康尼格拉食品 (CAG) 2013 Q2 法說會逐字稿

Good morning. And welcome to today's ConAgra Foods second-quarter earnings conference call. This program is being recorded. My name is Jessica Morgan and I will be your conference facilitator. All audience lines are currently in a listen-only mode, however speakers will address your questions at the end of the presentation during the formal question and answer session. 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, welcome to our second-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. This morning, we will talk about our strong second-quarter performance, offer a few comments on the strategic rationale of the pending Ralcorp acquisition, and then we will open up the call for your questions. At that point, Andre Hawaux, President of Consumer Foods, and Paul Maass, President of Commercial Foods will join us. Before we get started, Chris has a few remarks.

Good morning. During today's remarks we will make some forward-looking statements. And while we're 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. If you would like to learn more about the risks and factors that could influence and affect our business, I will 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 document, or on our website under the financial reports and filings link and then choosing non-GAAP reconciliations.

In regard to Ralcorp, I will remind that you we are still some time away from closing and finishing our plans for our integration timetable. So many of the financial details will need to be shared at a later date. That will be after we close, after we close the transaction, of course, complete our planning work. We won't have any new details on those matters today and we do look forward to updating you on those in the future. Now I will turn it back over to Gary.

Thanks, Chris. I am very pleased with our second quarter to where we posted good growth for both operating segments. EPS on a comparable basis was $0.57 for the second quarter, up 16%. The overall quality of the quarter was high, with strong profits, even as we increased marketing investments for the base business, by 18%, as part of long-term brand building. We're raising our fiscal 2013 expectations to comparable EPS of at least $2.06, which includes a strong increase in marketing for the full fiscal year. That estimate does not include any fiscal 2013 benefit from the pending Ralcorp acquisition. That benefit will be determined after the transaction closes.

In terms of our operations, let me start with the Consumer Foods segment, where sales were up 11%, driven by acquisitions. Organic volumes were down 4%, and price/mix was favorable by 4%. On an unrounded basis, organic volume improved sequentially from Q1 by about 60 basis points. We expect that overall organic volumes to be down, given consumer purchasing trends in the still-challenging economy and importantly the pricing we took in recent quarters to combat inflation is also a factor. In addition, we have been very disciplined with our pricing architecture and in some cases we've deliberately chosen to improve profit margin instead of growing volume.

Acquisitions drove the overall sales growth but several of our brands also posted good organic results. We expect volume trends to continue to improve sequentially throughout the remainder of the fiscal year, as we more fully lap last year's price increases, and as the benefit of the recent innovation, marketing, and customer connect initiatives continue to accelerate.

Frozen as you know is a big and important retail category. We continue to innovate here, building on our strength in frozen single-serve meals and increasing our presence in strategic adjacencies such as multi-serve meals and desserts. We're also investing in more marketing in frozen to help bring more growth to the category. In regard to the quarter, once again, the Marie Callender's brand performed well overall. Single-serve and multi-serve frozen meals showed very good growth in dollars, volume, and share. The Marie Callender's baked platform that allows the consumer to get oven-baked quality in much shorter time in the microwave is doing well. And we've taken that innovation to the Healthy Choice brand and the baked entrees are doing well there, too. We have a strong adjacency story in Marie Callender's dessert pies. They're off to a good start in the holiday season in terms of both volume and share. And our Healthy Choice Greek frozen yogurt, whether you look at that as a dessert or snack, has performed well since we launched that a few months ago.

In other parts of the store, Reddi-wip and Pam, both leaders in the marketplace posted very strong growth in share, dollar, and unit sales. Pam's innovative new no-residue recipe focuses on its strong competitive difference. We're communicating about that now on air and it is clearly driving sales. We also were pleased to see gains in other core businesses, driven by marketing investment, such as our Hunt's campaign that is on air now, communicating the key Hunt's point of difference, flash steaming. We're looking forward to more break through innovation in the new calendar year.

In January, shoppers will begin seeing a new product line from Orville Redenbacher's that is unique. This innovation is called Pop Crunch and it is truly different. This is a ready-to-eat popcorn with a very significant crunch. It has half the fat of a regular chip, and allows us to compete in a bigger way in salty snacks. We introduced this product at the National Association of Convenience Stores trade show this fall as part of 18 new branded items. We also launched 10 store brand products such as those from our pretzel business, as well as products like energy bars. There was a lot of excitement from the C-store owners, which as you know, is a growing and important channel, especially when it comes to snacks.

We're very pleased with the profit trends in our Consumer Foods segment. Comparable operating profit grew 8% and that is with the 18% base business marketing increase that I mentioned earlier. Our margin management played a big role in our profit growth and that's evident in our strong organic price mix, as well as good productivity efficiencies. We're also incurring more manageable inflation and the benefit of some good hedge positions. Overall, those elements mean higher margin dollars relative to the year-ago period. Acquisitions meaningfully contributed to the profit growth. We've done six transactions over the last 12 months or so, all good businesses that strengthen our foundation. And I'm happy to report the integration of those acquisitions is going well.

Moving on to Commercial Foods, the segment performed well in the fiscal second quarter, up in both sales and profit. Our Lamb Weston potato operations performed well with notable success in international markets, and ongoing strong operating efficiencies. Lamb Weston posted favorable price mix and good volume. Demand for our potato products is strong, requiring us to add capacity. We announced last month a $200 million expansion to our Boardman, Oregon potato processing plant which will increase our capacity for making french fries and other frozen potato products.

