Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Michael Massi

Jerry S. G. Fowden - Chief Executive Officer and Director

Jay Wells - Chief Financial Officer and Vice President

Analysts

Karru Martinson - Deutsche Bank AG, Research Division

John A. Faucher - JP Morgan Chase & Co, Research Division

Kevin A. McClure - Wells Fargo Securities, LLC, Research Division

William Schmitz - Deutsche Bank AG, Research Division

Amit Sharma - BMO Capital Markets U.S.

Mark D. Swartzberg - Stifel, Nicolaus & Co., Inc., Research Division

Dara W. Mohsenian - Morgan Stanley, Research Division

Cott (COT) Q2 2013 Earnings Call August 1, 2013 10:00 AM ET

Operator

Welcome to Cott Corporation's Second Quarter 2013 Earnings Conference Call. [Operator Instructions] The call is being webcast live on Cott's website at www.cott.com and will be available for a playback there until August 15, 2013.

We remind you that this conference call contains certain forward-looking statements reflecting management's current expectations regarding future results of operations, economic performance and financial condition. Such statements include, but are not limited to, statements that relate to estimated revenues, volumes, gross margin, selling, general and administrative expense, EBITDA, net income, free cash flow and earnings per share and leverage ratios.

This conference call also includes forward-looking statements reflecting the company's business strategy and include statements related to the company's capital deployment strategy, the payment of future dividends, share repurchases under our share repurchase program, the redemption of a majority, if not all, of our 2017 senior notes and the refinancing of our 2018 senior notes, the reduction of interest expense and the investment in organic and bolt-on opportunities, such as the recently announced Calypso Soft Drinks transaction, future revenue enhancements and cost savings, such as the restructuring plan announced on June 13, and goals and expectations concerning our market position, future operations, product mix and estimated capital expenditures and commodity costs.

Forward-looking statements are subject to certain risks and uncertainties, which could cause actual results to materially differ from current expectations. These risks and uncertainties are detailed from time to time in the company's securities filings. The information set forth herein should be considered in light of such risks and uncertainties. Certain material factors or assumptions were applied in drawing conclusions or making forecasts or projections reflected in the forward-looking information.

Additional information about the material factors or assumptions applied in drawing conclusions or making forecasts or projections reflected in the forward-looking information is available in the company's press release issued earlier this morning and its Annual Report on Form 10-K for the year ended December 29, 2012, which are available on the Investors section of the company's website.

The company does not, except as expressly required by applicable law, assume any obligation to update the information contained in this conference call. A reconciliation of any non-GAAP financial measures discussed during the call, with the most comparable measures in accordance with GAAP, is available on the company's second quarter 2013 earnings announcement released earlier this morning, as well as on the Investor Relations section of the company's website at www.cott.com.

I'll now turn the call over to Michael Massi, Cott's Director of Investor Relations.

Michael Massi

Hello, and thank you for joining our call. Today, I'm accompanied by Jerry Fowden, our Chief Executive Officer; and Jay Wells, our Chief Financial Officer. Jerry will start this morning's call with some introductory remarks before turning the call over to Jay for a discussion of our second quarter 2013 financial performance. Jay will then turn the call back to Jerry who will complete the call with his perspective on our second quarter performance, as well as a discussion of business drivers and expectations for the remainder of 2013. Following our prepared remarks, we will open the call up for questions. With that, let me now turn the call over to Jerry.

Jerry S. G. Fowden

Thank you, Michael. Good afternoon, or should I say, good morning, to all of you in the U.S., as we are performing our call from our Kegworth plant in the U.K. Before Jay reviews our financial results, I wanted to offer a few introductory comments. While free cash flow increased 6%, as a whole the second quarter was challenging, as we indicated it would be on our first quarter's call, with a combination of lower volumes, gross margin and overall profitability.

Our volume in the second quarter declined 12% due to several factors, including lower case pack water sales, an overall CSD market decline and increased national brand promotional activity, all of which resulted in unfavorable fixed cost recoveries in our plants, which impacted our gross margins.

As mentioned on previous conference calls, we do not see the case pack water category as attractive from a profitability standpoint and thus, we have and expect to further reduce our water volume across 2013 and 2014.

Our first and second quarters' performance highlight the ongoing importance of not just following our 4 C's of customers, costs, capital expenditures and cash, but also the need for us to continue executing our strategic plan to improve our growth and gross margin prospects over time via stronger capital programs, new customers and contract manufacturing wins, alongside organic and bolt-on diversification.

As part of our continued focus on the 4 C's, and given the weak overall CSD market we saw in the first and second quarters, we announced a restructuring plan on June 13 that consists primarily of SG&A staff reductions across all corporate and business unit locations. As we do not have many cost levers to pull, we strive to ensure our SG&A and cost of sales are being managed on a least cost basis. The benefit of these SG&A actions is approximately $6 million on a full year basis, and the staff reductions are expected to be predominantly implemented during the third quarter.

