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 - SanfordBernstein
Ken Zaslow - BMO Capital Markets
Karen [Lenarc] - Federated Investors
Vincent Andrews - Morgan Stanley
Todd Duvick - Banc of America
Andrew Lazar - Lehman Brothers
Sara Lee Corporation (SLE) F1Q08 Earnings Call November 7, 2007 10:00 AM ET
Operator
Welcome to Sara Lee Corporation's first quarter earningscall for fiscal 2008. (Operator Instructions) I would now like to turn the callover to Mr. Aaron Hoffman, Vice President of Investor Relations for Sara LeeCorporation. Thank you, Aaron, you may begin.
Aaron Hoffman
Thanks, Wendy. Good morning and welcome to Sara Lee's firstquarter 2008 earnings conference call. As always, we very much appreciate yourtime and your interest. Joining me for today's call are Brenda Barnes, ourChairman and CEO; and Theo de Kool, our Chief Financial and AdministrativeOfficer.
Our first-quarter results were released at 6:30 Central time this morning via pressrelease that you can find on our website at SaraLee.com. If you have anyproblems 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 morningcontain forward-looking statements about Sara Lee's future operations,financial performance and business condition. These forward-looking statementsare based on currently available competitive, financial and economic data, aswell 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 thoseexpressed or implied in these statements. Consequently, I need to caution younot to place undue reliance on forward-looking statements. We've providedadditional information in our press release and Form 10-K for fiscal 2007 that Iencourage you to review concerning factors that could cause actual results todiffer materially from these forward-looking statements.
With that out of the way, let me turn the time over toBrenda.
Brenda Barnes
Thanks, Aaron. Goodmorning, everyone and thanks for joining us today. I'd like to start off todayby updating you on some organizational changes we announced internallyyesterday. Our is and has been firmly grounded in our strategy to organizearound our customers and consumers, while achieving operating excellence acrossthe company.
In our efforts to continue toward these goals and to betterleverage our scale in North America, CJ Fraleigh is nowChief Operating Officer of Sara Lee North America. Our three North Americansegments -- 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 businesssegments. Jim Nolan, who has been in charge of our Foodservice business, is nowCEO 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 performanceof that business.
Tom Hayes, who most recently was our Chief Customer Officerin Foodservice, will succeed Jim as the President of our Foodservice segment. And,Monty Pooley is now President for the Retail Meat segment. Most recently, hewas the Chief Customer Officer for our North American Retail business.
I firmly believe that these moves better position our NorthAmerican business for continued growth and success over the long term.
Now, turning to the first quarter, let me offer myperspective. In many ways, the first quarter saw important investments thatwill provide a strong base to achieve a successful fiscal year. We increasedour MAP spending by 21%, or $26 million, supporting new innovative productsthat will deliver incremental sales and margin dollars over the course of theyear.
We also made strategic pricing decisions to addresshistorically high commodity costs. During the quarter, pricing slightlyoutpaced commodity increases. We expect this situation to reverse itself duringthe remaining nine months, and that we will end the year with incrementalcommodity costs fairly even with price increases.
We overcame about $70 million of incremental input costs inthe quarter. The combined markets for the basket of commodities we purchasedrose 12% compared to a year ago, and almost 6% compared to last quarter. Ourability to offset that increase with pricing actions speaks to our improvedskill in appropriately assessing the situation and successfully implementingchanges with our customers. It also speaks to the strength of our brands.
The net result of these actions and the commodityenvironment is a mixed first quarter, with most of our segments seeing adjustedoperating segment income declines. I would emphasize that we are managing ourbusiness for the longer-term goals, not just quarters in mind. As we'vediscussed with you in the past, we will make investments in the business whenit makes sense to support the right products at the right time with the rightmarketing mix.
The first quarter of 2008 is, clearly, a quarter thatmerited that investment. Even in the short term, these investments, along withpricing 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 theindividual segments, where there are some good stories and initiatives.
Our North American Retail Meat business is successfullymoving its portfolio to consumer focused, on-trend value-added products thathelped drive adjusted sales growth of 3.3% for the quarter, while adjustedoperating segment income was down. With a 20% increase in MAP spending and $16million of input cost headwinds, we had a challenging quarter. We continue tosupport successful new products like Jimmy Dean Breakfast Bowls and D-Lightsbreakfast 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 exitof what we term commodity meats, which is broken out from our retail businessin the net sales bridge in the press release.
As part of shutting down our West Point,Mississippi meat facility, we didnot exit some hog purchase contracts and are now selling entire hogs to anotherslaughter operator. The result is higher commodity volumes with very negativemix. More importantly, on the retail side, you'll see volumes were roughlyflat, but price mix was up over 6 points, reflecting the improved overallproduct mix that we have achieved through innovative new products.
