SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

 

Commission File Number 1-3385

 

H. J. HEINZ COMPANY

(Exact name of registrant as specified in its charter)

 

 

412-456-5700

(Registrant’s telephone number)

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

 

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

None.

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated filer  þ     Accelerated Filer  o      Non- Accelerated Filer  o

 

Indicate by check mark whether the registrant is a shell Company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

As of November 1, 2006 the aggregate market value of the Registrant’s voting stock held by non-affiliates of the Registrant was approximately $13,237,975,131.

 

The number of shares of the Registrant’s Common Stock, par value $.25 per share, outstanding as of May 31, 2007, was 322,030,854 shares.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Registrant’s Proxy Statement for the Annual Meeting of Shareholders to be held on August 15, 2007, which will be filed with the Securities and Exchange Commission within 120 days after the end of the Registrant’s fiscal year ended May 2, 2007, are incorporated into Part III, Items 10, 11, 12, 13, and 14.

 

 

PART I

 

 

H. J. Heinz Company was incorporated in Pennsylvania on July 27, 1900. In 1905, it succeeded to the business of a partnership operating under the same name which had developed from a food business founded in 1869 in Sharpsburg, Pennsylvania by Henry J. Heinz. H. J. Heinz Company and its subsidiaries (collectively, the “Company”) manufacture and market an extensive line of processed food products throughout the world. The Company’s principal products include ketchup, condiments and sauces, frozen food, soups, beans and pasta meals, infant food and other processed food products.

 

The Company’s products are manufactured and packaged to provide safe, wholesome foods for consumers, as well as foodservice and institutional customers. Many products are prepared from recipes developed in the Company’s research laboratories and experimental kitchens. Ingredients are carefully selected, washed, trimmed, inspected and passed on to modern factory kitchens where they are processed, after which the intermediate product is filled automatically into containers of glass, metal, plastic, paper or fiberboard, which are then sealed. Products are processed by sterilization, homogenization, chilling, freezing, pickling, drying, freeze drying, baking or extruding, then labeled and cased for market.

 

The Company manufactures and contracts for the manufacture of its products from a wide variety of raw foods. Pre-season contracts are made with farmers for a portion of raw materials such as tomatoes, cucumbers, potatoes, onions and some other fruits and vegetables. Dairy products, meat, sugar and other sweeteners including high fructose corn syrup, spices, flour and certain other fruits and vegetables are generally purchased on the open market.

 

The following table lists the number of the Company’s principal food processing factories and major trademarks by region:

 

 

The Company also owns or leases office space, warehouses, distribution centers and research and other facilities throughout the world. The Company’s food processing plants and principal properties are in good condition and are satisfactory for the purposes for which they are being utilized.

The Company has developed or participated in the development of certain of its equipment, manufacturing processes and packaging, and maintains patents and has applied for patents for some of those developments. The Company regards these patents and patent applications as important but does not consider any one or group of them to be materially important to its business as a whole.

 

Although crops constituting some of the Company’s raw food ingredients are harvested on a seasonal basis, most of the Company’s products are produced throughout the year. Seasonal factors inherent in the business have always influenced the quarterly sales and operating income of the Company. Consequently, comparisons between quarters have always been more meaningful when made between the same quarters of prior years.

 

The products of the Company are sold under highly competitive conditions, with many large and small competitors. The Company regards its principal competition to be other manufacturers of processed foods, including branded retail products, foodservice products and private label products, that compete with the Company for consumer preference, distribution, shelf space and merchandising support. Product quality and consumer value are important areas of competition.

 

The Company’s products are sold through its own sales organizations and through independent brokers, agents and distributors to chain, wholesale, cooperative and independent grocery accounts, convenience stores, bakeries, pharmacies, mass merchants, club stores, foodservice distributors and institutions, including hotels, restaurants, hospitals, health-care facilities, and certain government agencies. For Fiscal 2007, one customer represented 10.4% of the Company’s sales. We closely monitor the credit risk associated with our customers and to date have never experienced significant losses.

 

Compliance with the provisions of national, state and local environmental laws and regulations has not had a material effect upon the capital expenditures, earnings or competitive position of the Company. The Company’s estimated capital expenditures for environmental control facilities for the remainder of Fiscal Year 2008 and the succeeding fiscal year are not material and are not expected to materially affect either the earnings, cash flows or competitive position of the Company.

 

The Company’s factories are subject to inspections by various governmental agencies, including the United States Department of Agriculture, and the Occupational Health and Safety Administration, and its products must comply with the applicable laws, including food and drug laws, such as the Federal Food and Cosmetic Act of 1938, as amended, and the Federal Fair Packaging or Labeling Act of 1966, as amended, of the jurisdictions in which they are manufactured and marketed.

 

The Company employed, on a full-time basis as of May 2, 2007, approximately 33,000 persons around the world.

 

Segment information is set forth in this report on pages 68 through 71 in Note 15, “Segment Information” in Item 8 — “Financial Statements and Supplementary Data.”

 

Income from international operations is subject to fluctuation in currency values, export and import restrictions, foreign ownership restrictions, economic controls and other factors. From time to time, exchange restrictions imposed by various countries have restricted the transfer of funds between countries and between the Company and its subsidiaries. To date, such exchange restrictions have not had a material adverse effect on the Company’s operations.

 

The Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to section 13(a) or 15(d) of the Exchange Act are available free of charge on the Company’s website at www.heinz.com, as soon as reasonably practicable after filed or furnished to the Securities and Exchange Commission (“SEC”). Our reports filed with the SEC are also made available to read and copy at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. You may obtain information about the Public Reference Room by contacting the SEC at 1-800-SEC-0330. Reports filed with the SEC are also made available on its website at www.sec.gov.

 

 

In addition to the factors discussed elsewhere in this Report, the following risks and uncertainties could materially adversely affect the Company’s business, financial condition, and results of operations. Additional risks and uncertainties not presently known to the Company or that the Company currently deems immaterial also may impair the Company’s business operations and financial condition.

 

Competitive product and pricing pressures in the food industry could adversely affect the Company’s ability to gain or maintain market share.

 

The Company operates in the highly competitive food industry across its product lines competing with other companies that have varying abilities to withstand changing market conditions. Any significant change in the Company’s relationship with a major customer, including changes in product prices, sales volume, or contractual terms may impact financial results. Such changes may result because the Company’s competitors may have substantial financial, marketing, and other resources that may change the competitive environment. Such competition could cause the Company to reduce prices and/or increase capital, marketing, and other expenditures, or result in the loss of category share. Such changes could have a material adverse impact on the Company’s net income. As the retail grocery trade continues to consolidate, the larger retail customers of the Company could seek to use their positions to improve their profitability through lower pricing and increased promotional programs. If the Company is unable to use its scale, marketing expertise, product innovation, and category leadership positions to respond to these changes, its profitability and volume growth could be negatively impacted.

 

The Company’s performance is affected by economic and political conditions in the U.S. and in various other nations where it does business.

 

The Company’s performance has been in the past and may continue in the future to be impacted by economic and political conditions in the United States and in other nations. Such conditions and factors include changes in applicable laws and regulations, including changes in food and drug laws, accounting standards, taxation requirements and environmental laws. Other factors impacting our operations include export and import restrictions, currency exchange rates, recession, foreign ownership restrictions, nationalization, the performance of businesses in hyperinflationary environments, and political unrest and terrorist acts in the U.S. and other international locations where the Company does business. Such changes in either domestic or foreign jurisdictions could adversely affect our financial results.

 

Increases in the cost and restrictions on the availability of raw materials could adversely affect our financial results.

 

The Company sources raw materials including agricultural commodities such as tomatoes, cucumbers, potatoes, onions, other fruits and vegetables, dairy products, meat, sugar and other sweeteners, including high fructose corn syrup, spices, and flour, as well as packaging materials such as glass, plastic, metal, paper, fiberboard, and other materials in order to manufacture products. The availability or cost of such commodities may fluctuate widely due to government policy and regulation, crop failures or shortages due to plant disease or insect and other pest infestation, weather conditions, or other unforeseen circumstances. To the extent that any of the foregoing factors increase the prices of such commodities and the Company is unable to increase its prices or adequately hedge against such changes in a manner that offsets such changes, the results of its operations could be materially and adversely affected. Similarly, if supplier arrangements and relationships result in increased and unforeseen expenses, the Company’s financial results could be adversely impacted.

Disruption of our supply chain could adversely affect our business.

 

Damage or disruption to our manufacturing or distribution capabilities due to weather, natural disaster, fire, terrorism, pandemic, strikes, the financial and/or operational instability of key suppliers, distributors, warehousing and transportation providers, or brokers, or other reasons could impair our ability to manufacture or sell our products. To the extent the Company is unable, or it is not financially feasible, to mitigate the likelihood or potential impact of such events, or to effectively manage such events if they occur, particularly when a product is sourced from a single location, there could be an adverse affect on our business and results of operations, and additional resources could be required to restore our supply chain.

 

Higher energy costs and other factors affecting the cost of producing, transporting, and distributing the Company’s products could adversely affect our financial results.

