The Kraft Heinz Company (KHC) Q3 2012 Earnings Report, Transcript and Summary

Good morning. My name is Frances, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the H.J. Heinz Company Fiscal Year 2012 Third Quarter Earnings Release Conference Call. This call is being recorded at the request of the H.J. Heinz Company. [Operator Instructions] I'd now like to turn the call over to Meg Nollen, Senior Vice President of Investor Relations. Ms. Nollen, you may now begin the conference.

Thank you, Frances, and good morning, everyone. I'd like to welcome you to our conference call and webcast. Copies of the slide used in today's presentation are available at our website at heinz.com. Joining me on today's call are Art Winkleblack, Executive Vice President and CFO; and Ed McMenamin, Senior Vice President, Finance. Before we begin with our prepared remarks, please refer to the forward-looking statement currently displayed, which 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 understanding the company and its results. We ask you to refer to our April 27, 2011 Form 10-K and today's press release, which lists some of the factors that could cause actual results to differ materially from those in these statements. Heinz undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by securities laws. We may also use non-GAAP financial measures in our presentation, as the company believes such measures allow for consistent period-to-period comparison of the business. The most directly comparable GAAP financial measures and reconciliations of these non-GAAP measures are available in the company's earnings release and on our website at heinz.com. Please note, we plan to file our third quarter 10-Q next Tuesday, February 21. Our complete financial highlights pages or stat pages will become available with the filing of the 10-Q and will be posted on the Investor Relations section of the heinz.com towards the bottom of the page. The P&L is out there today. Now onto today's call. We'd like to request that you limit your questions during the Q&A session to one single-part question in order to ensure adequate time for all who wish to participate and to ensure we end the call timely. With the formalities out of the way, let me turn the call over to Art Winkleblack. Art?

Thanks, Meg. Good morning, everyone. Today, Ed and I will take you to through our Q3 results and expectations for the remainder of the fiscal year, and we'll try to be brief since we'll be seeing all of you next week at CAGNY. Overall, we're very pleased with our results for this quarter, highlighted by strong top line growth and good P&L leverage. Key facets of the performance for Q3 include strong sales growth, again driven by Emerging Markets, Global Ketchup and our Top 15 brands; continuing investments in marketing, processes and systems to drive future growth and productivity; and a double-digit increase in EPS, reflecting solid growth in operating income and a better-than-expected tax rate. In short, we drove both top and bottom line growth despite a very challenging environment in developed markets. Turning to our ex items P&L scorecard for the quarter, you can see that currency translation had a negligible effect. Overall, sales grew by more than 7%, operating income increased better than 4% and EPS was up 13%. That's a good result as we continue to increase the investment in our brands and on Project Keystone while tightly controlling other spending. EPS got a boost from the favorable tax rate, which was 20% for the quarter. Again, this was better than expected and added $0.07 to the year-on-year increase in EPS. The most difficult result for the quarter was gross margin. While this margin level represents a continuation of sequential improvement in the business and is our high-water mark so far this fiscal year, it was still 140 basis points below last year. And to put this into perspective, our gross margin performance for the quarter was the third best in the peer group. We've left off specific company names here, but you can see that the whole group is working to overcome the harsh commodity inflation buffeting the industry. We're obviously not satisfied with this and our expectations are that commodity inflation, while not going away, will continue to moderate, easing the pressure on gross margins somewhat. With that said, let's turn back to the top line story. We're very proud of the fact that we've now driven 27 consecutive quarters of organic growth. And this quarter's organic growth of 4.6% represents our highest growth rate in nearly 3 years. Importantly, all segments reported positive organic sales growth in the quarter, led by the Rest of World and Asia/Pacific segments, but also reflecting positive growth in the difficult developed markets of Europe and North America. Again, this quarter, the formula for growth is based on our trio of growth engines: Emerging Markets, Global Ketchup and our Top 15 brands. On our last earnings call, we mentioned that growth in Emerging Markets would accelerate in Q3, and that's exactly what happened. For the quarter, Emerging Markets generated very strong organic growth of 20%, and on a reported basis, the number was even stronger, up about 40% when you include sales from the Quero business we bought in Brazil in Q4 last year. Now on an organic basis, growth was driven by Latin America, China, Russia, Indonesia, India and Africa/Middle East. Q3 was another strong quarter for Global Ketchup as well, where we delivered 9% organic growth, led by Latin America, U.S. Foodservice and Russia. Though smaller in scale, we also posted big percentage gains on Heinz Ketchup in Brazil and in China. And to round out the discussion of our growth engines, the Top 15 brands posted 6% organic growth, led by the Heinz brand, the Master brand of soy sauces in China and our ABC brand in Indonesia. Our Top 15 brands represent more than 70% of global sales and continue to grow as a percentage of our total mix. A key to the continued growth in our portfolio is increasing support of our brands. Over a 5-year period ending in fiscal 2011, Heinz increased marketing spending by almost 60% to help drive organic growth, and we're continuing to increase our investment level this fiscal year. Through the first 9 months of FY '12, our spending is up another 10%, reflecting higher spending in both emerging and developed markets. Now, let's take a quick look at top and bottom line performance in each of our key segments. First, in North American Consumer Products, we posted stable results in a difficult market with a challenged consumer. Organic sales were up 1%, offset by a 2% impact from the exit of Boston Market. Organic sales of frozen products were up in the U.S., while Ore-Ida sales were basically flat. The gains in frozen were partially offset by weaker sales in pasta sauces. Gross margin was impacted by net commodity inflation and lower margin product mix. We effectively leveraged SG&A spending, and we're excited to see the new accessible price point products reaching store shelves in Q4. We'll talk more about that next week at CAGNY. U.S. Foodservice business returned to sales and profit growth in Q3, driven by branded/front-of-house products and continuing productivity initiatives. Importantly, Dip & Squeeze distribution continues to expand and is now available at Wendy's. With this addition, Dip & Squeeze already represents about 25% of our total branded portion control Ketchup business in the United States. The industry saw modest improvement in overall restaurant traffic, particularly in December, driven largely by quick serve restaurants, though traffic at some of our key customers is still down slightly. Gross margin strengthened sequentially but was still below prior year as net pricing has increased and commodity inflation is beginning to moderate. And finally, we continue to rationalize the factory footprint in order to drive down fixed costs. Despite the headlines coming out of Europe these days, Heinz Europe posted solid results, with constant currency sales up over 4% and operating income about flat. Organic growth for the region was driven by another strong quarter in the U.K., up 6%, and continuing momentum in Russia, up 19%. Italy, on the other hand, was impacted by the country's debt crisis and incurred a 3-day national truck strike at the end of our quarter in late January. We continue to invest in processes and systems across Europe and are very pleased with ongoing progress in the rollout of Project Keystone and the establishment of the European supply chain hub and new Innovation Center. Turning to the Asia/Pacific, that region posted nearly 7% constant currency sales growth and almost 23% operating income growth, a dramatic improvement from their results last quarter. Each emerging market in the region drove double-digit sales growth, led by China, Indonesia and India. China is generating particularly good growth in Foodstar, western sauces and infant nutrition. Operating income improvement for the segment was led by excellent growth in China, Japan and Indonesia. We also saw sequential improvement in Australia this quarter, driven by new leadership there. Turning to the Rest of World segment, on a constant currency basis, both sales and operating income more than doubled. This growth was driven by continued strong performance in Latin America. A key element here is the addition of the Quero brand in Brazil, where the quarter sales in Brazil exceeded $100 million. Notably, we began distributing Heinz Ketchup in Brazil through the Quero sales force and have seen Ketchup sales almost double. Though still small, we have high expectations for this Ketchup business. Adding to the growth story in Latin America, we recently launched new baby food and ketchup pouches in Mexico and Central America. They're off to a great start, and we think this will be an important packaging innovation for cash-strapped consumers. And finally, Africa/Middle East contributed to the strong sales growth in the quarter as well. Now, I'd like to turn it over to Ed for a bit deeper insight on the quarter. Ed?

