UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended July 29, 2012

OR

 

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from          to         

Commission file number 333-107830-05

 

 

DEL MONTE CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Delaware		75-3064217
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification Number)

One Maritime Plaza, San Francisco, California 94111

(Address of Principal Executive Offices including Zip Code)

(415) 247-3000

(Registrant’s Telephone Number, Including Area Code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ¨    No  x

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer		¨		Accelerated filer		¨
Non-accelerated filer		x  (Do not check if a smaller reporting company)		Smaller reporting company		¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The number of shares outstanding of the Company’s common stock, par value $0.01, as of close of business on September 7, 2012 was 10.

 

 

 

 

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Table of Contents

 

PART I.		FINANCIAL INFORMATION			2
ITEM 1.		FINANCIAL STATEMENTS			2
		CONDENSED CONSOLIDATED BALANCE SHEETS –July 29, 2012 (unaudited) and April 29, 2012			2
		CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS) (unaudited)  – three months ended July 29, 2012 and July 31, 2011			3
		CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (unaudited)  – three months ended July 29, 2012 and July 31, 2011			4
		CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)  – three months ended July 29, 2012 and July 31, 2011			5
		NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)			6
ITEM 2.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			15
ITEM 3.		QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			27
ITEM 4.		CONTROLS AND PROCEDURES			28
PART II.		OTHER INFORMATION			30
ITEM 1.		LEGAL PROCEEDINGS			30
ITEM 1A.		RISK FACTORS			30
ITEM 2.		UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS			31
ITEM 3.		DEFAULTS UPON SENIOR SECURITIES			31
ITEM 4.		MINE SAFETY DISCLOSURE			31
ITEM 5.		OTHER INFORMATION			31
ITEM 6.		EXHIBITS			31
		SIGNATURES			33

 

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PART I. FINANCIAL INFORMATION

 

ITEM 1.

FINANCIAL STATEMENTS

DEL MONTE CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in millions, except share and per share data)

 

		July 29, 2012				April 29, 2012
		(unaudited)				(derived from audited financial statements)
ASSETS
Cash and cash equivalents		$	272.4			$	402.8
Trade accounts receivable, net of allowance			205.1				195.3
Inventories			860.7				748.7
Prepaid expenses and other current assets			158.0				125.1
Total current assets			1,496.2				1,471.9
Property, plant and equipment, net			736.3				729.2
Goodwill			2,119.7				2,119.7
Intangible assets, net			2,761.7				2,774.2
Other assets, net			138.1				148.1
Total assets		$	7,252.0			$	7,243.1
LIABILITIES AND STOCKHOLDER’S EQUITY
Accounts payable and accrued expenses		$	585.4			$	501.9
Short-term borrowings			3.3				3.3
Current portion of long-term debt			6.5				91.1
Total current liabilities			595.2				596.3
Long-term debt, net of discount			3,876.7				3,883.0
Deferred tax liabilities			962.5				953.8
Other non-current liabilities			308.5				308.7
Total liabilities			5,742.9				5,741.8
Stockholder’s equity:
Common stock ($0.01 par value per share, shares authorized: 1,000; 10 issued and outstanding)			—				—
Additional paid-in capital			1,588.0				1,586.1
Accumulated other comprehensive income (loss)			(13.3	)			(12.9	)
Retained earnings (accumulated deficit)			(65.6	)			(71.9	)
Total stockholder’s equity			1,509.1				1,501.3
Total liabilities and stockholder’s equity		$	7,252.0			$	7,243.1

See accompanying Notes to the Condensed Consolidated Financial Statements.

 

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DEL MONTE CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS) (unaudited)

(in millions)

 

		Three Months Ended
		July 29, 2012				July 31, 2011
Net sales		$	821.1			$	776.2
Cost of products sold			600.6				554.4
Gross profit			220.5				221.8
Selling, general and administrative expense			174.7				172.5
Operating income			45.8				49.3
Interest expense			65.2				62.6
Other (income) expense			(25.8	)			30.3
Income (loss) from continuing operations before income taxes			6.4				(43.6	)
Provision (benefit) for income taxes			0.1				(16.0	)
Net income (loss)		$	6.3			$	(27.6	)

See accompanying Notes to the Condensed Consolidated Financial Statements.

 

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DEL MONTE CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (unaudited)

(in millions)

 

		Three Months Ended
		July 29,				July 31,
		2012				2011
Net income (loss)		$	6.3			$	(27.6	)
Other comprehensive income (loss):
Foreign currency translation adjustments			(0.4	)			(0.1	)
Pension and other postretirement benefits adjustments:
Prior service credit arising during the period, net of tax			—				(4.4	)
Total other comprehensive income (loss)			(0.4	)			(4.5	)
Comprehensive income (loss)		$	5.9			$	(32.1	)

See accompanying Notes to the Condensed Consolidated Financial Statements.

 

4

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DEL MONTE CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

(in millions)

 

		Three Months Ended
		July 29,				July 31,
		2012				2011
Operating activities:
Net income (loss)		$	6.3			$	(27.6	)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization			41.1				36.6
Deferred taxes			7.5				(16.8	)
Write off of debt issuance cost			2.9				—
Loss on asset disposals			0.2				1.2
Stock compensation expense			2.5				1.2
Unrealized (gain) loss on derivative financial instruments			(29.1	)			29.5
Changes in operating assets and liabilities			(32.2	)			42.0
Net cash provided by (used in) operating activities			(0.8	)			66.1
Investing activities:
Capital expenditures			(25.4	)			(22.7	)
Payment for asset acquisition			(12.0	)			—
Net cash used in investing activities			(37.4	)			(22.7	)
Financing activities:
Payments on short-term borrowings			—				(4.6	)
Principal payments on long-term debt			(91.1	)			—
Capital contribution, net			—				1.0
Net cash used in financing activities			(91.1	)			(3.6	)
Effect of exchange rate changes on cash and cash equivalents			(1.1	)			1.4
Net change in cash and cash equivalents			(130.4	)			41.2
Cash and cash equivalents at beginning of period			402.8				205.2
Cash and cash equivalents at end of period		$	272.4			$	246.4

See accompanying Notes to the Condensed Consolidated Financial Statements.

 

5

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DEL MONTE CORPORATION AND SUBSIDIARIES

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

For the three months ended July 29, 2012

(unaudited)

Note 1. Business and Basis of Presentation

On March 8, 2011, Del Monte Foods Company (“DMFC”) was acquired by an investor group led by funds affiliated with Kohlberg Kravis Roberts & Co. L.P. (“KKR”), Vestar Capital Partners (“Vestar”) and Centerview Capital, L.P. (“Centerview,” and together with KKR and Vestar, the “Sponsors”). Del Monte Corporation (“DMC” and, together with its consolidated subsidiaries, “Del Monte” or the “Company”) was a direct, wholly-owned subsidiary of DMFC. On April 26, 2011, DMFC merged with and into DMC, with DMC being the surviving corporation.

The Company operates on a 52 or 53-week fiscal year ending on the Sunday closest to April 30. The results of operations for the three months ended July 29, 2012 and July 31, 2011 each reflect periods that contain 13 weeks.

Del Monte is one of the country’s largest producers, distributors and marketers of premium quality, branded pet products and food products for the U.S. retail market. The Company’s pet food and pet snacks brands include Meow Mix, Kibbles ‘n Bits, Milk-Bone, 9Lives, Pup-Peroni, Gravy Train, Nature’s Recipe, Canine Carry Outs, Milo’s Kitchen and other brand names, and food brands include Del Monte, Contadina, S&W, College Inn and other brand names. The Company also produces and distributes private label pet products and food products. The majority of its products are sold nationwide in all channels serving retail markets, mass merchandisers, the U.S. military, certain export markets, the foodservice industry and food processors.

For reporting purposes the Company has two segments: Pet Products and Consumer Products. The Pet Products segment includes the Pet Products operating segment, which manufactures, markets and sells branded and private label dry and wet pet food and pet snacks. The Consumer Products segment includes the Consumer Products operating segment, which manufactures, markets and sells branded and private label shelf-stable products, including fruit, vegetable, tomato and broth products.

The accompanying unaudited condensed consolidated financial statements of Del Monte as of July 29, 2012 and for the three months ended July 29, 2012 and July 31, 2011 have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for annual financial statements. These unaudited condensed consolidated financial statements should be read in conjunction with the notes to the consolidated financial statements contained in the Company’s 2012 Annual Report on Form 10-K (“2012 Annual Report”). In the opinion of management, all adjustments consisting of normal and recurring entries considered necessary for a fair presentation of the results for the interim periods presented have been included. All significant intercompany balances and transactions have been eliminated. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect reported amounts in the financial statements and accompanying notes. These estimates are based on information available as of the date of the unaudited condensed consolidated financial statements. Therefore, actual results could differ from those estimates. Furthermore, operating results for the three months ended July 29, 2012 are not necessarily indicative of the results expected for the fiscal year ending April 28, 2013.

Note 2. Recently Issued Accounting Standards

In June 2011, the Financial Accounting Standards Board (“FASB”) amended its guidance on the presentation of comprehensive income. The new accounting guidance requires entities to report components of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. Additionally, this new accounting guidance requires presentation on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented. The Company adopted the applicable provisions of this update in the first quarter of fiscal 2013; however, all provisions included in the update were not adopted due to the issuance of an Accounting Standards Update in December 2011, which deferred the requirement related to the reclassification adjustments from other comprehensive income to net income. This Accounting Standards Update indefinitely deferred the provision that required entities to present reclassification adjustments out of accumulated other comprehensive income by component in the statement of net income. The adoption of this standard resulted in expanded disclosures to the Company’s condensed consolidated financial statements but did not impact the financial results.

In September 2011, the FASB issued an Accounting Standards Update that permits companies to assess qualitative factors to determine if it is more-likely-than-not that goodwill is impaired before performing the two-step goodwill impairment test required under current accounting standards. The guidance became effective for the Company beginning in the first quarter of fiscal 2013, with early adoption permitted. The adoption of this standard did not impact the financial results.

 

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In July 2012, the FASB issued an Accounting Standard Update that permits an entity first to assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test in accordance with current accounting standards. The guidance is effective for the Company beginning in the first quarter of fiscal 2014, with early adoption permitted. The adoption of this standard will not impact the Company’s financial results.

