TreeHouse Foods Inc (THS) 2018 Q2 法說會逐字稿

Welcome to the TreeHouse Foods Second Quarter 2018 Conference Call. This call is being recorded. At this time, I would like to turn the call over to TreeHouse Foods for the reading of the safe harbor statement.

Good morning. Before we get started, I'd like to point out that we've posted the accompanying slides for our call today on our website at treehousefoods.com/investor-relations.

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 achievement expressed or implied by these forward-looking statements.

TreeHouse's Form 10-K for the period ending December 31, 2017, and other filings with the SEC discuss some of the risk 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 expectations with regard thereto or any other change in events, conditions or circumstances on which any statement is based.

For the purpose of our discussion today, statements such as Private Brands or the former Private Brands business refer to the TreeHouse Private Brands business. Private label, on the other hand, refers to the customer and corporate brand industry.

I'd now like to turn the call over to the CEO and President, Steve Oakland.

Good morning, everyone, and thank you for joining us. I'm pleased to be with you today sharing a quarter of good results as we posted another period delivering upon our internal objectives and external commitments. Since our first quarter call, I've had the pleasure of meeting many of you face to face in New York. And since then, I've spent a great deal of time on the road, listening to our customers and getting to know our people throughout our organization through town halls, plant visits and divisional reviews with the leadership teams and the general managers. I've taken time to do a deep dive, and I've come away even more enthusiastic about the opportunities that lie ahead.

As I think about how we frame the opportunities, we all know that the consumer packaged good industry is changing and consolidating quickly. On a macro level, retailers today are facing competitive pressures and disruptions on many fronts: growth from limited assortment and hard discounters, a shift to cleaner labels, growth within natural and organic and the rise of e-commerce and click and collect. The good news in all of this is that private label has an important role to play for our customers in all of these disruptions.

Amid this evolution, I'm confident that TreeHouse has a long runway for growth. It's clear that the retailers are seeking to build their own brands to drive traffic and improve profitability. We recognize that outstanding customer service has to be the foundation of the relationship with our customers. In fact, customer service is as critical to the retailer partnership as cost and quality. To be frank, we haven't consistently delivered on our service commitments over the last 2 years. So that's an area where we have great focus and we are seeing improvement, in some cases significant improvement. This work on service is key to our ability to take full advantage of the growth opportunity that private label presents.

Delivering the highest levels of customer service is essential to taking our relationship with the retailer to a more strategic level. Accordingly, it's absolutely critical to understand that private label will play a different role with each retailer based on how they reach their consumers. In the most fundamental of terms, they offer value or they offer experience. As we partner with our customers and better understand their strategies, we can apply the right resources and align ourselves to help each of them achieve their goals.

As we improve service levels and deepen our relationships with our key customers, we can fully leverage our leadership position in private label and then unleash the power of our scale. It's very exciting to me personally to think about how we capture that opportunity at TreeHouse.

The execution of the TreeHouse 2020 plan is key to our long-term competitiveness. Having sat with our teams and our divisional leadership, I know there's a lot of heavy lifting taking place. We're asking a lot of our people, but it's quarters like these where we get to see the fruits of our efforts hitting the numbers and see the progress flow through the P&L. This energizes our teams, and they're on board and totally committed to doing the hard work to get the job done.

We've also reinvigorated our strategic planning process across the whole company with a fresh and deeper look at the businesses by category. Recently, we announced the sale of the McCann's Irish Oatmeal business to B&G Foods, which is a small step towards getting our organization focused and pointed in the right direction.

So as I mentioned on the last call, we are evaluating everything we do and changes will be required. I'm not yet ready to share those details today, but I am looking forward to bringing you more detail on our strategy before the end of this year.

Before I turn it over to Matthew for the financial review, let me give you a quick update on our previously announced cost reduction initiatives. TreeHouse 2020, our company-wide restructuring effort to lower our cost structure through programs such as simplification, plant consolidation and the rollout of our TreeHouse Management Operating Structure or TMOS remains on track as noted in Slide 6.

We recently announced the closure of our Omaha office, which is slated for the first quarter of 2019. In June, we completed smaller office consolidations in Pittsburgh and St. Paul. These shouldn't be much of a surprise given how our company has evolved.

Addressing the fragmentation of our operations presents opportunities for consolidation, which will better enable us to operate as one TreeHouse. Consolidation facilitates greater alignment around our mission and our culture. It provides better career development opportunities for our people and will certainly improve operating efficiency and cost structure.

Turning to the Structure to Win on Slide 7, which is our specific program to focus and align our SG&A expenses and our division structures in order to better serve the customer. Much of the SG&A progress you'll see in the numbers this quarter is a direct result of this effort. We are largely complete with this program, although we expect to make this a foundational part of a continuous improvement culture.

What we've tried to do on this slide is to give you a visual sense of how our organization has changed. We're streamlining the decision-making process and improving our cross-functional strategic customer teams. On the general manager front, we've broadened their roles and gone from 22 GMs to 14. This is where the rubber meets the road. We are building capabilities and professional entrepreneurs, leaders for our future.

Now on to numbers, which is really why we're here today. I'm pleased to discuss another quarter of delivering on our guidance. Both revenue and EPS were above our guidance range in the second quarter, and we saw sequential improvement from our divisions. I'm encouraged by the progress around TreeHouse 2020 to become operationally excellent and align our capacity with the marketplace opportunities.

I want to thank our teams for embracing the Structure to Win changes. We ran faster and delivered our strategic savings goals ahead of the original timing. These programs are allowing us to harness our capabilities across the operations and across our employee base, and I personally believe that we are in the early stages of unleashing the opportunities that the growth inherent in the private label space affords us. I'm confident that we can continue to improve our execution as we move forward and deliver our commitments for the balance of this year.

With that, let me turn it over to Matthew to provide you with the details.

Thank you, Steve. Good morning, everyone, and thank you for joining our call today.

