News Column

BIG HEART PET BRANDS - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

July 3, 2014

This discussion summarizes the significant factors affecting our consolidated operating results, financial condition and liquidity during the three-year period ended April 27, 2014. This discussion should be read in conjunction with our consolidated financial statements for the fiscal years ended April 27, 2014, April 28, 2013, and April 29, 2012 and related notes included elsewhere in this Annual Report on Form 10-K. 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 throughout this filing, particularly in "Item 1A. Risk Factors."



Discontinued Operations

On October 9, 2013, we entered into a Purchase Agreement (the "Purchase Agreement") with Del Monte Pacific Limited ("DMPL") and its subsidiary, Del Monte Foods Consumer Products, Inc. (now known as Del Monte Foods, Inc.), (the "Acquiror"). Pursuant to the terms of the Purchase Agreement, we sold to the Acquiror the interests of certain subsidiaries related to our Consumer Products business (the "Consumer Products Business") and generally all assets primarily related to the Consumer Products Business (the "Transferred Assets") for a purchase price of $1,675.0 million, subject to a post-closing working capital adjustment. The Acquiror assumed related liabilities (other than certain specified excluded liabilities). The transaction closed on February 18, 2014. In connection with the closing, we received approximately $110 million in incremental proceeds representing the preliminary working capital adjustment subject to a true-up in accordance with the terms of the Purchase Agreement. See "Executive Overview" below regarding the use of the proceeds from the sale. Following the divestiture, we changed our name from Del Monte Corporation ("DMC") to Big Heart Pet Brands. Accordingly, the results of the Consumer Products Business have been reported as discontinued operations for all periods presented. Expenses allocated to discontinued operations are limited to selling, administrative and distribution expenses that were directly attributable to the Consumer Products Business. Consequently, certain expenses that have historically been allocated to the Consumer Products Business are not included in discontinued operations. We have combined cash flows from discontinued operations with cash flows from continuing operations within the operating, investing and financing categories in the Consolidated Statements of Cash Flows of our consolidated financial statements in this Annual Report on Form 10-K for all periods presented.



From closing, we will have continuing involvement with the Acquiror under the terms of a transition services agreement and expect to have continuing cash flows with the discontinued operation for at least 12 months after the transaction close date. Our continuing involvement will include providing continued information technology, accounting, and administrative service functions during the term of the agreement.

The discussion below in "Executive Overview" and "Results of Operations" refers to continuing operations only, unless otherwise stated.

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"). Under the terms of the merger agreement, the stockholders of Del Monte Foods Company ("DMFC") received $19.00 per share in cash. 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"). DMFC stockholders approved the transaction on March 7, 2011. DMFC's common stock ceased trading on the New York Stock Exchange before the opening of the market on March 9, 2011.



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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Fiscal Year

Our fiscal year ends on the Sunday closest to April 30. Every five or six years, depending on leap years, our fiscal year has 53 weeks. Fiscal 2014, fiscal 2013, and fiscal 2012 each contained 52 weeks. Fiscal 2015 will contain 53 weeks.



Background

Big Heart Pet Brands and its consolidated subsidiaries ("Big Heart Pet" or the "Company") is the largest U.S. standalone producers, distributors and marketers of premium quality, branded pet food and pet snack products, with brands for dogs and cats such as Meow Mix, Milk-Bone, Kibbles 'n Bits, 9Lives, Natural Balance, Pup-Peroni, Gravy Train, Nature's Recipe, Canine Carry Outs, Milo's Kitchen and other brand names.



Key Performance Indicators

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

Fiscal Fiscal 2014 2013 Change % Change Volume (a) Rate (b) Net sales $ 2,190.1$ 1,989.0$ 201.1 10.1% 7.5% 2.6% Cost of products sold 1,408.8 1,301.0 107.8 8.3% 9.8% (1.5%) Gross profit 781.3 688.0 93.3 13.6% Selling, general and administrative ("SG&A") expense 526.5 454.9 71.6 15.7% Operating income $ 254.8$ 233.1$ 21.7 9.3% Gross margin 35.7% 34.6% SG&A as a % of net sales 24.0% 22.9% Operating income margin 11.6% 11.7%



(a) This column represents the change, as compared to the prior year period, due

to volume. Volume represents the change resulting from the number of units

sold, exclusive of any change in price. Volume changes in the above table

include elasticity, the volume decline associated with price increases.

(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, as well as mix. Mix represents the change attributable to shifts in volume across products or channels. Trailing Trailing Twelve Twelve Months Months Ended Ended April 27, 2014April 28, 2013



Adjusted EBITDA (as specified in our debt agreements (c)) $ 449.8 $ 418.2 Ratio of net debt to Adjusted EBITDA (d)

5.6x 5.7x



(c) Refer to "Reconciliation of Non-GAAP Financial Measures" below.

(d) Net debt is calculated as total debt at the end of the period (including both

short-term borrowings and long-term debt and excluding debt discount) less

cash and cash equivalents, and includes both continuing and discontinued

operations. For fiscal 2013, Adjusted EBITDA used in the calculation of the

ratio includes the Adjusted EBITDA of the Consumer Products Business as this

was prior to the sale of the Consumer Products Business.

Executive Overview

On February 18, 2014, we completed the sale of our Consumer Products Business as described above, and the results of the Consumer Products Business are reported as discontinued operations. In connection with the sale of the Consumer Products Business, we changed our name to Big Heart Pet Brands. Unless otherwise noted, the amounts discussed below are for continuing operations only. On February 24, 2014, we repaid $881.0 million of the outstanding balance of our Senior Secured Term Loan from the after tax net proceeds from the sale of the Consumer Products Business and repriced and extended the maturity. On March 6, 2014, we refinanced 24



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our Senior Secured Asset-Based Revolving Credit Facility with a new $225.0 million, five-year ABL Facility. On March 13, 2014, we used a portion of the remaining net proceeds from the sale to redeem $400.0 million of our Senior Notes due 2019 at a redemption price equal to 103.813% of their aggregate principal amount plus accrued and unpaid interest to the redemption date, as announced on February 11, 2014. As a result, we lowered our leverage and reduced our weighted average cost of debt. In connection with these debt pay down and modification activities, we incurred certain costs, including redemption premiums and non-cash write offs of deferred financing fees, in the fourth quarter of fiscal 2014.



