Chris Jakubik - Vice President, Investor Relations Tony Vernon - Chief Executive Officer Teri List-Stoll - Executive Vice President and Chief Financial Officer.

Matthew Grainger - Morgan Stanley Alexia Howard - Sanford Bernstein Jonathan Feeney - Athlos Research Bryan Spillane - Bank of America Andrew Lazar - Barclays Eric Katzman - Deutsche Bank John Baumgartner - Wells Fargo Ken Zaslow - Bank of Montreal David Palmer - RBC David Driscoll - Citi Research Robert Moskow - Credit Suisse Chris Growe - Stifel Jason English - Goldman Sachs.

Good day, ladies and gentlemen, and welcome to the Kraft Foods Third Quarter 2014 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this call is being recorded.

I'd now like to introduce your host for today's conference, Chris Jakubik, Vice President of Investor Relations. Please go ahead..

Thanks. Good afternoon and thanks for joining our business update for the third quarter of 2014. With me today are Tony Vernon, our CEO; and Teri List-Stoll, our CFO. During our remarks, we will make some forward-looking statements that are based on how we see things today. Actual results may differ due to risks and uncertainties.

These are discussed in our press release. We'll also be discussing some non-GAAP financial measures during the call today, and you can find the GAAP to non-GAAP reconciliations within our press release and in the Investor Center of kraftfoodsgroup.com.

Now, I'll hand it over to Tony and Teri to provide our third quarter business update and discuss what we expect going forward..

operational discipline, cash productivity and marketing effectiveness to name a few. Taken all together, we remain on the right path, strengthening execution of our playbook and proactively addressing the macro and consumer trends that will drive sustainable profitable growth.

As a result, we're on track to deliver full year EPS performance consistent with the expectations we laid out to you in early February. As you would expect, that path has had a few twists and turns this year as consumer and customer trends accelerated and commodity cost trends remained volatile.

So we've had to be agile, taking the size of actions to respond appropriately. Looking forward, we discussed several times now the fact that rapid changes in the environment and consumer behavior remained both a challenge and an opportunity for both Kraft and the industry at large.

So today, in addition to providing you with some further color on the key business drivers of our third quarter results, we'll talk a bit more about the proactive efforts we're taking to adapt to this industry and consumer dynamic, how we expect that to shape our full year results and what we think will be important actions for Kraft to drive sustainable profitable growth going forward.

Now, I should hand it over to Teri to talk through the numbers. But before I do that, I'm going to talk about my excitement in our innovations. These are our team's response to consumer megatrends that are here to stay. Let's start with protein.

Oscar Mayer P3 Portable Protein Packs continued to drive incremental growth by sourcing from new protein seekers. P3 is many of the most significant food trends we outlined at the beginning of the year, protein, snacking and simple ingredients.

In cold cuts, our Oscar Mayer Deli Fresh BOLD line continues to bring excitement to the category, tapping into a trend inspired by millennials and multi-cultural consumers and that's demand for bolder, spicier flavors.

While these consumers want more complex flavors, they also want simple ingredients and our BOLD varieties are made without artificial preservatives or artificial flavors.

Moving to the dairy case, we're rejuvenating our Philadelphia soft Cream Cheese line with a renovation that's inspired by several of those same trends, simpler ingredient lines and more flavorful varieties. And this comes on the heels of another successful innovation, Kraft singles with no artificial preservatives.

In coffee, we just completed the successful rollout of McCafé in Canada, and we're very excited about the US launch early next year of McCafé. And we continue to be very pleased with the ongoing success of our on-demand pods business.

Given our agreement with Keurig Green Mountain that we announced in August, we'll have the opportunity for expanded distribution and increased capacity to supply multiple channels and on-demand formats. These innovations were all huge enablers in the quarter and point to the importance of continuing to contemporize our great brands.

Now this is the right point for me to pass it on to Teri to discuss the key drivers of the third quarter and what we expect to see for the balance of the year.

Teri?.

Thanks, Tony. And by the way, I'm equally excited about the innovations as Tony is, but he is the CEO after all. Good afternoon, everyone. I want to just echo Tony's opening comments.

While some aspects of our third quarter results were similar to what we saw in the second quarter and in the first half, we did see sequential improvement in certain areas that we find encouraging. Let's start with the topline and organic revenue growth.

Yes, the environment remains challenging and rapid changes in consumer preferences and behavior persist. Despite this, we grew organic revenue approximately 1%. This is compared to a decline in the second quarter after adjusting for the benefit of the Easter shift.

And Tony talked you through, our innovations and renovations continue to gain traction in the marketplace. These big bets, particularly the ones in meat, cheese and coffee not only help our topline growth, but they are the kinds of equity-building actions that help us to price when necessary to offset higher input costs.

