The Kraft Heinz Company (KHC) Q2 2008 Earnings Report, Transcript and Summary

At this time I’d like to welcome everyone to the H.J. Heinz Company fiscal year 2008 second quarter earnings release conference call. [Operator Instructions] I’d like to turn the call over to Meg Nollen, Vice President, Investor Relations. Ms. Nollen you may begin your conference.

Thank you and good morning. I’d like to welcome everyone to our conference call and web cast. Copies of the slides used in today’s presentation are available on our website at Heinz.com. Joining me on today’s call are Bill Johnson, Chairman and CEO, Art Winkleblack, EVP and CFO and Ed McMenamin, Senior Vice President-Finance, Corporate Controller who will also be available during Q&A. Before we begin with our prepared remarks please refer to our 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 predictive statements about our business that are intended to clarify results for your understanding. We ask you to refer to our August 1, 2007, form 10-Q and our May 2, 2007, 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 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 measure and reconciliations of these non-GAAP measures are available in the company’s earnings release which is also available on the website at Heinz.com. Now with the formalities out of the way let me turn the call over to Bill Johnson to talk about our great results.

Good morning everyone. The H.J. Heinz Company delivered outstanding second quarter results. With reported sales up 13% and organic sales growth of 8.1%, operating income up 10%, earnings per share growth of more than 20% to $0.71 per share and operating free cash flow of $133 million. We are very pleased to report to our shareholders the company’s continued strong performance during the second quarter and through the first half of fiscal 2008 building on our great year in fiscal 2007. During this mornings call I will briefly walk you through the drivers of this performance and the plans to sustain our momentum which were built around four strategies: - Growing The Core Portfolio - Accelerating Growth In Emerging Markets - Strengthening And Leveraging Global Capabilities - Making Talent In A Competitive Advantage Heinz is executing extremely well which is not only contributing to our strong growth but also helping us overcome the significant commodity inflation the food industry is experiencing. We are sustaining strong growth in North America, Consumer Products in Australia and building very good momentum in Europe and emerging markets. I’m pleased to say that across virtually the entire Heinz world we are leveraging improved consumer insights, innovation and pricing to deliver above target growth. We now anticipate full year sales growth between 9 and 10% which would produce record sales of $9.8-9.9 billion, by far the best performance in Heinz’ 138 year history. Our organic sales growth of 8.1% in the second quarter extends our streak of consecutive top playing growth quarters to 10. The step change in growth trajectory over the past 18 months has been driven by our strong commercial talent, a pipeline of successful consumer driven product introductions and double digit increases in marketing support. During the second quarter for example, we increased our investment in marketing by 23% and in R&D by 17%. We continue to focus much of this investment against our top 15 brand which grew 14% during the quarter and now represent about 70% of total Heinz sales. Organic growth in the quarter was broad based with positive contributions from all business segments. Half of the more than 200 products Heinz will introduce in fiscal 2008 are planned for Europe, which is where we have invested the majority of our increased marketing dollars this year. We are seeing good returns from this investment and organic sales growth of 10% for the quarter in Europe and improved market shares across much of the European business. The strong performance was outpaced only by the 20% organic sales growth in our emerging markets which I will discuss momentarily. Importantly, we are delivering profitable growth. After normalizing for the 53rd week in fiscal 2006, Heinz has posted nine consecutive quarters of profit growth. Key to this growth has been our ability to achieve net price gains, our emphasis on continuous productivity improvements and the optimization of our manufacturing footprint, which is combined with some benefits from currency to offset the escalating commodity costs that have affected our industry. Given this strong momentum we are raising the top end of our EPS target range to $2.62 per share, while simultaneously increasing our investments in future growth and productivity. We are projecting approximately $15 million in additional marketing investment versus our May 2007 commitment for this fiscal year. This additional spending will support our brand building activities and aggressive innovation pipeline. We are also increasing our investments behind the alignment of our global processes and SAP and we are making significant investments in our health and wellness, global supply chain and global customer task forces. With strong earnings and additional investments in future growth are impressive given the difficult commodity environment and in our view clearly distinguish us from the majority of our peer group. To continue counteracting rising costs we expect to take additional pricing action where necessary and will occasionally walk away from unprofitable business as we have done in US Food Service which has been disproportionately hit by rising commodity costs. We anticipate that Food Service will continue to trail our other businesses and I fully factored this expectation into our full year outlook. We believe that we have a formula for sustainable growth and consistent results as we execute in the four strategic pillars, the first of which is “Growing the Core Portfolio”. Heinz is consumer validated innovation and go to market execution produce compelling sales growth in each of our core categories in the quarter. Ketchup and sauces grew 9%, meals and snacks increased 14%, infant nutrition posted a very strong quarter with sales up 26%. Let me briefly share some of the highlights for the quarter and our plans to sustain this momentum. Smart Ones and Weight Watchers nutritional meals, together with Boston Market grew sales 31% in the second quarter on the strength of improved taste, innovation and effective marketing support. Smart Ones any time selections hand held snacks launched in the first quarter are performing well behind strong repeat purchases. Smart Ones is also selling very well in Canada following its introduction last year. Weight Watchers meanwhile was also a contributor to Heinz strong organic growth in Europe and Australia. Importantly as we approach the upcoming diet season the innovation pipeline for these brands is full and we have invested in additional production capacity to meet growing demand. Set to launch in the US next week is the very unique Smart Ones Fruit Inspirations. The first range of nutritional meals with a half serving of fruit and among our highest growing product concepts ever. Heinz is also winning in the soup category, our second quarter sales up nearly 18% across the world. British consumers have responded well to the new items we introduced in the first quarter resulting in 23% sales growth and a record category dollar share. We plan to build on this success with additional innovations in the second half. Importantly Heinz Australia achieved the market leading share position in soup during the key second quarter season on