The Kraft Heinz Company
Q1 2009 Earnings Call Transcript

Published: 21 Aug 2008

[Operator:]

I would like to welcome everyone to the H. J. Heinz Company fiscal year 2009 first quarter earnings release conference call. (Operator Instructions) I’d now like to turn the call over to Meg Nollen, Vice President, Investor Relations.

[Meg Nollen:]

I’d like to welcome everyone to our conference call and webcast. Copies of the slides used in today’s presentation are available on our website at Heinz.com. Joining me on today’s call are Art Winkleblack, Executive Vice President and Chief Financial Officer and Ed McMenamin, Senior Vice President, Finance and Corporate Controller. Before we begin with our prepared remarks please refer to this forward looking statement currently displayed. This is also available in our earnings release this morning and in our most recent SEC filings. To summarize, during our presentation we may make predictive statements about our business that are intended to clarify results for your understanding. We ask you to refer to our April 30, 2008, Form 10-K, which lists some of the factors that could cause actual results to differ materially from those in our predictions. Heinz undertakes no obligation to update or revise any forward looking statements, whether as a result of new information, future events, or otherwise, except as required by Securities laws. We may also use non-GAAP financial measures in our presentation as the company believes such measures allow for consistent period to period comparison of the business. The most directly comparable GAAP financial measures and reconciliations of these non-GAAP measures are available in the company’s earnings release and is also available on our recently redesigned website at Heinz.com. Please note we plan to file our first quarter 10-Q this afternoon. Our related financial highlights pages or stat pages will then become available in the Investor Relations section of the website towards the bottom of the page. Now with the formalities out of the way let me turn the call over to Art Winkleblack to talk about our great results

[Art Winkleblack:]

We’re holding our Q1 call a little earlier this year so that we don’t interfere with your last days of August and frankly because we’re very excited about sharing our results for the quarter. Overall the company delivered an outstanding first quarter of fiscal ’09 with sales up nearly 15%, operating income up 7% and EPS up more than 14%. Our top line growth was highlighted by a record quarterly organic sales increase of more than 10% and was well balanced between volume and price. Importantly this strong growth was supported by another double digit increase in R&D and consumer marketing. These results, when combined with our results in Q1 of last year reflect continuation of strong momentum in the business. Q1 represents the 13th quarter in a row of positive organic sales growth with a strengthening trend over time. As we’ve discussed before this reflects our more focused portfolio, better commercial talent, improved discipline around innovation, progress on pricing and enhanced sales execution. We would all love to see double digit organic growth every quarter and I would love to be 25 years old again. Suffice it to say, we’re very comfortable with our expectation at meeting our full year commitment to deliver sales growth of 6% plus. This morning I’ll put our results into the context of our new two year high performance plan, primarily focusing on our key growth drivers. I’ll then turn it over to Ed to give you a more detailed look at the financials before I conclude with an updated outlook for the full year. You may recall that our two year high performance plan is built around four key pillars. These include

[Ed McMenamin:]

