TreeHouse Foods Inc (THS) 2010 Q2 法說會逐字稿

Welcome to the TreeHouse Foods Investor Relations conference call for the second quarter of 2010. This call is being recorded. At this time I will turn the call over to TreeHouse Foods for the reading of the Safe Harbor Statement.

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 guidance, 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 31, 2009 and subsequent report on Form 10-Q 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 during this conference call.

The Company expressly disclaims any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement contained herein to reflect any change in its expectations with regards thereto or any other change in events, conditions, or circumstances on which any statement is based.

At this time I would like to turn the call over to the Chairman and Chief Executive Officer of TreeHouse Foods, Mr. Sam K. Reed.

Thank you P.I. Good morning all and welcome back to our TreeHouse. Once again we've posted outstanding quarterly results.

Operating cash flow increased 65% to $72 million. This record level of EBITDA was generated by a combination of double digit legacy growth coupled with the inclusion of our recent Sturm Foods acquisition. Gross margins gained 240 basis points as all three strategic business units enjoyed productivity and purchasing improvements.

Although top line revenues were essentially flat due to dismal soup category dynamics and depressed ingredient sales, our core retail grocery and Food Away from Home businesses bucked the general industry trend with steady solid growth in salad dressing, salsa, jams and sauces, pickles, and aseptic products.

While food retailers, food service operators, and manufacturers alike hit a speed bump in the second quarter, our diverse product portfolio and broad non-supermarket distribution enabled us to sustain positive momentum. Thank goodness, as the old adage goes, that man does not live by soup alone.

Before David and Dennis analyze the quarter, forecast the year, and provide insight into grocery market conditions, I'd like to put our current performance and condition into a long term perspective.

At midyear we celebrated the fifth anniversary of TreeHouse Foods as a public company. While our financial performance and acquisition driven growth are well known I was pleased to discover new statistical evidence supporting our most fundamental go to market premise, that of the TreeHouse foods portfolio strategy.

The Private Label Manufacturers Association, our industry's leading trade association, publishes a quarterly survey of private label sales through all retail grocery outlets. In analyzing the data we measured the performance of our current product portfolio, ranging from legacy pickles to newly acquired powdered beverages over the five years since our Company's inception. In doing so, we are able to track the organic category growth of our TreeHouse portfolio independent of acquisition timing. Results unequivocally confirm our core strategy specifically. As expected, private label growth has exceeded that of brands in a steady series of annual gains in market share.

Next, our portfolio's growth, that of TreeHouse, exceeded that of total private label food by 140 basis points annually.

Finally, our categories, again the existing portfolio at TreeHouse, outperformed all other private label dry grocery by 250 basis points of growth per year.

Perhaps these findings should have been intuitively obvious to all of us at TreeHouse. Even so, it is comforting armed with the facts to know that the market data bear out the vitality of our basic strategic premise just as our financial performance validates its execution. We are clearly in the right place at the right time with the right stuff and once we have it, we know what to do with it.

David?

Thank you Sam and good morning. I'll provide an overview on the operating performance of the business plus provide some comments on the retail environment as we head into the second half of the year.

Total revenue grew 20% due to the addition of Sturm and operating profit grew 46%. Almost half the operating profit increase was due to the legacy business as we continue to improve our mix and achieve productivity gains.

Before I delve into the specific channels I'd like to comment on conditions in both the retail and Food Away from Home environments as these macro trends do have an influence on our business.

First, as it relates to retail, I think it's hard to find many people in the food world, either retailers or manufacturers, who would characterize the second quarter as being better than the first quarter in terms of year over year performance.

Syndicated data for 12 major branded food companies indicated that only one had a better year over year performance in the second quarter versus the first quarter.

Retailers are struggling as well with some price deflation and disappointment that deep discounts are only driving selective purchases versus building store traffic and filling shopping carts.

While some non-traditional, non-measured customers are growing, our market intelligence indicates that conditions are challenging across the board. My opinion, for what it's worth, is that retailers and manufacturers have drifted into transactional relationships versus merchandising relationships and that this shift is limiting innovation and promotions other than just price but the good news is that we are now beginning to hear from large retailers that they need to return to being merchants versus buyers and this is good news for us given our innovation, speed to market, and category management capabilities.

In terms of Food Away from Home, industry traffic declined for the seventh consecutive quarter with all major segments declining in the low single digits, be it quick service, casual dining, mid scale, or fine dining. These declines are on top of low single digit declines a year ago.

Propping up the industry is an increased reliance on promotions to gain traffic. Value meals such as dollar menus increased 20% this year. This led to the quick service industry outpacing other segments but still with traffic below a year ago.

With that background, let me turn to our business which performed very well in this challenging environment.

Legacy revenue declined 1% due to a combination of softness in the soup business and declines in our ingredient and co-pack business that related to both volume and lower contracted pricing. North American retail grocery revenue increased 30% with our legacy revenue up 1%. That 1% legacy growth was in the face of an 11% decline in soup and continued declines in branded baby food.

As I mentioned on the last call when we announced our first quarter results, we had a first quarter benefit from the timing of Easter. That timing had a negative effect in the second quarter especially on cooking soups which are used in holiday meals.

In soup, we saw deep discounting by the national brands. In ready-to-serve soup, branded prices in the second quarter were down over 10%. Promoted cases increased as much as 70% and volume performance was either negative or only slightly positive and this is in the lower seasonal consumption period.

While we are optimistic that the soup category will become less promotion driven, our own soup business has been pretty stable over the past two months which gives me reason to be cautiously optimistic but it is the low consumption season.

Beyond soup, out total legacy North American retail grocery revenue was up 2.7%. We showed continued good growth in salad dressing, salsa, and pickles. Salad dressing continues to be a star for us. Not only are we seeing good top line growth but our 2009 investment in a new high speed production line has really paid off for us and has been a key contributor to our margin gains.

Salsa continues to do very well and we are looking closely at expanding capacity at a lower cost ala salad dressing, to allow us to put salsa on an even more aggressive growth curve.

