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Executives

Steve Himes - Investor Relations

Ed Lonergan - President and CEO

Brian Kocher - Chief Operating Officer

Rick Frier - Chief Financial Officer

Analysts

Omar Mejias - BB&T Capital Markets

Bryan Hunt - Wells Fargo Securities

Carla Casella - JPMorgan Chase & Company

Chiquita Brands International, Inc. (CBQ) Q2 2014 Results Earnings Conference Call August 8, 2014 9:00 AM ET

Operator

Good day everyone. Welcome to the Chiquita Brands Second Quarter 2014 Earnings Call. As a reminder today's call is being recorded. At this time I would like to turn the conference over to Mr. Steve Himes. Please go ahead sir.

Steve Himes

Thank you Alan. Good morning everyone and welcome to our second quarter 2014 earnings call. On the call today are Ed Lonergan, President and Chief Executive Officer; Brian Kocher, Chief Operating Officer; and Rick Frier, Chief Financial Officer.

After today’s prepared remarks we will take questions as time allows. A copy of today’s press release is available on the company’s website www.chiquita.com and you may also contact Chiquita’s Investor Relations department at 9806365637 to receive a copy. Our press release includes reconciliations to U.S. GAAP of any non-GAAP financial measures that we mentioned today.

This call contains forward-looking statements regarding operating performance or industry developments and any such statements are intended to fall within the Safe Harbor provided under the securities laws. Factors that could cause results to differ materially are described in the forward-looking statement section of today’s press and in Chiquita’s SEC filings concluding its annual report on Form 10-K and quarterly reports on Form 10-Q.

And with that I'd like to turn the call over the Ed.

Ed Lonergan

Thanks Steve. Good morning and thank you all for joining us. Today, I will review the company's performance and outlook for the bananas business as well as update status of our merger with Fyffes. Brian will cover the salads and healthy snacks review and Rick will run through our financial performance.

We're pleased to announce second quarter financial results that improved overall versus year ago and placed us back on track to delivering 2014 and our long term goals following the weather related setbacks we experienced in Q1.

As we will discuss, this quarter was not without its challenges, but the simple focus of our return to the core strategy is enabling us to manage through difficulties and to make the progress toward our strategic goals.

For the second quarter we reported adjusted EBITDA of $62 million compared to $58 million in the second quarter of 2013. Looking first at our banana business, we renewed all key existing North American contracts upon our exploration and continue deliver incremental customer wins. These contract wins were driven by our quality initiatives and reflect share improvement with current customers as well as select new customer wins in attracted geographies with attracted conditions.

We grew banana volume in North America almost 6% in quarter two 2014 versus 2013. The renewed contracts had come with modest price increases offset slightly by a lower commodity surcharge. This surcharge which is tied to the [Platts] daily price tracker index and adjust quarterly reflects lower bunker fuel index prices versus the same period last year.

In Europe, we continue to prioritize business building with customers who recognize and value our commitment to superior quality and service. In Q2 average U.S. dollar pricing across our European markets including Med, the Middle East was 8% above year ago. This reflects year-over-year benefit from higher euro exchange rates as well as local currency contract pricing improvements.

Our core European bananas volume was down 200,000 boxes and the [med] was down 600,000 boxes year on year. This reduction was due to short fall in Chiquita supply relative to our demand caused by difficulties procuring and shipping food in the quarter which I'll cover in more detail.

Both top and bottom line banana results have been impacted by adverse growing conditions throughout the first half of the year. Unfortunately, the unique breadth of our sourcing model and own farming has been impacted disproportionally versus the broader industry in 2014.

Our network has experienced adverse conditions in Panama, Costa Rica, Northern Guatemala and [Ecuador] concurrently. While the entire industry has exposed to Costa Rica, Chiquita and its third-party grower represent the majority producers in Panama and Northern Guatemala and Honduras. And while the productivity at our farms remains above historic levels, we are performing below year ago and below our 2014 plan on boxes per stem basis.

As a result, we have paid fixed cost absorption impact on our own farms and have been required each week this year and make the difficult choice of buying volume in the spot market or for growing sales. In either case, the choices we make come with increased costs and inefficiencies in our production, purchasing and shipping operations and reduced realization in the weekly markets.

Concurrently the trading markets in Med and Black Sea were hurt by political instability throughout the year. There are now few ports in which there is demand and safe passage. And consumption and important Chiquita markets like Ukraine has dropped substantially.

Meanwhile, Ecuador is experiencing good growing conditions and volume growth year on year while Russia and China are currently observing volumes, the political situation in the net trading markets set more industry fruit into weekly pricing markets in Europe and North America resulting in lower realization per box on these non-contract sales versus the more balanced 2013 base period.

We will continue to take difficult year-over-year weekly market pricing comparisons into Q3 due to the extraordinary conditions that existed in the early September 2013. Pricing maybe supported short-term by some of the more recent weather events in the traffics including the heavy rains in [Villanueva], Colombia.

That said Ecuador continues to produce ahead of year ago through the most recent measured periods and we do anticipate the market will return to normal seasonal access supply in late Q3 and Q4. In the face of these issues as noted in Q1 we are carefully managing our plans to mitigate risks. This include shifting capital spend toward irrigating Panamanian and Costa Rican farms, carefully considering our purchase commitments, sourcing locations and second half prove dispositions and crafting substantial efficiency and flexibility enhancements to our shipping rotations in the U.S. Gulf and in the Med.

