TreeHouse Foods, Inc.
Q2 2013 Earnings Call Transcript

Published: 8 Aug 2013

[Operator:]

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 the reading of the Safe Harbor statement.

[PI Aquino:]

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 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, 2012, and subsequent Forms 10-Q 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 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.

[Sam K. Reed:]

Thank you, PI. Good morning, all, and welcome back to our TreeHouse. Dennis and I have much to report with news of real progress across a broad of initiatives. We are particularly pleased to announce another addition to our TreeHousehold as our Private Label home continues to expand. Strategically, the acquisition of Associated Brands will both broaden and deepen our center of store private-label presence across North America. We will gain both new grocery distribution, as well as operational synergies in powdered beverages, hot cereal, side dishes and other dry-blended categories. Additionally, Associated's expertise in specialty tea offers a new avenue of growth that parallels our current single-serve coffee program. We plan to integrate our go-to market operations supply chain and managerial teams under a joint program, uniting Associated, Bay Valley Foods and, in Canada, E.D. Smith in a common campaign directed at top line growth and productivity gains in shared categories, channels and customers that we already know well. The campaign will be further leveraged through our acquisition of Cains Foods in July. Cains will serve as both a gateway to the northeastern markets and an innovation platform in premium mayonnaise and salad dressings. Having followed and observed both Associated and Cains' progress since 2008, I am confident that these deals will be good ones for all TreeHousers, especially our shareholders. Financially, our performance through mid-year indicates that 2013 will be a year of solid performance and steady improvement. Despite sluggish market conditions, we have combined modest top line growth and the expansion of single-serve beverages with substantial operating improvements to increase margins in all 3 of our go-to market segments. Direct Marketing income margin, our principal measure of category channel and customer profitability, increased 250 basis points in the second quarter versus last year on a composite TreeHouse-wide basis. Our assessments of general market trends, Private Label industry conditions and internal business plans for the second half are such that we have announced an increase in earnings guidance for the full year, excluding the Associated Brands transaction. In short, we are performing far better now than we have in the past. Operationally, our business units, functional teams and go-to market teams are tactically executing our strategic plans with high degrees of precision and determination. Our investments in information technology, customer marketing, food safety, R&D, procurement programs and logistics networks have provided the dedicated resources required to compete in today's marketplace. Our operational Supply Chains have been particularly adept in integrating the bolt-on acquisitions of Naturally Fresh, AMPI and Cains under the TreeHouse infrastructure seamlessly and without customer disruption. These same groups have also undertaken large-scale, consolidation projects in the salad dressing and soup categories. It is this agenda of scale, standardization and ultimately, simplification that provides the internal impetus to drive our external expansion soon to exceed $2.5 billion in annual revenues. These strategic financial and operational gains have been made against a backdrop of a sputtering and uncertain consumer economy. The entire food and beverage sector has struggled to generate real growth as indicated by IRI's syndicated data covering 102 product categories. This data shows a steady decline in sequential quarterly volume comps for both brands and Private Label since the fourth quarter of 2011. For the second quarter of this year, IRI's general food and beverage index reflects year-over-year decreases in unit sales of 2.1% for brands and 1.0% for Private Label. The consequences of these trends upon all manufacturers are further exacerbated by the channel shift from conventional to discount retailers. Taken in this context, I'm particularly pleased with our progress under such choppy industry conditions. Dennis, would you please take everyone behind these headlines, as well as provide your seasoned CFOs perspective, on our financial condition, the Associated Brands acquisition and our future prospects?

[Dennis F. Riordan:]

