Pinnacle Foods' (PF) CEO Bob Gamgort on Q2 2014 Results - Earnings Call Transcript

Aug.13.14 | About: Pinnacle Foods (PF)

Pinnacle Foods (NYSE:PF)

Q2 2014 Results Earnings Conference Call

August 13, 2014, 09:30 AM ET

Executives

Maria Sceppaguercio - SVP, IR and Communications

Bob Gamgort - CEO

Craig Steeneck - CFO

Analysts

Bryan Spillane - Bank of America

David Palmer - RBC Capital Markets

Eric Katzman - Deutsche Bank

Ken Zaslow - Bank of Montreal

Robert Moskow - Credit Suisse

Farah Aslam - Stephens, Inc.

Matthew Grainger - Morgan Stanley

Karru Martinson - Deutsche Bank

Chris Growe - Stifel Nicolaus Weisel

Michael Gallo - CLK

Operator

Good morning, ladies and gentlemen and thank you for standing by. Welcome to the Pinnacle Foods Inc. Earnings Call for the Second Quarter ended June 29, 2014. This conference is being recorded and there will be a question-and-answer session at the end of the call.

I would now like to introduce your host for today’s conference, Pinnacle’s Senior Vice President of Investor Relations and Communications, Ms. Maria Sceppaguercio. Ms. Sceppaguercio, please go ahead.

Maria Sceppaguercio

Thank you, Danielle. Good morning, everyone and thanks for joining us today. Here with me to discuss our results for the quarter are Pinnacle’s CEO, Bob Gamgort; and our CFO, Craig Steeneck. Earlier this morning, we issued our press release for the second quarter of 2014. If you haven’t received a copy, you can get one on our website at www.pinnaclefoods.com.

As you know, a lot has transpired since our call last quarter. At that time, we had just announced signing of a definitive merger agreement with Hillshire Brands. However, six weeks later on June 30, we announced that we exercised our right to terminate the agreement. As a result, Pinnacle received a termination fee of $163 million from Tyson Foods on behalf of Hillshire that we used along with cash on hand to reduce debt by $200 million in early Q3. Craig will take you through the details of this and how it benefits our financials a little later.

In addition, last week we announced that our Board authorized a 12% increase in our quarterly dividend to $0.235 per share, effective with our upcoming third quarter dividend payable in October. This increase brings our annualized dividend to $0.94 per share and our payout ratio to approximately 50% of net earnings, an objective we maintained since our IPO.

Turning to the quarter, consistent with our reporting in previous quarters, we have provided in our press release and will discuss here this morning, our results on an adjusted pro forma basis. This assumes that our 2013 IPO and subsequent refinancing occurred on the first day of fiscal 2012, I am sorry, 2013, and excludes IPO and refinancing expenses and restructuring related and other items, which we collectively refer to as items affecting comparability.

Stock-based compensation expense as discussed previously is now included in our results. The company believes that the adjusted pro forma basis provides investors of additional insight into our business and operating performance trend. While the exclusion of these items is not in accordance with GAAP, we believe it is the most meaningful comparison and the most appropriate basis for discussion of our performance.

Details of the excluded items are included in the reconciliation tables included in our press release and are discussed in detail in our 10-Q, which will be filed later today.

Also reconciled in our release and 10-Q is adjusted EBITDA which is a non-GAAP measure. We define adjusted EBITDA as GAAP net earnings before interest, income taxes and depreciation and amortization adjusted to exclude items affecting comparability. Other adjusted metrics discussed on the call are calculated using this methodology unless otherwise indicated.

Finally, I would like to remind you that our discussion this morning may include forward-looking statements, which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially and the company undertakes no obligation to update these statements based upon subsequent events. A detailed discussion of these risks and uncertainties is contained in the company’s filings with the SEC.

With that, I will hand it over to Bob.

Bob Gamgort

Thanks Maria and thanks to everyone for joining us today. After the interesting event of the past quarter that Maria just referenced, it's a pleasure to be fully focused on realizing the opportunities we have in front of us Pinnacle.

Our business model has proven to be quite resilient in the face of increasingly difficult industry dynamic. While we are not immune to the challenges, we continue to execute well, driving volume and market share growth as well as improved product mix and strong productivity.

I believe we are striking the right balance between investing in our brands, remaining price competitive at retail and delivering strong earnings growth, using all the levers available to us to do so. As you know, the benefits of strategic accretive acquisitions is clearly evident in this environment and the addition of Wish-Bone continues to be an important contributor to our performance.

We are also continuing to focus on cash flow and capital allocation to maximize shareholder returns in a low growth environment. In the latest period, we had accelerated debt reduction, which enables us to achieve a step down in interest rate; more on that from Craig shortly.

Finally given our results through the first half and our outlook for the balance of the year, we remain on track to achieve EPS growth of 12% to 15% for the year, translating into a range of $1.70 to $1.75, consistent with our guidance back in early March.

Now turning to the second quarter, starting with the topline, we grew consolidated net sales by approximately 9% due to the benefit of Wish-Bone and higher volume mix on the business, which included the benefit of Easter, partially offset by lower net pricing.

We again grew our composite market share with consumption up in excess of 2% in categories that declined. We held or grew share in eight of 13 categories with gross focus in many of our largest businesses namely, Birds Eye and Birds Eye Voila! Mrs. Paul's, Van de Kamp's, Hungry-Man, Duncan Hines and Armour.

Wish-Bone's share was down for the quarter as expected as the business continued to stifle a heavy year-ago promotional activity prior to our acquisition of the business. We indicated previously that we expect the performance to begin to improve in the second half of this year and early results from July bear this out.

Turning to margin, we expanded our adjusted gross margin by 70 basis points, driven primarily by the addition of Wish-Bone, improved product mix and productivity, partially offset by inflation and lower net pricing.

Our operating expenses in the quarter increased less than 3%, despite a double-digit increase in consumer marketing investment as we continue to aggressively control our SG&A overhead and other expenses. As a result, EBIT advanced 21% in the quarter.

