Feb 26, 2008
Executives
Meg Nollen – VP IR Art Winkleblack – EVP, CFO Ed McMenamin – SVP Finance, Corporate Controller
Analysts
David Driscoll – Citi Investment Research Chris Growe – Stifel Nicolaus Todd Duvick – Bank of America Terry Bivens – Bear Stearns Alexia Howard – Sanford Bernstein Eric Serotta – Merrill Lynch Ann Gurkin – Davenport Eric Katzman – Deutsche Bank Bob Cummings – [Sheils] & Company Robert Moskow – Credit Suisse Pablo Zuanic – J.P. Morgan Andrew Lazar – Lehman Brothers
Operator
Good morning, my name is Regina and I will be your conference operator today. At this time I would like to welcome everyone to the H.J.
Heinz Company fiscal year 2008 third quarter earnings conference call. This call is being recorded at the request of H.J.
Heinz Company. All lines have been placed on mute to prevent any background noise.
After the speakers’ remarks, there will be a question and answer session. If you would like to ask a question during this time, please press star then the number one on your telephone keypad.
If you would like to withdraw your question, press the pound key. I would now like to turn the call over to Meg Nollen, Vice President Investor Relations.
Ms. Nollen, you may begin your conference.
Meg Nollen
Thank you Regina and good morning, I’d like to welcome everyone to our conference call and webcast. Copies of the slides used in today’s presentation are available on our website at Heinz.com.
Joining me today is Art Winkleblack, Executive Vice President and Chief Financial Officer and Ed McMenamin, Senior Vice President Finance and Corporate Controller. Today’s question and answer session has been password protected.
Any investor or analyst who would like to pose a question and who does not yet have the password, please email Lori Varady in Investor Relations at [email protected]. Please be advised that any caller entering the Q&A session under false pretenses will be immediately disconnected.
Before we begin with our prepared remarks, let’s refer to the forward looking statement currently displayed. This is also available in this morning’s earnings release and in our most recent SEC filings.
To summarize, during our presentation we may make predictive statements about our business that are intended to clarify our results for your understanding. We ask you to refer to our August 1st and October 31st 2007 10Q’s and our May 2nd 2007 form 10K 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 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.
And as directly comparable GAAP financial measures and reconciliations of these non GAAP measures are available in the company’s earnings release and in the slides accompanying this presentation, which are available on our website, again at Heinz.com. So with the formalities out of the way, let me turn the call over to Art Winkleblack to discuss these great results.
Art.
Art Winkleblack
Thanks Meg and good morning everyone. I’m pleased to report that Heinz sustained its excellent sales, profit and cash flow momentum in the third quarter of fiscal 2008.
We generated very strong sales growth of 14%, driven by broad based organic growth of more than 8.5%. Operating income grew 8% while investing an additional 16% in consumer marketing and while overcoming very high commodity cost inflation.
Our EPS was $0.68, was up 3%, despite a significant year over year increase in the tax rate. And operating free cash flow more than doubled during the quarter, putting us basically in line with the cash flow we generated through the first nine months of last year.
Overall, Q3 was another very strong quarter for the company. Our sales growth continues to be paced by our top 15 brands which increased by 17% in the quarter.
This includes 6 brands that grew by 20% or more and the global Heinz brand which grew by almost 15%, 9% on an organic basis. Importantly, every one of these top brands posted positive sales gains in the quarter.
Looking at our results by category, we posted strong double digit increases in each of our three core categories, our ketchup and sauces and meals and snacks categories each rose by almost 14% while infant nutrition led the way growing by 17%. We’re very pleased that all of our global categories are healthy and growing at a very brisk pace.
The growth in the infant nutrition business reflects strong results around the globe, with excellent momentum in Italy, India, Latin America, Canada, Australia, New Zealand and China. Heinz is capitalizing on the intersection of two very powerful dynamics, one our fastest growing global food categories and the burgeoning middle classes in emerging markets.
Heinz is leveraging these dynamics with successful innovation, a worldwide up-aging strategy and strong growth in our core jarred, cereal and biscuit ranges. Heinz’s progress in emerging markets continues to be a clear point of differentiation from many of our peers.
These markets delivered nearly 30% sales growth in Q3 or 21% on a purely organic basis. Overall, the emerging markets accounted for more than 12% of Heinz total sales in the quarter and represented 23% of our total sales growth.
We continue to invest behind our strong brands and infrastructure in these markets. Remember that these businesses are quite profitable for us and they generate positive cash flow.
We’ve developed strong competencies operating in these high growth economies and are becoming increasingly important contributors to Heinz profitable growth. Our organic sales growth in the quarter was well balanced between volume and net pricing, up 5.2% and 3.4% respectively.
The 3.4% increase in price is the highest quarterly increase we’ve achieved in five years and as you can see, our pricing momentum has generally been building over the last seven quarters. Heinz continues to beat commodity inflation through a potent mix of strong organic growth, pricing, productivity and foreign exchange.
Our strategy is to drive strong gross profit growth which in the present environment means a trade off of some gross margin. Over the long term we believe this is the best approach for optimizing top and bottom line growth.
Our ability to drive volume and net price improvements is being fueled by investments in innovation and brand building. The third quarter represented the sixth quarter out of the past seven to include double digit increases in consumer marketing.
R&D also increased at a double digit rate in the quarter as we continue to strengthen our global innovation pipeline. Looking at segment performance, we are proud of the fact that each one of our major lines of business posted positive organic sales growth.
We continued to achieve double digit growth in Asia Pacific and the rest of world and delivered another outstanding quarter in North American consumer products with nearly 10% growth. With that overview, I’d like to take you on a quick tour around Heinz world to highlight some of the products and innovations that are driving our growth.
Starting with US food service, we had a strong quarter at the top line, posting 4% volume growth. Heinz is a leader in the food service business with some of the strongest brands in the industry.
We are increasingly partnering with our casual dining customers to develop the concept of complete meal solutions which led to a double digit increase in sales of our proprietary soups and better than 20% growth in deserts during the quarter. While we delivered a solid top line, profits in this segment continue to be below prior year levels as a result of reduced traffic in some customer accounts and disproportionate commodity cost increases affected the business.
Going forward, we’re working to leverage the scale of our combined North American retail and food service businesses to drive profitable growth. Turning to Europe, where Scott O’Hara and his team are generating a very rich innovation pipeline, our top line continues to gather steam.