Thanks, Sam. Although the second quarter showed some challenges at the top line in some of our segments, our operating teams did a great job in navigating the soft consumer market with cost-containment programs. In fact, all 3 of our reporting segments improved their operating income margins and profits despite the softness in each segment's marketplaces. We are particularly pleased that our North American Retail Grocery segment showed positive volume/mix despite the growth challenges many other food companies are having. Our total volume/mix in retail grocery increased by 0.7%, leading to a net sales increase of 1.1% to $375.7 million from $371.5 million last year. That volume/mix number is all in. If we exclude the soup business that was negatively affected by the partial loss of a major customer late last year, the volume/mix would have been up 3.6% for all categories. Single-serve hot beverages made up most of the increase. While sales of our traditional grocery products, such as pickles, nondairy creamers, sauces, dressings and hot cereal, were essentially flat as a group compared to last year. This pretty much matches the overall volumes in U.S. retail, as Sam outlined earlier. The only products with noticeable sales decreases came from sugar-free powdered beverages, which continue to feel the pressure of liquid beverage enhancers and a generally cooler summer in the midwest and east that may also be affecting overall consumption. In regards to margins, our gross margins improved to 22.5% from 21.6% in retail last year, with the increase coming primarily from an improved mix of sales and operating efficiencies that were partially offset by increased input costs, such as sweeteners and thickeners. Additional savings in freight and distribution, along with lower direct selling and marketing expenses, resulted in direct operating income improving by 11.4% compared to last year. With respect to the Food Away From Home segment, total sales were down slightly from last year's second quarter, primarily as our simplification process and SKU rationalization programs focused on driving higher gross margins rather than producing inefficient or very low margin business. This shift in emphasis helped to improve our sales mix, resulting in gross margin improvement of 170 basis points from 18.1% to 19.8% and an increase in total direct operating income by 14.1% to $12 million. Our Industrial and Export business had a similar quarter to Food Away from Home, and that the business that was rationalized away was in very low margin categories and our new business came in better margin products, which more than offset the effect of the sales shortfall. In the case of Industrial and Export, our new contract manufacturing accounts significantly improve the overall sales mix. In addition, we had the benefit of stabilized input cost in our Industrial Non-Dairy Creamer business. These factors helped to improve our industrial and export gross margins to 23.4% from 15.5% last year, resulting in direct operating income improving from 12.2% to 20.8%. We will continue to focus on selling more value-added products and de-emphasize low margin products to our internal simplification efforts over the balance of the year. As we look at the total company results, you will see that sales has a small decline of 0.2% from last year's second quarter. But the improvement in mix and internal operating activities resulted in gross margins improving 60 basis points to 20.8% compared to 22.2% last year. Our selling and distribution expenses decreased to 6% of net sales compared to 6.4% last year, as our distribution cost continue to improve as we become more efficient with our network optimization programs and selling costs are kept in check. One area I do want to focus on is general and administrative expenses, which increased quite a bit from last year. This year, we spent $29.1 million or 5.5% of net sales in the second quarter compared to only $22.7 million or 4.3% of net sales in the prior year. This year, we are running at our normal and historical spend rate, but last year was very low due to the poor operating results that caused us to reverse nearly all previously accrued incentive compensation cost. The rate for the quarter was very much in line with our planned rate for the year. With regard to taxes, our effective tax rate for the quarter was 33.4%, higher than our normal run rate, as we incurred higher state sales taxes and a shift in income from Canada to the U.S., where corporate income tax rates are higher. Net income in the second quarter was $18.6 million compared to $19.5 million in last year's second quarter. This equates to fully diluted earnings per share of $0.50 in the quarter compared to $0.53 last year before considering unusual items. After adjusting for the unusual items highlighted in our press release this morning, our adjusted earnings per fully diluted share for the quarter increased 8.3% to $0.65 compared to $0.60 last year. While this is a nice increase in earnings, from a quality standpoint, the results are much better. Taking into account the approximately $7 million in normalized incentive compensation that was not in last year's results would imply an additional $0.12 in quality earnings this year compared to last year's second quarter. That's the result we focus on internally and why we are very pleased with the results we are posting this quarter. In regard to the outlook for the remainder of the year, we believe the trends of the first half are very likely to continue during the second half of the year as well. This means volume/mix should be positive, but more challenged than we had originally estimated. However, the cost controls in business simplification plans we now have in place, combined with a favorable trend of sales mix, should allow us to generate gross margins to offset the softer top line. As such, we are raising and tightening our earnings expectation for the year to a range of $3.75 to $3.12 in full-year adjusted earnings per share before considering the effects of Associated Brands that Sam discussed. We will provide additional guidance on the effect of Associated Brands' acquisition on our 2013 earnings once we have the final transaction close date and integration costs are more fully estimated. We do expect the transaction to have an immaterial effect on 2013 earnings per share of $3.07 to $3.12. As noted in this morning's press release, we do expect the transaction to be nicely accretive, adding approximately $0.14 to $0.16 in earnings on an annualized basis. Now I want to take a few minutes and talk about our recent acquisition announcements. First, we announced the acquisition of Cain Foods, which became effective at the beginning of July. Cains' has annual sales of about $80 million and its products include spoonable and pourable dressings and sauces. It's main product focus is mayonnaise, which fills a void in our U.S. product offerings in both retail and Food Away from Home. Approximately half of their revenue comes from retail sales. The other half from Food Away from Home. Since the acquisition closed after the end of the second quarter, there was no effect on our reported results for the quarter. Cains will be immaterial to our 2013 earnings per share, but should generate about $0.05 in accretive earnings in 2014. Our new announcement from this morning is our agreement to acquire Associated Brands. Associated is a Canadian-headquartered company that makes an assortment of Private Label products for both Canadian and U.S. retailers, along with a small amount of products manufactured for other branded companies. Their annual sales are just over CAD $200 million Canadian, with approximately 80% of their net sales being in the retail channel. Their products include drink mixes, specialty teas, side dishes, sweeteners and other dry mix products sold in the center of the store. Their product line is highly complementary to ours, especially the products produced by our Sturm and S.T. Specialty divisions. Associated employs approximately 650 people and produces the majority of their products at their Medina, New York and Vancouver, British Columbia locations. Most of the dry mix products are produced in Medina, while Vancouver specializes in tea products. Additionally, they have a very talented and experienced management team and we are very happy that they will become part of the TreeHouse team. The transaction is expected to be accretive to our annual results by $0.14 to $0.16, but will likely have an immaterial affect on our 2013 earnings. We expect the transaction to close in our third quarter, subject to the usual closing conditions. We will finance the transaction with borrowings under our current revolving credit facility. After the transaction closes, we expect our leverage ratio to be in the range of about 3.3x debt to pro forma EBITDA. This will leave us plenty of dry powder to pursue additional attractive transactions as we can lever up to 4x debt to pro forma EBITDA to make acquisitions. Sam?

[Sam K. Reed:]

Thanks, Dennis. In the interest of time and the context of news of our Associated deal, I'll limit my closing remarks to a strategic overview of our prospects through 2014. First, TreeHouse will continue to improve internally and to reflect those productivity gains and increased profitability. Second, whatever the macro industry conditions, we will utilize our growing and diverse portfolio to pursue strategically and financially sound top line growth. Third, we have sufficient capacity and resources for more external expansion whether bolt-on or strategic and the appetite for both. On this last point, please note that, as of mid-year, we have already added nearly $300 million in revenues to our TreeHouse. Given the strength of the M&A market and our cash-generation capability, there is always room for more. Aaron, you can open the lines for Q&A.

[Operator:]

[Operator Instructions] We'll go first to Jonathan Feeney with Janney Capital Markets.

[Mark E. Williams:]

This is Mark Williams for Jonathan. Congratulations on the Associated transaction, I would like to know how much it effects your ability to compete in single-serve? And was that a consideration of the deal?

[Sam K. Reed:]

Mark, this is Sam Reed. Thank you. Your question shows great insight. We believe that the single-serve beverage platform, though it's currently focused on coffee and other certain hot beverages, will be a platform for broader expansion and that, in particular this transaction, introduces us to the world of specialty tea and that we see that as kind of the next step in a series of expansions of this platform and look forward to being able to do that. And that was a significant part of the whole of the matter.

[Mark E. Williams:]

And Sam, did it materially increase your capacity to produce single-serve beverages?

[Sam K. Reed:]

The focus of the current business is primarily on Starbucks, Tazo Tea and a limited amount of grocery product that is served -- is packaged in conventional packets for that particular category. What it offers us is a much newer, much broader vista of opportunities to utilize with the capital equipment that we've committed to our current program and which we've indicated on several occasions in the past that we continue to expand that capital base. I think this will only accelerate that long-term growth.

