Conagra Brands Inc (CAG) — Q2 2018 Earnings Call Transcript

Good morning, everyone. During today's remarks, we will make some forward-looking statements. While we are making those statements in good faith and we are confident about the company's direction, we do not have any guarantee about the results that we will achieve. So, if you would like to learn more about the risks and factors that could influence and impact our expected results, perhaps materially, we refer you to the documents we filed with the SEC, which include cautionary language. Also, we will be discussing some non-GAAP financial measures during the call today. References to adjusted items including organic net sales refer to measures that exclude items impacting comparability. Please see the press release for additional information on our comparability items. As a reminder, starting in fiscal 2018, we introduced the metric of organic net sales, which excludes the impact of FX, divestitures, and acquisition until the anniversary date of the transaction. The reconciliations of those adjusted measures to the most directly comparable GAAP measures for Regulation G compliance can be found in either of the earnings press release or in the earnings slides, both of which can be found on our website at ConAgrabrands.com/investor-relations. Now, I'll turn it over to Sean.

Thanks, Brian. 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, merchandising, 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 ready-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 ingrained 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 as 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 SKUs. 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, merchandising, 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, and we expect this trend to move upward in the back half supported by net gains as the pruning of low-performing SKUs 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 products and discontinue weak SKUs, 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 percent 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, merchandising, 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 price; 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 meal 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 going forward, but it is a large and 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 of 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 opportunities. 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 meat snacks with increasing household penetration among millennials; Orville Redenbacher, the largest selling brand in microwave popcorn and the best-selling brand of popcorn online; David 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 growing 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 meals 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 in our categories and 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?

