TreeHouse Foods Inc (THS) 2014 Q2 法說會逐字稿

Welcome to the TreeHouse Foods conference call. This call is being recorded. At this time, I will turn the call over to TreeHouse Foods for a reading of the Safe Harbor statement.

Good morning. 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, approximately, nearly, intends, predicts, projects, potential, promises 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 achievements expressed or implied by these forward-looking statements.

TreeHouse's Form 10-K for the period ending December 31, 2013 discusses some of the risk factors that could contribute to these differences. You are cautioned to not 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 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. At this time, I would like to turn the call over to the Chairman, President and Chief Executive Officer of TreeHouse Foods, Mr. Sam K. Reed.

Thank you, PI. Good morning, all and welcome back to our TreeHouse. As of midyear, 2014 is proving to be the most epical of our nine-year history. Dennis and I will review our second-quarter progress, recent events and latest outlook for the year before turning to the coming year ahead.

In order to place our present condition and circumstance in strategic context, I would like to return to our mid-year analyst call of last year. At that time, a short 12 months ago, we were well along the road to post-recession recovery and the acquisitions of Associated Brands and Cains Foods. I then characterized our 2014 prospects as a quality-of-earnings model of increased profits based upon productivity, strategic top-line growth in private label and external expansion through acquisitions.

A year later, after seven successive strong quarters, we have expanded our revenue base approximately 40% through two growth-oriented acquisitions, posted organic growth of 6% in grocery channels, improved legacy margins, raised new capital and successfully reverse-engineered branded single-serve beverage technology. As I had foreseen a year ago, much has changed for the better at our TreeHouse.

Before Dennis addresses our performance and outlook in more detail, I'd like to expand further upon our extraordinary progress in private label single-serve beverages. Five weeks ago, shortly after the Fourth of July holiday, we declared our coffee independence to our customers in successfully developing prototype single-serve cups that are 2.0 compatible. This is only the latest in a series of advances that mark our consistent private label leadership in this burgeoning category.

In four short years starting from a zero base, we have established a private label business that leads the category accounting for more than three [score] specialized private label programs, each tailored to our customers' unique Retail Grocery strategies. We have now initiated commercialization of our prototypes and will convert them to scale production for retail distribution before year's end. This massive undertaking involving more than 300 SKUs is yet another example of the close cooperation between our grocery customers, their custom products and our unmatched commitment to their private labels. Once again, we have earned the gratitude and trust of our customers, thus confirming our private label go-to-market strategy and our excellent prospects for continued expansion.

In anticipation of Q&A, please allow me to remind you of our corporate policy regarding ongoing litigation. We cannot comment upon details of our reverse-engineering or process due to the pending litigation with Keurig Green Mountain. Our lawsuit, which is a matter of public record that speaks for itself, is unaffected by our progress in developing our own second generation of cups.

In summing up our single-serve beverage program, I say to one and all, this is what we do, have done and will continue to do to provide value without compromise to our private label customers and their consumers alike. Now let's turn to Dennis for both his financial observations and business insights. Dennis?

Thanks, Sam. In regard to the financial results for our second quarter, we had another quarter of very good top-line growth. Although much of our organic growth has come from our single-serve hot beverages, our second-quarter had positive sales growth in many of our core categories, including pickles, which grew 2.9%, Mexican sauces up 4.3% and aseptic cheese and puddings up 8.2%. Clearly, there are challenges in the broader food sector, but our sales and marketing teams continue to find ways to bring new products and innovations to existing customers while also taking private label share in new accounts or categories.

So turning to our North American retail segment, we did have a very good quarter. Total sales increased 18.2% driven by 13.5% from acquisitions because last year did not include Cains, Associated Brands or Protenergy while 2014 had full quarterly sales for two of them plus one month of sales from Protenergy Natural Foods.

As we look at the legacy businesses, we had a very strong volume mix increase of 6% driven by single-serve hot beverages, pickles and salad dressings. These categories more than offset the continued weakness we have seen in hot cereal as that category has been highly promotional all year and as you know, when brands rely heavily on promotions, private label volumes can suffer.

In regard to the pricing environment, our average selling prices in the quarter were relatively flat, down 0.3%. This is a balance of price increases that were required to recover some input cost changes and price investments that needed to be made in some cases to take additional marketshare.

One trend that is continuing to develop is the reemergence of the traditional grocer. Our sales to full-line grocers continue to recover with sales up in the quarter by 3.2% over last year. This contrasts with some weakness we are seeing in a couple of our premium segment accounts. We see more traditional grocers, both large and midsize, placing more emphasis on the better-for-you food segment with premium private label products. This is one of the reasons why we are so focused internally on reformulations and new products that appeal to customers who desire natural or organic products.

Our gross margins in retail increased 30 basis points from 22.5% to 22.8% in 2014. This represents a combination of margin improvement for our legacy Bay Valley Foods business, partially offset by the mix of lower margin products from our recent acquisitions. Excluding acquisitions, our gross margins were up approximately 100 basis points in the quarter and this is actually right on our original expectations. Direct operating income in the retail channel totaled $73.2 million, an increase of 19.6% compared to last year. This compares favorably to the 18.2% increase in sales with the improvement coming primarily from better gross margins.

