Sara Lee F1Q08 (Qtr End 9/30/07) Earnings Call Transcript

Sara Lee Corporation (SLE)

F1Q08 Earnings Call

November 07, 2007 10:00 am ET

Executives

Aaron Hoffman - VP, Investor Relations

Brenda Barnes – Chairman, CEO

Theo de Kool – EVP, CFO

Analysts

Terry Bivens - Bear Stearns

Pablo Zuanic – JP Morgan

Bill Leach - Neuberger Berman

Tim Ramey - D.A. Davidson

Eric Serotta - Merrill Lynch

Eric Katzman - Deutsche Bank

Jonathan Feeney - Wachovia

Alexia Howard - Sanford Bernstein

Ken Zaslow - BMO Capital Markets

Karen [Lenarc] - Federated Investors

Vincent Andrews - Morgan Stanley

Todd Duvick - Banc of America

Andrew Lazar - Lehman Brothers

Presentation

Operator

Welcome to Sara Lee Corporation's first quarter earnings call for fiscal 2008. (Operator Instructions) I would now like to turn the call over to Mr. Aaron Hoffman, Vice President of Investor Relations for Sara Lee Corporation. Thank you, Aaron, you may begin.

Aaron Hoffman

Thanks, Wendy. Good morning and welcome to Sara Lee's first quarter 2008 earnings conference call. As always, we very much appreciate your time and your interest. Joining me for today's call are Brenda Barnes, our Chairman and CEO; and Theo de Kool, our Chief Financial and Administrative Officer.

Our first-quarter results were released at 6:30 Central time this morning via press release that you can find on our website at SaraLee.com. If you have any problems accessing the release in any way, please call Gene Williams at 230.598.4966. Also, our 10-Q for the first quarter was filed this morning.

To begin, I will caution you that our remarks this morning contain forward-looking statements about Sara Lee's future operations, financial performance and business condition. These forward-looking statements are based on currently available competitive, financial and economic data, as well as management's views and assumptions regarding future events.

Such forward-looking statements are inherently uncertain, and investors must recognize that actual results may differ from those expressed or implied in these statements. Consequently, I need to caution you not to place undue reliance on forward-looking statements. We've provided additional information in our press release and Form 10-K for fiscal 2007 that I encourage you to review concerning factors that could cause actual results to differ materially from these forward-looking statements.

With that out of the way, let me turn the time over to Brenda.

Brenda Barnes

Thanks, Aaron. Good morning, everyone and thanks for joining us today. I'd like to start off today by updating you on some organizational changes we announced internally yesterday. Our is and has been firmly grounded in our strategy to organize around our customers and consumers, while achieving operating excellence across the company.

In our efforts to continue toward these goals and to better leverage our scale in North America, CJ Fraleigh is now Chief Operating Officer of Sara Lee North America. Our three North American segments -- Retail Meat, Bakery as well as Foodservice -- will report to him, along with marketing, supply chain and R&D that support these businesses.

We have strong leadership for our North American business segments. Jim Nolan, who has been in charge of our Foodservice business, is now CEO of DSD Bakery. Jim has a real wealth of experience in DSD organizations, and I strongly believe he will make a significant difference in the performance of that business.

Tom Hayes, who most recently was our Chief Customer Officer in Foodservice, will succeed Jim as the President of our Foodservice segment. And, Monty Pooley is now President for the Retail Meat segment. Most recently, he was the Chief Customer Officer for our North American Retail business.

I firmly believe that these moves better position our North American business for continued growth and success over the long term.

Now, turning to the first quarter, let me offer my perspective. In many ways, the first quarter saw important investments that will provide a strong base to achieve a successful fiscal year. We increased our MAP spending by 21%, or $26 million, supporting new innovative products that will deliver incremental sales and margin dollars over the course of the year.

We also made strategic pricing decisions to address historically high commodity costs. During the quarter, pricing slightly outpaced commodity increases. We expect this situation to reverse itself during the remaining nine months, and that we will end the year with incremental commodity costs fairly even with price increases.

We overcame about $70 million of incremental input costs in the quarter. The combined markets for the basket of commodities we purchased rose 12% compared to a year ago, and almost 6% compared to last quarter. Our ability to offset that increase with pricing actions speaks to our improved skill in appropriately assessing the situation and successfully implementing changes with our customers. It also speaks to the strength of our brands.

The net result of these actions and the commodity environment is a mixed first quarter, with most of our segments seeing adjusted operating segment income declines. I would emphasize that we are managing our business for the longer-term goals, not just quarters in mind. As we've discussed with you in the past, we will make investments in the business when it makes sense to support the right products at the right time with the right marketing mix.

The first quarter of 2008 is, clearly, a quarter that merited that investment. Even in the short term, these investments, along with pricing and product mix, drove adjusted sales growth of 4.5% for the company, and increases in five of the six segments. Now let's take a look at the individual segments, where there are some good stories and initiatives.

Our North American Retail Meat business is successfully moving its portfolio to consumer focused, on-trend value-added products that helped drive adjusted sales growth of 3.3% for the quarter, while adjusted operating segment income was down. With a 20% increase in MAP spending and $16 million of input cost headwinds, we had a challenging quarter. We continue to support successful new products like Jimmy Dean Breakfast Bowls and D-Lights breakfast sandwiches with strong marketing campaigns, which led to an 18% increase in sales for the brand this quarter.

I want to spend a moment clarifying the effects of our exit of what we term commodity meats, which is broken out from our retail business in the net sales bridge in the press release.