As I go through the results for Q1 I think you will see that our excellent performance over the last few years is continuing with a strong start to fiscal 2009. First I’ll focus on our P&L Scorecard. Net sales grew by almost 15% another outstanding performance at the top line. Organically sales grew over 10% driven by balance 5% increase in both volume and price. This organic growth is largely due to our top 15 brands which grew nearly 17% overall and 13% organically. We continue to increase our investment in consumer marketing above our previous estimate investing 3.9% of sales on a 15% sales increase. Our gross margin at 36.2% continues to be challenged by the rising commodity costs environment, down 110 basis points versus the first quarter of last year our highest gross margin quarter of fiscal 2008 but more in line with Q4 of last year. In the first quarter we overcame these commodity increases and delivered a 7% increase in operating income driven by our top line growth along with productivity improvements. In addition to offsetting increased commodity costs with strategic price increases and productivity our top line also allowed us to continue to increase our marketing support and invest in global task forces. At $0.72 our strong EPS growth of 14.3% resulted from leveraging the 7% operating income growth with improved financing costs, combined with reduced shares outstanding while overcoming approximately $0.02 of headwinds from the 210 basis point increase in the effective tax rate this year versus this time last year. Now let’s take a deeper look at the income statement. I’ll focus on a few of the items that were not on the Scorecard. Gross profit increased by over 11% to $934 million a nearly $100 million increase from last year. Marketing expense hit an even $100 million up 13%. SG&A was up in line with our sales growth while funding task force initiatives and compensating for higher fuel costs. I’ll review the drivers of operating income growth on the next few slides but I’d like to cover the activity below operating income here. Net interest and other expenses were down $16 million primarily resulting from reduced interest rates, down about 15 basis points. You’ll note that fully diluted shares outstanding are down about 3% benefiting from the completion of $1 billion in net share repurchases over the last two years. The company’s effective tax rate increased to 28.7% from 26.6% last year. Both the current and prior years’ effective tax rates reflect discrete benefits resulting from the effects law changes in the UK. This year’s law change was the primary reason that the current quarter tax rate was below our ongoing annual estimate of 31% to 32%. As a result, we would anticipate the effective tax rate for the year to be in the lower half of that range. Now let’s take a deeper look at sales. As I said, first quarter delivered record organic sales growth of 10.2%. I might add this is on top of a very healthy 5% organic growth in Q1 of last year. The increase was led by impressive volume growth of 5% and price of 5.2% while foreign exchange added 4% and acquisitions increased sales 0.7%. We’re pleased to have generated a balance about strong volume and strong pricing. The momentum from volume growth continued with developed markets gaining nearly 4% including the impact of US Food Service and the emerging markets growing an impressive 14%. Favorable pricing was realized in every segment. Turning to Net Sales performance by segment, every region delivered double digit increases with the exception of US Food Service which has been hit hard given the current trends in eating outside the home. The leader among segments was Europe where sales grew almost 20%. Organic growth approached 11% with volume contributing 6.4% and pricing 4.3%. The volume increase was mainly due to new product introductions and increased promotions in the UK and continental Europe. Specifically, we drove increased volume on Heinz Ketchup across Europe, Heinz Beans and Salad Cream in the UK and Pudliszki brand of products in Poland. The price increase was largely the result of commodity related price increases on Heinz Ketchup, Beans and Soup and the majority of our products in the Russian market. Foreign exchange added 8% while the Wyko acquisition in the Netherlands added about 1%. North American consumer product sales were very strong up 11.5% with a 4.7% volume improvement driven largely by Smart Ones and Ore-Ida. Additionally, consumer products related almost 6% in price this quarter helping to offset commodity costs. Foreign exchange contributed an additional 1.3%. Asia/Pacific had a great quarter this year up 23%. Volume for the segment was up 10% driven by significant improvements in ABC Syrup in Indonesia resulting from the timing of the Ramadan Holiday and increased consumer demand. Branded condiments in Australia, beverage sales in India and baby food in China also contributed to the increase. Net pricing in the segment of 5.6% was led by Australia and Indonesia. Topping off these gains was a 6% increase from foreign exchange primarily the Australian Dollar and 2% from acquisitions. US Food Service continues to face softness in the US restaurant business resulting from reduced foot traffic. In addition, we’ve eliminated a number of SKUs and customers that were not providing sufficient returns. This resulted in reduced sales for the quarter despite an overall price increase. The Rest of World segment sales were up 36% with a 13% increase in volume and a 25% increase in price. As I noted earlier gross profit was up 11% but our gross margin decreased to 36.2% as we experienced significant input cost increases. As you can see, the 5.2% price increase contributed 300 basis points to gross margin. Commodity and other inflation reduced gross margin by 780 basis points, virtually all of our key ingredients were up with substantial increase in packaging, edible oils and tomato products. Offsetting a portion of these headwinds was 350 basis points of productivity most notably our continued efforts on procurement of direct and indirect materials. We continue to expect commodity costs to be higher than last year for the remainder of the fiscal for we are confident that we have this covered in profit outlook through continued pricing, productivity as well as strong volume. Turning to operating income by segment, North American Consumer Products grew 10% to $168 million primarily driven by strong organic sales growth. Benefits from increased pricing and productivity improvements were partially offset by increased commodity costs and increased S&D due to higher volume and fuel charges. Europe’s results were up 13% from last year again driven by outstanding sales growth. The strong top line driven increases were partially offset by increased commodity costs, higher manufacturing costs in the UK, higher S&D resulting from increased volume and fuel as well as investments in task force spending. Although foreign exchange translation has helped the European segment at the top line, cross currency sourcing between the Euro and the Pound has offset most of that benefit at operating income. The Asia/Pacific segments operating income was up a very impressive 30% resulting from increased volume, pricing and foreign exchange translation rates which more than offset increased commodity costs, higher marketing spending and increased S&D due to higher volume. Art took you through the key drivers for Food Service which resulted in operating incomes down $19 million this quarter. Finally, the Rest of World segment delivered great results this quarter up 25%. Now let’s move to the Balance Sheet Scorecard. Capital Expenditures up $42 million were 1.6% of sales down 100 basis points from the prior year. Capital Spending is expected to increase in subsequent quarters as we invest in capacity related projects in support of future growth and ongoing investment in better systems. We still anticipate full year CapEx to be in the 3% to 3.5% of sales range. Our first quarter Cash Conversion Cycle was 52 days up eight days from the prior year largely due to accounts payable which increased only modestly compared to the increase in cost of goods sold. About one half of the reduction in DPO was due to closing out currency hedging contracts which did not impact operating free cash flow or the P&L. Operating Free Cash Flow showed little change from last year at a $55 million outflow and Net Debt increased slightly. ROIC was 16.7% up 80 basis points from this time last year primarily due to increased earnings. Quick Operating Working Capital was up due to receivables and inventories which grew in line with sales while accounts payable increased marginally resulting in an 8 day increase in CCC from Q1 but in line with Q4 of last year. This slight increase in net debt is largely due to our significant amount of share repurchase activity that took place in the prior year. Our net debt/EBITDA multiple improved to 2.5 times reflecting our strong earnings growth with a relatively flat debt position. As I mentioned earlier Operating Free cash flow was in line with last year’s Q1 performance. QOWC requirements to fund a 15% top line growth were higher than last year while the timing of tax payments benefited the overall cash flow. I touched on Capital Expenditures earlier and dividends reflected 9.2% increase we announced in June. In summary, we are extremely pleased with our performance again this quarter. Our increased innovation and marketing continued to drive strong top line growth. In addition, our ability to drive volume, take price and our focus on productivity improvements are enabling us to more than compensate for the commodity headwinds and allow us to fund the significant investments we are making for future growth and improved productivity. With that I’ll now turn it over to Art to update you on our full year outlook.

