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Executives

Chris Jakubik - Vice President Investor Relations

Irene Rosenfeld - Chairman and CEO

Tim McLevish - Chief Financial Officer

Analysts

Vincent Andrews - Morgan Stanley

Terry Bivens – JP Morgan

Christine Mccracken – Cleveland Research

Alexia Howard - Sanford Bernstein

Andrew Lazar - Lehman Brothers

Ken Zaslow - BMO Capital Markets

Jonathan Feeney - Wachovia

David Driscoll – Citi Investment Research

Eric Serotta - Merrill Lynch

Todd Duvick - Bank of America

Chris Growe - Stifel Nicolaus

Robert Moscow - Credit Suisse

David Palmer – UBS

Kraft Foods Inc. (KFT) Q2 2008 Earnings Call July 28, 2008 8:00 AM ET

Operator

Welcome to the Kraft Foods second quarter 2008 earnings conference call. (Operator Instructions) I’d now like to turn the call over to Chris Jakubik, Vice President Investor Relations for Kraft.

Chris Jakubik

Thanks for joining us on our conference call. I'm Chris Jakubik, Vice President of Investor Relations. With me are Irene Rosenfeld, our Chairman and CEO, and Tim McLevish, our Chief Financial Officer.

Our earnings release was sent our earlier today and is available on our web site, Kraft.com. Also available on our web site are slides that we will refer to during our opening comments. As you know, during this call we may make forward looking statements about the company's performance. These statements are based on how we see things today so they contain an element of uncertainty.

Actual results may differ materially due to risks and uncertainties. Please refer to the cautionary statements and risk factors contained in the company's 10-K and 10-Q filings for a more detailed explanation of the inherent limitations in such forward looking statements. Some of today's prepared comments will exclude those items that affect comparability. These excluded items are captured in the GAAP to non-GAAP reconciliation within our news release, and they are also available on our web site.

We’ll begin the call with Irene providing her perspective on our second quarter and our outlook for 2008. Then Tim will highlight our financials and review the results for each of our business segments. After that we'll take your questions. With that, I'll hand it off to Irene.

Irene Rosenfeld

As most of your have already seen we just reported strong second quarter revenue and earnings growth. There are a few puts and takes in the numbers that Tim will review in a minute. Even excluding those factors we delivered very strong financial performance. More importantly we’re demonstrating that despite very challenging economic conditions we can and we will cover input costs inflation while building our brand equities and delivery improved financial results.

In terms of input costs our new decentralized structure is effectively dealing with an environment of escalating costs while protecting investments for long term growth. This is coming through in two ways. First, our business leaders are reacting faster to changes in the marketplace. This means quickly taking the lead on cost driven price increases.

As we enter Q3 we’ve had to take additional pricing to offset continued increases in input costs especially grain and dairy. It also means taking decisive actions like cutting inefficient trade spending or giving up unprofitable volume. Although some of these actions may result in near term share loss they are the right thing to do for the long term health of our business.

Second, our decentralized structure is also delivery cost savings. Our managers are generating significant manufacturing productivity and they’re hitting their targets for restructuring savings and cash flow. They fully understand that these savings are the key to their ability to continue to make the necessary investments in building their brands while delivering profitable growth.

More specifically, in terms of building our brand equities our investments in product quality, marketing and innovation continue to pay off. We’re seeing it in several categories including these. Salad dressings where despite a slow start in April our reinvention of this business has led to share gains in each of the last two months. Mainstream coffee, where our restaging of Maxwell House drove over one point of share gain this quarter.

Cakesters, which is on its way to $100 million in revenue this year driven by the recent launch of Nilla Cakesters. European chocolate where new products and significantly higher marketing spending behind Milka and Toblerone drove another quarter of double digit growth. In developing markets where Jacobs coffee is the number one coffee in Ukraine.

In this difficult economic environment our reframing efforts across the portfolio have further demonstrated the value proposition of our brands. For instance, Mac & Cheese, our icon of value oriented meal solutions grew nearly 20% in the quarter and it delivered its fourth consecutive quarter of market share gains, fueled by our investments in quality and innovation.

Oscar Meyer Deli Fresh Cold Cuts remain on fire. Positioned against more expensive deli counter meats they just delivered their 21st consecutive quarter of share and volume growth. Consumers are also finding that our Oscar Meyer Deli-Creations sandwiches represent a significant value compared with take out sandwiches. They’re highly incremental to our base cold cuts business and are on their way to reaching the $100 million mark.

In Pizza where we’re reframed against pizzeria offerings we’re growing volume in the mid single digits and our share is up over a point. We’ve also reframed our marketing of Jell-O dry packaged deserts and Kool-Aid and Country Time powdered soft drinks. We’ve done this by emphasizing their value oriented positions versus higher cost per serving alternatives. As a result we’re seeing renewed growth in these high margin businesses.

Having said that during the quarter our market shares were under pressure for two reasons, first as I mentioned we took out inefficient trade spending to improve the return on our trade investments. We expected this to have a short term share impact particularly in ready to drink beverages and snacks. Second, while we’ve acted decisively with cost driven pricing actions a number of competitors lagged us. As a result we saw some temporary dislocation that affected both our 13 week and our 52 week market shares.