Within ConAgra Mills as a reminder last year's second-quarter milling profits were very strong, making for an extremely tough comp. So as expected, we experienced a slight year-over-year decline in that business this quarter. We're pleased with the productivity, cost savings, and mix of products sold in our Commercial segment overall, and we continue to focus on products and innovation that drive both the top and bottom line. As we mentioned last quarter, although retail demand for food prepared at home continues to be a bit soft, away from home eating occasions, particularly in QSRs have held up well, and we have benefited from that in our Commercial Food segment. We've had success in bringing innovation into the commercial and food service space, which has helped our mix across this business segment. And that focus on innovation and efficiencies is representative of our commitment to helping our customers grow.

Before I move on to offer a few comments about Ralcorp and our excitement about the benefits of that pending transaction, I will repeat that we are pleased, very pleased, with the organic performance of our core operations in both segments. You've heard me talk before about how critical it was for us to get our foundation right, and we have made an incredible amount of progress on that. I would like to say thank you in this holiday season to my team who has worked so hard to get us here. From the very substantial cost savings generated by our supply chain over the last several years, to our industry-leading platform innovation approach, to our strengthened customer partnerships and our more disciplined pricing architecture, we're seeing the benefits of our improved operating capabilities across our business. It is that type of progress with the foundation of our Company that gives us confidence to significantly add to our portfolio. It is great to be in a position to leverage our capabilities for accelerated growth. And that's exactly what we have begun with the six recently completed transactions, and of course, it is our plan with Ralcorp.

Our recipe for growth has us focused on three main areas. One, core adjacencies. Two, international. And three, private label. All of the six completed transactions we've announced over the past 12 months or so have been aligned with this direction. We have exercised strong financial discipline and we're well positioned for growth. The Ralcorp transaction will clearly be a game changer in terms of our private label footprint, and it supports our goal to be the fastest growing and true industry leader in the private label space. We're very excited about this for three main reasons. First, the growth prospects for private label in general. Second, the strong private label business and market segment leadership that Ralcorp has. And third, the CPG capabilities that we can bring to this business. Along with the talented Ralcorp team, we plan to utilize our CPG capabilities to accelerate top line growth, realize synergies, and strengthen strong customer relationships. Our innovation, supply chain, category management insights, and other customer- and consumer-centric capabilities will help us to drive strong top and bottom line results from this business over time.

In our view, the private label opportunity for the future is one that retains the customer responsiveness and agility while adding strong CPG capabilities to partner with growing customers. And it is a different business from the one that many people historically associated with private label, meaning one where it was only about low price, low margin, product emulation, and generic packaging. The business has evolved a lot from there based on customer and consumer expectations, with Ralcorp playing a key leadership role. Therefore, our focus will be on value-added opportunities with strategically important customers, making a business model for private label that we expect will consistently post strong top line and bottom line growth over time.

We're confident that we can manage this business well alongside our branded operations. We have been doing a version of this for many years and understand where the two types of businesses need to be separate for marketplace reasons and where they can be combined for efficiencies. We will be working with the Ralcorp team to figure out the optimal structure. We're not in a position today to discuss specifics on organizational design, but the point I want to make is that we respect the differences in the two types of business, and we will absolutely find the right balance. I will also reinforce that we expect this deal to be accretive in the short term and long term, and we will say more about financial details when we're further along in the process.

In closing, we believe it is a great time to be a part of the ConAgra Foods team with all of the excitement developments under way and ongoing confidence in sustainable profitable growth. At this point, I will wish you all happy holidays, and turn it over to John.

Thank you, Gary. And good morning, everyone. I'm going to touch on four topics this morning. Our second-quarter performance highlights, comparability matters, cash flow, capital, and balance sheet items, and finally some comments on our outlook for the balance of fiscal 2013.

Before I start, I will remind that you that my comments today will focus predominantly on the results of and our expectations for our base business, exclusive of the impacts from our recently announced and pending acquisition of Ralcorp. As we have noted a couple of times, and during our conference call last week, or a few weeks ago, we do expect to provide a more complete update on the impact of the Ralcorp acquisition on our 2013 and 2014 fiscal years in due course after the transaction has closed. At that point, we will be in a position to provide more details on matters such as the near-term performance expectations for the Ralcorp business, the financing structure, the purchase price allocation, synergy timing, as well as other matters.

Now, let me address our business, starting with the fiscal second-quarter performance highlights. Overall, the second-quarter results reflect a continuation of the good business trends that we saw in the first quarter. For the quarter, we reported net sales of $3.7 billion, up 9%, driven by pricing and acquisitions in our Consumer Foods segment. And in our Commercial Food segment, we had modest volume gains in Lamb Weston, as well as improved mix and pricing across the segment. Net sales also reflect the impact of higher year-over-year wheat prices in our flour milling operations. In this quarter, we reported fully diluted earnings per share from continuing operations of $0.51 versus $0.43 in the year-ago period. Adjusting for items impacting comparability, fully diluted earnings per share from continuing operations were $0.57 versus $0.49 in the prior-year quarter, a 16% increase.

While Gary has addressed our segment results, I would also like to touch on a few highlights, starting with our Consumer Foods segment, where net sales were approximately $2.4 billion, up about 11% from the year-ago period. This reflects about 11 points of growth from acquisitions. Organic net sales were essentially flat, as favorable price mix of about 4% was offset by a base volume decline of about 4%. Our Consumer Foods segment operating profit adjusted for items impacting comparability was $293 million, or up about 8% from the year-ago period. The operating profit improvement reflects the benefit from acquisitions, our margin management initiatives, moderating product cost inflation, as well as a significant and planned increase in marketing costs. The impact from foreign exchange this quarter on both net sales and operating profit for the segment was immaterial.

