TreeHouse Foods Inc (THS) 2007 Q4 法說會逐字稿

Good morning. And welcome to the TreeHouse Foods investor relations conference call for the fourth 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 and 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 terminology. 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 industry's actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievement expressed or implied by these forward-looking statements.

TreeHouse's Form 10-K for the period ending December 31st, 2006 and subsequent quarterly reports 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 as of the date made when evaluating the information presented in this presentation. The Company expressly disclaims any obligation or undertaking to disseminate any updates or revisions to any forward-looking statements contained herein, to reflect any change in its expectations with regard thereto or any other change in 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. Good morning everyone and welcome back to your quarterly visit to our TreeHouse. We have a great story to share with you today. It is a tale of private label progress in three chapters. First, an outstanding fourth quarter. Next, a difficult but gratifying past year. And finally, a new year of challenges but one of even greater promise. As is our custom, David Vermylen, Dennis Riordan and I will provide an integrated strategic, operational and financial perspective on our TreeHouse. We will however depart from our usual rotation and address Q4 and the past year first, before turning our full attention to the new year. This sequential chapter by chapter approach will make our story of past progress, current accomplishments and future prospects clearer and easier to follow.

To begin, let me establish our general theme and story line. First, the fourth quarter was the best ever at TreeHouse. It marked a culmination of a hard-fought, year-long campaign to regain margins in the wake of extraordinary commodity cost inflation. In doing so, we not only overcame long odds but also achieved organic top line growth in our core business. Next, 2007 was a year of recovery, redemption and expansion at TreeHouse. We stumbled early but quickly regained our balance and posted steady, quarter-by-quarter margin gains throughout the year. TreeHouse achieved its original earnings guidance with a 25% increase in adjusted EPS. Operating cash flow, the most fundamental indicator of value, increased 26% to $138 million, in spite of across the board commodity cost inflation. The acquisitions of San Antonio Farms and E.D. Smith upgraded our product portfolio as well as expanded our geography. We also made great strides in integrating these two major acquisitions and in generating synergies from their inclusion into our business system. Most importantly, these acquisitions expanded our horizons with strategic growth opportunities, new customers and fresh, young talent.

Lastly, as has just been announced, we have passed the strategic crossroads, the end of the beginning, if you will, in our long-suffering pickle category. Finally, turning to the new year, TreeHouse Foods is in the top tier of packaged foods companies and projecting another year of double-digit growth in earnings. Like all of you, we are weary of the even greater escalation in commodity and input cost inflation to come. However, we expect the difficult circumstances in our industry to work to our relative advantage, especially in value oriented private label grocery and food service products. As consumer confidence falters and both grocery and food service operator seek solutions in troubled times, TreeHouse will offer greater value to consumers and greater economy to our customers. It is worth noting that these same customers view TreeHouse now expanded by E.D. Smith Premium Salsa in a new light.

We are no longer the upstarts with cheap pickles to peddle but now represent an integrated grocery products marketer that is an industry leader in six major product categories. TreeHouse is now a major presence in both retail grocery and food service across North America. In summary, you should expect, as we do, another long and challenging year. It will be marked by the steady quarterly progression of programs focused on margins and growth. Risk will be ever-present, but opportunity beckons. You should also expect, as we do, that TreeHouse will once again achieve our earnings estimates for the new year. With that rather lengthy prelude, let me turn the narrative over to David and Dennis for richer detail and color commentary on the quarter, past year and then the new year. David?

Good morning, thank you, Sam. I will focus on two areas. First, the fourth quarter performance of the base business and second, the first ten weeks of our ownership of E.D. Smith. Later, I will provide a perspective on 2008. Let's start with the fourth quarter. Despite the commodity headwinds, we had an excellent quarter with strong gains in both net sales and across the board increases in our adjusted gross margins. We are very pleased that we had three quarters of year-over-year improvement in our margins, given the commodity challenges all food companies are experiencing. In terms of revenue, excluding San Antonio Farms and E.D. Smith but including DeGraffenreid, net sales were up 6.3% led by nondairy creamer sales which were up over 20% and pickles 8%. We had pricing and volume growth in both those segments. Soup and branded infant feeding sales were down 7%, primarily due to an infant feeding customer loss. The soup business was slightly below a year ago as the market was flat and higher branded ready to serve merchandising levels affected our ready to serve consumption.

Our key operating financial metric, adjusted gross margin, increased by 120 basis points to 16.1%, and we showed year-over-year gains in every segment. Pickle AGM increased 50 basis points to 13.1, nondairy creamer AGM increased 100 basis points to 20.2 and soup and infant feeding AGM increased 180 basis points to 14.2%. These gains came in the face of year-over-year increases in key commodities such as soybean oil, up 46%, sweeteners up 25%, casein up 50% and diesel fuel up 15%. We have fought these headwinds with pricing execution, our productivity programs and our purchasing strategies.

In terms of pricing, the conventional wisdom is that private label is at the mercy of branded pricing and that brands have more pricing tools available to offset input cost increases such as reducing trade spending and couponing. We disagree. While we don't have trade spending or couponing that we can cut, we do have an excellent sales organization armed with fact based selling that has been able to implement a remarkable level of pricing ahead of branded list pricing. But in the last few months we've seen a high level of branded pricing as large companies have come to grips with the realities of their cost structures. The packaged food cost basket increased over 6% in 2007 and is expected to exceed 8% in 2008. With the economy moving towards a recession, the private label consumer value equation improves.

Let me now turn to E.D. Smith which we acquired in mid October. We have been focusing on four key areas. First, we recognize going in that E.D. Smith was a loose consistent federation of three separate companies with no coherent strategy or leadership. In just a couple of months we have unified the business with strong TreeHouse leadership running the company with a centralized keep it simple approach. Within the cost structure of the business, we keep turning up more and more opportunities that we will realize over the next 18 months. For example, one of our three salad dressing plants is recognized by many as being a low cost producer. Yet none of its best practices have been shared with the other plants. They are being shared today.