Going forward we’ll continue to invest in our brand equities and in the value positioning of key brands. We’ll benefit further from product news in core categories like crackers, pourable salad dressings, single serve pizza and cheese. As a result we expect to see our market shares rebound in the back half of the year, which brings me to our financial results.

Our business continues to strengthen and performance is exceeding our expectations. In fact, organic revenue and operating income grew in all segments for the first time in many years. On the revenue front our Q2 volume held up well even in the face of our unprecedented pricing actions. As a result of our underlying momentum and the expectation of additional pricing we’ve raised our guidance for 2008 organic revenue growth to at least 6% from at least 5%.

Below the revenue line during the second quarter we booked some gains from hedging activities. However, even excluding these gains we’re exceeding our expectations while continuing to invest for future growth. For the full year we expect our operating momentum to continue and so we’ve raise our EPS guidance to at least $1.92 from at least $1.90.

In summary, our second quarter results were strong in fact even stronger than we expected and a significant indication that our business continues to gain momentum. Our results despite very challenging economic conditions showed that we can and we are covering input cost inflation while building our brand equities and delivering improved financial results.

Now I’ll turn the call over to Tim.

Tim McLevish

Please keep in mind that unless otherwise noted my comments will exclude the items affecting comparability that were highlighted in our press release. Let’s look at Q2 results starting with revenues. Our Q2 net revenues increased almost 7% on an organic basis. As expected net pricing was a key contributor as we increased prices to cover higher input costs. It was up 7.2 percentage points versus about four points in Q1 and less than two points in all of 2007.

Despite significant pricing we’re encouraged by our overall volume and mix performance. It held up better than expected reflecting the benefits of our investments in quality, marketing and innovation. However, as anticipated our second quarter volume comparisons were down in some categories. This is especially true in ready to drink beverages, cheese and our spoonable dressings and enhancers businesses. In all of them we took significant cost driven price increases.

Near term pricing will remain the primary driver of revenue growth as input costs continue to escalate and volume comparisons will remain difficult. However, we’ll continue to invest behind a strong pipeline of innovations. We expect them to drive solid volume in mix performance in the second half of the year and to set the stage for 2009.

Turning to margin performance, our gross margin was up 40 basis points versus Q2 last year. However, this included approximately $150 million of realized and unrealized gains from hedge requirements for future quarters. Excluding these gains gross margins would have been approximately 35%. We’ve called out these gains because we see them as a timing issue, effectively pulling cost protection benefit we would have had in the second half into the second quarter.

Early recognition of these gains will result in higher reported cost of goods sold in the second half of the year. While this means our gross margins would have been down 80 basis points year over year it was up 130 basis points over Q1 as the effective improved price realization began to come through.

Now I’d like to spend a few minutes in input costs and the magnitude of increases we’re facing in 2008. This chart shows prices by year versus the 10 year average for each of our 11 key commodity inputs. Compared to numbers as recently as April you can see that the prices of many commodities have increased.

To put this in context for Kraft, in Q2 our input costs were up about $400 million over last year. Through the first six months our input costs were up about $800 million. For the full year we now expect them to be up about $2 billion or about 13% over 2007. That’s higher than we anticipated in January or even in April. That means that more than half of the increase will come in the back half of this year.

Because of these significant cost pressures we’ve taken addition pricing actions in Q3. While we’re pricing to cover costs and grow profits in dollar terms it’s proving difficult in this environment to grow margin percentages. However, this pricing together with further productivity savings and overhead leverage we’ll still deliver our expected earnings dollars. Despite the challenging cost environment we’ll continue to invest in our growth and we’ll deliver ahead of our previous expectations. We’ve raised our guidance accordingly.

Turning to Q2 earnings per share, the strong contribution from operations just discussed was partially offset by a few factors below the line. Higher interest expense was a $0.07 headwind versus the prior year. We currently expect interest expense for the year to be roughly $1.3 billion. In addition, a higher year over year tax rate was a $0.03 headwind. Our effective tax rate excluding items was 36.1% in the second quarter. This is higher than our full year forecast due to the timing of several discrete items.

However, we continue to expect an average rate of 33.5% for all of 2008 with some variation quarter to quarter depending upon when the anticipated discrete items fall. Finally, the interest and tax headwinds were partially offset by $0.03 from lower shares outstanding. I’d note here that between our usual black out for earnings and a black out related to the Post transaction we were prevented from repurchasing any shares during the quarter. However, we still expect complete our share repurchase authorization before it expires in March of 2009.

I’ll take a few minutes now to share some highlights of our business segment results. I’ll start with US Beverages where organic revenues grew at 3.4%. Ready to drink beverages, powdered beverages and coffee all contributed to growth in the quarter. In Ready to drink a big factor was our successful effort to reduce inefficient trade spending on Capri Sun. In Q2 revenue is up in the mid-single digit range and profitability improved significantly. At the same time volume was down.