Our Consumer Foods supply chain cost reduction programs continue to yield good results and delivered cost savings of approximately $80 million in the quarter. For the fiscal second quarter, we experienced inflation of about 2%, a bit better than our expectations. On marketing, Consumer Foods advertising and promotion expense for the quarter, was $133 million, up about 31% from the prior-year quarter, and principally driven by an 18% increase in marketing investments in our base business.

In our Commercial Food segment, net sales were approximately $1.3 billion, or up about 5%, reflecting modest volume growth at Lamb Weston, due in part to strong international growth. Higher net sales also reflect improved pricing and mix across the segment, including disciplined pricing to offset higher input costs. The pass-through of higher wheat costs in the milling operations had a positive $11 million impact on sales for this fiscal quarter. The Commercial Food segment's operating profit increased 5% from the year ago period, to $169 million. The strong year-over-year performance reflects continued good fundamentals in all of our Commercial business units. I would also note that the prior-year quarter was one of our strongest ever so we are very pleased with this year's second-quarter results.

Corporate expenses adjusted for items impacting comparability were $63 million for the quarter, versus $75 million in the year-ago quarter. The year-over-year decrease reflects lower benefit costs, and the favorable impact from the timing of certain costs within the year. And all of that offset by some higher incentive costs. The reported tax rate and the rate on comparable earnings for this fiscal quarter was approximately 34%.

Now, I will move on to my second topic, items impacting comparability. Overall, we have approximately $0.06 per diluted share of net expense in this quarter's reported EPS, related to several items. First, on hedging. For the fiscal second quarter, the net hedging loss included in corporate expense was approximately $16 million, or $0.02 per share. In addition, we recorded approximately $15 million, or $0.03 per share, of acquisition-related expenses. Also, we had some small amounts of restructuring in related costs and rounding that accounted for the other $0.01 of comparability items.

Now, I will cover my third topic, cash flow, capital, and balance sheet items. First, we ended the quarter with $477 million of cash on hand and no outstanding commercial paper borrowings. We continue to emphasize cash flow within our business and for fiscal year 2013, we expect to deliver strong operating cash flows in the range of $1.2 billion to $1.3 billion, exclusive of the impacts of the recently announced impending Ralcorp acquisition. On working capital, we continue to make progress against our working capital initiatives. For the full fiscal year, we expect that working capital improvements in our base business will contribute modestly to cash flow from continuing operations, as we maintain our focus on cash conversion cycle metrics. On capital expenditures, for the quarter, we had capital expenditures of $82 million, versus $65 million in the prior-year period. And for the full fiscal year, we now expect CapEx to be in the range of $500 million, including fiscal 2013 requirements for our recently announced expansion at our Lamb Weston facility in Boardman, Oregon. Net interest expense was $53 million in the fiscal second quarter, versus $51 million in the year-ago quarter. Dividends for the quarter increased from $95 million in the year-ago quarter to $97 million, reflecting a higher dividend rate, offset by a lower number of shares.

Now, let's turn to capital allocation. In light of the pending Ralcorp acquisition, I think it is safe to say that we have prioritized growth. The transaction is very significant and will affect our capital allocation over the next 18 to 24 months. Specifically, as we have previously noted, we intend to maintain our dividend at $1 per share and significantly reduce our share repurchase activity until we deleverage and return to more normalized debt metrics. And on share repurchases, I would note that we purchased about $170 million of our shares in the fiscal second quarter, and as of quarter end, we had approximately $280 million of available share repurchase authorization. And while we plan to constrain our acquisition activity in the near term as we repay debt, we will continue to prudently support the right investments for our business, including investments to support innovation, production capacity, and our cost savings initiatives. The other elements of our balanced capital allocation approach remain unchanged. We are confident in our ability to maintain our investment-grade credit rating, and while we plan to limit dividend increases over the next couple of years, we are committed to our strong dividend over the long term.

Now, I would like to share some comments on our fiscal 2013 outlook. As Gary mentioned, we currently expect fully diluted earnings per share, adjusted for items impacting comparability and excluding any impact from the Ralcorp transaction, to be at least $2.06 per share. Our fiscal 2013 earnings estimate also reflects net sales in the range -- net sales growth in the range of 7% to 8% with sales growth for the Consumer segment expected to be in the high-single digits, primarily driven by our recent acquisition. And in our Commercial Foods segment, we expect modest top-line growth in the 3% range. And for the full fiscal year, we now expect net inflation to be around 2% to 3%. And we expect cost savings to exceed $250 million in our Consumer Foods business. Additionally, the effective tax rate for fiscal 2013 is expected to be in the range of 34% for the full year. Although this rate may fluctuate somewhat from quarter to quarter. Overall, we're excited about our performance in the first half of the fiscal year. And as we look at the second half, we expect both operating segments to continue to execute well on the fundamentals. We also expect a strong year-over-year increase in our marketing investments in support of our brands and innovation. The second half EPS outlook also reflects a modest amount of unplanned dilution, resulting from the reduction in share repurchase activity.

