康尼格拉食品 (CAG) 2014 Q3 法說會逐字稿

Good morning, and welcome to today's ConAgra Foods' third-quarter earnings conference call.

This program is being recorded.

My name is Jessica Morgan and I'll be your conference facilitator.

(Operator Instructions)

At this time, I'd like to introduce your host for today's program, Gary Rodkin, Chief Executive Officer of ConAgra Foods.

Please go ahead, Mr. Rodkin.

Good morning, and welcome to our third-quarter earnings call.

Thanks for joining us today.

I'm Gary Rodkin, and I'm here with John Gehring, our CFO; and Chris Klinefelter, VP of Investor Relations.

Before we get started, Chris has a few words.

Good morning.

During today's remarks, we will make some forward-looking statements, and while we are making those statements in good faith and are confident about our Company's direction, we do not have any guarantee about the results that we will achieve.

So if you would like to learn more about the risks and factors that could influence and impact our expected results, perhaps materially, I'll refer you to the documents we filed with the SEC which include cautionary language.

Also, we will be discussing some non-GAAP financial measures during the call today, and the reconciliations of those measures to the most directly comparable measures for Regulation G compliance can be found in either the earnings press release, the Q&A, or on our website.

Now I'll turn it back over to Gary.

Thanks, Chris.

Our comparable diluted EPS for the quarter was $0.62 which represents 13% growth.

This is in line with revised expectations, and we continue to expect comparable diluted EPS of $2.22 to $2.25 this fiscal year.

While there are some operating headwinds in our segments, as we discussed in mid-February when we revised our fiscal 2014 EPS outlook, we've started to realize good SG&A efficiencies, and we have line of sight to substantial SG&A savings over the next couple of years, as we shared with you at CAGNY.

I will offer some high-level remarks on each of our segments, and then go into more detail in a couple minutes.

Within Consumer Foods, volume was down 3%, price mix was flat, and comparable profit was in line with year-ago amounts.

We expected the volume decline given the challenges we have with Orville Redenbacher's, Healthy Choice and Chef Boyardee, and we knew the top line challenges would weigh on profit, but effective cost management helped us post a decent profit performance despite a soft top line.

Some of our other brands are performing well, and we will continue to invest in those parts of the portfolio with strong growth potential.

I will share more depth on Consumer Foods, but first I want to provide a couple of headlines on Commercial Foods and Private Brands.

Within Commercial Foods, performance was largely as expected with comparable profit down 8% due to the potato crop and lower margins from a customer shift.

And within Private Brands, the synergy capture from the acquisition is coming in a little ahead of target, which is clearly good news.

We've been successfully working through some operational and customer service related issues, as we previously explained.

Overall, we are making gradual progress on the business and remain confident in our long-term private brand strategy.

As we communicated last month, we are intensely focused on significant improvements across our three business segments, and while there is ground to make up, there are bright spots in each segment, and the work we're doing now is intended to strengthen our prospects for long-term success.

We remain committed to our earnings per share guidance for this fiscal year, as well as our cash flow and debt reduction commitments.

With regard to fiscal 2015 performance, we'll say more about timing and amounts, and all other relevant details when we have our fiscal 2014 fourth-quarter earnings call in June.

Now more on Consumer Foods.

Our Consumer Foods segment posted sales of approximately $1.9 billion and operating profit of $266 million, as reported.

Sales declined as expected, reflecting a 3% volume decrease in flat price mix compared to the year-ago period.

As you know, we have some brands with challenges, and I'll touch on those in a minute, but that's not the full picture.

We also have brands with dollar-sales growth and market share gains for the quarter, including Slim Jim Meat snacks, Swiss Miss Hot Cocoa, Reddi-Wip topping, Bertolli frozen meals and others.

While we will continue to support a number of our brands with advertising, such as Hunt's Tomatoes, Slim Jim, Reddi-Wip, Pam, Marie Callender's and others, our intense focus is on being what we call perfect at retail.

We believe that in this ultra-competitive market, getting the four Ps right -- meaning pricing, packaging, placement, and promotion is especially critical.

We offered a few examples of perfect at retail at CAGNY, and for the brands where we are seeing growth and taking share, our four Ps are playing a big role.

Within the three big brands that we are working to turn around; I'm talking about Healthy Choice, Chef Boyardee, and Orville Redenbacher's, we have specific action plans underway to stabilize and improve performance through product and packaging changes, focused messaging, and more impactful in-store initiatives.

Some of these changes will happen quickly, and others will take place across the next several quarters.

Net-net, we expect to see better performance in aggregate across these three brands in fiscal 2015 and we will keep you apprised.

Of course, we have other elements to our growth plans for Consumer Foods.

We have a number of new products entering the market like PAM cooking spray with coconut oil, and Bertolli tortas, with a more balanced investment plan than we did this fiscal year.

Our focused programming on pot pies, where our market share is high and we've got an advantage supply chain, this has already helped drive growth in the Marie Callender's and Banquet businesses.

We are capitalizing on that demand trend with our Bertolli brand by using our pot pie capabilities to create Italian-style tortas; meat-filled pies stuffed with ricotta, Parmesan and mozzarella cheese inside a flaky pastry crust.