As we discussed last quarter the heavy nature of Ready to drink beverages weighed on the volume performance of our entire US Beverage business. This quarter is was a nine percentage point drag on volume. Excluding Ready to drink our beverage segment volume was up 4.6%. In coffee our investments to restage the business are paying off.

We posted double digit growth in both Maxwell House and Tassimo. Maxwell House drove a market share gain in the mainstream segment for the second quarter in a row. Our new Starbucks branded tea disks produced revenue growth of more than 30% in our premium on demand Tassimo platform. During the quarter powder beverages also delivered solid growth.

This is driven by double digit volume gains in Kool-Aid and Country Time as we’ve improved our marketing and as consumers seek lower cost alternatives to soft drinks. At the profit line Beverages operating income grew 6% and margin increased 100 basis points. Here the benefits from cost driven price increases especially in Ready to drink beverages more than offset higher input costs.

In US Cheese organic revenues were up 10%, this is due entirely to price increases in response to higher dairy costs. Compared to a year ago list prices are up 6% to 33% across our cheese categories with the largest in Natural cheese. Overall volume mix in cheese was down about 5% versus the prior year. Innovation such as Bagel-fuls, Singles Select and Live Active continue to deliver solid benefits in both volume and mix.

However, this was offset by volume weakness particularly in Natural cheese and culture products, as consumers continue to adjust to higher absolute price points. We also showed on profitable volume as private label ran some deep discounts during the quarter. During Q2 we announced further pricing actions covering 90% of the portfolio.

We expect this pricing to pressure volume comparisons in the near term, however as we continue to invest in innovation we’ll see further growth for Bagel-fuls which is running well ahead of trial and repeat expectations and we’ll complete the launch of our 2% milk RBST free cheese products in the second half of the year. Going forward we expect solid revenue growth to continue.

Turning to operating income, it was up 7.3% versus Q2 2007. Pricing and lower overhead expenses more than offset the impact of higher input costs and lower volume. Consistent with our guidance our cheese margin was up again sequentially from the prior quarter, 13.6% versus 12.9% in Q1. As gains from innovation and price realization continue we expect further sequential improvement in operating margins.

Moving on to US Convenient meals, our team delivered another quarter of strong performance. Our investments in quality, base marketing and new products drove 7.6% organic revenue growth with 5.1 points due to volume and mix gains. In Oscar Meyer the strength of our Deli-Fresh Cold Cuts platform continued with strong double digit revenue growth and about two points of share gain in the overall Cold Cuts category.

Our Deli Creations sandwiches also grew strongly in Q2 driven by the new flat bread breads line. This is proving to be higher incremental to our base business. Finally, strong volume growth in Pizza continued. Not only from our base DiGiorno and California Pizza Kitchen offerings but also from the roll out of our new line of single serve offerings under the For One banner. This drove more than a point of market share gain in frozen pizza during the quarter.

At the operating income line we grew roughly 3% versus the prior year. Here our strong growth was partly offset by two factors. The launch cost of our Pizza For One initiative and price increases lagging higher costs particularly cheese. As we move forward we expect our year over year profit performance to improve as well.

On to US Grocery where organic net revenues were up 4.5% and operating income grew 30 basis points. Here our investments to contemporize the portfolio are paying off. Two of our early investments Jell-O and Mac & Cheese again delivered a combination of pricing, market share gains and higher operating income margins in the quarter.

Both categories are benefiting from the current economic environment as consumers search for value oriented meal solutions. Our pourable salad dressing investment is contributing to the improvement as well. The launch of our new line of Kraft Pure salad dressings led to strong volume growth in the quarter. This came despite considerable cost driven price increases. These gains were partially offset by declines in other parts of the business including enhancers like barbeque sauce and spoonable dressings as pricing actions led to volume declines.

Overall we’re encouraged by the progress we’re making to grow our high margin grocery portfolio. In the third quarter we expect to gain even more attraction from our investments which will lead to continued growth in the second half.

Looking at US Snacks & Cereals, organic net revenues were up 5.1% in Q2 that was entirely due to pricing. At the category level solid gains in biscuits and pricing in nuts were partially offset by a decline in snack bars. In biscuits 100 calorie pack cookies and crackers were up a double digit rate again as the momentum from that platform continues. The addition of Nilla Cakesters and the ongoing growth of Oreo Cakesters pushed the Cakesters platform further toward the $100 million mark.

Investments in product quality and marketing led to strong growth in three of our five largest brands, Oreo, Chips Ahoy, and Ritz. However, our overall performance in crackers was weak in the quarter for two reasons both related to timing. One was the fact that our key cracker competitors lagged our price increases resulting in larger than normal price gaps during the quarter.

Second, the product news and marketing programs for two of our cracker brands Triscuit and Wheat Thins are more back half weighted. Going forward we expect our cracker performance to improve and lead to even better biscuit performance in the second half.

Turning to snack bars our business was down significantly in the quarter. This is mainly due to the timing of new product announcements as well as our rationalizing SKUs. However, the trend should improve in the second half as we invest in quality upgrades and marketing. At the operating income line strong growth and margin gains were offset by a $50 million realized gain from hedging activity. Excluding this factor, operating income was down approximately 8%.