Thanks, Art, and good morning, everyone. I'll take you through some of the details underlying our financial results, which reflect strong top line and bottom line growth. Let's look first at EPS. Consistent with our previous releases this year, we're reporting our results in fiscal 2012 adjusting for the special charges related to our productivity initiatives. To summarize Q3, going from right to left, including the $0.07 cost of our productivity initiatives, reported EPS was $0.88, up $0.04 or almost 5% from last year. Our constant currency EPS and EPS excluding special charges were both $0.95, up 13.1% as foreign exchange activity this quarter had virtually no impact on the bottom line. Here, you can see the components of our productivity charges and where they're reflected in the P&L. In Q3, we incurred $9 million for severance and employee benefit costs relating to the reduction of the global workforce; $11 million related to asset write-offs for the closure of 6 factories so far this year, and we're working towards exiting at least 2 more factories by year end; $14 million of other implementation expenses, primarily professional fees, contract termination and relocation costs, incurred to improve manufacturing efficiencies, most notably affecting our Australian business. Overall, we recorded charges of $34 million pretax, of which $22 million is in cost of goods sold and $12 million in SG&A. The after-tax impact of the charges was $23 million or $0.07 per share, and the entire amount was reported in our non-operating segment. As a reminder, we currently expect the total cost of these initiatives to be around $215 million pretax or $0.50 per share for the full fiscal year, and we continue to look for additional opportunities to drive cost down further. The rest of our financial discussion will focus on the results excluding these special items, as we believe it provides the most useful perspective for evaluating our performance. Now turning to the P&L. Net sales exceeded $2.9 billion, up almost 8% on a constant currency basis. Gross profit dollars were up 4% on a constant currency basis as higher pricing and acquisitions were partially offset by higher net commodity costs. As Art mentioned, gross margin was down, along with all of our peers as a result of the commodity cost movements. Marketing expense increased in line with our strong top line growth while SG&A increased at only 1/4 of the rate of sales. SG&A was up 2% on both a reported and constant currency basis, reflecting increases from acquisitions, incremental talent to support growth in our Emerging Markets, as well as Project Keystone. We continue to prioritize investment to support the future while balancing overall costs. In fact, SG&A in our developed markets was down versus the prior year, reflecting our focus on tight cost controls. Operating income was up around 5% on a constant currency basis despite soft results in the U.S. and Italy, as well as incremental investments for marketing and Keystone. Net interest and other expense increased $5 million, primarily due to interest expense. The effective tax rate for the quarter was 20% compared to 26.1% last year primarily due to the release of foreign tax reserves no longer subject to claims, as well as reduced repatriation costs. We're now anticipating a tax rate for the full year, excluding special charges, in the mid to low 20s. This reflects the reserve I just mentioned, as well as other foreign tax planning initiatives. At the bottom line, we delivered a net -- an increase in net income of 12% and EPS of 13% in Q3. Looking at the key components of sales growth, as Art mentioned, we delivered organic sales growth of 4.6% for the quarter, the highest growth since fiscal 2009. Price improvements of 4.2%, particularly in the U.S., U.K. and Latin America, drove this growth, while volume was slightly positive at 0.4%. The Emerging Markets delivered balanced organic growth, with volume and price both up approximately 10%, and the developed markets in Europe posted positive volume with the exception of Italy. Japan had a strong performance, exceeding 10% volume growth this quarter, while we saw declines in Canada and Australia, as well as a small decline in the U.S. The Quero net acquisition, net of Boston Market, added 2.9% to our top line, while foreign exchange reduced sales by 40 basis points. Our gross margin at 36.4% declined 140 basis points as our pricing and productivity initiatives effectively offset approximately half of the headwinds from the commodity markets. Looking specifically at commodities, we've seen inflation in most of our key raw materials, particularly sweeteners, metals, meat and dairy. The overall result has been market inflation for the quarter of around 7%, in line with our full year expectations. Finally, for the quarter, operating free cash flow was about $250 million, down from last year. This reflects a $34-million outflow for productivity initiatives, increased QOWC, particularly receivables driven by growth in Asia and Brazil, while inventory and payables will roughly offset each other. Additionally, increased capital spending reflected further investments in Project Keystone, capacity projects in the Emerging Markets and new productivity initiatives. In total, capital expenditures were 3.4% of sales, up 70 basis points from the prior year. Dividends reflect a 6.7% increase that we announced in May. And finally, the increase in treasury stock reflects the repurchase of about 800,000 shares at a total cost of $42 million, net of options exercised. Now let's move to the balance sheet scorecard through 9 months. Capital expenditures were 3.2% of sales, up 70 basis points from the prior year, reflecting the investments I just mentioned. We're still anticipating spending of around 4% of sales for the full fiscal year. Our cash conversion cycle at 45 days slipped by 1 day versus last year as a 3-day improvement in payables was offset by 2 days in receivables and inventory. Operating free cash flow of $476 million was down from last year. We spent $64 million in our productivity initiatives so far this year, and QOWC has increased primarily due to the timing of payables. Overall, QOWC should be in line with fiscal '11 by year end as a result of our concerted efforts to reduce inventories. Additionally, in line with our plans, cash taxes are higher this year, and capital spending is up on a year-to-date basis. Net debt to EBITDA was 2.0x this year versus 1.8x last January. The increase was due to higher net debt primarily related to the Brazilian acquisition, but we remain quite pleased with the improvements in net debt to EBITDA from just a few years ago. ROIC was 18.6%, down 70 basis points from this time last year. But if you adjust for the Brazilian acquisition, the base business would show an improvement of 20 basis points over the comparable period last year. In summary, our performance for this quarter reflects solid top line and EPS growth, with substantial incremental investments back into our business to help support future growth. With that, I'll now turn it back to Art to take you through our full-year outlook.