Interest expense of 24.5% was in line with our expectation and reflected the impact of the debt we assumed with the Wish-Bone acquisition. Our tax rate of 38.1% was favorable versus year ago. The combination of all of these factors enabled us to deliver adjusted diluted EPS of $0.33 compared to $0.27 in the year ago period.

Before turning to a discussion of our segments, I want to spend a moment on cash flow. As you know, industry leading cash flow generation is hallmark of Pinnacle and we delivered very strong results in this area during the quarter. Craig will take you through all of the details, but it's important to note that this level of cash flow provides us with significant optionality drive shareholder value.

As we previously discussed with you, our 2014 priorities for cash flow are first debt reduction, which we recently did in early Q3. This enables a reduction in interest payment and increases our capacity for accretive M&A. reinvesting in the business to drive margin expansion such as taking Wish-Bone and Duncan Hines manufacturing in-house and increasing our quarterly dividend to achieve our targeted payout ratio of 50% of net earnings, which we just announced last week.

Let me turn to our divisions, Birds Eye frozen division revenue was up approximately 1% with strong volume mix performance largely offset by lower net pricing. Both the volume and pricing performance reflected in part the impact of Easter and the planned trade investments made during the quarter.

Importantly Birds Eye vegetables and Birds Eye Voila! both registered net sales and market share growth in the quarter as well as improved distribution. Our foundation brand portfolio was down for the quarter due to softness of frozen pizza and frozen breakfast, while Hungry-Man was even with year ago.

Our Frozen portfolio significantly outpaced the performance of our categories and grew composite market share by 60 basis points due to our 3% increase in consumption in the quarter, compared to composite categories that declined. All of our frozen Leadership Brands registered share growth in the quarter.

EBIT for the division declined 5% as the pacing of productivity in the quarter was more than offset by inflation and promotion investment. EBIT performance is expected to improve in the second half as the relationship between productivity and input cost improves.

From an innovation perspective, we introduced kale variety to our Birds Eye Steamfresh line and three new varieties to Birds Eye Steamfresh Chef's Favorites. We also continued the expansion of our Birds Eye Voila! Family Size line. Birds Eye Voila! currently has a market share of 31.6%, which is double the shared it had when we acquired the business in 2009.

Our Duncan Hines Grocery division posted another quarter of strong topline growth, largely driven by the benefit of Wish-Bone as well as the strength of Duncan Hines and Vlasic due, in part to Easter timing.

On the other hand, sales for our Canadian business and our foundation brand portfolio declined. In terms of the market share, our grocery division also outpaced the performance of our categories. Composite market share grew 20 basis points due to a 1% increase in consumption in the quarter.

Shares advanced for Duncan Hines and Armor brands, while syrup held. EBIT for the division was up 43%, largely reflecting the benefit of Wish-Bone while favorable pacing of productivity savings versus inflation was partially offset by increased consumer marketing for the Leadership Brands.

During the quarter, we continue to expand our Duncan Hines Decadent line with the introductions of Decadent Black & White Cupcake and Duncan Hines Limited Edition Summer Velvets. Decadent continues to expand household penetration and buying rate among consumers and its market share of the baking mix category has grown to almost 5%.

For Vlasic, sales were up in the quarter and we had good consumption around the Easter holiday, although share for Q2 was down slightly. We just launched a new line of Vlasic bold and spicy pickles and will have more detail on this on our Q3 call.

Turning to Wish-Bone, the business continues to track with our expectations including our planned timing for the start-up of internal manufacturing at the end of the first quarter of 2015. Our new integrated print sharper marketing and social media campaign launched late last quarter, leverages Wish-Bone's heritage and leading share position in a tiny dressing.

Our specialty foods division which includes our private label food service and snack businesses posted a 5% decline in sales for the quarter as growth from our snacks business and the benefit of Wish-Bone Food Service was offset by lower sales of private label candy. Despite the sales decline, specialty EBIT advanced 25% in the quarter.

And with that, I will hand it over to Craig to take you through the financial details of the quarter.

Craig Steeneck

Thanks Bob and good morning, everyone. Starting with sales, our consolidated net sales increased 8.6% in the second quarter to $617.8 million, largely driven by the benefit of Wish-Bone and higher sales of our Leadership Brands, partially offset by lower sales of our foundation brands.

The later Easter holiday benefitted the net sales comparison by approximately 1.5 growth points, reflecting a heavier promotion environment in Q2. North American retail sales advanced 11%, reflecting an 11.2% benefit from Wish-Bone and higher volume mix of 3.2% on the base business.

Partially offsetting this growth were lower net pricing of 3.2%, driven by Easter related promotional activity and trade investments as well as unfavorable foreign currency translation of 0.2%.

For our Frozen division, net sales increased 0.9% driven by a 5% increase from volume mix, partially offset by lower net pricing of 4.1%. As Bob mentioned earlier we made a number of planned trade investments during the quarter behind Birds Eye and Birds Eye Voila! which strengthened our presence at retail and these investments helped to drive growth in that sales for both of these Leadership Brands.

During the quarter, given the run-up in protein costs we took price on three Birds Eye Voila! items containing shrimp and a Hungry-Man turkey item to bring it to parity with our new select pricing tier.

For our Duncan Hines division, net sales advanced 21.4% due to a 22.6% benefit from Wish-Bone and higher volume mix of 1.3% on the base business. Partially offsetting these drivers were lower net pricing of 2% and unfavorable foreign currency translation of 0.5%.

Growth in our Leadership Brand portfolio in particular Wish-Bone, Duncan Hines and Vlasic was partially offset by declines in our foundation brands and Canadian business.

Finally for our Specialty food segment, net sales were down approximately 5% in the quarter driven by lower volume mix of 4.6% and lower net pricing of 1.7% partially offset by a 1% benefit from the Wish-Bone foodservice business.

For the base business, growth and snack was more than offset by lower sales of private label canned meat. Despite the decline in sales specialty EBIT increased an impressive 25% in the quarter due to productivity, lower commodity prices and favorable mix. For the second half of this year we are continuing to expect strong profit performance.

Turning to gross profit, we expanded our adjusted gross margin by 70 bases points to 26.6% driven by productivity saving and favorable mix, partially offset by lower net pricing and inflation.