Price increases and cutting inefficient trade spending were offset by three things, higher input costs, unfavorable product mix from lower cracker volume and higher marketing and overhead costs. Going forward the realized gain in this quarter will essentially be given back in the form of higher input costs flowing through our P&L in Q3 and Q4. None the less, we will continue to invest in innovation and base brand support and we expect our snacks business to deliver mid-single digit profit growth for the full year.

Finally, it’s noteworthy that our Cereal business grew in the quarter despite difficult comparisons with the re-launch of our Kids Cereal business in Q2 last year and significant pricing this year. Top line growth in the quarter was driven by both pricing and ongoing growth of the Honey Bunches of Oats adult cereal business. We remain on track to complete the transaction to exit our Post Cereal business in the coming weeks.

Turning to Canada & North America Foodservice organic net revenue growth was up 4.4% versus last year. We had another solid quarter in Canada. It was driven by strong volume and share growth from increased investments in marketing and innovation across all categories. The implementation of improved customer plans as we leveraged our scale with the reestablishment of Canada as a stand alone business.

In North America Foodservice growth came from a combination of pricing and to a lesser extent volume. The effects of lower consumer restaurant traffic were offset by strong response to our quality improvements and innovation. At the operating income line margin was up 290 basis points, top line growth manufacturing efficiencies and overhead cost leverage more than offset higher input costs.

Going forward both Canada and Foodservice will benefit from announced price increases to cover significant commodity cost increases. Volumes may soften in the near term but given the base business gains from marketing and innovation we expect solid year over year margin improvement to continue in the second half.

Now I’ll turn to our International business where we continue to show good organic growth by focusing our investments in our core brands, core categories and in key markets. In the EU this resulted in 3.4% organic revenue growth. We delivered double digit growth in Chocolate from the ongoing success of our investments behind core brands Milka, Toblerone and Cote d’Or. Cheese also grew at double digit rate from both pricing and improved marketing behind Philadelphia.

In Coffee revenue declined slightly this is due to pricing related volume weakness in our roast and ground business and it offset the growth for realizing for investments to trade consumers up to our on demand and soluble coffee offerings. At the profit line in line with our forecast EU operating margins declined slightly versus last year but they improve sequentially from Q1. Versus prior year pricing and favorable product mix were offset by higher input costs.

Going forward as our price realization and product mix further improve and the benefits of integrating the LU biscuit business come to fruition we expect our EU margins to show year over year improvement.

In Developing Markets we had organic growth of 17% it was driven by solid volume and mix gains despite more than 12 points of pricing. We’re continuing to see payoff from our focus on and investments in core categories, core brands and key markets. Here’s what drove Q2 growth, Jacobs Coffee in Ukraine and Milka and Alpen Gold chocolates in Russia. Further gains from Club Social and Oreo Biscuits in Latin America and consumption and distribution gains in our Asia/Pacific region particularly Oreo in China.

At the operating income line margin was up 170 basis points. This resulted from a combination of top line growth and the acquisition of the LU biscuit business. It more than offset input costs and investments in marketing and distribution infrastructure. Looking forward with input costs continuing to be a challenge as consumers adjust to higher prices our profit margin in the second half should remain stable year over year.

Finally before we take your questions a few notes on cash flow. Capital expenditures through six months were $590 million. That’s up from $506 million through six months last year but on pace to spend just over 3% of net revenue for the year. I’d also note that we continue to make solid progress on our working capital program despite the rise in input costs. Our cash conversion cycle is reduced by two days versus the second quarter last year.

To summarize, we’ve had a strong first half and we remain confident that our strengthening brand equity, our investments and cost reductions we’ll maintain our operating momentum, increase margins over time and deliver a raised guidance of at least $1.92 per share ‘x’ items in 2008. Now we’d be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Vincent Andrews - Morgan Stanley.

Vincent Andrews - Morgan Stanley

I just wanted to hear a little bit about two things, one in several categories you mentioned that the competitors had lagged on pricing is that something you’re worried about on a go forward basis or have those competitors already put those price increases through now?

Irene Rosenfeld

I think we’re starting to see those gaps narrow and in fact if you look at our market shares we’re starting to see even through the data in June the last five weeks our shares are improving sequentially relative to the April/May period. I think everybody is dealing with the same input cost situation and you’re gradually seeing the entire market respond to that situation.

Vincent Andrews - Morgan Stanley

Since you’ve had to implement another round of price increases in the third quarter are we set up for another quarter of lagging price increases? Are we going to see the same dynamic in the third quarter?

Irene Rosenfeld

No, I think as you look across the landscape everybody is dealing with the same input costs and I think they’re all coming to understand that this isn’t going away any time soon. The actions that we’re seeing in the marketplace as I said is that most of our price gaps are narrowing and I think a number of other companies are looking out to Q3 the same way that we are.

Vincent Andrews - Morgan Stanley

In other words there will be a little bit more of a catch up from a competitor perspective in Q3 relative to the actions you’re going to take is that a fair statement?