 

Rising fuel and energy costs may have a significant impact on the cost of operations, including the manufacture, transport, and distribution of products. Fuel costs may fluctuate due to a number of factors outside the control of the Company, including government policy and regulation and weather conditions. Additionally, the Company may be unable to maintain favorable arrangements with respect to the costs of procuring raw materials, packaging, services, and transporting products, which could result in increased expenses and negatively affect operations. If the Company is unable to hedge against such increases or raise the prices of its products to offset the changes, its results of operations could be adversely affected.

 

The results of the Company could be adversely impacted as a result of increased pension, labor, and people-related expenses.

 

Inflationary pressures and any shortages in the labor market could increase labor costs, which could have a material adverse effect on the Company’s consolidated operating results or financial condition. The Company’s labor costs include the cost of providing employee benefits in the U.S. and foreign jurisdictions, including pension, health and welfare, and severance benefits. Any declines in market returns could adversely impact the funding of pension plans, the assets of which are invested in a diversified portfolio of equity and fixed income securities and other investments. Additionally, the annual costs of benefits vary with increased costs of health care and the outcome of collectively-bargained wage and benefit agreements.

 

The impact of various food safety issues, environmental, legal, tax, and other regulations and related developments could adversely affect the Company’s sales and profitability.

 

The Company is subject to numerous food safety and other laws and regulations regarding the manufacturing, marketing, and distribution of food products. These regulations govern matters such as ingredients, advertising, taxation, relations with distributors and retailers, health and safety matters, and environmental concerns. The ineffectiveness of the Company’s planning and policies with respect to these matters, and the need to comply with new or revised laws or regulations with regard to licensing requirements, trade and pricing practices, environmental permitting, or other food or safety matters, or new interpretations or enforcement of existing laws and regulations, may have a material adverse effect on the Company’s sales and profitability. Avian flu or other pandemics could disrupt production of the Company’s products, reduce demand for certain of the Company’s products, or disrupt the marketplace in the foodservice or retail environment with consequent material adverse effect on the Company’s results of operations.

The need for and effect of product recalls could have an adverse impact on the Company’s business.

 

If any of the Company’s products become misbranded or adulterated, the Company may need to conduct a product recall. The scope of such a recall could result in significant costs incurred as a result of the recall, potential destruction of inventory, and lost sales. Should consumption of any product cause injury, the Company may be liable for monetary damages as a result of a judgment against it. A significant product recall or product liability case could cause a loss of consumer confidence in the Company’s food products and could have a material adverse effect on the value of its brands and results of operations.

 

The failure of new product or packaging introductions to gain trade and consumer acceptance and changes in consumer preferences could adversely affect our sales.

 

The success of the Company is dependent upon anticipating and reacting to changes in consumer preferences, including health and wellness. There are inherent marketplace risks associated with new product or packaging introductions, including uncertainties about trade and consumer acceptance. Moreover, success is dependent upon the Company’s ability to identify and respond to consumer trends through innovation. The Company may be required to increase expenditures for new product development. The Company may not be successful in developing new products or improving existing products, or its new products may not achieve consumer acceptance, each of which could negatively impact sales.

 

The failure to successfully integrate acquisitions and joint ventures into our existing operations or the failure to gain applicable regulatory approval for such transactions could adversely affect our financial results.

 

The Company’s ability to efficiently integrate acquisitions and joint ventures into its existing operations also affects the financial success of such transactions. The Company may seek to expand its business through acquisitions and joint ventures, and may divest underperforming or non-core businesses. The Company’s success depends, in part, upon its ability to identify such acquisition and divestiture opportunities and to negotiate favorable contractual terms. Activities in such areas are regulated by numerous antitrust and competition laws in the U. S., the European Union, and other jurisdictions, and the Company may be required to obtain the approval of such transactions by competition authorities, as well as satisfy other legal requirements. The failure to obtain such approvals could adversely affect our results.

 

The Company’s operations face significant foreign currency exchange rate exposure, which could negatively impact its operating results.

 

The Company holds assets and incurs liabilities, earns revenue, and pays expenses in a variety of currencies other than the U.S. dollar, primarily the British Pound, Euro, Australian dollar, Canadian dollar, and New Zealand dollar. The Company’s consolidated financial statements are presented in U.S. dollars, and therefore the Company must translate its assets, liabilities, revenue, and expenses into U.S. dollars. Increases or decreases in the value of the U.S. dollar may negatively affect the value of these items in the Company’s consolidated financial statements, even if their value has not changed in their original currency.

 

The failure to complete the strategic transformation through further simplification and cost savings could adversely affect the Company’s ability to increase net income.

 

As publicly announced, the Company has been implementing a strategic transformation initiative to simplify its business, further prune and realign its portfolio, sell underutilized assets, reduce cost and increase efficiency, and sharpen its focus on three core categories of Ketchup & Sauces, Meals & Snacks, and Infant Food. The success of the Company could be impacted by its

inability to continue to execute on its plans through product innovation, implementing cost-cutting measures, enhancing processes and systems on a global basis, and growing market share and volume. The failure to fully implement the plans could adversely affect the Company’s ability to increase net income.

 

CAUTIONARY STATEMENT RELEVANT TO FORWARD-LOOKING INFORMATION

 

Statements about future growth, profitability, costs, expectations, plans, or objectives included in this report, including the management’s discussion and analysis, the financial statements and footnotes, are forward-looking statements based on management’s estimates, assumptions, and projections. These forward-looking statements are subject to risks, uncertainties, assumptions and other important factors, many of which may be beyond Heinz’s control and could cause actual results to differ materially from those expressed or implied in this report and the financial statements and footnotes. Uncertainties contained in such statements include, but are not limited to:

 

 

 

The forward-looking statements are and will be based on management’s then current views and assumptions regarding future events and speak only as of their dates. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by the securities laws.

 

 

None.

 

 

See table in Item 1.

 

 

None.

 

 

The Company has not submitted any matters to a vote of security holders since the last annual meeting of shareholders on August 16, 2006.

 

PART II

 

 

Information relating to the Company’s common stock is set forth in this report on page 30 under the caption “Stock Market Information” in Item 7 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and on pages 71 through 72 in Note 16, “Quarterly Results” in Item 8 — “Financial Statements and Supplementary Data.”

 

In the fourth quarter of Fiscal 2007, the Company repurchased the following number of shares of its common stock:

 

 

Of the shares repurchased, 4,028,692 shares were acquired under the share repurchase program authorized by the Board of Directors on June 8, 2005 for a maximum of 30 million shares. Once that program was completed in April 2007, the remaining 1,580,208 shares were repurchased in April under the 25 million share program authorized by the Board of Directors on May 31, 2006. All repurchases were made in open market transactions. As of May 2, 2007, the maximum number of shares that may yet be purchased under the 2006 program is 23,419,792.

 

 

The following table presents selected consolidated financial data for the Company and its subsidiaries for each of the five fiscal years 2003 through 2007. All amounts are in thousands except per share data.

 

 

 

 

As a result of the Company’s strategic transformation, the Fiscal 2006 results from continuing operations include $124.7 million pretax ($80.3 million after tax) for targeted workforce reductions consistent with the Company’s goals to streamline its businesses and $22.0 million pretax ($16.3 million after tax) for strategic review costs related to the potential divestiture of several businesses. Also, $206.5 million pretax ($153.9 million after tax) was recorded for net losses on non-core businesses and product lines which were sold and asset impairment charges on non-core businesses and product lines which were sold in Fiscal 2007. Also during 2006, the Company reversed valuation allowances of $27.3 million primarily related to The Hain Celestial Group, Inc. (“Hain”). In addition, results include $24.4 million of tax expense relating to the impact of the American Jobs Creation Act. For more details regarding these items, see pages 46 to 47 in Note 4, “Fiscal 2006 Transformation Costs” in Item 8 — “Financial Statements and Supplementary Data.”

Fiscal 2005 results from continuing operations include a $64.5 million non-cash impairment charge for the Company’s equity investment in Hain and a $9.3 million non-cash charge to recognize the impairment of a cost-basis investment in a grocery industry sponsored e-commerce business venture. There was no tax benefit recorded with these impairment charges in Fiscal 2005. Fiscal 2005 also includes a $27.0 million pre-tax ($18.0 million after-tax) non-cash asset impairment charge related to the anticipated disposition of the HAK vegetable product line in Northern Europe which occurred in Fiscal 2006.

 

Fiscal 2004 results from continuing operations include a gain of $26.3 million ($13.3 million after-tax) related to the disposal of the bakery business in Northern Europe, costs of $16.6 million pretax ($10.6 million after-tax), primarily due to employee termination and severance costs related to on-going efforts to reduce overhead costs, and $4.0 million pretax ($2.8 million after-tax) due to the write down of pizza crust assets in the United Kingdom.

 

Fiscal 2003 results from continuing operations include costs related to the Del Monte transaction and costs to reduce overhead of the remaining businesses totaling $164.6 million pretax ($113.1 million after-tax). These include employee termination and severance costs, legal and other professional service costs and costs related to the early extinguishment of debt. In addition, Fiscal 2003 includes losses on the exit of non-strategic businesses of $62.4 million pretax ($49.3 million after-tax).

 

 

Executive Overview- Fiscal 2007

 

The H.J. Heinz Company has been a pioneer in the food industry for 138 years and possesses one of the world’s best and most recognizable brands — Heinz^®. While the Company has prospered for a long time, we are constantly finding new ways to capitalize on emerging consumer trends and better methods of doing business. Over the past several years, we have been making great progress in simplifying and focusing the Company on three core businesses. This strategic transformation began with the spin-off of our non-core U.S. businesses in December 2002, and was completed in Fiscal 2006 with the sales of our European Seafood and New Zealand Poultry businesses.

