Del Monte Foods Company (DLM)

Q2 2009 Earnings Call

December 3, 2008 10:00 am ET

Executives

Richard Wolford – CEO

David Meyers – CFO

Larry Bodner - SVP

Analysts

Carla Casella – JPMorgan

Tim Ramey – D.A. Davidson

Robert Moskow – Credit Suisse

Erik Katzman – Deutsche Bank

Farha Aslam – Stephens Inc.

Reza Vahabzadeh – Barclays Capital

Ken Goldman – JPMorgan

Vincent Andrews - Morgan Stanley

Ann Gurkin – Davenport & Co.

Presentation

Operator

Welcome and thank you for joining Del Monte Foods Company second quarter fiscal 2009 earnings conference call. (Operator Instructions) Now I will turn the call over to Larry Bodner, Senior Vice President Finance, Investor Relations and Corporate Communications, Del Monte Foods.

Larry Bodner

Good morning everyone, thank you for joining us for Del Monte Foods fiscal 2009 second quarter conference call.

With me today are Richard Wolford, Del Monte’s Chairman and CEO, and David 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 and 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.

In October, 2008 the company completed the divestiture of its seafood business including StarKist. Unless otherwise specified all financial results discussed during today’s call relate to continuing operations only and therefore exclude StarKist.

The all outlets share data we will discuss today are internal estimates based on Nielson grocery share data and Nielson All Outlet panel data for the 13 weeks ended October 26, 2008. Additional All Outlet 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, Richard Wolford will take you through our results.

Richard Wolford

Thank you very much Larry and good morning everyone. I am pleased with Del Monte’s Q2 results. Overall we are tracking to expectations with greater then anticipated volume upside. Our results reflect a pricing and promotional strategy that’s working. Price points have moved up with corresponding elasticity and volume disruptions consistent with our expectations.

As a result our pricing actions combined with our productivity savings we’re able to offset costs a quarter ahead of our original expectations.

Looking at the categories in which we participate, we see positive trends overall. As a result of the current economic conditions we continue to see consumer migration towards value channels and an increased focus on buying on-deal and bigger package sizes.

Importantly our category trends indicate that people are eating more meals at home. Pet food trends remain largely unchanged and pet families are continuing to treat their pets.

We also saw an increase in private labels sales as consumers react to the current economic conditions and react to increased retailer activity. This private label increase was reflected largely in promotional volumes with some baseline gains as well, and was anticipated in our forecasts.

We are comfortable with the levels of private label performance in Q2 but of course we’ll continue to actively monitor this during the upcoming promotional season.

I’ll discuss this in more detail when I address our business unit performance. First I want to provide a brief update on our accelerated growth strategy targeted to grow our EPS performance over the coming years.

Our first of three strategic initiatives is to use pricing actions and productivity savings to essentially neutralize our cost inflation. In Q2 I am very pleased with the pricing and productivity actions more then offset operational cost inflation. We expect this trend not only to continue, but to accelerate.

Importantly we are on track to hit our pricing target of 3x the level of pricing taken last year. Productivity and transformation initiatives generated approximately $15 million of savings in Q2 and similar to pricing we remain on track with our plan and expect to deliver a total of approximately $50 million in annual savings.

Our second initiative is focused on margin expansion by unleashing the full potential of our core brands. Specifically we are increasing our investment against our core brands, we’re tightening the focus of our marketing spending, and we are driving innovation beyond business as usual.

Progress includes the upcoming launch of our Chillers Tubes which continues our innovation on Del Monte’s Chiller center-store fruit line.

Importantly as well, in pet snacks we have announced a major Pup-Peroni media campaign which is targeted to aggressively build trial and repeat of this leading snack brand.

Our third strategic objective is to drive packaged produce and pet products growth engines with category-building innovation and marketing. I am pleased with our progress to date. In our consumer packaged produce our grapefruit citrus bowls were launched on time with customer acceptance ahead of plan.

We more recently launched SuperFruit which features cut fruit packed in nutrient-rich fruit juices.

With our pet business we have launched both the Meow Mix Think Like A Cat Game Show and Milk-Bone’s 100-year anniversary campaign. Both have received a very positive response.

To ensure successful execution of these strategic initiatives we have implemented three support actions; increased marketing investment, further increasing the marketing-centric focus of our organization, and upgrading of our portfolio.

