The Kraft Heinz Company
Q2 2010 Earnings Call Transcript

Published: 25 Feb 2010

[Operator:]

Good morning. Welcome everyone to the H.J. Heinz Company fiscal year 2010 third quarter earnings release conference call. (Operator Instructions) I would now like to turn the call over to Margaret Nollen, Vice President, Investor Relations.

[Margaret Nollen:]

Good morning. 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 www.heinz.com. Joining me on today’s call are Art Winkleblack, Executive Vice President and CFO, and Ed McMenamin, Senior Vice President Finance and Corporate Controller. Before we begin with our prepared remarks, please refer to the forward-looking statement currently displayed. This is also available in this morning's earnings release and in our most recent SEC filings. To summarize, during our presentation we may make forward-looking statements about our business that are intended to assist you in your understanding of the company and its results. We ask you to refer to our April 29, 2009, Form 10-K, and today’s press release, which lists some of the factors that could cause actual results to differ materially from those listed in these statements. Heinz undertakes no obligation to update or revise any forward-looking statement whether as a result of new information, future events or otherwise, except as required by securities law. 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 on our website at www.heinz.com. Please note we plan to file our third quarter 10-Q today and that will be at the end of the day. Related financial highlights pages or the stat pages are available now in the Investor Relations section of the website towards the bottom of the page. Importantly these stat pages provide a quarterly historical restatement for discontinued operations. Now on to today’s call, Art will review Heinz strong financial performance and our recently upgraded fiscal 2010 outlook. Ed will review our financial scorecards during the quarter and a quick year to date update. Then of course we’ll all be available to take your questions. So with the formalities out of the way, let me turn the call over to Art Winkleblack.

[Art Winkleblack:]