As part of our diversification strategy, we recently completed our Calypso Soft Drinks transaction. We believe Calypso is an excellent example of a bolt-on transaction that diversifies our product, package and channel mix. Calypso brings new products and packaging formats, such as single serve Combi cartons, single serve cups and cuplets and 2 freezable products into our portfolio, alongside providing us opportunities in the food service channel.

As we look to the back half of the year, our outlook is more positive because we'll start to see the benefits of our SG&A cost actions, the completion of our installation of U.S. bottle-blowing, our pouch line startup, as well as some confirmed contract manufacturing wins that will start shipping at the end of quarter 3. These factors, coupled with lessening commodity pressure, plus easier comparisons, should assist us in delivering more positive volume, revenue, gross margin and EBITDA trends as we go through quarter 3 and quarter 4, in particular.

I will comment more on this and our volume and margin performance by business unit later in the call.

Lastly, we are moving closer to our November date of redeeming a majority, if not all, of our 2017 senior notes, which should deliver significant interest savings. Debt reduction is an important part of our capital deployment strategy, alongside investing in the diversification of our business and returning funds to shareholders. To that end, quarter 2 saw us repurchase approximately $6 million worth of shares under our share repurchase program during the quarter, and we announced our quarterly dividend this morning. On this note, let me hand the call over to Jay to cover our financial metrics, our quarterly dividend and our share repurchase program in more detail.

Jay Wells

Thank you, Jerry. Total sales beverage case volume, excluding concentrate sales, was lower by 12% at 212 million cases versus the second quarter of 2012. Globally, the volume decline was from a combination of factors, including lower case pack water sales that accounted for approximately 1/3 of the decline. Roughly another 1/3 was due to a general CSD market decline and increased promotional activity from the national brands. The remaining decline was due primarily to poor weather in the United Kingdom and in Canada, alongside the loss of some thirst quencher business in North America and other CSD volume decline in various business units.

Revenue was lower by 10%, 9% excluding the impact of foreign exchange, due primarily to lower global volumes slightly offset by an increase in average price per case on a global basis. Average price per case increased primarily as a result of product mix. For example, selling more apple-based products compared to low-revenue products, such as case pack water.

Gross margin was 13.6% compared to 14.7% last year due to lower global volumes that resulted in unfavorable fixed cost absorption that was not offset by pricing or operational efficiencies. In addition, the lower volumes we experienced in the first quarter resulted in us carrying higher inventory levels going into the second quarter, which significantly impacted our labor utilization and fixed cost absorption in April.

In May and June, we experienced reduced inventory levels, which, coupled with our SG&A cost actions, resulted in a corresponding improvement in our gross margin trend in those months.

SG&A was lower by 15% at $42 million versus the prior year due primarily to lower employee-related costs compared to a higher annual incentive accrual in the prior year, lower legal expenses and reduced costs associated with our information technology strategy.

As Jerry mentioned, on June 13, we announced a restructuring plan that consists of SG&A reductions in our corporate function and across all reporting units. This restructuring will save us approximately $6 million on an annual basis and has a one-time cost of approximately $2 million within the quarter. We believe this was an appropriate step based on recent market and operating trends and of course, is consistent with our low-cost philosophy.

Adjusted net income was $20 million compared to $26 million in the second quarter of 2012, and reported net income was $17 million compared to $25 million last year. Adjusted earnings per share on a diluted basis was $0.20 compared to $0.27 in the prior year, and reported earnings per share on a diluted basis was $0.17 compared to $0.26 last year.

Excluding purchase accounting adjustments, integration expenses and restructuring expenses, adjusted EBITDA was $61 million compared to $68 million in the second quarter of 2012. And reported EBITDA was $58 million compared to $67 million in the prior period.

Turning to the balance sheet. Cash on hand at the end of the second quarter was $67 million. Net debt was $538 million and our unused borrowing availability was $263 million. The cash on hand of $67 million takes into account the $25 million to acquire Calypso; the $6 million of share repurchases; and $11 million for dividends as we paid 2 dividends in the quarter.

Free cash flow increased 6% compared to the prior year, but we believe it is still too early to provide guidance regarding our annual free cash flow amount. However, as we've seen -- as we see improving financial trends as we go into our cash generative second half of the year, we are confident in our ability to reduce debt and execute other capital deployment initiatives.

With respect to our capital deployment strategy that returns approximately 30% of our free cash flow to shareholders, we believe the most effective means of doing this is through our quarterly dividend supplemented by our discretionary share repurchase program. I am pleased to report that our Board of Directors approved the dividend of $0.06 per share in Canadian currency, payable on September 11, 2013.