In fact, we have completed infrastructure improvements to our Panamanian and Guatemalan ports and announce the court shift in Orleans to accommodate a more flexible and lower cost container shipping operation to the U.S. Gulf to commencing quarter four. We plan to make further efficiency improvements to our European Southern service commencing Q1 2015.

Of course, we believe the proposed merger with Fyffes will add further flexibility and benefit driven by our highly complementary sourcing and logistics models and further diversification of our sourcing countries. Ultimately these actions are expected to reduce our cost per box. With regard to the Fyffes merger, we continue to see the transaction is transformational for our combined businesses.

As we've disclosed, we expect to secure at least $40 of synergies by combining our complementary operations. The breadth of portfolio and sourcing will mitigate risks and enable the combined company to serve customers and consumers more effectively and efficiently than either company alone to accomplished.

While, we are limited in the details we can divulge our shareholder meetings are set for September 17th and regulatory processes are proceeding as expected. We have established an integration management office and critical work streams have been identified. While today we remain peers competitors, we will be prepared for execution day one with shareholder approval on (inaudible) required regulatory clearances our current expectation remain to close the transaction by the end of the year.

With that I'll turn the call over to Brian to discuss our commercial results and actions from our salads and healthy snacks businesses.

Brian Kocher

Thank you, Ed. We are pleased with the progress that we have made in the salad business in the second quarter after weather related disruptions that we experienced in North America in Q1. While we continue to compete for new contracts our short-term focus is on growing business profitably with our current customers through pricing and efficiency actions, mix enhancements, innovations and continued velocity improvements. We've seen improvements in the mix to more value-added products, which will be further aided with market uptake of our envision effort.

In the second quarter, we realized a 4.2% increase in pricing resulting principally from an improvement in product mix within the Fresh Express brand. Our core innovations continue to perform well and we expect additional pricing and margin enhancement.

As we mentioned in our last call, starting with this current quarter, we have cycled out of our major 2013 solid contract wins and there are a few large new contracts available to win in 2014. We did not add any new customers in the quarter. However, we did see mix related pricing gains in the quarter offset by lower volume across retail food service and healthy snacks versus a year ago. Shelf velocity and promotional volumes came as expected. Overall results were negatively impacted by consolidation of certain retailers, promotional frequency and food service consumption.

Critical to both our short-term and long-term success is the implementation of substantial changes to our value-added salad business announced in May. These changes including announce reduction in certain SKUs and case pricing increases mitigate some of the impact that we have seen from significant input cost increases overtime and enable progress towards our long-term goals.

These initiatives were effective in early July and the positive impacts from these actions will begin to support our results in the third quarter. While our mid-contract change initiative was not received with elation our customers have reactive positively and are working with us to improve our joint returns in this business.

While the preponderance of our second quarter sales effort was dedicated to these pricing initiatives at this expense of some of other volume enhancing activities, our action served the long-term health of the business and no customer relationships were exited in the process. Importantly we have been able to demonstrate to our customers the substantial impact of cost increases on the category. And both our internal organization and our customers understand the cost impact will not lessen going forward.

Within our salads value chain, we continue to see efficiency improvements from our Midwest salad facility. The plant is fully operational and we remain on plan for both Q2 and 2014.

As you know, our plant startup represented an $18 million drag on earnings in 2013 and $7 million of this occurred in the second quarter of 2013. We have not experienced similar cost in 2014.

Salad supply and quality continues to be good in 2014. At this point, we have not experienced significant weather event. We have diversified supply, executed our yield enhancement initiatives and managed the drought impact in California, most particularly impacting the seasonal transition sourcing Heron.

Finally, we also experienced reduced volumes in our food service and processed fruit and banana puree business. Foodservice volumes are down on lower demand although we have seen the overall foodservice business return to the stable levels that we would expect as opposed to the reductions that we experienced in Q1 as a result of the difficult weather patterns that disrupted typical sales.

Our processed fruit plant in Costa Rica has suffered from the same fruit availability shortfall that impacted our core banana business. I will now turn the call over to Rick to run through our financial results.

Rick Frier

Thanks Brian. For the second quarter of 2014, we are reporting GAAP net income of $18 million compared to GAAP net income of $31 million the same period in 2013. For the reported period, any adjustments between our comparable operating income results and GAAP results are reconciled in a table in our press release.

For the quarter, we are also reporting comparable operating income of $46 million versus $42 million last year. Adjusted EBITDA for Q2 was $62 million in 2014 compared to $58 million in 2013 which represents 7% growth year-over-year.

Looking at our segments, we are reporting $537 million of comparable sales in our banana segment compared to $519 million in the second quarter of 2013, an increase of almost 3.5%. The increase is primarily related to higher contract sales of bananas in North America and the positive impact of higher euro exchange rates that resulted in higher U.S. dollar pricing on our European banana sales. These benefits were offset by lower volume available to support weekly pricing markets, most notably in Europe and the Mediterranean.

Comparable operating income of bananas for the second quarter 2014 was $48 million compared to income of $55 million in 2013. The decrease is a result of the higher sourcing and logistics cost Ed described earlier. In the salads business, Q1 sales were $249 million versus $260 million last year, a decrease of approximately 4%. Higher pricing of retail value added salads of 4.2%, primarily due to product mix was more than offset by lower volume of retail value added salads, foodservice products and processed fruit ingredients as well as the exit of certain non-core businesses subsequent to the base comparison period.