Our ketchup business in Europe enjoyed another strong quarter with sales up more than 12%. This performance reflected effective advertising, increased penetration of top down and reduced sugar and salt varieties in continental Europe, record market shares in Spain, TK with a twist in UK and continued robust growth of the Heinz brand in Russia and the Pudliszki brand in Poland.
In the last 12 months, the UK ketchup business has topped 100 million pounds sterling for the first time, reflecting a value share of 80.5%. Growth in the UK was very strong in Q3 with nearly 90% of our product lines demonstrating a volume share growth in the quarter and nearly 60% in value share growth.
Heinz soups were particularly robust as we drove growth in the ambient soup category at a rate that outpaced the chilled soup category for the first time in several years. Our soup sales were up 21% this year on the continued strength of new ranges, including farmers market, taste of home and soups of the world.
Also in the UK, Heinz continues to drive category growth in convenience meals, including our new single serve snap pot beans and pasta hoops. Snap pots already contribute 6 points to our beans share and 75% of snap pots volume has been incremental to our base beans business.
We are now about 90% distribution with excellent repeat purchase rates making snap pots one of the most successful UK grocery launches this year. Another drive of our growth in Europe is the successful rollout of Weight Watchers branded products in a number of new markets across the continent.
We launched Weight Watchers big soups in Germany, Austria and Switzerland in the quarter which helped increase our sales of Weight Watchers products across Europe by more than 30%. Total Weight Watchers and Smart Ones sales worldwide are now more than $700 million on an annual basis as we continue to build on our advantaged position in weight management.
Meanwhile, in Poland, our Pudliszki brand continues its torrid growth rate, led by the very popular ready meals brand. During the quarter, Pudliszki grew 45%.
Turning to North America consumer products, Dave Moran and his team posted another quarter of great results. In the very competitive US and Canadian markets, the consumer products group has driven strong organic results for more than three and a half years.
Both the US and Canadian businesses are consistently generating top line growth as new products and strong sales execution are delivering real value to our customers and consumers. The Smart Ones brand in particular continues its strong performance in the US and Canada.
Smart Ones fruit inspirations launched during the quarter is ahead of plan in the US and our anytime selections varieties launched earlier this year, very strong as well. The relocation of Smart Ones deserts to the frozen meals isle in the grocery store has created an impactful cross selling opportunity that has dramatically increased sales of deserts.
Smart Ones in Canada, meanwhile, is driving the nutritional meals category as we continue to increase share since our launch last year. We are ahead of the launch expectations we set a year ago and have captured more than 14% of the market north of the border.
Ore-Ida, the leader in the US retail frozen potato market delivered another strong quarter with sales growth of over 19%. These results were driven by improved mix and the timing of our second announced price increase this fiscal year on french fries as we strive to keep up with escalating commodity costs.
Importantly, we completed the removal of all trans fats in Ore-Ida products during the quarter and increased marketing on our roasted potato varieties in line with the strategy to accelerate growth beyond fries. Looking north of the border again, Heinz achieved a record ketchup share in Canada at 81.2% in the quarter.
We expect to sustain this momentum by replicating the successful US ketchup category upsizing strategy accompanied by the rollout of the fridge fit bottle beginning this week. Looking east, our Asia Pacific segment posted 14% organic sales growth for the quarter and as we continue to drive excellent growth in the Pacific markets of Australia and New Zealand and in the Asian markets of Indonesia, China and India.
This is the 13th quarter in a row of organic growth in this segment. In Australia, our teams generated 23 quarters in a row of positive sales growth.
In Q3, sales growth was 35% reflecting broad based increases across the product portfolio. This growth was driven by our Cottee’s and Rose’s brands acquired earlier this year, which are performing ahead of expectations, favorable foreign exchange and continued organic growth in convenience meals including Heinz big eat and microwavable soups and new infant nutrition products like cook at home toddler pasta sauces.
In New Zealand, sales of the Wattie’s brand grew 17% for the quarter and grew 6%, volume grew 6%. Sales of steam fresh vegetables, a technology pioneered in New Zealand by Heinz several years ago, increased a very strong 39%.
The Wattie’s brand also enjoyed excellent growth in condiments, sauces and infant nutrition. Wattie’s is an iconic and growing brand in New Zealand and the total brand portfolio represents more than $0.06 out of every grocery dollar spent in that market.
Turning to key Asia markets, we achieved excellent growth in Indonesia, China and India under the strong leadership of Chris Warmoth and his team. Innovation and strong commercial execution in Indonesia drove the 32% sales increase led by the re-launch of our abc soy sauce.
Our long fong brand in China continued to be one of the fastest growing brands in the company with sales increasing 34%. The balance of our Chinese business grew strongly as well, based on another great quarter of growth in the infant nutrition business.
And in India, strong marketing and sales execution drove momentum in our Glucon-D energy drink and Complan nutritional beverages resulting in sales growth of 34%. We continue to expect these Asian emerging markets to be a major growth driver for the company going forward.
Finally, let’s move to the rest of the world segment. What that segment lacks in scale, it makes up for in growth under the guidance of Mike Milone and his team.
Rest of world posted the highest organic growth rate in the quarter, up 17.5%. As in other parts of the business, this represents the continuation of an excellent trend as ROW is well on its way to achieving its third year in a row of positive sales growth.
The growth in rest of world is being led by strong sales in Latin America, up 25% in the quarter, primarily driven by strong growth in infant nutrition. The new production line installed last quarter is already at full capacity and we’re currently evaluating several options for additional capacity to keep up with this strong demand.
While not large yet, our business in South Africa generated very strong growth in the quarter as well, up 22%. Now with that quick world tour, I hope you can see that our brands and businesses are very healthy.
The third quarter represented the 11th consecutive quarter of organic sales growth for the company and the fourth in a row at 5% or better on an adjusted basis. The quality of our earnings continues to be strong.
As I mentioned, we’ve increased consumer marketing spending at a double digit rate in six out of the last seven quarters. All of this growth at the top line is important because its generating some terrific results at the bottom line.
Our 8% increase in operating income in Q3 represents our tenth quarter in a row of positive OI growth, again after adjusting history for the 53rd week in 2006. I’ll now turn it over to Ed who will walk you through a more thorough update of the numbers for the quarter and year to date.