Also during the quarter, we repurchased approximately 700,000 shares at an average price of $7.99, totaling approximately $6 million. As always, we will manage the share repurchase program opportunistically, in line with the objectives outlined in our overall capital deployment strategy.

To add further detail to Jerry's comments regarding our Calypso U.K. transaction, that transaction was officially closed on June 17 for a purchase consideration of approximately $30 million, made up of $7 million of upfront cash, inclusive of a seasonal working capital adjustment; $18 million of acquired debt that was immediately paid down at closing; and $5 million of deferred consideration payable over a 24-month period. The business and integration process is off to a positive start, and we believe the transaction will yield annual revenues of approximately $50 million and will become EPS- and EBITDA-accretive on a reporting basis once we have lapped various purchase accounting adjustments, such as inventory step-up and integration costs.

Lastly, we still anticipate redeeming a majority, if not all, of our 2017 senior notes later in the year with cash on hand and drawing on our ABL. This redemption should strengthen our balance sheet and improve our financial metrics, specifically, our net income, earnings per share, free cash flow and leverage ratio. This redemption should allow us to lower our interest expense by approximately $12 million to $15 million by the end of 2014. Further, we also anticipate refinancing our 2018 senior notes near the end of 2014 with a lower interest rate, depending on market conditions at that time, which should reduce our interest costs further. By the beginning of 2015, we will have our long-term debt structure in place, and at that time, we will rebalance our overall capital deployment strategy between returning funds to shareholders and investing behind the diversification of product, package and channels that should assist in the improvement of the overall business and maximize shareholder value. With that, I will now turn the call back to Jerry.

Jerry S. G. Fowden

Thanks, Jay. I'll now review the performance in each of our reporting segments. In North America, revenue was lower by 12% for the quarter and volume was lower by 14%. The decrease in volume was the result of a combination of factors. First, we had lower case pack water sales, which should come as no surprise to anyone as we have signaled our view of this category on previous conference calls. The lower case pack water sales contributed approximately 1/3 of this North American decline. Next, during the quarter, the CSD category declined a little over 5%. The decline in the CSD category has placed additional pressure on our core business, alongside an increased amount of promotional activity undertaken by the national brands. These factors together, contributed approximately another 1/3 of the volume decline. This continued CSD category decline confirms our need to execute against our diversification strategy which is designed to help offset these market conditions over time.

Lastly, as mentioned by others in our industry, poor weather had an impact in the quarter. Not just in the U.S., but particularly in Canada and the U.K. However, it's nice to note that the weather here in the U.K. turned warm and sunny in July, and we saw the consequential lift in our July U.K. volumes. But more on the U.K. later.

North America did experience an increase in average price per case, as we sold more apple-based products versus lower-revenue products, such as case pack water. We continue to focus on getting the right balance between revenue, gross margin and volume. Lastly, the second half of the year brings easier comparisons for us to lap and we will begin manufacturing pouch products from our Dallas-Fort Worth facility. Also, our added commercial management resource, specifically in contract manufacturing, have won us some incremental manufacturing business that we'll begin shipping at the end of quarter 3 and into quarter 4. We also believe that our juice volume performance will improve across the back half of the year as retailers are showing a greater interest in rebuilding the category.

These positive actions, on top of our cost reductions and the completion of our U.S. on-site bottle-blowing, should set the scene for more favorable volume, revenue and profitability trends to North America in the second half of the year.

Turning to the U.K., revenues were flat in local currency, down 3% as a result of foreign exchange. Alongside these flat revenues, U.K. volumes were down 3% due to poor weather in conjunction with narrowing price gaps and increased competition in the energy category.

This volume reduction on product mix adversely impacted gross margin. As we look forward, the recent completion of our Calypso transaction provides us new products and packaging formats, as well as access to new channels. Additionally, since the start of July, the United Kingdom has finally experienced some good weather and that has resulted in a 15%-plus growth in our July volume and top line performance.

We know that 1 month does not make a quarter, but this is certainly a change for the better that will assist in improving our volume and revenue trends for the U.K. third quarter. In RCI, revenue increased 20% as a result of some business wins and an increase in average price per case that more than offset RCI's volume reduction. The quarter saw RCI's first production of products for a new customer with additional opportunities for the future.

Turning to Mexico. Mexico's results reflected the exiting of low-gross-margin, 3-liter private label business, alongside continued growth in their contract manufacturing business, providing a better overall business mix and reduced commodity exposure.

As we summarize the second quarter and look to 2013 as a whole, our second quarter results reflected a continuation of the trends we experienced in the first quarter. While the past 2 quarters have been challenging, we remain focused on following our 4 C's and executing our capital deployment strategy. As we enter the second half of the year, despite the challenging market conditions, which we do not see abating, we believe we will see improved top line and financial trends supported by our new business wins, new commercial management resource, particularly in contract manufacturing, alongside the production of new products.

