McCormick & Company Inc (MKC) 2007 Q2 法說會逐字稿

At this time I'd like to welcome everyone to the McCormick & Company second quarter earnings conference call.

(OPERATOR INSTRUCTIONS) Thank you.

It is now my pleasure to turn the floor over to your host , Ms.

Joyce Brooks.

Ma'am, you may begin your

Good morning and thank you for joining this mornings teleconference.

With me on today's call are Bob Lawless, Chairman and CEO of McCormick; Alan Wilson, President and COO: Fran Contino, Executive Vice President, Strategic Planning and CFO; and Paul Beard, V ice President, Finance, and Treasurer.

Bob will be discussing McCormick's financial results for the second quarter ending May 31, a business update, and our latest guidance for the year.

At the end of these remarks we look forward to your questions.

Before we begin our discussion, please note that during the course of this conference call, we may make projections or other forward-looking statements and actual results could differ materially from those projected in our forward-looking statements.

In addition, information we present today which excludes restructuring charges are not GAAP measures and we present this information for comparative purposes alongside the most directly comparable GAAP measures.

Please refer to this mornings press release which is posted on our website for more specific information on these topics.

As indicated in the press release, the Company undertakes no obligation to update or revise publicly any forward-looking statements whether as a result of new information, future events, or other factors.

Today's event is being webcast and following the call an audio replay can be abscessed at ir.Mccormick.Com.

I would now like to turn the discussion over to Bob.

Thanks Joyce and good morning to those on the call and joining us by webcast.

I'm pleased to report that we're able to follow a great first quarter with second quarter results that exceeded our expectations.

As a result of our first half year performance, we are raising our EPS guidance for the rest of the fiscal year.

Let's start with a look at the second quarter and I'll begin with the consumer business.

Sales for the consumer business rose 6.4% with favorable impacts of 2.9% from foreign currency and 2.5% from Simply Asia Foods Business acquired in Mid 2006.

Sales in the Americas were up 4.7% this quarter with foreign currency having no impact and incremental sales from Simply Asia Foods adding 3.7%.

This quarter, higher sales with grocery retailers offset lower sales to alternate channels including warehouse clubs.

Areas of particular strength during this quarter included our gourmet line and Hispanic products in the U.S, Club House branded products in Canada.

Sales also increased as a result of higher pepper prices although this was offset in part by lower pepper volumes.

In our core business, we continue to make great progress with the conversion of our stores to the new merchandising set.

The number of stores converted is currently 4750, up from 3,600 stores that we reported to you in late March.

Our retailers are benefiting from more efficient restocking with the new system and consumers are increasing their purchases.

They're finding their favored products more easily, discovering new items, and we're experiencing fewer out of stocks.

We measured sales lists from the new system in some of the recently set stores and the results were similar to what we experienced in the test markets with the McCormick sales increase in the mid single digits and a category increase in the low single digits.

I mentioned earlier that sales have benefited from the pepper price increase.

Many of you have been asking about pepper costs.

The market cost of pepper currently approximates $1.80 per pound which is up from about $0.77 per pound a year ago.

In our January call we indicated a price increase had been taken on pepper.

To offset further increases in the cost of pepper, we have announced the second price increase which will be effective August 1.

We're also taking pricing actions on certain Hispanic items in response to higher costs.

The impact of the January pepper price increase was a 1% increase in U.S.

consumer sales.

These additional price increases are expected to have a similar impact in the second half of the fiscal year.

Although we're likely to experience further pressure from lower pepper volume.

Looking ahead to the second half, we're encouraged by our new product activity.

This includes our seafood revitalization which is well under way.

Nine new seafood items were launched in early April and have gained 97% acceptance where presented.

Our Zatarain's line of products now includes new lower sodium versions of some of the most popular items.

Items that are beginning to attract new users rather than cannibalizing existing items.

The expanded gourmet organic range added nearly 4% to our unit market share in the gourmet category when measured on a year-to-date basis.

Before we move from our consumer business in North America, let me provide a first year report on Simply Asia Foods.

We've been very pleased with this acquisition.