And we have priced aggressively in the face of what are truly unprecedented price levels in certain parts of our commodity basket. Importantly, over the course of the third quarter, our pricing actions really began to take hold. We've seen evidence of competitors also pricing to cover their higher commodity costs.

We're experiencing elasticity impacts that are generally in line with or better than our expectations. We're pleased with the progress in those areas, but we're not yet where we want to be or expect to be in terms of performance versus the competition.

Similar to the second quarter, we gained our health share in roughly 50% of our business, with much of the share weakness represented by categories with the most significant pricing activity, cheese, meat and roast-and-ground coffee.

Now below the revenue line and excluding the effects of market-based impacts related to our post-employment benefit plans, our gross profit dollars were down mid single-digits versus the third quarter last year. Despite productivity benefits, the impact of lower volume mix continued to put pressure on our gross profit dollars and gross margin.

Not surprisingly and again similar to the second quarter, lower volume mix in our cheese business where we've had increased prices the most was the biggest year-on-year driver. That being said, we've made meaningful progress on pricing net of commodity costs. In the third quarter, pricing net of commodity costs was $40 million unfavorable.

That's about half the impact that we experienced in the second quarter. And we did this despite what have been highly volatile commodity prices, particularly in the butter and cheese markets, as well as the fact that we decided to spend back in select categories such as mac and cheese to defend market share.

So on balance, we remain pleased with our PNOC discipline. Moving down the P&L and again excluding the effects of market-based impacts related to our post-employment benefit plans, the pressure we saw at the gross profit line was more than offset by a mid-teens percentage decline in SG&A. There were three main drivers to the reduction in SG&A expense.

First, advertising was down meaningfully in the third quarter versus the prior year. Second and similar to the second quarter, consumer spending was lower as a result of lower in-store activity. And third, overhead expenses continued to come down.

Of these three drivers for the first quarter in quite some time, advertising expense was the new factor and it was meaningfully lower than the prior year. So just let me take a little time to explain why. To a significant extent, this was due to comparisons.

In the second half of last year, we were increasing our advertising quite aggressively, while we were reducing spending during the second half of this year. So third quarter year-over-year comparisons are more challenging.

As a reference, our advertising spending levels in the third quarter of this year were well above double-digit percentages above pre-spin levels from the third quarter of 2012. Having said that, there are a couple of factors driving this year's trend.

As we discussing on last quarter's call, we've been going back to make sure we're focusing on the most efficient highest return programming. We're not looking to drive down advertising costs per se. We're driving for improved advertising effectiveness. That is to reach the right consumer at the right time in the right medium with the right message.

With this focus on effectiveness, we're also realizing meaningful efficiencies as we shift our spending to more targeted digital media. Let me give you some numbers. On a year-to-date basis after factoring in the benefit of efficiencies, our advertising is about flat versus last year. The composition however is very different.

Traditional media is down double-digits, while digital offsets most of that. And in the third quarter, digital was over 35% of our total spend, up from about 25% a year ago.

As we've talked about before, several of our most impactful initiatives this year have been entirely digital, Velveeta Cheesepocalypse response, ad support for specialty café coffee pods and our buzz-worthy activations for Oscar Mayer bacon.

At the same time, we need to maintain our discipline around fewer, bigger, better at a time when returns on advertising promotion are under pressure. For some of our businesses like meals and desserts where we're still developing investible plans to rejuvenate our brands, we're pulling back until we can generate good returns on the investment.

For all these reasons, timing, efficiencies from the shift to digital and making sure we maintain discipline around return hurdles, our advertising expense in the third quarter was down significantly versus the prior year.

In the end, the lower SG&A drove our operating income dollars up at a mid to high single-digit rate versus last year, excluding the market-based impacts related to post-employment benefit plans.

Dropping down to the EPS line, on the same adjusted basis, we were up strong double-digits from the prior year with the additional help of some tax favorability. On the tax line, at about 26.5%, our effective tax rate was significantly lower than our expected run rate due to the realization of some discrete benefits we've been working on.

So what does all of this mean for the year? It means that despite the fact that we continue to make progress overall, the impact of mixed execution in certain parts of our business means that we fell short on some of our key metrics.

On the topline, while we have continued to drive for profitable growth, we expect organic revenue growth to lag the market this year. Versus the broader food and beverage industry through the first nine months of 2014, our organic revenues were flat versus the prior year and trailed industry growth of roughly 1.7%.

Now that's mainly due to the fact that our volume growth has been meaningfully lower than the industry so far this year, as we've spent much of the year pricing aggressively to cover higher input costs. And we're experiencing softness in certain categories due to either lack of innovation or brand building activities.

At the same time, we're seeing sequential improvement in organic growth from what was a bit of a decline in the second quarter excluding the Easter shift, to about 1 point of organic growth in this quarter and what we anticipate will be even higher organic growth in the fourth quarter.