 

On June 1, 2006, the Company presented its Superior Value and Growth Plan for fiscal years 2007 and 2008. Under this plan, the Company set forth three key operational imperatives: grow the core portfolio, reduce costs to drive margins and generate cash to deliver superior value. Under each of these imperatives, the Company set financial and operational targets, aimed at increasing shareholder value. The Company achieved its targets for Fiscal 2007 and is well positioned for continued growth in Fiscal 2008. Specifically:

 

 

The following is a detailed update on the Company’s progress against the three imperatives under our Superior Value and Growth Plan at the end of Fiscal 2007 as well as a summary of our expectations under these imperatives for Fiscal 2008.

 

Grow the Core Portfolio

 

This imperative is focused on a strategy to grow our largest brands in our three core categories. This strategy established targets for increased marketing spending of $50 million and double digit increases in research and development costs (“R&D”). In addition, this strategy also focused on growth in various emerging markets, where growth potential was viewed as high. During Fiscal 2007, we made excellent progress against this imperative as evidenced by the following:

 

 

Looking forward to Fiscal 2008, the Company’s innovation pipeline contains over 200 consumer-validated new products across our markets. The Company is planning incremental improvements in the health and wellness profile of its products in Fiscal 2008 as well as convenience products like

portable hand-held snacks under the Smart Ones^® brand and microwavable soups in the UK, Australia and New Zealand.

 

The Company plans to support new products introduced in Fiscal 2008 with an additional $30 to $40 million of incremental marketing spending, completing a two-year increase of around $100 million. The Company will continue to invest for growth in our emerging RICIP and Latin American markets, which we expect to continue delivering double-digit growth in Fiscal 2008. By the end of Fiscal 2008, we expect these markets to reach $1 billion in sales.

 

Reduce Costs to Drive Margins

 

The Company’s investment in growth behind the core portfolio has been fueled by the second pillar of our two-year plan, Reducing Costs to Drive Margins. Key targets set under this imperative included productivity improvements on deals and allowances (“D&A”), cost of goods sold (“COGS”) and selling, general and administrative expenses (“SG&A”). The following summarizes our progress in Fiscal 2007 relative to this imperative:

 

 

In Fiscal 2008, the Company will continue to invest in improved business systems in order to boost the efficiency of its promotional programs, particularly in Europe. We expect further decreases in trade spending with a goal of reducing it by 130 basis points as a percentage of gross sales over the two-year plan. Trade promotion reductions and other productivity measures coupled with strategic pricing are expected to drive gross margin expansion.

 

A Global Supply Chain Task Force has been established with the goal of further driving cost reductions, primarily in COGS. We expect additional SG&A savings in Fiscal 2008 aided by headcount reductions, pension savings and more efficient indirect procurement. The Company’s total anticipated productivity is now $380 million over two years, which exceeds its previous estimates.

 

Generate Cash to Deliver Superior Value

 

Heinz’s growth, cost savings and working capital productivity drove operating free cash flow of $878 million, or almost 10% of revenue. This was 10% ahead of the goal for the year and better than the prior year. Much of this increased cash flow has been returned directly to shareholders, as evidenced by the following:

 

 

In Fiscal 2008, we expect to continue to generate strong cash flow. Based on this confidence, the Board of Directors increased the dividend for Fiscal 2008 by 8.6%, for an annual indicative rate of $1.52 per share. We expect to return approximately 60% of our earnings to our shareholders in the

form of dividends. We also expect to return an additional $500 million to shareholders through net share repurchases in Fiscal 2008.

 

Results of Continuing Operations

 

The Company’s revenues are generated via the sale of products in the following categories:

 

 

Fiscal Years Ended May 2, 2007 and May 3, 2006

 

Sales for Fiscal 2007 increased $358.2 million, or 4.1%, to $9.00 billion. Sales were favorably impacted by a volume increase of 0.7%, despite one less selling week in Fiscal 2007 compared with Fiscal 2006. Volume growth was led by North American Consumer Products, Australia, New Zealand and Germany, and the emerging markets of India, China and Poland. These increases were partially offset by declines in the U.K. and Russian businesses. Pricing increased sales by 2.1%, mainly due to our businesses in North America, the U.K, Indonesia and Latin America. Divestitures, net of acquisitions, decreased sales by 1.6%. Foreign exchange translation rates increased sales by 2.9%.

 

Gross profit increased $299.8 million, or 9.7%, to $3.39 billion, and the gross profit margin increased to 37.7% from 35.8%. These improvements reflect higher volume, increased pricing, productivity improvements and favorable foreign exchange, partially offset by commodity cost increases. Also contributing to the favorable comparison are the $91.6 million of prior year strategic transformation costs discussed below.

 

SG&A decreased $33.3 million, or 1.7%, to $1.95 billion and decreased as a percentage of sales to 21.6% from 22.9%. These decreases are primarily due to the favorable impact of the prior year targeted workforce reductions, particularly in Europe and Asia, and the $144.8 million of prior year strategic transformation costs discussed below. These declines were partially offset by increased marketing and R&D expenses, costs related to the proxy contest affecting the Company’s 2006 election of directors, and higher incentive compensation costs, including the expensing of stock options (SFAS No. 123R). Selling and distribution costs (“S&D”) were higher as a result of the volume increase; however as a percentage of sales, S&D declined.

 

Total marketing support (recorded as a reduction of revenue or as a component of SG&A) increased $4.4 million, or 0.2%, to $2.18 billion on a gross sales increase of 2.8%. Marketing support recorded as a reduction of revenue, typically deals and allowances, decreased $59.7 million, or 3.1%, to $1.85 billion. This decrease is largely due to spending reductions on less efficient promotions and a realignment of list prices, partially offset by the impact of foreign exchange translation rates. Marketing support recorded as a component of SG&A increased $64.1 million, or 23.8%, to $333.5 million, consistent with the Company’s continued strategy to invest behind its key brands.

 

Operating income increased $333.1 million, or 29.9%, to $1.45 billion, which was favorably impacted by increased volume, the higher gross profit margin and the $236.4 million of prior year strategic transformation costs discussed below.

 

Net interest expense increased $8.3 million, to $291.4 million, due primarily to higher average interest rates and higher average debt in Fiscal 2007. Fiscal 2006 income from continuing operations

was unfavorably impacted by the $111.0 million write down of the Company’s net investment in Zimbabwe. Other expenses, net, increased $4.9 million, to $30.9 million, largely due to increased currency losses and minority interest expense, the later of which is a result of improved business performance in our joint ventures, partially offset by the $6.9 million loss on the sale of the Company’s equity investment in The Hain Celestial Group, Inc. (“Hain”) in the prior year.

 

The current year effective tax rate was 29.6% compared to 36.2% for the prior year. During the first quarter of Fiscal 2007, a foreign subsidiary of the Company revalued certain of its assets, under local law, increasing the local tax basis by approximately $245 million. This revaluation reduced Fiscal 2007 tax expense by approximately $35 million. During the third quarter of Fiscal 2007, final conditions necessary to reverse a foreign tax reserve related to a prior year transaction were achieved. As a result, the Company realized a non-cash tax benefit of $64.1 million. At the same time, the Company modified its plans for repatriation of foreign earnings, ultimately incurring an additional charge of $89.8 million. Full year Fiscal 2007 repatriation costs were $107.8 million, exceeding Fiscal 2006’s repatriation costs by approximately $78.2 million. In addition, Fiscal 2007 tax expense benefited from reductions in foreign statutory tax rates and initiatives associated with R&D tax credits. The Fiscal 2006 tax expense benefited from the reversal of a tax provision of $23.4 million related to a foreign affiliate along with an additional benefit of $16.3 million resulting from tax planning initiatives related to foreign tax credits, which was partially offset by the non-deductibility of certain asset write-offs.

 

Income from continuing operations was $791.6 million compared to $442.8 million in the prior year, an increase of 78.8%, primarily due to the increase in operating income and a lower effective tax rate, partially offset by higher net interest expense. Diluted earnings per share from continuing operations was $2.38 in the current year compared to $1.29 in the prior year, an increase of 84.5%, which also benefited from a 2.8% reduction in fully diluted shares outstanding.

 

FISCAL YEAR 2007 OPERATING RESULTS BY BUSINESS SEGMENT

 

North American Consumer Products

 

Sales of the North American Consumer Products segment increased $185.4 million, or 7.3%, to $2.74 billion. Volume increased 2.6%, largely resulting from strong growth in Smart Ones^® and Boston Market^® frozen entrees and desserts, Classico^® pasta sauces and Ore-Ida^® frozen potatoes. The increases reflect new distribution, increased consumption driven by new product launches and increased marketing support. These increases were partially offset by the expected volume decline in Heinz^® ketchup, reflecting a reduction in promotion expense as part of the strategy to increase consumption of more profitable larger sizes. Pricing increased 2.1% largely due to Heinz^® ketchup, Ore-Ida^® frozen potatoes, Smart Ones^® frozen entrees and Bagel Bites^® and TGIF^® frozen snacks, all resulting primarily from reduced inefficient promotions. Acquisitions increased sales 1.9%, primarily from the prior year acquisitions of Nancy’s Specialty Foods and HP Foods as well as the current year acquisition of Renée’s Gourmet Foods. Favorable Canadian exchange translation rates increased sales 0.7%.