the strength of its new microwavable range. Heinz is the global leader in healthy and convenient beans meals and grew sales more than 13% this quarter with numerous innovation initiatives in the UK including the launch of plastic Snap Pots. Also in the UK Heinz Ketchup achieved its highest household penetration in over three years behind new varieties like reduced sugar and salt, organic top down and TK with a twist which brought new consumers into the category. Across Europe Heinz increased Ketchup sales 20% and globally Ketchup sales increased 5%. Heinz Canada meanwhile achieved a record Ketchup share of 81%. US Ketchup line declined slightly in the quarter largely due to our first quarter trade buy in ahead of our August price increase. Year to date US Ketchup line is up 1%. In the nearly one year since our acquisition of Renee’s Gourmet canned as leading chilled dressings and toppings brand we are delivering on the targeted cost synergies. We are leveraging Heinz can distribution network to expand Renee’s from its traditional Ontario stronghold to the faster growing Western Provinces in Quebec. Also in Canada, Heinz achieved record share in pasta sauce in the quarter of 46% on the strength of new Classico varieties. In Australia we launched a new line of Heinz cooking sauces, dressings and condiments during the quarter which contributed to the strong organic growth we achieved in Australia. As I mentioned, Heinz delivered truly remarkable results during the quarter in Infant Nutrition. With sales up 20% or more in six of the eight markets in which we compete. This includes impressive growth in our Plasmon Italian business where we remain focused on innovation and consumer marketing, including a growing emphasis on medical nutrition. This broad based growth in Infant Nutrition resulted from increased innovation, line extensions and solid execution of our strategy to up-age into biscuits, beverages and toddler meals and snacks as well as an increased focus on the nutritional needs of expectant mothers. Our fastest growth in Infant Nutrition came in emerging markets which brings me to our second strategic pillar “Accelerating Growth in Emerging Markets”, for Heinz is advantageously positioned versus many of our peers. Organic sales in emerging markets grew 20% during the quarter and in aggregate these markets now represent 13% of total company sales. Our plan is to introduce new items that appeal to rapidly expanding middle classes in these nations while continuing to build distribution and availability of existing products. Emerging markets are contributing disproportionately to Heinz success. They will be increasingly featured in our growth story moving forward as we build our strong local brands while strategically introducing the iconic Heinz brand through our global retail and food service customers. It’s important to point out that while some of our US based peers are just beginning to explore these markets, we are already well established with well known profitable and rapidly growing brands. We will continue to invest heavily to bring consumer validated innovation to these markets and build on our first mover advantage. In China our rapidly growing Long Fong brand continues to do well, growing more than 27% in the first half of fiscal 2008 and solidifying its leading share positions in frozen rice bowls, dumplings, hot pots and steam bread. Heinz increased its steak in Long Fong in the quarter while retaining the leadership of Long Fong’s dynamic founder [Hecor Yay] and his core team. The theme of Long Fong’s innovation including new varieties targeted the varying taste profiles in different regions of China, leading into the Beijing Olympic Games; all Long Fong packaging now carries the image of Olympic Table Tennis Champion and National Hero Zhang Yining. She is also appearing in our TV and print ad campaigns and has been very effective in generating positive brand awareness in trial. We anticipate a big third quarter that includes the run up the Chinese New Year. In Poland the Pudliszki brand continues is growth momentum behind the successful restage of its jarred home-style meals range. Sales of the Pudliszki brand overall increased 31% in the second quarter. Heinz achieved very strong growth in India during the quarter with sales up 55%. Our performance was driven by the continued growth of Complan nutritional beverages, which is benefiting from effective advertising that we showed last year at Cagney. Additionally the Heinz brand Infant Nutrition business grew rapidly during the quarter across our other emerging markets, underscoring the strategic importance of Infant Nutrition in building the Heinz brand. In Latin America, Infant Nutrition sales increased 43% in the quarter behind new manufacturing capacity in Venezuela that we added to meet growing demand. We anticipate the need to add even more capacity as we expand distribution in select Latin American countries. We delivered equally strong growth in China where sales increased 42% as the re-launch of the Heinz premium cereal and wet food lines continued to gain traction. In the third quarter we will launch a pre-biotic digestion aid and in addition to the re-launch of the cereal value line targeted to more price conscious Chinese parents. Finally, in Russia we grew Infant Nutrition sales by 30% in the quarter and have plans in place to maintain this excellent momentum. Let me now turn to our third strategic pillar “Strengthening and Leveraging Global Capabilities”. We aim to accelerate productivity gains in fiscal 2009 and beyond as a result of investments we are making today to improve and expand our global capabilities. We have fully resourced three important global task forces on the Supply Chain led by Scott O’Hara, Health and Wellness led by Dave Moran and Customers led by Chris Warmoth, to facilitate these improvements. These initiatives are designed to improve the way we go to market and build long term competitive advantage in these three areas. The teams are in the midst of extensive data collection and analysis and we look forward to implementing their recommendations as we move through fiscal 2009. The task forces are tightly linked to our overall plans to upgrade and harmonize our business processes and systems globally. Key to this initiative is the continuing implementation of SAP. In fiscal 2009 we will continue the rollout across Europe with the ultimate goal of being wall-to-wall coverage worldwide. I’m proud of the progress we have made on the final pillar “Making Talent a Competitive Advantage”. We have assembled a world class leadership team and established a clear performance driven winning culture. Around 70% of our top leaders are new to their positions in the last five years with 35% new to the company. This infusion of talent is the primary reason, aside from our portfolio improvements that we are delivering sustainable, profitable growth quarter by quarter. One of the most important jobs of a CEO is to identify and develop high potential people and build managerial bench strength. At this phase of my tenure as Heinz CEO I’m spending a considerable part of my time on development and training, ensuring that we have the right people, in the right jobs across the entire company to drive superior growth. I have the hard earned insight and experience both good and bad to impart to the rising generation of talented Heinz leaders. I am pleased with the progress we have made in this area which our results clearly confirm. With that brief overview let me turn the meeting over to Art to walk you through the details of our second quarter performance and our annual outlook.

