Treehouse Foods, Inc. Q4 2009 Earnings Call Transcript

Transcripts

Treehouse Foods, Inc. (NYSE:THS) Q4 2009 Earnings Call February 11, 2010 9:00 AM ET

Executives

Sam K. Reed –Chairman, Chief Executive Officer
David Vermylen – Chief Operating Officer
Dennis Riordan – Chief Financial Officer

Analysts

William Chappell – Suntrust Robinson Humphrey
Andrew Lazar – Barclays Capital
Akshay Jagdale – Keybanc Capital Markets\
Ken Goldman – J.P. Morgan
David Driscoll – Citi
Heather Jones – BB&T Capital Markets
Jonathan Feeney – Janney Montgomery Scott
Robert Moskow – Credit Suisse
Jon Anderson – William Blair

Operator

Welcome to the Treehouse Foods investor relations conference call for the fourth quarter of 2009. This call is being recorded.

This conference call may contain forward-looking statements within the meaning of the Private Securities Litigation 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, expect, anticipate, plan, beliefs, estimates, intends, predicts, projects, potential or continue or the negative of such terms or other comparable terminology.

These statements are only predictions. The outcome of the events described in these forward-looking statements is subject to known and unknown risks, uncertainties and other factors that may cause the company or its industry’s actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements.

Treehouse Form 10-K for the period ending December 31, 2008 discusses some of the factors that could contribute to these differences. You are cautioned not to unduly rely on such forward-looking statements which speak only as of the date made when evaluating the information presented during this conference call.

The company expressly disclaims any obligation or undertaking to disseminate any updates or revisions to any forward-looking 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 and Chief Executive Officer of Treehouse Foods, Mr. Sam K. Reed.

Sam Reed

Thank you Loretta. Good morning all and welcome back to our Treehouse. We are gathered today to look back on 2009, the best ever year at Treehouse and also to look forward to 2010 which in its early days promises to be even better. In doing so, David Vermylen, Dennis Riordan and I will assess our recent progress as well our strategic prospects as our portfolio expands to encompass powdered beverages and hot cereal.

First, a look back. Treehouse generated cash flow last year of $191 million, an increase of 21% as volumes increased, especially in private label grocery, and margins expanded thanks to productivity and procurement savings.

As David and Dennis will explain in detail, we capitalized on the growing demand for value without compromise in customer brands and custom products that continues to surge forward. Private label sales as tracked in measured channels over a broad array of categories continue to lead the grocery industry in growth even as the economy begins to recover.

The reasons for this growth are straightforward if not simple. Beset by unemployment and uncertainty, consumers have returned to thrift and frugality and are demanding more for less. In parallel, grocers, eager to retain customer loyalty and regain lost profits have embraced their customer brands as strategic marketing tools.

Only private label can address these needs of both food consumers and grocery customers for value, quality and distinction. Treehouse has responded to this demand in the old fashioned way as I described at our mid year analyst and investor call.

We have met consumer and customer demands with a steady supply of products and programs to enhance the value of customer brands without compromising the quality of our products or the integrity of our service.

In doing so, we have differentiated Treehouse from the welter of sub scale competitors who lack our product portfolio and economies of scale. Our top line growth, margin expansion, and profit improvement are all derived from our singular devotion to the fundamental premise that we will deliver value without compromise and do so with unmatched efficiency and effectiveness.

Next, a look ahead; 2010 promises to be another excellent year as our Treehouse expands its private label portfolio, generates organic growth in its base business, expands gross margins and budgets double digit increased in operating cash flow and net earnings.

We will continue to demonstrate great progress in the four critical factors which form the foundation of our growth platform. These cornerstones include; strategy. The acquisition of Sturm Foods will propel Treehouse into two private label mega categories that will open new markets and offer new technology to our dry grocery portfolio.

Not only will Treehouse extend its private label leadership to eight major grocery categories, four times our original base, but we will also do so with a 50% increase in operating cash flow to fund continued innovation, productivity and expansion.

Next, tactics; our go to market initiatives and supply chain execution are directed by the dual disciplines of our portfolio’s strategy and EVA analysis. From pickles, once the bane of our portfolio to pourable salad dressings, the jewel in the crown of ED Smith, our strategically critical categories have thrived over the past year.

This trend will continue into the new year as our Bay Valley, ED Smith and Sturm Foods operating teams will drive volume increases, share gains and market spreads over the eight major private label categories in which we are the market leader.

Thirdly, operations; our unrelenting drive to capture productivity gains and procurement economies will not only make us more efficient but also more competitive especially if input costs reverse last year’s decline. That competitive edge will translate into more volume opportunities, thus furthering our economies of scale.

The steady improvement in Treehouse margins at 100 basis points or better annually will continue unabated.

And finally, finance; our capital structure post the Sturm transaction will be a well balanced combination of prudent leverage to service debt and available capacity to fund further expansion. We regard our capital structure and sources of capital as strategic assets essential to the Treehouse business model.

Our policy will be to deploy capital prudently for strategic expansion just as we have done since the inception of Treehouse.