I'm very pleased with the sales successes we've had so far this year, what we call "big wins." Year to date in retail we have recorded over $50 million in annualized big wins. Initial shipments of most of the big wins take place in the second half of the year. We've had big wins in salsa, dressing, soup, pasta sauce, and non-dairy creamer.

Our Food Away from Home segment again had a good quarter with revenue up 2%, excluding Sturm, with excellent growth in operating profit. Like the retail industry, the Food Away from Home industry was softer than anticipated but we did well by continuing to focus on product mix and leveraging our expanded portfolio. A simple example of improving our product mix is in the growth of our refrigerated pickle business. It's a higher quality pickle with better margins that requires more sophisticated supply chain planning than regular processes pickles and that plays to our strength.

Our industrial and export segment had a soft top line due to Food Away from Home industry trends plus contracted price declines in our bulk powder business but we had a strong bottom line as mix and effective cost and pricing management drove excellent results.

While the Sturm numbers are embedded in the channel data, let me provide my overview. First, top line performance of the business has been good despite the ready-to-eat cereal promotion activity causing the hot cereal category to suffer. The hot cereal market declined over 5% in the quarter. Our business did slightly better than that but was still below last year. The powdered beverage category was basically even with year ago as was our business.

Second, in terms of sales synergies we have had one big win in Food Away from Home and are well along with many other retail customers in the U.S. and Canada and Food Away from Home customers in terms of gaining authorizations in both hot cereals and sugar free beverages.

As I have mentioned many times, the selling process in private label and Food Away from Home is painfully slow but we will get there. After we acquired San Antonio Farms and E.D. Smith it was a few quarters before we really started to see traction and right now many of our current 2010 big wins are associated with salsa and salad dressing.

Before I turn it over to Dennis, let me comment on our second half outlook. We have a lot of things going on in the business related to both driving our top line as well as attacking the center of the P&L. We had an uncommonly good second half last year that we plan to exceed but until we have greater visibility as to what the competitive and retail environment will be like in a couple of our key cold season categories, it is difficult for me to be anything but cautiously optimistic. Those of you who have followed us for a few years must know by now that while we set ambitious goals, we are disciplined and pragmatic.

I'll now turn it over to Dennis Riordan.

Thank you David. In regard to our reported operating results for the second quarter, revenues increased 19.8% compared to last year with nearly all of the increase due to the additional of Sturm Foods. Excluding Sturm, revenues would have increased by 1.1% primarily due to lower volumes and prices in our industrial and export segment.

Total Company gross margins were very strong in the quarter, improving to 23.8% compared to 21.4% last year as legacy margins improved due to a favorable sales mix of Sturm products and internal operating efficiencies.

As we look at our reporting segments, sales in our North American retail grocery channel increased by 30.4% due to the addition of Sturm Foods in 2010. Excluding Sturm, sales would have increased 1.1% as currency exchange offset a 0.7% reduction in unit volumes in the quarter. As David mentioned, the unit volume reduction was driven by lower branded baby food sales and softness in the soup category during the second quarter. Excluding the branded baby food, our total unit sales would have been up 0.7% despite the challenging quarter for soup.

Our direct operating income margins in retail improved to 17% from 15.2% due to the positive mix of higher margin powdered beverages and hot cereal along with productivity improvements in our salad dressing business as a result of last year's plant expansion project.

In the Food Away from Home segment we had very good results as revenues in the quarter increased from $75 million to $80.3 million. Unit sales decreased (corrected by Company following the call) 1.3% as the market continues to be challenged but a positive mix of sales contributed to the revenue increase.

Direct operating margins of 15.7% were significantly better than last year's 10.8% margins as productivity issues in 2009 caused last year's second quarter margins to be much lower than normal. Still, this quarter's margins were an improvement over the first quarter of 2010 as pickle margins continued to improve.

Industrial and export revenues were down 5.4% compared to last year and down 12.5% excluding Sturm's co-pack sales as lower shipments of non-dairy coffee creamer to industrial customers along with lower pricing due to cost pass through contracts contributed to the decline.

Direct operating income however, increased to 19.1% of net sales compared to 16.1% last year due to our continued emphasis on productivity improvements.

Total selling, distribution, general, and administration expenses in the quarter were $56 million compared to $48.4 million last year with the increase due primarily to the growth of our Company. As a percent of sales these expenses were 12.5%, a decrease from last year's 13%.

Other operating income expense of $2 million in the quarter compared to only $200,000.00 last year. The increase is primarily due to a charge to eliminate excess costs in our baby food business. Note that this total charge is $4.6 million as an additional $2.7 million has been recognized in gross profit.

Interest expense in the quarter totaled $11.8 million compared to $4.8 million last year. The large increase was due entirely to the new high yield bonds and additional revolver borrowings that were used to partially fund the Sturm foods acquisition.

In terms of cash flow, we ended the quarter with $887.3 million in debt, a reduction of $35 million from the first quarter of this year. In regard to our revolving credit facility, many of you know it expires in August of 2011. We anticipate we will negotiate a new credit facility this year and we have assumed higher interest costs in our revised 2010 guidance as a result of moving towards rates that are more aligned with current market conditions.

Our effective tax rate for the quarter was 32.9% compared to last year's 34.6%. This year's rate has been lowered due to the deductible acquisition expenses associated with the Sturm Foods purchase.

In total, our earnings for the quarter were $21.7 million compared to $18.4 million, representing a growth of 17.5%. Our fully diluted earnings per share increased from $0.58 to $0.60 a share. However, those numbers include non-recurring or unusual items that affect comparability. Let me now walk you through the unusual items.

As we've reported for the past few quarters, our reported results include two non-cash, non-operating gains. The first is a mark to market on an interest rate swap agreement and the second is a non-cash foreign currency adjustment of an inter-company note with our Canadian operating unit, E.D. Smith. These two items totaled $0.03 per share in the second quarter of 2010 and $0.08 per share in the second quarter last year.