Thanks Bill. Good morning everyone. In analyzing our results for the second quarter I’m very pleased with our top line momentum, the returns from increased marketing investment and our successful leverage of fixed costs. As Bill said we drove excellent results for the quarter with sales up 13%, operating income up 10% and EPS up 20%. You can see that we continue to reallocate our marketing investment as we pulled an additional 30 basis points out of trade spending and increase consumer marketing by a commensurate 30 basis points. Gross margin was down a point for the quarter as we encourage significant commodity cost headwinds but we offset most of these through increased pricing and leverage of SG&A costs which, excluding marketing were down 80 basis points as a percentage of revenue for the quarter. Now let’s take a deeper look at the income statement. Gross profit increased 10% powered by strong organic sales growth which drove the 10% increase in operating income for the quarter. Below operating income, net interest expense, excluding other items increased by 19%, about three quarters of which relates to higher net debt due to share repurchase activity. Growth in NPBT is 7% was leveraged at 15% growth at net income driven by a reduction in the effective tax rate from 34.8% last year to 29.8% this quarter. This reduction was primarily due to the timing of repatriation on foreign earnings and a higher mix of profit from relatively low tax jurisdictions. EPS growth of 20% exceeded that of net income reflecting a reduction in fully diluted shares outstanding of almost 4%. For perspective, had we generated a tax rate for the quarter in line with our 31% estimate for the full year our EPS would have been $0.69 still a year over year increase of 17% and had the tax rate been consistent with the Q2 of last year EPS would still have grown at a double digit rate. Turning to sales growth as Bill mentioned we generated 8.1% organic sales growth for the quarter, well ahead of our target rate and well ahead of that generated by many of our peers. Importantly we delivered this growth on top of 4.2% organic growth in the same quarter last year. The sales increase was led by strong volume of 5.5%, net pricing at 2.6% and foreign exchange of 5%. Volume growth was driven by big results in Europe where total volume was up more than 9% and in North America Consumer Products and in the Rest of World where volumes were up 6.7% in both segments. From a category standpoint, volumes were up approximately 10% in Infant Nutrition, 7% in Meal and Snacks and 4% in Condiments and Sauces. Emerging market volume was up 10% for the quarter. Net pricing was up in every segment around the world, led by 13.8% growth in Rest of World and a 3% price hike in North America Consumer Products. Turning to our sales performance, every segment delivered higher revenue and in fact each was up double digit with the exception of US Food Service. Details of our segments sales performance split between volume, price, foreign exchange and net acquisitions are provided in the press release so I won’t repeat that information here. A few key highlights include the following. Organic sales in Rest of World segment grew in excess of 20% primarily driven by very strong results in Latin America in Infant Nutrition. Europe posted organic sales growth of 10% for the quarter with volume up 9%, strong volume gains were largely attributable to outstanding performances in Heinz Ketchup, Soup, Beans and Salad Cream in the UK, strong Infant Nutrition sales in Italy, broad based growth in Russia and momentum in Hoenig and Pudliszki branded products in the Netherlands and Poland. North America Consumer Products generated organic sales growth of almost 10% led by Smart Ones, Boston Market, Ore-Ida Frozen Potatoes and Classico Pasta Sauces. These results were partially offset by a decline in Heinz Ketchup with largely reflects the timing of an August price increase. Asia/Pacific had another good quarter with organic sales growth of 6%. India and China delivered excellent growth behind strong innovation and increased marketing support. US Food Service organic sales were up .4% driven by favorable net pricing at 2.1%. Overall, sales for this segment were up slightly as net price improvements and volume gains in frozen deserts were largely offset by lower volumes in specialty tomato products and in frozen appetizers. An important factor driving our top line growth is increased in investment and consumer marketing. For the quarter we increased our marketing investment by $18 million or 23% to support consumer driven innovation in our top brands. Taking a bit broader view of Q2 we’ve increased second quarter marketing in a cagier of almost 16% over the last two years which has helped drive compounded sales growth of 8% and operating income at a double digit rate. Clearly, this investment is yielding results. As I noted earlier, gross profit was up 10% for the quarter while our gross margin decreased to 36.9%. As pricing and productivity improvements were more than offset by increased commodity costs our net price of 2.6% contributed 140 basis points to gross margin while commodity and other inflation of about 7% reduced gross margin by 480 basis points. The cost of virtually all of our key ingredients increased led by a 35% increase in dairy and 20% plus increases in oils, beans and grains. Offsetting a portion of these headwinds was 250 basis points of productivity. Clearly, our plan is to continue pricing up and to aggressively drive productivity initiatives to offset the escalating commodity costs in the industry. Leverage of SG&A was an important tool in offsetting the lower gross margin and driving profitability for the quarter. Excluding marketing expenses our SG&A costs were 16.5% of sales, down 80 basis points from Q2 of last year. In fact, this Q2 result is better by 140 basis points over a two year time horizon despite double digit annually increases in R&D spending. Our plan is to continue our aggressive management of ongoing administrative costs but we do expect to ramp up investment and task forces to strengthen our global capabilities and systems over the back half of the year. Turning to operating income, you can see that all segments were above prior year with the exception of Food Service. We drove strong double digit profit increases in Rest of World, Asia/Pacific and Europe and posted a 7% increase in North America Consumer Products. The 23% growth in Rest of World was largely driven by another great quarter of