As part of shutting down our West Point, Mississippi meat facility, we did not exit some hog purchase contracts and are now selling entire hogs to another slaughter operator. The result is higher commodity volumes with very negative mix. More importantly, on the retail side, you'll see volumes were roughly flat, but price mix was up over 6 points, reflecting the improved overall product mix that we have achieved through innovative new products.

North American Retail Bakery delivered a solid first quarter, with 4% adjusted sales growth and a modest decline in adjusted operating margins, driven primarily by a 16% increase in MAP spending. I'm pleased to note that our price increase announced in early September was fairly well-received by our customers, and allowed us to offset higher wheat prices. However, as we look forward, if wheat remains at its current levels, we will take additional pricing late in our second fiscal quarter.

Our ability to successfully partner with our customers during this challenging period demonstrates the real strength of our sales organization and the power of the Sara Lee brand. It remains the #1 fresh bakery brand and grew sales by 19% in the United States. I see tremendous opportunities to further drive top and bottom line performance in the bakery business.

Our Foodservice segment volumes and sales declined as we strategically exited various commodity meat products and DSD routes. We also saw volume softness in baked goods from a timing shift to the second quarter. We continue to see fiscal 2008 as the time to exit our commodity meat business, and expect that volumes will drop accordingly. Over the long term, I'm confident that this strategy will yield improved profitability. In the first quarter, commodity volatility, combined with these volume declines, had a short-term negative effect on margins, but we remain comfortable that the business will show much better results as we move into our seasonally strongest quarters.

Fundamentally, we have improved our customer relationships and our category relevance through better selling capabilities and more innovative on-trend products, like Caffiato and Stuffins, which were just launched and have been well received by operators. All of these factors give us confidence in the full-year plan.

Clearly, our International Beverage business had a fantastic quarter. Importantly, we see good results across all of our product categories and in the majority of our key geographies. Adjusted sales rose 15% and adjusted operating segment income increased almost 24% on the strength of improved pricing and better product mix.

An important driver of improved mix has been the successful new strategy in Brazil. We are more focused on profitable sales instead of just volumes. These changes and continued success in Europe drove adjusted operating margin to 17.5%, up 130 basis points. On the strength of new offerings, international Senseo sales rose 26%, even six years after the initial launch. The results are very much in line with our strategy of driving revenue through innovation, while maintaining or enhancing our attractive margin structure.

The first quarter marked the beginning of overall results for our International Bakery business. Adjusted sales rose almost 2%, while adjusted operating segment income was up 3%, pushing adjusted operating margin up 10 basis points. As our new management team continues to improve our selling and distribution models, we are confident that we'll see solid base business improvement over the course of the fiscal year.

Household and Body Care made significant investments in the quarter, setting them up for another strong year. While adjusted sales grew a solid 3.6%, adjusted operating profits declined by 20%. The change came largely from a 35% increase in MAP spend, along with an increase in trade spending designed to drive trial.

These investments supported the successful rollout of Ambi Pur 3volution, which is now sold in 10 countries, and Ambi Pur Puresse, which was launched in four countries during the first quarter, helping the brand grow 21%. Sanex grew 13% from continued strong deodorant sales, and Radox was up 20% this quarter behind effective sales promotion campaigns. The outlook for our new products and the rapid pace of innovation certainly merit the large marketing investments so that we can quickly roll out our best products, positioning the business for excellent long-term growth, as we saw in fiscal 2007.

Turning to the financials, let me start with reported diluted earnings per share from continuing operations, which were $0.28 for the quarter. The number includes $0.18 per share from the tobacco gain and no net impact from significant items.

Talking about cash: as we reported this morning, cash used by continuing operations in the quarter was $62 million, representing a $174 million improvement if you consider the $88 million of cash flow from Hanesbrands and other discontinued operations in the first quarter of fiscal 2007.

Let me close by reviewing our guidance for fiscal 2008. We are forecasting diluted EPS in the range of $1 to $1.06 per share, which includes an $0.18 per share gain from the sale of our tobacco business in fiscal '99 and no net significant items from the first fiscal quarter. Our guidance does not include any other significant items that may occur during the remainder of the year.

Our core EPS guidance, which excludes significant items, is $0.82 to $0.88 per share. As you'll notice, both reported and core EPS guidance increased by $0.05 per share. This is solely the result of a much more favorable euro/dollar relationship then we had originally anticipated. We have increased our full-year expectation for the euro $[1.36] to $1.37. That means that our underlying business forecast has not changed.

We also now anticipate sales growth of over 7%, which incorporates our modified euro/dollar assumptions. We continue to expect volumes to be flat to up slightly as a result of planned exits of unattractive business in our DSD bakery, DSD foodservice coffee systems, and our commodity meat position in foodservice. These declines will offset volume growth in many of our other businesses.

For the total company, that means the bulk of our sales growth will come from price mix improvement and favorable currency exchange rates.

In spite of continuing commodity volatility, we remain comfortable with our guidance for the full year of adjusted operating margin of 7.6% to 8%. This would represent a very healthy 60 to 100 basis point increase compared to fiscal 2007.

To summarize, the first quarter is yet another important building block, not only for achieving our fiscal '08 objectives, but also for positioning Sara Lee for years of consistent top and bottom line growth.

We are executing a plan that is about building brands, organizational capability, and a culture of growth and resiliency. All those qualities continue to enhance our performance. The progress we've talked about is translating into positive performance, and reinforces my confidence and our team's confidence in our ability to deliver further results.

Now Theo, Aaron and I are happy to take your questions.

Question-and-Answer Session

Operator

Your first question comes from Terry Bivens - Bear Stearns.