In regard to the Food Away From Home segment, the new Cains Foods and Associated Brands businesses were the primary reason for the 13.6% increase in total sales. Excluding acquisitions, our sales in this channel were flat, which considering the broader Food Away From Home channel is very much as expected. Gross margins in this business declined from 19.8% to 18.6% due to the mix of new products.

Our aseptic business, which was a contributor to our first-quarter margin erosion, is back on track and finished the quarter with margins up almost 100 basis points from last year. Our pickle margins are still a bit soft due to the higher priced cucumbers we need to supplement the lower than planned receipts of certain cucumbers sizes from our contracted growers.

Our Industrial and Export business had a large sales increase of 33.1% with acquisitions totaling 25.6% of the increase and 8.7% of the increase coming from new co-pack business. As we have mentioned in the past, the top line in this segment has a tendency to move up and down based upon co-pack business that can be very opportunistic based on availability of production capacity. Direct operating income, however, tends to be relatively steady and this is the case again this quarter. Our direct operating income totaled $13.5 million, which was flat to last year's second-quarter income.

Turning to our total TreeHouse results, our gross margins improved from 20.8% last year to 21.6% this year. Excluding the effects of unusual items, as detailed in our press release, gross margins would have been 22.3% both this year and last year. Margins are flat to last year for two principal reasons. First, Canadian exchange rates are lower this year compared to last year and that had the effect of lowering margins by about 40 basis points. Second, the addition of new business compared to last year changed the overall mix of the portfolio resulting in lower margins of 80 basis points. Overall, we are comfortable with the margin-enhancing activities of our operating teams.

Moving to operating expenses, our selling, distribution, general and administrative and amortization increased to 14.4% of net sales compared to 13.1% of net sales last year. These expenses include the unusual items that are removed in determining our adjusted earnings per share. Excluding the impact of these one-time items, the bulk of the increase is due to higher depreciation and amortization resulting from three acquisitions since last year and higher incentive compensation expense in light of the very good results so far in 2014. I do want to point out that adjusted EBITDA as reported in our press release this morning remained steady at 13.9% of net sales despite the addition of lower margin business from acquisitions.

As we look at the non-operating parts of the income statement, interest expense for the quarter was down $3.2 million due to lower interest rates associated with the high yield debt refinancing. With regard to taxes, our effective tax rate for the quarter was 35.5%. This rate is up from last year's rate of 33.4% and up slightly from our original guidance for the year. The increase is due to an increase in state tax expense, acquisition-related expenses that are not deductible for tax purposes and the tax impact of a shift in revenue between jurisdictions.

Net income in the first quarter was $21.8 million compared to $18.6 million in last year's second quarter. This equates to fully diluted earnings per share of $0.57 in the quarter compared to $0.50 last year before considering unusual items. And after adjusting for the unusual items highlighted in our press release this morning, primarily the refinancing costs this year and plant closure costs last year, our adjusted earnings per fully diluted share for the quarter increased 29.2% to $0.84 compared to $0.65 last year.

In regard to the outlook for the year, we continue to track very closely to expectations. We previously estimated that the acquisitions of Protenergy Natural Foods would add between $0.05 and $0.07 in adjusted EPS in 2014 while Flagstone Foods would add between $0.05 and $0.08 in additional adjusted EPS. We are reaffirming those earnings estimates and believe that the full-year earnings per share will be in the range of $3.60 to $3.75. These earnings-per-share estimates are based on an additional 4.9 million shares outstanding beginning July 22 when we raised gross proceeds before fees of $374 million from our secondary share offering.

Before I turn it back to Sam, I want to provide some additional color on our most recent acquisition, Flagstone Foods. Flagstone is an $800 million producer of private label nut mixes, trail mixes and dried fruit with an emphasis on the perimeter of the store as opposed to center of the store commodity nuts. We believe this is where eating trends are heading in the US and Flagstone is perfectly situated to take advantage of these trends. They have had substantial organic growth over the last three years and we expect to see continued low double-digit sales growth in the near term.

In addition, we see Flagstone as a new branch of our TreeHouse with the ability to be the foundation for future growth in snacks and value-added fresh products. This will be a great complement to our existing center of the store business and allow us to continue our acquisition strategy in categories throughout the grocery store. Together with Protenergy Natural Foods that we completed in the second quarter, these companies add nearly $1 billion of new revenue to TreeHouse and further diversify our portfolio. We now have 25 food production facilities in the US and Canada and nearly 5500 employees.

We completed the Flagstone acquisition on July 29, so we will have about two months of their results in our third-quarter financial statements. Although this is a little sooner than we thought, it will not change the accretion estimate of about $0.05 to $0.08 in adjusted earnings in 2014. As I mentioned earlier, we funded the transaction in part with a secondary share offering on July 22. On that day, we issued approximately 4.950 million shares at an average price of $75.50, which resulted in gross proceeds before fees of approximately $374 million.