North American Retail Bakery delivered a solid firstquarter, with 4% adjusted sales growth and a modest decline in adjustedoperating margins, driven primarily by a 16% increase in MAP spending. I'mpleased to note that our price increase announced in early September was fairlywell-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 willtake additional pricing late in our second fiscal quarter.
Our ability to successfully partner with our customersduring this challenging period demonstrates the real strength of our salesorganization and the power of the Sara Lee brand. It remains the #1 freshbakery brand and grew sales by 19% in the United States. I see tremendous opportunities tofurther drive top and bottom line performance in the bakery business.
Our Foodservice segment volumes and sales declined as westrategically exited various commodity meat products and DSD routes. We alsosaw 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'mconfident that this strategy will yield improved profitability. In the firstquarter, commodity volatility, combined with these volume declines, had ashort-term negative effect on margins, but we remain comfortable that thebusiness will show much better results as we move into our seasonally strongestquarters.
Fundamentally, we have improved our customer relationshipsand our category relevance through better selling capabilities and moreinnovative on-trend products, like Caffiato and Stuffins, which were justlaunched and have been well received by operators. All of these factors give usconfidence in the full-year plan.
Clearly, our International Beverage business had a fantasticquarter. Importantly, we see good results across all of our product categoriesand in the majority of our key geographies. Adjusted sales rose 15% andadjusted operating segment income increased almost 24% on the strength ofimproved pricing and better product mix.
An important driver of improved mix has been the successfulnew strategy in Brazil.We are more focused on profitable sales instead of just volumes. These changesand continued success in Europe drove adjusted operatingmargin 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 throughinnovation, while maintaining or enhancing our attractive margin structure.
The first quarter marked the beginning of overall resultsfor our International Bakery business. Adjusted sales rose almost 2%, whileadjusted operating segment income was up 3%, pushing adjusted operating marginup 10 basis points. As our new management team continues to improve our sellingand distribution models, we are confident that we'll see solid base businessimprovement over the course of the fiscal year.
Household and Body Care made significant investments in thequarter, setting them up for another strong year. While adjusted sales grew asolid 3.6%, adjusted operating profits declined by 20%. The change came largelyfrom a 35% increase in MAP spend, along with an increase in trade spendingdesigned to drive trial.
These investments supported the successful rollout of AmbiPur 3volution, which is now sold in 10 countries, and Ambi Pur Puresse, whichwas launched in four countries during the first quarter, helping the brand grow21%. Sanex grew 13% from continued strong deodorant sales, and Radox was up 20%this quarter behind effective sales promotion campaigns. The outlook for ournew products and the rapid pace of innovation certainly merit the largemarketing investments so that we can quickly roll out our best products,positioning the business for excellent long-term growth, as we saw in fiscal2007.
Turning to the financials, let me start with reporteddiluted earnings per share from continuing operations, which were $0.28 for thequarter. The number includes $0.18 per share from the tobacco gain and no netimpact from significant items.
Talking about cash: as we reported this morning, cash usedby continuing operations in the quarter was $62 million, representing a $174million improvement if you consider the $88 million of cash flow fromHanesbrands and other discontinued operations in the first quarter of fiscal2007.
Let me close by reviewing our guidance for fiscal 2008. Weare forecasting diluted EPS in the range of $1 to $1.06 per share, whichincludes an $0.18 per share gain from the sale of our tobacco business infiscal '99 and no net significant items from the first fiscal quarter. Ourguidance does not include any other significant items that may occur during theremainder 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 guidanceincreased by $0.05 per share. This is solely the result of a much morefavorable euro/dollar relationship then we had originally anticipated. We haveincreased our full-year expectation for the euro $[1.36] to $1.37. That meansthat our underlying business forecast has not changed.
We also now anticipate sales growth of over 7%, which incorporatesour modified euro/dollar assumptions. We continue to expect volumes to be flatto up slightly as a result of planned exits of unattractive business in our DSDbakery, DSD foodservice coffee systems, and our commodity meat position infoodservice. These declines will offset volume growth in many of our otherbusinesses.
For the total company, that means the bulk of our salesgrowth will come from price mix improvement and favorable currency exchangerates.
In spite of continuing commodity volatility, we remaincomfortable with our guidance for the full year of adjusted operating margin of7.6% to 8%. This would represent a very healthy 60 to 100 basis point increasecompared to fiscal 2007.
To summarize, the first quarter is yet another importantbuilding block, not only for achieving our fiscal '08 objectives, but also forpositioning 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 thosequalities continue to enhance our performance. The progress we've talked aboutis translating into positive performance, and reinforces my confidence and ourteam's confidence in our ability to deliver further results.