Terry Bivens - Bear Stearns

Back during Steve McMillan's tenure, you guys went largely unhedged on currency. That would have to be the inference this morning, but is that correct? Are you basically letting the euro and other currencies kind of do what they do?

Theo de Kool

At the moment that is the situation, Terry. We are unhedged from a translation of earnings perspective. We do hedge, however, transaction results or other commodities or other purchases in foreign currency; we normally hedge those purchases from the moment that we enter into commitments.

Terry Bivens - Bear Stearns

What would the volume picture have been like? Obviously, you did have that unusual volume situation with the commodity meats. If you exclude that, what would the corporate volumes have looked like?

Brenda Barnes

You can see the effect on the meat business on the attachment to our press release.

Aaron Hoffman

We haven't really calculated that, Terry but, clearly, that would have a meaningful impact, one would expect, on the unit volume.

Terry Bivens - Bear Stearns

The volumes would probably have been down excluding that situation?

Theo de Kool

I don't think so. If you look at the table on page 15 of the press release, you can see that the corporate volume is 1% up, and that North American Retail Meats counts for 3.1%, but that it would have been flat without that commodity impact.

Terry Bivens - Bear Stearns

Flat without it.

Theo de Kool

For retail meats. So if you take out that 3% North American retail meat, you're still positive on the total, but less than 1%

Operator

Your next question comes from Pablo Zuanic – JP Morgan.

Pablo Zuanic - JP Morgan

Good morning, everyone. I'm just trying to put the 21% increase in MAP spending in context. The only guidance you've given for the year, if I'm not wrong, is that MAP spending is going to be up 50 to 70 basis points for the year. I'm just trying to get an idea of is 21% way above the average for the year, in line? Just give us a sense of that.

Theo de Kool

First of all, Pablo, we have not given any specific guidance on that. What we have done in inventory management is where we have combined R&D net and other, and then we gave an increase there. So you should not just project that on that only.

Secondly, this is, clearly, a quarter where we have invested heavily, not only in MAP, but also in trade promotions, and that has the best results in some of our segments. But clearly that's an investment that has also driven top line. I have to say this to a large extent is fading; we don't expect all quarters to invest that heavily. This is front-loaded with MAP.

Pablo Zuanic - JP Morgan

Your guidance does not imply that you expect to have to increase MAP spending in any way, right,? Relative to the guidance, relative to what internally you're planning to increase it by?

Theo de Kool

No. We have not done that. This is in line with our internal plan, but we have not given any guidance on the quarter, so I understand that this is a surprise for the market. But internally it's totally in line with our plans.

Pablo Zuanic - JP Morgan

We don't know your charges, how much goes into COGS and how much goes into SG&A. But on a pro forma basis, can you give us a sense of what happened with gross margins year-on-year in SG&A? I calculate that gross margins were up 140 basis points. But again, I don't know where charges went. Can you comment on that?

Theo de Kool

First of all, we had very low charges in this quarter, like $22 million in total of which $[60] million was in IS systems; that all goes into SG&A, basically. But for last year, I don't have that top of mind, but I think our gross profit percentage went slightly up to 38%, and now I'm talking by heart and I don't have the right page in front of me.

Pablo Zuanic - JP Morgan

Then just to follow-up, buybacks, you had said that buybacks would be front-loaded. You're keeping the $350 million for the year, but the first quarter was only $24 million. What happened there? You're still planning to front load in the first half, the buybacks?

Theo de Kool

We still stick to the number. Yes, we have only bought $42 million or $43 million in the quarter. But the $350 million, we will certainly get to that number during the year.

Pablo Zuanic - JP Morgan

One last one, if I may, Brenda a bit more strategic. On the M&A front, I know you don't like to comment too much, but IDC it's out there, and we hear that [Bimbo] is looking at it. Then P&G is talking about selling Folgers. We don't know what you guys are doing. I don't know what you can tell us. But from outside it seems that maybe okay, great you're focusing on your business and turning around what you have, but there can be a window of opportunity there and maybe you are letting it pass by.

Brenda Barnes

I'll go back to what I tried to say at Meet the Management, which is for sure we are looking at our core categories, which include bakery and coffee as you mentioned, and ways to grow it organically and over time to look at tack-on acquisitions, which we did through the Butter-Krust bakery acquisition is one example.

So just rest assured that we are always looking at things and examining the market, and we're looking for quality companies to join up with us if it makes sense, and if it is accretive to what we're doing.

Pablo Zuanic - JP Morgan

Last question. The tack-on means buying a company that has 40% market share in coffee in the US; that's not tack-on, right? So you're ruling it out.

Brenda Barnes

I would not put that in the tack-on.

Pablo Zuanic - JP Morgan

That's my point. That means that you're only sticking to tack-on acquisitions, so you will not be looking at such a big transaction then?

Aaron Hoffman

I would just say that we're just not going to comment on acquisitions and divestitures any further. I think we've been pretty clear over time that generally we're going to look at getting our house in order, and making some bolt-on, tack-on acquisitions. That's what we've said publicly, and I think that's what we want to say today.

Pablo Zuanic - JP Morgan

Significant management changes there, congratulations to CJ. What can we expect from the Foodservice side that will be different from what Jim might have been doing?

Brenda Barnes

A change that probably didn't come out in the comments I made, but one change that we're making with this integration under our North American structure is the integration of our supply chain network. So that's on the back-end operating side of things, but I think that's going to significantly both the retail side of the business as well as foodservice.

You can expect a continued focus on our key customer segments. Tom Hayes, who presented at our Meet the Management business, brought a lot to the party in terms of customer focus, bringing real differentiation both in terms of product but as well as cost to serve for the retail operator. So you can see that on an ongoing basis.