These new business wins and new products, together with easier comparisons, a less-challenging commodity landscape and our SG&A cost reductions should positively impact volume, revenue and profitability trends as we go into quarter 3 and, in particular, quarter 4. As always, we remain focused on being a low-cost, high-service provider, while continuing to diversify our overall business via organic initiatives and bolt-on opportunities.

We believe this diversification of our business, along with our balanced capital deployment strategy, that sees us allocating some 30% of free cash flow for the return of funds to shareholders while continuing to reduce our level of debt and interest cost during 2013 and 2014, should create shareholder value over the long-term.

For a slightly fuller commodity update, high fructose corn syrup represents a headwind for us in 2013 versus 2012, and we are fully covered for our 2013 high-fructose corn syrup requirements.

For aluminium, the commodity itself appears to be favorable with some recent metal softness, but we have seen can conversion cost increases, and we are covered by a majority of this year's aluminium requirements.

Regarding fruits and fruit concentrates, we are again covered for the majority of this year's requirements, with some degree of open positions towards the back end of the year. PET resin has been relatively stable and as a reminder, is a spot exposure for us.

For 2014, while corn at this stage looks more positive, it's too early to provide insight into 2014 commodities, and we'll provide a fuller picture when we report our quarter 3 results.

We anticipate 2013 CapEx to be around $70 million as we complete our investment in vertical integration of bottle-blowing. With this completed, 2014 CapEx will be lower, and we'll provide more insight into this later in the year.

All in all, despite the challenging market conditions, we continue to aim to be a tightly-run, cash-generative, high-service, low-cost producer while implementing our balanced capital deployment strategy, which includes investing behind the diversification of our product, package and channel mix alongside the return of funds to shareholders and continued debt and interest reduction.

In summary, this quarter continued to be impacted by lower volumes, which resulted in unfavorable fixed cost absorption and led to a disappointing financial result. However, we did increase free cash flow, 6%, and returned approximately $17 million to shareholders through both dividends and our share repurchase program.

As of today, we believe the second half offers improved operating trends that will lead to improved volume, revenue, gross margin and EBITDA trends versus the results we have seen so far in 2013. Additionally, we are nearing our November date to redeem a majority, if not all, of our 2017 senior notes, which should provide significant interest savings.

Before I turn the call back to Michael, as many of you know, Michael has accepted a new role within our finance department and I would like to take this opportunity to thank him for all his hard work over the last 2 years in Investor Relations. This will be Michael's last conference call before Rob Meyer takes over Investor Relations in the third quarter. We wish Michael good luck in his new role. With that, back to Michael.

Michael Massi

Well, thank you, Jerry, for the kind words. I have enjoyed working in Investor Relations and with all of you over the last 2 years and I look forward to my new role and the next chapter at Cott. And I wish everyone the best. [Operator Instructions] Thank you for your time. Shay, please open up the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Karru Martinson from Deutsche Bank.

Karru Martinson - Deutsche Bank AG, Research Division

When we look at the CSD promotional environment, I mean, the category, from what we've seen, it still remains weak, it's still competitive. I mean, how do you feel about that space going forward and just kind of looking at the back half of the year, I mean, do you feel that you're still going to see that same kind of margin pressure that we saw here in the second quarter?

Jerry S. G. Fowden

I guess 2 thoughts to that question. It sounds like volume and margin are in there. And I think as we mentioned in the prepared remarks, we do see the challenging market environment, something that's going to continue in the second half. And as many people will know, we built our strategic plan on a kind of CSD market declining in the 1% to 3% sort of range. And what we've seen in this quarter is a just over 5% decline. And what we saw in quarter 1 was around about a 4.5% decline. So there's no doubt that the pressure on the CSD category has slightly increased, and we see that as an environment that will be maintained. Having said that, as we pointed out on the call, through a combination of factors, easier comps, starting up in some new product categories, such as the pouch area of the business, some contract manufacturing wins we've had, overall, as we look forward for the second half moving through quarter 3 and particularly, quarter 4, we do see a landscape that offers improving trends for us, not just in volume and revenue, but also in gross margin and EBITDA compared to that, that we've seen over quarters 1 and quarters 2. I hope that tries to pick up both bits.

Karru Martinson - Deutsche Bank AG, Research Division

Yes, you did. Then just on the fruit juice side, I mean, you're certainly talking abut easier comps and you've seen some pick up in apple. But I mean, from a broader perspective in that category and the Cliffstar acquisition, where do you see retailers positioning it? Certainly, we've seen shifts to mix, we've seen lower volume. I mean, do you feel that we can kind of get back to those levels that we thought of when we made acquisition, or is this kind of the new run rate for the business?