At the operating income line and excluding the effects of market-based impacts related to our post-employment benefit plans, we're up about 8% through nine months, while we're relatively flat when you strip out the benefits of lower spending and cost savings initiatives and unrealized hedging gains.

We're expecting strong growth versus the prior year in the fourth quarter and we expect to see solid growth for the full year. But how are we getting there reflects a combination of our playbook at work and some mixed execution along the way. We expect to be down in terms of pricing net of commodity cost increases.

As I said earlier, our pricing is stuck in areas like cheese and meat and we're now seeing competitors move to offset their costs, but we likely will get to even this year. But in certain categories, we've had to spend back to defend market share in the absence of investment-ready brand-building ideas, which we expect to have in place next year.

In productivity, we expect gross just shy of 4%, which will still be industry leading. But despite the fact that we're back in the range of 2% in the third quarter, our net productivity is likely to be in 1.5% to 2% range for the year, short of our 2.5% ongoing target. There are two reasons for this shortfall.

One is the set of execution missteps we've talked about before, a combination of recalls and higher-than-anticipated startup costs related to our innovation and renovation initiatives this year. The second reason is industry-wide logistics headwinds we're seeing heading into the end of the year, which could translate into higher logistics costs.

Now while not material from the full year perspective, from where we stand today, there's simply not enough time for us to offset these costs within the 2014 fiscal year.

At the overhead line, we expect to see continued progress for the year, keeping costs flat to down despite some significant investments to build the new marketing capabilities that we talked about in the September back-to-school conference.

For the second year in a row, we are realizing the tail benefits as we true up experience in our medical and benefit plans after our early retirement plan and workforce reductions. And at the advertising line, we expect spending to be lower this year, reflecting a combination of the efficiency gains and the targeted cuts I mentioned earlier.

In the end, we still expect EPS to be consistent with the initial expectations. This is one of the twists and turns that Tony referenced. In that, we expect to get there through a combination of the growth from operations I just described as well as a lower-than-expected tax rate. I view this benefit as a great example of total cost management.

In this case, we've been able to leverage tax favorability for the flexibility to focus on profitable growth versus volume for volume's sake. Excluding the effect of market-based impacts to our post-employment benefit plans, our tax rate is likely to fall below the 34% run rate we would expect on a going basis.

We expect that we'll end up somewhere closer to 32% for the full year. The downside of this is that it will put some pressure on our free cash flow productivity as the realization of tax favorability doesn't always translate into free cash flow in the same year.

And together with some working capital pressure, we're likely to end the year with free cash flow productivity in the range of 70% to 80% of net income, certainly well $1 billion, but below our 90% ongoing target. So that's all we expect for this year.

Clearly it remains a difficult environment and we clearly missed the market with execution in some areas, but we've done a good job protecting the investments that are working and we have very good visibility on what needs to be fixed to drive profitable growth in the future, which is a good point for me to hand it back to Tony to talk about our path forward into next year..

Thanks, Teri. I wanted to close out today by providing some perspective on what we think will be important to driving sustainable profitable growth going forward. To fulfill our long-term potential, there are three areas on which we need to focus going forward. The first is execution.

We've put a playbook in place to ensure that we're well positioned to innovate and evolve with the times rather than fall into some of the costly traps that we've all seen over the years. And we've shown over the past two years that our playbook helps to drive profitable growth when and where we execute with discipline.

But as we've seen this year, more consistent execution is critical as we move forward. For instance, while we continue to lead the industry in gross productivity, our organization is focused on net productivity. That's because this is what matters to the P&L. Every Kraft employee including and especially me owns this.

And where we need to make changes to ensure a better execution, we have and we will do the right thing. Second, we recognize and are embracing the rapid changes we're seeing in consumer behavior.

This time last year, we were all talking about the challenges of strapped consumers, for example, with cuts being made to the SNAP program and how that might affect consumption going forward.

This past February at the CAGNY Conference, we talked about something broader and more profound on unprecedented confluence factors that would have the potential to change the way we operate for years and perhaps for decades to come. We called it the Cs of Change.

At the center of it all, consumers with new emerging cohorts who have a whole new set of expectations of food and beverages and companies that make and deliver them. Our customers are coming to terms with changing shopping patterns and channel shifting and the rise of digital media driving the need for new communication tools and capabilities.

It is clear that this is not a one-time market shift. This is a transformative time in our industry. It is also clear that this is pressuring returns on traditional advertising and promotion.

So we will continue to focus our spending to develop and execute our best most investible ideas and ensure that we're living our mantra of fewer, bigger, better to enable this. We're reinventing marketing by building a new infrastructure that can effectively harness data, which we talked about this past September at back-to-school.

