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Lance, Inc. (NASDAQ:LNCE)

F3Q08 Earnings Call

October 31, 2008 9:00 am ET

Executives

Russell Allen - Director, Planning and Investor Relations

Rick D. Puckett - Chief Financial Officer, Executive Vice President, Treasurer, Secretary

David V. Singer - President, Chief Executive Officer, Director

Analysts

Heather Jones - BB&T Capital Markets

Jonathan Feeney - Wachovia Capital Markets LLC

Mitchell Pinheiro - Janney Montgomery Scott LLC

Ann Gurkin - Davenport & Company LLC

Diane Geissler - Merrill Lynch

Ben Brownlow - Morgan Keegan

Operator

Welcome to the Lance, Inc. conference call. All lines will be in a listen-only mode until the question and answer segment. I would like to inform all participants that this call is being recorded at the request of Lance, Inc. today October 31, 2008. You may disconnect at any time.

I would now like to turn the call over to your host, Mr. Russell Allen for Lance, Inc.

Russell Allen

With us today is Dave Singer, our President and Chief Executive Officer, and Rick Puckett, our Executive Vice President and Chief Financial Officer. In today’s call Dave and Rick will discuss our 2008 third quarter results as well as our outlook for 2008 full year. As a reminder, we are webcasting this conference call including the supporting slide presentation which you can find at our website at www.lance.com.

Before we begin I would like to point out that during today’s presentation management may make forward-looking statements about our company’s performance. Actual results could differ materially from those projected in such forward-looking statements. Information concerning certain factors that could cause results to differ materially from those projected forward-looking statements is contained in the company’s most recent Form 10K filed with the Securities and Exchange Commission.

I will now turn the call over to Rick Puckett, Executive Vice President and Chief Financial Officer, to begin management comments.

Rick D. Puckett

We again showed very strong revenue growth in the third quarter and our margins turned the corner towards the end of the third quarter as additional pricing was realized. We believe that we are well positioned to perform during the current environment. However, Q3 fell short of our original expectations which I will highlight.

If you’ll turn to page 4 in the presentation, you’ll see a few bullet points. As I mentioned, we had solid revenue growth in the core products and channels. Certainly solid revenue growth in the private label part of our business. Cape Cod and home pack continued with strong gains, both in double digits.

The cost of key ingredients and energy still negatively impacted margins as we got pricing in later in the quarter. These going into the fourth quarter are now in place and this will be back in sync. The additional price increases implemented late in the quarter was not quite enough to offset the commodity increases but again starting in the fourth quarter we will be in equilibrium there.

We had some temporary spikes in the cost of potatoes and peanuts, and this is one of the items that hit our third quarter pretty dramatically. As a matter of fact, these two items alone were worth about $0.05 a share for the quarter and these two items were generated by for the most part some significant weather conditions in the Midwest. Some of the floods in the Midwest caused the potato crop to be very slow and actually destroyed some of the potato crop which left us in a situation where we had to pay almost three times the normal rate for potatoes. So this impacted the quarter by about $0.05.

The issues that we mentioned on the second quarter phone call as it related to the consolidation of our Canadian facilities have now been resolved. We showed remarkable improvement in our Canadian facility and we are now back to acceptable levels there.

We have continued improvement in the supply chain and DSD operating efficiencies. Our logistics cost improvements continue to help offset the higher fuel costs.

On page 5 are some key statistics around the quarter. We did report $225.6 million. It was a record for our company, 14% above last year. Our gross margins were 36.6% versus 41.6% last year. The pricing versus the inputs are worth about half of that. There’s some mix shift that’s worth an additional 2 points and the mix shift is towards more private label products.

However on the SG&A expense side you can see remarkable progress there; 340 basis points coming out of that year-over-year. Our operating profit was 4.5% and in actual terms if you take out the potato and peanut issues that comes to 5.6% for the quarter three. Tax rate was 32.2%, a little bit higher than last year. We expect the tax rate for the full year to be about 35%. So our diluted earnings per share was $0.21 versus $0.24 last year.