Ed.
Ed McMenamin
Thanks Art and good morning everyone. We are very pleased with our strong top line momentum, the returns from increased investments in marketing and innovation and our ability to sustain strong operating income growth.
As Art mentioned, we drove excellent results for the quarter with sales up almost 14%, operating income up 8% and EPS up 3% to $0.68, overcoming the 560 basis points increase in the [satch] rate. You can see that we continued to refocus our marketing investment, pulling an additional 70 basis points out of trade spending and redeploying it to consumer marketing, up another 16% this quarter.
Gross profit dollars were up 10% while gross margin was down 130 basis points as we incurred significant commodity cost increases. Our strong top line growth has been the main driver of our 8% increase in operating income.
Organic sales were up 8.6% this quarter and with 60% of our operations outside of the US, our diversified global portfolio has enabled us to benefit from foreign exchange to further enhance our growth. Now let’s take a deeper look at the income statement.
Gross profit increased 10% despite significant commodity cost pressure, powered by strong sales, continued focus on productivity improvements and favorable foreign exchange. As I mentioned before, marketing support was up 16%, an even higher rate than our strong top line growth while SG&A decreased 50 basis points as a percentage of sales.
Below operating income, net expenses rose $6 million in the quarter with net interest expense up $13 million, partially offset by gains on foreign currency contracts. The 8% growth in net profit before taxes translated to $219 million of net income, consistent with last year.
The higher effective tax rate, 31.6%, versus 26% last year had about a $0.06 impact on EPS for the quarter. The increase in the tax rate versus last year was primarily due to last year’s benefit from the reversal of the foreign tax reserves.
Our effective tax rate for this quarter was lower than our previous expectations due to favorable tax audit settlements for several of our foreign businesses. Looking forward, we expect our full year tax rate to be about 31% or slightly better.
And finally, our EPS growth benefited from a reduction in fully diluted shares outstanding of just over 3%. The overall sales increase was driven by very strong volume of 5.2%, pricing of 3.4% and foreign exchange of 5.3%.
Organic sales growth for the quarter was well ahead of our targeted growth rate and well ahead of the growth generated by many of our peers. Notably, we delivered this growth on top of 3.7% organic growth in the same quarter last year.
Net pricing was up 3.4% as price increases to offset commodity pressures added to the top line for all of our segments, with the exception of US food service, where we were down slightly due to promotional timing. Sales performance was up across the board.
Food service delivered almost 4% top line growth while every other segment was up double digits. I won’t spend a lot of time on this chart since our previously discussed our sales performance around the world and the components of our sales growth by segment are provided in the press release.
An important factor driving our top line growth has been increased investment in consumer marketing. For the quarter, we increased marketing investment by $13 million to support consumer driven innovation and our top brands.
Taking a bit broader view of Q3, we’ve increased third quarter marketing at a compound annual growth rate of almost 18% for the last two years which has helped drive compounded sales and operating income growth of around 9%. Clearly this investment is yielding results.
Gross profit for the quarter reached $935 million, up 10% this year on top of the 7% increase last year. Our ability to drive price, volume and productivity has enabled us to deliver solid profit growth despite the impact of commodities.
Taking a closer look at the cause of change for gross margin, our net price increase of 3.4% contributed 190 basis points to gross margin, while commodity and other inflation of about 9% reduced gross margin by 610 basis points. The cost of virtually all of our key ingredients increased, led by dairy, oils and grains, all up more than 25%.
Offsetting a portion of these increases was 260 basis points of productivity [unintelligible] to drive pricing up and to aggressively drive productivity initiatives to offset escalating commodity costs in the industry. Leverage of SG&A was an important tool in offsetting the commodity impact on gross margin and driving profitability for the quarter.
Excluding marketing expenses, our SG&A costs were 16.7% of sales, down 50 basis points from Q3 of last year and 100 basis points better than FY06, this despite double digit annual increases in R&D spending. We plan to continue to aggressively manage G&A while we have begun to ramp up the investment in task forces to strengthen our global capabilities and systems and we expect this to continue into fiscal 2009.
Turning to operating income, you can see that all of our operating segments were above prior year with the exception of food service. We drove strong double digit profit increases in North American consumer products, Asia Pacific and in the rest of world and posted an 8% increase in Europe.
The 13% growth in North American consumer products is primarily due to strong sales growth and productivity improvements, partially offset by heavy commodity cost and marketing expense increases. The increase in European profit reflects strong organic sales growth along with the benefits from foreign currency, partially offset by increased commodity and manufacturing costs, particularly in the UK and frozen businesses.
The 38% growth in Asia Pacific reflects excellent profit moment in Australia, Indonesia, China and India, aided by foreign exchange. The 11% growth in rest of world was largely driven by another great quarter of organic sales and profit growth in Latin America.
Operating income in US food service decreased 14% despite a good performance at the top line. This reflects the disproportionate impact from commodity costs which were partially offset with favorable commodity futures contracts.
The increase in non operating cost is primarily due to the investments in improved processes and systems that I mentioned earlier. Looking briefly at the balance sheet for the quarter, we drove an additional $1 billion improvement in cash conversion cycle and our capital spending as a percentage of revenue remained fairly flat at 2.6%.
Operating free cash flow of $186 million was $114 million better than last year, more than twice last year’s performance, aided by a reduction in tax payments. Now let’s take a very brief look at where we are through nine months.
The year to date P&L scorecard shows a continuation of our strong trends. Sales are up over 12%, operating income up almost 11% and EPS up nearly 10%.
Our sales growth is led by our top 15 brands, which are up almost 14% on a year to date basis and by our emerging markets where sales are up a very strong 23%. Operating income growth of 11% largely reflects our strong organic sales growth of over 7%.
Additionally, while it’s not shown on the scorecard, as a percentage of revenue, we’ve reduced SG&A costs net of marketing by 100 basis points which more than offsets the gross margin drop of 90 basis points related to higher commodity costs. Our EPS grew almost 10% despite the 190 basis point increase in the year to date tax rate.
Additionally, we have increased our investment in consumer marketing by 21%, R&D by 16% and have taken 80 basis points out of trade spending while delivering these strong results. The year to date balance sheet scorecard reflects an improvement of two days in the cash conversion cycle and an increase in ROIC of 100 basis points.