Note 3. Supplemental Financial Statement Information

		July 29,				April 29,
		2012				2012
Trade accounts receivable:
Trade		$	205.1			$	195.3
Allowance for doubtful accounts			—				—
Total trade accounts receivable		$	205.1			$	195.3
Inventories:
Finished products		$	658.5			$	590.9
Raw materials and in-process materials			48.3				48.2
Packaging materials and other			145.8				105.3
LIFO reserve			8.1				4.3
Total inventories		$	860.7			$	748.7
Property, plant and equipment, net:
Land and land improvements		$	46.3			$	44.9
Buildings and leasehold improvements			263.4				252.3
Machinery and equipment			430.8				417.9
Computers and software			52.3				49.4
Construction in progress			49.0				47.9
			841.8				812.4
Accumulated depreciation			(105.5	)			(83.2	)
Total property, plant and equipment		$	736.3			$	729.2
Accounts payable and accrued expenses:
Accounts payable - trade		$	281.4			$	236.8
Marketing and advertising			63.3				48.3
Accrued benefits, payroll and related costs			62.0				65.7
Accrued interest			56.7				32.2
Current portion of pension liability			21.2				21.5
Other current liabilities			100.8				97.4
Total accounts payable and accrued expenses		$	585.4			$	501.9
Accumulated other comprehensive income (loss):
Foreign currency translation adjustments		$	(0.6	)		$	(0.2	)
Pension and other postretirement benefits adjustments			(12.7	)			(12.7	)
Total accumulated other comprehensive income (loss)		$	(13.3	)		$	(12.9	)

 

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Note 4. Goodwill and Intangible Assets

The following table presents the Company’s goodwill and intangible assets (in millions):

 

		July 29,				April 29,
		2012				2012
Goodwill:
Pet Products segment		$	1,976.1			$	1,976.1
Consumer Products segment			143.6				143.6
Total goodwill		$	2,119.7			$	2,119.7
Non-amortizable intangible assets:
Trademarks		$	1,871.4			$	1,871.4
Amortizable intangible assets:
Trademarks			82.3				82.3
Customer relationships			876.7				876.7
			959.0				959.0
Accumulated amortization			(68.7	)			(56.2	)
Amortizable intangible assets, net			890.3				902.8
Total intangible assets, net		$	2,761.7			$	2,774.2

Amortization expense for the periods indicated below was as follows (in millions):

 

		Three Months Ended
		July 29,				July 31,
		2012				2011
Amortization expense		$	12.5			$	12.2

As of July 29, 2012, expected amortization of intangible assets for the remainder of fiscal 2013, for each of the five succeeding fiscal years and thereafter is as follows (in millions):

 

2013 (remainder)			37.3
2014			49.7
2015			49.7
2016			49.5
2017			49.0
2018 and thereafter			655.1

Note 5. Derivative Financial Instruments

The Company uses interest rate swaps, commodity swaps, futures, option and swaption (an option on a swap) contracts as well as forward foreign currency contracts to hedge market risks relating to possible adverse changes in interest rates, commodity, transportation and other input prices and foreign currency exchange rates. The Company continually monitors its positions and the credit ratings of the counterparties involved to mitigate the amount of credit exposure to any one party. As of July 29, 2012, all of the Company’s derivative contracts were economic hedges.

The Company utilizes hedging instruments whose change in fair value acts as an economic hedge but does not currently meet the requirements to receive hedge accounting treatment. In the past the Company has utilized, and in the future expects to utilize, hedge accounting treatment for certain of its transactions.

Interest Rates: The Company’s debt primarily consists of floating rate term loans and fixed rate notes. The Company maintains its floating rate revolver for flexibility to fund seasonal working capital needs and for other uses of cash. Interest expense on the Company’s floating rate debt is typically calculated based on a fixed spread over a reference rate, such as LIBOR (also known as the Eurodollar rate). Therefore, fluctuations in market interest rates will cause interest expense increases or decreases on a given amount of floating rate debt.

 

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Swaps are recorded as an asset or liability in the Company’s consolidated balance sheet at fair value. Any gains and losses on economic hedges are recorded as an adjustment to other (income) expense.

The Company from time to time manages a portion of its interest rate risk related to floating rate debt by entering into interest rate swaps in which the Company receives floating rate payments and makes fixed rate payments. As of July 29, 2012, the following swaps were outstanding:

 

Contract date		Notional amount (in millions)				Fixed LIBOR rate				Effective date				Maturity date
April 12, 2011		$	900.0				3.029	%			September 4, 2012				September 1, 2015
August 13, 2010		$	300.0				1.368	%			February 1, 2011				February 3, 2014

Commodities: Certain commodities such as soybean meal, corn, wheat, soybean oil, diesel fuel and natural gas (collectively, “commodity contracts”) are used in the production and transportation of the Company’s products. Generally these commodities are purchased based upon market prices that are established with the vendor as part of the purchase process. The Company uses futures, swaps, swaption or option contracts, as deemed appropriate, to reduce the effect of price fluctuations on anticipated purchases. These contracts may have a term of up to 24 months. The Company accounted for these commodities derivatives as economic hedges. Changes in the value of economic hedges are recorded directly in earnings.

The table below presents the notional amounts of the Company’s commodity contracts as of the dates indicated (in millions):

 

		July 29, 2012				April 29, 2012
Commodity contracts		$	219.8			$	166.3

Foreign Currency: The Company manages its exposure to fluctuations in foreign currency exchange rates by entering into forward contracts to cover a portion of its projected expenditures paid in local currency. These contracts may have a term of up to 24 months. The Company accounted for these contracts as economic hedges. Changes in the value of the economic hedges are recorded directly in earnings.

The table below presents foreign currency derivative contracts as of the dates indicated (in millions). All of the foreign currency derivative contracts held on July 29, 2012 are scheduled to mature prior to the end of fiscal 2014.

 

		July 29, 2012				April 29, 2012
Contract amount (Mexican pesos)		$	52.8			$	41.6

 

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Fair Value of Derivative Instruments

The fair value of derivative instruments (all of which are not designated as hedging instruments) recorded in the Condensed Consolidated Balance Sheet as of July 29, 2012 was as follows (in millions):

 

		Asset derivatives						Liability derivatives
Derivatives in economic hedging relationships		Balance Sheet location		Fair value				Balance Sheet location		Fair value
Interest rate contracts		Other non-current assets		$	—			Other non-current liabilities		$	50.5
Interest rate contracts		Prepaid expenses and other current assets			—			Accounts payable and accrued expenses			22.4
Commodity and other contracts		Prepaid expenses and other current assets			34.2			Accounts payable and accrued expenses			3.4
Foreign currency exchange contracts		Prepaid expenses and other current assets			0.4			Accounts payable and accrued expenses			—
Total				$	34.6					$	76.3

The fair value of derivative instruments (all of which are not designated as hedging instruments) recorded in the Consolidated Balance Sheet as of April 29, 2012 was as follows (in millions):

 

		Asset derivatives						Liability derivatives
Derivatives in economic hedging relationships		Balance Sheet location		Fair value				Balance Sheet location		Fair value
Interest rate contracts		Other non-current assets		$	—			Other non-current liabilities		$	50.6
Interest rate contracts		Prepaid expenses and other current assets			—			Accounts payable and accrued expenses			15.5
Commodity and other contracts		Prepaid expenses and other current assets			9.5			Accounts payable and accrued expenses			8.0
Foreign currency exchange contracts		Prepaid expenses and other current assets			1.0			Accounts payable and accrued expenses			—
Total				$	10.5					$	74.1

The effect of the Company’s economic hedges on other (income) expense in the Condensed Consolidated Statements of Income (Loss) for the periods indicated below was as follows (in millions):

 

		Three Months Ended
		July 29, 2012				July 31, 2011
Interest rate contracts		$	7.4			$	29.1
Commodity and other contracts			(34.7	)			0.6
Foreign currency exchange contracts			0.9				(0.1	)
Included in other (income) expense		$	(26.4	)		$	29.6

Note 6. Fair Value Measurements

A three-tier fair value hierarchy is utilized to prioritize the inputs used in measuring fair value. The hierarchy gives the highest priority to quoted prices in active markets (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels are defined as follows:

 

•

Level 1 Inputs—unadjusted quoted prices in active markets for identical assets or liabilities;

 

•

Level 2 Inputs—quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument; and

 

•

Level 3 Inputs—unobservable inputs reflecting the Company’s own assumptions in measuring the asset or liability at fair value.

The Company uses interest rate swaps, commodity contracts and forward foreign currency contracts to hedge market risks relating to possible adverse changes in interest rates, commodity prices, diesel fuel prices and foreign exchange rates.

 

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The following table provides the fair values hierarchy for financial assets and liabilities measured on a recurring basis (in millions):

 

		Level 1								Level 2								Level 3
		July 29,				April 29,				July 29,				April 29,				July 29,				April 29,
Description		2012				2012				2012				2012				2012				2012
Assets
Interest rate contracts		$	—			$	—			$	—			$	—			$	—			$	—
Commodity and other contracts			23.8				9.5				10.4				—				—				—
Foreign currency exchange contracts			—				—				0.4				1.0				—				—
Total		$	23.8			$	9.5			$	10.8			$	1.0			$	—			$	—
Liabilities
Interest rate contracts		$	—			$	—			$	72.9			$	66.1			$	—			$	—
Commodity and other contracts			1.3				1.0				2.1				7.0				—				—
Foreign currency exchange contracts			—				—				—				—				—				—
Total		$	1.3			$	1.0			$	75.0			$	73.1			$	—			$	—

The Company’s determination of the fair value of its interest rate swaps was calculated using a discounted cash flow analysis based on the terms of the swap contracts and the observable interest rate curve. The Company’s futures and options contracts are traded on regulated exchanges such as the Chicago Board of Trade, Kansas City Board of Trade and the New York Mercantile Exchange. The Company values these contracts based on the daily settlement prices published by the exchanges on which the contracts are traded. The Company’s commodities swap and swaption contracts are traded over-the-counter and are valued based on the Chicago Board of Trade quoted prices for similar instruments in active markets or corroborated by observable market data available from the Energy Information Administration. The Company measures the fair value of foreign currency forward contracts using an income approach based on forward rates (obtained from market quotes for futures contracts with similar terms) less the contract rate multiplied by the notional amount.

As of July 29, 2012, the book value of the Company’s floating rate debt instruments approximates fair value. The Company uses Level 2 inputs to estimate the fair value of such debt. The following table provides the book value and the fair value of the Company’s fixed rate notes (“Senior Notes”) (in millions):

 

		July 29,				April 29,
Senior Notes		2012				2012
Book value		$	1,300.0			$	1,300.0
Fair value		$	1,287.0			$	1,306.5

Fair value was estimated based on quoted market prices from the trading desk of a nationally recognized investment bank. As the Senior Notes are only available to accredited investors through certain brokerage firms, the Company has classified this debt as Level 2 of the fair value hierarchy.