Thank you, Sean. Good morning everyone and happy holidays. As you can see on Slide 23, we continue to make strong progress improving our financial profile as we reshape our portfolio. Reported net sales for the second quarter were up 4.1% and organic net sales were up 2.3% reflecting significant sequential improvement in our net sales growth from previous quarters. As mentioned in our release, we estimate 220 basis points of sales improvement from the hurricanes across both our grocery and snacks and food service segments. Adjusted gross profit dollars were up $5 million or 0.7% for the quarter. Adjusted gross margin was 30.1% for the second quarter, down approximately 100 basis points from the prior year. I will discuss the drivers of gross profit in more detail shortly. A&P expense decreased 11.7% or $11 million in the second quarter. As Sean discussed, we look at total marketing investment which includes A&P spending along with trade spending and slotting that is charged to net sales when taken together for the quarter total marketing investment increased as the decrease in A&P investment was more than offset by increased trade investments to expand distribution with slotting, to enhance presence, and to generate consumer trial. We also increased merchandising for certain brands to better leverage improved ROI events identified in our trade productivity work. These marketing investments were important to our strong volume growth in the quarter. Adjusted SG&A increased 4.1% or $8 million in the second quarter versus a year ago in line with our second quarter net sales growth. Adjusted SG&A as a percentage of net sales was 9.5% for the quarter, the same as the second quarter a year ago and remains top tier in the industry. SG&A as a percentage of net sales is expected to be lower in the second quarter than for the full year since the second quarter is typically our largest sales quarter. Adjusted operating profit was up $8 million or 2.2% for the quarter. Dollar profit increases from positive volume growth more than offset the negative impact of both inflation and the increase in total marketing investment. Adjusted diluted EPS was $0.55 for the quarter which was up 12% and exceeded our expectations. I will discuss the drivers of this increase shortly. Slide 24 outlines the drivers of our second quarter net sales change versus a year ago, total company organic net sales were up 2.3% driven by volume in price mix improvement. As mentioned in our earnings release, about 220 basis points of the second quarter net sales growth was from increased shipments related to the hurricanes experienced in the quarter. Organic volume increased 1.7% driven by growth in the Grocery and Snacks and Refrigerated and Frozen reporting segments. Price mix increased primarily from favorable product and customer sales mix and food service along with positive pricing in the International segment. This was partially offset by increased investments to expand distribution, enhance shelf presence, and generate consumer trial in our Grocery and Snacks and Refrigerated and Frozen segments. The acquisitions of the Frontera, Duke's, and BIGS brands in fiscal 2017 and Angie's Boom Chicka Pop in the second quarter of fiscal 2018 added about 140 basis points to second quarter net sales growth. The impact of FX also contributed 40 basis points of reported net sales growth. Slide 25 highlights our net sales and adjusted operating profit and margin by reporting segment. All operating segments grew both reported and organic net sales in the second quarter versus a year ago and overall operating profit grew 2.2% to 16.7% of net sales. In our Grocery and Snack segment, reported net sales of $900 million were up 5.5%. The acquisitions of Frontera, Duke's, BIGS, and Angie's Boom Chicka Pop added 330 basis points of growth in the quarter. Organic net sales grew 2.2%. The company estimates that the recent hurricanes benefited the grocery and snacks net sales growth rates by approximately 200 basis points driven by our estimates of consumer pantry stocking and customer inventory builds. We expect that this dynamic will have a negative impact in the third quarter. Volume increased 3.4% in the quarter driven by hurricane-related demand and increased investment and higher quality merchandising events on certain brands. This investment resulted in a price mix decline of 1.2%. Adjusted operating profit of $212 million decreased 4.5%; this decrease was driven by inflation on input costs and transportation costs associated with the recent hurricanes along with increased total marketing investments driven by the investment in higher quality merchandising events partially offset by lower A&P. These increased costs were partially offset by the favorable impacts of volume growth and supply chain realized productivity. In our Refrigerated and Frozen segment, reported net sales of $758 million grew 2.3% and organic net sales grew 2.2% as the acquisition of Frontera added 10 basis points of growth in the quarter. Volume increased 3.9% due to core business improvements and innovation launches under the Marie Callender's, Healthy Choice, and Banquet trademarks. Continued growth in the quarter ready with business and the addition of Frontera frozen innovation also added to top line growth. Investments in trade to drive distribution and hands-off presence and increase consumer trial of new products led to a price mix decline of 1.7% versus a year ago. Adjusted operating profit of $128 million increased 6.9% in the quarter driven by volume growth and supply chain realized productivity. These improvements were partially offset by increased inflation on input costs and higher total marketing investments were lower A&P was more than offset by trade investments previously mentioned. In our International segment, reported net sales were approximately $220 million for the up 4.2% versus the prior year. This reflects a 2.1% decline in volume which was offset by a 2.3% improvement in price mix as the international team continues to focus on value over volume. FX favorably impacted net