The improvement in CCC reflects better performance in payables and the higher ROIC was driven by base business improvements and the FAS 158 pension accounting change. Cash flow from operating activities was up over $80 million while operating free cash flow was down roughly $10 million from the prior year.
This was a result of $50 million more capital investment and $40 million less in proceeds from asset disposals. Looking forward to the full year, we are on target to deliver our commitment of approximately $825 million for the year.
Finally, net debt is up about 4% reflecting our share repurchases. As you’ll recall, we’re targeting $500 million in net share repurchases this fiscal year and we’re about 2/3rds of the way there through nine months.
With that, I’ll turn it back to Art who will comment on our full year outlook.
Art Winkleblack
Thanks Ed. Before we take your questions I’d like to make a few comments regarding our outlook for the balance of the year.
We expect to finish the year well ahead of the original projections that were part of the superior value and growth plan communicated back in June of 2006. We now forecast our sales to grow by at least 10% for the year and we have a shot at achieving $10 billion in sales for the first time in the company’s history.
In doing so we expect to invest approximately 15% more in consumer marketing than we did last year and over the 07-08 time period we anticipate exceeding our two year target of increasing marketing spending by $100 million. In thinking about our marketing spending in Q4 and remember that we are overlapping a 44% increase in consumer marketing in Q4 of last year.
We believe that operating income for the full year will be up a very strong 8-9%, even after the impact of commodity inflation, double digit increases in consumer marketing and R&D, the spending associated with SAP and our task forces to strengthen global capabilities. We expect EPS to grow by 9-10% versus last year which would put us in the $2.60-$2.62 range for the full year in line with our pre earnings release announcement.
Keep in mind that this forecast factors in an increase in the tax rate which we expect to be 31% [audio interrupt] slightly better for the full year. Finally, we expect to have another strong finish to the year on cash flow in line with our trends in prior years.
At $825 million, operating free cash flow will be about 8.3% of sales for the year. And in general, we’re looking to deliver on these full year targets and invest for a strong future going forward.
As we look forward to fiscal 09 and beyond, we’re bullish on the outlook for Heinz. We believe we have demonstrated that we have the brands, the people and the capabilities to drive strong growth.
We plan to share the final full year results with you on May 29th at our earnings release and will discuss our plans going forward at our investor conference in New York that day as well. Now with that, we will be happy to take your questions.
Operator
At this time I would like to remind everyone, in order to ask a question please press star followed by the number one on your telephone keypad. Your first question will be from the line of David Driscoll of Citi Investment Research.
David Driscoll – Citi Investment Research
Thanks a lot, good morning everyone. Well first off congratulations on a good quarter and a great start to the year.
Art I’d like to ask you about margins and pricing. So certainly the earnings is coming out where we’d like to see it but the margins of course have declined something about 80 basis points in the quarter.
Can you talk to us a little bit about the level of pricing and the level of productivity, AKA the offset that you would have to commodity inflation and where do you see these numbers trending going forward over the next couple of quarters? Should we see a continued ramp in pricing?
Art Winkleblack
Yeah I think what you’ve seen David is that we’re quite successfully getting pricing through the markets. It’s never an easy situation but I think we and the rest of our peers are certainly facing some very, very high commodity costs and as we sit down with our customers and talk through it we are successfully getting price through.
You’re seeing that pricing has ramped up over the last seven quarters or so as I mentioned. We would expect that pricing would continue to ramp up as required to as it relates to the commodity costs.
So this is very much commodity cost driven and as I mentioned, what we’re trying to do is drive for absolute dollar profit growth both in terms of gross profit and operating income as opposed to being overly concerned with the margins in the short term. Given the pressures of commodities that we have seen, we think that the best long term answer for both top line and bottom line growth is to price to almost cover commodities but not, certainly not go past that which would be required in order to hold the margin up.
David Driscoll – Citi Investment Research
Understand, one question on marketing in the emerging market. This has really been a tremendous growth story for the company.
Can you give us some outline as to what your marketing plans have been there? How much has marketing increased in those [audio interrupt] that?
Art Winkleblack
You know I think in general we’ve been increasing marketing at a higher rate in our emerging markets and in fact in many of our emerging markets, the percent of sales is higher than some of our other markets as well. So, we’re investing in those markets to drive growth.
You’ve seen we’ve got a very successful track record and we very much like those markets given the strong profitability and strong cash flow generation capabilities that they have in addition to the top line growth we’re getting.
David Driscoll – Citi Investment Research
And so your forecast would have no sign of letup in the very strong sales growth generation from those emerging markets?
Art Winkleblack
That’s correct and we’ll tell you more about the projections going forward in our May conference but we feel very good about our prospects for growth in those markets.
David Driscoll – Citi Investment Research
Great, thanks for all the comments.
Operator
Your next question will be from the line of Chris Growe of Stifel Nicolaus.
Chris Growe – Stifel Nicolaus
Good morning Art.
Meg Nollen
Hey good morning, welcome back.
Chris Growe – Stifel Nicolaus
Thank you, thank you. I just have two questions for you, the first one was, you had outlined a cost savings program that technically ends at the end of 08 here.
I presume there will be more to come on that front but can we be somewhat confident you’re going to have a good bit of cost savings coming through as a way of blunting the input cost inflation?
Art Winkleblack
Yeah, absolutely Chris. As you know we set forth pretty specific goals back in June of 2006 as part of the spirit, value and growth plan.
We are tracking ahead of all those productivity measures. So we feel very good about the track record over the last two years.
As we go forward we’re looking to increase the pace of that productivity based on the task forces we have in place. I think Bill has talked to you and I’ve talked to you historically about the supply chain task force that we have in place and some of the work on global processes and systems along with SAP that we’ve got going.
So, we’ve got a number of global initiatives underway to you know continue and maintain and strengthen our productivity initiatives.
Chris Growe – Stifel Nicolaus
Okay and I assume we’ll hear more about that in May I presume?
Art Winkleblack
That’s right.
Chris Growe – Stifel Nicolaus
Okay and then second question was just, relative to the US soup service division and you had mentioned some weak traffic and I was surprised to see on a year over year basis at least pricing down. Volume growth certainly picked up which is encouraging but it would seem like there’s some real pricing required for that division.
Is that ahead and what led to that weaker pricing in this quarter?
