver sustainable profitable growth. And as promised the flywheel is now turning. I firmly believe that going forward we can benefit now from a virtuous cycle. We’re setting growth objectives off a solid base.

We’re managing input costs by maintaining strong brand equities and pricing accordingly. We’re driving vol/mix gains through focused prioritized investments. We’re leveraging our scale while driving down overhead costs, and we’re meeting or exceeding our earnings commitments while reinvesting in future growth.

We’ve made good progress but we’re certainly not satisfied that our base business has reached its full potential. We remain focused on driving further improvements in our vol/mix growth and in strengthening US market shares.

We’ve essentially completed our product line discontinuations and we now have a solid base from which to grow. We’ll continue to further optimize trade spending while increasing A&C. And as the economic environment stabilizes and consumer sentiment improves, we’ll be shifting the balance of efforts back toward new product development from value based marketing.

On the cost side we’re continuing to execute significant programs to improve productivity and reduce overhead. We’re well into the execution phase of our end to end productivity programs and the overhead cost reset initiatives we outlined in September.

These initiatives will enable us to continue to fuel our investments in quality, marketing, and innovation while delivering on our targets of reaching mid teens margins on our base business by 2011. So as I’ve said before we didn’t need to acquire Cadbury to deliver our existing growth targets.

In fact when we first announced our intention to acquire Cadbury, many of you asked, why now? And the answer is that having successfully reinvigorated our base business, we’re now ready to write the next chapter in our transformation.

The time is right for us to accelerate our transformation from a position of strength. We can leverage our strong financial momentum to accelerate our progress. And we’ve prepared our organization to execute with excellence in a number of important ways.

We’ve strengthened our leadership team. We’ve streamlined our organizational structure. And our global organization has the skills and appetite to integrate a large scale combination. Now we’re ready to take both Kraft Foods and Cadbury to a level neither could reach on its own, and create a combined growth company with unmatched talent, brands, capabilities, and resources.

Let’s take a brief look at the newest member of our family. [visual presentation] As I’ve said over the past several months, this combination is all about growth. The new Kraft Foods will deliver top tier organic revenue growth through a focus on higher growth, higher margin categories and expanding footprint in developing markets and a greater presence in growing trade channels.

And we’ll target industry leading margins through improved product mix and leveraging our global scale. Cadbury and Kraft each had strong plans to get to mid teen margins prior to our combination. And the synergies inherent in combining the two companies will enable us to take things to a whole new level of long-term growth and margin potential.

Let’s start with our category mix, the fast growing confectionery and snack segments will now make up the majority of our portfolio. In fact almost 70% of our revenue outside North America now comes from snacks and confectionery, two rapidly growing highly expandable categories.

We go to market with a portfolio of iconic brands that consumers around the world love and trust. In fact we now have 11 brands with annual revenues of more than a billion dollars, six of them are confectionery and snacks brands.

And we have at least one billion dollar brand in every consumer segment in which we compete. On a local basis we’re even stronger, 80% of our worldwide revenues are derived from brands where we hold the number one market position.

This is driven by more than 70 brands including more than 40 confectionery brands with revenues in excess of $100 million. These brands are icons in their respective markets. We take enormous pride in our stewardship of these brands and the legacies entrusted to our care.

And I’m confident that these beloved brands will thrive with focused incremental marketing and merchandising investments that we can now provide. From a geographic perspective more than half of our business is now outside North America. More than a quarter of our revenue comes from fast growing developing markets, up from 20% before.

Our developing markets’ scale is now greater than any of our North American food peers. And this scale, this presence is the cornerstone on which we will grow our strong brands even faster. For instance as we’ve said before the geographic footprint of Kraft and Cadbury is highly complementary. We now have considerably greater scale in key developing markets that will benefit all of our categories.

As this chart shows combined net revenues will be approximately $1.5 billion in Brazil, $1 billion in Russia, about $400 million in India, $500 million in China, and about $800 million in Mexico. This will lead to significant revenue synergies as we expand the distribution of each of our respective brands into new markets.