This year we also had two new unusual items. First, we had an additional $0.04 of acquisition related expenses in the quarter associated with the Sturm Foods acquisition.

The second item relates to a charge of $0.09 to write down certain assets associated with our branded baby food business as we adjust our cost structure and asset base to better align with the lower sales volumes of this business.

After considering these one time items our adjusted earnings per share increased by 40% to $0.70 per fully diluted share in 2010 compared to $0.50 per fully diluted share in 2009.

In regard to the outlook for the balance of the year we are obviously very happy with how our first half of the year earnings have progressed. As David pointed out however, the U.S. retail grocery business has been surprisingly unpredictable lately. In the most recent quarter there has been no real improvement in the consumer Food Away from Home marketplace yet unit sales in retail grocery have been sluggish at best. Most packaged food manufacturers and retail grocers alike are reporting decreases in unit sales over the past quarter. While this trend may continue into the third quarter, we believe the retail marketplace will right itself as we progress during the second half of the year so despite those challenging near end trends we remain positive on outward prospects and believe we will continue to outperform the overall food sector. Therefore, we are raising our full year guidance again from $2.65 to $2.70 per share to a range of $2.70 to $2.75 per share.

Sam, I'll now turn it back to you.

Thank you Dennis. At this juncture I usually look forward to our prospects for future expansion via acquisition. This quarter I'll do so in historical context of our go to market portfolio strategy to which I alluded in my opening remarks.

First, M&A is undergoing a revival in the food and beverage space. Within a few short months of our Sturm acquisition, others have since followed suit with significant midsized deals in the customer products segment with the dried pasta, fruit juice, protein, salty snacks, and over the counter supplements categories.

Financing is readily available for market priced transactions, backed by sound industrial logic and operating synergies. I for one, expect that we will see more of the same in the near future.

Second, we are in great condition to pursue another round of strategic expansion opportunities. Total debt is only marginally above three times cash flow while our internal forecasts indicate that we can easily accommodate another $200 million plus or minus deal before year's end.

The Sturm management team has bolstered our acquisition and integration resources with their keen sense of customer marketing and product innovation. Credit market conditions should remain favorable as we undertake refinancing of our $600 million revolver.

Third, and most importantly, buyers and sellers have abandoned the sidelines in favor of the M&A playing field. It is worthy to note that in the five instances of private label deals I just mentioned, all were undertaken by a strategic buyer with an established presence in the seller's principal product category and channel of distribution. As the major players return to the field, both the game itself and current playing conditions favor our TreeHouse team.

Finally, allow me to return to the subject of our portfolio strategy with an overview of our principal private label grocery categories and a report on their progress since joining the TreeHouse family of customer brands.

Pickle margins have gained 540 basis points as we have rationalized our product offering and procurement procedures while closing redundant production facilities.

Powder profits have stabilized despite commodity volatility and industrial price rollbacks due to the introduction of new flavored coffee creamer extensions, line extensions and procurement sourcing initiatives.

Soup, although currently in a category-wide malaise, has benefited from quality and processing improvements and the also important condensed segment has reduced sodium and no MSG formulations have boosted our better-for-you offerings.

Salsa revenue has grown 67% since our San Antonio Farms acquisition and we'll soon undertake a major expansion to boost production capacity.

Salad dressing, a category in which private label has gained four share points since our E.D. Smith acquisition, will soon add yet another high speed, low cost producer blending and bottling line as private label demand continues its rapid growth.

Hot cereal margins, already improved through purchasing economies, will show further gains as lean manufacturing principles are applied throughout Sturm.

And lastly, powdered beverages, in introducing a dozen new flavors this year and also converting from tubs to more convenient sticks will further distinguish Sturm Foods as the category's customer brands leader across all of North America.

On parallel paths, similar progress is underway in our food service, institutional, and industrial product portfolios. As the recession has deepened and the recovery has sputtered, we at TreeHouse have developed and relied upon an agenda of internal improvements focused on innovation and productivity to guide our portfolio through these lean times. My point in reciting this litany is that while your curiosity is always focused on our M&A prospects for the next deal, the real value creation results not from the acquisition transaction itself but from the ingenuity, innovation, and integration that follow. Please keep that thought in mind as we all await the next round of TreeHouse expansion. It is after all, the trademark of our Company without a brand.

Dana will now open the lines for Q&A.

Thank you. The question and answer session will be conducted electronically. (OPERATOR INSTRUCTIONS)

And we'll go first to Andrew Lazar with Barclays Capital.

Mr. Lazar, your line is open.

Good morning everyone.

Good morning Andrew.

Good morning Andrew.

Good morning Andrew.

First just one overall question and then just a couple of specifics, you're certainly not the first company to talk about the broader industry weakness around volume trends and that's been going on for some time now. When you link that up with the weakness we've seen in Away from Home, I guess I'm just yet to hear a really great cohesive answer from industry participants around where that volume is going or is it just that it's a lower overall caloric intake or is it just purely unemployment related and people are just making harsher choices around, within non-discretionary food even, that some things are more discretionary than others? I'm just trying to get a, if you have a better sense of that.

Andrew, this is David. I wish I could pull out my economics undergraduate degree and come back with a very coherent, cogent response. I think it's related to, in terms of why the volume isn't growing, when I just look at what's happening in my own home you just see a little bit more of using up a little more of the inventory that is sitting around the house and all it takes is a little bit of that to affect the markets.

It's almost as though the consumer is sitting there, sitting on the fence in terms of do they step back or do they start moving forward and all it takes is sitting in the middle of the fence for the markets just to stay very, very stable.

In terms of caloric intake, I don't think it's changed at least based on my waistline but I think it is more just that, Sam used the word "malaise" and I think it's just affecting everybody. As I commented in my opening remarks, I also think that from a manufacturer and a retailer standpoint that there isn't a lot of innovation out there. The merchandising and promotion activity that is taking place tends to be more price driven versus imagination driven, putting items together in a display in a store to drive multiple purchases. It seems as though everyone is more focused on transactions versus merchandising and innovation on the retail side.