Art Winkleblack
We had a pretty active promotional calendar within the quarter and I think you saw that we drove some pretty nice volume there. We also had a bit of a mix change.
You saw strong desert performance along with that bundled or complete meal solution that I talked about. You saw strong soup performance as well.
You know the good news is our ketchup continues to perform well also. But you know it’s not an easy pricing environment in the food service industry right now given the economy.
Chris Growe – Stifel Nicolaus
Okay, great, thanks a lot.
Operator
Your next question is from the line of Todd Duvick of Bank of America.
Todd Duvick – Bank of America
Yes, good morning, got just a couple of real brief questions. One has to do with kind of the capital structure.
Your performance has been very strong over the last couple years and I’m just wanting to know in terms of your capital structure, are there leverage metrics that you’re managing to and how are you looking at things like share repurchases and acquisitions going forward.
Art Winkleblack
Yeah, one of the key metrics that we follow is net debt to EBITDA and we look to make progress on that. We have made progress over history even with the fact that we have one of the highest dividend yields or payout ratios in the industry and we’ve shared our cash with investors you know as appropriate.
In fact this year we’re heading toward a share repurchase of $500 million. That’s pretty consistent with the prior year and I think might have even been higher in past years.
So we have you know I think managed the balance sheet very carefully. I’ll probably reserve comment on the go forward capital structure and we’ll unveil that in May, the May discussion that we have.
But we understand how important dividends are to our investors and we look to drive an appropriately, positioned capital structure in order to optimize shareholder return.
Todd Duvick – Bank of America
Okay and just one other follow up question. With respect to debt specifically you’ve got a $300 million note that I believe is coming due next month and I would assume that you’re going to refinance that either with commercial paper and then maybe look at the capital markets at some point?
Art Winkleblack
Yeah I think that’s pretty well but we’ve got adequate cash to handle that and we’ve certainly got access to the commercial paper market but we could be looking at financing somewhere later on in the year.
Todd Duvick – Bank of America
Okay very good, thank you.
Operator
Your next question will be from the line of Terry Bivens of Bear Stearns.
Terry Bivens – Bear Stearns
Good morning, can you guys hear me? Good morning all, a few questions Art, first of all, you singled out the Italian baby food business in the remarks to a great extent, can you give us a brief update on how that business is performing?
Art Winkleblack
Yeah Terry, Italy is doing quite well. We’re doing I think very well in the biscuit arena and in a number of products in a number of channels.
I would say the battle ground remains in the jarred baby food arena where it’s still a very tough and competitive market with [Numico] there. So you know we posted a strong performance for the quarter.
We like where the business is trending, that will be interesting to see now that [Denome] has acquired [Numico] but that changes in that market but we are moving ahead on very strong marketing. We’ve got products in the specialty arena that are doing well and some of milk products are doing well as well.
But you know the main competitive battle ground appears to be in the jarred area and we continue to innovate to take it to be a consumer battle.
Terry Bivens – Bear Stearns
Down at CAGNY, Conagra mentioned I think what was interpreted as maybe backing off a little bit of the very strong motion in frozen, Healthy Choice specifically. Have you guys seen any evidence of that as yet?
Art Winkleblack
Yeah, you know Dave Moran would be probably better to comment on it but I think that we haven’t seen maybe quite the same degree of promotional depth on pressure in the markets but you know it remains a great category. The category has grown, we continue to grow share, we’re very pleased with the results there and our team continues to innovate strongly to drive the market.
Terry Bivens – Bear Stearns
Okay and one last thing, I think this kind of gets back to what Todd was asking but you know, as the performance continues to do very well, for whatever reason you know food stocks haven’t performed especially well lately. Is there, do you think investors should look to any particular Board pressure coming for a higher rate of share repurchase?
Art Winkleblack
I wouldn’t say so necessarily Terry. I think we balance lots of factors as we think through the approach to our capital structure.
One as you know, we very much like being an investment grade company. We will manage to that.
And so you know we will give you a better feeling for the balance of share repurchase and dividends as we go forward but we’ll always be keeping in mind the concept of investment grade credit rating. And in terms of food stocks, you know the good news is that Heinz has been leading the industry if you look at a number of our, the timeframes, one, three, five, ten years, I think The Wall Street Journal came out with an article yesterday that showed Heinz performance over a lot of different timeframes and the Heinz stock has performed quite well within the industry.
Terry Bivens – Bear Stearns
Okay, thanks very much.
Operator
Your next question will be from the line of Alexia Howard at Sanford Bernstein.
Alexia Howard – Sanford Bernstein
Hello there. Great, a couple of quick question, firstly on marketing.
There’s obviously been a step up in marketing as a percent of sales over the last couple of years. Where do you, given the percentages are now around about 3.5, 3.7% of sales, is it [step up] but it’s still a little bit lower than the rest of the peer group.
Obviously you have a significant proportion of food service which obviously needs a lot less marketing behind it. But how do you think about what the path forward from here is in terms of stepping up the marketing spending?
Art Winkleblack
Yeah I think you know the beauty of the Heinz portfolio now that we’ve done the hard work of pruning the portfolio over the last number of years is that we have a very focused portfolio, top 15 brands represent about 70% of our sales. And so our spending can be quite focused.
As you say, we have increased marketing significantly, we would look to continue to increase marketing going forward but only to the extent that we have the ideas and the people to effectively spend the money and you’ve seen where we spent the money we’ve gotten very good returns. We do anticipate continuing to step up marketing going forward, we will talk further about that in May but you know it’s always behind our key brands and it’s behind great ideas.
Alexia Howard – Sanford Bernstein
Okay great and one other quick one. The European margin were obviously down this quarter and I think there was a comment in the press release that part of that was increased manufacturing costs in the frozen business over there.
Is that likely to persist? Is that something that’s likely to with us for some time or was that from one off a factor?
Art Winkleblack
Well I think there was a little bit of you know, a little bit of manufacturing cost, probably more unfavorable than maybe some of the other quarters. We do anticipate continuing high commodity cost increases there so that’ll continue to be something we manage.
But with Scott O’Hara and his team, they have done I think an exceptional job of accelerating the growth momentum at the top line across all the markets and that really is the game that we’re very excited about, healthy and nutrition, convenience, a lot of good strong innovation. We see that pipeline very full and continuing into next year.