We are also satisfying the consumer demand for pot pies in our strength in that platform with new flavors from Banquet and Marie Callender's, such as Salisbury steak, deep-dish, pot pie from Banquet.

This demonstrates our ability to grow an already strong platform by leveraging our insights and capabilities.

Moving onto segment profits, comparable Consumer Foods operating profit was $270 million for the quarter, in line with year-ago amounts.

While the top line declined weight on profitability, several factors favorably contributed to the quarter's profit performance including supply chain productivity initiatives that more than offset manageable inflation, lower incentives, and a strong focus on SG&A-related efficiencies.

We also reduced advertising and promotion expense as we focused on efficiencies and rebalanced spending to strengthen and be more effective with promotional support where it made sense, we mentioned this as a plan earlier in the fiscal year.

Within Commercial Foods, our third-quarter results were in line with what we expected.

As we've discussed, we are dealing with a sub-optimal potato crop, as well as a margin decline from a food service customer loss.

We've taken the margin hit on the customer shift this year, so we should be past that in fiscal 2015.

And separately, we will be into a new potato crop in the second quarter of fiscal 2015.

Additionally, we continue to see rapid growth in Lamb Weston's international sales, which grew at a double-digit rate in the fiscal third quarter as we capitalized on international expansion of key customers.

In our milling business, sales declined reflecting the pass-through of lower wheat costs and lower volumes, and profit increased on the basis of better mix and efficiencies.

As we've said before, we expect the Ardent Mills transaction to close in the second quarter of this calendar year.

The Ardent JV will allow us to take part in financial gains of a more efficient milling business without the sales volatility of a commodity-oriented business in our base results.

We view this as a long-term strategic win that will enhance ConAgra Foods' shareholder value over time.

Long term we expect good accretion from the transaction making this a financially and strategically sound move.

And, of course, our biggest strategic move has been to dramatically expand our presence in Private Brands.

We are pleased with the cost synergy identification and realization we've seen so far, we are slightly ahead of our fiscal 2014 target of $30 million.

However, as we conveyed in February, we are not satisfied with the fundamentals of our base business.

We continue to work to stabilize the base business, and our efforts to stabilize have included price concessions we've had to make this fiscal year to prevent further volume issues.

Those concessions mean that the margins for the Private Brands segment will continue to be challenged for the next several quarters.

There's no question this has been a period of fighting fires while working to establish a solid foundation with the right structure and focus.

We continue to get positive feedback on the strategy and our opportunities from customers.

For example, with one major customer we increased our Private Brands sales by more than $20 million since the acquisition, as we gained business in snacks and cereal.

With another customer, we've recently gained business in three categories previously served by our competition, and this customer has noted its own commitment to double-digit growth in their private brands business.

So clearly, there's still a lot of ground to make up in areas that need to turn around.

But we shouldn't lose sight of the fact that there are some encouraging bright spots.

And while we expect that the marketplace for Private Brands will continue to be very competitive, just as it is for everyone in the food business, we are confident that our model of offering scale and CPG capabilities in branded and Private Brands is a differentiated and winning proposition long term.

Now let me address a few questions some of you have been asking about how we plan to manage brands and Private Brands.

We will continue to prioritize and resource our branded portfolio as our largest segment.

We don't have much overlap among branded and Private Brand product lines and we plan for that to continue to be the case.

Overlap will be the exception, not the rule.

We will leverage our assets and product lines together where it makes sense to drive growth and create more efficiencies for our business and our customers.

We are rewiring our organization to become even more customer centric and working directly with retailers to develop products that fit their shoppers and their growth plans.

And our growth agenda involves the right use of branded and private label items.

We will continue to launch some branded new products nationally.

We may launch other new branded items at particular customers, and we will launch new Private Brand products on a customer-by-customer basis.

One size won't fit all.

That's the exciting part about having a portfolio like we do.

We have the agility and the capabilities of a broad portfolio, and we will thoughtfully do what's best to deliver a win-win with each of our key customers.

As we do that, I want to be very clear that we plan to manage our brand equities for long-term health.

We will not jeopardize the long-term health of our brands or our margins.

I will wrap up by saying that our rich synergy pipeline, as well as improvement initiatives for each of our segments, and our intense focus on efficiencies and cost reduction across our cost of goods and SG&A expense areas put us in a good position to resume quality growth as we get past these challenges for our segments.

We believe the hard work we're doing to configure a more effective and customer-centric organization to leverage the breadth and scale of our portfolio will be worth it, and we look forward to reporting on our progress in due course.

Thanks for taking time to join the call today.

Now I'll turn it over to John.

Thank you, Gary, and good morning, everyone.

I'm going to touch on a number of topics this morning.

First, I will discuss our fiscal third-quarter performance.

Next I will address comparability matters.

Then on to cash flow, balance sheet and capital items, and I will close with some brief comments on our outlook.

As Gary noted, the fiscal third-quarter results were slightly better than we had anticipated due principally to lower SG&A, some of which is timing.