Now Theo, Aaron and I are happy to take your questions.
Question-and-AnswerSession
Operator
Your first question comes from Terry Bivens - Bear Stearns.
Terry Bivens - Bear Stearns
Back during Steve McMillan's tenure, you guys went largelyunhedged on currency. That would have to be the inference this morning, but isthat correct? Are you basically letting the euro and other currencies kind ofdo what they do?
Theo de Kool
At the moment that isthe situation, Terry. We are unhedged from a translation of earningsperspective. We do hedge, however, transaction results or other commodities orother purchases in foreign currency; we normally hedge those purchases from themoment that we enter into commitments.
Terry Bivens - Bear Stearns
What would the volumepicture have been like? Obviously, you did have that unusual volume situationwith the commodity meats. If you exclude that, what would the corporate volumeshave looked like?
Brenda Barnes
You can see theeffect on the meat business on the attachment to our press release.
Aaron Hoffman
We haven't really calculatedthat, Terry but, clearly, that would have a meaningful impact, one wouldexpect, on the unit volume.
Terry Bivens - Bear Stearns
The volumes wouldprobably have been down excluding that situation?
Theo de Kool
I don't think so. Ifyou look at the table on page 15 of the press release, you can see that thecorporate volume is 1% up, and that North American Retail Meats counts for3.1%, but that it would have been flat without that commodity impact.
Terry Bivens - Bear Stearns
Flat without it.
Theo de Kool
For retail meats. Soif you take out that 3% North American retail meat, you're still positive onthe 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 MAPspending in context. The only guidance you've given for the year, if I'm notwrong, is that MAP spending is going to be up 50 to 70 basis points for theyear. I'm just trying to get an idea of is 21% way above the average for theyear, in line? Just give us a sense of that.
Theo de Kool
First of all, Pablo, wehave not given any specific guidance on that. What we have done in inventory managementis where we have combined R&D net and other, and then we gave an increasethere. So you should not just project that on that only.
Secondly, this is, clearly, a quarter where we have investedheavily, not only in MAP, but also in trade promotions, and that has the bestresults in some of our segments. But clearly that's an investment that has alsodriven top line. I have to say this to alarge 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 toincrease MAP spending in any way, right,? Relative to the guidance, relative towhat internally you're planning to increase it by?
Theo de Kool
No. We have not done that. This is in line with our internalplan, but we have not given any guidance on the quarter, so I understand thatthis is a surprise for the market. But internally it's totally in line with ourplans.
Pablo Zuanic - JP Morgan
We don't know your charges, how much goes into COGS and howmuch goes into SG&A. But on a pro forma basis, can you give us a sense ofwhat happened with gross margins year-on-year in SG&A? I calculate thatgross margins were up 140 basis points. But again, I don't know where chargeswent. Can you comment on that?
Theo de Kool
First of all, we hadvery 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 lastyear, I don't have that top of mind, but I think our gross profit percentagewent slightly up to 38%, and now I'm talking by heart and I don't have theright page in front of me.
Pablo Zuanic - JP Morgan
Then just to follow-up, buybacks, you had said that buybackswould be front-loaded. You're keeping the $350 million for the year, but thefirst quarter was only $24 million. What happened there? You're still planningto front load in the first half, the buybacks?
Theo de Kool
We still stick to the number. Yes, we have only bought $42 millionor $43 million in the quarter. But the $350 million, we will certainly get tothat number during the year.
Pablo Zuanic - JP Morgan
One last one, if Imay, Brenda a bit more strategic. On the M&A front, I know you don't liketo comment too much, but IDC it's out there, and we hear that [Bimbo] islooking at it. Then P&G is talking about selling Folgers. We don't knowwhat you guys are doing. I don't know what you can tell us. But from outside itseems that maybe okay, great you're focusing on your business and turningaround what you have, but there can be a window of opportunity there and maybeyou are letting it pass by.
Brenda Barnes
I'll go back to whatI tried to say at Meet the Management, which is for sure we are looking at ourcore categories, which include bakery and coffee as you mentioned, and ways togrow it organically and over time to look at tack-on acquisitions, which we didthrough the Butter-Krust bakery acquisition is one example.
So just rest assured that we are always looking at thingsand examining the market, and we're looking for quality companies to join upwith us if it makes sense, and if it is accretive to what we're doing.
Pablo Zuanic - JP Morgan
Last question. Thetack-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 thatin the tack-on.
Pablo Zuanic - JP Morgan
That's my point. Thatmeans that you're only sticking to tack-on acquisitions, so you will not belooking at such a big transaction then?
