TreeHouse Foods Inc (THS) 2007 Q3 法說會逐字稿

Good morning, and welcome to the TreeHouse Foods Investor Relations conference call for the third quarter of 2007. This conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include all statements that do not relate solely to historical or current facts that can generally be identified by the use of words such as may, should, could, expects, seeks to, anticipates, plans, believes, estimates, intends, predicts, projects, potential or continue or the negative of such terms and other comparable technology. These statements are only predictions. The outcome of the events described in these forward-looking statements is subject to known and unknown risks, uncertainties and other factors that may cause the Company or its industries' actual result levels or of activity performance or achievements to be materially different. Any future result levels or activity performance or achievements expressed or implied by these forward-looking statements.

TreeHouse's form 10-K for the period ending December 31, 2006 and subsequent quarterly results discuss some of the factors that could contribute to these differences. You are cautioned not to unduly rely on such forward-looking statements which speak only of the date made when evaluating the information presented in these presentations. The Company expressly disclaims any obligations or undertaking to disseminate any updates or reversions to any forward-looking statements continued herein to reflect any changes in its expectations with regards thereto or any other changes and events, conditions or circumstances on which any statement is based. This call is being recorded.

At this time I would like to turn the call over to the CEO of TreeHouse Foods, Mr. Sam K. Reed. Please go ahead sir.

Thank you, Darryl. Good morning all, and welcome back to our TreeHouse. As usual, I am joined this morning by David Vermylen and Dennis Riordan. We once again welcome the opportunity to report our recent performance, strategic progress and longer-term prospects to you. We have excellent performance to report in the third quarter. Operating cash flow increased 18% to $33.8 million as operating margins improved and the San Antonio Farms acquisition added higher margin salsa to our portfolio. Operating cash flow or adjusted EBITDA, gained 100 basis points to reach 12.4% of sales, the highest quarterly level since we formed TreeHouse 2.5 years ago.

A combination of price increases and productivity gains more than offset spiraling commodity costs, allowing AGM, adjusted gross margin, our measure of segment profitability, to reach its highest level in six quarters. I am particularly pleased to note that this critical measure, AGM, increased across the board in the private-label grocery, foodservice and industrial channels of distribution. These solid gains more than offset weakness in smaller channels and product categories. Sales revenue increased $20 million due primarily to pricing programs and the addition of salsa.

Sales dollars increased in all three segments -- pickles, powder and soup and infant feeding -- in spite of weak market fundamentals in the canned soup category. Consolidated SG&A expenses, excluding stock option expense, declined 100 basis points as compared to the third quarter of 2006. We have both tightened our belts and gained economies of scale over the past 12 months as SG&A expenses have increased at only two-thirds the rate of revenue expansion.

We closed the E.D. Smith transaction and completed the integration with San Antonio Farms in the quarter. All in all, it was a very satisfactory quarter and one that, despite rampant input inflation, confirmed our dual agenda of pricing programs to offset cost inflation and internal improvements to increase operating margins. While we see storm clouds on the horizon, portending even greater cost inflation in 2008, we approach the year end with great confidence that we will achieve all that we originally set out to do last January. Not everyone in our industry can make that same claim.

I will now turn it over to David and Dennis for a more thorough review of recent performance and year end outlook. I will then wrap up with some thoughts on the coming year and our longer-term strategic prospects. David.

Thank you, Sam. Good morning, everybody. Given that we reviewed the E.D. Smith business with investors just three weeks ago, I will focus my comments on our business and review revenue and adjusted gross margins, along with highlighting the continued headwinds we see in our input costs.

Net sales were up just over 8%. While this was primarily due to acquisition activity, our core strategic businesses did well with good revenue growth, with good gains and adjusted gross margin despite significant year-over-year cost increases. Pickle revenue was up 3.6%, which is an improvement over the year-to-date running rate of minus 1%. Private-label and foodservice sales were good offset somewhat by an expected decline in branded pickle sales principally the Peter Piper brand. The pickle adjusted gross margin of 13.8% was 270 basis points ahead of year ago and 270 basis points above the first six months of 2007.