Overall, for the fiscal third quarter, we reported net sales of $4.4 billion, up 15% from the prior year.

As a reminder, the prior-year amounts included only a few weeks of Ralcorp activity due to the date of the transaction.

And for the quarter, we reported fully diluted earnings per share from continuing operations of $0.58 versus $0.28 in the year-ago period.

Diluted EPS, adjusted for items impacting comparability, were $0.62 versus $0.55 in the prior-year quarter, a 13% increase.

While Gary has addressed our segment results, I would also like to touch on a few points.

Starting with our Consumer Foods segment, where net sales were approximately $1.9 billion, about 4% below the year ago period, reflecting a 3% decline in volume, flat price mix, and a negative 1% impact from foreign exchange.

Our Consumer Foods segment operating profit, adjusted for items impacting comparability, was $270 million, in line with the year-ago period.

The operating profit reflects the impact of lower net sales, modest inflation and effective cost savings, as well as the benefit from lower incentives, marketing and other SG&A costs.

Marketing costs decreased about $15 million, or about 13% from the prior-year quarter.

On foreign exchange, for this quarter, foreign exchange negatively impacted net sales by $16 million and operating profit by $6 million.

Our Consumer Foods supply chain cost reduction programs continue to yield good results and delivered cost savings of approximately $49 million in the quarter.

For the full fiscal year, we expect cost savings in this segment to be approximately $200 million.

Approximately $30 million of additional cost savings will be reflected in other segments as the result of the change in our segment reporting structure.

For the fiscal third quarter, we experienced inflation of about 2%.

In our Commercial Foods segment, net sales were approximately $1.5 billion, or about 1% below the prior-year quarter.

The net sales decline reflects the pass-through of lower wheat costs in our flour milling business, and sales declines in the legacy ConAgra Foods food service unit point formerly included in our Consumer Foods segment.

These declines were partially offset by the addition of food service business previously reported in the Ralcorp Frozen Bakery segment for which the year-ago quarter reflected limited activity.

Net sales in this segment also reflects stronger volumes in our potato operations, offset by lower net pricing.

The Commercial Foods segment's operating profit, adjusted for items impacting comparability, decreased 8% from the year-ago period to $180 million.

The year-over-year decrease reflects the expected decline in our Lamb Weston business, partially offset by the contribution from the food service business included in the Ralcorp acquisition, and a modest net increase from other businesses in this segment including flour milling.

Our Private Brands segment delivered net sales for the quarter of $1.1 billion, and operating profit, excluding items impacting comparability, of approximately $66 million, in line with our revised expectations.

The operating profit results reflect the impact of price concessions and volume softness across several categories.

Also, we are making good progress on both COGS and SG&A synergy initiatives, and we are on track to achieve our synergy targets for fiscal 2014.

Moving on to corporate expenses, for the quarter, corporate expenses were $50 million.

Adjusting for items impacting comparability, corporate expenses were $34 million versus $87 million in the year-ago quarter.

The year-over-year change was driven principally by lower incentive and pension costs and other operating cost reductions.

The tax rate for this fiscal quarter was approximately 27%.

The rate for this quarter was lower than planned, driven by several favorable settlements and changes in estimates, some of which are treated as items impacting comparability.

Now I'll move on to my next topic, items impacting comparability.

Overall, we have approximately $0.04 per diluted share of net expense in this quarter's reported diluted EPS from continuing operations related to several items.

First, we recorded approximately $38 million, or $0.06 per share, of net expense related to integration and acquisition-related and other restructuring costs in connection with our acquisition of Ralcorp.

On hedging, for the fiscal third-quarter, the net hedging gain included in corporate expenses was approximately $52 million, or $0.08 per share.

We also recognized a loss of $55 million, or about $0.08 per share, related to interest rate derivatives that were acquired several years ago as a hedge in anticipation of refinancing the $500 million of 5.875% debt that matures in April 2014.

Based on an assessment of our debt repayment alternatives, and consistent with our commitment to debt reduction, we have decided not to refinance this debt and have, therefore, recognized a loss on the interest rate hedges in the fiscal third-quarter earnings versus deferring the loss over future years.

The recognition of the loss has no impact on our previous cash flow estimates.

In addition, we recorded a charge of approximately $17 million, or $0.02 per share, related to an asset impairment in our Commercial Foods segment.

And finally, we recorded a tax benefit of about $17 million, or approximately $0.04 per share, primarily resulting from an international tax settlement and additional benefits realized from a change in estimate related to tax methods used for certain international sales.

Next I'll cover cash flow, balance sheet, and capital items.

First, we ended the quarter with $239 million of cash on hand and about $140 million in outstanding commercial paper borrowings.

For fiscal year 2014, we expect cash flows from operating activities to be in the range of $1.4 billion, including a modest contribution from working capital improvement.

On capital expenditures, for the quarter, capital expenditures increased to $139 million from $107 million in the prior-year period, reflecting the addition of the Ralcorp businesses.

And for fiscal year 2014, we expect capital expenditures to be approximately $625 million.