The integration has gone smoothly, including a recent conversion to SAP and some related cost reductions we've added new talent to the knowledgeable and experienced Simply Asia team the ACV for the Thai Kitchen brand has increased nearly 25% and we've doubled the ACV for the simply Asia branded products.

During the year, we have gained distribution with new retailers that include traditional grocery as well as alternative channels.

With our current retailers we're working to expand the number of products within these stores.

I'd like to next turn to our consumer business in Europe.

As in the Americas, there's a number of factors that affected our second quarter results.

In total, sales rose 10.1%.

Foreign currency rates had a significant impact adding 9.2% to sales.

In local currency, sales in our largest European markets increased approximately 4%.

Earlier this year, we're able to put through a price increase for our Schwartz branded products in the UK, our first in five years for that market.

With improved and incremental marketing support we grew sales volume over Ducros branded products in France.

In both of these key markets we are continuing to make strides with improved merchandising with our retail customers.

Two factors unfavorably impacted second quarter sales: First was the continued impact of lower distribution in the Netherlands.

Second was our decision to exit Finland in 2006.

These two factors reduced second quarter consumer sales in Europe by approximately 3%.

Operationally as part of our restructuring program, we've announced the 2008 consolidation of our production facility that makes buying a dessert products with another facility in France.

We reported in April, in our April investor conference that we had nine manufacturing sites in Europe at the end of 2006 down from 12 in 2005.

With this move, we'll be at eight manufacturing sites.

In the Asia Pacific region, we increased sales 8.1% with a 7% benefit from foreign exchange.

Sales in China continued at a strong growth rate increasing at a double digit pace this quarter.

Changes that we made with this business over the last two years, changes at our distributor network, product line up and organization are delivering positive results.

Sales growth in China was offset in part by lost distribution of branded spice and herb line with a retailer in Australia.

Our emphasis in Australia remains on value-added items including our (inaudible) line of airplane brand gelatin products which are selling very well, as well as the new 2007 launch of cuisine stocks.

Across all regions, operating income for the consumer business was 53.1 million when restructuring charges are excluded.

This was up 8.9% from the second quarter of 2006 with a benefit of higher sales and the impact of the Company's cost savings program.

In the second quarter, advertising expense was down 2.2 million due to the timing of our marketing plans.

If you recall, first quarter advertising was up $2 million.

The lower advertising expense was more than offset by 2.8 million of unfavorable increase in stock based compensation expense.

Recall that this expense had a favorable impact of approximately the same amount on profit in the first quarter when compared to the prior year.

Turning to our industrial business, we increased sales 8.6% and in local currency 6.3%.

This includes a reduction of 2% from the elimination of low margin industrial business in U.S.

and Europe.

In the Americas, sales rose 1.7% from last year.

Foreign exchange rates lowered sales 0.1% and customer and skew elimination reduced sales 2.2%.

A sales increase of 4% was mainly due to price and product mix.

As costs for certain commodities including flower, cheese, and soy oil have risen, we are passing these increases through to our customers in higher pricing for our products.

Because our price increases will occur periodically we will more fully offset higher input costs as we move through the next two quarters.

Sales volumes rose for snack seasonings, several new seasoning products for large food manufacturers and condiment products for the restaurant industry.

Offsetting these increases was a general sales weakness with certain restaurant customers both quick service and casual dining.

As we look out to the second half of the year, sales for industrial business in the Americas are expected to have a modest increase as we continue to be impacted by the elimination of small and low margin customers and SKU's.

Sales will benefit from higher pricing and a pipeline of new products for our strategic customers but we expect sales in the foodservice industry to show further weaknesses.

As we have discussed with many of you, we are in Phase II of our U.S.

industrial business transformation.

Our strategic customers are realizing the benefit of our greater focus on their business and there is an increasing demand for our product development services.

Natural flavor solutions and the elimination of transfats are areas of particular interest right now.

We're also working on improvements to the supply chain and finding ways to meet customer product requirements with less frequent shipments.

One of our initiatives has been the potential to benefit sales for both the industrial and consumer businesses.