So we, while the cost pressure will certainly be there, we believe we’ve got the growth and the productivity initiatives to grow the bottom line quite well.
Alexia Howard – Sanford Bernstein
Thank you very much.
Operator
Your next question will be from the line of Eric Serotta of Merrill Lynch.
Eric Serotta – Merrill Lynch
Good morning. You guys have shown some pretty nice SG&A leverage or SG&A ex marketing leverage this year and over the past few quarters.
I’m just wondering if you could give us a bit of an update on how much leverage is left to be realize, how low can you go on non marketing SG&A as a percent of sales? A lot has changed since mid 06 and I’m sure you’ll address this more in May but could you give us a little bit of a sneak peek now given the investments behind the task forces and the like?
Art Winkleblack
Yeah, over time I think we’ve got room for further productivity improvement over time. You know the reality is we have a very global organization that has administrative pods and things like that in lots of places and so as we think about going forward I think there are a number of productivity initiatives we can get after.
It will take some money to get there, we’ve got a number of task forces ongoing and I think one of the key things that we are looking forward to doing is the continuing rollout of SAP which will give us better visibility and the ability to get very productive and very efficient in our back office operations. So you know the task forces are hard at work in determining how big is the prize in that arena and we’ll continue driving down that path.
So we’ve also got some good initiatives in the distribution arena to offset some of the fuel cost upcharges that we’ve got as well. So, anyway, as you look at it I think we’re excited about it, we’re looking to grow SG&A obviously at a slower rate than our top line and so we should continue to get leverage.
Eric Serotta – Merrill Lynch
Great and then a quick follow up on a different subject on commodities. Last week at CAGNY some companies who are on sort of midyear fiscal years or [unintelligible] fiscal years, they did some commentary regarding what they were looking for in terms of overall commodity inflation for calendar 08 or at least their coverage on hedge-able commodities for the calendar year.
Could you give us an update on that?
Art Winkleblack
Yeah I think we’re just finalizing the annual operating plan for next fiscal year, as you know that starts on May 1 so you know we’re in that process, we want to share that with our Board before we share it much more broadly but what I will say is we do not anticipate any reduction in the rate of growth on commodities. We certainly hope the commodities would be better than that but we’re not counting on it.
We’re still seeing continued commodity cost inflation. We’re confident we’ve got it covered through pricing, productivity, volume growth, et cetera.
But we do anticipate it to continue and as always we’ve got some of it covered looking forward where we can do that.
Eric Serotta – Merrill Lynch
Okay, care to give any rough percentages on that at this point?
Art Winkleblack
You know, not at this point Eric [overlay].
Eric Serotta – Merrill Lynch
[Overlay] was going to try to, I’ll pass it on.
Art Winkleblack
Sorry not to be more thorough but I do really want to finish up the annual plan and then we’ll be very clear and open with you as we go forward.
Eric Serotta – Merrill Lynch
Great, thanks a lot Art.
Operator
Your next question will be from the line of Ann Gurkin at Davenport.
Ann Gurkin – Davenport
Couple of things, can you give us what you’ve imbedded in your 08 outlook for oil prices and then 09, hello?
Art Winkleblack
Yeah, hi Ann, yeah you know in terms of oil prices, we here again, we don’t anticipate much of a change in that. We’d love to think that it would come down but we’re certainly not going to count on it.
Ann Gurkin – Davenport
So you have $100 oil in your 08-09 forecast right now?
Art Winkleblack
That’s roughly probably about right.
Ann Gurkin – Davenport
Okay and then can you just review prospects for Russia over the next 12-18 months?
Art Winkleblack
Yeah, we’re quite excited about business in Russia. The Heinz brand in particular is doing extremely well so that growth is ahead of our plan expectations.
Infant nutrition is doing quite well. You know we’re focusing the portfolio, we’re building our marketing spending, we’ve got a leading market share position in ketchup in the two major cities of Moscow and St.
Pete and we’re looking to expand that further. We’ve got a new strong leader there and he’s off to a great start and we’re just really excited about the business and the team there.
Ann Gurkin – Davenport
Great, thank you.
Operator
Your next question will be from the line of Eric Katzman of Deutsche Bank.
Eric Katzman – Deutsche Bank
Hi, good morning everybody. I guess Art my first question has to do with foreign currency.
Did you say how much contribution that made to both EBIT and to the bottom line?
Art Winkleblack
It’s in the, I think it’s separated out in the press release in terms of the top line, it’s about 5, 5.3% for the quarter. That would be roughly right at OI, Eric and as we think about it, the impact of foreign exchange has been positive and that’s a good thing and it’s powered by our strong global portfolio so we like that and we think we’re well positioned there.
You know, having said that I think the commodity headwind was probably three to four times that level of impact going to opposite direction. So it’s helped but you know it’s certainly not offsetting the commodity inflation.
Eric Katzman – Deutsche Bank
So the 5% OI contribution, is it fair to just kind of drop that down to the EPS line or?
Art Winkleblack
Well if you want to drop the commodity costs down to the bottom line at four times that, you know I don’t know how you’d want to look at it, but the way we look at it is we are managing all the good things and the bad things to drive very strong top line and very strong bottom line.
Eric Katzman – Deutsche Bank
Okay and then on a separate topic, maybe I think following up on Eric Serotta’s line of questioning, in terms of the input cost environment. I mean if I remember correctly, historically when you have let’s say high cost ketchup or high cost potatoes that’s actually been beneficial to your business because it’s limited the ability for private label to actually get raw material to compete with you.
What, how does, is inflation more of an energy, packaging, transport type of thing or is it more raw material related and how does your kind of input cost basket relate to that?
Art Winkleblack
Yeah I think we’re seeing the increased cost across the board you know in terms of packaging materials, in terms of raw materials, agricultural products, all those costs are up. You know with the cost of fuel and the bio-fuel thing, et cetera, et cetera.
So you know all of those costs are up. I think given the brand strength that we have and the strong position that we have in the market, you know we are in a great position to weather through that storm, probably in a better position than folks that have the number three or four or five brand in a particular category.
So it’s, the cost inflation is real, it’s across the board but I think we are well positioned to handle it.
Eric Katzman – Deutsche Bank
Okay and then the last question, I’ll pass it on and maybe this is more appropriate for Bill, but is, I mean the company has obviously grown in the last few years as a percentage coming from outside the US, the growth in developing markets is doing very well in driving the business along with good US results for that matter but I’m just kind of wondering, is Bill, I mean is he still, in terms of the responsibilities, is he still Chairman, CEO, President, you have no COO, is that right?