Thanks Margaret, and good morning everyone. We’re extremely pleased with our results for our third quarter which were very much in line with the estimates we provided at Cagney. You’ll note though that the final EPS was $0.83 versus around $0.82 we discussed last week. Now just to refresh your memory, for the quarter we grew organic sales by 3% driven by volume growth in our big retail businesses in the US and UK and double-digit growth in our emerging markets, expanded our gross margins through both carryover net pricing and strong productivity, increased our marketing investment by over 40% in order to support our terrific brand equities and drive volume, delivered very strong operating income and EPS growth, along with extremely strong cash flow. And overall maintained our disciplined approach to growth. In short it was a very high quality performance. Turning to key financial highlights, for continuing operations on a reported basis, sales, OI and EPS grew approximately 13%, 14%, and 9% respectively. Foreign currency turned to a favorable tailwind for us during the quarter but the positive impact moderated significantly as you go down the P&L, specifically currency helped sales by 7%, operating income by 4%, but EPS by only 1%. Ed will provide more detail on this in a few minutes. So on a constant currency basis sales increased almost 6%, OI grew nearly 10% and EPS was up more than 8%. The other notable achievement was that we once again delivered outstanding cash flow. Operating free cash flow was almost $440 million, which is nearly double the prior year level. Putting the quarter into perspective we have now delivered 19 quarters in a row of organic sales growth and we expect to achieve our 20th consecutive quarter of organic growth in Q4 reflecting continuing innovation and strong marketing support. Volume was positive for the quarter driven my emerging markets which posted volume growth of almost 7% and our US retail business up more than 4% and our UK business up more than 9% powered by our very effective It Has To Be Heinz campaign. As Bill said at Cagney, our global volume growth rate would have been close to 3% without our US foodservice business. This business continues to be impacted by weak restaurant traffic as well as the timing of a ketchup promotion in Q3 last year, and our ongoing rationalization of foodservice SKUs. We’re on track to reduce SKUs in this business by about 40% over a two year period. As you know Heinz is comprised of a highly focused portfolio anchored by the almost $4 billion Heinz brand. Our top 15 brands represent about 70% of sales and their growth continues to set the pace for the company. On an organic basis these brands grew more than 5% for the quarter, nearly double the growth of the total portfolio. This speaks to the power of our brands and our consistent focus on them. Our top 15 brands have consistently led our organic growth while evolving to include fast growing emerging market brands like Complan nutritional beverages in India, ABC sauces and beverages in Indonesia, and Pudliszki tomato products and ready meals in Poland. Turning to our core categories, on an organic basis we drove balanced growth in all three categories. Importantly the meals and snacks category delivered positive growth in both ambient meals and frozen foods, reversing the lower frozen volumes we experienced last quarter. Notably we also experienced strong growth in our beverage business which helped further improve our overall organic growth rate. Consistent with our long-term strategy we continue to drive excellent growth in our emerging markets. For the quarter organic sales grew by more than 15% led by our key Asian emerging markets of Indonesia, India, and China, as well as our growing business in Russia. With this strong growth rate emerging markets generated 14% of sales this quarter and almost 70% of the company’s organic sales growth total. For the full year we expect emerging markets to represent 15% of our total sales which would be up six percentage points over the last five years. We believe we are well positioned to continue to generate disproportionate growth in these markets and drive to at least 20% of sales by FY13. Now let’s take a quick spin around the world of Heinz, we’ll start with North American consumer products. We’re pleased with the operating performance of this segment. Higher constant currency sales were driven by volume growth of about 3% and net pricing of 1%. As I mentioned US retail volume was up more than 4% but was partially offset by softness in our Canadian business who’s economy is lagging the global recession. Gross margin continued to improve in the quarter despite somewhat higher promotional spending. This allowed us to amp up investment in our brands through the teams’ consumer value program. This program includes TV and print advertising, coupons, and co-marketing with our retail partners. Importantly we’re brining innovation to our categories and our retail customers are working with us on new promotions recognizing that our brands drive profit for both of us. In summary North America achieved disciplined and we believe sustainable results. On demonstrating our strong innovation capabilities we’re bringing new ideas to our key products in North America and ketchup is no exception. We are meeting our consumers’ desire for increasing health and wellness by reducing sodium 15% across our core US ketchup line within the next few months. We’re also focused on addressing lifestyle and dietary preferences for some consumers with our latest ketchup innovation. Simply Heinz, which is made with sugar joins our specialty ketchup line of no salt, organic, and reduced sugar ketchups. Shifting categories, next week we’ll be launching a new wave of Smart Ones innovation to drive growth. The new items include additionally Anytime snack selections, including mini burgers and chicken wraps, additional meals for price sensitive consumers, and new breakfast entrees. The launch of reduced calorie mini burgers, our Sliders, has tested particularly well and we’re optimistic about their potential. In fact we’re also introducing Sliders in full calorie version to expand our growing TGI Friday’s line. Other recent and coming new products in the US include appetizing new snacks and skillet meals in our TGI Friday’s line, new Boston Market hearty casseroles, OreIda steam and mashed cut red potatoes, and a launch of OreIda sweet potato fries which some of you had the opportunity to sample last week at Cagney. Now turning to our US foodservice business we continue to execute our plan to reduce complexity and drive productivity. The quarter sales decline of 3% included increased pricing of 4% and a 7% reduction in volume. This quarter’s volume was the result of softness in the industry, our continued simplification of the portfolio, and year over year promotional timing differences. The business is operating according to plan this year as our streamlining, simplification, and productivity efforts continue to generate strong profit results with operating income up almost 20% for the quarter. Looking forward we are partnering with our national customers to drive innovation and host food consumption supported by several new marketing programs and the uniquely targeted ketchup advertising campaign that will launch in a few weeks. Our foodservice innovation includes Dip & Squeeze, our exciting new dual purpose package that represents a true consumer breakthrough. This new package gives consumers a clear choice, they can either peel back the label for easy dipping or tear off the tip to squeeze Heinz ketchup on their favorite foods. It is much easier to use, more convenient, and delivers three times more Heinz ketchup while using less packaging than the standard nine gram ketchup packets that have been used for decades. Our research indicates that Dip & Squeeze will in fact drive demand for host foods like fries and chicken nuggets. Now let’s turn to Europe, for the quarter Europe posted constant currency sales growth of 2.4% led by 3% volume growth with only a slight reduction in net price. European sales growth was primarily driven by the UK behind It Has To Be Heinz marketing campaign. We’re particularly pleased with the growth in the quarter as we are comping a strong 8% constant currency sales growth last year. Double-digit operating income growth in Europe was driven volume and favorable mix combined with excellent productivity. The UK’s third quarter results were impressive with It Has To Be Heinz. This has been one of the company’s best campaigns as displays such as this one are popping up all over Great Britain. The events had big impact on the quarter and the momentum continues as this display from a Cash and Carry store in Birmingham, England was photographed just last week. Another statistic that speaks to the power of the program, in a cold and snowy January we sold 57 million cans of soup, a record for the UK and nearly one can for every man, woman, and child in Great Britain. And again to keep the momentum going, our UK team continues to warm Great Britain recently topping the coldest bus stop in Scotland with an oversized hat and providing the country with piping hot tomato soup. The press coverage on this as you might expect has been great. Our European ketchup business is also growing nicely. Our teams are focusing on increasing ketchup penetration across the continent as Bill described last week at Cagney. The result is that our 52 week shares have increased in 11 out of 12 European markets notably Russia achieved another record share during the quarter. We covered a lot of ground last week at Cagney but I didn’t want you to miss the discussion of our growing beans business in Russia. This is a small but fast growing business for us and a category that is larger than the soup category in Russia. We’re excited about the opportunity it presents for us. Also at Cagney we mentioned our plans to launch infant formula in Russia. We currently hold more than 25% share in both baby cereals and biscuits and have a strong foundation on which to build. For the launch of formula we will leverage the expertise from our infant nutrition center of excellence in Milan, Italy, which possesses about 50 years of experience in formula and infant nutrition. In our Asia Pacific market constant currency sales growth was largely driven by acquisitions and growth in the key emerging markets of Indonesia, India, and China. Overall volume increased by 2.5% and price increased modestly. Our Australian market remains challenging and the entire industry there saw a tough January. But on the innovation front we recently launched several promising new juice products including [Raw] and LOL beverages. And for the quarter constant currency profit in this whole segment was up almost 17%. Indonesia, one of our largest emerging markets businesses drove significant growth behind new varieties of soy and chili sauces and our popular adult ready to drink beverages including my favorite the ever popular [inaudible] drink. In India our key Complan and Glucon D brands continue to drive growth and we are preparing for the launch of Complan Toddler and new Glucon D products. In China we drove growth in infant nutrition, particularly in ketchup and sauces where we are growing alongside our global foodservice partners. Also in China we’re pleased with our Long Fong frozen dim sum business returned to volume growth in the quarter. Chinese New Year which is just wrapping up now is the peak season for dim sum. We strengthened our commercial capabilities and implemented a strong promotional program to ensure that our Long Fong products were well positioned for this big holiday event. And early returns indicate its going to be a good season for us. In China the Heinz brand is well trusted and possesses great equity after more than 25 years in the market. Consumers there actually expect Heinz to offer formula and we intend to capitalize on this untapped potential. We will launch infant formula in late spring with an aggressive far reaching marketing campaign. We have developed a unique formulation using 100% imported ingredients which are preferred by Chinese mothers over domestic brands. Now around the globe, Heinz is already a recognized brand in infant nutrition as we are the number three baby food provider in the world and number five including formula. We have aggressive growth plans and we believe we have the brand strength and expertise to win. In our rest of world segment the team continues to deliver robust growth with double-digit increases in sales and operating income on a constant currency basis. Volume grew by almost 2% and pricing contributed 19%. We posted volume growth in the Middle East and South Africa while pricing was led by our businesses in Latin America. We’re also excited about our prospects in Mexico and we believe that this represents a big opportunity in a big market. This fiscal year we started up a new baby food production facility in Guadalajara, launched new 100% pure fruit wet baby food and recently achieved a double-digit ketchup share in the modern trade in Mexico, which is the ninth largest ketchup market in the world. And finally during the quarter we purchased the remaining interest in our Egyptian joint venture Cairo Foods. Now one last point before turning it over to Ed, we delivered another quarter of great cash flow in Q3. Operating free cash flow increased 88% through the continued reduction in working capital, improved inventory levels, and disciplined management of capital spending. I’m really pleased with the progress our business units are making around the world. Now with that let me turn it over to Ed to provide a bit more depth on our results.