organic sales and profit growth in Latin America, 22% growth in Asia/Pacific reflect excellent profit momentum in India, China and Australia. The 15% increase in European profit again reflects double digit organic sales growth across the division with the UK and Italy leading the profit momentum. The 7% growth in North America Consumer Products is due primarily to strong sales growth partially offset by heavy commodity cost increases. In line with our expectations, operating income in US Food Service decreased 14% reflecting a disproportionate impact from commodity costs. For the quarter, commodity inflation rate in our Food Service business was a couple of points higher than for the company overall. Given the food service industry outlook and the commodity costs environment our balance of year projections for the Food Service business include profit expectations that are below prior year levels. Looking quickly at the balance sheet for the quarter, we drove an additional one day improvement in the cash conversion cycle and increased our capital spending by 70 basis points to 2.9% of sales. A higher capital spending reflect increased investment capacity and in systems. Operating pre-cash flow of $133 million was below prior year but ahead of our plan for the quarter. Now let’s take a very brief look at where we are for the first half of the year. Year to date P&L score card shows a continuation of our strong trends. Sales are up 11%, operating income up 12% and EPS up almost 15%. Our sales growth was led by our top 15 brands which are up 12% on the year to date basis and by our emerging markets where sales are up very strong 21%. Operating income growth of 12% largely reflects our strong organic sales growth of almost 7%. Additionally, while not shown on the score cards we’ve reduced SG&A costs again excluding marketing, by 110 basis points which more than offset the gross margin drop of 60 basis points related to higher commodity costs. Importantly we posted EPS growth of almost 15% with a flat year to date tax rate. We are also pleased with the quality of first half earnings based on the fact that we’ve increased our investment in consumer marketing by 24%, R&D by 15% and have taken 90 basis points out of trade spending above the net sales line. Year to date balance sheet score card reflects an improvement of 2 days in cash conversion cycle and an increase in RLIC of 190 basis points. The improvement in CCC reflects better performance and receivable and payables and the higher RLIC was generated by 140 basis points of organic improvements and 50 basis points from the PHAS 158 accounting change. In terms of operating free cash flow we are in line with our plan, capital spending, net proceeds from sale of PP&E represents a $76 million incremental year on year investment and year to date cash tax payments of $48 million above prior year. Over the back half of the year we expect very strong cash flow particularly in the fourth quarter largely driven by strong reduction in inventory levels. Finally, net debt is up about 12% reflecting our share repurchase activity. As you recall we’re targeting $500 million in net share repurchases this fiscal year and through the first half of the year we’ve executed about half of this amount. Now let’s wrap up with the forecast for the year. As Bill mentioned we’re increasing the top end of our EPS range based upon our confidence and momentum in the business. In thinking about our outlook for the back half of the year there are a number of factors to keep in mind, these include our expectations for strong volume growth, continued net pricing and aggressive productivity initiatives while managing commodity inflation, the income tax rate and business building investments that we’re planning. With regard to commodities, we do not expect the pressure on costs to abate in the short term. At this point we anticipate commodity inflation to exceed the 7% market for the full fiscal year and this builds on approximately 3% inflation in fiscal 06’ and 5% inflation in fiscal 07’. A positive factor here is that approximately 60% of our portfolio is outside of the United States but as foreign exchange movements have helped offset some of this unprecedented commodity headwind. Having said this we estimate that 4X will offset only a small portion of the full year inflation cost hit that we are incurring this year. As I mentioned earlier our year to date tax rate is flat with last year at 28.3%. However, we expect our full year rate to come in around the 31% mark which is higher than last years full year rate of 29.6%. Thus, we anticipate higher tax rates for the back half of the year both in comparison to the year to date rate this year and to the rate we posted in the back half of last year. Additionally, we expect the tax rate to be considerably higher in the third quarter than in the fourth quarter. Keep in mind that the tax rate in Q3 last year was quite low at 26%. Overall, we still feel very good about our tax planning and the tax rate for the year but as usual there is some quarter to quarter variability that must be considered. Over the back half of the year we also anticipate making incremental investments in a number of areas to drive sustainable momentum in the business for the long term. These investments include an additional $15 million in consumer marketing that Bill discussed earlier, dedicated project staffing to accelerate our task force initiatives and additional costs associated with the continuing roll out of SAP. We are excited about each of these initiatives and believe that they will help us optimize long term shareholder value. The net story is that we feel very good about the business as Bill mentioned we are raising our sights for the full year and now anticipate sales to grow 9 to 10% versus prior year, operating income to increase between 7 and 10%. We increased the top end of our EPS range to $2.62 and expect and increase of 9 to 10% for the year. We continue to forecast operating free cash flow to be around $825 million and finally based on the timing of marketing spending and the phasing of tax expenses we expect the EPS in Q4 to be considerably higher than that projected for Q3. To summarize, we are extremely pleased with our performance again this quarter and are confident in our outlook for the full year. The company continues to perform well and we’re tracking at or ahead of the key targets we outlined in our superior value and growth plan almost 18 months ago. With that, we’d be happy to take your questions.