[Mark E. Williams:]

And just the last question I had on the single-serve business. You noted it seemed to strengthen that business during the quarter, can you just talk about the, I guess, your near-term outlook for that business, how you are doing with what you're seeing in terms of Private Label getting share there. And has your assessment of your ability to compete there increased at all, since you launched?

[Sam K. Reed:]

Well, let me reiterate a few of the trends that are underlying this. So first of all, we indicated from the very beginning that we would bootstrap our investment in this business in a year in some layer like we still see that as the case. And our outlook for the remainder of this year and you going deep into 2014 is that we've got a substantial -- we've got a forward book of business that requires that we make ongoing investments to expand capacity as that business comes onstream. And that rate of growth continues to be very strong and it is in its aggregate beyond our original expectations. In terms of being able to compete in the category, I had indicated at the beginning that I expected that TreeHouse will be first among equals in the Private Label business. And while we could not estimate the aggregate share that Private Label would have the totality, that we expected that, that share would settle out over time, to be well within the range of similar products in dry grocery. And we are clearly first in this regard and have in the Private Label sector quite a substantial lead over any and all of the others. And with regard to the share here, we're just beginning to see through Nielsen and IRI what those true numbers are as you get past the period of the initial rollout where it's quite hard to read that. And again, I'll reiterate that with regard to the split between brands and Private Label, I'll let the marketplace sort that out, but we are greatly focused on accommodating all of the substantial growth that we see here. And it's not just in single-serve coffee, our Grove Square line of nonfiltered products continues to grow at very strong rates as that distribution is expanded. And as I said, our next venture would be to incorporate specialty teas in conjunction with the expertise that the Associated Brands acquisition brings us.

[Operator:]

We'll take our next question from Farha Aslam with Stephens Inc.

[Farha Aslam:]

Question regarding the category of tea, could you just kind scale for us the category size, Private Label share in the category, Associated's role in that category? And what category growth trends are, just so we can get a better feel for this new acquisition?

[Sam K. Reed:]

Farha, this is Sam. I don't have the data at hand. I will say that you see here a substantial business in not only black and green teas, but specialty teas across all of North America and both of grocery and Food Away from Home. And that the business is largely one now, of -- lot of the 3 very substantial branded leaders, they tend to focus more on the black and green tea end and very little, most of the specialty sector is left to independents and regional companies. And again, focused primarily on to loose tea and teabags. Where we see the opportunity is to use tea as an adjunct to the Private Label coffee program and as an adjunct to Grove Square, and where we have already established the presence with grocers that is working greatly to their advantage that the merits of an incremental expansion of that into other beverages offers them a substantial opportunity to establish a Private Label presence in a sector that is not at all consolidated, highly diverse, with little in the way of brand recognition more than on a regional basis among the specialty suppliers. And I think that the message here is less one about what's the exact size of tea than it is about finding new sectors, new frontiers on which we can extend the single-serve beverage platform.

[Farha Aslam:]

Absolutely. And then in terms of growth, could you share with us kind of the growth trends of the Associated business? And now that it's in your hands, how quickly those sales can grow over the next, perhaps, 2 to 3 years?

[Dennis F. Riordan:]

They've had moderate growth over the past few years as the case with us as well, certain categories up, certain down. What we liked about it, Farha, was that their business really has great penetration in some of the key accounts in Canada that we really don't have a stronger presence in and that will be a very nice plus for us, roughly just under 50% of their revenue comes from Canada, just over 50% is in the U.S.. So as we did with E.D. Smith, as we've done with San Antonio Farms and others. What we're interested in is finding outlets in the U.S. for the products that were primarily Canadian and finding Canadian outlets for our products that we didn't have penetration at their account. So we think there's a great opportunity for growth. We're not ready yet to talk about long-term growth trends there. I think we usually don't do that on our numbers either. But we really do envision a kind of a mini E.D. Smith here in terms of our ability to expand distribution. That's what really excited us.

[Operator:]

We'll take our next question from Thilo Wrede with Jefferies.

[Thilo Wrede:]

Sam, I understand that tea and coffee are complementary. Yet, Private Label market share in tea, I think, is lower than coffee at least in the U.S. So just a question, what is the attractiveness in tea and why, unlike in coffee where you entered it in organically, why was M&A the right route to get into tea?

[Sam K. Reed:]

I think here that the category to focus on is not tea in its aggregate, but in fact, the specialty tea sectors. And that as I'd indicated in an earlier answer, that is an industry that is replete with a large number of small regional and local suppliers. And that the presence of Private Label to date has been limited to the large volume sectors of black tea and green tea. Primarily because of that's where these, the suppliers and the stores can find a critical mass. What we offer that's different here is that we will bring expertise in specialty tea. And when one combines that with the filtered coffee in Grove Square and then on top of that, you then have an advantage to entry point that once we've moved into specialties then offers us a second or third generation of further expansion. And with regard to the internal development versus M&A, I think we've been quite clear from the beginning that our programs here are a combination of expansion through M&A first. Secondly, to - as new business systems come into TreeHouse to take advantage of the breadth and scope of our distribution system, they find new distribution for products that are already established in certain parts of the marketplace, but are not universally distributed. And then lastly, that there is organic growth that has been of the 3 vectors of growth, the one that was least emphasized until the development in single-serve coffee. We'll take the growth where we find it. And kind of one comment in that regard to follow-up with regard to Cains is that while this was a relatively small acquisition, the third bolt-on in I think the last 5 or 6 quarters, it has great strategic value to us in having an established base in the northeastern United States as does Associated Brands and we see the combination of those 2 as offering an advantage to all of TreeHouse that without them, we have not been able to fully exploit.

[Thilo Wrede:]

Right. And then Associated Brands, obviously, doesn't just come with tea, but there's among other things, powdered beverages and soup in there as well, which are categories that -- soup you have key emphasized, powdered beverage, you called out some weakness today. How much should we factor in SKU rationalization within the Associated business 1 year or 2 from now?