On July 15, 2013, we completed the acquisition of Natural Balance, maker of premium pet products for dogs and cats sold throughout North America.

In fiscal 2014 our net sales were $2,190.1 million, operating income was $254.8 million and loss from continuing operations was $7.8 million. In fiscal 2013, we achieved net sales of $1,989.0 million, operating income of $233.1 million and loss from continuing operations was $6.0 million.



Net sales increased $201.1 million in fiscal 2014 driven by the acquisition of Natural Balance.

Operating income in fiscal 2014 increased by $21.7 million driven by the increase in net sales, partially offset by increased marketing costs.

Adjusted EBITDA was $449.8 million for the trailing twelve months ended April 27, 2014 and $418.2 million for the trailing twelve months ended April 28, 2013. Our ratio of net debt to Adjusted EBITDA was 5.6x for the trailing twelve months ended April 27, 2014 and 5.7x for the trailing twelve months ended April 28, 2013 (For fiscal 2013, Adjusted EBITDA used in the calculation of the ratio includes the Adjusted EBITDA of the Consumer Products Business as this was prior to the sale of the Consumer Products Business.) Refer to "Reconciliation of Non-GAAP Financial Measures" below for a reconciliation of these measures to the most directly comparable GAAP measures as presented in our financial statements. At April 27, 2014, our total debt was $2,626.4 million. As a result of the amendment to our Senior Secured Term Loan Credit Agreement in February 2014, no excess annual cash flow payment will be due for the fiscal year ended April 27, 2014.



As we transition to a new pet only company, we have aligned our purpose, commitment and values to our pet only focus.

Strategy

Our strategic direction, which we refer to as the 4C's, focuses on our Consumers, Customers, Capabilities and Costs. Each of the 4C's work together to define the strategic destination to which we aspire, which will drive our financial performance:

Consumers-Our goal is to create compelling brand value propositions grounded in superior insights and fueled by appropriate portfolio roles, brand investment and innovation. Customers-We will strive to emerge as the strategic supplier of choice for our customers, jointly serving our consumers across channels with differentiated category insight, customer and shopper marketing, and category and retail execution.



Capabilities-We aspire to evolve our culture to meet marketplace needs by creating competitive and cutting-edge capabilities and a compelling employee value proposition.

Costs-Our plan is to create a focused, efficient, service-oriented cost structure with top-tier productivity and business processes.

Underlying the 4C's is our culture. Our strategy requires that the entire organization work with cross-functional alignment and collaboration, an eye toward continuous improvement, and a focus on the consumer and customer. The culture needs to activate our core values and be the foundational platform upon which business priorities and strategies are enabled. The 4 C's form the fundamental elements of our strategy with a focus on our pet snack brands, the pet specialty channel and our mainstream food brands (generally distributed in grocery stores, club stores and supercenters). We seek to gain keen insights into our consumers' needs and to delight their pets. We make products that create a better future for pets, brands that people love to buy and experiences that strengthen the bond between pets and the people who love them. 25



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Table of Contents Results of Operations Fiscal 2014 vs. Fiscal 2013 Net sales Net sales increased by $201.1 million, or 10.1%, in fiscal 2014 compared to fiscal 2013. The increase was primarily due to the acquisition of Natural Balance. New product sales also benefitted net sales, offset by a decline in existing products reflecting the impact of the prior year voluntary recall of certain Milo's Kitchen products and the continued competitive environment experienced by our mainstream food brands.



Cost of products sold

Cost of products sold increased by $107.8 million, or 8.3%, in fiscal 2014 compared to fiscal 2013. This increase was primarily due to the higher sales volumes mentioned above, partially offset by productivity savings and the absence of the costs of the recall.

While the impact of economic hedge transactions is reflected in other (income) expense, we are now utilizing and expect to continue to utilize hedge accounting treatment for certain of our hedging transactions which began to impact cost of products sold in the second quarter of fiscal 2014. See other (income) expense below. Gross margin



Our gross margin percentage for fiscal 2014 increased 1.1 points to 35.7% compared to 34.6% in fiscal 2013. The increase was primarily due to cost savings, including the absence of the recall costs described above. Pricing positively impacted gross margin, offset by unfavorable product mix.

Selling, general and administrative expense

Selling, general and administrative ("SG&A") expense increased by $71.6 million, or 15.7%, during fiscal 2014 compared to fiscal 2013. This increase was primarily driven by increased marketing expense as well as the Natural Balance acquisition, including the amortization of intangibles, and costs associated with the sale of the Consumer Products Business.



Operating income

Operating income increased by $21.7 million, or 9.3%, during fiscal 2014 compared to fiscal 2013, primarily due to the increased net sales mentioned above as well as productivity savings and the absence of the prior year costs associated with the recall, partially offset by increased marketing costs, the acquisition of Natural Balance and costs associated with the sale of the Consumer Products Business.



Loss on partial debt extinguishment

The loss on partial debt extinguishment in fiscal 2014 represents the write off of debt issuance costs related to the early repayment of debt and the excess cash flow payment, as well as the redemption premium paid in connection with the redemption of a portion of the 7.625% Notes. The loss on partial debt extinguishment in fiscal 2013 represents the write off of debt issuance costs related to the excess cash flow payment and debt repricing.



Interest expense

Interest expense decreased by $28.9 million, or 11.6%, in fiscal 2014 compared to fiscal 2013. This decrease was driven primarily by lower rates and lower average debt balances.