Inflation in the quarter totaled approximately 1% while productivity totaled about 3%. For the full year, we continue to expect inflation of approximately 2%. Our productivity outlook remains at 3% to 4% of comps with a good planning assumption for the year at the 3.5% midpoint as previously discussed.

Adjusted EBITDA advanced 17.5% to $105.9 million in the quarter reflecting the growth in net sales, gross margin expansion of 70 bases points and lower administrative expenses, partially offset by a higher consumer marketing investments.

Interest expense for the quarter on an adjusted pro forma basis increased 24% to $24.5 million driven by the debt we incurred from the Wish-Bone acquisition. The effective tax rate for the quarter was 38.1% compared to 39.5% in the prior year driven by a benefit in the current quarter from a change in state tax legislation.

Given this benefit as well as the benefit we recorded in Q1 we now expect our full year effective tax rate to come in slightly below our original expectation of 38.9%. For the second half our effective tax rate outlook remains at approximately 39%.

Adjusted pro forma net earnings advanced by 23% to $38.3 million or $0.33 per diluted share in the quarter, compared to $31.2 million or $0.27 per diluted share in 2013. In terms of our outlook for the year we continue to expect adjusted diluted EPS in the range of $1.70 to a $1.75 or growth of 12% to 15% versus a year ago.

Now turning to cash flow. Cash flow from operations advanced significantly in the second quarter to $93 million compared to $44 million in the year ago period. This strong performance was driven by growth in pretax earnings and improvement in working capital.

Capital expenditures in the quarter totaled $33.8 million compared to $25.6 million in the second quarter of 2013. For the year, we continue to expect CapEx in the range of $120 million to $130 million including approximately $50 million for Wish-Bone and $5 million of Cap Ex associated with the Duncan Hines manufacturing facility in Centralia Illinois that we purchased in early Q2.

Turning to liquidity. At quarter end total debt was $2.5 billion including $2.1 billion in term loans and $350 million in foreign senior notes. We had no outstanding revolver borrowings during the quarter.

Cash at the end of the quarter totaled $171 million bringing our net debt to $2.3 billion. Pro forma for the Wish-Bone acquisition our net leverage at the end of quarter was 4.6 times.

At this point, before turning the call back to Bob I want to discuss the $163 million termination fee, how we used it and how the related impacts on our financial results this year and next.

At the beginning of the third quarter, we received a $163 million merge determination fee. One-time fees and expenses associated with the merger are now expected to total approximately $20 million versus our original expectation of $25 million.

About $14 million of the fees are expected to be cash with the balance in non-cash. The vast majority of the termination fee translates into after tax benefit as we expect to pay minimal cash taxes on it due to utilizing a portion of our sizable NOL balance. Importantly, we expect to pay only modest cash taxes in 2015, but continue to expect to become a full cash tax payer in 2016.

At that point in time we expect our 2016 effective tax rate to decline by about two percentage points due to qualifying for the domestic manufacturing deduction, which was not available to us when we were fully shielding our federal taxable income with NOLs.

In addition we used a fee in concert with cash on hand to reduce debt by $200 million in early Q3. The annualized interest savings associated with this debt pay down approximates $6 million and the benefit in 2014, will total about $3 million, which we plan to reinvest back into the business. In terms of the quarterly impact we expect interest expense in Q3 to approximate $25 million falling to $22 million to $23 million in Q4.

Finally due to the debt pay down and our anticipated ongoing strong cash flow we now expect our net leverage ratio at the end of the third quarter to fall below the four and a quarter times threshold that will trigger a 25 basis point reduction in the interest rate on our term loans. However, the leverage tax is based on file financials, which for us will be mid November.

And therefore interest savings associated with this anticipated step down will be minimal in 2014, giving us only a benefit for six weeks. However, the annual interest benefit in 2015 associated with the step down will be approximately $5 million combined with the benefit of the $200 million debt pay down in early Q3, interest expense in 2015 will decline in excess of $10 million from the current run rate.

With that I’ll turn the call back to Bob before taking questions.

Bob Gamgort

This morning we covered a lot of information beyond the usual quarterly reports. I thought it might be helpful for me to provide a quick summary before opening it up to your questions.

The business model has proven to be resilient and will continue to be a challenging industry environment. We are pleased that we have been able to gain market share, expand gross margin and drive double-digit EPS growth. We believe we are striking the right balance between investing in our brands, remaining price competitive and delivering strong earnings growth.

We are also continuing to convert earnings into cash flow at industry leading level and we are using all available levers to drive value for our shareholders. As a result we are holding our guidance for the year.

We recognize the value of accretive M&A, particularly in this environment and we view strategic acquisitions as a catalyst to accelerate our growth. Reducing debt as we've just done provides us with interest savings and keeps our powder dry in what remains an attractive interest rate environment should the right deal materialize.

And with that, let's open it up to your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And our first question comes from the Bryan Spillane from Bank of America. Your line is now open. Please go ahead.

Bryan Spillane - Bank of America

Hi. Good morning.

Bob Gamgort

Good morning, Bryan.

Bryan Spillane - Bank of America Merrill

Just two questions related to the promotional environment or just promotion activity in the second quarter and I guess maybe looking forward; one -- and I think you were alluded to this in the press release. If you could just try to quantify or give us some concept of just how much of the promotion in the quarter was really holiday related and how much might have been outside the holiday and then second question related is just -- as we look forward to other holiday periods, is what happened at Easter a sign that maybe retailers at least right now in the near-term are looking to be more promotional around holiday periods, maybe to attract traffic or gain market share.

Bob Gamgort

Sure. From an Easter standpoint we talked about what we thought the impact of Easter was on Q1 given its timing into Q2 on our last call. I think we found this from a volume standpoint, Easter came at around what we expected it to be, but pricing was certainly more aggressive than we had forecasted which is really the evidence of the promotional intensity that you’re referencing.

I think that has actually continued beyond Easter, although it was more intense than Easter, we’re seeing more price competition than before and I believe that’s really expected because as we’ve seen in some previous years, when there’s a weak first quarter and think about how weak the first quarter was not just for the food industry, but for the economy in total, it puts a lot of pressure on manufacturers and retailers trying to try to recapture that in the balance the following quarters and the fastest tool to use is promotion.