Our pricing fully kicked in at the beginning of the third quarter allowing us to offset a 5% increase in crop costs, an 11% increase in glass and a 9% increase in corrugated costs. While we have made gains in our pickle adjusted gross margins, we're not satisfied with where we are and are very focused on customer by customer profitability. Our nondairy creamer sales were up 9.6% due to higher pricing. This aggressive pricing to offset input cost increases did not result in meaningful volume declines. This business has faced extraordinary increases in costs such as the 28% increase in corn syrup and sweeteners and a 41% increase in soybean oil. Despite these increases, our pricing and productivity programs resulted in our adjusted gross margin growing 160 basis points to 20.2%. This is also 200 basis points above the first six months of 2007.

Soup and Infant Feeding sales were up 1.6%. Soup sales were essentially flat, and we had a decline in our branded infant feeding business with an offset in our copack Soup and Infant Feeding. The adjusted gross margin of 15% was down 190 basis points versus a year ago due to the decline in the higher margin branded infant feeding business. While we benefited from some soup pricing in the quarter, the majority of soup pricing affects the fourth quarter. The soup market is not as robust as it was a year ago as we are seeing less in the way of innovation plus an increase in merchandising activity in the ready to serve segment. As measured by Nielsen, category dollar sales for the latest 12 weeks are flat versus a 52-week trend of plus 2 to 3%. These trends temper our optimism for the fourth quarter. Some sustained cold weather would be a good thing, which we did not have last year until the middle of January.

In total, as we look to the fourth quarter we are cautiously optimistic, primarily given we have our pricing in place to deal with the higher input costs. While we were late out of the box on pricing in Q1 '07, for the year we will realize pricing of $43 million with an annualized impact of over $70 million. As we head into 2008 we are being more proactive than a year ago on having pricing in place that will protect our margins next year.

In summary, despite all of the cost challenges it was a solid quarter. I will not turn it over to Dennis.

Thank you, David. From a financial point of view we continue to make good progress in restoring and improving on our operating margins despite the strong headwinds of input cost inflation. We were particularly pleased with the progress made in pickles and our ability to efficiently integrate San Antonio Farms and DeGraffenreid into the Bay Valley Foods business.

Sales in the quarter increased 8.1% due to the addition of the DeGraffenreid pickle and San Antonio Farms salsa acquisitions. Excluding these acquisitions legacy revenues increased 1.6%. As David indicated, we saw some softening in the soup business in the quarter but pickles, powder and other products performed as expected.

In terms of gross margins, our reported gross margins of 21.6% were slightly higher than last year's gross margins of 21.5% and improved sequentially over the second quarter's margins of 20.9% and the first quarter's margins of 20.1%. The continued improvement in margins is due to aggressive pricing actions needed to stay level with rising input costs, along with internal cost savings programs to drive incremental margin.

As I discuss the key product category margins, please keep in mind that we analyze our segment margins by looking at gross profit less commissions and freight expenses on customer shipments. We refer to this variable contribution measure as adjusted gross margins or AGM. Pickle AGMs increased nicely in the quarter, improving to 13.8% compared to 11.1% last year and 11.2% in the second quarter. Pricing actions accounted for the bulk of the improvement.

Nondairy creamer AGMs improved to 20.2% from 18.6% last year as pricing actions offset much higher input costs and productivity gains added margin dollars.

Soup and Infant Feeding AGMs were 15% in the quarter compared to 16.9% last year. The decline was due to a mix shift from branded baby food to lower margin copack sales. Soup margins were down slightly compared to last year as lower than forecasted sales resulted in the need to adjust down our production schedules, resulting in some inefficiencies in the quarter.

Our reported operating expenses totaled $36.8 million in the quarter, which was down slightly from the prior year. SG&A expense, excluding stock option expenses were $31.7 million or 11.7% of net sales in the third quarter of 2007, compared to $31.9 million or 12.7% of net sales last year. The quarter-over-quarter improvement was replicated on the year-to-date basis, as well. SG&A costs excluding stock option expenses were 11.9% of net sales compared to 12.5% last year. We have lowered our operating costs as a percent of net sales in each of this year's three quarters as compared to the same quarters last year.

Interest expense in the quarter was $5 million compared to $4.6 million last year, an increase of only 9.7% despite the combined $100 million in acquisition costs associated with the DeGraffenreid and San Antonio Farms acquisitions. This attests to the strong cash flow of the underlying businesses. Our effective tax rate for the quarter was 37.6%, just slightly lower than our full-year rate of 38.2%. Last year's tax rate for the third quarter was 35.5%, and included a relatively large tax adjustment to match the tax expense to our first filed tax returns last year.