Now let me turn the mike to David and then to Dennis who are eager to provide more detail and color commentary on our Treehouse story.

David Vermylen

Thank you Sam and good morning. What I will do is cover Q4 results, provide a perspective on the year just concluded and highlight some of our key initiatives for 2010.

In terms of the fourth quarter, we finished the year in stellar fashion, sequentially building on the momentum we established early in the year. Every channel showed sequential year over year volume improvement highlighted by Food Away From Home up almost 2% in the quarter in a sector that is suffering a mid single digit decline.

Total company unit volume was up 1.4% with revenue up 1.7%. Total adjusted operating income increased 39% and gross margins increased 320 basis points. For all of 2009, revenue was up 0.7%, adjusted operating income up 31% and gross margins increased 210 basis points to 21.6%.

I’ll now highlight key segment data. North American retail had an outstanding quarter with volume up 3% and up 4% excluding branded infant feeding. That growth was consistent with the third quarter. Leading the growth were pickles and salsa, both up over 10%. Despite a disappointing Q4 soup market, we were up over 3.5% in volume. Salad dressing and non dairy creamer were also above year ago.

With one exception, Q4 Neilson data indicates a clean sweep for Bay Valley with all five key legacy categories showing both case and dollar share increases. This is with price gaps in the quarter comparable to last year.

The exception was salad dressing case share which was equal to year ago. The salad dressing case dollar share was above a year ago.

Also noteworthy was that with the exception of soup, all key Bay Valley retail categories showed healthy growth rates in the quarter with volume up 2.5% to 4%. These trends held true for the full year which is an exception to the CPG rule that most volume growth is taking place outside of measured channels.

For the quarter, North American retail operating income was up 30% with margins up 330 basis points. For the year, operating income was up 33% with margins up 320 basis points. North American retail had a great year. The categories we compete in are generally healthy. We are gaining share and doing so without narrowing price gaps.

Before I cover our other channels, let me briefly comment on the state of the private label industry. IRI data for 92 categories indicates that store brand case volume was up 4.6% in the fourth quarter on top of 8.5% in the fourth quarter of 2008. That’s very healthy growth on top of an extraordinary year ago growth. That momentum continued into January where private label case volume was up 4.8% on top of last January’s 9.9/% growth rate.

In terms of private label pricing, with the exception of dairy, meat and oils, private label pricing is quite stable. As our mentioned, in our key categories, our price gaps in the fourth quarter were virtually identical to the fourth quarter of ’08.

Food Away From Home had an excellent quarter with volume up 1.8% despite an industry which was down over 5%. Segment operating income in the quarter was up 53% due to both volume growth and the flow through of all our pickle productivity initiatives.

Pickles are a large part of our Food Away From Home business, thus the channel really benefited from our pickle restructuring efforts.

Our ingredient co-pack and export business referred to internally as ICE, had a very good quarter with volume down only 4% versus a nine month trend of minus 18%. The key to this business is ingredient sales of non dairy creamer whose primary customer base is the Food Away From Home industry.

We are optimistic that going forward, we will see a further recovery in the running race. Despite the volume decline, segment operating income was 8%.

While there are many highlights in 2009, I’d like to comment on four. First, the massive analytic and strategic efforts we undertook on pickles in 2008 really paid off for us in 2009. Operating profit increased 37%, margins increased 520 basis points, and we exited the year with volume momentum.

While we benefited from a good crop year, it was secondary to the strategic changes and tough decisions we made.

Second, ED Smith had another outstanding year both in Canada where it operates stand alone, and in the U.S. where it is fully integrated into our U.S. sales channels. Top line growth has been very strong and our productivity initiatives have generated stellar results.

Third, our procurement team had an outstanding year and is really leading the charge on attacking the center of the P&L. Private label is a low margin business and no matter what added value we bring to our customers, cost will always be a key driver.

Fourth, our focus on generating big sales wins early in the year paid off for us with our year over year volume performance improving by 590 basis points in the second half of the year versus the first. That momentum is continuing into this year.

Now let me briefly turn to 2010. Our focus is very simple. First, top line growth led by our EVA portfolio strategy that focuses on products and customers where we can grow profitably. Growth for the sake of growth is not our strategy.

Second, continue to attack the center of the P&L. By the end of next week, Harry Walsh, President of Bay Valley and his leadership team will have visited all sixteen plants and every distribution center with those meeting entirely focused on achieving our very aggressive productivity targets.

As our guidance indicates, we are very optimistic about the outlook for 2010. I’ll now turn it over to Dennis.

Dennis Riordan

Thank you David. Since David covered the revenue growth, I will focus on other key aspects of our operating results including gross margins, operating costs and our effective tax rate. In addition, we had unusual items in the quarter that in total decreased reported income, but were not related to our normal operations.

These included a non cash charge to write down the value of a branded trademark, costs relating to the acquisition of Sturm Foods, a non cash mark to market adjustment of an interest rate swap agreement, an adjustment to our inner company note to reflect current Canadian exchange rates and residual costs associated with the Portland Pickle plant that we closed last year.