I'll begin on Slide 10 with the consolidated Q2 results. On the top line, sales of $1.46 billion were slightly ahead of our guidance range of $1.3 billion to $1.4 billion for the quarter. Second quarter adjusted EBIT margin of 3.8% was 1 point below the prior year but represents a sequential improvement of 1 point from the first quarter. The sequential improvement was a result of pricing catching up to commodities and Structure to Win savings kicking in.

Second quarter adjusted EPS of $0.37 was $0.07 better than the top end of our Q2 guidance range. This includes a lower-than-anticipated tax rate which was a $0.04 benefit in the quarter due to certain state rule changes in the quarter and the impact of a higher stock price on the tax impact of stock compensation expense. Overall, we are encouraged by our progress. That said, there is plenty of hard work ahead as results are still below our prior year and where we need to be.

Turning now to Slide 11 on the revenue drivers in the quarter. Consolidated revenue declined $66 million or 4.4% versus last year. Of that decline, about $63 million was driven by the SKU rationalization and another $17 million was related to the Soup and Infant Feeding divestiture last May. Excluding these 2 items, our top line grew 0.9% compared to last year.

Volume and mix were slightly negative across nearly every division. In Beverages, we are not yet up to full production levels in the nondairy creamer business, but we did see some pull-forward of sales from Q3 into Q2 in single-serve beverages. In addition, as we discussed last quarter, we believe we were one of the first to market with our pricing for higher commodity and freight costs, and margin management continues to be a priority for us, which has led to the exit of some less attractive business.

Moving on to pricing. We saw pricing flow-through as expected in Q2 up 1.3% on a consolidated basis. The exception was in Beverages where the single-serve market remains very competitive.

Turning now to Slide 12 and the key EPS drivers in the quarter. Adjusted EPS was down $0.14 compared to the prior year. Within this, division DOI declined $0.34 and was partially offset by $0.16 of SG&A and a $0.05 tax benefit. Excluding the net negative impact of resetting the bonus and lower amortization, the SG&A improvement was actually $0.20.

Slide 13 gives you a sense for the division DOI drivers on a dollar-millions basis. Division DOI of $146 million in the second quarter was down $27 million versus prior year mostly due to volume, mix and freight. As I noted earlier, pricing net of commodities turned slightly positive in the second quarter. Rising freight costs continue to be a challenge although largely in line with our expectation.

You'll notice on the slide that operations had a negative contribution to the quarter. There's very strong performance here that is being masked by 3 factors. The biggest near-term operating challenge here has been the prolonged impact of the Pecatonica strike on the Beverages division, which is showing up in both volume and mix and operations. As a reminder, the strike at the Pecatonica nondairy creamer plant began last November and concluded in April.

Our plans to get the plant back up to full production assumed about a $0.06 drag in the second quarter. Unfortunately, that restart has not happened as quickly as we would like. The low unemployment rate and competitive market conditions for talent in this area have made it difficult to hire back some of the skilled labor, so it is taking longer and costing us more than we originally thought. We expect this to be a drag on earnings in Q3 and, to a lesser extent, in Q4.

Secondly, within the Snacks business, we've had challenges, particularly in bars, where promotional activity and new business wins have pressured our cost structure in the near term as we scramble to meet the increased demand.

Finally, lower volumes across the entire business have resulted in absorption challenges, which take us time to work through. Divisional SG&A improved year-over-year by $12 million as we implemented the Structure to Win initiatives and have seen tighter expense control across the business.

On Slide 14, we've given you an indication of the divisional DOI performance by key drivers. A couple of things I'd mention here without going into line item detail. Clearly, you can see the significant negative impact within Beverages as we work to get our nondairy creamer business back to full production.

On freight, while driver shortages and rising rates don't look to abate anytime soon, we're actually pretty pleased with the progress we've made. Yes, freight costs are a headwind. But as we discussed with you last quarter, we've taken steps to minimize that impact. Specifically, we completed the carrier RFP and have improved and diversified our network of carriers such that we have significantly reduced the need to go into the spot market for our transportation needs. In addition, the steps we took earlier this year to functionalize our manufacturing and lock down production schedules so we can advance has created greater shipping stability.

And then lastly, while I don't want to minimize the fact that our results are still below last year, on a sequential basis, we are moving in the right direction. In fact, the second half EPS this year is expected to be within pennies of last year as we see pricing fully offset commodities and freight and SG&A savings continue to flow through.

Next, let's turn to the balance sheet. On Slide 15, we've provided an update to net debt and our progress around working capital. We ended the quarter with $2.3 billion in net debt, down over $600 million since we closed the Private Brands acquisition. Compared to the end of 2017, our net working capital has improved by $150 million. But keep in mind that in anticipation of our Q4 sales peak driven by normal seasonality, we expect to end Q3 with increased inventory.

Many of you saw our announcement in early June around the amendment to our credit agreement leverage ratio, broadly defined as net debt divided by trailing 12-month EBITDA. The amendment allows for an elevated leverage ratio over the next 6 quarters and then it gradually steps back down to 4x by Q4 of 2019. In return, our credit is now secured, and by the terms of the agreement will return to unsecured status at the end of 2019.

What you should take away from that amendment is that: one, we now have greater operational flexibility to potentially consider accelerating our efforts around TreeHouse 2020; and two, as Steve works through his efforts around strategy, initiatives and portfolio evaluation, the amendment gives us greater flexibility to move forward despite being in a period of peak cash restructuring spend for Structure to Win and TreeHouse 2020.

We finished the second quarter with a leverage ratio as calculated per our covenants of 3.84x compared to the 5.25 limit.

Let's now turn the discussion to our outlook for the balance of 2018 starting with Slides 16 and 17. With the first half of the year behind us, we have reaffirmed and tightened our full year guidance range to $2.05 to $2.35 in adjusted earnings per share.

Our guidance does assume a few puts and takes. First, on the top line, we will continue to feel the impact of SKU rationalization. As I mentioned earlier in my remarks around the second quarter results, we did see some volume softness across most of our divisions compared to the prior year, and we expect that trend to accelerate somewhat as we get into the back half of the year. We were one of the first to market and took a lot of commodity and freight-related pricing earlier on this year.