That’s how we’re seeing both manufacturers and retailers move to that tool very, very rapidly. So I think I would -- our expectations, our planning assumption is that we’re going to continue to see more of the same going forward both an everyday basis as well as at holidays and that’s what’s built into our assumptions as we look forward to second half.

Bryan Spillane - Bank of America Merrill

Okay. Thank you.

Bob Gamgort

Sure.

Operator

Thank you and our next question comes from David Palmer, RBC Capital Markets. Your line is now open. Please go ahead.

David Palmer - RBC Capital Markets

Hi, good morning and just a follow-up to Bryan’s question there, it was a particularly dramatic swing there and not just in Birds Eye, but across the business for volume versus price in -- would it be similar to what we’re seeing in Nielsen where your reported results for the second half in terms of a more muted pricing and volume in terms of complexion of your topline. You’re saying that there is going to be a weighing on price, but I am just trying to get a sense of the magnitude versus what we saw in the second quarter.

Bob Gamgort

Yeah. Dave, it’s a good question. I think the second quarter is probably more significant because of the Easter effect and the fact that we shipped some of that volume in, a little bit of in, in the first quarter and then all the promotion gets charged to the sales in the second quarter, so it has a bit of disproportionate effect.

But I think it’s -- again it’s safe to say, you guys are looking at the same numbers that we are, an IRI and Nielsen that you’re seeing a bit more promotional intensity. So even if we put that back out what I think was more severe around Easter, you’re seeing just a general level of pricing get dialed up and again it is a reaction to just overall weak growth across the economy and across the industry.

David Palmer - RBC Capital Markets

And just looking back on that Hillshire saga, what you learned from that? As a company, you had a mere miss, no doubt looked harder at your own business. Perhaps you also had some distraction but what did you sort of take from that as you look back both positives and potential negatives?

Bob Gamgort

Yeah, I think – let me just go back and talk a little bit about the impact on our business and as you refer to the impact of distraction and I’ll talk about what the lessons learned are. Just to reiterate, we talked about it before. This was a completely unsolicited and unexpected offer, so it caught all of us by surprise and of course, it was a distraction.

I think some of the good news in that is that it began as it and it ended within six weeks and we hadn’t lost any key executives as a result of that. So while it’s great that it only lasted six weeks in this environment, I don’t want six hours of distraction, let alone six weeks of distraction. But I think it’s a really good indication of how solid our team is, that we’ve been able to rally and deliver strong performance.

If we lost any momentum, it was really where we interfaced with the outside world, so that would be in customer planning because customers weren’t sure for that period of time exactly who they were going to be dealing with in the back half of the year. A little bit in the world of productivity where we work with some external partners on that for the same reason and then also in M&A where we lost some weeks of some momentum that we had there.

But look I think the good news is we’re fighting really hard to regain any lost ground and the fact that we we're able to weather this storm in the second quarter, which has been really tough and be able to deliver the results that we did I think is a good sign as well as the fact that we’re holding on to our guidance for the year.

The positive thing is we’ve taken that $163 million and we put it to really good use and we talked about the debt reduction and the impact on accelerating our interest rates step down and we also used part of it as a retention incentive and performance incentive for all of our employees, not just our top executives. So I think that’s fusion opt on where we are.

The lessons learned on this, it goes right back to the conversation that we had, I believe it was at the CAGNY lunch and I know you were there. We talked about the environment is right for consolidation in the food industry, a combination of lack of growth relatively low cost financing, no easy answer into where you go next, emerging markets aren’t delivering the performance they once did. Even some of the specialty retailers are soft on their performance, so it’s not such an easy answer.

But when you get right down to it, and you see pressure from activity from some other companies, consolidation makes a ton of sense. I think what surprised us is that we felt we were going to be the consolidators and that’s why it was unexpected. We will go back on that front and continue to be consolidators and I think the lesson learned internally, we had a lot of discussions here.

We like the business model that we’ve created. We like the culture and the environment of this company. We just got to have keep dialing up the speed and continue the aggressive posture that we take on costs, on innovation as well as M&A and I think that was the takeaway from all of us.

David Palmer - RBC Capital Markets

Thank you.

Bob Gamgort

Sure.

Operator

Thank you. And our next question comes from Eric Katzman from Deutsche Bank. Your line is now open. Please go ahead.

Eric Katzman - Deutsche Bank

Hi, good morning.

Bob Gamgort

Good morning, Eric. Welcome back.

Eric Katzman - Deutsche Bank

Thank you. I guess just so maybe a couple of questions for Craig. First, you mentioned so you’re now anticipating in 2016 that the tax rate is going to drop by two points?

Craig Steeneck

That’s correct.

Eric Katzman - Deutsche Bank

Okay. Second, Craig, maybe you can just talk about -- I realize the inflation is pretty benign and you have a pretty diversified mix of inputs, can you go in a little more detail as to what you’re seeing out there, whether it’s raw materials versus energy versus packaging and how those roll – pull a lesson around 1% to 2%?

Craig Steeneck

Sure. So first of all Eric, in our previous guidance, we said that productivity would be less than the first half, more in the second half. We continue to see that being the case. We have about 3% productivity for six months and expect 4% in the back half. That’s just kind of the timing of the flow through P&L. We also said that inflation would be heavier in the first half than the second half and that it would be average the 2% that we’ve given in guidance. And again we still feel that to be the case.

When you decompose our market basket, places that we’re seeing deflation, which is similar to what everyone’s seeing when you look at all the USDA reports -- grains particularly wheat and corn and soya oil are clearly deflationary for us as are sugar and cocoa which is a benefit to the Duncan Hines brand. Our all in vegetable portfolio that’s vastly cauliflower plus everything that we make internally, that’s round about even very kind of low deflation.

Where we’re seeing inflation is more on the packaging side linked energy as you talked about. Warehouse and transportation of our capacity in the trucking industry is constrained and fuel prices are driving up some inflation, and a little bit in wages and benefits relative for manufacturing sides, but all of that basket is very low single digit inflation.