I’ll describe these unusual items in more detail as I walk you through our fourth quarter P&L. First, gross margins improved sequentially to 23.3% compared to 21.3% last year as both our retail and Food Away From Home segments showed strong direct operating income margin improvement.

Retail margins were especially strong in both pickles and soup as a result of operational improvements and a good crop season for cucumbers. Food Away From Home margin improvement was driven by better cucumber costs and lower costs in our refrigerated business.

Margins in our bulk and industrial segment improved to 14.3% from 11.7% as improvement was realized across most categories and low margin co-pack sales were a smaller percentage of total category sales.

Although revenue was lower this quarter compared to last year, direct operating income in the segment grew to $10.6 million from $8.9 million.

Selling and distribution expenses continued to see year over year decreases as lower fuel costs combined with more efficient transportation programs have lowered the cost of moving product from our factories and warehouses to customer locations. Total selling and distribution costs were down $1.1 million from last year and that represents just 6.9% of net sales.

General and administrative costs increased $3.3 million from the third quarter of 2009 and increased $9.3 million from last year. The increase in spending from last quarter was driven by approximately $.18 million in costs associated with the Sturm Foods transaction along with a final adjustment to 2009 incentive costs.

Compared to last year’s fourth quarter, total G&A expenses were up $9.3 million due to much higher incentive costs reflecting the strong results of 2009, the Sturm Food deal costs and slightly higher salaries and benefit costs as we invest in new positions to better manage our growth and staff of our previously announced ERP project.

Other operating expense was $7.7 million in the quarter compared to $1.3 million in last year’s fourth quarter. Nearly all of the expense relates to the write down of the value of our Nature’s Goodness trademark as we de-emphasize our branded offerings and focus on private label products.

The $1.3 million in expense in the fourth quarter of 2008 related to costs associated with a pickle plant closing last year.

Amortization expense was slightly higher in the quarter compared to last year and the third quarter of 2009 as we adjusted certain amortization periods to better match future useful lives.

Interest expense for the quarter dropped significantly from $5.8 million last year to $4.3 million this year due to a combination of lower average interest rates and a significantly lower level of debt. Our outstanding borrowings were reduced by $74.5 million from last year, reflecting very strong cash flow from operations.

Gain on currency exchange in the quarter relates primarily to the revaluation of a Canadian inter-company note. Last year as Canadian exchange rates dropped, we had to take a non cash mark to market write down on this note. This year, the Canadian dollar has strengthened relative to the U.S. dollar, resulting in a non cash write up.

We consider these fluctuations to be non operating items because they have no affect on the cash flow of the company and they will eventually balance out over time.

Our non operating income and expense included $.8 million in non cash gains to mark to market our interest rate swap agreement. This adjustment to reflect current LIBOR rates but does not have any affect on the future interest payments. This adjustment is in contrast to the $7.4 million non cash loss we recorded last year, as LIBOR rates dropped dramatically at the end of 2008.

Last year’s charge will continue to reverse as a non cash gain over the remaining life of the swap agreement, netting out to zero by August 31, 2011.

Regarding taxes, our effective tax rate for the quarter was very low at 27.1% compared to the run rate of 35.5% through the third quarter of this year. The much lower rate in the quarter reflects favorable impact of the Canadian tax rate reduction and enacted during the quarter as well as an increased benefit from inter-company interest due to higher Canadian exchange rates. Last year’s fourth quarter effective rate was also low due to tax deductions associated with the large mark to market expenses.

Also affecting the effective tax this quarter was an acceleration of Canadian tax deductions resulting from the closure of our Cambridge salad dressing plant and the transfer of a portion of its production to our expanded U.S. salad dressing plant.

Income from continuing operations in the fourth quarter was $22.1 million compared to $7.1 million in last year’s fourth quarter. This equates to fully diluted earnings per share of $0.66 in the quarter compared to $0.22 last year.

Excluding the unusual items I highlighted above, and consistent with the reconciliation in our earnings press release issued today, our adjusted earrings for the quarter totaled $0.78 per share compared to $0.55 last year.

The significant improvement in operating results was directly attributable to the improved unit sales and our focus on the center of the P&L to drive efficiencies along with a favorable effective tax rate.

Now for the full year of 2009, reported earnings per diluted share from continuing operations was $.2.48 compared to $0.91 last year. Excluding the unusual items I discussed previously, adjusted earnings per share would have been $2.23 this year. This is a 38% increase over last year’s $1.62 and well above our original expectations for the year.

Our full year results show top line growth despite the challenges in both our Food Away From Home and bulk and industrial segments. We were especially pleased with the 5.9% increase in retail sales.

Margins for the company improved in all three segments when comparing full year 2009 to 2008. Although operating expenses increased on a year over year basis due to both incentive compensation programs and deal related costs, we still significantly increased operating income. We clearly finished with a lot of momentum heading into the new year.