We've also continued to focus on margin management. We do expect our year-over-year volume comps to be negative in the back half of the year, with it being most noticeable in Snacks where we've lost a chunk of low-margin business that will have a meaningful top line impact as well as in meals. As a result, we are lowering our full year revenue estimate by about $100 million to $5.8 billion to $6 billion. As I mentioned, we're holding our earnings guidance.

Working our way down the income statement, as you saw, the pricing to offset commodities that was put in place earlier this year is now fully offsetting both commodity and freight inflation. A number of you have asked about the impact of tariffs, not just Canada, but more broadly, the global impact on our business. At this point, there are some knowns and some unknowns.

With regard to Canadian tariffs, our teams immediately went to work to get the necessary pricing for products on that list, such as pourable and spoonable dressings. While there will be a Q3 lag of a few pennies on getting that pricing reflected, we expect to fully recover the impact in Q4 such that the net impact to the year is negligible. Longer term, however, it remains to be seen the effect Chinese tariffs will have on more than just aluminum and steel.

In addition, the impact on global agricultural flows and the potential impact on commodities here in the U.S. are difficult to predict. For example, the 25% Chinese tariff on soybeans earlier this year has already put downward pressure on domestic soybean prices.

I talked at length earlier about Pecatonica. Our assumption for the back half of the year now includes further drag from the startup costs, but we anticipate getting the plant fully back to run rate by the end of the year.

And finally, we expect the contribution from Structure to Win in 2018 will finish ahead of our original plans of $30 million in savings. Our exit run rate continues to be approximately $55 million in annual savings.

We've provided you with the additional line items for the year on Slide 17 to reflect the tighter EPS guidance range of $2.05 to $2.35. This is broadly in line with our original estimates from February with some progress on interest expense and a slightly lower full year tax rate given the state tax changes this quarter.

On Slide 18, we've provided an update to our full year cash flow guidance. We anticipate that cash generation net of restructuring and after the completion of our $50 million in share repurchase, in accordance with the 10b5-1 plan, will be in the neighborhood of $120 million to $150 million. Importantly, we continue to work toward fully offsetting our investment in restructuring the business with our liquidity initiatives.

Looking to the third quarter on Slides 19 and 20, we're guiding $1.39 billion to $1.45 billion in sales and $0.50 to $0.60 in adjusted earnings per share. On the top line, we won't lap the impact of the SKU rationalization until early in 2019, and I talked earlier about the softer volume forecast related to some of the lost business that we've reflected here.

Pricing is anticipated to fully offset commodities and freight, and the impact of TreeHouse 2020 and Structure to Win savings will more than offset the operational drag from Pecatonica and the timing delay related to Canadian tariffs. Interest expense for the third quarter is expected to be between $27 million and $29 million.

I'm not going to read through Slide 21. But to sum it all up, we're pleased to have delivered another quarter meeting our financial commitments, and we continue to work diligently towards improving the overall cost structure of our business. I believe our third quarter and full year guidance ranges reflect a very realistic and pragmatic view of how the balance of the year will play out.

With that, let me now turn it back over to Steve for his closing comments.

Thanks, Matthew. Let me leave you with a couple of thoughts about the balance of the year and the guidance that Matthew just took you through before opening the call up to your questions.

We have a lot going on as an organization. The nature, the amount and the pace of change are critical factors we are balancing as we make long-term investments in our capabilities and our platform from which we will grow. Let me give you a few examples.

First, margin management. Matthew first talked about this last year in conjunction with TreeHouse 2020. While we're still honing our pricing expertise throughout the organization, it is already allowing us to be more proactive on the front end. You saw us as one of the first food companies in market with pricing for commodity and freight inflation late last year, and we saw good success. As Matthew mentioned, we're also very much on top of the Canadian tariff impact for the back half of this year, and we're pleased with the results in both of these areas.

Secondly, you're going to see some changes to the top line of the business as we re-craft our portfolio. Some of the second half sales softness that Matthew discussed are driven by market forces, and some of the changes are designed to position our platform for future, more profitable growth. We've factored this into our guidance for the back half of this year and we'll incorporate when we provide our 2019 guidance next February. As we move forward, we will be purposeful and profitable about the growth that we take on.

Finally in closing, let me just say that I feel very good about reaffirming the midpoint and tightening the guidance range for 2018. I'm confident in those statements because our organization is much more mature than it was a year ago. Our 5-division structure has now been in place for the last 19 months. Our forecasting abilities -- capabilities have improved significantly, and our business visibility continues to improve as our IT integration and consolidation projects are moving ahead quickly.

100% of our plans are targeted to be on SAP order to cash, and 6 ERP platforms are scheduled to be eliminated by the end of 2018. The result is tighter communications across a streamlined organization and better forecasting skills and processes to support our TreeHouse for the future.

I continue to be excited about being part of the next phase of growth of this wonderful organization. We've spent a lot of time over the last year talking to you about cost structure and the necessity of getting that right. And while that work continues, the challenges I look forward -- is to shift the balance of our discussion and share more with you around our opportunities for organic growth and how we're investing in our future. I look forward to coming back to you later this year to bring you more detail around our strategy for delivering long-term shareholder value.

With that, let me open the call up to your Q&A.

(Operator Instructions) And we'll take our first question from David Driscoll of Citi.

I have 2 questions, 1 on pricing and then 1 on the fourth quarter. On pricing, the third quarter, on Slide 20, pricing seems to be a material acceleration over the first half. Could you guys just give us a bit more color? Second quarter pricing actually came in at 1.3%. Is the third quarter pricing locked in with your customers? Or is there still pricing that you need to secure? And basically I'm just trying to get a sense of how much risk do we have on this pricing recovery to cover these commodities and freight inflation. And then if I can follow up on the fourth quarter in a moment, I'd appreciate it.