As we announced earlier this year, we have formed the McCormick Science Institute to advance knowledge on the health benefits of culinary spices and herbs by sponsoring scientific research at leading Universities and through targeted communication initiatives.

I am pleased to report that we've established the Scientific Advisory Council.

In addition we're funding University research to study the bioavailability of antioxidants in selected spices and herbs and the anti-inflammatory properties of spice and herbs, both areas of consumer interest.

Europe had another good sales quarter for its industrial business.

Following an 8.4% sales increase to local currency in the first quarter, sales in the second quarter rose 26% which was a 16% increase in local currency.

In this region, the elimination of low margin customers and skews reduced sales 1.9%.

An increase of 17.9% was due to the continuation of higher volumes of condiments and of seasonings for snack products.

Incremental sales of condiments were largely due to a joint venture in South Africa which was added in the fourth quarter of 2006.

Sales of Schwartz branded foodservice products in the UK also lifted sales.

Industrial sales in the Asia Pacific region rose 34.4% and in local currency 26.9%.

This followed an 18% sales increase in local currency last quarter.

We increased sales in both Australia and China especially with the Quick Service restaurant customers.

These customers have awarded the supply of new items to McCormick and we're benefiting from their promotions in these markets.

With this rapid growth, the Asia Pacific region is becoming a more important contributor to overall industrial sales.

Excluding restructuring charges, operating income for the industrial business was $21 million.

This was up 2.1 million or 11% from the second quarter of 2006.

The increase was primarily due to higher sales and cost savings.

Operating income for this business was unfavorably affected by $900,000 of higher stock based compensation expense compared to the prior year.

Again, this was a benefit to profit when comparing the first quarter to the prior year.

Next, I'd like to comment on the financial results for the total business.

Across both segments we increased sales 7.4% and in local currency the increase was 4.8%.

This increase was driven by favorable price and product mix, higher volume including the impact of Simply Asia Foods which added 1.4% to sales.

Moving to gross profit margin, we reported an increase of 40 basis points.

Restructuring charges in the second quarter of 2007 were less than the prior year and accounted for 60 basis point increase.

Cost savings activity had a favorable impact in this quarter.

In the second quarter, we had an unfavorable impact from the lag between raw material cost increases and the effective date of our price increases, in both the consumer and industrial businesses.

We also incurred some costs related to maintaining customer service levels during several facility consolidations.

Even with these headwinds, looking back at the first two quarters together, the increase in gross profit margin was 50 basis points, excluding the impact of restructuring charges.

As we move into the third and fourth quarters we expect these headwinds to lessen and we're projecting an increase of approximately 50 basis points in the second half of the year, excluding the impact of restructuring charges.

As you know, this is in line with our goal for 2007.

As a percent of sales, second quarter selling, general, and administrative expenses were 28.9% this year compared to 29.3% last year.

Again, we're benefiting from reductions in these operating expenses as part of a $30 million goal for 2007.

We also had 2.2 million of lower advertising expense due to the timing of our marketing support plans.

We achieved an overall reduction in SG&A as a percent of net sales despite a 3.7 million increase in stock based compensation expense.

This was offset by a favorable variance in the first quarter.

As explained in our March call, the variance in both periods was related to the grant date of stock based compensation which incurred in the second quarter of 2007 compared to the first quarter of 2006.

The tax rate for the second quarter was 31.1%, a bit below our guidance of 32%.

Year-to-date our tax rate was 30.3%; however, our tax rate guidance for the remaining two quarters of 2007 is 32%.

As a reminder, the third and fourth quarters of 2006 had unusually low tax rates.

As a result, we expect the higher tax rate in 2007 versus 2006 to create an unfavorable (inaudible) of $0.02 in each of the next two quarters.

Other income statement items, interest expense, other income, unconsolidated operations, and our diluted shares, were close to our expectations.

We reported second quarter EPS of $0.31 compared to $0.46 in 2006.

Charges related to the restructuring program reduced earnings per share $0.04 in the second quarter of 2007 and the net impact of the credits related to our programming increased EPS by $0.14 in the second quarter of 2006.

Excluding the impact of these restructuring charges and credits, EPS rose $0.03 or 9.4%.