Thanks, Ed. Now let's finish after a quick look at the full year forecast. On an ex items basis, we're confident that we'll deliver on the expectations we established at our Analyst Day last May. Those goals included constant currency sales growth of 7% to 8%, EPS growth of 6% to 8% and operating free cash flow of around $1.15 billion. As discussed last quarter, given the negative changes in the economic environment, our path is a bit different than we had originally expected. On a reported ex items basis, we're narrowing our range and expect to deliver EPS of between $3.32 and $3.34. This includes the full year benefit of approximately $0.05 from foreign currency. Thus, this range should equate to constant currency performance of around $3.27 to $3.29, which is at the middle of our original outlook of $3.24 to $3.32. And this effectively takes up the bottom of our expected range. So as we look forward, we expect to continue our top line momentum, further invest in the business, deliver double-digit EPS growth in Q4 and aggressively reduce inventory levels. As part of this, as Ed mentioned, we now expect our full year tax rate to be in the mid to low 20s. And finally, we expect to deliver $1 billion in operating free cash flow on a reported basis after the impact of spending for special items. So to summarize, we're posting solid sales and EPS results in a challenging environment; driving the top line primarily through growth in Emerging Markets, Global Ketchup and an increase in marketing behind our Top 15 brands; continuing to invest in the business for sustainable long-term growth despite the environment; successfully executing our productivity initiatives to further build the foundation for the future; and expecting to deliver our original full year outlook. So with that, I'll turn it back to Meg, and we'll take your questions. Meg?

All right, operator?

[Operator Instructions] Our first question is from the line of Ken Goldman from JPMorgan. Kenneth Goldman - JP Morgan Chase & Co, Research Division: It seems, at least optically, that you're guiding to a little bit of a drop in performance between 3Q and 4Q, maybe a little bit more sudden than some people might have expected. So I guess my question is, first, is this accurate? And second, if so, maybe you could walk us through some of the drivers of that relative softness.

No, I think, frankly, we're real pleased with the performance in the business. I mean, you saw the strong growth at the top line. The 3 growth engines are continuing to bang away. We've got sequential improvement in Australian foodservice. We're investing in the business. We're taking out inventory. For the quarter, ROI was up nicely, and we continue to drive the productivity initiatives. So we're feeling very good about the business. I think what you're seeing is some timing in terms of the tax impact. Certainly, the tax was better than we expected this quarter, probably a little bit worse than we expected next quarter, so largely timing there. This allows us flexibility, frankly. I mean, in this tough environment, there is just no reason to be heroic. So I think we are prudently balancing the P&L. We're also aggressively taking out inventory in the fourth quarter. And as you know, as you reduce inventory, you take an absorption hit. You're pulling basically fixed costs off the balance sheet into the P&L and there's a hit associated with that, but we think that's the right thing to do, to pull inventory out and to drive cash flow. So now, we feel very good about the business and feel very good about the fact that we're taking it to the middle of the range and taking up the bottom end of our guidance.