On page 6 you’ll see a breakdown of the net sales between our branded and non-branded products. We did see $135.8 million in branded, up 8.8% over the previous year. 3 points of that was in fact price. The rest of that was driven by again strong home pack and Cape Cod growth. On the non-branded side it showed a 2.4% increase over last year. Price accounted for 15% of that increase.

On page 7 you’ll see additional key statistics for the quarter. EBITDA, again a function of the price versus input costs more than anything, percent of sales of 6.2% versus last year. Our debt’s at $81 million. We expect this to go down as we continue through the year probably to around $75 million or $76 million by year end. Our leverage ratio is still 1.6 well below the industry averages.

On page 8 we’ll see year-to-date statistics. Net sales of $637 million, a 10% increase over last year. Again gross margins 37.2%, 6 points below last year, and half of that is in fact the price versus ingredients inconsistencies. We’ve taken 210 basis points out of the SG&A expense year-to-date and we are showing 2.7% year-to-date for the operating income. Again excluding the potatoes and peanuts that would be about 3.8%. On a diluted earnings per share basis for the year we’re showing $0.32 year-to-date versus $0.72 last year.

Just looking at some of the charts you can see a significant, on page 9, growth on revenue. 13.9% growth in the third quarter. Again 6% of that is pricing and the rest is actually very favorable volume. That’s up from 8.4% and 8.5% in the previous quarters.

On page 10 the gross margin trend we reported 36.6%. That would have been 37.7% excluding the peanuts and potato issue which is higher than any quarter since last year in terms of gross margins. It’s indicative of the pricing that we did realize in the end of the third quarter. We expect the fourth quarter margins to be slightly higher than this.

On page 11 the trend is very good there. You can see that we are reporting 32.1% in SG&A percent for the quarter. If you look at last year’s third quarter that was 35.5% and you can still see the rolling 12 trend line coming down. So we have continued progress on this line in spite of the higher fuel costs of both gasoline and diesel.

Some of the things we’re doing here that are impacting this is in fact our turnover is down, we have more efficient routes and less routes, our casualty claims are down so our workers’ comp costs have gone down as a result of that, but also we have logistics network synergies that we continue to experience, and we are getting continued investment in our manufacturing efficiencies. All of those things are driving these things down as we go forward.

On page 12 operating profit margin. You can see that we made significant progress over Q2 going from 2.5% to 4.5%. That actually would be 5.65 excluding the potato and peanut issue. Good momentum going forward reflecting the pricing that we realized in the third quarter.

On page 13 our cash flow from operating activities was $27.1 million offset by $30.6 million year-to-date in cap ex. We still have a negative cash flow before dividends of $3.5 million. As you saw in the press release today, we changed our guidance. Net sales we’ve narrowed the guidance to $840 million to $850 million for the year. Our diluted earnings per share is now $0.53 to $0.57. This is down from $0.62 to $0.70 during the last quarter.

It is all driven by the third quarter results. We expected about $0.09 more internally on the third quarter than we received. Half of that was in fact the potato issue. We also had some energy costs that popped up in the last part of the quarter that we did not expect and we had slightly more promotional spend during the third quarter as we sold into pricing.

The fourth quarter’s believed to be solid as we had previously guided as it relates to earnings per share. Our capital spending has been revised to $37 million to $40 million from previously $40 million to $42 million.

I’ll now turn it over to Dave Singer for some other comments.

David V. Singer

We’re really excited about our sales momentum. We were operating in a very difficult environment but I think Lance is really well positioned. We really have no liquidity concerns as it relates to this credit crunch. We anticipate positive free cash flow for the foreseeable future. We have very little debt for our size and nothing comes due for three years, and we have a revolving credit agreement with a solid bank group that provides quite a bit of liquidity for us over the next three years.

In addition we’re in a really good business. Our branded categories generally hold up well in tough economic times and private brands which have really been growing nicely for years generally gain additional share in recessionary periods. This is really evidenced when you look at our sales for the quarter which were up about 14% of which about 2 points was acquisitions and the rest was split between pricing and volume. Our branded sales were up 9%. About 3% of that was pricing and 6% was volume. As Rick mentioned, our non-branded sales were up 22% with about 15% of that being pricing and most of the rest was acquisitions and internal growth.