Second, we also knew that despite two years of commodity inflation, E.D. Smith had taken very little pricing leading to margin erosion. In addition, the lack of detailed customer P&Ls meant that we didn't know where to attack the problem. As we demonstrated last year, dealing with these issues is one of our core competencies. We completed the development of these customer P&Ls in early December and early January rolled out a $22 million annualized pricing plan that offsets the two years of input cost increases. That pricing will be fully operational in the second quarter. The retailer acceptance has been excellent as we have brought Bay Valley's fact based selling to bear behind private label salad dressing and other E.D. Smith products.

In third, in terms of Bay Valley and E.D. Smith's integration, we have already consolidated the U.S. sales organization, reduced corporate overhead and have generated productivity savings and synergies that in 2008 will generate almost $14 million in lower costs than in 2007. We will begin the IT integration in the second quarter of 2008. Once that integration is complete, additional savings will be realized. Finally, despite the intense efforts associated with reorganizing the business and with pricing, we are well along the path of leveraging the E.D. Smith Canadian customer penetration with Bay Valley products. High margin salsa, condensed soup and nondairy creamer are our biggest opportunities and we have had excellent response from Canadian retailers to our products. In the U.S. our food service division has created a total sauce solutions program that combines legacy Bay Valley cheese sauce, San Antonio Farms salsas and E.D. Smith food service sauce makers into a single product development and marketing program that leverages our Canadian, Midwest and Southwest manufacturing and distribution capabilities.

Keep in mind that neither San Antonio Farms nor E.D. Smith had a U.S. presence in food service. E.D. Smith will be a very good business for us. Strategically, it gives us a leading North American presence in salad dressings and opens up Canada to Bay Valley products. The E.D. Smith top line is solid. Our aggressive pricing programs are in place and we are already realizing excellent integration and productivity savings. As I look back over 2007, I'm quite proud of what we have accomplished. We completed the integration of soup and infant feeding, made three acquisitions and fully integrated two of them, experienced organic growth, offset over $40 million in higher input costs through pricing and productivity gains, increased adjusted EBITDA by 26% and adjusted earnings per share by 25%. I'll now turn it over to Dennis.

Thank you, David. I will now cover the fourth quarter results, the headlines of which are sales growth was achieved in the legacy businesses, gross margins improved despite very high input costs, and operating costs were again well-controlled. Also, we had three unusual items in the quarter. A a gain from a currency hedge used to fund the E.D. Smith acquisition, one time accounting adjustments associated with the acquisition and a favorable tax benefit from revaluing certain deferred tax liabilities acquired from E.D. Smith. I will describe these unusual items in more detail as I walk you through the fourth quarter P&L. First, net sales were $370.9 million in the quarter, up 31% from last year, due primarily to the acquisitions of San Antonio Farms and E.D. Smith, but also due to encouraging revenue growth in our legacy businesses.

Gross margins improved both sequentially and compared to the prior year's fourth quarter. After a slow start to the year, we saw sequential margin growth in the second, third and fourth quarters. Compared to last year's fourth quarter, gross margins improved to 20.5%, from 23 -- from 20.3% last year, despite the input cost pressures. As David indicated, all the key product categories showed improvement over last year, as pricing and cost controls contributed to the improvement. Selling and distribution expense increased from $21.8 million in 2006 to $30.2 million in 2007, due primarily to the increase in sales resulting from the San Antonio Farms and E.D. Smith acquisitions. As a percent of sales, selling expenses increased to 8.1% of net sales in 2007 from 7.7% last year, due primarily to higher average fuel costs. G&A costs in the quarter decreased slightly due to lower stock option expenses. These costs have trended down naturally as the underlying options age. Lower stock option expense offset increases in base G&A due to the addition of E.D. Smith and San Antonio Farms. However, even excluding the benefit of lower stock option expenses, G&A as a percent of net sales improved to 3% in the quarter, compared to 3.5% last year.

Other operating income for the quarter was minimal in 2007, but totaled $21.1 million in 2006. In 2006, we had $29.4 million gain, associated with the transfer of certain post retirement medical benefit obligations from a company administered plan to a multi employer union sponsored plan. Although the benefits to employees covered under the plan remained substantially the same, those benefits will be funded as the benefits are actually paid. This eliminates the need to reflect the unfunded benefit obligation in our balance sheet and resulted in the non-cash gain in last year's quarter. Offsetting this large gain last year was an $8.2 million charge to write down the value of our Mocha Mix trademark to reflect the estimated fair value of that mark. Amortization expense in the quarter increased from $1 million last year to $3.3 million this year, due to additional amortizable intangibles, such as customer lists, trademarks, and trade names from the E.D. Smith acquisition.

Our non-operating income and expense included a $3.3 million gain on a foreign currency hedge contract associated with the purchase of Canadian dollars, used as currency for the purchase of E.D. Smith. Although this was related strictly to the acquisition, accounting rules require that this gain be included in earnings rather than component of the net cost of the transaction. Interest expense for the quarter rose significantly from $4.6 million to $9.2 million, due to higher borrowings outstanding. The borrowings were for the new acquisitions in 2007. Our effective income tax rate in the quarter was unusually low at 35.8%, compared to 38.5% last year. The decrease was due to positive tax adjustments relating to deferred tax liabilities associated with the E.D. Smith acquisition. We revalued these tax liabilities at the new lower Canadian statutory rates during the quarter and those adjustments resulted in lower income tax expense. This adjustment is non-recurring.