Jerry S. G. Fowden

Good question. And the juice market, year-to-date, shelf-stable juice that we're in, is down about 2%. So not a positive market, but not as bad as CSDs. We know there was a significant increase in commodity cost behind the juice market across-the-board, especially apple and more recently, grape. And that has put pressure on the overall size of the market. But this year, we're seeing it hold up much more resiliently at minus 2 compared to the impacts we saw last year and in the back end of the year before that.

As we look forward, we are seeing an increased appetite of retailers to get back behind rebuilding that category. And we do have, coming up, some slightly less challenging commodity costs, particularly in the spot price of apple, and we see an opportunity in retailers appetite to try and start to rebuild that category and get consumers engaged. So our outlook for the juice category is one that's a lot more positive than that continuing challenging environment in CSDs.

Operator

Our next question comes from John Faucher from JPMorgan.

John A. Faucher - JP Morgan Chase & Co, Research Division

I guess, if you could talk a little bit about -- you talked about the difficult environment in CSDs. There's been some discussion about sort of diets causing more of the problem and also sort of elasticities breaking down from that standpoint. Do you guys have any thoughts in either of those topics in terms of how much that's going to create sort of a longer-term headwind?

Jerry S. G. Fowden

John, and I guess you're probably the expert on some of the work on elasticities and whether it's breaking down, because I certainly found your piece of work on that very insightful and very helpful. And of course, that same piece of work pointed to more opportunity on juice than potentially it did in CSDs. I think we've had here a lot going on in the quarter. And it's quite hard to unpick exactly which of these elements have to be driving different things. We've had some pretty grim weather, and if I just take the example of the U.K., where I'm looking at today, sunny, yesterday, shuttered down with rain all day. But we are year-to-date up something like 3% or 4% up to the end of June in our U.K. volume. And we've just finished July with some 15%-plus volume growth. So weather has certainly played a part in this front end of the year. We all know that the national brands have been spending more above the line, have been investing in package diversification for usage occasion. And we've seen more recently, in quarter 2, a bit of an increase in their price promotion and promotional activity. And I think that's played a part. And then on top of all of that, there's this ongoing media noise about sugar-sweetened beverages, sodas, obesity taxes, et cetera. And I think we have to say that's played a part in there. And all in all, that's taken what might have been a 2% or 3% market decline to this 5%, mid-4s, mid-5% market decline. I find it a bit challenging to unpick all of that. I think it has all contributed to the overall picture. I don't know if that helps, John. But I'm happy to take a follow-up on that.

John A. Faucher - JP Morgan Chase & Co, Research Division

No, it does. And instead of a follow-up on that, per se, it sounds as though you guys -- maybe hinting at this, you're doing some work on the capital structure. You talked about the cash return to shareholders. It sounds as though there's sort of a longer-term plan that maybe could be coming down the pipe, or am I reading sort of the wrong thing into that? And when do you guys think you're going to be able to look at sort of the next, big steps on your capital structure?

Jerry S. G. Fowden

I think -- and I'll ask Jay to add to this, but where we stand at the moment, we're in a good position with cash on hand and with our ABL to redeem the majority, if not all, of our 2017 notes in November this year, which will add a substantial interest saving, in the order of $12 million to $15 million. And that's not very far away now. I think that will put the business in a much more favorable light, as many people externally look at us and the sheer amount of debt and interest reduction that brings. But it's only 10-odd months later than that, that we have the opportunity to do more. And on that, I'll have Jay expand because I think he did point towards it, and you did a good job picking up on it, John, that, that might give us opportunity a year later.

Jay Wells

I mean, we've been pretty vocal about our intent to use that cash in the ABL to call and redeem our 2017 notes in November of this year. And we've said, all of our majority, depending on our liquidity forecast on that time. But you look to September, by that point in time, all of the notes should be redeemed and put in a different longer-term structure. That should drive down our interest rates significantly.

And you saw in this quarter, we did buy some shares back also because we've said we want a balanced approach and we said 30% of our free cash flow is to go to shareholders. If you look at our dividend, it only is really $23 million, so we thought it was an opportunistic time to top up our return to shareholders with our capital deployment strategy. And we're continuing to do that into the next couple of years. But toward the back half of the year, it's going to be really more of a focus on the getting the debt to where it can be. Next year -- yes, next year we're refinancing, redo all of our debt. And then 2015 is really at the point in time we feel our debt is taken care of, we have our long-term debt in place that we want, and then we'll really rebalance our capital deployment strategy with a focus between returning funds to shareholders and continuing to invest behind diversification and growth of the business.