Other (income) expense, net

Other income of $12.1 million and $9.8 million for fiscal 2014 and fiscal 2013, respectively, was comprised primarily of gains on commodity hedging contracts, partially offset by losses on interest rate hedging contracts.



Provision (benefit) for income taxes

The effective tax rate for continuing operations for fiscal 2014 was (66.0%) compared to 58.0% for fiscal 2013. The effective tax rate in fiscal 2014 was impacted by unfavorable changes in state tax rates and state tax law, as well as non-deductible transaction costs, coupled with a near break-even pre-tax loss. We expect our effective tax rate to be between 37% and 39% in fiscal 2015.



Income (loss) from discontinued operations

Loss from discontinued operations for fiscal 2014 was $122.4 million and resulted primarily from an impairment charge of $193.8 million. Income from discontinued operations for fiscal 2013 was $98.2 million and represented the operations of the Consumer Products Business. Lower sales also contributed to the decrease. 26



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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 Annual Report on Form 10-K, we also provide certain non-GAAP financial measures-Adjusted EBITDA and ratio of net debt to Adjusted EBITDA. We present Adjusted EBITDA because we believe that it is an important supplemental measure relating to our financial condition since it is used in certain covenants in 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. Trailing Twelve Months Ended April 27, 2014 April 28, 2013 (in millions) Reconciliation: Operating income $ 254.8 $ 233.1 Other income (expense) 12.1 9.8 Adjustments to derive EBITDA: Depreciation and amortization expense(1) 100.3 102.1 Amortization of debt issuance costs and debt discount(2) (20.8) (24.2) EBITDA $ 346.4 $ 320.8 Non-cash charges 3.5 3.9 Derivative transactions(3) 13.8 (0.9) Non-cash stock based compensation 14.5 7.3 Non-recurring (gains) losses - 14.1 Merger/acquisition-related items 13.2 9.0 Disposed business reclassification(4) 28.5 32.9 Business optimization charges 15.4 20.7 Other 14.5 10.4 Adjusted EBITDA $ 449.8 $ 418.2 (5) Adjustment to present prior year leverage on a comparable basis $ - $ 178.5 (6) Denominator for calculation of ratio of net debt to Adjusted EBITDA $ 449.8 $ 596.7 (6) Net Debt(7) 2,513.6 3,390.9 Ratio of net debt to Adjusted EBITDA 5.6x 5.7x



(1) Represents depreciation and amortization expense for continuing operations only. Includes $7.8 million of accelerated depreciation in the trailing twelve months ended April 28, 2013, related to the closure of our Kingsburg, California facility.

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(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) Represents overhead costs historically allocated to the Consumer Products segment (not reflected in discontinued operations in accordance with generally accepted accounting principles). This reclassification is required to determine Adjusted EBITDA, excluding the Consumer Products Business (a disposed business as defined in our credit agreements), for the trailing twelve months ended April 27, 2014 and April 28, 2013. Subsequent to the divestiture of the Consumer Products Business, such overhead costs will be borne by Big Heart Pet Brands to the extent the costs are not offset by income from a transition services agreement (in place until February 2015) or reduced by cost saving initiatives. (5) For comparability, Adjusted EBITDA for the trailing twelve months ended April 28, 2013 has been recast to exclude the Consumer Products Business. See also (1) above. (6) According to the terms of our credit agreements, Adjusted EBITDA shall exclude the EBITDA of any business that has been sold. As such, Adjusted EBITDA for the trailing twelve months ended April 27, 2014 excludes the Adjusted EBITDA of the Consumer Products Business as it was sold prior to the end of the period. For the trailing twelve months ended April 28, 2013, Adjusted EBITDA used in the calculation of the ratio of net debt to Adjusted EBITDA includes the Adjusted EBITDA of the Consumer Products Business as it had not been sold as of April 28, 2013.



(7) Net debt is calculated as total debt at the end of the period (including both short-term borrowings and long-term debt and excluding debt discount) less cash and cash equivalents, and includes both continuing and discontinued operations.

Fiscal 2013 vs. Fiscal 2012

Net sales Fiscal Fiscal 2013 2012 Change % Change Volume (a) Rate (b) (in millions) Net sales: Pet Products $ 1,989.0$ 1,860.8$ 128.2 6.9% 2.9% 4.0%



(a) This column represents the change, as compared to the prior year period, due

to volume. Volume represents the change resulting from the number of units

sold, exclusive of any change in price. Volume changes in the above table

include elasticity, the volume decline associated with price increases.

(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, as

well as mix. Mix represents the change attributable to shifts in volume

across products or channels.

Net sales increased $128.2 million, or 6.9%, in fiscal 2013 compared to fiscal 2012. The increase was driven by net pricing and new product sales, partially offset by elasticity. New product sales included Meow Mix Tender Centers, Pup-Peroni Mix Stix, Meow Mix PatÉ Toppers, and Milk-Bone Trail Mix.



Cost of products sold

Cost of products sold increased by $81.6 million, or 6.7%, in fiscal 2013 compared to fiscal 2012. This increase was primarily due to higher ingredient costs as well as the higher sales volumes mentioned above, partially offset by productivity savings.



The impact of hedging is reflected in other (income) expense. See other (income) expense below.

Gross margin Our gross margin percentage for fiscal 2013 remained flat at 34.6% compared to fiscal 2012. The positive impact of pricing was offset by increased costs as well as unfavorable product mix. 28



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Selling, general and administrative expense

Selling, general and administrative expense increased by $23.0 million, or 5.3%, during fiscal 2013 compared to fiscal 2012. This increase was primarily driven by increased marketing expense and increased compensation costs under our Annual Incentive Plan, partially offset by lower consulting costs in fiscal 2013.