Absolutely. The only other thing I would add is, if you take the numbers we've given you on FX, we're going to take a hit next quarter on FX, and that obviously was not anticipated. So we are at a positive $0.08 for the company year-to-date, and our guidance this morning includes a positive $0.05. So that's a $0.03 hit potentially in the fourth quarter from FX alone. So you take the FX hit, you take the absorption hit and a little softness, but it's not major softness. It's -- I think we're going to have an incredibly strong quarter. If we hit these numbers we put out there, guys, that's double-digit OI [ph] and EPS, and that is nothing to be -- to sneeze that. So we're hitting on all cylinders, as you saw, with all of our segments at positive organic growth. So...

Yes. So in short... Kenneth Goldman - JP Morgan Chase & Co, Research Division: What does that mean, though? Art, I'm sorry. I didn't mean to interrupt you, but what does that mean? Could you add a little bit of color on the inventory? Is it an inventory hit because volumes weren't as strong as expected? Or is this more of a planned hit as you close some of your plants?

I think we're looking to drive cash flow and drive quality of earnings. That's been a hallmark, I think, for Heinz, and so we're aggressively taking inventory out. It's certainly a little harder to project in this kind of environment and in some of the developed markets. But the reality is, if you take a lot of inventory out, which is what our expectation is, it comes with a P&L impact.

And typically, in the fourth quarter, you would see our inventories drop just due to the seasonal nature of our business. This year, we're making a very, very concerted effort to drive that down further than we normally would.

To your point, Ken, we have some acquisitions. Their inventory levels are higher than kind of company average. Company average is high. And there's a little bit of volume softness, but I wouldn't attribute this wholesale to that at all. This is going to be a big effort for us, and it really sets us up for the long term. It's the right thing to do. Kenneth Goldman - JP Morgan Chase & Co, Research Division: Is it a 1 quarter inventory issue? Is it 1 quarter and then done?

I think we're looking to be very aggressive here. But over time, we'll continue to always look to take inventory out, not -- certainly not at the pace of what we're expecting in the fourth quarter. But this is very much in line with Bill's strategy. I think in this kind of environment, you want to make sure you're driving cash flow to provide flexibility for the business and for shareholders. So aggressively taking out inventory, driving out fixed costs. It's clear that customers these days won't pay for people's overhead. So we are getting aggressive across the board.

Your next question is from the line of Chris Growe from Stifel, Nicolaus. Christopher Growe - Stifel, Nicolaus & Co., Inc., Research Division: I wanted to ask you, Art, I guess about the -- like the cost inflation in relation to your pricing and productivity. Can we just understand kind of the phasing of the cost inflation for this year? I was surprised to hear that you only had about half of it covered in this quarter. Is that expected to get better in Q4? Is there any that's lingering into 2013? I don't want to get too far ahead of ourselves here, but how do you see those 2 lining up?

Yes, as we have projected, we said that inflation was going to hit its high-water mark in the second quarter, which it did. I think we're around 10% market inflation at that point. It's down to around 7% market inflation in the third quarter. We do expect that to continue to moderate into the fourth quarter. And the good news is that over time, we have been getting better price realization. If you recall, particularly in U.S. Foodservice, pricing comes in chunks as national account contracts come up and things like that. So our price realization is getting better and commodity inflation is moderating. So we do expect sequential improvement from a gross margin standpoint. And so we're looking to finish up the year pretty much as expected on that front.

And then if you go back to our earlier releases, the earlier quarters, we were seeing commodity inflation higher than the 7%. The 7% we experienced this quarter is in line for the full year, so you see that trending down, which is what we said in previous calls. And that still looks to be the truth. Christopher Growe - Stifel, Nicolaus & Co., Inc., Research Division: Okay. And was there -- just to follow up on a point made to Ken, is there -- are you quantifying the inventory hit for the fourth quarter?

No, not really. I think we'll see, as things come out and it's all a question of exactly when the inventory comes down, is it early in the quarter, is it late in the quarter, et cetera, so -- but it's certainly a factor in why we guided or put together the outlook that we did.

Your next question is from the line of David Palmer with UBS.

2 questions, 1 on Europe and then 1 on Ore-Ida. The Europe business seems to be hanging in there pretty well. It's a pretty good top line this quarter. Profit is stable against, I guess, a little bit tougher margin comparisons. I think a lot of folks are just scared of Europe right now. You're hanging in there. How are you thinking about how this next year is setting up into fiscal '13 in Europe? Folks are obviously more concerned about Southern Europe. You have that baby food business down there. U.K. business, you seem to be in a very good competitive position. Any color would be helpful.

