金寶湯 (CPB) 2005 Q2 法說會逐字稿

Good morning and welcome to the Campbell Soup Company 2nd Quarter 2005 earning conference call. [OPERATOR INSTRUCTIONS] Now I will turn the meeting over to Mr. Leonard Griehs, Vice-President of Investor Relations.

Sir you may begin.

Thank you Tonya.

Good morning and welcome to Campbell Soup Company's 2nd Quarter Fiscal 2005 Conference Call.

On our call this morning will be Doug Conant, President, Chief Executive Officer;

Bob Schiffner, Senior Vice-President and Chief Financial Officer;

Anthony DiSilvestro, Vice-President and Controller.

Our financial results press release and supplemental schedule were sent out earlier this morning, they are also posted on our website, www.campbellsoupcompany.com.

Our call this morning will be approximately 1 hour.

It will be replayed approximately 2 hours after the call is complete.

The replay number is 1-866-393-0852 or 1-203-369-0428.

It will run through midnight February 25th.

You may also listen by logging on to our website, www.campbellsoupcompany.com, and clicking on the web cast banner.

As a matter of policy, our conference calls are open to all interested investors and members of the media.

This discussion will contain forward-looking statements that reflect the company's current expectations about its future performance.

These forward-looking statements rely on a number of assumptions and estimates that could be inaccurate and which are subject to risks and uncertainties.

These include statements concerning the impact of marketing investments and strategies, new product introductions, cost savings initiatives, quality improvements, capital expenditures and tax rate on sales, earnings and margins and other factors described in the company's most recent 10-K as updated from time to time by the company and its subsequent filings with the Securities & Exchange Commission.

Actual results could vary materially from those anticipated or expressed in any forward-looking statement made by the company.

This discussion also includes certain non-GAAP measures as defined by SEC rules.

We have provided a reconciliation of those measures to the most directly comparable measures and that is available on our investor website at www.campbellsoupcompany.com.

Now, here is Anthony DiSilvestro to discuss the financial results for the 2nd quarter.

Good morning.

As a reminder, this year we have new reporting segments, which reflect changes in our organizational structure.

These organizational changes were announced last fiscal year and the restated segment information has been provided for the last 2 fiscal years in the 10-Q filing for the 1st quarter.

Let's start with some highlights.

We are pleased with the top-line performance of US Soup, especially condensed soup where we have seen positive sales performance for the 1st half of the year.

Ready-to-serve soup has also performed well in the 1st half although the 2nd quarter was down as compared to a very strong quarter a year ago and following a first quarter of increased and earlier trade promotion activity.

In its first 6 months Chunky chili sales are tracking to an annual rate of sales of $70 million.

Baking and Snacking had strong sales and earning growth driven by the strong performance of Pepperidge Farm.

Outstanding performance of refrigerated soups contributed to double-digit top and bottom line growth in "Away From Home" in the quarter.

Godiva had strong sales growth with all channels in North America growing double digit.

Our cash flow was very strong with cash flow from operations reaching $500 million in the 1st half.

Now let's turn to the specifics of our financial results.

Net sales rose 6% to $2.2 billion, after 6 months, sales were up 8% to $4.3 billion.

Sales growth for the quarter breaks down as follows.

Volume and mix added 4%, price and sales allowances added 1%, increased promotional spending subtracted 1%, currency added 2%, EBIT was $389 million, flat with the prior year.

After 2 quarters, EBIT was $770 million, up 4% versus a year ago.

Gross margin declined to 40.6% from 42.3% primarily due to cost inflation and increased trade promotions, partially offset by productivity improvements.

Marketing and selling expenses rose 22 million to $362 million, a 6% increase primarily due to higher advertising and currency.

Administrative expense declined $7 million to $129 million due in part to savings from the cost reduction efforts we announced in June of last year.

Research and development costs rose $3 million to $24 million reflecting increased spending behind new product initiatives.

Other income of $2 million compares to $2 million of expense in last year's 2nd quarter due to lower adjustments related to the carrying value of investments in affordable housing partnerships and lower expenses from currency hedging transactions offset by last year's gain from a Godiva insurance settlement.

Net interest expense was $45 million, up $3 million versus a year ago due to higher interest rates.

The tax rate was 31.7% versus 32.3% in last year's quarter but consistent with last fiscal year's rate and with this fiscal year's expected full-year rate.

Net earnings for the quarter were 235 million equal to the comparable quarter a year ago and diluted EPS for the quarter was $.57 also even with the year-ago quarter.

For the 1st half, diluted EPS was $1.13, up 5% versus a year ago.

Now let’s turn to operating highlights by reporting segments.

I will discuss the numbers for the quarter only.

The supplemental schedule you received contains 6 months' comparisons.

I will offer some comments on the year-to-date numbers where they make comparisons more meaningful.

US soups, sauces and beverages.

Sales of $956 million were up 1% from $950 million in the year-ago quarter.