In addition, we entered into a term loan with our bank group for $200 million at substantially the same terms and pricing as our revolving credit agreement. So as of yesterday, our outstanding borrowings looked like this -- $400 million of high yield notes at 4.875%, a $300 million term loan A, a $200 million term loan A and $670 million outstanding under our revolver. The average interest rate for the term loans and the revolver are about 2%, so we continue to enjoy a very low interest rate on our debt and with only $670 million outstanding under our $900 million line of credit, we have plenty of liquidity.

On our last call, we discussed terming out a portion of our revolving debt to the high yield market. We are still considering this and will take advantage of market conditions when the time is right for us. Rates continue to be very attractive and we believe they will stay that way for the near term. We expect that any such refinancing will directly free up revolver space for us and would be at a rate that would be close to our current high yield notes.

In terms of leverage, we expect to have a leverage ratio of between 3.5 and 3.6 times debt to EBITDA as of September 30 with strong fourth-quarter cash flow delevering us to close to 3.2 times debt to EBITDA by year's end. I think this demonstrates that we can and will seek great companies to buy, but we will do so with a prudent capital structure. We know the challenges of running a growing company well and believe our approach to growth is the best way to ensure long-term shareholder value. I will now turn it back to Sam for some closing comments.

Thanks, Dennis. Now as I did last August, I would like to turn your attention to our future prospects for the new year ahead and beyond. Given that I am prone to making forward-looking statements, please note that I foresee great opportunity ahead for sustained growth in private label food and beverage as our industry evolves beyond its traditional norms and conventional NBE or national brand equivalent model. Change resonates throughout the marketplace as the opportunities for private label growth shift with population demographics, consumer attitudes and behavior, health and wellness, customer brand ascendancy, social media-based marketing and same-day home delivery of household staples.

While we are generally fast followers of national brands, we must also adapt to these changes seizing the lead selectively when and where strategic opportunities arise. For example, when assessing the future prospects of our customer brands and custom products, consider the following. In acquiring Flagstone and Protenergy, we have elected to follow the consumer around the grocery store and into the millennial era of private label. Flagstone bridges center of store staples to perimeter healthy snacks and in crossing that divide links their abounding innovation with our abundant capital in pursuit of double-digit growth. We envision a healthy snacks platform that will be steadily expanded into new distribution, product adjacencies and perimeter merchandising. This growth platform in snacks will complement our commanding presence in staples, thus extending our TreeHouse presence across the breadth and width of grocery stores of all formats.

In a similar vein, the acquisition of Protenergy introduces us to evolving consumer preferences for convenient receivable packaging and pantry mainstays. Aseptic packaging, which has transformed the usage of broth and stock as meal components, can readily be extended to other adjacent product categories, including soup, gravy and sauces. When this technology is coupled with its companion, recarton processing, an entire array of products conventionally found in bottles, cans and jars is open to innovation through packaging technology. Such advances promise to give new meaning to the joy of cooking, especially in private label kitchens.

My confidence in exploiting these possibilities for growth is bolstered by the high degree of performance exhibited by both our legacy operating units and integration teams. Bay Valley Foods, as Dennis has demonstrated, has coupled its simplification agenda with renewed go-to-market vigor in improving fundamentals across our broad and growing portfolio.

Similarly, our integration teams are repeatedly hitting the mark as they incorporate one accretive bolt-on after another into our private label realm. In concert, these two groups show early signs of meeting the greatest integration test to date, uniting old and new alike in a common cause to reclaim our prior category leadership in soup and broth. This time with the only competitive product portfolio that meets all private label customer needs in the category.

Lastly, once the current brouhaha subsides, we will all find that single-serve beverages continue to offer great promise for brands and private label alike. Household penetration of brewers in their daily use as measured by attachment rate are both expected to multiply in the foreseeable future. Among consumers, innovators and early adopters will soon be joined by the majority as single-serve brewers become as commonplace and convenient as microwave ovens. As CPG history has repeatedly shown, national brand equity built upon consumer benefit and communication propels category growth and in doing so expands private label opportunity in its wake.

In closing, I foresee a not-too-distant future when single-serve beverages constitute a major category unto itself. When we may look back upon the present as merely a tempest in a teapot or perhaps, as you like it, much ado about nothing. With that, Christie, please open the phone lines for Q&A from the sell side analysts.

(Operator Instructions). David Driscoll, Citi.

Thank you, good morning. I had a couple of questions. Dennis, to start off with two little ones and then a bigger-picture question. The two little ones were previous gross margin guidance was for about 100 basis points expansion on the year, but now you have got the deals coming into it and I think those deals were margin-dilutive. So can you update us on the gross margin guidance? And the second little detail is what is the new interest expense guidance? And then I have a question for Sam.

I don't have the consolidated one. We normally don't project forward. We will get the 100 basis points on our legacy business, David, but I am still working through all the nuances of the margins with the new acquisitions. As you know, Flagstone we just closed, so we are still working through those numbers there, so I am going to have to pass on that for right now.

In terms of interest expense, I provided the numbers on those, 2% on all the debt with the exception of the high yields, which will be up 4 7/8 and we will have positive cash flow in Q4. So I think you will be able to work through those numbers.

Dennis, the only trick on that one was there was an expectation of the high yield issuance and so every day that that doesn't happen, so I was in effect asking you is the high yield issuance going to happen by the end of the year or is that a 2015 event?

