CAG
#Thanks, <UNK>
Good morning everyone, happy holidays
Thank you for joining our second quarter fiscal 2018 earnings conference call
We delivered strong results in Q2 and remain squarely on track with our transformation plan
Strategically our top priority this year is strengthening top line performance behind modernized brands and a strong innovation slate
Two quarters in, we like what we see, our top line return to organic growth in the second quarter, ahead of schedule
After a fast start to the year, we were in a position to add incremental support behind our brands in Q2 to enhance distribution, merchandizing, and consumer trial
Most of these investments were above the net sales line and consistent with our strategy to reacquaint our consumer base with our modernized brands
However, we again experienced elevated inflation, including increased costs as a result of the recent hurricanes
The net result in Q2 was that, despite pricing ahead of our categories, gross margins were pressured by the convergence of higher startup costs to support our brands and elevated inflation
Importantly, we remain confident in our long-term margin expansion opportunity and our ability to deliver on the 2020 outlook we provided at our investor day last year
We continue to be active with our M&A agenda to bolster our strong positions in the important Snacks and Frozen categories
During the quarter, we completed our $250 million acquisition of Angie's Artisan Treats, the maker of Angie's Boom Chicka Pop, the fastest growing national read-to-eat popcorn brand in the U.S
, and as you saw earlier today, we announced an agreement to acquire Sandwich Bros
, which I will elaborate on in a few minutes
We also continue to deliver on our target to repurchase $1.1 billion of shares during fiscal 2018. We repurchased approximately $280 million of common stock during the second quarter
The bottom line is we're encouraged about our year-to-date performance, and we're updating our 2018 guidance to reflect organic net sales and adjusted EPS to be near the high end of their respective guidance ranges
During the quarter, we marked our one-year anniversary as a branded pure play CPG company
And compared to where we were just three years ago the transformation has been quite remarkable
Between exiting private brands, successfully spinning off Lamb Weston as a thriving public company, and remaking our core business and culture into a more energized competitive unit, we have been and we will continue to be relentlessly focused on value creation
It's been heavy lifting unwinding decades of engrained behaviors, but we like where we are, and we're confident in our future
Most of you are familiar with the expected cadence of our transformation plan shown on slide seven
I'm happy to say that we remain squarely on track with these expectations
Fiscal 2016 and 2017 were indeed a heavy lift as we put in the work to thoughtfully and methodically upgrade our revenue base and reset the top line by cutting back on excessive deep discount promotions and rationalizing a long tail of low-performing skews
We also focused on improving efficiencies to build a strong foundation on the bottom line and expand margins
But as we've said all along, we can't cut our way to prosperity; we must grow the top line
And we will do it the right way, by investing in renovation and innovation to achieve sustainable growth over the long-term
As we entered fiscal 2018 we were working from a much stronger revenue base
We have a healthier, less promotional business in U.S
retail
And our focus is now on improving brand saliency, which means reacquainting consumers with our modernized brands, and making them top-of-mind again
Accordingly, we're making investments in innovation and renovation to enhance distribution, merchandizing, and consumer trial to drive top line growth
And top line growth is exactly what we've achieved
On slide eight, you can see organic net sales grew 2.3% in the quarter
Strong volume performance particularly in our U.S
retail businesses drove this result
Further, we estimate that even after adjusting for the positive impact of the recent hurricanes we delivered slight organic net sales growth in the second quarter
We estimate an approximately 220 basis point benefit related to hurricanes during the quarter
Our Food Service segment saw a one-time benefit from the hurricanes, and our Grocery and Snacks segment benefited from some customer warehouse and consumer pantry stocking
But the underlying strength of our core business is an encouraging affirmation of our plan and aggressive actions to jumpstart the top line
Make no mistake, we have much more to do, but we're making great progress in bending the sales trend and we're doing it the right way
The data on slide nine speaks to the quality of our growth
Our distribution performance shown here as TPDs, or total points of distribution is continuing to improve, we expect this trend to move upward in the back half supported by net gains as the pruning of low-performing skews abates and innovation continues to roll out
Importantly, we have continued to increase sales velocity as we upgraded the quality of our TPDs