[Operator Instructions] Your first question comes from David Driscoll with Citi Investment Research David Driscoll – Citi Investment Research: Good morning everyone. Congratulations on a very nice quarter. I’d like to go into the pricing side a little bit and the cost inflation. The first question is I would have thought that after the first quarter that we would have seen maybe a bit more pricing coming through, I think you did a remarkable job given that net pricing I think was just 1.4 points but can you talk to us about the rate of change of pricing as it should flow through and furthermore the US our Nielsen data suggested some very strong pricing gains in the US equivalized unit pricing was up something like 4.7% across your entire portfolio what I’m trying to also understand is what’s the difference in pricing you are achieving in different geographies.

I think as we showed you David pricing year to date is up just under 3% about 2.7% across the company and we feel very good about where we are in terms of the balance between pricing and volume, I don’t think you can ignore the 8.1% organic volume and price growth in the second quarter and year to date is just under 7%. We are balancing very carefully price and volume and it varies by market. From a pricing perspective we take price on an independent basis we make our own decisions case by case depending on the category, the health of the category, the health of our brand the product and market conditions and we try to emphasize innovation and quality to justify the pricing in addition to mitigating costs, so it’s not just based on cost it’s based on the opportunity. We continue to see opportunities and necessity for price and you’ll continue to see us move in that direction across the company and again it will vary by market depending on the conditions and on the pressures and on the opportunities.

David I might add the 1.4% that you mentioned that’s the 140 basis point impact on our gross profit margin but as Bill says the pricing overall is a 2.7% increase. David Driscoll – City Investment Research: Is the difference between those numbers the effective promotions because I believe it just calls that net pricing so you’re saying that promotions in the quarter were actually up 120 bps.

No the net price number at 2.7% is net of promotions so that’s both gross pricing and discounts or allowances, if you do the math that amount of pricing translates to 140 basis points at gross margin. If you have any questions we can talk further but it’s a pure mathematical thing. David Driscoll – City Investment Research: I understand it. Last question, input costs inflation certainly very onerous what’s the amount that you have hedged for the back half of the year?

David it varies, I can’t give you a precise amount, it varies depending on the ingredient and the location some things are hedged, some things are not because our belief is that some, if they haven’t topped out are certainly nearing the top and to hedge right now on some of those we would make the wrong call but we are clearly protected on our key ingredients and key areas but there are certain things contractually we can hedge, packaging for example is very difficult and clearly as oil rises and we’ve assumed oil to be about where it is now or slightly higher for the rest of the year. Resin costs come in and again it depends on the timing of contracts but I would say in the US we’re hedged probably for half or so but everything else we anticipate to stay the same or get a little higher for the rest of the year and we’re trying to understand what the market is going to go long term before we make any commitments. We have factored in fairly onerous costs to our outlook for the rest of the year across the globe and we take a slightly different view on hedging. Hedging is a short term opportunity in some cases but in other cases it presents you with a long term issue, particularly given the mark to mark requirements and other things that we need to deal with. Right now I’m fairly comfortable with where we are in our projections for the year. David Driscoll – City Investment Research: Congratulations on the quarter, thank you.

Your next question comes from Chris Growe with AG Edwards Chris Growe – AG Edwards: Good morning. I just want to follow up on David’s question on pricing. Could you discuss, I didn’t see it in the slides, what sort of benefit mix had and would that be in your pricing line?