Irene Rosenfeld

We believe so yes.

Vincent Andrews - Morgan Stanley

From a volume perspective, volume was only down 1% in the quarter despite all the pricing. How do you see volume trending for the rest of the year especially because you’re taking another set of price increases?

Irene Rosenfeld

I have to tell you Q2 held up better than we had expected and feel quite good about that. I think the investments that we’ve made in our brands are certainly paying off and the fact that we have a number of brands in the portfolio that play well in the current environment from a value perspective. As we go forward though we are heading into some un-chartered territory as additional pricing actions hit the marketplace. We have to see how it will play out but I think we are well staged to be able to weather the storm.

Vincent Andrews - Morgan Stanley

Would you care to give us any idea of what type of volume you’d be pleased with in the back half of the year?

Irene Rosenfeld

I’m not going to give you a specific volume forecast but what I will tell you is that we did say that our year over year performance would improve in the second half and it will.

Vincent Andrews - Morgan Stanley

On market share you’ve traditionally said that you’re goal is to grow share I believe even greater than 60% of categories it sounds like you fell below that goal in the quarter and I don’t know if you’re backing away from that in the near term just because of the pricing dynamics, any comments related to market share goals would be helpful.

Irene Rosenfeld

We’re clearly disappointed by our share performance this quarter but we’re certainly not surprised given the significant pricing out in the marketplace and the fact that as we’ve said a number of our key competitors lagged our actions as well as there was a couple of cases of some deep retailer discounting that we chose not to chase. As I said, the good news is that these price gaps are starting to narrow. We’re seeing sequential improvement in our shares and I expect that we will gain or hold share in the majority of our revenue in the back half.

Operator

Your next question comes from Terry Bivens – JP Morgan.

Terry Bivens – JP Morgan

In terms of the dimension of the hedging offset in the back half temp can we assume that’s roughly equal to what it was in the second quarter?

Tim McLevish

Yes, we experienced about $150 million in total of recognition of mark to market hedge gains in the second quarter that essentially will be offsetting in the back half of the year. It’s spread between the third and fourth quarter a little bit more heavily on the third quarter.

Chris Jakubik

As Tim was talking about in his opening comments our costs are expected to be up about $2 billion from a P&L perspective you had about $800 million flow through in the first half so the second half is going to be a little heavier.

Terry Bivens – JP Morgan

On the Salad dressings I think the performance there surprised us a little bit according to the data we were looking at. Could you give us a little more color there, do you think there was a pipeline fill element to that or if you could add a little color as to the market dynamics on that one.

Irene Rosenfeld

I’m not sure in which way it surprised you. I will tell you we’re quite encouraged by the results of our reinvention of that business. We did have a tough April as I said but we gained share in May and June really for the first time in a long time. We expect to gain share as the year progresses.

Operator

Your next question comes from Christine Mccracken – Cleveland Research.

Christine Mccracken – Cleveland Research

On your outlook for commodity costs for the second half you’d obviously mentioned that you’re expecting costs to go up but there are a number of areas specifically dairy and pork that look like at this point they’re going to be a little beneficial to you in the second half given what’s happening right now. Is that playing into your increased guidance at all and maybe you could talk given the magnitude of those two specific areas to your portfolio.

Tim McLevish

We’re very confident in our ability with the strengthening of our brands to match cost increases through pricing and productivity and we’re committed to that. Overall we’re seeing considerable commodity costs increases. There are a couple of offsets I’m not sure what’s going to happen in dairy. Pork seems to see a little bit of a come off but it looks like it tipping back up again. Our expectations you can see from the futures markets what is expected.

We are hedged across a good deal of our portfolio for the second half of the year. So we’re just going to deal with the cost situation through pricing and productivity as we go forward through the second half of the year.

Christine Mccracken – Cleveland Research

As costs decline do you get any pricing, do you adjust your pricing, and you’ve done that in Coffee now as costs came down. Is that something you look at in cheese or in cold cuts?

Tim McLevish

Clearly we have to look at the competitive situation, that’s the primary driver. As costs go up and costs go down and the marketplace adjusts accordingly we have to respond.

Operator

Your next question comes from Alexia Howard - Sanford Bernstein.

Alexia Howard - Sanford Bernstein

Advertising spending or brand support how did that trend this quarter. I don’t know how the comps were year on year could you give us any clarity into that?

Irene Rosenfeld

Our spending was up in the quarter and it will be on the year as we’ve said I feel very good about our ability to continue to make the necessary adjustments in the brands even in the face of the challenging cost environment. You will see our spending up both, you did see it in the quarter and you’ll see it up for the full year.

Tim McLevish

Spending in dollar terms clearly is up as we continue to invest in our brands. On a percentage basis with very high increase in pricing and therefore revenue you’ll see that the percentage is not up quite as much as we had expected but up none the less.

Alexia Howard - Sanford Bernstein

On the Europe Union seems to me that the LU business was a 16% margin business I think last year. Obviously Europe was in single digits on a recurring basis last year. Are you expected a couple hundred million in cost synergies and yet we’re still seeing the margins drift away for the six months after that acquisition was completed. Can you talk about how the integration process is proceeding and how you expect the margins to develop in the EU going forward as you start to realize those cost synergies?