Sales growth for the quarter breaks down as follows.

Volume and mix added 3%; increased promotional spending subtracted 2%.

Operating earnings of $216 million declined 12% from $246 million in the year-ago quarter.

This decline was due to increased trade promotion and advertising and higher materials costs, partially offset by productivity savings and lower administrative expenses.

US soup sales for the quarter declined 1% with condensed soup sales up 4%, ready-to-serve soup sales down 9% and Swanson broth sales up 15%.

This year there has been a relative shift between the 1st and 2nd quarter promotional spending and marketing programs.

So let’s take a look at the first half sales numbers for soup, which are more indicative of our true performance during this soup season.

For the 1st half, total US soup sales were up 6%, condensed sales were up 7%, ready-to-serve sales were up 3% and broth sales were up 11%.

So through the 1st half of the year for the first time in 5 years all of our soup businesses showed positive results.

In the condensed category both eating and cooking soup sales improved in the quarter.

Condensed eating soup sales achieved solid sales growth, in part due to the combination of successful merchandizing and kids marketing programs, as well as increased advertising.

Condensed cooking soup sales grew in part due to stronger holiday promotion events and the introduction of 3 new Southwestern-style cooking soups.

Both eating and cooking condensed soups continued to benefit from the installation of gravity-feed shelving systems in stores.

We have over 11,000 now installed.

The convenience soup platform, which includes Soup at Hand, sippable soup and microwaveable bowls for "Chunky" and "Select" had flat sales versus the year-ago quarter.

Good growth in microwaveable bowls was offset by a decline in Soup at Hand sales.

Now let’s move to the other parts of this reporting segment.

Campbell's Chunky chili has had a very successful introduction now with 5 varieties in cans and microwaveable bowls added in January.

Both trial and repeat purchase are running above projections.

Within our beverage business, V-8 vegetable juice and Campbell's Tomato Juice sales increased while sales of V-8 Splash juice beverage declined.

While our core Prego business continues to achieve increased volume as category trends improve, sales declined in the quarter resulting from lower sales of our pasta bakes product line.

Sales of Pace Mexican sauces increased in the quarter.

Campbell's Spaghetti-O's sales increased significantly as that business continues to benefit from the conversion to the Campbell's brand supported with increased advertising.

Now let’s turn to our 2nd reporting segment, baking and snacking.

Sales for the quarter were $433 million compared with $397 million, an increase of 9%.

Sales growth for the quarter breaks down as follows.

Volume and mix added 5%, price and sales allowances added 4%, increased promotional spending subtracted 1%, currency added 1%, operating earnings rose 12% to $47 million from 42 million in the comparable quarter as the impact of pricing and higher volume was partially offset by increased marketing and commodity cost inflation.

Pepperidge Farm had strong sales results with all 3 of its businesses showing improvement.

Sales of fresh bread and bakery products were up double digit.

The wheat and grain bread business has done well as has the newer line of carb-style breads and rolls.

Additionally we continue to expand distribution of Pepperidge Farm bagels and English muffins.

Pepperidge Farm cookie sales rose on the strength of a successful holiday campaign and the introduction of a new line of sugar-free cookies and 4 new varieties of soft-baked cookies.

Sales of Goldfish snack crackers also increased in the quarter.

Pepperidge Farm frozen premium potpies had outstanding sales growth driven by increased marketing against 3 new varieties.

Arnott's sales rose driven by currency as well as by volume and pricing gains in both biscuits and salty snacks.

Strong promotional activity and new product introductions also contributed to growth.

Our 3rd reporting segment is International Soups and Sauces.

Sales were $502 million compared to $457 million, an increase of 10%.

Sales growth for the quarter breaks down as follows.

Volume and mix added 4%, increased promotional spending subtracted 1%, currency added 7%.

Operating earnings were $70 million compared with $65 million, an increase of 8%, primarily due to the favorable impact of currency.

Sales were up in Europe primarily due to currency.

In addition, the UK, France and Belgium delivered growth from volume and mix improvements.

In the UK our new instant dry products, Batchelors Super Noodles ToGo and Batchelors dry soup in a cup are both doing well.

In France, revitalized marketing programs are delivering strong growth in both our Royco dry and Liebig wet soup businesses.

In Asia Pacific, sales were up, driven by significant volume growth in that region.

In Canada sales increased due to currency, however the business is experiencing growth in ready to serve soups from the introduction of Gardennay aesthetically (ph) packaged soups.

The balance of our portfolio is being reported as 'Other'.

This includes the business of Godiva Chocolatier worldwide and the business of "Away From Home" in the US and Canada.

Sales were at $332 million compared to $296 million, an increase of 12%.

Sales growth breaks down as follows.

Volume and mix added 7%, price and sales allowances added 4%, currency added 1%.

Operating earnings were $72 million, up 14% compared to a year ago primarily due to strong sales growth.

