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Cott Corporation (NYSE:COT)

Q2 2014 Earnings Conference Call

July 31, 2014 10:00 AM ET

Executives

Jarrod Langhans – Director, IR

Jerry Fowden – CEO

Jay Wells – CFO

Analysts

Perry Caicco – CIBC

Bill Schmitz – Deutsche Bank

Mark Swartzberg – Stifel

John Faucher – JPMorgan

Judy Hong – Goldman Sachs

Amit Sharma – BMO Capitals

Operator

Welcome to Cott Corporation’s Second Quarter 2014 Earnings Conference Call. All participants are currently in listen-only mode. This call will end no later than 11 AM. The call is being webcast live on Cott’s website at www.cott.com and will be available for playback there until August 14, 2014.

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 and SG&A.

This conference call also includes forward-looking statements reflecting the company’s business strategy, the payment of future dividends, the reduction of interest expense and investment in organic and acquisition opportunities including expected synergies in relation there to goals and expectations concerning our market position, future operations and estimated capital expenditures, working capital, commodities and taxes.

Forward-looking statements are subject to certain risks and uncertainties which have caused 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 the inclusions or making forecast or projections reflected in the forward-looking information.

Additional information about the material factors or assumptions applied in drawing conclusions are making forecast or projections reflected in the forward-looking information is available in the company’s press release issued earlier this morning and its quarterly report on Form 10-Q for the quarter ended June 28, 2014.

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 and accordance with GAAP is available on the company’s second quarter 2014 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 Jarrod Langhans, Cott’s Director of Investor Relations.

Jarrod Langhans

Good morning 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 2014 financial performance. Jay will then turn the call back to Jerry who will complete the call with his perspective on our second quarter 2014 performance including an overview of our business units, a discussion of business drivers and expectations for the future.

Following our prepared remarks, we will open the call up for questions. In addition we have a posted a few slides on our Investor Relations website to provide further information on our recent private placement of $525 million of senior notes due in 2022 as well as a profile of Aimia Foods, our recent UK acquisition.

With that, let me now turn the call over Jerry.

Jerry Fowden

Thank you, Jarrod. Good morning everyone. Before Jay reviews our financial results, I wanted to comment on our second quarter’s performance and update you all on the progress that we’ve made in executing against our five point strategy. During the quarter, our volume trend excluding Aimia volumes improved. With total volume including concentrate being up 3% in 8-ounce equivalent cases and the 4% in servings.

While excluding concentrate 8-ounce equivalent case volume was down just 1% and servings were flat. For those of you on the call, who already had a chance to review our press release, you will see that we’re starting to report volume in servings as well as 8-ounce equivalent cases.

We’re doing this to improve understanding of our business and our volume trends as we continue to diversify into more product and package formats, including powdered beverages and other non-traditional formats. Jay will elaborate more on this approach in his remarks.

Now turning to the quarter. While our volume trend improved and we made good initi1al progress in the number, strategically important areas. The North American CSD landscape remained challenging as we predicted. We continued to see narrow North American CSD price gaps, due to a continuation of aggressive, national brand promotional activity in large format retail stores.

With $1 or below two-liter price points and $3 or less for 12-packs, 12-ounce cans. These particular packs on the large format retail store segment represent a very significant proportion of our CSD business and thus the narrow price gaps continued to adversely affect our North American CSD volumes.

However, the quarter also saw a significant improvement in our North American juice and drinks business, which was up 14% in volume as well as excellent progress in contract manufacturing which grew over 140% and this is an area where we believe we had good momentum.

Now while we expect to see this competitive North American national brand CSD promotional environment continue. We have recently seen, the first week in a long time where national brand pricing for two-liter CSDs was over $1 and 12-pack 12-ounce cans were over $3. Now while this more rationale pricing did not last for long, just one week in fact it is an encouraging sign as we look to the future.

Now let’s turn to the five strategic priorities we announced last quarter, which were designed to enhance long-term shareholder value and create a more sustainable growth oriented business over time.

I’m happy to report that we’ve made some good initial progress in executing against this strategy during the quarter. First, we have continued with our 4 C’s approach of running the business tightly focusing on customers cost, CapEx and of course cash flow. This quarter, we finalized the closure of two of our production plants as part of our 2013 annual footprint and efficiency review.

The closure of these two parts as gone smoothly and we anticipate a two year cash payback. Jay will update you on the details in a few minutes. We also remained dedicated to customer service and we’re delighted in June to be awarded The Grocer Gold Own-Label Supplier of the Year Award, which identified Cott UK as the best private label supplier across all 19 different food and beverage categories in the UK.

We also maintained tight control of our capital expenditure, with CapEx of $12 million in the quarter. This CapEx including cost and efficiency initiatives of approximately $4 million, which we expect to support our low cost philosophy going forward. These actions along with many others assisted our strong cash generation with second quarter adjusted free cash flow increasing by $14 million to $34 million.

The second of our strategic priorities was to increase the allocation of new dedicated resources against contract manufacturing and channel diversification, which is being showing considerable growth and which we believe is now gaining momentum.

