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Executives

Chad Ramsey – VP, Financial Planning and IR

Charles Pizzi – President and CEO

Paul Ridder – SVP and CFO

Autumn Bayles – SVP, Strategic Operations

Analysts

Mitchell Pinheiro – Janney Montgomery Scott

Nick Kovich – Kovich Capital Management

Sanjay Shetty – BOE Securities

Tom Graves – Standard & Poor’s

Tasty Baking Company (TSTY) Q2 2010 Earnings Call Transcript August 2, 2010 10:00 AM ET

Operator

Good day ladies and gentlemen, and welcome to the Tasty Baking Company’s second quarter 2010 financial earnings call. (Operator instructions) I would now like to turn the conference over to your host for today, Chad Ramsey, Vice President of Financial Planning and Investor Relations. Please go ahead.

Chad Ramsey

Good morning everyone. Thank you for joining us for Tasty Baking Company’s conference call to discuss second 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 215-221-8538 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 web cast 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 Company’s current expectation 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 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 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 introductory comments from management, we will open the call to your questions. Go ahead Mr. Pizzi.

Charles Pizzi

Good morning. The second quarter of 2010 was challenging for us in terms of both sales and operations. The quarter included declining category sales, softness in the larger consumer packaged goods market, record heat in the month of June, as well as increased level of expenses associated with the transition of production to the new facility at Navy Yard.

We are focused on those areas and will improve our performance as it relates to growing top line and optimizing the Navy Yard bakery. We anticipate that during the fourth quarter of 2010 we will achieve the efficiency required to generate the annualized target pre-tax savings of $13 million to $15 million net of lease expense, but before debt service.

In terms of some specifics regarding our performance in the second quarter, we reported that gross sales declined $4.6 million or 6% to $73.9 million versus the prior year period. This was driven in part by declining category sales, record heat waves, and the production limitations stemming from the issue related to the transition to the Navy Yard bakery.

Total net sales declined 7.3% in the second quarter compared to the prior year period driven by lower volume as well as the impact of higher promotional and production return costs. While Tasty performed slightly better than the category in our core markets, in terms of sales dollars and unit volume, the category experienced a year-over-year decline in the month of June that resulted in a more than a 5% reduction in category sales for the entire quarter.

This market softness extended beyond just the sweet baked snack goods category and impacted many consumer packaged goods markets. While these trends have continued for the company’s sales into the third quarter of 2010, they have not been nearly as severe as we experienced in June of 2010. Furthermore, we believe that we have the right strategy including an increased emphasis on innovative products and programs, and are executing on them to grow top line and to leverage the capabilities of our new facility.

In terms of the new bakery project, in late June we announced that we ended production at our Hunting Park of more than 88 years of service and transitioned the remaining production operations to the new Navy Yard bakery. With regard to the sale of Hunting Park and Fox Street properties, the due diligence period ended July 30, and the buyer has deposited an additional $500,000 into a non-refundable escrow account.

The company anticipates that this will close on this sale on September of 2010. The completion of this sale will be an important step in our overall manufacturing strategy, as the $6 million in funds we expect to receive will allow the company to reduce the debt associated with our investment in the new facility and enhance our overall liquidity.

During the second quarter of 2010, the company incurred approximately $5.1 million of additional operating costs related to maintaining two production facilities in Philadelphia, as well as the expense associated with transitioning to and optimizing the Navy Yard facility and closing the Hunting Park facility. As I had mentioned, we faced challenges with the transition process during the second quarter that caused these costs to be in excess of our original expectations. Those challenges, including being able to consistently run certain elements of the equipment at the required specification.

To solve these issues in a timely fashion, I have mobilized a multifaceted team that leverages the skill of third-party experts in the plant optimization with those of our vendor partners and an expanded internal team. We continue to anticipate that during the fourth quarter of 2010, we will achieve the efficiencies necessary to generate the annualized targeted savings of $13 million to $15 million. I can assure you that we are focused on this result.

In addition to the pending sale of our Hunting Park and Fox Street properties, we negotiated and completed the sale of spare parts and equipment that were not relocated to the new Navy Yard facility. The net proceeds of this equipment were approximately $700,000, and were received at the end of the second quarter.

Now Paul will comment on some specifics regarding the second-quarter financial results. Paul.