Last years operating earnings included a $4 million insurance settlement for the loss of the Godiva stores in September of 2001. "Away From Home" sales grew significantly due to the growth of refrigerated soups.

Godiva sales rose on the strong performance across all channels in North America, which includes retail, direct sales and wholesale.

Same store sales were up double digit in North America as new and stronger in-store merchandising, increased advertising and promotional activity and new product introductions drove higher traffic through Godiva retail stores.

Now let’s turn to the balance sheets.

Total debt was $3.1 billion compared to $3.5 billion a year ago.

Cash flow from operations for the 1st half was $500 million versus $332 million.

The primary drivers of this higher cash flow were increased earnings, improved working capital and lower cash settlements related to foreign currency hedging transactions.

Capital expenditures were $104 million compared to $76 million.

This higher amount is consistent with our forecasted capital spending this year of $380 million.

Now Bob Schiffner will make a few comments before we open up for questions.

Thanks Anthony and good morning everyone.

I am pleased with our 6-months results.

As I look across our portfolio, we have some pluses and minuses, but our results are generally in-line with our expectations.

Our decision to invest marketing aggressively in the 1st half of the year has delivered the desired result of growing soup sales in all 3 areas of condensed, ready-to-serve and broth with improved market share and solid category expansion.

As we look to the 3rd and 4th quarter we expect earnings performance versus the prior year to be heavily skewed to the 4th quarter.

We continue to expect to deliver full-year results consistent with our goals.

Sales growth of 3% to 4%, growth in earnings before interest and taxes of 5% to 6% and EPS growth of 5% to 7% off the adjusted fiscal 2004 base of $1.58 per-share.

I am also very pleased with the strength of our cash flow for the 6-months.

As I have said numerous times, strong cash flow is a hallmark of the Campbell Soup Company and we are working hard to better leverage it to create improved shareholder value.

We will take a price increase, effective February 28th in our US soups, sauces, and beverage business that will benefit our margins later on this year and into next year.

Additionally, we continue to implement cost savings projects and manage our administrative expenses aggressively, which should benefit future margins as well.

I will be glad to expand on these points as we take your questions.

Len, back to you.

Hey Tonya, could you open up the lines please and start our questions session?

Thank you. [OPERATOR INSTRUCTIONS] Our first question comes from Todd Duvick from Banc of America Securities.

Sir your line is open.

Yes good morning.

Could you just—I guess for housekeeping purposes, do you happen to have available your cash balance on the balance sheet?

The answer is yes. [indiscernible] Do you have anything else?

Yes I do.

I was wanting to know if you could provide us an update on the Vlassic's litigation and also anything with respect to the IRS settlement?

Yes.

Let me first answer your first question on the cash balance.

We have $51 million of cash on the balance sheet as of the end of our 2nd quarter.

In terms of your other 2 questions regarding the litigation, the only thing that we will say about those is they are in fact still in the process of being litigated and it would be just pure speculation on my part as to when we might in fact have answers on those.

Just one other question, I guess with respect to the quarter, very strong cash flow as you mentioned and also it looks like you took a pretty good hit at the debt and I am wanting to know, as you have free cash flow going forward for the balance of the year, what do you plan to do with that?

Would it be more towards the share repurchase?

I know you are going to be investing some more in your brand support efforts, if you could just speak to that I would appreciate it.

Yes.

Our stated objective in terms of our free cash flow after the payment of dividends is to repay debt.

That has been our strategy frankly for the last 3 to 4 years.

We are undergoing a strategic plan review, which is what we do at this time of year every year, and that is always an area that we reevaluate and it will be the same thing this year.

But as far as our stated objective, it is now to repay debt.

Tonya, next question.

Judy Hong, Goldman Sachs, your line is open.

I guess I want to start with a question on the margin because in the 2nd quarter you did experience a substantial decline, particularly in the soups segment.

Can you just talk about how much of that was increased trade promotion spending versus the raw materials increases?

And then it appears that your guidance indicates that in the 2nd half of the year you are actually going to see margin expansion, so if you can address how those factors are going to impact the 2nd half performance as far as margin is concerned.

Yes.

Both the trade promotion, as well as cost inflation, impacted 2nd quarter margins.

Cost inflation was a heavier component of the margin decline.

We tend to look at this as an investment in our business because clearly by in fact not taking a price increase earlier we have certainly made our products much more competitive and we think with all the quality and other changes we in fact made, bringing incremental consumers into our categories is a plus for Campbell's Soup.

Having said that we do expect our margins to improve in the 2nd half of the year.

The primary factor will clearly be the price increase as I stated in my remarks and that's—hopefully answers your question.

Judy, this is Doug.

Building on that, the price advance will be effective but really won't be fully effective and reflected until the 4th quarter so we did lead you towards anticipating a stronger 4th quarter than a 3rd quarter and unfortunately we have walked into somewhat of a perfect storm as we pulled away from providing quarterly guidance this year in a very seasonal category where we had a major pricing shift going on that was unprecedented for the last 5 years and we also had a strategy shift going on in terms of wanting to promote earlier in the year so it has made things challenging.