Yes. At this point, I'm probably not going to say a lot about '13, but let me just give you a flavor for how we're thinking about Europe and what's going on there. Reality is, about half of our business in Europe is in the U.K. That business has been going extremely well for us. We're very, very pleased with the execution and the strategy that the guys there have from a marketing and a sales standpoint. So very good performance there. U.K. soup in the quarter was up dramatically. We're coming out with great innovations, things like Squeeze & Stir, the Talking Labels. We've got a lot of PR going on, so there's lots of good things going on there. And I just think we are executing extremely well in a tough market. There's no doubt about it. But I think we are advantaged by the fact that the bulk of our business or certainly roughly half of our business is in the U.K. But even beyond the U.K., if you look at what else is working there, Ketchup in Europe, across Europe, is doing extremely well. Rolling airboats [ph] has been driving that for us globally and certainly across Europe. And we've talked to you about the performance there in the past, and that performance continues to do extremely well and, in fact, accelerate. So Ketchup across Europe is doing well. If you think about Russia, that's a real growth engine for us. Organic sales up around 19%, as I recall, in the quarter. So that's a combination of sauces and also baby food. So we feel very good about that. I mean, to your point about Southern Europe, yes, it's a tough environment, no doubt about it. Italy is a tough place to be doing business. We had a truck strike at the end of the third quarter that certainly impeded sales somewhat in Q3. But here again, we're innovating. We're bringing new products out there. We've just got Aseptic, which is a much higher quality baby food product that has come out in Italy and that's in the U.K. as well. And as we look forward, we're investing in the supply chain hub there, which should bring great manufacturing efficiencies. We're putting in the Heinz Innovation Center, which should amp up our ability to innovate across Europe. And finally, Keystone continues to roll out. So net-net, yes, Europe is a tough environment, but I think we're doing all the right things.

And then Ore-Ida, it seems to -- in some period, the Nielsen data, it looks like Ore-Ida is over 100% of the volume hit to that, to what you're doing at retail. Can you just talk about what the prospects are there, what's being done to fix that? I know you obviously have the new packaging coming this quarter. But what should we be looking for?

Yes, no, good question. I mean, Ore-Ida, sales were basically flat for the quarter, with price up and volume down. And as we said before, we -- as the leader of that category, we took significant pricing last fall -- or actually before then. So it's been quite a while. Private label tended to stay down. The result was a bit of a value gap there. And frankly, we could get that share back tomorrow, but what we're trying to do is balance really volume, price share and margin. I would say elasticity in that category is probably higher than we'd originally anticipated. And I think if Bill were here, he would use his old maximum of fix the problem and market the fix. So we're addressing it with -- addressing the value gap on our 2-pound bag. We're also, as you know, launching a 1-pound bag at $1.99. We have high hopes for what that will do for us. And the plan basically is, once we've resolved the value gap, then we'll go back on air from a marketing standpoint to market the fix. But we want to make sure that we've addressed the root issue, and then once we're confident of that, we will market that fix.

Your next question is from the line of Thilo Wrede from Jefferies. Thilo Wrede - Jefferies & Company, Inc., Research Division: Could you give us a little bit of an overview of how you see the U.S. economy right now? You're about to or you've started to ship these smaller pack sizes to lower opening price points, and some of your competitors are talking about volume weaknesses that are hurting their profits. But are these small pack sizes, are they still needed? Are they coming too late given that the overall economy seems to be improving when you look at some of these indicators?

Yes, frankly, I'll say what I've always said about the U.S. economy. I am maybe more pessimistic than certainly our government is about where this economy goes. I think this is going to continue to be a tough place to do business, in the U.S. You're not seeing companies doing a lot of hiring. In fact, you're hearing more companies announcing layoffs and things like that. So with that, we're going to hope for the best and plan for the worst. I think you're seeing more perimeter shopping as people use ingredient cooking. Within the U.S., some people are shifting to more cheaper meals out, and you're seeing the benefit of that in some of the QSRs, particularly McDonald's and SUBWAY. But at the end of the day, we're not going to chase share. We could easily buy volume in this kind of market. But I think we're going to continue to try to do the right things, recognize the environment for what it is. I think value means different things to different people, and I believe Bill will expand upon that at CAGNY next week. For some people, volume means lower cost per ounce. For others that are really struggling, it is that entry level price point. And so that's what we're trying to address. And at all levels of the socioeconomic ladder, we're going to be innovating to meet those needs. It used to be a little simpler in that you could address just the relatively more affluent. Now we need to address, again, all parts of the ladder and that's what we're doing.

Yes. I think when you look at the economy, it's nice to see some improving statistics. But unemployment is still over 8%. You have more people on food stamps than ever before. There are a number of factors, and I don't want to take Bill's fire so I'll stop before I get in trouble. But I think small sizes have a place with the American consumer. We're going to get it in the right channels. Alternate channels are doing very well outside of that retail-measured data, and I think that's part of the piece that you guys can't see right now.

In addition to the economic stresses, I mean, I think the smaller sizes also address smaller household sizes, and that's probably here for a while regardless of the rebound in the economy.

Yes. So, Thilo, to -- a short answer to your original point, do we think it's too late on those smaller sizes? No, absolutely not. We think it's very well timed.

We would have loved to have had them sooner, but it's not too late. Thilo Wrede - Jefferies & Company, Inc., Research Division: Right. And this shift won't have any negative impact on your margins?

No, what we're working do is make sure that we do this smartly, and we're driving value engineering to take out non-value-added costs that the consumer doesn't want to pay for. So we don't anticipate that. We're looking to drive this in a margin-neutral kind of way.

Your next question is from the line of Alexia Howard from Sanford Bernstein. Alexia Howard - Sanford C. Bernstein & Co., LLC., Research Division: Can I ask about the frozen entrées segment? There wasn't too much commentary in the press release or on the call so far. But specifically, Smart Ones and T.G.I.F., maybe you could speak to those separately. It looked again from the measured channel data that the promotional spending was up quite a bit in the frozen entrées area, and I was wondering if that was an indication of just ongoing category weakness and competitive dynamics in there.