For example products under the Cadbury and Trident brands will benefit from a substantially strengthened presence in countries like Brazil, Russia, and China. For Kraft brands such as Oreo and Tang, Cadbury gives us a meaningful entry into India, and fundamentally transforms the reach of our brands in Mexico, and South Africa.

But that’s only half the story, we now go to market from an even stronger position. Together we possess exceptional and complimentary sales and distribution capabilities. Kraft Foods is strong in modern retail channels, that is traditional grocery stores.

Indeed our scale is unmatched in North America where we have unique capabilities to drive performance. And as large retail formats grow globally, we’re in a strong position to capitalize on that. At the same time Cadbury is very strong in instant consumption channels. This is an important class of trade in both developed and developing markets, in part because instant consumption channels provide incremental reach to large retail formats.

What’s more these channels typically carry opportunities for higher margins and higher growth and nowhere is this more important than in the confectionery and snack segments. From a distribution perspective our leadership in confectionery is highly complementary to our biscuit business and being a global leader in both confectionery and biscuits will not only provide our combined business with significant scale but also with exciting innovation platforms.

Together we will be the global leader in sweet snacks with leading market shares in every major region in the world. This scale will be an increasing source of competitive advantage in both the confectionery and snack segments and the food industry as a whole.

For these reasons I’m highly confident that we are well positioned to drive top tier organic revenue growth for the foreseeable future. Our portfolio is now more heavily weighted towards faster growing categories and geographies. And on top of that we have a long runway of meaningful revenue synergies ahead of us with every geography benefiting.

In the end I firmly believe that this portfolio with its unique profile can deliver at least 5% organic revenue growth on a consistent basis over the long-term. This assumes highly achievable growth objectives for every geography, 3% to 5% in North America, 2% to 3% in Europe, and 10% plus in developing markets.

On the cost side we will access the benefits of our significant global scale with about $50 billion in revenue, we’re the world’s second largest food company and number one in North America. But I’m not talking about big for bigness sake. In an ever consolidating marketplace scale is a source of great competitive advantage.

Our size and presence in more than 160 countries gives us that scale. Great scale should lead to meaningful cost savings. As you know both Kraft and Cadbury each has strong cost savings pipelines. But we’re targeting cost synergies of at least $675 million on top of each company’s base plans including Cadbury’s vision into action program.

Thus far we’ve identified potential annual pre-tax cost savings in three areas; operational synergies of $300 million. The result of efficiencies and economies of scale in procurement, manufacturing, customer service, logistics, and R&D, general and administrative synergies of approximately $250 million, and marketing and selling synergies of $125 million from efficiencies in economies of scale and marketing, media, and selling expense.

We expect to achieve the run rate on those savings by the end of the third year and we estimate one off implementation cash costs of about $1.3 billion. We believe these targets are highly achievable. We’ll provide more detail on the flow of both the costs and the benefits, in the coming months.

This strong pipeline of cost savings initiatives is designed to accelerate our margin expansion. Productivity savings will better leverage our scale in manufacturing and operations. We’ll leverage our overhead costs to fuel further margin expansion. We’ll use a portion of these savings to fund higher A&C as a percent of net revenue.

And we’ll increase investments in sales, R&D, and marketing to support future growth. As a result I firmly believe we can simultaneously fuel investments in quality, marketing and innovation for top line growth while still delivering healthy sustainable margin expansion.

In fact we’ve set our sights on a long-term operating profit margin in the mid to high teens, up from 13.7% in 2009. This combination improves our overall growth profile and positions us for sustainable, profitable growth in the top tier of our industry.

We’ll be driving high quality organic revenue growth, executing a strong pipeline of cost savings initiatives while still increasing investments in marketing, sales, and R&D. As we do this we’re targeting long-term organic revenue growth to accelerate from 4% or more to 5% or more.

