Del Monte Foods F2Q08 (Qtr End 10/28/07) Earnings Call Transcript

Del Monte Foods Company (DLM)

F2Q08 Earnings Call

November 29, 2007 10:00 am ET

Executives

Larry Bodner - IR

Rick Wolford - Chairman, President and CEO

Dave Meyers - CFO

Analysts

Jonathan Feeney - Wachovia Securities

Farha Aslam - Stephens Inc

Zafar Nazim – JP Morgan

Robert Moskow - Credit Suisse

Ken Goldman - Bear Stearns

Reza Vahabzadeh - Lehman Brothers

Eric Katzman - Deutsche Bank

Ann Gurkin - Davenport & Co.

Eric Serotta - Merrill Lynch

Presentation

Operator

Thank you for joining Del Monte Foods Co. second quarter fiscal 2008 results earnings conference call. (Operator Instructions) Now I will turn the call over to Larry Bodner, Vice President of Finance and Investor Relations, Del Monte Foods. Thank you, sir, you may begin.

Larry Bodner

Good morning everyone. Thank you for joining us for Del Monte Foods fiscal 2008 second quarter conference call. With me today are Rick Wolford, Del Monte's Chairman and CEO; and Dave Meyers, our CFO.

The call today will last one hour. In the interest of time, we'd ask you to limit your questions to one per person.

Let me remind everyone that statements made during this conference call which are not historical facts, including any statements about the company’s targets, beliefs, plans or expectations are forward-looking statements and are based on management’s current plans, estimates and projections. The company does not undertake to update any of these statements in light of new information or future events.

Forward-looking statements involve inherent risks and uncertainties. Investors should not place undue reliance on them. There are a number of important factors that could cause actual results to differ materially from those contained in such statements. These factors are described in more detail in the earnings release we issued today and in our filings with the SEC.

Grocery share data we will talk about today is for the 13 weeks ended October 27, 2007. In some cases, we will discuss all-outlet share data, which are internal estimates based on Nielsen all-outlet data. Additional grocery share data, as well as the basis for our share data, are available in the appendix of the presentation which is available on the company's website.

Now our Chairman and CEO, Rick Wolford, will take you through our results.

Rick Wolford

Thank you very much, Larry. Good morning, everyone. Starting with our second quarter, we delivered a solid top line growth of 5% with both our pet and consumer businesses contributing significantly to growth as they continue to perform well in the marketplace. Our consumer and pet top lines benefited from strong new product performance as well.

However, EPS came in at $0.13. This primarily reflected increased costs, particularly the impact of higher fish and pet ingredients costs, both of which have escalated aggressively to levels much higher than anticipated.

While we believe that we continue to make strong progress with our brands in the marketplace and upgrade overall our company's competitiveness, we are reducing EPS guidance for the year. This primarily reflects the impact of three volatile cost factors -- fish, fats and oils, and diesel.

Clearly it continues to be imperative that Del Monte continues to execute against cost reduction programs and pricing initiatives to offset cost pressures as we also continue with our progress in the marketplace.

Now let me address our Q2 performance. This quarter's top line reflects strong all-outlet share gains in pet, vegetables and fruit. Importantly, we are making demonstrated progress in innovation across the portfolio which should further enhance our share strength. This progress was supported by strong execution in our go-to-market platform and supply chain.

Costs, however, continue to pressure margins and it is vital that we remain squarely focused as we address these challenges. Our cost reduction efforts are absolutely core to our operations. We continue to successfully execute against our VIP program and are on track to capture $70 million in cost savings by the end of fiscal '08. In Q2, VIP efficiencies were achieved through successfully executing economic return projects and structural lean initiatives.

We also continue to successfully implement our transformation plan with all four initiatives on plan to drive $40 million in run rate transformation savings expected by the end of fiscal '08.

Importantly, these initiatives will also upgrade Del Monte's competitive strength, including demand forecasting, sales and operational planning, as well as trade promotion management.

During the quarter, we continued to eliminate miles out of the system with our upgraded drive manufacturing metrics. In addition, our new trade spend measurement program is currently being implemented to drive improved ROI promotional activity and tracking in fiscal '09.

Del Monte's pricing actions are clearly critical as we work to offset rising costs. Our fall 2006 fruit, May 2007 pet, and Fall 2007 seafood pricing actions all benefited Q2 operating income and helped combat higher year-over-year costs, including fish as well as hedgeable corn, soy and wheat costs. However, in light of continuing escalating fats and oils and diesel costs, we have announced this month necessary pricing actions in vegetable and tomato products and will continue to evaluate additional pricing actions in pet products.

Despite the cost environment, we remain committed to returning value to our shareholders. In Q2, we announced and initiated our three-year $200 million share repurchase authorization, enabled by our continued strong cash flow.

Turning to our consumer products business, net sales were up almost 5% fueled by another strong quarter in fruit as well as strong growth in vegetables. These gains were partially offset by lower StarKist seafood sales. Despite this strong top line and benefit from fruit and seafood pricing, second quarter operating income declined by 13%. This was driven largely by higher fish costs.

Turning to our top line, in Q2 fruit sales were driven by a strong performance in single serve as well as packaged produce, including our Fruit Naturals and Glass Fruit, both reflecting increased velocities and distribution. As well, volume in lower margin channels contributed to net sales as we took advantage of better fruit crop yields.