Looking first at marketing, our strategic commitment to drive ongoing EPS growth required increased marketing investment which we initially expected to expand by about 20% year-over-year. This heightened marketing investment has demonstrated very positive potential and good progress.

To date we see additional opportunities in our packaged produce business as well as specific pet snack brands. Correspondingly we intend to further increase our F09 marketing investment and will now target year-over-year spending increase in the low to mid 30% range.

We believe this investment will drive momentum through fiscal 2009 as well as into fiscal 2010.

The organizational structure to drive marketing execution is in place. We have centralized marketing in San Francisco under a unified CMO leadership. All our key marketing positions are filled and the relocation of the marketing function to San Francisco is now essentially complete.

Importantly we are beginning to realize the benefits that we had anticipated as a result of this change.

Streamlining our portfolio around strong brands with cost structures consistent with a consumer brand based strategy has been a core strategic objective. The StarKist divestiture is a major milestone achieving that goal and reduces the volatility of our cost structure.

Given the current financial market conditions we are pleased that we have been able to close that transaction as expected in Q2. Going forward we are now executing the operating services agreement and supporting StarKist and its new owner, Dongwon.

In summary I believe that we are making good progress against our accelerated growth strategy and are pursuing the right steps to deliver higher ongoing EPS performance.

Now let me turn back to Q2, Del Monte’s strong top line performance was largely driven by pricing actions and new products across both consumer and pet. With our pricing actions we anticipated elasticity-driven volume declines and a lower Q2 volume was largely consistent with those projections.

Our Q2 EPS was $0.14 compared to a prior year of $0.13. Margins while still down year-over-year are showing improvement on a sequential basis. This reflects a 10% increase in year-over-year costs which was more then offset by our pricing and cost reduction actions.

It also includes the investment that we are making to support our growth strategy. Looking to the back half, the pricing versus cost dynamic is expected to continue to improve. We anticipate that pricing actions and productivity savings will fully offset the second half 2009 cost increases.

The 10% cost increase primarily reflects the higher year-over-year ingredient and raw products cost similar to those we described in Q1. While most commodity and ingredient costs have recently declined from the historic highs reached earlier this year, they remained elevated when compared to the prior three years.

Raw product costs remain significantly above last year, we also had higher logistics and tin plate packaging.

Now I’ll run through consumer and the pet business unit performance. Let me start with consumer, overall we are pleased with the performance of our consumer business with net sales up 6% and operating income up 4%.

The Q2 net sales reflect aggressive pricing actions with Del Monte as the price leader and with new products. Consistent with our pricing actions overall, we have experienced expected elasticity driven volume declines.

As well we have altered our promotional strategy to reflect the higher price levels required in our categories. As anticipated we did experience reduced volume primarily promotional volume, during the quarter.

This combined with aggressive Q2 private label promotional activity and very high prior year comparative shares, lowered our Q2 share performance. Over the next few quarters we expect and upward migration in overall category pricing reflecting the higher costs that have been experienced by all players.

We anticipate branded and private label category shares to trend back to more normalized levels in the back half of fiscal 2009 as private label price points become reflected on shelves and promotional activities better reflect the higher base pricing in the categories.

Generally in our consumer categories on an all outlet basis, we saw a migration to value channels and the positive effect of more consumers eating at home. Del Monte’s strong distribution base serves all retail channels including value channels.

The 4% increase in consumer operating income reflects pricing actions ahead of operational cost increases. Cost increases were primarily from raw products, driven by vegetables due to ethanol-related crop competition, higher logistics costs, and higher packaging costs.

Now let me turn to pet products, similar to consumer products we are also pleased with the top line performance of our pet business. Q2 top line grew 19%. Operating income increased 3% as a benefit from the strong top line was essentially offset by the higher cost levels.

Also similar to consumer Q2 pet’s net sales reflect aggressive pricing actions and new products. Unlike consumer we did experience an overall increase in volume even with the elasticity impact from the pricing actions driven largely by the dry pet performance.

In pet food we are pleased with our dry pet food performance, in dry dog we’re seeing the growth benefits of strategies that we have previously implemented. In dry cat sales reflect share growth in value channels behind the improved product positioning and a migration to larger sizes.

In pet snacks, sales were up with Pup-Peroni and Milk-Bone shares essentially flat. However overall pet snack sales were below the growth rate of the category primarily due to the performance of our secondary brands.