On the Food Away from Home side, I think that relates as much to unemployment as anything else.

Okay, alright, fair enough and then with respect to your business, first off I know last quarter there was a lot of discussion around price gaps of your private label towards, to the core branded items and at that stage those price gaps have held I think fairly consistent and you saw those results in your volume results last quarter. I'm assuming those changed somewhat more dramatically over the course of this quarter just given what we've seen around some of the branded promotional activity but perhaps you could give us a little more color on where those gaps are now and how you see that changing if at all in the back half.

In the five categories that we have consistently been tracking very close on, and I look at coffee creamers, pickles, relish, salsa, salad dressing, those gaps, when I see a change of a nickel year over year, that to me is not a big change in a gap when the gap starts at $0.60 or $0.70 but it really Andrew, has been in soup in the last quarter. For example, as we look at ready-to-serve soup, match up say, one of our products to a branded product, last year if there was a gap of $0.64 on a can of 18.5 ounce chicken noodle, the gap was $0.64. This year it was $0.31. When we compare to a Chunky soup last year, the gap was $0.56. This year it was $0.23. Those are dramatic changes in price gaps.

Right.

But across the rest of the business, the ups and downs to me are normative. It's soup where it's been quite dramatic. On hot cereal I think what we do is look at what's going on in ready-to-eat cereal and that's been highly visible about some of the manufacturers and a very, very aggressive, deep discounting especially in the latter part of the second quarter.

Okay, and then you had mentioned specific to soup that you were I think more hopeful at this stage than anything I guess, around it becoming a little bit less promotional as we go forward across some timeframe but obviously we have to see. Given that a lot of the branded players will lock in their merchandising arrangements a good six months forward, assuming that some of the branded players have done so for the next couple of key quarters, even anecdotally from what you see should we expect maybe, is it fair to say that the next couple quarters might still be fairly intense promotionally but sequentially a little less than what we saw in the second quarter because the second quarter just seemed like so dramatic across many categories from a promotional standpoint or do we not know that yet?

We have not seen the planned programming for the second half of the year but when you look at the second quarter and at least the articles that I have read about the branded companies and what they're saying, I haven't heard any branded company in the soup category being thrilled with the results that they have achieved given the promotion strategies that they have executed and so the question is, what will they be doing? Based on what I read and the write-ups on those companies, I anticipate that the environment will be better this holiday hot soup season than it was last year but as I said in my comments we need to be cautiously optimistic and be prepared to a certain extent that it's going to continue to be very aggressive.

Right.

But I also mentioned though Andrew, that our business where the soup, for the second quarter while we were down over 10%, we were way down in the month of April and May and June were better and that we're seeing more stability the last couple of months so that gives me a reason to be cautiously optimistic but again, we are in the low consumption season.

Right, okay great, thanks very much.

And we'll go next to Bill Chappell with SunTrust.

Good morning.

Hey Bill.

Just to follow up a little bit on Andrew's call, can you kind of talk about the pricing environment as we move with higher commodity costs? I don't think you have a whole lot of exposure to wheat but in particular, does that slow some of your competitors from the discounting or do you actually see price increases in some categories as we move into the fall or early next year?

Bill, Dennis here. Wheat is a very, very minor piece for us so we really are on the outside of that but I think in general though as we look at our weekly internal commodity calls it does seem that there is starting to get to be some firming going on and although we haven't had any pricing actions at this point, if it continues that's something I think we have to look at in the future but for the most part the most volatile aspect of it, and you pointed out wheat, that that's not a big one for us.

And on the soup category, I think you talked we were in the low season. Are you expecting any change to promotion in your guidance as we move into the fall or are you expecting kind of status quo from what we saw this quarter?

We're expecting to see a bit of a rebound as I indicated. I don't think it's going to stay quite as soft but we're taking maybe a bit of a conservative view in our guidance as to how the soup market will go and we're, as David used the terms, I think "cautiously optimistic" so that's the way we're looking at the soup business.

Got it and then just a couple quick ones. Any, with the charges taken to the infant care business, I assume that that's a near term benefit. Any idea what that helps in terms of accretion this year or next year, and then also, housekeeping, can you just give us what you expect for annual interest expense and tax rate? Thanks so much.

The, first on the baby food, that's a relatively small and decreasing piece of the business so that'll be, the gain if you will on the out will be relatively small so that's really inconsequential.

On the interest rate I don't have a hard answer for you. I will say that in the quarter our interest rate was 1.1% on our revolver and that's clearly well below the market conditions and our anticipation in the guidance is that will be refinanced. I'm not at a position to say exactly when because that's a subject of not only market conditions but also to the extent that any acquisition activities take place so that can be fluid but again, we try to be conservative there.

The tax rate I expect will be pretty consistent. It may tick up a little bit if we get over our acquisition costs but it will be lower than the original 36% we had originally expected.

So just on that, consistent with the second quarter level or consistent with what you're running year to date?

With the second quarter.

Okay so around that 33%, 34-ish range?

In the 34-ish range, yes.

Okay, thanks so much.

And we'll go next to David Driscoll with Citi Investment Research.

Thanks a lot. Good morning everyone.

Morning, David.

Just big picture here, so if you guys were maybe $0.07 or so above consensus, you raise your guidance by a nickel. Is, this is a hard one right now for me. You guys have been conservative in all of your forecasts but you really are calling out like a deceleration in the volume trends in retail and I think some of us are worried about this so can you talk to me a little bit about what's the telegraph here? Is it really the number one issue is we are seeing the slowdown at retail or are you guys just doing the same thing that you've been doing for awhile and just giving us a good solid forecast that has conservatism embedded into it? So help me understand the guidance relative to the beat today.

Dennis here. Two items, we've got now five years of being relatively conservative. We are not changing our feathers in this quarter but I think the big item that you need to be baking into the numbers as I indicated was the expected change in the refinancing compared to year ago numbers. As I indicated, that 1.1% rate on the revolver we experienced in Q2 will definitely not happen once it's refinanced and our expectation is it will be refinanced this year so we've ticked up the numbers for that interest and that's a key component of the year over year change that might occur in the back half.