Importantly, successful new products contributed nicely to the top line, supported by our Fruit Chillers and no sugar added fruit single-serve items. As well, we continue to increase support behind our new fruit products.

In vegetables, top line growth was driven by effective merchandising behind our Just One More consumer program and a reduced price gap to private label. These gains in fruit and vegetables were partially offset by volume declines in seafood, primarily in our chunk lite halves as we reduced our promotional activity in light of lowered overall supply availability during the quarter.

As discussed, consumer products continued to face cost pressures, primarily in fish, as average market skipjack prices remained higher than anticipated at $1,325 per short ton during Q2 compared to an average of $800 a year ago. This business also experienced some higher crop costs, particularly in vegetables, driven by a crop competition stemming from the increased demand for alternative fuels.

In sum, fruit and vegetables performed well in a tough cost environment. However, seafood continues as a core issue to consumer products performance. Sustainable pricing actions in this business, combined with cost reduction programs, have not been adequate to offset the historic levels fish costs have reached. This year we anticipate we will reduce costs in all key cost components in seafood except raw products. However, with fish costs at 50% of seafood operating costs, the higher price of skipjack is not expected to be offset.

This business model, with its margin significantly dependent on a single cost factor and as well, highly sensitive price elasticity, is different from the remainder of our portfolio. The team responsible for StarKist has, very importantly, successfully implemented a series of merchandising innovation marketplace initiatives to stabilize performance of this business, resulting in a Q2 year-over-year share gain. The new label execution in specialty tuna drove a second sequential quarter of share growth.

Our innovation pipeline is also showing results. Our improved pouch product is on shelf and we released two new products into test markets -- StarKist Seasations and StarKist Gourmet Seas -- both significant innovations.

Now looking at our consumer products third quarter fiscal 2008. On the top line we anticipate very strong growth. Notably we expect all categories of the business to contribute to this growth, enabled by a very strong Thanksgiving and holiday-related promotion period.

For fruit, we expect continued strong volume in single-serve and produce, including the momentum in our new product initiatives. In vegetables, we expect strong promotional execution to drive the business. We also expect seafood to begin to see the impact of our efforts with increased net sales, supported by a return of more traditional levels of promotional activity compared to Q2.

Q3 consumer products operating income is expected to post very strong growth, driven by top line factors mentioned as well as the continued benefit of pricing actions. In addition, Consumer Products OI will benefit from the S&W sale in the Eastern Hemisphere.

Now turning to our pet products business, here we're pleased with our Q2 top line growth of 5.4% which reflects healthy pet business fundamentals including continued momentum of new and existing products. Importantly, Q2 was our first comparable year-over-year quarter since adding Meow Mix and Milk Bone to the portfolio and both were strong net sales contributors, reflecting the positive impact of the Del Monte go to market platform.

Pet top line performance was solid; however, operating income declined 10% primarily related to ingredient cost pressures, partially offset by the absence of integration and purchase accounting.

New products were a key driver of top line growth. New pet food products such as Meow Mix Market Select Cups and 9Lives Daily Essentials, along with our 2007 new pet snack introductions, all drove positive volume. Good execution, as well as innovation, combined to support share strength as we grew our Q2 all-outlet shares in seven of eight portfolio categories. Notably, the pet category overall drives more than half of its list sales from non-grocery mass channels.

Turning to costs. Increased costs here, however, have negatively impacted our Q2 pet results. As we have discussed over the last six months, the industry has seen aggressive cost increase in pet ingredients primarily grains, fats and oils, which have been driven by increased demand for alternative fuels. We continue to have a good handle on our exposure to hedgeable commodities such as corn, wheat and soy as we have hedges covering over 90% of our '08 needs, although at higher prices year over year.

Higher year-over-year hedgeable commodity costs were largely anticipated in our original outlook for the pet business when we took a 3% May 2007 price increase across the portfolio. However, these pricing actions did not take into account the impact of a second leg up in fats and oils input costs that the industry has experienced starting in mid-calendar 2007. These input costs, which are not hedgeable, have risen at a significant pace over the last six months. We continue to evaluate additional pricing actions to combat these incremental costs and preserve margins.

Looking at Q3, we expect pet products top line to increase, fueled primarily by the same drivers as Q2, including: healthy pet business fundamentals, continued momentum of new products behind the launch of new SKUs in January of 2008 and continued outperformance of Meow Mix and Milk Bone. In addition, we look forward to the kickoff of the Milk Bone 100-year anniversary celebration in Q3.

However, net operating income we will be challenged in Q3 due to recent cost pressures which we expect will not be offset with pricing in the quarter. These factors will drive a Q3 decline in operating income. However, we do believe that the dynamics of the pet category should support further pricing actions in the future as we work to offset cost increases.

With that, I will now hand it over to Dave.

Dave Meyers

Thanks, Rick. In Q2, we delivered solid top line growth of 5%. However, it was below our expected range. Consumer products net sales were less than expected, primarily driven by timing of promotional activity in fruit and increased competitive activity in tomatoes.

Pet products net sales were also less than expected, primarily driven by lower promotional effectiveness. EPS of $0.13 compares to our guidance range of $0.13 to $0.17; net sales were softer than expected, including higher promotional spending, partially offset by a reduction in marketing support.