Jerry S. G. Fowden

So I think, simply put, and not getting it right here, John, at the moment, we are plus or minus 1/3 to shareholders, plus or minus 1/3 to debt reduction, maybe a bit more in the short-term, and plus or minus 1/3 towards investing in the business, it's probably less than 24 months away before one of those requirements reducing our debt is no longer there. So then we'll have the 100% of the cash flow to divide up between shareholders and driving the diversification of the business in order to get us more balanced against these mature soda elements. That's quite a large part of our business today.

Operator

Our next question comes from Bryan Hunt from Wells Fargo Securities.

Kevin A. McClure - Wells Fargo Securities, LLC, Research Division

Jerry and Jay, this is Kevin McClure, standing in for Bryan. I apologize if you've already covered this, I joined a little bit late, but looking at your corporate cost, your SG&A expenses, much lower than we were forecasting. Can you delineate for us how much was attributable to some of this IT savings you referenced in the release versus the lower incentive comp?

Jerry S. G. Fowden

Yes. And I'll start and then I'll pass over to Jay to add onto that. I think we have historically said our SG&A run rate, normally somewhere around the $45-odd million mark. Last year, our SG&A in the quarter was slightly higher than that run rate as we accrued for some additional incentive and bonus payments. So the comp of quarter 2 this year to quarter 2 of last year has an element of flattery within it because last year was higher than that run rate. So really, we are looking at a quarter with $42 million playing a run rate of around $45 million. And that's where 3 elements have contributed towards it: some reduction in accruals, some IT savings and some legal savings. And I'll have Jay just try and pick out where he thinks we were between some of those elements.

Jay Wells

If you look at the IT part, I would say it was about 1/3 of the decrease that you would have seen in the year, and it's part of our SAP implementation. And toward the end of this year, we should have that completed. But I'm going to say about 1/3 of the benefit related to IT, probably a little bit over 1/3 related to the comp and the rest was legal and other items.

Jerry S. G. Fowden

But I think, going forward, around $45 million is kind of a midpoint obviously from quarter-to-quarter, some costs fall slightly differently.

Kevin A. McClure - Wells Fargo Securities, LLC, Research Division

Great. Thank you for the clarity. And then my follow-up has to do with more your long-term capital structure. And I know you've spent some time on the previous question discussing that. It may be premature to get your thoughts, but it sounds like you have a much better outlook for the remainder of the year and into 2014. You generate consistent free cash flow. You expect to refinance the 2014 notes at a lower interest rate. So what are your thoughts of capitalizing the lower interest rate into a larger bond deal, considering the deleveraging that should occur between now and the end of 2014? And as it relates to your ideal capital structure.

Jerry S. G. Fowden

I'll have Jay expand on what you're looking ahead at for 2015, those capital structure. But let me just pick up on one point you mentioned there. It's our 2017 notes that, in November this year, we can call and redeem at $104 million, and those notes are paying a coupon of just over 8%, and we intend to do that with a combination of straightforward cash on hand, which, at the moment, we're getting nothing for, and use of our ABL, which costs us just over 2%. So that removal of a majority, if not all, of that $215 million worth of 2017 notes for a blended cost that's probably no more than 2% instead of the over 8% today, is very attractive. It's near to hand. And we just see that as debt reduction. And what's on the ABL, we can quickly and easily pay down with our cash flows as we go forward.

Then as we get to the 2018 notes that are redeemable in September of next year, that's when I think we have an opportunity to address our long-term structure.

Jay Wells

And you look at the 2018 notes, I would say that amount of debt is probably the minimum amount of that we would like to get to as a company. So right now our intent is not to pay that amount off, but to refinance and depending at markets at that time and what the best instruments are, we will decide the best way to structure at that time. But I would not view the 2018 as debt we are looking to pay off. And that's why we say, by the time we get to 2015, we're really not going to be focused on paying debt down any further, but investing behind diversification and growth and returning funds to shareholders.

Operator

Our next question comes from Bill Schmitz from Deutsche Bank.

William Schmitz - Deutsche Bank AG, Research Division

So can you talk about what you can do to sort of stem the private label share losses? So, like, maybe how some of the retailers are thinking about? Because obviously, the CSD category is pretty miserable. A lot of it was weather-related. But if you look at the private label shares broadly, they're obviously in really big decline. So what do you have within your power to kind of get that going again, if you do?

