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| HNZ > SEC Filings for HNZ > Form 10-Q on 20-Aug-2009 | All Recent SEC Filings |
20-Aug-2009
Quarterly Report
Executive Overview
The global recession has dramatically affected consumer confidence, behavior, spending and ultimately food consumption patterns. The Company has adapted its strategies to address this difficult environment, with a concentration on the following:
• Investing behind core brands and proven ideas to drive growth;
• Shifting investments in marketing and research and development toward delivering value to consumers;
• Continuing its focus on emerging markets where economic growth remains well above the global average;
• Increasing emphasis on margins through productivity initiatives, reductions in discretionary spending and tight management of fixed costs; and
• Increasing cash flow with a focus on reducing inventory and tight management of capital spending.
During the first quarter of Fiscal 2010, the Company reported diluted earnings per share of $0.67, compared to $0.72 in the prior year. The decrease in EPS resulted from the precipitous decline in foreign currency translation rates versus the U.S. dollar that occurred during Fiscal 2009. Given that approximately 60% of the Company's sales and the majority of its net income are generated outside of the U.S., foreign currency movements can have a significant impact on the Company's financial results. Excluding the impact of foreign currency movements on translation and particular transactions such as inventory sourcing, our key financial performance measures of sales, operating income and EPS all experienced growth versus prior year. While we expect Fiscal 2010 results to be impacted by unfavorable foreign currency rates and commodity input costs, the Company remains confident in its business fundamentals and plans to continue executing its strategy.
Results of Operations
Sales for the three months ended July 29, 2009 decreased $115 million, or 4.5%, to $2.47 billion. Foreign exchange translation rates reduced sales by 9.0%, reflecting the impact of a stronger U.S. dollar on sales generated in international markets compared to the first quarter of the prior year. Net pricing increased sales by 6.0%, largely due to the carryover impact of price increases taken in Fiscal 2009 across the Company's portfolio to help offset increased commodity costs. Volume decreased 4.3%, as favorable volume in emerging markets was more than offset by declines in the U.S. and U.K. businesses, which have been impacted by the recessionary economic environment. Emerging markets and our Top 15 brands continued to be important growth drivers, with combined volume and pricing gains of 13.6% and 2.2%, respectively. Acquisitions, net of divestitures, increased sales by 2.9%.
Gross profit decreased $60 million, or 6.4%, to $874 million, as higher net pricing and the favorable impact from acquisitions was more than offset by a $79 million unfavorable impact from foreign exchange translation rates as well as higher commodity costs, including transaction currency costs most notably in the U.K., and lower volume. The gross profit margin decreased to 35.4% from 36.2%, as pricing and productivity improvements were more than offset by lower margins on recent acquisitions and increased commodity costs, which includes the impact of cross currency sourcing of inventory, most notably in the U.K. In addition, gross profit was unfavorably impacted by $7 million from targeted workforce reductions and non-cash asset write-offs related to a factory closure.
Selling, general and administrative expenses ("SG&A") decreased $34 million, or 6.2%, to $508 million, and improved as a percentage of sales to 20.6% from 21.0%. The $34 million decline reflects a $45 million impact from foreign exchange translation rates and the Company's focus on tight cost control, partially offset by $9 million related to targeted workforce reductions in the current year, increases from acquisitions, inflation in Latin America, and a prior year gain on a small portion control business in the U.S.
Operating income decreased $26 million, or 6.7%, to $366 million, reflecting the items above, particularly a $35 million (8.9%) unfavorable impact from foreign exchange translation rates, higher commodity costs and $16 million of charges for targeted workforce reductions and non-cash asset write-offs related to a factory closure.
Net interest expense decreased $9 million, to $54 million, reflecting an $8 million increase in interest expense and a $17 million increase in interest income. Interest expense increased largely due to the higher coupon on the dealer remarketable securities which were remarketed on December 1, 2008, partially offset by lower average interest rates on the remaining debt portfolio. The improvement in interest income is due to a $20 million mark-to-market gain in the current period on a total rate of return swap, which was entered into in conjunction with the Company's remarketable securities on December 1, 2008. This swap contract was terminated in August 2009 subsequent to the end of the first quarter (see Note 13, "Derivative Financial Instruments and Hedging Activities" for additional information). Other expenses, net, increased $3 million primarily due to increased currency losses.