Now I am disappointed with our earnings per share for the quarter but as Rick mentioned these issues were isolated and temporary, and I am totally confident that we’ve turned the corner on that. We finally cycled the start of this ingredients and energy bubble. We’ve locked our input costs in line with our strategy, and we’ve implemented sufficient pricing to restore our margins to where they were before the costs began to escalate. Each period in quarter three was better than the period before and our September period was very strong.

Our guidance reflects a very profitable fourth quarter, well above any fourth quarter in recent history, and really indicative of a solid annualized profit rate. Our fourth quarter is generally well below 25% annual EPS based on seasonality and it’s generally closer to 20% than 25% as a percentage of our full year EPS.

In addition we have solid sales momentum. We have the best pipeline of product innovations we’ve had for years. We’ve got some really excellent marketing support including a new logo for the Lance brand as well as plans to increase our investment in consumer marketing.

Our key initiatives around supply chain and DSD efficiency continue to show results and that’s helping drive our costs down further as a percentage of sales.

Lastly, the headwinds that have really squeezed our earnings over the past four quarters seem to be shifting as we move through 2009 and we may ultimately begin to feel these winds at our back.

I’d like to turn this back to the moderator for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Heather Jones - BB&T Capital Markets.

Heather Jones - BB&T Capital Markets

On this potato/peanut issue, I’m wondering when it became an issue because I went back to the Q2 conference call and we had asked you about that at that point because Frito Lay had pointed it out, our spot market pricing data showed significant increases. At that point you had indicated that you didn’t seem like it was a problem and also that’s when you gave guidance. So I’m just wondering when potatoes and peanuts became such an issue that it caused you to take down guidance this dramatically that you had just given in late July?

David V. Singer

The issue that really hit us is that we had contracted to purchase almost all of our potatoes at prices that were about 1/3 of what they ultimately ended up being. We did not anticipate that the specific farmers with whom we contracted would be hit as bad as they were hit. That’s really what got us. It just happened to be very specific farmers that got hit that had contracted to sell us potatoes at lower prices. So when we were giving guidance and we were projecting, we weren’t worried about the open market because we hadn’t anticipated having to buy that much in the open market when we gave you the guidance.

Heather Jones - BB&T Capital Markets

So you had to end up buying a lot in August on the open market?

David V. Singer

Yes. At least half of our overall volume was bought in the open market.

Heather Jones - BB&T Capital Markets

And you said now things are back to normal. Does the potato crop recover that quickly?

David V. Singer

It’s not so much the potato crop recovery. We buy from different farmers at different times in the year so we’re back under our contracts from farmers that weren’t flooded out. The ones that we had contracted to buy from during that period of time just happened to be the ones that got flooded out.

Heather Jones - BB&T Capital Markets

Are there any weather issues that have happened that could potentially hit the farmers that you use during Q4?

David V. Singer

There’s nothing that we anticipate but on the other hand we didn’t anticipate that issue either. This is very unusual. It’s not something that’s happened in the experience of the folks that we have around here, anything to this magnitude.

Heather Jones - BB&T Capital Markets

What about ’09? These farmers that were hit in Q3, are they raising prices on you dramatically given that they lost so much of their crop this year? What are you seeing now for potato cost pressures in ’09?

David V. Singer

Most of our needs for the first part of ’09 contracted. It will be ultimately built into our guidance but it’s not some huge change for us.

Rick D. Puckett

It’s not significantly more than what we would pay under normal contracts this year.

Heather Jones - BB&T Capital Markets

What about for the second half?

David V. Singer

Right now it’s a similar story.

Heather Jones - BB&T Capital Markets

What about for peanuts? What are you seeing for ’09 on that front?

Rick D. Puckett

Our peanut costs going into next year are slightly higher than they were this year but we contract those up front as well with farmers so those are pretty well locked in.

Heather Jones - BB&T Capital Markets

Was that a weather issue as well that you had to buy on the spot market?