I can easily tell it has made things challenging for people outside the four walls of Campbell's to forecast the quarters but now Bob's exactly right, we will see a stronger 2nd half on margins reflecting the price increase, particularly in the 4th quarter.

Then on a positive note, this is really the 2nd quarter in a row that you've shown growth in the condensed sales and I was just wondering if you can comment on what you are seeing in the stores that have had the gravity-feed shelving system now for more than a year, are those stores still seeing a positive pick-up in growth or are most of the growth in condensed really coming from the new stores that have added these gravity-feed shelving systems?

We'll have more detail on this at Cagney next week but basically we continue to see positive trends from the IQ Shelf Maximizer Program we have in place.

We are getting it from the established stores as well as from the new stores.

It basically is making soup easier to find for consumers and it's easier a year later as it is in the 1st year and so we see a lift to the category of condensed and we see, actually a lift to all condensed soups, not only our soups but also private label. (multiple speakers) the retailers are so excited about it as well.

Tonya next question.

David Nelson of Credit Suisse First Boston, your line is open.

So thinking about the costs that are up and then your pricing, I guess the implication since your guidance for top-line is 3-4% for the year, but you are up 7.6% through the 1st half is that you are kind of implying that volumes will go down in the back half?

David, we're taking a pretty conservative stance on the sales growth for the year of saying 3-4%.

We in fact could be a little bit stronger than that.

If that happens, that will obviously be good news.

David this is Doug, building on Bob's comment though, as I just mentioned with Judy, we are in unprecedented territory on pricing and it would be premature for us to take that all to the bank.

We will see how the consumer votes on it—we're cautiously optimistic that we're well positioned to maintain the top line though.

And what you mean by unprecedented is that you waited 6 months to follow Progresso?

Well that now we've got the full ready-to-serve category at higher price points in the 2nd half of this year and we'll see what the impact is on volume and we'll also see what the volume is going to—the volume—the performance is going to be in condensed in the 2nd half as well.

[indiscernible]

Condensed is very good.

Yeah.

David, the other thing I would say, we haven't taken a price increase on RTS in 5 years so this is kind of virgin territory.

That's the point I was making.

OK.

Unallocated capitol was $16 million versus $27 in last years 2nd quarter and then for the 1st half we're at $33 versus a $55, is that what you expected?

Anthony?

Yes it is certainly consistent with our expectations and reflects the items I mentioned earlier about lower adjustments related to affordable housing and lower expenses related to currency transactions.

So for the full year we could kind of double that 33?

No I don't think you can make that assumption.

OK.

Did I hear that Soup at Hand was down again, and was that at line with your expectations given the relatively fewer new SKUs?

Soup at Hand had a solid year last year and we expect this thing to shake out over the course of the year and Soup at Hand to get back on track but there is nothing alarming in that, we just had a major focus on Chunky and bowls and that's where the bulk of the promotional activity drifted to in the 1st half.

We expect it to get back on track in the 2nd half.

Thanks.

Next question Tonya.

Christine Mccracken of Midwest Research your line is open.

You've made a number, or you've had great success I guess with a number of your new products but some of the new products don't seem to be doing as well and I am wondering at what point do you pull the plug on products like Invigor8 or Kitchen Classics?

Though they're not big pieces of your portfolio, they don't seem to have worked and I guess even pasta bakes this quarter, for the past couple of quarters I guess, has been a little weak, is there a bit of paring back of your portfolio that needs to happen here?

The answer is we manage all of those lines—we scrutinize them closely and we –the definition of success is different for each one of them.

Pace Mexican Creations sauces is one that we tried to broaden our Pace franchise with that didn't work and we actually discontinued it.

Kitchen Classics had a different agenda in terms of rounding out our soups portfolio and it was an important component to our competitive posture in soup and so it's been maintained at different level and we manage against it accordingly.

So each one of these is being carefully looked at.

We discontinue some and we manage others smartly so that we minimize our financial exposure, but we're all over this area.

As we are ramping up innovation we've got to be very selective about what we keep in-market and we just have to manage it smartly, which we do.

Fair enough.

And Bob maybe, can you comment on where we are in terms of the systems upgrade, the investments you are making there and if you expect to see any savings in this fiscal year or if it will fall into the next fiscal year?

Yeah, the 2 projects that we told you about last June, our SAP project in North America which we have officially kicked off this year, obviously we are absorbing the one time P&L expenses of that project in our P&L.

We will not though expect any benefits from that until late in fiscal year '07 but in fact mainly in fiscal year '08.

The other project is our Australian Route-to-Market project which is the transfer of our selling system, from a DSD system to a central warehousing system and again that project is also in place and starting to be executed and again our expectation of the benefit of that project is not until fiscal year '08.