 

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Note 7. Retirement Benefits

Del Monte sponsors a qualified defined benefit pension plan and several unfunded defined benefit postretirement plans providing certain medical, dental and life insurance benefits to eligible retired, salaried, non-union hourly and union employees. See Note 9 of the 2012 Annual Report for additional information about these plans. The components of net periodic benefit cost of such plans for the periods indicated below are as follows (in millions):

 

		Pension Benefits								Other Benefits
		Three Months Ended
		July 29,				July 31,				July 29,				July 31,
		2012				2011				2012				2011
Components of net periodic benefit cost:
Service cost for benefits earned during the period		$	3.4			$	3.4			$	0.4			$	0.4
Interest cost on projected benefit obligation			5.1				5.8				1.9				2.1
Expected return on plan assets			(8.1	)			(8.2	)			—				—
Net periodic benefit cost		$	0.4			$	1.0			$	2.3			$	2.5

Note 8. Legal Proceedings

Except as set forth below, there have been no material developments in the Company’s legal proceedings since the legal proceedings reported in the 2012 Annual Report.

On September 6, 2012, a putative class action complaint was filed against the Company in U.S. District Court for the Northern District of California alleging product liability claims relating to Milo’s Kitchen chicken jerky treats (“Chicken Jerky Treats”). Specifically, the complaint alleges that plaintiff’s dog became ill as a result of consumption of Chicken Jerky Treats. The complaint also alleges that the Company breached its warranties and California’s consumer protection laws. The complaint seeks certification as a class action and damages in excess of $5.0 million. The Company denies these allegations and intends to vigorously defend itself. The Company cannot at this time reasonably estimate a range of exposure, if any, of the potential liability.

On July 19, 2012, a putative class action complaint was filed against the Company in U.S. District Court for the Western District of Pennsylvania alleging product liability claims relating to Chicken Jerky Treats. Specifically, the complaint alleges that plaintiff’s dog became ill and had to be euthanized as a result of consumption of Chicken Jerky Treats. The complaint also alleges that the Company breached its warranties and Pennsylvania’s consumer protection laws. The complaint seeks certification as a class action and damages in excess of $5.0 million. The Company denies these allegations and intends to vigorously defend itself. On August 3, 2012, plaintiffs’ counsel filed a motion to consolidate the previously filed two similar class actions against Nestle Purina Petcare Company, owner of the Waggin’ Train brand of chicken jerky treats, in U.S. District Court for the Northern District of Illinois under the federal rules for multi-district litigation (“MDL”). Plaintiffs’ motion also seeks to include the case against the Company in the proposed MDL consolidation as a “related case.” The Company cannot at this time reasonably estimate a range of exposure, if any, of the potential liability.

On June 22, 2012, a putative class action complaint was filed against the Company in Los Angeles Superior Court alleging false advertising under California’s consumer protection laws, negligence, breach of warranty and strict liability. Specifically, the complaint alleges that the Company engaged in false advertising by representing that Chicken Jerky Treats are healthy, wholesome, and safe for consumption by dogs, and alleges that plaintiff’s pet became ill after consuming Chicken Jerky Treats. The allegations apply to all other putative class members similarly situated. The complaint seeks certification as a class action and unspecified damages, disgorgement of profits, punitive damages, attorneys’ fees and injunctive relief. The Company denies these allegations and intends to vigorously defend itself. On September 6, 2012, the Company filed a Notice of Removal to remove the case to the U.S. District Court for the Central District of California. The Company cannot at this time reasonably estimate a range of exposure, if any, of the potential liability.

On April 5, 2012, a complaint was filed against the Company in U.S. District Court for the Northern District of California alleging false and misleading advertising under California’s consumer protection laws. The complaint seeks certification as a class action and damages in excess of $5.0 million. On June 15, 2012, the Company filed a motion to dismiss plaintiff’s complaint. Plaintiff filed an amended complaint on July 6, 2012, negating the Company’s motion to dismiss. In its amended complaint, plaintiff alleges the Company made a variety of false and misleading advertising claims including, but not limited to, its lycopene and antioxidant claims for tomato products; implying that its refrigerated products are fresh and all natural; implying that Fresh Cut vegetables are fresh; and making misleading claims regarding sugar, nutrient content, preservatives and serving size. The Company denies these allegations and intends to vigorously defend itself. The Company filed a new motion to dismiss plaintiff’s complaint on July 31, 2012. A hearing on this motion is scheduled for September 25, 2012. The Company cannot at this time reasonably estimate a range of exposure, if any, of the potential liability.

On September 28, 2011, a complaint was filed against the Company by the Environmental Law Foundation in California Superior Court for the County of Alameda alleging violations of California Health and Safety Code sections 25249.6, et seq. (commonly known as “Proposition 65”). Specifically, the plaintiff alleges that the Company violated Proposition 65 by distributing certain pear, peach and fruit cocktail products without providing warnings required by Proposition 65. The plaintiff seeks injunctive relief, damages in an unspecified amount and attorneys’ fees. The Company intends to deny these allegations and vigorously defend itself. The court has set a trial date for April 8, 2013. The Company cannot at this time estimate a range of exposure, if any, of the potential liability.

Note 9. Segment Information

The Company has the following reportable segments:

 

•

The Pet Products segment includes the Pet Products operating segment, which manufactures, markets and sells branded and private label dry and wet pet food and pet snacks.

 

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•

The Consumer Products segment includes the Consumer Products operating segment, which manufactures, markets and sells branded and private label shelf-stable products, including fruit, vegetable, tomato and broth products.

The Company’s chief operating decision-maker, its CEO, reviews financial information presented on a consolidated basis accompanied by disaggregated information on net sales and operating income, by operating segment, for purposes of making decisions about resources to be allocated and assessing financial performance. The chief operating decision-maker reviews assets of the Company on a consolidated basis only. Fixed assets are neither maintained nor available by operating segment. The accounting policies of the individual operating segments are the same as those of the Company.

The following table presents financial information about the Company’s reportable segments (in millions):

 

		Three Months Ended
		July 29,				July 31,
		2012				2011
Net sales:
Pet Products		$	458.3			$	422.0
Consumer Products			362.8				354.2
Total		$	821.1			$	776.2
Operating income:
Pet Products		$	51.5			$	56.2
Consumer Products			13.8				14.4
Corporate (1)			(19.5	)			(21.3	)
Total			45.8				49.3
Reconciliation to income (loss) from continuing operations before income taxes:
Interest expense			65.2				62.6
Other (income) expense			(25.8	)			30.3
Income (loss) from continuing operations before income taxes		$	6.4			$	(43.6	)

 

(1)	Corporate represents expenses not directly attributable to reportable segments. For the three months ended July 29, 2012, Corporate includes $6.0 million of restructuring related expenses.

Note 10. Related Party Transactions

See Note 14 of the 2012 Annual Report for a description of the Company’s related party transactions. As of July 29, 2012, there was a payable of $1.3 million due to the managers related to the monitoring agreement, which is included in accounts payable and accrued expenses on the Condensed Consolidated Balance Sheets. As of April 29, 2012, there was a payable of $0.2 million due to the managers related to the monitoring agreement and a payable of $0.1 million due to Capstone Consulting LLC for consulting services, which amounts were included in accounts payable and accrued expenses on the Condensed Consolidated Balance Sheets.

Note 11. Exit or Disposal Activities

On May 14, 2012, the Company approved and announced plans to consolidate its peach production across California at its processing facility in Modesto, California and plans to close its Kingsburg, California processing facility. The consolidation is designed to lower the Company’s cost of production. As a result of the consolidation, approximately 70 full-time employees and approximately 1,100 seasonal employees are expected to be impacted. The Company expects to complete the plant consolidation by June 2013. For the three months ended July 29, 2012, a total of approximately $6.0 million, as further described below, was recognized in cost of products sold and was recorded as Corporate expenses, as it is the Company’s policy to record such restructuring expenses as Corporate expenses.

Del Monte expects to incur pre-tax charges and cash expenditures associated with exit or disposal activities related to (i) employee separation costs and (ii) other associated costs. Del Monte expects to incur approximately $8-11 million of total pre-tax cash charges associated with exit or disposal activities described above, consisting of (a) approximately $4 million of one-time employee termination costs and (b) approximately $4 -7 million of other associated costs. During the three months ended July 29, 2012, Del Monte incurred approximately $1.2 million of total pre-tax cash charges associated with exit or disposal activities, consisting mostly of one-time employee termination costs.

 

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In addition, in connection with the plant consolidation, the Company expects to incur non-cash accelerated depreciation expense related to property, plant and equipment totaling approximately $10.0 million. During the three months ended July 29, 2012, Del Monte incurred non-cash accelerated depreciation expense related to property, plant and equipment totaling approximately $4.8 million.

 

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ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This discussion is intended to further the reader’s understanding of the consolidated financial condition and results of operations of our Company. It should be read in conjunction with the financial statements included in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year ended April 29, 2012 (the “2012 Annual Report”). These historical financial statements may not be indicative of our future performance. This Management’s Discussion and Analysis of Financial Condition and Results of Operations contains a number of forward-looking statements, all of which are based on our current expectations and could be affected by the uncertainties and risks described in “Part I, Item 1A. Risk Factors” in our 2012 Annual Report and in “Part II, Item 1A. Risk Factors” of this Quarterly Report on Form 10-Q.

Corporate Overview

Our Business

Del Monte Corporation (“DMC”) and its consolidated subsidiaries (together, “Del Monte” or the “Company”) is one of the country’s largest producers, distributors and marketers of premium quality, branded pet products and food products for the U.S. retail market, with pet food and pet snack brands for dogs and cats such as Meow Mix, Kibbles ‘n Bits, Milk-Bone, 9Lives, Pup-Peroni, Gravy Train, Nature’s Recipe, Canine Carry Outs, Milo’s Kitchen and other brand names and food brands such as Del Monte, Contadina, S&W, College Inn and other brand names. We have two reportable segments: Pet Products and Consumer Products. The Pet Products segment includes the Pet Products operating segment, which manufactures, markets and sells branded and private label dry and wet pet food and pet snacks. The Consumer Products segment includes the Consumer Products operating segment, which manufactures, markets and sells branded and private label shelf-stable products, including fruit, vegetable, tomato and broth products.

Merger

On March 8, 2011, we were acquired by an investor group led by funds affiliated with Kohlberg Kravis Roberts & Co. L.P. (“KKR”), Vestar Capital Partners (“Vestar”) and Centerview Capital, L.P. (“Centerview,” and together with KKR and Vestar, the “Sponsors”). The acquisition (also referred to as the “Merger”) was effected by the merger of Blue Merger Sub Inc. (“Blue Sub”) with and into DMFC, with DMFC being the surviving corporation. As a result of the Merger, DMFC became a wholly-owned subsidiary of Blue Acquisition Group, Inc. (“Parent”). On April 26, 2011, DMFC merged with and into DMC, with DMC being the surviving corporation. As a result of this merger, DMC became a direct wholly-owned subsidiary of Parent.