Operator

Your next question comes from Bill Leach - Neuberger Berman.

Bill Leach - Neuberger Berman

I was confused about the tax rate. It looks like if you take out the tobacco payment, the tax rate was [48]%. In your guidance for the year you have 28% reported and 33% ex-items, but it doesn't look like the items are very significant. So could you just walk us through that?

Theo de Kool

I think the tax rate for the total year to start with was 29%, and we lowered it now to 28% overall because of $13 million of discrete items. The tobacco payment is tax-free, but you scrap the effect of that over the years so I think to calculate the way you do it, I don't think that's totally correct. I think the thing to keep in mind is that our effective tax rate on the core business, like we gave from the guidance table, is unchanged and that 28% is the overall rate.

Bill Leach - Neuberger Berman

What is the difference between the 28% and the 33% again? I'm sorry.

Theo de Kool

That is tobacco, because in our core earnings we don't include tobacco that is tax-free. That is spread out over the years, so that leaves us for core ’08 on a full year basis 33%, and you can do what you did on tobacco through the quarter, but technically, that's not correct.

Bill Leach - Neuberger Berman

Your corporate expense was down almost 40%, about $30 million. Is this a good run rate now, your $54 million it looks like? Should we just multiply it by four for the year?

Theo de Kool

I don't think you should multiply it by four, because there are some elements that caused that. First of all, there was last year more significant items in that area as well than there is this year, and there are always some one-time items running through corporate. But in general, corporate should come down in line with total other SG&A, which actually for the total corporation, if you exclude MAP, did come down as well in line with our cost control measures that we are continuously implementing into the company.

Bill Leach - Neuberger Berman

Corporate should be down modestly for the year you're saying?

Theo de Kool

I don't think we gave guidance for the year, but we are on a good track.

Bill Leach - Neuberger Berman

Do you have any guidance for interest expense for the year?

Theo de Kool

It's in the table. It's $130 million for the full year.

Aaron Hoffman

Page 5 of the press release, on the guidance table.

Operator

Your next question comes from Tim Ramey - D.A. Davidson.

Tim Ramey - D.A. Davidson

Can we drill down a little bit more on the profitability of Household and Body Care, and also Coffee, because those were bigger swings than I might have anticipated? Obviously with Coffee, there was an impact from green coffee prices but your margins did improve. To what extent have you looked at what units did there?

Brenda Barnes

A big part of Coffee profit improvement is the change we made in Brazil. If you remember last year we had huge volume increases, and we had too much emphasis on the volume and not enough emphasis on the margin. So we really focused on the higher brand that's in Brazil, higher quality and are putting our support behind that. So that's margining up, as well as a more balanced mix on the profitability, along with a margin upgrade on the increasing Senseo sales.

Theo de Kool

The increase in the net sales is 15%. It's about 5% coming from unit volume and 10% coming from price mix. I think we're happy to be able to add to that basically all categories increased in volume. Senseo, which is higher profit than the average business, did increase more than average, and that helped the margin as well. Overall, I think we have a very healthy business in hand there, that we have high expectations for the remainder of the year.

Tim Ramey - D.A. Davidson

By the same token, the performance in Household and Body Care probably wasn’t then as bad?

Theo de Kool

I think they promoted heavily in the quarter, and that was a consideration as well. To a certain extent that the volumes went up more than 8%, and net sales about 4% so that kind of tells the story as well. On top of that, they invested heavily in MAP, so they were driving the sales in the quarter and the profitability in the quarter somewhat. We're still very optimistic about the remainder of the year, and stick to our plan.

Brenda Barnes

As we've talked about in the past, we will spend and invest behind new product activity. Sometimes that new product activity falls disproportionately in a quarter. That happened to be the case in some of our segments this quarter.

Tim Ramey - D.A. Davidson

Would profits on that segment have been up without the 35% increase in MAP and trade?

Aaron Hoffman

Pretty close. It would be pretty close to flat, the MAP dollars versus the decline in [inaudible] are fairly close.

Theo de Kool

If you do the math, Tim, and you take the increasing MAP out then you're flat. But as I said, we invested heavily in trade promotions as well and that decreased the gross profit for the quarter. That's not the expectation for the remainder of the year.

Operator

Your next question comes from Eric Serotta - Merrill Lynch.

Eric Serotta - Merrill Lynch

Mix is clearly a big driver of your strategy here. Could you just break out the overall 3.5% price mix contribution into price and mix? Along the same lines, it struck me, the HBC mix you highlighted as being unfavorable in the press release. Could you give some detail behind that?

Aaron Hoffman

First of all, we do not disclose the separation between price mix and other, so that's something we will not do. But I'll let Theo take the second question.

Theo de Kool

What was the second question again?

Eric Serotta - Merrill Lynch

The unfavorable mix in HBC.

Theo de Kool

The mix in HBC is driven by what I just explained, and that is quite heavy promotions on some of our top products like in Sanex and in Ambi Pur. We introduced Ambi Pur Puresse, I think in four countries. There was again quite a promotion on the 3volution to give that another boost in a few countries. So that decreased gross profit in an unfavorable way. It's not so much the price mix deteriorated as it was conscious decisions to promote certain products.

Brenda Barnes

The promotion, by the way, is in this case a part of our marketing mix. Getting trial in the early stages of a launch of a product requires a consumer to try it and build a repeat pattern, so that's why it got reflected in the trade discounts.

Eric Serotta - Merrill Lynch

Along those lines, do you have a total estimate as to what all-in brand support was up in the quarter when you take the portions of that which is accounted for in gross to net that you truly classify as marketing investments rather than traditional trade spending?