When we modernize our product and discontinue to weak skews we recondition consumers to purchase updated products off the shelf at full margin and the velocities are getting better every time we look at the data
As our base sales velocities improve our dollar sales have followed, turning positive in the second quarter
As you can see on slide 10, these trends have allowed us to continue to price above our categories on average
We have also remained true to our value-over-volume strategy as the present sold on promotion has decreased every quarter for more than two years
While that trend is not sustainable in perpetuity, this clearly indicates that our strong volume performance was not driven by deep discounts or price rollbacks
We remain squarely focused on improving our base sales and reducing our reliance on inefficient trade promotion
Turning to slide 11, we remain on track to deliver against our 2020 margin goals
In the early innings of our transformation plan we got a fast start on margin improvement as we began to implement our value-over-volume strategy
But as we've always said, the path forward will not always be linear
Our margin improvement will not be a straight line particularly as we make the necessary investments to support innovation and drive trial and distribution across our brands
Margins may also move around quarter-to-quarter as we confront dynamics, like inflation, exiting lower margin businesses, and enhancing our portfolio with margin accretive acquisitions
As I said at our inaugural investor day, when you take on a transformation of this magnitude there will be quarterly volatility in gross margin from time to time
But regardless of short-term dynamics, we will move the centerline of our profitability north over time
As I noted earlier, there were a few near-term factors impacting our gross margin performance
Better than expected top line performance through Q2 is enabling us to invest more in our U.S
retail business and add incremental support to further enhance the distribution, merchandizing, and consumer trial of our brands, especially where we have new renovation and innovation
As I mentioned earlier, this is consistent with our strategy to increase brand saliency with consumers
This increased investment had a near-term impact on our overall price mix, which is reflected in our results this quarter
Some of this will show up as slotting, and some of this will show up as priced given the structure of our joint business planning partnerships with customers this is not surprising
Simply put, we are focused on strategic investments behind higher quality product presentation, and our investments will be brand and customer specific as we both reacquaint consumers with legacy brands and introduce new offerings to the market
We are strategically using trade as a catalyst for our modernized brands
This fuels new distribution, better shelf presentation, end-aisle display, and customer circular visibility to generate awareness of the new relevant benefits of our products
Dave will provide a bit more detail on the additional factors that impacted near-term gross margin performance shortly
But the bottom line is that none of these factors change our long-term margin outlook or our commitment to chip away at the margin opportunity over time
Now turning to our segment performance on slide 12, you can see the continued growth in our Refrigerated and Frozen segment, which was aided this quarter by innovation launched under the Marie Callender's, Healthy Choice, and Banquet trademarks
In addition, the Frontera brand introduced frozen mean innovation, and we also saw continued growth in the core Reddi-wip business
On slide 13, you can see scanner data that highlights the acceleration in this segment
Looking at the chart on the left, you can see the top line improvement in our frozen single-serve meal business through the end of Q2, which we believe is the best proxy for the traction of our plan
As you know, our recent brand renovation work focused on Frozen
And within Frozen, we put significant effort toward renovating Banquet, the largest single-serve frozen meal brand by volume in the U.S
, after considerable effort to modernize the brand and recondition shoppers to purchase the products off shelf at full margin, Banquet returned to growth in the second quarter
We're pleased to have this brand back on track, and are encouraged by the positive consumer response
We're also mindful of our expectation for the brand and its role in our portfolio as a reliable contributor
We do not expect Banquet to be a rapid grower growing forward, but it is a large important brand
We're very pleased to have liberated it from a $1 retail price point, and to have improved both top and bottom line performance
Overall, you can begin to get a sense for why we feel good about our growth algorithm both this year and for the long-term
One of the most compelling reasons for our optimism continues to be the success of our innovation slate which is building distribution and performing well in its early days in the market
We started rebuilding our innovation slate with a focus on our Frozen business, and you can expect to see us apply the same level of rigor and discipline across our portfolio where we see opportunity
Turning to our Grocery and Snacks segment on slide 15, you can see that we're continuing to drive improvement