This increase was due to higher sales and improved operating income margin which added $0.05.

The negative effect of the later date for our stock based compensation grants lowered EPS $0.02.

Let's take a look at the first half of our fiscal year which will eliminate some of the timing issues discussed.

Through the first half, EPS is up $0.08.

Charges related to restructuring program reduced earnings $0.05 The remaining increase is $0.13 or 22%.

Three things contributed to the majority of this increase.

First, sales growth of 7%.

Second, an increase of 50 basis points in gross profit margin when measured on a comparable basis which excludes the impact of restructuring charges in both 2007 and 2006.

And third, a 50 basis point reduction in operating expenses as a percent of net sales, again on a comparable basis.

We're very pleased with these results and our financial performance.

At the end of the first quarter we indicated we were likely for earnings per share at the upper end of our 8 to 10% range.

When measured on a comparable basis excluding restructuring charges.

We now expect EPS to grow in the range of 9 to 11%, again on a comparable basis.

Our outlook for sales growth in the second half is 5 to 7%.

This assumes a continuing 2 to 3% benefit from favorable foreign currency as well as growth driven by marketing programs and innovation.

We also have confidence in a 50 basis point gross profit margin improvement and expect to benefit further from cost savings in our SG&A.

Our pace of share repurchases will accelerate in line with the increased cash from operations that we generate in the second half of our fiscal year.

On a reported basis, assuming $0.18 of 2007 restructuring charges, this was a range of $1.69 to $1.73.

This higher projection includes incremental marketing programs which are planned for the second half.

I'll finish up my financial march with a look at the balance sheet.

At the end of the quarter, accounts receivable was up $34 million or 10% due primarily to higher sales and foreign currencies.

Inventories continue to be high, ending the quarter at $428 million compared to $382 million at the end of May 2006.

The reasons for this increase are very similar to what we reported at the end of the last two quarters.

Again, this quarter, the majority of the increase related to specific factors such as increases in strategic inventory, build up related to facility consolidations, foreign exchange rates, and the acquisition of Simply Asia Foods.

Inventory has also been affected by the higher cost of pepper and commodities including cheese and soy oil.

While we continue to be impacted by these higher costs, we have projects under way to reduce inventory levels.

During the quarter we repurchased 1.240 million shares at an average price of $37.58 for a total of $46.6 million.

This compared to $47.6 million in the second quarter of 2006.

At May 31, 2007, $148 million remained on the current $400 million authorization that the Board approved in June 2005.

Our planned capital for share repurchase remains in the 150 to $180 million range for 2007 which is expected to reduce shares 2% when option and RSU activity is considered.

Let me summarize.

Through the first half of our fiscal year, we were very pleased with our progress in both domestic and international markets.

The growth initiatives are under way.

Our restructuring program, the revitalization of our consumer businesses, and our industrial business transformation are on track and delivering great results in 2007.

We have momentum and confidence behind these important programs and our pursuit of acquisitions that fit our business.

Our financial results have been ahead of our expectations.

This will give us an opportunity to invest back in the business to drive future sales, as well as tremendous confidence that we'll be ahead of our initial goals for 2007.

Throughout McCormick, employees are focused on the right things to move our business forward in achieving positive change.

They are the ones behind this great performance.

To our shareholders and everyone on the call we thank you for your interest and attention, Alan, Fran, Paul, Joyce, and I would now like to entertain any questions you may have.

Thanks so much.

Thank you.

(OPERATOR INSTRUCTIONS) Your first question is coming from Terry Bivens with Bear Stearns.

Good morning, everyone.

Good morning, Terry.

Just a question on the gross margin, slightly below our estimates.

I suppose it doesn't yet fully reflect the pepper price as you mentioned, Bob, and I was a bit curious too, to what extent would that reflect higher sales in the industrial unit versus consumer?

If you could just kind of give us a little color around that, please?

Just, Terry, it's just some sales.

I think what we tried to say in the conference call script is that as with anything, our cost increases are ahead of our price increase impact in our P&L, and there is some small softness in pepper volumes especially in the United States but that's small, but even in the industrial business, there is this lag period that happens and that's why the gross margin was a little bit behind what our expectation is but once again, we're still very pleased with where it's at on a year-to-date basis.