Now let me cover the outlook for 2010. Last year I started off by saying we viewed 2009 as being a year of opportunity for Treehouse, and as a results show, it certainly was. For 2010 we still see opportunity both on our base line business and with the future addition of Sturm Foods to our product array.

For 2010 guidance I will focus on Treehouse excluding the acquisition of Sturm. We expect the top line revenue to increase in the range of 2% in 2010 as growth in the retail business offsets expected softness in the Food Away From Home category. We do not expect much in price increases in 2010 but will react as needed to any significant changes in our input costs.

In terms of gross margins, we expect that the very good margins we experienced in the fourth quarter of 2009 will continue into 2010 resulting in full year margins that should be over 100 basis points better than the full year of 2009. This margin improvement will be the result of internal efficiencies.

In terms of expenses, our operating costs will continue to be well controlled. We expect to have normalized levels of operating costs next year but will see some increases in staffing as we grow the business through acquisitions. In addition, as we progress with our new systems implementation project, we expect to incur an incremental $3.5 million to $4 million in project related expenses.

Excluding the ERP related expenses, we expect operating costs to be very consistent with the 2009 operating expense ratio of 13.4% to net sales.

Now let me cover a few other items that are considered in our full year outlook. First, interest expense will be relatively flat to the 2009 total of $18.4 million. Much of the balance of our outstanding debt is effectively at a fixed rate due to our prior interest rate swap.

In addition, we expect to see an increase in U.S. interest rates over the course of 2010 and this will affect the remaining balance of floating rate loans outstanding under our revolving credit agreement. The higher rates will offset lower debt levels resulting from normal operating cash flow. Our effective tax rate should stay close to 36% in 2010, very much in line with the effective rate of 2009 excluding the fourth quarter unusual items.

In terms of capital investments, we are forecasting that operating capital spending levels in 2010 will be at a typical level of $35 million to $40 million. This is in line with the 2009 capital spending of $37 million.

In addition, we are allocating an incremental $20 million to $25 million in ERP capitalization. Therefore, we expect total capital spending to be in the range of $58 million to $62 million.

Non cash items for 2010 include depreciation and amortization which will show a very moderate increase from 2009 levels. Stock option expenses are expected to rise to approximately $15 million from the $13.3 million in 2009 as we increase the participant pool for the increased staffing levels and assume an increase for new acquisitions.

In regards to shares outstanding we have assumed fully diluted shares outstanding to be approximately 34.4 million before considering the equity issuance relating to the Sturm financing.

In total, we see our base Treehouse earnings per share growing to a range of $2.32 to $2.37 per share in 2010. Please note that this improvement in earnings is inclusive of the incremental ERP costs and it reflects the higher and normalized effective tax rate for next year and also assumes an increase in the shares outstanding in 2010. All considered, we see 2010 an another year of solid earnings growth for Treehouse.

In regard to the Strum acquisition, we are progressing as planned with the acquisition. We still expect the transaction to close late in the first quarter so we will see the full affect of Sturm in our results beginning with our second quarter. Still, these estimates are dependant on a variety of factors including the timing of the transaction closing, valuation estimates and market conditions at the time of closing. We will update the acquisition guidance after the transaction closes.

At this time, I will recap our previously disclosed estimates relating to Sturm. First, we expect their full year results to be accretive by $0.38 to $0.40 per fully diluted share so our unadjusted results will be increased by about $0.27 to $0.30 based on a late first quarter closing.

This is before considering the normal gross margin adjustment that results from writing up acquired inventories to fair value. This write up effectively eliminates gross profit until those acquired inventories are sold.

We expect this accounting adjustment will negatively affect the accretion by $0.08 to $0.12 in EPS depending on the level of inventories at the time of closing. This inventory adjustment will only affect the first two months of results because it is based on how the inventories turn over. The later months will not be affected by this adjustment.

Further, most of the transaction costs will be expensed as incurred under the new accounting rules. We expect these costs will be in the range of $0.20 to $0.22 per share and include legal, accounting, investment banking, valuation and certain financing costs. These costs will be expenses mostly in the month we close with some minor costs expected to spill into the first two months after the transaction closes.

In summary, the transaction should add $0.38 to $0.40 in accretive earnings per share on a full year basis and $0.27 to $0.30 for the partial year under our ownership. Those results will be further reduced this year by the one time inventory adjustments and transactions costs of $0.29 to $0.32 a share resulting in close to breakeven on total reported earnings in calendar year 2010.

Now I’ll turn it back to Sam.

Sam Reed

Thanks Dennis. I’ll close our introductory remarks with a summary of our progress on the Sturm acquisition and our plans for the upcoming debt and equity road shows.

Regarding Sturm, the business continues to perform very well with top line growth and bottom line margins consistent with past performance and our acquisition model. We are on track to close the transaction in March.

The high yield and secondary equity markets appear to be highly receptive to our anticipated $500 million offering. Although we budgeted no year one synergies, we have unearthed promising near term sales and savings opportunities.

Our Treehouse and Sturm teams are highly compatible and collaborating opening on a shared agenda of expanded distribution of powdered beverages and hot cereal.