But to be clear, you're just staring the work on these, it's not gone live?

That's right, it has not gone live.

Next question Tonya.

Andrew Lazar of Lehman Brothers, your line is open.

In thinking about some of the clear improvement you've seen in condensed through the 1st half of the year, or the soup season, I know you do a probably pretty significant kind of post-mortem on what worked, what didn't and all of that as you go through it from the soup season.

But I am curious in thinking about the sustainability of the improvement you've seen in condensed kind of going forward, do you have a sense for perhaps where the success comes from, the earlier start to the soup season and making sure you are kind of “in the pantry” versus anyone else—versus all of the things you've obviously done over the last 3 years.

How do those things, even if it's preliminary, kind of shake out in your mind as it relates to sustainability and have you been tested with anything that historically that would have thrown condensed off track that, even though that might have happened, whether it's price gaps or what have you, condensed stayed on track so that maybe gives you a better sense of the sustainability?

That's really what I am trying to get after.

Andrew, this is Doug, I am going to touch on this more fully at Cagney but we think, and the way we've built the condensed success model, is all about building a sustainable growth platform here.

It's not about a one-time shot, get a promotional benefit and ride it out for a year and cross your fingers the next year.

We have very methodically gone about laying a bed—a foundation of getting the products better, the packages better, the marketing propositions better, the innovation better and then pulling it all together with the shelving and the presentation at retail.

Because of the way we have built it and the way it has incrementally responded year-over-year, we think fundamentally we have a very sustainable proposition.

We are not talking about growth rates that are going to, over time, approach what we think the potential is for ready to serve soups, but it is not unreasonable for us to aspire to—certainly to aspire to what we've committed to, which is moderating the decline or even to beginning to stabilize the business so it's not a drain on our company and we are very comfortable with that posture and you know, we string together a few more quarters of condensed improvement and we may even get a little bolder with it.

One last thing, just on a different tack, I am just curious how you think about this, the added complexity, let's say, and the implications to your brand value of, let's say, doing a private label offering in condensed versus some of the fixed cost absorption and managing the whole category for a retailer on the positive side.

I am just curious how you think about that and how you trade off those things in your mind?

Andrew, clearly we are a branded food company and the way we will win is by building the world's greatest brands in the categories in which we compete and leveraging that capability fully.

We are willing to invest to establish that kind of growth profile in a way that we can sustain it so our focus is all on the brand side.

That having been said, we also know that we have margin challenges and we have to manage the cost side responsibly, but we won't do anything that's going to compromise our branded success, so anything we might ever pursue that would go beyond the branded success would be very carefully looked at.

Next question Tonya.

David Adelman of Morgan Stanley your line is open.

First I was curious, do you think your focus, not just this quarter but over the last several quarters, on condensed is having an adverse impact on your ready to serve business either in terms of your internal focus or with consumers?

Absolutely not.

The way to view ready to serve is probably most appropriate on a half basis and then, I think Anthony covered that and said we were up by, I think, 3% for the half which is a lower growth rate but that is on top of 17% growth in the prior half and in the midst of some major strategy shift in terms of the way we promoted the business earlier.

So there are a lot of moving parts here and we feel very good that the ready to serve proposition is a winning proposition and also, when you think about ready to serve, although we don't count it, we also have a Chunky chili business that we've also migrated into which is layered on top of our Chunky performance and when you put it all together you see that we've got good momentum on the ready to serve side as well.

Now undoubtedly in a quarter there may be, or in a month, there may be merchandizing shifting going on where we are promoting ready to serve very aggressively and we are not promoting condensed and there can be shifts in a period of weeks or possibly months, but over time we think we've got—we're going full throttle on both fronts and they can, over time, operate independent of one another.

[indiscernible]

And in all of the margin structural issues that affected the soup business this quarter, is it still the case that when you go to market, that condensed has higher margins than ready to serve?

So in other words within all of the different dynamics, at least that shift this period into condensed would have flattened your margins, all else equal?

Overall mix of margins throughout the whole company for the quarter was basically flat, so yeah, even though condensed was a plus and condensed continues to have higher margins, the way that we measure mix around the whole company, there were other products that offset that and so for the total company, David, we are about flat.

And Bob one last thing, I think at the end of the 1st quarter you had indicated that you thought for the full year, operating margins would be down slightly, do you hold to that view?

Yes I do.

I in fact hold to that view.

David, just a point of clarification, I want to make sure, we do not include the Chunky chili in our ready to serve numbers that we report to you.

So just a point of clarification on that.

Next question Tonya.

David Driscoll of Smith Barney your line is open.

Thanks a lot.

Did you just say that margins were expected to be down for the full year?

That's what—yes.

OK.

Our forecast is for a slight decline in gross margins year-on-year.

Which is consistent with the guidance Bob provided at our June meeting.

I actually wanted to ask you about that because I had written myself a note that you guys had said 'margin stabilization' and that was the word that you were using.