Okay, and the contribution or rather, the influence of perhaps the greater sales in industrial, was that a factor at all?

Mix is always a factor, Terry, but no, I wouldn't say that at this particular point in time.

It's more the former than anything else.

Okay, very good.

I'll pass it on.

Thank you.

Thanks, Terry.

Thank you.

Your next question is coming from Jonathan Feeney with Wachovia.

Good morning, everyone.

Congratulations.

Thanks, John.

Bob, pretty strong quarter all around.

There was one area that was maybe a little bit, that we were just wondering about, it's this U.S.

consumer business, if you exclude the impact of Simply Asia, still in the middle of this relaunch, I shouldn't say relaunch, I should say the impact of gravity feed shelving, I would have expected consumer to be stronger in the U.S.

And I'm wondering, is the launch of these Weber Spices or any other competitive getting tougher in the U.S as we speak?

I think it's a -- this is Alan Wilson.

It's a question of the channels.

The grocery channels where we're resetting and revitalizing are actually performing pretty well.

We've got some headwinds as Bob talked about in the script from some of the alternative channels where we have the impact of some additional private label products being introduced in the warehouse clubs.

But specifically, you'd call out private label activity, not other brands as competitive headwinds?

Yes.

It's more of a private label impact than other competitive brands.

And are you feeling that sort of lift in your own private label business?

We're seeing some impact but not significant.

Okay, thank you very much.

Thanks, John.

Thank you.

Your next question is coming from Chris Growe with A.G.

Edwards.

Good morning.

Good morning, Chris.

Hi.

I just wanted to ask about the cost inflation and should we presume that the cost inflation in industrial would outpace that out of the consumer, things like cheese costs and of course now pepper as well.

Is that a reasonable assumption for the second half of the year?

Chris, it may outpace it, but once again, we do have these pass throughs, so it isn't a P&L impact when you look at it from a total year perspective but if we're focusing on quarter by quarter, there is this lag that I talked to Terry about that is always a problem there and it's something we're dealing with on a quarter by quarter basis, but no, I don't think there's anything there on the industrial side that's going to cause any impact on cost greater than the consumer side at this point.

Okay.

And then I had a question also on the marketing expenditures.

I had expected those to be up for the year.

I think you had mentioned those being up for the year.

Do you have any kind of rough estimate of what they should be or could be up for the year?

I think as we said in the script, Chris, and please, the second quarter is an anomaly.

That's just purely a timing.

That was not pre-medicated cut in marketing or advertising spending by us at all.

What we have said is consistently that our U.S.

operations will spend their marketing dollars as per their budget estimates if we have extra money to spend, we're going to continue to allocate more money to Europe to support the Ducros and Schwartz brand and what gives Alan and I tremendous confidence relative to increased marketing and advertising spending and hoped everybody heard it on the call is we've seen some real good movement in the last two quarters on the Ducros brand in France with some significant advertising expenditures around core items and some new products, so we're going to continue to spend the advertising mostly directed at Europe and to some degree a smaller amount in China.

Sounds like you've been pleased with the progress in Europe and that's an area you said ideally the spending will lead to better sales growth so you're seeing that now and the Ducros brand is the breast barometer of that success?

Yeah, both brands in the UK.

Okay, great.

Thank you.

Thanks, Chris.

Thank you.

Your next question is coming from Eric Serotta with Merrill Lynch.

Good morning.

Good morning, Eric.

Bob, you spoke a bit about expanded distribution for Simply Asia, which is certainly positive.

I'm wondering whether you could also comment on whether Simply Asia has allowed you to expand distribution for some of the core McCormick products in channels where they were strong and you guys were under represented yet.

We are, this is Alan Wilson again.

Hi, Eric.

We are starting to see movement as we develop relationships with some of the natural accounts with some of our more core products.

It is not substantially enough to move the dial at this point but we're seeing that we're getting more attention and activity there.

Okay, and then Bob, on the industrial, you spoke about expectations for Foodservice growth flowing in the second half.