Comparable operating income in salads was $9 million in the quarter versus income of $3 million in 2013. The increase resulted principally from the realization of year-over-year benefits from improved performance and non-repeating transition charges at our Midwest salad facility.

SG&A excluding the expenses related to the proposed merger with Fyffes was 11% down compared to 2013 and was approximately 6.7% of sales. Corporate overhead was 4 million less than the second quarter last year on a comparable basis. And as we have said previously, we remain focused on driving further efficiencies as we move forward.

Cash flow from operations was $46 million for the second quarter of 2014 compared to $47 million provided by operations in the same period last year.

At the end of the quarter, cash was $55 million and the company had $92 million of ABL availability net of amount outstanding for the letters of credit. We continue to like our liquidity position at this point of the year.

With that update, I’d like to turn it back over to Ed, to run through certain expectations of 2014 and closing remarks.

Ed Lonergan

Thanks Rick. We made solid progress against key strategic work areas and we continue to realize benefits from our return to the core strategic choices. While we’re behind last year in our year-to-date results due to our Q1 performance, we believe we remain on track to our annual plan and our 36-month EBIT targets.

This reflects our ongoing beliefs that both our broader bananas and salads markets will remain stable as the year progress. As well, we expect a benefit from the Midwest salad plant efficiencies and our salad ounce reduction and pricing initiatives in the balance of the year.

While it’s too early to predict a banana excess fruit season, the Colombia weather impact has tightened the market in a normal excess period, and continued Central American production issues are impacting supply. Finally, we’ll begin to benefit from our new Gulf shipping rotation in quarter four.

Before we go to questions, let me reiterate a couple of key message points. We continue to see incremental volume growth in our North American bananas business as a result of the continued recognition that our quality commitment and brand drives sales velocity for our customers. While adverse growing conditions have reduced banana productivity in key growing areas relative to our sourcing plant, we are taking appropriate steps to mitigate these risks that will ultimately result in lower sourcing and logistics costs.

We launched bold actions in our solid and healthy snacks segment to drive performance and results back to our plan. We have found that customers understand our messages and we are working together to achieve profitability. We are confident the actions we are taking across our core businesses will create profits in the second half of 2014 that carry forward into 2015. And we believe the fundamentals of our ‘return to the core’ strategy remains sound.

The actions we’ve taken year-to-date in 2014 enhance that strategy and we continue on the trajectory to our long term performance targets. Most importantly, the pending merger with Fyffes will create an enterprise combining the best of both to deliver better than build value to our stakeholders.

With that update Alan, let's open the call for questions. Thanks.

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions). Brett Hundley.

Omar Mejias - BB&T Capital Markets

Hey guys, this is Omar filling in for Brett. How are you guys doing today?

Ed Lonergan

Good. How are you?

Omar Mejias - BB&T Capital Markets

Doing well. The first question here is, we are glad to see the improvements in the salad business. But going forward, can we expect further margin expansion or is the increased pricing just simply to cover incremental cost?

Ed Lonergan

Well, I think one of the things Omar that we wanted to do with the pricing actions is we recognized in the first quarter that we need to take some significant changes to the business model or we were not on track to achieve our long-term objective. So, these changes that we’ve put in place with support of the customers and the work that they are helping us do to drive joint margin enhancement will get us back on track to deliver those long-term salad target.

So, I think by definition, these increases were important to recover some cost, but also were important to get us back on track to deliver our long-term objectives in the salad and healthy snack business.

Omar Mejias - BB&T Capital Markets

Got it. I guess against your expectations, what are some of the variables that can throw your current estimates going forward, especially for reaching the salad margin goals by the end of 2015?

Ed Lonergan

I’m sorry, just to repeat, what are some of the variables that may impact us achieving that objective?

Omar Mejias - BB&T Capital Markets

Correct. Some of the variables that can have a negative impact and may not allow you guys to achieve that objective.

Ed Lonergan

I think we have a business plan that’s based upon quality, service and innovation. And so, a part of that is also making sure that we’ve got sound operational activities, so that we can deliver that at the right cost profile. So, what you’ve seen us working on in Streamwood, the Midwest salad facility was a good example of that. You’ve seen us working on trying to sure up our operational activities, to give us the flexibility and the efficiency we need to deliver the products, the innovation and the returns we need in terms of quality, that is an example; another example is that the work that we’ve done on agricultural operations we haven’t had any significant noticeable weather events that have impacted our salads business in -- on the ag side I should say, not on the revenue side but on the ag side. It isn’t that we have an experienced any, it’s that the changes we’ve made in diversification, in yield enhancement, in draught management have helped us overcome those without being noticeable in the business.

So, I think one aspect of those variables is continuing and shaping our manufacturing and value chain network, so that we’re efficient and effective and can offer the quality, service and innovation at the right component. I think another aspect is continuing our innovation plan. We have an innovation strategy that’s yielded more new products in the last 18 months than in the last three years combined.

So, we need to continue innovating and we expect that and our customers expect that and the consumers expect that. And then clearly one of the actions that we took this summer, the pricing actions was to provide some emphasis on the fact that we have -- cost. So we’ll get some enhancement, margin enhancement with our innovation and our mix initiatives but we also have to be able to work with our customers at a price side that’s reasonable to recover the cost and provide the value that we’re providing in the industry. I think those are the big factors that will impact our success. And I would like to think of them as opportunities as opposed to negative factors.

