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Executives

Chad Ramsey – VP Financial Planning & Investor Relations

Charles Pizzi – President, Chief Executive Officer

Paul Ridder – Senior Vice President, Chief Financial Officer

Autumn Bayles – Senior Vice President Strategic Operations

Analysts

Mitch Pinheiro – Janney Montgomery Scott

Tom Graves – Standard & Poor’s

[Morris Williams – Williams & Co.]

Nick Kovich – Kovich Capital Management

[Sanjay Sheti – BOE Securities]

Tasty Baking Co. (TSTY) Q1 2010 Earnings Call May 6, 2010 11:00 AM ET

Operator

Welcome to the Tasty Baking Company’s first quarter 2010 financial results conference call. (Operator Instructions) I would like to introduce your host for today’s conference, Mr. Chad Ramsey, Vice President of Financial Planning and Investor Relations.

Chad Ramsey

Good morning everyone. Thank you for joining us for Tasty Baking Company’s conference call to discuss first quarter 2010 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 215-211-3538 and request a copy, which will be faxed to you immediately.

Today’s call is also being broadcast over the internet at www.tastycake.com in the investor section under the webcast and presentation sub heading.

This conference call may contain statements that are forward-looking within the meaning of the applicable Federal Securities laws and are based on Tasty Baking Co.’s current expectation and assumptions, which are subject to number of risks, and uncertainties which could cause actual results to differ 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 non-GAAP measures as defined by SEC rules. We have provided a reconciliation of those measures to the most directly comparable measures. This is available in our press release which is on our website as well.

With us today from Tasty Baking Co. 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 introductory comments from management, we will open to your questions. Go ahead Mr. Pizzi.

Charles Pizzi

Thanks, Chad and good morning. As you can see from our releases this morning, there were numerous events that impacted our results in the first quarter of 2010. Looking back to three years ago, when we embarked on the new bakery projects, we believed then that the end of 2009 and the first half of 2010 would be the most challenging period in terms of managing the costs and complexity of this transition.

This has proven to be the case, but the situation was exacerbated by a series of events. It’s important that we provide clarity regarding the complexity issues faced in the first quarter of 2010. Throughout these challenges, we have remained focused on ensuring the successful transition our new remaining production line to the new facility at the Navy Yard, so that we can complete optimization of our operations there.

That being said, I’d now like to turn to discussing some of the specifics of this quarter. In the first quarter of 2010, the company reported that gross sales declined $4.6 million or 6% to $72.3 million. This decline was driven by volume decrease of 5.5% versus the prior year period. That was due almost entirely to the impact of an oven fire at the Hunting Park facility, the severe winter weather and production and distribution issues stemming from our transition to the Navy Yard facility.

We estimated that unfilled orders from these issues totaled approximately $4.6 million which includes approximately $2.7 million related solely to production and distribution issues resulting from the transition to the new facility.

The total net sales declined 6.6% in the first quarter of 2010 compared to the prior year period driven by the decline in volume as well as lower net sales realization from higher promotional costs and a shift in sales mix. However, in terms of Neilson category performance data, for the first quarter of 2010, within our core territory, Tasty performed slightly better than the category in terms of both sales, dollars and unit volume.

In February 2010, we had a significant oven fire at Hunting Park bakery that rendered one of our cupcake production lines unusable and shut the entire bakery down for the day. This impacted our order fulfillment rate and altered our transition schedule. These production difficulties occurred while we were transferring production and distribution to the Navy Yard facility.

In addition to that, the Northeast experienced record setting snowfall that hampered our ability to get the product into the market. The travel restrictions imposed by local authorities during these severe storms made many of the transportation routes for both our fleet and our independent sales distributors impassable.

This created numerous logistical challenges for a DSV company, dependant on having fresh cake delivered to about 16,000 stops weekly. Historically, we have been able to effectively manage through challenges like these. However, the confluence of all these events in the midst of our moving our production and distribution operations to the Navy Yard, made it difficult for us to fulfill all of the orders we received.

Also impacting our results this quarter were $2.9 million in transition related expenses. These were primarily related to redundant costs associated with maintaining two production facilities in Philadelphia as well as the cost related to the transition of production and distribution to the new facility.

We previously indicated that the amount of transition costs would increase from the levels we experienced in the fourth quarter of 2009 as we reached the peak of our transition and commissioning process in the first half of 2010. While we endeavor to minimize the cost associated with the transition, we anticipate that we will continue to experience significant transition costs through the second quarter of 2010.

In terms of the overall project, we continue the methodical transition of production to the Navy Yard facility which is the world’s largest lead registry bakery. Presently, we have five of seven lines commissioned. We still have two lines remaining and are transitioning as we speak.

There is a period of time following the commissioning of each line during which the speed and the overall performance of the line must be optimized. As with any project of this magnitude, ensuring peak harmonization between the different components of each production line is a complex process. While we are making good progress, we expect this optimization period to continue in varying degrees through the third quarter of 2010.

With regard to changes in labor which represents the bulk of our expected savings from this project, we still expect that by the end of the second quarter 2010, we will have reduced our hourly labor by the 215 positions we stated when we began this project.