David V. Singer

It was a combination of a couple things. There’s a serious drought throughout the Georgia region here a lot of peanuts are grown, where a lot of our farmers are. Yields were much less than we anticipated. Our growth was actually stronger than we anticipated. Those two things kind of conspired to get us buying outside of our contracted levels so we ended up paying more than we anticipated because we anticipated a contract rate. That was really the issue there.

Heather Jones - BB&T Capital Markets

What about this energy issue that arose at the end of the quarter?

Rick D. Puckett

Actually it was more about the natural gas than gas and diesel. We had not locked in natural gas through the rest of the year and we did not anticipate the prices to continue to escalate. That is more being short coming out of the second quarter than it is anything that wasn’t planned. We’re now longer on natural gas than we were at the end of the second quarter and we know what our prices and costs are going to be going into next year.

Heather Jones - BB&T Capital Markets

So as far as going into next year, I was wondering if you could give us some color on I believe the price increases you’ve taken were based on meaningfully higher wheat and soybean oil. It sounds like potatoes and peanuts will probably be higher. Natural gas might be higher for you. Given that wheat and soybean oil are almost 30% of your costs, I would assume you should have a significant cost tailwind going into next year. I’m just wondering if you can let me know if I’m wrong and where I would be wrong on that.

David V. Singer

We have a strategy that we have talked about to have at least six months forward in our major ingredients and we have stuck with that since we had that up and running as we worked our way through this most recent bubble. We anticipate continuing to have six months forward purchase at least.

In terms of where we ultimately buy commodities as we work our way through next year, I think it’s so volatile I don’t think it’s certain. But at this point it appears to be lower than it has been. I think from that perspective it’s unlikely in my mind that it would bounce back to the levels we saw in the past several months. I think you’re probably right in terms of those expectations for lower costs. But again not until we cycle through the forward box.

Heather Jones - BB&T Capital Markets

Right now you have through April locked in?

David V. Singer

We’ve not disclosed exactly how much our commitment is. We would have at least six months. As commodities come down over time we end up extending that somewhat but we will work with at least six months forward.

Heather Jones - BB&T Capital Markets

At least six months forward that you’ll have 100% of your costs covered, 50%?

David V. Singer

On a six month basis we look very closely to have the vast majority covered. It’s not 100% in every single category because we have to worry about volume and over-committing, but generally we’re looking to have a pretty solid expectation for our costs so that we can maintain margins and reduce volatility on pricing to our customers and consumers.

Heather Jones - BB&T Capital Markets

Assuming you’re rolling that forward as we speak at lower costs but for the coming six months, did you hedge that at very high levels, levels that were closer to the peak than levels closer to now? I’m just trying to get an idea of what kind of cost structure you’re dealing with in the early part of ’09 or did you leave enough open that you’ve gotten some benefit as wheat has started to come down?

David V. Singer

I think the way I’d be comfortable describing it is we had a plan that got our gross margins restored by the fourth quarter. We believe we are there. We believe our fourth quarter gross margins by product line will be a little bit lower than last year or than two years ago because we’ve got an increase in private brands as a percentage of our mix which has a lower gross margin. But if you look at it by product line, we’ll generally have our gross margins restored by the fourth quarter. We anticipate that continuing into early next year.

There is some potential that it could improve but at this point our strategy is to get our gross margins where they need to be, drive our business and then let all the operating improvements that we’re generating as well as the volume leverage from growth drive our operating margins upward. So we’re really on that strategy. To the extent that there’s a margin improvement because of commodity, that would be upside but at this point our focus is making sure that we do those things.

Heather Jones - BB&T Capital Markets

I just want to stay on this real quick. On Q4 of ’06 you had a gross margin of 43%. Two questions. One, how much do you think the hit has been because of just mix shift? Secondly, are you talking about restoring it on a run rate basis by Q4 or Q4 the whole quarter should be back to that gross margin level?

David V. Singer

What we had said early on was we expected our margins to be back by the fourth quarter. We would anticipate the full quarter ought to be in line and back on track by product line, therefore the operating expense benefits that we’ve been working on will start to show through.