Net interest expense was $95 million in the fiscal third quarter versus $71 million in the year-ago quarter.

The increase is driven by additional interest expense related to financing the Ralcorp acquisition.

Dividends for the quarter increased from $101 million in the year-ago quarter to $105 million due to the increase in shares outstanding.

On capital allocation, our priority continues to be the repayment of debt, as well as strengthening our credit metrics.

Consistent with that priority, we currently expect to repay approximately $550 million of debt in fiscal 2014, and a total of $1.5 billion by the end of fiscal 2015.

This target excludes any additional repayment we expect to fund from cash proceeds related to the Ardent Mills transaction.

For fiscal 2014, debt repayment will be concentrated in the fourth quarter, consistent with our historical seasonal cash flow pattern.

As previously noted, as we delever, we expect to maintain our current annual dividend at $1 per share and limit our share repurchase plan.

This quarter we did not repurchase any shares.

And while we expect to limit M&A activity in the near term as we focus on deleveraging and integration, we will continue to look for opportunities to strengthen our portfolio for the long term.

We will also continue to prudently invest behind innovation, production capacity, and our cost savings initiatives.

Now I'd like to share some comments on our fiscal 2014 full-year outlook.

As we noted during our CAGNY presentation a few weeks ago, we expect that are full fiscal year diluted earnings per share from continuing operations, excluding items impacting comparability, will be in the range of $2.22 to $2.25.

And while the third quarter EPS results were slightly better due to lower SG&A costs, we remain cautiously -- we remain appropriately cautious about some of the short-term challenges we face over the balance of 2014, which is why our yearly guidance has not changed.

As we have noted previously, we are in the process of developing our plans for fiscal year 2015.

While we are not in a position today to provide a detailed outlook for fiscal 2015, I would like to reiterate a few key points from our CAGNY comments.

First, on the top line, we are focused on solutions to the top line challenges we have faced this year in each of our operating segments.

Second, on margins, we believe our strong supply chain productivity and our focus on SG&A efficiency and effectiveness will provide us with the opportunity to expand margins over time.

While we do face some headwinds, such as the pace of margin recovery in Private Brands, Ardent Mills dilution, and higher incentives, we continue to expect EPS growth for fiscal 2015, but we currently expect that it will be less than the double-digit rate we previously estimated.

We will provide more specific comments about the fiscal 2015 outlook in connection with our fiscal 2014 year-end release when final plans have been completed.

That concludes our formal remarks.

I want to thank you for your interest in ConAgra Foods.

Gary and I, along with Tom McGough and Paul Maass, will be happy to take your questions.

I will now turn it over to the operator to begin the Q&A portion of our session.

Operator?

Thank you.

Now we'd like to get to an important part of today's call, taking your questions.

(Operator Instructions) And our first question today will come from Andrew Lazar with Barclays Capital.

Good morning, everyone.

Good morning, Andrew.

Gary, I know you're not at a point yet, as John mentioned, where you are going to give fiscal 2015 guidance.

But I think most Street estimates have you at, call it, roughly 7% or 8% earnings growth for next year.

I thought maybe it would be helpful just to go through a quick, maybe, mental accounting of some of the puts and takes, some of which John had mentioned, as they -- the ones that are kind of discrete that we know about today, as they relate to 2015?

And that can help isolate maybe where there is still a little less visibility on some of the core.

but, so on tailwinds you've, obviously, got the ongoing productivity.

You've got the incremental overhead work you are doing that you discussed at CAGNY.

I think you may have an extra week in fiscal 2015, but you can correct me on that if I'm wrong.

The Ralcorp synergies, I think, start to play out in a bigger way.

And you have certainly got some easier comparisons on volume, and as you mentioned, you are kind of lapping the poor potato crop and the loss of the food service customer.

I guess on the headwinds side, you talked about the Ardent Mills JV dilution, some compensation expense increase, and, I guess, that leaves us with the base business.

I guess, what I'm getting at is, are there anything major that I'm missing on the puts and takes for next year?

It would seem that you will have some flexibility, as you mentioned there, for some earnings growth, even in the context of some weaker core businesses.

But, we don't know this yet, but in terms of the core business, are you sort of anticipating, let's say, volume trends in Consumer and Private Brands can be roughly flattish for the year?

Or getting to flat by the end of year?

I'm just trying to get a sense of, if we've got these puts and takes right, and what that leaves you with flexibility?

Andrew, that's quite a comprehensive understanding of our business so --

Thanks for bearing with me.

I applaud you for that.

Let's be really clear, our challenges won't disappear on day one of the new fiscal year.

But we are making progress.

You outlined a lot of that, and we will have a better year than we did this year.

Yes, we do have a 53rd week next year.

That certainly is a plus.

If we take a look at each of the three businesses, I'd say Private Brands will make gradual progress.

The operational and customer service issues are mostly behind us.

Our organization is getting more experience in the business but we still will be dealing with a lot of the overlap of the pricing concessions that we made this year, and a continuing challenging market environment.

On the consumer side, the three big problem brands that we've discussed will perform better in F15, basically against a real maniacal focus on the core category users, some product and package changes, very targeted marketing.