Operating income

Operating income increased by $23.6 million, or 11.3%, during fiscal 2013 compared to fiscal 2012, primarily due to the increased net sales mentioned above as well as productivity, partially offset by increased operating costs, increased marketing costs and higher compensation costs under our Annual Incentive Plan. The increased operating costs were primarily due to higher ingredient costs. Operating income for fiscal 2013 was also impacted by approximately $10.1 million of costs associated with the voluntary recall of certain of our Milo's Kitchen chicken dog treat products, net of expected insurance recoveries.



Loss on partial debt extinguishment

The loss on partial debt extinguishment in fiscal 2013 represents the write off of debt issuance costs related to the excess cash flow payment and the repricing of debt. Interest expense



Interest expense decreased by $2.2 million, or 0.9%, in fiscal 2013 compared to fiscal 2012. This decrease was driven primarily lower average debt balances.

Other (income) expense, net

Other income of $9.8 million for fiscal 2013 was comprised primarily of gains on commodity hedging contracts, partially offset by losses on interest rate hedging contracts. The gains on commodity hedging contracts recorded in fiscal 2013 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 $49.6 million for fiscal 2012 was comprised primarily of losses on interest rate hedging contracts.



Provision (benefit) for income taxes

The effective tax rate for continuing operations for fiscal 2013 was 58.0% compared to 26.0% for fiscal 2012. The change in the effective tax rate was primarily due to the non-deductibility of certain severance related expenses in fiscal 2012, along with a decrease in state taxes resulting from a change in state tax law in fiscal 2013.



Income (loss) from discontinued operations

Income from discontinued operations for fiscal 2013 was $98.2 million compared to $99.5 million for fiscal 2012 and represented the operations of the Consumer Products Business.



Liquidity and Capital Resources

Our most significant cash needs relate to the production of our 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. We made contributions to our pension plan of $10.0 million for fiscal 2014. 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 pension plan if it does not meet the minimum funding levels. We have made contributions in excess of our required minimum amounts during fiscal 2014 and 2013 and is more than 100% funded as of April 27, 2014. 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 a contribution of approximately $8 million in fiscal 2015. 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. 29



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On July 11, 2013, we purchased a minority equity interest in a co-packer for $14.6 million. The investment is accounted for under the equity method and is stated at cost plus our share of undistributed earnings or losses. On July 15, 2013, we completed the acquisition of Natural Balance, a California corporation and maker of premium pet products for dogs and cats sold throughout North America. The total cost of the acquisition was $331.4 million. The total cost of the acquisition is subject to a post-closing working capital adjustment which was initially due from us 90 days after closing. Final agreement of the working capital adjustment with the seller has not yet occurred.



Discontinued Operations

On October 9, 2013, DMC entered into a Purchase Agreement with Del Monte Pacific Limited ("DMPL") and its subsidiary, Del Monte Foods Consumer Products, Inc. (now known as "Del Monte Foods, Inc."), (the "Acquiror"). Pursuant to the terms of the Purchase Agreement, we sold to the Acquiror the interests of certain subsidiaries related to our Consumer Products business (the "Consumer Products Business") and generally all assets primarily related to the Consumer Products Business (the "Transferred Assets") for a purchase price of $1,675.0 million, subject to a post-closing working capital adjustment. The Acquiror also assumed related liabilities (other than certain specified excluded liabilities). The transaction closed February 18, 2014. In connection with the closing, we received approximately $110 million in incremental proceeds representing the preliminary working capital adjustment subject to a true-up in accordance with the terms of the Purchase Agreement. We have used a portion of the net proceeds from the sale to repay debt and to pay taxes due in connection with the sale. See further discussion below. 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 facility, our senior note 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

We are party to a senior secured term loan credit agreement (the "Senior Secured Term Loan Credit Agreement") with the lenders party thereto, JPMorgan Chase Bank, N.A., as administrative agent and collateral agent, and the other agents named therein, that 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 an original term of seven years. On February 24, 2014, we repaid $881.0 million of the Term Loan Facility from the after-tax net proceeds from the sale of our Consumer Products Business and entered into an amendment to our Senior Secured Term Loan Credit Agreement. The amendment, among other things, (1) lowered the LIBOR rate floor on term loans under the credit agreement from 1.00% to 0.75% and the base rate floor from 2.00% to 1.75%; (2) established the applicable interest margin at 2.75% on LIBOR rate loans and 1.75% on base rate loans; and (3) extended the maturity date of the initial term loans to March 8, 2020 from March 8, 2018. Interest Rates. Loans under the amended 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 0.75%) or (ii) a base rate (with a floor of 1.75%) 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%. As of April 27, 2014, the applicable margin with respect to LIBOR borrowings is 2.75% and with respect to base rate borrowings is 1.75%. Principal Payments. The amended Term Loan Facility generally requires quarterly scheduled principal payments of 0.25% of the outstanding principal per quarter from June 30, 2014 to December 31, 2019. The balance is due in full on the maturity date of March 8, 2020. 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. On June 27, 2013, we made a payment of $74.5 million representing the annual excess cash flow payment due for the fiscal year ended April 28, 2013. As a result of the amendment described above, no annual excess cash flow payment will be due for fiscal 2014. As of April 27, 2014, the amount of outstanding loans under the Term Loan Facility was $1,726.4 million and the blended interest rate payable was 3.50%, or 4.96% after giving effect to our interest rate swaps. See "Note 8. Derivative Financial Instruments" to our consolidated financial statements in this Annual Report on Form 10-K for a discussion of 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:

50% (which percentage will be reduced to 25% if our leverage ratio is 5.5x or less and to -% 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;

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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.

