Tasty Baking Company Q1 2009 Earnings Call Transcript

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Tasty Baking Company (TSTY) Q1 2009 Earnings Call May 4, 2009 11:00 AM ET

Executives

Chad Ramsey Vice President, Financial Planning and Investor Relations

Charles P. Pizzi President and Chief Executive Officer

Paul D. Ridder Senior Vice President and Chief Financial Officer

Autumn Bayles Senior Vice President, Strategic Operations

Analysts

Mitchell Pinheiro Janney Montgomery Scott

John [Sibless] Regal Regional Securities

Tom Graves Standard & Poor's

Operator

Good morning, everyone. Thank you for joining us for the Tasty Baking Company's conference call to discuss first quarter 2009 results. You should have received a copy of this morning's release; however, if for some reason you have not received a copy, please call (215)2218538 and request a copy which will be faxed to you immediately. Today's call is also being broadcast over the internet at www.tastykake.com in the investor section under the webcasts and presentations subheading.

This conference call may contain statements that are forwardlooking within the meaning of the applicable federal securities laws and based on Tasty Baking Company's current expectations and assumptions, which are subject to a number of risks and uncertainties that could cause actual results to differ materially from those anticipated.

Factors that could cause actual results to differ from those anticipated are detailed in the company's press release, annual report to shareholders, and Securities and Exchange Commission filings. The company assumes no obligation to publicly update or revise any forward-looking statements.

This discussion also includes certain nonGAAP measures as defined by SEC rules. We have provided a reconciliation of those measures to the most directly compatible measures. This is available in our press release which is on the website as well.

With us today from the Tasty Baking Company are Charles Pizzi, President and Chief Executive Officer; Paul Ridder, Senior Vice President and Chief Financial Officer; and Autumn Bayles, Senior Vice President, Strategic Operations. Following the introductory comments from the management, we will open the call for your questions. Now at this time for opening remarks and introductions, I would like to turn the call over to Mr. Chad Ramsey, Vice President of Financial Planning and Investor Relations, please go ahead.

Chad Ramsey

Mr. Pizzi,  Please go ahead.

Charles Pizzi

Thank you. Good morning. The first quarter of 2009 the company reported that gross sales increased 11% to $76.9 million. In terms of net sales, the company reported growth of 7.8% in the first quarter of '09, compared to the prior year period, which is the fourth consecutive quarter that the company has reported an increase in net sales. This topline performance in the first quarter of '09 was driven by solid growth in both route and nonroute portions of our business.

On the route side, net sales grew 9.1% versus the prior year period driven by high volumes and selling prices as well as a balanced performance across all major product categories. In addition, a shift in the timing of the Easter holiday has a favorable impact on route sales. On the nonroute side, the company benefited from higher sale volume with third party distributors, as well as the impact of higher selling prices in the first quarter of '09 as compared to the prior year.

We continually work to strike the proper balance between product pricing and promotion. These efforts, combined with consumer focused marketing programs, helped to drive continuing sales growth and increase market share in the company's core markets. For 13 weeks ended March 28, 2009, the category grew by 6.6% and 3% in terms of dollars and volume, respectively.

Tasty outpaced the category in both dollars and units during this period of time and increased its overall market share. While increasing market share is an important objective, our goal is to do so profitably. During the quarter, we experienced an increase in the variable manufacturing expense. A net benefit of higher selling prices and the changes in our promotional strategy, however, more than offset the impact of higher manufacturing costs.

As a result, the $7.6 million increase in gross sales generated in the first quarter of 2009 as compared to the first quarter of 2008, translated into an 18% increase in gross profit and a 71% increase in adjusted EBITDA. During the quarter, we continued to focus on increasing our operational efficiencies through targeted investments in technology and in our facilities. We expect these investments to not only improve our operations, but also help as we prepare for our upcoming move to the new bakery and distribution facility at the Navy Yard.

For example, in the first quarter of 2009, we began piloting a voice product picking system in our current distribution center, which will help us streamline operations. In addition, we are piloting changes to our enterprise resource planning system that will allow us to automate certain production recording processes. This new application will allow us to continuously improve our operations and provide additional real-time production information.

In terms of our facilities, we also continued to make investment in our Oxford, Pennsylvania, bakery with a goal of improving efficiencies and streamlining operations. Our facilities at Oxford are important to our operations and we want to improve production flexibility and further reduce costs.

On a net basis, the company reported a loss of $0.01 per fully diluted share in the first quarter of '09, compared to a net loss of $0.12 per fully diluted share in the first quarter of 2008.