Omar Mejias - BB&T Capital Markets

Okay thanks. That was very helpful. And switching over to the banana pricing, I guess you guys talked a little bit about it. Can you talk about the outlook for pricing in the back half of the year, and can pricing be seasonally stronger than expected this year?

Ed Lonergan

That’s probably the billion dollar question, so the industry… we can control what we can control, so certainly most of the volume in the United States call it 80% plus of our volume is contracted and about 35% of our volume in Europe is contracted. So, we have an impact on the realization in those contracts and they’ve all been renewed at this point. And as we noted we’ve seen modest pricing improvement in those contracts, which is a shift from where the industry has been over the last several years as well in North America we adjusted our surcharge to include both a bunker index as well as a paper index going forward because we see those two large cost pools continuing to expand over time.

And so in those areas we can certainly chart our own destiny. In the weekly pricing markets that’s highly dependent on the amount of fruit available today and what we’ve seen with the reduction in port availability in the Med is more fruit in Europe and in North America for the weekly traders and that has impacted pricing.

The wildcard is excess fruit in the second half, the Columbian weather situation and blowdown certainly reduced cases in the market in July, but Ecuador continues to produce above year ago and as you probably recall in August or so of a year ago they had about a 20% increase year-on-year versus 2012. As long as Ecuador produces aggressively, we don’t see tremendous tightness in the market through the second half of the year.

At the same time, we’re hopeful that there is more balance than there was a year ago and that reflects both the continued difficulties in Central America, we don’t see tremendous improvement in productivity at the moment in any country. And of course the impacts of Columbia but I don’t know if there is any…

Brian Kocher

I think you also remember just the last year particularly July and August was a very good year for pricing. At that point in time we were -- I think there was even some discussions about was there a structural change in the market and at that point in time we said look we don’t see it, I mean it appears balanced now, but gave us some pricing support in 2013. So, I’d say for July and August we also have some tough comps to manage through. Certainly Columbia and the weather events have taken some excess out of the market, but we’d like to remain cautious and just look at how to -- every week make the decisions we can make to optimize our cash flow for that week.

Omar Mejias - BB&T Capital Markets

Got it. Yes, that's very helpful. And just moving on to the merger with Fyffes, what level of concern do you guys have regarding some of the -- I guess there's been some talks in Congress recently about no any potential changes to the (inaudible) law from the U.S. how do you guys look at that and are you guys concerned at all?

Ed Lonergan

Yeah. When we announced our transaction in March of this year we certainly didn't anticipate the firestorm that occurred. Thanks to the number of farmer mergers that have been announced subsequently. I think it's really important to note that tax didn't motivate our transaction and it wasn't a driver of our synergies. We have very public reporting of these synergies that we're accounting upon not a single dollar of those synergies comes from tax. And as you also know, we have substantial net operating losses in both the U.S. and Europe. So, the best thing that we could have happen to this company overtime is that we pay more taxes because it that means we were performing better.

For us, this merger was motivated by compelling business rationale and we were merging two long standing and very proud companies. One based in Ireland with substantial business in Europe, and one based in the U.S. with substantial business across the world. At the end, we're going to have a merger of equals led by an Irish CEO and a Irish CFO who will be based in Dublin.

The shareholding is split almost 50-50 and a majority of our volume and profitability will be in Europe and a majority of our employees will be in the global market, I think out of the 30, 3,000 or 4,000 combined employees, 5,000 here in the U.S. and the balance are not.

Brian Kocher

Right.

Ed Lonergan

So, and our objective is to be a great citizen of the United States and a great citizen of every country where we play, both in our growing markets and in our selling markets. And frankly there is no impact of any of the discussed changes that would make us not want to progress with it. And in fact there is no out for a change in tax treatment in this deal.

Omar Mejias - BB&T Capital Markets

And I guess if the scenario comes around and there's some issue with the merger, do you guys have any backup plan in case it doesn't go through?

Ed Lonergan

Yeah. I mean the backup plan we have is the standalone plan we've been looking at since 2012 and frankly we're quite comfortable in that plan. The reason we chose to progress with the Fyffes mergers, we think that is plan plus. We think that by bringing few companies together if you think about the breadth of portfolio between the two businesses with a substantial position in pineapples, a substantial position in melons, a substantial position in U.S. and European banana and banana like products. And on portfolio that ranges from private label to the best quality branded products that you can find.

There really isn't anything that a customer could ask for in this space that we couldn't deliver as a combined company and I couldn't say that today yet for Chiquita, we're heading in that direction. As we talked in the last calls, we move beyond selling just Chiquita branded bananas and just Fresh Express branded salads to include private label and organics and overtime additional products but this just speeds that process.

Omar Mejias - BB&T Capital Markets

Thanks for taking my question guys.

Ed Lonergan

Sure.

Operator

Next we'll go to Jonathan Feeney.

Unidentified Analyst

Good morning. This is Mark Williams for Jon.

Ed Lonergan

Did you say Mark?

Unidentified Analyst

Hello?

Ed Lonergan

Yes. Did you said Mark?

Unidentified Analyst

Yes. I am sorry. This is Mark Williams on for John.

Ed Lonergan

Yeah. Thanks Mark.