I think in terms of gross margin you saw the mix was essentially flat, had virtually no impact on gross profit. Chris Growe – AG Edwards: Is mix contributing to your sales growth, I mean all these new products coming through would have been a little more enhancing to your mix?

I think it’s a combination of things that clearly the new products are enhancing to mix but you’ve got to remember we’re also getting very strong growth out of our emerging markets and other markets where the gross margins are slightly lower than the company average and so you have the benefit and the cost on that mix and generally some of it is just being offset by the pure commodity costs but generally where we are launching products in developed markets they are at or better margins and we are seeing some improvement in that regard but again it’s exactly where we thought it would be. I think our organic growth is probably in the top side of where we thought it might be, I mean 8.1% is extraordinary growth in this industry in this environment. We are very pleased with where we are.

Christ from a mechanical perspective the mix is part of our volume number that we brought forth as Bill mentioned it is not a large factor. Chris Growe – AG Edwards: The other question I had for you was just relative to your Food Service division. I’m just curious how much of that is competition, your raising prices and how much of it is a slow down in the consumer that we keep hearing about?

That’s a good question Chris and we are seeing a definite slow down in the industry in terms of restaurant patronage and we are also seeing a shift from the mid levels down to QSR and you certainly seen that on the results from some of our customers and a disproportionate impact on commodity pricing because we tend to be more dairy and cheese oriented in Food Service and we tend therefore, to be a little bit more vulnerable in terms of pricing. You also tend to be more contractually obligated which means you can’t move as quickly to offset that so you have to wait until contracts expire or reset in order to address that but I think generally right now I’d say that based on the trends we’re seeing in the Food Service industry, clearly the economy is something we all need to watch going forward as it tends to be a precursor. We are seeing softness in customer counts. Chris Growe – AG Edwards: That’s very helpful, thanks a lot.

Your next question comes from David Palmer with UBS David Palmer – UBS: Thanks, congrats on the quarter. You commented that innovation was benefiting areas like Italian baby food and UK soups but I have a feeling there are factors beyond maybe your own execution that are helping these businesses. I was wondering if you could comment on category growth for these two businesses, the UK soups and Italian baby food and discuss what might be happening in the macro environment even with regard to competitive pressures that might be helping you.

I think you have to keep in mind that we, in both those markets, fundamentally are most of the category. We have 60% give or take of the Italian baby food market and 60% give or take of the UK soup market so basically when the market grows it’s in response to our initiatives and our activity and so I think generally the market growth we are seeing in both those markets is in response to our initiatives. The second thing I would point out is in the UK soup market we are continuing to gain value share we grew value share pretty strongly in the second quarter which means we are disproportionately growing relative to the market and in Italy we continue to hold share which means we are growing at least at the rate of the market and we are seeing obviously a lot of promotional activity in the Italian baby food market, we’ve opted to go the consumer route our competitors opted to go the deal route. We think over the long haul our approach will be the correct approach. David Palmer – UBS: A second area I wanted to hit on is, I know this is rather simplistic, but your Food Service business was under pressure and your frozen entrée business was strong again, I mean these aren’t new trends for you either, but they seem to be kind of accelerating in either direction. In your opinion are these really two sides of the same coin, do you see this as peoples habits migrating to eating at home.

We are seeing certainly that in some of our developed markets in UK for example we’re seeing a return to the dinner table by whatever you define the family unit as being. We are seeing some of the same trends in the US and clearly for us that is a benefit given the margin differential between our retail business and our Food Service business. We see it as a real positive trend but we are clearly picking up signs that consumers are returning more to their home and their table to eat, that does not mean that they are necessarily preparing food, although we are seeing the return of that in the UK and Western Europe but it does mean that they are picking up foods that they can prepare at home or picking up foods that they just have to heat at home so we are seeing the beginnings of some movement in this area. I think it is too early to call it a trend but I think it’s a perceptive thought in terms of there clearly is an offset benefit to some of the customer count issues we are seeing in Food Service. David Palmer – UBS: Lastly, energy related costs are a big deal for Heinz and I’ve gotten a sense lately that it’s little bit more complex than usual with natural gas perhaps going a different direction than say barrel oil or at least there is a little bit of a basis difference in terms of the magnitude of changes. Could you talk about your costs that are energy related diesel, packaging and other and perhaps how those might filter through over the next four quarters or so.

As Art showed you we’ve assumed for the year, for the quarter about 7% or more inflation. In terms of how energy impacts us, the primary impact on energy for us is in packaging because we use plastic packaging so much and it affects resin costs and as we come off contractual periods on resin costs we see significant spikes in response to oil, that is factored in as I said I want to repeat this, we have assumed that oil is not going to get better in fact we’ve assumed that oil may get a little worse than it is today in our go forward outlook and that factors primarily into packaging. In terms of transportation and logistics, we have seen some impact not only from our standpoint but from the supplier standpoint and obviously from a customer standpoint in terms of a shipped, in terms of pick ups and or delivery and then in terms of what we bring in suppliers and those costs pass through. We are seeing fuel surcharges again and we are experiencing some increases in transportation logistics costs. The final area is in manufacturing in the supply chain itself in terms of utility costs. We are obviously seeing an increase there but that is not the dramatic impact that packaging and transportation are having on us and again we have factored in oil to be in the $90-100 range for the rest of this year and going forward because we simply don’t know anything better to project and that’s fully factored into our outlook and do our thinking going forward.