[Ed McMenamin:]

Thanks Art, and good morning everyone. As Art mentioned we are extremely pleased with our third quarter results and I’m glad to provide you with the details behind our strong top line, bottom line, and cash flow performance. As I go through the results for Q3 you will see that several unfavorable trends that have impacted the company over the last year are finally beginning to ease, notably foreign exchange and commodity costs. Again this quarter we divested businesses that are recorded as discontinued operations, so I will give you three key perspectives on the company results. EPS from continuing operations was $0.83, $0.07 better than last year. Given the volatility of currencies we think its helpful to look at the results on a constant currency basis which shows EPS would have been $0.79 for the quarter, up 8% to the prior year. More on currency in a few minutes. Finally total company reported EPS was down $0.04 to $0.72 reflecting an $0.11 loss from discontinued operations. During the third quarter the company sold two small businesses which will help simplify our foodservice and UK portfolios resulting in an $0.11 per share loss recorded in discontinued operations. Going forward the P&Ls for all periods will exclude the results from these businesses as well as for the Kabobs divestiture we completed in Q2. In total these businesses accounted for around $140 million of sales and delivered a small operating loss last fiscal year. Now let’s move to our P&L scorecard. Focusing on continuing operations we had a very strong quarter both on a reported and constant currency basis. Focusing first on the reported results, sales increased almost 13% approaching $2.7 billion. Gross margin improved 180 basis points to 37.5%. We increased consumer marketing over 40%, operating income grew almost 14%, and finally EPS of $0.83 was up 9.2%. We have significantly ramped up our marketing investment and its apparent that these investments are yielding benefits to our top line, driving higher volumes of margin enhancing products. Peeling away the impact of foreign exchange you can see the strength of the underlying business, with healthy improvements throughout the P&L, with sales up almost 6%, and operating income up 10%. Now let’s take a deeper look at currency, the good news is that translation rates showed a rebound across the board. In fact Australia and New Zealand are up over 30% from last year but none of them are back to the levels we saw in the summer of 2008. Another important currency factor is the transaction impact to the pound euro cross rate. This rate has somewhat stabilized but at a considerably higher rate than historical norms. We’re now reaching the anniversary of the new range and the cross rate penalty should lessen going forward. As we have done over the past year here we’ve laid out the dynamics of the currency changes relative to our P&L. This quarter currency benefited sales by $164 million but only had a $0.01 positive impact to EPS growth. Looking across the bottom of the chart, you can see that $0.06 of favorability is due to translation, partially offset by a $0.02 unfavorable impact from the UK cross rate. Last year we had a $0.03 gain from currency translation hedges in Q3 so you see $0.73 is the base for last year rather than the $0.76 we’d reported. In total EPS is up $0.07 in reported currencies and $0.06 on a constant currency basis. Turning now to the full P&L, there are few lines that I would like to draw your attention to, gross margin improved 180 basis points driving gross profit increases well in excess of sales growth on both a reported and constant currency basis. Marketing expense is up over 40% compared to prior year, SG&A was up 12% on a constant currency basis reflecting increases from acquisitions and higher pension and incentive compensation expenses. Operating margins were 16.3%, surpassing the high watermark achieved in Q3 of last year. Below operating income net interest and other expenses were up $17 million due to the prior year currency hedge gains I mentioned, while net interest expense was slightly favorable to last year. The effective tax rate for the quarter increased 130 basis points to 27.2% primarily due to increased income in higher tax rate jurisdictions. We are still expecting our full year tax rate to be at the low end of our previous estimate of 28% to 29%. Now let’s focus on sales, the second quarter delivered organic sales growth of 3% with all of the key drivers contributing to growth. As Art mentioned the volume increase of 1.2% was largely a result of growth in our emerging markets as well as the US retail and UK businesses. Volume was softer in Australia and in US foodservice but as you will see in a few minutes foodservice delivered an outstanding profit performance as margins recovered to more normal historical levels. And as we mentioned on our last earnings call the comparisons are aided by the timing of price increases which impacted customer shipments in the third quarter of fiscal 2009. Net pricing increased 1.8%, we have now lapped the majority of the price increases we took last year and are implementing targeted promotions particularly in the US and UK. Acquisitions net of divestitures increased sales by 2.9%, largely due to the Golden Circle business in Australia while foreign exchange translation rates increased sales by almost 7%. Turning to net sales performance by segment, all of the regions delivered organic, constant currency and reported increases with the exception of US foodservice. Art took you through the key brands and initiatives by region but here you can see the overall recap of our top line results across the company. As I noted earlier our gross margin increased 180 basis points to 37.5% on a reported basis and 240 basis points on a constant currency look. The two major factors driving this improvement were pricing which contributed 110 basis points and productivity projects which added 240 basis points. Some of the key productivity initiatives include procurement, waste reduction and yield improvements. These were partially offset by 150 basis points from higher commodity costs including a 40 basis point impact from the UK cross rate. And finally lower margin acquisitions had a 40 basis point impact on overall margins. Looking at commodities, input costs were up 3.6% in Q3 including the impact of cross currency sourcing. Net commodity increases reflect higher prices for oils, metals, glass and potatoes, partially offset by savings on tomatoes and sweeteners. Turning to operating income by segment, North American consumer products grew 8.2% including a 2.9% favorable impact from currency. The performance was driven by volume, pricing and productivity improvements which supported substantially increased marketing investment, as well as offsetting higher pension cost and performance incentives. Europe’s results were up 13.9% on a constant currency basis setting aside about 1% of net favorable impact from currency movements on both translation and the UK transaction costs. The double-digit growth reflects increased volume and productivity improvements which more than offset increased commodity costs, and higher SG&A expense which reflect the impact of marketing investments and higher incentive accruals. Asia Pacific segments operating income increased 16.6% on a constant currency basis and over 50% after the favorable impact of currency primarily from the Australian and New Zealand dollars. The constant currency increase is due to higher volume and productivity improvements partially offset by increased commodity costs and marketing investments. Acquisitions had a favorable impact on operating profits but reduced overall operating margin. US foodservice delivered great profit results this quarter as a result of the teams’ efforts to streamline the business and drive efficiencies. Operating income was up 19.3% as pricing and productivity improvements as well as favorable commodity costs more than offset unfavorable volume and increased incentive accruals. We are very pleased with the profit performance of this business which is effectively responding to a challenging external environment. And finally the rest of world segment delivered outstanding results this quarter up 42% on a reported basis and 56% excluding currency translation primarily related to the Venezuelan devaluation. Going forward we would not expect Venezuela to have a material impact on our overall results. Now let’s move to the balance sheet scorecard which shows the results of our focus on cash flow management. Capital expenditures of $54 million were 2% of sales, down 50 basis points from the prior year. This decline reflects strong CapEx management and the timing of spending. Our third quarter cash conversion cycle was 51 days, a 13 day improvement from the prior year. The asset securitization program contributed five days but the biggest improvement came from inventory efficiencies enabling operating free cash flow to continue on the trend of significant improvement over last year, up $206 million for the quarter. Now let’s briefly review our year to date performance, looking at our EPS results from the same three perspectives that I shared with you earlier, shows the dramatic impact currency had on our results so far this year. Despite the recent favorable trends currency had a $0.33 unfavorable impact on the comparability of our results. Stripping that away EPS on a constant currency basis has grown by nearly 12% versus last year. Our year to date P&L scorecard shows our underlying strong performance across the board. On a constant currency basis sales increased almost 5%, gross margin improved 100 basis points. We increased consumer marketing 16%, operating income was almost 9% higher, and finally as I mentioned, EPS rose almost 12%. We are meeting our beating our full year constant currency targets on the key lines of the P&L which underpins our revised outlook for the year. Updating the chart I showed you earlier, the year over year currency impact has been adverse $0.33 year to date. As you can see translation is still unfavorable by $0.03, $0.08 from a headwind from UK cross currencies, and $0.01 for currency translation hedges executed this year. Additionally the prior year base has been adjusted by $0.21 for the impact of currency translation hedges in fiscal 2009. Looking at the year to date balance sheet scorecard our performance has been strong all year. Capital expenditures were 1.9% of sales, down 50 basis points from the prior year. We expect increased spending in the fourth quarter and project the full year estimate between 2.5% and 3% of sales. Cash conversion cycle was 50 days, down six days from the prior year benefiting three days from our asset securitization program but again, inventory improvement as a result of improved supply chain processes was the main lever. Operating free cash flow of $853 million actually achieved our original full year target range in just nine months. Net debt to EBITDA improved to 2.3x and finally excluding the impact of the losses in discontinued operations ROIC was 18.2% and 17.4% including the losses from these divestitures. With that I’ll now turn it back to Art to update you on our full year outlook.