Paul Ridder

Thank you Charlie. As mentioned earlier, our top line performance in the second quarter of 2010 suffered due to challenges within the category as well as challenges within the broader consumer packaged goods markets. These category trends combined with record heat and $1.3 million in unfulfilled orders stemming from production limitations during the quarter, manifested themselves in lower sales and higher product returns in our core growth markets.

As sales (inaudible), the amount of product returns increased and along with higher promotional costs negatively impacted net sales realization. Cost of sales, excluding depreciation increased $4.8 million on a unit volume decline of 4.9% in the second quarter of 2010 as compared to the same period a year ago. This increase in cost of sales was driven by the impact of the $5.1 million in transition related costs, $4.6 million of which were classified as a component of sales, with the remainder classified as a component of SG&A costs.

Also driving the increase was $1.6 million in higher costs for key ingredients in packaging, particularly sugar. While the company is contracted for supply of sugar through July of 2011 and rates favorable to the market, these rates still remain higher than those experienced in the prior year. In addition to higher input prices, during the second quarter of 2010 we incurred $1.5 million of rental expense associated with the new manufacturing and distribution facility, $1.4 million of which was non-cash.

Partially offsetting these increases were lower fixed manufacturing costs, beneficial sales mix and the impact on costs of sales from lower sales volumes. Additionally, in the second quarter of 2009 the company recorded a $3.7 million benefit related to the termination of the company’s post retirement life insurance plan, $2.2 million of which was recorded as an offset to cost of sales.

This benefit did not reappear in the second quarter of 2010. Gross profit declined $8.8 million in the second quarter of 2010 as compared to the prior year period. This decline was driven by increase in cost of sales and higher depreciation expense, as well as from the impact of lower sales volumes.

During the second quarter of 2010, SG&A expenses decreased by 2.9% or approximately $400,000. This decline was primarily due to favorability in incentive compensation expense, driven by the reversal of our 2009 bonus accrual. Partially offsetting this was approximately $500,000 in expenses related to the transition of the new production and distribution facility at the Navy Yard in the second quarter of 2010.

Additionally in the second quarter of 2009, the company recorded a $3.7 million benefit related to the termination of the company’s post retirement life insurance plan, $1.5 million of which was recorded as an offset to SG&A expenses. This benefit did not recur in the second quarter of 2010.

As Charlie mentioned, late in the second quarter of 2010 we sold certain spare parts and equipment that were not relocated to the Navy Yard, with net proceed totaling $7000. As part of this transaction, we’ve recorded a gain of $700,000 that is included as a component of other income and expense. Also in other income and expense is approximately $600,000 in post employment severance costs related to reorganization of sales and corporate office personnel, as well as the completion of the transition of production to the Navy Yard.

As of the end of the second quarter of 2010, we amended our bank credit facilities primarily to provide for additional flexibility to avoid an instance of non-compliance and to change certain financial covenants, including our maximum operating leverage ratio and minimum required EBITDA, up to and including the fourth quarter of 2011.

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

Charles Pizzi

Thanks Paul. In closing, while this was a challenging quarter and certainly disappointing for myself and shareholders, I would like to assure our investors that we are diligently attacking and addressing the optimization of our new bakery and our top line sales performance. I believe we have the ability to overcome these short-term challenges and have put in motion specific plans with clear lines of responsibility to address the issues.

This has been a long and complex project and we have successfully hit the important milestones over the last three years. That being said, we recognize that as investors you are eager to see tangible results and returns from these investments. We’re eager as well, and we are putting all appropriate and needed resources in place to obtain our stated annual savings and to make this a successful project.

Now, we will open up the call to your questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question comes from Mitchell Pinheiro with Janney Montgomery Scott.

Mitchell Pinheiro – Janney Montgomery Scott

Good morning.

Charles Pizzi

Good morning.

Paul Ridder

Good morning Mitch.

Mitchell Pinheiro – Janney Montgomery Scott

So, I guess, one of the things I wanted to get a grip on is sort of the composition of the transition expenses, is there a way that you could help clarify what you put into here, so I can understand you know how to better treat these. I understand that of the 5.14, 0.6 is in cost of goods and the remainder in SG&A. But I’m looking more like, looking for what these expenses are and how you came up with these numbers?

Autumn Bayles

Hi, Mitch, it is Autumn. So, as we said, we have $5.1 million in transition costs for Q2. And to give you some clarity of what that is comprised of, $3 million of that is the optimization of the new bakery facility and the reminder of those pieces are basically redundant costs associated with running two facilities at the same time.