Irene Rosenfeld

The LU business has turned out to be everything we thought it would be and in fact more. The business is growing strongly. If we look at the like to like growth we see it up 6% in the EU and up about 27% in Developing markets. We are on track to deliver all the savings that we forecast. I’m even more confident today that it will be significant platform for our future growth and in fact for the profitability of our International business in general and for the EU in particular.

We certainly continue to expect it to be accretive in 2008. Some of those margin impacts are related to the significant pricing that’s going on a number of those businesses in response to input costs.

Operator

Your next question comes from Andrew Lazar - Lehman Brothers.

Andrew Lazar - Lehman Brothers

If I look at the contribution on the top line for mix up 0.7% I know that it’s been saying that 2%, 3% or even 4% range over the last two years or so. I’m curious if there’s anything that happened in mix specifically in the quarter or is that something that we’re likely to see at a somewhat slower pace than we have as obviously the pricing piece really ramps up.

Irene Rosenfeld

I think what you’re seeing is just the temporary dislocation driven by the pricing impact and we expect that mix going forward will continue to play an important role but as Tim said for the balance of this year the major factor driving our revenue will in fact be pricing.

Andrew Lazar - Lehman Brothers

Is there any way to think about what overall corporate volume was ‘x’ the 9% decline in Ready to drink I know the weight of that product impacts the overall volume number pretty dramatically.

Irene Rosenfeld

It’s about flat ‘x’ Ready to drink.

Andrew Lazar - Lehman Brothers

On take away is there any way to gauge we only have what we have in terms of data, IRI, Nielsen, etc. which I know is limited in a lot of ways. Obviously looking at the big difference between what we’ve seen over the past quarter in terms of volume for Kraft versus the volume that you posted is that merely just what we’re seeing in terms of trade down, in terms of channel shift and such. Any comments you have on helping reconcile that would be helpful.

Tim McLevish

It’s hard to say what exactly is going on. You’re seeing lots of dynamics in the marketplace with lots of pricing. That has had some volume impact there may be in some new categories where we’re introducing and building a little bit of the pipeline but again we’re encouraged as we go into the third quarter that we’re feeling strong about our brands, we’ll continue to realize the pricing and think we can pass that through.

We’re obviously dealing with very difficult economic conditions but again we’re covering our input costs, building our brand equities and we’re committed to deliver the financial results that we have identified.

Operator

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

Ken Zaslow - BMO Capital Markets

You have $150 million of hedging $78 million out of Corporate, $50 million out of the Snacks, where are the other $22 million come out of?

Tim McLevish

The other $22 million is really spread across the rest of the segments. The $50 million that you identified is specifically in Snacks and we called that out because of the significant magnitude of it. The rest of it is spread and that’s probably about proportional to what we usually see in any given quarter. The reason we called it out this quarter is because of the magnitude of it. Any given quarter we always have some realized gains in the results.

Ken Zaslow - BMO Capital Markets

In terms of private label can you talk about your trends relative to private label and how you are positioning yourself for the future relative to private label given the potential trade down in some of your more important categories?

Irene Rosenfeld

I think there’s no question that we’re seeing our investments paying off. We are experiencing some temporary dislocation in a couple of categories due to the significant pricing actions that we’ve taken in response to costs. As we’ve said, private label lagged in a couple of these categories and in some cases we actually saw them doing some deep discounting in the face of the high cost environment. In fact, I think you’re seeing some retailers reporting lower margins due to some of their pricing activities.

In addition, in a couple of our categories we’ve chosen not to chase unprofitable volume in the short term. It’s a number of factors that are contributing I feel very good though about our ability to continue to grow share in the current environment and as I said earlier the good news is that our price gaps are starting to narrow and we are seeing sequential improvement in the five week shares through June and we do expect to gain or hold share in a majority of all the categories in the back half of the year.

Operator

Your next question comes from Jonathan Feeney – Wachovia.

Jonathan Feeney - Wachovia

I wanted to follow up on Andrew’s question about mix a little bit when you dig into this. By the way thank you for this mix disclosure, I think this is excellent. When you look at the different segments despite whether you took really substantial pricing or not in these different segments you did see a deceleration in that. I wonder if its possible is there any impact in there away from just sticker shock that consumers are maybe looking for less expensive ways to buy Kraft foods within these categories. Could that be sort of going on across the grocery store?

Irene Rosenfeld

It’s hard to say. I do think that some of what we’re seeing is just the mathematical impact of what’s happening on the volume front and therefore mix becomes less of a factor in a number of our core categories. I remain very comfortable that the investments that we have made in quality and marketing and innovation in each of our core categories will continue to fully our brands and enable us to maintain our strong shares in our core categories.

Jonathan Feeney - Wachovia

When you think about volumes being flat it would seem to me that the data I’ve seen take home food volumes are up a little bit ahead of population for the second quarter up 2% to 3%. Do you think you’re with your current category spread if you weren’t taking price in this quarter should you be at a volume growth that’s in line with 2% to 3%?