Ability to Incur Additional Indebtedness. 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 Credit Agreement

We have historically maintained a revolver for flexibility to fund our seasonal working capital needs and for other general corporate purposes. Following the sale of our Consumer Products Business, we no longer expect to have material changes in working capital needs due to seasonality. On March 6, 2014, we refinanced our credit agreement (the "Senior Secured Asset-Based Revolving Credit Facility") with JPMorgan Chase Bank, N.A., as administrative agent, and the other lenders and agents parties thereto, that provides for a new $225.0 million facility (with all related loan documents, and as amended from time to time, the "ABL Facility") with a term of five years. Interest Rates. 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) 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 currently 1.50% (and may increase to 1.75% depending on average excess availability) and with respect to base rate borrowings is currently 0.50% (and may increase to 0.75% depending on average excess availability). Commitment Fees. In addition to paying interest on outstanding principal under the ABL Facility, we are required to pay a commitment fee of 0.25% per annum in respect of the unutilized commitments thereunder. We must also pay customary letter of credit fees and fronting fees for each letter of credit issued. Availability under the ABL Facility. 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) 85% of the net orderly liquidation value of eligible inventory, (provided that net orderly liquidation value cannot exceed the net book value) 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 6, 2019. We borrowed $234.6 million under our former ABL Facility during the nine months ended January 26, 2014 and repaid a total of $234.6 million. We have not made any borrowings under the new ABL Facility. As of April 27, 2014, there were no loans outstanding under the ABL Facility, the amount of letters of credit issued under the ABL Facility was $33.4 million, and the net availability under the ABL Facility was $161.6 million. The ABL Facility includes a sub-limit for letters of credit and for borrowings on same-day notice, referred to as "swingline loans." We are the lead borrower under the ABL Facility and other domestic subsidiaries may be designated as borrowers on a joint and several basis. Ability to Incur Additional Indebtedness. 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 $325 million. 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).



Guarantee of Obligations under the Senior Secured Term Loan Credit Agreement and Senior Secured Asset-Based Revolving Credit Agreement

All our obligations under the Senior Secured Term Loan Credit Agreement and Senior Secured Asset-Based Revolving Credit 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. Subsequent to the July acquisition described above, Natural Balance became a guarantor subsidiary under our debt agreements.



Senior Notes Due 2019

We have $900.0 million of senior notes due February 15, 2019 with a stated interest rate of 7.625% (the "7.625% Notes"). The indenture governing the senior notes is hereinafter referred to as the "Senior Notes Indenture." On March 13, 2014, we used a portion of the net proceeds from the sale of our Consumer Products Business to redeem $400.0 million of our 7.625% Notes at a redemption price equal to 103.813% of their aggregate principal amount plus accrued and unpaid interest to the redemption date. 31



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Interest Rate. Interest on the 7.625% Notes is payable semi-annually on February 15 and August 15 of each year commencing August 15, 2011.

Guarantee. 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.

Redemption Rights. 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. 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

Indebtedness under the Term Loan Facility is generally secured by a first priority lien on substantially all of our assets other than 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 any 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.



Deferred Debt Issuance and Debt Extinguishment Costs

During fiscal 2014, we wrote off certain deferred debt issuance costs of $32.7 million and unamortized discount of $1.5 million, primarily in connection with the amendment, refinancing and redemption described above, as well as the excess cash flow payment made on June 27, 2013. In connection with entering into an amendment to the Senior Secured Term Loan Credit Agreement and a new Senior Secured Asset-Based Revolving Credit Agreement, we capitalized $1.2 million and expensed $2.9 million of debt issuance costs. These costs are being amortized as interest expense over the term of the related debt instrument. In connection with the tender offers for the 7.625% Notes, we recognized $15.3 million of expense (included in loss on partial debt extinguishment) which represents the redemption premium.



Maturities

As of April 27, 2014, mandatory payments of long-term debt (representing debt under the Term Loan Facility and the 7.625% Notes) are as follows (in millions) 1: 2015 $ 17.3 2016 17.3 2017 17.3 2018 17.3 2019 917.3 Thereafter 1,639.9



1 Does not reflect any excess cash flow or other principal prepayments beyond fiscal 2015 that may be required under the terms of the amended Senior Secured Term Loan Credit Agreement, as described above.

Restrictive and Financial Covenants

The Term Loan Facility, ABL Facility and the Senior Notes Indenture contain restrictive covenants that limit our ability and the ability of our subsidiaries to take certain actions.

Term Loan Facility and ABL Facility Restrictive Covenants. The restrictive covenants in the Senior Secured Term Loan Credit Agreement and the Senior Secured Asset-Based Revolving Credit Agreement include covenants limiting our ability, and the ability of

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our restricted subsidiaries, to incur additional indebtedness, create liens, engage in mergers or consolidations, sell or transfer assets, pay dividends and distributions or repurchase our capital stock, make investments, loans or advances, prepay certain indebtedness, engage in certain transactions with affiliates, amend agreements governing certain subordinated indebtedness adverse to the lenders, and change our lines of business. Senior Notes Indenture Restrictive Covenants. The restrictive covenants in the Senior Notes Indenture include covenants limiting our ability and the ability of our restricted subsidiaries to incur additional indebtedness or issue certain types of preferred stock, create liens, engage in mergers or consolidations, sell or transfer assets, pay dividends and distributions, repurchase our capital stock, make investments, prepay certain indebtedness, and engage in certain transactions with affiliates, as well as limiting the ability of our restricted subsidiaries to create restrictions on payments to us. Financial Maintenance Covenants. The Term Loan Facility, ABL Facility and Senior Notes Indenture 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. Effect of Restrictive and Financial Covenants. The restrictive and financial covenants in the Senior Secured Term Loan Credit Agreement, the Senior Secured Asset-Based Revolving Credit Agreement and Senior Notes Indenture 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 April 27, 2014. 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 Senior Secured Term Loan Credit Agreement, the Senior Secured Asset-Based Revolving Credit Agreement and Senior Notes Indenture, there would be a default, which, if not waived, could result in the acceleration of a significant portion of our indebtedness. See "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."



Off-Balance Sheet Arrangements and Contractual Obligations and Commitments

Off-balance sheet arrangements are generally limited to the future payments under non-cancelable operating leases, which totaled $96.4 million as of April 27, 2014.