[Art Winkleblack:]

Thanks Ed, now to quickly wrap up, last week at Cagney and for the second time this year we raised our fiscal 2010 outlook for continuing operations. The new EPS range is now $2.82 to $2.85, up from the prior range of $2.72 to $2.82. We also raised our outlook for operating free cash flow to better than a billion dollars and now expect to have room to enable additional discretionary funding of our pension plans during the fourth quarter. Importantly in targeting these higher ranges we expect to continue investing for the long-term health of the business. Specifically we anticipate launching several new products and varieties, increasing fourth quarter marketing by more than 50%, implementing several new productivity initiatives to drive and sustain our margins, investing in capital to drive productivity and build capacity for our Dip & Squeeze launch, and use our cash flow upside to make further discretionary investments in our pension plans as I mentioned. So overall we’re very pleased with the high quality and nature of this quarter’s results, our strong P&L and cash flow momentum, and our ability to invest in the future. As a final note, please mark your calendars for our analyst day in Pittsburg on Thursday, May 27. We expect a full day of presentations from our key leaders from the Heinz world. Invitations will be sent out shortly. And with that, Ed, Margaret and I would be happy to take your questions.

[Operator:]

(Operator Instructions) Your first question comes from the line of Vincent Andrews – Morgan Stanley

[Vincent Andrews:]

I’m wondering if you might be willing to give us a little peak into F2011 at this point, what you’re seeing, obviously there’s a lot of chit chat at Cagney last week from the other companies so maybe you could put yourself in perspective relative to what you see or to where everybody else is.

[Art Winkleblack:]

I think given where we are in our fiscal year we’ll probably not comment a lot on that at this point. The reality is that we’re still two and a half months away from the end of the fiscal year. We’re consolidating and locking down our plans, talking to the Board about it, etc. So probably won’t give you much sense for that. The last time we talked I think we had given a long-term guidance of three to four top line, six to nine at the EPS line, but what I would say is that we’re working through the plans and we’ll tell you more later.

[Operator:]

Your next question comes from the line of Andrew Lazar – Barclays Capital

[Andrew Lazar:]

I’m trying to get a sense of in some way of the magnitude of the increase in D&A spend in the quarter, you had some carryover pricing still flowing through on the top line so I’m trying to get a sense of how much the offset to that pricing came from let’s say trade spend because I think you mentioned during the prepared remarks that you’ve now lapped a lot of the pricings taken last year so I want to get a sense of if trade spend, if that piece of it starts to bring the overall price metric lower year over year as we go forward into the fourth quarter.

[Art Winkleblack:]

As you saw the net pricing is favorable for the quarter and that’s with increased promotional spending. I think Bill talked about it a bit at Cagney. We’re probably in the 70 to 80 basis point range of increased D&A spending but this partially offsets the incremental price that we got so net, net net pricing is up. As we’ve all talked about I think net pricing will be harder to gain as we go forward so really the key drivers in the P&L need to be volume and also productivity, which we talked quite a bit about last week.