Income from continuing operations in the fourth quarter was $14.3 million, compared to $22.4 million last year. Excluding the unusual items I highlighted above and consistent with the reconciliation in our earnings release this morning, our adjusted earnings for the quarter totaled $0.45 per share compared to $0.30 per share last year. We are obviously very pleased with this improvement in earnings in the quarter, especially when compared to so many packaged food companies that were not able to show margin improvements in the face of sever input cost pressures. Our management team and sales organization at Bay Valley Foods did an outstanding job in the quarter. For the full year 2007, net sales came in at $1,158 million, a 23.3% increase over 2006, primarily due to our new acquisitions. Excluding San Antonio Farms and E.D. Smith, sales would have increased 12.8%, due to having the soup and infant feeding business for a full 12 months in 2007 compared to eight months in 2006.

In looking at legacy businesses, pickle sales increased 1%, as pricing offset softness in volumes, while powder increased 11.9% over last year, due primarily to increased pricing to offset higher costs of casein and edible oils. Soup and infant feeding showed year-over-year increases, however this was due entirely to having a full year of sales in our operating results. As David pointed out earlier, we did experience softness in both Soup and baby food in the fourth quarter of 2007. Full-year gross margins finished at 20.8% compared to 21.4% last year, due to the weak first quarter margins in 2007. We did manage to right the ship in the second quarter and were successful in steadily increasing margins in the second, third and fourth quarters.

Selling, general and administrative expenses increased from $132.8 million in 2006 to $148.6 million in 2007, due to the addition of the new acquisitions. Due to our significant growth in both 2006 and 2007, we use spending as a percent of sales as our benchmark for spending. Using that metric, our SG&A expense even excluding the benefits of lower stock option expenses this year, improved to 11.7% in 2007 compared to 12.1% in 2006. Interest expense in 2007 rose significantly to $22 million compared to $13 million in 2006, as we took on debt to fund the 2007 acquisitions. The full-year effective tax rate was 37.4% in 2007, which was slightly lower than last year's rate of 37.9%. As I indicated earlier, we did get a benefit in the fourth quarter effective tax rate resulting from the adjustment of the Canadian deferred tax liabilities. Continuing earnings per diluted share are reported as $1.33 compared to $1.42 last year. Excluding the unusual items and other operating expense I discussed earlier, adjusted earnings per share would have been $1.32 this year. This compares to a $1.06 last year. We are very pleased that we were able to finish at the high end of our original guidance in this very challenging year. David?

Thanks, Dennis. Let me comment briefly on some key challenges and initiatives for 2008. First how we deal with and manage commodity inflation will again be critical. Last year our input costs increased $40 million versus 2006. This year we expect they will be up an additional $68 million, not including E.D. Smith. The good news for us is that we learned our lesson from a year ago and are dealing with the issue every week, if not every day. But let me be clear on one thing. When the commodity markets are volatile, you will often hit periods when pricing lags cost increases. You can see this across most of the food industry. We faced that last year and showed that we can recover but it takes time and is not manageable month to month, let alone quarter-to-quarter. For example, you cannot take price increases in the middle of soup or nondairy creamer seasons when even when costs increase.

Second, we completed an EBA analysis of our business that has led to a portfolio strategy that we are building into our long-term plans. This portfolio strategy categorizes our segments into four quadrants based on size of business and return on capital employed. As we build our business plans, they will be guided by our portfolio strategy. For example, our Canadian focus on Bay Valley salsa, condensed Soup and nondairy creamers reflects their priority within the portfolio strategy. In the U.S. we are applying this strategy to our retail and food service businesses in terms of where we commit R&D, marketing and capital investment. We will continue to update and refine the strategy and measure our internal performance against it. This is a model that we utilized so successfully at Keebler.

Let me describe how this will work on pickles. Pickles are a large business with a low return on capital. Pickles are capital intensive with assets utilized less than half the year. The retail pickle market has been declining 2 to 3% per year due to not having a strong category leader. It's also a business with a legacy within our company of accepting low margin customers to cover high fixed costs. Over the next two years, we will approach this problem from three directions. Customer rationalization, plant consolidation, global sourcing and strategic alliances. In terms of customers rationalization, we will either achieve acceptable margins for our customers or exit their business. We offer incredible quality, value and customer service and should get a reasonable return. We are executing that strategy right now. With some customers where we make little to no margin we are taking double-digit price increases.

In terms of plant consolidation, we will restructure our manufacturing base to support a smaller, more profitable business. As a first step in June, we will be closing our Portland, Oregon plant which is a very high cost location in terms of both crop sourcing and manufacturing. We have a very high market share in the Pacific Northwest, and we can significantly improve our returns by relocating production. Closing that plant will improve earnings almost $6 million annualized. In terms of global sourcing and alliances, we have developed an exclusive strategic alliance with Global Green, a very large pickle manufacturer in India that in the third quarter will begin to provide us with lower cost products where the crop needs to be hand picked and hand packed. Think of jars of small, whole pickles such as gerkins. That type of product is expensive to produce in the U.S. Global green can source crops in India 11 months of the year. In the U.S. we will focus our manufacturing on those products where we can source lower cost machine harvested crops and low cost automated packing. Combination with Global Green, Bay Valley will be a full line marketer but only a manufacturer of products where we can be a low cost producer.

In addition to the above moves, we are also studying how to better source cucumbers so we can produce fresh pack a greater portion of the year versus just the summer months. In tandem with our Global Green alliance and other alliances we are working on, this will lead to a significantly better use of our assets and working capital. By the end of 2009, we will either have a smaller, higher return pickle business or a business of comparable size but with better returns. It will not be the same old pickle business. As we execute our portfolio strategy, we are bringing the same strategic analysis to other parts of our business. With our revenue running rate at $1.4 billion and our large scale participation in six key categories versus only two, two years ago, we have a lot more opportunity to remix our portfolio through both internal strategic planning as well as external development. I'll now turn it over to Dennis.