As I mentioned previously we plan to invest to improve this dynamic in this high margin category.

Looking at our pet categories, they are generally healthy. On a dollar basis both food and snack categories were up materially reflecting the significant pricing which is taken by all category players. We are seeing consumers continue to indulge their pets despite the economic crisis.

The 3% increase in pet operating income reflects costs offset by the positive impact of the top line. Cost increases were primarily from ingredient costs. Now I’ll turn it over to David.

David Meyers

Thank you, in Q2 net sales exceeded our expectations primarily driven by results in tomatoes, vegetables, and dry pet food.

In tomatoes and vegetables, the categories performed better then expected as consumers seek value alternatives as part of the trend to increase the at home eating occasions. Dry pet food responded strongly to more favorable price gaps to competitive brands as well as consumer migration from grocery to value channels.

EPS from continuing operations of $0.14 is slightly favorable relative to our expectations. Our EPS results reflect the benefit of a lower tax rate which I will discuss later. We also realized a $0.02 EPS mark-to-market valuation loss primarily related to heating oil contracts that we utilize to hedge diesel costs.

This cost is reflected below operating income and does not appear in either operating segments.

In Q2 net sales growth of 11.5% was strong. Looking at Q2 top line drivers in greater detail, pricing increased net sales by 12.3 points which was partially offset by 6.3 points of pricing related volume elasticity.

New products contributed 3.4 points while existing product volume contributed 2.1 points. Gross margin for the quarter was 26%, a decrease of 110 basis points versus last year. Net pricing drove an 8.6 point increase however higher commodity and ingredient costs including grains, fats, oils, and meats, and other raw product increases drove a negative 8.3 points of margin contraction.

As expected the relationship of pricing versus cost has dramatically improved versus Q1 as we have continued to successfully implement pricing actions across the portfolio. In addition volume mix drove a 1.4-point reduction reducing the positive impact of our strong top line performance.

That mix was negatively impacted by consumer migration to purchasing larger size packages which tend to have a lower margin. In consumer products, while our higher margin cut tomato business was solid, we realized stronger growth in lower margin portions of the tomato business as well as lower volume in higher margin portions of our fruit business.

Q2 operating income increased 4% with operating margins decreasing 60 basis points. Operating income growth was driven by the $15 million increase in gross profit as very strong top line growth exceeded the impact of lower margins.

We also realized higher SG&A due to higher transportation related energy costs, as well as a strategic investment in marketing and our organization. The increases were partially offset by the absence of transformation expenses.

Interest expense in the quarter was $6 million lower, primarily driven by lower interest rates. During the second quarter we spent $21 million on capital projects versus $23 million a year ago. Capital spending would be higher year-over-year excluding the transformational investments in the year-ago period.

We incurred $25 million in depreciation and amortization costs which includes $2 million of fee amortization included in interest expense. On a year-to-date basis, cash flow, operating less investing was positive $30 million versus a negative $194 million a year ago.

This increase in cash flow was driven by the sale of the seafood business. As we have disclosed we have used approximately $300 million from the sale for reduction of our term loans. Excluding the impact of the seafood sale, adjusted cash flow on a year-to-date basis was negative $270 million versus a negative $194 million a year ago.

The decrease in adjusted cash flow is largely driven by higher inventory levels, primarily due to a larger vegetable pack in the consumer products business, and higher input costs across the portfolio which increases the value per case.

We also have higher prepaid assets reflecting approximately $40 million of additional commodity futures positions that we have taken for hedging purposes.

Now I’d like to discuss guidance for full year fiscal 2009. While we are maintaining our expected EPS from continuing operations range of $0.58 to $0.62 we are increasing our expectations that EPS will be at the midpoint rather than the lower end of the range.

The increase reflects an increase in net sales expectations, an increase in marketing investment, and a decrease in the tax rate.

Given our strong first half top line growth, we are increasing our expected net sales growth from previous expectations of 6% to 8%, to be 8% to 10%.

We are increasing our planned investment in year-over-year marketing spending from approximately 20% growth to approximately mid 30% growth. As Richard mentioned, the results from our year-to-date marketing investment have been very positive.

We have identified additional brand-building activities supported by proven media testing that we now plan to field in F09. These targets further increasing household penetration of produce, fruit, and certain pet snacks businesses where our brands enjoy high repeat purchases but relatively low household penetration.