Unidentified Analyst

Are there any other milestones besides the shareholder meetings this year for the deal? And can you just talk about how the regulatory reviews are progressing?

Ed Lonergan

Yeah. Well, obviously there is really two key milestones remaining. One, is the September 17 shareholder votes for Fyffes and Chiquita shareholders; and the second is regulatory approval in Europe. And beyond that we are, we’ve satisfied the hurdles that we needed to satisfy when we announced in March.

We're well in progress with European commission and as we said before, we still feel confident that we'll close by the end of the year.

Unidentified Analyst

Okay. Great. And it’s encouraging to hear that you, that the contracts in the US are being renewed at modestly higher prices. I was wondering if you could also talk about the promotional activity in the U.S.? What you are seeing on that front, some traffic driving prices, but any color would be helpful.

Ed Lonergan

Okay. Normally, we would see more promotional activity in the United States in the second half as fruit becomes more broadly available obviously in the first half, we cannot see much as we are all pretty tight. We have seen some retailer pricing investments and produce overall and in the banana category within produce to drive traffic to stores, in fact with one of our key partners this week talking about that, those represent retailer investments driven by consumer inside day-to-day have it says that drives basket size for them.

At the same time, as we have incremental fruit available in the second half, we also work with our retailer partners to give them some opportunities to sell more bananas. So you generally will see more in the second half at a moment, I would say most of the pricing that’s happening in the U.S. is investor driven, investors retailer driven not supported by manufactures for their own purposes.

Unidentified Analyst

Got it. And the salads business, can you talk about the cost reductions that you are initiating, as of July? If there is a breadth of the reductions you can give and an explanation?

Brian Kocher

Well, just remember the impact that went into July or I would call them more on the pricing side, primarily they were a price increase across all cases and then resizing of certain skews throughout the portfolio. Those went into effect on July 7th, we had broad support from a 100% of our retail customers.

Again I think as we said in our prepared remarks, no-one is happy about receiving a mid-contract discussion on price increases. But our customers understand the cost impact that we have in this business and just to be clear across the Board, costs are already increasing, labors increasing paper, plastics, converging costs, certainly logistics you probably know many of your customers are facing increased costs in trucking and logistic services.

So those are happening and our customers recognize that and if work to help us offset some of those costs and then mutually create some margin expansion opportunities for each other. So I just wanted to clarify that Mark that it was, we are facing cost increases. We expect those cost increases to continue, but this was a big step for us, for our customers for the industry to recognize that we had to deal with those cost increases in a way that could protect some margin.

Ed Lonergan

Let me just a couple of things on the cost containment side.

Brian Kocher

Sure.

Ed Lonergan

Just so that we cover both sides. Obviously the Streamwood plant transition to moving three plants in a warehouse, into a single facility was designed to drive efficiencies for us. And as we've noted, we don't anticipate incurring the $18 million of transition costs that we did last year, again this year we also expect to see some benefits from efficiencies in those facilities.

We're also working on the overall network and all of our plans to become more efficient in those plans. And volume of course is the best single drug to improve a plant’s efficiency, but we're also looking at yields and productivity of lines. I think the other thing that we should note is we're looking at our suppliers across both banana’s and salads and having deep discussions with our suppliers around joint business development, by joint business planning with the idea that we make both our businesses better. And a great example of that; in April of this year, we made a complete transition of supply of both our linerboard, so the cardboard we use to make our banana boxes and all of our Fresh Express box supply in the course of the month.

And now it is about 200 SKUs of sale boxes as well as the full supply of paper. That wasn't necessary to save significantly, but it was a cost mitigation opportunity. And at the same time an opportunity aligned with a supplier that was deeply committed on a multi-functional basis and a top-to-top basis to find ways to make the overall system more efficient.

And so we now have a joint business plan with our suppliers that every six months we sit down top-to-top and review key building blocks to help us both. And that has including shifting the ports in which we shift liner auto from Gulf to the Northeast. So that was good for us in managing plant supply good for our supplier. So those are the types of things that we are working in order to either mitigate or reduce costs in our system in addition to the pricing.

Brian Kocher

There isn’t a day that goes by that we don’t talk about another project to try to mitigate cost increases and offset some of the commodity increases that we see. I think it is important for this industry and it’s important for us and our customer relationships to know that we can’t do that through cost mitigation efforts alone, there has to be some pricing support that helps us reach our returns and help the customer reach their appropriate returns as well.

Unidentified Analyst

Thank you, guys. It certainly seems that complexity and alignment are part of delivering the profitability of the targets on salads. Has there been a shift on the pricing strategy, per se? I mean, is this just an improvement in price realization or has there been a shift in pricing strategy towards more alignment with customers kind of proven cost pricing?

Ed Lonergan

I would say the industry in both bananas and salads overtime had not focused aggressively on pricing and I think what we have done on both sides of the business is be very transparent with our customers about the impacts in our industry. Overall no input costs are going, labor no matter what you look at nothing is going down but the industry overtime had not been able to recover those costs. So we are leading in both bananas and salads to help our customers understand the impacts we face and work with us to improve not only our profitability but theirs as well.

Unidentified Analyst

Right. And keeping on salads, you talked about the value added business and all the innovation going on there. A few quarters ago, it seemed to be more of a focus on low cost and private label. Can you talk about how value-added versus private label has been trending; and whether you are still focused on growing that private label business? I mean what the trend is on the value added business, as well?