What do you mean by that when you say it?

Are you looking at it on a quarterly comparison, a full year comparison, what's the goal and then if you could talk about, maybe beyond just fiscal '05, but really into fiscal '06.

We, in fact, look at margins over the total business cycle.

Obviously there, in fact, will be fluctuations for a number of reasons on a quarterly basis but in fact we do talk about it on annual basis and 'stabilization' to us is within a plus or minus margin of prior years so again, I think the words that, in fact, we use would in fact suggest our forecasted performance in fiscal year '05 would be termed 'stabilization' on our part.

Basically we are talking about how we're approaching being flat for the year which is an improvement versus the prior 2 year trend and also during the course of this year, we believe on a quarterly basis, we will be back in positive territory as we exit the year.

Yeah.

As we look down the road clearly we believe and in fact we have said this publicly a number of times, that in fact we expect margin improvement as we leave fiscal year '05 and go forward.

Doug, you and your team have put a lot of effort into revitalizing the condensed soup business and you've certainly done a nice job with the sales line, what gives you though the confidence that you can increase those condensed soup margins and retain positive volume growth going forward?

Specifically condensed soup.

Well, we feel great about the condensed soup proposition and it is a terrific value in the broader market of simple meals, which is much broader than just condensed soup and ready to serve soup, on a price per-ounce basis, it's a great offering versus other simple meal alternatives.

It's really well positioned in terms of the consumer mega trends around wellness and around the increasing concerns around obesity.

It's at the heart of many of the diet fads that are—that continue to come and go but soup is always in the mix and our condensed soup is just a terrific priced value proposition relative to the broader simple meal arena.

You can still get, on promotion, you can easily get soup for well under $1.00, but you go out and buy a Snickers candy bar, you are spending $1.25, I love my friends at Snickers by the way.

But fundamentally it offers a great price value proposition and it's well positioned in terms of wellness and we are very—we are not talking about it growing at the rate of ready to serve, but it's very reasonable and the models we have built, if we can approach it and begin to stabilize it or even moderate the declines meaningfully, we've got a great proposition here going forward.

Just a point of clarification though.

The prices are going to go up in that business and what's the sensitivity to your mind in the price increase versus what kind of volume reaction are you expecting?

Well you can't take prices up independent of value creation, that we know.

So the answer here is that prices are going up in the stores, on everything.

Costs have gone up and price is getting passed on to the consumer, not in a huge way, but I think, I was just reading yesterday that the consumer price inflation index is targeting 2.5-2.6% over the next 18 months so prices are going up and we are just moving up in line with everything else and the challenge is that we have to be adding value at the same time and our value addition formula was making the products better, it was getting the easy open lids put on, it was establishing the shelving, putting appropriate marketing support in but not going over the top on it and so we feel very good about the value proposition on condensed soup right now.

And we think it's a sustainable model.

Maybe just one final question on the pricing side here is that –in the ready to serve side, of course we all know that Progresso had been trying to get a price increase back before the soup season started, when I look at the quarterly results for that division, profits were down I think 12%, so it's a significant decline in profitability there appears to have been an opportunity to take prices but as you said you chose not to do it to try to really make a value creating proposition, but in terms of –for those of us out here in the financial community that are just watching these numbers, it's a little, perhaps, tough to swallow and how would you say that—how do you guys look at this and really say that this was a good decision, or do you in fact believe it was the right decision?

We feel great about this.

We feel great about this.

We are looking on a full year—or just on a half basis, we have sales up, our net sales of soup we reported as being up 6%.

If you can peel the onion back and get the net sales of private label soup or the net sales of Progresso soup, you are going to find that we won.

And you are also going to find, when you look at our reporting, we were reporting 5% EPS growth through the 1st half which is on target for our projection for the year of 5-7 and our margins will be better in the back half.

This is working out, quite frankly, very much as planned and as anticipated and in a way that we view as being a sustainable proposition.

Thank you.

Next question Tonya.

Terry Bivens of Bear Stearns your line is open.

Just a quick question on margins to make sure I understand what you are trying to indicate there.

Would you expect margins to be up '06 over '05 both on the gross and operating basis?

We said that, in fact, we expect a future margin improvement across the board.

I am not going to comment.

Terry, on specifics, but as a general trend that is our expectation.

And again Terry we are looking at it on annual basis because the quarters as you know, with promotional activity, with the seasonal activity, we can't—we couldn't be specific on each quarter so that's really an annual kind of comment.

No, that's what I took it as, but I just wanted to be clear that you would think maybe this year would be the trough in margins and next year, Bob is indicating over time they should move up, I guess my question is more specific to '06.

Terry this is Doug.

I can't really amplify much more on what Bob said, but what I think we would all be comfortable saying is the years of gross margin decline in any meaningful way, we believe, are behind us.