Brenda Barnes

We have increased our MAP spend by $26 million. Is that the number you're looking for?

Eric Serotta - Merrill Lynch

No. I'm actually looking for if you could give us an idea of the percentage of the total increase in consumer support when you include the portion that's included in gross net.

Brenda Barnes

I don't have that calculation handy right now.

Aaron Hoffman

Give me a call and we can talk about it.

Eric Serotta - Merrill Lynch

Lastly, Theo, in the footnotes it mentioned the $100 million tax charge in the quarter related to repatriation of a portion of fiscal '08 foreign earnings. From that statement, is it fair to assume we should expect continued charges throughout this year for repatriation?

Theo de Kool

What this $100 million is, that is baked into our 29% tax rate and our 28% for the year. The $100 million is an annual number that is expected to be charged when we repatriate current year earnings.

Let me use this opportunity to also explain that we have already repatriated in this fiscal year $1.4 billion from prior year earnings. We have not paid the taxes on that yet. That will not run through the P&L anymore, but will run through the cash flow statement in the remainder of the year. That number is what I think I explained during the Meet The Management, around $420 million. That has no relation to the $100 million; that relates to current year earnings.

Operator

Your next question comes from Eric Katzman - Deutsche Bank.

Eric Katzman - Deutsche Bank

Good morning, everybody. I have a few question. First a simpler one. The hog change issue down in the plant in Mississippi, how long is that going to go on for? Is that going to affect the fiscal second quarter?

Theo de Kool

It will continue to run like that for about two years or so before the volumes come down significantly. That is because we are still committed to a contract that we made earlier. So we buy the hogs and sell them. It has to run through the P&L in the way we explained it in the footnotes.

Eric Katzman - Deutsche Bank

So if it's a two-year issue, how should we think about then North American meat top line in context, or profit for that matter?

Theo de Kool

Profit impact is very minimal in principle because we buy and sell instead of before that when we bought the hog, slaughtered it, and sold the remainder. So from a top line perspective there is impact, and that is actually baked into our numbers. It's baked into the first quarter actuals. It was not in our original projection, so there may be some higher net sales number because of that and no profit impact. So in principle, it hurts somewhat our operating margin there.

Brenda Barnes

That's one reason we've started to reflect it separately in the chart in the press release, just to bring more clarity to that.

Eric Katzman - Deutsche Bank

I'll follow up with Aaron off-line on that. Second, more of a broader issue, and correct me if I'm wrong, but I think that at the Meet the Management meeting you suggested that incremental commodity and inflation costs would be running up about $400 million for the company for fiscal '08, and that that was more on the 5% increase level. Brenda, I think you mentioned now that your commodity cost basket in the fiscal first quarter was up 12%?

Theo de Kool

Having the percentage available, Eric, our commodity cost in the quarter in the P&L went up I think $69 million. We were offsetting that with $77 million pricing. So we are happy that on the first quarter we were able to overcome that commodity issue. We expect that going forward, there may be some slippage and so we are a little bit ahead of the game; that will not be the case in the quarters to come. So there is some uncertainty there.

The overall number, $400 million, I don't recognize. But I think it's fair to say that our commodity increase for the full year will exceed $300 million.

Eric Katzman - Deutsche Bank

What I'm trying to do is bridge the gap between your core earnings ex-tobacco of $0.10 and your full year core estimate of roughly $0.85. If inflation is going to be a headwind versus pricing for the remaining nine months, however slight, how should we expect such a ramp up over the remaining quarters?

Theo de Kool

We don't give specific guidance quarter by quarter.

Eric Katzman - Deutsche Bank

I'm not asking for that. What are the levers that are going to work in your favor to offset what's going to be greater commodity pressure by your own admission, vis-a-vis pricing?

Brenda Barnes

When we talked about what's going to contribute to the margin improvement over time, we said in general, this is a general principle, that pricing over the course of the year would offset commodity increases. That's what we believe will continue to happen, although by quarter it will look a little bit differently. We are experiencing a big mix shift as we talked about our new products; each of our new products has a different margin structure than the core base does. So that's another part.

Then offsetting basic inflation on other areas are significant efforts and progress that we've made on continuous improvement, process work, SAP implementation all of that also contributes quite nicely to helping the margin picture.

Eric Katzman - Deutsche Bank

So to summarize over the next three quarters, the remainder of the year, it's a combination of mix and some of the lean and other efforts that you have been making over several years, plus a few pennies on currency?

Brenda Barnes

Plus pricing to offset -- [Break in audio broadcast]

Eric Katzman - Deutsche Bank

That was basically my next question in that are you seeing any demand elasticity vis-a-vis pricing? Is that really the major risk? I would assume that you're seeing some in Foodservice, because that just seems to be an industry phenomenon. How about in some of the other areas?

Brenda Barnes

Today we have not seen a significant effect by that. There's a little bit of a small little bit of a drop-off in bakery that could be attributed to that, but it’s not significant. It's something we're going to keep an eye on over time. As you know, the commodity situation is pretty volatile. So we're making our own assumptions about what the go-forward picture is going to look like. We're doing it on our best assumptions at this point in time, and we're going to keep an eye on is there a consumer impact of this or not? To date, we haven't seen a big part of that.

Operator

Your next question comes from Jonathan Feeney - Wachovia.

Jonathan Feeney - Wachovia

You talked about pricing offsetting commodities. I wondered would that also be true specific, and I don't know if you can give this level of detail, but specific to the North American Meat and North American Bakery business, where I have to think the vast majority of your proportional commodity impact would be? Are you recovering commodity costs with pricing in those two segments specifically right now?