We are also planning investments in additional market research and consumer testing to support additional expansion opportunities in F10 consistent with our growth strategy. Importantly we see this increase in investment as building business momentum heading into the second half of fiscal 2009 but more importantly, building the long-term health of key businesses into fiscal 2010 and beyond.

We are reducing our expected tax rate from 38% to 40% to 36% to 38% reflecting the extension of the favorable tax treatment for the Samoa operation as part of the Economic Stabilization Act of 2008. Consistent with GAAP all financial impacts resulting from tax regulation changes are captured in continuing operations.

Looking at cash flow we are maintaining our adjusted cash flow guidance at the lower end of the $150 million to $170 million range excluding the impact of the StarKist divestiture. The slide illustrates additional key guidance metrics including D&A and CapEx.

In looking at out cost buckets in greater detail, we are maintaining the $300 million in gross inflationary and other cost increases we discussed in our last conference call. This translates into a gross cost increase of approximately 12% on our approximate $2.5 billion operational cost base.

The benefit of this sudden pullback in commodities and energy will be limited this fiscal year as we were already 80% hedged for our fiscal year in August and are now over 90% hedged. As a result of our hedged positions and the sudden pullback in commodities and energy, our second quarter EPS includes a $0.02 mark-to-market loss.

As a reminder, hedgeable commodities represent approximately 15% of our operational costs. Overall we are very comfortable with our overall cost estimates on our $2.5 billion in operational cost this fiscal year.

Looking at our $300 million of cost increases in greater detail you can see that the changes are not significant across any of our cost buckets relative to our last estimate. In Q2 we realized the benefit of our aggressive pricing as pricing fully offset net cost increases for the full portfolio.

In consumer pricing exceeded cost increases while pet realized a lag due to timing of implementing pricing actions. Looking to the second half of our fiscal year we continue to expect that pricing will fully offset net cost increases which the vast majority of pricing action already reflected on the shelf.

Looking to Q3, we expect solid top line growth across both consumer and pet. Q3 is a key quarter for us given the importance of the holiday season on our business and one that we will be monitoring closely.

EPS is expected to benefit from our aggressive pricing actions as we anticipate that net cost pressure will be fully offset by our pricing. As discussed, we are expecting to significantly accelerate our marketing spending both relative to our recently completed second quarter of fiscal 2009 as well as prior year’s third quarter of fiscal 2008.

Overall we expect EPS to be below what we earned a year ago in Q3 driven by strategic investments in marketing. As a reminder in Q3 we will be lapping the prior year $10 million benefit from the sale of the S&W trademark and related assets in the Eastern Hemisphere.

Given the recent volatility in the financial markets I also wanted to update you on our liquidity and capital structure. First we are comfortable with our overall capital structure as well as liquidity. We are comfortable with the funding status of our $450 million revolver which has good diversification with over 60 lenders.

Consistent with previous fiscal years our revolver peaked toward the end of our [pack] season this year in October at around $300 million. We anticipate that the balance will decline to zero at the end of our fiscal year.

Looking at our long-term debt we currently have approximately $1.6 billion outstanding with roughly 70% fixed and 30% variable with an average interest rate of approximately 6.5% at current LIBOR levels.

Our bank debt instruments mature beginning in early calendar 2011 therefore we expect to complete a refinancing in the next 18 to 24 months. Accordingly we continue to monitor the financial markets and expect to enter the markets when it appears appropriate to do so.

We have two main covenants, a fixed charge and leverage ratio. Given that we used the approximate $300 million of net proceeds from the StarKist divestiture to pay down term A and B long-term debt, we believe we have more then adequate coverage with each of our covenants.

As is typical we tap our revolver to fund our [pack] season requirements. Our targeted leverage is 3x to 3.5x debt to EBITDA. We expect to finish up F09 with a debt to EBITDA ratio of roughly 3.5x which we are very comfortable with given the consistently strong cash flow generation of our business.

Many of you have also asked about the status of our pension, at the end of fiscal 2008 our pension plan had approximately $340 million in assets and was approximately 88% funded. The asset allocation was approximately 52% equity, 48% fixed income, and other investments.

Our overall asset performance from December 31, 2007 through October 31, 2008 has been approximately negative 22%. The impact of the plan asset performance on our fiscal 2009 financial results is not expected to be significant relevant to our guidance of either EPS or cash flow.