 

Gross profit increased $85.8 million, or 8.2%, to $1.14 billion, and the gross profit margin increased to 41.4% from 41.1%. These improvements were due primarily to increased volume, higher pricing and the favorable impact of acquisitions, partially offset by increased commodity costs. Operating income increased $42.3 million, or 7.3%, to $625.7 million, mainly due to the improvement in gross profit and $6.6 million of prior year transformation costs discussed below. This increase was partially offset by a $32.2 million or 40.4% increase in consumer marketing, primarily for Heinz^® ketchup, Smart Ones^® frozen entrees, Ore-Ida^® frozen potatoes and frozen snacks, and increased R&D costs. In addition, operating income benefited from reduced S&D as a percentage of sales due to reduced transportation costs resulting from distribution efficiencies.

U.S. Foodservice

 

Sales of the U.S. Foodservice segment decreased $13.5 million, or 0.9%, to $1.56 billion, primarily due to the impact of divestitures. Divestitures, net of acquisitions, reduced sales 2.1%. Pricing increased 1.7%, largely due to Heinz^® ketchup and tomato products, single serve condiments and frozen desserts. Volume decreased 0.4%, as higher volume in Heinz^® ketchup was offset by declines resulting primarily from one less week in the fiscal year and a decision to exit certain low margin accounts.

 

Gross profit increased $29.0 million, or 6.6%, to $465.3 million, and the gross profit margin increased to 29.9% from 27.8%, due to $7.5 million of prior year reorganization costs discussed below and a $21.5 million impairment charge in the prior year related to the sale of the Portion Pac Bulk product line. In addition, increased pricing was offset by higher commodity costs. Operating income increased $38.8 million, or 21.9%, to $216.1 million, largely due to the increase in gross profit and reduced S&D expense as a percentage of sales resulting from productivity initiatives.

 

Europe

 

Heinz Europe’s sales increased $89.0 million, or 3.0%, to $3.08 billion. Pricing increased 1.7%, driven primarily by value-added innovation and reduced promotions on Heinz^® soup and pasta meals in the U.K and in the Italian infant nutrition business. Volume declined 2.4% as improvements in Heinz^® ketchup, Heinz^® beans, Weight Watchers^® branded products and Pudliszki^® ketchup and ready meals in Poland were more than offset by market softness in non-Heinz^® branded products in Russia and the non-branded European frozen business and declines in U.K. ready-to-serve soups and pasta convenience meals. Volume was also unfavorably impacted by one less week in the current fiscal year. The acquisition of HP Foods and Petrosoyuz in Fiscal 2006 increased sales 1.9%, while divestitures reduced sales 5.6%. Favorable exchange translation rates increased sales by 7.3%.

 

Gross profit increased $112.0 million, or 10.0%, to $1.24 billion, and the gross profit margin increased to 40.2% from 37.6%. These improvements are due to higher pricing, favorable impact of exchange translation rates and $36.3 million of prior year transformation costs discussed below. These improvements were partially offset by reduced volume and increased commodity and manufacturing costs. Operating income increased $152.2 million, or 36.7%, to $566.4 million, due to the increase in gross profit, the $112.2 million of prior year transformation costs discussed below, and reduced general and administrative expenses (“G&A”), partially offset by increased marketing expense. The decrease in G&A is driven by the workforce reductions, including the elimination of European headquarters.

 

Asia/Pacific

 

Sales in Asia/Pacific increased $85.1 million, or 7.6%, to $1.20 billion. Volume increased sales 4.2%, reflecting strong volume in Australia, New Zealand and China, largely due to increased marketing and new product introductions. Higher pricing increased sales 2.1%, mainly due to commodity-related price increases taken on Indonesian sauces and drinks. Divestitures reduced sales 0.3%, and foreign exchange translation rates increased sales by 1.7%.

 

Gross profit increased $51.5 million, or 15.4%, to $386.8 million, and the gross profit margin increased to 32.2% from 30.0%. These improvements were due to volume increases and higher pricing, partially offset by increased commodity costs, most notably in Indonesia. The prior year also included an $18.8 million asset impairment charge on an Indonesian noodle business. Operating income increased $50.6 million, to $135.8 million, largely reflecting the increase in gross profit and reduced G&A, partially offset by increased marketing. The reduction in G&A is a result of effective cost control in our Chinese businesses, targeted workforce reductions, including the elimination of Asian headquarters in the prior year, and $10.2 million of reorganization costs in the prior year related to the workforce reductions discussed below.

Rest of World

 

Sales for Rest of World increased $12.2 million, or 2.9%, to $427.1 million. Volume increased 6.1% due primarily to market and share growth in nutritional drinks in India, ketchup and baby food in Latin America and in our business in South Africa. Higher pricing increased sales by 7.6%, largely due to reduced promotions on ketchup and price increases taken on baby food in Latin America. Divestitures reduced sales 8.8% and foreign exchange translation rates reduced sales 1.9%.

 

Gross profit increased $16.1 million, or 12.1%, to $148.9 million, as increased volume and higher pricing were partially offset by higher commodity costs in India and the impact of divestitures. The prior year also included $5.8 million of asset impairment charges discussed below. Operating income increased $36.0 million, to $53.9 million, due primarily to the increase in gross profit and the $27.9 million in prior year transformation costs primarily related to divestitures.

 

As a result of general economic uncertainty, coupled with restrictions on the repatriation of earnings, as of the end of November 2002 the Company deconsolidated its Zimbabwean operations and classified its remaining net investment of approximately $111 million as a cost investment. In the fourth quarter of Fiscal 2006, the Company wrote off its net investment in Zimbabwe. The decision to write down the Zimbabwe investment related to management’s determination that this investment was not a core business and, as a consequence, the Company would explore strategic options to exit this business. The Company is still exploring such options. Management’s determination was based on an evaluation of political and economic conditions existing in Zimbabwe and the ability for the Company to recover its cost in this investment. This evaluation considered the continued economic turmoil, further instability in the local currency and the uncertainty regarding the ability to source raw material in the future.

 

Fiscal Years Ended May 3, 2006 and April 27, 2005

 

Sales for Fiscal 2006 increased $540.0 million, or 6.7%, to $8.6 billion. Sales were favorably impacted by a volume increase of 3.8% driven primarily by the North American Consumer Products segment, as well as the Australian, Indonesian and Italian businesses. These volume increases were partially offset by declines in the European frozen food business. Pricing decreased sales slightly, by 0.1%, as improvements in Latin America, Indonesia and North America were offset by declines in Australia, U.K and Northern Europe. Acquisitions, net of divestitures, increased sales by 4.4%. Foreign exchange translation rates decreased sales by 1.5%.

 

Gross profit increased $59.5 million, or 2.0%, to $3.1 billion, primarily due to the favorable impact of acquisitions and higher sales volume, partially offset by unfavorable exchange translation rates. The gross profit margin decreased to 35.8% from 37.4% mainly due to the strategic transformation costs discussed below, pricing declines in the Europe segment, particularly in Northern Europe and in the U.K. and due to increased commodity costs, particularly in the North American and Indonesian businesses.

 

SG&A increased $227.4 million, or 13.0%, to $2.0 billion, and increased as a percentage of sales to 22.9% from 21.6%. The increase as a percentage of sales is primarily due to the $144.8 million (1.7% of sales) of strategic transformation costs discussed below, the impact of acquisitions, and higher fuel and transportation costs. These increases were partially offset by decreased G&A in Europe, due primarily to the elimination of European Headquarters and reduced litigation costs.

 

Total marketing support (recorded as a reduction of revenue or as a component of SG&A) increased $108.8 million, or 5.3%, to $2.2 billion on a gross sales increase of 6.5%. Marketing support recorded as a reduction of revenue, typically deals and allowances, increased $107.0 million, or 5.9%, to $1.9 billion. This increase is largely a result of increased trade promotion spending in the U.K. and Australia and the impact of acquisitions. These increases were partially offset by decreases in the Italian infant nutrition business and foreign exchange translation rates. Marketing support recorded

as a component of SG&A increased $1.8 million, or 0.7%, to $269.4 million, as increases from acquisitions were largely offset by declines in the U.K.

 

Operating income decreased $167.9 million, or 13.1%, to $1.1 billion. Net interest expense increased $78.0 million, to $283.1 million due to higher average interest rates and higher average debt in Fiscal 2006 due to acquisitions and share repurchases.

 

Fiscal 2006 income from continuing operations was unfavorably impacted by the $111.0 million write down of the Company’s net investment in Zimbabwe. Fiscal 2005 includes the non-cash impairment charges totaling $73.8 million related to the cost and equity investments discussed below. Other expenses, net, increased $11.1 million to $26.1 million primarily due to the loss on the sale of equity investments in Fiscal 2006.

 

The Fiscal 2006 effective tax rate was 36.2% compared to 30.3% in Fiscal 2005. The increase in the effective tax rate is primarily the result of increased costs of repatriation including the effects of the American Jobs Creation Act (“AJCA”), a reduction in tax benefits associated with tax planning, increased costs associated with audit settlements and the write-off of investment in affiliates for which no tax benefit could be recognized, offset by the reversal of valuation allowances, the benefit of increased profits in lower tax rate jurisdictions and a reduction in tax reserves.