[Art Winkleblack:]

As you can see, fiscal year 2009 is clearly off to a good start and looking forward we feel very good about our forecast for the full year. As a reminder, the annual targets that we set forth on May 29 for fiscal ’09 and ’10 were sales growth 6%+ supporting by marketing increases of 8% to 12%, operating income growth of 6% to 7%, EPS growth of 8% to 11% or a range of $2.83 to $2.91 for FY09 and annual Operating Free Cash Flow of approximately $850 million. We believe we’re on track to achieve these targets and in fact there may be bit of upside to the top line projection for FY09. As we mentioned in the press release we are narrowing our EPS target to the top-half of our range. In other words, we now anticipate EPS to be $2.87 to $2.91 for this fiscal year. As you think about the quarterly P&L for the remainder of ’09 keep in mind a couple of things. First, Q1 got a bit of help from the timing of the Ramadan Holiday particularly in Indonesia and Ore-Ida benefited from a relatively easy comparison in Q1. Secondly, from a cost standpoint we expect Q2 S&D will be impacted by high fuel costs and then hopefully moderate. Additionally, last years spending on task force SKU primarily toward the back half of the year while this year’s investments are more heavily weighted toward Q1 and Q2. Finally, we anticipate a higher tax rate in the back half of the year but for the full year as Ed mentioned we expect to be in line with the lower end of our target range of 31% to 32%. As a result, we expect quarterly EPS this year to be more level than last year, generally in line with the EPS we achieved in Q1. Again, culminating with an EPS range for the year of $2.87 to $2.91. With that we’ll turn it over to you and take your questions.

[Operator:]

(Operator Instructions) Your first question comes from Alexia Howard – Sanford Bernstein.

[Alexia Howard:]

A quick question on the emerging markets you mentioned that you’ve got particularly in the Rest of World. It seems to me that price growth is extremely strong out there, volume growth also, particularly in China. We’re hearing some concerns that the economies may be weakening. How do you think about that and what the trajectory is likely to be going forward are we going to get the same kind of pricing momentum as we look outwards and do you have any concerns about that?

[Art Winkleblack:]

We feel very good about emerging marketing. As we said, the sales were up 36% for the first quarter, very strong volume, very strong pricing and the softness that I think some folks are worried about we are less worried about. To be quite honest, I think the guys are doing a great job of innovating bring high quality healthier products to the market, they’re a good value and that seems to be carrying the day very much in those markets. Its broad based, it’s not just one market we’re seeing good results. Latin America, we’re seeing it in the Middle East, we’re seeing it in South Africa, China, India, etc. We’re very excited about it and we expect to continue to generate good strong results. In each quarter you’ll see volume and pricing variable, you won’t always see one up or one more or less. Net net we feel very good about the organic outlook going forward.