Art Winkleblack
That’s correct Eric, absolutely. Chairman, President and CEO and driving some great results.
Eric Katzman – Deutsche Bank
Well maybe it’s a, it just seems to me that if there’s one risk out there it’s that there’s, as the business becomes you know more global and more complex and more reliant upon growth in these outer markets that there needs to be more, I don’t know, kind of delegation or whatever it is because you know it just seems it’s hard for with that kind of complexity, you know for something not to slip or come up unexpected. So I don’t know, maybe I’m just, maybe it’s a topic to discuss at the next meeting but it seems to me that if there’s one risk that’s out there, that could be it.
Art Winkleblack
I think we’re in very good shape on that Eric. The reality is our Board takes that responsibility very seriously, we take it very seriously and I think we’ve got extremely strong talent and as I’ve mentioned I’m just very pleased with the talent and the team that we have in place.
We’ve got a very good bench and we’ve got strong leaders in each one of our four key markets. They’re very seasoned leaders and so I you know, I just view it as we’re in a great position and you know on Bill’s leadership, this organization has come a long, long way in the past few years, as you know.
We’re in a good place and we feel confident about the future.
Eric Katzman – Deutsche Bank
Okay, I’ll pass it on.
Meg Nollen
Hey Eric, it’s Meg, I just wanted to let you know, talent has become quite a competitive advantage for Heinz and we continue to build that out. So both with Chris Mormonth and Mike Milan and their teams, there’s a lot of strength and Bill is very involved but everyone’s, it’s a very strong team.
Eric Katzman – Deutsche Bank
Well I know the numbers obviously speak to that over the last two years but it just, you know I think maybe other than Wrigley you’re probably the most global company that most US analysts follow and yet you know and I know you’ve kind of sent out the various, I forget what you call them, but various lines of response of these that are a little bit broader that is just seems to me that it’s, that there’s maybe a, there’s more need for more direct lines of responsibility in between the operating heads and the below and Bill.
Art Winkleblack
Yeah, I appreciate the point, we feel like we’re in a very good spot on that and we’ve got great talent with very clear accountability.
Eric Katzman – Deutsche Bank
Alright, thank you.
Operator
Your next question will be from the line of Bob Cummings of [Sheils] & Company.
Bob Cummings – [Sheils] & Company
Hi everybody. Following up on the question of foreign exchange, as a US based company reporting in US dollars with very substantial international businesses, obviously gives a nice boost to your numbers, I’m just wondering what your strategy is in managing net benefits of earnings, on other words, are you able to reinvest some of those funds in increased marketing as a result of the foreign exchange benefit or is it simply just flowing through to the bottom line?
You know as a US company you might have advantages over companies that are reporting in say Deutsche Marks or other currencies.
Art Winkleblack
Yeah, no I understand your point Bob and I think to your point we are investing heavily back in the business. We, as you know, we’ll increase marketing spending by more than $100 million over a two year timeframe.
We’re growing R&D at double digit rates. We are investing behind our global task forces to you know to really gain true leverage of our scale and so you know I think we are managing all the levers appropriately to optimize for the short and long term here and that’s the key as we’re looking to, as we’ve ramped up the top line growth rate, we’re very pleased with that and we’re looking to continue that and so the investment in the business I think is a big part of that.
And you know the great part about the Heinz portfolio is about 60% of our sales outside the US is that we have nice and very strong and solid profitable positions in a number of those fast growing markets. So, set aside currency, those markets I would certainly say are going to be growing at a lot faster rate than many of the developed markets around the world.
Bob Cummings – [Sheils] & Company
Great, thank you.
Operator
Your next question will be from the line of Robert Moskow of Credit Suisse.
Robert Moskow – Credit Suisse
A couple of questions, one is a follow up to Eric Katzman’s which I thought was a good one. Will SAP, you mentioned that it’s going in administrative pods I think you’ve called it, will SAP globally help you at headquarters in Pittsburg consolidate information faster and on similar terms so you can make decisions better?
And then the second question is on you know your ability to take pricing in Europe I would imagine depends a lot on what private label is doing and I have no visibility on what private label is doing in Europe, so can you tell me, is that really what’s happening? I seen it’s happened here in the US with private label taking pricing, you mentioned competition is taking pricing, is that what’s happening in Europe and in the UK?
Art Winkleblack
Yeah let me take the first question first Rob. In terms of the decision making, SAP absolutely will be a benefit there.
As you know, you know the decision making, a lot of it is very well pushed down into the markets, we empower our managing directors in the businesses to make decisions but it certainly will help us with internal benchmarking and understanding the businesses and understanding the trends on a real time basis to have SAP. You know we just completed very successfully the SAP rollout in Poland, we finished our frozen business, most of the frozen business just very recently, that’s gone without a hitch so we’re pleased with that.
We’re continuing to rollout SAP further in Europe next year, so we’re excited about that. The prospects not only from the systems side of it but from the process discipline side of it, because that’s the key, as you get the processes right, then you put SAP in to automate those processes.
Turning to pricing, in Europe yeah we are getting pricing. We have not seen growth, any disproportionate growth in private label, the reality is that they have the same kind of pricing pressure as we do if not more and so you’ve seen quite a bit of pricing there and so I think probably similar to what a lot of our peers said at CAGNY, we’re not seeing any great resurgence or anything in private label at this point.
Robert Moskow – Credit Suisse
Does your team give you updates on price gaps to private label in Europe so you can see whether you’re maintaining the right gap?
Art Winkleblack
Yeah, I mean as you would imagine, we manage and stay very attuned and close to the markets and understand the key issues so it’s market by market but you know to the earlier conversation, we do not dictate policy from Pittsburg, the managing directors manage their businesses.
Robert Moskow – Credit Suisse
Thank you very much.
Meg Nollen
Sorry, I was just going to add in there for you, same formula in Europe that we’ve got going on in North America and really throughout the company which is one of innovation and value add so as we’re pricing, we’re also differentiating to the consumer and so they’re willing to pay for that.
Art Winkleblack
Yeah, that is a key point because over time the pricing and any price gap that you have will only be justified by your ability to bring great ideas and bring innovation and strong brands and so I think Meg’s right, that has been a key for our success and we expect to continue that way.