Contractual and Other Cash Obligations

The following table summarizes our contractual and other cash obligations at April 27, 2014: Payments due by period Less than 1 More than 5 Total year 1 - 3 years 3 - 5 years years (in millions) Long-term debt obligations (1) $ 3,442.8$ 171.2$ 339.9$ 1,222.4$ 1,709.3 Capital lease obligations - - - - - Operating lease obligations 96.4 21.1 31.9 23.1 20.3 Purchase obligations (2) 1,174.9 401.4 249.7 242.9 280.9 Other long-term liabilities reflected on the Balance Sheet (3) 88.1 - 34.4 16.0 37.7 Total contractual obligations $ 4,802.2$ 593.7$ 655.9$ 1,504.4$ 2,048.2 (1) Includes interest expense calculated using the stated interest rate for the 7.625% Notes and the interest rate at April 27, 2014 for the Term Loan Facility, as described above. Does not reflect any excess cash flow payments or other principal prepayments that may be required under the terms of the Senior Secured Term Loan Credit Agreement, as described above. (2) Purchase obligations consist primarily of fixed commitments under ingredient, packaging, co-pack and other agreements. The amounts presented in the table do not include items already recorded in accounts payable and accrued expenses at April 27, 2014, nor does the table reflect obligations we are likely to incur based on our plans, but are not currently obligated to pay. Many of our contracts are requirement contracts and currently do not represent a firm commitment to purchase from our suppliers, and therefore, are not reflected in the above table. However, certain of our suppliers commit resources based on our planned purchases and we would likely be liable for a portion of their expenses if we deviated from our communicated plans. In the above table, we have included estimates of the probable "breakage" expenses we would incur with these suppliers if we stopped purchasing from them as of April 27, 2014. Aggregate future payments under employment agreements are estimated generally assuming that each such employee 33



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will continue providing services for the next five fiscal years, that salaries remain at April 27, 2014 levels, and that annual incentive awards to be paid with respect to each fiscal year shall be equal to the amounts actually paid with respect to fiscal 2013, the most recent period for which annual incentive awards have been paid as of April 27, 2014. Aggregate future payments under the monitoring agreement with the Sponsors are estimated as the minimum payment for five years. (3) As of April 27, 2014, we had non-current unrecognized tax benefits of $8.4 million ($7.3 million net of tax benefits). We are not able to reasonably estimate the timing of future cash flows related to this amount. As a result, this amount is not included in the table above.



Standby Letters of Credit

We have standby letters of credit for certain obligations related to insurance requirements. The majority of our standby letters of credit are automatically renewed annually, unless the issuer gives cancellation notice in advance. On April 27, 2014, we had $33.4 million of outstanding standby letters of credit.



Cash Flow

We have combined cash flows from discontinued operations with cash flows from continuing operations within the operating, investing and financing categories in the Consolidated Statements of Cash Flows of our consolidated financial statements in this Annual Report on Form 10-K for all periods presented. As such, the discussion below includes both continuing and discontinued operations. In fiscal 2014, our cash and cash equivalents decreased by $481.4 million. In fiscal 2013 and fiscal 2012, our cash and cash equivalents increased by $191.4 million and $197.6 million, respectively. Fiscal Fiscal Fiscal 2014 2013 2012 (in millions) Net cash provided by (used in) operating activities $ (409.1)$ 306.3$ 340.7 Net cash provided by (used in) investing activities 1,305.5 (116.4) (122.8) Net cash used in financing activities (1,379.5) (0.6) (23.7) Net cash used in operating activities during fiscal 2014 was $409.1 million compared to net cash provided by operating activities of $306.3 million in fiscal 2013. This decrease was driven primarily by the sale of the Consumer Products Business. We made approximately $365 million of income tax payments related to the sale. Additionally, cash flow from operations was negatively impacted by the annual packing of inventory for the Consumer Products Business along with lower sales for the Consumer Products Business. Inventories in our continuing pet business were also higher to support new product launches. Cash provided by operating activities during fiscal 2013 decreased $34.4 million compared to fiscal 2012. This decrease was driven primarily by the absence of a prior year $61.7 million income tax refund and unfavorable timing of accounts payable payments in fiscal 2013. This decrease was partially offset by the absence of fiscal 2012 merger related payments.



Investing Activities

Cash provided by investing activities was $1,305.5 million during fiscal 2014, which included $1,740.8 million of net proceeds from the sale of our Consumer Products Business, partially offset by $334.6 million for the purchase of Natural Balance and $79.6 million of capital expenditures. Cash used in investing activities was $116.4 million during fiscal 2013, of which $108.0 million represented capital expenditures and $12.0 million was for the purchase of a fruit processing plant and warehouse facility based in Yakima County, Washington out of the bankruptcy estate of Snokist Growers.



Cash used in investing activities was $122.8 million during fiscal 2012, of which $81.8 million represented capital expenditures and $41.0 million related to amounts paid in connection with the Merger (relating to our financial contribution to the shareholder litigation settlement).

Capital spending for fiscal 2015 is expected to approximate $70 million to $80 million and is expected to be funded by cash on hand and cash generated by operating activities. In addition to capital expenditures, we enter into operating leases to support our ongoing operations. The decision to lease, rather than purchase, an asset is the result of a number of considerations, including the cost of funds,

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the useful life of the asset, its residual value and technological obsolescence. Additionally, some equipment is proprietary to the lessor and cannot be purchased. All material asset-financing decisions include an evaluation of the potential impact of the financing on our debt agreements, including applicable financial covenants. Financing Activities During fiscal 2014, we made term loan principal payments of $955.5 million (including the excess cash flow payment of $74.5 million due for fiscal 2013 and $881 million term loan repayment), redeemed $400.0 million of our 7.625% Notes, and had net repayments on short-term borrowings of $1.0 million. During fiscal 2013, we made term loan principal payments of $97.8 million (including the excess cash flow payment of $91.1 million due for fiscal 2012), borrowed an additional $100.0 million on our term loan and had net borrowings on foreign short-term borrowings of $1.4 million.