Looking to fiscal 2010 we estimate that if our overall asset level at the October 31, 2008 remains at roughly the same level through the end of the calendar 2008 year, our cash flow funding impact would grow by roughly $20 million above fiscal 2009 levels.

Similarly if our asset level remains at the same level at the end of fiscal 2009 the F10 EPS impact would be approximately $0.03 above F09 levels.

Clearly the volatility of the financial markets is likely to change the magnitude of these estimates. We will provide you an update towards the end of our fiscal year.

To conclude, we feel good about our top line, our marketing investments, and our ability to deliver the midpoint of our guidance range. We also are comfortable with our capital structure and liquidity. With that I’ll turn it back to Richard.

Richard Wolford

Thank you David, in closing I am pleased with our company’s quarterly performance, particularly the strength of our top line. Our results reflect the fact that we are seeing increased benefit from our pricing actions with volume coming in better then we had anticipated.

As a result we were able to offset continued cost increases in Q2 with pricing and productivity. Our accelerated growth plan is critical to future earnings and we are making solid progress so far.

We remain focused on combating cost increases with pricing actions and productivity gains and as well, driving our core brands and key growth engines. Compared to a year ago, we have increased marketing investment and as well have upgraded our portfolio with the StarKist divestiture.

And importantly we have also largely completed the steps needed to further focus Del Monte as a more marketing-centric organization. The combination of these strategic efforts is expected to drive long-term sustainable EPS growth for the company and for its shareholders.

With that we would like to take any questions that you might have and thanks for joining us.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Carla Casella – JPMorgan

Carla Casella – JPMorgan

One clarification, on your bank side did you say how much was available under your revolver at the end of the quarter?

Richard Wolford

No I didn’t, we have a $450 million revolver. We had approximately $300 million in usage.

Carla Casella – JPMorgan

And there’s no letters of credit?

Richard Wolford

And we have about $75 million in letters of credit. So we have more then ample cushion.

Carla Casella – JPMorgan

And that was your seasonal peak, so it should start coming down from that?

Richard Wolford

Exactly.

Carla Casella – JPMorgan

On the term loan that we repaid with StarKist proceeds, was that pro rata between the term loan A and B?

Richard Wolford

Yes.

Carla Casella – JPMorgan

How much of your business right now is private label and do you see that percentage changing?

Richard Wolford

We have a little bit less then 10% of our business is private label and we do not really anticipate that changing greatly. We are not aggressively pursuing that business. We have specific arrangements with specific customers that are more of a partnership-base driven private label business and the focus of our company really is against branded strategy and branded growth.

We divested, we made this decision I guess three years ago when we elected to divest our private label [soup] business and focus the company on branded growth and correspondingly that’s one reason why we centralized our marketing organization, built it stronger, and moved our pet out here to California and have a new CMO leadership structure that I think is driving some of this branded growth that we’re seeing.

Operator

Your next question comes from the line of Tim Ramey – D.A. Davidson

Tim Ramey – D.A. Davidson

I was wondering if you could tell us a little bit more about the increased commitment to marketing. You talked about it in percentage terms but is this trade spending? Is this consumer directed advertising, is it merchandising? What exactly are we looking at here?

Richard Wolford

No its not trade spending. As we announced at the beginning of this year we have substantially changed our commitment to supporting our brands this year and the increase year-over-year is a consumer spend. When we look at the back half you’ll see substantially higher spending then in the first half. That reflects (a) the fact that we now have our organization together in one location and leadership in place that’s able to provide I think much more effective control of our spending.

You’ll see that spending against two major strategic objectives of ours. One is to drive our pet snack business which as you know is a high margin business and there we are going to be investing in Pup-Peroni which is a brand that’s got a lot of potential that we haven’t supported as aggressively as we’d like to in the future.

It’s a high margin business with good opportunity and the second area that we’ll be focusing our increased spending on will be packaged produce where we believe there’s a substantial unmet consumer need for shelf-stable products in the produce aisle and here we have a very significant benefit which tends to be true with our pet snacks as well.

And that is that we have very high repeat but relatively low household penetration particularly in the produce area and our spending will be aimed at driving that household penetration with packaged produce and to some degree for our pet snack as well that’s true.

This will drive momentum for us this year but importantly it leads us into next year which we feel its important that we lay the foundation for as we work our way through fiscal 2009.