I would fully expect that to be a 2014 event, but, as you know, markets are soft in the month of August. They tend to open back up in September, so we will evaluate then. But given where our interest rates are, we'd like to have that termed out and our guidance right now reflects that that would happen late in the third quarter.

Sam, a question for you. First off, congratulations on all the single-serve success. Very exciting and these acquisitions are tremendous. So just incredible compliments from me on how you have executed versus what I've seen across the peer sector. In single-serve, how strong was your sequential growth? Did you add any new net customers? And then finally on single-serve, do you expect, and this might be the most interesting one, do you expect significant new additions because of the TreeHouse ability to make this new Keurig 2.0 compatible K-cup?

Well, David, first, thank you for your kind congratulations. And then with regard to the single-serve category, let me start with looking at just the last quarter. Both dollar sales and unit sales of private label across the whole of the industry increased by 90% and we maintained our lead at approximately two-thirds of that total as we've gotten -- the industry has achieved both new distribution, as well as expanded placement in current customers.

As we look ahead, we see continued growth in that regard. I think Dennis has mentioned in the past that we've recently authorized and are installing yet another round of capital to expand our base. And we are finding that much of this growth, David, is coming outside the handful of core product flavors that maintain the center of both coffee and other hot beverages. So as we have been able to develop new flavor combinations and also educate our customers with regard to the category management, merchandising, price point management, consumer communication, we found that the growth prospects remain quite robust for us.

Great, thank you. I will pass it along.

Chris Growe, Stifel.

Hi, good morning. Two questions for you, if I could. One, Dennis, you had mentioned about some pricing going through. I think it was in relation to North American Retail Grocery, as well as some incremental promotion. And there has been a lot of discussion amongst the branded companies about incremental promotions, but those not really generating very good returns for the brands and the branded companies. So I am just curious if you are reacting to that in any way, are you changing your promotional tactics in any way? I know you don't have full control of those; I'm just curious how you see that part of the promotional program.

With private label, we don't really have that much in promotions, so we are kind of reacting with the brands. You have some one-off situations, but generally no, our pricing that we did had a net negative I mentioned of 0.3% in Retail and that is partly due to some increases in certain categories where inputs demanded it. But we are also trying to get more aggressive in gathering some new business and it is a competitive marketplace. But, overall, we have been able to take some share, but that requires some price investment and accounts for that negative 0.3% pricing impact.

I think the one area where we saw it and I mentioned was hot cereal and when the brand gets highly aggressive in promoting, we've always said it doesn't drive incremental usage; it just drives pantry load. And we think that's been happening and there is not much you can do when the brands are pricing themselves on promotion below private label. So generally, we have done very well throughout the categories, but we did have that in hot cereal in particular where it is challenging.

Okay. Then I had a question for Sam, if I could. You had mentioned this sort of new branch of the tree and I don't want to read too much into that, but I'm just curious how much opportunity you see on more of the snacking and the fresh side and then the capabilities that you have through Flagstone to accommodate fresh products. I'm just curious what capabilities you have on that front.

Well, there is a confluence of three very significant trends here. One is the movement to kind of grazing and all-day eating, kind of redefinition of the meal occasion. The second are the consumption attitudes and behavior of what we call the millennial consumer where people are both savvy with their money and also environmentally socially conscious and looking for health and wellness above all else.

And then third is kind of the perimeter that some have characterized as the racetrack. And what we have seen when you put these three together is that there is great opportunity beyond the traditional conventional definition of single -- in private label, the focus is on center of the store. And we think that Flagstone offers an extraordinary opportunity to create a platform around those and focus primarily on healthy snacking. They have pioneered the double placement of products both in center of store and in produce and there is a great deal of that opportunity still in front of us.

We think secondly that their productline lends itself to expansion into adjacent categories that will prove to have very fine growth and margin opportunities. And then, thirdly, when we look around here it is that, in healthy snacks in particular, it kind of reminds me of the cottage industry that we saw nine years ago in center of store, the staples and that is there are a lot of small businesses that have very fine products, but limited distribution, limited capital, limited customer base. And we can incorporate those businesses into Flagstone in the same way that we will in parallel continue to incorporate businesses into Bay Valley Foods.

Last comment is I think that when one looks at the overall consumption data, snacks are growing several times faster than food. Healthy snacks are growing several times faster than snacks and Flagstone itself is outpacing healthy snacks by another multiple. So we have picked the real winner in all of this and one that where, as I indicated, they have got abounding innovation and we have got abundant capital. We will find that to be a very healthy combination.

Okay. Thank you for your time.

Farha Aslam, Stephens Inc.

Hi, good morning. You had mentioned your focus on natural and kind of organic. What portion of your portfolio today would you categorize as natural and organic and what is your target of where you want that to go in the future?

Farha, Dennis here. I don't have an exact number, but it is clearly less than 10%. It is growing, but it is a small segment. It is hard to say. This kind of goes back to the coffee types of questions we got two years ago when people asked what do you think the marketshare of private label will be. We don't know, but what we do think is we are well-positioned to be a leader in taking advantage of however the consumers move towards those types of products. We have got capabilities in nearly every one of our categories to do natural and organic and we've got a strong team of R&D and food scientists working there. So whether that ever gets to 15% or 20% of food, I am not sure, but we definitely have the capabilities to be right there and we will participate in that.