Looking at the 5% increase in year-over-year net sales, base unit volume growth driven by fruit and vegetables contributed 2.8 points. Volume growth in new products, particularly in pet food, pet snacks and fruit as well as price increases, contributed 2.5 and 2.4 points respectively, which was partially offset by 2.7 points of pricing-related volume elasticity.

Gross margin for the quarter was 24.9%, a decrease of 250 basis points versus last year. Net pricing contributed 1.1 points, while mix drove a 0.7 point margin reduction, due primarily to lower margin, non-retail fruit volume, as Rick discussed.

Cost increases for grains, fats and oils driven by demand for alternative fuels, coupled with higher fish, vegetable and diesel costs, impacted gross margin by a negative 2.9 points.

Operating income was essentially flat with operating margins decreasing 50 basis points. Lower gross profit was offset by lower SG&A. $11 million SG&A reduction was driven by lower transformation and absence of integration expenses. Interest expense in the quarter decreased $2 million, primarily due to lower debt levels and lower rates versus last year.

GAAP EPS from continuing operations of $0.13 included $0.01 of transformation compared to $0.12 a year ago which included $0.06 of transformation, integration and purchase accounting.

Operating cost increases exceeded our pricing actions with the most severe impact being felt in our pet business as the pricing we took in May 2007 reflected our cost outlook as of February 2007. Further, the impact from higher net sales was neutralized by the unfavorable mix and incremental fruit trade spending to support new products.

During the second quarter, we spent $23 million on capital projects versus $18 million a year ago. We incurred $26 million in depreciation and amortization costs which included $1 million of fee amortization included in interest expense.

Total debt, net of cash on the balance sheet was $2.2 billion; $59 million lower than the $2.259 billion debt net of cash at the end of the second quarter fiscal 2007, primarily due to scheduled debt payments on long-term debt and lower short-term borrowings which were used in the prior year to partially finance the acquisitions.

On a year-to-date basis, operating cash flow was a negative $150 million versus and a negative $108 million a year ago. The decrease in operating cash flow is primarily driven by incremental pension funding which is not expected to recur in future years, as well as higher inventories driven by better fruit yields and a very good tomato harvest.

Now I'd like to discuss guidance for 2008. We are maintaining our sales growth guidance of 5% to 7%. While our Q2 top line was softer than initially anticipated, we are experiencing a strong start to the key Thanksgiving and holiday promotional period in consumer products.

In pet, we expect continued, very strong performance from Milk Bone and Meow Mix coupled with robust innovation expectations including our Cycle Natural Pet Food product line and upcoming January new product launches in snacks and dry food.

From an operating cost perspective, we are increasing our estimated gross cost increases to approximately $170 million versus our previous $145 million estimate. The $25 million increase is driven by higher fish costs, fats and oils, and increase in diesel prices and resin-based packaging. As a result, we have announced incremental pricing in our vegetable and tomato businesses in the last few weeks, which will be implemented during the calendar first quarter.

With respect to pet, we believe these cost increases are impacting the entire industry and historically the industry has priced to cover costs. In addition, in Q3 we completed the sale of our S&W trademark and related assets in the Eastern Hemisphere. Accordingly, we are reducing our fiscal 2008 EPS from continuing operations from the low end of $0.70 to $0.74 to be $0.64 to $0.68, including $0.08 for transformation costs.

To reflect the higher operating costs, we are reducing our gross margin guidance to be 25.2% to 26.2% from the previous guidance of 26.5% to 27.5%. In addition, operating margin is now expected to be between 9.5% and 10.5% versus the previous guidance of 10% to 11%.

The rest of our fiscal 2008 guidance remains the same, as you can see on slide 16, including our cash flow guidance of $180 million to $200 million. Despite the reduction in earnings estimates, we are maintaining our cash flow guidance, driven by continued strong working capital management.

Looking at or costs in more detail, as I said, we now expect our gross operational cost increases to be approximately $170 million for the year, up from the $145 million provided in our previous guidance. This additional $25 million cost increase is primarily due to higher raw material costs, including skipjack costs which have not moderated as much as anticipated.

Skipjack costs did moderate from the very high August cost and tracked to our expectations through October. However, in the key month of November, the cost moderation from August levels was significantly less than we expected at the time of our Q1 conference call.

Importantly, the Western Tropical Pacific Fishery where we purchase the majority of our skipjack, has experienced a rapid improvement in fishing conditions more consistent with historical norms. However, the normal seasonal improvement in fishing conditions in the Indian Ocean and Eastern Tropical Pacific, the primary sources for Europe and Latin America, did not materialize.

As a result, the shift in global demand to the Western Tropical Pacific has kept prices high, despite better fishing conditions. We now project the Q3 market cost for skipjack to be approximately $1,260 per short ton or about 30% higher than our Q1 expectations.

Importantly, our current purchases for December are consistent with this estimate. In addition, we still anticipate some moderation by Q4 though still above our Q1 expectations.

We also anticipate commodity-related fats and oils to remain at elevated levels above our Q1 expectations. The cost increase in these unhedgeable inputs lag the initial increase related to alternative fuels. In addition, we expect to experience higher diesel costs related to the increase in the energy markets, partially offset by some improvement in line haul rates. Diesel costs have spiked by approximately 13% in the last four weeks from about $3 a gallon to over $3.40 a gallon and we expect them to remain near current levels.