This quarter saw our North American contract manufacturing business, grow by 9 million 8-ounce equivalent cases from around 6 million cases to 15 million cases all by over 140%. We also recently signed two new contract manufacturing agreements for some 13 million to 16 million additional 8-ounce equivalent cases per annum that we expect to start to phase in across quarter four this quarter and quarter one of 2015.

And we won our first meaningful contract in the North American food service channel and expect to see initial volume shift during quarter three. All of these items together main we’ve made good progress against our longer term goal of winning 50 million to 80 million 8-ounce equivalent cases of contract manufacturing over the next three years.

With regard to our third strategic priority during the quarter, we successfully refinanced our 2018 senior notes in parallel with an expansion of our overall debt capacity, while reducing both our interest rate and total interest cost. Jay will cover more of the details on this later and as mentioned we posted a few slides on our Investor Relations website to provide further information on this topic.

Our full strategic priority is that of increasing our return of funds to shareholders to up to 50% of our free cash flow, while an increase in our opportunistic share repurchase plan and the continuance of our quarter dividend.

We returned $8.4 million to shareholders over the quarter, which included the repurchase of approximately 370,000 shares during the quarter. As you may recall, our new share repurchase program was announced at our Annual Shareholders Meeting on May the 6th and came into effect on May 22nd.

As a result, the new program was only in place for five weeks during the quarter. Now the fifth of our strategic priorities is to accelerate in pace and scale our acquisition-based diversification outside of CSDs and show stable reduces with a focus on other beverage categories and beverage adjacencies.

As well as on driving our channel mix beyond large format retail and supermarket stores, while ensuring our transactions of value creating. On this front, we acquired Aimia Foods on May the 30th. And this acquisition exemplifies the type of diversifying acquisition that we’re targeting.

Aimia provides us with access to growing, higher value categories including hot chocolate, coffee, malt drinks, creamers and whiteners and cereals alongside its existing presence in energy drinks and dilute to taste liquid beverages. In addition Aimia Foods as a strong presence outside of large format retail and supermarket stores with approximately 75% of revenues in the wholesale, vending, food service and contract manufacturing channels.

While the Aimia Foods acquisition is a great start, we continue to review our target list and are actively evaluating other businesses to further diversify our product package and channel offerings. Jay will again expand on Aimia Foods, its purchase and financial profile shortly.

Overall, I believe we’ve made good progress in executing against our five point strategy during the quarter, even though I know we have a long way to go. Cott is in a stronger position now, but it was just one quarter ago, and I believe our continued focus on and execution of this strategy will lead to a more sustainable, diversified and growth oriented business over time, which in turn should lead to higher value for our shareholders.

On this note, let me hand the call over to Jay to cover our second quarter financial results in more detail, as well as expand on our new volume methodology, our recent boundary financing and the Aimia acquisition.

Jay Wells

Thank you, Jerry. Before discussing our financial results, I would like to highlight a change that has been made in this quarter’s press release, as well on 10-Q that will be filed next week. As Jerry noted, we continue to diversify the company and expand our product, package and channel mix. As a result, we’re moving to a common serving measurement to reflect our increasing variety of products on a consolidated volume basis.

This will be done by converting each of our business units, physical volume and to U.S. food and drug administration guidelines for single serving sizes, if similar approach is used to plan number of other diversified companies. And on a go forward basis, we report the volume percentage changes in servings of our products and our earnings release.

Looking at historic volumes, this new methodology will only change the reporting of freezables, as the serving for ready-to-serve beverages is equal to our previously reported 8-ounce equivalent. In addition as Jerry noted, we have excluded Aimia’s June volume from our consolidated volume, as we are in the process of converting Aimia over to this new volume standard and we will include Aimia in our consolidated volume next quarter.

With that said, total volume excluding Aimia increased by 3% on 8-ounce equivalent cases and 4% in servings, excluding concentrate in Aimia volume was lower by 1% in 8-ounce equivalent cases and flat in servings. You saw a sequential improvement in the volume trends as increased juice and drinks volume, growth in the new age category additional contract manufacturing wins and the addition of Calypso offset the volume impact of aggressive CSD promotional activity by the national brands on our key packs within North America.

Revenue was lower by 2%, 4% excluding the impact of foreign exchange at $551 million. The revenue decline was due primarily to an overall product mix shift in the contract manufacturing, whether the revenue associated with contract manufacturing is well over on a per case basis. As it does not include a charge for ingredients and packaging as the customer generally provide these commodities.

Revenue also declined due to the pass-through of certain fruit commodity benefits as previously discussed. Adjusted gross profit as a percentage of revenue which excludes the inventory step up for purchase accounting was flat at 13.6%. Gross margin began to stabilize during the quarter, as we remained focus on the operations each, on the operations each of our business units and have implemented a number of initiatives to improve gross margin.

We believe that over the next two to three years we would be able to grow our margin as a result of a number of factors including, but not limited to the additional volume and fixed cost absorption associated with the growth in our juice and drinks business, wins and contract manufacturing and channel diversification.

Our ongoing focus on reducing production cost by improving [indiscernible] practices. Increase in operational efficiency and eliminating ways and reducing packaging cost. The acquisition of diversifying higher growth and higher margin businesses as part of our five point strategy toward building long-term shareholder value as well as capturing synergies associated with these acquisitions. And the easing of North American CSD volume declines, as and when the national brands move to a more normal or historic promotional level.