sales in the second quarter by 4%. Adjusted operating profit was $21 million, up 19.9% versus the prior year driven by increased pricing, favorable brand margin mix, and favorable FX. In our Food Service segment, net sales were approximately $295 million for the quarter, up 4.1% versus the prior year. We estimate that the recent hurricanes benefited the net sales growth rate by approximately 10 percentage points. We continue to implement our value over volume strategy and food service with volume decreasing 7.1% as the companies exceed non-core and low-performing business. Price mix increased 11.2% driven by favorable product and customer mix as well as pricing. Adjusted operating profit was $47 million, up 48.4% versus the prior year with operating margins expanding 481 basis points versus the prior year. The operating profit performance was driven by the sales increase from pricing and customer and product mix. Adjusted corporate expenses were $46 million for the quarter, up 27% reflecting an increase in certain self-insurance costs and a reduction in income from transition service agreements. Total adjusted SG&A of $206 million in the second quarter was up 4.1% versus a year ago in line with our reported net sales growth. Moving to slide 26, this chart outlines the drivers of the 12% adjusted diluted EPS improvement in the second quarter versus a year ago. Adjusted gross profit dollars increased $5 million in the second quarter driving $0.01 of EPS improvement. Gross profit was favorably impacted by volume increases in the Grocery and Snacks and Refrigerated and Frozen segments along with favorable price mix in the Food Service and International segments. Gross profit was negatively impacted by elevated inflation of approximately 4% in the quarter driven by increases in animal proteins, oils, dairy, and packaging along with increases in transportation and warehousing costs as a result of the hurricanes. Gross profit was also impacted by the increase in total marketing investment to expand distribution and generate consumer trial. These cost increases were partially offset by favorability in supply chain realized productivity for the second quarter. Favorable interest expense and an increase in equity income from Ardent Mills added $0.03 of EPS improvement, with share repurchases adding $0.04. EPS was negatively impacted by $0.02 as the effective tax rate in the second quarter was 34.4% versus 32.4% a year ago. The tax rate increase primarily from higher deductions for stock option exercises in the prior year and an increase to our reserve for uncertain tax positions related to state taxes. Slide 27 summarizes selected balance sheet and cash flow information for the quarter. Net cash flow from operating activities of continuing operations was $383 million for the year-to-date period, down from $461 million for the same period a year ago. This decrease was primarily from the timing of tax payments versus the prior year. Dividends paid are down as the prior year second quarter dividend occurred prior to the Lamb Weston spin-off and was paid at the prior ConAgra Foods rate. We repurchased approximately 8 million shares of stock at a cost of approximately $280 million in the second quarter. Total share repurchases for the first half of fiscal 2018 amounted to $580 million. We ended the second quarter with net debt of approximately $3.4 billion as planned, up from $2.7 billion fiscal year end 2017. This increase supported our share repurchases and the $250 million acquisition of Angie's Boom Chicka Pop which closed in the second quarter. As we have stated previously, we remain committed to an investment-grade rating for the business. As outlined in our earnings release, we continue to cooperate fully with the FTC as it conducts its review of the Wesson transaction. Slide 28 outlines our updated guidance for fiscal 2018. We expect organic net sales growth to be near the high end of our range, which was previously communicated at minus 2%-to-flat. Reported net sales is expected to be 100 to 150 basis points higher than the organic net sales growth rate due to acquisitions and FX. We expect adjusted operating margin to be near the low end of our range of 15.9% to 16.3%. We now expect inflation to be 3.7% for the full year, up from the 3.3% full-year estimate we provided in the first quarter. This higher inflation along with the incremental marketing investments we started this quarter will impact our gross margins in the second half. We remain on track for our fiscal 2020 long-term targets communicated at investor day, including a gross margin of 32% in fiscal year 2020. While our updated effective tax rate guidance is between 33.5% and 34.5%, we are in the process of assessing the extent of the positive impact from the new federal tax legislation. We expected adjusted diluted EPS from continuing operations to be near the high end of our range, which is $1.84 to $1.89. We remain on track to repurchase approximately $1.1 billion worth of shares in fiscal 2018 subject to market and other conditions, including the absence of any synergistic acquisition. Our fiscal 2018 outlook includes the full-year estimated financial results of the Wesson business since the sale is still pending. In summary, our transformation is squarely on track. ConAgra Brands continues to make excellent progress. We continue to bend the trend on organic sales and have made great progress upgrading our volume base. Gross profits and operating profits grew year-over-year while we weathered elevated inflation and funded incremental marketing investments to support growth. We've made several modernizing acquisitions over the last year, and our balance sheet remains strong and gives us flexibility to pursue synergistic acquisition opportunities to drive shareholder value. And we are confirming our full-year organic net sales and EPS guidance near the high end of the range. Thank you. This concludes my remarks. Sean, Tom McGough, and I will be happy to take your questions. I will now pass it back to the operator to begin the Q&A portion of the session.