 

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Key Performance Indicators

The following tables set forth some of our key performance indicators that we utilize to assess results of operations (in millions, except percentages):

 

		Three Months Ended
		July 29, 2012				July 31, 2011				Change				% Change				Volume (a)				Rate (b)
Net sales		$	821.1			$	776.2			$	44.9				5.8	%			5.1	%			0.7	%
Cost of products sold			600.6				554.4				46.2				8.3	%			5.5	%			2.8	%
Gross profit			220.5				221.8				(1.3	)			(0.6	%)
Selling, general and administrative expense (“SG&A”)			174.7				172.5				2.2				1.3	%
Operating income		$	45.8			$	49.3			$	(3.5	)			(7.1	%)
Gross margin			26.9	%			28.6	%
SG&A as a % of net sales			21.3	%			22.2	%
Operating income margin			5.6	%			6.4	%

 

(a)

This column represents the change, as compared to the prior year period, due to volume and mix. Volume represents the change resulting from the number of units sold, exclusive of any change in price. Volume changes in the above tables include elasticity, the volume decline associated with price increases. Mix represents the change attributable to shifts in volume across products or channels.

(b)	This column represents the change, as compared to the prior year period, attributable to per unit changes in net sales or cost of products sold.

 

		Three Months Ended								Trailing Twelve Months Ended
		July 29, 2012				July 31, 2011				July  29, 2012
Adjusted EBITDA (c)		$	113.6			$	101.2			$	603.1
Ratio of net debt to Adjusted EBITDA (d)			n/a				n/a				6.0	x

 

(c)	Refer to “Reconciliation of Non-GAAP Financial Measures—Adjusted EBITDA” below.

(d)	Net debt is calculated as total debt at the end of the period (including both short-term borrowings and long-term debt) less cash and cash equivalents.

Executive Overview

In the first quarter of fiscal 2013, we had net sales of $821.1 million, operating income of $45.8 million and net income of $6.3 million, compared to net sales of $776.2 million, operating income of $49.3 million and a net loss of $27.6 million in the first quarter of fiscal 2012. Adjusted EBITDA was $113.6 million for the three months ended July 29, 2012 and $101.2 million for the three months ended July 31, 2011. Refer to “Reconciliation of Non-GAAP Financial Measures—Adjusted EBITDA” below.

Net sales in our Pet Products segment increased by 8.6% and net sales in our Consumer Products segment increased by 2.4%, resulting in an overall increase in net sales of 5.8% for the quarter. This increase was driven by new product sales primarily in the Pet Products segment, as well as increased sales of existing products in both our Pet Products and Consumer Products segments. Net pricing (pricing net of trade spending) also contributed to the increase in net sales.

Operating income for the quarter decreased 7.1% as compared to the year-ago quarter. The decrease in operating income was driven primarily by increased operating costs, including costs associated with the closure of our Kingsburg, California facility and increased marketing spending partially offset by the absence of the prior year make-whole payment to our Chief Executive Officer.

Other income of $25.8 million for the three months ended July 29, 2012 was comprised primarily of gains on commodity hedging contracts (all of which are economic hedges), partially offset by losses on interest rate swaps. The gains on commodity hedging contracts recorded in the quarter partially offset both ingredient cost increases seen in cost of products sold and ingredient cost increases that we expect to see in future quarters.

Adjusted EBITDA increased 12.3% as compared to the year-ago quarter. As noted above, gains and losses on economic hedging positions are recorded as other (income) expense. The cash impact of these activities is reflected in Adjusted EBITDA. The positive impact of the increased sales, partially offset by increased costs, also contributed to the increase in Adjusted EBITDA.

 

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During the remainder of fiscal 2013, we expect severe drought conditions in the U.S. to impact our commodity costs, primarily in our Pet Products segment. We have announced price increases effective November 2012, which are expected to partially offset the impact of these higher costs in fiscal 2013. Additionally, these severe drought conditions are expected to tighten supplies of pea and corn crops in our Consumer Products segment. We have seen similar conditions in the past and plan to respond with a number of actions, including reducing promotional activity and implementing further cost savings initiatives.

As of July 29, 2012, our total debt was $3,892.0 million. On June 28, 2012, in accordance with the terms of our Senior Secured Term Loan Credit Agreement, we made a payment of $91.1 million representing the excess annual cash flow payment due for fiscal 2012. As a result of this excess cash flow payment, no quarterly payments will be due in fiscal 2013.

Results of Operations

The following discussion provides a summary of operating results for the three months ended July 29, 2012, compared to the results for the three months ended July 31, 2011 (in millions, except percentages).

Net sales

 

		Three Months Ended
		July 29, 2012				July 31, 2011				Change				% Change				Volume (a)				Rate (b)
Net sales:
Pet Products		$	458.3			$	422.0			$	36.3				8.6	%			8.3	%			0.3	%
Consumer Products			362.8				354.2				8.6				2.4	%			1.3	%			1.1	%
Total		$	821.1			$	776.2			$	44.9				5.8	%

 

(a)

This column represents the change, as compared to the prior year period, due to volume and mix. Volume represents the change resulting from the number of units sold, exclusive of any change in price. Volume changes in the above tables include elasticity, the volume decline associated with price increases. Mix represents the change attributable to shifts in volume across products or channels.

(b)	This column represents the change, as compared to the prior year period, attributable to per unit changes in net sales or cost of products sold.

Net sales increased 5.8% for the three months ended July 29, 2012 compared to the three months ended July 31, 2011. The increase was driven by sales of new products, primarily in our Pet Products segment and increased sales of existing products in both our Pet Products and Consumer Products segments. Net pricing also contributed to the increase in net sales.

Net sales in our Pet Products segment were $458.3 million for the three months ended July 29, 2012, an increase of $36.3 million, or 8.6%, compared to $422.0 million for the three months ended July 31, 2011. This increase was primarily driven by new product volume as well as increased sales of existing products, primarily pet snacks. Net pricing also contributed to the increase in net sales.

Net sales in our Consumer Products segment were $362.8 million for the three months ended July 29, 2012, an increase of $8.6 million, or 2.4%, compared to $354.2 million for the three months ended July 31, 2011. This increase was primarily driven by net pricing and increased non-retail sales.

Cost of products sold

Cost of products sold for the three months ended July 29, 2012 was $600.6 million, an increase of $46.2 million, or 8.3%, compared to $554.4 million for the three months ended July 31, 2011. This increase was primarily due to the higher volume of sales, as well as approximately $6.0 million in costs associated with the closure of our Kingsburg, California facility, increased ingredient costs in our Pet Products segment and increased packaging costs in both our Pet Products and Consumer Products segments. Since we do not currently apply hedge accounting, the impact of economic hedge positions we take is not reflected in cost of products sold, but in Corporate other (income) expense. See other (income) expense below.

Gross margin

Our gross margin percentage for the three months ended July 29, 2012 decreased 1.7 points to 26.9% compared to 28.6% for the three months ended July 31, 2011. Gross margin was impacted by a 2.0 margin point decrease related to the higher costs noted above and a 0.1 margin point decrease due to product mix, partially offset by a 0.4 margin point increase due to net pricing. While the impact of hedging is not currently reflected in our gross margin, in the future, we expect to utilize hedge accounting treatment for certain of our hedging transactions which will primarily impact fiscal 2014 and beyond and will cause the impact of hedged costs to be reflected in our gross margin in those future periods.

 

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Selling, general and administrative expense

SG&A expense for the three months ended July 29, 2012 was $174.7 million, an increase of $2.2 million, or 1.3%, compared to $172.5 million for the three months ended July 31, 2011. This increase was primarily driven by increased marketing expense, partially offset by the absence of the prior year make-whole payment to our Chief Executive Officer and disciplined cost management.

Operating income

 

		Three Months Ended
		July 29, 2012				July 31, 2011				Change				% Change
Operating income:
Pet Products		$	51.5			$	56.2			$	(4.7	)			(8.4	%)
Consumer Products			13.8				14.4				(0.6	)			(4.2	%)
Corporate (1)			(19.5	)			(21.3	)			1.8				8.5	%
Total		$	45.8			$	49.3			$	(3.5	)			(7.1	%)

 

(1)	Corporate represents expenses not directly attributable to reportable segments. For the three months ended July 29, 2012, Corporate includes $6.0 million of restructuring related expenses.

Operating income for the three months ended July 29, 2012 was $45.8 million, a decrease of $3.5 million, or 7.1%, compared to $49.3 million for the three months ended July 31, 2011. This decrease reflects the higher cost of products sold and higher SG&A expense, both as noted previously.

Our Pet Products segment operating income decreased by $4.7 million, or 8.4%, to $51.5 million for the three months ended July 29, 2012 from $56.2 million for the three months ended July 31, 2011. Increased marketing expense, as well as higher ingredient costs contributed to the decline in operating income, partially offset by the increase in net sales.

Our Consumer Products segment operating income decreased by $0.6 million, or 4.2%, to $13.8 million for the three months ended July 29, 2012 from $14.4 million for the three months ended July 31, 2011. Higher marketing expense drove the decrease in operating income. Net pricing partially offset the decline in operating income.

Our Corporate expenses decreased by $1.8 million, or 8.5%, during the three months ended July 29, 2012 compared to the prior year period. This decrease was primarily due to the absence of the prior year make-whole payment to our Chief Executive Officer and the absence of Merger-related expenses, partially offset by approximately $6.0 million in costs associated with the closure of our Kingsburg, California facility.

Interest expense

Interest expense increased by $2.6 million, or 4.2%, to $65.2 million for the three months ended July 29, 2012 from $62.6 million for the three months ended July 31, 2011. This increase was primarily driven by the write-off of $2.9 million of deferred financing fees in connection with the excess annual cash flow payment.

Other (income) expense

Other income of $25.8 million for the three months ended July 29, 2012 was comprised primarily of gains on commodity hedging contracts, partially offset by losses on interest rate swaps. The gains on commodity hedging contracts recorded in the quarter partially offset both ingredient cost increases seen in cost of products sold above and ingredient cost increases that we expect to see in future quarters. Other expense of $30.3 million for the three months ended July 31, 2011 was comprised primarily of $29.1 million of losses on interest rate swaps.

Provision (benefit) for income taxes

The effective tax rate for continuing operations for the three months ended July 29, 2012 was 1.6% compared to 36.7% for the three months ended July 31, 2011. The change in the effective tax rate for the three month period was primarily due to the income tax benefit recorded in the quarter from a change in state tax law.

Reconciliation of Non-GAAP Financial Measures—Adjusted EBITDA

We report our financial results in accordance with generally accepted accounting principles in the United States (“GAAP”). In this Quarterly Report on Form 10-Q, we also provide certain non-GAAP financial measures — Adjusted EBITDA and ratio of net debt to

 

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Adjusted EBITDA. We present Adjusted EBITDA because we believe that this is an important supplemental measure relating to our financial condition since it is used in certain covenant calculations that may be required from time to time under the indenture that governs our 7.625% Senior Notes due 2019 (referred to therein as “EBITDA”) and the credit agreements relating to our term loan and revolver (referred to therein as “Consolidated EBITDA”). We present the ratio of net debt to Adjusted EBITDA because it is used internally to focus management on year-over-year changes in our leverage and we believe this information is also helpful to investors. We use Adjusted EBITDA in this leverage measure because we believe our investors are familiar with Adjusted EBITDA and that consistency in presentation of EBITDA-related measures is helpful to investors.