And so that 10% is pre-Flagstone?

That's correct.

And then we could add Flagstone, which is going to be around 25% of your sales. Would you consider all of that natural and organic?

So I have got to learn a little bit more about that. I mean clearly nuts have a lot of natural benefits, but not necessarily are they all organic, but that's something I have still got to learn.

Fair point. And then my final question is just if you look at your commodity basket in terms of inputs, any callouts in overall commodity inflation or deflation you would point us to into the second half of this year and into next year?

I don't think so. We have seen some moderation. I think the one thing people were asking a lot about was coffee. We saw a lot of increase in that early in the year. It started to go down. When you are talking about single-serve, unlike a bagged coffee program, it represents a much smaller partner of the cost of sales of that category. So at the moment, I don't think there is any significant callout one way or the other. Our cucumber crops are just coming through. The bulk of our crop comes from the upper Midwest and those harvests will be starting shortly or just kicking off. So that is always the final piece of our commodity picture, but I think so far things look good.

Okay. Thank you very much.

Bill Chappell, SunTrust.

Good morning, thank you. Can you just maybe break out a little bit on the core grocery sales? I'm just trying to understand if there is a way to do this. Was there organic growth, excluding coffee, both overall, but also in the grocery channel? Just trying to understand like how far we've come in terms of the recovery.

Yes, Bill, there actually was and so we saw that in this quarter in general throughout grocery, which we consider positive. I think it was driven more towards some of the premium and specialized private label we have been doing for some of our customers. Although we also frankly had some good success in the value side as well. So we kind of won on both sides of the category. I think it was interesting that we are seeing more traditional grocers doing more of what we call premium products and they seem to be responding to some of the specialized grocers that are kind of premium only. So that still represents just over 50% of our retail sales. So as the traditional grocer finds success at it, I think that still bodes pretty well for us.

And is that just from what you can tell largely consumers migrating to these products or are these largely distribution gains as well?

Well, some of them are distribution gains, but at least my theory here is that one of the things that has been interesting is that even midsize chains have become very price competitive with the big mass merchandisers when you look at surveys of basket prices where you take a sample of goods. And frankly, it is difficult for somebody with 100 stores to be competitive with somebody with 4000 stores. But I think if you have got a very strong private label program that generates extra profits, and we know you make more penny profit on private label, you can use that to fund some other categories where you want to be price competitive. And it seems that that tactic is working well for many of our customers.

Bill, this is Sam. To amplify Dennis' comments, what we are seeing in this return of the traditional grocer is that some things have run their course and that the industry itself now is bifurcating along the lines of those that are going to support their brands. And there are only two that are really not -- one has elected to go back to national brands; the other big one that is on hold is in the midst of an acquisition and an integration. But the other big names that we track very carefully are all moving in a positive way. I think that goes hand-in-hand with the improvement in the fortunes of the traditional grocer. And by the way, I was addressing a group of 200 of our suppliers earlier this week and I reminded them that consumer surveys show that the number three reason that people shop in grocery stores, the number three reason is the presence of customer brands in that store.

That's good to hear. I don't think we have heard that on the grocery channel in a long, long time. One question on coffee. As you have gone out to customers and told them about your compatibility for 2.0, have you heard of any competitors that have compatibility or does this really differentiate you?

Well, there are always -- in every coffee shop in America, there is conversation and rumors and I won't comment on those or others. I will tell you that -- I will go back to my earlier response to one of the first questions. I mean the category in the second quarter grew 90% in units, the category for private label. And the aggregate of that category on the same IRI measure I think was up 27% in dollars and it demonstrates to you that this has still got legs. The story is still resonating with customers and consumers both and I presume that as we go into the new year with the advent of those who produce single-serve cups and those that produce single-serve brewers will bring competitive innovation to the marketplace. It's the way private label works.

Got it. And actually go back to my last question, are you actually seeing negative trends out of the premium channel or just a slowing trend?

Just a slowing. It wasn't really negative.

Okay, great. Thanks so much.

Robert Moskow, Credit Suisse.

Hi, Sam. Things must be good when you are quoting Shakespeare in your initial remarks. So it must be a very strong year. And I guess I wanted to ask a little bit more about your comments on organic and natural and how the retailers you said are asking for more offerings from I guess private label suppliers. But I wanted to ask you -- you have been in the food industry a long time; you have managed branded companies before. To what extent do you think this consumer shift or retailer shift to organic and natural presents a real structural problem for processed food in general?

And do you think that if you looked 5 years, 10 years from now that more and more of consumer demand is just going to keep shifting away and more towards the fresh part of the store? Obviously, the acquisition of Flagstone helps you in that regard. But do you think that you and others in processed food are going to have to do more of that in order to meet the changing demand dynamic?

Well, I am delighted that you've picked up the notion that the bard inspired us.

Sure enough.