Aaron Hoffman
I would just say thatwe're just not going to comment on acquisitions and divestitures any further. Ithink we've been pretty clear over time that generally we're going to look atgetting 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 whatJim might have been doing?
Brenda Barnes
A change thatprobably didn't come out in the comments I made, but one change that we'remaking with this integration under our North American structure is theintegration of our supply chain network. So that's on the back-end operatingside of things, but I think that's going to significantly both the retail sideof the business as well as foodservice.
You can expect a continued focus on our key customersegments. Tom Hayes, who presented at our Meet the Management business, broughta lot to the party in terms of customer focus, bringing real differentiationboth 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 aboutthe tax rate. It looks like if you take out the tobacco payment, the tax ratewas [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 walkus through that?
Theo de Kool
I think the tax ratefor the total year to start with was 29%, and we lowered it now to 28% overallbecause of $13 million of discrete items. The tobacco payment is tax-free, butyou scrap the effect of that over the years so I think to calculate the way youdo it, I don't think that's totally correct. I think the thing to keep in mindis that our effective tax rate on the core business, like we gave from theguidance table, is unchanged and that 28% is the overall rate.
Bill Leach - Neuberger Berman
What is thedifference between the 28% and the 33% again? I'm sorry.
Theo de Kool
That is tobacco, because in our core earnings we don'tinclude tobacco that is tax-free. That is spread out over the years, so thatleaves us for core ’08 on a full year basis 33%, and you can do what you did ontobacco through the quarter, but technically, that's not correct.
Bill Leach - Neuberger Berman
Your corporateexpense 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 theyear?
Theo de Kool
I don't think youshould 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 wellthan there is this year, and there are always some one-time items runningthrough corporate. But in general, corporate should come down in line withtotal other SG&A, which actually for the total corporation, if you excludeMAP, did come down as well in line with our cost control measures that we arecontinuously implementing into the company.
Bill Leach - Neuberger Berman
Corporate should bedown modestly for the year you're saying?
Theo de Kool
I don't think we gaveguidance for the year, but we are on a good track.
Bill Leach - Neuberger Berman
Do you have anyguidance 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 pressrelease, 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 ofHousehold and Body Care, and also Coffee, because those were bigger swings thanI might have anticipated? Obviously with Coffee, there was an impact from greencoffee prices but your margins did improve. To what extent have you looked atwhat units did there?
Brenda Barnes
A big part of Coffeeprofit improvement is the change we made in Brazil.If you remember last year we had huge volume increases, and we had too muchemphasis on the volume and not enough emphasis on the margin. So we reallyfocused 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 marginupgrade on the increasing Senseo sales.
Theo de Kool
The increase in thenet sales is 15%. It's about 5% coming from unit volume and 10% coming fromprice mix. I think we're happy to beable to add to that basically all categories increased in volume. Senseo, whichis higher profit than the average business, did increase more than average, andthat helped the margin as well. Overall, I think we have a very healthybusiness in hand there, that we have high expectations for the remainder of theyear.
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 promotedheavily in the quarter, and that was a consideration as well. To a certain extent that the volumes went upmore 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 inthe quarter and the profitability in the quarter somewhat. We're still veryoptimistic about the remainder of the year, and stick to our plan.
Brenda Barnes
As we've talked aboutin the past, we will spend and invest behind new product activity. Sometimesthat new product activity falls disproportionately in a quarter. That happenedto 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. Itwould 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, weinvested heavily in trade promotions as well and that decreased the grossprofit for the quarter. That's not the expectation for the remainder of theyear.
Operator
Your next question comes from Eric Serotta - Merrill Lynch.
Eric Serotta - Merrill Lynch
Mix is clearly a bigdriver of your strategy here. Could you just break out the overall 3.5% pricemix contribution into price and mix? Along the same lines, it struck me, theHBC mix you highlighted as being unfavorable in the press release. Could yougive some detail behind that?
Aaron Hoffman
First of all, we donot disclose the separation between price mix and other, so that's something wewill 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 mixin HBC.
Theo de Kool
The mix in HBC is driven by what I just explained, and thatis quite heavy promotions on some of our top products like in Sanex and in AmbiPur. We introduced Ambi Pur Puresse, I think in four countries. There was againquite 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 theprice mix deteriorated as it was conscious decisions to promote certainproducts.
Brenda Barnes
The promotion, by theway, is in this case a part of our marketing mix. Getting trial in the earlystages of a launch of a product requires a consumer to try it and build arepeat 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 whatall-in brand support was up in the quarter when you take the portions of thatwhich is accounted for in gross to net that you truly classify as marketinginvestments rather than traditional trade spending?