The area in our portfolio which fortunately for us is a very small component is proteins and protein costs are certainly the highest inflation that we have in our portfolio.

The inflation is concentrated in beef, a little bit less so in chicken and pork and that we’re keeping a very close eye on and clearly it has been higher in Q2 and will migrate into Q3 and as a result of that, as we talked about -- we've taken some pricing actions to be able to offset on shrimp and on Turkey and we have announced price increases in our third quarter in our Canadian business and our Armor canned meat business to able to offset some of that high protein inflation.

Eric Katzman - Deutsche Bank

Thanks for that. And then Bob, if I can just -- not so much about M&A because obviously that’s kind of more discrete but just in terms of the industry, what kind of gets the industry out of this real kind of difficulty of disappointing volume and more promotion and it seems like the bigger players are just struggling to come up with good products that are appealing and when those fail they go back to the easy method of just promoting more. So what do you see having being around the industry for a while? What do you see is kind of an answer to such a tough situation?

Bob Gamgort

Sure. Let me give it to you in sort of multiple time frames because I think there’s a variety of answers depending on the timeframe you’re looking at.

I think longer term and it’s hard to find out what that is, we need to see improvement in the economy and the way I define improvement in the economy is that the average American period is earning more money in real dollars and we take a look at that metric of the average American household, which drives a disproportionate amount of the food sales because they’re preparing food at home etcetera.

Their real earnings continue to be depressed and not moving very much at all. We look at numbers like the unemployment number but what we really look at is income hours work and how’re people failing. You see all of those metrics still continue to be incredibly weak now going on five years.

When that turns around, a great majority of these problems will be solved. But none of us can sit around and wait for that to happen and as we’ve talked about in previous calls, we made a shift a couple of years ago on our planning to assume that it didn’t get better, that we lowered our topline expectation and put pressure on other areas of the business model to still deliver the EPS growth.

I think in the medium term, but that’ a long term. I think the medium term is consolidation is clearly an answer here. We know that the right acquisition that generates synergies and efficiencies can really cover up for a lot of the volumes -- takes very much more efficient operating model for the industry in total. There's a variety of reasons which we can talk about why that hasn’t happened faster, although it has happened at a faster pace in 2014 than it has in recent years.

I think the last part of the very short term is, if you’re left with -- if I got to make this quarter over these next months, people are leaning on promotion very much because there is a delayed reaction to any marketing. I think innovation is really -- is an important part of this discussion because as we talked about what we would like to believe to be innovation that we introduced as new consumers and expands our business, we’re looking at this industry right now as very much a zero sum game. We're not seeing growth in total.

So we’ve made sure that we do looking at innovation is that all of it is margin accretive. So that it delivers incremental growth terrific even if it doesn’t, it still helps expand our gross margin and that’s the balance that we struck in the first six months of this year. We have to price competitive, otherwise we start losing market share and we know what happens in that situation.

We know that we don’t like doing that so we’re very targeted in where we have to do it. We add money in for consumer marketing where it makes a lot of sense and then we target our innovation to be margin accretive and I think it’s the combination of all of those which delivers good results. So apologies for the long answer, but it's obviously something we spend a lot of time thinking about and I know that you do as well.

Eric Katzman - Deutsche Bank

Okay. Thanks. That’s all.

Bob Gamgort

Sure.

Operator

Thank you. And our next question comes from Ken Zaslow from Bank of Montreal. Your line is now open. Please go ahead.

Ken Zaslow - Bank of Montreal

Hi, good morning everyone.

Bob Gamgort

Good morning, Ken.

Ken Zaslow - Bank of Montreal

And welcome back as well.

Bob Gamgort

Thank you.

Ken Zaslow - Bank of Montreal

I guess my question is you said a couple of times that its right for consolidation, the industry is right for consolidation and you guys are now in a better balance sheet out there. When you look at the acquisition environment out there, you see more assets available but at prices that you don’t want to pay for them or do you see less assets available given all the prices, like how do you see the environment because it seems to me that people like you guys can tend to be very disciplined will have a hard time in this environment. Can you talk to that?

Bob Gamgort

Yeah. Look the flow of potential assets, which it was on the increase of 2014 has continued at that pace. So there’s more opportunities for us to have conversations and look at some assets and again just the -- something we always say but it is really important. There are those assets that go up for sale and there are those who are proactively trying to unlock and that for us is the more attractive side because we think that the right transaction could allow us to unlock something at a much greater scale in a tax efficient way.

But I think that you bring up a really good point, which is the price of assets right now and one of the things that I’ve noticed in the last seven -- the last seven sizeable transactions that have been done in the food industry in 2014, five of the seven are U.S. based public companies. So if you look at the impact, the acquired stock price was either flat or down upon announcement of the acquisition and that’s quite a departure from what we’ve seen in the previous four or five years.

And what it says to me that -- either the prices were too high or it wasn’t great strategic fit. So I think our discipline remains around, is it the right strategic fit which means does it make us a better company over the long term and really forget about the headline multiple, what are the after tax, after synergy multiple that we get and that’s what we stay really focused on and that’s why we pay good prices like we did for Wish-Bone but still deliver great benefits to the business.

But clearly prices got heated up pretty quickly and you can see the reaction from investors. So I think just you’re becoming a little more discerning on the acquisitions, that some of the manufacturers are making sure that we stay disciplined as well.

Ken Zaslow - Bank of Montreal

Okay. And here’s somewhat of a sensitive question, I guess I’ll ask is, look when you were being acquired -- thought to be acquired one of the points that Hillshire made was that the sales opportunities in your businesses maybe higher than what you actually initially thought.

Can you talk about are there opportunities that maybe you might be working today, maybe there are greater growth -- sales growth opportunities within your portfolio because part of -- again the thesis that Hillshire had in terms of acquiring was that you are growth other than on the topline may be a little later than what they would expect it be going forward. Can you talk about that?

Bob Gamgort

Yeah, I think what they were talking about, I don’t remember that reference exactly, but you may have been involved in some communication maybe if that wasn’t it with them.