We believe we are well positioned now to be approaching stabilization and to be managing this in a way where we are not going to see further gross margin deteriorations.

From our point of view I guess that's key.

You've clearly done a good job with the top line and I guess what we are all fishing for is when do the margins start to kind of respond appropriately.

Just one other quick question.

Can you give us an update, you know, the Wal-Mart question, of whether they are going to take the shelving or not, I guess it's been kicked around for a while in there.

Is there any update on that – if you could kind of share your latest communications with those folks?

Terry, we really don't comment on specific customers, just reiterating what I have said before.

What I can tell you is if our performance with any customer of that size was not healthy, it would be reflected in our reporting.

Clearly we feel pretty good about what we've reported for the 1st half on the top line, so the fact that Wal-Mart or any other customer doesn't have shelving is not necessarily a negative thing for our business.

We are up to 45% of ACV with these 11,000 shelves.

We will be installing about 1,500 more this year as we kind of get down to when customers can take them and as we manage through this, which should get us up to about 50% of ACV which is great because now we have another 50% to be working on and over the next 3-5 years we will keep building the momentum on this thing and we'll design shelving systems that work for every customer in a way that meets their needs and some customers are just taking a little longer than others to find the win-win solution there.

Tonya, next question.

Eric Larson from Piper Jaffray your line is open.

First question is for Bob and I am curious as to how much more debt you need to take off your balance sheet before you can convince the rating agencies to get rid of your split rating on short-term paper so that at some point we could see more of your cash flow allocated towards your equity stakeholders as opposed to your bond stakeholders?

Well that's a very good question, from my perspective it seems that every time I reach out the carrot gets pulled a little further away.

Frankly, I thought we would be closer to that point at this time.

As I said earlier this is something that, in fact, we evaluate every year doing our strategic planning process and I can confirm that, in fact, we will continue to look at this as part of this years’ planning process as well.

So, that's how I will leave it Eric.

In looking at your 1st half, which I think is the appropriate way to look at your margins for the 1st half, is it also—I think you mentioned that for your 2nd quarter the majority of your margin decline, or the bulk of it, was, related to cost pressures as opposed—it was cost inflation as opposed to anything else, was that also true for the 1st half?

Can you just give us a little bit of flavor as to the majority of the margin decline, gross margin and for 1H?

Yeah, the impact of cost inflation was very similar in the 1st quarter as it was in the 2nd quarter, so on the half it averages out to about the same impact year-on-year.

Next question Tonya.

Eric Katzman of Deutsche Bank, your line is open.

Bob I've got a – I guess kind of following up on Dave Nelson question, I can't let you get away with this, if I take 4% sales growth on last year that's about $280 million incremental, I think you've already done $300 and you are putting through a price increase, you feel good about your business, it seems to me you're being really conservative about what you expect in the 2nd half, particularly when the comps in the 4th quarter are really easy.

Eric—I didn't—Let's be clear.

I didn't give you a sales forecast for the year.

OK?

What we said was that our target sales growth is 3-4%, OK, and I did say that if you looked on a year-to-date basis and you start trying to evaluate that over the full year that we could be either viewed as very conservative or with some upside to the 2nd half and I think we tried to fairly state that, yeah, in fact, there might be some upside to the 2nd half but I would also say that, in fact, the price increase as Doug mentioned clearly has an impact that, in fact, it's very hard from our standpoint to evaluate that.

So again, we are in fact sticking to our target with the acknowledgement that, in fact, there could be some conservatism there.

OK, well maybe I misunderstood.

How about –it sounds like—

Eric, Eric can I just, yeah, to finish my thought as well.

You know currency has also had an impact and again it's been very -- it's clearly hard to forecast that and I think when we spoke of a 3-4% sales target, OK, that was more of an organic number and I think the last 2 years we have had very, very strong currency impacts.

So overdelivering the 3-4% is, in fact, justified given the weakening of the dollar.

I guess like the SEC has been kind of looking at people's pension assumptions again, can you remind us, are you below 9% on your ROA and where are you in terms of a discount rate?

We are at 9% in terms of our return on assets and this past year, I believe we are at 6.5% and clearly as we look toward next year, the flattening of the yield curve is clearly—probably going to mean that that 6.5% is going to come down and, in fact, could come down pretty substantially.

And as we look at pension expense for next year, right now we are probably looking at an increase that, in fact, could be in excess of 20% so it's clearly something that is on our radar screen and we are, in fact, working through that.

Doug I am a little bit surprised that you are not a bit more concerned with the Soup at Hand numbers.

It seems to me that that's—the microwaveable bowls have actually been around for awhile and the new—like the incremental and, what I thought was a very interesting platform, was the Soup at Hand and then I would think that in the 2nd year that should really still have a lot of momentum and you seem to be kind of, I guess less concerned about it.

Why should we be that way?

Well broadly we talk it about it as a convenience platform.

The microwaveable bowls were around before, the technology was not particularly well designed and the products were basically inferior to the canned soup offerings.