Ed Lonergan

Yes I’d just be cautious to kind of read too much into one mover or the other. I think for the last 18 months we have been very consistent in our approach that we want to differentiate our business on quality service and innovation at the right price. So cost optimization have to be a part of that. That includes, aggressively going after private label it includes expanding the brand where appropriate, it includes an aggressive innovation program because we know that’s one way to drive volume and loyalty and in the consumers.

So it includes all of those factors at any one point in time, one of those factors maybe more significant news in a quarter’s results. So last year we won a big flagship private label account that’s performed very well, on the volume side it’s probably exceeded our expectations a little bit. And we have managed to win a couple of other private label smaller in size and scope, but a couple of other private label accounts over the course of the year. It doesn’t mean at all just because we necessarily didn’t highlight that this quarter, it doesn’t mean at all that we aren’t still driving it, aren’t still happy with the performance and won’t still continue to push that. It’s just this quarter we have been focused on the pricing actions. In the salad business it consume most of the sales activity and effort for the quarter. But we are still focused on delivering volume growth and differentiation in the business through quality, service and innovation at the right price.

Rick Frier

I think we also noted in Q1 there really aren’t any substantial private label contracts that are due in 2014, they really all come in ‘15 and ‘16.

Unidentified Analyst

Thank you. That's helpful. Lastly, do you have any visibility on where you might end the year on your salads margin towards your long-term -- towards your ‘15 target I guess, where you might end 2014?

Ed Lonergan

We really have not given that outlook other than to say the steps that we took in the second quarter that are effective in the third quarter, the pricing and the resizing of certain [skews] where necessary to keep us along the path to achieve our 2015 financial targets. And we think the size and significance of those changes will allow us to be along the path to achieve our 2015 targets.

Unidentified Analyst

Got it. Thank you very much guys.

Ed Lonergan

Sure.

Operator

And next we'll go to Bryan Hunt.

Bryan Hunt - Wells Fargo Securities

Thank you. When you look at the lack of productivity and the weather impacts in Central and South America on your banana businesses, is there any way you can quantify the volume impact to your business, where it could have been in Q2 relative to where it fell out due to the lack of fruit?

Ed Lonergan

I think Bryan, it’s hard to say a specific volume number, but we can give you some color on productivity impact. So it’s running above 10% reduction per stem relative to where we anticipated we’d be and where we’ve been before. So, that's two kilos to three kilos, depending upon where you are in Central America. And that’s been pretty consistent through every week of the year.

And having been now in all of divisions this year, its different causes in different parts of Central America. In Panama and Costa Rica, it was drought; and Honduras, Sigatooka, and Guatemala, blow downs in the north.

Every time we think we’re moving beyond this, then there is a few other little things that come along. So, Mexico had a blow down three weeks ago. So, we’re keeping an eye on things. We’re doing the right things from a productivity perspective; we are rejuvenating farms; we're replacing irrigation. We don't think this is a long-term situation. So, I shouldn’t say that. I mean we think that there are weather and pattern changes in Panama and Costa Rica that require differences in how we farm. No question about it. So, we think the balances are short term in nature.

And so normally we would be in the spot market for the first quarter. This year we’re still in the spot market and exiting now. So, that’s a separate for the way Chiquita would manage the business, but it's just what we’ve run into. And that's why we said every week, we make the difficult choice do we buy or not buy? And we look at that against what we're able to sell for. And if we can make a profit at the cost price in the spot market and the selling price in the weekly market, then we buy and if we can't, then we don't.

And so we noted that 200,000 box shortfall in core Europe, 600,000 in Med. Clearly the 600,000 in the Med is all about making the decision every week, whether we want to product there. And in core Europe, it was basically the same discussion.

Bryan Hunt - Wells Fargo Securities

So, when I think about you all being in the spot market, up until here we are, beginning of August versus only being through March, is there any way you can quantify the cost of it on a relative basis, as well?

Brian Kocher

Well, Bryan, let me, we haven’t disclosed that cost impact for the second quarter. But let me remind you of the -- in the first quarter, we did say it was about $9 million of impact, just to kind of gauge that. I think the other thing that's important to remember is we’re constantly managing through a continuum. If you remember last year, we had, I’d say about as much as excess fruit as we planned, but it was significant and we felt a significant financial impact to this year -- last year. This year we intensely went in and decided that we’d have a little less excess fruit. So we contracted for less fruit, which inherently puts us at a little bit more exposure to weather events in the first half of ‘14. And we felt the impact of that.

So, I think we constantly look at this as a continuum. We try not to make big swings. When you make swings in your fruit level and your excess fruit position, we almost always end up in the wrong side of that transaction. But we changed our outlook on committed value by 50,000 boxes a week and you could feel it. I mean over the first half that would have been another 1.5 million boxes or 1.2 million boxes in the portfolio. So, just to kind of give you a flavor of what we're seeing and what we're trying to do and how our design can have impacts on the business. So, I think the important as Ed said, each week we're making a decision on what can drive the most cash for our business. And we're either just selling it or choosing not to buy it. And in either case, it probably is going to add more cost to the system than what we’d planned.

Ed Lonergan

I think the important is as we look to the second half of the year is we anticipate having less excess fruit than we had last year.

Brian Kocher

Yes.

Ed Lonergan

Both from our decisions on contract purchasing and as well on what’s happened over the course of the year.