Overall, we are confident in our ability to deliver very attractive earnings growth for fiscal 2013. That concludes our formal remarks. I want to wish everyone a happy holiday season, and thank you for your interest in ConAgra Foods. Gary and I, along with Andre Hawaux and Paul Maass, will be happy to take your questions. I will now turn it back over to the operator to begin the Q&A portion of our session. Operator?

(Operator Instructions)

Andrew Lazar, Barclays Capital.

I guess my question is about trying to get a better sense of some of the key drivers of gross margin in the quarter. You mentioned that a number of things came in perhaps a bit more favorably in the quarter, inflation up about 2%, strong productivity, which was up sequentially from the first quarter, and you still had 4% pricing as well. I'm just trying to get a sense of perhaps why gross margin at least on a year over year basis wasn't stronger in the quarter. And if there are some things in there that are harder for us to see that might have impacted it in the quarter.

Yes, Andrew, this is John. I think you certainly named a number of the drivers in terms of what is working well in the margin line. Clearly, inflation was down a little bit from where we expect and productivity and pricing are all well. I think we have seen some gross margin improvement. I'm not sure where the expectation would have been. But certainly, I would say we might have had a little bit of unfavorable mix even though our pricing mix overall was very positive. So I would say that's probably the one decliner of the bunch.

In other words, John is saying that the price/mix of 4% leans more towards price and a little less towards mix.

Got it. Okay. That's helpful. And then I certainly understand the strategy you're employing around protecting profitability sort of above all else right now, and the strong commitment to sort of the pricing discipline and the stock certainly shows that. And as you expected, volume was going to be down for part of the year and it's coming in sort of as you would have thought.

I'm just trying to get a sense of at what point, I guess how closely can you monitor the threshold for which volume goes past the point at which you're comfortable in terms of feeding some share in certain businesses for a period of time to protect profitability? How closely can you monitor that? And at what point do you get a sense that the impact is too great let's say on plant absorption or things like that?

Andrew, as you know, our portfolio is extremely broad, so it is a bit different by each segment. But I can tell you that we clearly have our finger on that, from a threshold standpoint, as we take a look at market share in particular. I would tell you that we're where we expected to be at this point in the year, and that in the second half, you're going to see us show more top line improvement.

And that's really primarily timing. We were probably a little bit later than some of our competitors in terms of where we took the bulk of our pricing. So at this point in the year now, we're about 70%. We've overlapped about 70% of the pricing that we took from last year. That's why, as we go through the rest of the year, you will start to see more improvement. Obviously, we've made some good investments in marketing innovation, et cetera. So I think maybe, and I'm going to turn it to Andre here in a minute, Andre's team is not chasing the volume. They're being very careful about this balance. And that truly is reflected in the margin improvement. So let me ask Andre for a little bit more color on that.

Yes, thank you, Gary. I would say Andrew, we've talked about the discipline and the resources we've put against revenue growth management, so from your first question's perspective, was around what are the thresholds. I mean we look at our plant absorption. We look at market shares very critically and make sure that we've got the right balance. And it is not only -- what you saw in this quarter, was not only a good operating profit flow-through as we talked about but really this investment back in our brands. We have been very deliberate at talking to folks about this was an organization that historically relied a whole lot more on trade than it did on classic pull.

We're trying to change that balance a little bit and really invest in our brands and you saw it in this quarter relative to the amount of investment me made against the marketing which we believe is critical as we build these brands. I think we've got the balance right. We've had a lot more metrics than we've ever had. And the team works really hard against that.

We are poised to course correct when we need to. But right now we're staying really disciplined. And you saw that in the net realizable price flow through that you saw in the margin flow through and that allowed us to invest back in our brand.

David Driscoll, Citi Research.

And congratulations on the quarterly results. Wanted to ask a little bit about, John, the guidance in terms of first half, second half. First half shows, I think it is about 25% earnings growth year over year. And then the second half would show, I think fairly limited growth, or maybe even just about a $0.01, I think, in the second half.

And maybe, could you guys pull together some of these comments about why the pressures would build so much? Because perhaps it is just you guys are being conservative, and nothing wrong with that, but we're trying to get a sense here of if we have moderating inflation and the expectation that volumes are going to grow, third quarter and the year-ago margins just got hammered and so it feels like, I hate to use the word easy comp but I will. So can you help me understand the back half of the year and why such limited EPS growth expectations?

So let me start with a couple of things David. As we look at H1 versus -- or first half versus second half, the first thing I would tell you is that we still expect both business segments, both of the operating segments to perform well and have good fundamentals and show good results at the operating profit line. One thing I just -- I would remind everybody of is that if you look at the first half, we have had some softer laps in the first half, and in particular, I think we are very clear that our first quarter a year ago was very soft. We had a number of things, especially in the Commercial business, that we lapped in a very strong way this year. So on average, the laps, and in the absolutes, the laps are stronger in the second half.

The other thing I would note is that to kind of piggyback on to Andre's comment about really focusing on investing behind our brands, we are maintaining a fair amount of flexibility for what I would term to be some fairly significant increases and maybe I should say ongoing increases in our investment behind our brand. So we're certainly I think maintaining a fair amount of flexibility there.

And then the other thing, just mechanical, I would note, is that we do end up with some negative impact at the EPS line, because we're going to terminate, or essentially terminate and restrict our share repurchase activity. So we would have planned for some accretion there, which won't happen. But I guess the other comment I would make is that we feel very confident about the $2.06 and part of our change in raising our guidance was to be clear that we don't see this as coming in below there.