You also expressed some confidence in your customers new product launch schedules.

Could you, I guess characterize your, I should say how close you are these days or your visibility these days into your customers launch schedules?

I know clearly a part of the revitalization of the industrial business was to get closer.

Could you give us some sort of at least a qualitative characterization as to where we are there?

Sure, Eric.

I think what we tried to share with you in the script when you look at our European and especially China results were up significantly and that's based upon promotions and launches of new products which we should show that we're really much more confident and in line with their promotion periods and when they are going to do it than we have been in the past.

In the United States, it's very similar, the launches are very much on plan and where we anticipated them.

What's mitigating that a little bit as I said in the script, Eric, is some softness as you're reading in the public domain sort of in these fast food and foodservice channels.

Okay, and do you see that perhaps altering new product launch plans?

Actually, and this is just my editorialization, I think especially in the United States we'll accelerate it because one of the things that's really positive in the environment of the Quick Service and fast food sector is a whole promotional domain they operate within and that's really good for everybody so I'm hoping, I'm optimistic that during the second half of the year that we see increased activity in the United States in the promotion area.

Makes sense, great.

Thank you very much.

Thanks, Eric.

Thank you.

Your next question is coming from Robert Moskow with Credit Suisse.

Good morning.

Hi, Rob.

Hi.

The results in France and the UK were quite a bit stronger than I expected.

I recall back a couple of years when the concern was the consumer in France to some degree, deep discounter retailers.

What do you see the environment looking like now, Bob, in France specifically and do you think that you have been able to market yourself out of that tough situation.

I think as we've said all along, Rob, there was really only ten items that impacted our particular sector, as far as the discounters were concerned.

One area that we also have been fairly declarative on is that because of some of the situations we had in Europe, the marketing expenditures and advertising expenditures were not at the levels we desired and we made a conscience effort in 2007 to increase those.

As a result, as we focus these on promotion items and on new product launches, as we proved in the United States and in Canada, if we focus these dollars correctly and we measure them as you know through the return on investment of the marketing expenditures, this really is working, so what gives me tremendous confidence as I said earlier, I think I said it to Terry is that we're spending increased advertising dollars in Europe, we're seeing some new products that are expanding more rapidly than we anticipated, and we're seeing our core business grow in the UK and in France.

And just to comment on the Ducros brand, we're seeing a turnaround.

I said in the March conference call and I continue to see it today, a turnaround in unit movement of our Ducros brands in the major chains and that's real positive for us in the European environment and one again, it may be blunted a little bit as you read press releases and conference call scripts by removal of our business in Finland and from distribution losses in the Netherlands but all in all both industrial and consumer and Europe, our restructuring program in Europe and the activities, they're exactly where Alan and I would want them right at this point in time.

And as far as the U.S.

goes, do you have a plan for how to get back some of that business that you're losing in the warehouse clubs?

We do.

Once again as Alan said, we're losing some of it to private label and once again you know we are a private label packer so we are packing some of the private label but once again, I think we can revert back to a major chain on the retail side about six or seven years ago, these accounts make strategic decisions to change a focus on some items from branded to private label and that just happened to be in our category.

Obviously, we participate with them.

This alternative channel whether it's mass merchandise or whether it's warehouse clubs are a significant portion of our business and we're very aggressively pursuing it, especially in the new products area.

Okay, thank you.

Thanks.

Thank you.

Your next question next question is come Christina McGlone with Deutsche Bank.

Good morning.

Good morning.

Maybe taking Eric's question a little bit further, Bob, can you just talk about your business model in terms of break out consumer and industrial and international and domestic and talk about how a slowdown in out of home eating in the U.S.

will affect McCormick in total?

The slowdown in in home eating?

Out of home.

Out of home eating?

Uh-huh.

I think as I've said for many years on these conference calls, one of the unique things about this great company is that we really have that balance between when people eat at home or when people eat out in the restaurants, for us it doesn't matter.