 

Income from continuing operations was $442.8 million compared to $688.0 million in Fiscal 2005, a decrease of 35.6%. Diluted earnings per share from continuing operations was $1.29 in Fiscal 2006 compared to $1.95 in Fiscal 2005.

 

FISCAL YEAR 2006 OPERATING RESULTS BY BUSINESS SEGMENT

 

North American Consumer Products

 

Sales of the North American Consumer Products segment increased $297.3 million, or 13.2%, to $2.6 billion. Volume increased significantly, up 7.7%, as a result of strong growth in Heinz^® ketchup, TGI Friday’s^® and Delimex^® brands of frozen snacks, Classico^® pasta sauces, Smart Ones^® frozen entrees and in Ore-Ida^® potatoes. Pricing was up 0.4% and the HP Foods and Nancy’s acquisitions increased sales 3.9%. Divestitures reduced sales 0.1% and favorable Canadian exchange translation rates increased sales 1.3%.

 

Gross profit increased $106.6 million, or 11.3%, to $1.0 billion, driven primarily by volume growth and acquisitions. The gross profit margin declined to 41.1% from 41.8%, primarily due to increased commodity costs and a benefit in Fiscal 2005 from the favorable termination of a long-term co-packing arrangement with a customer. Operating income increased $52.9 million, or 10.0%, to $583.4 million, due to the increase in gross profit, partially offset by increased S&D, primarily due to acquisitions and increased volume, $6.6 million of transformation costs, and increased R&D costs associated with the new Heinz Global Innovation and Quality Center.

 

U.S. Foodservice

 

Sales of the U.S. Foodservice segment increased $66.0 million, or 4.4%, to $1.6 billion. The acquisition of AAI and Kabobs, Inc. increased sales 3.9%. Volume increased sales 0.2%, as increases in Truesoups frozen soups were partially offset by declines in Heinz^® ketchup. Pricing increased sales 0.3% as increases in custom recipe tomato products and frozen desserts were partially offset by declines in ketchup.

 

Gross profit decreased $21.2 million, or 4.6%, to $436.3 million, as the favorable benefit of the AAI acquisition was partially offset by $7.5 million of reorganization costs discussed below and a $21.5 million impairment charge for the planned sale of the Portion Pac Bulk product line. The gross profit margin decreased to 27.8% from 30.4% primarily due to the reorganization costs and the asset impairment charge, as well as increased commodity and fuel costs. Operating income decreased

$47.5 million, or 21.1%, to $177.3 million, chiefly due to $34.8 million of reorganization and asset impairment charges and increased SG&A, largely due to higher fuel and distribution costs and marketing support.

 

Europe

 

Heinz Europe’s sales increased $79.1 million, or 2.7%, to $3.0 billion. The HP Foods and Petrosoyuz acquisitions increased sales 9.1%. Volume increased 1.2%, principally due to the Italian infant feeding business, convenience meals in Poland and the U.K., and ketchup growth across Europe. These increases were partially offset by the frozen foods business in the U.K., resulting from general category softness. Lower pricing decreased sales 1.4%, driven by increased promotional spending in the U.K on Heinz^® soup, partially offset by price increases on Heinz^® beans and improvements in the Italian infant feeding business. Divestitures reduced sales 1.8%, and unfavorable exchange translation rates decreased sales by 4.3%.

 

Gross profit decreased $10.9 million, or 1.0%, to $1.1 billion, and the gross profit margin decreased to 37.6% from 39.0%. These decreases are primarily due to $36.3 million of transformation costs discussed below, unfavorable exchange translation rates, decreased pricing in the U.K and higher manufacturing costs in Northern Europe. Operating income decreased $85.8 million, or 17.2%, to $414.2 million, due largely to the gross profit decrease, unfavorable exchange translation rates and the $112.2 million of transformation costs discussed below, partially offset by the favorable impact of acquisitions, reduced G&A and decreased marketing expense in the U.K.

 

Asia/Pacific

 

Sales in Asia/Pacific increased 7.6%. Volume increased sales 8.1%, reflecting double-digit volume growth in Australia along with strong performances in the Watties business and in Indonesia. These increases reflect new product introductions and increased promotional programs. Unfavorable exchange translation rates decreased sales by 1.0%, while lower pricing reduced sales 0.5%, primarily in the Australian business. The acquisition of LongFong in China, net of a small divestiture, increased sales 1.1%.

 

Gross profit decreased $16.1 million, or 4.6%, to $335.3 million, and the gross profit margin declined to 30.0% from 33.9%. These declines were primarily a result of an $18.8 million asset impairment charge on an Indonesian noodle product line divested in Fiscal 2007 and increased commodity and manufacturing costs in Indonesia and China, partially offset by the favorable impact of acquisitions and sales volume. Operating income decreased $27.9 million, or 24.7%, to $85.2 million, primarily due to the decline in gross profit margin, increased S&D and $10.2 million of reorganization costs related to targeted workforce reductions discussed below.

 

Rest of World

 

Sales for Rest of World increased 4.6%. Volume increased 3.8% reflecting strong infant feeding sales in Latin America and beverage sales in India. Higher pricing increased sales by 6.2%, largely due to price increases and reduced promotions in Latin America. Divestitures, net of acquisitions, reduced sales by 2.6%, and foreign exchange translation rates reduced sales by 2.8%.

 

Gross profit increased $5.0 million, or 3.9%, to $132.8 million, due mainly to increased pricing which was partially offset by $5.8 million in asset impairment charges discussed below. Operating income decreased $16.9 million, to $17.9 million, as the increase in gross profit was more than offset by the $27.9 million in transformation costs primarily related to divestitures. In addition, Fiscal 2005’s results include the proceeds of an agreement related to the recall in Israel.

Discontinued Operations

 

During fiscal years 2003 through 2006, the Company focused on exiting non-strategic business operations. Certain of these businesses which were sold are accounted for as discontinued operations.

 

In the fourth quarter of Fiscal 2006, the Company completed the sale of the European seafood business, which included the brands of John West^®, Petit Navire^®, Marie Elisabeth^® and Mareblu^®. The Company received net proceeds of $469.3 million for this disposal and recognized a $199.8 million pretax ($122.9 million after tax) gain which has been recorded in discontinued operations. Also in the fourth quarter of Fiscal 2006, the Company completed the sale of the Tegel^® poultry business in New Zealand and received net proceeds of $150.4 million, and recognized a $10.4 million non-taxable gain, which is also recorded in discontinued operations.

 

In accordance with accounting principles generally accepted in the United States of America, the operating results related to these businesses have been included in discontinued operations in the Company’s consolidated statements of income for all periods presented. The Company recorded a loss of $3.3 million ($5.9 million after-tax) from these businesses for the year ended May 2, 2007, primarily resulting from purchase price adjustments pursuant to the transaction agreements. These discontinued operations generated sales of $688.0 million (partial year) and $808.8 million and net income of $169.1 million (net of $90.2 million in tax expense) and $47.8 million (net of $23.3 million in tax expense) for the years ended May 3, 2006 and April 27, 2005, respectively.

 

In addition, net income from discontinued operations includes amounts related to the favorable settlement of tax liabilities associated with the businesses spun-off to Del Monte in Fiscal 2003. Such amounts totaled $33.7 million and $16.9 million for the years ended May 3, 2006 and April 27, 2005, respectively.

 

Fiscal 2006 Transformation Costs

 

In executing its strategic transformation during Fiscal 2006, the Company incurred the following associated costs. These costs were directly linked to the Company’s transformation strategy.

 

Reorganization Costs

 

In Fiscal 2006, the Company recorded pretax integration and reorganization charges for targeted workforce reductions consistent with the Company’s goals to streamline its businesses totaling $124.7 million ($80.3 million after tax). Approximately 1,000 positions were eliminated as a result of this program, primarily in the G&A area. Additionally, pretax costs of $22.0 million ($16.3 million after tax) were incurred in Fiscal 2006, primarily as a result of the strategic reviews related to the portfolio realignment.

 

The total impact of these initiatives on continuing operations in Fiscal 2006 was $146.7 million pre-tax ($96.6 million after-tax), of which $17.4 million was recorded as costs of products sold and $129.3 million in SG&A. In addition, $10.5 million was recorded in discontinued operations, net of tax. The amount included in accrued expenses related to these initiatives totaled $51.6 million at May 3, 2006, all of which was paid during Fiscal 2007.

Other Divestitures/Impairment Charges

 

The following gains/(losses) or non-cash asset impairment charges were recorded in continuing operations during Fiscal 2006:

 

 

Of the above pre-tax amounts, $74.1 million was recorded in cost of products sold, $15.5 million in SG&A, $111.0 million in asset impairment charges for cost and equity investments, and $(1.0) million in other expense.