I think what they were really talking about it taking our brand for example and expanding them into refrigerated where they have capabilities that we don’t have and we’re also talking about taking some of their brands into the shelf-stable world where they don’t have as much capability and then co-promotion, co-merchandising and even co-branding in some cases, some of the frozen businesses into some components into full meal.

So it’s really -- the point there we're trying to make was the combination of these businesses and the expansion of brand into new territory would drive higher growth, not where they could take this portfolio and grow at a faster rate just like them managing it. We would have strongly disagreed with that point if it was made. It think was more of the performer that I’ve just discussed.

Ken Zaslow - Bank of Montreal

Great. I appreciate it. Thank you.

Bob Gamgort

Okay. Thanks.

Operator

Thank you. And our next question comes from Robert Moskow from Credit Suisse. Your line is now open. Please go ahead.

Robert Moskow - Credit Suisse

Hi, thanks. Bob, the market share gains that you talked about, I think you're gaining share in 8 of 13 categories that’s a down a little bit from first quarter where you were gaining in 10 of 13 and maybe it’s holding and gaining is your definition and given all of the promotional spending that went into the quarter, are you satisfied with that and are you concerned at all that the back half that your competition may have to react to the fact that they were the ones losing share in the first half and now they want to come back more aggressively to get their share back.

Bob Gamgort

Yeah. We’re always weary of the last point on a constant basis. I think that’s part of the way that we manage the business is we’re very happy when we are delivering good performance and we’re very watchful about what kind of reaction others may put in front of us. So that last part is kind of an ongoing thing.

I think we’re very satisfied with the share growth that we’ve got not only in second quarter but year-to-date and when I look at the latest July numbers, the July numbers were very good and we grew share in 9 out of 13 category.

What it says to me is although we’re reluctantly having to match some of the promotion that’s out there we’re getting good response for that. There is a lot of discussion that I have seen about promotional efficiency or inefficiency and yeah, the more that the industry promotes the lower efficiency is going to be. It’s almost a given.

But we’ve been really, really focused on building internal capabilities about spending that money in a smarter way and one of the -- we've a fairly sophisticated internal metrics, but when I look at the IRI merchandising effectiveness metric, which is available to you guys.

You would see that merchandising effectiveness for our categories is down slightly but nowhere near where the categories are and I think that’s why that spending is at least translating in the share growth. I think if we invested that money in business to see the flow of share growth we wouldn’t be disappointed, we are happy with the share growth that we are getting. We wish the categories were going faster. We wish the industry was growing faster.

Robert Moskow - Credit Suisse

That makes sense. And may be if I can ask a follow-up. I think a year or two or two years ago the learning in the industry was that deals that were like 10 for 10 trying to drive a lot of volume weren’t working and so a lot of players reduced the volume component of that and then this year, I heard a lot of companies talk about just that the space was very crowded. Everyone was trying to merchandize at once and so it just got very confusing and dial displays.

What do you think we are now? Is it just a lot of money and the deals are too deep? Is it the frequency? Is there a way to talk broadly about how that evolved?

Bob Gamgort

Sure. It might be helpful as I just give you sense of how we plan our promotions and I think it will really shed light on certainly what’s happening in Pinnacle, but I think by extension you could look at the industry as well.

We don’t sit back and say okay we are going dial up our promotion spending. We will really manage everything at a much more micro level. We look at category by category, retail by retailer and we have these discussions about what’s it going to take to minimum hold share in those intersections if you want to look at it that way.

Because you don’t fight this battle at 100,000 feet, you don’t fight it at total retail level. You really do it category by retailer and what happens is we plan our promotional activities accordingly and as we talked about before the further you get out ahead and are planning for this, the better the quality of the promotion that you are going to secure. It's when you come in at the last minute and try to cover for short at last minute you will get the less desirable space, which is there.

But what happens as we plan these it could be intersection category by retail and what is occurring in 2014 is those retailers that are more a retailer price focused and has been very aggressive on price point are the ones that are winning and that wouldn’t be a problem if the other one weren’t declining.

The problem is this is zero some gain and what you are seeing is the mix of customers in which we are generating our sales have shifted towards those that are more promotional, which has the impact of driving our total promotional spending up if that makes sense and I believe that’s happening for the industry in total.

So it's not that we for sure and I think most of our peers are not out there just indiscriminately spending money, I think they are planning and what’s surprising them is the shift in customer mix going forward and again if the industry was growing at another one or two point higher growth this will be a non-issue and the fact that it's complete substitution from one customer that's driving up the rate. Does that make sense?

Robert Moskow - Credit Suisse

I think it does. Thank you so much.

Bob Gamgort

Sure

Operator

Thank you. And our next question comes from Farah Aslam from Stephens, Inc. Your line is now open. Please go ahead.

Farah Aslam - Stephens, Inc.

Hi good morning.

Craig Steeneck

Hi. Farah. Good morning.

Farah Aslam - Stephens, Inc.

Could you talk about how you are managing your Leadership Brands versus your foundation brands in the current environment and kind of how you are allocating marketing resources and what margins you are achieving on those?

Craig Steeneck

Sure. The great majority of our consumer marketing spend is focused on our Leadership Brands. We spend very little from a consumer marketing standpoint on our foundation brands.

When we think about innovation, we are targeted more towards renovation on the Leadership Brand versus true innovation on our foundation brands. The foundation brands are renovation, the Leadership Brands are true innovation.

I’ll give you an example on foundation brand. Hungry-Man we put new flavors out there. We got some new flavors at a higher price point that I wouldn’t put in the category of great innovation, but they delivered good profitability, good margin expansion as well as it allow us to maintain our market share in that position.

On Aunt Jemima, which is a foundation brand, we are transitioning to new retail packaging, which is the first in the industry and also upsizing the pack. So that’s the kind of work that we do on the foundation brands to keep them hold and our margins interestingly have expanded across both.

So while the relationship that Leadership Brands have a greater gross margin the foundation brand continues and that’s why we like to focus on Leadership Brands, the margins have grown on both, which is the benefit of productivity versus inflation, which cuts across our entire portfolio.

Farah Aslam - Stephens, Inc.