[Margaret Nollen:]

Innovation and marketing.

[Andrew Lazar:]

So I guess anticipation would be hopefully [inaudible] potentially some of the better volume that you’ve seen can continue to accelerate into the fourth quarter perhaps.

[Art Winkleblack:]

That’s exactly right and we expect good organic sales growth in the fourth quarter here. Again we talked about that at Cagney so yes its, I feel good about what we’re doing to drive the business in terms of increasing our marketing support behind the key brands, and we’re launching a number of new products as we alluded to and we’ve also got a very, very strong focus on the emerging markets where our growth rate continues to be excellent.

[Operator:]

Your next question comes from the line of Jonathan Feeney – Janney Montgomery Scott

[Jonathan Feeney:]

Looking at this from over the past three years, I may be a little wrong on these numbers but probably you can correct me, but over the past three years it looks like operating profit per unit given the volume disclosure you have, is about flat in Europe now over the past three years which makes sense to me and is impressive. Down a little bit in foodservice in North America which makes sense, there’s been some deleverage there, its been a tough environment now for a couple of years in a row, but up 27% in North America that’s your operating profit per unit of volume as you disclose it, is there some major mix factor I’m missing in there or and in particularly considering how ready I think retailers have been to get more aggressive on private label and discounting in different places, are you comfortable that the sort of gaps you’re at pricing and promotion wise are sustainable given that really really impressive performance over the past three years and just in North America.

[Art Winkleblack:]

I think it speaks to the power of the brands, the reality is we’ve got a very focused portfolio in North America and so our ability to invest efficiently behind those brands is very high. And I think the team down there frankly has done just an exceptionally good job. So if you combine the focus on few brands and also the strong drive in the supply chain to grab productivity, we’ve made major progress there. Bob Ostryniec and his team have really worked some strong results down there and you just saw as Bill announced that Bob has now been promoted to the global supply chain role. So yes we think we’ve done a good job, the results have been impressive and I think they are sustainable because and particularly as you look at some of our peers we’re competing with some of our peers that have higher gross margins and in fact higher operating margins. If you look across the globe many of our food company peers have gross margins that are in the 40-plus percent range, ours are not as you know, about 37.5% for this quarter overall. So yes, we’ve made good progress, we expect to continue to make progress and we’ve got a good opportunity on the innovation side for the top line as well as from the productivity aspect.

[Margaret Nollen:]

I think the only thing I would add to that is that from an innovation perspective its been mix enhancing so we’ve been very focused on driving improvement there as well.

[Jonathan Feeney:]

Just on that point, I’m sorry just to clarify could you give me a good for instance as far as a mix enhancing aspect of the portfolio.

[Margaret Nollen:]

Steam and Mash as an example so taking premium to the potato category.

[Operator:]

Your next question comes from the line of [Diane Deelser] – COSA

[[Diane Deelser]:]

You’ve talked about emerging markets being 20% of your total sales by fiscal 2013 for some time now so I guess my question is did that include your anticipated launch into infant formula in China and Russia and if not how much will that add in terms of what your goal, in terms of emerging markets as a percentage of total revenue.

[Art Winkleblack:]

I think all of that is included. We’ve got a goal to get to 20% and in fact frankly I’d like to see it get higher. And we’re certainly working plans to make it higher. And I think that will be a combination of organic growth, the launch of things like infant nutrition and hopefully and acquisition or two along the way, some bolt-on acquisitions in emerging markets as you know are part of our strategy and we continue to look for good opportunities in that arena.

[Operator:]

Your next question comes from the line of Rob Moskow – Credit Suisse

[Rob Moskow:]

Just a couple of quick questions, fourth quarter I’m trying to model it out and based on what your gross margins are tracking it just seems like there’s going to be a huge investment in I guess marketing in fourth quarter and maybe some cost savings, can you help me out with that. If your top line organic growth is probably still tracking around 2% to 3% and all that, what kind of SG&A as a percent of sales are we looking at here, is it like 24% or along that line.

[Art Winkleblack:]

I think the key is that as I mentioned we’re investing pretty heavily, some of those investments will land in gross profit margins, some of them will be down in SG&A but the net story is really commercial investment. We’ve got the CVP plan going on in North America, we’ve got It Has To Be Heinz over in the UK, we’re launching a number of new products and varieties in the quarter. We do have the productivity initiatives and the other thing to keep in mind that our tax rate will probably be at least a couple of cents higher or hurt to EPS versus our Q3 number. So if you think about it as commercial investments, productivity investments, and also the tax rate bringing us to the estimate for the fourth quarter which is roughly in line as I recall with what the fourth quarter was last year.

[Ed McMenamin:]

Last week we talked today about how much marketing was up in Q3 but last week we also indicated that marketing would be up in Q4 by about 50%.

[Rob Moskow:]

And pricing in emerging markets, the emerging markets tend to be more inflationary than developed markets, so is it just as difficult to take price in your emerging markets or is it a little bit easier in China and India and Russia.

[Art Winkleblack:]

Its never easy right but it is I think there’s certainly more capability to take price largely because of the highly fragmented trade environment. And so that gives you a bit more leverage in those kinds of markets and so we do tend to, and I think you see from our peers that we all tend to be more able to price in those markets.

[Operator:]

Your next question comes from the line of Eric Serotta – Consumer Edge Research

[Eric Serotta:]

Was hoping to dive a bit into your productivity progress, I think you gave what the basis point impact was on gross margins in the quarter about 240 basis points, what does that equate, could you give us some estimate year to date as to where you are versus your original $250 million or I think it was about 2.5% of sales productivity target and then I believe it was maybe it was the first quarter of this year you talked about some upfront investment in productivity savings, I don’t think you mentioned it the last two quarters, I could have my quarters mixed up, but could you talk about the spending that you’re putting behind realizing some of these productivity savings and the expected returns that you have.