Achieving brand ubiquity across channels remains another key opportunity. We've improved our representation in growing channels such as dollar and club. In fact, our growth in non-traditional channels is 8% year-to-date, some five to seven times that of total US retail. But there is more work and more opportunity in front of us.

We need to pay for it all by living total cost management. We will continue to find the path to ensure that we're leveraging our scale. And as one of the biggest players in North America, we'll continue to redefine the standard for our lean organization design to grow.

As Teri laid out in February and as we talked about on today's call, we'll continue to take an enterprise view of total cost management. From trade spending to taxes, we need to look at everything. From a consumer lens, we need to remove every inefficiency that creates costs, that moms are not willing to pay for.

The third area of focus is that we continue to proactively evolve our strategy to ensure we're well positioned to drive profitable growth over the long term. Make no mistake, we continue to believe that job one for Kraft is growing our great brands and our great people enabled by our lean operating model.

The hallmark of every great team and every great company is that they make the right adjustments at the right time. We are going to embrace the emerging megatrends by taking a 20,000 foot view of our business, to assess whether there is more we can do to win on a more consistent basis. These are our consumers. We can lead here.

The megatrends we're all seeing are an opportunity for Kraft to leverage our brands, focus our innovation efforts and agile digital marketing capabilities to provide meal solutions to growing cohorts, millenials, Hispanics and value-driven consumers.

Again, we are going to take out the inefficiency that moms will not pay for and identify and act on opportunities that drive operational excellence. At the time of a spin and in the two years since we became an independent company, we've looked to own our own destiny by evolving our strategy to drive profitable growth.

And this discipline is an important part of staying true to that commitment. We expect to come back with our thoughts in early 2015. So in closing, we've made progress, but we're clearly focused on the work that needs to be done to deliver the year and fulfill our mission to deliver long-term profitable growth.

And now I'll turn it back to Chris Jakubik..

Thanks, Tony. Before we begin the Q&A, I'd like to take a minute to thank Doug DuMars for all his good work in Investor Relations and wish him well as he takes on a new assignment at Kraft. As many of you know, Doug has been part of the team since we launched the new Kraft Foods. Behind the scenes, he has consistently been grazed under pressure.

And I'm sure you'll agree he is a great person to work with. Doug's next assignment will bring him back to the work of creating real value and building brands where he'll be working on the Kraft master brand team and our enhancers business. Please join me in wishing Doug all the best, and I would be happy to take your questions..

(Operator Instructions) Our first question comes from Matthew Grainger from Morgan Stanley..

Tony, just first I wanted to ask about the promotional environment and you've called out a couple of categories where you are pretending to defend market share and it doesn't come as a surprise based on the data we're seeing. But I always your perspective just from a 20,000 foot view.

So could you talk about what you've seen from retailers and from competitors during the third quarter? Has the frequency moderated or simply remained the same and not worsened? And how has your behavior modified relative to the couponing and the promotional issues you had in the second quarter?.

I think the industry behavior has moderated somewhat, but we're still up a bit in quarter three. We were up a bit due to the innovation pipeline we mentioned and some select share defends like Kraft macaroni and cheese.

I think in general, Matt, in the absence of brand building, innovation and renovation that drive profitable growth, Chris always calls this a prisoner's dilemma. And someone is likely to go back to promotion and price. That's why we talk and are so focused on our playbook.

As to couponing, I've been accused of taking you down a rabbit hole in last quarter's call. The trend I was speaking to and driving that rabbit hole was the consumers' ability to stack trade offers and coupon offers and loyalty cards and all the things that lower price in-store. I think we've done a better job in the third quarter.

And I think in general, this is a broader industry issue that we're all getting after..

On the restructuring expenses for the nine months, I guess, have been lower than we would have expected.

Are there any targets you can share for us in terms of where you expected to come in for the full year and whether we should still expect it to normalize I suppose to $125 million or so next year?.

Yes. We're still exactly there. We still expect it to be in the range of $125 million to $150 million is what we expect..

$125 million for 2014 or just long term?.

For 2014. We haven't gotten any more specific on 2015, but that is kind of the goal and assumption..

Our next question comes from Alexia Howard from Sanford Bernstein..

Can I turn to the meals and dessert segment? In general, it seems to me that the chilled products like cheese and meat fit better into the new consumer landscape that you described than some of the meals and dessert products and maybe powdered beverages as well.

So how do those high-margin products fit into this new world? And what's your strategy for dealing with them? Are you going to do more in way of investments, renovation, promotion, innovation, or are there some cases when you may have to manage in terms of cash and perhaps raised prices? And then how do you ensure that you're going to get adequate return on that investment?.