Turning to SG&A, SG&A expenses excluding acquisition and integration cost were higher by $4 million, $3 million excluding the impact of foreign exchange at $45 million compared to $41 million. The increase in SG&A was due primarily to an increase in employee related cost as well as the SG&A associated with the Calypso and Aimia operations.

The increase in employee-related cost was due to the reversal and removal of various bonus and incentive cost in the second quarter of last year. Thus reducing Q2 2013 SG&A cost. As a reminder, we previously stated that our quarterly SG&A cost for 2014 would be in the $42 million to $45 million and we currently see SG&A cost for the second half of the year before the addition of Aimia been at the high-end of that range as we have added Calypso’s SG&A cost and are occurring from our normalized bonuses and long-term incentive cost in 2014.

During the quarter, we incurred approximately $0.4 million in charges related to our two plant closures bringing the cost to-date to $4.2 million. The cost associated with these closures and related restructuring are expected to have an approximate two year payback period and we are expecting to have approximately $0.8 million of charges during the second half of the year in relation to this closures.

Interest expense for the second quarter was lower at $8.4 million compared to $12.8 million. The $4.4 million reduction in interest expense was due primarily to last year’s redemption of our 2017 senior notes and the amendment of our asset based lending facility to provide to more favorable pricing terms.

Based on current debt levels we expect full year 2014 interest cost to be approximately $36 million and 2015’s interest cost to be approximately $34 million. Other expense was $19.8 million in the second quarter compared to nil, predominantly due to cost associated with the purchase of $296 million of our 2018 senior notes and a cash tender offer in the quarter. Remaining $79 million of 2018 senior notes were redeemed on July 24th and $4.6 million of charges associated with this will be reported in the third quarter.

Income tax expense was $2.5 million in the second quarter compared to $1.6 million. The increase in income tax expense was primarily due to pre-tax income in certain jurisdictions that was not offset by pre-tax losses and other jurisdictions where evaluation allowances offset those losses.

Adjusted net income and adjusted income per diluted share were $17 million and $0.17 respectively, compared to adjusted net income of $20 million and adjusted earnings per diluted share of $0.20 in the prior year. Adjusted EBITDA was $56 million compared to $61 million.

The adjustments to EBITDA included the addition of bond redemption cost of $20 million and acquisition and integration cost of $3 million. Adjusted free cash flow during the quarter, which excludes debt redemption cash cost of $16.4 million was $34 million, an increase of $14 million versus Q2 2013, as a result of managing our CapEx and working capital tightly within the quarter.

We continue to be optimistic about delivering free cash flows consistent with prior years, but we believe it is still too early to provide guidance regarding our full year free cash flow.

Turning to our balance sheet. Cash on hand at the end of the quarter was $92 million, after taken into account the payment of approximately $80 million related for the acquisition of Aimia, $2.6 million of deferred payments relating to the Calypso acquisition, $2.6 million of share repurchases and $16.4 million of cash cost associated with the purchase of $296 million of our 2018 senior notes in the quarter. Net debt was $565 million and our unused foreign availability was $254 million.

Turning to our strategic priorities, we issued a private placement of $525 million 5.38 senior notes due 2022 on June 10th, which resulted in an overall interest expense savings of approximately $2.3 million per year after taking into account our repurchase of all, of our 8.125 2018 senior notes.

We have provided a schedule for the timeline and data points for refinancing on our website to assist you. Our strategic priorities also provide for the accelerated investment behind diversification, and based on our current view of the operating environment return up to 50% of our free cash flow to shareholders.

We believe the most effective means of returning funds to shareholders is through maintaining our quarterly dividend not denominated in U.S. currency supplemented by an increase on our discretionary opportunistic share repurchase program.

During the quarter, we paid a dividend of $0.06 per share and we repurchased approximately 370,000 for $2.6 million, for a total of $8.4 million return to shareholder in the quarter.

In addition, our Board of Directors has approved a quarter dividend of $0.06 per share payable on September 10, 2014 to shareholders of record on August 28, 2014. We have repurchased approximately 340,000 shares for $2.4 million in the first five weeks of our third quarter.

With respect to accelerating investment behind diversification as Jerry mentioned, we acquired Aimia Foods on May 30th. Aimia had revenues of approximately $110 million, and EBITDA of approximately $17 million for the 12 months ended March 29, 2014. The Aimia Foods transaction incorporates a growth oriented two-year earn out with a target payout of $20 million if the year-two EBITDA excluding the synergies this £12.75 million were approximately $21 million.

Quarter included on the four weeks of Aimia operating results, which accounted for revenue of approximately $7 million and adjusted EBITDA of approximately $750,000. We provided aside on our Investor Relation website, which provides additional information about Aimia.

With the addition of Aimia as well as our continued growth in North American contract manufacturing and channel diversification, our global revenues from CSDs on a pro forma basis is reduced from 36% in 2013 to less than 30%. With North American CSD revenues accounted for less than 25% of our global revenues.

With that, I will now turn the call back to Jerry.