Okay, going to David, your comments on soup. When I listen to what Campbells says, they really make this argument about the simple meal category competition as soup just being one of many simple meals and that their analysis is that they saw just significant pressure on prices effectively, that other simple meal categories were just better positioned in the year. If that analysis is right, it doesn't seem logical for me to think that in the next soup season the promotional environment gets better for us. It would seemingly say that soup needs to be aggressive on price in order to maintain its share of the simple meal category. Can you respond to those comments?

David, I certainly don't have the insight into their price elasticity modeling with simple meals in order to be able to validate it. All I would comment on is that the deep price promotion to compete that way doesn't seem to have paid off for anybody. Therefore, I'd really have to look at a different approach to the market going forward.

But you seem to be confident that we would see a better environment going forward and I just, I want to come to that conclusion but I'm really struggling in getting to it just given the fact that the promotions didn't seem to work as well as they'd like and I don't necessarily see a really different strategy emerging for next soup season so that's just my point. You seem to be confident and I was kind of hoping you really could convince me.

I really don't, it's the dialog that you need to have with the branded companies. All I would say is that if I had executed a big program and did not have results that paid out I'd certainly be looking at changing my strategy and my tactics.

David, this is Sam. I'd also echo my earlier comments that as important as this business is to us now it's one part of our portfolio and we will manage it very closely and carefully as we do and I think it will have at the margin, an effect on our business but if you look at this quarter where the category is down 11% and yet our earnings and cash flow from our North American retail business were very strong even before the addition of Sturm.

That's a great point. Two more questions for me if I may. The first one is just going back to the hot cereal category. I appreciate the comments you were making about looking at cold cereal and how that might impact the hot cereal category. Have you seen any change in this very, very aggressive promotional environment, like most currently, I'm not really talking about the reported results from these other guys but just when you talk to your retail partners, have you actually seen any rationality even start to creep into this or is it just as intense as what we've heard second quarter results turned out to be?

No, I think we will see, you'll certainly see, there has certainly been through July and probably into early August, some of the aggressive activity because I think it's just, I'm hopeful that it's winding down. Every company that has been talking about the cereal category is very disappointed with the results that they're getting as they have seen in soup.

Okay so it's still ongoing but your expectation is that perhaps it's winding down?

Yes.

Final question, productivity savings and I apologize if missed this if you said it but can you comment on what you expect productivity savings to be in 2010 and potentially '11 if you have that number?

We don't David, quantify the dollar number. What we said going into the year was that we expected the year to have relatively flat input costs and no pricing of consequence yet. We, our goal is to raise our gross margin on our legacy business by 100 basis points and we've also said that's a near in goal for 2011 as well so if you think about the productivity, it should net to a roughly 100 basis point improvement in gross margins.

And David, productivity is a combination of better mix and operating efficiencies.

So the environment, the commodity environment doesn't worry you about '11 thus far?

At this point it's something we're monitoring but it's not something that is overly concerning to us.

Really appreciate the comments, thank you.

Thanks.

And we'll go next to Akshay Jagdale with KeyBanc.

Good morning everyone. This is Adam Josephson in for Akshay. Thanks for taking my questions. Forgive me if I missed this but what was Sturm's sales growth in the quarter?

We didn't report that out but I think in my comments I said that hot cereal was down slightly because of the market. The market was down 5% and our business was down less than that and that the powdered beverage category was flat and our business was pretty stable year over year.

Okay and related to Sturm, jumping on David's question pertaining to the hot cereal category, has your view of the category changed at all since you bought Sturm?

No, not at all. We think of it is a, continue to believe it is a very good category. There are a lot of health benefits associated with it. I was happy to read a report last week from Quaker where they were talking about reinvesting and really reinvigorating the Quaker cereal brand because of those benefits so it's a great category.

And lastly, you talked about costs earlier. Can you give us any sense of your expectations for cost inflation over the next few quarters?

Yes, for the next few quarters we should be in pretty good shape because we typically have forward contracts out that go six months to a year and generally we're locked in for the next six months almost 100% on our key inputs so the second half of this year, we don't see any issues and we're looking at obviously 2011 and starting to layer into that but for the next two quarters, it should not be an issue for us.

Terrific, thank you.

Sure.

And we'll go next to Farha Aslam with Stephens Equity Research.

Hi, good morning.

Good morning.

Good morning.

When you go and look at the retail environment currently, are you going to market any differently now? Are there new tools that you can use once you do see the promotional programs that the branded players put in? I know private label there are some limits in terms of how you can go to market but are you doing anything differently in this environment than you have in the past?

This is David, Farha. No, we're really not. The keys for us are our R&D capabilities for new items and our speed to market along with our category management capabilities. I think that as the market starts to shift back towards more merchandising and innovation, we're going to be very, very well positioned.

And when you're talking to your retail partners about the fourth quarter have you, in your conversations have they come to you and said, "Let's review innovation. Let's see what we can do differently." Have those conversations already started?

Yes they have. In fact, I spent all day Tuesday with one very large retailer talking just about that which is we went through category by category all of our innovation capabilities, new items that we are prepared to launch and the importance of private label, off shelf merchandising so it was pleasant to have that kind of conversation versus just transaction oriented conversations.

And my final question is have you heard retailers being dissatisfied with their private label volumes and profitability in the current branded promotions and do you think that's going to be one of the things that's going to change how they go to market going into the future?

I don't think they've been disappointed by their private label programs. I think that where the disappointment has been is that when they have been deep discounting some of the branded products they're just not getting the consumer response that they would hope. People are, consumers are being very selective in their shopping so it's not helping the retailers build traffic or fill in the shopping cart.

Okay, thank you very much for your comments.

We'll go next to Jonathan Feeney with Janney Montgomery Scott.

Good morning, thanks very much.

Hey Jon.