Tim Ramey – D.A. Davidson

The Samoa tax issue, what is the total impact of that either in the sense per share or in dollars for the full year, do you know what that might be?

David Meyers

It’s the approximate $0.02 that happened in the second quarter.

Tim Ramey – D.A. Davidson

So this is a one-off here?

David Meyers

Exactly.

Operator

Your next question comes from the line of Robert Moskow – Credit Suisse

Robert Moskow – Credit Suisse

I wanted to know about your commodity cost outlook, I know you can’t talk about fiscal 2010 yet but if you’re right and commodity costs are going to start falling and you’re still taking pricing in the second half of your fiscal 2009 the theory goes anyway that that would set you up for some margin expansion. Are you concerned that your pricing may not go through if retailers are pushing back because they see these commodity costs falling and are your competitors, are you taking pricing in line with your competitors or are you ahead of your competitors?

Richard Wolford

In terms of our pricing I think a very important point to make is we took pricing aggressively this year. We realized the kind of cost hit we were going to have in both our consumer and our pet business and that pricing as we announced earlier was going to be 3x the average taken for the prior year, actually the prior couple of years.

We took that pricing and its now largely in place so we don’t have additional pricing to deal with in terms of bringing new pricing initiatives to our customers. What we face now is, and in terms of the second part of your question, in terms of competitors in line, in the pet business we clearly have our competitors backing, in fact we’re tracking some of our competitors, but we are generally pricing at the same levels in our pet business.

In the consumer business we’re leading pricing there and we expect private label to move up and meet the levels, the increases in pricing that we have already established. Their cost structure is composed of the same factors as ours and we have seen as I have mentioned dramatic increases year-over-year in consumer in our raw products, vegetable, fruit, and tomatoes, as well as in packaging as well as in logistics.

We believe our supply chain, if anything is competitively favorable to the cost structure of our private label competitors and we believe that those manufacturers will have to raise their prices accordingly. For that to show up on the shelf it is a question of timing. You have two factors there. One is when the contracts are signed and when the higher pricing from manufacturer to customer takes place and the second is the customers’ own strategy in terms of private label pricing.

But eventually we expect as the category leader in fruit, vegetable, and tomato, to have pricing move up to the level that we have led to and we expect that as that happens, shares will tend to go back to normalized levels. We expect this to be a process which will take another couple of quarters but we are committed to maintaining the price leadership to ensure that the higher cost levels are met with higher pricing and that’s what our commitment is in our consumer business.

Operator

Your next question comes from the line of Erik Katzman – Deutsche Bank

Erik Katzman – Deutsche Bank

On the pet ownership, I guess its been a great category for many years but I keep hearing anecdotal evidence out of the southeast, even here in the northeast that consumers are unfortunately so pressured that they are giving up pets and so I’m wondering is it because you’re relatively low end that you are seeing some benefit versus the overall category. What do you think about that and then to kind of follow-up on Rob’s question, if private label doesn’t follow you on pricing in fruit, vegetables, tomato, can you give us a sense as to what that would mean given that you’ve I guess locked in higher prices with the growers that you have relationship with?

Richard Wolford

We have not seen any hard data that would indicate household pet ownership to be declining and so anecdotally we’ve heard about pets being left in foreclosed homes and that sort of thing, but we have not seen any data or seen any evidence with our customers that that really is a problem.

In terms of our products I don’t think I would consider our products low end frankly. I would say that our brands are mainstream and I think that the mainstream brands are benefitting from current economic conditions in the pet food category.

What we have seen in the pet food category, the food category, is we’ve seen a migration to (a) the value channels and (b) larger sizes with sales made on, focusing on deals as well, deal transactions as well.

When we look at our pet business we don’t see reduction in the market size with household, we see our pet food brands benefitting from their mainstream positioning and the positioning we’ve worked to put them in particularly our dry dog position, and we see our pet snack business and the category continuing to grow and that category growth I think continues to imply that you’ve got, that families are continuing to indulge and treat their pets.

So that’s kind of the way we would see the pet business, turning to private label and the implications of the pricing, all of our pricing actions over the last three to four years, have been leading actions and in all cases we’ve seen private label move up. We would expect that to be the case.

Their cost structure is the same as ours and we all have the same components of ingredients, distribution, and packaging. We believe that our costs tend to be, our cost structure tends to be more competitive, and as a result we think we probably do a better job dealing with the higher cost levels.