[Sam K. Reed:]

Well, we will -- first of all, this integration and this acquisition is one that unlike virtually everything else we've done. This is clearly marked by a substantial overlap from a product category perspective, with different geographic and account channel based points and pockets of strength. So a substantial amount of this program will be an integration whereby, what we will attempt to do is identify where in the combined companies do we have the greatest economies of scale with regard to production and distribution? And where do have the biggest opportunities with regard to the go-to-market. And I think what we will see is much like E.D. Smith that there is on -- will be a both north and south of the U.S. Canadian border, marketing and sales teams that will be able to go to existing customers with new variations, new varieties and in some cases, new categories of product. And that the operations and supply chain that backs that up will be a combination of Bay Valley and E.D. Smith and Associated operations and a supply chain that will give us the best costs available over the combined network. So it offers, even in those categories, where we already have a substantial presence, there's a complementary opportunity that comes with the new business that we will be sure to fully use to our advantage.

[Thilo Wrede:]

Okay, then maybe one last quick question for Dennis. The margin expansion that you've had on the retail business, how much of that was driven by your productivity programs versus the growth of the single-serve coffee business?

[Dennis F. Riordan:]

Out of that margin growth, a little more than half of it is sales mix. And the rest is productivity and other improvements.

[Operator:]

We'll take our next question from David Driscoll with Citi.

[David Driscoll:]

I wanted to ask a little bit about powdered beverages and liquid beverages. You called out weakness there, can you give us some sense of magnitude, I mean, is the combined operations, both powdered and liquid, I mean, are we talking double-digit declines, single-digit declines? And what's the prognosis for this business going forward?

[Dennis F. Riordan:]

David, we don't break out the subsections. I will say that the total of the beverage business, which includes hot and cold is, was up 36.5% in the quarter from roughly $52 million to just over $71 million. You'll see those product numbers come out in the 10-Q this afternoon. All of that growth was driven by the hot side, not just filtered but unfiltered products as well. So we definitely did see the decline in the powdered side. Our liquid beverage enhancers have just started shipping. We just saw the first fruits of that come out in the second quarter, but it was really pretty minor at this point. So we're gaining traction, but it's a little late. But out of that 36% increase, as I said, that was all due to the hot platform.

[Sam K. Reed:]

Hey, Dave, this is Sam, if I could add a little further commentary. I think the headline here is -- and while we all will carefully watch kind of the single segments and single quarters, the headline here, David, is that for TreeHouse, beverages in their, primarily in a powdered or nonliquid form, are now seen by us as a great expansion opportunity and far beyond that of what we had originally expected when we had started the business and that we will be managing a portfolio of beverages, in the same way that we currently manage our portfolio of product categories that are largely canned or bottled or other packaged in the center of the store. And we'll look back and say that in this 2011, 2012, 2013 period, we put -- it was the basis of the formation of what will effectively be a TreeHouse in beverages that will rival the TreeHouse in the center of the store solid foods.

[David Driscoll:]

All right, two questions. Interest expense for the year and your inflation outlook for the year?

[Dennis F. Riordan:]

Interest expense will be pretty steady. We have a $100 million senior note that will be coming due that will be refinanced at least in the short term through the revolver. So that note carried interest at roughly -- just over 6%, and our current borrowings rates are just under 2%. So in our guidance and in our expectations for the year, David, we had expected that to be refinanced through the revolver, The rest of it will be pretty steady, so that should be straightforward. When we put our accretion estimates together for Associated, we use a longer-term rate. So our expectation is that at some point, on a long-term basis will be different financing. So that is based on a more long-term market rate, something approaching the high-yield markets that we could tap. So think about that in terms of your models for that piece.

[David Driscoll:]

Inflation?

[Dennis F. Riordan:]

So far, I said I wouldn't use the word benign. Everytime I sat that, something happens. But I think benign is the word. Pricing this year has been just above 0% on average for us, and we price for inputs, so I think you can kind of get the sense that input costs for this year have not been an issue. Based on our forward buys, we don't expect it will be an issue. I think we're solid in, on all of our commodities, a little nervous on cucumbers. The crops were a little bit late in the Southeast and the cool weather has delayed some of the plantings and we've had some storms in the upper Midwest that could have a bit of an impact on the cucumber crop. But at this point, nothing major to call out. But that's probably the only input that we still have to wait to see what happens.

[David Driscoll:]

And then just a clarification on Associated Brands, I think that you have alluded to the fact that you would expect significant revenue synergies, but no quantification. And on cost synergies, I don't think I heard anything about that, so I'm assuming that there's nothing embedded in your 2014 outlook related to it, is that true?

[Dennis F. Riordan:]

That's correct, and that's our usual process. We've tended to buy good companies and our objective is to how do we make good companies better? And that's through the sale synergies. And this is, Associated is exactly in that same case, it's a very good company that we were looking forward to looking at how we can drive that top-line. But at this point, we're not ready to give a top-line growth number.

[David Driscoll:]

And final question, K-Cup repeat rate, it's certainly it sounds like the business is going well, but I was wondering if you just happen to have data on the K-Cup repeat rate to give us some sense of how strong the business momentum was in existing customers after its been in there for a little while? Any comments would be helpful.

[Sam K. Reed:]

David, it's Sam, the fascinating data that I've seen indicates that the repeat rate for the Private Label products that most closely emulate the industry branded leader is twice that of other formats. That where the other companies had taken, if you would, the shortcut or the low road to get into the marketplace without the type of technology that we have invested in. And that portends quite well for us because, as I've indicated at the beginning, I was quite confident that we could take this measured iterative bootstrap approach to private label, knowing that after we -- as we got our business settled, that we will always have a competitive advantage in costs, thanks to our distribution network. But I'm pleased to find out also that, based on the consumer data that we have, that in the Private Label arena we have a great product quality and consumer perception advantage versus other Private Label manufacturers. And that is evidenced in this pre-purchase rate that essentially twice that of our most direct competitors.

[Operator:]

We'll take our next question from Bill Chappell of SunTrust.