And are you happy with kind of how your foundation brands are holding up in this current environment?

Craig Steeneck

I think we got real mix results on our foundation brands. And thinking from a share standpoint, we got some good success and others not. We referenced in the quarter that some of our foundation brand portfolio was down.

I think that's reflective of what’s going on in the environmental level of price competition in those categories. We will never be happy if we were losing share, we don’t have positive growth on a relative basis all part of the mix of our business model that we drive to get through our total EPS. So we will continue to address that.

Farah Aslam - Stephens, Inc.

And then in terms of growth on your Leadership Brands overall historically you have targeted 2% growth, but it seems like you are getting better than that right now on your Leadership Brands, what would be your new target level or it does remain at sort of that 2% level?

Craig Steeneck

No, I think our long-term target level remains the same. So as you are pointing out, we got slightly more growth in our Leadership Brands than we would target long term and slightly less growth than we would target in our foundation brands.

So our outlook in the way we manage the business hasn’t shifted but on a quarter to quarter basis especially around when we get a little bit distorted by a big holiday you see during Easter that Duncan Hines and Birds Eye for example are much stronger in Easter. So we are going to get a boost out of that. So I think that’s just a quarter by quarter fluctuation rather than a change.

Farah Aslam - Stephens, Inc.

Right. Thank you.

Craig Steeneck

Okay.

Operator

Thank you and our next question comes from Matthew Grainger from Morgan Stanley your line is now open. Please go ahead.

Matthew Grainger - Morgan Stanley

Hi. Good morning, everyone.

Bob Gamgort

Good morning.

Matthew Grainger - Morgan Stanley

Bob this could be I guess both an M&A question or an innovation question, you talked a few months ago at the CAGNY launch about the importance of health and wellness and faster growing categories of channels and the time that that has to Birds Eye.

So outside of core momentum you have in terms of making vegetables more accessible to consumers focusing on that from a marketing standpoint how important of a strategic priority will this be for you? So I guess can you talk about whether you have initiatives in place outside Birds Eye to focus on evolving the portfolio towards these consumer needs or do you see yourself extending over time into new categories to give you more exposure to those trends?

Bob Gamgort

Yes, I think. So we will step back in part of our Birds Eye and you are 100% right that pockets of growth in this euro some gain in total are really around health and wellness and that we see Birds Eye as being an opportunity to play an active role in that.

Given that while there is a lot of debate about what is health and nutrition, nobody debates that eating more foods and vegetables is important. So we think we are in a advantage and by the way if you look at our year-to-date share position on Birds Eye you will see that we are gaining very, very nicely.

So the way that we are going to attack that as we talked about in CAGNY given that we see this is such a megabrand in the space is a combination of internal and external and what would you expect to see is an accelerated innovation pipeline that will stretch us not only to more depth within our existing category, but start to stretch us into adjacent categories to deliver the same benefit and part of the way that we'll be able to accelerate that could be through M&A and it will be less about buying a specific brand and renovating in that case. What it might be is buying a capability or smaller brand that we could either co-brand or rebrand Birds Eye to get into that space.

Our desire is not to launch multiple brands that all need support. That’s really against what would you indicate for this industry, but rather use the umbrella of Birds Eye to be able to expand the new benefit all around delivering fruits and vegetables.

Matthew Grainger - Morgan Stanley

Okay. That’s helpful. Thanks. And just a quick follow-up on Wish-Bone, you talked a little bit about the actions you have taken to rebalance marketing and promotional support, can you just talk about where you stand today and whether you think you are at the right balance going forward given what appears to be an incidentally more promotional environment in that category.

Bob Gamgort

Yeah. So we had a really -- stay disciplined during the first six months because as we ourselves knew and we talked to you about we expected share to be down in the first six months of the year because we were lapping some very serious promotions in advance of the business being sold to us and that we expected that would reverse in July.

It's hard to sit there and watch out by month and month and stay disciplined and to your point promotional environment not be intense and just jump in there, but we did and I would tell you that at least the first share of period that we got in for the month of July we are seeing positive share on Wish-Bone.

So I would say that we are certainly moving in the right direction. We are constantly collaborating as we learned the business and we learned the category, but I am happy that we didn’t try to match the year ago promotional level because I think that would a potential waste to the bottom that we didn’t want to do instead we did right thing and were being rewarded at least in the early days of July.

Matthew Grainger - Morgan Stanley

Okay, That's good to hear. Thanks again, Bob.

Bob Gamgort

Sure.

Operator

Thank you and our next question comes from Karru Martinson from Deutsche Bank. Your line is now open. Please go ahead.

Karru Martinson - Deutsche Bank

All right. Just in terms of Wish-Bone, when you guys look at production starting internally in the first quarter, do you still feel confident on that $65 million pro forma EBIDTA and can you -- what's the outlook for you having that fully flow through?

Craig Steeneck

Yeah, so the $65 million all-in EBIDTA from Wish-Bone as we’ve articulated flows through next year. We’re looking to take the Unilever co-pack arrangement that we have today and we’ll in-source that into our existing St. Elmo Illinois facility at the end of the first quarter of ’15.

Once that happens we’ll have the full run rate benefit of that starting in the second quarter of ’15. So you’ll get three quarters of benefit next year and then obviously full benefit in ’16.

Everything relative to the integration, the upfront things relative to order to cash and systems integrations all went brilliantly for the first three months that we owned the business, which was 44 last year and then all of the other synergy in terms of SG&A procurement and distribution are all on track, so we feel very good about the integration plan and are on track to hitting that $65 million once we get to the middle of next year.

Karru Martinson - Deutsche Bank

Okay. And just lastly, on the inflation front you mentioned your protein as a small part of the portfolio; I was somewhat surprised that we weren’t seeing more given the drought in California’s kind of wondering if you talk to your vegetable sourcing on that side.

Bob Gamgort

Yeah. Sometimes you’re good, sometimes you’re lucky. Most of our vegetable sourcing is Mid West based. That’s where our manufacturing sites are and that’s where we internally grow our corn and peas and carrots and beans and those areas have been unaffected by the drought.