We estimate organic sales were roughly flat for the quarter after adjusting for the hurricanes
That's a significant improvement over Q1. Our Q2 Grocery and Snacks reported sales reflect approximately 200 basis points of positive impact related to the hurricanes, which drove customer warehouse and consumer pantry stocking behavior
While this was a benefit in Q2, we expect the shift to negatively impact Q3 sales in this segment
The improvement in the base business is encouraging, but it is still very early days
We have a lot of work to do ahead to renovate certain brands and provide the appropriate investment support, similar to the work we've done with our Frozen portfolio
So let me take a step back and provide some perspective on how we think about this segment
Clearly we see Snacks as an attractive growth opportunity
As a reminder, our snacks business includes strong brands such as Slim Jim, one of the leading players in mean snacks with increasing household penetration among millennials; Orville Redenbacher, the largest selling brand in microwave popcorn and the best selling brand of popcorn online; <UNK> Seeds, the leader in seeds with more than twice the share of the next largest competitor; Swiss Miss, which accounts for over half of the volume of hot cocoa sold in U.S
retail, it's also the preferred choice of millennials by more than four times over the nearest competitor; and Act II which is growth both domestically and internationally
We're also very pleased with the robust performance of recently added brands such as Duke's, Bigs, and Frontera
And we're quite excited about the opportunities presented by the acquisition of Angie's Boom Chicka Pop
So overall, snacks will be an extremely important area for us going forward, and we're just getting warmed up
We'll be sharing more about snacking renovation and innovation in the months to come
As we articulated at investor day, a simple way to think about our large grocery business is to break it into two groups; condiments and enhancers, and shelf stable meals and sides
We do that because generally speaking these groups will play different roles over time
With condiments and enhancers, such as Hunt's Tomatoes, Ro-Tel, Frontera Salsa, and Pam, we see on-trend brands that align with the needs of young millennial households which are starting to cook affordable by flavorful meals at home
Accordingly, they will be a focus area for continued investment
The role of shelf stable means and side dishes such as Chef Boyardee, Libby's, and La Choy is to be reliable contributors, providing steady cash flow to fund growth opportunities elsewhere in the portfolio
That doesn't mean, we will neglect these brands to the contrary, we absolutely need to keep them fresh so they continue to reliably contribute
Overall, we remain focused on our disciplined portfolio segmentation approach to apply the appropriate support for each brand
So while it's early days, we're happy with our growth momentum and we're excited about the future
Importantly, we're growing share and our categories are growing with our sharpened focus and enhanced capabilities we have reason to be excited about our future
And before I wrap up, a few thoughts on M&A, as you can see on Slide 19, we have been highly active leveraging M&A to reshape our portfolio for better long-term growth and margins, clearly the inbound businesses have been smaller modernizing acquisitions versus larger more synergistic deals
You should not interpret that as a string of pearl strategy in lieu of more transformational deals
As I've said many times, we are always on the lookout for both modernizing and synergistic acquisitions the former tend to be more plentiful than the latter but we're always in a position of readiness should the right property and the reasonable valuation emerge
Earlier today, we announced our planned acquisition of the Sandwich Bros
business simply put this is a frozen capability play, handhelds offer great convenience to consumers and this business provides some terrific capabilities
These are freshly prepared delicious sandwiches that are then flash frozen to be ready when you are, they play across breakfast, lunch and dinner
The business generated approximately $60 million in net sales over the past year and is growing rapidly
Once this deal is closed, we expect to see some exciting expansions of this on-trend format both under the Sandwich Bros
line and other ConAgra Brands
I'll wrap it up with Slide 21, in summary we're encouraged by our return to growth and the performance of our innovation
We'll continue to support growth through disciplined and strategic investments to drive distribution, merchandising and trial
Executional excellence remains a key focus in everything that we do particularly as we move through an inflationary environment
As we just discussed, we'll stay active in our pursuit of value enhancing M&A and will be relentless about doing what's necessary to deliver our long-term algorithm
Given our strong performance, we've updated our 2018 guidance to reflect organic net sales and adjusted EPS to be near the high end of their respective guidance ranges
With that, I'll hand it over to Dave to share more on the details of the quarter
Dave, over to you?