[William B. Chappell:]

Just want to dig back into kind of the single-serve side and just get your take on -- Green Mountain last night basically said that they have excess capacity, and they're aggressively go after the unlicensed market and that seems to mean they're going after your customers to do Private Label. So trying to understand, I presume they already have some kind of cost advantage so they could offer the lowest priced if they wanted to. How do you fend that off when you think about kind of a business out there that you're already have orders in the future, do you have set contracts or how do you look at that with their kind of renewed interest at going after what's kind of been your core market for the past year?

[Sam K. Reed:]

Well, I think we're about 6 weeks into our 8th year of doing this. And we started out with 2 substantial Private Label categories and now are approaching 15. And I think that our business system is unlike that of others who are not dedicated to customer brands and custom products. Our whole business system is built at that one thing, and it is to provide a combination of price quality, service and resources that enables grocers to fully exploit their own banners and to make that Private Label an integral part of the store's image and its position in the marketplace. There are others who can focus on primarily only on costs and of a basic product. And we've seen that there is that niche for others here that have not committed the resources and the intellectual property to customer brands that we have. And frankly, it's like the deal business, Bill. There's always somebody out there with deeper pockets. And what we have to do in terms of not only M&A, but our go-to-market proposition is to make sure that we develop superior strategic insights and then execute those in a superb way. And whether it's kind of a national brand leader or somebody else, I can't think of a single category or product line where we do not compete and where there's not at one-time or another, someone else out there that strictly on an eremetic basis can get to costs that either rival or surpass ours. But it's more business as usual from our perspective.

[William B. Chappell:]

But there's nothing contractual that they could, if somebody wants to come and underprice you or do whatever, they could pick off a customer or 2 over time?

[Sam K. Reed:]

You have addressed the essence of the private label business.

[William B. Chappell:]

Okay. Second just kind of switching to Associated Brands. I'm doing back of the envelope in terms of valuation, it looks like kind of using your accretion for next year. Maybe you paid 8x to 9x EBITDA and I guess, can you give me an idea of, I mean, the ballpark and if so, does that kind of imply that overall multiples in the space have moved up a little bit over the past year?

[Dennis F. Riordan:]

Bill, we don't give out the number. But obviously, with EPS, you could make your assessments. We've said before the transaction that we thought the multiples were probably up just a little bit because of financing. I would say that we consider this transaction to be consistent and what we think a good situation. It was -- we think we paid a good price, a fair price, and I think the sellers thought they got a good price and it worked out. And I think this is very much in line with our historical transactions. As you indicated, probably a little bump and as we've said before due to just circumstances in 2013 with interest rates.

[William B. Chappell:]

Okay. So we're in the ballpark and this is kind of where you would normally pay, that weren't kind of paying up for the growth or the category, it was kind of more in line with what you would expect?

[Dennis F. Riordan:]

Yes, I think I'll just stay with what I just said, Bill.

[William B. Chappell:]

And last one, Dennis. Tax rate for the full year now?

[Dennis F. Riordan:]

To be honest, that's been one of our hardest things to calculate. This, obviously, went up a little bit because of a shift. It's -- next quarter is always a challenging one. That the one that moves around the most, if you go back in history because you filed the final tax returns. But I'm not ready to make a change yet. We're a little light early on. We went a little heavy now. So I'm still thinking we'll finish in about the range we started our original guidance with. But I admit that's going to be kind of a TBD, we'll have to see what happens in third quarter.

[Operator:]

We'll take our next question from Rob Moskow with Crédit Suisse.

[Robert Moskow:]

I think I'm going to ask the 6th question on Associated Brands. But no one's asked, I want to know what's the growth rate of the business over the past few years? I didn't see it in the press release. And also, when I've seen Associated Brands at the trade shows, it just seems like a lot of powdered beverage business and my impression would be that, that powdered business has been in decline because of liquid. I understand the strategic rationale for buying it, that makes total sense, but is the overall business right now growing?

[Sam K. Reed:]

Yes, the overall business has grown, and I would say in the low-single digits in general. But they've had acquisitions so that kind of distorts it a little bit, so they had the purchase of the North American tea and coffee companies as they've expanded their business model. But I think the center of the store categories are similar to the rest right now in terms of relatively low-single digits. But as we've said, we think there's great opportunity to expand the distribution. I'll point to what we did with salad dressing, there's a category that historically has grown at about 1% to 2% and you look at our numbers that we have reported over the years. And since we've purchased the E.D. Smith private label, share has gone from 12% to about 24%. So our goal with Associated and that's a lofty number, I'm not sure we can do quite that, but similar programs, see how we can take these categories and grow them. In regard to the drink mixes, there's really 2 elements that are in drink mixes, the single-serve stick type business that has been impacted by liquid beverage enhancers. But the 12 quart packs, the individuals that make quarts at a time, that's actually done very well. And we've seen nice growth in our business and Associated has maintained their business. So it's not all about single-serve. So we think there's still legs in that one as well, Rob.

[Operator:]

We'll take our next question from Andrew Lazar with Barclays.

[Andrew Lazar:]

Sam, from an overall industry perspective, you spent a lot of time in your prepared remarks talking about how volumes are still sluggish at best across the broader group. And that in your sort of more recent data volume, scanner data for both brands in private label was still down year-over-year, although private label had a little bit less of a rate. So I guess, I wanted to ask the question that maybe was asked a bunch of times to a lot of food companies a year ago, where do you think that sort of volume is going? I mean, I'm assuming at this point, consumers have kind of unloaded their pantries of everything they can, although I could be mistaken. I guess, there's always the wasting less at home argument. I'm just trying to get a sense of if you've got any further clarity on that? And if they're not trading down to private label in any significant way, like were is all that going? Because we've kind of lapped a lot of the pricing that the industry thought might be the main culprit and it's not turning out to have been.