Yes, let me -- David, it's Matthew. Let me take the first stab at the pricing question. We have literally all of this pricing locked in and almost all of it flowing through the P&L. So we're very, very confident with the Q3 guide around pricing, and we're very pleased that it's going to flip from just covering commodities to effectively covering commodities and freight. I would draw your attention to the comparable period in -- back in 2017, which is where we really first started getting upside down on commodities. You'll remember, I think it was in Snacks where we had some inflation in nut pricing that we just didn't have the ability to cover, so we're also lapping a comparable period that's an easy beat.

I really appreciate that. On the fourth quarter, I think the implied guidance -- because you gave third quarter guidance, the implied EPS guidance is about $1 to $1.20. And I'd just like to understand the implications of the fourth quarter run rate on 2019 and just going forward. And in my opinion, it would seem to be a quite material number and very different from any of the other quarters in 2018. And the fourth quarter, I believe it should really inform investors' views as to what the earnings power of the company is in 2019 at least. I know there's more to go with the program 2020, but I'd just like to get your thoughts on the fourth quarter and then what it means for the future.

Yes, I think -- why don't I take a stab at that as well and Steve can jump in. I think we've always said that this year is a year of 2 halves. The first half was going to be spent catching up on this pricing, and that's been a tough fight for our guys out in the field but we're really thrilled with what they've done. The second piece was that we said SG&A was going to grow as we went through the first half, and we'd have

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where we need to be to position for the back end of the year. So I would say you got to be careful about taking Q4 and multiplying

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4 because we do have the seasonality in this business and it really

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categories, single-serve beverages in particular with the holiday stuff. So I wouldn't take that and multiply it by 4. But if you think of the things that are driving the profitability and the building blocks we've put in place, we feel really good about the strength of that Q4 and its representative ability of where the business is.

Yes, and the only thing that I would add, David, is that the 2020 project, we will be in 13 plants by the end of this year. We have 50, and so that should be a gift that keeps giving. It's a lot of work, and we'll start to roll out Phase 2 and Phase 3. Those processes -- as you know, from other major food companies, those processes take time but deliver results over time. So I would expect 2020 to continue to pay dividends this year. I would expect the SG&A to be pretty much set, and then it will.

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to us to pivot this thing over next year from a cost story to a growth story.

(Operator Instructions) And our next question comes from Jonathan Feeney with Consumer Edge.

Just one real quick. Just one question I had. So when I look at the total addressable market here, I mean private label is on fire. It's -- you look at scanners. I may be cutting some of your categories wrong but it looks like it's pretty close to double-digit growth in sell-through in private label, and I don't get [through] channels in there. But clearly, there's some -- as you rationalize customers and SKUs, there's some share loss. Could you comment on how -- who's doing business, broadly speaking, industry capacity utilization and maybe when we reach a point where -- I mean, that TreeHouse can keep up with this rapid growth?

Sure, Jonathan, I'll.

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and Matthew can jump in. That is in fact what -- as we talked about strategy, the devil's in the details by category. We've got a couple of categories that we sell literally

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package we can make, right? And where capacity

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and we're investing in those, things like Protenergy, things like

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things -- there's a number of those businesses. Our bars business quite frankly. And we'll talk in the future about investments we're making in those to take advantage of that. We've got some other categories that aren't as

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And so like any other [broad] organization, we have some. So as

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better allocate both our capital, better allocate (technical difficulty)

organization and our focus on those growth businesses, I think we can accelerate the share of private label that we take, right? How we swim maybe in the faster current, right? The good news, you're right, we're going with the current, right? We've got to put ourselves

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little faster streams. We have a pretty good

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now. It's interesting if you

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really is in the details. It's also by customer, category and by customer. And it's not -- if you look at the macro data, you see growth, but there are customers growing and focusing on private label and others that aren't. So part of the 2020 program and the Structure to Win program was to build the strategic customer teams. And I spoke in the opening remarks about how each one is different. We're putting teams [together]

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to put innovation where innovation makes sense, to put logistics where logistics make sense, et cetera, on each one of those teams. So we have a little bit of work to do, but you

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the reason I'm so excited about it.

Just to add a couple of things there. We really don't.

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material capacity coming online in any categories that I'm aware of with the exception of single-serve beverage, and we talked about that a fair bit. And I would say, the dialogue with some of our customers have very aggressive growth

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is definitely pivoting to a concern about available profitable capacity, which we think is a huge positive.

And next from JPMorgan, we'll hear from Ken Goldman.

I have 2.

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Steve, I wanted to get a better sense, it sounds like you're preparing The Street for additional either SKU rationalizations or asset divestitures. Is there any way for us at this point

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size the maximum potential of maybe some of the reductions to sales going forward? Or is it just too early to tell? And I guess my second question, I'm trying to get a better sense for how you're being so successful. Is there any color you can provide on taking pricing right now? Because for you to have covered all of your inflation including freight, frankly, is very

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Many of your peers out there are seeing less pricing right now. And I know you can't reduce box size as you can't reduce trade, but I'm just trying to get a sense if you're doing something unusual with your negotiations. You're just being successful at a time when others aren't. I wanted to sort of get your take on what you think that's a result of.

Sure. Let me get the first one. And with regard to -- I think it is just a little bit premature. You would argue -- I've been here for 4 months.