If I can add to that, with the fuel costs going up and the impact on logistics costs we’re particularly pleased with our SG&A performance. The great leverage of those costs that we’ve got had been despite those higher logistics costs. We are pleased with that.

I think going forward we are all going to have to at in this industry and probably other industries is our ability to continue to grow the top line, managed gross margin line and hold fixed or drive down fixed costs thereby leveraging the bottom line and I think that’s going to be a way we are going to have to look at the industry going forward, if least commodity trends remain and again no one really knows. I’ve heard it’s now becoming endemic and we’re going to see these for the next ten years we really just don’t know so I think we have to be prepared accordingly. David Palmer – UBS: I’ll leave it there. Thank you very much.

Your next question comes from Bill Leach with Neuberger. Bill Leach – Neuberger: Good morning. It sounds like you are full year tax rate guidance implies about a 34% tax rate in the back half. Can you just elaborate a little bit more you say the third quarter would be much higher than the fourth quarter? For those of us that have to model quarterly earnings that’s obviously a big variable?

I think you are right, Bill, in terms of around 34% in the back half of the year and timing of discrete items. In terms of the third quarter, it will be higher tax rate so we don’t typically give too specific of guidance on that but I think you can figure 200-300 basis points higher potentially in the third quarter would be a rough guess off the top of my head. Bill Leach – Neuberger: So we might use like 36-37% and then 32% for the fourth quarter?

I’d say closer to 35-36% in the third and then lower in the fourth. Bill Leach – Neuberger: The other question I have, could you please comment on the sustainability of the European volume growth that was so strong this quarter. That’s really a large number given the maturity of some of your businesses in the UK. Was there pre buying in anticipation of price increases, anything that would suggest that’s unsustainable?

No, if you’ll recall, we had a pretty good first quarter in European volume, we built it in the second quarter, and we have a lot of new activity a lot of new product initiatives and lot of innovation. In soup we launched three discrete lines of soup. We will be coming with more innovation in the second half which we’ll talk about later. A lot of it is innovation driven, in Italy a lot of it is being driven by up aging in terms of the way we are approaching our baby food business and on the continent we’ve launched a number of new initiatives some of which we’re still waiting to see how they are going to play out, but fundamentally it’s a response to several things. It’s a response to aggressive innovation, increased marketing, substantial improvement in our talent, particularly our commercial talent, rapid growth in our Russian business and our Eastern European business, Poland continues to do extremely well, as does Russia in terms of top line growth and then the benefits we are seeing from just the new product initiatives in the UK, particularly in soup where we’ve driven category growth in beans where we are seeing the same thing and in condiments and sauces. It’s a function of improved marketing more innovation and a lot of very good new product initiatives and a 10% organic growth in Europe in the quarter, I’m not going to say we’ll sustain 10%, but we feel pretty good about our growth going forward in the European markets. Bill Leach – Neuberger: Okay, thanks very much.

Your next question comes from Christina McLellan with Deutsche Bank. Christina McLellan – Deutsche Bank: Just following up on Food Service. That business has struggled for a while and now conditions are worse with inflation and with a slowing consumer. I know got profits dropping in the back half, but what kind of things can you do to improve the business? Also, are your hands tied in terms of the pricing on contractual basis or are there kind of escalation clauses in those contracts?

Christina it varies by customer and by business and there are escalator clauses in many of the contract and we have pushed through pricing, we pushed through better than 2% pricing in the second quarter on Food Service so we are getting some pricing. I think that Food Service issue is basically bifurcated in the sense that regarding customer counts the one benefit that we will get with customer counts changing and shifting down to QSR as it benefits our higher margin pieces of our Food Service business which tends to be our condiments and sauces pieces, which were we are branded are clearly distinguishable from our competitors and allow us to do more things in terms of passing costs along. The other areas of the business where we are really commodity oriented in terms of costs, in terms of dairy costs impact and in terms of other costs we are all feeling this pressure and it’s just an issue of customer counts there. In terms of going forward on the Food Service business, again we are seeing a commensurate pick up in retail which actually benefits us as a company. I think back to the point made earlier and we will continue to look at ways to improve Food Service through the following initiatives; one we are looking at centralizing more of our food service activity and relocating it to Pittsburgh as opposed to the discrete units we’ve operated in the past; two we’re going to focus more on the areas that are branded where we bring leverage, primarily in condiments and sauces and in soups; and we are also going to be looking at opportunities to marry the capability in our retail division with our Food Service division so that we can begin to attack the perimeter areas and the emerging channels in both the super market area and in other areas. Food Service is still the strategic business for this company and again we are not looking for substantial turn around until we see a change in the economy but we have factored that into our thinking, we are not surprised by this, as we’ve been saying and we feel okay about where we are headed. We will continue to upgrade the management team and to make improvements across the talent base in Food Service to get it commensurate with where we are in retail. Christina McLellan – Deutsche Bank: Okay, thank you, and then on Ketchup in the US you talked about the buy in impacting the volumes in the quarter, but the competitive activity in that segment has been really intense based on what we see in scanner data. Can you comment on that and if you expect that to continue and what actions you are taking to compete there?