We’ll drive our margins as I said to the mid to high teens, and we’ll enhance our long-term EPS growth rate from 7% to 9%, to 9% to 11%. We know that these are aggressive financial targets but we also know that we have a very unique portfolio and a unique set of opportunities in front of us.

I look forward to updating you on our progress in the months ahead. Now let me turn it over to Timothy McLevish.

Timothy McLevish

Thanks Irene, and good morning. At this point I’d like to update you on the status of our transaction and discuss what you can expect from us going forward. First, here’s where we stand in the tender offer, as of February 4, 75% of Cadbury shares had been tendered which enabled us to initiative the delisting process.

So Cadbury will be delisted from the London Stock Exchange as early as March 8. In terms of tenders received to date, as of late last week over 90% had been tendered and yesterday, we initiated the process for a compulsory acquisition also known as a squeeze out.

So within six to seven weeks, we expect to own 100% of Cadbury. And finally, through yesterday we’ve completed settlement of all shares accepted through February 2 or about 72%. We’ve also completed the financing for the transaction. On this chart you can see a profile of our current debt including Cadbury’s outstanding debentures.

Earlier this month we successfully raised $9.5 billion in the US in a four tranche bond offering. As we committed at the outset of this process, we’ve maintained our investment grade credit rating, importantly while maintaining good access to tier 2 commercial paper.

We expect to reduce our debt to EBITDA ratio to around three times over the next 18 to 24 months. We’ll deliver through a combination of debt reduction and EBITDA growth. We’ll apply proceeds of approximately $2.5 billion from the sale of our pizza business. Also, under the terms of our agreement with European Commission, we’re required to divest certain Cadbury operations in Romania and Poland.

The combined revenue of these businesses is approximately $200 million, so these divestitures will provide additional funds albeit modest, to further de-levering. As we’ve stated throughout the transaction, we’ll maintain our dividend. However until our debt leverage targets are achieved, we have no plans to increase it, nor will we be repurchasing any shares.

We also expect to draw on our bridge facility in the near-term but we’ll quickly take out the balance through a combination of proceeds from the pizza divestiture, and cash generated from our operations. From the very beginning of this process, we set out four key criteria to maintain financial discipline.

First, accretive to cash EPS in the second year. This transaction is expected to add approximately $0.05 to earnings in 2011, the first full year of our combined companies. Second, a return on investment well in excess of our cost of capital, and we expect to deliver mid teens internal rate of return.

Third, maintain our investment grade credit rating. This has been confirmed by the rating agencies. And fourth, maintain our dividend per share. With our strong cash flows and the capital structure we’ve put in place, we expect to work down our leverage while still maintaining our dividend.

Throughout the process there were some doubters and much talk about the ultimate size of our checkbook. But as you can see the final terms of the deal fell well within the bounds of our original criteria.

So not only is this deal a strategic homerun, we’ve touched all the bases on the financial front as well. Let me now turn to integration, at this point we’ve been working with the Cadbury team for less than two weeks. While we don’t have all the answers yet, I can share some early thoughts about how we will proceed.

Let’s start with back room systems and processes, it will generally be more cost effective and efficient to adopt the Kraft platform. On the other hand, with front room activities, we’ll go with the best practice from whichever company has it. And when it comes to people decisions, we’ll chose the best person for the right role.

And how will we make those decisions? We have a global team of executives from both companies in charge of bringing our companies together; Tim Cofer is leading from Kraft and he’s paired with Mark Reckitt from Cadbury. Tim is ideally suited for his role. He’s an 18 year veteran of Kraft. He most recently led our pizza business.

Perhaps even more important, Tim managed our 26 country European chocolate business from 2003 through 2006. He’s a proven leader who is familiar with growth businesses, and has a relentless focus on costs and quality.

Working hand in hand with Tim will be Mark Reckitt. Mark is a 20 year Cadbury veteran. He knows the company through and through from structure to financials to people. Indeed he’s been a chief architect of the strategies that have made Cadbury so successful.