Dennis and I will both answer parts of this. Let me talk about the general strategic themes and ask Dennis to complement that with his great knowledge of the business. I think the big issue for us is -- it is not only health and wellness and natural and organic, but what the CPG industry is dealing with here is it's the end of the era of mass marketing and everybody understands how that applies to brands, but there is also a direct application to grocery retailers and to suppliers of their customer brands. And it is this that the evolution of private label is such that one now has to market in a targeted series of niches and combinations of category customer and then with regard to variety or a price point.

We track now six different levels ranging from opening price point all the way to natural organic and what we all have to do is identify those intersections of the category, the degree of value add, if you will and the customer or a channel to identify this. I think that the marketplace will respond to this. There will be -- they are already in our portfolio and that of our grocers. There are real significant advances. There are certain ones that you run into restrictions on fruit or vegetable capability or just the processing. But we are all adapting to those things and I think what comes out of it is that you will find in customer brands that the fragmentation here in these categories will benefit those like us and several of our customers that have made real long-term commitments to developing those supply chain, the science, the operations to do this. And I think Dennis can cite chapter and verse about specific categories, brands and customers in that regard.

Just to quickly add on, Rob, I think we are well-positioned. I don't think this is a fad, but I think it is going to grow over time. It is pretty clear from surveys that millennials are much more involved in the quality of their food or the type of food, not to say that processed food does not have good quality, but it is just different. And I think that will continue to grow. I think our retailers are finding that out and as you look at how they are reacting to it, it is no longer just the store brand that is being presented; it is now the corporate brand. And the corporate brands are getting much more focused not only in the product themselves, but the names. So whether you are dealing with a product that is called Open Nature or Simple Truth or Nature's Promise, Simply Balanced, I mean these are all corporate brand names that are resonating with not only millennials but another generation and we think that trend will continue, but I think it is going to be a slow growth just in part because this product is more expensive. So you can't offer this at the same price you can the everyday mainstream food. So it will grow and we will be right there to participate in that.

What specific categories, Dennis, do you see that effort being the most aggressive, like the retailers are taking the most aggressive actions to develop those brands?

Well, at least in our categories, it's definitely in the things like the sauces, sauces and marinades, dressings. It is in soups, all those that were cooked and processed, we are finding great opportunities not just for natural and organic, but some really interesting flavor profiles and you will see a lot of our products now that are beyond just the salsa being hot, mild and medium into the very fancy bean and corn combinations and fruit combinations and all in an organic offering. So those are interesting products. We will never see that in our nondairy creamer; that just doesn't fit. But I think most of our categories are still right on the trend.

Very good. Thank you very much.

Akshay Jagdale, KeyBanc.

Thank you for taking my question. I am going to ask about coffee, as always. So first question is can you tell me -- I am trying to understand the decision to convert your current manufacturing to make it 2.0 compatible. Why take that step? Is it because you have lost some customers as a result of this 2.0 strategy that Keurig is employing or are customers really asking you to absolutely have that option because they are confident that the 2.0 is in fact going to work? So that is my first question.

Good morning, Akshay. With regard to your particular question about the 2.0 operations and supply chain, last month, we celebrated our ninth anniversary. We now have over a dozen product categories. And with the single exception of the businesses that we have acquired in the last year, I can go through that entire list and show you in every category where, in order for us to maintain our premier position of private label in that category, we have either followed with quality packaging or product improvements or we have led, in that case, where we've seen the opportunity as well. And this is another one of those instances and I should tell you there will be more this year in other categories and the year after that. It's simply the way we differentiate ourselves from the great mass. And from the very beginning, our premise was that we wanted to create a premium for our products beyond the RFP-based lowest landed cost national brand equivalent model and we are going to do that it in single-serve beverages exactly the same way we do it in salad dressings.

That's helpful. And just going back to the question, are you aware of any customers that you have lost as a result of the 2.0 strategy that Keurig is employing because there is some conflicting information like there always is? So I am hoping for some clarity there out there announcing conversions from non-licensed to licensed, especially on private label. So far the ones they have announced aren't from what we know are your customers, but there are some rumors out there that some of your customers have also switched. So it certainly doesn't show in your results, but I'm curious to know if you have thought of any who have made decisions to switch.

Well, Akshay, we have a corporate policy about not talking about the individual customers or the particulars and clearly, if there is one person on the line that understands that policy, it's you. I go back to the second-quarter numbers. Private label single-serve beverages increased 90% in the quarter while the category, as measured by IRI, increased 27% and as I said earlier, we've maintained our leading share of approximately two-thirds of that business in private label. And I expect that wherever private label continues to ascend, it will settle somewhere I presume in the low double digits, you will look up and you will find that just as is the case in 9 of the other 11 categories that we operate in that we will remain number one.

Thank you. And just one last one on that same subject, so as we look forward and just over the next year or so, should we expect the growth of this business to sort of mimic whatever happens with the category in general with some share gains or losses on the margin? So in other words, if the category grows 25%, 30% over time, I think should we expect private label as a percentage of that single-serve category, as well as your growth rate to move more in line with that category growth going forward?