Yes, as you remember, Alexia, the frozen entrée category is very cyclical with strength of the economy. And so what you're seeing is continued softness in that nutritional frozen entrée category. Having said that, I think we're doing all the right things and driving innovation and very aggressively going after each of the dayparts very successfully with Smart Ones. So I think that's proof positive of, hey, you do the right thing, you got the right kind of innovation, you hit the right kind of value equation and you can win in this kind of market. And that's what we're trying to do. It would be nice if the category would stabilize and go up, but we're not going to hold our breath on that. It's been a number of years now that, that entrée category has been down. And again, if the economy strengthens, we should be well positioned to ride that. But we're going to continue to plan our game based on the environment that we're faced with.

Yes, Smart Ones, I don't think the team is getting enough credit for a lot of great work they've been doing: diversifying the portfolio, going for the 24/7 platform. Remember, we're very heavily weight management focused, and Weight Watchers has been doing well, advertising, celebrity spokespersons, et cetera. And Smart Ones has been gaining share for the last 2 years every quarter, so there's some really good things going on there. Your point, the category -- and the frozen category is soft, but we've been winning with Smart Ones. Alexia Howard - Sanford C. Bernstein & Co., LLC., Research Division: And then T.G.I.F.?

T.G.I.F., we feel very good about snacks business within T.G.I.F. That's about 70% of the platform there. So that part of it, we like. It's been working. I think on the entrée side, a bit weaker, and that's really reflecting a very tough category dynamic there. So we'll continue to take a look at what the environment looks like there and what the appropriate actions are.

Your next question is from the line of Eric Katzman from Deutsche Bank.

I guess I want to focus in on M&A a little bit. Can you talk about between Quero and Foodstar from a EPS perspective, what they either subtracted or added to this past quarter, what it looks like for the fourth quarter. And then any -- just, at least, a quantitative or qualitative sense on what those could mean for F '13.

Yes, yes. Eric, we are thrilled with how those businesses are performing. They are just off to a roaring start. You're seeing just some huge numbers coming out of Foodstar over in China. I think our team there is managing it very, very well and not trying to bite off more than they can chew. They're building their capacity. They're going one province at a time. And you're seeing some big numbers coming out of there, and we fully expect that to continue. In terms of Brazil, that is tracking right on plan. As I mentioned, we got Ketchup in there now going through the Quero sales force, big growth coming out of there now. It's off a small base, but we're very excited about that and, frankly, just excited about all the categories in Brazil and our ability to take their products through the modern trade or upgrading their manufacturing capability, et cetera, et cetera. So I think, frankly, I think that from a bottom line standpoint, I won't quote you specific numbers because I don't have them off the top of my head, but I think just moderately positive this year. So probably a bit of a help, and next year, we certainly have high expectations for them.

Yes. I mean, obviously, the goal for us is to take those earnings and reinvest them back into the business. So we've just launched television for the first time with the Quero brand this quarter, went on air, seeing tremendous response from that. We're back on air after many years of being dark with the Master brand, soy brand in China. And frankly, I think in some cases, we just can't spend it fast enough. So there are plans to continue to invest and keep these brands growing. But it's not -- I don't think it's substantial, but I think they clearly brought [indiscernible]...

In a nutshell, we're driving this for the long haul. And what we're trying to do is really invest in that brand and make sure that this thing turns into a very, very big, important business for us over time.

That's understood and logical. I'm just trying to go back to the Analyst Day last May. And I think that you had quoted that between Foodstar and Quero, they would be, at least, I think it was $0.05 per share dilutive. And now you're saying that those are going to be moderately positive. So is some of the performance in the earnings a function of those actually doing a bit better than you thought on the bottom line?

Yes, Eric, I wouldn't be too specific. I don't recall $0.05...

Yes, that was last year's number, I think. I think we were flat this year...

Yes, I think that was probably last year's. But I do think we're slightly better than planned at the bottom line. But again, the strategy is to invest in the business as opposed to letting all of the sales upside fall to the bottom line.

Eric, I'll source the transcript and give you a call this afternoon.

Okay. And then just as a quick follow-up on -- you've got the cash cost of the restructuring, the higher CapEx, Project Keystone, et cetera. All these spending levers, some expense, some cash. How are you feeling about the company's capability of making a larger acquisition?

I think as we've always said, our sweet spot is in that sort of bolt-on kind of arena. Things like Foodstar and Quero, that's our bread-and-butter. We know how to do it, we do it very well, focused on Emerging Markets and things like that. So that tends to be our sweet spot. For the right situation that fit well, we'd certainly do a larger deal. We did HP/LP a while back. That was an $850-million deal. So we've done larger deals in the past, but our sweet spot is really the bolt-on side.

I think that's a great question for Bill next week.

Your next question is from the line of Jason English from Goldman Sachs.

I want to go back to this inventory issue because, sorry, I was a little distracted, maybe I missed it. It sounds like you plan on taking a lot of inventory out of the system in the fourth quarter. I was just looking through your balance sheet and noticed that for a couple of years, you had great success in lowering your finished goods or work-in-process inventory below the rate of sales. And for the last 4 quarters, it surprisingly ramped higher. Is this sort of correctional actions to reverse what's happened in the last few quarters?