If I could add one question on the Commercial Foods, Gary, I really appreciated your comments back at CAGNY on Lamb Weston and was hoping perhaps if you could spend a moment talking about the export opportunity for Lamb Weston and if at all possible, could you remind us or tell us about kind of the dollar size of that opportunity over time.

David, that is a really exciting significant growth vector for the Company. Big opportunity that we have really shined the light on. And let me ask Paul to give you just a little bit more color on that.

Sure. And the one I would just highlight, we mentioned the Boardman, Oregon, plant expansion, and that's an important strategic investment for our Lamb Weston business and is very much aligned with our growth in emerging markets and what we see there. And we have a lot of momentum there. We feel really good about what we are executing. And we're making the right kind of investments to continue that growth going forward.

I don't know, I think you had a question around the specific size. We probably won't get into that. But I just, I would say double-digit growth is what we're experiencing and we are doing the right things to make sure that we maintain that.

Bryan Spillane Bank of America Merrill Lynch.

My question is about just the contribution from acquisitions. Can you talk to -- can you give us a little bit more color in terms of not so much how much they've contributed to the growth, to the base, but how the acquisitions themselves are performing on their own? So as you have integrated them, are they -- have the sales growth for the acquired properties accelerated? What type of growth rate are you seeing in those businesses? And then also, if you could give us some idea of what the earnings accretion was in the quarter.

Yes, Bryan, I will just tell that you we're very pleased with the integration. So we're definitely right on expectation for each one of those acquisitions. And we expect over time that they are going to be top line and bottom line accretive, because that has been the discipline in terms of our acquisition strategy. So I think over time, you will see each one of those live up to that. And the contribution to our Consumer Foods business is important, but before I give it over to John, I would also just want to reiterate that the core Consumer Foods business grew operating profits, too, while still maintaining a significant increase in marketing, which obviously is a long-term benefit. So the core business is strong, but significant contribution from the acquisitions. And these acquisitions are all consistent with our strategy, particularly in the area of core adjacencies.

Gary, I think you covered a lot of it. I would probably emphasize a couple of points. Year to date, our base Consumer business at the operating profit level has contributed an awful lot of the growth. Acquisitions are making a good contribution in line with our expectations. So I think the things are on track.

And we're very, very pleased with how the contributions are coming in. And again, I would reiterate Gary's point that while the base has contributed less than 50%, at the Consumer line at this point, we also do want to remind people of the significant increase in A&P that we've got in the base business numbers.

But you feel pretty good about the -- your ability to execute the integration. I guess that is the point I'm trying to get at is you've made some acquisitions and now you're proving to yourselves that you can integrate them well and add to them as you brought them into your portfolio.

Brian, as we've talked a bit about before, we've got an extremely disciplined process that is not only on the front end but on the back end from an integration standpoint, so we keep the spotlight on these acquisitions for quite some time before we basically turn them into our base business model. We clearly have a number of metrics that we review regularly, and I would tell you that the answer is yes. Every one of the acquisitions we feel very good about at this point. And continue to believe that long term, that they will be, as I said, top and bottom line accretive.

Ken Goldman, JPMorgan.

Just to build a little bit on Andrew's question, hoping to dive a bit deeper into the increased Consumer marketing spending, there seems to be a bit of a divergence among strategies among food producers right now. On one hand I guess you have companies like you and Heinz among others and they're really redoubling their efforts to raise advertising and build that Consumer pull. And I guess on the other hand you have other companies like Mills, Campbell's Soup that are temporarily and tactically doing the opposite, and shifting some marketing spending away from advertising and toward promotions. And if you look at comments by grocers like Kroger, promo spending is the way most companies are going right now. I'm a little long winded here but I'm just curious if you're seeing a lot of your direct competitors in your categories promoting heavily, and if so are there maybe some tactical moves you can make to combat that until we're in more of a normal promo environment?

Ken, this is Andre. Let me take some of that and if Gary has something to add to it. I think again, I would say that we are spending appropriately behind our business, on the brands that make sense and have a meaningful point of difference in terms of the marketing mix. So I will get -- we've given Marie Callender's examples time and again and that brand is performing very well against that. But we've also talked about Pam Cooking Spray and the whole non-residue formula being a point of difference to consumers and really communicating that message and that brand has responded very, very well. The same with Reddi-wip which is a combination of both the messaging there as well as the ability to merchandise that with host foods such as our pies but also in the summer and the springtime with berries and fruit and things like that. And Hunt's Diced Tomatoes where we're really putting an effort on our point of difference there which is really flash steaming. We believe we need to do that to make a meaningful difference and to show consumers that there are meaningful differences in our brands.

But that doesn't mean that all of our brands get marketing. We have brands that play a different role. So there are brands in our portfolio that don't get a lot of the marketing mix that really rely more on in store merchandising and promotion. So we actually balance I think that equation very well. I would tell you though Ken at the outset of the year, we said that this organization has to make sure that it puts some of its money back into the pull, and historically it has not. I see competitors depending on the category, it is very different, you cited a few, that are down-playing marketing and putting a little bit more in trade. Again, that is their strategy. And in some cases, it is right for their brand and right for that segment. For us, we believe that we have a lot of the things working well, and that's why we're very pleased with the results you saw in the first half of our year and right now in Q2.

Ken, I would tell you, you're asking exactly the right question, it is the kinds of debate that we have at the Management team, on an ongoing basis, and it is all about the right balance. Whether it is between the different brands, or it is between the trade spend, merchandising, and marketing. It is really something that we have to continually rebalance over time. And as we watch what happens in the marketplace, obviously we will try and stay as disciplined to our strategy as we can be. But we're pragmatic and realistic at the same time. So this will continue to evolve but right now as Andre says, we're pleased with where we are and we will continue down this path.