Brenda Barnes

Each category is quite different, as I'm sure you know. In the Bakery we have offset our commodity increase. In Meat we have not to the full extent. Some of it has to do with lead times about when you know about the increase and when you are actually able to implement it with the trade. There's a longer lead time on some of the businesses. In Bakery we can do it fairly quickly, in Coffee we tend to be quite successful in it, and less able to do it immediately in the Meat segment.

Jonathan Feeney - Wachovia

When you look specifically at those two businesses where it seems like the vast majority of your pressure has been incrementally, is there any substantial kind of change to the hedging position over the next two or three quarters that might impact, maybe, the margins there?

Theo de Kool

Nothing substantial. Our policy is, like we explained before, from the moment that we enter into a commitment until the moment that we think we can either pass it on to the customer that we use hedging as much as we can. Not all markets make that possible, one reason being just our size. But there is nothing specific in the next months that make me give a different expectation. Obviously, there is some lead time with the costs as well so the market is somewhat higher than the cost that we experienced in our P&L because of this hedging.

Jonathan Feeney - Wachovia

Taking a step back, Brenda when you gave your longer-term vision for Sara Lee's structural earnings power and operating margin, it seems like since we've been talking about those long-term numbers the International Beverage business, and to some extent Household and Body Care, probably maybe outperformed what seems like expectations, while North America has kind of lagged behind a little bit.

I know there's a huge difference in operating margin between your North American businesses and other businesses. Relative to a year ago, are you less optimistic now in counting on the North American business and counting more on the international? Or is this just really the timing of MAP spending and things are unchanged?

Brenda Barnes

All along each of the divisions had a unique and different role within our portfolio. As we talked at Meet the Management and how we continue to believe, our goal in our high-margin business which you're right, are the international segments of household and coffee and tea, the goal there is to expand volume with maintaining a high margin. That's what we thought of in the original estimate of our long-term goal.

So we're very confident in that. We think that all the things that are coming to play across the globe, which include innovation, better sales activities, more value to the trade, lean activities, are also true in international as they are in the United States. So that's why I feel confident that the margin structure can hold while we're taking innovation and taking it to a broader definition of coffee and to new emerging markets, whether it be Russia or Brazil, like that.

I am still optimistic that we can make the significant changes in the US because of all the plans that we've put in place. Margin in the near-term will not be as high of a level as the international businesses are, though.

Jonathan Feeney - Wachovia

One final detailed question, if you wouldn't mind, Theo. On page 11 you have a nice breakout here of the non-GAAP adjusted operating income. It says that changes in foreign currency exchange rates have no impact on adjusted operating income for the company. Is that right, on this quarter there was no positive impact from FX?

Theo de Kool

No, that's not correct. There is, I think, a $10 million or $11 million impact on operating income.

Aaron Hoffman

What you want to look at is the $12 million in fiscal '06 the way we do it is –

Jonathan Feeney - Wachovia

Proportion. Okay. I see. So year over year it was a $12 million change?

Aaron Hoffman

Historically we do it that way.

Operator

Your next question comes from Alexia Howard - Sanford Bernstein.

Alexia Howard - Sanford Bernstein

A couple of questions on Foodservice and International Beverages. On the Foodservice side the sales declines are, obviously, coming through as expected as you get out of some of those commodity products. I guess you started that a while ago. I'm assuming that this kicked in this quarter, and there's going to be continued declines for the remainder of the year, in terms of the pullback on the Foodservice side. Is that correct?

Brenda Barnes

That's correct. We didn't one day say we're out of that business forever so there will be a gradual exiting of various contracts and customer relations on those products.

Alexia Howard - Sanford Bernstein

The pickup in the DSD, it seems as though the DSD coffee business in that segment seems to be doing quite well. Could you speak to that in terms of what's changed there? I guess it has been a bit of a burn on this side for a while now.

Brenda Barnes

We did exit some DSD routes, and we are improving the routing structure and the cost structure of that segment of business; I wouldn't call it a significant improvement.

Aaron Hoffman

It's getting better.

Brenda Barnes

It's getting better; it's not a radical improvement at this stage.

Aaron Hoffman

I think the good news/bad news is it's not where we want it to be is the bad news; the good news is that's a lot of opportunity for that business going forward to improve it.

Theo de Kool

Just to make sure, the coffee business in Foodservice is much bigger than just the DSD part. Overall, the coffee business is doing well, specifically the [rated] part, but that's not specifically related to DSD.

Alexia Howard - Sanford Bernstein

Finally, a longer-term question about the International Beverage business. It seems as though that business is on fire right now. How sustainable is this kind of margin expansion given that it's already your most profitable business? Obviously, the type of organic sales growth we're seeing at the moment and have been for a while is quite phenomenal. Is that something that can be sustained over time, or how do you feel about that?

Brenda Barnes

We have been and continue to be very, very excited about our International Beverage business. Quite frankly, I think, it's been overlooked for some time now. So we're very optimistic of the future of this business and the opportunity. It is not going to come through margin percentage increase; it's going to come from holding great margins and driving the top line. We feel that we have got the product ideas, we feel that we've got the capabilities, and we feel we have the geography to keep that going.

Operator

Your next question comes from Ken Zaslow - BMO Capital Markets.

Ken Zaslow - BMO Capital Markets

The structural change that you're making in Brazil in terms of how you're incentivizing your salespeople to focus more on pricing plus volume, how did you get that price mix to work down in Brazil? What did you do to get that to work?