[Ed McMenamin:]

I think also when you look at the pricing in those emerging markets it’s tied to higher input costs in those emerging markets relative to developed markets if we see a softening of the input costs you’ll likely see a softening of your price but the bottom line should still be driving strong growth.

[Alexia Howard:]

On the cost inflation in Food Service I know that we’re talking about dairy costs perhaps getting a little bit easier at some point going forward. Do you see that happening or are those pressures going to continue because of all the things having changed in the meantime.

[Art Winkleblack:]

In general we’re still seeing very high commodity inflation there. Across the businesses Ed mentioned we’re seeing double digit increases in the market inflation. Now we’re getting a bit better than that because of some of our forward contracts. It seems almost as input moderates another one goes up. The last few weeks we’ve seen oil come down and some of the other things come down slightly, we’re hoping that’s a start of a trend but we’ll see. Net net as I talk about commodities in general are still significantly higher than prior year.

[Operator:]

Your next question comes from Chris Growe – Stifel Nicolaus.

[Chris Growe:]

I wanted to ask two questions, the first one is, from the slides it looks like cost inflation in the quarter based on your gross margin bridge was over $150 million, $175 million if I’m doing my math correctly, your pricing up around 5% just doesn’t even cover that amount. Should we expect more price realization coming forward then? Also we could take sides saying costs could trend off a little bit from these highs right here.

[Art Winkleblack:]

As I recall the commodities were up $140 to $150 million on a market basis, a very sizeable number. If you go back and take a look at our plan that we laid out on May 29, the commodity inflation is above what our expectation was and in fact our pricing is above the expectation also. What we’re trying to do is watch the market very carefully and then change our plans accordingly to price up and also to drive productivity as hard as we possibly can. We’re working all levers to offset what so far is higher than expected commodity costs.

[Chris Growe:]

Can you say how well hedged you are for the year or is that something you’ve said probably?

[Art Winkleblack:]

We’ve got forward contracts on probably roughly two thirds of our commodities so we’re fairly well covered for the balance of the year.

[Chris Growe:]

My last question, you made a comment before about, I think Ed made the comment there was very little foreign exchange benefit to profits in the quarter, is that correct?

[Ed McMenamin:]

Right, obviously the top line benefited some but as you translate that down we source a lot of product from Europe from the continent over into the UK given the dynamics of the cross rate between the Euro and the Pound that offset a lot of the favorability there.

[Chris Growe:]

As we presume that your guidance then for the year would incorporate current exchange rates or how are you thinking about given the volatility in currencies recently how important it is for you how that plays into your guidance for the year?

[Art Winkleblack:]

We’re well covered on that at this point and so we feel like currency won’t be a factor either positively or negatively basically for the balance of the year. All of that is factored into our forecast.

[Operator:]

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

[David Driscoll:]

I wanted to ask a question on gross margins. You mentioned, I believe, on the fourth quarter analyst day that the guidance for the year had gross profit margins up potentially 50 basis points. What’s your updated guidance on gross profit margins?

[Art Winkleblack:]

I’m not sure I’d call it right now based on how early we are in the year. As I mentioned to Chris we’re managing all the levers and really trying to bring in the revenue number, the operating income number and the EPS number. Gross margin could be up a little more or less based on what we see in terms of commodities and a lot of that will depend upon what commodities do for the back half of the year and our pricing realizations. I wouldn’t frankly pin myself down to a gross margin number yet, obviously gross margin is going to be challenging.

[David Driscoll:]

Let me ask it like this, the margins in the quarter were down 110 basis points, so when I start to think about climbing a hill to actually see positive gross percentage margins throughout the year it would then logically say that they need to be up substantially more because of the first quarter performance. Is it realistic that these things are going to be up by the end of the year?

[Art Winkleblack:]

Again it depends on what commodities do. We have seen some softening in commodities over the last few weeks, I don’t know if three or four weeks makes a trend but we’ll hope that that continues. That could be helpful or obviously also pricing as effectively as we can while balancing all the things that are associated with that. To your point, gross margin was pretty much in line with our fourth quarter but we do have a ways to go if gross margin is to climb for the year.