And then in Commercial Foods, as you noted, Lamb Weston will have a -- we expect a normalized potato crop.

We will have that food service customer loss in our base, and we will continue to drive double-digit growth in international.

So I'd say net-net there certainly are still some headwinds, particularly as you look at the Private Brand business, but net-net, we will have a better year.

Next year, we will give you more detail in the Q4 earnings call.

Great, thanks for your help.

Thank you.

And we will move now to David Driscoll with Citi.

Good morning.

This is Cornell with a question for David.

Good morning, Cornell.

Great.

First, just with pasta looking to be one of the biggest parts of the Ralcorp private-label portfolio, we wanted to know is this product line where most of the issues that you are having within private label occurring?

Or are the problems more generally spread across the portfolio?

Yes, I would describe it as more generally spread.

The pasta business is an important category for us and we are very committed to improving that one as well, but everything that Gary described is -- I would describe is more general across the whole portfolio.

Okay, and then in terms of just going to Consumer Foods, are trade promotion dollars now at levels that you deem proper, or were sales coming in a little bit soft in that segment during the quarter.

Do you think that you need to ramp up trade spending further in future quarters?

Can you talk a little bit more about some of the tactical adjustments that you are taking to fix some of the troubled brands in Consumer like Chef Boyardee, Orville, and Wesson?

Sure.

This is Tom McGough.

There were several parts to your question, and let me decompose it into a couple factors.

If you look at our Q3 volume performance, 50% of our volume change was due to our changing consumption, and 50% of the change was due to a shift in the Thanksgiving timing when some volume that normally would have shift in Q3, shift in Q2.

So our underlying performance is somewhat better than the 3%.

When it comes to overall performance, the weaker consumption was a result of the three brands that we've discussed.

We are executing some changes on these brands to be sharper in terms of our pricing, promotion, getting our packaging, our in-store conditions right, that's the perfect at retail.

Those type of changes are going to happen more quickly, while others are going to take place over several quarters.

We expect the volume on those businesses to generally improve throughout FY15.

When you look at our business, excluding those three challenged brands, the volume for the rest of the portfolio has actually grown in each of the last three quarters, and we feel very confident that our marketing and our promotional programs are on target with those brands.

And we will move now to a question from Bryan Spillane with Bank of America Merrill Lynch.

Hey, good morning, everyone.

Good morning, Bryan.

John, just a question about free cash flow, or operating cash flow.

I guess for 2014 you are still looking at $1.4 billion for operating cash flow, and then for 2015, I guess, what you said at CAGNY was that you expected it to be $1.6 billion or better.

So, given that the earnings outlook for 2014 and for 2015 is below the original plan, just how do we bridge that the operating cash flow in 2014 more or less stayed the same, and then the plan is to grow operating cash flow almost 15% next year.

Can you just talk about some of the moving parts within operating free cash flow and maybe potentially free cash flow?

Yes.

We will, obviously, update this as we get into our full outlook.

But I'd say a couple of things that I would point to is that I think the cash flow committed to incentives in 2015 versus 2014 because those are paid in arrears, we are going to have a pickup as we go into next year.

I think we also see some working capital opportunities in certain parts of our business that we will be working on.

And I just think some of the cash outlay we have in terms of one-time integration costs and those sorts of things will be smaller.

So I think there's a number of factors there, and as I said, we will certainly be updating that and providing more visibility as we get into next quarter.

If the earnings had tracked to original plan, would the operating cash flow generation actually be higher than it is?

Just trying to get a sense for whether or not, if you get into a more normal or more inside the range of what you've envisioned in terms of profitability, whether the cash flow generation actually will be higher than these levels?

I think all things being equal as earnings go up cash flow generally will track with it.

There can be some periodic disconnects, but, yes, over time we certainly would expect that to be the case.

Okay, great.

Thank you.

And Jonathan Feeney with Janney Capital Markets has our next question.

Good morning.

Thanks very much.

I wanted to ask about Ralcorp synergies.

Specifically, not only where you stand right now, which I think you've updated us on, but also you have made some structural changes to the business, Gary, at least versus what was original plan.

Maybe brought in some costs for management and you've changed the way you are approaching things.

Have you changed your thought about how much synergy this can in its best incarnation produce?

And can you update us as to where we stand versus that goal now and maybe going forward?

Yes, Jonathan, this is John.

Let me take a shot at that.

I think, as we've said, I think we talked about this first year we would capture about $30 million.

I think we feel good about being on track, we will probably be slightly above that.

I think in terms of our target run rate by the end of fiscal 2017, I think we still feel good about the $300 million.

I would note that separately, as Gary has talked about, we have talked about additional work around our business structure and SG&A effectiveness and efficiency in how we wire the organization.

We will mine some additional benefits out of that.

But as part of the pure synergy play we are talking about is really still that $300 million.

I will also note that most of that is going to be in the cost of goods supply chain area.

No real change there, but we still feel good and we feel like we are on track.

How much -- since the close of the acquisition, how much has the cost of goods coming down a little bit, just a trajectory of input cost in that sort of sticky price business helped you?