Thanks, David. I will now cover our outlook for 2008. Overall, we expect net sales to grow between 27 and 28%, due primarily to pricing and a full year of sales from the San Antonio Farms and E.D. Smith acquisitions. We will focus on maintaining our margins in 2008, and place more emphasis on growing unit volumes where feasible. We do expect that the first quarter and even the first half margin growth will be constrained due to a combination of very high input costs, because our pricing programs at E.D. Smith will not be fully realized until late in the second quarter. On a full year basis, we will continue to improve our operating expenses as a percent of total revenue and use those savings as a contingency against margin constraints. As a result we expect to see earnings per share on a fully diluted basis finish between $1.50 and $1.55 in 2008, an increase of 14 to 17% compared to 2007.

Regarding the first quarter of 2008, we expect that the first quarter of each year will be our lowest margin quarter due to a combination of sales seasonality and the timing of price increases. Typically, price increases are timed to the start of a shipping season for each product category. Our first quarter falls at the end of our key soup and powder seasons and precedes the summer shipping of pickles and sauces. As a result, we expect first quarter EPS will be in the range of $0.24 to $0.26, a small improvement over the $0.24 in the first quarter of 2007. Beginning in the second quarter, we expect increased quarter-over-quarter earnings culminating in the full-year guidance of $1.50 to $1.55. Now, let me cover a few other items that are inherent in our full-year estimate. First, interest expense will be higher on a year-over-year basis in 2008, due to the full-year impact of holding debt associated with the 2007 acquisitions. We expect interest expense to be about $32 million next year.

Our effective tax rate should stay in the range of 38% in 2008 as the lower tax rates in Canada will not significantly drive down the overall tax rate, due to the relatively small amount of taxable income in Canada as compared to the consolidated results. In terms of investments, we are planning to increase our capital spending levels in 2008 to roughly $50 million. The large increase in spending is related to productivity improvements and maintenance programs at our plants which will now number 17 across the U.S. and Canada. Non-cash items for the year include depreciation and amortization, which will increase from $35 million to $45 million, due to a full year of acquisitions. And that's both capital depreciation and amortization of intangibles and the increase in capital spending. Stock option expense will again decrease from $13.6 million in 2007 to about $12 million, with the decrease being slightly higher in the second half of the year based on our vesting schedules.

In conclusion, we have demonstrated in 2007 that we can manage through inflation and we believe that we did better than our peers. Uncertainty in commodity prices including both ag and energy related products will continue throughout 2008, but we expect to manage through that successfully like we did in 2007. In addition, we will be highly focused in 2008 on achieving the same margin successes at E.D. Smith that we realized in our legacy businesses this past year, although we won't see those benefits until late in the second quarter. Now I'll turn it back to Sam.

Thanks, Dennis. In the past half hour, we have laid out a comprehensive overview of TreeHouse Foods' strategic, operational and financial agenda. As you assess our performance and prospects, please note that our chapter by chapter story line is built upon a consistent theme of six critical elements. Number one, protect margins. We will protect margins through a program of pricing, productivity and procurement. As we mark to market today, annualized pricing of approximately $85 million will be required to maintain gross margins across all of TreeHouse. Another $30 million in new productivity, procurement and other cost savings projects are under way. Our primary risk is in second half commodities, especially soybean and other oils, key ingredients in nondairy creamer powder and salad dressing. We have complemented our commodity hedging programs with the fact based selling approach that David mentioned. As costs have continued to escalate, we have established a new sense of partnership with both our customers and suppliers. We are all jointly determined to squeeze out every last penny of waste and inefficiency in our combined supply chain from farm to consumer.

Number two, grow the base. We will utilize portfolio strategy, market segmentation and EBA analysis to pursue strategic growth opportunities and also upgrade our product portfolio. Strategically important product categories, especially those in high potential, high margin segments, will benefit from growth and innovation initiatives. We have supplemented our grocery and food service teams with additional marketing, food technology and packaging resources. These will foster more timely and innovative customer solutions and in doing so, provide new volume opportunities. Additionally, we have revised management bonus programs to reward growth and innovation, as well as margins and profitability.

Number three, reform our supply chain. We will reform our supply chain to enhance asset utilization, labor productivity and the application of food science and technology. Closure of one pickle packing facility coupled with global sourcing is the first in a series of restructuring programs. We have also funded a salad dressing plant expansion and automation project, a distribution center to consolidate mixed product truck loads and new direct labor productivity software. And enhanced R&D team has been reorganized, apart from quality assurance, so that the one can better focus on product and packaging innovation while the other concentrates on quality standards. Purchasing functions across the several acquired businesses have been consolidated to maximize procurement savings. Bay Valley Foods, which already sets the industry standard for effectiveness and customer service, will now become far more proficient.

Number four, strengthen our platform. We will strengthen our business platform through a combination of acquisitions, and downsizing. The San Antonio Farms and E.D. Smith acquisitions have extended our product line into attractive growth categories and opened new markets, thereby enhancing our standing with major customers in all channels of trade. Once the E.D. Smith integration is complete and financial markets stabilize, we will be well-positioned for further acquisitions. While we cannot predict timing, our strategic focus, management team and capital structure remain devoted to expansion by acquisition. In the interim, we will concentrate on the generation of free cash flow to pay down debt in order to prepare for the next major strategic expansion opportunity. In parallel, we will scale back our commitment and investment in non-strategic underperforming businesses. Our portfolio strategy and EBA analysis have identified those that either must be fixed or abandoned. Our strategic agenda will thus incorporate internal improvement as well as external expansion.