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there are obvious we could do. There's one -- and I made a little but about this in my prepared comments, but of course, sequencing and pace of transformation here is going to be critical. What I mean by that is to continue to stretch the organization but not overwhelm it, okay? And if you think about just the

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progress as we talk, we've got TreeHouse 2020. So TMOS within that is restructured

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transformed our complete operating system and culture across our plants, and so that's where most of our people are. We're closing plants. We're moving lines. We're doing -- we're addressing a bunch of capacity issues. Structure to Win is really an initiative across our entire G&A, okay. And within that, there are micro projects like accounting transformation. The entire go-to-market model has been re-

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These are big moves. The

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SAP, and we're not taking SAP from one legacy platform to SAP. We're taking it from 13 legacy platforms to SAP. We'll close 6 of those by the end of this year. We divested the Soup and Infant Feeding business a year or so ago, so we just wrapped up the TSA there. We sold the McCann's business to B&G. We think that will be pretty clean and they're great partner. That business is going to be a wonderful. So there's a lot -- when I say that there's a lot going on here. So would I like to get out with this? Absolutely. Is that fair? Or will that -- and the only other thing I would suggest is the reason there was so much focus on customer service in my message is to send that to you

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transparent to you all but also to our customers and to our team. We have to accomplish all of this and continue to serve the customer because serving the customer in that relationship will be key. So there's a lot going on. I think it'd be

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to tell -- to talk about it. The fact that I feel comfortable doing it by the end of the year is really a testament to the organization, they can take all of that on. So that's where we'll be and why the timing is what the timing is. Your other question on pricing, I would suggest -- we've had great dialogue with our customers on the fact that we are the supply chain

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We have not tried to price our inefficient

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We have not tried to price our changes. We've tried to price true commodities and true freight. And I think that dialogue goes a lot different.

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understand our margin structures -- our relationship is transparent and so I think they've been receptive. Has it put the categories out to bid? Absolutely. Has it exposed us where we need to do more work? And where TMOS needs to really be effective? Absolutely. That's why a little bit of the top line softness [which is up]. But it also gives us a very clear indication on

(technical difficulty) we need to do from a supply chain standpoint, where the real market price of these things are. And it has -- in some cases, sort of rejiggered where we put our resources

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I think that's probably the best way to articulate it. Matthew, I don't know if you have any other thoughts?

Well, I was up in front of our sales team just yesterday giving them a big thank you for a lot of hard work. I do think we got out ahead of this, and anecdotally, we're sort of the front of the line which made it pretty uncomfortable in some [parts]. But as you've seen, sequentially, there's been a lot more dialogue around price. I think the other thing.

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live through a period of deflationary commodities

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been engaged in a lot of fact-based cost [transparency]. The dialogue on the way down. So though it's less comfortable, it was a dialogue that us and the customer were used

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It's just that commodities were moving in a different way. So I [don't] think this was quite as new as -- and as Steve said, there's been some payback

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and it did, to be fair, cost us in Q1 and, to a lesser [degree], in Q2 as we pushed it through. So we're thrilled to be beyond it. We're very confident going in and that's what's driving a lot of the

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in the back half.

And our next question comes from Chris Growe with Stifel.

Just had two question for you if I could. I want to make sure I'm clear on the -- like the timing of the SKU rationalization activity in relation to the plant closures. I'm just curious does that -- plant closures more -- become more closely, kind of, associated with the SKU rationalization the second half of the year? Related to that, the third quarter requires a bit of [an acceleration] and the sales decline. Is that just the SKU rationalization activity at the current and second half of the year.

(technical difficulty) I'll give Matthew, but the plant closures are really from the SKU rationalization. I would suggest there's.

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out there but generally, the SKU rationalization, go back and look at the tail of our business and the complexity to allow us to launch TMOS. By taking almost 1/3 of our SKUs, 27-some-percent, 30% of our SKUs out of our system, it allows you to bring sophisticated operating process to your plants. It allows you to free capacity for those

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customers where we know we can

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we can bring

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and we can bring [growth]. The SKU rationalization really just allowed us to be much more sophisticated

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the environment. The plant closures are addressing overhead and not all of our categories are created equal

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Not all of our equipment is created equally, and quite frankly, we had too much overhead in

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businesses, and we needed to get that out of the system.

On the sales decline, I think you should think about SKU.

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second half being broadly similar to the first half. So you won't see a big uptick there. What it really comes down to -- the biggest chunk by far, and I mentioned it briefly in my prepared remarks, is the loss of a fairly sizable chunk of low-margin business in the Snacks division. That's the biggest driver of what you see dropping off in the back half compared to the first.

You'll see a few of those as we go.

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The margin management culture will put -- will make us much more disciplined in a

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capacity for higher profit capabilities, right, and higher profit opportunities. So there may be a few things that we weed out as we get better.

Okay. And just one quick one on the inflation overall as you -- is this a good run rate for inflation on, like, freight cost and input cost for the.

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year?

I'd definitely break those 2 into 2 pieces. We do see some commodity [inflation] ahead of us for '19 in select categories. So I would say it is [significantly] less across the portfolio of commodities we buy than it was going into 2018. [We] also see continued freight inflation everywhere like everyone. We're working hard to mitigate it and we talked a lot about the work we've done with our RFP and secondary and tertiary carriers. And a pretty significant improvement, I think our spot market usage in the second quarter was down about 20% from the first. So we really like the operational actions we're putting in place to mitigate this. But make no mistake, I think freight's going to go up for the [foreseeable] future.

Next from Wolfe Research, we'll hear from Scott Mushkin.

So I guess I wanted to poke at the volume losses that you're seeing, and [it's hard for me] not to look at some of the Slides, 11 through 14, and not say hey, you're taking price but you're really kind of taking on [thin], losing some accounts and some volumes. And I'm just trying to understand what would be wrong of that thought and maybe even a little more detail on what's going on with that deals business where I think you guys lack competition.

Yes. Let me start off and then Steve can leap in. As I said, I'm fairly convinced we were the [first ones] banging on the door with pricing, and in our case, pretty much all categories, all customers given the inflation we faced. And I think as.

[Steve] mentioned earlier, taking pricing on the back in some cases where your service levels weren't where they needed to be met with some pretty difficult discussions, and we paid the price in certain areas. What we're finding as we go through this is that some of those people that won that really business are really struggling to pick it up, and we're actually continuing longer with those contracts than planned, which I think is testament to the different

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the scale and capability we bring in some of the [small]

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And in fact, we're also seeing some of that already come back to us. So it's difficult to

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how much of this is transitory and how much was a little bit of punishment for being first out the gate. But there is no doubt in my mind from a P&L perspective, we have to get out and price it was

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to do.

Yes, and I will also say -- I made this.

