CONAGRA BRANDS INC. quarterly report, Q1 FY2014

Business context and reporting period

ConAgra Foods, Inc. filed this Form 10-Q for the 13 weeks ended August 25, 2013, the first quarter of fiscal 2014. The company’s four reporting segments were Consumer Foods, Commercial Foods, Ralcorp Food Group and Ralcorp Frozen Bakery Products. The Ralcorp segments were included following the January 2013 acquisition; accordingly, year-over-year consolidated sales include a substantial acquisition effect and are not directly comparable.

Financial results and key metrics

Sales rose $899.5 million, or 27%, primarily reflecting Ralcorp. Consumer Foods sales fell 2% to $1,995.9 million and Commercial Foods sales were essentially flat at $1,263.9 million. The new Ralcorp Food Group and Ralcorp Frozen Bakery Products segments recorded sales of $703.4 million and $238.6 million, respectively.

Reported gross profit was $830.9 million, or approximately 19.8% of sales, versus $868.6 million, or approximately 26.3%, in the prior-year quarter. These calculated figures reflect a changed business mix as well as operating pressures. Segment operating profit totaled $398.0 million, up from $375.6 million, with the new Ralcorp segments contributing $81.7 million. However, general corporate expense was $126.5 million versus income of $42.5 million a year earlier, and net interest expense increased to $95.6 million from $49.3 million. Pre-tax continuing income fell to $175.9 million from $368.8 million. The effective tax rate declined to 19% from 33%, partly due to discrete tax benefits; the filing reports a $22.4 million tax benefit among comparability items.

Cash and cash equivalents were $194.2 million at quarter-end, versus $183.9 million at fiscal year-end. Current assets were $4,457.4 million and current liabilities $3,463.3 million. Operating cash flow from continuing operations was $163.9 million, down from $327.6 million; capital expenditures were $181.1 million. Cash dividends paid were $104.8 million, and the declared dividend was $0.25 per share.

Long-term debt, including current installments, had a carrying value of approximately $9.4 billion; notes payable were $282.2 million. Total liabilities were $15.0 billion. The company had $280.0 million outstanding under its commercial paper program, $900.0 million under its Ralcorp-related term loan, and no borrowings under its $1.5 billion revolving credit facility. It reported compliance with the facility’s financial covenants and investment-grade senior debt ratings.

Material changes versus the prior comparable period

• Consolidated sales increased 27%, but this principally reflects the Ralcorp acquisition; legacy Consumer Foods sales declined and Commercial Foods sales were flat.
• Net income attributable to ConAgra declined 42% and diluted EPS fell from $0.61 to $0.34. Higher interest expense and corporate expense, along with weaker performance in existing segments, offset the additional Ralcorp operating profit.
• Operating cash flow from continuing operations roughly halved. Management cited lower continuing-operations income, higher incentive compensation payments, acquisition-related severance and benefits, and seasonal inventory needs from Ralcorp.
• Capital expenditures increased to $181.1 million from $98.4 million; prior-year investing cash flows also included the $266.9 million P.F. Chang’s and Bertolli frozen-meal acquisition.

Outlook, management commentary, risks and unusual items

• Management expected a fiscal 2014 effective tax rate of approximately 34%, capital expenditures of approximately $650 million, and to refinance $500 million of senior debt due in April 2014. It expected available cash, operating cash flows, credit facilities and capital-market access to cover liquidity needs, capital spending and anticipated dividends for at least 12 months.
• Management intends to repay the remaining $900 million Ralcorp term loan by the end of fiscal 2015. The $1.5 billion revolving credit facility was extended after quarter-end to September 2018.
• The Ralcorp integration and restructuring plan is expected to span multiple years and include operational efficiencies, headquarters integration and manufacturing/distribution optimization. The company recognized $7.3 million of related charges in the quarter but could not estimate total expected costs or timing.
• First-quarter comparability items included $16.6 million of integration costs, $10.9 million of transaction-related costs, $9.5 million of restructuring charges and the $22.4 million tax benefit. Prior-year items included a $7.5 million peanut-butter-recall legal charge, $6.2 million of restructuring charges and $4.7 million of transaction costs.
• After quarter-end, ConAgra sold the Lightlife business for $54.7 million cash and expected a $32.0 million pre-tax gain ($15.3 million after tax) in the next quarter. It also agreed to acquire frozen-dessert production assets for approximately $39 million.
• Key operating pressures included promotional competition and lower volumes in some Consumer Foods categories, higher input costs, and loss of a sizeable Lamb Weston foodservice customer. Wal-Mart and affiliates represented 17% of quarterly sales.
• Risk exposures include commodity, energy, interest-rate and foreign-exchange movements; execution and synergies of the Ralcorp integration; customer and competitive conditions; and access to capital. The filing also describes legacy litigation and environmental matters, including a California lead-paint case awaiting a decision and $63.0 million of reserves for Beatrice-related environmental matters. Management stated that, after recorded liabilities, the disclosed matters were not expected to have a material adverse effect, while noting estimates could change.
• Disclosure controls were judged effective, but Ralcorp, representing $942.0 million of quarterly sales and $8.24 billion of assets, was excluded from the internal-control assessment under the SEC’s recently acquired business guidance.

Important facts for investors to verify

• How much of reported sales and earnings growth is attributable to Ralcorp versus underlying volume, pricing and mix, and whether integration benefits emerge.
• The trend in Consumer Foods and Commercial Foods segment profits, input-cost inflation, promotional intensity and major-customer exposure.
• Debt repayment and refinancing progress, covenant headroom, interest costs and the effect of elevated capital spending on free cash flow.
• The final cost, cash requirements and timetable for Ralcorp integration and restructuring, which management could not estimate.
• Whether the 34% full-year tax-rate outlook and the expected Lightlife sale gain are realized, and developments in material legal and environmental contingencies.