Great question, Alexia. Some people have put this in perimeter of the store versus the center of the store frame. It's no coincidence that our protein offerings like meat, cheese, nuts are doing quite well. There is a wind at the back in those categories. They are in the perimeter of the store.

We've executed our playbook quite well across those businesses, even with higher commodity costs. That said, we have an obligation to the center of the store and the great brands we have in them to execute the playbook equally well. And we think we can contemporize our offerings in meals and desserts to address the center of the store lack of traffic.

We think we owe that to our retailers and to these brands. It's interesting, two years ago, meals was actually a very vital segment for our retailers and us with Velveeta innovating, with mac and cheese doing well, with some of our competitors innovating. I think we all got away from the power of these brands to contemporize.

And I think you're going to see a rebound..

Our next question comes from Jonathan Feeney from Athlos Research..

Tony, you talked a lot and probably before anybody about how hard things were for the US consumer, what that would mean for the center store. And now I look since August, gas prices are plummeting. After Q4, we've lapped the SNAP cuts. Food costs outside of unfortunately to [ph] maintain coffee will be coming down somewhat significantly.

We're now into '15, which should still help the consumer wallet a little bit.

So are there any places you have a reason to hope that maybe the consumer will be better? Or alternatively are a lot of these lack of promotional effectiveness, I mean how much of this is just macro driven that people want to behave the way they always had historically? It's just the ones who ordinarily would have done all that activity stock up, impulse, whatever, just didn't have any money in their pocket?.

My economic forecasting abilities are questionable, I would say. But I think we're talking about a consumer, the 10% of households that make $50,000 a year or less are still quite strapped. And yes, I'm hoping the same response to gas that we saw four years ago.

The reality is gas prices, they're down in Philadelphia, Jonathan, but they're still $3.39 in Chicago. I will say, from your mouth to God's ears, I hope that the consumer who is raising most of the families in America have the opportunity to invest in food with these declining gas prices..

But it sounds like that's not your operational assumption that a lot of the decreased promotional activity is really just other factors. It doesn't really sound like a lot of what's been going on is macro in your opinion. Forget about the forecasting.

Just what you see as far as the correlations over the past 18 months?.

I think it's about the ability of brands that are in the center of the food store to contemporize and offer consumers these new cohorts that are growing, what they want in those brands. And I point to what we've done on cheese and meat and nuts and coffee and what the industry has done frankly and say we know how to do this.

I think it's focusing on the center of store brands to now get into those growing consumer cohorts..

You mentioned 8% growth in non-traditional as a whole. It's pretty impressive.

Can you give me a sense of how big those channels are now in aggregate for you, not individually, but all of them together?.

We haven't published that. You guys have written on this beautifully. We're still beneath our fair share, but I think industry percent when you add those all through channels is in 10% to 15% range..

And you're a little below that?.

Yeah..

Our next question comes from Bryan Spillane from Bank of America..

I've got two questions, the first, Tony, for you. You've mentioned execution in your prepared remarks and there being some missteps.

Can you talk a little bit more about just what you have done or what's been done up to now to change those execution or fix the execution issues, so that we could have some confidence that they don't repeat again next year?.

You bet. Just to put the headline on it, these are product quality recalls and startup challenges as we optimized our network, especially in cheese.

It's important that you recognize that every recall, and I think there were six in the last 18 months, was a voluntary decision made by Kraft employees, a reflection of a quality culture, lean, Six Sigma where personal responsibilities are expected from everyone.

We're going to do the right thing, whatever happens, but to address it we're adding quality experts across the organization. We're increasing the frequency of our audits. We're making sure that we become very criteria-driven and not schedule or launch-driven, which can have people doing something that doesn't optimize the network.

So it is a huge focus of ours and we'll always fall on the side of doing the right thing..

At this point, do you feel like you've done enough to get some confidence that we won't be back in that cycle again next year?.

Yeah, this is a land of relentless measurement and continuous improvement. And it's always a journey when you're making food to make sure that you're consistently seeking root causes and improving every day..

Teri, just to follow up on some of the pieces you put together for us on the profit metrics for this year, can you correct me if I'm wrong, but it sounds like in terms of the falling short on net productivity this year and maybe just kind of where we stand on gross margins so far year-to-date, a lot of this stuff has already happened.

So I guess I kind of get the sense that as we look into fourth quarter and then getting into next year, it should get closer to what the plan is supposed to be as opposed to some of the things that have fallen off.

Is that the right way to look at it?.

Yeah, I think that's largely correct. We're certainly seeing progress on the net productivity line. The good thing is, as we said, the gross line has been fairly consistent and best in industry. So that always gives us the confidence that we have the ideas and the savings there.

It is the executional misstreps, both the recalls that Tony just talked about. But the one that lingers on a bit is some of these startup issues will not be fully fixed, but they're certainly diminished as we go through the year. So you're right.