In addition to the work being performed at the Navy Yard, we continue to invest in our Oxford facility. We have transitioned all donut production to Oxford and continue to make investments in the facility with the goal of constantly improving efficiency, quality and flexibility as we did during Q1 of 2010.

Also related to the overall Navy Yard project, was our announcement on April 6, 2010 that we entered into an agreement to sell our Hunting Park and Box Street properties for $6 million. The closing of the transaction remains subject to completion of a due diligence period and zoning change for the properties, both of which are in process.

This pending sale is an important step in the completion of our overall manufacturing strategy. The funds we expect to receive from the sale, will allow the company to reduce its debt associated with the investment in our new manufacturing facility.

In addition, the transaction will enable us to achieve our goal of leaving the surrounding community better than we found it more than seven and a half years ago, when I first joined the company. Finally, the buyer has committed to providing financial support to the Allegheny West Foundation in an effort to support local residents and improve the community.

Despite our move to the Navy Yard, our company will continue its 40 plus year partnership with Allegheny West Foundation and the community where we have opened and operated for the last 88 years. In addition, we are currently negotiating the sale of the equipment that is located in the Philadelphia properties and which will not be relocated to the Navy Yard. We estimate that the aggregate proceeds will be approximately $1 million.

Since we began this project almost three years ago to the day, we have remained focused on the task at hand and the management team is energized and committed to successfully completing this transformational project.

Now, our CFO, Paul Ridder, will comment on some specifics regarding our first quarter financial results.

Paul Ridder

Thank you, Charlie. As mentioned earlier, our top line performance in the first quarter of 2010 suffered due to the challenges that hampered our ability to fulfill orders and meet existing market demand.

Our gross sales declined $4.6 million in the first quarter 2010 as compared to the first quarter the prior year. We estimate that the impact of the unfulfilled demand in the quarter was approximately $4.6 million with $2.7 million of this amount related solely to issues stemming from the transition of production and distribution operations.

Cost of sales increased approximately $140,000 or one-half percent in the first quarter of 2010 as compared to the prior year period. The increase was driven by the impact of transition related costs, $2.4 million of which were classified in cost of sales, with the remainder classified as a component of selling, general and administrative costs.

Also driving the increase was $1.5 million in rental expense associated with the new manufacturing and distribution facility, $1.4 million of which was non-cash. Partially offsetting these increases was the impact on cost of sales from lower sales volumes along with changes in product mix and moderately lower costs for key ingredients and packaging.

In addition, despite the transfer of donut production, we have improved overall operating efficiency at our Oxford bakery which favorable impacted cost of sales versus the prior year period.

Gross profit declined $4.6 million in the first quarter of 2010 as compared to the prior year period. This decline was driven by $1.5 million in higher depreciation expense as well as the transition costs, non-cash rental expense related to the new bakery and the impact of unfulfilled demand stemming from the transition to the new facility.

With regard to the effect of the unfulfilled demand of $2.7 million stemming from the transition issues, we estimate that the gross profit impact of these lost sales was approximately $1.1 million during the first quarter of 2010.

With regards to the loss of sales resulting from the fire at the Hunting Park facility, this did not significantly impact gross profit during the first quarter of 2010 as the estimated insurance proceeds almost fully offset the gross profit impact of the fire.

During the first quarter of 2010, SG&A costs increased 1.7% or approximately $200,000. This increase was primarily due to $500,000 in transition costs classified as selling, general and administrative expenses as well as $300,000 in building rentals related to the company’s corporate office which were not occupied until the second quarter of 2009. These increases were partially offset by a reduction in bad debt expense and other employee related costs.

Near the end of the quarter as part of our focus to improve sales growth, we reorganized our sales department. As a result of this change, we recorded a severance charge of approximately $500,000 which is classified as a component of other operating expenses.

While this was a challenging quarter, we are focused on managing risk throughout the entire business, containing costs and completing the new manufacturing and distribution facility. In addition, we continue to believe that when complete, this project will have added $13 million to $15 million in pretax cash flow, net of leases but before debt service.

That ends my financial discussion. I’ll now pass it back to Charlie.

Charles Pizzi

In closing, while this was a challenging quarter, I would like to acknowledge our continued commitment to increasing long-term shareholder value. We began the process of moving to a new manufacturing plant almost three years ago to the day. Since that time, we have done what we said we were going to do within the time frame and budget we laid out in May of 2007.

We are now focused on completing the transition, closing our Hunting Park facility and optimizing our new line so that we can begin fully utilizing this new asset to fuel top line growth through increased production flexibility and reinvestment back into the business.

Now we will open the call up to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Mitch Pinheiro – Janney Montgomery Scott.

Mitch Pinheiro – Janney Montgomery Scott

You went kind of rapidly through you comments so I’m going to have to go back on some of these line items and if you wouldn’t mind, so if you take the $2.9 million of transition expense, you’re saying $2.4 million is in cogs and $.5 million is in G&A. Is that correct?

Paul Ridder

Correct.