As we have discussed on the previous calls, we continue to record approximately $1.3 million per quarter in accelerated depreciation as a result of the change in the useful lives of assets that will not be relocated to the new manufacturing and distribution facility at the Philadelphia Navy Yard. This accelerated depreciation equated to approximately $800,000 on an aftertax basis or $0.10 in earnings per share in the first quarter of both '09 and '08.

With regard to the new bakery and distribution center at the Navy Yard, we are pleased to report that the project is progressing well and that we remain on time and within budget. The construction and process fitout components are on schedule, and we have begun to accept delivery of equipment. Installation of the equipment will continue through the second and third quarters of '09, while the building, fitout, and utility work is being completed. This process will be followed by full testing of all equipment and connections.

Once all testing is successful, we will then move into the commissioning stage of the project, which is planned to start in the fourth quarter of '09. The commissioning process will consist of methodical, linebyline transition into our new facility, which we expect to be fully completed by June 2010.

In addition to the new bakery, we are proud to announce the successful transition into our new corporate headquarters at the Navy Yard Corporate Center. The building is an environmentally sustainable facility that is just a mile from the site of the new bakery. The new offices are expected to achieve U.S. Green Building Council LEED Gold Certification. We are proud that we were able to team with our partners to make this possible.

While we have only been in our new offices a short time, we expect to reap the benefits associated with consolidating our headquarters function into a more efficient and open office space. Our prior office space at Fox Street was a converted warehouse that had many physical separations between departments and people. We no longer have to overcome those barriers now that we are working in an open and environmentally friendly space.

As we have said before, while the successful completion of the new bakery project is critical, we are also focused on effectively managing the current business and growing the top line in a profitable and efficient manner as we did this past quarter. We are cognizant of the challenging economic environment, and we are moving the forward on several fronts from driving sales to improving efficiencies and transitioning into new production facilities with the ultimate goal of improving longterm shareholder value. Now, Paul will comment on specifics regarding the first quarter's financial results.

Paul Ridder

Thank you, Charlie. As Charlie detailed, we have strong sales performance this quarter, with net sales increasing 7.8% versus the first quarter of 2008. The changes we made in our promotional programs created more balance between the depth and frequency of promotions as compared to the prior year, and allowed the company to achieve solid sales growth in our route markets.

Additionally, increased sales volumes with our third party distributors, as well as the benefits from increased selling pricing, helped to drive a 3.6% increase in nonroute net sales. In total, the net benefits of increased selling prices contributed approximately 4.9 percentage points of growth to net sales this quarter as compared to the prior year period.

The growth in sales volumes, along with the benefits of increased selling prices, yielded significant benefits in gross profit and gross margin as well. Gross profit grew 18% compared to the prior year period, and gross margin increased 2.5 percentage points to 28.2% of net sales versus 25.7% of net sales in the prior year period. This margin expansion was partially offset by $200,000 of higher depreciation expense and an increase of approximately $600,000 in variable manufacturing expenses.

While we saw decreases in selected commodities, on a yearoveryear basis aggregate commodity costs were moderately higher in the first quarter of 2009 than the first quarter of 2008. Despite the fact that the overall trend in the commodity market is generally favorable, we continue to actively manage our risk in this area and will enter into supplier arrangements to protect the company against the risk of higher prices and to insure adequate supply.

During the quarter, we held fixed manufacturing expenses flat to the prior year. We were able to do this, in part, thanks to our continued focus on cost containment programs and improved operating efficiencies. Selling, general, and administrative expenses increased $700,000 or 5.7% in the first quarter of '09 as compared to the prior year.

When measured as a percentage of sales, total selling, general, and administrative costs dropped to 27.5% of net sales in the first quarter of '09, compared to 28.1% of net sales in the prior year period. This drop in expenses, when measured as a percentage of net sales, demonstrates the additional benefits of growing the top line as the company is better able to leverage its fixed cost base.

Our debt position as of March 28, 2009, was approximately $70.6 million. Total capital expenditures in the first quarter of '09 were approximately $14 million, including $12.1 million of payments for equipment related to the new manufacturing and distribution facility.

In summary, we were pleased with the strong top line growth during the quarter and our ability to translate this growth into higher profits as evidenced by the 18% growth in gross profit and the 71% increase in adjusted EBITDA versus the prior year period. That ends my financial discussion, and I will now pass it back to Charlie.

Charles Pizzi

Thanks, Paul. Before I turn the call over to questions, I would like to thank first and foremost every member of the company for their hard work and dedication since we embarked on this process to build a new bakery and transform the company.