We’re delighted that Mark has accepted our offer to partner with Tim in helping us combine our two great companies. Mark embodies the heart and soul of Cadbury. We know he’ll be a great partner in helping up truly capture the best of both and capitalize on the growth opportunities created by this combination.

As we work our way through this, Tim, Mark, and the rest of the team will be guided by six practical principles. First and foremost, we’ll maintain business momentum. Many integrations fails, not because of the cost synergies have not been captured but rather because the base businesses have not been properly looked after.

We’ll minimize the disruption to our day to day business so as to keep building and growing our brands. Second principle, we’ll follow the money using the 80/20 rule. By that we mean spending time on those things that will bring the greatest benefit to the organization. Third, capture best of both.

Fourth, treat people fairly and with respect. Fifth, move quickly. And sixth, communicate, communicate, and communicate.

The process will be as fair and as transparent as possible. And we’re going to move quickly but prudently. The reality is we all have a lot of homework to do because of the way this transaction came together. We’re just starting some critical conversations. So when can you expect some more answers, let me share a timeline.

Within the first 45 days, we intend to name the executive team, the leaders of the regions, areas and countries and direct reports to the functional leaders. Once those are completed and within the first 90 days, we intend to announce the next level of management for each region, country, and category.

We’ll also determine whether and how we’ll consolidate any region, area, and country office locations or our various research and development facilities. Within six months we’ll finalize the blueprint for our combined manufacturing network.

I hope now you can appreciate all that’s going on, to ensure both a smooth integration and to validate or original assumptions on the deal. Which brings me to earnings guidance, at present our ability to issue earnings guidance remains limited for two important reasons.

First, UK listing authority rules require any earnings forecast to be reported upon by an independent third party and I can tell you from recent experience, it’s a time consuming and expensive process. Second, and even more important, is the fact that its still very early in the integration process.

As I mentioned we’ve had less than two weeks to evaluate Cadbury’s existing operating plans and financial statements and to begin verifying our initial assumptions regarding synergies. We won’t make you wait six months. We expect to issue 2010 earnings guidance and an outlook for 2011 when we announce our first quarter results in May.

In the meantime, this is what I can offer to help you build your models. We delivered $2.03 per diluted share in 2009, in line with our recent guidance. We continue to target EPS growth for the Kraft Foods base business at the high end of our 7% to 9% long-term growth objective in the near-term.

We will be consolidating Cadbury results from February 2 onward. We’re targeting about $0.05 cash accretion to our 2011 base business from the Cadbury acquisition. That excludes one-time implementation costs of about $1.3 billion which will be incurred over the next three years.

It also excludes expenses related to the transaction and the incremental non-cash items such as the amortization of intangibles, related to the acquisition. The divestiture of our pizza business is expected to lower earnings by about $0.05 per share on an annual basis. And that transaction is expected to close in mid 2010.

Overall the combination of Kraft Foods and Cadbury promised to deliver substantial value for our shareholders. This combination will increase our long-term growth targets while still generating significant near-term benefits.

It will accelerate our long-term growth targets to 5% plus on the top line and our long-term EPS growth target to 9% to 11%. At the same time we expect the transaction will be accretive to cash EPS and have a mid teens internal rate of return.

Together these benefits result in a transformational combination that will create a top tier performer in the global food industry. Thank you, and now we’d be happy to take your questions.

Question-and-Answer Session

Unspecified Analyst

If I could just ask a portfolio question here, using Maxwell House as kind of an example, I know you’re doing some trending there, but when you look at some of the sales declines notably Wal-Mart that comes to mind, I guess a person more cynical than myself might suspect you’re setting this thing up for sale, which I know you can’t comment on but just portfolio decisions henceforth, do you think we’re through with divestitures in North America and maybe a little more color on what might be divestitures as you merge with Cadbury.