David, you made a comment about, I thought that's an interesting point about the sort of pantry de-loading in reference to Andrew's question. Do you have any, I mean, I know Campbell isn't really public about the statistics that they have. Do you have any good statistics across any of your categories about pantry levels and are you seeing any sort of hard evidence that that's the case across some of your categories?

Jon, my comments are from articles that I've read and anecdotal but I certainly have not seen any statistics. I do know that there has continued to be reductions in retailer inventories and that certainly has an effect on the manufacturer. That doesn't have an effect on the retailer's volume per se.

I also wanted to follow up on the promotional execution comment. The comment was made that deep discounting isn't driving the kind of basket that retailers would like and I think that's right. I mean, something's not driving the kind of, something's not working because the baskets aren't filling up yet I guess, are you seeing any retailer actually act tangibly on that insight and say hey listen, we're going to raise prices, back off on promotions and kind of come what may for our comps? I mean, there's one public retailer that sort of has that strategy right now of the three majors but is there anybody at the margin, over the past two months you've heard take a step back and say hey, these discounts aren't working so we're getting rid of them totally.

I think you made the comment that there is one very large retailer who has commented on it and we are optimistic that that will help start directing the ship in the right direction in total which is being more aggressive in displays, in merchandising versus just pricing it. So that's part of my reason for being cautiously optimistic.

Jonathan, this is Sam. I'll offer the observation that when one gets outside the syndicated channels of the supermarket channel we see our shipments to those that have made customer brands a centerpiece of their strategy. Those shipments continue to be very strong and those retailers I think continue to lead their brethren in the supermarket channel.

So you're saying the non-measured channels?

That's correct, particularly those customers who have made customer brand foods a center of their strategy.

You certainly saw that from Costco this morning. Great, well okay, that's all I had, guys. Thank you very much.

Thank you.

And we'll go next to Ken Goldman with JPMorgan.

Good morning.

Good morning Ken.

Good morning Ken.

Good morning Ken.

You talked about how you've been having conversations lately with certain large retailers about your innovation which obviously is a good sign but one of the conversations I've had with you guys in the past is about how sometimes retailers really look for branded manufacturers to lead the way with innovation and they won't necessarily take innovation from private label until that happens. Is that something you see as shifting or do we necessarily maybe have to wait for some of that innovation cycle to play out until your next products hit the shelves? I'm just curious how you think about the timing I guess, of innovation in helping your top line.

I think -- Ken, this is David again. The key for our innovation is working with retailers to look at a specific category and how they are segmenting that category and our opportunities to help them fill in portions of that segment. For example, with salsa we really operate in the premium segment of the salsa market and what we really work with retailers on is understanding where the category is, where it is going, how a premium offering can help category growth and that we are the manufacturer with our R&D capabilities to deliver that.

So what we are not doing per se is investing heavily in branded type innovation but it is really more within specific categories and how to better segment those categories.

Okay and you had mentioned I believe that powdered beverages were flat year on year. Was that a bit of a disappointment to you, I mean considering what a hot summer it's been or is that what you expected? I know it's a little early in Sturm to start making large judgments but I'm just curious how that played out against your forecasts.

I think as we looked at all of our categories in terms of year over year growth from the first quarter to the second quarter, most of our categories and then throughout the whole grocery industry, the year over year growth rates were a little more tepid and I would have hoped that powdered beverages would have defied the laws of gravity but the category -- I mean, the category I think did fine. Again, those are the syndicated channels. So we're not disappointed. We see a lot of good innovation that is taking place within the category so we're very pleased with that.

Okay and one more question, now that you've been hit a little bit by some heavy promotional activity in soup and in cereal, are there any other categories you're seeing that we may be not seeing in some of the syndicated data, where promotional activity is heating up that may directly affect you, and not just categories that you're in but maybe any tangential categories much like ready-to-eat cereal affected your hot cereal?

No, most of our categories we don't see any of the, except for soup and hot cereal and frankly, I don't spend a huge amount of time looking at what's happening in ketchup versus salsa but from the price promotion activity and everything else it's really just been in the cereal, in the total cereal category and soup that it's -- and I think as Sam pointed out, our portfolio is now broad enough so that if any one or even two categories have escalating competitive activity we're able to drive the rest of the portfolio to help to offset those challenges and when you look at our salad dressing business, how well it has done, we've got a good portfolio and a good mix of businesses to withstand that kind of heat.

Okay, thanks very much.

And we'll go next to Robert Moskow with Credit Suisse.

Hi, thank you. David, I just wanted to know, you said that commodities don't look like they'd be a problem right now for 2011 and I'm just wondering at what point do you think that rising commodities might actually be a positive because it might help you justify some price increases with retailers or is it just way too early to even broach the subject?

Rob, Dennis here. I think to be honest, you're right that a slowly increasing controlled commodity environment is actually something we can very easily deal with and it certainly allows an opportunity for some pricing so you know, the problems are the wildly swinging ones up and down that we had a few years ago. So the environment, although it's starting to inch up it seems very controlled and that's why I said that doesn't seem to be a concern to us right now because given where we're at for the balance of the year and looking for next year, hopefully there will be opportunity in that as opposed to risk.

David, do you have any, have you started any conversations in that regard with customers?

No, not at all and principally because as we're looking forward we are well covered through the end of the year and with some commodities into the beginning of next year and there's no need at this point to have those conversations.

Okay and then just one quick follow up. The numbers for profitability on Sturm were a little bit below what we had modeled. It doesn't sound like you've lowered your expectations at all for what that division can deliver for 2011 but then again, you've got a tough consumer environment and maybe even a tougher retail environment. Maybe they're -- and you bought a business that was probably growing double digits so can that business still grow double digit in this type of consumer environment?

Our plan was to, we weren't looking at top line growth of double digit but solid single digit and we are in front of many customers, retail customers in the U.S. and Canada and Food Away from Home customers in the U.S., developing programs and as I've said many times, it's a very, very slow process but when we're able to get in front of the customer and talk about our R&D capabilities, our ability from category management to help them build it, we're getting a very good reception that -- it takes months up front to go through this process but no, we continue to be very, very optimistic about where we will be with Sturm.