No. No, I mean, if you think about it, you've got the impact of the acquisitions in there. Particularly, you've got both Foodstar and Quero that -- our inventory that obviously we didn't hold before we acquired them. So that is a big chunk of the increase. I think in this kind of environment, where some of the demand side of things is a little more volatile than it has been in the past, it's gotten more challenging to constantly stay on top of exactly where demand goes and exactly what your production forecast should look like. So this is just in recognition of the fact that we want to take this inventory out. It's the right thing to do for the business. We think we have the opportunity and let's get after it.

I understand on the acquisition, but the acquisition is also in the sales growth. So I guess what I'm getting at is, I'm curious if -- the fact that your finished goods have been ramping ahead of sales, you kind of had better utilization rates. Has that artificially boosted gross margins the last few quarters?

I wouldn't say materially that I know of. But keep in mind also that with the productivity initiatives that we've got going and the closure of a number of plants, in certain cases before you close the plant, you are going to have to build some buffer stock and things like that. So that's a bit of the story as well. So I think that probably plays into the equation. And with a lot of that behind us, though, a bit more to come, as you know, it's time to get very focused on inventory and take it out.

And one last question and I'll pass it on. Venezuela, there's been a lot of chatter. And I know Hugo Chavez mentioned Heinz is one company that it's investigating for potential price controls. Is there any update on that? And if we were to presume that price controls were put in place, how might the abatement of the hyperinflation impact your Emerging Markets sales growth?

It's unclear, the exact situation in some ways down there, but we've operated in Venezuela for over 50 years. We have a great team there. We manage that environment, I think, extremely effectively. We're continuing to deal with the vagaries of the market, but at the end of the day, we don't expect a material impact.

Your next question is from the line of Andrew Lazar from Barclays Capital.

Just, I guess, first thing would be, Art, can you just remind us what you have already kind of set out there about how the incremental sort of productivity actions you're taking, Keystone and such -- how do they play out from a benefit standpoint as we go into fiscal 2013? And I know you're not going to get into '13 guidance, but what have you said, if you could remind me, on the benefits and how they play out in '13?

Yes, from a Keystone standpoint, as you recall, that's -- it's really kind of a slow build. We've taken a very, I would say, methodical approach in rolling out Keystone, making sure that we don't bet the farm and introduce too much risk into the business. So we continue to knock off the markets one at a time here. And so that -- we probably won't be largely done with Keystone until, I don't know, end of 2014, something like that. FY '14 is what we have -- what we've said and we're sticking to that. And so I think the bulk of the benefits will be out a ways from Keystone. Now you're certainly seeing -- we've got SAP in the U.K., for instance. U.K. business has been doing extremely well, and I will chalk most of that up to very, very strong leadership with the right strategy and the right execution. But I got to tell you, I think we're arming that team with the right tools and giving them the right visibility of the business, and we're seeing benefit out of it. But market by market, you'll start seeing that. But I think the big chunks of benefits out of Keystone will be more toward FY '14 and beyond.

Great. That's helpful. And then I just want to pick up on the pricing and productivity question earlier. It's just interesting, like from a group perspective, over time, the group has typically been able to cover inflation with pricing, and productivity sort of helped margins. And then I'd say more recently, it's really been pricing and productivity that's generally for the industry been needed to sort of cover inflation. And I just -- I thought it was notable this quarter when you mentioned that pricing and productivity covered half of inflation. And again, I don't think that's necessarily all that dissimilar from some of your peers, but it is a notable difference than what we have seen over time. Do you think that's something that has just structurally changed? Or are we in just such an anomalous sort of time frame from a consumer and sort of input-cost perspective that it just wasn't doable this time around? I'm just really curious on your thoughts there.

Yes. I think the reality is that the -- it is an interesting time here from an economic standpoint where the unemployment rate went quite high at the same time that commodity inflation went up significantly. I think all this washes out over time. And so you've got an interesting period of time here, and it certainly varies by market. I mean, in many of our Emerging Markets, we're seeing strong growth in margins and -- both at the gross and the operating margin line. But in some of these developed markets, it's a tougher equation. And -- so again, I believe it'll wash out over time. But with the combination of high unemployment, a lot of people deleveraging in terms of taking down their personal debt and commodities going up at the same time, pretty tough environment. But frankly, good question to ask Bill, and I think...

Yes, I think you're going to hear a lot from Bill next week.

Yes. Why don't you talk to him about that next week? And I'm sure he'll have a pretty strong point of view on that.

Your next question is from the line of Rob Moskow from Crédit Suisse. Robert Moskow - Crédit Suisse AG, Research Division: You have kind of another question on the gross margin. If I look at what the numbers are shaping up for the year, it looks like you're guiding gross margin down for fourth quarter. Can I assume it's about a 100-basis-point hit, partial as a result of the inventory absorption?

I'm not sure I want to get that specific about it. We do expect gross margin to be down on a year-over-year basis in the fourth quarter, but sequentially better than what we have been seeing.

As we said in the earlier quarters, going back to the way commodities and pricing are going, is we expect that comparison to gradually get easier as the year went through, but still a challenge.

Yes, yes. So -- and that's why during this time, I think we're doing the right things. We are very aggressively going after fixed costs and trying to take that out to take pressure off. We're looking to value engineer, and again, we're looking to maintain very strong quality of the products, obviously. But there are often non-value-added costs that you can get out in terms of packaging or cartons or whatever, also taking out the fixed costs associated with some of the plants that, frankly, we didn't need. So we're working it hard. Robert Moskow - Crédit Suisse AG, Research Division: Yes, let me ask you then on SG&A. The last -- first 2 quarters of the year, you were up about $60 million, $50 million year-over-year. I think the acquisition played a role in that. You're only up $27 million in third quarter, and you said that you've attacked SG&A costs, you've tightened those. Can you tell us what has been cut in SG&A? And then also, if advertising is up, I think, about 7% this year, what do you think it's going to be for the full year? Is it going to be up again in the fourth quarter?