EBITDA is defined as income before interest expense, provision for income taxes, and depreciation and amortization. Adjusted EBITDA is defined as EBITDA, further adjusted as required by the definitions of “EBITDA” and “Consolidated EBITDA” contained in our indenture and credit agreements. Our presentation of Adjusted EBITDA has limitations as an analytical tool. Adjusted EBITDA is not a measure of liquidity or profitability and should not be considered as an alternative to net income, operating income, net cash provided by operating activities or any other measure determined in accordance with GAAP. Additionally, Adjusted EBITDA is not intended to be a measure of cash flow for management’s discretionary use, as it does not consider debt service requirements, obligations under the monitoring agreement with our Sponsors, capital expenditures or other non-discretionary expenditures that are not deducted from the measure.

We caution investors that our presentation of Adjusted EBITDA and ratio of net debt to Adjusted EBITDA may not be comparable to similarly titled measures of other companies. The following table provides a reconciliation of Adjusted EBITDA for the periods indicated, (in millions):

 

		Three Months Ended								Trailing Twelve Months Ended
		July 29, 2012				July 31, 2011				July 29, 2012
Reconciliation:
Operating income - Quarter ended July 31, 2011		$	—			$	49.3			$	—
Operating income - Quarter ended October 30, 2011			—				—				107.1
Operating income - Quarter ended January 29, 2012			—				—				124.5
Operating income - Quarter ended April 29, 2012			—				—				89.3
Operating income - Quarter ended July 29, 2012			45.8				—				45.8
Operating income - Fiscal 2012			—				—				—
Other income (expense)			25.8				(30.3	)			0.6
Adjustments to arrive at EBITDA:
Depreciation and amortization(1)			41.1				36.6				154.3
Amortization of debt issuance costs and debt discount(2)			(6.1	)			(6.3	)			(25.0	)
EBITDA			106.6				49.3				496.6
Non-cash charges			0.2				1.2				3.4
Derivative transactions(3)			(7.6	)			35.6				17.2
Non-cash stock based compensation			2.5				1.2				11.0
Non-recurring (gains) losses			2.4				2.9				22.8
Merger-related items			—				7.0				6.4
Business optimization charges			6.9				1.6				35.5
Other			2.6				2.4				10.2
Adjusted EBITDA		$	113.6			$	101.2			$	603.1
Net Debt(4)										$	3,619.6
Ratio of net debt to Adjusted EBITDA											6.0x

 

(1)

Includes $4.8 million of accelerated depreciation in both the three months ended July 29, 2012 and the trailing twelve months ended July 29, 2012 related to the closure of our Kingsburg, California facility. See “Note 11. Exit or Disposal Activities” in our Notes to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

(2)	Represents adjustments to exclude amortization of debt issuance costs and debt discount reflected in depreciation and amortization because such costs are not deducted in arriving at operating income.

(3)	Represents adjustments needed to reflect only the cash impact of derivative transactions in the calculation of Adjusted EBITDA.

(4)	Net debt is calculated as total debt at the end of the period (including both short-term borrowings and long-term debt) less cash and cash equivalents.

 

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Liquidity and Capital Resources

We have cash requirements that vary based primarily on the timing of our inventory production for fruit, vegetable and tomato items. Inventory production relating to these items typically peaks during the first and second fiscal quarters. Our most significant cash needs relate to this seasonal inventory production, as well as to continuing cash requirements related to the production of our other products. In addition, our cash is used for the repayment, including interest and fees, of our primary debt obligations (i.e. our revolver and our term loans, our senior notes and, if necessary, our letters of credit), contributions to our pension plan, expenditures for capital assets, lease payments for some of our equipment and properties and other general business purposes. We have also used cash for acquisitions, legal settlements and transformation and restructuring plans. We may from time to time consider other uses for our cash flow from operations and other sources of cash. Such uses may include, but are not limited to, future acquisitions, transformation or restructuring plans. Our primary sources of cash are typically funds we receive as payment for the products we produce and sell and from our revolving credit facility.

As of July 29, 2012 and July 31, 2011, we had not made any contributions to our defined benefit pension plan for fiscal 2013 or fiscal 2012, respectively. We currently meet and plan to continue to meet the minimum funding levels required under the Pension Protection Act of 2006 (the “Act”). The Act imposes certain consequences on our defined benefit plan if it does not meet the minimum funding levels. We have made contributions in excess of our required minimum amounts during fiscal 2012 and for the twelve months ended May 1, 2011. Due to uncertainties of future funding levels as well as plan financial returns, we cannot predict whether we will continue to achieve specified plan funding thresholds. We currently expect to make contributions of approximately $15.0 million in fiscal 2013.

We believe that cash on hand, cash flow from operations and availability under our revolver will provide adequate funds for our working capital needs, planned capital expenditures, debt service obligations and planned pension plan contributions for at least the next 12 months.

Our debt consists of the following, as of the dates indicated, (in millions):

 

		July 29, 2012				April 29, 2012
Short-term borrowings:
Revolver		$	—			$	—
Other			3.3				3.3
Total short-term borrowings		$	3.3			$	3.3
Long-term debt:
Term Loan Facility			2,588.7				2,679.8
7.625% Notes			1,300.0				1,300.0
			3,888.7				3,979.8
Less unamortized discount			5.5				5.7
Less current portion			6.5				91.1
Total long-term debt		$	3,876.7			$	3,883.0

Description of Indebtedness

The summary of our indebtedness and restrictive and financial covenants set forth below is qualified by reference to our senior secured term loan credit agreement, our senior secured asset-based revolving credit facility, our senior notes indenture, and the amendments thereto, all of which are set forth as exhibits to our public filings with the Securities and Exchange Commission (“SEC”).

Senior Secured Term Loan Credit Agreement

Our senior secured term loan credit agreement initially provided for a $2,700.0 million senior secured term loan B facility (with all related loan documents, and as amended from time to time, the “Term Loan Facility”) with a term of seven years.

Loans under the Term Loan Facility bear interest at a rate equal to an applicable margin, plus, at our option, either (i) a LIBOR rate (with a floor of 1.50%) or (ii) a base rate (with a floor of 2.50%) equal to the highest of (a) the federal funds rate plus 0.50%, (b) JPMorgan Chase Bank, N.A.’s “prime rate” and (c) the one-month LIBOR rate plus 1.00%. The applicable margin with respect to LIBOR borrowings is 3.00% and with respect to base rate borrowings is 2.00%. See “Note 5. Derivative Financial Instruments” to our condensed consolidated financial statements in this Quarterly Report on Form 10-Q for a discussion of our interest rate swaps.

The Term Loan Facility requires quarterly scheduled principal payments of 0.25% of the outstanding principal per quarter from September 30, 2011 to December 31, 2017. On June 28, 2012, we made a payment of $91.1 million representing the excess annual

 

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cash flow payment due for the fiscal year ended April 29, 2012. No quarterly payments will be due in fiscal 2013 due to the excess cash flow payment being applied to such quarterly payments. The balance is due in full on the maturity date of March 8, 2018. Scheduled principal payments with respect to the Term Loan Facility are subject to reduction following any mandatory or voluntary prepayments on terms and conditions set forth in the Senior Secured Term Loan Credit Agreement. As of July 29, 2012, the amount of outstanding loans under the Term Loan Facility was $2,588.7 million and the blended interest rate payable was 4.50%, or 4.60% after giving effect to our interest rate swaps.

The Senior Secured Term Loan Credit Agreement also requires us to prepay outstanding loans under the Term Loan Facility, subject to certain exceptions, with, among other things:

 

•

Commencing with our fiscal year ended April 29, 2012, 50% (which percentage will be reduced to 25% if our leverage ratio is 5.5x or less and to 0% if our leverage ratio is 4.5x or less) of our annual excess cash flow, as defined in the Senior Secured Term Loan Credit Agreement;

 

•

100% of the net cash proceeds of certain casualty events and non-ordinary course asset sales or other dispositions of property for a purchase price above $10 million, in each case, subject to our right to reinvest the proceeds; and

 

•

100% of the net cash proceeds of any incurrence of debt, other than proceeds from debt permitted under the Senior Secured Term Loan Credit Agreement.

We have the right to request an additional $500.0 million plus an additional amount of secured indebtedness under the Term Loan Facility. Lenders under this facility are under no obligation to provide any such additional loans, and any such borrowings will be subject to customary conditions precedent, including satisfaction of a prescribed leverage ratio, subject to the identification of willing lenders and other customary conditions precedent.

Senior Secured Asset-Based Revolving Facility

Our senior secured asset-based revolving facility provides for senior secured financing of up to $750 million (with all related loan documents, and as amended from time to time, the “ABL Facility”) with a term of five years. We maintain the ABL Facility for flexibility to fund our seasonal working capital needs, which are affected by, among other things, the growing cycle of the fruits, vegetables and tomatoes we process, and for other general corporate purposes. The vast majority of our fruit, vegetable and tomato inventories are produced during the harvesting and packing months of June through October and depleted through the remaining seven months. Accordingly, our need to draw on the ABL Facility may fluctuate significantly during the year.

Borrowings under the ABL Facility bear interest at an initial interest rate equal to an applicable margin, plus, at our option, either (i) a LIBOR rate, or (ii) a base rate equal to the highest of (a) the federal funds rate plus 0.50%, (b) Bank of America, N.A.’s “prime rate” and (c) the one-month LIBOR rate plus 1.00%. The applicable margin with respect to LIBOR borrowings is currently 2.0% (and may increase to 2.50% depending on average excess availability) and with respect to base rate borrowings is currently 1.00% (and may increase to 1.50% depending on average excess availability).

In addition to paying interest on outstanding principal under the ABL Facility, we are required to pay a commitment fee at an initial rate of 0.500% per annum in respect of the unutilized commitments thereunder. The commitment fee rate may be reduced to 0.375% depending on the amount of excess availability under the ABL Facility. We must also pay customary letter of credit fees and fronting fees for each letter of credit issued.

Availability under the ABL Facility is subject to a borrowing base. The borrowing base, determined at the time of calculation, is an amount equal to: (a) 85% of eligible accounts receivable and (b) the lesser of (1) 75% of the net book value of eligible inventory and (2) 85% of the net orderly liquidation value of eligible inventory, of the borrowers under the facility at such time, less customary reserves. The ABL Facility will mature, and the commitments thereunder will terminate, on March 8, 2016. As of July 29, 2012, there were no loans outstanding under the ABL Facility, the amount of letters of credit issued under the ABL Facility was $30.7 million and the net availability under the ABL Facility was $492.1 million.