Jerry Fowden

Thanks Jay. I’ll now review the performance in each of our reporting segment. In North America, total volume including concentrate increased by 1% in 8-ounce equivalent cases and in servings. Excluding concentrate the volume was lower by 3% in 8-ounce cases and 3% in servings.

The main contributory factors to our more stable North American volume was a significant increase in juice and drinks volume, which grew 14%. As well as 140% plus growth in contract manufacturing, which increased from $6 million to $15 million 8-ounce equivalent cases.

These strong performances were offset by lower CSD volumes as a result of the continued 1.6% CSD market decline as well as prolonged national brand promotional activity on the key packs, the narrowed price gaps between national brands and private label.

Revenue in North America was lower by 11%, 10% excluding the impact of foreign exchange due to a combination of factors including an overall product mix shift towards contract manufacturing, where the revenue does not include a charge for ingredient, as the packaging are generally provided by the customers as well as the commodities, and the customer retains the risk of commodities.

Additionally, there were some pass-through of certain fruit commodity cost changes. As we look forward within North America, I’m pleased to be able to report that we recently signed two new contract manufacturing agreements, which together should deliver a further 13 million to 16 million 8-ounce equivalent cases per year as they phase in across quarter four 2014 and the first quarter of 2015.

In addition, it’s also pleasing to see our North American business also in its first meaningful food service customer. Initial production trials for this new customer started in July, we should be shipping just before the end of the third quarter.

Turning to the UK, revenue increased 24%, 14% excluding the impact of foreign exchange and volume including concentrate, but excluding Aimia Foods increased 1% in 8-ounce equivalent cases and 4% in servings. Excluding concentrate UK volumes were up 3% in 8-ounce cases and 6% in servings.

The quarter also continued to reflect across the broad growth in Calypso with volume, revenue and EBITDA all on a like-for-like constant currency basis, as well as a good overall mix within our UK business. We remain pleased with Calypso’s performance and believe it demonstrates the benefit of diversification into different product packages and channels.

We look forward to Aimia Foods following in Calypso’s positive steps. As we look to the rest of the year, we continue to expect improved financial performance in the UK from a combination of the Calypso acquisition and it’s synergies as well as cost controls on operating efficiencies in the base business.

At the same time, we need to remember last year’s late summer heat wave may cause quarter 3’s UK comparables to be a somewhat steeper hill to climb. At this point, I would like to recognize the tremendous achievement of our entire UK team for winning The Grocer Gold Own-Label Supplier of the Year Award. Congratulations, well done and thank you from me and on behalf of all Cott stakeholders.

Now turning to our all other reporting segment. As a reminder, this segment includes our Mexico operations Royal Crown International and other miscellaneous expenses. Revenue was up 3% of $18.3 million due to increased contract manufacturing sales in our Mexico operating segment, as well as increased exports and concentrates out in our Royal Crown International operating segment.

As we summarize the second quarter, and look to the second half of 2014 as a whole, we will continue to focus on making our plans and operations more efficient and growing our juice and drinks volume alongside the expansion of our contract manufacturing business to offset the challenging North American CSD landscape. We will also continue with our drive to diversify the business and win incremental food service contracts in parallel with our acquisition strategy and return the funds to shareholders, in order to put the company in a stronger, more sustainable position.

On the operations front, we’ll maintain our time capital of control with 2014 CapEx in the $50 million to $55 million range. We expect our cash taxes to remain minimal and as Jay mentioned interest cost to be around $36 million this year and $34 million next year. As a short update on commodities, no major changes are worthy of note since our last report.

Aluminum in combination with the Midwest premium, as recently formed by some $0.03 to $0.04, PET resin has increased a further $0.02 and held on to the small inflationary pressure noted at our last call. On coal initial crop indications are good, but as 2012 late summer drought reminds us it’s still too early to tell.

And on fruit very little has changed with higher prices and occasional shortages persisting on certain smaller fruits such as lemon, lime, raspberry and prune. Thus all-in-all while the environment for North American CSDs remains difficult. We are pleased with the progress being made on the contract manufacturing front, the increasing momentum we’re seeing for juice and drinks volume, as well as the strong overall performance of our UK and European business.

We are also pleased with the refinancing and issuance of our 2022 notes, which has reduced our interest rate and interest cost on a go forward basis, as well as our continued strong cash generation. All of these factors together have started to stabilize our top-line which along with some new contract manufacturing wins to come and the addition of Aimia Foods should put Cott in a stronger and more robust position, as we look to the future.

We will continue to run the business tightly, focus on cash generation and on being a low cost high service business while executing against our five strategic priorities designed to accelerate our organic growth and acquisition-based diversification strategy in conjunction with returning funds to shareholders.

With that, back to Jarrod.

Jarrod Langhans

Thank you, Jay and Jerry. During to Q&A so that we can hear from as many of you as possible, we would ask for a limit of one question and one follow-up per person. Thank you for your time. Operator, please open up the line for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Thank you. Our first question comes from the line of Perry Caicco with CIBC. Please proceed with your question.

Perry Caicco – CIBC

Yes, good morning. Just wondering if you could clarify or indicate what your actual North American CSD volume decline was in the quarter? And I’m also interested if – if you saw that volume improved during that famous week when the price list of the brand popping up?