[Ed McMenamin:]

It’s in line with fourth quarter and pretty much with the full year last year. First quarter was quite high compared to rest of our fiscal year last year and you saw commodities run up as we went through last year. I think we’re on a more normalized basis now be it at a higher commodity growth than we’ve seen in the past.

[Art Winkleblack:]

The key is that we’re managing to dollar profits both on a gross profit basis and an operating income basis as opposed to feeling like now is probably not the time to be focused on pure percentages.

[David Driscoll:]

In Europe we’ve heard comments from other companies about a slow down in that market. Obviously your results in the quarter were excellent in Europe. Can you comment on what the future might hold? Do your people talk to you at all about a potential slow down in the European market. If you could make a specific comment on private label trends in that market I’d appreciate it.

[Art Winkleblack:]

Obviously the European market is tough these days. I think they had a quarter with the European GDP down so things are not easy there. Having said that I think we sell some of life’s little luxuries and our sauces play from hamburgers to filet mignon. I think we are well positioned to play in either a strong or a weak market. We’re seeing good results through the first quarter and we expect strong results over the balance of the year. That’s not to say it’s easy and we’re monitoring it very carefully. We are seeing private label get stronger in some markets globally and in some categories. As you can see with 10% organic growth it hasn’t impacted us but we do keep an eye on it. We’ll continue to watch it.

[Operator:]

Your next question comes from David Palmer – UBS.

[David Palmer:]

I wanted to ask about the UK. This has been a key turn around market for you guys and I think if I’m not mistaken it’s been the majority of your currency neutral profit growth for the European division over the last year or so. Your press release talked about promotion spending in the UK being up and being a bit of an offset to net pricing and profit in the quarter. Is profit growth in this market becoming tougher, could you give us an update about the trends you’re seeing there in net pricing going forward, profit growth going forward from this market?

[Art Winkleblack:]

We expect to continue to make net price gains there based purely by on the commodities. I think it is a tough market no doubt about it. Our guys are driving such strong innovation and I tried to go through a few of those but with the value that we’re bringing and the partnership with our trade customers we’re seeing great success there. It’s packaging innovation, its better quality, its better products and that I think has allowed us to continue to take price there. We are spending a bit more on the trade side but I think that’s part and parcel to the environment and just a good strategy overall because as you price up you’re going to need to take the flexibility occasionally for the right circumstances to go a little deeper, a little less deep.

[Ed McMenamin:]

Last year at this time also the UK was suffering through some supply constraints where they backed off on promotions so you might say this year’s back to more normalized levels for that company.

[David Palmer:]

Interest costs for fiscal ’09 how should we model that?

[Art Winkleblack:]

I think we did a good job on interest in the first quarter. We held off for putting our bond in preferred stock in place from a mix management standpoint it’s probably high watermark in terms commercial paper which has a very good rate. We did a pretty darn good job on managing interest costs in the first quarter. For the back half of the year I would not expect that same kind of favorability, it’s probably more in line with last year. As you know we did do a bond deal $500 million on that and then $300 million on preferred stock. That has fixed a bit more of our debt at a bit higher rate but the right thing to do and we’re real pleased with the rates we got.

[David Palmer:]

Are you seeing any economic slow down when you squint through your numbers knowing what you’re doing on innovation. Are you seeing any sort of impact from an economic slow down at all across the globe. Could you give us a sense of where you’re seeing a sequential economic impact?

[Art Winkleblack:]

If you look at the retail side we’re feeling very good about what we see. Obviously Food Service is a soft spot, that’s a very tough market particularly in the US but it’s also somewhat tough in Europe and some other markets. That’s why we’re trying to be conservative on our Food Service projections assuming it’s not going to get any better any time soon. We’re going to take the time to do the job right, we got a new team in Food Service, they’re working top line, they’re working SKUs, and they’re working the bottom line, streamlining the factory footprint and things like that. We’re trying to address it as aggressively as possible but the short answer to your question is we’re really only seeing a slow down in the Food Service arena. The other thing as I think about it, the things like Snacks and Appetizers also are a little more discretionary and those might be impacted a bit but that’s not a big portion of our business so not a big concern.

[Operator:]

Your next question comes from Eric Katzman – Deutsche Bank.

[Eric Katzman:]

My first question, maybe this is more to Bill, unfortunately Art you’re the one who gets it. What was Bill thinking about at the Annual Meeting when he responded regarding the Campbell Soup comment? Can you go into more detail regarding that?