Let me be very careful because I don’t want to disparage a competitor who is doing something in our mind that is relatively foolish. We have moved pricing up in terms of what consumers are prepared to pay on Ketchup. We have a competitor out there that’s offering 36 oz Ketchup at $0.99. We do not think that is in the best interest of the category, we do not think that is in the best interest of the business long term. It is not our plan to meet that head on it is our plan to continue to bring consumer innovation and drive the consumer to Heinz which is clearly the preferred product and has the higher market share in penetration. We are not anticipating that they back off that, we are assuming that if that competitor continues to price aggressively and again that is factored into our thinking going forward. Christina McLellan – Deutsche Bank: Okay, thank you.

Your next question comes from Andrew Lazar from Lehman Bros. Andrew Lazar – Lehman Bros.: On last quarters call I think a couple times this morning you mentioned the need again for more manufacturing capacity in a number of different areas. I’m curious if you can give a little color on what geographies and categories specifically the bulk of this investment is coming in. In light of that do you still see returns improving overall for this full year?

The answer to the last question is yes, we still see overall for the year improving versus the last couple of years. We are investing in capital basically broadly, we have added infant feeding capacity in Latin America, literally in the last six weeks we’ve already capped that out we are getting ready to look at additional capacity in the southern cone where we think there are significant opportunities for further growth in infant feeding. We have added additional capacity in frozen in the US, where again, given our growth we will continue to look at adding additional capacity. We’ve added Ketchup capacity in other parts of the world; we are clearly looking at adding capacity at Long Fong in China, also in baby food in China and some of our Indian business. Fundamentally the business right now in terms of the top line is simply so healthy that we are looking at adding capacity in a number of areas. It’s factored into our outlook for capital spending this year which should come in somewhere between 3 and 3.5% of sales which is dramatically higher than we’ve been spending over the last couple of years, but again, factored into our cash flow assumptions for the year it’s a nice opportunity and we continue to view it that way and we will continue to add capacity particularly in infant feeding which are very high margins, high growth businesses and 26% growth in the quarter is driving the need for capacity in a lot of places. Andrew Lazar – Lehman Bros.: Clearly this sounds different than where this industry as a whole was in the 80’s and early 90’s where capacity additions were more just if you build it they will come, this seems far more, I don’t want to put words in your mouth, but focused on where you see pretty clear and visible demand levels, does that make sense to you?

This is not Field of Dreams; we’re not building and hoping they will come. It’s actually come and we are building it and in many cases our co packing has dramatically increased in virtually every business around the company as before we make the investments in capital we prove the need as opposed to adding it and then hope we can fill it. In some cases we are behind the curve. Clearly that’s the case in infant feeding in a number of markets and it’s also the case in frozen in the US and again in other markets. Fundamentally, we are down to 70 or so manufacturing facilities around the US around the world down from 101 three years ago and so we are trying to prove the concepts, prove the business and then we will add the capacity as opposed to going about it the other way. Andrew Lazar – Lehman Bros.: The last thing is around leveraging the SG&A that you talked about and kind of the model going forward as long as we are in this input cost environment, can you give me an example or two this quarter as an example how you are able to manage the SG&A non-marketing side of it to the level that you were. It is just a matter of growing the top line on the overhead base you have and being incredibly focused on not increasing the overhead base or is there a lot of taking out of overhead that you still have that you can still do?

This is part of the plan that we showed you 18 months ago and fundamentally what we are doing is leveraging the fixed costs base without trying to grow fixed costs. I think in the second half of the year you will see a slightly different SG&A number relative to what you saw on the second quarter as we invest behind the SAP and the task forces it will go up a bit versus what you saw in the second quarter but still will be relatively better than last year and in prior years. Fundamentally what we are trying to is leverage the top line without making significant investments and SG&A line would commence really offset that growth. Again, I think that is going to become the way we have to manage this business. Certainly in this commodity environment the company simply cannot allow fixed costs to get away from them given the pressure on the gross margin line and so I think we are paying extra attention to it. There was nothing extraordinary done in the quarter in terms of any downsizings or any fundamental changes, this is a continued evolution of the plan we laid out 18 months ago, frankly just the pressure we’ve put on SG&A over the last four or five years. Andrew Lazar – Lehman Bros.: Thanks very much.

There are no further questions at this time.

Thank you all for participating in today’s call. I just have a minute or so wrap up. As you have heard this is an exciting time for the H.J. Heinz Company we are growing well in categories and geographies where we are best positioned to win, we are managing commodity inflation through a combination of faster sales growth, net pricing gains, productivity gains and foreign currency, while continuing to make significant investments in future growth. I look forward to updating you next year on our continuing progress toward our goal of becoming the world’s premier food company. We will not be a Cagney in February but we are planning to host a half day investor meeting in New York on March 19th. Meg will provide more details to you shortly. Thank you, happy holidays to everyone and thanks for listening.

Thank you for participating in today’s conference call.