Number five, change with the times. We will adapt our business and business methods to the fundamental changes brought by commodity inflation, energy volatility, and economic uncertainty. At TreeHouse, we recognize that these forces represent a fundamental challenge to the food industry status quo and to business as usual. They demand more imaginative customer solutions, greater supply chain cooperation, sustained productivity gains, faster, cheaper innovation, and finally, sound, strategic thinking coupled with resolute execution. We are attacking these issues on all fronts in order to establish a new internal order to cope with an environment of greater external challenge. Number six, reaffirm our commitment. Finally, we will reaffirm our commitment to our investors and employees alike that TreeHouse remains fully devoted to strategic expansion, internal improvement, workplace opportunity and most emphatically shareholder value. While we have been sorely tested, we remain steadfast to our original vision and loyal to those who have entrusted their monies and wellbeing to us. That concludes our story of recent progress and future prospects at TreeHouse. Cynthia, please open the phone lines for questions and comments.

Thank you, sir. Today's question-and-answer session will be conducted electronically. [OPERATOR INSTRUCTIONS]. We will take our first question from Robert Moskow with Credit Suisse. Please go ahead.

Good morning. Congratulations.

Thank you.

That was a great presentation. I appreciate all the detail on your strategic plan. It sounds very well thought out. I guess my question today is going to be on productivity to begin with. Did you say you had $14 million in productivity during the year this year and you expect 30 next year? Did the productivity come in better than you thought in '07 and what's changed since -- we met with you in November, guys and I was wondering if anything changed with what your finding in terms of cost synergies.

This is David. We will have for 2008, just within E.D. Smith, $14 million in year-over-year savings that relate to SG&A savings from U.S. sales consolidation, reduction in E.D. Smith corporate overhead as well as in manufacturing productivity and synergies with Bay Valley. I believe that $30 million is the total productivity gains for all of TreeHouse in '08 versus '07.

Okay. Got you. So was there any -- were there any productivity improvements in '07 that you enjoyed or is this all new stuff, I guess.

No, we had -- unless Dennis has the exact figure, we had productivity savings within just the core Bay Valley business that were north of -- that were over $20 million. Which were a big part of our margin improvement year-over-year, especially in the last three quarters.

Got it.

Rob, this is Sam. I think the most gratifying of these projects was the installation of new direct labor productivity software, where we allowed -- asked the foreman and supervisors in each factory as we roll this software out to in fact design its implementation and we will have that across all of our plants at the end of 2008. We have seen immediate changes in productivity ranging from 2 to 4% in the start-up phases of that new focus on the shop floor.

Congratulations there. And then on pricing I guess you mentioned that you think that the branded players are just now starting to realize that there's been a change in their cost structures. Are you seeing that just in the categories that you're in or are you talking about everywhere? And then secondly, maybe you're not in a position to comment on how much pricing they're taking, but do you think that they are finally taking pricing up enough to meet their commodity cost inflation pressure?

You know, we are definitely seeing a lot more pricing, not just in our categories, but across the board, in terms of list pricing. I think that with the branded companies, you can back off your trade spending and since that operates above the net sales line it's a way of driving your -- improving your net sales without taking a list increase. But I think we're seeing it across the board, especially as you look at it as measured by Nielsen or IRI. I think that, having run branded businesses for a long time, you can back off your trade spending and your couponing activity and -- for a certain amount of time but then it comes down to, you've really got to deal with the input cost inflation and I think we are seeing it happen. I mean, when you sit in front of a retailer and you talk to them about pricing, just about everyone is in front of them right now. And I think when you look at the level of food price inflation last year and the packaged goods food basket increase year-over-year, it's not just in changing your trade spend, it's in the list increases.

Okay. Do you think that private label got pricing earlier than the brands in the second half of '07?

In looking at the syndicated data, it does appear that way. I saw a report that came out a couple of months ago that really showed, when you take a look at -- not a couple of months ago, in the last month, when you take a look at -- it may have been 100 private label categories. Their percent -- in aggregate their percent increase in pricing was quite a bit higher than for the branded companies. And again, the private label companies, given our margin structure, you really have to deal with that -- with the pricing. List pricing, because with just about all customers, you are net price. You don't have trade spend in your budget.

Thank you very much. Congratulations again.

Thanks.

We'll take our next question from Terry Bivens with Bear Stearns. Please go ahead.

Good morning, gentlemen.

Good morning, Terry.

Good morning, Terry.

Couple of things. Sam, as you look out in the M&A environment out there with an eye to your debt, how does it look? And you had a very thoughtful, strategic approach this morning. Has that pointed a search light at any particular categories that you may not have looked at that much before?

First of all, with regard to the outlook here, clearly the financial markets have tightened and will continue to face for a period of time uncertainty. We have determined from our models that, should the opportunity arise and that opportunity be one that is both superior strategically and one that is beneficial financially, we have the capability with our current lines of financing to enter another large dry products category along the size and dimension of the things that you've seen us do in the last several years. Internally, our E.D. Smith integration is well along the way and we will have both the capital structure and the management capability to entertain another one before the end of the year. With regard to your comment about a thoughtful strategic approach, that's the nicest thing anyone said to me on Valentine's Day in many years.

Don't take it the wrong way.

[ LAUGHTER ] I think that the important progress that we have made in the last year is best articulated by David about the portfolio strategy and that strategy is in part dependent on the EBA analysis that Dennis and his team have undertaken. And what we now can add to our strategic acquisition filter, are quantitative measures that in effect will place the new product category channel combinations that an acquisition would bring into that strategic quadrant analysis of the portfolio and we clearly look for businesses that will bring us better margins and better growth opportunities and some combination thereof. So I think that's the advance and that in its first stages it will play out again, as David indicated, in our current portfolio and where we will significantly downsize pickles. But it also points out that there are great opportunities in salsa, soup, salad dressing for strategic initiatives to grow those businesses beyond their current run rate.