Irene Rosenfeld

Sure we’ve got a pretty big [win] to swallow right now and I think we’re feeling awfully good about the fundamental profile of the portfolio. I like the category composition. I feel very good about the geographic footprint particularly in developing markets. We like the channel profile, and we’re going to spend the foreseeable future integrating it and delivering on the financial commitments that we’ve made.

We will continue to look at our portfolio as we always do and we’ll keep you posted as things evolve but I feel quite comfortable with the portfolio as it sits today and most importantly quite confident that we can deliver on the financial commitments that we’ve laid out.

Unspecified Analyst

Following up on divestitures a little bit, I think a lot of us were surprised to see pizza as a choice for something you would sell. Wasn’t that long ago that might have been described as the crown jewel of the North American business. Could you talk as much as you can about how much of that choice to divest that was just it was a large attractive asset that was salable in the current environment and how much of it is that maybe some of the developments we’ve heard about discounting-wise in the frozen food arena, that’s become very, very competitive. How much of that was actually tactical in that perspective.

Irene Rosenfeld

The divestiture of pizza was an important strategic decision for us. It was not something we were looking to sell, but the reality was as we looked ahead at the future of that business, the challenge is it’s a frozen business. We don’t have any frozen assets outside North America. It did not scale well within our wall to wall capability in North America which is an important competitive advantage as you know.

And so from a strategic perspective it was a good business to think about divesting at some point. We didn’t necessarily, wouldn’t have chosen today except for the fact that we had a very good offer and it made very good economic, had very good economic returns for us. So it was a difficult decision but I think it was the right decision for the long-term profile of our portfolio.

Unspecified Analyst

Just in terms of your margin targets, you ended last year with a 13.7 margin, used to do 20% several years ago. I believe you proposed something on the order of 30 planned. Fourth quarter margin were only 11.8, why should we believe your targets for Cadbury frankly would seem very aggressive given your record.

Irene Rosenfeld

Well I think that we’ve made very good progress in delivering on the margin commitments that we’ve made. We said we would expand margins this year and as you saw we were up about 450 basis points. I feel very good about the progress overall both at the gross margin level and then at the operating margin level.

I think the fundamental programs that we’ve laid out on our base business in terms of overhead and end to end productivity will continue to drive the margins toward the mid teens commitment that we’ve made by 2011 for our base business. And then the overlay of the synergy on top gives us some added opportunity.

So I think net, net we are not going back to 20. I’ve been quite clear about that. That was not a sustainable level but I’m quite confident that we can deliver in the mid teens and that we’re well on our way to get there.

Timothy McLevish

I will just add to that, the fourth quarter is not typically our strongest quarter of the year and we did, you may recall it one year ago, one year ago that the global economic situation was virtually in crisis. At that time we chose to gait some of our spending. So we lightened up our spending in the first half of the year. We started to release that in the second half.

Some of that got released in the fourth quarter and I would say we heavied up on a lot of our spending in the fourth quarter which took down the margins, but that was the right thing to do for our business.

Unspecified Analyst

I wanted to touch base on working capital if you could. You mentioned that as consumer confidence increases, you’re going to shift some of the value based spending approach to more new product development again and that’s something we normally associate with a build up of inventory which can be a drain on your cash flow. Can you talk about what your expectations are in terms of working capital as a source or use of cash flow and how that may or may not impact your ability to de-lever in the near-term.

Timothy McLevish

Let me tell you to start out, I sat here two years ago and committed that Kraft could generate an additional billion dollars worth of cash flow and I guess I just didn’t realize that it comes quickly as it did. Irene commented that the 4.2 or 3.8 that we actually generated depending upon which level you look at it was aided by some, a lot of the late year of spending that I mentioned in the fourth quarter sat in accruals or sat in payables at year end.

So there’s probably about a half of billion dollars worth of what I will call not sustainable level of working capital. I will say though, yes, we do commit to increase our new product development. We still have a ways to go in lowering our overall inventory levels and our working capital levels. We have engaged this year in our project saver which is a sourcing initiative to generate a fair amount of reduced costs but also to extend the terms and to get all of our terms right in our payables.