Mitchell Pinheiro – Janney Montgomery Scott

Okay, great. And when you talk about optimization, what kind of things go in there scrap?

Autumn Bayles

Yes.

Mitchell Pinheiro – Janney Montgomery Scott

Is it – and do you calculate it by normal scrap versus actual, I mean…

Autumn Bayles

Yes.

Mitchell Pinheiro – Janney Montgomery Scott

Okay. So the delta is between that, I mean, you are adding what additional labor?

Autumn Bayles

Yes. So it is both components Mitch, it is scrap and labor. And what we do is measure it against the projection of what the line should be performing at compared to where they are in the pre-optimization stage.

Mitchell Pinheiro – Janney Montgomery Scott

Okay, perfect. In terms of – so, when you look at these transition expenses for the third quarter, I would guess a lot of the redundant costs go away because Hunting Park is no longer operating.

Autumn Bayles

Yes.

Mitchell Pinheiro – Janney Montgomery Scott

But it does sound like that I guess what Charlie said, you might have some third parties in there, you know, so a little bit of extra spending might offset some of that?

Autumn Bayles

Yes.

Mitchell Pinheiro – Janney Montgomery Scott

Okay. But then obviously scrap and labor versus projections in that, like sort of $3 million estimate, that which should start to come down as the quarter progresses, correct?

Autumn Bayles

Exactly. So the way we look at it is we have the $3 million that we’ve had in Q2. We are expecting in the fourth quarter to have those reduced to 0. So Q3 would be ramping down in between.

Mitchell Pinheiro – Janney Montgomery Scott

Okay, and what about – what kind of rough estimate do you think, you know, the third-party consultants, whatever or other maybe vendor costs, things like that. How big of an item is that, is that $1 million, is that – I mean, any idea to – anyway to think about it?

Paul Ridder

Hi, Mitch, it is Paul, let me get it through. We’re obviously, as Charlie said, he has mobilized a team that does include some outside experts, as well as our vendor partners, and some expanded internal resources.

Mitchell Pinheiro – Janney Montgomery Scott

Right.

Paul Ridder

So, there are costs that come from a variety of different places. I think we will need to work through as long as we are committed to doing it, all the action that need to be taken to get us there. So, I think the costs aren’t overly significant, you threw out a number of $1 million, I don’t want to hit into it. We would expect it to be less than that.

Mitchell Pinheiro – Janney Montgomery Scott

Okay, good.

Paul Ridder

Those third-party partners, but I don’t want to go into details of modifications.

Mitchell Pinheiro – Janney Montgomery Scott

Okay. Also, when I look at your accelerated depreciation expense this year versus last year, and subtract that out from the actual, it looks like your new depreciation run rate is around 2.5 million, is that about right?

Paul Ridder

I think if you just looked comparatively period-over-period and forward [ph] that is about where you get to. There will obviously be some incremental assets that get placed in service after June.

Mitchell Pinheiro – Janney Montgomery Scott

Okay.

Paul Ridder

But those would be smaller in nature.

Mitchell Pinheiro – Janney Montgomery Scott

Okay.

Paul Ridder

When you place additional asset in service that might drive some additional depreciation from a baseline perspective, but I think you’re going about it in the right way.

Mitchell Pinheiro – Janney Montgomery Scott

Okay, and then looking at transition and optimization, you know, out of the seven lines how many would you characterize at the end of the quarter or today as being close or add after certain levels, and how many still are being worked on.

Autumn Bayles

Mitch, for competitive reasons, we don’t want to call out specific lines.

Mitchell Pinheiro – Janney Montgomery Scott

Right.

Autumn Bayles

We can say that it falls into two categories. There is some equipment issues and then there are some process issues, and as Charlie said, projects [ph] that we’re working on, getting those resolved with this team. The focus is really around getting them to perform consistently.

Mitchell Pinheiro – Janney Montgomery Scott

Right. So, I mean when you look at it, I mean out of the seven lines, just forgot about which ones, two or three running where you want and there are still three or four that need to get optimized or is it, any way that you care to share?

Paul Ridder

We actually just spoke about this last week and this morning as well. I think the better way to look at it is we have certain groups of equipment that may span some of the lines that are not operating to their consistency.

Mitchell Pinheiro – Janney Montgomery Scott

Okay.

Paul Ridder

It is more a sampling of the pieces of equipment that aren’t operating consistently as opposed to line by line.

Mitchell Pinheiro – Janney Montgomery Scott

Okay, got you.