We expect to close the transaction next month and will update you on our plans thereafter to expand the Sturm base of business to all branches of our Treehouse. Stay tuned. This chapter of the Treehouse story should be very special indeed.

On a closing note, we will shortly undertake a road show to market Treehouse securities to be issued to finance the Sturm Foods acquisition. For those of you who will miss our presentations, our message is clear. Treehouse, which has posted 25% compounded growth in earnings and operating cash flow since its inception is expanding into two major categories of private label foods.

Sturm Foods which has combined private label category leadership in two $1 billion plus categories with unrivalled technology and innovation is the ideal partner for Treehouse. The combination of Treehouse’s scale and Sturm’s growth will increase our cash flow by one half, add double digit accretion to our earnings, expand our diversify our investor raise all the while maintaining prudent leverage and coverage ratios.

Hell, even I could sell this deal. Lauren will now open the lines for Q&A.

Question-and-Answer Session

Operator

(Question-and-Answer Session) Your first question comes from William Chappell – Suntrust Robinson Humphrey.

William Chappell – Suntrust Robinson Humphrey

On business for 2010, I’m just trying to understand. You talked about Food Away From Home being weak. Maybe you could give a little more color. You’re coming off a pretty decent number in the fourth quarter. Obviously the food service business has had a pretty tough year, so I think the comparisons get a little bit easier. How bad should it be or are you seeing any signs of recovery there.

David Vermylen

We are seeing signs of recovery. I think as we were building the 2010 plan for Food Away From Home which we were building early in the fourth quarter, I think we’re probably more optimistic about Food Away From Home now than when we constructed the plan so while the numbers are, we’re cautious about the state of the industry, but we are optimistic about what our potential is for t his year.

William Chappell – Suntrust Robinson Humphrey

On that same vein, I can’t say I have a great idea how to model industrial ingredient business because it’s so lumpy, how should we look at that coming off the fourth quarter number.

David Vermylen

Lumpy. It’s tough business to model because it’s not while the largest component is our powder ingredient business, there’s a lot of co-pack business in there that we really don’t control the sales of, and that creates the lumpiness. On the other side, the profit operating income contribution of that co-business is modest at best.

Dennis Riordan

As the industrial side on one highly tied to Food Away From Home in the powder side and that is the segment that has a lot of pass through contracts on input costs so you see volatility in the top line as well which tends not to go to the bottom line because again, it’s pass through so we can maintain the margins, but we see that lumpy top line.

So as David said, that contributes to the up and down. As we found this year though, really focused on our margins, we did quite well there and with the drop in co-pack business, it actually resulted in a richer mix of industrial sales which certainly helped the overall margin percent.

William Chappell – Suntrust Robinson Humphrey

When you’re talking about the Sturm accretion for this year both the $0.27 to $0.30 of actual and the $0.38 to $0.40 on pro forma, is that including the $0.20 to $0.22 of investment banking and other fees and maybe $0.10 of inventory write off?

Dennis Riordan

No, those would be the run rate numbers and the other items represent roughly $0.29 in one time costs so on a full year basis we would expect the EPS to be basically zero for the addition this year all because of those first quarter costs, those one time costs that will eat up the nine months pro forma accretion.

William Chappell – Suntrust Robinson Humphrey

On ERP, I think I got the number that you were going to capitalize this year. Did you say what you were going to expense this year for the ERP implementation?

Dennis Riordan

We expect it be in the range of $3.5 million to $4 million which is basically eating about $0.07 in EPS.

Operator

Your next question comes from Andrew Lazar – Barclays Capital.

Andrew Lazar – Barclays Capital

From an overall industry perspective, I think you talked about top line in 2010 around 2% or so, obviously better in retail and also a little bit by industrial, what are your thoughts around the expectations around the top line for U.S. retail? I’m trying to get a sense of if you continue to think you’ll outperform from a private label perspective, where your sights are for the overall grocery industry growth perspective for the year.

David Vermylen

I think we’re looking at about 3% to 4% top line. There’s very little if any pricing assumed in that. We’re having good momentum on pickles because of the restructuring and our focus on what we refer to as strategic customers. Salsa continues to do well and I think salad dressing continues to do well. So I think it’s good growth across the majority of the portfolio.

Andrew Lazar – Barclays Capital

In the quarter obviously volume in U.S. retail accelerated sequentially a bit but you had in the third quarter you had 8% pricing and then in this quarter it looked like pricing was down a bit and you did get the 1% volume acceleration sequentially but I’m wondering if you thought that trade off of what pricing came down by over the last quarter and what volume accelerated by was what you were looking for or if it was not as great as it could have been.

Dennis Riordan

The actual pricing at retail for the quarter is going to come in at under 1%, so we’re basically lapping all the pricing that was taken in 2008. So what you’re seeing there is predominantly volume and some positive mix.

Andrew Lazar – Barclays Capital

I’m getting a sense of the whole industry is kind of dealing with this, but as the industry and as you have lapped a lot of the pricing, did you necessarily expect the consumer to react more positively from a volume perspective or is that just being somewhat naïve on my part given where the consumer is at right now.