Okay. And just one more quick one. We noticed some kind of funky market share numbers with regard to your baby food business. And I'm wondering, I think someone mentioned at the outset that you lost a customer with regard to soup. Have you lost any customers with regard to baby food that you're aware of?

This is David. Where we lost a customer was in our branded baby food business and a very large percent of our baby food business is done outside of measured channels. So if you're looking at either Nielsen or IRI for our baby food business, it's not a very good measure of how the business is doing. But we did lose an IRI measured customer.

Okay. One that starts with a T?

No. But don't go through all the letters of the alphabet, please.

Okay, I won't.

[ LAUGHTER ]

I won't wish you a happy Valentine's day. But it was a very nice quarter and thanks for your answers.

Thanks, Terry.

[OPERATOR INSTRUCTIONS] We will take our next question from Andrew Lazar with Lehman Brothers. Please go ahead.

Good morning, everyone.

Good morning, Andrew.

Good morning.

So David, I think you mentioned the need for around $85 million of incremental pricing in '08 and I guess that's around, the way I calculate it, 5 or 6% price increase. Trying to get a sense of how similar is that to the pricing that you got through -- in '07 and then what's your assumption on what type of input cost pressure that's going to cover. In other words, is that based on where some of your key costs are now and where you think they'll go or is it trying to be, where you can, a little anticipatory given some of your more cautionary comments around some of the oils potentially and the volatility in the second half of the year.

The pricing on a percent basis, and again, the 85 is slightly higher -- again, that's all inclusive for all our businesses, slightly higher than in '07 and it is really based on the costs that -- certain commodities were covered for the year, others as Sam mentioned is still risk in the second half of the year in terms of soybean oil. It really will relate to different channels and different customers with some of our customers, we will literally hedge the commodity for the full year and lock in pricing for the full year. With other customers and other channels, depending on the commodity environment in the second half of the year, and again, this would really be focused on soybean oil, there could be additional pricing in the second half to deal with that. So there's no perfect single answer, given the channels of business that we're in and the type of products that we have. Did that answer your question, Andrew?

Yep. Is it fair to say that where you can, just given there is some potential additional volatility as we go through this year, you're trying to be as aggressive and obviously sensitive to competitive sort of engagements and things, but trying to be as aggressive as you can, let's say relative to even '07 in trying to deal with that sort of currently.

I think we are being -- we are being aggressive but with our customers we really try to be very straightforward in terms of the fact based selling. In a nutshell, our strategy is really very simple. This is what we communicate to our -- internally here and to our customers. We want to use pricing to offset input cost increases and we want to use our productivity improvements to really be that which enhances our margins. There is risk if we're trying to enhance our margins, that is to price ahead of commodity, it puts us at risk, the nature of the business that we're in.

It's good lead in around the fact based selling to my next question, which is not just with you, but I think all food companies these days are being far more transparent in the way they are going to retailers, saying, look, this is the reality around input X, Y and Z, and therefore we absolutely just need this pricing relief. And that makes sense to me. But I wonder whether that transparency at some point ultimately becomes a double-edged sword. Let's say if and when the rate of inflation moderates or dare I say input costs go down, although that's just maybe wishful thinking at this point. Does that kind of transparency come back, do you think, and make it more difficult for the industry to hold on to some of this pricing, which historically they've really had a wonderful ability to do?

This is Sam, Andrew.

Hi, Sam.

Good morning. There is always that risk. I think that what differentiates our approach here is that, one, we are trying to establish a greater degree of cooperation and transparency, not only with customers, but also suppliers and, along the way, prove ourselves to be a better partner. And if we can become more effective, more efficient and squeeze the waste out of the system, that will be recognized and appreciated. Secondly, our major focus here is where we have large -- high share in large product categories and so that we have a leading share in a business and a long-standing business relationship with a major customer, then while clearly there is always negotiation over which way the last penny falls, you find that you're doing that in an atmosphere with someone who has become less of a confrontational party on the other side of the table and more of a partner.

And then thirdly and last, as we have found, the degree of profitability in private label across different customers and food service, for that matter, is a far wider degree of profits than is the case in most branded companies when the only real differentiator is the trade spend. But we are quite focused here on those major customers where we are important to them and where they are important to us and not simply for today but for the long run. And with that, we're willing to have that double-edged sword as part of the portfolio.

Got it. Okay. Thanks. One last thing and I'll pass it on. I know the dynamics around private label in general are a lot different in Canada, just given how well-developed private label is and how consolidated the retail trade is. Does that change the dynamic or the success that you think you will have around pricing versus kind of what you've been able to do in the states?

I don't believe so. We are applying the same fact based selling to the E.D. Smith portfolio up in Canada as we are in the U.S. and I think we're getting good acceptance. And the pricing that is required for us because of the mix of businesses in Canada is not as aggressive as we have to take in the U.S.

Got it. Got it. Okay. Thank you.

We will take our next question from Jonathan Feeney with Wachovia. Please go ahead.

Good morning and thank you.

Good morning, Jonathan.

I wanted to dig in just first on the $22 million cost of this plant shutdown. I mean, I've never been in the pickle business. But that seems kind of high, given that you have 17 plants. Could you give us a sense of how much of that is sort of cash and what's the complexities with -- does that include like relocating that capacity. I would just like to understand that cost savings opportunity a little more.

Approximately $16 million of that is cash and the key aspects of that are lease -- there are some longer term leases and growing contracts that we have to deal with there and that's what helped to drive that cost up higher.

I see.