Jerry Fowden

Yes Perry, and good morning. Jay is just double checking the number and it might be a percent or so difference from where I am, I have got in the back of my mind 15%, Jay saying that to correct it, if you round up 16 – if you round down 16, if you round up. So 15% down in CSDs, what we did see Perry is, we mentioned on the call is about a 14% growth in juice and drinks and I think we had about a 10% growth in new age beverages and is that together is driven the better volume trend and the answer is yes, it’s incredible what that price gap can do.

In that single week, when there were none of those $1 two-liters the volume lifted in that week relative to the weeks before and afterwards by 20%. So if we do get a return somewhere over the next several quarters towards a more normal pricing environment and we maintain the momentum we have on juice and drinks, contract manufacturing et cetera. I think we can all see the overall picture will be a much better one as we look to the future.

Perry Caicco – CIBC

And then Jerry specific to the juice, what was – what were the dynamics of the – of the strong growth in juice volume and should we expect that to continue at a similar pace?

Jerry Fowden

I think there is three elements that contribute to it Perry. As we’ve mentioned on prior calls and even at the end of last year coming into this year, after two or three years of significant commodity cost increases. We did say that our intent was to pass back where there were commodity cost benefits which is not all fruits, as I mentioned, things like prune, raspberry, lemon and lime going up. But where there were commodity benefits past those pack so that we could reinvigorate that category which had been heavily hit by price increases over prior years.

So, I think that’s one element. The opportunity to see prices moving back closer to a historic level on some of those fruit products is lead to our retail partners being more willing to promote and support certain of those products. So we’ve seen a great desire to have display on promotional activity. And then thirdly we had done very well in the contract manufacturing area winning juice and drinks volume that goes on to those hot fill. So it’s those three things together that have led to that, and while there always being lumps and bumps in our business, I think as we look to the future and the new contract manufacturing that we have won quite a bit of which is in that hot fill juice and drinks areas. I can’t say it will always be 14% every quarter in North America, but we do look forward to some continuing good momentum in that area.

Perry Caicco – CIBC

Okay that’s good for now. Thank you.

Jerry Fowden

Thank Perry.

Operator

Our next question comes from the line of John Faucher with JPMorgan. Please proceed with your question.

Jerry Fowden

Good morning John. Hello?

Operator

Mr. Faucher perhaps your line is on mute.

Operator

Our next question comes from the line of Bill Schmitz with Deutsche Bank. Please proceed with your question.

Bill Schmitz – Deutsche Bank

Hi, good morning guys.

Jerry Fowden

And John if you’re listening somewhere we’ll happily pop you back in high up in the queue. So if the operator and Jarrod can keep that in mind. I’m sorry Bill, how about you?

Bill Schmitz – Deutsche Bank

Right to the back of the line John, just kidding. So can you just give me like a very brief story on the contract manufacturing business like, how long these contracts last, who you’re taking the contracts from, the margins associated with them and just broadly the competitive dynamics to gain these contracts?

Jerry Fowden

Yes, good question and I think we have covered some of this in the past, but it becomes a more significant element of our business and an area where we see future growth, let me just hit some of those high points again. The majority of our contract manufacturing business would be, medium to longer term contracts, often three years is about the average period of them. With major national brands, that really are looking for a supply chain partner where our manufacturing footprint location geography that freight line advantages or some of the package types and sizes we have fit their brand vision for either new product launches or the growth that they had within their base business.

So they would typically be large, longer term contracts where you go into the supply chain of those companies for a three plus year period of time. In the majority of cases the brand, I don’t know would supply their unique ingredients and packaging materials so the working capital cost associated with that is quite low and we would be really providing a totaling fee on manufacturing fee to reflect labor, materials and management of certain elements of the supply chain. In percentage terms the margin for contract manufacturing is pretty similar to the rest of our business albeit that percentage is on the conversion cost rather than being a percentage including the raw materials as well. Do I need to expand on any more of that or does that will fit together Bill.

Bill Schmitz – Deutsche Bank

No, no that makes good sense that’s great, that’s very helpful. Thank you. But, it sounds like on the margin side most importantly it’s pretty much agnostic to the corporate average?

Jerry Fowden

Yes. And it takes a long time to win this business and get momentum going, I think if you recall it was probably five quarters ago that we made some management changes and allocated some additional dedicated results to this area and we’ve continued to grow that results. And here we are really a year later because it started to come through last quarter. We can see not just that business coming through now, but that we’ve signed up some more contracts that should start to come through, end of this year and benefit next year.

Bill Schmitz – Deutsche Bank

Got you. And the only incremental question I have before I hang up is, the transition cost, how long are those going to come through, I started those in the SG&A commentary?

Jerry Fowden

And to post some scale around that for people, it’s about $1 million in freight that we incurred and that’s because to get certain of these project up in running quickly. We may have made the product in one location where in the aimed game plan of you would be to make it in a different location closer to where that customer wants it. And I would anticipate, after two with the very outside three quarters, we would adjust our supply chain to reflect that and be making the product, in the best location long-term. Obviously, Bill as we win new contracts like the two we’ve described the 13 million to 16 million additional cases for that new business, you may have some of those start-up costs as well. But that’s pretty typical, whether would be start-up for contract manufacturing or in the other large new piece of business.