 

Also during the third quarter of Fiscal 2006, the Company sold its equity investment in Hain and recognized a $6.9 million ($4.5 million after-tax) loss which is recorded within other expense, net. Net proceeds from the sale of this investment were $116.1 million. During the third quarter of Fiscal 2005, the Company recognized a $64.5 million impairment charge on its equity investment in Hain. The charge reduced Heinz’s carrying value in Hain to fair market value as of January 26, 2005, with no resulting impact on cash flows. The Company also recorded a $9.3 million non-cash charge in the third quarter of Fiscal 2005 to recognize the impairment of a cost-basis investment in a grocery industry sponsored e-commerce business venture. Due to the uncertainty of realizability and executing possible tax planning strategies, the Company recorded a valuation allowance of $27.3 million against the potential tax benefits primarily related to the Hain impairment. This valuation allowance was subsequently released in Fiscal 2006 based upon tax planning strategies that are expected to generate sufficient capital gains that will occur during the capital loss carryforward period. See further discussion in Note 7, “Income Taxes” in Item 8— “Financial Statements and Supplementary Data.”

 

In the fourth quarter of Fiscal 2005, the Company recognized a non-cash asset impairment charge of $27.0 million pre-tax ($18.0 million after-tax) related to the HAK^® vegetable product line which was sold in Fiscal 2006.

 

There were no material gains/(losses) on divested businesses or asset impairment charges in Fiscal 2007.

 

Other Non-recurring — American Jobs Creation Act

 

The AJCA provided a deduction of 85% of qualified foreign dividends in excess of a “Base Period” dividend amount. During Fiscal 2006, the Company finalized plans to repatriate dividends that qualified under the AJCA. The total impact of the AJCA on tax expense for Fiscal 2006 was $17.3 million, of which $24.4 million of expense was recorded in continuing operations and $7.1 million was a benefit in discontinued operations.

The Company reports its financial results in accordance with accounting principles generally accepted in the United States of America (“GAAP”). However, management believes that certain non-GAAP performance measures and ratios, used in managing the business, may provide users of this financial information with additional meaningful comparisons between current results and results in prior periods. Non-GAAP financial measures should be viewed in addition to, and not as an alternative for, the Company’s reported results prepared in accordance with GAAP. The following table provides a reconciliation of the Company’s reported results from continuing operations to the results excluding special items for the fiscal year ended May 3, 2006:

 

 

(Note: Totals may not add due to rounding.)

 

Liquidity and Financial Position

 

In Fiscal 2006, the Company divested its European seafood business and Tegel^® poultry business in New Zealand, and such divestitures were accounted for as discontinued operations. The cash flows from these discontinued operations have been combined with the operating, investing and financing cash flows from continuing operations (i.e., no separate classification of cash flows from discontinued operations) for all periods presented. The absence of the cash flows from these discontinued operations will not have a material impact on the Company’s future liquidity and capital resources.

 

For Fiscal 2007, cash provided by operating activities was $1,062 million, a decrease of $12.7 million from the prior year. The decrease in Fiscal 2007 versus Fiscal 2006 is primarily due to unfavorable movement in accrued liabilities largely due to the payment of accrued reorganization costs in the current year, partially offset by favorable movement in income taxes due to the timing of payments. The Company continues to make progress in reducing its cash conversion cycle, with a reduction of seven days in Fiscal 2007 compared to Fiscal 2006, to 49 days.

 

During the first quarter of Fiscal 2007, a foreign subsidiary of the Company revalued certain of its assets, under local law, increasing the local tax basis by approximately $245 million. As a result of this revaluation, the Company incurred a foreign income tax liability of $29.6 million related to this revaluation which was paid during the third quarter of Fiscal 2007. Additionally, cash flow from operations is expected to be improved by approximately $100 million over the five to twenty year tax amortization period related to the revalued assets.

 

Cash used for investing activities totaled $326.2 million compared to $451.8 million last year. Capital expenditures totaled $244.6 million (2.7% of sales) compared to $230.6 million (2.5% of sales) last year. Proceeds from disposals of property, plant and equipment were $60.7 million compared to $19.4 million in the prior year. This increase includes the disposal of a number of plants during the

current year. In Fiscal 2007, acquisitions, net of divestitures, used $93.1 million primarily related to the Company’s purchase of Renée’s Gourmet Foods and the purchase of the minority ownership interest in our Petrosoyuz business in Russia. Divestitures during the current year included the sale of a non-core U.S. Foodservice product line, a frozen and chilled product line in the U.K., and a pet food business in Argentina. In addition, transaction costs related to the European seafood and Tegel^® poultry divestitures were also paid during the current year. In Fiscal 2006, acquisitions required $1.1 billion, primarily related to the Company’s purchases of HP Foods, Nancy’s Specialty Foods, Inc., Kabobs, Inc. and Petrosoyuz. Proceeds from divestitures in Fiscal 2006, provided $856.7 million, related primarily to the sales of the European seafood and Tegel^® poultry businesses, the sale of the Company’s equity investment in Hain and the sale of the HAK^® vegetable product line in Northern Europe.

 

Cash used for financing activities totaled $620.9 million compared to $1.3 billion last year. Proceeds from short-term debt and commercial paper were $384.1 million this year compared to $298.5 million in the prior year. Net payments on long-term debt were $52.1 million in the current year compared to $497.0 million in the prior year. The prior year payments reflect the retirement of Euro-denominated long-term debt of €418 million. Cash used for the purchase of treasury stock, net of proceeds from option exercises, was $500.9 million this year compared to $681.3 million in the prior year, in line with the Company’s plans of repurchasing $1.0 billion in net shares over Fiscals 2007 and 2008. Dividend payments totaled $461.2 million, compared to $408.2 million for the same period last year, reflecting a 16.7% increase in the annual dividend rate on common stock.

 

In Fiscal 2003, the Company spun-off businesses to Del Monte and treated the operating results related to these businesses as discontinued operations. In Fiscals 2007, 2006 and 2005, the Company generated cash flows from the favorable settlement of tax liabilities related to these spun-off businesses. These cash flows, which represent solely cash flows from operations, have been classified separately on the Company’s Consolidated Cash Flow Statements for Fiscals 2007, 2006 and 2005 as “Cash provided by operating activities of discontinued operations spun-off to Del Monte.” There was no impact on cash flows from investing or financing activities from these spun-off businesses in these fiscal years.

 

On June 1, 2007, the Company announced that its Board of Directors approved an 8.6% increase in the annual dividend on common stock for Fiscal 2008 (from $1.40 to an annual indicative rate of $1.52 per share), effective with the July 2007 dividend payment. Fiscal 2008 dividends are expected to approximate $480 million. In addition, the Company anticipates spending approximately $500 million on stock repurchases, net of options exercised, during Fiscal 2008 to complete its $1 billion goal referenced above.

 

At May 2, 2007, the Company had total debt of $4.88 billion (including $71.2 million relating to the fair value of interest rate swaps) and cash and cash equivalents of $652.9 million. The $469.9 million increase in total debt since prior year end is primarily the result of share repurchases and net acquisitions.

 

Return on average shareholders’ equity (“ROE”) is calculated by taking net income divided by average shareholders’ equity. Average shareholders’ equity is a five-point quarterly average. ROE was 37.4% in Fiscal 2007, 29.1% in Fiscal 2006 and 34.4% in Fiscal 2005. Fiscal 2007 ROE was favorably impacted by decreased average equity reflecting the adoption of SFAS No. 158 and share repurchases. Fiscal 2006 ROE was unfavorably impacted by 6.5% due to the previously discussed strategic transformation costs. ROE in Fiscal 2005 was unfavorably impacted by 4.2% related to asset impairment charges and by increased average equity reflecting fluctuations in foreign exchange translation rates.

 

ROIC is calculated by taking net income, plus net interest expense net of tax, divided by average invested capital. Average invested capital is a five-point quarterly average of debt plus total equity less cash and cash equivalents, short-term investments and the value of interest rate swaps. ROIC was 15.8% in Fiscal 2007, 13.1% in Fiscal 2006 and 15.4% in Fiscal 2005. Fiscal 2007 ROIC was

favorably impacted by higher net income and lower average equity reflecting effective management of the asset base and the adoption of SFAS No. 158. Fiscal 2006 ROIC was unfavorably impacted by higher average debt and by 5.5 percentage points related to the previously discussed strategic transformation costs. ROIC was unfavorably impacted by 1.7% in Fiscal 2005 related to asset impairment charges.

 

The Company maintains a $2 billion credit agreement that expires in 2009. The credit agreement supports the Company’s commercial paper borrowings. As a result, these borrowings are classified as long-term debt based upon the Company’s intent and ability to refinance these borrowings on a long-term basis. The Company maintains in excess of $900 million of other credit facilities used primarily by the Company’s foreign subsidiaries. These resources, the Company’s existing cash balance, strong operating cash flow and access to the capital markets, if required, should enable the Company to meet its cash requirements for operations, including capital expansion programs, debt maturities, share repurchases and dividends to shareholders.

 

As of May 2, 2007, the Company’s long-term debt ratings at Moody’s and Standard & Poor’s were Baa2 and BBB, respectively.

 

In Fiscal 2007, cash required for reorganization costs related to workforce reductions in Fiscal 2006 was approximately $50 million. The Company achieved full year estimated savings of $45 million in Fiscal 2007 as a result of the reorganization.

 

Contractual Obligations and Other Commitments

 

Contractual Obligations

 

The Company is obligated to make future payments under various contracts such as debt agreements, lease agreements and unconditional purchase obligations. In addition, the Company has purchase obligations for materials, supplies, services and property, plant and equipment as part of the ordinary conduct of business. A few of these obligations are long-term and are based on minimum purchase requirements. In the aggregate, such commitments are not at prices in excess of current markets. Due to the proprietary nature of some of the Company’s materials and processes, certain supply contracts contain penalty provisions for early terminations. The Company does not believe that a material amount of penalties is reasonably likely to be incurred under these contracts based upon historical experience and current expectations.