Sam Reed

I think it’s just we went through the period of incredible price inflation. It’s stable now and what we are seeing is the consumer continuing to respond very well to private label. As I pointed out, in the fourth quarter for those 92 categories, physical volume was up north of 4.5% on top of 8% plus a year ago.

The category continues to do very, very well. We like the price environment we’re in right now. That stability really allows us to focus on going after sales wins. As I highlighted, in 2008, we spent all of our time chasing pricing and in 2009 we were able to put a lot of effort into going after the big sales wins, and those sales wins started coming in really strong for us in the second half of the year such that our physical volume year over year in the second half was up north of 500 basis point versus the first half. We’re very encouraged by that.

Andrew Lazar – Barclays Capital

The overall North American retail grocery EBIT margin at least for the year is starting to approach 16% or so in ’09 and obviously you’re looking for some expansion on that going into 2010. From an absolute perspective, that’s kind in and around where some branded manufacturers margins might be on the EBIT line, so I’m just curious on your commentary around that and sustainability at that level.

Sam Reed

One of the things we’ve got going for us is obviously despite the margins being nice there, we still have significant room to improve on gross margins. We’re in that 23% which obviously we see opportunity so we’ll continue to focus on that.

Overall though, what we continue to see is the opportunity for margin enhancement not just through efficiency but through mix as more and more retailers are focusing on more premium offerings which are not only more margin for them, but more margin for us. So as the category dynamics change we see opportunity.

Andrew Lazar – Barclays Capital

Did you say that your core underlying Treehouse guidance X Strum includes the higher share count that you’ll have because of Sturm?

Dennis Riordan

Yes. It includes the higher share count. It includes the roughly 36% tax rate which is an increase from this year and it includes the $3.5 million to $4 million in ERP expenses.

Operator

Your next question comes from Akshay Jagdale – Keybanc Capital Markets.

Akshay Jagdale – Keybanc Capital Markets

Regarding guidance for 2010, you had a pretty good 4Q. I think it beat most people’s expectations even on the operating line. Can you talk about why you didn’t raise guidance and maybe talk to the range that you have. When I look at 100 basis point margin expansion and 2% top line growth, clearly we get to the top end of your guidance range so I’m just trying to get a sense of variability there, what you’re worried about when you go into 2010 that could make you feel not too comfortable about the top end of that range.

David Vermylen

I just think it’s too early in the year for us to make any changes and I think we’ll be back with you in May as we see how the first quarter shakes out, how we’re looking with Sturm, how the whole business comes together. As I pointed out, Harry Walsh and his team have been out literally, I refer to it as the Where’s Waldo Tour, visiting every plant, and I think at the end of this quarter, we’ll have a better sense for where we are.

The way the fourth quarter finished, there wasn’t one thing that stood out in terms of either top line or by a segment, or by a channel. Everything just did a little bit better from an operating perspective, so there isn’t that one event that we can point to that we can say is sustainable.

It’s just a little too early for us to want to move on it, but we are very encouraged.

Dennis Riordan

I second that. I think our history has been even the last two years, we’ve had some very good first quarters and we tend not to adjust that guidance until we get into the year. Obviously we’re very happy with how the fourth quarter ended and quite comfortable with our guidance range and as David said, would love to provide a great update in May.

Akshay Jagdale – Keybanc Capital Markets

To that point, can you give us a little bit more color on the operational efficiencies that are going to drive the margin expansion next year for your base business? I’m assuming some of that has to do with the systems you’ve put in place, but if you can give us some color on that, that would be helpful.

Sam Reed

First of all on the systems, the project has kicked off the but implementation we’re expecting and the turn on will be February of 2011. So the systems won’t drive that but as David has mentioned, and Harry Walsh, the President of our Bay Valley Foods operation have focused on is that center of the P&L and we’re really looking at factory efficiencies.

We’re looking at purchasing and not in terms of just commodity costs changes, but we’ve really stepped up our purchasing team and I think David can talk more about that.

David Vermylen

There are three big areas; procurement, we have on both raw materials and packaging. We have a much better team in place now to go after these opportunities and we’ve really identified and are well into the implementation of significant packaging and raw material savings.

As I pointed out, Harry and his team have been travelling all over the place really driving through plant by plant, line by line on how we improve our conversion rates and very important for us is our inventory management and reducing our levels of unsalable finished goods etc.

So it is a very aggressive program. When you look at it as a percentage of cost of goods sold it’s north of 3% when you look at our cost of goods sold for 2009. So it’s an aggressive program and it is really internally within the Bay Valley organization, probably the number one initiative for this year.

Akshay Jagdale – Keybanc Capital Markets

On overall trends within retail as it relates to pricing etc., I think Andrew talked a little bit about elasticity and things of that sort, but can you talk a little bit about the environment that you see at retail from a private label perspective given the backdrop that we have on the consumer side and talk a little bit about how it was going into 4Q and then what you see into 2010, and if you could focus on pricing, that would be great.