We all tend to pay the same price to our growers. In fact there is industry pricing for fruit and tomatoes and there is a little bit more competitiveness in the vegetable business but there again we would believe this year we actually end up with prices that were certainly comparable and we would believe favorable.

We expect the reality of the private label manufacturers’ cost structure to require them to move up and we would expect the category to move up accordingly and consistent with historic trends.

Operator

Your next question comes from the line of Farha Aslam – Stephens Inc.

Farha Aslam – Stephens Inc.

Given that consumer purchasing habits are changing so quickly, could you share with us volume flows through your businesses in July, September, October, and how they’re trending in November and particularly starting with pet snacks. Was pet snack volume particularly strong in July versus October, November?

Richard Wolford

We wouldn’t really be able to answer you on a monthly basis here on this call candidly. When we do look at volumes I can tell you on a quarterly basis our pet food, our dry dog, on a quarterly basis dry dog as a category on all outlet basis is actually up a bit, wet dog is down, overall dry dog is essentially flat on a category basis.

The same tends to be true in the cat food business where you have people migrating for convenience as well as economy. In the pet snack business as I said we don’t track volume there. Its largely measured in dollars and there the category is up significantly year-over-year in the last quarter as well as the last 52 weeks.

As I said, our shares there, we’re pleased with, in the snack business, pleased with our Milk-Bone and Pup-Peroni shares which held categories and show very strong dollar growth but our secondary brands is an area we have to work on and that’s what we’re working on.

But overall the pet snack category was up 5%. If you look at volume trends in our consumer business, there in the last 13 weeks, fruit is down slightly, the category on an all outlet basis and a volume basis is down about 5% and that’s a number that we expected to take place with the higher pricing and that is consistent with the historical experience that we have had. I think that, and is actually slightly favorable to what we had expected.

In terms of vegetables, there actually has been a, particularly core vegetable, there’s actually been an improvement in the rate of decline. That’s a category that on a volume basis has been declining as compared to a dollar basis where it has been increasing on a dollar basis, the vegetable category increased, core vegetable increased 11% and is doing much better in dollar basis, then we expected.

That we think largely reflects eating at home and the tomato category overall which truly reflects more meals at home given the versatility of our cut and other tomato products is up significantly on a volume basis, more or less 7% the last 13 weeks, with cuts that has been a margin business for us up 11% and our dollar volume is up significantly more then that at 17% over the last quarter.

So generally speaking as we said earlier, we’re pleased with our volumes and actually in pet they actually went up and in the consumer the anticipated elasticity for our brands and for the category were really less then what we had expected and in some part offset by the positive category trends for eating at home.

I think the core question for us as I mentioned earlier over the next couple of quarters is for us to maintain the pricing leadership that we have traditionally held and that comes back to making sure that we hold our ground on the promotion volumes and promotional activities; we intend to do that.

And as a result we expect to see in our consumer business some share differences, some share, we expect share performance to reflect our moving, our maintaining our position in the promotional activity but we do believe that private label will track on up as they always have.

Operator

Your next question comes from the line of Reza Vahabzadeh – Barclays Capital

Reza Vahabzadeh – Barclays Capital

On the marketing spending that you incurring here in the fiscal third quarter, do you anticipate a flow-through to profitability down the road perhaps in calendar 2010 and is there any sense of timing of that because obviously it is an [outsize] increase in marketing spending?

Richard Wolford

Two things, what we’re doing we believe, is moving marketing up to a more healthy level to support our branded business. That was something that we talked about with our accelerated growth plan strategy and that was a commitment we made to ensure that we can build growth not only in 2009 but in future years.

When we look at the increased spending it is particularly, specifically targeted against higher margin higher growth categories. I would point you to our commitments and our significant spend against Pup-Peroni which will increase its awareness and its trial.

Again this is a product where we have a great product advantage in terms of comparative palatability but we don’t have the same household awareness that one of our competitors have. So as we move that up we expect to see significant build of our pet snack business and that is a significantly higher margin business in our portfolio.

We’re investing marketing against our packaged produce business which again has good growth potential, high margin potential, and that also is a product that got tremendous repeat but low household penetration and the combination of that, those are both representative of the kind of benefits that we think we will get with the increased marketing.

We also are spending against our core business to ensure that that is healthy and as a result we believe is help to support the additional pricing we’ve taken which eventually will find its way into moving our margins back up to traditional levels with what our objective is.