Bill Schmitz – Deutsche Bank

Great, thank you so much.

Jarrod Langhans

Thanks Bill.

Operator

Our next question comes from the line of Mark Swartzberg with Stifel. Please proceed with your question.

Mark Swartzberg – Stifel

Yes, thanks, hey Jerry, hey guys.

Jarrod Langhans

Hi Mark.

Mark Swartzberg – Stifel

How are you guys?

Jerry Fowden

Fine, thank you.

Mark Swartzberg – Stifel

I guess follow-up on this topic, I guess Perry raised in terms of the North America pricing dynamic and my – I have two questions is, one is and the both relating to large format retailers. One is could you do a bit of a compare and contrast in terms of how these retailers are choosing to treat the carbonated category versus the different juice businesses that you help some with? So that’s one question. And then the second is, specifically it’s related to the carbonated component of their business for lack of the better term I would may be its repentance, but what I mean is, like they are collectively doing high degree of promotion on the category out of their own pockets. And, because we see the numbers from Coke, we see the numbers from Pepsi, we see the numbers from Dr Pepper Snapple, so they are just choosing to promote the category pretty aggressively with their own money. So are you seeing any evidence that they are showing any willingness to change that behavior, in the carbonated component of their business?

Jerry Fowden

Okay, thanks Mark. And I think a very, very important question, and to start really for quarter two this year, we saw the same level of promotional activity, in our large format retail stores on those two-liter packs and 12-ounce packs. As we saw last quarter and quarter one and as we saw in quarter four last year, and if you remember this much more aggressive activity started in quarter three last year around of that August and it started in August last year on two-liter PET and by the time we got to the end of the year more around the holiday period has spread to can.

So we will start to let some of that, as we move to the back-end of this year and that will make comps easier. I think what we have seen which is a different dynamic and I believe one of the national brands inferred this on its recent earnings call, their approach to achieving more favorable or flat overall pricing was by then putting much more effort into managing the mix price and share of business they have in higher value smaller packs in certain stores and channels and over to get, and over is a way of getting to that overall flat average pricing even though they were continuing to sell two-liter and 12-ounce cans cheap in the large format retail channel.

So I think given their credit, they have done a better job of getting to flat overall pricing by our aggressive discounting of two-liter and 12-packs in large stores and pushing the business a bit more towards those higher value, higher cost smaller packs whether the average cost per liter goes up.

I do think some retailers are contributing towards this activity, but I actually think that Catalyst was the national brand owners and it takes two to tango and both are contributing financially towards this activity in large format retail stores.

In terms of when is it going to change, very difficult for me to predict, I think the first opportunity for people to meaningfully reassess this is probably towards the back-end of this year quarter four when they start to really lap the time period when they were doing it both on PET and can, because at that point the kind of marginal volume benefit they are getting from this activity will stop showing through, because they are lapping a period of time when they were already aggressively low prices. And I don’t think prices can go lower.

Certainly if I was a major brand owner, would it be trying to take prices lower, mainly because, what is that brand suppose to do unless it is encouraged consumer to give it trust, confidence for which they will inter-pay a little bit, if all they are going to do is sell it at a few cents of up private label why spend all the money on marketing. But there the different dynamics, I think both are contributing towards it. We did see a 20% lift in that one week when it was more normal price gaps and it should be an opportunity for people to reappraise as we get to quarter four when they start to lap the full effect of when they started last year. Does that make sense Mark?

Mark Swartzberg – Stifel

Yes, sure it does and thank you. If I could follow, as you’ve drawn your own experience in the carbonated component of your business in North American, what would you anticipate would be the behavior; we might see from the retailers? And maybe if it helps, do you think that it’s advantageous to have a more favorable cost environment or advantageous to have challenges if you will persisting on the cost, because that keeps a certain amount of price discipline that would and otherwise be there. So can you just, there is variability there depending on how the cost picture plays out, but what is your experience say about how that’s – what’s a better scenario I guess?

Jerry Fowden

I think on the second point, cost being flat to modestly up beat year, I think creates a much more rational normal easier pricing dynamic for everyone. It’s when you get steps down in cost, so it gets very easy for people to be tempted to invest that back in promotional activity, because they can still hit their targets having done that. So, on average flat to modest increases in input cost create some more rationale pricing environment.

Now with my experience what would I do with what’s being going on within carbonated soft drinks, well I think that’s very clear and well I know all of you on the call well I think I’m biased, I think I can say this truly from my heart as a businessmen. I would drive private label harder, it delivers a margin significantly above that the national brands and the opportunity for retailers to make more money driving private label harder, I think is enormous.

In driving these branded promotions at lower retail margins, the only person they are helping of the brand owners, they are not helping their retail customer brand loyalty. But, as I said mostly you probably think I’m biased there.

Mark Swartzberg – Stifel

Well that’s really biased we would be looking for, so thanks Jerry.

Jarrod Langhans

Thanks Mark.

Operator

Our next question comes from the line of John Faucher with JPMorgan. Please proceed with your question.