Brenda Barnes
We have increased ourMAP spend by $26 million. Is that the number you're looking for?
Eric Serotta - Merrill Lynch
No. I'm actuallylooking for if you could give us an idea of the percentage of the totalincrease in consumer support when you include the portion that's included ingross net.
Brenda Barnes
I don't have thatcalculation handy right now.
Aaron Hoffman
Give me a call and wecan talk about it.
Eric Serotta - Merrill Lynch
Lastly, Theo, in the footnotes it mentioned the $100 milliontax charge in the quarter related to repatriation of a portion of fiscal '08foreign earnings. From that statement, is it fair to assume we should expectcontinued charges throughout this year for repatriation?
Theo de Kool
What this $100million is, that is baked into our 29% tax rate and our 28% for the year. The $100million is an annual number that is expected to be charged when we repatriatecurrent year earnings.
Let me use this opportunity to also explain that we havealready 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&Lanymore, but will run through the cash flow statement in the remainder of theyear. 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 currentyear earnings.
Operator
Your next question comes from Eric Katzman - Deutsche Bank.
Eric Katzman - Deutsche Bank
Good morning, everybody. I have a few question. First asimpler 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 secondquarter?
Theo de Kool
It will continue torun like that for about two years or so before the volumes come downsignificantly. That is because we are still committed to a contract that wemade earlier. So we buy the hogs and sell them. It has to run through theP&L in the way we explained it in the footnotes.
Eric Katzman - Deutsche Bank
So if it's a two-yearissue, how should we think about then North American meat top line in context,or profit for that matter?
Theo de Kool
Profit impact is veryminimal in principle because we buy and sell instead of before that when webought the hog, slaughtered it, and sold the remainder. So from a top lineperspective there is impact, and that is actually baked into our numbers. It'sbaked into the first quarter actuals. It was not in our original projection, sothere 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 reasonwe've started to reflect it separately in the chart in the press release, justto bring more clarity to that.
Eric Katzman - Deutsche Bank
I'll follow up with Aaron off-line on that. Second, more ofa broader issue, and correct me if I'm wrong, but I think that at the Meet theManagement meeting you suggested that incremental commodity and inflation costswould be running up about $400 million for the company for fiscal '08, and thatthat was more on the 5% increase level. Brenda, I think you mentioned now thatyour commodity cost basket in the fiscal first quarter was up 12%?
Theo de Kool
Having the percentage available, Eric, our commodity cost inthe quarter in the P&L went up I think $69 million. We were offsetting thatwith $77 million pricing. So we are happy that on the first quarter we wereable to overcome that commodity issue. We expect that going forward, there maybe some slippage and so we are a little bit ahead of the game; that will not bethe case in the quarters to come. So there is some uncertainty there.
The overall number, $400 million, I don't recognize. But Ithink it's fair to say that our commodity increase for the full year willexceed $300 million.
Eric Katzman - Deutsche Bank
What I'm trying to do is bridge the gap between your coreearnings 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 ninemonths, however slight, how should we expect such a ramp up over the remainingquarters?
Theo de Kool
We don't givespecific guidance quarter by quarter.
Eric Katzman - Deutsche Bank
I'm not asking forthat. What are the levers that are going to work in your favor to offset what'sgoing to be greater commodity pressure by your own admission, vis-a-vispricing?
Brenda Barnes
When we talked aboutwhat's going to contribute to the margin improvement over time, we said ingeneral, this is a general principle, that pricing over the course of the yearwould offset commodity increases. That's what we believe will continue tohappen, although by quarter it will look a little bit differently. We areexperiencing a big mix shift as we talked about our new products; each of ournew products has a different margin structure than the core base does. Sothat's another part.
Then offsetting basic inflation on other areas aresignificant efforts and progress that we've made on continuous improvement,process work, SAP implementation all of that also contributes quite nicely tohelping the margin picture.
Eric Katzman - Deutsche Bank
So to summarize over the next three quarters, the remainderof the year, it's a combination of mix and some of the lean and other effortsthat 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 mynext question in that are you seeing any demand elasticity vis-a-vis pricing? Isthat 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 theother areas?
Brenda Barnes
Today we have notseen a significant effect by that. There's a little bit of a small little bitof a drop-off in bakery that could be attributed to that, but it’s notsignificant. 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 assumptionsabout what the go-forward picture is going to look like. We're doing it on ourbest assumptions at this point in time, and we're going to keep an eye on isthere a consumer impact of this or not? To date, we haven't seen a big part ofthat.
Operator
Your next question comes from Jonathan Feeney - Wachovia.