Rick D. Puckett

You need to adjust for seasonality for the fourth quarter.

Heather Jones - BB&T Capital Markets

Yes. 43% was Q4 of ’06 so should I take 200 basis points, 300 basis points for the mix shift with private label?

Rick D. Puckett

In that range is fine.

Operator

Our next question comes from Jonathan Feeney - Wachovia Capital Markets LLC.

Jonathan Feeney - Wachovia Capital Markets LLC

I just wanted to understand the mix shift question a little bit better. You said about half of your sales growth was pricing so if I took that out of your top line and the 18 in commodity inflation out of the bottom line, would I get something on the order of 100 basis point year-over-year margin contraction? Would that get me to what the negative mix shift was or is there something else affecting cost of goods sold I need to think about?

David V. Singer

We don’t normally break things out by segments or anything but generally our gross margins on our non-branded business tends to be anywhere between 1/3 and ½ of our branded business.

Jonathan Feeney - Wachovia Capital Markets LLC

Have those generally been raising or falling, the gross margins on those non-branded business?

David V. Singer

The gross margins on the non-branded business have been prior to the bubble our strategy is to get them to grow. With the bubble they dropped dramatically and they’ll have been restored fully by the fourth quarter. But we have a strategy to make those grow that has a couple of legs. One is to get into categories that have higher margins and then to take costs out of our business and take modest price increases in categories where we think there’s opportunity.

Basically we’re really looking at having our private brands margin grow but even if it grew by a couple points it’s still going to be well under half of the branded. So as that business grows, it pulls our average margin down. Our operating margins are fine over time because the operating margin on our private brand business or non-branded business is a solid operating margin once we restore our gross margins.

Rick D. Puckett

We’ve discussed in the past that we’re investing in innovation and it’s not just in branded products that we’re investing in innovation. We’re doing the same thing in private brands and we’re investing in innovation in private brands in higher margin products than what we have historically sold. We would expect as we go forward to continue to improve those margins slightly.

Jonathan Feeney - Wachovia Capital Markets LLC

I understand cuts and trade spending and price realization as you’re going into the fourth quarter given where maybe as an echo of the cost increases that have made profitability below trends. But what I’m wondering is in the market place I suspect promotional activity will be increasing. Have you seen any signs recently that others are becoming more promotional looking into the fourth quarter?

David V. Singer

It’s interesting. I’ve read articles about it and I would anticipate if in fact commodity prices come down as much as they may come down, people will be more aggressive with promotions particularly in a soft economic environment. But frankly I would be surprised if the combination of incremental promotions and commodity declines wouldn’t net out to be at least neutral if not positive.

Jonathan Feeney - Wachovia Capital Markets LLC

You’re talking about low ticket items, the demand for these products is somewhat inelastic and if others aren’t taking down pricing - I guess store brands if you look at sandwich crackers aren’t an awfully huge force especially when you say they can be using gas channel or alternate channels where you guys are very powerful. Do you think that lower prices would stimulate volume? How elastic is this category do you think given what we’ve experienced over the past year?

David V. Singer

Our experience is it’s much less elastic than most categories.

Operator

Our next question comes from Mitchell Pinheiro - Janney Montgomery Scott LLC.

Mitchell Pinheiro - Janney Montgomery Scott LLC

Looking at the sales, the 6% volume growth that you had in the quarter on the branded side, where’s that coming from? Is it a same-store sales increase? Are we seeing increased distribution? Is it increased third party distribution? Can you talk about that a little bit?

David V. Singer

It’s really all of those things. We’ve had solid growth on a same-store basis, extremely solid growth with some accounts, less solid growth with others, but we’ve gotten expanded distribution, we’ve done a good job of getting incremental space. Both the Cape Cod business and our home pack sandwich cracker business have really exhibited solid growth.

Rick D. Puckett

Our back-to-school promotions this quarter were very successful in some of our channels but that was offset to some degree by the convenience store channel because of some of the gas shortages in parts of the country, particularly in this part of the country where some convenience stores were closed for a while so we were not selling. So we did see some declines there.