 

The following table represents the contractual obligations of the Company as of May 2, 2007.

 

 

 

 

Other long-term liabilities primarily consist of certain specific incentive compensation arrangements and pension and postretirement benefit commitments. The following long-term liabilities

included on the consolidated balance sheet are excluded from the table above: income taxes, minority interest and insurance accruals. The Company is unable to estimate the timing of the payments for these items.

 

Off-Balance Sheet Arrangements and Other Commitments

 

The Company does not have guarantees or other off-balance sheet financing arrangements that we believe are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources. In addition, the Company does not have any related party transactions that materially affect the results of operations, cash flow or financial condition.

 

Market Risk Factors

 

The Company is exposed to market risks from adverse changes in foreign exchange rates, interest rates, commodity prices and production costs. As a policy, the Company does not engage in speculative or leveraged transactions, nor does the Company hold or issue financial instruments for trading purposes.

 

Foreign Exchange Rate Sensitivity:  The Company’s cash flow and earnings are subject to fluctuations due to exchange rate variation. Foreign currency risk exists by nature of the Company’s global operations. The Company manufactures and sells its products in a number of locations around the world, and hence foreign currency risk is diversified.

 

The Company may attempt to limit its exposure to changing foreign exchange rates through both operational and financial market actions. These actions may include entering into forward contracts, option contracts, or cross currency swaps to hedge existing exposures, firm commitments and forecasted transactions.

 

The instruments are used to reduce risk by essentially creating offsetting currency exposures. The following table presents information related to foreign currency contracts held by the Company:

 

 

As of May 2, 2007, the Company’s foreign currency contracts mature within two years. Contracts that meet qualifying criteria are accounted for as either foreign currency cash flow hedges or net investment hedges of foreign operations. Any gains and losses related to contracts that do not qualify for hedge accounting are recorded in current period earnings in other income and expense.

 

Substantially all of the Company’s foreign business units’ financial instruments are denominated in their respective functional currencies. Accordingly, exposure to exchange risk on foreign currency financial instruments is not material. (See Note 13, “Derivative Financial Instruments and Hedging Activities” in Item 8 — “Financial Statements and Supplementary Data.”)

Interest Rate Sensitivity:  The Company is exposed to changes in interest rates primarily as a result of its borrowing and investing activities used to maintain liquidity and fund business operations. The nature and amount of the Company’s long-term and short-term debt can be expected to vary as a result of future business requirements, market conditions and other factors. The Company’s debt obligations totaled $4.9 billion and $4.4 billion at May 2, 2007 and May 3, 2006, respectively. The Company’s debt obligations are summarized in Note 8, “Debt” in Item 8 — “Financial Statements and Supplementary Data.”

 

In order to manage interest rate exposure, the Company utilizes interest rate swaps to convert fixed-rate debt to floating. These derivatives are primarily accounted for as fair value hedges. Accordingly, changes in the fair value of these derivatives, along with changes in the fair value of the hedged debt obligations that are attributable to the hedged risk, are recognized in current period earnings. Based on the amount of fixed-rate debt converted to floating as of May 2, 2007, a variance of 1/8% in the related interest rate would cause annual interest expense related to this debt to change by approximately $3.4 million. The following table presents additional information related to interest rate contracts designated as fair value hedges by the Company:

 

 

The Company had interest rate contracts with a total notional amount of $107.6 million at May 2, 2007 and May 3, 2006 that did not meet the criteria for hedge accounting but effectively mitigated interest rate exposures. These derivatives are accounted for on a full mark-to-market basis through current earnings and they mature within two years from the current fiscal year-end. Net unrealized losses related to these interest rate contracts totaled $2.3 million and $4.4 million at May 2, 2007 and May 3, 2006, respectively.

 

Effect of Hypothetical 10% Fluctuation in Market Prices:  As of May 2, 2007, the potential gain or loss in the fair value of the Company’s outstanding foreign currency contracts and interest rate contracts assuming a hypothetical 10% fluctuation in currency and swap rates would be approximately:

 

 

However, it should be noted that any change in the fair value of the contracts, real or hypothetical, would be significantly offset by an inverse change in the value of the underlying hedged items. In relation to currency contracts, this hypothetical calculation assumes that each exchange rate would change in the same direction relative to the U.S. dollar.

 

Recently Issued Accounting Standards

 

In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106 and 132(R). Among other things, SFAS No. 158 requires an employer to record non-cash adjustments to recognize the funded status of each of its defined pension and postretirement benefit plans as a net asset or liability in its statement of financial position with an offsetting amount in accumulated other comprehensive income, and to recognize changes in that

funded status in the year in which changes occur through comprehensive income. The Company adopted the recognition and related disclosure provisions of SFAS No. 158 on May 2, 2007. As a result of this adoption, the current funded status of the Company’s defined benefit pension plans and other postretirement benefit plans is reflected in the Company’s consolidated balance sheet as of May 2, 2007. Refer to Note 2 in Item 8—“Financial Statements and Supplementary Data.”

 

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109 (FIN 48), which clarifies the accounting for uncertainty in income taxes recognized in financial statements. This Interpretation includes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, and disclosures. The provisions of FIN 48 are required to be adopted by the Company in the first quarter of fiscal 2008. The cumulative effect of applying FIN 48, if any, is to be reported as an adjustment to the opening balance of retained earnings in the year of adoption. The Company is currently evaluating the impact of adopting FIN 48 in the first quarter of Fiscal 2008.

 

Discussion of Significant Accounting Estimates

 

In the ordinary course of business, the Company has made a number of estimates and assumptions relating to the reporting of results of operations and financial condition in the preparation of its financial statements in conformity with accounting principles generally accepted in the United States of America. Actual results could differ significantly from those estimates under different assumptions and conditions. The Company believes that the following discussion addresses its most critical accounting policies, which are those that are most important to the portrayal of the Company’s financial condition and results and require management’s most difficult, subjective and complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.

 

Marketing Costs—Trade promotions are an important component of the sales and marketing of the Company’s products and are critical to the support of the business. Trade promotion costs include amounts paid to retailers to offer temporary price reductions for the sale of the Company’s products to consumers, amounts paid to obtain favorable display positions in retailers’ stores, and amounts paid to customers for shelf space in retail stores. Accruals for trade promotions are initially recorded at the time of sale of product to the customer based on an estimate of the expected levels of performance of the trade promotion, which is dependent upon factors such as historical trends with similar promotions, expectations regarding customer participation, and sales and payment trends with similar previously offered programs. Our original estimated costs of trade promotions may change in the future as a result of changes in customer participation, particularly for new programs and for programs related to the introduction of new products. We perform monthly and quarterly evaluations of our outstanding trade promotions, making adjustments where appropriate to reflect changes in estimates. Settlement of these liabilities typically occurs in subsequent periods primarily through an authorized process for deductions taken by a customer from amounts otherwise due to the Company. As a result, the ultimate cost of a trade promotion program is dependent on the relative success of the events and the actions and level of deductions taken by the Company’s customers for amounts they consider due to them. Final determination of the permissible deductions may take extended periods of time and could have a significant impact on the Company’s results of operations depending on how actual results of the programs compare to original estimates.

 

We offer coupons to consumers in the normal course of our business. Expenses associated with this activity, which we refer to as coupon redemption costs, are accrued in the period in which the coupons are offered. The initial estimates made for each coupon offering are based upon historical redemption experience rates for similar products or coupon amounts. We perform monthly and quarterly evaluations of outstanding coupon accruals that compare actual redemption rates to the original estimates. We review the assumptions used in the valuation of the estimates and determine

an appropriate accrual amount. Adjustments to our initial accrual may be required if actual redemption rates vary from estimated redemption rates.

 

Investments and Long-lived Assets, including Property, Plant and Equipment—Investments and long-lived assets are recorded at their respective cost basis on the date of acquisition. Buildings, equipment and leasehold improvements are depreciated on a straight-line basis over the estimated useful life of such assets. The Company reviews investments and long-lived assets, including intangibles with finite useful lives, and property, plant and equipment, whenever circumstances change such that the indicated recorded value of an asset may not be recoverable or has suffered an other than temporary impairment. Factors that may affect recoverability include changes in planned use of equipment or software, the closing of facilities and changes in the underlying financial strength of investments. The estimate of current value requires significant management judgment and requires assumptions that can include: future volume trends, revenue and expense growth rates and foreign exchange rates developed in connection with the Company’s internal projections and annual operating plans, and in addition, external factors such as market devaluation and inflation which are developed in connection with the Company’s longer-term strategic planning. As each is management’s best estimate on then available information, resulting estimates may differ from actual cash flows.