We greatly appreciate the support of our bank group, led by Citizens Bank, which also includes Sovereign Bank, Bank of America, and M&T bank, who have been valued business partners. We also value the support of our property developer, Liberty Property Trust; their general contractor, Pentex; our office fitout contractor, INTECH; our architects, Nelson and Cubellis; as well as our process engineering expert from Fluor Corporation and all the other outside vendors that helped us move into our new office space at Three Crescent Drive.

Everyone involved in this project has been a true partner. Now, we will open the call to your questions. Operator.

QuestionandAnswer Session

Operator

(Operator Instructions) Our first question is from Mitchell Pinheiro Janney Montgomery Scott.

Mitchell Pinheiro Janney Montgomery Scott

Let me ask. You played that Easter had an impact, obviously occurring later this year. Is there any way you can quantify it or help me think about it?

Paul Ridder

I think the best way to think about it is really that we had one more selling day in the first quarter of 2009 than in the first quarter of 2008. We made some changes as we said in our promotional strategy in the latter half of last year. With that change, caused Easter to have less of an impact on us this year than in previous years. I think the best way to look at it is just the fact that we had one more selling day in the first quarter of 2009.

Mitchell Pinheiro Janney Montgomery Scott

When I look, so your discounts were up on a percentage basis, and you talked about in the past about having bigger but fewer promotions. Can you sort of talk through that strategy? I mean, how are you doing in the nonpromoted periods?

Paul Ridder

I think there's a couple questions in there. Overall, we're very pleased with the performance we've seen both in the fourth quarter of last year, after we changed the strategy, in the first quarter of this year and believe the things that we're doing are the right things for the business. They're allowing us to grow volume and grow profitability. We're pleased with those results.

I don't think that we want to go into specific details in terms of what we changed, but as we said, we have provided a little more balance between how deep we're going and how frequently we're going. That's really allowed us to drive the top line, particularly in the route market.

Mitchell Pinheiro Janney Montgomery Scott

I guess what I would like to understand is, I mean typically, a significant portion of Tastykake volume, family pack volume, is done on promotion, a meaningful piece. Is that staying stable with your new promotion strategy or I mean reasonably stable? Or has something changed? That would have an impact. I mean are consumers in this environment really waiting for deals or are you still seeing steady flow in between promotions?

Paul Ridder

There's some mix issues that go into, certain products that are promoted. But we've seen our new promotional strategy be much more in tune with the consumers. I don't think you've seen a drastic change, but we have seen some movement towards that promotional strategy and having some more sales, particularly in family pack, while on promotion.

Mitchell Pinheiro Janney Montgomery Scott

As far as your variable expenses, you're referring to I guess commodity costs, packaging, are there any other variable costs that were up?

Paul Ridder

I think that we had, across the board, some moderate increases in labor, manufacturing variances, scrap, things like that. They have all, if you look at the total number of $600,000, fairly moderate increases with a decent size component of that being commodities and putting packaging and ingredients.

Mitchell Pinheiro Janney Montgomery Scott

I guess, we've talked before about commodities. I understand commodity costs are still at historical high levels, though down from where they had been. Based on how you buy your commodities, there is a lag impact. We've got to be getting closer to yearoveryear benefit at some point. I don't know if you would be willing to talk about it, but do you start seeing a little turn in Q2 or is it really maybe much in the back half of the year?

Paul Ridder

Without going into anything forwardlooking, Mitch, I think the way to think about it is if you go back, we saw steady increases really beginning in the middle of 2007, the whole way through 2008. And at the very end of 2008, the commodities market started on this favorable trend downwards. We saw that favorable trend month by month the whole way through the first quarter, and we saw it continue into April and May. I think it's fair to say that the current commodities markets prices are below the average point of the first quarter. And the first quarter, we only saw a moderate increase here.

Mitchell Pinheiro Janney Montgomery Scott

So Oxford, you talked about some efficiencies at Oxford, I forget what, you're improving production flexibility. But Oxford is going to be where all your fried product is ultimately manufactured, is that correct?

Autumn Bayles

Yes. I can answer your question on that one. Some of the improvements we've made at Oxford, we expanded our freeze capabilities there. And we also made some improvements to the various lines to improve, change over other efficiencies of that nature. We continue to make progress there.

Mitchell Pinheiro Janney Montgomery Scott

So when does the Hunting Park production move to Oxford?

Autumn Bayles

We are in the middle of that transition. It's completed by June of 2010 with the rest of the project, but we have done some portions of that already.