Jonathan Feeney - Wachovia
You talked about pricing offsetting commodities. I wonderedwould that also be true specific, and I don't know if you can give this levelof detail, but specific to the North American Meat and North American Bakerybusiness, where I have to think the vast majority of your proportional commodityimpact would be? Are you recovering commodity costs with pricing in those twosegments specifically right now?
Brenda Barnes
Each category isquite different, as I'm sure you know. In the Bakery we have offset ourcommodity increase. In Meat we have not to the full extent. Some of it has todo with lead times about when you know about the increase and when you areactually able to implement it with the trade. There's a longer lead time onsome of the businesses. In Bakery we can do it fairly quickly, in Coffee wetend to be quite successful in it, and less able to do it immediately in the Meatsegment.
Jonathan Feeney - Wachovia
When you lookspecifically at those two businesses where it seems like the vast majority ofyour pressure has been incrementally, is there any substantial kind of changeto 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 explainedbefore, from the moment that we enterinto a commitment until the moment that we think we can either pass it on tothe customer that we use hedging as much as we can. Not all markets make thatpossible, one reason being just our size. But there is nothing specific in thenext months that make me give a different expectation. Obviously, there is somelead time with the costs as well so the market is somewhat higher than the costthat 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 earningspower and operating margin, it seems like since we've been talking about thoselong-term numbers the International Beverage business, and to some extentHousehold and Body Care, probably maybe outperformed what seems likeexpectations, while North America has kind of lagged behind a little bit.
I know there's a huge difference in operating margin betweenyour North American businesses and other businesses. Relative to a year ago,are you less optimistic now in counting on the North American business andcounting more on the international? Or is this just really the timing of MAPspending and things are unchanged?
Brenda Barnes
All along each of thedivisions had a unique and different role within our portfolio. As we talked atMeet the Management and how we continue to believe, our goal in our high-marginbusiness which you're right, are the international segments of household andcoffee and tea, the goal there is to expand volume with maintaining a highmargin. That's what we thought of in the original estimate of our long-termgoal.
So we're very confident in that. We think that all thethings that are coming to play across the globe, which include innovation,better sales activities, more value to the trade, lean activities, are alsotrue in international as they are in the United States. So that's why I feelconfident that the margin structure can hold while we're taking innovation andtaking 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 significantchanges in the USbecause of all the plans that we've put in place. Margin in the near-term willnot be as high of a level as the international businesses are, though.
Jonathan Feeney - Wachovia
One final detailedquestion, if you wouldn't mind, Theo. On page 11 you have a nice breakout hereof the non-GAAP adjusted operating income. It says that changes in foreigncurrency 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 notcorrect. There is, I think, a $10 million or $11 million impact on operatingincome.
Aaron Hoffman
What you want to lookat is the $12 million in fiscal '06 the way we do it is –
Jonathan Feeney - Wachovia
Proportion. Okay. Isee. 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 - SanfordBernstein.
Alexia Howard - Sanford Bernstein
A couple of questionson Foodservice and International Beverages. On the Foodservice side the salesdeclines are, obviously, coming through as expected as you get out of some ofthose commodity products. I guess you started that a while ago. I'm assumingthat this kicked in this quarter, and there's going to be continued declinesfor the remainder of the year, in terms of the pullback on the Foodserviceside. Is that correct?
Brenda Barnes
That's correct. Wedidn't one day say we're out of that business forever so there will be agradual 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 coffeebusiness in that segment seems to be doing quite well. Could you speak to thatin terms of what's changed there? I guess it has been a bit of a burn on thisside for a while now.
Brenda Barnes
We did exit some DSDroutes, and we are improving the routing structure and the cost structure ofthat 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 goodnews/bad news is it's not where we wantit to be is the bad news; the good news is that's a lot of opportunity for thatbusiness 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, butthat's not specifically related to DSD.
Alexia Howard - Sanford Bernstein
Finally, a longer-term question about the InternationalBeverage business. It seems as though that business is on fire right now. Howsustainable is this kind of margin expansion given that it's already your mostprofitable business? Obviously, the type of organic sales growth we're seeingat the moment and have been for a while is quite phenomenal. Is that somethingthat 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 InternationalBeverage business. Quite frankly, I think, it's been overlooked for some timenow. So we're very optimistic of the future of this business and theopportunity. It is not going to come through margin percentage increase; it'sgoing to come from holding great margins and driving the top line. We feel thatwe have got the product ideas, we feel that we've got the capabilities, and wefeel we have the geography to keep that going.
Operator
Your next question comes from Ken Zaslow - BMO CapitalMarkets.