I will now walk you through our guidance for Q3 fiscal 2008. We expect sales to increase 5% to 7% compared to Q3 last year, based on drivers already covered by Rick. Gross margin is anticipated to be between 25.5% and 27% versus 27.9% last year, driven primarily by higher grains, fats and oils, fish costs and higher diesel prices, partially offset by pricing and improved transportation rates.

Inflationary cost increases will be particularly acute in our pet business. Operating margin is expected to be between 11.2% and 12.2% including 1 point of transformation cost. We expect to realize transformation expenses of approximately $9 million. This also reflects the announced sale of our S&W trademark and related assets in the Eastern Hemisphere which generated a gain of approximately $10 million.

We expect interest expense to be between $36 million and $40 million versus $42 million last year. This lower interest expense is expected to be driven by lower average debt levels and lower rates. Our tax rate for Q3 is expected to be between 33% and 35%. Our Q3 reported EPS from continuing operations is expected to be in the range of $0.22 to $0.26 and includes approximately $0.03 of transformation-related expenses. We reported EPS from continuing operations of $0.22 in Q3 a year ago, including $0.04 of transformation, integration and purchase accounting.

Capital expenditures in Q3 are expected to be between $20 million and $25 million versus $17 million a year ago. Depreciation and amortization is expected to be between $25 million and $27 million. This includes approximately $1 million of amortization of financing fees which is expected to be included in interest expense.

In order to facilitate understanding of the anticipated year-over-year increase in Q4 GAAP EPS of $0.09, I wanted to provide more texture on key drivers. First, Q4 should benefit by $0.05 due to the absence of the pet products recall and the Pacer arbitration which occurred in Q4 FY07, as well as anticipated insurance proceeds related to the pet products recall in Q4 FY08.

We also expect to experience $0.01 EPS less in transformation, integration and purchase accounting expense versus the prior year. We also anticipate $0.03 EPS from solid net sales growth with better mix, impact of incremental pricing actions, lower interest expense and relatively flat overhead costs which collectively will more than offset a higher tax rate as we lap credits received in the prior year. Net, we believe the building blocks are in place for us to deliver an increase in Q4 EPS.

With that, I'll turn it back to Rick.

Rick Wolford

Thank you, Dave. In looking at our performance in Q2 and our projections for the year, our brands are performing well in the marketplace and we are responding to unprecedented cost pressures with aggressive pricing, strong productivity and transformation cost savings which collectively will improve our competitiveness.

Despite our actions, we now expect flat year-over-year EPS, excluding transformation, integration and purchase accounting expense. This business performance reflects the recent cost increases in fish, fats and oils, and diesel; while seafood, as discussed, has unique aspects which limit pricing actions to cover costs. We do anticipate our pet business regaining margin, as the industry typically prices to cover costs here.

With that, I would like to thank you for joining us this morning and we now would be happy to take your questions.

Question-and-Answer Session

Operator

Your first question comes from Jonathan Feeney - Wachovia Securities.

Jonathan Feeney - Wachovia Securities

The tuna costs were expected but when you look at pet, why all the promotional activity that Dave talked about? Could you have cut back some of that promotional activity to reflect a more difficult cost environment?

Is the answer maybe that competitors are not raising prices? I was very surprised to see that. I would assume if any category would price to cost in this environment, it would be pet food. If you could just give us a little more color on how that profit shortfall came to be?

Rick Wolford

In terms of pricing in pet food, as we indicated, historically this is a category that has priced to cost increases. There is a certain cycle to these pricings to some degree, and the last pricing was taken in May and we would anticipate that pricing would take place here in the course of the next reasonable period of time, broadly in the industry, and we're going to be monitoring that very carefully.

It is an important business to all of our competitors and we expect that they would manage it accordingly. It's a very healthy category which we believe would also support these kinds of necessary price increases.

In terms of promotional activity that took place in the category this quarter, those are normal promotional programs. What we try to do with our marketing, our promotion, our in market execution has been to maintain the health of our business so that we don't make short-term decisions at the expense of long-term business health and opportunity.

Having said that, we have prudently looked at our marketing and selling expense and have reduced marketing and selling expense to some extent, but not to the extent that we believe would impact our overall competitiveness and future growth opportunities.

Jonathan Feeney - Wachovia Securities

To generalize, it seems like the kind of investments that you'd make that are recognized as an offset to revenue which are more trade spending related would seem to me to be of less long-term benefit and maybe more tactical in response to what competitors were doing. Are you confident that your pricing right now, year-over-year at retail, is in line with that of competitors? Have they taken pricing up faster than you? Or have they taken up pricing slower than you, roughly?

Rick Wolford

Jon, are you talking about our pet business?

Jonathan Feeney - Wachovia Securities

Just pet, yes, just pet.

Rick Wolford

We believe that our pricing and our promotional activities are consistent with our competition. We've seen no pricing in the industry and we've seen promotional activities generally consistent with prior practices. Actually, we have seen somewhat soft and somewhat lower levels of promotion in the snack business and normal levels in our food business.

The promotional activity that we've taken in the quarter and the promotional activity that the industry has taken in the quarter is largely consistent with what we've seen historically. As I said, historically Q1 of the calendar year is when the industry has typically looked at pricing.

Jonathan Feeney - Wachovia Securities

And you expect that to improve?