We seem to capture the consumer no matter where they choose to go and that doesn't matter whether it's wait table restaurants, whether it's fast food restaurants, or whether they decide to eat at home and if you look at the statistics and we follow these statistics every day, a lot of people are continuing to eat more meals in their home, want value-added products that are convenient, priced appropriately, which caters to what Alan was talking about earlier, all of the new product launches and the Zatarain's and the Simply Asia, so we capture them, everybody knows our consumer margins are greater than our industrial margins and as a result, the phenomenon of eating more in-home I think favors us more from an overall profitability standpoint but if you move to the eat the restaurant areas, once again we capture it through significant volume and through significant promotions.

I think the summary in all that is it doesn't really matter to us where people go to enjoy their meals.

Okay, and Alan, when you were talking about the fact that the loss to private label is impacting you, are we just in the early innings of that?

You'd think with gravity shelving with the new products, with change in the graphics, the gourmet line, all of that that you would be kind of accelerating sales in consumer in the Americas.

Do we look at this private label issue as being a headwind for the rest of the year?

We think it will impact us somewhat, but remember our core grocery business is continuing to grow and what we're seeing is a little bit offset in the alternative channels and I just add to what Bob says.

We have a large focus on new products, specifically for those channels to help offset some of that.

Okay, and then last question.

Fran, the Netherlands and the Finland issue, is this the very last quarter of that or will we see an impact next quarter?

This is the last quarter for both.

Okay, thank you.

Thanks.

Thank you.

Your next question is coming from Ann Gurkin with Davenport.

Good morning.

Good morning, Ann.

Just wondering if you're seeing change with respect to your relationships with customers to work with them to develop new products or are customers taking more of that in house or outsourcing more to you, or is there any change going on there?

Really no change at all, Ann.

On the industrial side it's still focus on the strategic customers and probably the answer on the strategic customers we're doing more and tighter linked with the marketing and with the research and development than we've ever been before, and on the critical customers it continues to increase if you go down to the value-added customers it's probably the other way.

Okay.

Do you care to comment on your acquisition pipeline, how does that look right now?

I really don't choose to comment Ann, sorry.

Okay and how about update on progress in entering India?

Any update there?

We're continuing to look.

We have a retail test market in very limited retail test market in Southern India right now and we continue to look at other options to grow the business there.

That's great.

Thanks.

Thanks, Ann.

Thank you.

(OPERATOR INSTRUCTIONS) Your next question is coming from Mitch Pinheiro with Janney Montgomery Scott.

Hi, good morning.

Good morning, Mitch.

You didn't change your last name, did you?

I got married, yes, I changed my name.

But anyway, pepper, I was just surprised to hear that sort of pepper demand would fall as a result of higher pepper prices or at least that's the sense I got.

Is that in fact happening or is it just delayed purchases and there will be sort of pent-up demand.

I think it's a combination of both, Mitch.

It's probably a combination of both is that there is some delayed purchases there.

There's some higher pricing.

This isn't a new phenomenon as we've gone through these price escalations in pepper years and years ago, we did see some slight tail off in some of the unit volume movement but once again, it's over time and once again the important word is over time, Mitch, it's made up by and offset by the price increase.

So we shouldn't view that as a negative.

What we were trying to share in case somebody remembered from conference calls in 2001, when pepper prices escalated, is that there is a slight impact in volumes.

And so your pepper price increase, could you remind us what that was the first price increase and if you care to tell us what it will be going forward?

Yes.

The impact in the first increase was a little less than 1% of total U.S.

consumer sales and will be about the same for the second half, but the impact on straight fill pepper for both increases at first was about 13% and the second one will be about 8%.

Okay.

And that was, that total, less than 1% was for total sales?

Total consumer sales.

All right, thank you.

In terms of -- changing the subject here, the industrial business in Europe, the 16% or 18% depending on how you look at it increase, you said it was largely due to joint venture in South Africa; is that correct?

Some was due to that, Mitch, yes.

Well, I guess my question is, excluding that, what is your sustainable, I mean that was far above expectations, my expectation, so what is sustainable?

Is that going to have an impact for the next two quarters?

How should we look to model that?

I think modeling it in the low double digit including the impact of the joint venture in South Africa for the next two quarters is fair for industrial business in Europe.