So I think there’s still working capital improvement opportunity. Some of it may be absorbed as we expand inventories a little bit, maybe geographically or in new product development but I think on balance working capital will still be a source of cash flow as we go forward.

Irene Rosenfeld

We’ll show those actual targets with you in May when we give our guidance for 2010 but I’m quite comfortable that targets that we’ve laid out will provide adequate capital expenditure as well as provide for the inventory build on some of these new products while at the same time delivering against the EPS commitments we’ll provide.

Unspecified Analyst

Just a point of clarification, 2011 cash EPS accretion, what’s that accretive to. Is it accretive to—

Timothy McLevish

Well its accretive to the base business we’ve established. The best unfortunately that we haven’t laid out specifically but we said that we’re going to be at the high end of our 7% to 9% long-term growth targets in the near-term. So I would apply that to 2011.

Unspecified Analyst

So where that trajectory would have been for 2011—

Timothy McLevish

Where that trajectory would have taken you to 2010 into 2011, from that we would expect to be $0.05--

Unspecified Analyst

And that’s with our without the pizza dilution.

Timothy McLevish

That’s, pizza needs to be adjusted.

Unspecified Analyst

Just a point of clarification, the pizza dilution, that was a full year basis or half year.

Timothy McLevish

That’s on a full year basis. Obviously we expect that we’ll close sometime mid year so it will be kind of half that for the first year. And that’s not a forever thing. The majority of that is stranded overheads that we’ll be working on bringing back down over the coming years.

Unspecified Analyst

Just two quick comments, I think its somewhat scary to say $0.05 dilution from that, $0.05 accretion from Cadbury. The transactions are obviously related. I’m not sure how you really check the box at the top there that says we delivered on year two accretion. And then just also was we go forward on this process, the mixing of volume and mix is really, you might as well say volume and color, they’re just not related and it would be much more helpful, Kraft for years and years and years delivered a tonnage or a volume number and particularly as this acquisition goes forward and if we’re to judge you on have you reestablished this virtuous cycle which we’d love to see, but we got to see volume to know that.

Timothy McLevish

I would not agree with your assertion that its like mixing with volume with color, there is a real reason why we chose to bring them together and largely it relates from our ready to drink business which is very heavy and to the extent that we would see significant distortions when we would see volume up in ready to drink and it would take our mix down and vise versa.

So we chose to bring them together. However for the last two years since we’ve put it in place, we’ve been hearing pretty consistently that that’s not something that is well received by analysts and investors and we are looking at ways of better giving you the information that you need without combining them. We have some ideas, we need to flesh them out.

Irene Rosenfeld

If its any consolation, Cadbury has the same problems. They’re selling a lot of [Wispa] and very lightweight things which is messing up their volume as well. So we need to figure this out but we understand your issues and we will attempt to deal with it.

Unspecified Analyst

Just in terms of your base business, the fourth quarter vol/mix trends for your base business, the 1.6% growth is an improvement but you were lapping a pretty easy comparison a year ago in the fourth quarter so can you just elaborate on some of the factors in the fourth quarter and what’s to say that some of the heightened promotional activity that you’ve seen in some of your categories really doesn’t spread it into the other categories.

Irene Rosenfeld

I feel very good about the progress we’ve seen in the fourth quarter. As we said it came in a little bit lighter than we had hoped but the reality is as we start to get some of the unsustainable volume out of the base as we start to see some of the promotional activity subsiding, we expect that we will see the necessary progress.

I was pleased to see progress in market share. I was pleased to see the contribution of vol/mix improving even though it didn’t quite hit the number that we had expected to see and we did see very strong profit and cash flow growth which we expect to continue. So I expect that the first quarter will reflect the continued improvement in our underlying vol/mix health and in our trends and that should play through not only in our aggregate revenue growth but also in our market share particularly in our US categories.

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