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a moment ago, but it has helped us understand market [progress] and where are we efficient, where aren't we, and where do we need to invest both time and capital and operating structure. So I think we have a better look at the competitive set, where the capacity is, by [category] and where we need to get better, frankly. And I (technical difficulty) by because (technical difficulty) but because it is broad-based and

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that for us and it's really focused our resources, (technical difficulty)

picked for the projects we're working and there's no secret why we picked those plans, right? They're the places where we have the biggest [opportunities].

Just a quick follow-up. I wanted to talk about the Condiments area, and what we've been seeing out in retail is a pretty aggressive pricing in the barbecue season of a lot of condiments. And I know you guys are playing in those markets. Can you just give us some insight into who's footing that bill or is that business traded away from you guys and people are letting the retailers price it so much lower.

I would suggest Condiments might be one that's visible.

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several in our system where pricing has been very aggressive. There's no secret that there's a little bit of a price war on the East Coast of the United States. There's some hard discounts stuff starting there that several customers are trying to

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and we're not finding that. There's some [variance] of pricing both in private label and I know in brand in some of those markets. And [we're a] retailer, and some [cases] it's changed our volume dramatically. So we're working closely with those retailers who were involved in that, but there is very aggressive pricing in certain markets in the United States right now. So -- and again, I think that's the retailer's strategy. That's them positioning themselves competitively against both new and existing entrants, and we're just trying to stay close to them and to make sure we stay on top of that and have the capacity in the product where they need it and when they need it. Because it does (technical difficulty)

volumes dramatically.

We'll now hear from Robert Moskow with Crédit Suisse.

I guess getting back to the freight question. When you say you have good visibility that your pricing that you've put in place can cover your freight cost in the back half, is that -- well, why isn't it covering it in the first half, I guess? Is it just a -- it's not like you're introducing new pricing in the back half. And then if we can kind of fast forward into 2019, do you expect to have to do this again? Do you have expect to have to raise prices again in order to try to offset freight?

That's a good question, Rob. One of the things that we've talked about before is the timing with which we approached our [customer] and that started, I would say, middle Q4 and depending on the division and the category.

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[put] its way out in dialogue all the way through Q1 and [Q2]. As you know, there's this standard of at least a 60-day delay so that the customer can realign their setup and manage the change in price. So we won on Jan 1. And if we hadn't been it, would've been [60 days] to hit the P&L so it was a staggered approach, the lag that ended up with us

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gap both on commodity and freight in the first half. As I mentioned in response to one of the [questions] just a second ago, we are seeing some [commodity] inflation that we think is going to be out there. Bear in mind we're still in August and we've got next year.

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that there's a lot of months and a lot of market activity still to come but we are seeing signs of commodities in selected areas and we're seeing freight across the board. So that's something we need to think about, and certainly, we're cognizant of

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for the timing this year, and we'll obviously, try and get out earlier -- as earlier as we possibly can (technical difficulty)

[market's] clear.

I would also say our business is a series of variable-length contracts. Some of the retailers run an automatic annual bid. Some of them are on other time cycles. So the good news in ours is the.

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[macro] issue, it's not a TreeHouse issue. And so if that needs to be in it, all of those annual bid customers will

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annual bid cycle -- those other cycles. So our business comes up pretty regularly or much of it does. And so I think we will have the opportunity to price in the contract season, outside the contract season and over the next year. This year was particularly difficult just because the magnitude and the fact that it was across the board, and I think there was an attempt to work with [customers]. Some things went out to bid, and the bids -- most of them came our way some of them didn't. And you're seeing that in some of those volume losses, but -- and that also suggested pricing for freight is real. So we'll be managing it with the retail. We're going to try to do as partners with the retailer this time.

I think we got some good examples just recently where that started working where because of the network, the retailer's running versus the network we're in, they have naturally got empty backhauls. So we've gone from some delivered to customer pickup, taking costs out of the supply chains. So I think that kind of activity is where we're going to have to take the dialogue and optimize the whole supply chain, not [just a] piece of it.

And now we'll hear from Farha Aslam with Stephens.

Question about Pecatonica. Could you share with.

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who's been producing the product for you? Do you have to win

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customers, just kind of how that ramps at (inaudible)?

Yes. That's been a broad-based impact, not just a cost impact. So we've struggled on the cost side. As we mentioned in the remarks, it's been tough in this tight labor market especially around certain skilled trades where there's just a shortage of good people that we can get to come join us. So we struggled with getting that full.

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and it's resulted in 2 things. One is cost

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and the other thing is some customer accounts reloaded to the extent we possibly can the other

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in that network but we haven't managed to fully offset it. So we've seen that impact in both the top line and the cost. We're making progress. Every week. Every day we have a call on the manning there. We know what the gap was when we started. I'd say we made terrific progress. We're probably close to getting the manning where it needs to be. We then got to get the plant operating. So there is going to be a bit of a drag in second half. But we think without a doubt, we'll be done by year-end and have this business back where it needs to be.

Yes. So Farha, what we did, we loaded the other 2 plants and we moved volume around. We had temporary workers in the facility which performed at a fraction of the normal operating performance at Pecatonica. We

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the other plants. That business is a combination of both private label and industrial [ingredient]. We stepped out of some of that industrial ingredient business. All in all, it was tough. I think we welcome those folks back to work. We now -- we think we have a labor agreement [that] better reflects the changes in the [agreement] and will allow us to position the business more closely aligned with

[where work] forces are. So it was expensive. It was difficult on all parties, but I think long term, I'm just most pleased that we're able to tell you (technical difficulty)

for guidance. So the rest of the teams have

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and found ways to cover that cost. So that's the resilience that I'm most impressed with.

And next, we'll hear from Steve Strycula with UBS.

Two-part.