Once again, you have to remember, Mitch, we did have some softness in 2005 and early 2006 in our industrial business.

We've gained increased distribution.

We've got new seasoning lines that we talked about last quarter.

Business tends to be fairly robust over there right now.

So also, is it fair to say that your growth there in Europe obviously with your customer rationalization and your focus on your larger customers, is it coming from your top customers or is there new business to be had here?

New business from our top customers and further enhancing the business that we already had.

Okay.

Last question, just on inventory so I can get some sort of sense for the impact of the various moving parts.

Can you sort of weight those in terms of is it foreign currency, is it pepper, cheese, soy, flour?

Yes.

Equally, is there one primary factor?

I don't think there's a primary factor as you look at the increase.

Currency is a big issue.

Foreign currency is a big issue.

The absolute prices of the commodity whether it's cheese, soy, flour, or pepper is an issue.

As we look at Simply Asia and once again that will disappear shortly but year on year Simply Asia's inventory is an incremental add and we're looking as we said before to doing further consolidations and we're building inventory in selected markets in the world for SAP which we're putting in in certain places in the United States and Canada and certain places additionally in Europe so we're building inventory to protect overall customer service levels especially on the industrial side but once again, I will summarize inventories this way, as I said in the script, it's not an area we have a comfort level at this time.

Inventories must and will come down and we have a specific plan championed by Alan with the various Presidents around the world and Fran to make those inventories come down.

We're working on the plan.

It's not a plan that's going to happen at the next three weeks.

It's a plan that is going to have legs over the next six months to nine months.

I'd just like to add, Bob, that we have made progress in bringing some of the inventory down and that was somewhat offset this quarter by the higher commodity cost of some of the raw materials.

So there's a blunting there of some of our efforts but they're ongoing, continuous, and relentless.

Okay.

Actually, I said it was my last question but I do have one more.

Soy bean oil costs related to your Mexican business?

Yes.

How big of an impact did that have and are you getting pricing in Mexico?

Yes, we are and we have purchasing strategies around -- well, we buy that commodity much different than we had five years ago, Mitch, so while it's having a small impact it's not significant.

Okay, thank you, guys.

Thanks, Mitch.

Thank you.

Your next question is coming from Oliver Wood with Stifel Nicolaus.

Hi, good morning.

Good morning.

Just getting back to the pepper question, was wondering if you could help us understand some of the fundamentals within the pepper industry itself, how quickly can producers react to the higher prices, how consolidated is the pepper producing industry, and then finally, how would normalization of pepper prices impact margin performance at some point in the future?

The pepper markets there's four big markets in the world, Brazil, India, Indonesia, and Vietnam, there's also various varieties of pepper and this is a non -- this is an expected cycle of pepper.

It goes through a supply and demand curve.

Pepper had been below $0.75 for a number of years and obviously what happens when they are low people go to alternate crops as they start to see the price increase in pepper they plant the crops and it takes about 2 to 2.5 years to cycle through the pepper plant cycle and then the volumes go back up again, supply and demand curve fixes that and over time the prices go back down again.

If I had to predict we're kind of in the third inning of a nine inning game relative to pepper.

Pricing is not established at this particular point in time.

Is there increased pricing on the raw material market?

That's purely a supply and demand situation that we can't control.

We're pricing to the as Alan said earlier to the current level of pepper which we indicated is in the $1.60 to $1.75 range, and it's going to continue to go up a bit higher in fiscal 2007.

Having said all that, how you manage the future really is really on the supply and demand curve and since we're one of the largest purchasers of pepper in the world we have some visibility with our growers around that but once again as pepper starts to come down, the growers then obviously move out of that and plant with other crops so it's not a simple answer.

It's a complex cycle.

It's a predictive cycle and it's something that I believe we're kind of in the early stages of and we'll work our way out of it and we have pricing mechanisms we put in place both on the consumer and industrial to mitigate some of the increase and that will protect us as we move through the cycle.

Great.

That's helpful.

That's all I have.

Thank you very much.

Nice quarter.

Thank you.

There appear to be no further questions at this time.

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