Okay, thanks a lot.

And we'll go next to Bryan Spillane with Bank of America.

Good morning guys.

Morning Bryan.

Just a question on the M&A environment, Sam, you had mentioned that maybe there is an increase or there is more potential sellers in the market right now and so can you talk about first, and if I remember it correctly, you had a list of targets or companies that you had been sort of looking at over time and had developed relationships with so is that list expanding, first? And then second, if there's going to be more properties for sale, does it change at all your thought about maybe moving into other sections of the grocery store whether it's chilled or sort of getting out of the, expanding beyond just the core dry grocery segment?

Let me answer the second part first. We see far greater opportunity in private label dry grocery now than we had originally and we intend to stay there. We've just completed a three year strategic planning process and I was quite pleased to see the number of adjacencies to our existing categories and the number of categories in other sectors where we currently do not participate that show very favorably in our acquisition filter both in terms of their growth and their fundamental economics, their potential for economic value added.

Moving closer in to the current situation in Canada, the important thing is not only have sellers come to the market but also buyers and you need both to really create a really robust environment and I think we've seen in the last several months more than we had seen, relevant deals, in the last several years.

With regard to our particular scope I think I described it when we got down to Sturm, that approximately half of our bakers' dozen on our high priority list were in that, the list of eligibles at the time we had done Sturm. It was then and remains the best of those candidates.

Of the others, the great majority with one notable exception are still ones that we have a great interest in and then I will say that with regard to Sturm, it has led us to begin to look at powder and blending technology on a broader basis. If you'll remember we have 400 million pounds of non-dairy creamer in industrial sales and what we are seeing now is that our industrial might combined with Sturm's innovation offers an opportunity to look at blending operations and dry powder operations in agglomerated products in a much more specific way at a broader group of attractive candidates.

And then just as a follow up, is there -- you know, you've got a few things I guess that are, I'm assuming are sort of driving the M&A market. One is that financing is relatively inexpensive. It's a tough environment so I'm assuming on some smaller companies this is putting some pressure on maybe some smaller operators.

And then I guess the third is is there any potential changes in taxes going forward? Is that also accelerating maybe that process -- I'm just trying to get a sense for if things, if those are the factors that might be accelerating the M&A market.

I do think that privately held companies are, and particularly smaller ones, are under increasing pressure here and it's not only from the state of the economy but from the expectations of their customers whether they're in the retail grocery business or Food Away from Home. In the long run, that works to our benefit.

With regard to the tax issue, we really regard that as anecdotal and it may create for a short window a one quarter or a two quarter acceleration but when you look over our time horizon which is basically to, in every 12 months following an acquisition, pay down a full turn of debt and put ourselves back into position to do another large scale acquisition, that really is a minor factor.

Alright, thank you.

And we'll go next to Vincent Andrews with Morgan Stanley.

Thank you. Good morning everyone. My questions have been actually already been answered so I'll pass it along, thanks again.

And we'll go next to Reza Vahabzadeh with Barclays Capital.

Good morning. My questions have also been answered. Just on the leverage area, I just did not make what you indicated was your pro forma leverage as of now for full year contribution of Sturm, and then where you would like leverage to go in order to be able to take advantage of organic as well as acquisition growth opportunities.

Sure, this is Dennis. We, I indicated we reduced our debt by $35 million in the quarter and our pro forma leverage is just under 3.2 now.

And where would you like that leverage to go?

Well, it's -- we de-lever very quickly, in the range of maybe 0.8 turns a year, close to one, so that's where that's going to go. Obviously we'll continue to de-lever but the next deal that comes along will change that so it's -- we don't have a low end target. We like to live within our credit agreement which allows us to go between, as a general top end of 3.5 times but four times with an acquisition and that's what we've had over the last four years so we'll live within that range.

Thank you much.

Sure.

And we'll go next to Heather Jones with BB&T Capital Markets.

Good morning. You had mentioned earlier that the non-measured channels continue to outperform the traditional channels but I was wondering if sequentially from Q1 to Q2 did you see a similar slowdown in those channels as compared to traditional channels?

Heather, I don't have that specific data but my bet would be that the answer would be yes but I don't have the facts right in front of me.

So sort of broad based?

Yes.

Okay and then moving -- I know several people have asked questions on input costs but for you specifically, soybean oil has moved up, oats, paper, and I guess I'm just wondering if you could give us a sense of your view of retailers' willingness to set price increases at this point and given increasing consumer malaise, what your view of what the impact would be on the consumer. Could volumes fall further? Just if you could give us some sense of as we move into 2011 and we've quickly moved from a deflationary environment to an inflationary environment on the input cost side, how you would think that could be handled.

This is Dennis. Typically, as we've done in the past even when we've had high periods of input cost inflation our process of pricing is usually a one on one with our customer, going through the components of their product and as we go through the components if in fact soybean oil or packaging costs are rising we've laid that out and we work together on how to get the pricing necessary or if required, repackaging, reformulations and other changes that might help to keep the costs down but unlike a branded company, our process is collaborative and one on one. As David has said in the past, it's fact based selling so we remain as confident as ever just as we were in '08 when things went crazy that if there is a gradual increase in costs that we'll be working together to price accordingly.

I understand that. I guess I'm sort of asking you to speculate as to the consumer. I mean, would you expect these price increases, do you think there is a significant risk that this could exacerbate the volume weakness we've seen? Should -- just broad based, not just TreeHouse but just on a broad based basis, people having to, manufacturers having to raise price.

Heather, this is David. I think when we go back and look at '07 and '08 when commodities soared and retail prices escalated, category performance was really quite good, not just in our categories but across the food industry and what's curious about the current environment is that prices are very stable and in fact, certain categories there is deflation and the categories have not done particularly well but when the prices went up it did not have an effect on consumption.

Heather, this is Sam. My view is that the consumer behavior in this instance is far more driven by their expectations with regard to employment and their expectations with regard to things like housing prices and what we have seen in the past is that when those expectations are largely negative they overshadow all other factors and I think it appears now that we will have a slower recovery than originally anticipated and that those are the two areas that are the most difficult. Our view is that they're going to get better and it will be slower. They'll have a greater impact than the list price per se of a given consumable.