[Art Winkleblack:]

Actually the reaction to what I would term as an offhand comment last week I don’t think I’m even going to go there.

[Eric Katzman:]

Obviously maybe more broadly you’ve commented your free cash flow is growing, the business is obviously doing well, you’re making comments about acquisitions, what’s the scale of acquisitions, should we just expect small things or does the company feel so good and the Board feels confident that you’re willing to look at bigger things.

[Art Winkleblack:]

We’re certainly confident in our outlook and the way we’re managing the business. We’ve got a lot of momentum. I would just generally say that as always we look to add shareholder value and create value for our shareholders. That could be bigger or smaller. You can rest assured that we know that our job one is to drive shareholder value and that’s going to be our focus.

[Eric Katzman:]

Did you buy back any stock in the quarter? I don’t remember whether you mentioned that.

[Art Winkleblack:]

No, basically we offset options exercised as you know our prioritization of cash flow this year is more on dividends first and then also in terms of acquisitions that will add value. Share repo is less of a strategy this year.

[Eric Katzman:]

The last question I have is can you walk us through how the rules regarding mark to market hedging accounting is affecting your cost to goods? I’m not sure that you talked at all about whether there were mark to market gains or losses in the quarter and based on your contracts is that accounting relevant to the business?

[Ed McMenamin:]

We do everything to avoid the hedge accounting. We lock in long term supply agreements so we lock in the purchase price, whatever our suppliers do, if they employ hedging or not it’s up to them. We’ve said at this point we don’t want to take the chance and the volatility with FAS133 hedging so we just do it with our suppliers rather than going out to the futures markets. Yes, it doesn’t impact us. We had a small impact last year in the fourth quarter but as a policy we don’t do it.

[Eric Katzman:]

Were there any charges that you not necessarily quoted one time given it’s a longer term turnaround but in the US Food Service business the 40% drop in profits was there any one time costs within that number?

[Art Winkleblack:]

No, it’s plusses and minuses in there so that’s mainly the organic results and reflects again the fact that volume down slightly combined with the fact that commodities are up so significantly in that segment.

[Operator:]

Your next question comes from Eric Serotta – Merrill Lynch.

[Eric Serotta:]

I wanted to drill down a bit on the operating leverage question. I thought that SG&A FX marketing increased at about the rate of sales. You mentioned some of the puts and take there like the timing of task force investment and fuel and I imagine currency played a factor as well. In the quarter could you give us some idea as to what a currency neutral fixed cost growth was so we could get a handle on operating leverage you delivered and how you’re looking at that going forward for the rest of the year.

[Art Winkleblack:]

I would say that the impact of SG&A from FX would have been the same as revenue. In terms of operating leverage if you think about it, we’re pleased that we have invested back in the business and continue to do so in a rough economic environment with marketing spending up double digit we put back double digit increases in R&D, we spent behind the task forces. In Q1, like I expect Q2 the fuel costs I mentioned that the crude oil up about 93% is almost double. That was a big impact on our selling and distribution costs. We, I think, have done a very good job of leveraging our growth down to the bottom line through very stringent cost controls. Rest assured we are still stringently controlling our costs but we are investing back in the business and I think that will pay some dividends going forward.

[Eric Serotta:]

Could you just remind me as to where you are in terms of SAP roll out to Europe this year?

[Art Winkleblack:]

The roll out continues along, we’re in across all of the UK now, we’ve done the frozen business in Europe and we’ve also done Poland. Our next stop will probably be in continental Europe and then we’ll go from there. Our task forces are busily designing the global blueprint which will be the foundation of the next business unit that gets rolled out and we’re in the process of determining that roll out schedule and probably be talking more internally with our Board over the next two to three months on that.

[Eric Serotta:]

You’d expect to be able to absorb any incremental costs offset elsewhere?

[Art Winkleblack:]

Yes, that’s built into the formula and certainly we will incur higher depreciation expenses and some expenses associated with the implementation and with the design of the blueprint. I think you’re seeing good strong results in the UK this year and in fact last year so I think SAP and the better process discipline is helping that’s certainly not all of it but it is certainly a help. We would expect that same help in our other business units.

[Operator:]

Your next question comes from Robert Moskow – Credit Suisse.