As we get into the fourth quarter, we should be back to more normalized net productivity absent these new kind of emerging cost trends that we need to deal with. But for the most part, we do expect that we're seeing the progress improvement and we'll get back there..

Our next question comes from Andrew Lazar from Barclays..

I'm still not totally sure why the year-over-year change in gross margin, I guess, declined sequentially from the second quarter when you had more pricing coming through and your productivity I think seemed like it was better in the third quarter at least than it was in the second quarter. So perhaps a little bit of help there would be good..

Andrew, we can come back to you in more detail. But I think what you're really seeing is a lot of volatility, particularly in the cheese area. We priced early based on expectations and there was continued volatility. So some of those commodity trends didn't move in a normalized curve like we would expect.

We will get there over time, but I think any one quarter is probably too short to be able to look and see the sequential improvement you're looking for. But if you dig into it, you do see the productivity you described, but the pricing a commodity still isn't sufficient. And you have to remember we look at it more on gross margin dollars.

As you're pricing for commodities, of course you're going to get a little compression in the margin percentage..

Tony, last quarter, you talked openly about some certain segments where you got caught up in either discounting or promotional activity that you didn't want to repeat, kind of went against or counter to what Kraft sort of more, let's say, return-focused or cash-oriented sort of model is meant to be.

It's always a little bit tough to tell from the outside, but do you feel like in this quarter you've moved past that? And if so, what metric would I look at to feel more comfortable about that? Or are there still areas maybe where you're not exactly where you want to be on that front? Folks maybe questioned sort of a discipline around what Kraft's operating model was supposed to be from the outset and last quarter was supposed to be just a one-off, and I'm just trying to get a sense if that was the case?.

Yeah, I think we got better, Andrew. We're still seeing some effect in Q3 around coupon stacking and trade offers, but not enough to call it out as we did in the second quarter.

We certainly instill the discipline here to look at every event and every retailer request, because as you know, this is a negotiation, and our retailers are serving a strapped consumer base and cents off matters. But I think we've imposed good discipline and I think you're going to continue to see it improve..

Our next question comes from Eric Katzman from Deutsche Bank..

Teri, maybe just to add on to the net productivity figure coming in below plan, I think you also mentioned industry logistics headwinds. It doesn't sound like something that you can control.

What are you referring to and how long is that development likely to be a headwind?.

I wish I could answer the latter part of your question. The former part is it's kind of emerging. We're seeing some escalation in pricing there, which I think is largely a function of supply and demand for drivers frankly. I think there is a lot of demand for transportation and the driver shortage is putting a little pressure on the cost.

So it's an emerging impact. We don't know exactly how significant it will be and/or how long it will last. But just given where we are heading into the fourth quarter, if it ends up being significant, ability to offset that in a short timeframe is pretty limited..

And if I could just follow up on a different point on the free cash flow, last quarter I was a bit worried about the numbers not pointing to a good full year. It sounds like that is in fact the case. I understand the working capital part of that eventually coming back next year maybe when you get the pricing.

Is the low tax rate this quarter kind of a deferred tax negative to your cash flow, and that's also you plan to reverse next year? Is that what you were referring to?.

Those discrete items' impact can take a variety of forms, but they don't typically come back in terms of cash certainly in the period.

I don't want to go into a lot of specifics of what kind of was built into that number, but we do we expect as we go forward, as you said, to really be focusing on the working capital components, inventory in particularly.

About a third of the inventory build is purely a function of higher commodity costs, but there are some builds in there as well that we're going to be working very aggressively to bring down. And then the other part is there are some non-cash components of earnings, even beyond the tax line. So it's kind of a tough one.

If you go back and look historically, as we certainly have been, there is a fair amount of volatility in free cash flow productivity. And the fourth quarter is a very big cash quarter for us. So we'll be focused on it.

We feel very confident that we can get back to the 90% target on a going basis, but we can't overcome some of these events we're seeing so far this year..

Our next question comes from John Baumgartner from Wells Fargo..

Tony, (inaudible) go through activity to drive the business. And I guess given the weakness in meals and desserts in your comments there about reassessing, brand building, could you speak more to that and maybe just what surprised you about these categories? And then just big picture, you mentioned about being nimble in course correction.

Can you envision a scenario where you'd reinvest less than $0.50 of the cost savings dollar if this environment doesn't improve?.

Take this comment about investible ideas as investible ideas based on margin materiality, momentum and message. What we need to contemporize and to drive the consumer back to those shelves, because I don't think it's a question of pulling support for mac and cheese in the long term.

It's making sure that the ideas are driving profitable incremental category growth for us and our retailers. Now your question about the portfolio as a whole, I think different brands play different portfolio roles. We've talked to you about how much successful we've become in bacon using digital marketing versus traditional broadcast media.