David Vermylen

What we saw in the fourth quarter when we looked at our legacy Bay Valley, there are five major categories that we track through Nielson and we looked at price gaps for the fourth quarter of ’09 versus the fourth quarter of ’08. There was virtually no difference in any of those gaps and they tended to be in the 20% to 30% range and year over year there might have been 100 or 120 basis point change plus or minus versus a year ago.

So the fact that it’s been quite stable, and I think we are expecting that it will continue to be stable this year. So it’s a good environment. As I pointed out, in all of those categories with the exception of case share in salad dressing, where our case share was flat versus a year ago, our case share and dollar share in every category grew without a change in our price gap.

So the environment really continues to be in our favor.

Sam Reed

Before the next questioner, I would like to weave together some comments on the various issues that have come up. First of all, with regard to 2010 in the eight retail private label categories that are the core of our strategy we are including the two Sturm categories.

We are forecasting unit sales increases in all eight of those and they range from 2.2% to 6.4% on the Bay Valley category and higher numbers at Sturm.

With regard to the overall performance, while revenues grew only 1.7% on a real basis in the fourth quarter, you have to look at infant feeding and the Canadian dollar. I’ve very pleased to see that our core private label unit volume for the category grew by 3.2% which was a very strong performance.

It’s interesting to note that although prices have been soft in certain businesses, that the price gaps and that’s the critical measure that we watch, are relatively constant across the board and with regard to pricing elasticity, a relative position for the brands is still quite good.

Further with regard with looking into pricing and margins in the next year, we have a continuing drive for productivity and purchasing budgeted variable cost savings of over $46 million in improved efficiency for the coming year, much of which will hit our private label margins.

And then lastly, in contrast to concerns in some other parts of the greater food world where there are now greater concerns about input prices increasing, particularly on branded foods that are affected by dairy and other matters, our current outlook for our business is that once you consider the forward positions we’ve taken, our hedging programs and our cost reduction programs, and we’re looking at the aggregate cost of our inputs to be relatively flat and not a threat to our margins as input cost inflation has been in the past.

I hope that is helpful to those of you who are all asking individual questions around the central issue here.

I’ll take it back to further Q&A.

Operator

Your next question comes from Ken Goldman – J.P. Morgan.

Ken Goldman – J.P. Morgan

A question on the $0.08 to $0.12 that you mentioned non recurring as part of the I believe all non cash costs of the acquisition. Will you call those out in detail as you do all the other non cash items on the back page of your press releases?

Dennis Riordan

I will do that. We’ve done that for the last few acquisitions as well and this is really we’re required to revalue an acquiree’s finished goods to almost net realizable value, so effectively what happens is that as the finished goods are sold, you get no margin. Once it bleeds through typically in one to two months, then margins are back to normal, so I will call that out as an unusual item, and that’s what that $0.08 to $0.12 estimate is.

It’s a fairly wide range only because it’s dependant on exactly what the inventory levels are at the time of acquisition.

Ken Goldman – J.P. Morgan

I’ve gotten a couple of questions this morning on what the real guidance is for next year and there’s a couple of puts and takes. I imagine that in your mind the real guidance excludes that $0.08 to $0.12 in costs on a pro forma basis.

Dennis Riordan

On a pro forma basis, it would exclude that and if you put it all together including the one times it would be roughly Sturm would be break even for the calendar year 2010. Excluding the one time it would accretive by about $0.27 to $0.30 for the nine month period.

Ken Goldman – J.P. Morgan

We’re all lemmings on the sale side or at least I am. When the company suggests taking it out we often do so I just wanted to make sure we were all thinking about that the same way.

In terms of new categories, one part of the story I always found attractive was the potential. As you do more business, provide better service to retailers, those retailers will look at some of their smaller maybe less efficient manufacturers and private label and say you know, Treehouse is so good at category X, maybe Treehouse can go into category Y for us also, and that way you could expand without having to spend on an acquisition. I think the classic example may have been going from salsa to perhaps something like tomato sauce where it’s a very similar product in terms of manufacturing. Has any of that happened yet, and if not I’m just curious where that stands in your mind as a potential benefit going forward.

David Vermylen

I think it’s a great area, and yes we have been able to do that. We are now in the pasta sauce business with a premium pasta sauce that we’re producing in our San Antonio facility. I think a way to approach it is when we are able to show those retailers, say the supply chain benefits and then what our assets are capable of producing, you put the two together and that opens up the opportunities.

For example, with one very, very large customer over the last six months because of the opening of our large Midwest distribution center, we have been able to consolidate from seven distribution centers down to one, now are putting six product lines onto one truck.

We have taken our average truck weight from 15,000 pounds to 39,000 plus. We’ve been able to help that very, very large customer reduce their inventory weeks of supply, improve their in stock level and have taken an average of 28 trucks off the highway on a per weekly basis.

Then you combine that with here are what our assets are capable of producing and in tandem with discussions about where they are going strategically, we really think with very large customers, we can launch ourselves into new categories in a way that we don’t have to use acquisitions to get there.