Jerry Fowden

Hi John, I don’t know what went wrong earlier on, but glad we found you.

John Faucher – JPMorgan

Yes, sorry about that it’s a lot of companies reporting today. It’s sort of following up a little bit on the topic that Mark was focused on, one of the ancient things about the side and promotional environment is it, it seems and so sugar and CSD full calorie CSDs has bounced back a little bit and the weakness in the category seems more pronounced on diet. So can you talk a little bit about, as this pricing volatility lessen, do you think more people will come back to the full calorie business and does that help you a little bit in the longer term, because you don’t have as much exposure on the diet, if they are actually bringing the people back to that part of the category, or do you just think it’s promotional driven and as the promotions go away, the trends on full calorie CSDs will revert back to normal? Thanks.

Jerry Fowden

I mean I think it’s the latter John, I mean the market and for all our kind of large format channels was still down 1.6% in volume during the quarter, despite this continue on going height and promotional activity. So if people are getting lower and better value and the category is still declining, I think that does kind of fit pretty closely to all of you in our strategic plan where we said we see the long-term carbonated soft drink category and that kind of, three plus percent decline level, if it’s still declining at 1.6% despite the shop pricing.

So I don’t think this is people coming back to the category, I think they are being, brave back to the category with the promotional pricing. On diet, I mean we all read the media around that which is not helpful, despite the fact all the research continues to show that there is no concern with the products and despite the recent research that was published, but actually showed people drinking diet soft drinks as part of their calorie control diet, lost more weight than people drinking case pet water.

So, it was obviously satisfying something in the dietary requirements that maybe overall diet easier to follow. But when media is around everywhere with a bit of a cloud over a category, I think it does create consumer doubt and it’s very easier for consumers at the edge to drop off and I think that’s what happening in diet and it’s the promotional price that is supporting in the short-term the regular, so it is.

John Faucher – JPMorgan

Got it. Thank you.

Jerry Fowden

Thanks John. And thank you for that work you provided last year on price elasticity compared to juice and drinks, comparing that category to the CSD category, you can see we did take it as part of our strategy as people would know we did decide to pass certain commodity benefits in fruit back to try and stimulate that category, your research showed that there should be a volume lift associated with that, because there was good elasticity in juice and drinks. And I’m pleased to see that some of that seems to be coming through in our work. So thank you very John.

Jarrod Langhans

Excellent thanks.

Operator

Our next question comes from the line of Judy Hong with Goldman Sachs. Please proceed with your question.

Judy Hong – Goldman Sachs

Thank you, good morning everyone.

Jerry Fowden

Hi Judy.

Judy Hong – Goldman Sachs

So just going back to the contract manufacturing, I just wanted to get a couple of clarifications here, first when you commented that the margins are actually comparable to your existing business, I’m thinking that’s more in present margin business side, because if you look at the revenue base obviously that’s a lot lower.

Jerry Fowden

Correct.

Judy Hong – Goldman Sachs

Yes, so in terms of the penny profit that would be a lower than your existing business, I just wanted to first clarify that?

Jerry Fowden

Correct, and on a per case basis, I think we’ve said in the past, good contract manufacturing be anywhere in the $0.50 to $0.90 range versus may $0.70 to $1.20 for some other business, in straightforward, since the case. But in percentage terms it is very much comparable.

Judy Hong – Goldman Sachs

Okay, and then just in terms of phasing of the incremental volume that is coming into your business with the two ends. Can you just give us a little bit of more perspective one is that phased evenly throughout fourth quarter and the first quarter of 2015 and then the increase that you saw in the current quarter as well as there the benefit of also getting that for the rest of this year as well?

Jerry Fowden

Okay. Yes the business in quarter two is all business that is long-term business therefore, we believe that should be part of our business going forward, obviously we’ll get to a point that we start to overlap it a year later, because we also saw strong growth in the first quarter of this year, but first Judy that business is ongoing.

Then of the two new contract signed they are both roughly similar in volume, so of that 13 million to 16 million 8-ounce cases about half of it is one of the contract that we believe would start shipping in quarter four, so you could potentially assume half of quarter four for that and the other contract would start shipping in quarter one, so you could potentially consider half of quarter one for the other one. So actually by the time we get to the end of quarter one next year, both those contracts would be up in running and as we say the 8-ounce equivalent cases its about 13 million to 16 million on a full year 12 month basis.

Judy Hong – Goldman Sachs

Okay and then maybe just broadly speaking, what do you think is driving increased success in winning these businesses. I mean I think in the past you’ve talked about the industry having excess capacity there is more a competition for these contract manufacturing businesses. So, I’m just curious what you think is driving your success there?

Jerry Fowden

Well I think there is a number of elements, historically contract manufacturing has not been by anyway meaningful thought or focus of our North American business and in fact people will recall, but when we announce the change and move of our President of our UK and European operations to the U.S. at the end of quarter one start of quarter two last year, we said part of the reasoning behind that move was his experience of understanding all and ability to look at and drive the winning of some of this contract manufacturing, because it is a different type of business that needs different relationships.