Mitchell Pinheiro - Janney Montgomery Scott LLC

Rick staying on that, was the C store channel for you down in the quarter?

David V. Singer

In volume it was down and in sales it was up modestly.

Mitchell Pinheiro - Janney Montgomery Scott LLC

How have you done in the other channels; grocery, mass, club, alternative? Can you talk about that a little bit?

David V. Singer

We’ve had historically a really solid growth rate both in mass and grocery, and that has continued. The other channels are up and down the street. And the food service DSD channels have been dropping at a pretty significant rate in the 15% to 20% a year, but actually that rate has slowed down although the channels have gotten small enough for us that they’re not that important anymore.

Our third party distributors we had solid growth. Good growth in club stores, dollar stores; really across the board we’ve had good business. Really what I think more than anything else is we’ve upgraded our sales force, we’ve realigned them, we’ve got better marketing support for them. The organizational changes we’ve made over the past couple of years are starting to pay some dividends.

Mitchell Pinheiro - Janney Montgomery Scott LLC

That’s a good segue. I noticed at the [NAC] show your rebranded Lance products, the new look. It is the biggest new product pipeline that I can remember at Lance along with Tom’s as well. I think it’s a whole new look for Tom’s. My question is, I would assume that this is going to be accompanied by a more aggressive marketing push. I was curious, one, was there any unusual expense in this quarter related to the rebranding or the relook, however you describe that? Did you pay any slotting fees as it related to some of these new products? Can you talk about that as we look forward?

David V. Singer

One of the things that we’re working hard on is trying to reduce the complexity in our business, and when we add a lot of new products that tends to add complexity. One of the things we’re working very hard on is actually reducing the number of SKUs that we sell. As part of our innovation, we’re actually kind of in a add one reduce two mode. Not exactly but pretty close. We anticipate even with the innovation to be down more than 10% in total SKUs over the next year. When we look at bringing these new items in, although there’ll be some modest slotting in some cases, in many cases we’re just replacing less productive SKUs with these items.

Rick D. Puckett

We have suggested that in 2009 we’re going to ramp up our advertising expenses and media expenses, and we still plan to do that which is consistent with our new logos and new packaging and so on.

Mitchell Pinheiro - Janney Montgomery Scott LLC

Was there anything unusual in this particular quarter?

Rick D. Puckett

No, not really.

Mitchell Pinheiro - Janney Montgomery Scott LLC

When I look at the receivables and inventories, I don’t know if I missed that but they were up. Any unusual items there?

Rick D. Puckett

It reflects the increased pricing on the receivables side and also on the inventory side it reflects the increased costs. Our inventory days outstanding is still very, very good. It’s in the 20s and the DSO is in the very low 30s. Pretty consistent with our past. Nothing really significant changing. We continue to see improvement in our inventory days over time as we get better and better at systems and logistics and so on. So that’s being brought about by some of the supply chain efforts. Reductions in inventories we look to reduce our stock rooms as we take routes out as well, so that reduces inventory as well.

Operator

Our next question comes from Ann Gurkin - Davenport & Company LLC.

Ann Gurkin - Davenport & Company LLC

I want to talk to you about your ability to get promotional sets in stores, the free-standing racks. We did some store checks and it seems like there is inconsistency and some pushback from retailers to add those independent racks. I was just wondering if you could talk about that.

David V. Singer

In many cases if it’s a storewide program that’s something that’s negotiated at the headquarters level, then we tend to be able to do it across the board. In other cases with the [BSD] system, it’s based on relationships at store levels. So probably the relationships in store levels combined with not having an across the board program, again depending on which chain it is, is probably what’s behind the inconsistency.

Ann Gurkin - Davenport & Company LLC

Is it causing any kind of disruption in branded product sales or is it kind of in line with the normal business operations?

David V. Singer

It’s really more in line with the normal business operations. In fact I think if you were to track what percent we have in the market place, it would be growing slightly. That’s one of the things that supports our growth.

Ann Gurkin - Davenport & Company LLC

I was wondering if you could talk about Wal-Mart. There’s been a lot of discussion about Wal-Mart pushing back on price increases, and I was wondering if you could talk about that.