The effective tax rate for the current quarter was 28.5% compared to 28.2% last year. The current quarter effective tax rate benefits from tax planning implemented during the third quarter of Fiscal 2009. The prior year first quarter effective tax rate reflected a discrete benefit resulting from the tax effects of law changes in the U.K. of approximately $11 million.
Net income attributable to H. J. Heinz Company was $213 million compared to $229 million in the prior year, a decrease of 7.2%. The decrease is due to unfavorable foreign exchange rates and $12 million in after-tax charges ($0.04 per share) for targeted workforce reductions and non-cash asset write-offs, partially offset by reduced net interest expense. Diluted earnings per share was $0.67 in the current year compared to $0.72 in the prior year, down 6.9%.
The translation impact of fluctuating exchange rates in Fiscal 2010 has had a relatively consistent impact on all components of operating income on the consolidated statement of income. The impact of cross currency sourcing of inventory, most notably in the U.K., reduced gross profit and operating income but did not affect sales.
North American Consumer Products
Sales of the North American Consumer Products segment decreased $14 million, or 1.9%, to $727 million. Net prices grew 5.4% reflecting the carryover impact of price increases taken across the majority of the product portfolio in Fiscal 2009 to help offset higher commodity costs. Volume decreased 4.9% as increases from the new TGI Friday's® Skillet Meals and snacks were more than offset by declines in Heinz® ketchup and Smart Ones® and Boston Market® frozen products. The decline in Heinz® ketchup is a result of reduced promotions and increased competitor promotional activity. The Smart Ones® decrease was due to softness in the category and the timing of price increases, and Boston Market® products were affected by aggressive competitor promotions. Unfavorable Canadian exchange translation rates decreased sales 2.4%.
Gross profit increased $9 million, or 3.1%, to $310 million, and the gross profit margin increased to 42.6% from 40.6%, as increased pricing and productivity improvements more than offset increased commodity costs, the impact from unfavorable volume and unfavorable foreign exchange translation rates. Our disciplined approach to promotional programs on our key brands has underpinned our improved margin and absolute dollar gross profit and operating income growth. Operating income
increased $16 million, or 9.6%, to $184 million, reflecting the improvement in gross profit, reduced selling and distribution expenses ("S&D") and decreased general and administrative expenses ("G&A"), partially offset by increased marketing investment. The improvements in S&D and G&A were a result of tight cost control and reduced fuel costs.
Europe
Heinz Europe sales decreased $129 million, or 14.1%, to $789 million. Unfavorable foreign exchange translation rates decreased sales by 17.1%. Net pricing increased 5.1%, driven by the carryover impact of price increases taken in Fiscal 2009 as well as reduced promotional activity on Heinz® ketchup, beans and soup and frozen products in the U.K. Volume decreased 4.3%, principally due to Heinz® beans, soup and pasta meals as well as frozen products in the U.K., all of which reflect reduced promotions along with increased competitor promotional activity. Volume improvements were posted on Pudliszki® branded products in Poland, soups in Germany, and ketchup and infant feeding products in Russia. Acquisitions increased sales 2.2%, due to the acquisition of the Bénédicta® sauce business in France in the second quarter of Fiscal 2009.
Gross profit decreased $73 million, or 20.4%, to $284 million, and the gross profit margin decreased to 36.0% from 38.8%. The decline in gross profit is largely due to unfavorable foreign exchange translation rates, the cross currency rate movements in the British Pound versus the Euro and U.S. dollar, increased commodity costs, lower volume and decreased capacity utilization to reduce inventory levels in the U.K. and Netherlands. These declines were partially mitigated by higher pricing, productivity improvements and the favorable impact from acquisitions. Operating income decreased $31 million, or 19.8%, to $126 million, reflecting unfavorable foreign currency translation and transaction impacts.
Asia/Pacific
Heinz Asia/Pacific sales increased $11 million, or 2.5%, to $469 million. Unfavorable exchange translation rates decreased sales by 12.0%. Pricing increased 4.1%, reflecting current and prior year increases on ABC® syrup and sardines in Indonesia as well as reduced promotions and the carryover impact of prior year price increases in New Zealand. Volume decreased 2.2%, as significant growth in Complan® and Glucon D® nutritional beverages in India and ABC® syrup in Indonesia were more than offset by declines on Long Fong® frozen products in China and general softness in both Australia and New Zealand, which are being impacted by competitive activity. Acquisitions increased sales 12.7% due to the prior year acquisitions of Golden Circle Limited, a health-oriented fruit and juice business in Australia, and La Bonne Cuisine, a chilled dip business in New Zealand.