Good morning everybody, and happy holidays.

Morning.

I have two questions. First, are you planning to continue with the incremental trade spend above the net sales line that we observed in the second quarter for the rest of the year? If so, what gives you confidence that you are achieving the expected return on that spending and that it won’t generate unsustainable volume? I also have a follow-up.

Yes, good morning, Andrew. Yes, this is Sean. 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 that we 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.

Thanks for that. And then as M&A continues to be an active part of ConAgra's, particularly in snacks, I guess I wondered if you could comment on your view on maybe some of the multiples that we've seen some snack assets trade at more recently, and how that sort of fits into your desire obviously to continue to be disciplined but also try and use the balance sheet in an accretive way.

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 cost of 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, good morning.

Hi, Bryan.

Just two follow-ups to Andrew's questions; first I guess as we think about gross margins going forward and the continued investments. As the investment shifts more to grocery and retail, that becomes a bigger part of the innovation, is that less expensive to sort of renovate and launch new products than it is in frozen? So even as we think about that into next year would it potentially be less of a drag on gross margins and require less of a gross investment than is the case in frozen food?

We have a variety of brands within our portfolio. As we've previously mentioned, we focus on several consumer areas, including meals, which primarily feature frozen items, enhancers, and snacks. Moving forward, you can expect us to engage in more significant innovations in the meals and snacks categories. In the grocery section, enhancements will resemble renovations, which may not involve as many new products. Instead, we might refresh our product designs and introduce some new varieties, leading to a different mix. The crucial point is our overall approach to marketing, encompassing both above-the-line and below-the-line expenditures. When we mention marketing for our brands, we're referring to investments aimed at engaging consumers. This includes a range of activities from traditional advertising to distribution, merchandising, sampling, digital marketing, and customer loyalty initiatives. Our marketing efforts encompass a broad spectrum that affects both sales and costs. As we adjust our activities, we might shift spending between these categories, and we aim to keep you informed about what we are doing and the reasons behind those choices. When we are in ramp-up mode with significant changes to our brands, particularly within the frozen category this year, we concentrate our efforts heavily on the store environment since that yields the highest engagement with consumers for our revitalized brands in this startup phase. We believe this strategy will result in the best long-term revenue growth and returns.

Okay, thanks. And then just a follow-up on M&A; just one of the themes I guess that's come across throughout the last six to 12 months is it just seems like the cost of business is going up. And maybe that's a function of what's happening in the retail environment. So that being the case, do you think that that's going to motivate more synergy-type deals to happen? Seems like a lot of the acquisitions, the M&A that we've seen across food and beverages have really been growth deals, and not as many synergy-type deals. But if the cost of business is going higher and it's becoming more complex, do you think that scale becomes more important and maybe that's going to start motivating more synergy-type opportunities to come up?

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.

Hi, thank you. In your opening comments you talked about inflation rising faster than you thought. Are you going to have to raise your prices faster as a result, and do you expect a lag? Is that part of the guidance or not, I didn't quite catch that? And then the second thing, and this is just a question about your average pricing at retail still being high but your trade promotion also being higher. Given all the disputes with the very public disputes with retailers, is there anything that you see in the industry where the vendors are giving the retailers more money, but it's not making its way all the way to the consumer? Like we all see promotion being lower than it was a year ago and prices being higher than a year ago. But then all of our vendors are experiencing gross margin. So is it possible that the retailer is just getting some of that money and keeping it for themselves in some form or fashion?

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 eye-level 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 merchandising; 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, and I just want to add to that as it relates to gross margin the broader question first-half and then as we look forward. As we mentioned, inflation will be higher in the second-half. We will continue the marketing investments that Sean just talked about, and pricing where we've already taken it we've already taken it on several brands. It's important to understand the impact of food service in the second quarter and the benefit we got from that, and that not repeating in the second-half. And so when you look at that and also the volume in grocery/snacks that's going to negatively impact the third quarter. When you add all that up it's going to result in the second-half gross margins being in line with the first-half gross margins generally speaking. And that really drives ultimately our operating margin guidance that we gave.

Hi, thank you. And I imagine, like your peers, the answer will be it's too early to say. But I wanted to ask a little bit about your thoughts on the benefits of tax. Is there anything you should be aware of in terms of major offsets to you guys in particular from a lower corporate rate, and any early thoughts you have on how much of a benefit you'll let flow to the bottom line versus spending back on wages, CapEx, and pricing? Just any general thoughts would be very appreciated.