And, I guess, as part of that, it seems like some things didn't go exactly according to plan, so was it just that your initial plans were really, really conservative and so now you are still able to deliver despite you having to make a little bit more investment?

Or what all have been the puts and takes that allow you to maintain that despite some costs you are putting back in the business?

Let me take a shot and then I will maybe turn it over to Paul.

I think as we look at synergies, we are looking at how do we drive costs out of our inputs, our conversion, our distribution, and I think we expect those to track.

I think the challenges we've had in the business have been more in terms of top line and pricing.

So I think the challenge for us is to continue to deliver on that lower cost base.

At the same time, we look at all of the other levers in the business to continue to rebuild those margins over time and, again as Gary indicated that will be a gradual process.

But I don't want to say those two issues are not connected because they ultimately connect at the gross margin line in the business, but the synergies are really focused on cost, the numbers we talk about are cost not top line.

I might add just a little just around a lot of focus on better customer execution, sold to the supply chain, believe there are a lot of synergies around the operational aspects, the total network, and we are very focused on that.

I think you did reference just the structure, the organizational structure and more focus, and we believe that will absolutely payoff over time.

Thank you.

Ask one detail question, I know you probably are sensitive about customer names, but the food service customer you lost, was that a distributor or a restaurant?

Can you tell us?

It was in the food service distribution arena.

And we will take a question now from Akshay Jagdale with KeyBanc Capital Markets.

Hi, can you hear me?

We can.

Good morning, Akshay.

Good morning.

My question is on Private Brands, and I'm just trying to understand in that business specifically, what are the structural issues that you are dealing with that perhaps are going to take a longer time to fix relative to, let's say, the previous management team?

And then, what are some of the more operational issues?

And if you can help us quantify some of that just roughly, that would be great because it seems to us from the numbers we are looking at and whatever we have to compare.

Which is when you bought this business, the previous management team had it running at $100 million in EBIT per quarter and the latest quarter you reported was 50%, 60% below that despite the benefit from synergies.

You are talking about price concessions and things of that sort.

But if the magnitude of the deterioration in that business is so severe that I'm having a hard time understanding what part of that is structural and what part of that is operational issues that you can fix?

And if you can give us some color on categories, that would be very helpful.

Thanks.

Akshay, this is John.

Let me start with just making sure we are clear on one thing which is, we have now changed our operating segments and the way we report our business.

The businesses that we acquired from Ralcorp are now spread throughout three operating segments we operate today.

So it is not as simple as looking at legacy Ralcorp financial statements and then comparing it to the Private Brands segment because those pieces have been reorganized and split up.

That comparison isn't the right comparison.

Clearly, there have been some challenges in the center of the store Private Brand business that we acquired, that largely is part of our Private Brands business now, but I just want to make sure that we are clear that that comparison is not the right one.

I will turn it over to Paul now to maybe just comment on some of the issues in the business that he's working on.

Yes, maybe just a little bit on the environment itself, so the backdrop of some commodity deflation, increased merchandising promotional activity by the brands, our short-term executional challenges that I would clearly link to just the challenges of integrating two companies together.

So that's the backdrop, that increased the contracting bid activity with customers.

We saw an abnormally high level of that in the short term, and I would say we are through a lot of that, and really focused on stabilization and improving margins as we go forward.

So, Akshay, you'll get all three of us here.

That's a really important question.

And, clearly, we are not happy and satisfied with our overall results in this business.

But importantly, we need to remember this is a long-term play.

Private Brands, for all the reasons we've talked about, we believe will absolutely be a long-term growth vector in the industry, and long term we are advantaged; scale, breadth, capabilities.

None of these advantages have thus far come into play, not yet.

Honestly, in this year one, we've been back on our heels, like Paul talked about.

It has all been about price.

But as we get a more solid foundation with our customers and, frankly, our own organization, we will bring these competitive advantages to bear.

And over time, this will absolutely change.

This is a transformation, and, frankly, it is a lot more complex than just a normal integration because of that.

The long-term strategy is sound.

And we will move now to Thilo Wrede with Jefferies.

Thilo, we are having difficulty hearing you.

Can you hear me now?

Yes, that's better.

Good morning, this is Scott Barber on for Thilo.

Just a couple questions around the inflation outlook.

What is the outlook, and is there any impact from the California drought expected?

This is John.

What I would tell you is, as we look for the balance of this year we expect inflation to continue to be in the 1% to 2% range.

I would say, as it relates to next year, we are not going to commit to a final estimate yet until we go through the rest of our work.

Obviously given some of the recent volatility, especially in proteins -- and you referenced California, we have some exposure, obviously, with tomatoes.

We are bit more cautious about fiscal 2015, but, again, I think we will continue to evaluate those trends as we finalize our plans.

Okay, great.

And then, a follow-up, in terms of the CapEx and the interest expense guidance, why the change, and what are you planning to do with the incremental upside from the expected lower interest expense?

Thanks.

I'm not sure our interest expense outlook has changed all that dramatically for this year.

CapEx, I think our CapEx call for fiscal 2014 is probably down about $25 million.