Mitch Pinheiro – Janney Montgomery Scott

What kind of line items? Can you talk about what they are in cogs and G&A, like what type of expense you’re referring to?

Paul Ridder

I’ll let Autumn walk through the types of expenses since she’s most closely related to the project.

Autumn Bayles

I can walk you through the buckets of where these costs come in. First of course, we’re running two facilities at the same time, so we have redundant costs like utilities, maintenance costs, labor, things like that.

The second bucket is really related to the optimization of the new line. These lines are consisting of equipment that come from multiple vendors. There’s custom pieces in there and getting them to flow and integrate property takes some time, especially with this type of high speed production equipment So that mostly comes out in things like scrap and downtime that would cause additional labor costs like overtime.

Mitch Pinheiro – Janney Montgomery Scott

So when it comes to these redundant costs versus optimization costs, is this a 50/50 kind of break out or how would you just weight it roughly speaking.

Paul Ridder

That will change over time as we migrate away from the Hunting Park facility. The redundant facility costs will come down and you may see the optimization costs go up as we have more lines in that phase at the same time. So that will be a fluid mix period by period. I think the key is, as Charlie mentioned, we do expect the first half of 2010 to be the kind of peak period of commissioning and transition, so we do expect the second quarter to have significant transition costs.

I think the most important part is those costs go away. They are temporary as Autumn mention and then we expect to be at a normalized run rate by the time we get into the fourth quarter.

Charles Pizzi

We recognized at the beginning of the project, that we didn’t have the luxury of leveraging multiple plants and had to keep the Hunting Park facility open at the same time that the transition of the state of the art facility at the Navy Yard, and we knew that this would create short term costs associated with the transition that would be temporary, but necessary to ensure a necessary completion of the project.

Mitch Pinheiro – Janney Montgomery Scott

I understand the transition costs. When I look at it, I’m just trying, I underestimated transition costs in the quarter, so therefore, and they’re difficult for me to predict, so I’m just trying to get a little bit of color. If I can tell that you’re no longer operating two facilities, I can kind of start to back out one of those buckets and increase the other bucket. So that’s what I was trying to drive at. I guess just maybe roughly, are we going to look at, is the second quarter going to have more, less or about the same level of transition costs at this point? What’s your best guess?

Autumn Bayles

I can tell you that we will be doing the same types of transitional activities in Q2 that we were doing in Q1. So we’re still moving lines and we still have the other facility open, and we’ll be continuing that through second quarter.

Paul Ridder

I think you’re thinking about it the right way though Mitch. If you think about transitioning and optimizing seven lines, we didn’t have all seven lines going through that process in the first quarter, but we clearly had both facilities kind of at peak operations. As you get into the second quarter, you eventually have the Hunting Park facility wind down and some of those duplicate costs go away, but you have more lines in. So those buckets do move, but as Autumn said, you probably have a similar type of overall picture.

Mitch Pinheiro – Janney Montgomery Scott

As you enter the third quarter, the dual facility, the redundant costs are almost all gone and then we’re on just the transition costs related to optimization, is that correct?

Autumn Bayles

That’s correct. So in Q3, we’ll be in optimization mode, really focused on getting the new lines running the way that we want them to be run, and then we expect that in Q4, we would have a more consistent run rate.

Charles Pizzi

I think it’s important to reiterate again, what I said in my opening statement. The bulk of the savings came from labor and we are on target for the elimination of those costs as we move into the second half of 2010.

Mitch Pinheiro – Janney Montgomery Scott

Relating to labor and obviously your transition costs have masked any type of efficiencies or benefit from the new facility at this point. But are there benefits that you’ve begun to receive such as consolidation of distribution centers or depots. Is anything in the number that is an incremental positive in the first quarter?

Autumn Bayles

I think you’re thinking about this right way where as Charlie said, there is labor leaving, but there’s other costs that have increased that may be covering or masking that for the moment. While we have the redundant facilities, you won’t see the benefit from the move of the distribution center. But when the other facility goes away, then the move, you’d be able to see any benefit that we got from moving it.

Paul Ridder

To follow on what Autumn said, there is some benefit that comes through, but most of it is offset by the redundant costs in the transition, and you really, Charlie mentioned, you get the labor benefit really closing on the end of the second quarter as you complete the elimination of the positions and then as we really start to the optimization period in full. So there’s been some benefit, but it has not been significant.

Autumn Bayles

And there are specific line that are in various states of optimization and some of the benefit from those we may be getting, but then some of the other lines that are not along the path as fully or more complicated, we’d be generating higher transitions costs that would sort of mask that as well.

Mitch Pinheiro – Janney Montgomery Scott

It’s an extensive project to say the least, and you’ve been on budget, which is kudos to you and everybody on your team. The question I guess is what areas may have been a surprise to you on the negative side? Is there anything that is out there that was not budgeted? I’m sure there’s some others where you’ve over budgeted and they’ve been benefit, but what has been some of the stickier issues, or maybe there aren’t any.