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The first would be if you could walk us through, Steve, a little bit of [SKU] rationalization, should we expect it to -- it sounds like it should be a little bit more acute in the back half relative to the front half. And when should we expect that to fully kind of wrap into the baseline of the business? It feels like that might be 2Q of next year, but any guidance there would be super helpful. And then a higher level question for you on customer feedback. I know you've been traveling the country meeting with a lot of your largest retailers. What has been the most candid conversation that you've had in terms of how can TreeHouse really improve and gain share of wallet relative to what they've done the last 2 or 3 years? And what are the 1 or 2 things that are needle-moving that you can do to kind of

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and really capitalize on the opportunity?

Sure.

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question and Matthew can chime in as well. The SKU rationalization, I think, should be pretty much through the system by the year-end, and they started that process and identified them all in the previous year. They executed them in the first and second quarters. Sometimes when you stop making something and we let the inventories run out, packaging run out, all that stuff. So it's sort of an evenly spread [Audio Gap]

quarter-to-quarter throughout the year. So that [will be] behind us. There will be some conscious [pruning of the] portfolio both existing business and future business as we go forward as contracts come up to better align capacity with where we think the real [opportunities] are. With regard to the [customer], I think it's -- if I have the obligation to bring a big transformation to [TreeHouse], I needed to do a couple of fundamental things. And I had a chance early on to talk to you all, to talk to the investor and I've been both with the

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organization and I've been with our largest shareholders personally. I had a chance to go to our top customers and I went to more than the top customers. I went to the large customers. I also went to, what I would call the, super regionals, right? I met the hard discounters. I got

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sort of look at private label that's a little deeper. What's their strategy? What did they need from us? I heard loud and clear, "fill the order, damn it", right? And so that was pretty clear and so that's why that's so transparent in my comments to-date. So we're working really hard on that and I'm pleased with the process there. So we have to [still live] with that. We've just not applied it as selectively as we will in the future. And then being the right

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right? And really understanding where they're going to focus. So the strategy going forward will be to

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in a position to leverage that and to understand where we think private label of future is, there's going to be an e-commerce component. Obviously, there'll be a traditional component. There'll be a natural and organic component. So how we balance those things, how we position each one of our divisions to participate in the best parts of those categories is the focus going forward.

And Amit Sharma from BMO Capital Markets is next.

Steve, a question for you. If we -- when we look at measured channel pricing data for private label, it is a large variance in what you're reporting and what data we're seeing. Is that just a function of your customer base? Or are your private label competitors haven't really fully caught up with the pricing yet?

I think retail pricing data is very difficult right now. We talked about -- it all depends on where that data is being picked up, how much that retailer does on the East Coast of the United States right now because you'll see pricing across the country. (technical difficulty)

bottle of salad dressing, for example, that will vary more than $1, okay? You'll see pricing in Eastern half of the Unit States that will [vary] more than $1 and this is all unit sales for $1. So we've got it. You'll see salad dressing at $1 and you'll see it at $2. So I think it's hard to take the IRI or Nielsen pricing data and

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our sales

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There's some pretty

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stuff going on right now. And it depends on how that...

And one quick one for Matthew. Matthew, how much incentive comp headwind is going to come in.

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Most of the incentive comp headwind is going to come in the back half of the year. As [we] went through the year last year, our performance.

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down and we were releasing accrual set out in the second half. So that's where we've got the most difficult beat and it's probably $10 million -- $8 million to $10 million a quarter in Q3 and 4.

And next, we'll hear from John Baumgartner with Wells Fargo.

Steve, wanted to come back to the Snacks business. When we see the pricing net of commodities was positive and that new volume essentially offset the impact of the SKU rationalization but margins are still down. It feels like the complexion of the business is really changing from a mix perspective. So how do you think about the ability to rebuild profitability in that segment? And I guess what needs to happen to rebuild the mix?

I would suggest that the Snacks business is getting tremendous amount of effort -- attention and effort from us. And I think we understand that the business (technical difficulty)

And the business we're running are very different. And I'm not sure that we put the right operating model in place. I think there's a big [difference] within Snacks between trail mix, between nuts, between all of these different things. You've got to be innovation- focused. You got to be very close to your customer, to your cost structure. So the work we're doing with that [organization]

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give them a lot of credit to better position ourselves. The other thing that's going [there] that isn't fair to do it is the bars thing that Matthew talked about. Quite frankly, the bars business is on fire, and what I mean by that in a good way. We are oversold in bars, and we are scrambling, and I hate to use that term, because that's not fair to the amount of work and the professionalism going on, [but] to position ourselves to make more bars. So [this business] business has a lot of complexity to it. The

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business maybe painted it with the

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numbers that we think are great investments in the future, and I would make them in a heartbeat. But leave it to say that we think the Snacks business is a great business. It's going to take a lot of work and maybe a little bit different operating model than what we have today, and we're working hard to get us there.

I mean, I guess.

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sure, given your review is ongoing. But I mean, think about, I guess, the ultimate margin structure here. Can you get back to the high watermarks of 2015? I mean, is this more of a mid-single-digit business going forward? What's the right way to think about it?

Again, I think it depends on how we do in each one of those categories. I think bars is a great business. There's a lot of high value-add. These new high-protein, high-particulate bars are very high value bars and there's a lot of opportunity in that. And I think if you get the trail mix business right as a mix within Snacks, you can go to historic margins. I think.

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[margins] are very doable but we've learned -- we put 2 very different businesses together. (inaudible) Private Brands, Snacks business and the Flagstone business. And getting the operating model right is going to be key to do that, and I would suggest we haven't quite got there yet but I think we have line of sight on how to get there.

And now from SIG Financial, we'll hear from Pablo Zuanic.

Two quick questions. Steve, one, as you met with customers, and then.

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analyze by retailers within categories. But how is their attitude towards private label evolving? Are they more focused on trying to bring a lower price to compete with [healthy counters]? Are they trying to introduce tiers? I mean we talked normally about base versus

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but talk more about how are they

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private label. I see Walmart, how

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willing to use very premium, pure balanced food, if you can comment on that. And again, I know I tried to generalize. And the second question, very briefly, in the press release, you talked about trying to find ways to unleash the power of scale. I mean from our perspective, whether it's branded or private label, it's about your scale within the category, right? That doesn't seem to be a bit cost (technical difficulty)

in being in every aisle whether it's branded or private label. And maybe the complexity of results from having so many

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it actually worsens the cost picture, so if you can talk about that.