David V. Singer

They’re very focused on price increases as they always have been and you need to justify and get them comfortable that they’re justified. Really ours have all been. We don’t need to take more than is justified to generate the margins we need. I think we have a good relationship with them and I expect them to continue to be the same way.

Ann Gurkin - Davenport & Company LLC

Were you able to get price increases through at Wal-Mart in the third quarter?

David V. Singer

We were. The increases across all of our product lines in order to kind of regain the gross margins, and Wal-Mart’s nearly 20% of our total business so in order to get our gross margins back in place we needed to adjust pricing there too.

Ann Gurkin - Davenport & Company LLC

You had terrific branded growth in the third quarter. Can you break it out in what was driving that growth between Cape Cod and the branded Lance product?

David V. Singer

As a percentage of total dollar sales, the home pack sandwich crackers would have been a little bit more because it’s a larger business. As a percentage of growth versus itself, our Cape Cod business was a little stronger. But both were well above 10% and really close to 20%.

Ann Gurkin - Davenport & Company LLC

How is the cookie rollout going across your system?

David V. Singer

You mean the branded Sam’s?

Ann Gurkin - Davenport & Company LLC

Yes.

David V. Singer

That’s gone well. For the most part that’s a private brands item. Well over 2/3 of the sales of the Brent & Sam’s support our private brands customers and we’re seeing really in line with our expectations that is working out.

Ann Gurkin - Davenport & Company LLC

One more question about store sets. We also in our store visits saw some retailers who had shifted the shelf space and were highlighting their brands more predominantly than Lance branded snack crackers. Is there any kind of shift going on there?

David V. Singer

There really isn’t a shift. Our growth has been good. Private brands we anticipate will grow but I don’t have a specific number but my guess is we have the vast majority of the market share for private brand sandwich crackers.

Operator

Our next question comes from Diane Geissler - Merrill Lynch.

Diane Geissler - Merrill Lynch

On the potato issue, I guess just a comment and then a question. When you make long-term contracts with growers, the intent is to know what your pricing is. So if there’s a loss because they have a flood, I guess you don’t want to be exposed to that kind of volatility. What kind of recourse is there? I realize that these are probably long-term suppliers so if they have a bad year, you don’t necessarily want to cut them loose but isn’t there some way to recapture from the farmer? Because if his crop is short because he has a flood, isn’t he the one who should bear that loss rather than you?

David V. Singer

I don’t have the contracts in front of me but my sense is it’s a lot like the airlines. If you miss a flight because the weather grounded it, that’s not their problem. Really with the farmers, I think it’s the same way.

Rick D. Puckett

It’s a forced Missouri kind of initiative. It’s something that we have no recourse back to the farmer on and we’re on the open market like any other buyer of potatoes. When we were on the open market, there were some very major potato buyers out there buying as we were. Therefore the price was driven up.

David V. Singer

This is a very unusual situation. It’s really the first time it’s happened to this level that anybody at our shop recognizes.

Ann Gurkin - Davenport & Company LLC

When you talk about we’re hedge out; we want to try to be 100% or as fully hedged as we can for the next six months, to what extent are your hedge contracts similar to the ones that you had in the potato business? Or are they more exchange traded derivative contracts?

David V. Singer

The only places where we have contracts directly with farmers are in potatoes and peanuts. The other purchased out relates to suppliers of vegetable oil and suppliers of flour, and it’s their responsibility to get the raw materials.

Ann Gurkin - Davenport & Company LLC

On your comment about the third quarter, you said half of the miss to your plan was really from the potato/peanut issue and then you said some energy that you didn’t expect. And then I think you said you had some promotional expenses. That you hadn’t planned or what is behind that? Is that just you had an opportunity to take some share from somebody so you went ahead and did it? If you could comment on that a little.

Rick D. Puckett

The success of our promotions in the third quarter, particularly the back-to-school kinds of promotions were very successful and more than we anticipated so our promotional expenses were a little higher but our sales were a little higher as well.