Jerry S. G. Fowden

Yes. I think there's a number of factors, but I would not want to overpromise. And the factors are not just around private label, they're also around what else should we be doing. But to kind of be in the bull's-eye of what you're talking about, I think that we can and we have to do a better job, particularly in North America, on our private label promotional program. And perhaps, we have been a bit too wedded to the EDLP, everyday low price, and not done enough in ensuring we're getting the right share of promotional features display, product allocations. And we have to do a better job on that. That's one factor. I don't believe we will be changing the market dynamics. And I believe, within CSDs and private label CSDs, that will stay challenging. The next factor, and still in private labels, is we have retailers, retailers that are growing where we still either have no business or very little business. They might be retailers that are less to do with traditional supermarkets and more to do with the healthy channels, more to do with emerging new channels, club stalls, some other dollar channels, but most of those healthy, more-premium end retailers we're not in. We added some dedicated contract manufacturing salespeople around about 6 to 9 months ago and we've got some business wins there. We have added some focused alternative channel commercial resource during quarter 2, and we are currently recruiting for more, that I believe means we will make some progress in getting and increasing and starting some private label programs with retailers where we've had little penetration or no penetration in the past. And I think that's the second element that's very much in the category you have stated. So for example, when we start up our first 2 pouch pillars, in September, October this year, we have already signed up an anchor customer for over 60% of the volume out of those pillars, and that's a customer that hitherto we've done nothing or very little with. So some of the gain in traction in these retailers, where we've had little private label penetration, is linked to new and different product formats. And then thirdly, not so much in the kind of bulls eye of private label, we have highlighted that we believe it's important for us to grow our contract manufacturing business. I'm over here in our U.K. operations where that accounts for 20%, 1/5 of our entire volume. Whereas in the U.S. today, it's something like 3% of our business, and we do see an opportunity to grow our contract manufacturing business. And we believe, as we've become more diversified and more balanced over time, that, that will be good for our overall business in that it provides more stability, more predictability. So a couple of things we could and should do more of in private label, but also this focus on diversification that links to that and move towards contract pack.

William Schmitz - Deutsche Bank AG, Research Division

Got you. Then just maybe a follow-up question again on the capital structure. How do you sort of figure out what the sort of the optimal leverage ratio is for the business?

Jay Wells

We -- one, I talk to a lot of bankers that are happy to tell me what the optimal [indiscernible]. Besides that, no. I mean, you look at our overall risk of the business, our desire to have plenty of liquidity and ability to draw down to go through the bumps on the road, and also but also have the ability to flex up on debt to do any deals that might come along. So, really feel at this point in time, around 2x leverage is where we should be. And when it comes to refinancing time, it really depends on what the market looks like on what type of debt we will used to refinance in. But we feel comfortable -- 2x is a good place for us to be out of gross debt.

Operator

Our next question comes from Amit Sharma from BMO.

Amit Sharma - BMO Capital Markets U.S.

Jerry, just trying to focus on the juice category. I mean, clearly, you mentioned that with apple prices coming down, you would like to be a little bit more active in that category. What are we seeing from the competitive point of view? Are others in the juice category starting to get more promotional? Is it a risk that we might get some volumes, but pressure on margins from that?

Jerry S. G. Fowden

I mean, I don't see, as we look forward, too much of a concern on the overall margin landscape. And I do see that many people will try and take any element of commodity benefit that comes along and try and rebuild the category. I think manufacturers are keen to rebuild the category. Especially in apple, I think retailers are keen to rebuild the category. You've got to remember, we saw a nearly doubling of concentrate price, and we saw some 20%, 25% be wiped off the entire shelf-stable apple juice category. And as I think commodity costs come back from some of those high points they were. That provides the opportunity for promotional activity and promotional pricing and price points to improve. And from what we've seen, the consumer is very willing to respond to that more affordable price point. So I see it as an opportunity for retailers and manufacturers alike to try and rebuild that category as we go through the back half of this year and in quarter 4, in particular.

Amit Sharma - BMO Capital Markets U.S.

Got it. And then in response to the last question about how to recover CSD, I didn't hear you mention anything about packaging or price packaging. Is that part of the strategy as well or are you're going to really continue to focus on the core packaging of 2-liter and the 12-ounce cans?

Jerry S. G. Fowden

Yes. I mean, obviously, our core is 12-ounce cans and 2-liter, but over the past 18 months or so, we have increased our manufacturing flexibility in that area. We have the capability now to do slim and sleek cans. We are adding the capability for some further can size flexibility that will be ready by around about September, October this year. And we have 1 customer signed up against that and another one keen to take advantage of that. But I think the -- our primary focus will be that of trying to win business in customers that currently we have a low penetration with and trying to get a better balance in our customer promotional program for products that we have already, albeit we do have the capability to do more in single serve and other pack formats.

Operator

Our last question comes from Mark Swartzberg from Stifel, Nicolaus.

Mark D. Swartzberg - Stifel, Nicolaus & Co., Inc., Research Division

Let me do a three-part question all on the same topic. Why depart from practice here? No, seriously, when you think about the dialogue with your customers kind of this fall and into kind of the back of the year, the very end of the year, I wonder if you could talk a little more specifically about 3 variables in that dialogue: the price conversation, where the commodity picture seems to be one where you don't go for price as you have in recent years; the second variable being kind of the service dimension and to what extent do you think there's an opportunity to improve the service to make them more suited to giving you more of what you want, kind of to Bill's question; and then the third variable being money, because displays are obviously something you want more of, but they require money, and to what extent do you think you need more money or they need more money to give you the kind of displays that you would hope to get?