And I think we can look at that across our portfolio and it may affect levels of spending that you've typically looked at as share of voice. We got to look at now the addressable impact of our spending as opposed to just a broadcast media number.

But each brand in our portfolio, I think, has a distinct role and laying that out is important to how we drive profitable growth..

Our next question comes from Ken Zaslow from Bank of Montreal..

Do you think the number of businesses you have make it more challenging to have a laser focus that you want to have on each business? And is there an opportunity or benefit to maybe extracting some businesses away from your portfolio and being able to really focus on certain businesses? For example, cheese used to be something that you used to be very proud of and said, hey, we're able to excel there.

Now you have execution issues.

How do you think about that?.

First thing I'd say is we're still incredibly of cheese and it's on a five-year trend that continues to be great and frankly is central to Kraft in the future. I don't think that the breadth of our portfolio is a disadvantage. I think it's about ideas and people that drive brands. So I've been pretty consistent in saying we love all of our brands.

That doesn't mean we don't look at other options and consider whether someone might do a better job on a brand or two. But the reality is today we think this is a great portfolio and creates advantage for us..

If taxes normalize in 2015, will you recapture the profit lost this quarter to reestablish your growth in 2015? Is that the way to look at it, or is the tax implication for next year just kind of rebasing your numbers for next year as well? I just didn't what you're thinking on that..

No, we wouldn't think about the taxes on the quarter as a rebasing. So it was fortuitous in some respects, but it provided us the flexibility to make some other good long-term choices. A lot of the gaps come from the things we've been talking about in terms of executional missteps, and we would expect to fix those..

So your operational profit next year should eventually restore your long-term growth targets, is that fair?.

That's fair..

Our next question comes from David Palmer - RBC..

Just one question on meats and cheese. The competition was lagging behind your price increases last quarter. And you said on this call there's been evidence of pricing by competitors, but it sounds like they may have been slow to follow through the quarter.

Could you give us a sense on how the competitor pricing evolved through the quarter and are they all caught up in both of those categories?.

I think in both those categories, we have seen more following during the quarter. In meats area, some of it was not in July-September, but was in October, they had some committed promotions which I think held them back a little bit longer than we might have normally expected.

So I don't have the exact percentage of following, but I think for the most part, we're getting good following and about the time lags we would normally expect..

Our next question comes from David Driscoll from Citi Research..

Year-to-date operating profit is, I think, about 24.81%. It's up about $183 million year-on-year. However, restructuring expenditures are down $194 million. Thus all of the operating profit growth is restructuring-driven. On the surface, this seems concerning.

I recognize that you guys have said that you're on plan and delivering, but I'd like to hear your take on these figures and what the implications are for the future as won't these restructuring expenses have to go back up to keep delivering on the productivity..

As we mentioned earlier, we do expect our restructuring spend to be in the $125 million to $150 million range that we had projected at the beginning of the year. And so you'll see the uptick of that in the fourth quarter.

I think a lot of what you're seeing in the operating income, the flatness when you normalize everything, is a function of the commodity costs and the volatility there to put the pricing in place and you have a bit of a lag effect before you get those completely matched up and then this lag in productivity as we have these executional missteps bringing our net productivity down below our going rate.

So we continue to believe that as we address both of those issues, we'll be back to the patterns of growth that we would expect..

Was any missed opportunity or can Kraft build the business inside the company organically similar to this to capture those trends in that hard-to-reach organic channel?.

I think you've asked a great question and I think you've answered it. I believe the latter. It's interesting to look at brands we have like Back to Nature that have some significant distribution in that organic mac and cheese area in key accounts and are doing very well and doing very well versus all mac and cheeses.

So we do really think that we've got some great brand names in our own stable that can accomplish those things. We've said before, David, that we'll look at everything however and talk about nothing until it happens..

If you're asking specifically about the fourth quarter, the thing I would remind you of is that we are anniversarying a fairly low period, which of course gives us a pretty strong growth percentage as well as we'll have at that point a better match between pricing and commodities.

So the combination of those two things is what gives us confidence that you'll see a very strong profit quarter for the fourth..

Our next question comes from Robert Moskow from Credit Suisse..

A broader question for you, Tony. You spoke broadly about a new set of consumers. I think you're talking about millenials and it's a growing cohort and may have different demands.

As you look at your portfolio, though, I see a lot of brands that I would consider antiquated and despite your best efforts it's going to be hard to get those consumers to buy them.

So have you looked through your portfolio and determined what percentage you're going to have trouble meeting the needs of those consumers?.

I'm a believer. There are no such things as mature brands and it's all about energetic idea-driven marketers. It's all about ideas in people. And when you think about it, would you have guessed that Velveeta would have had the five-year run it's had in the face of millenials? I mean it continues to delight.