Morning
Yes, good morning, <UNK>
Yes, this is <UNK>
We will continue to invest above the line and below the line behind the brands in the second half
When we got off to a strong start in the year it gave us the opportunity to do that as well as anticipating a tax reform
And the simple logic for that is with all the work we've done and put into building our innovation pipeline when we get our new innovations in the marketplace, particularly in stores at the point of purchase, it is critical that we build awareness around these new benefits and around the new modernized look of these products
Internally we've got a phrase here a phrase here that we use that use called "confidential innovation"
And what we mean by that is when we do all the work building out our innovation pipeline the last thing we want is to get it into the marketplace and have nobody see it
If that would be the case we'd call that confidential innovation
So we're trying to avoid that obviously
We're trying to create consumer awareness and let our package design and the food itself, the look of the food, the varieties, the modern flavors drive consumer pull
And we're highly confident that because of the quality of the food we're putting into products this year, in particular in frozen meals, that we will get strong repeat
And the early data that we're seeing on that bodes well
So, as we look at the return on these startup investments over time we expect them to be quite strong, but strategically we view it as vital to getting the right kind of uptick particularly given we really took a last year or year-and-a-half off when it came to new innovation
Yes, obviously M&A is an important part of our playbook going forward
And we've all seen high multiples in M&A in food in general for the last few years
Snacks is the flavor this week
We had condiments last quarter; we had other things before that
So it's been a high multiple environment
And in that environment we try to strike the right balance between our desire to be aggressive with M&A to help reshape our portfolio for better growth and better margins, but also to be disciplined
So we understand that there are higher multiples out there, but we still hold ourselves to pretty high standards in terms of being able to get an IRR on our deals that is above our weighted average to capital
So that's one of the ways we look at getting proper return on our M&A investments and we'll continue to strike the right balance between being aggressive and being disciplined going forward
Hi, <UNK>
Well, we have different brands across our portfolio
The consumer domains that we've talked about before, we've got meals which tends to lean toward frozen, we've got enhancers, and we've got snacks
You're going to continue to see us do probably bolder innovation on the meals and snacks consumer domains
And what you'll see more in the grocery part of the store and enhancers looks more like renovation
So may not be as much on new slotting there
Maybe things like updating the look of our products
Probably some skew varieties, but a bit of a different mix
I think the bigger point here is that we look at marketing in total, meaning above-the-line marketing spend and below-the-line marketing spend
And when we use the phrase marketing behind our brands we're referring to investments that engage the consumer with our brands
And that could be everything from traditional TV and print ads, to distribution investments, to merchandizing, to sampling, to digital marketing, even customer loyalty programs
So you've got a wide array of activities here ---+ marketing activities that span above net sales and below net sales cost buckets
And as we move our activity mix it may toggle spend above the line and below the line, and we'll try to be transparent with you all around what those activities are and why we're doing them
When we're on ramp-up mode on things that are quite materially different from how the brands looked in the past, think frozen so far this year with all the work we've done, we really focus our energy disproportionately on the in-store environment and centre store because that's where we get the biggest engagement with consumers around these meaningfully revitalized brands in that startup mode
And that's why we're doing what we're doing right now because we believe it's going to get us the best long-term top line performance and the best ultimate returns
Well, I think in the last few years growth has been on average more elusive for the industry
And when you see those cycles emerge where growth is more elusive you tend to hear more talk around consolidation and harvesting synergies
But as a potential participant in some of those deals we want to focus on our shareholders and the return we get for our shareholders
And obviously synergies are great
But when you give away all your synergies in a deal to the seller it's not particularly useful to our shareholders
So we're going to always keep our shareholders in mind as we think about portfolio changes that ultimately position us for long-term strength and value creation
Rob, let me tell you how I think about that
Let me start with the second half of your question first around trade investments