Bryan Hunt - Wells Fargo Securities

Okay. Two last questions. One, when we look at the drought impact, this time year, it’s our perspective that it has less of an issue because you can source lettuce from pretty much anywhere in the U.S., but it has the potential to pose some risks to your business late in Q3, Q4, or Q1. Can you talk about the risk to the business and the challenges you will face in the bag salad business as lettuce production kind of transfers back to Arizona, Mexico and California from the drought?

Brian Kocher

We spent a lot of time at the end of ‘13 planning for ‘14 trying to make sure we have better diversification of supply, different growing regions, different -- we plan it some excess supply in different geographies to try to add some more diversification. So we’ve tried to do a lot of that. In addition to some of the things that you mentioned about in the summer time, we have even more geographic diversity, we also have irrigation in the lettuce field. So, a lot of so far this year we’ve been able to manage it through diversification, irrigation, yield enhancements and things of that nature.

We have already made plans on the transition from California to Arizona and then back to Arizona to California for the next year, again mostly in terms of what type of excess supply levels would we like to plant, where are we going to plant which is different than what we’ve done in the previous years to minimize the impact, I mean Heron in particularly is really facing some water shortage. So we already have plans in place to work around that a little bit. So it’s something that our ag ops group think about everyday Bryan on our future planning.

And clearly, if we don’t get rain ever again that’s the problem. But we think that at least for the foreseeable future, we put the plans in place to manage through that risk as best we can. There is -- will take some cost pressures for that too, but again, we’ve been very transparent with our customers and they’re helping us work through some of that.

Bryan Hunt - Wells Fargo Securities

Okay. And, Ed, you have talked about the big cost savings initiatives in the business since the day you stepped in the door and there has been some pretty big and lumpy achievements, but I think you had talked about coming into 2014, there is an opportunity around in non-sellables and other corporate overhead reductions. Can you talk about where you are in that strategy or continuum, and whether you see any sizable cost savings opportunities as we transition from ‘14 into ‘15?

Ed Lonergan

Big and lumpy, I like that. Yes, we do have a strategic sourcing team and we have identified a broad group of suppliers that we think are strategic partners to Chiquita. And in fact I spent last week on the road to a number of suppliers of our Fresh Express business talking through opportunities to create efficiencies for both sides. And in some cases, as I said, we’ve talked a bit about our line of board in box situation, substantial spend. That’s a market where we don’t see reductions over time. But we did find a supplier who is willing to collaborate deeply with us in a way that hasn’t happened probably in that industry. And so, we’ve built into our plans with that supply efficiency improvements on both sides. And so that feels good to us. On the logistic side we’re working the same thing. On inland freight partnerships with suppliers to mitigate cost, you know that there are substantial increases, particularly in North America over the coming years. And so that’s been important to us. And then, we mentioned briefly in the commentary that we’ve made a substantial change in our Gulf shipping rotation. That required us to invest pretty significantly in our Guatemalan port to place short cranes in that port. And we will be shifting quarter four to much larger vessels that are shared with a partner and that allow us significant flexibility on moving product both North and South via containers. We haven't run the rotation once yet, so we haven't put a number on the table yet. By the next earnings call we'll give you the number. We wouldn't be making those substantial investments in Guatemala or the substantial changes in our network that we didn’t think the savings were significant.

At the same time, we see tremendous opportunity in our Southern service to Europe. Obviously all independent on whatever we do with Fyffes the primary overlap there is on North Europe service. And so, we'll also talk a little bit more when we get together next time on the changes there, combined those are substantial.

With that said, we also as Brian said, see cost increases everywhere. And certainly in labor and the traffics, labor in our U.S. plans and so we're looking at ways to be more efficient in all that we do. So, continued focus on rejuvenating farms, getting more output from the hectors that with operate critically important.

So, those are some of the big ones. Most of the others are a bit here and a bit there that add up to some benefits overtime. Brian, if don’t know if there is anything?

Brian Kocher

I think it's also have been fair to say that we’ve made -- the progress that we’ve made in substantial savings has -- to a certain extent being used to really offset increases.

Ed Lonergan

Yes.

Brian Kocher

As opposed to deliver bottomline results. I mean take the trucking and logistics example Brian, I mean if you look at the liner, the liner metrics for the last six months line haul cost have increased 18%, so even the work that we do is really helping offset or mitigate some of that increase as opposed to delivering that net savings and not probably a little -- a little different than maybe what we were anticipating a year ago, let’s say or 15 months ago.

Bryan Hunt - Wells Fargo Securities

Okay.

Ed Lonergan

I would add also on the SG&A side where we can control cost we are very aggressive on that so we focused on the headcount, compensation areas, you name it, where its variable we're heavy on that as far as the focus goes and we dropped our percentage. I mentioned earlier revenues, SG&A revenues to 6.7% against 7.7% last year so good progress there and as I said, chipping away, we continue to chip away at that.

Bryan Hunt - Wells Fargo Securities

Okay. If you, as based on all the work you have done in bananas and salads, and the cost reduction efforts, as well as on the overhead level? Do you believe you all are cost leader when you benchmark against your key competitors and if not, how close are you?

Ed Lonergan

No. We're not the cost leader. That's clear, but our strategic direction is not to be. I mean at the end of the day Brian said it well. We believe winning with the brands that we have is built around quality and food safety, brand innovation and differentiated service at the right cost.