 

Goodwill and Indefinite Lived Intangibles—Carrying values of goodwill and intangible assets with indefinite lives are reviewed for impairment at least annually, or when circumstances indicate that a possible impairment may exist, in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.” Indicators such as unexpected adverse economic factors, unanticipated technological change or competitive activities, loss of key personnel, and acts by governments and courts, may signal that an asset has become impaired. All goodwill is assigned to reporting units, which are one level below our operating segments. Goodwill is assigned to the reporting unit that benefits from the synergies arising from each business combination. We perform our impairment tests of goodwill at the reporting unit level. The Company’s measure of impairment for both goodwill and intangible assets with indefinite lives is based on a discounted cash flow model that requires significant judgment and requires assumptions about future volume trends, revenue and expense growth rates and foreign exchange rates developed in connection with the Company’s internal projections and annual operating plans, and in addition, external factors such as changes in macroeconomic trends and cost of capital developed in connection with the Company’s longer-term strategic planning. Inherent in estimating future performance, in particular assumptions regarding external factors such as capital markets, are uncertainties beyond the Company’s control.

 

Retirement Benefits—The Company sponsors pension and other retirement plans in various forms covering substantially all employees who meet eligibility requirements. Several statistical and other factors that attempt to anticipate future events are used in calculating the expense and obligations related to the plans. These factors include assumptions about the discount rate, expected return on plan assets, turnover rates and rate of future compensation increases as determined by the Company, within certain guidelines. In addition, the Company’s actuarial consultants use best estimate assumptions for withdrawal and mortality rates to estimate benefit expense. The financial and actuarial assumptions used by the Company may differ materially from actual results due to changing market and economic conditions, higher or lower withdrawal rates or longer or shorter life spans of participants. These differences may result in a significant impact to the amount of pension expense recorded by the Company.

 

The Company recognized pension expense of $31.6 million, $77.1 million and $65.6 million for fiscal years 2007, 2006 and 2005 respectively, which reflected expected return on plan assets of $198.5 million, $169.0 million and $168.4 million, respectively. The Company contributed $62.5 million in Fiscal 2007 compared to $64.6 million in Fiscal 2006 and $39.9 million in Fiscal 2005. The Company expects to contribute approximately $55 million to its pension plans in Fiscal 2008.

One of the significant assumptions for pension plan accounting is the expected rate of return on pension plan assets. Over time, the expected rate of return on assets should approximate actual long-term returns. In developing the expected rate of return, the Company considers average real historic returns on asset classes, the investment mix of plan assets, investment manager performance and projected future returns of asset classes developed by respected consultants. When calculating the expected return on plan assets, the Company primarily uses a market-related-value of assets that spreads asset gains and losses (difference between actual return and expected return) uniformly over 3 years. The weighted average expected rate of return on plan assets used to calculate annual expense was 8.2% for the years ended May 2, 2007, May 3, 2006 and April 27, 2005. For purposes of calculating Fiscal 2008 expense, the weighted average rate of return will remain at approximately 8.2%.

 

Another significant assumption used to value benefit plans is the discount rate. The discount rate assumptions used to value pension and postretirement benefit obligations reflect the rates available on high quality fixed income investments available (in each country that the Company operates a benefit plan) as of the measurement date. The Company uses bond yields of appropriate duration for each country by matching to the duration of plan liabilities. The weighted average discount rate used to measure the projected benefit obligation for the year ending May 2, 2007 increased slightly to 5.5% from 5.3% as of May 3, 2006.

 

Deferred gains and losses result from actual experience different from expected financial and actuarial assumptions. The pension plans currently have a deferred loss amount of $633.5 million at May 2, 2007. During 2007, the deferred loss amount was positively impacted by an increase in the average discount rate offset partially by actual asset returns less than expected. Deferred gains and losses are amortized through the actuarial calculation into annual expense over the estimated average remaining service period of plan participants, which is currently 11 years.

 

The Company also provides certain postretirement health care benefits. The postretirement health care benefit expense and obligation are determined using the Company’s assumptions regarding health care cost trend rates. The health care trend rates are developed based on historical cost data, the near-term outlook on health care trends and the likely long-term trends. The postretirement health care benefit obligation at May 2, 2007 was determined using an average initial health care trend rate of 8.7% which gradually decreases to an average ultimate rate of 4.9% in 2015. A one percentage point increase in the assumed health care cost trend rate would increase the service and interest cost components of annual expense by $1.6 million and increase the benefit obligation by $17.7 million. A one percentage point decrease in the assumed health care cost trend rates would decrease the service and interest cost by $1.4 million and decrease the benefit obligation by $15.9 million.

 

Sensitivity of Assumptions

 

If we assumed a 100 basis point change in the following assumptions, our Fiscal 2007 projected benefit obligation and expense would increase (decrease) by the following amounts (in millions):

 

Income Taxes—The Company computes its annual tax rate based on the statutory tax rates and tax planning opportunities available to it in the various jurisdictions in which it earns income. Significant judgment is required in determining the Company’s annual tax rate and in evaluating its tax positions. The Company establishes reserves when it becomes probable that a tax return position that it considers supportable may be challenged and that the Company may not succeed in completely defending that challenge. The Company adjusts these reserves in light of changing facts and circumstances, such as the settlement of a tax audit. The Company’s annual tax rate includes the impact of reserve provisions and changes to reserves. While it is often difficult to predict the final outcome or the timing of resolution of any particular tax matter, the Company believes that its reserves reflect the probable outcome of known tax contingencies. Favorable resolution would be recognized as a reduction to the Company’s annual tax rate in the year of resolution. The Company’s tax reserves are presented in the balance sheet principally within accrued income taxes.

 

The Company records valuation allowances to reduce deferred tax assets to the amount that is more likely than not to be realized. When assessing the need for valuation allowances, the Company considers future taxable income and ongoing prudent and feasible tax planning strategies. Should a change in circumstances lead to a change in judgment about the realizability of deferred tax assets in future years, the Company would adjust related valuation allowances in the period that the change in circumstances occurs, along with a corresponding increase or charge to income.

 

The resolution of tax reserves and changes in valuation allowances could be material to the Company’s results of operations for any period, but is not expected to be material to the Company’s financial position.

 

Inflation

 

In general, costs are affected by inflation and the effects of inflation may be experienced by the Company in future periods. Management believes, however, that such effects have not been material to the Company during the past three years in the United States or in foreign non-hyperinflationary countries. The Company operates in certain countries around the world, such as Venezuela, that have experienced hyperinflation. In hyperinflationary foreign countries, the Company attempts to mitigate the effects of inflation by increasing prices in line with inflation, where possible, and efficiently managing its working capital levels.

 

The impact of inflation on both the Company’s financial position and results of operations is not expected to adversely affect Fiscal 2008 results. The Company’s financial position continues to remain strong, enabling it to meet cash requirements for operations, including anticipated additional pension plan contributions, capital expansion programs and dividends to shareholders.

 

Stock Market Information

 

H. J. Heinz Company common stock is traded principally on The New York Stock Exchange under the symbol HNZ. The number of shareholders of record of the Company’s common stock as of May 31, 2007 approximated 39,000. The closing price of the common stock on The New York Stock Exchange composite listing on May 2, 2007 was $46.61.

Stock price information for common stock by quarter follows:

 

 

 

This information is set forth in this report in Item 7—“Management’s Discussion and Analysis of Financial Condition and Results of Operations” on pages 25 through 26.

 

 

TABLE OF CONTENTS

 

 

Report of Management on Internal Control over Financial Reporting

 

Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting refers to the process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer, and effected by our Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles, and includes those policies and procedures that:

 

(1) Pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company;

 

(2) Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and

 

(3) Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Management has used the framework set forth in the report entitled “Internal Control—Integrated Framework” published by the Committee of Sponsoring Organizations of the Treadway Commission to evaluate the effectiveness of the Company’s internal control over financial reporting. Management has concluded that the Company’s internal control over financial reporting was effective as of the end of the most recent fiscal year. Our management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of May 2, 2007 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which appears herein.

 

/s/  William R. Johnson

Chairman, President and

Chief Executive Officer

 

/s/  Arthur B. Winkleblack

Executive Vice President and

Chief Financial Officer

 

June 21, 2007

 

Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Shareholders of

H. J. Heinz Company:

 

We have completed integrated audits of H. J. Heinz Company’s consolidated financial statements and of its internal control over financial reporting as of May 2, 2007 in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

 

Consolidated financial statements and financial statement schedule

 

In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of H. J. Heinz Company and its subsidiaries at May 2, 2007 and May 3, 2006, and the results of their operations and their cash flows for each of the three years in the period ended May 2, 2007 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

As discussed in Note 1 to the consolidated financial statements, the Company changed the manner in which it accounts for share-based compensation effective May 4, 2006 and as discussed in Note 2 to the consolidated financial statements, the Company changed the manner in which it accounts for defined benefit pension and other postretirement plans effective May 2, 2007.

 

Internal control over financial reporting

 

Also, in our opinion, management’s assessment, included in the Report of Management on Internal Control over Financial Reporting appearing under Item 8, that the Company maintained effective internal control over financial reporting as of May 2, 2007 based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of May 2, 2007, based on criteria established in Internal Control — Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider

necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

/s/ PricewaterhouseCoopers LLP

 

Pittsburgh, Pennsylvania

June 21, 2007

H. J. Heinz Company and Subsidiaries

 

Consolidated Statements of Income

 

 

See Notes to Consolidated Financial Statements

H. J. Heinz Company and Subsidiaries

 

Consolidated Balance Sheets

 

 

See Notes to Consolidated Financial Statements

H. J. Heinz Company and Subsidiaries

 

Consolidated Balance Sheets

 

 

 

See Notes to Consolidated Financial Statements

H. J. Heinz Company and Subsidiaries

 

Consolidated Statements of Shareholders’ Equity