Autumn Bayles

Thank you. The team will really appreciate your comments. It certainly has been a challenging project, but one that I think we’ve learned a lot from. But to answer your question, I think something that was unexpected was the confluence of events. We’re going through a very difficult transition and then to have the weather issues and the fire at the old bakery on top of that, as well as managing the stretch of labor over two facilities. That has certainly been adding to the challenge.

Mitch Pinheiro – Janney Montgomery Scott

When you look at accelerated depreciation which was up substantially year over year, how does that roll into Q2? Is that the same level? I know there’s puts and takes in that number, but what do I estimate for Q2 on accelerated depreciation over and above.

Paul Ridder

I think you start to see during Q2; you start to see depreciation come down to what I call more normalized levels. If you think about it as we are, going away from production lines in the Hunting Park facility, those lines become fully depreciated, so we would expect that the first quarter would be the peak in terms of accelerated depreciation, and we would see that come down significantly to a more normalized run rate, recognizing there will still be some extra depreciation in the second quarter.

Mitch Pinheiro – Janney Montgomery Scott

How are you going to treat the cash received from the assets that you’re going to ultimately sell at Hunting Park? Is that a reduction of cost of goods? Is it a G&A or is it another item? How are you going to account for that so I can see that?

Paul Ridder

First and foremost, let me hit what we’re going to do with the cash. We’re going to use the cash to pay down debt. That’s a significant reduction in the debt that we’ve incurred from the project. But in terms of the accounting for, it will go through to the extent there are gains or losses, we will either call those out separately within other expenses or we’ll separately footnote or disclose those items prominently throughout our financial statement so the readers are aware of how we accounted for them and where that accounting took place.

Mitch Pinheiro – Janney Montgomery Scott

Is there any more severance anticipated in the second quarter?

Paul Ridder

As we go through that process there will be severance payments that are made during the second quarter. We currently don’t have any specific plans regarding additional severance activity that would impact the severance line although as Charlie said, we’re going the project ensuring that all the positions we’ve identified will be fully eliminated by the end of the second quarter so I can’t preclude that as we true up our accruals.

Mitch Pinheiro – Janney Montgomery Scott

Looking back on your fundamentals in the quarter, you talk about $4.6 million of unfulfilled demand. How do you calculate that? How do you arrive at that number?

Paul Ridder

The good part and sometimes the painful part of our business is as you saw in the first quarter we get orders in every day. So whether we’re able to fulfill that order or not, we get orders in from customers, sales distributors every single day by product. It’s how our teams paces out what they’re going to produce because we produce to order. So we know what we were unable to fulfill.

Charles Pizza

Thanks to our SAP platform.

Autumn Bayles

It’s very transparent.

Mitch Pinheiro – Janney Montgomery Scott

So that’s on the gross side. It looks like, you mentioned higher promotion costs, but when I look at the discount and allowance line, on a dollar basis it was down, so is it just, were you saying on a sort of a unit basis, promotion costs were up?

Paul Ridder

Yes, you’re right. There are a couple of competing activities. On a per unit basis, the promotional costs were higher. We did go through during the quarter, we were able to reduce product returns as a percentage and as dollars, but during the quarter, I think as you’re aware, in the food business, you make commitments to customers out a number of weeks ahead of time in terms of their promotional activity schedule, and it was important to us to make sure that we honor those commitments and we did.

So you will see as we did during the first quarter, when you have unfulfilled demand, that we drove higher promotion costs in making sure that we fulfilled those commitments to our customers that were on promotion during certain weeks in the first quarter.

Mitch Pinheiro – Janney Montgomery Scott

When you look at the cost of goods line, was there any impact from commodities plus or minus?

Autumn Bayles

There were some moderating prices in commodities, but there were also some things going the other way like cocoa and then sugar prices did come up a little bit. We do have a favorable contract there, but not as favorable as it was in our prior year.

Mitch Pinheiro – Janney Montgomery Scott

So commodities really didn’t have an incremental impact in this quarter.

Paul Ridder

Favorable, but minimal.

Mitch Pinheiro – Janney Montgomery Scott

As you look at commodities going out for the next three quarters, how would you characterize the impact or potential impact?

Autumn Bayles

One thing we’ve tried to do is minimize the risk during this transitional year, so we have locked a lot of our commodities in with some favorable contracts for the year, so there isn’t, we have a lot of it already in place. There’s not a lot of it that’s still open. So I would expect that, there’s some headwind especially as I said with cocoa being the lead one, but it’s small. So sort of tracking along.

Mitch Pinheiro – Janney Montgomery Scott

You’ve obviously had a tough first quarter on the top line for the reasons you noted, but I’ve noticed in the IRI data which is a national IRI, it’s not regional to your core markets, but April is certainly very strong, and the strongest of all of the competitors. You’re far outpacing the category with I’m seeing unit growth of 5% and sales equal to that. My question is, anything change, anything that changed? Is that the family pack issue, meaning are you getting some good traction there? Is something changed and how would you characterize let’s say quarter to date the second quarter here with regard to the rest of the business that we can’t see. You’re up and down the street and national accounts.