The ABL Facility includes a sub-limit for letters of credit and for borrowings on same-day notice, referred to as “swingline loans.” No new letters of credit were issued under the ABL Facility on March 8, 2011 but certain letters of credit outstanding under a prior credit facility were deemed to be outstanding under the ABL Facility. We are the lead borrower under the ABL Facility and other domestic subsidiaries may be designated as borrowers on a joint and several basis.

The commitments under the ABL Facility may be increased, subject only to the consent of the new or existing lenders providing such increases, such that the aggregate principal amount of commitments does not exceed $1.0 billion. The lenders under this facility are under no obligation to provide any such additional commitments, and any increase in commitments will be subject to customary conditions precedent. Notwithstanding any such increase in the facility size, our ability to borrow under the facility will remain limited at all times by the borrowing base (to the extent the borrowing base is less than the commitments).

 

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Senior Notes Due 2019

Our senior notes due February 16, 2019 have an aggregate principal amount of $1,300.0 million and a stated interest rate of 7.625% (the “7.625% Notes”). Interest on the 7.625% Notes is payable semi-annually on February 15 and August 15 of each year.

Prior to February 15, 2014, we have the option of redeeming (a) all or a part of the 7.625% Notes at 100% of the principal amount plus a “make whole” premium, or, using the proceeds from certain equity offerings and subject to certain conditions, (b) up to 35% of the then-outstanding 7.625% Notes at a premium of 107.625% of the aggregate principal amount and a special interest payment. Beginning on February 15, 2014, we may redeem all or a part of the 7.625% Notes at a premium ranging from 103.813% to 101.906% of the aggregate principal amount. Finally, beginning on February 15, 2016, we may redeem all or a part of the 7.625% Notes at face value. Any redemption as described above is subject to the concurrent payment of accrued and unpaid interest, if any, upon redemption.

Security Interests and Guarantees

Indebtedness under the Term Loan Facility is generally secured by a first priority lien on substantially all of our assets (except inventories and accounts receivable), and by a second priority lien with respect to inventories and accounts receivable. The ABL Facility is generally secured by a first priority lien on our inventories and accounts receivable and by a second priority lien on substantially all of our other assets. The 7.625% Notes are our senior unsecured obligations and rank senior in right of payment to the existing and future indebtedness and other obligations that expressly provide for their subordination to the 7.625% Notes; rank equally in right of payment to all of the existing and future unsecured indebtedness; are effectively subordinated to all of the existing and future secured debt (including obligations under the Term Loan Facility and ABL Facility described above) to the extent of the value of the collateral securing such debt; and are structurally subordinated to all existing and future liabilities, including trade payables, of the non-guarantor subsidiaries, to the extent of the assets of those subsidiaries.

All our obligations under the senior secured term loan credit agreement and senior secured asset-based revolving facility agreement are unconditionally guaranteed by Parent and by substantially all our existing and future, direct and indirect, wholly-owned material restricted domestic subsidiaries, subject to certain exceptions. The 7.625% Notes are required to be fully and unconditionally guaranteed by each of our existing and future domestic restricted subsidiaries that guarantee our obligations under the Term Loan Facility and ABL Facility. Currently, there are no guarantor subsidiaries under any of our debt agreements.

Maturities

As of July 29, 2012, scheduled maturities of long-term debt (representing debt under the Term Loan Facility and 7.625% Notes) are as follows (in millions)¹:

 

2013 (remainder)		$	—
2014			26.3
2015			26.3
2016			26.3
2017			26.3
Thereafter			3,783.5

 

1	Does not include any excess cash flow or other principal prepayments that may be required under the terms of the senior secured term loan credit agreement, as described above.

Restrictive and Financial Covenants

The Term Loan Facility, ABL Facility and indenture related to our 7.625% Notes contain restrictive covenants. See “Note 5. Short-Term Borrowings and Long-Term Debt” to our consolidated financial statements in our 2012 Annual Report for additional information regarding the covenants.

The Term Loan Facility, ABL Facility and indenture related to our 7.625% Notes generally do not require that we comply with financial maintenance covenants. The ABL Facility, however, contains a financial covenant that applies if availability under the ABL Facility falls below a certain level.

The restrictive and financial covenants in the Term Loan Facility, the ABL Facility and indenture related to the 7.625% Notes may adversely affect our ability to finance our future operations or capital needs or engage in other business activities that may be in our interest, such as acquisitions.

We believe that we are currently in compliance with all of our applicable covenants and were in compliance therewith as of July 29, 2012. Compliance with these covenants is monitored periodically in order to assess the likelihood of continued compliance. Our ability to continue to comply with these covenants may be affected by events beyond our control. If we are unable to comply with the

covenants under the Term Loan Facility, the ABL Facility and indenture related to the 7.625% Notes, there would be a default, which, if not waived, could result in the acceleration of a significant portion of our indebtedness. See “Part II, Item 1A. Risk Factors—Restrictive covenants in the Credit Facilities and the indenture governing the Notes may restrict our operational flexibility. If we fail to comply with these restrictions, we may be required to repay our debt, which would materially and adversely affect our financial position and results of operations” in our 2012 Annual Report.

 

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Cash Flow

During the three months ended July 29, 2012, our cash and cash equivalents decreased by $130.4 million and during the three months ended July 31, 2011, our cash and cash equivalents increased by $41.2 million.

 

		Three Months Ended
		July 29, 2012				July 31, 2011
		(in millions)
Net cash provided by (used in) operating activities		$	(0.8	)		$	66.1
Net cash used in investing activities			(37.4	)			(22.7	)
Net cash used in financing activities			(91.1	)			(3.6	)

Operating Activities

Cash used in operating activities was $0.8 million for the three months ended July 29, 2012, compared to cash provided by operating activities of $66.1 million for the three months ended July 31, 2011. This change was primarily driven by the prior year $44.0 million income tax refund. Higher working capital, primarily trade receivables, contributed to the decline.

Typically, the cash requirements of the Consumer Products segment vary significantly during the year to coincide with the seasonal growing cycles of fruit, vegetables and tomatoes. The vast majority of our fruit, vegetable and tomato inventories are produced during the packing season, from June through October, and then depleted during the remaining months of the fiscal year. As a result, the vast majority of our total operating cash flow is generated during the second half of the fiscal year.

Investing Activities

Cash used in investing activities was $37.4 million for the three months ended July 29, 2012 and $22.7 million for the three months ended July 31, 2011. Capital spending was $25.4 million for the three months ended July 29, 2012 compared to $22.7 million for the three months ended July 31, 2011. In addition, we paid approximately $12.0 million for the purchase of a fruit processing plant and warehouse facility based in Yakima County, Washington out of the bankruptcy estate of Snokist Growers during the three months ended July 29, 2012. Capital spending for the remainder of fiscal 2013 is expected to be approximately $65 million to $75 million and is expected to be funded by cash on hand and cash generated by operating activities.

Financing Activities

During the first three months of fiscal 2013, we made $91.1 million in payments on long-term debt representing the excess annual cash flow payment due for the fiscal year ended April 29, 2012.

During the first three months of fiscal 2012, we made net repayments of $4.6 million on our short-term borrowings and received capital contributions from Parent of $1.0 million from the issuance of Parent common stock.

Recently Issued Accounting Standards

In June 2011, the Financial Accounting Standards Board (“FASB”) amended its guidance on the presentation of comprehensive income. The new accounting guidance requires entities to report components of comprehensive income in either (1) a continuous statement of comprehensive income or (2) two separate but consecutive statements. Additionally, this new accounting guidance requires presentation on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the components of net income and the components of other comprehensive income are presented. We adopted the applicable provisions of this update in the first quarter of fiscal 2013; however, all provisions included in the update were not adopted due to the issuance of an Accounting Standards Update in December 2011, which deferred the requirement related to the reclassification adjustments from other comprehensive income to net income. This Accounting Standards Update indefinitely deferred the provision that required entities to present reclassification adjustments out of accumulated other comprehensive income by component in the statement of net income. The adoption of this standard resulted in expanded disclosures to our condensed consolidated financial statements but did not impact our financial results.

In September 2011, the FASB issued an Accounting Standards Update that permits companies to assess qualitative factors to determine if it is more-likely-than-not that goodwill is impaired before performing the two-step goodwill impairment test required under current accounting standards. The guidance became effective for us beginning in the first quarter of fiscal 2013, with early adoption permitted. The adoption of this standard did not impact our financial results.

In July 2012, the FASB issued an Accounting Standard Update that permits an entity first to assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test in accordance with current accounting standards. The guidance is effective for us beginning in the first quarter of fiscal 2014, with early adoption permitted. The adoption of this standard will not impact our financial results.

 

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Critical Accounting Policies and Estimates

Our discussion and analysis of the financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis, we reevaluate our estimates, including those related to trade promotions, goodwill and intangibles, retirement benefits and retained-insurance liabilities. Estimates in the assumptions used in the valuation of our stock compensation expense are updated periodically and reflect conditions that existed at the time of each new issuance of stock awards. We base estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the book values of assets and liabilities that are not readily apparent from other sources. For all of these estimates, we caution that future events rarely develop exactly as forecasted, and, therefore, these estimates routinely require adjustment.

Management has discussed the selection of critical accounting policies and estimates with the Audit Committee of the Board of Directors, and the Audit Committee has reviewed our disclosure relating to critical accounting policies and estimates in this Quarterly Report on Form 10-Q. Our significant accounting policies are described in “Note 2. Significant Accounting Policies” to our consolidated financial statements in our 2012 Annual Report. The following is a summary of the more significant judgments and estimates used in the preparation of our financial statements:

Trade Promotions

Trade promotions are an important component of the sales and marketing of our products and are critical to the support of our business. Trade spending includes amounts paid to encourage retailers to offer temporary price reductions for the sale of our products to consumers, to advertise our products in their circulars, to obtain favorable display positions in their stores and to obtain shelf space. We accrue for trade promotions, primarily at the time products are sold to customers, by reducing sales and recording a corresponding accrued liability. The amount we accrue is based on an estimate of the level of performance of the trade promotion, which is dependent upon factors such as historical trends with similar promotions, expectations regarding customer and consumer participation, and sales and payment trends with similar previously offered programs. Our original estimated costs of trade promotions are reasonably likely to change in the future as a result of changes in trends with regard to customer and consumer participation, particularly for new programs and for programs related to the introduction of new products. We perform monthly evaluations of our outstanding trade promotions; making adjustments, where appropriate, to reflect changes in our estimates. The ultimate cost of a trade promotion program is dependent on the relative success of the events and the actions and level of deductions taken by our customers for amounts they consider due to them. Final determination of the permissible trade promotion amounts due to a customer generally may take up to 18 months from the product shipment date. Our evaluations during the three months ended July 29, 2012 resulted in a net increase to the trade promotion liability and decrease in net sales from continuing operations of $0.5 million which related to prior year activity, of which $0.1 million related to our Pet Products segment and $0.4 million related to our Consumer Products segment. This adjustment represented less than 1% of our trade promotion expense for the three months ended July 29, 2012. Our evaluations during the three months ended July 31, 2011 resulted in no significant adjustments to our estimates relating to trade promotion liability.