[Sam K. Reed:]

Well, it's clear that the totality of the retail market is -- it simply hasn't responded like we had expected a year ago and perhaps even longer than that. And I think the co-sells the underlying co-sells here have to do with the uncertainty in the consumer sector that, that part of the economy simply seems to kind of lack the catalyst to pull itself completely out of the aftermath of the Great Recession and the expansion of the business community that had little effect on middle-class families. With regard to and where is that business going, I think that as a general matter, it's some combination of changed consumer habits that by now the years have been lapped and whatever pantry deload and whatever reduction in household waste and increased leftovers, et cetera, that's already in there. What surprised me in the last quarter was that there is a calculation that one of the government agencies does that looks at the aggregate of food consumption and there's another that divides that into Food Away from Home and food at home. And the aggregate consumption, which had gotten up postrecession to growing as much as 4% is now back down to kind of hovering at 0 or slightly below on a lagging basis. And within that, the lowest numbers of aggregate, approaching 51% of purchases now are seen as being done through grocery stores for at-home consumption. And in the data that I looked at, that 51% share was in fact the lowest that had been reported in comparison to something like 53% a year ago in the same quarter. Then that the transfer appears mostly to be toward the value meals and the economy and the Food Away from Home, and I will grant you that what we have not seen in our Food Away from Home business is any substantial increase in revenues in there that would relate to that. But that's at least my interpretation of it now. And what you can see in our operating results is we've attempted to position the company so that we can ride this thing out even as we continue to marvel at the difficulty for all of us of being able to identify co-sells in a clear and concise way and then be able to take action against those.

[Andrew Lazar:]

And then just 2 quick ones on single-serve. First, once you close the Associated deal, how quickly can you, based on your current capabilities, start to offer a private label sort of specialty, single-serve tea? Is that something that's going to be tremendous amount of sort of planning and whatnot leading up to it or is it something that you can do relatively quickly? And then the second part of that would be more just for fun, thinking ahead. I mean, you haven't even closed this yet, but if one wanted to think broader in single-serve beverages, and you wanted to think beyond coffee and tea, where would you start to point to some potential opportunities, although admittedly, this is not something for right now?

[Sam K. Reed:]

Well, first, with regard to the specialty teas, we will plan to -- we presume that we will own this business for the whole of the fourth quarter and that will coincide quite well with the annual strategic planning and budgeting exercise to go forward. And before I can give you thoughts about exact timing of specialty teas and other product line extensions, what we really need to look at first, Andrew, is on a detailed basis, how is this business operating now and ensure that we first and foremost prove ourselves to be good partners to Starbucks and then begin to incorporate that new opportunity into the whole of the beverage program. As I had said a few minutes ago, when I look at with projections for the remainder of '13 and the projections going out to the first part of 2015, what I clearly see in beverages is that what we will continue to do is expand our capacity in both manufacturing and distribution and extend the product line through innovation and research and development as new business comes online. And as I look forward, I see no slackening, no diminution of new business coming on and the commitments to new business in this category or -- while these items always take and no matter what the category, it always takes a long time to develop in that. Here, what you've got to do is also include the provision for the purchase of green coffee and its roasting and its blending and going to working in conjunction with roast -- it's not only our customers, but roasters and growers as well. So the point in making that is that kind of the lead time one can look forward with regard to coffee and say new businesses coming online, that's a much longer lead time than some of these other businesses. And then with regard to what will come beyond this, I think that the answer there really lies in better understanding the consumer of these single-serve beverages and what is driving the occasion and what is the source of the satisfaction? And then once one understands that, kind of then to look across the panoply of beverages and decide where that opportunity lies elsewhere. And if this sounds like the way a branded company is or approached these things, I think that, that is generally the case here with regard to consumer research and R&D-led innovation. With all of that, probably what will happen is that somebody will come onto the scene with a great branded product that we had -- and make a big splash with it and we'll try to follow them as fast as we can --

[Andrew Lazar:]

Nestle has got an espresso infant formula capsule, so, hey, you never know. It would have come in handy for me a bunch of years ago, but I'm way past that at this point.

[Operator:]

We'll take our next question from Brett Hundley with BB&T Capital Markets.

[Unknown Analyst:]

It's actually Robert McGrory [ph] in for Brett. Just to expand on that sort of innovation side of things, can you -- I mean, we've seen a lot of the brands we recently increased their marketing spend and whatnot, are you guys -- can you talk to us about how you're matching their innovation and whatnot?

[Dennis F. Riordan:]

Yes, that's a great observation. We are looking forward to the brands transforming some of their margin improvement that were starting to see into innovation. Innovation is actually a key to success for private label. Frankly, when brands come out with new products, new packaging, it allows them to advertise, promote, draw consumers into the aisle, and our size and our expertise in research and development both from formulas and packaging, we think we are the best and fastest power in private label. And so bringing consumers into the aisle and us with our resources to be able to put in matched products, I think separates us from the rest of our private label competition. So the more they do, the better. And so that type of trend is something we actually really look forward to.

[Unknown Analyst:]

Excellent. And are you having any different conversations with your retailers today versus 2, 3 years ago on kind of that platform where you're seeing a lot more the spend from the big boys? And whatnot and kind of how that transitions to the customer and impacts the private label side of your business?

[Sam K. Reed:]

It's Sam. I think among the customers who have most clearly declared their brand to be a part of their overall merchandising strategy and retailing, there in fact has been greater demand for differentiated products and where that has worked best our advantage has been in premium end of the business. And Dennis has on the last several quarters indicated how we've seen substantial growth in a lot of the middle of the economy maybe really struggling, those in the top end of that frequent premium retailers, that demand has been quite strong and it has led us to work with those customers with regard to premium products that are brought out for them and that's been a welcome development from customers. And then there are others where they're much more transactionally based and you'll see if you can get into the data that those retailers where the customer brand is more regarded as kind of a secondary factor, they drifted back towards more and more branded merchandising and the monies that come with them. So we've finished that with our category and on account basis.

[Unknown Analyst:]

Okay. Great. And just lastly, on your margin improvement, I know it's somewhat touched upon earlier, but how do you see that kind of mix and just both the internals, as well as just the cost basket moving forward and going into 2014 and how could that impact your margins there?

[Dennis F. Riordan:]

Well, our original thought with this year would be about 100 basis points in margin improvement. And I think we'll get there. I'm pretty confident with that. And I'm not sure about next year, but I think we're nicely on track.