Jonathan, this is Sam. When the business was acquired by one of our predecessor companies, the terms of sale were effectively to reduce the initial cash purchase price by undertaking long-term agreements for crop and equipment to process the crop that were in effect deferred purchase price through higher input costs over a long period of time. It's that circumstance that provoked both the closing and the larger amount of money to in fact shut down the plant.

That makes sense. That's helpful. Thank you. David, I think you mentioned some merchandising in the soup category. Is that right? Has that hurt your private label business? Has that sort of abated or what's your outlook for that in 2008?

So much of it will really depend on the branded players. We really saw it in ready to serve where there was a -- ready to serve soup, where there was a significant increase in merchandising activity as measured both through IRI or Nielsen as well our look at some of the major non-syndicated channels. In the ready to serve soup, you really -- there was a big focus, especially by Progresso on their light line that had a Weight Watchers endorsement. I think it did really well. I think one of the challenges for the industry this past fourth quarter was that overall, the level of new news and innovation was not as high as in 2006, so case sales for the category were basically flat and the battle took place in ready to serve and we lost some share in there because we're just -- the price gaps narrowed between the branded players and private label. It's hard to say. I mean, what I really hope to see in 2008 is a return to more new news and innovation to really drive the category, rather than just merchandising and pricing.

And I guess just finally, I mean, all of you guys have run food businesses going into I guess a couple of recessions, at least.

I'm not that old. [ LAUGHTER ] Yes, I am. Sorry.

I was counting 2004 as a recession.

Oh, okay. [ LAUGHTER ]

But as far as the categories' response, it seems like nobody -- it seems to stand to reason that we've seen people eat more meals at home. Now when you start to drill down on these categories, you're actually seeing private label take a little more pricing, and maybe that is delaying a down trading effect. Or would you say that -- I guess would you say, would you -- I guess I would have expected down trading at least more talk of it at the retailer level to be happening right now across private label categories. What sort of data experience can you point to to show how the consumers usually react vis-a-vis their private label choices when money gets tight. Is anything you've seen from retailer reaction so far at all surprising in that way?

In looking at the private label world, I saw one report about a week ago that indicated that in 2007, the measurement I think consisted of about 105 private label categories and 65 to 75% of the categories, private label showed year-over-year share growth. Now, how much of that is due to trading down versus the customers putting more emphasis on their branded programs and one of the things we're actually trying to track down right now through the private label manufacturers association is trying to go back to those highly inflationary periods to see if they actually have the data on the kind of shifts that do take place. One of the things that is interesting just about pricing is that you step back and say when was the last time the food industry faced the kinds of input cost increases that we saw last year and we saw this year. I think you probably have to go back maybe 15 or 20 years and we had -- someone gave us a very interesting perspective in that there really aren't many people on either the manufacturing side or on the retailer side who have been through a period of significant commodity cost inflation and don't have a great deal of experience in managing through and the steps that you should take.

And I think what we are doing is trying to -- saying, listen, if the old conventional wisdom was, well, private label has to wait until the branded people go, we're saying that's not the way we're going to manage the business. We're going to deal with this on our own and assume that sooner or later everyone else will have to take the kind of steps in order to recover margins. I mean, I think if you look at the food industry in 2007, you take 25 companies, you know a lot better than I would about how many of them showed margin erosion versus margin gains and I think that the food industry really has to deal with this. So I may be pontificating here but the world has really changed over the last 12 to 15 months and the food companies need to be more aggressive in dealing with it.

Okay. Well, thank you very much and Sam, a special Happy Valentine's Day from me as well.

[ LAUGHTER ] Thank you, Jonathan.

We will take our next question from Pablo Zuanic with JPMorgan. Please go ahead.

Good morning everyone.

Good morning, Pablo.

Couple of questions. Dennis, on your side on guidance, what is that number you're looking at by the end of the year. Sam talked about large acquisitions by the end of the year. Trying to have a feel what does guidance imply in terms of net debt by the end of '08?

The debt number at the end of the year, it's hard to give you an exact -- I want to say about $540 million.

Okay. But you actually calculated by end of the year you have space there for a large transaction like E.D. Smith type of transaction. Is that what Sam said?

Yes, we believe that a combination of our cash flow and where we believe we will fit into the credit markets will still allow us to do another deal of size and we're very confident in that.

Do you want to give us a rough idea of how big are we talking about in terms of what you would fund?

Pablo, this is Sam. Without giving specific numbers, I think you can look back at our history and see the approximate side of an acquisition that it takes to add a significant dry products category and to do so with a leading market share in private label and a presence in food service. That will give you a sense of the order of magnitude of, one, what the opportunity is, and two, our capability. And we're quite confident that should the opportunity arise, that we have the capital structure to in fact accommodate that without a radical change to our financing, current financing arrangements.

And Pablo, I think if you look at where the cash flow has been and you ex acquisitions, you'll see that we do generate a fairly substantial amount of cash flow and that even on an internal basis we will have excellent cash flow again this year if you work through the guidance numbers.

Okay, great. And then in terms of E.D. Smith I'm trying to understand here the upside or down side that E.D. Smith could have to your earnings guidance for the year and I'm trying to get a sense here, you talked about the price increases and efficiencies, but are you factoring any type of organic sales growth in terms of E.D. Smith in terms of either new products or new customers. Just walk us through in terms of how much risk is there to that number or how much of EPS guidance is really coming from E.D. Smith.

Pablo, our view is that the E.D. Smith represents opportunity. We tried to factor in minimal incremental sales growth by doing the -- taking our products north of the border. I think, as you know, we have leading positions in soup and powder and frankly, we don't participate in those markets on a retail basis north of the border so we see opportunities. We will begin the process of self activities this year. We may get some but for the most part, those are late season products and the selling time takes a long time. So in our view, that is our contingency to be a hedge as opposed to the guidance we gave being reliant on a very strong growth at E.D. Smith.