Meg Nollen
We’ve got time for a couple more.
Operator
Your next question will be from Pablo Zuanic of J.P. Morgan.
Pablo Zuanic – J.P. Morgan
Very quick here but just on the marketing spending front, okay you know it’s 3.6% of sales but it’s obviously [unintelligible] results, where do you think there’s room to increase that more [unintelligible], I mean is Europe below the company average and North America above? I mean in the third quarter was the spending more loaded in Europe than North America, that would help just to have an idea of where marketing may go.
Art Winkleblack
You know I think we’re looking to invest in marketing everywhere and again behind good ideas. A lot of our innovation this year has come in Europe.
You’re seeing strong volume growth there as a result so we have increased marketing spending probably more in Europe this year than any of our other divisions and but you know having said that behind great ideas in every one of our segments, we would certainly look to increase the marketing investment. And we talked about emerging markets being a key target for us in that regard as well.
Pablo Zuanic – J.P. Morgan
Okay and just a quick follow up on emerging markets and maybe we’ll hear some more from investor day but you know when I hear companies talk about China and other markets, sometimes they talk about products they sell there where they have a very small market share in a very fragmented market, so the potential is there but they are a very fragmented market. I understand that [unintelligible] Poland and other markets you have robust market share but could you very briefly on just give us an idea about in emerging markets you know the type of penetration you have.
Is it fair to say that it’s a very fragmented market or you have really very robust share in some of those markets?
Art Winkleblack
Well I think we’ve got quite robust shares, I mean if you look at infant nutrition, we’re the number one player in the cereal category, looking to get bigger in some of the other categories of infant nutrition there. Our long fong frozen business is probably the number on player there as well.
Now the good news is to your point, it is still quite a fragmented market and that we view as spelling opportunity. There’s just opportunity to grow not only with the category but I think to gain share over time as well.
So we’re in a good spot and as I’ve mentioned before, we’re profitable, economic profit positive, cash flow positive and so these are businesses we’re investing in and they are generated a nice return for shareholders.
Ed McMenamin
On your marketing question I mean Europe is spending more than North American segment, but North America, if you recall, last year Europe increased its spending throughout the year. This year the increase is more pronounced in North America than it is in Europe.
Pablo Zuanic – J.P. Morgan
Alright, thanks and just one last one for Art, the 31% tax rate guidance, is that just for the fourth quarter or is that also for 09?
Art Winkleblack
No that’s for our full year this year, the roughly 31% is for this year. We’ll talk further about the tax rate for 09 and beyond next year.
But you know, I wouldn’t worry about that, we view our growth prospects as very strong at the EPS line, so we don’t view tax as something that’s going to be a problem.
Pablo Zuanic – J.P. Morgan
Alright, thank you.
Meg Nollen
Yeah we can work on this one offline, but if you just look at the math from the prior quarters, the tax rate in the fourth quarter will be higher.
Art Winkleblack
Probably in the 33-34% range.
Pablo Zuanic – J.P. Morgan
Alright, thank you.
Operator
Your final question will be from the line of Andrew Lazar of Lehman Brothers.
Andrew Lazar – Lehman Brothers
Good morning. Just two quick ones, one, trade spend efficiency continues to be very solid and as you saw in this quarter as well.
How do we want to think about the opportunity left there as we go into 09 and beyond? Is that still sort of going to be, I mean if there was something you were doing but is there a lot more left there and is it more Europe or North American based?
And then second would be, volumes have still been quite strong even this quarter with the pricing, but sequentially in North America and Europe they did come down as pricing ramped up relative to the second quarter. I’m just curious what the level of confidence is as you continue to price from here and sort of the volume picture as you go forward.
Art Winkleblack
Yeah, in terms of trade spending as you know we’ve made just great progress in trade spending over the past few years and we continue to make it this year. So I think they’ll be less progress to make there over time.
Having said that, you know the effectiveness and the efficiency of trade spending is one of the key challenges of any consumer products business so we will continue to focus on that, we’ll continue to improve our process capabilities, our talent that is looking at it and our systems. So it will continue to be a focus for us in terms of reducing trade spending as a percent of gross sales I would say it’s you know probably less of a reduction going forward certainly but it’ll continue to be a major focus for us mainly from an effectiveness standpoint and trying to grow volume and the top line you know and optimize that.
In terms of looking forward, as you saw we’ve taken pricing, we need to take pricing in this commodity environment and at this point we are balancing organic sales growth. The combination of volume and price and so you know you saw that our volume grew in Q3 more than 5% which we’re very pleased with.
You know going forward we’ll continue to balance between those two, the pricing and volume lever and I’m not sure I’d get real specific on quantification at this point but we feel good about where we are coming out for the full year, we’re setting up nicely for next year and we’ll fill you in more in May.
Andrew Lazar – Lehman Brothers
Thank you.
Operator
And there are no further questions at this time, I will turn the call back to management for closing remarks.
Art Winkleblack
Okay, great, thanks, let me just make a couple of closing comments. Thanks for your interest in Heinz, in closing we’re delivering on our commitments and believe that we’re poised to sustain strong momentum into FY09.
We’ll continue to follow our winning formula of consumer validated innovations, supported by effective marketing, increased capabilities and productivity, which are all made possible by our great people. We’ll have more to share with you as we’ve said on the call here in May and here’s Meg with just a couple final pieces of information.
Meg Nollen
Thanks Art, as many of you know we lost our venue for our March 19th meeting that we talked about previously and given the Easter holidays and Spring Break season, yearend timing became a problem, so as a result we’ve reverted to our year end schedule, we sent the data out recently, hosting our analyst date on May 29. It will be at the Sofitel Hotel in New York, but in the meantime we’re planning an aggressive calendar of marketing between now and then and hope to see many of you soon.
So with that, have a great day and we look forward to seeing you in May if not sooner.
Operator
Thank you for participating in today’s H.J. Heinz Company conference call.
This call will be available for replay beginning at 10:30 AM Eastern time today, through 11:59 PM Eastern time on Tuesday, March 4, 2008. The conference ID number for the replay is 34301126.
Again, the conference ID number for the replay is 34301126. The number to dial for the replay is 1-800-642-1687 or 706-645-9291.
Thank you, you may now disconnect.