During fiscal 2012, we made term loan principal payments of $20.3 million and made net repayments on foreign short-term borrowings of $5.3 million.

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 Annual Report on Form 10-K. Our significant accounting policies are described in "Note 2. Significant Accounting Policies" to our consolidated financial statements in this Annual Report on Form 10-K. 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 fiscal 2014 resulted in a net decrease to the trade promotion liability and increase in net sales from continuing operations of $1.4 million which related to prior year activity. Our evaluations during fiscal 2013 resulted in a net decrease to the trade promotion liability and increase in net sales from continuing operations of $0.3 million which related to prior year activity. Goodwill and Intangibles Big Heart Pet 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. 35



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We have evaluated our capitalized brand names and determined that some have lives that generally range from 5 to 22 years ("Amortizing Brands") 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 Brands are amortized over their estimated lives. We review the asset groups containing Amortizing Brands (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. Non-Amortizing Brands are considered impaired if the book value exceeds the estimated fair value. The goodwill impairment test is a two-step process. Initially, we compare the book value of net assets to the fair value of the reporting unit that has goodwill assigned to it. If the fair value is determined to be less than the book value, a second step is performed to compute the amount of the impairment. 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 unit is the same as our operating segment-Pet 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 goodwill, Amortizing Brands, or Non-Amortizing Brands during fiscal 2014, fiscal 2013, or fiscal 2012. As of April 27, 2014, we had $2,113.4 million of goodwill, $1,389.9 million of Non-Amortizing Brands, $29.4 million of Amortizing Brands, net of amortization and $735.9 million of customer relationships, net of amortization. The Meow Mix and Milk-Bone brands together, comprise 55% of Non-Amortizing Brands. We have not identified any events that lead us to believe that goodwill or Non-Amortizing brands are impaired as of April 27, 2014. In our fiscal 2014 impairment test, fair value exceeded the book value of net assets by approximately 35%. Additionally, the fair value of our Non-Amortizing Brands each exceeded the book value by at least 10%, except for one brand representing 22% of our Non-Amortizing Brands for which fair value exceeded book value by approximately 3%. Our forecasts utilized in our fiscal 2014 impairment test assume, among other things, that we will achieve sales growth by successfully executing new product innovation supported by 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. If these initiatives do not achieve the desired results, future impairment losses may occur.



Stock Compensation Expense

We believe an effective way to align the interests of certain employees with those of our equity stakeholders are through employee stock-based incentives. Stock options are stock-based incentives in which employees benefit to the extent that the 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-based incentives are incentives in which employees receive the right to own shares of common stock and do not require the employee to pay an exercise price. Restricted stock-based 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 compensation expense, 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 option is granted. Parent has issued to certain of our executive officers and other employees service-based stock options, performance-based stock options and restricted common stock. Service-based stock options and performance-based stock options generally vest over a four or five year period and the term may not be more than ten-years from the date of its grant. Performance-based stock options vest only if certain pre-determined performance criteria are met. Certain shares of restricted common stock vest in equal annual installments over a three-year period. We measure stock compensation expense at the date of grant using the Black-Scholes option pricing model. This model estimates the fair value of the options based on a number of assumptions, such as expected option life, interest rates, the current fair market value and expected volatility of common stock and expected dividends. 36



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During fiscal 2014, Parent modified the EBITDA-related financial target for fiscal 2014 for certain outstanding performance-based stock options due to the sale of the Consumer Products Business and the acquisition of Natural Balance.

Valuation of Service-based stock options. The fair value of service-based stock options granted during fiscal 2014 was $2.2 million. The following table presents the weighted-average valuation assumptions used for the recognition of stock compensation expense for stock options granted during the periods indicated: Fiscal Fiscal 2014 2013 Expected life (in years) 5.9 5.9 Expected volatility 45.0%



45.0%

Risk-free interest rate 1.03%



1.03%

Dividend yield 0.0%



0.0%

Weighted average exercise price $ 5.96 $



5.00

Weighted average option value $ 2.57 $



2.16

Valuation of Performance-based stock options. The fair value of performance-based stock options granted during fiscal 2014 was $1.1 million. The following table presents the weighted-average valuation assumptions used for the recognition of stock compensation expense for stock options granted during the periods indicated: Fiscal Fiscal 2014 2013 Expected life (in years) 5.9 5.4 Expected volatility 45.0% 45.0% Risk-free interest rate 1.03% 0.9% Dividend yield 0.0% 0.0% Weighted average exercise price $ 5.96 $



5.00

Weighted average option value $ 2.57 $



2.16

Sensitivity of Assumptions (1). For service-based and performance-based stock options granted during fiscal 2014, if we assumed a 100 basis point change in the following assumptions or a one-year change in the expected life, the value of a newly granted hypothetical stock option would increase (decrease) by the following percentages: +100 Basis -100 Basis Points Points Expected life 7.5% (8.4%) Expected volatility 1.9% (1.9%) Risk-free interest rate 4.0% (4.0%) Dividend yield (9.4%) NA (1) Sensitivity to changes in assumptions was determined using the Black-Scholes option pricing model with the following assumptions: stock price equal to the fair value on the date of grant, exercise price equal to the weighted-average exercise price of options granted during fiscal 2014, expected life of 5.9 years, risk-free interest rate based on the weighted-average rate for five-year and seven-year Treasury constant maturity bonds on the date of grant, average stock volatility based on the historical volatilities of comparable companies over a historical period that matches the expected life of the options on the date of grant, and expected dividend yield of 0%.