Charles Pizzi

I think with regards to April, historically April has always been a strong month for us. I would just tell you that we are meeting the projections that we have put out at the beginning of the year on the sales side and we are moving into some areas where there could be opportunity, but we have to play out the quarter and we won’t be able to answer that until the next call.

Mitch Pinheiro – Janney Montgomery Scott

I understand that you’re not going to guide us, but would you do anything different? Anything unusual in family pack that would have driven the IRI numbers or was it just maybe timing? I know four week data is dangerous to read, but nothing unusual?

Paul Ridder

I think there’s two things. You hit the first one. The four-week data especially across two months can be dangerous to read. I think the other thing is, as we move and as Autumn’s team moves through the transition, we move further away from the confluence of events that we had in February and March with the fire which had a significant. We’ve moved away from the weather. That had a significant impact.

At the same time as the transition, I think both of those events exacerbated the impact of transition. So as we move further away from that, there still will be some impact as move along on fulfilling demand, but we would expect that to be much smaller as we move along in the project. So I think we’re also seeing some of the benefit from eliminating those items that creates a lot of noise in the first quarter.

Charles Pizzi

Also, I need to, if we did do something differently as we stated. We did have a reorganization of our sales force moving away from relationship and more into an analytical approach to our customer base. We really think that this will provide long-term opportunities for us from a volume standpoint, and as we also related, we did enter a new market with Long Island.

So we are proceeding along a plan that we have put in place on the sales side both with personnel, with product, and also with geography.

Mitch Pinheiro – Janney Montgomery Scott

Yesterday, Lance was out with earnings and they talked about significant declines in their convenience stores and up and down the street segment. Are you seeing, is there a different regional market with the routes, but I was wondering if you’re seeing similar types of macro issues in your C store and just your general up and down the street business.

Paul Ridder

I think that we have not seen a significant impact as Lance did, or as they refer to on their call. I do think from a macroeconomic environment, the impacts of unemployment have impacted a number of consumers that are going through some convenience channels, and I think that our category has seen some increased competition particularly in the breakfast segment, although we feel confident the change that we have made and due to make are addressing that.

We’re committed to growing the top line so we can leverage the new asset that we have in place. So I think we feel confident about our ability to address those macro issues that we’ve seen and really as we’ve seen over the past year or two and have addressed already.

Charles Pizzi

As well has having long standing partnership in the convenience segment. I would say that this has not been a usual quarter.

Mitch Pinheiro – Janney Montgomery Scott

When should we expect to see either new products or new packaging. I noticed the new pie packaging change, but broadly speaking a new branded look. When does that happen?

Charles Pizzi

I would tell you that talking about new products, packaging, these are all part of our overall strategy and plans that have been involved along with this new facility. You can expect that our plant, besides being efficient, will be completely innovative, and that innovation will not only go to products, it will also go to packaging and beyond. You can be sure that now it will be more of a short term than a long term.

Operator

You're next question comes from Tom Graves – Standard & Poor’s.

Tom Graves – Standard & Poor’s

My impression from what you said earlier is that you feel like Q1 you were very much in the early stages of getting the cost saving benefits from the new facility. Is that correct?

Paul Ridder

I would say infancy stage.

Tom Graves – Standard & Poor’s

It sounded to me like you probably have much better visibility right now on the optimization process than you did a few months ago because you seem to be saying that you expect to have the optimization process completed by the end of the third quarter. Is that basically the visibility a function of you getting more experience with the new facility and just getting farther along in the process?

Autumn Bayles

Yes, I think that’s accurate.

Tom Graves – Standard & Poor’s

You touched upon the weakness in the category in Q1. I think what I hear you saying is that you view it largely as a function of economic factors in terms of affecting demand with people being out of work and maybe a little bit of impact on the promotional side from more competition in the breakfast category. Is that a fair summation?

Charles Pizzi

Let me rephrase that. I do think there have been some macro economic factors, not just this quarter but really over the past four to six quarters that have impacted the category at the convenience channel. I think if you look absent this quarter, we’ve demonstrated consistent growth, and we’ve outpaced the category.

I think at, we mentioned that we continue to outpace the category this quarter in terms of both unit volume and sales dollars in terms of the Neilson performance data for our category and our markets.

When we look at that data, and then adjust for the unfulfilled demand, we were comfortable with our performance with respect to category. So I don’t want to make it sound as though there are negative implications for us in terms of our operating in the category. I do want to say that there are pressures that we’re having to deal with and we feel we’re dealing with very well.

Tom Graves – Standard & Poor’s

What you just said, is was consistent with my impression. I think you felt like you did a pretty good job in terms of getting the kind of share that you would like within your category. I was trying to sort of address the category at large and I thank you for your comments.

Operator

You're next question comes from [Morris Williams – Williams & Co.]

[Morris Williams – Williams & Co.]

I’d really like to focus on getting a framework of how you would see things in 2011 once all of the transitions have been completed. Shareholders have suffered for the last four or five years with difficult returns and so as I look at your company and look at the investments you’ve made and the optimism, I’m wondering if you could put some perspective. Is it reasonable for example to think in terms of 7% to 8% operating margins in 2011 building toward 10% to 12% in 2012? And any color that you’d like to expand beyond that in terms of financial goals that you’re setting for the company in 2011 and 2012 because obviously 2010 is going to be a transition year. So give us some color for 2011. Give us hope.