Yes. Certainly. Thanks. Well, I'd say 2 things, and I tried to talk about that in the prepared remarks. The things that's obvious to me on your first question is, it really varies by retailer. And if you go across the country and you look at the super regionals, who've learned to compete in the hyper as the supercenter concept went national and as grocery evolved the last time. The super regionals did it on experience, right? And so.

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retailers asking a very different question for TreeHouse. They're asking us for our innovation [orientation]. They're asking us for custom. They're asking us for very different things. Some of the hard discounters and the large [mass]

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are looking for price point. They're looking for, in some cases, they're 100% private label. In other cases, they're

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private label. So the conversation is so unique (technical difficulty)

and that's the importance of the operating model that we just

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with the strategic account managers. So we're putting teams, which is a pretty normal

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across CPG, right, every other CPG organization does this, but we're putting teams on all these customers. And quite frankly, on those that want value, I mean that's the logistics team. It's all of those folks that help there on the experiential, on the super regional guys. And you know [who they are]. We don't like to talk specifically about each retailer that we do business with, but they want innovation. They want experience. And so we're building teams differently. We're bringing different things to market there, and that's where breadth help us, where scale helps. Note that the smaller vendor can bring across a number of categories a similar position. I would also argue where scale is going to help us in the long term is our distribution network. And I've talked a lot about that. [It's] cumbersome today because it's the accumulation of all these acquisitions. Our team, that'll be

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days of our supply chain structural initiatives is to consolidate our distribution network. You get it from some 119 locations to, say, 70 or less. And once we have the product close to the customer, once the customer can pick up or be delivered multiple items on one invoice, that's when we bring in to bring scale to this. Everyone's trying to drive cost out. Everyone's trying to drive [org] out. If you got a different vendor for every [category], you can't do that. So I think that we have yet to do it but it's going to come on the logistics side. And I think the freight cost environment is just going to make that much more attractive to the retailer.

And next from Jefferies, we'll hear from Akshay Jagdale.

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to ask about the implied 4Q guidance that implies about a couple of hundred basis point improvement sequentially in margins from 3Q. The business has become more and more seasonal. Can you help us [bridge] that gap between 3Q and 4Q as far as, at least, the controllable

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your side? Is the cost structure going to be materially

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Or is a lot of that just seasonality? I look back historically, I mean, seasonality maybe is 150 bps but it seems like this year, you're heading for a little bit more of that.

That's a good question. And when I look at Q4 over Q3 and the improvement we need, it is about 50-50 traditional seasonality and 50-50 cost improvements, and we will see new momentum with TMOS and 2020 and the impact of some of these plant closures where we're lapping periods where we still have plants in the network. There's some cost work to do. When you look sequentially, we'll see the impact of Pecatonica, the drag decline as we get into the last quarter of year. And I feel pretty good about our -- the balance of the half and the way we got it set up from a seasonality perspective.

Got it. That's helpful. And just one for Steve. I know you're not yet.

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[confident] on next steps in terms of

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At a high level, I mean, even if you look at TreeHouse 2020, other companies ones that, obviously, you worked at as well have done a better job, I would say, over the years of quantifying sort of gross and net savings when they're giving out long term margin target. Is that something that we can expect, you think, from TreeHouse? Is the business model enough to warrant

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of all communication? And any high level thoughts, and sort of, you've mentioned in your meetings that the strategy portion that you really want to [bring about] is out top line growth. But any other thoughts there, as you've been in the job longer, would be helpful.

Sure, Akshay. I did.

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expect us to bring metrics out. What do we think this business can do over the strategic time frame? What should you expect

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standpoint? What would M&A do? What will -- how will role differ from what's it's been before? So I'm resisting the temptation to share more but we're working on those things. And I think we owe you metrics with a little more detail. This business may have a little more ambiguity to it just because of the nature of -- the private label nature that we don't own the brands. We don't own the launch cycles. We don't own all those things. So maybe it's a little more difficult for some of the detail. (technical difficulty)

think we will bring you a strategic road map of today where we want to go, what the metrics look like

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And with SunTrust we'll hear from Bill Chappell.

Steve, sorry, I may have missed this. But in terms of refining the portfolio, I guess, would've thought it would've happened a little bit faster and maybe more than just kind of one relatively small deal so far. Is there -- as you've spent kind of the past 4, 5 months looking at the portfolio, has there been any change in kind of your view in terms of accelerating or pulling back or versus kind of the initial take in? Would you expect the pace if it has accelerated to kind of -- of refining to accelerate between now and year-end?

I would expect -- yes, I hope we can bring.

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a look at it and we'll be working on it when we bring that forward. So I think it -- would I like to move faster, absolutely? Is it fair to this organization to pour more on it at this moment? If you think about bringing out a strategy that may have some significant portfolio restructure on top of all things we're doing today, I'm concerned that we won't be able to serve the customer at the level that we need to, and that's going to compound our channel. The sequencing of this is critical. It's [obvious to me] that we have some great opportunities, and I'll just repeat what I said earlier. The fact that I think we can do it in the first year

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everything else we have going on makes me feel good. But it's not my lack of enthusiasm that's holding it back. It's really the idea that we need to be both public and private with it at the right moment.

That concludes today's question-and-answer session. Mr. Oakland, at this time, I will turn the conference back to you for any additional or closing remarks.

Yes. So I'd just again like to say thank you to everybody that was on the call with us today. And I'd like to reach out to our organization. I think we are working really hard. And.

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know [they're] something special and I'm really proud of them. I'm glad they had this kind of quarter, and I hope we can continue this and have this kind of year. So we feel really good about that, and I want to thank them and thank you all. Have a great day.

This concludes today's conference. Thank you for your participation. You may now disconnect.