Yes, year to date, we're up about 10%, and we will -- we do anticipate marketing spending to be up again in the fourth quarter. But from an SG&A standpoint, we continue to invest in the areas where we feel like we need added capabilities. So we've talked about Keystone hit, supply chain hub. We've talked about Emerging Markets. So we're continuing to invest in there, but I think good management teams make trade-off decisions. And so as we invest there, the question is, hey, what are you not going to spend money on? So we're just tightening our belt across the board. We've taken a look at layers in the organization, spans of control. We've taken a look at just lots of discretionary spending. And if we don't need to do it, we don't do it.

Rob, also if you look back to last year, the phasing of our investments last year were gradually increased all through the year, versus this year we've probably taken a more -- as we said before, a more steady approach throughout the year. So I think that's part of the comparisons that you talked about, say, first half to second half.

Absolutely.

Yes.

All right. Well, in interest of time, I know we've got another peer company with a call coming up. So I think we've got time for one more.

And that question will come from the line of David Driscoll from Citi Investment.

I'll make it quick. Nice quarter in a tough environment. I want to just ask a little bit more about the acceleration in the Emerging Markets. Certainly, growth in Asia/Pac of 6.5% and Rest of World at 30%. By the way, one of these days, you guys got to change the segment name of Rest of World to something more attractive. The growth in these segments was really terrific. How sustainable are these types of rates of growth? And can you talk about capacity constraints? Because I know in both the Foodstar acquisition and in the Quero acquisition, capacity issues were very key in your initial assessment of what those businesses would contribute to Heinz. So can you talk about both the growth rates going forward and then the capacity side?

Yes, I think this Emerging Market thing Bill's been working at for years and years, and we as a management team have been working at it years and years because we saw this coming. To be quite honest, you just have to look at the dynamics in these Emerging Markets where the rising middle class, more discretionary income, fragmented trade environment, fragmented competitive set, I mean, all dynamics in those markets are very positive. And so we see for a long period of time very strong growth in those kinds -- those markets. And you're seeing -- if you look over the past, and we've been at that double digit kind of rate. And we sure expect that kind of number to continue over the long haul. Because it's -- this is not a short-term phenomena. If you look at just some of the demographics over the next 10 to 20 years, you will see dramatic growth in those markets that will help consumer product kind of companies. So we're very, very attuned to that. The strategy is all built for it.

Bill will talk more.

Yes, Bill will talk more next week. But we've got the right kind of talent, we're investing in those businesses, we're building capabilities in it and I think we're in good shape there. From a capacity standpoint, yes, we're going to have to build factories occasionally. And we are in certain places. We are in the acquisitions, and that's why our capital spending this year, if you look at it, is a little bit higher than our historic -- I don't know, we've been at 2.5%. We're probably up to 3.5% to 4% this year. And a lot of that is around Emerging Markets. Good investment, very strong return to the shareholders.

On average, we've taken that CapEx spending up to 4%, but a disproportionate share of that CapEx spending relative to sales is going to the Emerging Markets.

Well maybe just a final follow-up. That 30% in Rest of World, that number is -- that's not just double-digit, that's one of the strongest numbers we've seen from any company. So that's the number that I find, from just modeling the future, the toughest number to deal with, because at one sense, it looks great and there's probably no reason to believe you don't continue in the next couple of quarters. But I always wonder if there's something out there that you know of that changes it back down to like 15% or something like that.

Yes, I wouldn't get into conjecture on particular segments of the business. But we expect very strong growth there across Latin America. We expect the Quero business to be a great addition to this portfolio. So I think we're continuing to look for strong growth there.

Well, and it's provided us additional scale in that whole region. So our -- Mexico, Costa Rica, Colombia, Peru, I mean, we have a lot of businesses that now have more scale to leverage. And I think they've really got a great team there driving those results. So...

You'd hope that would be a very strong platform for us throughout South America.

Absolutely. All right. Well, just quickly -- we'll see you at CAGNY. All right. Well then -- and speaking of which, great segue, thanks, Dave. There's a lot going on in the industry calendar, so I wanted to give you a quick list of the conferences that we're going to be attending. And you're going to get to experience some different members of the Heinz management team at each of these. So very quickly, Bill Johnson will be presenting at CAGNY. We are on for Wednesday at 3:00 p.m. Then we're at the BofA Merrill Lynch consumer conference. We'll be hosting one-on-ones. That will be Mike Milone, who's the Rest of World and Global Infant EVP. Then on March 15, we've got UBS global consumer conference. That's going to be Chris Warmoth from our Asia/Pac business. On March 20, we'll be in London at the CAGE Conference, and that will be Art Winkleblack and Dave Moran from our European business. And last but not least, please make a note, hold the date, Thursday, May 24, our fourth quarter and Heinz Analyst Day. So more details to follow. As always, Mary Ann and I will be around. But go gentle on us. We've got some work to do for CAGNY next week, and we look forward to seeing everyone there. Have a great day.

And ladies and gentlemen, this concludes your presentation. You may now disconnect, and have a good day.