It's the superball item of choices as laid out by John Stuart? But if you look to the data, you'd say it's one of the oldest brands in Kraft, right? So when I look at an A1 or a Shake'N Bake or a JELL-O, I say it's our job to contemporize the ceremony of those great brands.

They actually play to the preparation of the new millennial, right? A Latina mom was making a dessert for her kid. JELL-O is a perfect fit. We just got to take advantage of where the cohorts are going with our proprietary ideas..

Are you sure about that? I mean you've been banging your head against the wall on JELL-O for a while and there must be others like that. So it just seems like there should be some new thinking around what is worth investing in and what's not. And when you talk about it in that context, it feels like everything is worth investing in..

Well, I do think portfolio decisions about distortion should follow those four Ms in the model that we've talked about. We've been pretty transparent with where we think our playbook is working and where it hasn't. And I think if we all look back and said, wow, cheese, meat, nuts and coffee, you succeeded on over a number of years.

Those might not have been the ones you picked based on where we thought consumers were going or age of brands. But I do think you're right. I always say we're going to be very transparent about what we're doing well and what we're not and we're going to urge our people and our groups to pursue the investible ideas..

Our next question comes from Chris Growe from Stifel..

I just had two follow-ons if I could please. I guess the first one for Terry, in relation to gross profit dollars, they were down in the quarter. And I guess just using the figures you've given for PNOC in the quarter, even assuming you were to able to fully price in cash for the cost, your gross profit dollars still were down.

Is that defining the mis-execution? Is that the main driver of the gross profit dollar weakness in the quarter?.

It is if you think about the productivity benefits we realized being a bit short of our going target. That is a big piece of what is there in addition to the PNOC..

In relation to some of the mis-execution issues, are the costs in place and maybe it's capital and it's people to fix those issues, is that still an ongoing incremental factor for your earnings in, say, the fourth quarter?.

We will have some investments, as Tony talked, as we increase our audits, increase our resourcing against some of this process discipline work. There could be a little bit of an uptick. But for the full year, we do expect our SG&A trends to still be down..

In relation to the productivity savings, gross productivity, as you said, has been still relatively stronger on 4% and the net is a little lower. So is the hope that with PNOC mostly hopefully gets to a balanced position, mis-execution maybe those costs go away that you'll sustain that sort of 4% growth, but maybe more like 2.5% net.

Is that sort of the general outlook for 2015?.

We're not in a position to give a lot of specificity around 2015. But yes, that's the fundamental model..

Our final question comes from Jason English from Goldman Sachs..

I want to go back to Mr. Driscoll's comment about underlying segment EBIT has been disappointing. I think it's down around 4% year-to-date and something that fell short of our expectations this quarter.

With the offsets really being some of these other non-operating expenses, pension being an income this year, restructuring expense falling a little short, it's creating a lot of volatility in just trying to how to forecast this.

So can you give us some more color on what you expect from pension income this year? I guess you already commented on restructuring and the guidance to roughly $80 million or so in the fourth quarter.

In any other puts and takes below sort of a clean segment EBIT that we should be considering?.

I think we tried to walk through the pieces as clearly as we could. You're right there are a lot of puts and takes. The benefit cost is the piece that's probably relatively new.

And we haven't quantified those and in fact we don't even have a full visibility to those until we get through some of the re-measurements that come from those benefit plans, as you can well imagine. But I don't think there is anything extraordinary beyond what we took you through in the script.

But we're happy to sit down with you after this call and answer any specific questions you might have..

From an EBIT perspective, nine months, when you back up the market-based impacts and what not on the post-retirement benefits, the hedging impacts and you add in the cost savings initiative spending or not, we're flat to up.

So when you think about as we get to the fourth quarter and as Terry talked about earlier, combination of pricing, better matching costs and better matching competition as well as the comparisons that we have vis-à-vis Q4 from a growth rate perspective, I think we'll get where we talked about. But again, I'll follow up with you after the call..

Tony, you mentioned gas prices four years ago, you'd love to see what happened then happen again.

Remind us what happened last year and if it were to repeat, what are the implications for your business?.

Well, there was a blip as gas prices went down to those retailers that you typically drive to and you saw changes in some of the key retailers' trend lines based on gas prices.

So you get some pantry load benefit, right? You're talking about people who have enough money to drive their minivan to mass merchandiser and fill it up and fill it up with hopefully groceries and not TV sets..

Thank you. I would now like to turn the call back to Chris Jakubik for any further remarks..

Thanks very much and thank for joining us on the call today. For the analysts who have follow-up questions, Doug DuMars and myself will be around to take the questions. And for anybody from the media, Tony Ryan Basil Maglaris will be around to take any questions if you have them. Thanks very much for joining us and have a great evening..

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a good day..