Goodwill and Intangibles

Del Monte produces, distributes and markets products under many different brand names (also referred to as trademarks). During an acquisition, the purchase price is allocated to identifiable assets and liabilities, including brand names and other intangibles, based on estimated fair value, with any remaining purchase price recorded as goodwill. As a result of the Merger, we applied the acquisition method of accounting and established a new basis of accounting on March 8, 2011. Accordingly, each of our active brand names now has a value on our balance sheet.

We have evaluated our capitalized brand names and other intangibles and determined that some have lives that generally range from 5 to 25 years (“Amortizing Intangibles”) and others have indefinite lives (“Non-Amortizing Brands”). Non-Amortizing Brands typically have significant market share and a history of strong earnings and cash flow, which we expect to continue into the foreseeable future.

Amortizing Intangibles are amortized over their estimated lives. We review the asset groups containing Amortizing Intangibles (including related tangible assets) for impairment whenever events or changes in circumstances indicate that the book value of an asset group may not be recoverable. An asset or asset group is considered impaired if its book value exceeds the undiscounted future net cash flow the asset or asset group is expected to generate. If an asset or asset group is considered to be impaired, the impairment to be recognized is measured by the amount by which the book value of the asset exceeds its fair value. Non-Amortizing Brands and goodwill are not amortized, but are instead tested for impairment at least annually. Our annual impairment tests occur during the fourth quarter of our fiscal year. Non-Amortizing Brands are considered impaired if the book value exceeds the estimated fair value. Goodwill is considered impaired if the book value of the reporting unit containing the goodwill exceeds its estimated fair value. If estimated fair value is less than the book value, the asset is written down to the estimated fair value and an impairment loss is recognized.

 

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The estimated fair value of our Non-Amortizing Brands is determined using the relief from royalty method, which is based upon the estimated rent or royalty we would pay for the use of a brand name if we did not own it. For goodwill, the estimated fair value of a reporting unit is determined using the income approach, which is based on the cash flows that the unit is expected to generate over its remaining life, and the market approach, which is based on market multiples of similar businesses. Our reporting units are the same as our operating segments—Pet Products and Consumer Products—reflecting the way that we manage our business. Annually, we engage third-party valuation experts to assist in this process. Considerable management judgment is necessary in estimating future cash flows, market interest rates, discount rates and other factors affecting the valuation of goodwill and intangibles, including the operating and macroeconomic factors that may affect them. We use historical financial information, internal plans and projections, and industry information in making such estimates.

We did not recognize any impairment charges for our Amortizing Intangibles, Non-Amortizing Brands or goodwill during the three months ended July 29, 2012 and July 31, 2011. As of July 29, 2012, we had $2,119.7 million of goodwill and $1,871.4 million of Non-Amortizing Brands. The Pet Products segment has 93% of the goodwill and 68% of the Non-Amortizing Brands. The Del Monte brand itself, which is included in the Consumer Products segment, comprises 30% of Non-Amortizing Brands. The Meow Mix and Milk-Bone brands together, which are included in the Pet Products segment, comprise 41% of Non-Amortizing Brands. However, because the new basis of accounting established at March 8, 2011 set the book values of goodwill and Non-Amortizing brands equal to fair value and impairment tests are highly sensitive to changes in assumptions, minor changes to assumptions, including assumptions regarding future performance (including sales growth, pricing and input costs) and discount rates, could result in impairment losses. In our fiscal 2012 impairment test, our Pet Products reporting unit had excess fair value over the book value of net assets of approximately 6% and our Consumer Products reporting unit had excess fair value over the book value of net assets of approximately 16%. Additionally, three of our Non-Amortizing Brands (one in the Consumer Products segment and two in the Pet Products segment with a combined book value of $993.2 million) each had excess fair value over the book value of 2% or less. Our forecasts utilized in our fiscal 2012 impairment test assume, among other things, that we will achieve sales growth by successfully executing broad consumer messaging campaigns (including various forms of advertising, media and shopper marketing) which will improve category trends, enhance our pricing power, improve our share performance and facilitate further new product innovation. This assumption is particularly important for brands that have not historically experienced sufficient levels of advertising and other consumer communications because the impact of such activities on sales growth and pricing power is difficult to predict. If these initiatives do not achieve the desired results, future impairment losses may occur.

Retirement Benefits

We sponsor a non-contributory defined benefit pension plan (“DB plan”), defined contribution plans, multi-employer plans and certain other unfunded retirement benefit plans for our eligible employees. The amount of DB plan benefits eligible retirees receive is based on their earnings and age. Retirees may also be eligible for medical, dental and life insurance benefits (“other benefits”) if they meet certain age and service requirements at retirement. Generally, other benefit costs are subject to plan maximums, such that the Company and retiree both share in the cost of these benefits.

Our Assumptions

We utilize third-party actuaries to assist us in calculating the expense and liabilities related to the DB plan benefits and other benefits. DB plan benefits and other benefits which are expected to be paid are expensed over the employees’ expected service period. The actuaries measure our annual DB plan benefits and other benefits expense by relying on certain assumptions made by us. Such assumptions include:

 

•

The discount rate used to determine projected benefit obligation and net periodic benefit cost (DB plan benefits and other benefits);

 

•

The expected long-term rate of return on assets (DB plan benefits);

 

•

The rate of increase in compensation levels (DB plan benefits); and

 

•

Other factors including employee turnover, retirement age, mortality and health care cost trend rates.

These assumptions reflect our historical experience and our best judgment regarding future expectations. The assumptions, the plan assets and the plan obligations are used to measure our annual DB plan benefits expense and other benefits expense.

Since the DB plan benefits and other benefits liabilities are measured on a discounted basis, the discount rate is a significant assumption. The discount rate was determined based on an analysis of interest rates for high-quality, long-term corporate debt at the measurement date. In order to appropriately match the bond maturities with expected future cash payments, we utilize differing bond portfolios to estimate the discount rates for the DB plan and for the other benefits. The discount rate used to determine DB plan and other benefits projected benefit obligation as of the balance sheet date is the rate in effect at the measurement date. The same rate is also used to determine DB plan and other benefits expense for the following fiscal year. The long-term rate of return for DB plan’s

 

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assets is based on our historical experience, our DB plan’s investment guidelines and our expectations for long-term rates of return. Our DB plan’s investment guidelines are established based upon an evaluation of market conditions, tolerance for risk and cash requirements for benefit payments.

During the three months ended July 29, 2012, we recognized expense for our qualified DB plan of $0.4 million and other benefits expense of $2.3 million. Our remaining fiscal 2013 pension expense for our qualified DB plan is currently estimated to be approximately $1.1 million and other benefits expense is currently estimated to be approximately $6.8 million. Our actual future pension and other benefit expense amounts may vary depending upon the accuracy of our original assumptions and future assumptions.

Stock Compensation Expense

We believe an effective way to align the interests of certain employees with those of our equity stakeholders is through employee stock-based incentives. Stock options are stock incentives in which employees benefit to the extent that the stock price for the stock underlying the option exceeds the strike price of the stock option before expiration. A stock option is the right to purchase a share of common stock at a predetermined exercise price. Restricted stock incentives are stock incentives in which employees receive shares of common stock or the right to own shares of common stock and generally do not require the employee to pay a purchase price or exercise price. Restricted stock incentives include restricted stock, restricted stock units, performance share units and performance accelerated restricted stock units. We follow the fair value method of accounting for stock-based compensation, under which employee stock option grants and other stock-based compensation are expensed over the vesting period, based on the fair value at the time the stock-based compensation is granted.

Subsequent to the Merger, Parent has issued to certain of our executive officers and other employees service-based and performance-based stock options and restricted common stock. Service-based stock options generally vest in equal annual installments over a five-year period and generally have a ten-year term until expiration. Performance-based stock options vest only if certain pre-determined performance criteria are met and also have a ten-year term. Certain shares of restricted common stock vested immediately, while certain other shares vest in equal annual installments over a three-year period.

Our Stock Option Assumptions. We measure stock option expense for service-based options at the date of grant using the Black-Scholes valuation model. This model estimates the fair value of the options based on a number of assumptions, such as interest rates, employee exercises, the current price and expected volatility of common stock and expected dividends.

Valuation of Performance-based Options. The fair value of performance based options is determined based on an option pricing model.

Valuation of Restricted Common Stock. The fair value of restricted common stock is calculated by multiplying the price of Parent’s common stock on the date of grant by the number of shares granted.

No grants of service-based options, performance-based options or restricted common stock were made during the three months ended July 29, 2012.

Retained-Insurance Liabilities

Our business exposes us to the risk of liabilities arising out of our operations. For example, liabilities may arise out of claims from employees, customers or other third parties for personal injury or property damage occurring in the course of our operations. We manage these risks through various insurance contracts from third-party insurance carriers. We, however, retain an insurance risk for the deductible portion of each claim. For example, the deductible under our loss-sensitive worker’s compensation insurance policy is up to $0.5 million per claim. An independent, third-party actuary is engaged to assist us in estimating the ultimate costs of certain retained insurance risks. Actuarial determination of our estimated retained-insurance liability is based upon the following factors:

 

•

Losses which have been reported and incurred by us;

 

•

Losses which we have knowledge of but have not yet been reported to us;

 

•

Losses which we have no knowledge of but are projected based on historical information from both our Company and our industry; and

 

•

The projected costs to resolve these estimated losses.

Our estimate of retained-insurance liabilities is subject to change as new events or circumstances develop which might materially impact the ultimate cost to settle these losses. During the three months ended July 29, 2012 and July 31, 2011, we experienced no significant adjustments to our estimates.

 

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ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We have a risk management program that was adopted with the objective of minimizing our exposure to changes in interest rates, commodity, transportation and other price and foreign currency exchange rates. We do not trade or use instruments with the objective of earning financial gains on price fluctuations alone or use instruments where there are not underlying exposures. We believe that the use of derivative instruments to manage risk is in our best interest. As of July 29, 2012, all of our derivative contracts were economic hedges.

We utilize hedging instruments whose change in fair value acts as an economic hedge but does not currently meet the requirements to receive hedge accounting treatment. In the past we have utilized, and in the future expect to utilize, hedge accounting treatment for certain of our transactions.

During the first quarter of fiscal 2013, we were primarily exposed to the risk of loss resulting from adverse changes in interest rates, commodity and other input prices as well as foreign currency exchange rates.