Gross profit decreased $10 million, or 6.3%, to $147 million, and the gross profit margin declined to 31.4% from 34.3%. The decline in gross profit is due to unfavorable foreign exchange translation rates, increased commodity costs, which include the impact of cross-currency rates on inventory costs, and unfavorable volume, particularly in our Long Fong® business where we revised our distribution system and streamlined our product offerings. These declines were partially offset by higher pricing. Acquisitions had a favorable impact on gross profit dollars but negatively impacted gross profit margin. Operating income decreased by $13 million, or 19.9%, to $53 million, primarily reflecting the decrease in gross profit and increased S&D, largely related to acquisitions.
U.S. Foodservice
Sales of the U.S. Foodservice segment decreased $7 million, or 2.0%, to $347 million. Pricing increased sales 5.6%, largely due to the carryover impact of prior year price increases on Heinz® ketchup, portion control condiments, tomato products and frozen soup as well as decreased promotional spending on portion control condiments. Volume decreased by 6.0%, due to declines in ketchup and frozen soup, desserts and appetizers. The volume reflects softness in the U.S. restaurant business, promotional timing and increased competition on our non-branded products. Divestitures reduced sales 1.6%.
Gross profit increased $9 million, or 11.0%, to $88 million, and the gross profit margin increased to 25.4% from 22.5%, as pricing and productivity improvements more than offset unfavorable volume and decreased capacity utilization to reduce inventory levels. Operating income increased $6 million, or 25.0%, to $31 million, which is primarily due to gross profit improvements and reduced S&D reflecting distribution network upgrades last year. In addition, Fiscal 2009 operating income was affected by a gain on the sale of a small, non-core portion control business which was partially offset by costs to streamline the business.
Rest of World
Sales for Rest of World increased $23 million, or 20.9%, to $136 million. Foreign exchange translation rates decreased sales 3.1%. Higher pricing increased sales by 26.2%, largely due to current and prior year price increases in Latin America taken to mitigate raw material and labor inflation. Volume decreased 3.3% as declines in meat and seafood products in the Middle East and frozen products in South Africa were partially offset by increases in ketchup and baby food in Latin America. Acquisitions increased sales 1.0% due to the prior year acquisition of Papillon, a small chilled products business in South Africa.
Gross profit increased $12 million, or 31.2%, to $50 million, due mainly to increased pricing, partially offset by increased commodity costs. Operating income increased $5 million, or 43.1%, to $18 million.
Liquidity and Financial Position
Cash provided by/(used for) operating activities was $169 million in the current year and $(14) million in the prior year. The improvement in the first quarter of Fiscal 2010 versus Fiscal 2009 was primarily due to favorable movements in receivables and inventories which were partially offset by reduced payables and the impact of foreign exchange. Additionally, $132 million of cash was received in the current quarter in connection with an accounts receivable securitization program (see additional explanation below), which offset discretionary contributions made in Fiscal 2010 to fund the Company's pension plans. The Company's cash conversion cycle improved 2 days, to 49 days in the first quarter of Fiscal 2010. Receivables accounted for 3 days of the improvement, all of which is a result of the accounts receivable securitization program. There was a 6 day improvement in inventories as a result of the Company's efforts to reduce inventory levels. Accounts payable partially offset these improvements, with a 7 day decrease, a portion of which reflects inventory reductions and the resulting decrease in the amounts due to suppliers.
During the first quarter of Fiscal 2010, the Company made $144 million of contributions to the pension plans compared to $28 million in the prior year. Of this $144 million of payments, $132 million were discretionary contributions that were made as a result of adverse conditions in the global equity and bond markets. The Company expects to make approximately $260 million of pension contributions in Fiscal 2010, of which $200 million would be discretionary, however actual contributions may be affected by pension asset and liability valuations during the year.
On June 12, 2009, the Company entered into a three-year $175 million accounts receivable securitization program. Under the terms of the agreement, the Company sells, on a revolving basis, its receivables to a wholly-owned, bankruptcy-remote-subsidiary. This subsidiary then sells all of the rights, title and interest in a pool of these receivables to an unaffiliated entity. After the sale, the Company, as servicer of the assets, collects the receivables on behalf of the unaffiliated entity. The amount of receivables sold through this program as of July 29, 2009 was $132 million.