Rick Wolford

We would expect that the industry will continue to follow historical practices and we do know that the ingredient costs that we've seen are marketplace costs that, as we said earlier, are essentially unhedgeable and they are input costs that are experienced by all who are buying these fats and oils. It gets down to some fairly arcane factors.

Jonathan Feeney - Wachovia Securities

The S&W gain here, it looks like it is about $0.05. Was this factored into full year guidance before we talked this morning? I assume that $0.05 is factored into your EPS from continuing operations in the third quarter. So that is in the 22 to 26?

Rick Wolford

First of all, Jon, it's about $0.03. It was not in our original guidance. However, it is in our third quarter guidance and we are using it to offset some of the input costs that we talked about. Specifically as you recall last year, we also had an asset sale of about the same amount so this is not unusual for us.

Dave Meyers

It's historically been true with our business the last number of years.

Rick Wolford

Yes, three or four years.

Operator

Your next question comes from Farha Aslam - Stephens Inc.

Farha Aslam - Stephens Inc

Could you just share with us some details regarding your tomato and your vegetable pricing? What amount did you take?

Rick Wolford

Order of magnitude, an 11% increase in our vegetable business and about an 8% increase in our tomato business.

Farha Aslam - Stephens Inc

Are you following or leading this increase?

Rick Wolford

In the tomato business, we are following closely behind, but Hunts is already out there with a higher price so it's almost a simultaneous event to a large degree. In vegetables, we are ahead of the industry. We've typically lead with our Del Monte brands business in those categories and we are ahead of pricing in that category.

Farha Aslam - Stephens Inc

Do you anticipate volume loss on the back of these price increases?

Rick Wolford

Typically with our price increases we've seen elasticity. Over the last four years now that we've taken pricing in our brands business, elasticity has been essentially as we have modeled. We would expect that that would continue as we look at the impact for this year. But that does not translate into a net sales loss as typically the higher net sales offsets the reduced volume which reflects elasticity.

Dave Meyers

It's incorporated in our projections for the balance of the year.

Rick Wolford

The calculus that we've used on that has been consistent and really, quite accurate, across all of our businesses -- pet and consumer – historically, as we expect to be going forward.

Farha Aslam - Stephens Inc

Now both of those are pack businesses so you've already packed your volume and so when you raise your pricing, do you anticipate getting stuck with extra volume that you will have to promote against?

Rick Wolford

No, we don't anticipate any inventory issues at all with our business and in terms of our expectations for a variety of reasons, not the least of which we have a number of different channels that we can turn to for sales. Actually, we're continuing to manage our inventories extremely aggressively and we are on target to deliver our $50 million goal in our continuous businesses.

So we're looking very aggressively at our inventories across the business pack and continuous to say we are on track to hit that reduction target in continuous. A lot of this has been facilitated by our transformation initiatives, which have given us a much better connect with our supply chain and our customer base. These are the kinds of efficiency improvements that we would expect we'll continue to realize going forward.

Operator

Your next question comes from Zafar Nazim – JP Morgan.

Zafar Nazim – JP Morgan

Can you address the balance between debt paydown and stock repurchase going forward? Historically you've been focused primarily on debt paydown but with this $200 million share authorization, how should we view deployment of free cash flow?

Rick Wolford

What we've said is that of the $200 million program, we will do about one-third in each of the years. The balance of that we would expect, obviously, to pay our dividend and to pay debt down.

Zafar Nazim – JP Morgan

S&W sale, how much cash proceeds do you expect to get from that?

Rick Wolford

Approximately $10 million.

Operator

Your next question comes from Robert Moskow - Credit Suisse.

Robert Moskow - Credit Suisse

You're keeping your cash flow guidance the same for this year but you are lowering your earnings guidance. I can't remember if this is the first or second time that you lowered earnings guidance this year.

What makes you confident that the cash flow guidance can be maintained here? Does this have any kind of ramifications for your cash flow guidance going forward into fiscal '09?

Dave Meyers

The reason we're able to maintain guidance is the continued impact and efforts we're putting into working capital improvement. Rick mentioned it earlier about transformation, we're actually over delivering the cash flow from the inventory reduction on the continuous in transformation in excess of $10 million and we continue to focus on those areas. We are quite confident in our ability to deliver the $180 million to $200 million in cash flow this year and we're quite confident as we go forward that will increase over $200 million, as we've said.

Robert Moskow - Credit Suisse

Some of your peers in the packs food industry that are similar to you have initiative high dividend yield, maybe some increased debt leverage types of business models. But you guys, I mean, you do have pretty aggressive sales growth goals that you're investing in and a lot of the investments you're making aren't necessarily capacity but they seem to be more for cost savings, which I guess is good.

Given that we haven't seen much growth in the past couple of years on the earnings line and the cash flow has been a little disappointing, and maybe just stable and flat, have you considered moving to a high dividend yield model and is there anything that would make you think about that?

Rick Wolford

I think when we look at our strategy going forward, Rob, we continue with the discussions and the strategy that we've talked about in our various investor meetings. I think when we look at our cash flow, we believe it is generally higher than most of the mid caps and that our share repurchase provides some benefits compared to our dividend as well.

So when we look at our long-term strategy, we are still looking at the business the way we have before. We have been able to grow top line pretty effectively over the last four years. We have had flat EPS which we understand is a major issue and that is reflecting the cost problems that we've had.