Interest Rates: Our debt primarily consists of floating rate term loans and fixed rate notes. We maintain our floating rate revolver for flexibility to fund seasonal working capital needs and for other uses of cash. Interest expense on our floating rate debt is typically calculated based on a fixed spread over a reference rate, such as LIBOR (also known as the Eurodollar rate). Therefore, fluctuations in market interest rates will cause interest expense increases or decreases on a given amount of floating rate debt.

From time to time, we manage a portion of our interest rate risk related to floating rate debt by entering into interest rate swaps in which we receive floating rate payments and make fixed rate payments. On April 12, 2011, we entered into interest rate swaps with a total notional amount of $900.0 million as the fixed rate payer. The interest rate swaps fix LIBOR at 3.029% for the term of the swaps. The swaps have an effective date of September 4, 2012 and a maturity date of September 1, 2015. On August 13, 2010, we entered into an interest rate swap with a notional amount of $300.0 million as the fixed rate payer. The interest rate swap fixes LIBOR at 1.368% for the term of the swap. The swap has an effective date of February 1, 2011 and a maturity date of February 3, 2014.

The fair values of the Company’s interest rate swaps were recorded as current liabilities of $22.4 million and non-current liabilities of $50.5 million at July 29, 2012. The fair values of the Company’s interest rate swaps were recorded as current liabilities of $15.5 million and non-current liabilities of $50.6 million at April 29, 2012.

Assuming average floating rate term loans during the period and average revolver borrowings for the period equal to the trailing twelve months average (which were zero), a hypothetical one percentage point increase in interest rates would increase interest expense by approximately $6.0 million for the three months ended July 29, 2012.

Commodities: Certain commodities such as soybean meal, corn, wheat, soybean oil, diesel fuel and natural gas (collectively, “commodity contracts”) are used in the production or transportation of our products. As part of our commodity risk management activities, we use derivative financial instruments, primarily futures, swaps, options and swaptions (an option on a swap), to reduce the effect of changing prices and as a mechanism to procure the underlying commodity where applicable. We accounted for these commodities derivatives as economic hedges. Changes in the value of economic hedges are recorded directly in earnings.

On July 29, 2012, the fair values of our commodities hedges were recorded as current assets of $34.2 million and current liabilities of $3.4 million. On April 29, 2012, the fair values of our commodities hedges were recorded as current assets of $9.5 million and current liabilities of $8.0 million.

The sensitivity analyses presented below (in millions) reflect potential losses of fair value resulting from hypothetical changes in market prices related to commodities. Sensitivity analyses do not consider the actions we may take to mitigate our exposure to changes, nor do they consider the effects such hypothetical adverse changes may have on overall economic activity. Actual changes in market prices may differ from hypothetical changes.

 

		July 29, 2012				April 29, 2012
Effect of a hypothetical 10% change in market price
Commodity contracts		$	21.5			$	15.9

 

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Foreign Currency: We manage our exposure to fluctuations in foreign currency exchange rates by entering into forward contracts to cover a portion of our projected expenditures paid in local currency. These contracts may have a term of up to 24 months. We accounted for these contracts as economic hedges. Changes in the value of the economic hedges are recorded directly in earnings.

As of July 29, 2012, the fair values of our foreign currency hedges were recorded as current assets of $0.4 million. As of April 29, 2012, the fair values of our foreign currency hedges were recorded as current assets of $1.0 million.

The table below (in millions) presents our foreign currency derivative contracts as of July 29, 2012 and April 29, 2012. All of the foreign currency derivative contracts held on July 29, 2012 are scheduled to mature prior to the end of fiscal 2014.

 

		July 29, 2012				April 29, 2012
Contract amount (Mexican pesos)		$	52.8			$	41.6

A summary of the fair value and the market risk associated with a hypothetical 10% adverse change in foreign currency exchange rates on our foreign currency hedges is as follows (in millions):

 

		July 29, 2012				April 29, 2012
Fair value of foreign currency contracts, net asset		$	0.4			$	1.0
Potential net loss in fair value of a hypothetical 10% adverse change in currency exchange rates		$	(3.8	)		$	(3.8	)

 

ITEM 4.

CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

We conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, or “Disclosure Controls,” as of the end of the period covered by this Quarterly Report on Form 10-Q. This evaluation, or “Controls Evaluation” was performed under the supervision and with the participation of management, including our President and Chief Executive Officer (our “CEO”) and our Executive Vice President, Chief Financial Officer and Treasurer (our “CFO”). Disclosure Controls are controls and procedures designed to reasonably ensure that information required to be disclosed in our reports filed under the Exchange Act, such as this quarterly report, is recorded, processed, summarized and reported within the time periods specified in the U.S. Securities and Exchange Commission’s rules and forms. Disclosure Controls include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended, is accumulated and communicated to our management, including our CEO and CFO, or persons performing similar functions, as appropriate, to allow timely decisions regarding required disclosure. Our Disclosure Controls include some, but not all, components of our internal control over financial reporting.

Based upon the Controls Evaluation, and subject to the limitations noted in this Part I, Item 4, our CEO and CFO have concluded that as of the end of the period covered by this Quarterly Report on Form 10-Q, our Disclosure Controls were effective to provide reasonable assurance that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission, and that material information relating to Del Monte Corporation and its consolidated subsidiaries is made known to management, including the CEO and CFO, particularly during the period when our periodic reports are being prepared.

Limitations on the Effectiveness of Controls

Our management, including our CEO and CFO, does not expect that our Disclosure Controls or our internal controls will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Del Monte have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with associated policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

 

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Changes in Internal Control Over Financial Reporting

There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934, as amended) during the most recent fiscal quarter that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

CEO and CFO Certifications

The certifications of the CEO and the CFO required by Rule 13a-14 of the Securities Exchange Act of 1934, as amended, or the “Rule 13a-14 Certifications” are filed as Exhibits 31.1 and 31.2 of this Quarterly Report on Form 10-Q. This Part I, Item 4 of the Quarterly Report on Form 10-Q should be read in conjunction with the Rule 13a-14 Certifications for a more complete understanding of the topics presented.

 

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PART II. OTHER INFORMATION

 

ITEM 1.

LEGAL PROCEEDINGS

For a description of material developments in our pending legal proceedings, see “Note 8. Legal Proceedings” in our Notes to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, which is incorporated herein by reference.

 

ITEM 1A.

RISK FACTORS

This Quarterly Report on Form 10-Q, including the section entitled “Item 1. Financial Statements” and the section entitled “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, and Section 21E of the Securities Act of 1934. Statements that are not historical facts, including statements about our beliefs or expectations, are forward-looking statements. In some cases, you can identify forward-looking statements by the use of forward-looking terms such as “may,” “will,” “should,” “expect,” “intend,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” or “continue” or the negative of these terms or other comparable terms.

Forward-looking statements are based on our plans, estimates, expectations and assumptions as of the date of this Quarterly Report on Form 10-Q, and are subject to risks and uncertainties that may cause actual results to differ materially from the forward-looking statements. Accordingly, you should not place undue reliance on them. A detailed discussion of the known risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included in the section entitled “Risk Factors” in our 2012 Annual Report. Such risks and uncertainties include matters relating to:

 

•

our debt levels and ability to service our debt and comply with covenants;

 

•

the failure of the financial institutions that are part of the syndicate of our revolving credit facility to extend credit to us;

 

•

competition, including pricing and promotional spending levels by competitors;

 

•

our ability to launch new products and anticipate changing pet and consumer preferences;

 

•

our ability to maintain or increase prices and persuade consumers to purchase our branded products versus lower-priced branded and private label offerings and shifts in consumer purchases to lower-priced or other value offerings, particularly during economic downturns;

 

•

our ability to implement productivity initiatives to control or reduce costs;

 

•

cost and availability of inputs, commodities, ingredients and other raw materials, including without limitation, energy (including natural gas), fuel, packaging, fruits, vegetables, tomatoes, grains (including corn), sugar, spices, meats, meat by-products, soybean meal, water, fats, oils and chemicals;

 

•

logistics and other transportation-related costs;

 

•

hedging practices and the financial health of the counterparties to our hedging programs;

 

•

currency and interest rate fluctuations;

 

•

the loss of significant customers or a substantial reduction in orders from these customers or the financial difficulties, bankruptcy or other business disruption of any such customer;

 

•

contaminated ingredients;

 

•

allegations that our products cause injury or illness, product recalls and product liability claims and other litigation;

 

•

transformative plans;

 

•

strategic transaction endeavors, if any, including identification of appropriate targets and successful implementation;

 

•

changes in, or the failure or inability to comply with, U.S., foreign and local governmental regulations, including packaging and labeling regulations, environmental regulations and import/export regulations or duties;

 

•

impairments in the book value of goodwill or other intangible assets;

 

•

sufficiency and effectiveness of marketing and trade promotion programs;

 

•

adverse weather conditions, natural disasters, pestilences and other natural conditions that affect crop yields or other inputs or otherwise disrupt operations;

 

•

any disruption to our manufacturing or supply chain, particularly any disruption in or shortage of seasonal pack;

 

•

reliance on certain third parties, including co-packers, our broker and third-party distribution centers or managers;

 

•

risks associated with foreign operations;

 

•

pension costs and funding requirements;

 

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•

currency and interest rate fluctuations;

 

•

protecting our intellectual property rights or intellectual property infringement or violation claims;

 

•

failure of our information technology systems; and

 

•

the control of substantially all of our common stock by a group of private investors and conflicts of interest potentially posed by such ownership.

All forward-looking statements in this Quarterly Report on Form 10-Q are made only as of the date of this report. We undertake no obligation, other than as required by law, to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

 

ITEM 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

(a) NONE.

(b) NONE.

(c) NONE.

See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources” in our 2012 Annual Report for a description of the restrictions on our ability to pay dividends.

 

ITEM 3.

DEFAULTS UPON SENIOR SECURITIES

NONE.

 

ITEM 4.

MINE SAFETY DISCLOSURES

NONE.

 

ITEM 5.

OTHER INFORMATION

(a) NONE.

(b) NONE.

 

ITEM 6.

EXHIBITS

 

(a)

Exhibits.

 

Exhibit Number		Description		Incorporated by Reference
				Form		Exhibit		Filing Date
*31.1		Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
*31.2		Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
*32.1		Certification of the Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
*32.2		Certification of the Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
^101.INS		XBRL Instance Document
^101.SCH		XBRL Taxonomy Extension Schema Document
^101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document
^101.DEF		XBRL Taxonomy Extension Definition Linkbase Document
^101.LAB		XBRL Taxonomy Extension Label Linkbase Document
^101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

 

*	filed herewith

^	furnished herewith

 

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XBRL (eXtensible Business Reporting Language) information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Dated: September 11, 2012

 

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