We had our holiday party last night and I'm amazed I had a coherent question at all. (laughter) One other question, guys. You may have touched on this, and I missed it, but given the Ralcorp deal, are there other tack-on additions that -- is that off the table for the next 12 months, other deals, or if a great opportunity comes to you, and it is small, do you still have the desire and capability to take that on?

I will take a shot at this, Ken. This is John. First of all, we won't say absolutely no to anything. I think it is important to recognize that probably even more so than the financial constraints we're putting on, again, and we've got -- we feel very comfortable with where our debt rating is going to be and investment grade, and we think we will have some room in there, but probably more important than that is just making sure that anything that comes to light in the next 12 months is so compelling that we see -- and we have confidence that we can take it on from an additional integration standpoint.

We have made a big bet on the Ralcorp acquisition. And I think our Management team and our Board are very aligned around making sure that we execute the integration as flawlessly as possible. So again, that is not an absolute no. We still probably have our line in the water for things. But we're going to be pretty disciplined and focused on the task at hand.

Jonathan Feeney, Janney.

I wanted to ask specifically about the trajectory of costs and the effect it is having on your business. You mentioned 2% cost inflation. It seems like we got a spike in June, July, and moderating sequentially. I noticed particularly the Commercial Foods business is not back, is not back anywhere close to the kind of margins you were doing in fiscal '10 or '11.

So I guess just looking forward, should we expect a moderate cost environment to just in and of itself drive margin expansion because of the stickiness of pricing in that business? Or I guess the lack of pressure from costs in that business? And it may be premature to comment, but I know that aspect really well describes Ralcorp also. Do you have any thoughts about what that means to numbers in not only the rest of this year but going forward from that? Just that relief that could come? Thanks.

Let me -- this is John. Let me take a shot at that. I think most of your question was revolving around the Commercial business. And I don't have all of the margin stats in front of me. But one of the things we get mathematically in terms of margin compression is just driven by the milling business. Because as wheat prices go up, we tend to manage margin dollars in that segment versus margin percentages because it is a large pass-through. So that over the years can certainly have some impact on margin percentages. Because I think overall, during the last few years, we've been pretty comfortable with the margin dollars we've generated in that business.

As it relates to the inflation environment, I do think in some of those Commercial businesses, it can kind of really be a mixed bag. Again in the milling business you've got something that really is much more of a pass-through business. But certainly as the competition for acres has heated up over the last couple of years, some crop prices and some key input costs I think that we face in the Commercial segment have faced a lot of pressure. And I think that has been one of the challenges that Paul and his team have successfully navigated through. But Paul, I maybe turn it to you to see if you have anything to add to that.

I think just in operating the business, we will price accordingly to pass through inflation, or deflation. And really focus on driving business improvement through operational efficiencies and mix. As well as really leaning hard into the international growth opportunities.

Thanks. And if I could just ask one follow-up, please. When you looked at the Ralcorp acquisition, and you think about those numbers, did you -- do you consider the base of profitability this year at Ralcorp to have been depressed by the trajectory of costs this year? And therefore, potentially seeing some relief if cost trajectory is flat or even down in future periods? Thanks.

Yes, we really can't talk a whole lot about Ralcorp right now, but what we can tell you from the public disclosure information is that there were clearly some discrete events this year that won't be repeated next year. So the numbers are really kind of apples and oranges as we look forward.

David Palmer, UBS.

You commented that volume trends should improve into the second half. I would imagine Banquet is going to be a large part of that on the Consumer Foods division, maybe even the majority of your expected improvement. But perhaps you can comment on areas and reasons for potential volume improvement into the second half. Thanks.

David, this is Andre. So you're absolutely spot on. That has been the number-one volume drive for us in the beginning of the year. And that's largely because we took over 10% pricing on that brand. So absolutely as we come out of Q3 and Q4, and as it laps that pricing, it significantly gets better. So again for us, a lot of it, we said this up front, as Gary articulated, 70% of our pricing has been lapped in Q1 and Q2. Q3 and Q4 obviously have the remainder of that. But it is much more moderate.

You will see the advertising that we've talked about that we're putting against the business, that doesn't kick in day one. Obviously, you don't get an immediate bump for the work that you're doing there. You get -- it improves over time. So we see the advertising that we've been putting on, help us also sequentially get better. So we do have our forecast and plans for the back half of the year, and see our volumes sequentially getting better from where they are today, based on those things, lapping the price and marketing.

And the innovation that we've launched, also starts to benefit from obviously getting full distribution and we have new innovation, Gary articulated Pop Crunch that is going out in January and we have a couple of other C-store items that we are launching as well that we feel pretty good about. So you will see new innovation and then the benefit of all of what we launched in the early part of our year getting to, 80, 90 ACD distribution and then you will see the benefit of that as well.

And then from the high teens marketing investment, where are you expecting to see or are you already seeing the best response from that investment?

I mentioned some of those brands already. I mean we continue to just -- I can't say enough about what the marketing team and the brand team on Marie Callender's has done not only in the core business but what they've done in the dessert space as well. We really started the holidays off very, very strong there. I see it in areas like Pam, I see it in Reddi-wip, I see it in Hunt's. Our Chef -- canned pasta business has done very well from a market share standpoint both in units and in dollars, so I see the marketing campaign on that brand working. So we see a lot of those things working. It is going to be different by brand. But overall I feel very confident that that is working in the marketplace.