Sure, Ken. Let me start, and then Sean can join in. I'll begin with the tax rate. Over the last two years, we've had an effective tax rate of about 33%. With the corporate rate now at 21%, we will benefit from that change. However, there are other provisions in the new tax bill that we need to consider, such as the domestic manufacturing deduction, which we previously benefited from but is no longer available. This will impact our rate. We are currently assessing how our effective tax rate will change, knowing that we will see some benefits. Additionally, since we file in May and the new tax law takes effect on January 1, our effective tax rate for fiscal year '18 will reflect a blended rate. We will need to analyze the implications of the seven-month period at 35% and the five-month period at 21%. We expect to have more clarity on this by the third quarter. Regarding our investments, the additional profit generated will play a role in our ongoing evaluation of capital allocation. ConAgra is focused on growth, and we always seek investments that enhance shareholder value. This includes capital expenditures, which will benefit from immediate deductions, increased marketing investments we began in the second quarter, technology initiatives, human resource development, and pension-related actions. We are continuously evaluating these areas and will increase transparency about our decisions as they develop.

Thank you for that. My second question is, while I understand you prefer not to provide specific quarterly guidance on certain items, Dave, you mentioned earlier in response to Rob Moskow's question reasons why the guidance for the second half of the year might not be overly conservative. I would like to focus specifically on the third quarter to prevent any surprises for investors. Considering the reversal of the hurricane impact and the food service issue you brought up, is it possible that EPS in the third quarter could decline year-on-year due to these trends, or do you believe that is unlikely at this point?

Yes, we're not going to give specific quarterly guidance on anything, particularly EPS or whatever else. What I will say is that as you look at inflation we've obviously taken our estimate up for the year. There are dynamics in the third quarter with inflation and with the volume that we shipped in the second quarter for Grocery and Snacks. Another dynamic is that, if you remember last year in the fourth quarter, we started to see inflation hitting us. So we will start to wrap on it in the fourth quarter. So that's why as you look at the second half we won't see quite as much inflation as based on our estimates now in the fourth quarter as opposed to the third quarter. So there are the dynamics, but I'm not going to give specific EPS for Q3 or Q4 just given all the different dynamics.

Hi, good morning.

Hi, Chris.

Hi. I have a question regarding the timeline for new product innovation and how that progresses throughout the year. I noticed that you mentioned marketing expenses increased, but A&P decreased, which suggests promotions were higher. Was that the key factor for marketing, and could you provide a specific figure on how much that increased for the quarter?

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 net. But it is a diverse means of supporting the brands from actual physical distribution 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 just to add to that, because I can say that if you look at the $11 million reduction in A&P in the second quarter, the amount of increase in trade of the line that supported distribution, including slotting, and all the investments to get additional distribution more than offset that $11 million. We don't give specific numbers on total trade, but that is clearly the case for the A&P being more than offset by the investment in distribution.

And one thing to keep in mind as well going forward is we've 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.

Okay. And just a quick question if I could follow-up on the input cost inflation, that's gone up about a hundred basis points from the start of the year, and for obvious reasons around the hurricane in particular. How much of that is hedged now? Like do you still see further risk to that or you have a good read on at least the second half of '18 on input cost inflation?

Chris, it really varies by commodity area. So certain commodities we can lock in, certain ones we can't. So proteins we don't have as much ability to do that. Obviously we're halfway through the year so in certain commodities we're pretty locked in. So I would say animal proteins would be the biggest area of still potential exposure given any volatility in the market.

Great, thanks a lot. I want to follow on the innovation questions. So can you update us on where the company is as regards the goal that you laid out at the analyst day, I believe it was 15% of net sales from innovation? Where are you right now? And then can you tell us what the significant second-half innovations are? I assume you've already announced it to the trade, but I don't think you really mentioned it in the script? And then I do have a follow-up.