Operator

Your next question comes from the line of Ken Goldman – JPMorgan

Ken Goldman – JPMorgan

On your channel mix, an investor reminded me this week that about six months ago you reported in the K, that you were over 30% of your sales I believe are through Wal-Mart and Sam’s Club, and its my understanding that that’s sort of a limit for where in general Wal-Mart and Sam’s Club together want any particular manufacturer to be. So I’m wondering if you can talk about how you are right now with Wal-Mart and Sam’s Club, whether those sales through those channels as a percent of your total sales have gone up, and whether you’re getting any kind of, or having any kind of discussions with them about your channel mix.

Richard Wolford

Firstly there is no, we’re unaware of any customer limits being imposed by Wal-Mart. We’re pleased to be one of Wal-Mart’s important customers and its afforded us a good opportunity to work in partnership with them in a number of programs.

They are a, and so from that standpoint our interaction with Wal-Mart has been a very productive customer interaction. Frankly I would say our interaction with almost all of our customers has been very positive as we try to lead our categories to a more profitable overall performance for our customers.

In regards to our weight at 30% that is heavily impacted by two factors. The primary one is that we do private label for them and that is one of the few retail partners that we do participate with in providing some private label. So that is a non-branded and if you will, I would say somewhat different component of that 30% then the branded business.

We do that in both consumer and pet. The other component of our overall company mix with Wal-Mart is pet. Wal-Mart has a significantly higher US retail share in pet then they do in consumer product over food products and to the extent that we have a very healthy pet business with them, that also tends to increase our weight with them.

If you look at our consumer products those on a branded basis particularly, those tend to be pretty much in line with the category.

Operator

Your next question comes from the line of Vincent Andrews - Morgan Stanley

Vincent Andrews - Morgan Stanley

On vegetable costs, I’m just wondering if you could provide a little bit of color there, what you’re seeing in terms of vegetable costs.

Richard Wolford

Our vegetable costs were up significantly year-over-year. In that business we entered into a contract in sometime around December, I guess January, February, and that was set last year as commodity costs were increasing as the ethanol-driven demand for corn was increasing and competitive bidding for acreage in the Midwest was the hottest it had been in a number of years.

The increase that we had in costs there were substantially higher then in prior years and that is reflected in our numbers today. We will begin negotiating for next year in the next couple of months but the costs for this year are already in place.

The cost increased last year for vegetables on a double-digit basis.

Operator

Your final question comes from the line of Ann Gurkin – Davenport & Co.

Ann Gurkin – Davenport & Co.

I’d like an update on two things, one if we can get an update on I guess you call it your customer teams, your sales teams and what kind of impact that’s having on your top line growth and secondly as you move into the packaged fruit segment for the next 12 months, have you locked in all of your fruit needs or are any of those needs outstanding?

Richard Wolford

No, with our fruit we’ve, as I say with all of our consumer businesses, we lock in, we enter into annual contracts for the [pack], and so that is in place, that is now in place. In terms of the, our sales teams specifically, our head of sales would claim that’s absolutely true and I would have to agree with him on that although there are a lot of things we don’t always agree on.

I think seriously, our sales teams have done a very good job. We have some very, very professional folks leading our activities against all of our major markets, all of our major customers and that has I think really moved our company into a much more consistent partnership.

We were once again recognized as Category Manager of the Year which is I think the eighth year that we have received that award. That kind of thought leadership in consumer has been [inaudible] to driving long-term relationships with our customers and the customer teams have taken it to another level.

We are taking that same kind of category management to our pet aisle business both snacks and food. We think there’s an opportunity there. We don’t think its been developed to the same extent that we’ve seen in developed in consumer and we think as a result that that will also provide us benefit downstream.

I think one other organizational impact on our performance that we would hope to continue to see very positive and increasingly positive impact, is the structural realignment that we announced a couple of quarters ago. As I mentioned in the prepared comments that structure is now in place.

We have a CMO in place who is functioning at a very high level. I believe that with the centralization of all of our marketing in one location here in San Francisco and with an upgraded leadership structure by having them all together we are actually able to deliver consumer programs and coordinate those with our sales actions to a better degree then we have been able to do before.

And so when we look at our marketing and sales structure I think we are better off today by a measure then we were just a year ago at this time and our team needs to deliver against those expectations and that’s what we expect to do.

Thank you very much everyone.

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