[Robert Moskow:]

I wanted to know on the interest expense reduction year over year I get what you’re saying about being savvy or fortunate on the timing of your refinancing but I think you said that interest costs were down only 15 basis points from a year ago yet your interest costs are down $16 million from $91 million a year ago. That’s still a huge decline and I guess what you’re saying is now that you’ve refinanced at a higher rate it will probably go up in the range of maybe.

[Ed McMenamin:]

The rest of the year will be more in line with what we saw last year. Libor, etc. is down a fair amount in the first quarter this year compared to the first quarter of last year so we took advantage of that. We’re heavily into commercial paper before we redid the financing so obviously that’s about the cheapest interest rates are going to get with the long term debt out there now it would be a little higher than we saw in the first quarter.

[Art Winkleblack:]

I think Libor was 280 versus over 500 in Q1.

[Robert Moskow:]

So that’s the more relevant metric then.

[Robert Moskow:]

On Ore-Ida your sales are up 30% in the quarter and from my data you haven’t lost any market share at all to private label. This used to be I consider to be a rather commoditized category. What are you doing right on frozen potatoes?

[Art Winkleblack:]

It just shows what you can do with some of these categories that people feel are old and tired. The reality is you listen to your consumer and find out what their needs and wants are and you address them. We’ve addressed them with crispier French fries with faster French fries. You saw now that we’re just now rolling out the Steam ‘n Mash which I think is going to be a great product, taking away all the pealing and chopping and all that stuff, I know that’s not a favorite past time of mine. I think that will be a great product so we continue to bring innovation to the market and partner with our trade customers to determine what they want and what they need. So far so good and we’ve got a good pipeline going forward.

[Operator:]

Your next question comes from Terry Bivens – JP Morgan.

[Terry Bivens:]

In Europe that’s obviously been a great momentum story, are you seeing any signs of a shift to eating at home that’s helped the business over here? On the negative side have there been any signs that maybe Tesco or some of these guys are going to start doing price roll backs?

[Art Winkleblack:]

We have seen some shift to in home versus out of home so I think some of the same pattern that you have seen in the US is going to Europe. Our Food Service business in Europe is relatively small so that’s a real positive for us. With regard to what trade is up to certainly there’s always pressure on the price front and we’re very cognizant of it, we’re working with our trade customers on it. Those pricing discussions are never easy and probably will get harder over time. What we’re trying to do, as you can see by our gross margin we are not going out and pricing above inflation. We had 5% pricing, we had double digit commodity increases so what we’re trying to do it thread the needle the right way to balance the needs of our business with the needs of our customers and our consumers. We continue to have those dialogues and again I think if we continue to bring good strong value added innovation that meets consumer needs that we’ll do alright.

[Terry Bivens:]

As you look at your inflation I think on the fourth quarter call you gave an estimate of 8% to 9%. I’m taking from this call that maybe that number is held in advance for a while is that the right way to look at it?

[Art Winkleblack:]

It’s probably a little north of that would be our guess at this point in our forecast. We hope that it moderates but the 8% to 9% is probably at least 9% to 10% but we’ll see. Certainly in the year end we’ll see how it goes. We’ve got about two thirds of our commodities contracted forward so we have pretty good visibility to where the year will come out.

[Terry Bivens:]

On the cash flow I wanted to follow up to Eric Katzman’s question, you did about 1.2 last year in operating cash do you think you’ll land roughly in the same area this year and if you do I’m sure Bill was being a little mischievous with his Campbell Soup comment but nonetheless there is a case to be made that you guys are pretty under levered cash flow looks robust no reason to believe otherwise. The question really does come up what do you intend to do with that?

[Art Winkleblack:]

In answer to your first question the cash flow we focus on operating free cash flow so after capital spending as I told you we laid out a target of about $850 million I think that will be challenging but achievable number this year in the $850 million range. We are working very hard on the operating working capital side to deliver that. We feel good about our cash flow forecast as we’ve said we’re prioritizing the use of that cash first on dividends which we increased our dividend significantly this year which I think our shareholders appreciated. Also on good value added acquisitions and we’ll keep going on that front. We do not anticipate at this point share repurchases any higher than the proceeds of options exercised.

[Terry Bivens:]

You guys are looking hard on the acquisition front right?

[Art Winkleblack:]

Yes, we really are. With the strong organic growth that we’ve got we feel very good about that and we feel very good about the three core categories that we’ve staked out and there’s just lots of good opportunities to bulk up those categories and to strengthen them on a global basis. The idea is to play to win in those categories globally. We are looking hard and the pipeline is a bit better than it had been over the last couple of years. There’s a bit more to look at and we’ll see how we do.