Overall net income finished at $10.6 million or $0.34 per fully diluted share compared to $0.26 per share last year. Last year's results included unusual items such as a gain on the sale of a closed plant and plant closure costs. Excluding these costs, operating earnings per share last year would have been $0.24. Compared to last year's adjusted earnings per share of $0.24 our earnings per share this year increased by 41.7%.

I will now discuss the outlook for the remainder of the year. In the third quarter we were able to continue to increase key product category margins despite the run-up in commodity costs. The fourth quarter will see greater price realization as we enter the key shipping season for soup and nondairy creamers. Although we are entering the fourth quarter with good momentum, the headwinds from input costs have been stronger than we expected, and we see no abatement in sight. In addition, we are somewhat cautious on the velocity of soup sales given the light Q3 sales and a relatively warm startup to the fall soup season.

Despite these risks, we continue to expect strong year-over-year results in the fourth quarter. In last year's fourth quarter fully diluted earnings per share were $0.30 after unusual items. We expect the fourth quarter this year to contribute between $0.42 and $0.45 per share, an increase in earnings per share of over 40%. This will bring the full-year earnings per share to $1.29 to $1.32 per share before onetime costs associated with the E.D. Smith acquisition. This estimate is within the range of our previously issued guidance.

As I discussed during our last two conference calls, we expect approximately $0.07 in onetime acquisition costs primarily relating to the inventory revaluations that are required in purchase accounting. In summary, we remain optimistic for a strong finish to the year. Sam, I will now turn it back to you.

Thank you, Dennis. As I look forward to the year end, I am pleased that we at TreeHouse have been able to maintain our original baseline for earnings guidance. We have done so in the wake of commodity and other input cost inflation that was almost triple our original estimate last October. It is a testament to our market leading positions in key product categories across all major channels that we have done so with only isolated distribution losses. Further, it is a tribute to our Bay Valley Foods organization which has persevered in the face of great adversity and market uncertainty.

From a supply chain perspective productivity gains and cost savings are on track to contribute another $20 million to the overall profit improvement of the Company for the year. As a result, we now anticipate that operating cash flows or adjusted EBITDA will increase approximately 18% for the full year. The mid point of our EPS guidance equates to an increase of approximately 60 basis points and EBITDA as a percentage of sales.

As we improved performance, we also progressed our strategic agenda. We made three acquisitions, entered into a joint venture, expanded our product portfolio into salsa and portable salad dressings, and extended our distribution reach to Canada. Although the packaged foods industry will encounter even greater cost inflation in 2008 particularly in the commodity oriented oils, sweeteners and dairy sectors. While the environment will be difficult and the task formidable, we at TreeHouse are well prepared to meet the challenge of continued commodity and energy inflation. We have already established the pricing, purchasing and productivity programs necessary to weather the gathering storm. Further, our sales, marketing and supply chain team is in close contact with major customers in order to establish cooperative programs to squeeze inefficiency and waste out of every facet of our shared enterprise.

We fully anticipate that we will be able to successfully pass through cost increases, marginally grow the core business and significantly upgrade our product and channel portfolio in the coming year. We also expect to continue our expansion via acquisition in the new strategically attractive product categories in 2008. The integration of San Antonio Farms is already complete, and the consolidation plan for E.D. Smith is well underway. Our businesses generate substantial cash, free cash flow that in conjunction with new borrowings will also provide the additional capital needed for new acquisitions next year.

Whatever the economic climate, TreeHouse will have the resources, capital and wherewithal to get deals done. Finally, let me share two anecdotes that sheds light on our future as a consolidator of private-label and foodservice suppliers. David, Dennis and I recently toured our newest additions to the TreeHouse family; San Antonio Farms and E.D. Smith. We witnessed our integration teams and their newly acquired partners in full pursuit of new sales opportunities and supply chain efficiencies. This was as expected, but there was more. At San Antonio Farms we found a product development program that is a ready-made model for innovation across all product categories in our growing and diverse portfolio.

Similarly, at E.D. Smith we discovered an excellent prototype for manufacturing efficiency and private-label food processing. In both instances someone outside of TreeHouse had already developed a best practice methodology that far exceeds private-label industry standards. Thanks to our strategy and business model these progressive, small company entrepreneurial advances can be ruled out across the entire TreeHouse spectrum of products, customers, channels and operations.