So the amount of volume or the amount of our all in market basket that we procure from California is very, very small. Most of the areas affected have been in tomatoes, avocados, nuts and those are as I said very small components of our overall portfolio.

Karru Martinson - Deutsche Bank

Thank you very much guys. I appreciate it.

Bob Gamgort

Thank you.

Operator

Thank you. And our next question comes from Chris Growe from Stifel. Your line is now open. Please go ahead.

Chris Growe - Stifel Nicolaus Weisel

Thank you, good morning.

Bob Gamgort

Hi Chris.

Chris Growe - Stifel Nicolaus Weisel

Hi. Just a few questions if I could, the first one I guess to -- and there’s been a lot of discussion about promotion and kind of attacking the consumer. You had a large increase in consumer based market in this quarter as well as an increase in promotions. So is that the sustainable -- or is it a sustainable level you expect for the second half of the year as well? Will we see both of those levers being pulled if you were in the second half?

Bob Gamgort

No, we figured -- it will be again a little bit more balanced. You’re getting a big spike in the promotion piece partly because of the Easter timing and of course, we look through the rest of the year, the big holidays that we target is around for baking around near between Thanksgiving and Christmas but that’s always been our plan.

And the consumer spending was really specifically targeted to Wish-Bone and Vlasic in this quarter and again it’s not a conscious effort to say, we’re going to dial that up on ongoing basis.

We put it out there when we have new news and we want to build awareness around for example, those are both seasonable related because for the start of the summer, you want to be advertising both salad dressing as well as pickles. So I don’t think there’s any big shift in the way that we think about our business going in the second half of the year in terms of those two measurements.

Chris Growe - Stifel Nicolaus Weisel

Okay. I just have a follow-up question if I could and maybe it’s a bit promotional question, but when you at like the Birds Eye frozen division where you had an increase in promotion you had a pretty nice response and volume as well yet it didn’t translate into better profitability in the quarter.

Was that just the uniqueness of input cost and productivity savings, that kind of thing or you’re not getting enough volume response I guess is the way to say it through the promotional spending.

Bob Gamgort

The volume response is not an issue on that at all. That was actually good volume response there. I think this gets back to -- we talked about our guidance for the year. We said our productivity was going to be in the 3% to 4% range and we said a good target is in midpoint of 3.5% and inflation will be at 2%.

That relationship while good for the year doesn’t always get delivered in that manner during each quarter. You got a situation in Q2 particularly in the frozen side of the business with the relationship between productivity and inflation was less favorable than it was for example in the dry division.

But it’s really just a timing of how close through P&L rather than anything specific and actually on Birds Eye and Birds Eye Voila! we’re very happy with the volume response that we got from the promotion. We got some really good share for those businesses.

Chris Growe - Stifel Nicolaus Weisel

Okay. Well thank you for the time.

Craig Steeneck

Okay. Thanks.

Operator

Thank you and our final question comes from Michael Gallo from CLK. Your line is now open. Please go ahead.

Michael Gallo - CLK

Hi, good morning and congratulations on performing well.

Bob Gamgort

Thank you.

Michael Gallo - CLK

My question is just around Wish-Bone. You’ve owned the brand for around 10 months now. I was wondering if you can talk about some of the opportunities incrementally to your original expectations as well as perhaps some of the elements of the brand that might have been more challenging than your original expectations and whether you see some opportunities as you kind of co-brand -- can you co-brand that into frozen or some other opportunities around the brand other than the obvious move-in manufacture? Thank you.

Bob Gamgort

Yeah, I thought -- we will start with the last one, the obvious move is you know our biggest part of our thesis is that we can generate significant synergy from this business and that we were in unique position to do that given that we could integrate this as an addition to our liquid manufacturing plants that are in St. Elmo Illinois.

And we would like to take that and put it in the bank but our supply chain guys are working really hard to make that happen and the fact that that's on track I think is the first deliverable on this thing and all our hypothesis on how we will do that I think has proven out to be right.

The category itself is a little bit slower growth than it has been in the previous five years. Again it’s hard to react to something that’s less than a year and our focus is in our other categories is to do the right thing and gain share.

Our calibration around the level of promotion and the tactics needed I think again its early days are proving to be right. Clearly, we made a choice not to try to match the year ago promotions that cost us some share, but it was the right thing to do and I think as you look at the second half of the year or in the early days we’re gaining some share. So that’s something to watch for all of us and I think the last part is where do we go from here in terms of marketing this business?

As we look at our 2015 plans, one of the biggest opportunities we see is the bundling of this brand with other brands in our portfolio in terms of marketing and promotion and we talked about promotional effectiveness.

We know that bundled promotions around consumer themes make a ton of sense. They are much more effective and we see this as a brand that will unlock that for us. One thing that’s interesting about Wish-Bone is it’s the number one Italian brand -- Italian has become a really kind of a universal salad-dressing so it’s a nice position to be in.

But it’s probably and we’re trying to quantify it exactly not the largest, one of the largest, one of the largest marinates out there period, is Wish-Bone Italian dressing. And so with that around growing fees and combined with Vlasic and combined with Open Pit gives us all kinds of potential to do promotions I think in a smart way that we haven’t been able to do in the past and you’ll see that all in 2015.

And I think beyond 2015, you will see the innovations pipeline dial up, maybe it will be in the some point in ’15, it will all depend on getting that balance right between how much we want to invest in slotting versus how much do we want to drive consumer marketing in bundled promotion, so still relatively early days in the brand. I think all the assumptions have proven out well and we’re still very excited about what we can do in the future.

Michael Gallo - CLK

Thank you very much.

Bob Gamgort

Okay. Thanks.

Operator

Thank you. I would now like to turn the call back to Bob Gamgort for any closing remarks.

Maria Sceppaguercio

Hi everyone. It’s Maria. That completes our call today. If you have any follow-up questions you need to talk just give me a call. I am around the whole day. Take care.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today’s program. You may all disconnect. Everyone, have a great day.

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Pinnacle Foods (NYSE:PF): Q2 EPS of $0.33 in-line. Revenue of $617.8M (+8.6% Y/Y) misses by $11.53M.