Retirement Benefits

We sponsor a qualified defined benefit pension plan ("pension benefits" or "pension plan") and several other unfunded retirement benefit plans ("other benefits") providing certain medical, dental and life insurance benefits to eligible retired, salaried, non-union hourly and union employees. We also sponsor defined contribution plans and multi-employer plans for our eligible employees. The amount of pension benefits eligible retirees receive is based on their earnings and age and the amount of other benefits retirees receive are based on meeting certain age and service requirements at retirement. Generally, other benefits are subject to plan maximums, such that we and retirees both share in the cost of these benefits. 37



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Our Assumptions

We utilize third-party actuaries to assist us in calculating the expense and liabilities related to pension benefits and other benefits. Pension benefits and other benefits which are expected to be paid are expensed over the employees' expected service period. The actuaries measure our annual pension 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 (pension benefits and other benefits); The expected long-term rate of return on assets (pension benefits); The rate of increase in compensation levels (pension 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 pension benefits and other benefits expense. Since the pension 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 pension benefits and other benefits. The discount rate used to determine the 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 pension benefits and other benefits expense for the following fiscal year. The long-term rate of return for the pension plan's assets is based on our historical experience, our pension plan's investment guidelines and our expectations for long-term rates of return. Our pension plan's investment guidelines are established based upon an evaluation of market conditions, tolerance for risk, and cash requirements for benefit payments. The following table presents the weighted-average assumptions used to determine our projected benefit obligations for our pension benefits and other benefits: April 27, April 28, 2014 2013 Pension benefits Discount rate 4.60% 3.90% Rate of increase in compensation levels 3.94% 3.69% Other benefits Discount rate 4.85% 4.25%



The following table presents the weighted-average assumptions used to determine our net periodic benefit cost for our pension benefits and other benefits:

Fiscal Fiscal Fiscal 2014 2013 2012 Pension benefits Discount rate 4.07% 4.60% 5.50% Rate of increase in compensation levels 3.69% 3.68% 4.69% Long-term rate of return on plan assets 7.20% 7.25% 7.50% Other benefits Discount rate 4.41% 4.90% 5.75% 38



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For measurement purposes, an annual rate of increase in the per capita cost of covered health care benefits was assumed as indicated below:

Fiscal Fiscal Fiscal Plan 2014 2013 2012 Preferred provider organization and associated indemnity plans 7.80% 8.10% 8.40% Health maintenance organization plans 8.30% 8.70% 9.10% Dental and vision plans 5.00% 5.00% 5.00% The rate of increase is assumed to decline gradually to 4.0% for the preferred provider organization and associated indemnity plans, as well as for the health maintenance organization plans.



Sensitivity of Assumptions

If we assumed a 100 basis point change in the following assumptions, our projected benefit obligation as of April 27, 2014 and net periodic benefit cost for continuing operations for fiscal 2015 would increase (decrease) by the following amounts (in millions):

+100 Basis -100 Basis Points Points



Pension benefits Discount rate used in determining projected benefit obligation

$ (11.1)



$ 13.2 Discount rate used in determining net periodic benefit cost

0.1 (0.2) Long-term rate of return on plan assets used in determining net periodic benefit cost (1.3) 1.3



Other benefits Discount rate used in determining projected benefit obligation

(3.7) 4.6



Discount rate used in determining net periodic benefit cost

(0.8) 0.9 The health care cost trend rate assumption has a significant effect on the amounts reported. The following table presents the impact of a 1% increase or decrease of the health care cost trend rate on the projected benefit obligation and the aggregate of the service and interest cost components of net periodic benefit cost for other benefits for continuing operations, as of April 27, 2014 and for the year then ended, respectively (in millions): 1% Increase 1% Decrease Projected benefit obligation at April 27, 2014 increase/(decrease) $ 4.2 $ (3.5 )



Aggregate of service and interest rate cost components of net periodic benefit cost for fiscal 2014 increase/(decrease)

0.9 (0.7 ) Future Expense For fiscal 2015, pension benefits expense for continuing operations is expected to be approximately $3.9 million. Other benefits expense for fiscal 2015 is currently estimated to be approximately a net credit of $0.1 million as the net amortization gain exceeds service and interest costs. These estimates incorporate our fiscal 2015 assumptions. Actual future pension benefit and other benefit expense amounts may vary depending upon the accuracy of original assumptions and future assumptions.



Sale of the Consumer Products Business

Following the sale of the Consumer Products Business, we transferred a significant amount of the plan obligations and plan assets for the pension benefits and other benefits, as well as the related components of net periodic benefit costs, for the transferred employees and retirees of the Consumer Products Business to the Acquiror. See "Note 4. Discontinued Operations" to our consolidated financial statements in this Annual Report on Form 10-K for a summary, as of February 18, 2014, of the assets and liabilities transferred to the Acquiror. As a result of the plan spinoffs, the Company recognized a significant non-cash settlement loss, partially offset by a non-cash curtailment gain, in discontinued operations in the fourth quarter of fiscal 2014.



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 of 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. A 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; 39



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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 fiscal 2014 we reduced our retained-insurance liabilities related to the prior year by approximately $1.2 million primarily as a result of favorable claims history. During fiscal 2013 we experienced no significant adjustments to our estimates.



Recently Issued Accounting Standards

In February 2013, the Financial Accounting Standards Board ("FASB") issued an Accounting Standards Update ("ASU") related to comprehensive income. The amendments require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. This new accounting pronouncement is effective for fiscal years and interim periods within those years, beginning after December 15, 2012, with early adoption permitted. Accordingly, we have included the enhanced disclosure in "Note 12. Accumulated Other Comprehensive Income (Loss)" of our consolidated financial statements in this Annual Report on Form 10-K. InMay 2014, the FASB issued an ASU related to revenue from contracts with customers. The new standard provides a five-step approach to be applied to all contracts with customers. The ASU also requires expanded disclosures about revenue recognition. The ASU is effective for us for annual reporting periods beginning after December 15, 2016, including interim periods. Early adoption is not permitted. We are currently evaluating this guidance and the impact it will have on our consolidated financial statements. 40



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