And, again, I don't know that that's going to drive any significant change in any of our capital allocation given our focus on debt repayment.

This is Chris.

I would consider those refinements as we get further in the year to original estimates.

And we will take a question now from Goldman Sachs, Jason English.

Hey, good morning, folks.

Thanks for the question.

Good morning.

I too want to focus back on the Private Brands side.

So, Paul, I guess a question for you.

As you think about your contract positions you have with retailers and the volume expectations associated with that.

Clearly, this time last year they would have been going lower on the contract lawsuits.

Are they now moving higher off of the bottom?

And if so, when will we cycle that bottom?

Just to make sure I'm following, you are talking about volume decline, volume expectation going forward?

Yes, pretty much.

Yes.

We've been navigating through what I said an abnormally high contracting bid equation and it is driven by those things that I had referenced earlier.

I would describe that as more normalized, and as we go forward it will be a gradual improvement, and focusing the organization very heavily on margin improvement is the real key as we go through FY15.

Let's drill down on that a little bit more then, because clearly the margins are quite low for the business now.

What are the components that help you recover on a go forward in light of the pricing concessions you're having to make to stabilize this business?

Yes, in the customer facing piece; pricing, mix, distribution gains, really driven by leveraging our insights, category management capabilities is critical and we recognize that.

That will help on the customer side.

A lot of focus on operations and supply chain, the network optimization is something that -- it does take time, but we are committed to and believe that there's leverage there.

The combination of the Ralcorp acquisition with the legacy ConAgra Foods platform, the combination of the two that there's benefit to be had there.

We just have to aggressively get it executed.

And, Jason, this is Gary.

I would also go back again and say, we've been back on our heels.

So we've been in extreme reactive mode.

We have to get to the point as we stabilize, which we gradually will.

To be much more proactive with our customers, gain the confidence and credibility with our customers, take us out of as many bid situations.

I see that clearly coming.

And when that happens we will be able to improve our margins because it won't be about that last tenth of a penny every time.

Right now, frankly, I hate to admit it, but it is.

That's going to change over time.

So when you put all those elements together that Paul talked about and that over time, clearly, we will start to see margin improvement, and I expect to see that start to happen sometime next year.

We will move now to David Palmer with RBC Capital.

Thanks, and good morning.

Earlier in the fiscal year, you were leaning harder on innovation and advertising.

You shifted more of your dollars back to promotion, correct me if I'm wrong on this, but I see the ad spend moved down in the quarter.

Could you talk about the adjustments that you've made within this fiscal year and what's working, what's not working as you do that?

Sure, David, this is Tom McGough.

We look at our portfolio in two segments.

The three fix and grow brands that we've discussed.

Our plan there is to focus on three components.

One, getting the fundamentals right, you've heard Gary talk about being perfect at retail.

That's more than just price and promotion.

It's the product, the package, the placement in store.

We are making those changes now and we'll be flowing those in.

The second component of our -- the balance of our portfolio is actually growing net of those three brands.

And we feel that we've struck the right balance between the consumer pull, the merchandising push.

We feel we have the right balance on those businesses.

And we are focused our attention on getting the fundamentals right on the first -- on those three fix and grow brands and being more competitive in driving our brand preference.

We have a question now from Alexia Howard with Sanford Bernstein.

Good morning, everyone.

Good morning.

So I wanted to ask a question about the millennial consumer.

You mentioned, I think, at CAGNY that recruiting younger consumers is a challenge for those three big brands.

Which other brands can you use to target that demographic, and is it possible to renovate those brands to attract new consumers, or is it really just more a matter of managing the volume down on those products over time?

Thank you.

Alexia, I think some of our brands do certainly have some play with millennials, clearly, a brand like Alexia, which I'm sure you would like.

(laughter) I know it well.

That definitely has some pull there.

I would also tell you a number of places in our Private Brand business, that is clearly one that millennials are open to.

That would be another place in many of the categories we play.

And, frankly, primarily on the male side, but not exclusively, Slim Jim plays extremely well with millennials, and that brand is doing very, very well.

We do have some brands, but I would tell you the core businesses, those three that you mentioned, we're going to go after the core users and we will pick some millennials up along the way through osmosis, but it won't be our focus.

Our next question will come from Robert Moskow with Credit Suisse.

Hi, thank you.

Gary, thank you for the clarity on the issue that I think you raised at CAGNY about how to manage a hybrid business between brand and private level.

I think you mentioned the word being agnostic, and I think you have provided some good specifics here about what the guardrails are.

But I guess I'm still a little bit interested in what you meant when you said that you would launch branded products that would be specific to retailers.

I think what I've seen at times, or when retailers put their brand and then in conjunction there is a national brand on the label as well.

Are you exploring that?

And then lastly, maybe -- have you thought further about the possibility, or where you would and wouldn't introduce private label versions of your own brands?

Thanks.

Yes.

Rob, I would tell you that -- I'm going to let Tom give you a few specific examples about some brands that have been launched at particular customers.

Just conceptually, we want to really, as we've said, be very customer centric and recognize that the customers are very interested in what's going to sell with their shoppers.