However, we do believe that as we look at where we are in fiscal '08 and look at our long-term guidance, we believe that the guidance that we provided we will maintain in terms of top line and EPS and we believe we can deliver a continued growth at top line and we believe that we can achieve the operating income margins that we've outlined as well.

Along with that would be a growing cash flow. So we do believe that there is a significant opportunity for Del Monte pursuing our strategy and we are planning to continue to do so.

Dave Meyers

Just talking to the cash flow specifically, this year and last year you know that we've had two significant events; our transformation project and obviously we funded some of our unfunded pension plan this year. Absent those in '07 and '08, we would be significantly above $200 million. We think our cash flow is substantial and will continue at that level as we go forward.

Operator

Your next question comes from Ken Goldman - Bear Stearns.

Ken Goldman - Bear Stearns

My question is on financial forecasting. I've sort of lost track of how many times guidance has been taken down in the last 12 months. I don't mean to be too blunt, but if you are an investor, why would we believe that your guidance going forward is accurate given that it hasn't been accurate so far in the last year?

Rick Wolford

A couple of points. The first one I would make would be that at our last quarterly call, we indicated that we would be at the low range of the guidance that we had provided and as we said today, we're going to go ahead and drop guidance given the cost factors that have impacted the business.

Cost factors that have impacted the business are unrelated to the drivers that we have control of and in fact, the drivers we control -- our top line, our performance in the marketplace -- are all trending as we expected them to trend. But what we are recognizing with this change in guidance is an unexpected performance in seafood which reflects the commodity costs and catch rates of fish and the commodity run up in diesel as well as fats and oils. Those are external costs.

You always could make an argument that we should make provisions for costs well in excess of historic levels, but determining where that line is drawn above historical levels and above the best information we have is a significant challenge.

So we've made these estimates based on the best estimate we have of commodity conditions. The changes we're making to the guidance today reflects commodity changes in those markets; not something that we have immediate or direct control over.

Ken Goldman - Bear Stearns

That make sense. I think some clients I've talked to, some investors may be concerned that your hedging programs aren't as vigorous or strong enough as other companies. But I will move it onto the next question.

Rick Wolford

Just before you leave it, We believe we've got a pretty good hedging program in place. I would make the point that the cost increases have caused us to drop our guidance for this year are in markets that are essentially not hedgeable. That probably is not a consideration from that perspective.

I certainly understand people's concern about these costs having gotten beyond the ranges that we had forecasted but the fact is we have taken substantial steps to offset costs which in fact are even further beyond the range that we had anticipated, and we've offset a portion of those to get to the flat performance that we are reporting today in terms of guidance.

Dave Meyers

It's even simpler than that. Our original cost estimate was $110 million. We are now at $170 million, a $60 million variance. It is basically in fish, fats and oils. Those are the three areas that are unhedgeable and those are the three areas that we've incurred the incremental costs in. So it is very specific, very limited.

Ken Goldman - Bear Stearns

Hoping for an update on some of the new products we saw this summer, they looked pretty good at the time, Chillers, Harvest Selection and pet. Can you tell us which ones are doing better or worse than you expected?

Rick Wolford

Sure. Starting with our consumer business we are really pretty pleased with where we are with our Chillers, our no sugar added fruit products in single-serve are working as we had hoped they would. We are very pleased with that progress. The Chillers themselves are driving a share going close to 3%, closer to 4% in terms of its share of market. For a new product, that is I think a pretty reasonable performance. At the same time, our no sugar added which is an extension of our single-serve has been very successful.

In our naturals business, we also are seeing significant success with new flavors that we brought into that part of our consumer business. We're really quite pleased with those that we've introduced. When we look at the market testing that we're doing with Harvest Selection, that is still in market test and we will be reading that. So generally speaking, we are quite pleased with what we are doing in our consumer business.

When you look at our pet business, here we are pretty pleased with the success we've had with Meow Mix, our Market Select lines are working quite well and as I mentioned earlier, our 9Lives Daily Essentials are also working very well in the food business. So we are pleased with that. Our Steak Chews are off to a satisfactory start using the Milk Bone brand. As I mentioned, this coming January we will be introducing a broad array of new items that we're also very pleased with in pet.

So generally speaking in both pet and consumer, we are pleased broadly and we have some specific product lines that we believe are doing really quite well in terms of augmenting our performance in the marketplace.

As we said at the top of the presentation, new products is a big driver of our 5% top line growth. We recognize that 5% is somewhat below our guidance for the quarter; however, it is a strong number in a consumer packaged foods industry and we expect our numbers, we said in Q3 and for the full year, to be within the range that we've talked about which is 5% to 7% in terms of our top line. A big driver of that is innovation.

Just to amplify one more point on that, as we said before, one of the reasons that we are quite pleased with what we are doing with innovation in the marketplace and we believe it is important for the business health long term, is that if you look at something like the single-serve category and our Chiller product, that really drives our merchandising capability and our competitive strength both with our customer and our consumer.

When you look at new products with our Fruit Naturals, it drives an expanded presence in the packaged produce section of our retail customers, a very important contribution to the long-term growth of our business.

When you look at our pet snack and pet food categories, these are increasingly more complex areas for innovation and again, here innovation is playing a very important role in improving our competitiveness and the profile of our brands in those markets.

So we are pleased with where we are right now with innovation.

Operator

Your next question comes from Reza Vahabzadeh - Lehman Brothers.