I think it's a very simple mental model that a lot of investors have that when we talk trade we're talking putting that money right into deep discounting and deals
Increasingly that is not really anywhere near the full story
It's more about joint business planning with customers around everything from merchandising, which usually has some level of discount to it, in our case nowhere near the depths that we had historically
But it also has to do with points of distribution
It has to do with quality of shelf space and facings
Is it eyelevel or is it down in the well, the ability to sample products in store, the ability to target consumers on their apps that are customer-specific
So trade and customer investment is much more holistic than just deep discounting deals, and features, and things that you've heard about historically
And certainly in our case that is true
Keep in mind we've invested a fair amount in improving our trade efficiency capabilities
So we've now got post-event analytic tools, we've got trade planning management tools
We are able to look at thousands upon thousands of trade events, find the ones that are low ROI, get rid of those, and find the ones that are positive ROI and do more of those because we get more bang for our buck
Some of that is the structure of the merchandizing, some of it is timing
So we are spending above the line, but it is what I would describe as a significantly higher quality investment in terms of engaging consumers in our brands than what it used to be at ConAgra, which was really about taking very outdated and old fashioned products and just moving them based on deep, deep discounting
And as you saw in the slides, our promoted levels are down overall, and our pricing is up and above our categories
Now with respect to pricing, just a couple of thoughts on pricing, as I pointed out before, we've built an integrated margin management team and improved our pricing capabilities dramatically versus what we had just a few years ago
And over the past few years we've taken more price than most
And we think about pricing three ways
There's number one, inflation justified pricing; number two, trade efficiency, and I just talked a little bit about that; and three, premium-priced innovation which over time will be positive mix
So clearly pricing is complex when you pivot from deflation to inflation you want to price as fast as you can
Sometimes there's a lag
And sometimes if the inflation appears transitory on certain commodities and the forward curves drop back down retailers can be more reluctant to take price because they don't want constant shelf price volatility
And then the last factor is that not every brand and every category are created equal in terms of elasticities of demand
So all of this is why we are principally committed to pricing when justified, but also why we focus on the center line of our profitability over time and not on quarterly volatility because there tends to be a fair amount of noise
Yes, on innovation, Chris, we will continue to have innovation coming out in the back half of the year and we'll have startup support behind that
Some of it with some customers shows up as slotting, some of it just goes into debt net
But it is a diverse means of supporting the brands from actual physical distribution, as I mentioned, to quality of shelving, to in-store support
All of those things are the things that we're doing disproportionately
So what you saw in Q2 was some reduction of A&P that was then moved above the line, and then additional expense above the line in support of the brands in an in-store environment
And one thing to keep in mind as well going forward, we talked about this a little bit last quarter is, we're coming off of a base period where we didn't really have a lot of, what I'll call, brand support in the base, startup support, innovation support because we pushed the pause button last year while we rebuilt the funnel
So as we get these investments into our base this year we won't see the magnitude of year-on-year changes going forward because we're getting back to more normal going innovation launch cadence
Yes, sure
<UNK>, what you're referring to is a slide that we put up
It wasn't technically part of our guidance, but it was kind of a true north for us on innovation that we'd like to march towards over time
It's something we called renewal rate which is the percentage of annual sales that come from prior three-year innovations
And our point was that our company historically had been in the high single digits
Companies that are doing well and best in class are closer to 15%
So our aim over time is to really close that gap
It's not as if we need to get to 15% on a straight line march from where we started
And by the way, it's also something ---+ it's not the kind of metric you're going to look at on a quarterly basis, you've got to settle it in
But clearly, as you can imagine, with the slate of innovation that we've got hitting the marketplace now by the time we get to this year, we will see a pretty material uptick in that renewal rate
Tom, you want to comment on what's coming in the back half?