I think the big determinants of growth for the category in 2015 and beyond really are going to get back to what is the consumer benefit and how is it communicated from the industry to consumers. And there is nothing more important there than having the great national brand leadership that you see in one category after another that we deal with. That will relate to not only a technological innovation, but it will relate to productline expansion. We have found in our research that there are many forms of hot beverages outside of coffee that give us great extraordinary growth opportunity. And I go back to the acquisition of Associated Brands several months ago that was, in some quarters, seen as really as a small bolt-on of existing businesses. But the specialty tea business that we have, while it is currently primarily located -- its focus is now in Food Away From Home, we are finding a very fine reception among our grocery customers for specialty teas and then our leading presence in products that are non-filtered, non-coffee hot beverages is leading to our customers to ask us for other beverages that can in fact be shelved nearby, but meet other consumer needs.

So I think this category -- I still believe that it's in its nascent stages and as I indicated in my prepared remarks, what you are really looking for is to have in-home placement of single-serve machines by one manufacturer or another dramatically go up and at the same time with offering greater variety, convenience and value. The attachment rate will go up as well and we and others will benefit from that.

I appreciate it. Thanks so much. I will pass it on.

Ken Goldman, JPMorgan.

(technical difficulty) a bit of my thunder, but, Sam, let me just say I hope your words today aren't full of sound and fury and signifying nothing.

Faulkner, you are here with us.

You talked about your ability to engineer your cups to generally whatever systems come out, but I guess there is a difference between being capable of doing something and being allowed to do it. So my question is this, to what degree is it reasonable for us to expect that when you do launch a product compatible with 2.0 or other systems with more active patents, you will maybe see some pushback from the makers of these machines, whether legally or in some other form?

Ken, Dennis. I think we've got a great history here of having introduced products that are compatible, national brand equivalent products that don't overstep the line of -- the legal lines. We did that with our original coffee products and we will do that with this as well. So that is not something that is going to change our strategy because we do we think an excellent job of making sure we run clearly within the right legal framework to introduce these products and that will be the same with this one.

Okay. And then one quick one. Sam and Dennis really, you buy a variety of food products, a lot from California, I think. At what point do we start to worry about the drought? It seems like this summer helped by well water and irrigation, but that safety net may not be there in 2015. Is that the way you are looking at it too or do you think some of the worries are maybe overdone at this point?

The only real thing that I think we are really watching and get concerned about are the organic tomatoes. By our best information, we are the largest purchaser of organic tomatoes in the US and that is clearly a California product and so that is something we watch. We had some challenges last year on supply and so far so good, but that is the one product out there in California, Ken, that we do have to watch.

Thanks, everyone. Have a good day.

John Baumgartner, Wells Fargo.

Thanks for the question, good morning. Sam, just a big-picture question with the consolidation underway here in the dollar channel, how do you think that impacts the long-term growth potential of consumables in the channel? Maybe distribution opportunities for private label and maybe the margins for private label suppliers going forward?

Well, I won't comment about a particular transaction, but just our view of that category, that format is that we expect that it will continue to grow far greater than the industry itself and when one looks at kind of the model and the retail dynamics, it shows every indication of continuing to grow. I think that what pleases me is that, at the very beginning of this, food was the number five category in that sector leader and as the format has grown, food and beverage have begun to have a slightly better offering and that will work to our benefit. Consumers now would rather make a second stop than park their car at some mega-outlet and spend the better part of an hour getting just simply to and from the store and waiting. The dollar channel has found out how to exploit that greatly.

Great. And Dennis, just one follow-up, thinking about the traditional channel, a few years ago, there was a negative margin mix as consumers left traditional to go to the alternate channels. Are you finding much support for gross margins now as traffic comes back to the traditional trade?

I think what helps the margins with the traditional is the point we are talking about where their emphasis is growing in the premium side and premium products generally will carry a better margin for the retailer and a little better margin for us as well just because of the complexity and the nature of that particular product and so that helps in that regard. Certainly when we were dealing with opening price point products where it is a really kind of a commodity food product and therefore very competitive, not only for us in private label, but for retailers. So I think the move towards the premium natural and organic and better-for-you products actually bodes well for us and our customers.

Great, thank you.

Jon Andersen, William Blair.

Hey, good morning, Sam, Dennis. I wanted to ask I guess about -- you referenced the approximately $1 billion in sales that you have kind of recently added to the business through Protenergy and Flagstone. That I guess on a pro forma basis would constitute nearly 30% of the Company's sales at this point. Do you expect -- I mean is that piece of the business something that you think can continue to grow at a double-digit rate over the next few years? Is that your expectation, number one, I guess? And then, second, does that suggest we need to kind of rethink our organic growth assumptions for the Company overall in the next two to three years?

I do think that both of those acquisitions should allow us to get to that double-digit growth and you are right, with that representing $1 billion of a $3.5 billion business, that will have a positive impact on our organic growth assumptions. We've historically always talked about 1.5% to 2.5%. More recently, those numbers were more like 1% due to the challenges in food. So we do think that this bodes well for us. And frankly, those are key reasons why we bought these businesses. We see great growth prospects for them, which contrasts with some of the other center of the store categories we have.

Sam, with respect to Protenergy, I'd kind of love to hear your thoughts on the sequence of events in that business. I think that the cartons have really taken significant share in the broth category to date and I know private label is a significant component of that. But as you look to the next steps for Protenergy, can you talk about that over the next year or two, the go-to-market strategy and maybe the expansion into other categories over time? Thanks.