Reza Vahabzadeh - Lehman Brothers

If fat and oil prices, as well as the tuna costs, stay exactly where they are right now give or take, with your pricing actions when will you catch up from a pricing standpoint versus the higher cost? Will it be sometime in the first part of fiscal '09 or will it be in the last quarter of fiscal '08?

Dave Meyers

Ex-tuna, we would catch up in FY09. Tuna, as you know, with the elasticity in that category, it is very difficult to take price.

Reza Vahabzadeh - Lehman Brothers

Okay on tuna you will catch up in the first or second quarter of '09?

Dave Meyers

No, if tuna prices stay as high as they have been over the last 12 months, we won't be able to catch up.

Rick Wolford

As we said, the tuna business, you've got 50% of your cost base for Chunk Lite halves is skipjack. The historic highs that the purchase price reflect in our cost structure is way beyond the range that this category has seen and the consumer and our customers have seen over the history of the business. That need to move to a quantumly different price point, compounded with the high price elasticity that the category exhibits within normal ranges, preclude your ability to price fully for tuna.

However, when you look over the last four years of our business, we have been able to combine cost increases and cost savings and pricing actions which have really largely mitigated the cost increases we've realized across our company with the exception of StarKist.

So we have over the last four years been able to offset the cost increases we've seen with a combination of cost reduction, price increase activity; unable to do that in StarKist and we anticipate that we would be able to continue that performance as we see the pet business and the category priced to meet the cost challenges we have right now in that business.

Reza Vahabzadeh - Lehman Brothers

I'm sorry, I didn't catch your answer on the fat and oils. Can you catch up on that?

Rick Wolford

The fats and oils is the ingredient cost that is driving the pet margin decline. It's a cost for everybody in the industry and it is a cost which, as we said before, we would expect the industry to price for broadly.

Reza Vahabzadeh - Lehman Brothers

Have you seen any evidence of that pricing in pet yet for that?

Rick Wolford

Well, that is something we probably really wouldn't want to discuss publicly, but we clearly are paying very close attention to it and would have at this point no reason to believe that the industry would not follow historic practices.

Reza Vahabzadeh - Lehman Brothers

Will you have meaningful restructuring and transformation VIP type expenses in fiscal '09? An early view of it?

Dave Meyers

We should complete our transformation projects at the end of this year, FY08.

Operator

Your next question comes from Eric Katzman - Deutsche Bank.

Eric Katzman - Deutsche Bank

Rick, in this environment, we're not going to save our way to prosperity with the costs going up as much as they are. So that kind of forces you to drive top line. Despite the acquisitions, despite the project brand, the company has had, at times, difficulty with the pricing versus the elasticity and getting the volume growth as much as you want, net of elasticity.

More broadly speaking from a management perspective, do you think that you need to have a more decentralized kind of approach to allow the brand managers to try more stuff and get more product out there to get the top line moving? Because if there is one concern that I've heard, it is that the way you have the company structured at the moment is that it's a very centralized business model.

Rick Wolford

Eric, thank you for the comments and the question. I would start with a little different view of the top line. I would look at this year with 6% top line growth or forecast of 5% to 7% and I would look at the last couple of years and I would say that our top line has been a pretty robust top line performance. We've been able to do that with pricing, with volume and importantly, really driven by innovation. We've been able to do that and maintain our shares across our business.

So there is a lot of speculation about our company's top line in terms of can you take pricing in the brands’ business, can you take pricing in your consumer business? What about your pricing and your competitive position in pet?

I would say that over four years we taken extensive pricing, averaged about 3% across the board every year. Today, we are looking as you've seen in Q2, some pretty strong and healthy share performance.

I would look at top line and say we have done and we feel pretty good about where we are with top line. I would say that our biggest challenge clearly has been the cost issues that we have experienced. This year, as we said, we had very specific areas of cost challenges that we've outlined.

So when I look at our challenges, we can't save our way to prosperity. You are completely right on that. You do however have to keep chipping away at every cost potential you can and that is fundamental to the way we run our business.

At the same time, we've got to grow our top line to be healthy and I completely agree with you on that. That’s why I look at 6% this year in light of all the challenges that we've had, including the pricing, including the bottom line challenges and I say we are still moving there.

When I look at our long-term guidance which we believe is a good, long-term model -- we've got our top line of 3% to 5%, and our bottom line at 5% to 7% and we are exceeding that this year. So when you are looking at long-term at top line of 3% to 5% and a bottom line at 7% to 9%, we believe we can deliver against those goals. So we look at it from that perspective.

In terms of the structure of the business, I would be responsive in a couple of ways. One, at least from our point of view, Eric, we are really quite decentralized. We have our consumer business and our pet business. The two fellows that run that, Apu Mody in Consumer and Jeff Watters in pet, have a very, very strong and autonomous view as to where they want to take their businesses. I would say that where they've taken them has been pretty successful if you look at our top line, if you look at our performance, if you look at our innovation performance and if you look at what we shared with investors last investors day.

The one area that possibly you might be referencing in terms of centralized could be in our operations and supply chain which is centralized. We've done that purposefully along the model that it is not uncommon in the industry and one that we have had some good, outside people help us develop.