Irene Rosenfeld

Without a doubt, no question that we have seen tremendous strength in our base businesses as a result of the investments that we’ve made. Most important I think the results are showing that despite the challenging economic conditions we’re able to cover input costs while still building our brands and staging them for the future.

Operator

Your next question comes from David Driscoll – Citi Investment Research.

David Driscoll – Citi Investment Research

I want to come back the volume question. Our Nielsen data had unit volumes down something on the magnitude of 6% you reported down 1% for the full company. Can you give us a little bit more color on the channel splits, how are these non-measured channels performing? Are the numbers at double digit? What color can you give us here?

Irene Rosenfeld

They are fabulous. There’s no question that some of the volume difference that you’re seeing is due to the channel shift. We’re having a tremendous quarter and year with Wal-Mart and we believe that the outlook there continues to be strong as our brands and our value positioning is exceptionally well aligned with where they’re going for their shoppers.

David Driscoll – Citi Investment Research

Is there any delay affect here on how the pricing affects volumes as you report them, meaning do volumes in the quarter reflect the largest impact from higher pricing or would we really see that next quarter?

Irene Rosenfeld

It’s hard to say, as we said, we’re taking additional pricing. Certainly the pricing that we took so far through Q2 most of that is reflected in the numbers that you see. Q3 will continue to be a challenge. We make no bones about that. There are a number of factors that work. We start with the fact that we are taking some additional pricing in response to continued escalation in costs. In some of our categories we’re in some un-chartered territory.

At the same time we’ll also see the reversal of our commodity hedging gains in the third quarter. I continue to be encouraged by the volume performance to date and as I look at the programming and the innovation pipeline that we’ve got in the back half of the year I’m quite confident that we will be able to weather the storm. As we said, we expect to gain or hold share in the majority of our revenue in the back half of the year.

David Driscoll – Citi Investment Research

Can you run us through your eight division lines and tell us what those price increase were by division? It doesn’t have to be exact but I want to get a sense of magnitude. I think you said in the prepared comments that 90% of the portfolio had announced price increase in the second quarter.

Tim McLevish

We announced price increases over much of our portfolio in the last quarter and last several months. Much of it is already in the marketplace. Some of it is announced but is not effective yet at retail. I can’t go through the specifics of each of the businesses and the categories. Perhaps we can talk offline and Chris will share some of that with you if you’re interested.

Operator

Your next question comes from Eric Serotta - Merrill Lynch.

Eric Serotta - Merrill Lynch

It looks like through the first half your organic top line growth was up about 7.5% and for the full year you’re guiding to at least 6%. I realize 7.5% is greater than 6% but it would seem that you’re looking for some slow down in organic revenue growth in the second half. I’m just wondering, how much of that is related to the tougher comps as pricing started to accelerate in the second half of last year versus this additional pricing you’re taking, maybe some conservatism around the volume outlook. Any color you can give on that would be helpful.

Irene Rosenfeld

I think it’s all of the above actually. I come back to the fact that as we’ve said, Q2 volumes held up better than we had expected. We have announced some pricing that hasn’t yet hit the marketplace and we are contemplating some additional pricing and it’s a challenging environment obviously that has both positives and negatives for our business. The fact that people are eating at home more is certainly a positive. The fact that they continue to look for value, we’ve got to make sure that our brands are delivering that value.

Most importantly through I feel really confident that our investments in quality and marketing innovation will keep the brands strong and enable us to improve our year over year performance in the second half despite the pricing that we’re seeing.

Eric Serotta - Merrill Lynch

You mentioned some exciting programming in new products for the second half; you already mentioned that there would be some. Could you briefly run down what some of those large needle moving things could be?

Irene Rosenfeld

Some of the biggest needle movers are some of the items that we just launched that will play through in a much bigger way in the second half. For example the Pure Salad Dressing re-launch will play through. Our Bagel-fuls products are now fully at retail and we’ve started to advertise them, our Pizza For One. We also have a number of new items. As we’ve mentioned we’ve got our Natural 2% cheese coming out as a hormone free product we’re the first national brand to do that. We expect that to be a strong item.

We’ve got 100 calorie Oreo Snack Cakes. If you look at each of our categories we have a number of items coming out in the back half of the year.

Operator

Your next question comes from Todd Duvick - Bank of America.

Todd Duvick - Bank of America

With respect to the transaction spinning off of Post can you confirm that you’re still planning to see about $900 million of debt travel with that transaction?

Tim McLevish

Yes, that’s correct. As you know, we made a tender offer for split transaction that should be priced actually later on this week. We’re expecting closing of the transaction in the coming weeks and yes there is a little over $900 million of debt that’s expected to come with it.

Todd Duvick - Bank of America

With respect to terming out debt in the capital markets you’ve made a lot of progress over the last year. You do have a $750 million note that matures in October but it seems you’ve got plenty of availability with your credit facility to refinance that with short term debt. Do you expect to tap the debt capital markets again this year?