Just one other building on Tom's comments <UNK> one other thing that we're always thinking about which is we've got to wrap this year slate next year and it's not lost on us that we will be wrapping next year a big slate and as a result, you should assume that we've been very aggressive in making sure that our innovation slate for next year is going to be as impressive as this year
I continue to talk about frozen and how I think we have years and years of runway on frozen, undoubtedly we're going to continue to have a big slate there, you'll hear us talk more about some of these things that CAG is coming up after the holidays but then snacking is a big area for us and some of the most innovative things we've got going on as a company are some of the acquisitions we've made
Duke's is clearly one of the most innovative brands in the very hot meat snack space and now with Angie's Boom Chicka Pop as the national leader of branded ready to eat popcorn that's if that's a business we can do a lot with going forward
So you'll hear more about what comes next when we're at some invest meetings in the new calendar year
Yes, I think in our retail business, <UNK>, the dynamics we saw in the hurricane were very similar to the things that I've experienced throughout my long career in the world of food, which is when you have shelf stable goods that are either in meals or in snacks, you're tended to see a fair amount of stocking both warehouse stocking with customers and pantry stocking in and around the hurricanes
And in my experience there're almost always higher levels of stocking than there is immediate term consumption
So what we experienced, what we experienced last quarter to me was textbook with what I've experienced throughout my career
There is one particular nuance that's worth mentioning, which is specific to Chef Boyardee, just to provide a little bit more color on this and that is that our quarter two Chef saw some pretty significant impact on Chef we had previously negotiated much higher impact merchandising events in quarter two this year than last year with those key events timed around back to school
So in other words, we planned more trade support in the quarter
As it turns out, those major events that we planned upfront just happened to coincide timing wise with the hurricanes and the effect this had was to move a ton of volume but at compressed gross margins
So while inflation on his brand was up a good bit, the hurricane fueled sales spike came while the brand was on deal for back to school, so while we got far more takeaway than we originally expected, we also got a bit more margin compression on that business than we expected and higher absolute trade expenses and to your point as we mentioned earlier because a fair amount of that is sitting in could we believe is sitting in consumer pantries we expect to get some of that back in Q3 as consumers work through that inventory and that dynamic there is not different from what I've experienced before
Yes, we are seeing it, but let me go back to what I said before on this, because I think it's a really important point and I think it's a different experience with ConAgra than maybe what you all see elsewhere in the industry which is on a lot of our brands we saw a retailer margin compression for years and the reason that happens because our brands were locked into very low price points usually a dollar or a $0.99 or a $1.99. So in other words, over decades ConAgra saw compressed margins and our retailer saw compressed margins and as you can imagine and I mention as before when we talked to retailers about our aggressive innovation slate, one of the reasons why they were very supportive of it and our goal to modernize brands was actually the opposite of what a lot of times we hear about, which is a desire to take prices lower in our case it was a desire to take prices higher
And as we did that build back in better retailer margins so case in point there is Healthy Choice Power Bowls
We still have a small sliver of Healthy Choices that are these classic meals that are sold to older boomers that business has gotten smaller as we kind of sunset that piece of it but we are replacing it with higher margin
Higher dollar in businesses like Healthy Choice simply and now Healthy Choice Power Bowls, which are not only higher price points but better margin structure for our retailers
So we are participating and rebuilding retailer margins but in our case we're doing in the context of modernized brands with higher absolute price points and higher absolute food quality
On that latter piece, <UNK>, I'm not any more concerned this quarter than I've been previous quarters about private label as I've mentioned before
Private label on average under indexes in our categories it's about a 70 index versus food on average and in key strategic categories like frozen it's significantly lower than that so I'm not anticipating any change, it's not built into our planning posture in terms of private label interaction getting to be more of a headwind
With respect to investing behind our business in trade but I wouldn't over think this is a simple way to think about it is we were in launch mode in the front half of this year and we knew, we have we want to support our brand because we're trying to build future cash flows here by reestablishing consumer loyalty and household penetration on our brands and when we saw the early traction on the business when we saw we got up to a fast start of the year and fueled in part by a high degree of confidence, we're going to get a tax return
We made the strategic decision to put more money behind our businesses because we had confidence in our brands and in our innovation and by and large we got the response that we were looking for and that's bit of a higher level of support as we continue to launch stuff through the back half of the year and then next year we will wrap some of these levels investments will be baked into our core, so I wouldn't anticipate another step up as we move into the out years I think we're going to kind of get it in our base here as we proceed
But at the end of the day the fact that we've got traction on these brands and our investments are working in terms of driving consumer trial, and we have confidence in the products themselves to drive repeat
This is all part of a positive flywheel in our view