Brenda Barnes

It really has to do with starting with strategy and then translating into annual operating plans, that then translate into what every person's expectations are for their own delivery. So, it cascades through the organization and resets what each person is expected to deliver.

Ken Zaslow - BMO Capital Markets

Are there other divisions that you can do that in and maybe surprise us on the upside on other divisions that you can maybe change the structure of how people are either incentivized, or get that to change in the same way that you're doing in Brazil?

Brenda Barnes

What we've been doing across the company and continue to do is be really clear about what our direction is, our strategy, and our annual plans, and then make sure every person really understands their role in delivering it. Sometimes we've gotten that plan wrong, which I would say was the case in Brazil. We went for leadership market share position, and we had to dial that back just a little bit. So, we will recalibrate when we see something is either working wrong, or could be working better. But in all cases, the plan translates to every single person.

Ken Zaslow - BMO Capital Markets

Do you see that in other divisions now, any opportunity that you might let us know about now?

Brenda Barnes

None that I can give you, no.

Aaron Hoffman

Our strategy in the Foodservice business, which we just articulated, is one of shifting out of some non-profitable volume and focusing on profitable segments.

Brenda Barnes

I guess no new things right now.

Aaron Hoffman

There are certainly these kinds of strategies present in other segments.

Operator

Your next question comes from Karen Lenarc - Federated Investors.

Karen Lenarc - Federated Investors

Good morning. Just a question about your revised guidance, I was a little surprised at the visibility you have this early in the fiscal year, so I just want to make sure I understand. Is it due to the existing purchasing contracts you've got and then the hedges you have on them that you have visibility on currency? And if not, what is responsible for the visibility you do have to revise up on that basis? Thanks.

Theo de Kool

On currency, Karen, the way we did it is the average rate for the quarter, euro/dollar, which is the main driver of the currency benefit, is 1.37. The $0.05 incremental guidance that we gave on the table on page five is on the assumption that the full year will be at 1.37. So we don't have contracts in place that give us the visibility; it's kind of more our assessment that already four months in the year, being at 1.44, 1.45, that it's our expectation that it will not drop down to 1.10. And therefore, that is higher than the 1.30 assumption, the 1.31 that we put in the original plan that it is fair to show that this will go higher. We just want to give you the visibility if it would stay at 1.37; then we will have $0.05 more.

Operator

Your next question comes from Vincent Andrews - Morgan Stanley.

Vincent Andrews - Morgan Stanley

Brenda, I just wanted to circle back on the MAP spending, just in terms of at Meet the Management, you talked about launching 25 new products during the year across the different divisions. Obviously, you talked about the new products in Household and Body Care. I wanted to put that in line with there was an increase in MAP spending during 4Q, which we thought was really setting you up for the benefits of that coming into this year, then there's another quarter of MAP spending at about that level.

What should we think about how you're going to judge the performance of that MAP spending, when we should start to see the results of it, and in particular what will we see it in and where?

Brenda Barnes

The challenge of shifting to a more innovative mix in new product, a higher percentage of new products as a percent of your total, each time you launch a product the first quarter you launch it is typically not a positive picture in terms of profitability of that launch. So as we've been ramping up more and more products, there will be a steady flow of MAP increase. As we projected early in the transformation, we said that we would significantly increase our ongoing rate of MAP spending throughout the course of the five years.

What will happen is as the new products come in, some of the ones we launch earlier then shift into a profitable equation. So we're trying to balance the speed at which we roll out, the level at which we invest, while it's made up by our core products which we're also innovating against in these earlier introductions on new products.

I hope that was a clear explanation, but we have new product launches scheduled throughout the whole fiscal year.

Vincent Andrews - Morgan Stanley

Do you have the 25 products kind of ratably?

Brenda Barnes

Pretty close. Some of them are bigger than others, but I'd say pretty close to each quarter you have a steady state of new products coming out.

Operator

Your next question comes from Todd Duvick - Banc of America.

Todd Duvick - Banc of America

A couple questions on cash flow. In the first quarter it looks like working capital was a $238 million use of cash. I know that as you innovate and come up with more new products, you're going to have an inventory build, which we saw. I was just wanting to know if you can give us some guidance for how much of a drag working capital may be on cash flow for the full year?

Theo de Kool

No. I can't give you very specific numbers. I can give a few comments, though. One of the reasons why it's up is that there was some shift in the pricing. Foodservice normally sells their products in the first quarter. That was kind of delayed to the second quarter; obviously, some small impact on the results for the first quarter because of that as well. So that's a reason.

Currency is another reason. We see all the benefits coming in the P&L, obviously, there is a balance sheet impact of that as well and that gives a negative impact on working capital for that reason. Secondly, we structurally improved our processes around planning and inventory and those improvements go slower than over the quarter.

Over the full year, I don't expect a significant buildup in inventories and equity. I hope that we can bring it down, apart from currency impact that we can bring it down. When I look at the ratios, then the ratios are kind of similar to last year from a cash conversion basis versus this year. So there is nothing worrying in it. Obviously, with an increase in sales, working capital is coming along as well.

Todd Duvick - Banc of America

I'm not trying to put words in your mouth, but would you say that there was probably some seasonal impact of working capital in the first quarter that you would expect to maybe reverse for the balance of the year?

Theo de Kool

Somewhat, but I cannot quantify that for you. Secondly, what I am saying is that there are some structural improvement that should help. That is what it is for the year.

You cannot just look at the sales for the quarter and look at receivables, for example, because sometimes the last period is a much higher period in sales, and that then impacts the working capital by period end. So just to look at one point in time, and just making a picture on the last day of the quarter, doesn't tell the whole story always.