[Art Winkleblack:]

As I recall I think we’re tracking pretty well to our overall productivity target, that’s split between a number of areas, procurement productivity has been good in a number of areas. We’re making progress on the indirect procurement side as we roll out the SAP, what’s called SRM module. We’ve made progress on some direct materials. As Ed mentioned we’ve got waste reduction going and our HGPS program is working well on efficiencies and yields. So we’re making good progress. To your point we did spend some upfront productivity money in the first quarter really have not done so in the second and third quarters but we do expect to spend some in the fourth quarter.

[Ed McMenamin:]

I think as I said we tracking, its picked up this quarter in terms of the productivity and we expect that to continue going forward.

[Art Winkleblack:]

But we’re pleased with the progress we’re making in the supply chain and I think our new global procurement and global supply chain organization that Bill talked about last week at Cagney will do a lot to continue to drive and increase the focus in that arena.

[Ed McMenamin:]

And the other advantage we have is the indirect procurement not only benefits gross margin but it also comes through other areas of the P&L like distribution, G&A.

[Eric Serotta:]

And did you quantify what the upfront spending would be in the fourth quarter.

[Art Winkleblack:]

No we haven’t yet. We’re still working some of those plans and finalizing a number of things and so we’ll talk to you more about that in May.

[Eric Serotta:]

And then lastly could you talk a bit about volumes in continental Europe. I know that the UK was up something like 9% and your overall Europe as you reported was up significantly less than that, I think it was 3%, could you talk a bit about market conditions in some of your key markets there like Italy and some of your other markets.

[Art Winkleblack:]

I think, in Italy pretty solid results. Tough market no doubt about it and so it’s a constant tussle there but shares there are relatively stable, volume relatively stable, so we’re pleased with the performance there and the profitability coming out of that business. I think the weaker spots is really in the Iberian Peninsula, the Spain and France, the economies are not particularly robust there certainly. And the other thing is from our own strategy standpoint particularly in France we’ve made the decision to exit some private label business that we had gotten through a couple of acquisitions over the last few years. We’ve done a lot to rationalize SKUs and so we’ve taken down some of our volumes in France, quite consciously and we’re frankly very pleased with the bottom line impact of that, but it does have a bit of a top line impact.

[Margaret Nollen:]

But thanks for pointing it out, this is the first positive volume quarter for our European team in I think they had six negative quarters, so kudos to the team.

[Operator:]

Your next question comes from the line of Chris Growe – Stifel Nicolaus

[Chris Growe:]

I just have a question regarding market investment [inaudible]—

[Art Winkleblack:]

To tell you the truth you’ve been cutting in and out, I did not catch your question.

[Margaret Nollen:]

I think the question and correct me if I’m wrong I think your question is fourth quarter marketing investment, how much of that might be related to the launch of China formula.

[Chris Growe:]

Correct.

[Art Winkleblack:]

Not a lot, I think we’re investing across the board. We’ve got a heavy investment in all of our emerging markets including China but its really behind a lot of the new products and new programs that we’ve talked about earlier today and then also at Cagney. So a small amount may be related to that but the primary bulk of that will be in the future.

[Ed McMenamin:]

About half the total increase that we see this quarter is really coming in the North American area.

[Operator:]

Your next question comes from the line of Alexia Howard – Sanford Bernstein

[Alexia Howard:]

I wanted to switch to volumes in North America specifically I guess the outlook for next quarter or how things are trending it looks as though US retail was chugging along really nicely this quarter but I guess that was partly driven by the pricing taking in the year ago period, are we likely to see that momentum continue and I guess, in the context of North America, Canada did look particularly weak this time, Smuckers yesterday said they were having some retailer issues up there, was that a retail issue or was it a macroeconomic issue and is it likely to persist into Q4 and beyond.

[Art Winkleblack:]

I think Canada, probably is both to your question. Canada is lagging, their economy has been much stronger than say the US for instance or Western Europe and really now I think the recession is hitting them a bit. It’s a concentrated trade environment so its always a challenge there. We’ve got a great team up in Canada though that has done an excellent job for a long time and we certainly expect them to continue to generate excellent results. In terms of in the United States and in North America, we would anticipate for the fourth quarter our volume to be stronger than it was in the third quarter, probably a little less net pricing but volume momentum should be stronger.

[Margaret Nollen:]

You’ll see the consumer value program really kick into gear this coming quarter, particularly behind a launch of all the new products.

[Operator:]

Your next question comes from the line of David Driscoll – Citi Investment

[David Driscoll:]

Questions on the impact of the I believe you said in your prepared script that foodservice would see a 40% reduction in SKUs over the next two years, if I heard that right can you talk about the impact to sales and profits going forward. That does sound like an amazingly large number.

[Art Winkleblack:]

We mentioned that one before, and we’re well into it so frankly a lot of that is behind us and I can’t recall exactly how much of the 40% we already have but it’s a very, very strong portion of it.

[Margaret Nollen:]

I think about a quarter of it, or 25% last year, so certainly over 20% last year and the balance into this year.

[Art Winkleblack:]

I think we’re well done the path on that one so I think you’re going to see less of an impact of that going forward than you certainly have over the last 18 months.

[Ed McMenamin:]

--slower moving SKUs and we’d also be trying to generate direct to customers to other products that move more quickly and as you can see through the margins also have better margins.

[Art Winkleblack:]

We’re really pleased with the progress the team is making in foodservice. I think they’re making the right trade off decisions and you see that in their profitability and establishing good strong foundations for when that industry finally turns around. The other thing that we’re really gratified to see is some of the innovation coming back there in terms of Dip & Squeeze, you saw some of the PR that we’ve gotten out of that over the last few weeks. It just amazes me. So I think we’re very excited about that and the team continues to work on additional innovation opportunities as well.

[David Driscoll:]

Just to follow-up on Dip & Squeeze, can you talk to us a little bit about the volumes that you expect from that product and when should we start to see the benefit.

[Art Winkleblack:]

I think we’re a ways out from that, I don’t want to steal the thunder of the guys on the team that have done all the hard work on it, so I think on our analyst day in May, we’ll lay out more specifics about Dip & Squeeze and the plans and all that. But we’re driving hard on it now and we’re optimistic about the opportunity.