Ken Zaslow - BMO Capital Markets
The structural change that you're making in Brazilin terms of how you're incentivizing your salespeople to focus more on pricingplus 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 dowith starting with strategy and then translating into annual operating plans,that then translate into what every person's expectations are for their owndelivery. So, it cascades through the organization and resets what each personis expected to deliver.
Ken Zaslow - BMO Capital Markets
Are there other divisions that you can do that in and maybesurprise us on the upside on other divisions that you can maybe change thestructure of how people are either incentivized, or get that to change in thesame way that you're doing in Brazil?
Brenda Barnes
What we've been doingacross the company and continue to do is be really clear about what ourdirection is, our strategy, and our annual plans, and then make sure everyperson really understands their role in delivering it. Sometimes we've gottenthat plan wrong, which I would say was the case in Brazil. We went forleadership market share position, and we had to dial that back just a littlebit. So, we will recalibrate when we see something is either working wrong, orcould be working better. But in all cases, the plan translates to every singleperson.
Ken Zaslow - BMO Capital Markets
Do you see that inother divisions now, any opportunity that you might let us know about now?
Brenda Barnes
None that I can giveyou, no.
Aaron Hoffman
Our strategy in the Foodservice business, which we justarticulated, is one of shifting out of some non-profitable volume and focusingon profitable segments.
Brenda Barnes
I guess no new thingsright now.
Aaron Hoffman
There are certainly these kinds of strategies present inother segments.
Operator
Your next question comes from Karen Lenarc - FederatedInvestors.
Karen Lenarc - Federated Investors
Good morning. Just a question about your revised guidance, Iwas a little surprised at the visibility you have this early in the fiscalyear, so I just want to make sure I understand. Is it due to the existingpurchasing contracts you've got and then the hedges you have on them that youhave visibility on currency? And if not, what is responsible for the visibilityyou do have to revise up on that basis? Thanks.
Theo de Kool
On currency, Karen, the way we did it is the average ratefor 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 fiveis on the assumption that the full year will be at 1.37. So we don't havecontracts in place that give us the visibility; it's kind of more ourassessment that already four months in the year, being at 1.44, 1.45, that it'sour expectation that it will not drop down to 1.10. And therefore, that is higherthan the 1.30 assumption, the 1.31 that we put in the original plan that it isfair to show that this will go higher. We just want to give you the visibilityif it would stay at 1.37; then we will have $0.05 more.
Operator
Your next question comes from Vincent Andrews - MorganStanley.
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 newproducts during the year across the different divisions. Obviously, you talkedabout the new products in Household and Body Care. I wanted to put that in linewith there was an increase in MAP spending during 4Q, which we thought wasreally setting you up for the benefits of that coming into this year, thenthere's another quarter of MAP spending at about that level.
What should we think about how you're going to judge theperformance of that MAP spending, when we should start to see the results ofit, and in particular what will we see it in and where?
Brenda Barnes
The challenge ofshifting to a more innovative mix in new product, a higher percentage of newproducts as a percent of your total, each time you launch a product the firstquarter you launch it is typically not a positive picture in terms ofprofitability of that launch. So as we've been ramping up more and moreproducts, there will be a steady flow of MAP increase. As we projected early inthe transformation, we said that we would significantly increase our ongoingrate of MAP spending throughout the course of the five years.
What will happen is as the new products come in, some of theones we launch earlier then shift into a profitable equation. So we're tryingto balance the speed at which we roll out, the level at which we invest, whileit's made up by our core products which we're also innovating against in theseearlier introductions on new products.
I hope that was a clear explanation, but we have new productlaunches scheduled throughout the whole fiscal year.
Vincent Andrews - Morgan Stanley
Do you have the 25products kind of ratably?
Brenda Barnes
Pretty close. Some ofthem are bigger than others, but I'd say pretty close to each quarter you havea 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 oncash flow. In the first quarter it looks like working capital was a $238million use of cash. I know that as youinnovate and come up with more new products, you're going to have an inventorybuild, which we saw. I was just wanting to know if you can give us someguidance for how much of a drag working capital may be on cash flow for thefull year?
Theo de Kool
No. I can't give youvery specific numbers. I can give a few comments, though. One of the reasonswhy it's up is that there was some shift in the pricing. Foodservice normallysells their products in the first quarter. That was kind of delayed to thesecond quarter; obviously, some small impact on the results for the firstquarter because of that as well. So that's a reason.
Currency is another reason. We see all the benefits comingin the P&L, obviously, there is a balance sheet impact of that as well andthat gives a negative impact on working capital for that reason. Secondly, westructurally improved our processes around planning and inventory and thoseimprovements go slower than over the quarter.