Mitchell Pinheiro Janney Montgomery Scott

Is there any income statement impact? You know, positive or negative during that transition or where we are today relative to the fried line?

Paul Ridder

I think in terms of the impact this year, and we look at the transition, there are a number of impacts to the company. The first of which, as we talked about, is we recently moved into the new corporate office space here at the Navy Yard. And while we expect to reap some benefits from that, there will be an impact on the current year. As we said before, there's a sixmonth rent holiday associated with the office lease. However, for accounting purposes, you're required to report the cost of that lease straight line over the life of the entire lease.

We have a similar situation with the bakery lease. While there's a oneyear rent holiday, you're required to report those costs on a straight-line basis. We will have costs associated with those leases coming through the income statement.

In addition, as we start to transition the methodical transition line by line, which we talked about, there will some costs of commissioning and start up, etc., that will hit this year and next year and we start that process.

Charles Pizzi

The transition to Oxford of some of the operations that are currently in Philadelphia won't happen until 2010.

Mitchell Pinheiro Janney Montgomery Scott

Okay. So that would have a modest impact on the P&L this year?

Paul Ridder

This year, no.

Mitchell Pinheiro Janney Montgomery Scott

I mean modest to the negative.

Paul Ridder

We're not forecasting any kind of efficiencies out of that because we're doing that move in 2010, not this year.

Mitchell Pinheiro Janney Montgomery Scott

As far as, Paul, back to what you were talking about, as far as some of these, let's call them duplicate costs, while your still, your headquarters, but you still have Fox Street and the new bakery, you still have Hunting Park. How do I look at that from a modeling perspective? Is there any way that either not now but maybe next quarter, we can have some idea as to sort of the extra costs, especially those that are noncash, because of the way the accounting and the rent holiday workout? Is there any way we could have some sort of idea to anticipate?

Paul Ridder

I believe that's really appropriate, as you said, to talk about in the next quarter when we get past some of the other hurdles that we want to make sure we get through and feel very comfortable about. Then we can walk through in detail or a little more detail what we would expect to see in terms of the noncash impact in the leases, as you said, as well as the other redundant costs.

Mitchell Pinheiro Janney Montgomery Scott

I can find the leases in the 10K, is that correct, the terms?

Paul Ridder

They've been filed with the SEC at various times.

Mitchell Pinheiro Janney Montgomery Scott

So I can figure that out. It would be mostly the non, the other things that wouldn't be filed, those costs.

Paul Ridder

Correct. And I believe that next quarter conversation is a little more appropriate timing to go into some more detail.

Mitchell Pinheiro Janney Montgomery Scott

Last question I had was, it's two questions. The route business, it sounds like, if I took my notes correctly, the routes were up 9.1%.

Paul Ridder

That's right.

Mitchell Pinheiro Janney Montgomery Scott

Is that balanced between volume and pricing, roughly half and half?

Charles Pizzi

Yes. It is balanced on, the increase was balanced on both.

Mitchell Pinheiro Janney Montgomery Scott

How about on the nonroute side?

Charles Pizzi

I think we also, the gain was also one where the volume was down, but the net was up.

Mitchell Pinheiro Janney Montgomery Scott

The volume, but the net sales were up.

Charles Pizzi

Volume was down slightly.

Mitchell Pinheiro Janney Montgomery Scott

When you look at your nonroute business, obviously, you have some large mass merchant customers and third party distributors in some of your other budding territories, are you seeing sort of same store sales growth in the third party distributor business?

Charles Pizzi

We had good performances in the Northeast for example and in the midAtlantic and South regions, Florida. And we did open up the Carolinas, and we are working closely with our third party distributors to increase the distribution and grow sales in those existing outlets.

If you will remember, we set this course back in 2007 to expand into the target areas; and we're pleased with our efforts and investments and the return on our investments thus far. But we're only at the beginning of this story. We had to add and put in place an entire new sales organization, and which is led by Chris Rahey. But we are very hopeful that we'll be able to really develop those areas into a sustainable market for us.

Mitchell Pinheiro Janney Montgomery Scott

A question on the, your market share gains in the quarter. Can you talk a little bit about what you're seeing in the field as far as what's driving your (a) the category and (b) your market share and if you can color it with any sort of observations that you're getting from the field with how this category is performing in this current environment.

Charles Pizzi

Just to repeat first, and then I will try to answer your other questions. For 13 weeks that ended March 28, the category grew by 6.6% and 3% in terms of dollars and volumes, respectively. Now we did say that Tasty did outpace both in dollars and units during that period and increase its overall market share.