[Margaret Nollen:]

Its been creating a lot of excitement out there, some consumer demand pull having great conversations with our customers today, but we announced, that will be coming, you’ll see that more in the fall.

[Operator:]

Your next question comes from the line of Eric Katzman – Deutsche Bank

[Eric Katzman:]

I don’t know why I have to play the role of the heavy, even if I take away the foodservice hit although every company is dealing with that and every company is dealing with SKU cuts I’m not sure why I should get excited about 3% volume growth versus 6% down a year ago and marketing up over 40. You’re not even back to where you were two years ago, so I guess one I just kind of I want you to respond to that, if you can, and two what are the consumer off take numbers like because it seems pretty clear to me that if you’re driving 9% volume in the UK or mid single-digit in the US that’s on probably a fair amount of deal so the pantries are getting loaded and you didn’t talk about market share or what kind of consumer off take we’re seeing, I’m fearful that people are buying stuff in the UK on tremendous deal and next quarter or two quarters or whenever it is we’re going to see a hit because we loaded it in.

[Art Winkleblack:]

On that we would anticipate that our volume will be a bit stronger in Q4 than in Q3. So that’s not an issue. That is part of why we are driving such strong programs and such strong marketing spending is to drive that consumer pull and off take so I do not believe you will see that. I think at the end of the day, hey this is a tough environment, there’s no doubt about it. You talk to our peers and things like that and it’s a challenging environment. You saw in January really across the globe January wasn’t a particularly strong month and you saw private label still growing. So not an easy world to operate in. Having said that the ultimate proof of the pudding I think is that we’ve driven 19 consecutive quarters of organic sales growth and so I think you see the evidence of the programs working. What we’re trying to do is invest in the business and continue to ramp up not only our new products but our marketing spending so that we get the momentum and keep the momentum going. The other thing that I would keep coming back to is the emerging markets where its 15% of our sales, we’re looking to drive it to well more than that and even though 15% isn’t huge, when you’re driving organic growth of 15% kind of numbers and plus, that has a very helpful impact there as well. So I think in my mind its incumbent upon us and all of our peers to continue to innovate, continue to drive a reason for why consumers ought to be buying our products, we are certainly very cognizant and attuned to the need for value and I think you’re seeing us hitting better price points and the right price points that are driving that consumer off take. So net net tough environment but we feel good about what we’re doing.

[Eric Katzman:]

And can I as a follow-up I guess more specifically you have a big global soup business that’s largely ready to serve. I think you kind of mentioned Australia was pretty tough but you did pretty well in the UK, you’re probably aware that Campbell’s has been having challenges in their US ready to serve business, are you detecting any kind of elasticity issues with the consumer outside the US with regard to your ready to serve product.

[Art Winkleblack:]

No, I think every market is different and so hard for me to tell what story on Campbell is but with regard to our business we had a great quarter in the third quarter in the UK so that went very well for us. Australia has been tough but that’s not really a soup issue that’s a broader economic issue and so we’re working through that but no I think market by market the opportunities are different and we had a good quarter in Q3.

[Margaret Nollen:]

Cream of tomato soup in the UK is, it’s a stalwart there and the team is really I don’t know if you saw the picture earlier, we weren’t just being cute this is, its huge and its beloved in the UK and our team is playing into that and our whole portfolio in the UK is ready to serve. And soup is a meal in the UK.

[Art Winkleblack:]

And I think the It Has To Be Heinz campaign while it has a great halo over all our products certainly one of those key product categories is soup and so I think it has worked very nicely. And hey, we’ve had some cold snowy winters in a few places, that doesn’t hurt.

[Margaret Nollen:]

Actually that was going to be part of my comeback to your question on the pantry load which I won’t call it a fair question but I can certainly understand that there’s the cynical question out there. And so the cold weather has certainly helped with a potential stocking issue there. But I think as you saw, we didn’t give all of it away, the volume the elasticity is very strong.

[Ed McMenamin:]

A lot of the soup fortunately went out because of the weather without a lot of promotions against it so it was really a very good, against a planning for the weather but the reaction to get the radio commercial on TV to ensure that the stocks were there at the stores, good reaction [inaudible] opportunity in the UK, by the UK team.

[Operator:]

Your next question comes from the line of Bryan Spillane – Bank of America

[Bryan Spillane:]

Just as a follow-up to Eric’s question in the UK just in terms of the spending that you did to drive that volume growth how much of it was just driven to get incremental shelf space and how much of it was to actually drive price points down and if you could talk a little bit about price gaps and market share in the UK during the quarter.

[Art Winkleblack:]

It’s a comprehensive campaign and I probably can’t quote you exactly how much went to where but the beauty of this is that it is in store execution, it is display activity, and but a heavy up marketing campaign as well, its been tied into PR value as well from the, into various things, the hat over the bus stop and the—

[Margaret Nollen:]

More coming too, they’ve got some really creative plans coming up.

[Art Winkleblack:]

And the bean store and things like that so I think what you should be looking at is the volume momentum that we got in Europe and a big portion of Europe is the UK and also the profitability so if you combine that we feel very good about the trade offs that the guys are making in terms of driving both the top line and the bottom line at the same time.

[Margaret Nollen:]

In terms of your question related to if this basically getting more cans on shelf early, getting it into the pantry and consumed, Neilson data would suggest that there has been significant pick up in consumption and in takeaway and we gave you at least some stop light charts if you will in the Cagney presentation about that.

[Bryan Spillane:]

But my question is more just in terms of sustainability and maybe I had it wrong but I was under the impression the UK that one of the issues that you were having was you were cost disadvantaged and it was difficult to close price gaps relative to private label. So I guess what I’m after is that going forward is the delta, is the change that your merchandising is just great relative to what it was or is the delta also that you’re price gaps with private label are more competitive or has private label had to raise prices. That’s really what I’m after in terms of trying to see what the sustainability will be in terms of volume.