[Operator:]

Your next question comes from Todd Duvick – Bank of America Securities.

[Todd Duvick:]

Thanks for your comments on the acquisition front. I wanted to see if you could tie that in to your commitment to credit rating or how you think about the credit rating if you would for the right acquisition if you would consider going below investment grade for a period of time if it was a compelling acquisition?

[Art Winkleblack:]

Especially these days, let me step back, we always want to be investment grade credit rating in stepping back from it these days that’s very important even more important than usual. We hold that in high regard that is our target. Here again we’re always looking to drive shareholder value so we would certainly look at the larger acquisitions but over time the game plan is to be investment grade.

[Todd Duvick:]

Does that mean that you would consider using equity as a means of payment for part of an acquisition if you came up with something that’s large?

[Art Winkleblack:]

I wouldn’t speculate on that at this point. If we ever got to that point I guess we’d look at it but not something that I’d talk about now.

[Todd Duvick:]

You do have an $800 million note, remarketable note that matures in December and a couple companies General Mills and Rubbermaid haven’t been real fond of the pricing that they’ve got for their remarketable notes is that something that you plan to just remarket or would you consider just doing a regular debt deal instead?

[Ed McMenamin:]

At this point we plan to remarket that. I know we did pretty well in what we just went out and did and that’s our current plan.

[Operator:]

Your next question comes from Andrew Lazar – Lehman Brothers.

[Andrew Lazar:]

Perhaps you could give any color on if what you’re feeling as around sort of take away vis a vis shipments to get a sense if pipeline fill might have been for new products either a factor or not really or even retailers that are potentially buying ahead of what they think will be likely further price increases not just from you but for the industry?

[Art Winkleblack:]

We don’t view pipeline as a factor in the quarter. We have a very successful innovation engine going here so you’ve always got new products coming in. All the products are in varying stages there but I think as we look at our trade inventories around the globe they are at very low levels so it’s not something that I view as a factor.

[Andrew Lazar:]

Just thinking out a little bit as you’ve talked about your costs and others are up dramatically year over year and even though some commodities have come off in recent weeks if you will you’ve talked about the need for further pricing we’ll see more of a slant toward pricing going forward from you and I’m assuming others as well. Have you seen any evidence of either retailers or competitors in various categories blinking at all based on the more recent moves in commodities even though on a year over year basis you and others are frankly trying to catch up.

[Art Winkleblack:]

Those pricing conversations are always tough conversations. We try to be very sensitive to the consumers and customers. We’re not seeing that we can’t get the price through for the right reasons. These are commodity driven, we’re not looking to expand gross margin to any material degree in the short term. This is about balancing and keeping up and so I think you saw that commodities were higher than anticipated in Q1 so therefore we’ve flexed in our pricing is higher than anticipated. We’ll just be playing it by ear as the year goes along.

[Meg Nollen:]

The only thing I would add is obviously it varies by market but overall every manufacturer is faced with the same factors in commodity increases so I would say that everyone is behaving accordingly.

[Art Winkleblack:]

The key there really comes back to two key elements. The one is the brand strength that we have and again why it’s so important that we simplify and strengthen our portfolio over the last few years so that brand strength is very helpful factor to us and the other is that we’ve got to keep the innovation going.

[Meg Nollen:]

The problems we had last year have moderated.

[Andrew Lazar:]

It looks like foreign exchange you did actually get some operating leverage on the EBIT line in Europe though not necessarily in North America. I didn’t know if there was anything to read into that about what you may be doing in Europe that’s allowed you to do that or if it’s just the way things flow through in a given quarter.

[Art Winkleblack:]

Probably more how things flow through in a given quarter, it will obviously be somewhat variable in how much price versus volume and the timing of costs and the timing of SAP roll out and things like that. It will be variable but I think he focused on the full year and that’s what we’re driving towards.

[Ed McMenamin:]

I think I mentioned that the top line we certainly did get that benefit but as we drop down to operating income or EBIT we source between the Euro and the Pound and much of the gains on translation were wiped out this quarter when you compare the exchange between the Pound and the Euro has gone unfavorable for us from a sourcing perspective. Not a whole lot of benefit at the bottom line on that one.

[Meg Nollen:]

Before we conclude today’s call I just want to highlight upcoming marketing events. Heinz will be presenting at the Lehman Back to School Conference on Wednesday, September 4; I believe our speaking time is 1