Our launch of microwaveable products, first with Soup at hand then with Chunky bowls and Select bowls was with superior products and superior packaging technology so we view it as kind of the dawning of the real microwave—to-go age in soup and we also view it as a complete platform, the convenience platform.

That having been said, Soup at Hand obviously was the first one we went in with and we are actually in our 3rd year and we had actually tested it for a year in behavior scan before we launched it.

The reason I believe it's still a very solid proposition is we track very closely repeat purchase data and the repeat purchase data on this product has held up through all the other activities going on with Chunky and Select and merchandising and pricing and so we know from a consumer perspective that this proposition is right.

The challenge for us it to take products like Soup at Hand and make them more ubiquitous and get them into new channels and new places where consumers can use them and we are just getting good at that right now.

We had--there is opportunity here for us in alternate channels beyond traditional grocery and we are just building those capabilities.

Right now if you go beyond traditional grocery into these other channels you would see our US soup sales are up double digit and Soup at Hand is part of that but it's still a relatively small number and we have to get a broader and deeper distribution of it in channels where it might make more sense than in the traditional grocery store.

But repeat purchase is strong and we believe it's a viable long-term proposition.

Next question Tonya.

Mitch Pinheiro of Janney Montgomery Scott your line is open.

Hey Doug, so you said that the years of your gross margin decline are behind you, so 2 questions surrounding that.

Does the same apply to the operating margin and number 2, what do you believe to be the primary risk to your gross margin statement other than sort of unusual commodity costs—

Well, I will take a crack at it then turn it over to Bob.

You did understand me correctly, I do believe the years of our significant, our gross margin erosion are behind us.

I think we are approaching a steady state with upside.

Our operating margins, we took a good crack at that this year.

The first step was to get the organization right sized, we did that in June and we are actually seeing some favorable SG&A trends relative to the growth of the company and we are picking up some meaningful points there in terms of margin contribution and so we've done some appropriate belt tightening there.

The operating margin I think should also—I think it's reasonable for us to aspire to getting that trending in parallel with our gross margin so we believe that the 16% area that we are around right now, there's modest upside to that over time.

The thing I would say is that all of this discussion that we are having on margins, I want to emphasize we are absorbing in this P&L the SAP implementation and as we start to look into next year, that is a significant number.

And so—unfortunately, out of the 19 largest food and beverage companies in the world we are the only one that hasn't done this and we've got to go through this and it's going to put pressure on our margins next year.

But despite that we still believe we can stay on this trend.

The only thing that I would add to that Mitch is that when we spoke to you in June about the 2 projects, SAP as well as Route-to-Market, we will absorb in our P&L in this fiscal year in excess of $20 million in one-time costs.

So again that has obviously impacted operating margins, OK, most of those expenses are below the gross margin level, but we, in fact, recognize that.

We, in fact, made a decision that over long term those projects are, in fact, going to generate huge benefits to us and so we, in fact, made the decision to absorb those costs into our cost structure and sometimes we don't get as much credit for that as maybe we should.

I don't have my notes right in front of me but the—what did you—what will SAP cost you next year on an incremental basis?

Well, we're not—I mean we're not going to get into that specifically.

I think—but there, in fact, will be incremental expense versus this year associated with SAP.

Again, we'll in fact manage that in terms of our long-terms earnings guidance that, in fact, we've given you.

What we’ve said, the only number we'd give out, we said that the installation of SAP [ph] will cost us $125 million dollars and that we would start to get cost savings from that in fiscal 2008.

That was the public statement we've made on SAP.

And some of that is obviously, some of that is capitalized and some of that is expense?

That's correct.

And you haven't given out sort of a proportion of those two?

No.

OK.

In fact the only information that I just gave you is that we are absorbing—we will have absorbed over $20 million dollars this year in P&L associated with those projects.

OK great, and then in—just—just sort of getting back, is there any other risk to the gross margin—to your gross margin that you see, or how would you rank your risks excluding commodity costs shock and things like that--?

Well—the-the challenge for us, obviously, is to be able to over—in the fullness of time be able to appropriately price to cover our costs so the –whatever inflation we experience, ultimately we are going to have to find a –a proposition where we can price to cover those costs in a pretty—in a well managed way.

As Bob said earlier, we had not taken a price advance for 5 years on ready to serve soups and we've got to manage the business differently going forward.

We can't absorb 5 years worth of inflation and –and manage the business smartly on a year-to-year basis.

Tonya, how many more questions in queue?

There are no further questions.

OK we’ll wrap it up here then.

Thanks everyone for joining us this morning and just a reminder we will be presenting at the Consumer Analyst Conference next Wednesday.

Doug Conant, Carl Johnson and Bob Schiffner will be there and we hope that you are able to join us for our presentation and the lunch that we sponsor at that time.

Thank you very much.

Thank you.

That concludes today's call, all lines may disconnect.