That centralized operations supply chain has driven huge savings for us. We've taken 15 million miles out of our supply chain mileage of delivering product. You can't do that if you don't have a strong centralized operation that leverages scale. We've taken costs out across our operations which again is a benefit of centralizing our production and we've taken over $50 million out of inventory levels, broadly, which is a collective process of that centralized activity.

When I look at our businesses and the structure, I see our pet and our consumer businesses being led by two very focused, independent, capable teams. I see that being supported by an operations supply chain group that has delivered significant savings -- remarkable savings, I think -- in light of the challenges we've had. And I look at those two businesses being supported by a centralized sale force that again has been structured to leverage our scale. As you know, we have I think 70% of our sales is covered by specific teams with which we have specific consumer and pet expertise.

We believe that we've been able to match the independence and the autonomy of our BUs with a centralized activity that leverages the scale that has given us an ability to deal with the cost environments that we've had.

Operator

Your next question comes from Ann Gurkin - Davenport.

Ann Gurkin - Davenport & Co.

I wanted to get more detail on sales by the pet channel. Was there any area that did better than you expected or were slightly behind expectations in terms of snacks and pet food product sales in various channels?

Rick Wolford

For our business this year, overall we did pretty well in all categories as we grew share in seven out of eight categories on an all-outlet basis. When we look at our individual channels, the pet specialty channel right now is a little softer than it has been historically, largely reflecting recovery from the recall. But as our customers there have indicated publicly, they see the long-term health of that channel continuing to be robust.

At Wal-Mart, it is one of their lead categories in terms of the overall business and we've seen good health there in terms of what they expect. Grocery generally is continuing with pretty solid performance. However, you are tending to see the consumer move from the grocery channel to grocery mass to the non-major channels, which include Wal-Mart, specialty and club, as just a general trend in the industry.

Operator

Your next question comes from Eric Serotta - Merrill Lynch.

Eric Serotta - Merrill Lynch

Rick, in the past you've spoken about how you guys are typically price followers in the pet business and price leaders in most portions of consumer; not all. Looking at the pet pricing in particular from the industry, are you guys surprised that some of your larger, certainly very astute, competitors haven't taken more price to date or haven't taken pricing more quickly in response to the commodity environment?

You mentioned a couple of times an expectation that you will return to normal seasonal patterns of price increases in the fiscal first quarter, but it seems like we're in a pretty abnormal cost environment now. Why haven't the big players or the larger players acted more quickly, in your view?

Rick Wolford

In an aggressively defensive manner, I would say there is one big guy and there's a couple of us others. We feel that while certainly one competitor is a very large competitor comparatively, after that we all have pretty satisfactory scale.

In terms of the pricing itself, historically pricing has taken place in this industry in the first quarter of the calendar year. Historically, we've not really seen two pricing actions in the same year. We see a pattern this year that we would hope is the same pattern that we've seen historically. That is what we would hope and expect to see in terms of the pet industry this year.

Eric Serotta - Merrill Lynch

Lastly on tuna, you've spoken a lot in the past about the increase in skipjack prices that you've been seeing as being more cyclical than secular. Yet again this quarter you saw a nice pickup in fishing conditions in the key fishing grounds that you guys are sourcing from. It looks like it was more than offset by continued poor conditions in other fishing grounds, which from research I've seen there is at least some debate as to whether they are depleted or becoming depleted or over fished.

Could you address in that context of not just your fishing grounds but the impact the global fishing conditions are having? Is it still realistic to think that tuna prices we are seeing are cyclical and there is not a secular element to it?

Rick Wolford

A couple of things. The first point, I think, in terms of just the fisheries broadly, Eric and species performance; when we talk about the impact on our business we're talking about skipjack. Skipjack is abundant in virtually every fishery. You do have fisheries like Eastern Tropical Pacific that have seasonal fishing patterns. Those are established for species other than skipjack. So when you talk about species depletion or resource depletion, it becomes very species-dependent. The big eye and yellowfin in the Eastern Tropical, as I say, are fished right now at a maximum sustainable level and that is the reason why you do have seasonality imposed in fishing in the Eastern Tropical, as an example.

Skipjack is a different matter. Skipjack as a resource is considered to be more than satisfactory in supply in the Eastern, Western Tropical Pacific as well as the Indian Ocean.

Specifically, what has happened this time which is different from past circumstances is that all three fisheries for skipjack had extremely poor fishing conditions and very low catch rates. The Western Tropical Pacific has recovered to better than normal fishing conditions but unlike prior times, the other two fisheries have not returned to normal.

So as a result, the extreme tight skipjack supply that when all three fisheries were below normal catch rates has been followed by a return to normal in one but not the other two; the Indian Ocean and the Eastern Tropical Pacific. That has exacerbated the cost of tuna in the Bangkok market and that is what has driven pricing above a ten-year average.

Those are the conditions that are determining the cost of fish in terms of resource availability. I think that there is a concern for ongoing price levels with tuna and that is, you have to recognize that diesel costs at the higher levels will introduce a higher cost in the fishing industry. However, the levels of cost that we see right now, the levels of pricing that we see right now is far, far beyond that impact and really reflects the fishing conditions globally for skipjack.

Just by way of example, the skipjack fishery is 4 million tons a year and something like the albacore, which is a far more delicate resource, is only about 250,000 tons a year. So you are dealing with very, very different resource characteristics species to species.

Larry Bodner

Eric, we should probably wrap it up there and thanks for your call. That will wrap up our conference call for this quarter.

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