The same would apply of course in the U.S. market in terms of the salad dressings portfolio being expanded in terms of either SKUs or customers, that's not really being factored in the guidance, right? That's what you're saying?

No. We're really not. E.D. Smith had good top line growth last year. We're pretty much forecasting a continuation of its running rate. Really a lot of the initiatives that I spoke about early on will really be sort of incremental opportunity for E.D. Smith and for Bay Valley.

Okay. But just briefly, in the case of salad dressings, we see Kraft being more aggressive in terms of innovation and also marketing, Newman's Own extending their SKU portfolio. Just wondering about the risk to these price increase on a product that hasn't taken any for two years, as you said, whether there could be some form of volume impact.

Well, I think that there will be -- everyone is faced with the same input cost increases as we are. And I think we're going to see an inevitability in terms of the prices moving up across the board and we will be very enthusiastic with Kraft investing in a lot more innovation, because innovation is what drives a category. The salad dressing -- private label share in salad dressing has been growing a lot over the last few years. The category has not been growing that well. And if Kraft really starts stepping up with new products and advertising, that's good for us.

Okay. And a couple of follow-ups. If I understood right, you talked about great merchandising opportunities for you in terms of innovation along salsa, salad dressings and soup. Did I understand it right, particularly in the case of soup, what are you talking about and why isn't nondairy creamers on that list, are the opportunities more limited there?

In terms of our portfolio strategy, again, it really is -- it's driven by size of business and the return on invested capital. So we are not only looking at nondairy creamer, but what we are doing on nondairy creamer is really developing sort of both looking beyond nondairy creamer and really looking at our powder business, which is more than just nondairy creamer. The product's functionality, usability is more than just as a creaming agent. But also looking at the fact that -- a big thing of nondairy creamer is we have very strong spray drying capabilities and we're looking at those capabilities as opportunities for growth as well.

One last one, if I may. From your presentation, obviously paints a great picture about the outlook for the company and about all the strategies that you're putting through, passing on higher cost of pricing and there's all this that seems to be going in favor of private label. Then we have another company in the group like (inaudible) that's going through a transformative acquisition, going into branded, pretty much in my view saying that they probably have some concerns about private label and a way for them to hedge themselves is to have a leg on branded. What are they not seeing that I guess you're seeing that makes you so excited about private label?

Well, I really can't comment on another competitor other than to congratulate them on their success and hope that they, along with we, arise in the same -- due to the same strategic forces. We are steadfast in the belief that our current strategy is the correct one and that is that there is a secular growth rate in food service and in private label that exceeds that of at-home consumption and branded food sales. Secondly, there is the -- continues to be the crying need for consolidation in both channels of distribution. Our customer -- and we can see that in the customer response to our addition of premium salsa and the E.D. Smith product line to ours. We've now become an important factor in our customers' considerations. We do have branded businesses and, in fact, if you took I think all of our -- the businesses that don't fit the conventional private label grocery, bulk industrial and food service, you would find that we have more than a dozen brands and over $100 million in revenues in those branded businesses and we try to manage those very carefully, although they are a secondary rather than a primary business.

I think that the combination of private label food service and brands is not something that one can generalize about but in fact has to look at a category by category market dynamics as well as one's internal capabilities. And it is I think to me quite significant that when a leading competitor in private label moved into brands, that they did so on the basis of -- in conjunction with a very fine supply chain and manufacturing and distribution capability already in that same product category and I think that that -- that is a telling factor from those of us looking in from the outside at that particular acquisition.

Thanks. That's helpful.

Thank you, Pablo.

[OPERATOR INSTRUCTIONS]. We will take our next question from Bob Cummings with Shields & Company.

Good morning, everybody.

Good morning, Bob.

Some of the points that I was going to ask have already been covered, obviously but let me focus on one. You commented I thought very astutely on the problems you faced in the soup business this past year. But on the other hand, that's an area where you see opportunities to grow. I wonder, either using that example or some other example, tell us how you go about either picking up a new private label or food service customer or getting more shelf space in the store, just what is the strategy in dealing with customers and getting more business? Obviously you don't grow by advertising to consumers so there have to be other ways you can do it.

Bob, this I David. A good example is what we're doing in Canada, where we are able to present customers with an extraordinary product line of soups, and here in Canada we're really focusing on condensed soups, given our EBA which really shows that it is a -- condensed soups are a large high return on capital business for us. But our innovation capabilities in condensed soup, our cost position in condensed soup and our ability in Canada to link our soup business with the rest of the E.D. Smith portfolio in terms of supply chain efficiencies, really gives us a leg up with the customer, versus them just dealing with someone who is only in the soup business. So that's really a way for us to go after it and it's really the way for us to go after other business in the United States where we have gaps. If we have six big categories and we're dealing with a customer with four, we can really show, A, our innovation capabilities and the supply chain efficiencies that we can create by providing a broader portfolio of products to that single customer.

Are there any major chains that either don't carry private label soup or are using someone else or that represent major opportunities to double the shelf space.

I think that most retailers do carry private label soups. I think our share of private label is in the 60 to 70% area, so there's still opportunity for us.

Okay. Thank you.

Thank you, Bob.

At this time, there are no further questions. I will now turn the call over to Mr. Sam K. Reed for closing comments.

Thank all of you for joining us again today. As usual, you're always welcome as our guests at the TreeHouse. We'll look forward to our next visit in early May. And at that time provide you with an update, not only on the first quarter, but how our strategic plans are unfolding as well. Thank you.

Ladies and gentlemen, this will conclude the TreeHouse Foods investor relations conference call for the fourth quarter of 2007. We thank you for your participation and you may disconnect at this time.