Charles Pizzi

I absolutely think there is hope. We want to be cautious in terms of the forward-looking information we present. As we mentioned on our last call, until we get through the meat of the transition and commissioning process, I don’t think we will change our stance in terms of providing incremental information.

But one of the things that we’ve consistently said, and we believe provides a lot of the information that you’re looking for, is the magnitude of savings that we expect in this project. We do expect $13 million to $15 million in pre cash tax savings. That’s after the facility lease, before the debt service.

We have said that we expect to be in a normalized and full run rate in the fourth quarter, so I think that from that perspective you can expect to see those savings coming through. We have consistently said that the project is on time and in some particular cases ahead of time and within budget.

So I think that from a hope perspective, I think there’s significantly positive opportunity as we move forward and capture the savings and our goal is to actually grow the top line to leverage that new facility. But at this point, we’re not prepared to provide additional guidance until we get further through that commissioning and transition stage of the project.

[Morris Williams – Williams & Co.]

I guess I would simply encourage you to be a little bit more forthcoming. I presume you wouldn’t have made the kind of investment and commitment that you’ve made without having some particular goals and framework, and I guess given past returns that the company has achieved, getting a 7% kind of operating margin in 2011 and 2012 and once everything is really humming, shouldn’t be out of line. But I guess I will simply express frustration that you’re so cautious with regard to giving shareholders perspective with regard to your goals and hopes.

Charles Pizzi

I will just tell you from my perspective, we have been very methodical in our approach outlining going back to when I first came here, what our strategic plan was. We have followed that strategic plan and reported on that strategic plan and the progress that we’ve made.

There’s no question that this project of building a new facility, equipping the new facility, leaving a facility that was 88 years old into the largest state of the art green bakery in the United States. It sort of in some ways speaks for itself and what our convictions are and what we can produce for the shareholders in the future.

But as we have stated, at this point in time, we’re not giving any guidance.

[Morris Williams – Williams & Co.]

Again, I encourage you to share with the shareholders some of your, I would hope optimism that after at best a breakeven year we’ve seen in 2010 the table is being set for $0.75 to $0.85 in 2011 and $1.00 to $2.00 in 2012. So good luck.

Charles Pizzi

Thank you, and we do remain confident and we appreciate and are sensitive to your comments.

Operator

You're next question comes from Nick Kovich – Kovich Capital Management.

Nick Kovich – Kovich Capital Management

You talked about employment being down 215 by the end of the second quarter 2010. Where is employment at the end of the first quarter? Where do you expect it to be at the second quarter and at the end of the year for the total company?

Paul Ridder

As we said, we do expect to have fully eliminated the 215 positions that we committed to at the beginning of the project by the end of the second quarter. There have been some changes and some reductions in positions throughout the first quarter but any benefit or any significant benefit from those as Autumn referred to, was more than offset by the transition costs and the additional time those people had to spend operating both facilities.

We don’t want to get into the individual numbers of where we’re at today or the end of the quarter other than to commit to the fact that those positions that we committed to, will be eliminated and that we expect to achieve fully the savings from these positions by the time we get to a full run rate, and we’ve said we’ll be at a full run rate at the beginning of the fourth quarter.

I think the other piece to point out is that we committed to at the beginning of the process, attempting to do that through attrition and voluntary reductions, i.e., we didn’t want to involuntarily reduce any positions or eliminate any personnel, and we believe that we’ll be able to fully do that by the end of the project.

Nick Kovich – Kovich Capital Management

I have the annual report in front of me. Do you report employment levels for the company in the annual report or 10K?

Paul Ridder

Yes we do.

Nick Kovich – Kovich Capital Management

So what is the number at year end of employment.

Paul Ridder

I can get that number. I don’t have the annual report in front of me. I don’t want to guess. I’d rather give you an exact figure, but it is in the annual report and it can be pulled out of that.

Nick Kovich – Kovich Capital Management

So what you’re saying is, at the end of the second quarter of 2010, versus year end 2009 employment will be down 215 people, is that what you’re saying?

Paul Ridder

No, what we’re saying is from the inception of the project to the end of the project, we would eliminate a net 215 positions. The significant lion’s share of that comes at the end of the project, but there is some movement throughout the course of the project, so I don’t want to imply that 215 from year end. That would not be appropriate.

Nick Kovich – Kovich Capital Management

So the bulk of the employment will be taken out this year of the 215 people.

Autumn Bayles

I can comment on that. Yes, as Paul said, it’s the lion’s share happens near the end of the project, but we’ve been continuing this over the span of the project.

Nick Kovich – Kovich Capital Management

So lion’s share meaning greater than 50, less than 100? I’m just trying to gauge the headcount of the company as we go through this process to reengineer Tasty.

Autumn Bayles

I don’t want to comment on the specific. It changes every day, but the lion’s share it’s the majority of it.