Cash used for investing activities totaled $47 million compared to $35 million last year. Net proceeds from divestitures provided cash of $2 million in the first quarter of Fiscal 2010, compared to $5 million in the prior year from the sale of a small domestic portion control foodservice business. Capital expenditures totaled $49 million (2.0% of sales) compared to $42 million (1.6% of sales) in the prior year, which is in line with our full year estimate of approximately 2.5% of sales. Proceeds from disposals of property, plant and equipment were $1 million in both the current and prior year.
Cash provided by/(used for) financing activities totaled $33 million compared to ($13) million last year. Proceeds from long-term debt were $250 million in the current year due to the issuance of $250 million of 7.125% notes due 2039 by H. J. Heinz Finance Company ("HFC"), a subsidiary of Heinz, through a private placement in July 2009. These notes are fully, unconditionally and irrevocably guaranteed by the Company. The proceeds from the notes were used for payment of the cash component of the exchange transaction discussed below as well as various expenses relating to the exchange, and for general corporate purposes. Proceeds from long-term debt were $850 million in the prior year. The prior year proceeds represent the sale of $500 million 5.35% Notes due 2013 as well as the sale of $350 million or 3,500 shares of HFC Series B Preferred Stock. The proceeds from both of these prior year transactions were used for general corporate purposes, including the repayment of commercial paper and other indebtedness incurred to redeem HFC's Series A Preferred Stock. Payments on long-term debt were $27 million in the current year compared to $337 million in the prior year. Net payments on commercial paper and short-term debt were $67 million this year compared to $398 million in the prior year. Cash proceeds from option exercises provided $2 million of cash in the current year, and the Company had no treasury stock purchases in the current quarter. Cash proceeds from option exercises, net of treasury stock purchases, were $1 million in the prior year. Dividend payments totaled $133 million this year, compared to $131 million for the same period last year, reflecting an increase in the annualized dividend per common share to $1.68.
On August 6, 2009, subsequent to the end of the first quarter, HFC exchanged $681 million of 7.125% notes due 2039 (of the same series as the notes issued in the July 2009 private placement), and $218 million of cash, for $681 million of their outstanding 15.590% dealer remarketable securities due December 1, 2020. In conjunction with this exchange transaction the Company also terminated its $175 million notional total rate of return swap and received net cash proceeds of $48 million as well as the return of the collateral from the counterparty. In addition, HFC terminated a portion of the remarketing option by paying the remarketing agent a cash payment of $89 million. See Note 13, "Derivative Financial Instruments and Hedging Activities" for additional information. The exchange transaction will be accounted for as a modification of debt.
At July 29, 2009, the Company had total debt of $5.33 billion (including $229 million relating to the SFAS No. 133 hedge accounting adjustments), cash and cash equivalents of $551 million and $193 million of restricted cash. Total debt balances since prior year end increased due to the July 2009 note issuance discussed above.
The Company and HFC maintain $1.8 billion of credit agreements, consisting of a $1.2 billion Three-Year Credit Agreement which expires in April 2012 and a $600 million 364-Day Credit Agreement. These agreements support the Company's commercial paper borrowings and $230 million of Australian denominated borrowings. As a result, the commercial paper and Australian denominated borrowings are classified as long-term debt based upon the Company's intent and ability to refinance these borrowings on a long-term basis. These credit agreements include a leverage ratio covenant in addition to customary covenants, and the Company was in compliance with all of its covenants as of July 29, 2009. In addition, the Company maintains in excess of $500 million of other credit facilities used primarily by the Company's foreign subsidiaries.
Global capital and credit markets, including the domestic commercial paper markets, experienced increased volatility late in calendar year 2008. Despite this situation, the Company has continued to have access to the commercial paper market. The Company will continue to monitor the credit markets to determine the appropriate mix of long-term debt and short-term debt going forward. The Company believes that its strong operating cash flow, existing cash balances, together with the credit facilities and other available capital market financing, will be adequate to meet the Company's cash requirements for operations, including capital spending, debt maturities, acquisitions, share repurchases and dividends to shareholders. While the Company is confident that its needs can be financed, there can be no assurance that continued or increased volatility and disruption in the global capital and credit markets will not impair its ability to access these markets on commercially acceptable terms.
As of July 29, 2009, the Company's long-term debt ratings at Moody's, Standard & Poor's and Fitch Rating have remained consistent at Baa2, BBB and BBB, respectively.