Jerry S. G. Fowden

Okay. So price, service and money linked to display or promotion. And I think, behind all 3 of those points is probably a broader issue, which is with the CSD market, having been a bit of a challenging market and the rate of decline probably having notched up a couple of percent from where we were. Apathy would be too strong a word, but building CSDs is less the first word on in every buyers kind of lips at the moment, because we all know people like to focus on those areas that have basic underlying growth in their own right. So when you take a little less interest in the category overall as a whole from retailers and you add to that a little bit more, because we've seen the increase above the line investment from the national brands, we've seen the increase pack proliferation from the national brands and more recently, we've seen some increase price promotional activity. When you add that to it, I think all of that paints the challenging environment that we've had within CSDs. Our price gap is still not too bad. We always used to talk about that 35% to 40% range. There's no doubt we've had a bit more price promotion from the national brands in quarter 2, that's been a contributor factor. But the average price gap almost 192 ounce case equivalents we see, still looks like it's in our normal comfortable range. So I think it's more that we have to patch through a little bit more on the high/low rather than just the EDLP. That has its challenges for us in the way we would intend to go about doing that is on certain packs where our lines run very efficiently, where we can get retailers' commitments for long runs, we can share some of that production efficiency for long runs with the retailer and they can get behind some promotional activity. And we have some of that agreed for the second half of the year.

I won't give you a plethora of examples, Mark, but 24 suitcase packs or 24 shrink wrap packs runs superbly down our lines. If someone wants to commit to several hundred thousand cases of those, we have that quantity known in advance, we can ship it all at once, we can do long runs. There is a benefit in there that both parties can share.

With regards to service, we carry a lot ranges SKUs. We're at 98.5% on time in full service level. I don't think there's too much for us with regards to the challenge on service levels. Now when the sun came out 3 weeks ago, we had some 35-degree days here in the U.K. On a couple of products dilute-to-taste and some 1-liter stocks. We have had some challenges on service level, but we've also seen demand rise in the kind of 30% to 50% level of the order quantities. So I guess that's not surprising. But service, overall, we are a good, high-quality, high-service business.

And on the promotional side of the equation. We are saying very plainly inside our business, and one of these areas is directly in line with your question, the other one is less so. We will continue to cut our SG&A costs. Some of that, we will spend back in increased commercial resource in order to gain and win business in channels where our penetration is lower. So overall, there'll be savings, but taking that cost out from general SG&A cost allows us to actually increase some of our commercial sales resource in order to win new business. That's one part. And the other one, I think, links back to where I started, we don't see ourselves trying to promote and buy big displays everywhere. We see ourselves picking certain products and packs, where we can gain some very worthwhile manufacturing efficiencies and try to come to some agreement if there's advanced order quantities for certain amounts of products that are shipped straightaway through a full-truck, very efficient supply chain that can fund promotional activity.

Dara W. Mohsenian - Morgan Stanley, Research Division

That's great. And on the topic of the price gap and how you're thinking about 2014, is it the right assumption to believe that you will not take pricing, given the commodity picture improvement as it is?

Jerry S. G. Fowden

I mean, if I was to say today, albeit, we all know we are looking through a very cloudy pair of binoculars at the moment. But as we look through those cloudy binoculars, we don't see significant commodity-based price pressures for 2014. Now probably about this time last year, I thought we would have some substantial savings on corn. We've got something making a noise here and in our Kegworth office, but I'll plow on. We have -- we would have some substantial savings on corn, which then disappeared over the immediate following 12 weeks with drought. So today, we are looking forward, believing the commodity environment, probably to be more attractive than we've seen over the past 24 months. But that's not to say things could change. But as they stand today, we don't see a big price increase pressure. And I can now see about 30 people outside the glass office, I mean, we're not all leaving the building. Any follow-ups at all, Mark, or is that fine?

Dara W. Mohsenian - Morgan Stanley, Research Division

Considering the crowd out there, I'll just leave it at that.

Jerry S. G. Fowden

Thank you very much. It looks like I might be going to join a few of our U.K. team in the carpark here as this noise is not stopping. On that basis, I'd like to thank everyone, indeed, for joining our call. I'm just going to highlight the fact that we're working hard to continue to run this business as a low-cost business with high-service and that our outlook for the second half of the year is one that's certainly for better trends than we've seen in the first half. Thanks a lot, everyone, and I'll scoot out the door.

Operator

Thank you. This does conclude today's teleconference. You may now disconnect your lines at this time. Thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Cott Management Discusses Q2 2013 Results - Earnings Call Transcript
This Transcript
All Transcripts