[Art Winkleblack:]

I’m not sure I could quote you what the particular price gaps are, but I think the key is and what we’ve always said to compete effectively with private label is to innovate and give the consumer reason to buy our product and I think the guys through the It Has To Be Heinz campaign have done that. So I think price gaps are still a reality of the marketplace and should be. But I think given the marketing and the innovation that we’re driving and even if you go beyond the UK into the ketchup penetration opportunity that we have across Europe we’re feeling good about the sustainability of the programs we’re driving.

[Ed McMenamin:]

And recently we have seen some of our competitors increase the price of beans and that has helped our volume number narrow that price gap a bit.

[Art Winkleblack:]

Some of our peers and competitors they have to bring in their raw materials from some of the same places so even if you’re a private label bean provider you’re probably buying it from outside of the UK and so therefore some of that same pressure exists.

[Margaret Nollen:]

And just looking, I’ve got a little bit of Neilson data, the gaps were the widest in our first quarter this year and have improved some since, but its not drastic, its not that we’ve just slashed price, we’ve done a combination, we’re doing it a disciplined way.

[Operator:]

Your next question comes from the line of Karen Lamark – Federated Investors

[Karen Lamark:]

I wanted to ask a couple of questions about foodservice, understanding your editing down the business to more profitable accounts and SKUs I just wonder if you can comment in general about restaurant industry conditions, are you seeing any kind of increase in consumption or frequency and I guess if not what are your expectations around that.

[Art Winkleblack:]

I think there are a couple of accounts that are starting to show some better results but in general the restaurant traffic trends are continue to be down and they lap down numbers from prior. So as we look forward we are not counting on anything great in terms of restaurant traffic trends at some point they will start to stabilize and the level of reduction will drop. Our goal is to drive our sales and our volumes slightly ahead of those restaurant traffic numbers, whatever those might be.

[Karen Lamark:]

And any color on the couple of accounts that might be improving just to get a sense of what’s going on in the industry.

[Margaret Nollen:]

I think what you’ve seen out there is QSOs are finally to feel some of the pinch, there have been so much trade down and from a casual dining experience of full service if you will, there has been more of this value menu pricing. Historically now we’re seeing them go a bit to a smaller servings if you will, so there have been different shifts that have gone on whether we’ve gone from value menus where you got the fries and the cokes priced in, to ala carte and single, the value items. You’ve seen the full serve trying different solutions, bundling an appetizer and a dessert in to a price. Now it seems maybe there’s a trend to some smaller servings.

[Art Winkleblack:]

What I would encourage you to do on May 27 I’m sure Brendan Foley will be there who runs our foodservice business, and that will be a topic of conversation just to tell you what we’re seeing in the industry and he can give you a much more background, to be quite honest, he’s much closer to it then I am.

[Operator:]

Your final question comes from the line of Terry Bivens – JPMorgan

[Terry Bivens:]

Speaking of weather I’m down here getting snowed in for like the third time in a month if you have another one of those big floppy hats I could put over my house—

[Art Winkleblack:]

Sitting here in Pittsburg, we have no sympathy.

[Terry Bivens:]

Two things, we didn’t say much this morning about the level of promotion that’s going on with frozen entrees which has been kind of a continuing saga there, our data shows that Nestle is continuing to be pretty promotional, I think ConAgra has come back a little bit with some higher promotions so I guess I’m wondering if I know it’s a tough category right now but how would you characterize the level of promotion at present and kind of where do you see yourself going with that over the next six months or so.

[Margaret Nollen:]

What I’d tell you is you’re going to see the level of Smart Ones promotions pick up, relative to last year but don’t over react to that. You really have to compare it to two years ago and we’re really just kind of restoring our promotion levels. As you know we kind of cut off the tail and chose not to chase that consumer out the door to use Bill’s term. That profitless prosperity if you will. But we’re reengaging particularly behind the new innovation that’s coming out. We’re so excited about these Sliders, about the breakfast expansion, the whole 24/7 line. To your question, has this, has nutritional been promotional, sure, we’ve all been trying to get the consumer back and we’re seeing better trends but still not back to kind of normal levels if you will but we are definitely back out there and playing the game but I wouldn’t look at that as Heinz is stepping it up, rather Heinz is restoring kind of historic levels of promotion.

[Art Winkleblack:]

We’re trying to be disciplined about it. I think you’ll see it continue to be a competitive category. The category frankly I would have expected to see the category rebound a little sooner than this. I think the category was still down 5% to 6% something like that during the third quarter so the category not yet robust. That will come back, always does after a recession, this one’s taking a little while longer than certainly we had hoped. But I think we’ll be competitive but we’re going to be disciplined and responsible about it. And as Margaret said we’re trying to bring a very strong focus on innovation and drive it through that mechanism.

[Terry Bivens:]

The only thing I wanted to ask about is we’ve been very pleased to see the way the cash flow is progressed, given the performance particularly in this quarter I guess it puts more emphasis behind the question what are you going to do with the cash, how are you targeting right now uses of cash and I’m particularly interested in the acquisition portion of your answer.

[Art Winkleblack:]

Thanks for the notice on the cash flow, we worked hard at that one, after all cash is king. So yes, we have made great progress on that. I think we’ve always articulated that our priorities are really to continue to strengthen our dividend. We’re also looking for good solid bolt-on M&A opportunities particularly in our emerging markets or our three core categories. And then to reduce debt. I think Bill made it pretty clear last week that we really want to be investing in our business as opposed to buying back shares and things of that nature. The other area in the short-term here we will in the fourth quarter put some additional money into our pension plans. We think that’s the right thing to do from a number of angles so we haven’t quite decided exactly how much but the good news is we think we’re going to have plenty of room to do that.

[Margaret Nollen:]

I think we’ve actually run over here so I apologize, operator I’m just going to go ahead and wrap it up here. I want to apologize to those of you that we were going to be visiting in New York tomorrow. Due to the weather we’ve decided to go ahead and postpone those meetings so we’ll be back up there in the next couple of weeks so don’t fear. Note that we will, Art and I will be headed over to San Fran for the CLSA Asia US forum with our new analyst Diane. And that presentation will be webcast on Monday at 11

[Art Winkleblack:]

Stay out of the snow.