Contractual Obligations
The Company is obligated to make future payments under various contracts such as debt agreements, lease agreements and unconditional purchase obligations. In addition, the Company has purchase obligations for materials, supplies, services, and property, plant and equipment as part of the ordinary conduct of business. A few of these obligations are long-term and are based on minimum purchase requirements. Certain purchase obligations contain variable pricing components, and, as a result, actual cash payments are expected to fluctuate based on changes in these variable components. Due to the proprietary nature of some of the Company's materials and processes, certain supply contracts contain penalty provisions for early terminations. The Company does not believe that a material amount of penalties is reasonably likely to be incurred under these contracts based upon historical experience and current expectations. There have been no material changes to contractual obligations during the three months ended July 29, 2009. For additional information, refer to pages 24-25 of the Company's Annual Report on Form 10-K for the fiscal year ended April 29, 2009.
As of the end of the first quarter, the total amount of gross unrecognized tax benefits for uncertain tax positions, including an accrual of related interest and penalties along with positions only impacting the timing of tax benefits, was approximately $103 million. The timing of payments will depend on the progress of examinations with tax authorities. The Company does not expect a significant tax payment related to these obligations within the next year. The Company is unable to make a reasonably reliable estimate as to when cash settlements with taxing authorities may occur.
Recently Issued Accounting Standards
On April 30, 2009, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 157, "Fair Value Measurements," for its non-financial assets and liabilities that are recognized at fair value on a non-recurring basis, including long-lived assets, goodwill, other intangible assets, exit liabilities and purchase price allocations. SFAS No. 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. This statement applies whenever other accounting pronouncements require or permit assets or liabilities to be measured at fair value, but does not expand the use of fair value to new accounting transactions. The adoption of this standard did not have a material impact on the Company's financial statements. See Note No. 12 for additional information.
On April 30, 2009, the Company adopted SFAS No. 141(R), "Business Combinations" and SFAS No. 160, "Noncontrolling Interests in Consolidated Financial Statements - An Amendment of ARB No. 51." SFAS No. 141(R) and its related standards impact the accounting for any business combinations completed after April 29, 2009. The nature and extent of the impact will depend upon the terms and conditions of any such transaction. SFAS No. 160 changes the accounting and reporting for minority interests, which have been recharacterized as noncontrolling interests and classified as a component of equity. Prior period financial statements and disclosures for existing minority interests have been restated in accordance with SFAS No. 160. All other requirements of SFAS No. 160 will be applied prospectively. The adoption of SFAS No. 160 did not have a material impact on the Company's financial statements.
On April 30, 2009, the Company adopted FASB Staff Position ("FSP") EITF 03-6-1, "Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities." FSP EITF 03-6-1 provides that unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. As a result of adopting FSP EITF 03-6-1, the Company has retrospectively adjusted its earnings per share data for prior periods. The adoption of FSP EITF 03-6-1 had no impact on net income and less than a $0.01 impact on basic and diluted earnings per share for the first quarters of Fiscal 2010 and 2009.
The adoption had a $0.01 unfavorable impact on both basic and diluted earnings per share for full year Fiscal 2009, and is expected to have a $0.01 unfavorable impact on both basic and diluted earnings per share for full year Fiscal 2010. No material impact is expected for Fiscal 2011 forward. See Note No. 8 for additional information.
In December 2008, the Financial Accounting Standards Board ("FASB") issued FSP FAS 132(R)-1, "Employers' Disclosures about Postretirement Benefit Plan Assets." This new standard requires enhanced disclosures about plan assets in an employer's defined benefit pension or other postretirement plan. Companies will be required to disclose information about how investment allocation decisions are made, the fair value of each major category of plan assets, the basis used to determine the overall expected long-term rate of return on assets assumption, a description of the inputs and valuation techniques used to develop fair value measurements of plan assets, and significant concentrations of credit risk. This statement is effective for fiscal years ending after December 15, 2009. The Company is currently evaluating the impact of adopting FSP FAS 132(R)-1 in the fourth quarter of Fiscal 2010.
In May 2009, the FASB issued SFAS No. 165, "Subsequent Events," which establishes general standards of accounting for and disclosure of events or transactions that occur after the balance sheet date but before the financial statements are issued or are available to be issued. SFAS No. 165 describes the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements and provides guidance on the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. The Company adopted SFAS No. 165 during the first quarter of Fiscal 2010, and its application had no impact on the Company's consolidated financial statements.
In June 2009, the FASB issued SFAS No. 166, "Accounting for Transfers of . . .
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