Yes, definitely. What you mentioned is a slide we presented. Although it wasn't officially part of our guidance, it serves as a guiding principle for our innovation goals moving forward. We refer to it as the renewal rate, which represents the percentage of annual sales generated from innovations introduced within the past three years. Historically, our company has been in the high single digits for this metric. In contrast, top-performing companies are closer to 15%. Our goal is to bridge that gap over time, although we don't aim to reach 15% in a straight line from our current position. Additionally, this is not a metric to be assessed quarterly; it requires time to establish. However, given the range of innovations we are launching into the market this year, we anticipate a significant increase in that renewal rate.

Sure, David. There's really two things; one, we have an opportunity, two, and we are accelerating some new items on Healthy Choice Power Bowls. We've had a tremendous introduction and success on that line, and many retailers are picking in the next phase of products in the second half. Banquet Mega has been a really, really strong performer, and that's another area that we'll continue to build distribution through the balance of the year. And then as we get to the latter parts of the second half, our next wave of innovation will ship likely at the end of Q4 in some retailers. All this is really based on the end-market momentum that we have, the high incrementality that our innovation is driving within the category, and retailers are leveraging our brands for their growth, and as a result, we're accelerating our new products in those areas in the second half.

Just one other building on Tom's comments David, 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.

Okay, that's really helpful. I think the message right there is this innovation is going to continue at a strong pace. My follow up is just on the hurricanes, so I believe that the two major hurricanes one was at the end of August, one was at the beginning of September. So can you just maybe walk me through a little bit here of why the pantry loading would impact December and January, i.e. next quarter fiscal third quarter shouldn't we have seen any kind of negative impacts in like October and November? I'm thinking that this stuff should have been contained but I feel like your comments have been telling us about 2Q benefits from hurricanes that will negatively impact Q3. So I'm really just trying to get a sense of the size and really a little bit of the rationale behind it?

Yes, I think in our retail business, David, 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 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 this 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.

One more question, I think we've got.

Hey, guys. Thank you for squeezing me. I really appreciate it, and congratulations on really being in the trend here and top line; it's encouraging to see. We've covered a lot of ground, so just kind of follow off on a couple of the questions already asked, first on Rob Moscow's question about less on the trade spend side and a bit more on retailers taking some margin. We're clearly seeing it selectively in soup right now; can you give us a little more clarity on whether you're seeing in any of your categories?

Yes, we are noticing it, but I want to emphasize what I mentioned earlier, as it's an important point. The experience with ConAgra differs from what you might observe elsewhere in the industry. Many of our brands had experienced retailer margin compression for years because they were tied to very low price points, such as a dollar or a dollar ninety-nine. Consequently, over decades, both ConAgra and our retailers faced compressed margins. When we discussed our aggressive innovation plans with retailers, they supported our efforts to modernize brands, not out of a desire to lower prices, but rather to increase them. This approach has helped improve retailer margins. For instance, with Healthy Choice Power Bowls, we still have a small segment of Classic Healthy Choice meals aimed at older consumers, but that business is declining as we phase it out. We are replacing it with higher-margin, higher-priced options like Healthy Choice Simply and Healthy Choice Power Bowls. These products offer better margins for our retailers, allowing us to rebuild retailer margins while modernizing our brands with higher price points and improved food quality.

Thank you, that's very helpful. I have a quick follow-up regarding the retention of tax benefits mentioned in response to Goldman's question. You talked about increasing trade spending due to your success in the innovation space and your anticipation of tax reform. Should I take that to mean we can expect more trade and promotions following tax reform? Additionally, since you are involved with private label products, I'm curious about your perspective in a post-tax reform environment. We are already seeing a competitive bidding process that is quite aggressive. Do you expect the benefits to diminish more quickly in private label, and is there any risk of creating price gap issues? This question extends beyond just ConAgra and is industry-wide, so any insights you could provide would be appreciated.

On that latter piece, Jason, 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 overthink 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.

So, we weren't able to get to everyone in the Q&A queue, but Investor Relations is around for the rest of the day for any follow-up discussions. So, as a reminder, this conference is being recorded, and will be archived online as detailed in our release. Thank you for interest in ConAgra Brands.