CONAGRA BRANDS INC. quarterly report, Q2 FY2020

Conagra Brands, Inc. — Form 10-Q Summary

Business context and reporting period. This filing covers the 13 and 26 weeks ended November 24, 2019 (fiscal 2020 second quarter and first half), compared with the periods ended November 25, 2018. Conagra is a branded food company reporting in Grocery & Snacks, Refrigerated & Frozen, International, and Foodservice. Pinnacle Foods, acquired in October 2018, was included for a much larger portion of the current periods than the prior-year comparatives, so reported growth is substantially acquisition-driven.

Key financial results

Metric	Q2 FY2020	Q2 FY2019	First half FY2020	First half FY2019
Net sales	$2,820.8 million	$2,383.7 million	$5,211.5 million	$4,218.1 million
Net income attributable to Conagra	$260.5 million	$131.6 million	$434.3 million	$309.8 million
Diluted EPS	$0.53	$0.31	$0.89	$0.76
Net interest expense	$121.4 million	$80.6 million	$244.1 million	$129.6 million

Sales increased 18% in Q2 and 24% in the first half. Management attributed the increase principally to Pinnacle; organic segment trends were mixed but positive in Q2.
Gross profit was $797.9 million in Q2 and $1,462.4 million in the first half. Calculated gross margin was approximately 28.3% and 28.1%, respectively, versus 28.4% and 28.3% in the comparable periods.
Total segment operating profit was $515.8 million in Q2, up from $433.3 million, and $879.0 million in the first half, up from $772.3 million. Segment operating profit is before general corporate expense, interest, taxes, and equity-method earnings.
First-half operating cash flow was $427.5 million, versus $250.7 million. Capital expenditures were $183.7 million, implying operating cash flow less capital expenditures of approximately $243.8 million. Cash used in investing was $40.2 million; cash used in financing was $431.5 million. Cash and cash equivalents ended at $192.0 million, down from $236.6 million at fiscal year-end.
At November 24, 2019, total debt carrying value was approximately $10.47 billion, including current installments; cash was $192.0 million. Current liabilities exceeded current assets by $396.2 million. The $1.6 billion revolving credit facility had no borrowings outstanding, and the company reported compliance with its debt covenants.
The effective tax rate was 24.3% in Q2 versus 14.3% a year earlier, and 14.3% for the first half versus 20.3%. Tax benefits and charges from discrete items affected the current-period rates.

Material changes versus the prior comparable periods

The Pinnacle acquisition materially expanded reported sales and segment profits, while also contributing to higher interest expense. Management said integration was on track and expected annual cost synergies of $305 million when integration is complete.
Q2 income increased despite higher interest and tax expense. The comparison also benefited from lower SG&A expenses than the prior-year quarter, which included substantial restructuring and acquisition/divestiture costs.
First-half cash from operations improved, principally reflecting Pinnacle’s inclusion, partly offset by higher interest and tax payments. Inventory increased to $1,770.4 million from $1,548.9 million, reflecting seasonal builds, Pinnacle, and new product launches.
Debt declined from $10.68 billion at May 26, 2019 to approximately $10.47 billion. The company repaid $200 million of term loans during the first half and repaid the remaining $200 million after quarter-end. Approximately $1.2 billion of debt was due within the next 12 months.
Segment reporting was reorganized to incorporate Pinnacle into the company’s current management structure; prior periods were reclassified to conform.

Outlook, unusual items, and risks

No specific revenue or EPS guidance is provided in the supplied filing text. Management estimated fiscal 2020 capital expenditures of approximately $400 million and intended, subject to Board approval and conditions, to maintain the annual dividend rate at $0.85 per share for fiscal 2020.
The Pinnacle integration plan could involve up to $360 million of charges; approximately $267.4 million had been incurred or was expected for actions identified to date. A separate Conagra restructuring plan had $104.8 million of identified incurred or expected charges. Management expects restructuring and integration activity to continue over multiple years.
Q2 comparability items included $35.2 million of restructuring charges, a $27.6 million impairment charge for Lender’s bagel business, a $12.0 million contract settlement gain, and a $6.6 million legacy environmental charge. First-half items also included $59.0 million of impairments of businesses held for sale and $19.3 million of brand impairment charges.
Conagra sold its DSD Snacks business during Q2 for net proceeds of $139.0 million. It agreed after quarter-end to sell Lender’s bagel business; the sale closed January 2, 2020 for net proceeds of $33.2 million, subject to final working-capital adjustments. The filing also reports the subsequent sale of a peanut-butter manufacturing facility.
Key risks identified include realizing Pinnacle synergies and integration benefits, deleveraging and refinancing debt, commodity and foreign-exchange volatility, changing consumer preferences, competition, and potential impairment of goodwill or intangibles. Walmart and its affiliates accounted for approximately 25% of sales and 30% of receivables.
Contingencies include a California lead-paint settlement requiring $101.7 million in installments through fiscal 2026, with $74.2 million accrued at quarter-end and a guarantee of up to $15.0 million if a co-defendant defaults. Environmental reserves were $58.6 million, including a $6.6 million second-quarter increase. Securities and shareholder litigation related to Pinnacle is pending; management did not expect it to have a material adverse effect.
Management stated that liquidity sources should be sufficient for at least the next 12 months, including debt repayment or refinancing, working capital, capital spending, and dividends. That assessment depends on operating cash flows and continued access to financing and capital markets.

Important facts for investors to verify

How much reported growth and segment profit reflects Pinnacle versus organic performance, price/mix, and divestitures.
Progress toward the $305 million annual synergy target, the remaining integration and restructuring costs, and the cash versus non-cash portions of those costs.
Plans and financing terms for the approximately $1.2 billion of debt due within 12 months, and the pace of further deleveraging.
Whether inventory and working-capital requirements normalize and whether operating cash flow continues to cover capital spending and dividends.
Potential financial exposure from the lead-paint settlement, environmental matters, and pending litigation, as well as future impairment risk for reporting units and brands.
Execution and final proceeds from divestitures, including any working-capital adjustments to the reported sale amounts.