Okay, alright, well thank you for your comments.

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We'll go next to John Anderson with William Blair.

Good morning, thank you.

Good morning.

Hey John.

Hi, just a quick question on infant feeding. It looks like that has eluded volume growth by about a point and a half in the retail business in the quarter. Where are you with that business today and what kind of impact should we think about going forward?

It's a very small part of the business, very little. The branded side has been declining for quite a few years, very small, modest if any impact on earnings per share so as I said, we're going to continue to deemphasize the branded side while at the same time we are a, have a meaningful business in co-packing of infant feeding.

Okay and I know you talked about Sturm at least a couple of times already but just one quick follow up there. David, you mentioned you've been in front of many customers. I'm just trying to get a better sense for the reception that you're receiving and how long it typically takes to secure new distribution there and when this could begin to have an impact on sales and volumes going forward.

I would think that we would, I am hopeful that we will bring on new business that will start benefiting Sturm in the beginning of 2011. We have had some good wins, one good win in Food Away from Home and every week we go through our key account list and the sales calls that we're making in the progress but I don't anticipate anything meaningful until early next year. We saw the same thing John, with San Antonio Farms and E.D. Smith. It takes a long time to present your story, displace a current incumbent, and to start moving forward, painfully slow time.

Okay, one just quick clarification and question. When you talk about productivity savings and an objective of 100 basis points I think this year and also goal for 2011, is that purely from your cost savings program? Is there a mix component to that and if there is a mix component, what's driving the mix benefit? Is it the introduction of higher price point private label items or are there other things in there that we need to consider as well? Thank you.

John, Dennis here. The vast majority is really cost and we look at it in two ways. Clearly, the operating efficiencies we can gather at the plant whether it's through productivity changes, lean manufacturing, etcetera and also in terms of our purchasing as we look to better purchase existing products and look at ways to take costs out of other products through the purchasing so that's where the bulk of that is and the mix side can help but it's a small piece of that.

Okay and at this point, given kind of what you know about commodity costs, given what you know about new product opportunities, are you comfortable at this level or not overly concerned that the 100 basis point objective this year and next is still in tact?

We're comfortable with that, yes.

Okay, thanks a lot guys.

Sure.

And we'll go next to a follow up from Andrew Lazar with Barclays Capital.

Great, thank you for taking the follow up. Just two quick ones -- one, David, just a last one on soup would be are you concerned at all or have you had any indication that the weakness we've seen in the overall category of soup of late but really for like the last couple of years at the end of the day, that that's causing retailers to think differently about either how they shelve or how much space they give the category as a whole or you know, more significant changes in whatever, category captaincy or the kind of conversations they're having with you from a private label perspective. I know retailers move sort of slowly but it's been a couple of years now and I'm just wondering if there's anything more dramatic there that could potentially unfold.

I haven't heard anything about -- I mean, everyone is certainly disappointed in how the category is doing but it is still a very important category. The margins for the retailers are very good. I think what they are looking for is the innovation, new items, advertising, that will help the category at a minimum stabilize and in certain segments to be regrowing but I think everyone is frustrated by the results but not to the point of saying well, we're going to reduce shelf space. I haven't heard any of that at all.

Okay and then on the last call I think you guys gave guidance for a full year kind of organic sales growth rate around 2% or so. Is it your -- I mean, I know all of that has to play out obviously in the back half but is your sense that that might be overly optimistic or are some of the new product wins that you see coming on line I think you mentioned in the second half, ultimately $50 million worth on an annual basis. Can some of that offset some of this core weakness in soup and others to still get you to 2% or is that at this stage, overly optimistic?

No, I think in the first half of the year we were pretty close to the 2% top line growth. That's still on our target and I think hopefully with a lot of the wins coming in we'll be able to achieve that so I don't think it's -- it's still within our reach.

Okay and then I guess the very last thing and we've talked about this a lot already on the call but I think you're getting a sense that from a stock perspective really for a lot of the group, not just TreeHouse, everything seems to be now kind of hinging on do we, basically, is the second quarter set of results for the group, are we going to look back on that and ultimately say hey, that really was the peak in competitiveness if you will, from a promotional standpoint, for the overall packaged food group and even if the back half is still pretty competitive, it's sequentially less so. I think that's the big question, right, that everyone is I think trying to get a better sense of and I know that your sense is hey, hopefully that's the case. There's reason to think that given what's not worked it could be but I don't know, anything that you have that would suggest either from your conversations or what have you that, or changes you've seen of particular retailers that would make you feel like really confident that's going to happen in the next two quarters or is it still really out there?

Andrew, this is Sam. My view on it is that we are seeing, we have seen or are now seeing the bottom of this and that's more anecdotal than it is statistics. We, you have to remember here that there are several large categories that are effecting this primarily through syndicated channels and that while we are suffering on a broad scale from the state of the economy that really the bad practices are fairly isolated here although they are concentrated. We have seen from leading retailers statements about returning to merchandising and a realization that the recovery in the economy has sputtered and that expectations of being able to kind of ride a wave out were misplaced and now some of the biggest and best are ultimately espousing a return to being marketeers in their stores as opposed to those focused on kind of transactions with their suppliers.

On a manufacturer's side I think for the most part you're seeing investments that companies are making in both their capital structure and in their brands. There will continue to be that quarter to quarter, really not temptation but reaction to keep plants running but I think we will have looked back and say that this was not the beginning of the end but in fact the end of the beginning of this phase.

I always appreciate your thoughts, thank you.

And with no further questions in the queue I'd like to turn the conference back over to Management for any additional or closing remarks.

Thanks Dana. I'd like to thank everybody who was on the call and appreciate taking your detailed questions and trying to provide a greater understanding of our business and we'll look forward to our next get together in November if not sooner than that. Thank you.

That does conclude today's presentation. We thank you for your participation.