Akshay Jagdale, KeyBanc.

The first question is actually on the Lamb Weston business, and I know it has been doing really well, and congratulations on that first. But we've heard some negative commentary from Yum recently on China. Can you just put that into context in terms of your opportunity? I mean does that impact your sort of near-term trajectory on that business? And how exposed are you indirectly to China?

I won't get into specific comments on customers by name. Overall, what we see in emerging markets continues to be very positive, very favorable trends, and we look for that to continue. And we're positioned well and continue to penetrate those markets and really support our customers' growth. And I think quarter over quarter, you may have some ebbs and flow, but over the long haul, we feel very good about it and very optimistic and think the growth trajectory is very good.

And just maybe one other comment, just on our ability to execute, we're very focused on efficiencies. And we've got an ability with our manufacturing footprint in the Pacific Northwest to reach those markets in a cost competitive way, and we like that position very well.

I would just add to Paul's comments that the numbers continue to be very, very good. Double-digit growth in the emerging markets. So we saw that same news on Yum, but there is a big emerging market out there, and we continue to have a lot of confidence in that segment.

Thilo Wrede, Jefferies.

The number of brands in your Consumer business that are growing has been declining steadily for a year now. Would a turn-around there come from just easier comps or improving consumer -- I mean why wouldn't I be worried about this?

Well, Thilo, it is Andre. I think the largest issue we have as I articulated earlier is the pricing comps we have year over year. So I think what you will see in the back half is you will see a steady improvement in that. If you looked at our Q1 to Q2 comparisons in both IRI or Nielsen, whichever service you subscribe to, you will see that of our top 15 categories you will see that we significantly moved both dollar share and unit share in 10 out of the 15 and it was significant improvement Q1 to Q2. We expect that same improvement to continue to flow out of the year as we lap the pricing.

Ann Gurkin, Davenport.

I wanted to ask you to start with, about your outlook for the next 6 to 12 months for food away from home or food service. What are you incorporating in your outlook there?

I would just comment that overall, the trends are better and improving. I would say October was kind of a little bit of an outlier. Kind of across the industry. We saw that. And with the decent rebound in November. And I think -- I don't have the specific number I would give to you but I think the trend that we've seen over the last 12 months is really kind of the outlook for us going forward.

Eric Katzman, Deutsche Bank.

Two questions. I guess Gary, you have a consumer product, branded consumer product background, you're the first I would say major packaged food company that is embracing private label. You mentioned that there is much more margin in that business, as it stands today, versus years past. So I was wondering if you could go a little bit more into that, why you think that is true, and how that I guess impacts both the Ralcorp business that you're going to acquire and maybe some of your existing brands, and private label potential. And then is there any way you could comment on the $350 million -- I think it is $350 million of equity that is proposed in the deal? Is there -- like I'm just kind of surprised that the rest of it wasn't borrowed or is there some kind of tax implication or something that you would use equity as a relatively small part of a major deal? Thank you.

Eric, this is John. Let me start on the equity piece of the transaction. It is a relatively small part. And again, just to reiterate for everybody, what we've said is we will issue up to $350 million of equity. It is a smart part, I think it is included, primarily to make sure that we have some cushion, sufficient cushion in our debt rating, and quite frankly, I think it is something that our bond holders and our rating agencies viewed as, even though it is not significant as a percentage of transaction, I think they viewed it as an important acknowledgment that we are going to continue to balance, or promote a strong balance sheet. So again, we will be able to tell you more about the exact amount as we get closer to close, but it really was just to give a nod to our commitment to a strong balance sheet.

Eric, I would tell you kind of the headline is we're not doing private label the same way as everybody in the industry is doing it, meaning a lot of -- there is a lot of players in this very fragmented industry, and I think the reason we feel so good about it on a go-forward basis is there is a number of reasons. One would be as you take a look at other developed economies, you see a significantly bigger percentage of the food business being done in private label. And then if you take a look at the customers that are doing the best, for the most part, in this country, they're the ones that are emphasizing and in some cases almost exclusively private label.

So there is clearly a consumer pull for what has become a much higher quality product. Very, very different than it was, that we remember, say back in the '70s, '80s when it was much more generic. Consumers continue, particularly in tough challenging times, to try store brands, and they are pleasantly surprised and they keep coming back and we expect that will continue, beyond the recession. We have very little overlap in the private label businesses that are coming from Ralcorp with our core -- or with our current base business, so we're not looking strategically for the most part to compete in the same basic segments from a private label and a branded standpoint.

And maybe the most important factor of all, when it comes to the better financial viability, is that it is going up market. There is a lot of tiering of the private label business, and some cases, some would call it good, better, best. In some cases, the stores, the customers are looking to make a statement with their own products that they have an awful lot of interest in, in growing their own brands, and making product that is very high quality, and that is what gives us a lot of confidence as we go forward, that it is not going to be just about the lowest priced $0.005 bid, and I think Ralcorp has already done a pretty good job in terms of being selective in the kinds of private label businesses and categories that they have gone after. There is a lot of value add opportunities because of this consumer customer pull.

So when you wrap that all together with the significant amount of synergies that we will bring along with the significant capabilities that we can add to an already strong biggest leading private label player, wrap that all together, that's what gives us a very, very high degree of confidence, again that this is going to be both top and bottom line accretive for us.

Rob Moskow, Credit Suisse.