[Operator:]

We'll take the next question from Akshay Jagdale with KeyBanc Capital Markets.

[Akshay S. Jagdale:]

Dennis, first question is for you. So just on the gross margin trend this quarter, sequentially why did they deteriorate sequentially, if I'm right in saying they were worse sequentially. I wasn't expecting that. And I think you had said sequentially we should expect an improvement. But correct me if I'm wrong, and then just tell me what happened there?

[Dennis F. Riordan:]

Our margins actually were on track internally. One of the things you have to take into account is some of the seasonality. Q2 is our big pickle time and I think we've historically known that's a lower average margin category for us. So we do get a little of that deterioration. But other than that, nothing in particular, I think jumps out on a quarter-over-quarter basis, other than the normal flow of products. Compared to a year ago, we talked about the powdered beverage being down which is a better than average margin for us, typically certainly better than pickles. And so that's that Q2 mix a little bit.

[Akshay S. Jagdale:]

Great. And then on single-serve, maybe you can just talk about what are you hearing from retailers. First of all, I'm sure -- are you aware of the new strategy that Green Mountain is pursuing with retailers specifically and what are you hearing from retailers in response to that new strategy, which is being rolled out basically over the last 60 to 90 days?

[Sam K. Reed:]

It's Sam, actually. Good morning. We -- as you would expect, we stay abreast of developments of most of the branded companies in the various categories here. And all are searching in one form or another for more top line growth. And we adapt our strategies to -- we try to anticipate what the brands are going to do and then adapt accordingly. With regard to single-serve beverages here, the category now is one where the big headline has not been the private label entry as much as the number of brands that are proliferating, both licensed and unlicensed brands out there. And in a certain way, it reminds me of kind of the structure of the categories where you've got a leading national brand or global brand at one end, a private label at the other and then typically kind of the regionals that still account for around 52% of all the grocery business in dry grocery. Here, the equivalent of the regional brands are these kind of unlicensed brands. And there will inevitably be some type of evolution shakeout to where on the branded end of this business, there's apt to be more, if not consolidation, at least fewer branded players over a long period of time. And we're going to be affected by that. We'll watch it carefully. But again, I think that there's going to be, on the private label portion of this business, it's going to sort out in a way that is greatly determined by the grocer's approach, not only to single-serve beverages, but to the whole of coffee, whether it's ground or whole bean. And there's great variation there that allows us to align ourselves with those grocers that have a deep and abiding commitment to their coffee program and that they've had that for a long period of time. And where they do best is to prominently market display of the best brands in the industry and to complement that with an alternative that either is value-based or, in some cases, we have customers that have, I believe, 3 different private label offerings, coffee, so that they conclude our premium alternative as well. And it's the grocers' economics that favor us in that regard and that this private label product offers them very fine margins. And as I'd indicated earlier, if we've got repeat purchase patterns that are twice that of our private label competitors, that gives us a great quality advantage. And somewhere in the context of that is you learn to adapt to how the national brand leader adjust its strategy and tactics and we do that now across 15 categories all the time.

[Akshay S. Jagdale:]

That's helpful's. Just to follow-up on that topic. So in theory, the risk is that some of your larger private label customers might go over to Green Mountain because now they're saying, we're open for business and which previously they weren't to everyone, and they would do that presumably because of the same reasons some of the brands have partnered with Green Mountain, which is to be part of the future innovation pipeline. So can you address that, I mean like how do you think of that risk? And secondly, am I right in thinking that or my estimates are that you, relative to your largest private label competitor and most of the private label are nonlicensed competitors. Your mix is mainly private label and very little co-backing for other brands. And that's strategic, and I think the context of the conversation and Green Mountain new strategy, that positions you pretty well because I think what's at risk more than private label business is these co-backing relationships. So am I understanding that correctly? And then if you could respond to the first half, that would be great.

[Sam K. Reed:]

Well, let me take several questions in a certain sequence. First of all, regarding the private label and contract packing and for that matter, Food Away from Home opportunities here. Actually we're going to dance with the one that brought us, and that's private label and it's grocery. And that will always be the primary focus of this business, and it will always be strategic. We will look at other opportunities primarily from a financial perspective. And where they make sense and they don't interfere with the strategic imperative of the private label and grocery, we will pursue those. And I think there that the other matter with regard to coffee is that we believe that there is within the private label segment great opportunity for differentiation in the quality, the aroma of the taste. And that what we have to create is a business system that accommodates the way our grocery customers want to do that. So if you would, say, take a situation where the premium grocery customer has a great following for its whole bean coffee. And that is an integral part of the way that grocer relates to its customer, its consumers. In order to develop a single-serve beverage program with them, from a private label perspective, what one starts out with this kind of a double premise of one, you're going to have to do it their way, and two, you're going to have to meet their already defined standards. And that those may vary from one premium grocer to another. And in some instances, it's all about the blending and the roasting. Another instances, it's all about the logistics, some it's about the packaging and the merchandising, and we have a special capability to do all that stuff. And again, lastly, with regard to changing brand strategies and that type of matter, I seem to recall for 2012 that when I think about that year, if I looked only at major categories and major customers, I think that we have something in the range of 110 situations in which customers came to us. So we want you to competitively bid on this category, either to defend what you've got or to come in and access new opportunities. My point in mentioning that is it's part and parcel of the private label world. Over an 8-year period of time, we've gotten steadily better at dealing with this, whether it relates to a particular brand or a particular private label competitor. It's what we do.

[Operator:]

We'll take our next question from Jon Anderson with William Blair.

[Jon Andersen:]

It's okay, I'm going to buck the trend and not ask about single-serve or Associated Brands. But I would like to ask if you have an update on the status of your efforts on the soup rightsizing and the manufacturing consolidation at salad dressings? I think you previously indicated that those were going to result in annual cost savings of $30 million or $0.50 per share. We started to see any of those benefits or are those kind of still in the common or when they may begin to show up? And in the second question is kind of unrelated. Are you doing anything from an innovation standpoint in the natural and organic area given the trends there? Or is that just not as relevant in your categories or with your customers?