Well, in general terms, I see several stages of this. One, as I indicated, is that I think the immediate growth will be -- the closest adjacencies, which are soup and then sauces and gravy. In that regard, there are two different technologies here. Aseptic allows you to package items that do not have particular matter of any size. The recarton allows you to then go into the ready-to-serve items. That will be the first. I think here that we are seeing that the national brands have begun to address this as well and our focus will tend to be with specified grocers where there is really significant business to be had and particularly at the premium end, it will replicate our strategy in the pasta sauce to some degree there.

And then I think beyond that, what we see is that the packaging technology itself readily lends itself to repositioning some of the old mainstays. As you walk up and down that aisle, you see products in the same packages that your parents or your grandparents bought with only graphic design changes. And clearly, as meal occasions change and the size of household drops and you move from meal preparation to assembly, I think that offers just great opportunity here that will be more based on the packaging technology as the driver as opposed to individual categories. This has got legs for a long time to come.

Okay. And I guess I'd be remiss if I didn't ask one question on coffee. With the focus on conversion and producing a K 2.0 compatible pod, will there also be an effort to offer a carafe-size pod, which I think is part of the upgrade to that next-generation system? Thanks.

I think that the time that we will talk about the new year and its developments in more detail will be at the PLMA Investor Day. And you know that we are committed to this category and that, in addition to the base business that we have, that we are always looking either for innovation either to copy it or develop it on our own. So come by and bring a large mug.

I will be there. Thanks, guys.

Brett Hundley, BB&T Capital Markets.

Hi, good morning, gentlemen. I apologize; I joined late. So if I replicate a question here please just sidestep it. But, Dennis, we're curious if TreeHouse can continue to -- or if the environment exists for TreeHouse to continue to acquire over the next six plus months or do you think the Company needs time to maybe delever or integrate recent assets, etc.?

That's a good question. Obviously, we've done two good-sized deals in the last three months, but we've got the internal capability here with integration teams and we've got dedicated SAP teams that we can handle integrations relatively quickly. That being said, Flagstone will be a separate branch of the tree, as we said, so there will be far less integration activities per se. And we see that as another platform for us for future growth through acquisition. So with us, being delevered down to 3.2 times, at least that is our expectation by December 31, we believe we will still be active and are still looking for acquisitions. You may not see the $1 billion deals in the next few months, but we certainly are continuing to look at opportunities, especially in that better-for-you category and whether that is snacking or other parts of it, we think that is where the real growth is right now.

Okay, perfect. And then I just have one other question. A bit out of left field, but in non-dairy creamer, as that industry continues to potentially contract, do you guys get to a point where you can take those assets and think about maybe doing something else with them, selling them? I don't know if this is possible. Can you take those assets and turn them into dried milk powder production? Could you sell them for such an application? Can you just address that?

This is Sam. You are in left field, but you are not alone. I am there as well. We see two great opportunities with our current base and are working for those. One is Mexico where we've got a substantial business. We have got a base that we think when we bring private label marketing to it that matches that market opportunity that we will have what is a small and highly profitable business become a substantial one. And that will require that we take some of our capacity and make minor modifications to it to address the product needs of that market.

The other matter and this is somewhat ironic. The demands to government regulation to phase out partially hydrogenated oil at first seemed to me to be a real difficulty that our business would face and as I have looked at the work in the lab and work with consumers, it seems to us and the people that run Bay Valley Foods that this will add kind of a renewed opportunity for this product form to be rejuvenated a little bit in the eyes of consumers. And we are pursuing those two opportunities full out.

I appreciate it, Sam.

Christie, in light of the time, we will take one more question.

Bryan Spillane, Bank of America Merrill Lynch.

Hey, good morning. Just one clarification, Dennis, you talked about cucumbers I guess earlier in the call, I guess the cost of getting the right size cucumbers. But that was old crop, not new crop, right? So you weren't suggesting that cucumber costs are going higher later, but more related to just last year's crop, is that right?

That's correct. The Food Away From Home is more of a just-in-time crop that we would get in and process. So in the spring and early summer, we are sourcing from the south and there were weather issues down there.

Okay, great. Thanks. And then, Sam, when you referenced earlier -- I think I heard this -- that you have spoken to or communicated to retailers or customers that you've produced a 2.0 compatible cup. I guess has it actually been used in a 2.0 machine or have you sort of reverse-engineered a 2.0 machine and have a cup that works with that? I am just trying to make sure I understood the distinction about whether or not you have actually got one that has worked in an actual machine?

Well, given the pending litigation, I really can't comment about the prototypes and the process by which we reverse-engineered this. But I will stand by the statement I made also that what we've done once again here is -- in this case, we've not only earned again the trust of our consumers, but in a rare move for grocers we have actually earned their gratitude.

I appreciate your patience in taking all the questions around this topic. I know it is difficult to answer. Thank you, guys.

Thanks, everyone. We very much appreciate you joining us today and Dennis and I look forward to seeing you in the coming months. Goodbye.

This concludes today's conference. Thank you for your participation.