Todd Duvick - Banc of America

Fair enough. I guess going forward, looking at capital spending, you've put out your capital spending target for the full fiscal year. I know you haven't provided guidance for beyond that. I'm just wanting to know if you can help us understand the trajectory that we should expect going forward? Are there some one-time items in capital spending for this year that you would expect to not repeat in forward years?

Theo de Kool

As I've said in the previous calls as well, there is still substantial IS going through that. We also build our R&D facilities here, so there is some one-time impact. Actually, the increase that you can see in the guidance table of $15 million is only caused by currency impact as well.

Operator

Your next question comes from Andrew Lazar - Lehman Brothers.

Andrew Lazar - Lehman Brothers

Just a quick one, just so I make sure I'm clear on it. The EBIT change bridge that you gave at the Meet the Management meeting, '08 versus '07, in those six different buckets, in terms I know that it is annual, not quarterly. But in terms of where the fiscal first quarter differed most dramatically from that, could you give us a better idea of what has to change in the next few quarters? I guess it's primarily the R&D and MAP line, as the others, I guess, seem to have come in largely where you thought? Is that fair?

Theo de Kool

If I quickly look at the table, then I think it is indeed mostly in MAP, where it is. Where we have volume mix, because of trade promotion investments we made, I think that is off versus the total year as well.

Andrew Lazar - Lehman Brothers

So then as we think about the rest of the year, obviously, the MAP piece, I realize that's kind of lumpy; maybe that's not up to the extent that it was in the first quarter.

Theo de Kool

Although we have said in the full-year projection also that MAP would be significantly up. So it's not kind of this quarter; it's up and all next quarter will still be down. But this was more significant than the other quarters.

Andrew Lazar - Lehman Brothers

It's going to be up for the year, and that's in your table. I'm thinking about again what changes in the next few quarters again to get you to the 60 to 100 for the year? Because it seems like the others were you said largely in line with what you had thought.

Theo de Kool

I think in itself, the first quarter is normally not a very strong quarter from a seasonal perspective. So for that reason, the overall impact on the bottom line is always somewhat more modest in the first quarter and there are stronger quarters to come. Normally, the second quarter and the fourth quarter are strong quarters.

Andrew Lazar - Lehman Brothers

So your expectation at this point anyway would be we'll start to see progress towards that improved EBIT margin in that fiscal second quarter?

Theo de Kool

I expect margin improvement in the other quarters, certainly.

Operator

Your next question comes from Eric Katzman - Deutsche Bank.

Eric Katzman - Deutsche Bank

A follow up, I appreciate you taking it. Regarding the demand elasticity question I asked before, Brenda, could you comment? Is there any difference between at least your overview on the consumer between Europe versus the US?

In other words, it seems like coffee, you're taking price up, and you're not seeing any impact, and life is good. Is it fair to say North America the consumer is much more stretched and therefore, pricing is a little bit less easy to get here?

Brenda Barnes

I think it's more category-driven than Europe versus US-driven. So if you take your coffee example, there is some volume drop-off in the traditional roast and ground. If you look at that piece of the coffee business, you do see a drop as prices go up. But, we've been able to make up a big difference in mix shift and some geography shift like I talked about earlier in Brazil.

The question, is there elasticity to trade off to lower-priced products, and I think that's less of an issue in the meat business, to be honest. It's a branded business. There are some lower-priced options of course, but I think it is less elastic there. Private-label in bread hasn't been growing and there's still quite a price gap between the branded, non-branded. So, the consumer is going to have to obviously change their purchase patterns as other things use up their money. But our categories are daily-use items and I don't think they're the ones that are going to feel it quickest.

Operator

Your next question comes from Tim Ramey - D.A. Davidson.

Tim Ramey - D.A. Davidson

Brenda, the Meet the Management day was, I think, unequivocally pretty upbeat and I think this call is pretty upbeat in general. And yet I think it's been two-and-a-half years since you bought any stock on the open market and I don't think there's been any other employee purchases. What do you think the difference is between that rhetoric and action in terms of people [subtracting] their own accounts with their own money?

Brenda Barnes

Tim, I see no inconsistency whatsoever. I'll just take how I'm paid. I won't speak for other employees, I'll take how I'm paid. My entire wealth is wrapped up in Sara Lee success on the stock, totally. So everything I'm making at this company, I get a base salary, which is not small, I realize that. But everything I make in terms of wealth accumulation is tied directly to stock and option appreciation. So I have a very significant portion of my net worth tied up in Sara Lee stock. So to me, that's absolutely consistent with believing in this company. I'm spending my life devoted to making that happen.

Tim Ramey - D.A. Davidson

True. But don't you think there's sort of some incremental money that people have? It's odd that there hasn't been a single insider purchase with the open markets.

Brenda Barnes

I bought stock when I came in here, and I've gotten grants that as you look at the report you can see are worth nothing right now. Until I make them worth something, I am the lowest paid CEO in the country until that happens. So to me, if you're looking for my commitment to driving the stock price for our shareholders, it certainly affects me quite significantly. By the way, I'm also committed to having five times my salary in holdings after a five-year time period. I think that's on the high side of any company that you would look at in terms of requirements for the CEO. The same is true for our top-level executives. I see no inconsistency. I really don't. If you are all managing your portfolios of allocation of assets, I can promise you mine is behind Sara Lee.

Operator

I'm currently showing no further questions. I'd like to turn the call back over to Aaron Hoffman for any closing comments.

Aaron Hoffman

Thank you all very much. We appreciate as always your time, and we'll look forward to speaking with you soon. Have a nice day.

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