Now, with that being said, there's a couple things going on, I think. That is the execution has been, we've been very pleased with our execution. Bob Brown runs the route category for us, and the execution of his sales organization has been key working with our retail customers.

I do believe that the category is up because, in this kind of economic conditions, people want to have a little bit of comfort in their lives. And we're able to do it. And we're working and our promotional strategic is really based on consumer behavior that we sort of put in place back in, I would think, the end of the quarter of 2008. So we've been right on curve on our approach to the consumer behavior.

As I said, we're working with our retail customers; and with the great execution of our sales distributors we're able to really reap the benefits of those higher sales numbers that we posted.

I would also tell you that, just to give you a little further color, product innovation, when we came here, product innovation, we've developed a product innovation program and our marketing team, along with our supply chain and sales team are working to provide new products, new opportunities, adjacent categories like our protein bars. And we have a number of items that we continue to build to until Autumn gets us into the new facility, where we will have much, much more flexibility to provide product innovation in a very efficient manner.

Mitchell Pinheiro Janney Montgomery Scott

If I must say, when I look at it anecdotally, you certainly see a lot of in and out product, a very freshlooking shelf with your promotions, whether it's seasonal with the Flyers or Phillies or Eagles and your in and out, special limited time edition products, plus some of your new snack bars and your shelf looks fresh and full; and it's very encouraging from my vantage point to see that. So kudos to you guys.

Charles Pizzi

I would tell you, we're sort of at the beginning, this has been an evolution, having our marketing integrate with our sales organization, both routes and nonroutes. By driving efficiencies, we'll have additional dollars for, you know the old [kilts] proverb, drive efficiencies to invest in the brand. That's sort of what we're following.

Mitchell Pinheiro Janney Montgomery Scott

Perfect. Once again, thank you very much.

Operator

Now with Regal Regional Securities, we have John [Sibless].

John [Sibless] – Regal Regional Securities

Question. I might be misremembering this, so, and I didn't hear you guys mention it. I thought there was an opportunity in Florida where a competitor tried to go direct instead of using a third party distributor?

Charles Pizzi

We have a third party distributor. We used to have two distributors in Florida. We now have one that covers the entire state for us.

John [Sibless] – Regal Regional Securities

Was there any saving, any benefit to going to one? Or what was the benefit to going to one?

Charles Pizzi

The benefit going the one is really based on efficiency of distribution and coordination. So we're only coordinating with one larger and more efficient distributor than that and a smaller distributor.

John [Sibless] – Regal Regional Securities

I know you mentioned good growth in northeastern Florida. Any certain geographical areas that may be growing faster than others or are those the two primary or?

Charles Pizzi

In our Florida market?

John [Sibless] – Regal Regional Securities

In general, in your entire market. I mean, are those the two strongest segments?

Charles Pizzi

I think first and foremost, the Carolinas are doing well for us, which we just entered at the end of 2008. Florida and New England and the northeast are doing well. They're both doing well for us. Our numbers have been up consistently over the past year in those third party markets that we talked to you about.

Operator

Next in our queue we have Tom Graves with Standard & Poor's.

Tom Graves Standard & Poor's

Good morning. I just want to check in with you on a couple of items. I'm on the stock market side of S&P, not the debt rating side. I have not seen any new information or guidance regarding the prospective cost savings from the new facility other than what you've outlined previously. Should I view that as the guidance basically being in tact in terms of what kinds of savings you might be able to get from it?

Charles Pizzi

As you will recall, we kicked this off in May of '07, and we're sticking to our story.

Tom Graves Standard and Poor's

That's what I assumed. Are you in compliance on your debt covenants currently? I know there was a modification, I think, late last year. So I wanted to doublecheck on the current status.

Charles Pizzi

Yes.

Tom Graves Standard and Poor's

Lastly, I just want to confirm what I heard regarding input or commodity costs. I think I got the impression that if commodity costs remain where they are now, there is the prospect of some further easing of commodity costs, at least on a year to year basis going forward for the next couple of quarters.

Paul Ridder

I think that's a fair assessment. What we tried to say is we saw commodities begin to decline or have a favorable trend beginning really at the end of 2008. That trend has continued really up through today. While the midpoint of the first quarter of 2009 [inaudible] above 2008, current market prices are below that first quarter average.

Charles Pizzi

Thank everybody for joining us today and if there are no more questions, we'll bid you a productive week.

Operator

That does conclude today's conference call, thank you for your participation.

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