Paul Ridder

Just as a reference for you, on the bottom on page 4 of the annual report references the employee levels as of the end of the reporting period.

Nick Kovich – Kovich Capital Management

To follow on on Mr. Williams’ questions to the company, where do you expect capital spending and depreciation to be for the reengineered company on a normalized basis as we look out to 2011 and 2012?

Paul Ridder

I think as we’ve said, we’re not going to provide detailed guidance for those periods other than the savings levels which we’ve already said. I do know that on our last call, in response to a question, we referred to the fact that we have credit facility thresholds that restrict the amount of capital expenditures that we can do to approximately $6.75 million in 2010 and similar amounts for 2011.

That would give a top side gauge of what we’re currently allowed to spend for capital expenditures during those periods. We have not given information with respect to depreciation and are not going to provide incremental P&L line item guidance or additional metrics for 2011 at this time.

Nick Kovich – Kovich Capital Management

The reason I’m asking this question, I’m trying to gauge the cash flow of the company because when I look at Page 34 of your 10-K, you’ve got $68 million of debt coming due in September 2012. So I’m trying to gauge. You’ve obviously got $6 million coming in from sale of some of the old manufacturing plants. You’ve got $1 million from sale of old manufacturing equipment. So there’s $7 million or a little over 10% of what you need, but I’m trying to gauge the cash flow metrics of the company and how you’re going to address the $68 million debt payment coming due which is somewhat concerning, and I think you owe us some answers on capital spending and depreciation so that we can as investors, gauge how you’re going to address maturing in 2012.

Paul Ridder

I understand your question. With respect to depreciation, obviously depreciation will not impact the cash flow of the company. I think that we’ve given by the information that’s in the credit agreement does provide the maximum that we would be able to spend. It does give you a metric that you could use to assess what the cash flow would be along with the $13 to $15 million in savings.

Obviously we’re aware of the terms of the credit facility in September of 2012, and do evaluate our cash flow and opportunities to pay down debt as well as refinance various debt instruments as necessary and that’s a part of our long term strategy and will continue to be as we monitor and manage our debt levels closely.

Nick Kovich – Kovich Capital Management

What’s the dividend policy of the company?

Charles Pizzi

We currently pay $0.05 per share per quarter, is what the current dividend is.

Nick Kovich – Kovich Capital Management

But have you articulated a dividend payout ratio or, most companies have a policy on dividends and I’m trying to understand what Tasty’s policy is in terms of dividends.

Charles Pizzi

Our Board evaluates the company dividend payments and threshold requirements on a regular basis, and done in the past and will continue to do so.

Operator

You're next question comes from [Sanjay Sheti – BOE Securites]

[Sanjay Sheti – BOE Securites]

Regarding the incremental promotional costs year over year increase, can you give me some color on that? What was going on there? Was it like [inaudible] or just more of competition?

Paul Ridder

I think the biggest component of that, I tried to articulate. Let me go through it again. I think we referenced that we did have issues completely filling orders so what we had to make sure that we did with the product we had available was fulfill those commitments that we had made to customers where they had advertised promotions or advertised events within their stores.

So as a result of the unfulfilled demand, we had a greater SKU towards fulfilling order that were on promotion versus fulfilling orders that orders that were at full revenue, and that SKU’d the percentage of product in total for the quarter that was sold on promotion and impacted the year over year figures.

[Sanjay Sheti – BOE Securites]

Should I look at it as a one time event or will it be like do you have some commitments for the next quarter, Q2 or Q3?

Paul Ridder

We look at our promotional schedule, it’s looked at on a daily and weekly basis with our customers. As Autumn said, we do expect to have some impact in terms of unfulfilled demand in the second quarter because of the transition, but nothing nearly as significant as the first quarter. I think the promotional percentage that we spend year over year as a function of our promotional strategy which we look at and evolve and change on a regular basis to make sure we’re meeting market demands.

So in terms of the impact this quarter, it was driven by unique events. But I can’t comment on how that will evolve in the second quarter because we do make changes to our promotional strategy and have made changes as we’ve gone through the second quarter.

Charles Pizzi

The first quarter was clearly a unique situation because of the confluence of snow, extreme weather, the fire and then the movement of our distribution facilities. So we value our customers and so what we wanted to do was make sure that we fulfilled those orders.

So it was a unique situation in the first quarter. But our ongoing promotion occurs as Paul said, a daily and weekly basis.

[Sanjay Sheti – BOE Securites]

Since you have some visibility on your optimization and also you mentioned about new markets like Long Island. What will be the next strategy once your optimization is complete most of them in Q2 and after than in Q3. Will it be more on expanding new markets or introducing new products in the existing market?

Charles Pizzi

The whole notion of this project was to provide efficiency and innovation to drive volume. So the strategy is pretty simple, and that is, we need to grow volume and I don’t wish to discuss our tactical plans to do that, but needless to say, product innovation and new geography as well as new channel opportunities as well.

[Sanjay Sheti – BOE Securites]

The Long Island market, will that by in your route or non route category?