Ken Goldman – J.P. Morgan

I know it’s early and maybe it’s too early to ask this question, but where do you think you stand in terms of your plants in terms of do you need more. Are you thinking about consolidating? Where are you leaning right now so that we get a better sense of maybe some of the capacity utilization there? I guess I’m asking a whole lot of question in one, but I’m curious about do you need more facilities or do you think it’s a better thing at this point to consolidate them.

David Vermylen

I think we’re very comfortable with where we are now. Last year we closed one salad dressing facility and invested in a new high speed salad dressing line in our Northeast plant. We’re at good utilization levels. We’re not at a level anywhere that would require us to invest in a new plant and we’ll always look at opportunities to operate more efficiently.

If that leads to consolidation, that is one path, but it is not on the horizon near term. So our focus right now is how do we get more out of the facilities that we have.

Operator

Your next question comes from David Driscoll – Citi.

David Driscoll – Citi

You made a comment just a moment ago about your inflation outlook but I want to get you to clarify something. You said it was flat but I think you said that included the offsetting benefit of productivity savings. If that’s right, can you tell me what the underlying inflation outlook is?

Sam Reed

I have said that we expected on our major input costs, and those are ingredients, commodities, packaging and energy, that the net effect in our 2010 business plan would be plus or minus zero and that included not only the effect of the underlying costs where we’re seeing those rise in certain sectors, but also positions that we had taken already taken on a forward basis, our hedging programs and the cost savings that I had indicated were $45 million.

I think while the number is important, I think the much more important factor to consider is that how we have transformed a private label business here from only several years ago, if you’ll recall kind of the rampant inflation because of the global increase in demand for foodstuffs and energy, we now have a procurement program linked very closely to our sales and marketing effort and David and Dennis and Harry and myself are intimately involved in both to ensure that we are always taking prudent positions on a forward looking basis with regard to these inputs, and that should they spike unexpectedly, that we’ll be able to move quite quickly and far more nimbly than we have in the past and you saw a lot of that result in late 2008 and early 2009.

David Vermylen

One point of clarification when you look at input costs and our $45 million procurement program, about a third of our productivity of the $45 million would relate to procurement.

David Driscoll – Citi

Thanks for all that color. It’s very important. A lot of companies just give the raw inflation number and then productivity is like a different bucket. Other companies have fancy acronyms.

Andrew asked a question about volumes. I think he was looking at reported volume. I wanted to try, a North American retail question just looking at the volumes X pickles, and I think I’ve written the numbers down from your conference calls it was plus 6% in the second quarter, plus 4% in the third quarter and this quarter I think you said just a few moments ago it was plus 4%. I didn’t actually have an X pickle number for the first quarter but I think it was a fairly strong number. Can you talk about, it does seem as if the volumes have slowed a little bit and I suppose I want to just try to question about 2010 and see is the environment, you would characterize the environment as a good environment but it would be a lot slower than where we were in 2009. Is that a fair statement?

David Vermylen

I think on the North American retail volume growth, we tend to talk about an X branded infant feeding rather than X pickles and we’ve been very consistent the last two or three quarters at about a 4% physical volume, and that’s in the range of what we are forecasting for 2010, and consistent with the current running rates for private label case sales in the 92 categories that we’re tracking.

David Driscoll – Citi

If I could make a suggestion, I would love it if you put into your press release another table in there that just showed the volumes because it is a key metric.

When you called out in your prepared script that you had significant margin expansion in both pickles and soup and I think you called out just those two categories almost as if they were extra special in the margin enhancement for the quarter, can you delve into a few of the reasons why those two categories did so well?

David Vermylen

On soup, I think the margin improvement had certainly some productivity gains and the flow through of some pricing that had a positive effect. But frankly, a year ago the margins on our soup business were not particularly robust so the year over year is affected by that.

Pickles is really where an enormous amount of effort took place and some of the key dynamics there are, we got out of business with low to negative margin customers. We closed one high cost pickle manufacturing facility over a year ago. We were able to pick up new business with a couple of very large customers with limited SKU’s with the type of pickle that helped us to balance off our cucumber crop usage and all of those things really came together to lead to both that volume momentum in the second half of ’09 and that significant improvement in our margins.

At the same time, we did have a good cucumber crop in 2009 which helped those margins as well.

David Driscoll – Citi

On soup, I think you also called this one out as the one specific category within your mix that was weak. Can you talk about the category dynamics right there? Why is it weak? I get this question asked of me all the time. I know we’ve asked it of you in the past, but I’d love to hear your thought given that we’re in the middle of the soup season. Why isn’t this category doing better?

David Vermylen

I really don’t know. I think the marketing for the category has been better this year than last year. We’re finally beginning now to see some marketing that relates to the value of soup as a very good meal at a very good price rather than just taking prices down.

I think those questions are best asked of the branded leaders. They’re going to have a lot more market research and consumer insight into what is going on. We are very happy with how our business has done. The condensed segment is doing well and our business is moving along as planned.

Operator

Your next question comes from Heather Jones – BB&T Capital Markets.