Kraft Foods Q3 2010 Earnings Call Transcript

Kraft Foods (KFT)

Q3 2010 Earnings Call

November 04, 2010 5:00 pm ET

Executives

Irene Rosenfeld - Chairman and Chief Executive Officer

Christopher Jakubik -

Timothy McLevish - Chief Financial Officer and Executive Vice President

Analysts

Judy Hong - Goldman Sachs Group Inc.

Diane Geissler - Credit Agricole Securities (USA) Inc.

Andrew Lazar - Barclays Capital

Christopher Growe - Stifel, Nicolaus & Co., Inc.

Jonathan Feeney - Janney Montgomery Scott LLC

Vincent Andrews - Morgan Stanley

Terry Bivens - JP Morgan Chase & Co

Robert Moskow - Crédit Suisse AG

Bryan Spillane - BofA Merrill Lynch

Eric Serotta - Merrill Lynch

David Driscoll - Citigroup Inc

Edward Aaron - RBC Capital Markets Corporation

Presentation

Operator

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

Christopher Jakubik

Good afternoon, and thanks for joining us. With me are Irene Rosenfeld, our Chairman and CEO; and Tim McLevish, our Chief Financial Officer. Earlier today, we sent out our earnings release. The release, along with today's slides, are available on our website, kraftfoodscompany.com.

As you know, during this call, we'll make forward-looking statements about the company's performance. These statements are based on how we see things today. Actual results may differ materially due to risks and uncertainties. So please refer to the cautionary statement and risk factors contained in our 10-K and 10-Q filings for more details on our forward-looking statements. Some of today's prepared remarks will also include non-GAAP financial measures. And you can find the GAAP to non-GAAP reconciliations within our news release and at the back of the slide presentation.

So, let me now turn it over to Irene.

Irene Rosenfeld

Thanks, Chris, and good afternoon. First off, we had another good quarter in a challenging environment. Every geography delivered solid results. In North America, we posted sequential improvement in top line performance despite weak consumer demand and less merchandising activity than the prior year. In Europe, we delivered another quarter of solid revenue growth despite soft categories. We also continued to grow our margins and have sustained them in the low teens. In Developing Markets, further investment in our Power Brands and in priority markets again drove strong revenue growth in Asia Pacific and Latin America.

Second, as we told you in August, we plan to reinvest our first half earnings upside to build a stronger foundation for future growth. And that's exactly what we did. We continued to increase our investments in advertising, including a double-digit increase in North America. This ensures that our brands are as strong as possible as the economy improves. We also normalized Cadbury's trade inventories in certain developing markets. And as expected, this tempered our top line growth. So overall, the third quarter played out essentially as we planned. A notable exception was at input costs, including dairy, coffee and cocoa, rose much more than we had expected. To offset these higher costs, we began to price in several categories and in several markets. This affected our results in two ways: Our top line growth was driven more by price and by vol/mix and there was some pressure on gross margins because price realization trailed the increase in input costs.

The gross margin pressure we experienced in Q3 should ease, as price levels better align with input costs. The key take away is that the underlying momentum of our business remains strong. We're taking the necessary pricing actions despite a difficult consumer environment, as a testament to our strength in brand equities. And we continued to increase our advertising investments. This will further build our brands, stimulate our categories and position us well as the economy recovers.

Let me now turn it over to Tim to discuss our third quarter results in more detail.

Timothy McLevish

Thanks, Irene, and Good afternoon. As Irene just mentioned, we're pleased with our third quarter results. They came in largely in line with our expectations. Now, let me provide some details.

I'll start by discussing our top line, where pricing was the primary driver of organic revenue growth as we move quickly to offset higher input costs. Organic net revenues for the combined business grew 2.1% as focused investments drove continued growth in our Power Brands. In the Kraft base business, organic revenues increased 2.5%, including 2.3 points from pricing. In fact, net pricing was up in every one of our business units.

In the Cadbury business, organic revenue growth was essentially flat, but in line with our expectations. This is due in part to our decision to normalize trade inventories in certain markets. Doing so reduced Cadbury's top line growth by about two points and reduced our combined revenue growth by approximately 1/2 of a percentage point. As you know, we're also comparing against the hard push by Cadbury in the second half of last year.

Now turning to profit, on a combined basis, our operating income margin, excluding acquisition and integration costs, was 13.6%. In our Kraft base business, operating income margin fell by 50 basis points to 13.9%. This was entirely due to our stepped up advertising investment, which lowered margins by about 100 basis points. At the same time, we continue to make excellent progress in productivity and in reducing overhead costs. For the Cadbury business, margins were 12.4% in the quarter. This reflected stepped-up marketing investment and the impact of the trade inventory reductions we've already mentioned. Overall, we continue to demonstrate strong underlying momentum but clearly, there's more opportunity ahead.

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