So, I heard from our customers when I first came to this business is, your brands worth something. They drive more traffic to my stores so I value those brands. I am just not willing to pay the tax that you're charging me based on your bloated overheads and so on. I think we’ve made good progress. At one point our SG&A was 11% of sales, so 6.7 is a major change and we have taken cost out of our supply chain. Now, life would be much easier for managing consumer products business where we're just buying stuff converting it and selling it. We're managing business that is dependent upon whatever view that you want to think about there to determine whether we get water or whether we have event that impact our business and it's been substantial over the last two years.

So, I think Rick said it well, when you can't control all the elements of your value chain, you darn well better control the ones that are in your circle of influence and that's what we're trying to do.

I think at the end, being very efficient in our plans, being very efficient in our shipping, we think our shipping is probably best in class. But we are taking on some cost. For example, we have a different spec for our bananas in the industry at large, and that spec costs us more money, more fruit behind at the farm that's a choice we make, we could follow the industry and we could pack more fruit from a farm into the box, but then how do we justify the pricing differential that we get, we can’t. So I do think, I'm a firm believer, you either the lowest cost guy or you have differentiation you can defend and what we're trying to do is get the right costs, so the differentiation we have is worth money to our customers.

Bryan Hunt - Wells Fargo Securities

All right. I won't take any more of your time. I appreciate your answers. Thank you.

Ed Lonergan

Thanks Bryan.

Operator

Now second question from Carla Casella.

Carla Casella - JPMorgan Chase & Company

Hi, I had to jump on a little bit late, and so I may have missed this, and I apologize. On cost cutting you made, you mentioned you largely implemented it in July, did you give the cadence of when we would see the savings, or any magnitude of the savings, for the back half of this year or for next year?

Brian Kocher

Yes, Carla just to make sure we clarify. What we talked about being implemented in July was the initiative we spent in the second quarter in our salads business which was associated with; one, a price increase across all cases and two, a resizing of certain skews that would help change the profit profile on those products.

So both of those were effective that the beginning of July and both we said would help support our results in the third quarter in the second half. So that we were on a trajectory that would allow us to meet our stated goal for 2016 our stated margin target.

Carla Casella - JPMorgan Chase & Company

Okay. And you've not seen any pressure on volumes, as a result?

Brian Kocher

Well, it's again when on July 7th, it's early still, but we try to do it in a smart way. I mean I think if we would have hit all price or all sizing, we would have destroyed a consumer value proposition and we didn’t want to do that so we focused on a combination of both and that was by design. So it’s still early, I would not say we’ve seen any identifiable impact in volumes.

Ed Lonergan

I think what Brian did note is our sales organization definitely spent 98% of their time during quarter two selling this into our customers. So clearly we took our eye off of some of the opportunistic promotional activities they would normally be spending their time on and also took their eye off selling in some of the innovations which we're now jumping into.

Carla Casella - JPMorgan Chase & Company

Okay. Great. That's helpful. The rest of my questions have been answered. So thanks.

Brian Kocher

Good to have you back.

Ed Lonergan

Okay, Carla. Thanks.

Operator

And we will take our final question from Hale Holden.

Unidentified Analyst

Thanks for taking the call. I have two just very quick ones. On the potential to irrigate the Latin American farms, can you give us a sense of how much that costs, or if you extended that further, would that be a change in the CapEx thoughts?

Ed Lonergan

Yes. So what we said I think in quarter one is that, we don't anticipate changing our CapEx spend going forward. But what we can choose where to spend that CapEx. And this year's CapEx on the banana side of the business primarily was invested in ports in both Panama and Guatemala to ready us for our new rotations.

We did some rejuvenation of farms, some irrigation of farms. And we do have farms irrigated in Costa Rica and Panama that we can then benchmark against farms that aren't. So that we do know there is a productivity difference this year between those farms and then we can determine the pattern.

Next year, a substantial portion of our bananas CapEx will go to irrigating those two countries, it's going to take us I think we said in first quarter several years to irrigate all the farms. You were probably talking three to four years to get everything in, but you shouldn't anticipate us spending more to get there.

Unidentified Analyst

Okay. Great. And then the second question is, I assume there's no impact from potential Russian sanctions on foods to you guys?

Ed Lonergan

Well, obviously bananas are important to Russia and bananas are sourced mostly through traders from primarily Ecuador. And so Ecuador is not in the list of sanction countries and the business that we do as through local players. So we don't anticipate change there either. At the end, we do anticipate, Russia will consume more bananas over the next month if the sanctions go to play, because it replaces many fruits that are going to become scarce in the country. That said all the fruits that were headed to Russia from Europe are going to end up in Europe. And so I wouldn’t anticipate for the banana industry there is any help or hurt from these substantial changes, assuming they go into play and we’ll just have to see how it comes together in the quarter.

Unidentified Analyst

Great, thank you very much.

Ed Lonergan

Sure.

Operator

And there are no further questions at this time. So I would like to turn it back over to our speakers for any additional remarks.

Ed Lonergan

Okay, thanks John. Thank you very much for your questions and for joining us today. We look forward to updating you on Chiquita’s continued progress as we move through the year. Have a great day.

Operator

And this does conclude today's call. We thank you everyone again, for their participation.

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Source: Chiquita Brands International's (CQB) CEO Ed Lonergan on Q2 2014 Results - Earnings Call Transcript

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