David V. Singer

Our average net price for some of our key branded items was lower than we anticipated in our original guidance. I think it really related to getting the last round of price increases through. We made a price adjustment toward the end of the third quarter in both our home pack business as well as our Cape Cod business. In order to get that last price increase through, we just did some more promotions than we anticipated.

Ann Gurkin - Davenport & Company LLC

It sounds like you had a little bit of a buy-in there in the third quarter ahead of the price increase. Are you reasonably confident that the volume number for the fourth quarter will be on plan?

David V. Singer

At this point our expectations for the fourth quarter we feel confident in. Period 10 is behind us and it was in line with our expectations and I think that was the first period that followed some pretty significant price increases across all categories. The fact that our sales were in line with our expectations in period 10 made us feel pretty good.

Ann Gurkin - Davenport & Company LLC

I think you took down your cap ex number for the year. Does that signal that you’ve reached the end of the spend on some of your efficiencies or is it just a project [inaudible]?

David V. Singer

One of the things we did, it became apparent that we were having margin squeeze that we sat down and we went through everything we could do to take costs out of our business, and one of the ways was deferring items that had less of a near-term benefit. Anything that was cosmetic or things that would provide a return but maybe something we could push off, so we just reallocated and did the highest return projects first. We are getting towards the end.

With our DSD transformation process we have replaced most of the old fleet that we needed to replace. Our ongoing spending there will be down significantly. A lot of our oracle spending is behind us. There’ll be some more next year and that falls back. We still have projects that we’re working on but the level of cap ex that we did in five and six and seven will start to go back down and our capital spending as a percentage of sales going forward will be lower than it has been.

Operator

Our next question comes from Ben Brownlow - Morgan Keegan.

Ben Brownlow - Morgan Keegan

Given you’ve locked in input costs for Q4 and six months forward, can you talk a little bit more about if you see yourself at a disadvantage if the environment does become even more competitive and with the commodity cost decline, not being able to drop in line with competitors in terms of pricing?

David V. Singer

That’s certainly a risk. It’s more of a risk in non-branded than branded. We frankly don’t think that’s a big problem for us at this moment. It’s clearly some risk but we think that it seems likely to me that many of our competitors would have bought forward also. We provide great value and I think that our customers are going to be comfortable if in fact there’s pressure downward on pricing working with us until such time that costs come down. Frankly at this point that’s not something that is extremely concerning to us although it’s clearly a risk.

Ben Brownlow - Morgan Keegan

Can you talk a little bit about the productivity improvements that you’re taking in the ERP, gravity fed trucks, etc.? Where you are there and the timeline?

Rick D. Puckett

On the oracle side we have a fairly significant implementation at the beginning of the year and then we will continue through the third quarter of next year as we complete that across all of our locations. That will continue and will certainly be built into our guidance for 2009 cap ex. As it relates to the trucks, we are moving forward on all of our trucks to reshelf them, to make them more efficient and more standardized. I think we’re somewhere around 40% to 50% of the way finished with that.

David V. Singer

One other project that we have been working on which is our fleet of over-the-road transport trucks where we’ve gone from having 48 foot trailers to 53 foot trailers. We’re probably ¾ of the way through that. There’ll be one more set of expenditures to get us to where we need to be. Now we’re looking at opportunities as our business grows, future spending will be about productivity as well as some capacity.

Ben Brownlow - Morgan Keegan

Thinking about where you are in terms of guidance, the lower end of your guidance implies just a very modest uptick in operating margins for the fourth quarter. Do you feel that that guidance out there for the current fiscal year is pretty conservative?

Rick D. Puckett

I think it’s pretty real actually. The fourth quarter historically for us as Dave mentioned is not the strongest quarter from a seasonality perspective and generally represents less than 25% of our total year and closer to the 20% number.

David V. Singer

When we look at the annualization of that it really suggests decent margins and positions us well rolling into next year.

Operator

There are no more questions at this time.

David V. Singer

I appreciate everybody coming and we’ll talk to you next quarter.

Operator

Thank you for participating in today’s conference. You may now disconnect.

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Source: Lance, Inc. F3Q08 (Qtr End 9/27/08) Earnings Call Transcript
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