As we traveled back to Chicago I realized that while we are preoccupied with a never-ending agenda of short term problems, it is revelations like these that confirm the strategic vision of our TreeHouse adventure in the long run. Darryl, we will now open the lines for questions and comments.

(OPERATOR INSTRUCTIONS) Andrew Lazar, Lehman Brothers.

Just a quick question on some of the copacking side. I know that is business that can be far more volatile in nature than some other parts of your business. I'm curious how big a part of your business is that? Is it much larger in one particular piece, is it like Soup and Infant Feeding as an example? And have there been any pushback or more importantly I guess risk of losing kind of a chunk of business with some of these price increases coming Which would be different than, because it seems like the pricing is going through relatively well from the core retailer standpoint.

Most of the copack business is in Soup and Infant Feeding, and we have long-term contracts, very stable relationships, cost pass-through arrangements. And those businesses are again lower margin, but they are very stable and doing quite well.

Okay, and then you made a couple references obviously with respect to soup, and I think weather is what it is. But you kind of went a little beyond that and did say lack of or less branded innovation than we saw perhaps a year ago. And I think you had mentioned higher merchandising. Can you just perhaps -- I understand the innovation piece because obviously all of the low-sodium stuff was coming out last year and there hasn't been anything to sort of lap that; that still seems to be what the bigger players are going with this year. But from a merchandising standpoint I'm curious what you were getting at there.

What we are seeing there is an increase in cases moved under promotion in the ready to serve segment. And that also results in lower retail price points on the ready to serve. We are not seeing kind of activity on the condensed side, but there is a lot more share swapping activity on the ready to serve side than we saw a year ago.

Very helpful. Thanks a lot.

Jonathan Feeney, Wachovia.

This is actually [John San Marco] on behalf of Jonathan Feeney. Thank you for taking our questions. Can you talk quickly about the price gaps to branded competitors in soup, as well as pickles? And one, whether you're comfortable with that gap and, two how that compares to sort of historical levels?

I don't have the specific data, but the gaps have not changed over the last year or so. I would say that in pickles the gap has narrowed modestly because we have been, I think more aggressive on pricing than some of the brands, though we are seeing some pricing now from the brands. So I think the gaps will go back to the historic levels.

One quick second one, have there been any new surprises for you on the E.D. Smith -- within the E.D. Smith business, specifically have you seen any reason that they historically weren't or recently weren't more aggressive in terms of taking pricing, offsetting costs?

We are very focused on that. In fact, I was up in Canada this week, and we are he developing the '08 plan. And a big topic of conversation there relates to matching up input cost increases with the pricing that is required both north and south of the border. I think that their not being aggressive primarily relates to the company being put up for sale and wanting to maintain a strong top line. And their top line has been good this year.

That is very helpful. Thank you very much.

(OPERATOR INSTRUCTIONS) Robert Moskow, Credit Suisse.

Good morning. This is [Will Sawyer] for Rob. Quick question again on E.D. Smith. We've noticed that your earnings model is pretty sensitive to the gross margins of E.D. Smith. Do you think that the commodity cost headwind in this business is particularly harder than the rest of your businesses? I only ask this because it seems like you've got pricing through your core business. So whether the increased input cost, is anything changed regarding your gross margin estimate for E.D. Smith for Q4 and then into 2008?

No, the biggest raw material component that we have to deal with E.D. Smith will be soybean oil, and there have been significant year-over-year increases. I believe that as I pointed out for nondairy creamer for the third quarter our soybean oil cost were up about 40% year-over-year. E.D. Smith is facing the same things. We in fact find some cost synergy opportunities between the two companies, but we are a very focused on restoring the margins of that business as we are putting together the '08 plan. It is right out at the top of our priority list.

Thank you.

(OPERATOR INSTRUCTIONS) And there are no further questions. At this time I would like to turn it back over to management for any additional or closing remarks.

Thanks, everyone, for joining us this morning, and we hope we can see as many of you as possible next week at the PLMA, the Private Label Manufacturers Association, annual show in Chicago. Thank you.

Once again, ladies and gentlemen, this will conclude today's conference. We thank you for your participation. You may now disconnect.