Charles Pizzi

It will be in our route category.

[Sanjay Sheti – BOE Securites]

When you talk about innovation, are you talking about new products or repackaging your existing products? How should I look at that innovation?

Charles Pizzi

I think maybe the best way to explain it is, if you look at when we moved our pie production, we changed the packaging, made it more convenient and easy for the consumer to open. And we’re also baking our pie in its own pan which provides a much better quality of product as well.

So just think about it, maybe if I can let you think about it this way. We were operating in a facility where production was done the same way it was done in 40 years ago, 1950 let’s say. So this really gives us ability not only to stay within the category but to provide opportunities that are ancillary as well.

Autumn Bayles

I can add to Charlie’s comments. Something that the new plant gives us is more flexibility in production and that includes both packaging, taste pack sizes, carton count sizes as well as flexibility in the types of products we can produce as well. So we’re looking to harness this investment to drive serious innovation for the company.

Charles Pizzi

And we’ve had very good consumer response to the products that we have produced, because quality is very important to us. So not only do we want to innovate, we want to make sure we’re true to the values of our founders, and that is high quality products.

Autumn Bayles

Absolutely, and we’ve been tracking our consumer responses to make sure that we we’ve been producing products in both facilities, we’ve been tracking the responses from each type of product to make sure that consumers don’t have a quality difference that’s negative and we have not seen that.

Operator

You're next question comes from Nick Kovich – Kovich Capital Management.

Nick Kovich – Kovich Capital Management

What are the peer companies that you benchmark Tasty against?

Charles Pizzi

Our category is really made up of IBC, Little Debbie, J&J Snack Foods. It’s also listed in our annual report on Page 4 again.

Nick Kovich – Kovich Capital Management

When I look at the enterprise value of the company today, it’s a little over $150 million and you have $88 million of debt now. You’re going to pay off $7 million with assets so that leaves you $81 million of pro forma debt looking forward after these divestitures close. And when I look at the model for 2011, that’s public by Janney Montgomery Scott, they’re forecasting $0.80 a share which is $6.5 million of net income and $12 million of depreciation which gives you $18.5 million of cash flow.

You subtract the $0.20 dividend which is $1.6 million, leaves you $16.9 million of discretionary free cash flow. I assume you’re not disclosing capital spending, but I’m guessing $5 million as a normalized CapEx, so that leaves you $12 million of free cash flow. So currently the stock has an 18% to 19% free cash flow yield on the $65 million of equity value. So if you pay over 2011 and 2012, if you pay off $12 million of debt over the next two years, in 2011, 2012, leaves you pro forma debt of roughly $55 million.

You take a $65 million equity value. That gives $120 million of market value, firm value, enterprise value. Looking out to 2012, you could be generating somewhere on the order of $25 million to $30 million of EBITDA. So the stock is selling at four to five time’s firm value to EBITDA which is extremely inexpensive in your space of competition.

I’m trying to understand the priorities for the use of the discretional cash flow. You’ve talked about growing the company. Can you articulate how much money you need to reinvest the business to grow the top line and how much are you going to share with the shareholders because if you can’t articulate that and give the investors’ confidence that you’re going to be able to grow the enterprise, I think the company is very vulnerable to a takeover offer of $10.00 a share, and how would the company respond to that. So could you kind of flush out some of these macro issues on how you’re going to grow the company and how you’re going to reinvest this money.

Paul Ridder

Before Charlie comments on how we plan to grow the company, I don’t think that we can comment on Mitch’s model or go through it necessarily and say that we agree or disagree with the math that you went through. I don’t think it would be appropriate for us to comment on Janney Montgomery Scott’s model.

Nick Kovich – Kovich Capital Management

Even if you don’t comment on the model, you’ve very consistently said $13 million to $15 million of savings and if you eliminate 215 people, it both comes up with about $0.80 a share, and that’s what his earnings estimate is for next year. So we don’t even have to use his model. We can use your metric of $13 million to $15 million of savings. If you look at the numbers, the company is going to be generating a tremendous amount of free cash flow and you’re going to deleverage the enterprise very rapidly, so I’m trying to understand how much is going to go toward debt? What is the capital structure you want to have? How much money does it take to grow the enterprise in terms of what you think is reasonable to get a high return on investment and how much are you going to return to the shareholders?

Charles Pizzi

We do have a long term plan which we stated many years ago when I first came to this company. We are following that plan. We said that we were continuing to go invest in the brand and with the benefits of operating efficiencies, and that’s what we’re going to do. We’re going to invest in our brand and invest in our company.

Clearly this new facility and other facility we have puts us in a different place. And so although I’m not going to comment specifically on your question, I can just tell you, this is a plan that we’ve talked about, that we put out there over five years ago and that we have followed and that we will continue to follow.

Operator

There are no further questions at this time. Mr. Pizzi, I would like to turn the call back over to you for any closing remarks.

Charles Pizzi

We appreciate your interest in our company and we look forward to talking you at the end of the second quarter. Thank you very much.

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Source: Tasty Baking Co. Q1 2010 Earnings Call Transcript
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