HJ Heinz (HNZ)
October 28, 2010 8:30 a.m. ET
Meg Nollen - SVP, IR
Bill Johnson - Chairman, President and CEO
Art Winkleblack, Executive VP and CFO
Ed McMenamin - SVP, Finance
Diane Geissler - CLSA
Alexia Howard - Sanford Bernstein
David Driscoll - Citi
Vincent Andrews - Morgan Stanley
Ed Aaron - RBC Capital Markets
David Palmer - UBS
Jonathan Feeney - Janney Montgomery
Terry Bivens - JPMorgan
Andrew Lazar - Barclays Capital
Chris Growe - Stifel Nicolaus
Robert Moskow - Credit Suisse
Bryan Spillane - Bank of America
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Good morning. At this time, I would like to welcome everyone to the H.J. Heinz Company's fiscal year 2011 Q2 earnings call. [Operator Instructions.] I'd now like to turn the call over to Meg Nollen, senior vice president, investor relations. Ms. Nollen, you may begin your conference.
Thank you and good morning everyone. 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 on today's call are Bill Johnson, chairman, president and CEO; 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 28, 2010 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 a 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 on the company's earnings release and on our website at heinz.com.
Please note we plan to file our first quarter 10-Q early next week. Our related financial highlights pages, or stat pages, however, are available now in the Investor Relations section of the website, towards the bottom of the page. These pages will be updated with cash flow and balance sheet information after the release of our 10-Q next week. Importantly, these stats pages provide a quarterly historical restatement for discontinued operation.
Now on to today's call. Bill will review Heinz's strong performance, outlook, and growth drivers. Art will review the business unit, and Ed will touch on our financial scorecard. Of course, we'll be available then to take your questions. We'd like to request that you limit your questions during the Q&A session to one in order to ensure adequate time for all who wish to participate.
Now with the formalities out of the way, let me now turn the call over to Bill.
Thank you Meg. Once again good morning there everyone. Before turning the call over to Art and Ed, I want to briefly address our solid performance in the second quarter, which once again reflected the benefits of our emerging markets strategy, our continued global growth in ketchup, the continued operating discipline that underlies our success, the consumer and economic environment, and our outlook for the full year.
Turning to the second quarter, as we reported this morning on a constant currency basis, sales grew 1%, operating income rose almost 5%, and EPS from continuing operations increased nearly 7%. On a reported basis, EPS from continuing operations rose almost 3% to $0.78 a share. Encouragingly, during the quarter we saw a 100 basis point improvement in gross margin, and strong operating and free cash flow of almost $300 million.
Without question, emerging markets were the growth engine in the quarter and in the first half of the fiscal year. Emerging markets achieved double-digit organic sales growth of more than 10% in the quarter, enabling Heinz to deliver our 22nd consecutive quarter of organic sales growth.
The strong emerging markets sales growth was fueled by excellent results in China, India, Indonesia, and Russia. Overall, emerging markets generated 15% of the company's total sales in the second quarter, and have generated over 16% through the first half of fiscal 2011.
Notably, the emerging markets infant nutrition business delivered 17% organic sales growth in Q2, reflecting strong results in China, where we grew sales, achieved record shares in infant cereal, and successfully launched Heinz Infant Formula.
India continued to be a growth catalyst, with organic sales from Complan nutritional beverages, up 29%. Complan has quickly grown to become one of the company's top brands, and Heinz opened a new greenfield factory in India last December to support its continued expansion and growth.
Indonesia delivered 19% organic sales growth in ABC Sauces. ABC is one of the world's leading brands of soy sauce, and we have extended the ABC product line with new varieties of chili sauce to increase host food usage.
Russia achieved 16% organic growth in ketchup, as Heinz continued to build distribution while leveraging our partnership with McDonalds to strengthen our number one ketchup share position. Russia had a superb quarter overall and led our ketchup growth in Europe, where Heinz is now number one in 10 of our top 12 markets.
Looking forward, I see China in particular as one of the keys to unlocking future value for Heinz, and consequently we are investing aggressively there to accelerate growth, especially in sauces and infant nutrition. The acquisition of Food Star, whose brands of soy sauce and fermented bean curd hold leading positions in southern China, aligns perfectly with our strategy.
Food Star's brands give Heinz a solid growth platform in China's rapidly expanding $2 billion plus retail soy sauce market. We plan to invest heavily in marketing, people, and the supply chain of Food Star over the next 12 to 18 months to drive distribution, growth, and innovation. Therefore, I anticipate that short-term results will be modestly dilutive to income.
Food Star is already growing rapidly, and it represents a real opportunity for Heinz to leverage our global sauces capabilities to drive even faster growth while building a large and meaningful ketchup and sauces business in China.
Food Star and its 2500 employees joined Heinz just a few weeks ago, and the integration is already off to a good start. Art and I are visiting a number of countries in Asia next month, and plan to meet with our Chinese teams of baby food, frozen, and of course Food Star. Our visibility and commitment to China is such that I have also been asked to address a well-attended symposium of pediatricians and health officials on the important topic of infant and child nutrition.
Our visit coincides with the significant organic growth opportunities that we are seeing in Asia, as well as numerous core M&A opportunities, which we are exploring actively. Overall, I now expect emerging markets to deliver more than 20% of the company's sales by 2013, more than double their contribution of five years ago, and at least 25% shortly thereafter. We view the emerging markets as a target-rich base of consumers who are likely to spend more and more of their income on branded packaged foods as they prosper.
Turning to ketchup, we continue to prove that our brand is far from mature. Our flagship product has delivered 6% organic sales growth globally through the first half of the year, with organic growth of more than 3% in the second quarter. We continue to invest behind this growth with new capacity planned in both developed and emerging markets and innovative marketing initiatives like Dip & Squeeze and [Progress].
Innovation will be key to continuing our ketchup momentum, which is why we are so enthused about the upcoming launch of Dip & Squeeze, the biggest ketchup innovation in decades. The first Dip & Squeeze machine has been installed and we are on track to begin shipping nationally in early January. Consumers are responding very favorably to Dip & Squeeze, and many restaurant operators have tested it, with very positive results.