Congrats on a great calendar year. I was just looking at the popcorn business in my Nielsen data. I'm seeing some big volume declines and a lot of pricing action. And I was just wondering, Andre, I noticed that the quarter, Orville is back up again, which is a good sign. What is your outlook for the Orville brand? And is there any way that you can extend that into more snacking occasions like hand-held snacking occasions? I see in my town here, popcorners, and all kinds of popcorn snacks that are in a bag and want to know if that is a possibility for Orville. Thanks.

Thanks, Rob. I think you're absolutely right. We saw the same numbers that you have just quoted. I think to understand the backdrop, we took two price increases on Orville last year, in period four and period seven, so we were lapping that. So we're finally getting through most of that, and as you look at the back half of the year, we've gotten through -- we will have gotten through most of it. So you will start to see that rebound.

What we're is seeing with consumers is a move from microwave, still big viable business, and to this notion of ready-to-eat bag snacks and we're actually capturing that trend as well. We've had really good performance with our first launch of our Orville ready-to-eat product in standard flavors, and then now Gary articulated we are launching Pop Crunch, as well is being launched in January, or being shipped as we speak to retailers.

You will see us doing more of that as we see consumers moving to that convenience and that ready to eat. We believe the Orville franchise is very strong and we have a lot of opportunities and Al Bolles and the innovation team are looking through what exactly can we do with that franchise, beyond the ready-to-eat offerings that we have today and other things in microwave. We think we also have some opportunity in microwave as well with various blends and other things that we can do with popcorn. So we feel really good about the franchise. Very strong franchise.

Chris Growe, Stifel Nicolaus.

I just had a quick question for you, which is as you're being a little more diligent around promotion, could you characterize your new product plans? It would seem to be like an important component of that plan. I guess do you have a lot more activity? Or maybe in your -- a lot better, higher quality activity. And then if you have just seen any improvement, or what stage you're in, in terms of marketing and frozen, you talked about that being an area where you are marketing more heavily. Have you seen any improvement in that category?

So Chris, let me start with the latter part of that question. We are, as you know, we are touching the frozen space now. Not only in meals, or single-serve meals which is historically has been where we've played, and we're doing really well there with Marie, doing reasonably well with Healthy Choice. That whole healthy segment though where we compete is one that is really a challenge.

But we're also going into these adjacencies so you've seen us recently with respect to Marie Callender's pies, both the full-sized pies but also introducing smaller single-serve dessert pies, if you will. Our launch of Healthy Choice Frozen Greek yogurt, which has had specific advertising for it has actually done very, very well, we're very pleased with that. And you will start us see us do more things as we get into more snacking occasions in frozen as well as breakfast. You will start to see us do more there. And obviously with the assets we've acquired in multi-serve, Bertolli and PF Chang's, we're excited about that brand because those equities are very, very strong with consumers and it brings a new consumer to the franchise, a consumer that typically makes $75,000 a year or more. So we're bringing other consumers into our franchise which has been heavily weighted towards value consumers in the past. We feel really good about the marketing we're doing there.

With respect to our promotions, our in-store activity, we do put a very significant emphasis on when we're launching new items. So some couponing, sampling, store demos, if you will, really to get people to try and taste the food which we believe, the proof is in the eating so to speak, and we do very well there. But we are very happy at the launches we've done so far on innovation. It is tracking against the forecast that we had for all of the products. And we feel very good about where we are.

Alexia Howard, Sanford Bernstein.

Gary, you have done a nice job this morning of explaining the rationale for the Ralcorp acquisition by talking about premium private label products, and partnering with key retailers. And looking maybe to overseas models on private label, as something to emulate. As I think about Ralcorp's categories, on cereals, I look at the two big branded players and how focused they are on innovation and how much money they have to put into that. And then maybe in another category, I think about [try pastor], and I don't see a lot of premium innovation going on in there.

But when you talk about channels and maybe targeting I don't know the Whole Foods or the Costcos with more premium private label products I can kind of understand that. So I was wondering if you could just give an example, is this a channel focus where you're going to be maybe focusing on more of the premium outlets for private label products through the Ralcorp deal? Are there specific categories where you have got examples of where Ralcorp does that really well? Just to give me a better feel for how this is all going to work? Thank you.

Sure. The answer is, it is kind of all of the above. So clearly, there is very strong development and opportunity in channels that really emphasize store brand, so for instance, Ralcorp does a great job with folks like Trader Joe's, and Costco and clearly there are products all over the stores there that reflect that. One small example would be some of the frozen pasta meals in Trader Joe's that are a terrific product, maybe you've tried them, but that would be one example of what I would call a very much value add product.

In our own shop, what we've done with our bar business, so for instance, at two of our -- two biggest customers, you've seen us not just emulate product in the nutrition bar space but actually create new product that has done very well. And that is very much value-add. If you go into some of the categories that you talked about, it is really a different story by categories, so you're right. There is a lot of tough big players with big resources, like RGE cereal business, and we will have to be very selective about how we play there.

Ralcorp has done extremely well thus far. We expect that to continue. But we will place our bets selectively. And it is really both a category and a customer channel story. And we think there is enough pockets in both of those places that we can continue to do really well.

There are no further questions. 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. It will be archived on the web as detailed in our news release. And as always, we are available for discussions. We want to thank you very much for your interest in ConAgra Foods and wish you happy holidays.

This concludes today's ConAgra Foods second-quarter earnings conference call. Thank you again for attending. And have a good day.