Over the full year, I don't expect a significant buildup ininventories and equity. I hope that we can bring it down, apart from currencyimpact that we can bring it down. When I look at the ratios, then the ratiosare 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 saythat there was probably some seasonal impact of working capital in the firstquarter that you would expect to maybe reverse for the balance of the year?
Theo de Kool
Somewhat, but Icannot quantify that for you. Secondly, what I am saying is that there are somestructural improvement that should help. That is what it is for the year.
Youcannot just look at the sales for the quarter and look at receivables, forexample, 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 onepoint 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 capitalspending, 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 usunderstand the trajectory that we should expect going forward? Are there someone-time items in capital spending for this year that you would expect to notrepeat in forward years?
Theo de Kool
As I've said in theprevious calls as well, there is still substantial IS going through that. Wealso 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 isonly caused by currency impact as well.
Operator
Your next question comes from Andrew Lazar - LehmanBrothers.
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 atthe Meet the Management meeting, '08 versus '07, in those six different buckets, interms I know that it is annual, not quarterly. But in terms of where the fiscalfirst quarter differed most dramatically from that, could you give us a betteridea of what has to change in the next few quarters? I guess it's primarily theR&D and MAP line, as the others, I guess, seem to have come in largelywhere you thought? Is that fair?
Theo de Kool
If I quickly look atthe table, then I think it is indeed mostly in MAP, where it is. Where we havevolume mix, because of trade promotion investments we made, I think that is offversus the total year as well.
Andrew Lazar - Lehman Brothers
So then as we thinkabout the rest of the year, obviously, the MAP piece, I realize that's kind oflumpy; 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 thatMAP would be significantly up. So it's not kind of this quarter; it's up andall next quarter will still be down. But this was more significant than theother 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 youto the 60 to 100 for the year? Because it seems like the others were you said largelyin 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 seasonalperspective. So for that reason, the overall impact on the bottom line isalways somewhat more modest in the first quarter and there are strongerquarters to come. Normally, the second quarter and the fourth quarter arestrong quarters.
Andrew Lazar - Lehman Brothers
So your expectation at this point anyway would be we'llstart to see progress towards that improved EBIT margin in that fiscal secondquarter?
Theo de Kool
I expect marginimprovement 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 thedemand elasticity question I asked before, Brenda, could you comment? Is thereany difference between at least your overview on the consumer between Europeversus the US?
In other words, it seems like coffee, you're taking priceup, 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, pricingis a little bit less easy to get here?
Brenda Barnes
I think it's morecategory-driven than Europe versus US-driven. So if youtake your coffee example, there is some volume drop-off in the traditionalroast and ground. If you look at that piece of the coffee business, you do seea drop as prices go up. But, we've been able to make up a big difference in mixshift and some geography shift like I talked about earlier in Brazil.
The question, is there elasticity to trade off tolower-priced products, and I think that's less of an issue in the meatbusiness, to be honest. It's a branded business. There are some lower-pricedoptions of course, but I think it is less elastic there. Private-label in breadhasn'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 theirpurchase patterns as other things use up their money. But our categories aredaily-use items and I don't think they're the ones that are going to feel itquickest.
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 onthe 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 termsof people [subtracting] their own accounts with their own money?
Brenda Barnes
Tim, I see no inconsistency whatsoever. I'll just take howI'm paid. I won't speak for other employees, I'll take how I'm paid. My entirewealth is wrapped up in Sara Lee success on the stock, totally. So everythingI'm making at this company, I get a base salary, which is not small, I realizethat. But everything I make in terms of wealth accumulation is tied directly tostock and option appreciation. So I have a very significant portion of my networth tied up in Sara Lee stock. So to me, that's absolutely consistent withbelieving in this company. I'm spending my life devoted to making that happen.
Tim Ramey - D.A. Davidson
True. But don't youthink there's sort of some incremental money that people have? It's odd thatthere hasn't been a single insider purchase with the open markets.
Brenda Barnes
I bought stock when Icame in here, and I've gotten grants that as you look at the report you can seeare worth nothing right now. Until I make them worth something, I am the lowestpaid CEO in the country until that happens. So to me, if you're looking for mycommitment to driving the stock price for our shareholders, it certainlyaffects me quite significantly. By the way, I'm also committed to having fivetimes my salary in holdings after a five-year time period. I think that's onthe high side of any company that you would look at in terms of requirementsfor the CEO. The same is true for our top-level executives. I see noinconsistency. I really don't. If you are all managing your portfolios ofallocation of assets, I can promise you mine is behind Sara Lee.
Operator
I'm currently showingno further questions. I'd like to turn the call back over to Aaron Hoffman forany closing comments.
Aaron Hoffman
Thank you all verymuch. We appreciate as always your time, and we'll look forward to speakingwith you soon. Have a nice day.
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