And when they get behind that, that's the most powerful mechanism, more than any kind of marketing that we could do on our own is when they give us that kind of support.

So there are times, and, again exception rather than rule, where we might lay out an opportunity for a major customer.

Only when there's a big enough size of prize that in a particular category, where we might not play in that very specific segment, that we might be willing to go on the private brand side or let them go on the branded side.

But again, exception, not the rule.

But, Tom, want to talk about a few specifics?

Sure, there's three things that come to mind.

If you look at the channels that are growing the fastest, whether it is the club channel, dollar channel, you have to be able to customize your offering to have the right price, product package, to fit that format.

One example of that would be on PAM cooking spray.

For us to compete more effectively in the club channel, we are moving forward with an extra virgin olive oil product that is right in the bullseye of those club customers.

We are also -- look at how we can take a brand like Wolf Chili where we've actually made a steakhouse-style variety that's customized to the consumers within a particular class of trade.

And then we've talked about, and we showcased at CAGNY, the Bertolli Italian Torta.

That's a product that we have an ability to customize our varieties across classes of trade to fit that offering to that particular class of trade.

And we have a question now from Bank of America's Greg Hessler.

Hi, thanks for taking the question.

Sure, good morning, Greg.

I wanted to just go back to free cash flow, just looking through the guidance for the full year at $1.4 billion and what you guys are expecting in terms of CapEx.

I'm getting to, call it, $350 million or so of free cash flow in the fourth quarter.

So I'm just wondering how you bridge the gap on the debt reduction, getting to that $950 million number for the full year?

Yes, Greg, this is John.

I would say this year, I think as I've commented on several occasions, we will expect to use some of our offshore cash this year as well as some proceeds we've generated from sales of non-core assets.

Those will be sources of cash this year that we will utilize to achieve our goal.

So that's probably the major part of the bridge.

And we will take follow-up question now from Akshay Jagdale.

Thanks for taking the follow-up.

My question is on repositioning your product portfolio even more, and why not just take a few of your larger consumer brands and monetize those and get back a little bit faster on the M&A bandwagon on the private label side?

It seems to me that the market is valuing your stock like your consumer business is always going to be structurally challenged and has very little brand equity.

And you can't really own the stock for private label growth and not because of the issue you are having on your base business, but because your hands are tied on the M&A.

Is that something you might consider is to prune your consumer portfolio a little bit more, pay down debt faster, and sort of start with the M&A a little bit faster than you have applied it to on Private Brands?

Thank you.

Yes, Akshay, we are not going to speculate on things we might buy or sell at any point in time.

What I would tell you is I think we consistently and continually look at our portfolio.

And as you've seen us, if you have followed us for while, you know that we do make moves with our portfolio from time to time.

We continually evaluate it, but at this point we are pretty pleased with what we have, but, again, we will continue to refine it and improve it as we can.

Thanks.

And we will take another follow-up from David Palmer.

Hi.

A question for Paul.

It looks like the Asia food service, China food service trends were already growing double digits in that quarter.

Are you seeing a nice acceleration in that business even through the quarter as perhaps some of those leading chains over there are healing after the issues they had last year?

Thanks, David.

Our Lamb Weston international business is growing above double-digit and so we are pleased with that.

That's helping.

And I just would say the overall outlook in those regions feels like it is headed in a more improving and more positive outlook and have worked through a lot of those challenges that they had faced.

Great.

Thank you.

Thanks, David.

And we have a follow-up now from Bryan Spillane.

Hi, thanks.

John, just following up on the cash flow question again.

Can you just highlight for us cash restructuring costs, what you are expecting for 2014?

What you are expecting for 2015?

And then also, I guess, maybe what 2014 is today versus what you were thinking before?

Again, just cash restructuring costs.

I do not have that at my fingertips.

I'd have to go back and look, I think the proxy for that is probably go back and look at the comparability items over the year and you would probably get pretty close.

As it relates to next year, clearly, we would expect those costs as it relates to the integration of Ralcorp to continue to decline.

And I have talked previously about our efficiency and effectiveness restructuring over the next couple of years not being more than $80 million, over the next couple years.

So part of the increase in operating cash flow 2014 to 2015 should be that we would see less or a lower level of cash restructuring costs?

Yes, I think that's generally the trend we would expect.

And, again, just to be clear, fiscal 2013 incentives, we had a strong year in fiscal 2013.

Those incentives were high, those were paid out in fiscal 2014.

Fiscal 2014 incentives are lower, those get paid out in fiscal 2015, so you can probably estimate some math there that creates some tailwind beginning the year.

Okay, great.

Thank you.

Thank you.

This concludes our question-and-answer session.

Mr. Klinefelter, I will hand the conference back to you for final remarks or closing comments.

Thank you.

Just as a reminder, this conference is being recorded and will be archived on the Web as detailed in our news release.

And as always, we are available for discussions.

Thank you very much for your interest in ConAgra Foods.

This concludes today's ConAgra Foods third-quarter earnings conference call.

Thank you, again, for attending and have a good day.