We also said we would add unique dedicated resource in that area to go out and call on those customers. And I think for a company who is low cost high service, winner of major retailer supply chain collaboration award ahead of all 4,000 other suppliers just two or three years ago winner of the UK private label supplier of the year award just recently. When a company with that low cost high service credibility allocates the resources and the knowledge to specifically focus on this business and we have a strong balance sheet, we are well organized I think we offer a pretty attractive solution to these customers plus a broader footprint the many of the other companies they could talk to.

So I think it’s putting all those factors together that’s led to our ability to be successful in this area. And if you recall we said we felt there were 50 million to 80 million 8-ounce cases that we could win over a 3 year period of time, with some 18 million 8-ounces of that being won this year 2014. I think quarter two alone the growth was half of that target, so I’m pretty comfortable we’re on track for our first year of that three year vision based on the new wins we’ve signed up, I’m pretty comfortable with that overall 50 million to 80 million 8-ounce case target over three years.

Judy Hong – Goldman Sachs

Okay that’s helpful. Just if I can just squeeze in on about the UK market and your outlook in the next couple of quarters, you’ve talked about the weather comp being pretty tough in July, the retail environment obviously remains pretty tough there. Do you expect a meaningful slowdown in your business in that market, setting aside the acquisition?

Jerry Fowden

I mean I think quarter three is going to be harder to claim, because I think we had something like 35% volume lift in July last year for our UK European business, because not only it was incredible heat wave, it followed, a pretty sluggish first half of the year. Therefore retail stops that kind of product went high either. But if I was to kind of look at the business on an underlying basis, we got a position where excluding Aimia and excluding Calypso, our underlying business is maybe of 2% in volume. But it’s actually up something like 4ish percent in EBITDA.

Then obviously if you add Calypso on top of that where we’ve said we have like-for-like constant currency growth the board volume, revenue and the EBITDA with the EBITDAR and constant currency being up just shy of 30 odd percent. And obviously Aimia about to come through make a worthwhile contribution. I feel pretty comfortable the base business in the UK is solid and the additions are being, appropriately value created.

Judy Hong – Goldman Sachs

Great, thank you.

Jarrod Langhans

Thanks Judy.

Operator

Ladies and gentlemen due to time constraints our final question will come from the line of Amit Sharma with BMO Capitals. Please proceed with your question.

Amit Sharma – BMO Capitals

Hi good morning everyone.

Jerry Fowden

Good morning Amit.

Amit Sharma – BMO Capitals

Jerry quick clarification on the cold pack did you raise your expectation from 30 million to 50 million cases to 50 million to 80 million recently?

Jay Wells

I think the difference, Jerry used to talk in raw cases, now he is talking in 8-ounce equivalent. So no change in actual taste or change in measurement.

Jerry Fowden

I think the 30 to 50 was the real actual cases Amit and the 50 to 80 is the 8-ounce equivalent.

Amit Sharma – BMO Capitals

Got it, okay that’s good. And then the 20% lift that you talked about with the one week, was it just sequential and there was some timing or seasonality into it, was in the year-over-year comparison right?

Jerry Fowden

No I think it was the difference between $0.84 plays a $1, and $0.84 plays a $1.38.

Amit Sharma – BMO Capitals

Got it. And then from a longer term perspective, the margin, gross margin was stable and flat this quarter, I think that came out ahead of our expectations and it’s pretty encouraging despite, pretty substantial decline in North American CSDs. Can you talk about that what drove that sort of margin stabilization and if you could perhaps talk about it at a segment level as well?

Jerry Fowden

Yes I’ll do my best, but what I’ll do is give this to Jay, because I know it’s an area, he is got some numbers on and he is been looking at. So Jay?

Jay Wells

I mean you look at gross margin and Jerry mentioned and I mentioned as part of my prepared remarks, I mean in with the gross margin we did incur some additional freight associated with the sort of cold pack business. But you look at our volume stabilizing therefore our fixed cost absorption stabling out was a very big benefit to our gross margin in the quarter. We continue to take cost out of our business, but results so – very good benefit in the quarter. And as part of my prepared remarks, we’re also continue to look to get better fixed current cost absorption with more contract manufacturing, we’ve got many cost savings programs and we have talked, as part of our three year start plan it was to take 30 million of cost out of our business over the three year period and we’re moving along with taking those cost out. So I think we have a lot of projects underway, in addition to volume stabilization and really believe over the next two, three years we should start seeing improvements in our margin.

Amit Sharma – BMO Capitals

Just a quick follow-up on that Jay, so even if we continue to see maybe not this level of CSD client maybe a little moderate in decline CSD. We should expect your gross margins to be stable going forward, given that all of these things as you last said are on going?

Jay Wells

Yes, I mean last thing we said on last quarter’s call and still believe to be accurate is that, we still see on a full year basis the ability to hold overall gross margin percentage flat year-over-year. And with the first half year being done a bit we’d hope to see the back-half of the year being up a bit.

Amit Sharma – BMO Capitals

Got it, thank you very much.

Jarrod Langhans

Thanks Amit.

Operator

Mr. Langhans, we have no further questions at this time.

Jarrod Langhans

Thank you very much for joining our call today. This will conclude Cott Corporation’s second quarter 2014 call. Thank you for attending.

Operator

Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for participation and have a wonderful day.

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