[Dennis F. Riordan:]

Let me take the first, John. The restructure activities are moving along. The soup business has been transitioned over to our Pittsburgh plant. The teams are working diligently through their initiatives on cost savings and SKU rationalization and making great progress. The salad dressing business is in process. I think we'll be finished with that by the end of this quarter. And as result, we'll start to see the benefits of that program as we move into next year. And the Cains acquisition is another plus. As I indicated, there is -- about half of that is retail, it's spoonable dressings, it'll be in that part of that dressing category. So you'll see, we hope to see a nice little lift here as we move into 2014 on that, but they're progressing nicely.

[Sam K. Reed:]

And I think with regard to your question, Jon, about natural and organic. The way to look at this is on a broader basis and thinking about better-for-you and its aggregate naturally organic is clearly an important subsegment of that. And we are actively engaged there. It tends to -- better-for-you, it tends to be concentrated -- the big opportunity is with only a certain segment of our grocery customers and we're very keenly attentive to their needs and I'm working with them. It is a different proposition though than when one doesn't have a brand to focus on. It's not simply a matter of trying to get to the national brand equivalent, but in fact, trying to find the right -- better-for-you positioning for that customer that doesn't have a national brand to hold up and say, go copy that. When I think about what we're doing. Lately, specialty teas, I think offers a better-for-you proposition for us. Interestingly enough, when we looked at Cains, we found that they have a regional brand and the technology for private label to make a product that is at the very premium end of the spoonable salad dressing sector, we like that. And then when you think of the leading retailers that have a reputation for better-for-you, while we're restricted from saying that we make this range of products for this particular customer, I think you can take every name that is effectively a household word for a connotation of better-for-you products. And you'll find that TreeHouse Foods makes products for all of those grocers again and known primarily for premium presentations. And secondly, we offer better-for-you products in that regard for most of the product categories that we currently serve, we currently have.

[Operator:]

We'll take the next question from Amit Sharma with BMO.

[Amit Sharma:]

Sam, if I may ask you, if you look to 2014, most of the manufacturers talked about some sort of commodity tailwinds. Can you talk about the promotion environment that you foresee, are you expecting little bit more on the pricing gap between national brands and private label? And overall, if you look at '14, what's simulated [ph] going to be? I mean, we've had commodity admins, we've had volume weakness, we had some share gain dislocation back in '09, '10. As you look to '14, what do you expect the conversation to be?

[Sam K. Reed:]

I think while those factors are important, the overriding and paramount issue is going to be one about consumer demand. And there will be about consumer demand for at home consumption. And as we're talking some time ago, this doldrums in the consumer sector had lasted longer and been more perplexing than any of us had expected. And I think what we have to do is, one, we have to adapt our business systems and our economic models to that, and that's evidenced now, as Dennis took you through the improvement in margins in each of the 3 businesses. With regard to the brands, I would expect that given the margins that they're posting that we will continue to see high levels of merchandising. And to the extent that, that's related to innovation, it will give us great opportunity to copy it. To the extent that it's related branded discounted pricing, we'll just have to tighten up our belts and withstand it. But with regard to the promotional matters, that tends to be kind of cyclical and I don't expect that it will go to a heightened level and remain there for an extended period of time. And with regard to input costs, it's frankly too early for us to comment publicly about 2014. But Dennis gave you, I think, a very clear picture of what our 2013 position is.

[Dennis F. Riordan:]

I just want to add one thing on that. I think one of the more interesting aspects for 2014 is going to be retail consolidation and what's taking place there. Obviously, and Kroger and Harris Teeter and Sobeys and Safeway Canada and Loblaws with Shoppers Drug Mart, consolidation is generally what we've seen as one of the key reasons why European private label has been stronger than the U.S. And as we look at that type of consolidation, our belief is that it's going to actually play very well for private label. It's a little early, but I think that could be a very nice driver for private label as we look out to 2014 and beyond.

[Amit Sharma:]

And Dennis, on that point, apart from the overall benefit of consolidation, just a specific incidences of retail consolidation in the last 3 or 4 months, does that provide an opportunity for you to perhaps increase penetration in some of these customers?

[Dennis F. Riordan:]

I think it can. It depends. Kroger, as we all know, has a great private label program and they have a substantial amount of self manufacturing. But in general, I think what it does is that consolidation effect makes it more and more critical for the retailers to differentiate themselves, not just from a product standpoint, but the store experience. We've got some retailers that just do a fantastic job of that. But I think consolidation is going to continue to make that experience as important and in sometimes more important. Look at Publix down in the Southeast, more important than just price and private label is a key way to make that differentiation.

[Operator:]

And we'll take our next question from John Bumgartner with Wells Fargo.

[Dennis Geiger:]

This is Dennis Geiger filling in for John. Just in terms of single-serve, could you speak a little bit to any details around SKU expansion within the existing account?

[Sam K. Reed:]

This is Sam. I think the -- our general history right here is that we've got accounts that -- the penetration and the growth rate, there's a great deal of variation here, and it does depend on the commitment to the brand. At the high end, we have seen certain customers that tend to have every substantial private label -- that look at the brands and determine what are the best selling of those products. And in several instances, there are grocery customers of ours that may emulate through their local brands, 7 or 8 different flavors in private label. And that clearly represents something that is at the high end of penetration. And we have seen certain instances where private label will approach a 20% unit share within single-serve coffee. And again, that is at the high end. And that indicates to us what the possibilities are. And then there are others that will go with quite a limited line and that represent long-term projects to build out the category. And that will come as those that have really a limited the SKUs at the beginning see the missed opportunity that their competitors are taking advantage of.

[Operator:]

It appears there are no further questions, I'd like to turn it back to management for any closing remarks.

[Sam K. Reed:]

Thanks, again everybody. We look forward to seeing many of you this fall as investor and analyst interest turns to 2014. In the meantime, we are TreeHouse. Growing strong, standing tall. Thank you.

[Operator:]

This does conclude today's conference. We thank you for your participation.