Tim McLevish

You’re right we have about $700 million maturing in September. As we get closer to that we’ll communicate what our intent is to do with regard to terming out.

Operator

Your next question comes from Chris Growe - Stifel Nicolaus.

Chris Growe - Stifel Nicolaus

The first one is relative to the questions earlier about private label. I’m curious as I look at some of the categories where you did see a decelerating trend in market share. Can you say whether private label was the beneficiary of that? Was that where you’re seeing the share go or is it really category by category?

Irene Rosenfeld

It really varies category by category. What I’m most encouraged by is the fact that we are seeing those price gaps narrow. We’ve got very strong marketing programs and A&C investment behind our brands and I am confident that we will gain or own share in a majority of the revenue in the back half of the year.

Chris Growe - Stifel Nicolaus

Another clarification point on the increase in marketing you’ve talked earlier in the year about a 50 basis point increase in marketing as you define it and that would be around $200 million. Is the dollar number still a good number to use for the year but percentages are changing because of the increased sales growth?

Tim McLevish

Directionally that’s correct. We can’t say precisely but directionally $200 million would be a good number.

Chris Growe - Stifel Nicolaus

The share repurchase does that restart after the Post transaction closes, is that right?

Tim McLevish

We will go back into open market conditions after the Post transaction closes, that’s correct.

Operator

Your next question comes from Robert Moscow - Credit Suisse.

Robert Moscow - Credit Suisse

Not to pick on one division because I thought the numbers showed overall some improvement but Snacks & Cereals it sounded like you were a little disappointed in the second quarter results because your competitors didn’t take the pricing that you took right away. I thought I heard in your guidance that you think that the full year would be up mid-single digits in profits and I think you’re down in the first half even with a $50 million benefit on the mark to market hedging and that’s going to reverse. Doesn’t that require a pretty radical improvement in the back half in order to meet that guidance for the year?

Irene Rosenfeld

Actually we did see sequential improvement from Q1 in our margins even if we exclude the hedge gain. As we said, we expect the full 2008 margins to be flat with 2007. We have enormous strength in our top five core brands, Oreo, Chips Ahoy, Ritz, Triscuit and Wheat Thins. Some of those businesses have significant programming that will hit in the back half of the year. That’s what makes us confident that we will be able to deliver that margin performance.

Robert Moscow - Credit Suisse

Did I misunderstand the guidance so you think that the margin will be flat for the year what does that mean?

Irene Rosenfeld

The profit will be up; again we have this denominator effect due to the significant pricing that we’ve taken. The profit dollars will be up.

Tim McLevish

We’re expecting margins to be comparable to last year which obviously can reflect improved profit dollars with a higher pricing driven revenue. We’ll see margins hold about flat.

Robert Moscow - Credit Suisse

Does that guidance exclude the Cereal business or include the Cereal business?

Tim McLevish

It included the Cereal business at this point. Once we complete the transaction we’ll update the numbers and give you more clarity on that.

Operator

Your next question comes from David Palmer – UBS.

David Palmer – UBS

How you do feel about energy related versus agriculture related inflation as you head into ’09? In particular I wonder if it becomes more difficult pricing conversations saying you’re going to increase price on your products do those sort of costs, energy and packaging related in particular, or do your customers not really care about where you’re seeing the pressure and just think about these pressures equally?

Irene Rosenfeld

The reality is that it’s certainly easier to price for agricultural increases but the facts are they’re quite interrelated as you know right now and we anticipate that they will continue to be so into the future. I think the best thing that we can do is to make sure that we’re able to add value to our categories and price our businesses closer to the marketplace and that’s what we’ve been engaged in. I feel very comfortable that despite the challenging economic conditions we will continue to be able to cover input costs inflation while building brand equities and delivering solid financial performance.

David Palmer – UBS

Next question related to channel growth, if we assume that you’re inventory levels didn’t really change it does seem like your volume trends accelerated in unmeasured channels. Can you give us color on that, are you seeing evidence of channel switching or are your share trends improving in these unmeasured channels.

Irene Rosenfeld

It’s both and it’s what I said earlier. We have a very strong relationship with all of our customers. We certainly are seeing some channel shift and we have a lot of confidence that the value positioning of our brands is playing quite well in customers like Wal-Mart. That is a key piece of our stronger volume performance and we anticipate that that will continue for the balance of the year.

Operator

Your last question comes from Terry Bivens – JP Morgan.

Terry Bivens – JP Morgan

As we near the split off, have you guys changed your general guidance on the dilution?

Tim McLevish

No we have not. Later on this week we’ll be pricing that and that can have some impact but at this point we’re not changing any guidance on our expectations of the impact on dilution.

Operator

I would like to hand the floor back to Chris Jakubik for any further or closing remarks.

Chris Jakubik

Thanks everyone for joining us today. For those people in the media who have further questions Mike Mitchell will be available to take your calls. For any analysts and investors who have further questions I’ll be around all day. Thanks very much for joining us and we’ll speak to you soon.

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Source: Kraft Foods Inc. Q2 2008 Earnings Call Transcript
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