Paul Ridder

… is a better way to look at it.

Charles Pizzi

I think, I want to assure you Mitch that I am focused on this. And that is why I have mobilized additional resources to make sure to get us to the goal line. And as I mentioned, we face these challenges with the transition process, but to solve the issues in a timely fashion, I mobilized a multifaceted team that leverage the skills of the third-party experts, and plan optimization, as well as the vendor partners and we brought in our folks from Oxford to really supplement our management team here.

Mitchell Pinheiro – Janney Montgomery Scott

Okay.

Charles Pizzi

But I led a meeting this morning, which I intend on doing every week with all of the supervisors to make sure that these issues are being addressed, so that we can get the ball over the goal line.

Mitchell Pinheiro – Janney Montgomery Scott

Any – when it comes to you know, like different equipment, is there any issue in timing if you decide that you need to replace one-piece with a different type or add, is there any timing issues in getting this equipment or how would you help color that?

Autumn Bayles

Mitch, I would say not at this point.

Mitchell Pinheiro – Janney Montgomery Scott

Okay. When you say not at this point meaning that maybe there are other pieces of equipment or what you have learned to date, you know, anything that you do need right now that you have identified or think you will need, you think you can get your hands on?

Autumn Bayles

Yes, we are not at that point in the process. Mitch, we’re focused on the consistency piece, and that is what we are working on.

Mitchell Pinheiro – Janney Montgomery Scott

Okay. When you look at sales, sales were down more than I expected, I mean I realized the heat played a pretty big factor. When I look at IRI for the Northeast region, you know, what is this call for 12 weeks ending mid-June, the category was, I don’t have the category number, but you guys were a little better than the numbers, I mean you were down about 1% in sales. So, IRI doesn’t capture, probably captures only 40% or 50% of your business. So, number one, did it really weaken in late June? Number one, were your up and down the street in this [ph] channel weaker than the grocery store mass channel? Can you color some of that, why the discrepancy?

Charles Pizzi

Well, I – let me just start out by saying, you know, June I think, the entire packaged goods marketplace felt a slow down, and so I think absolutely the last two weeks of June were problematic for us.

Paul Ridder

I think as we also said Mitch, we saw some of those trends continue into July, but not nearly as severe as they were in June, you asked, as Charlie said, it was more towards the end of June than the beginning of June. I also do think obviously the category data that we talk about is Nielsen data, and there can be some inconsistencies between IRI and Nielsen depending on how you define the category, and which various it will catch, since we don’t cover the entire north-east market. I don’t think we that want to go into specific convenience up-and-down the street. I do think that we saw by and large a broad based decline in June, somewhat coinciding with the weather patterns that the rest of the category saw.

We were also hurt, as we referenced by some production cuts, the limitations from the new bakery really coming from the consistency of the equipment. That caused us to not be able to fulfill $1.3 million of orders during the quarter, when you look about a year-over-year decline of $4.6 million that was obviously a meaningful impact.

Mitchell Pinheiro – Janney Montgomery Scott

Okay. So, if you look at the decline of 7% overall in the quarter, if you could just group it above average or below average, or if everything was pretty much at the same, were convenience stores at your average? Were they above average or below average?

Paul Ridder

I think the better way to look at it Mitch is when you look at those – our non-core areas, those places where we don’t have a stronger presence…

Mitchell Pinheiro – Janney Montgomery Scott

Okay.

Paul Ridder

And particularly the third-party distributors and vendors, as you might expect when you’ve got category weakness or external factors such as weather that we would have been impacted by more in those areas than in our core route area.

Mitchell Pinheiro – Janney Montgomery Scott

Okay.

Paul Ridder

Which is what we saw and saw a generally average response or similar response across the categories within our core markets. It was much more a delta where those third-party distributors and new markets performed worse than our route markets.

Mitchell Pinheiro – Janney Montgomery Scott

Okay, that is helpful. And then in your business, which you defined as direct to customer business, how is that relative to your average performance, was that any different than the minus 7%?

Paul Ridder

Well that, the direct to customer business falls within that non-core, non-route market that we talk about that did perform worse than our route markets. So that would fall in the piece, or would have been worse than the average.

Mitchell Pinheiro – Janney Montgomery Scott

Okay. When it comes to competitive activity in the bakery snacks area, you know, just looking at the numbers I see, you look like you’ve had reasonable promotional activity, but some of your competitors have been a lot more aggressive, and are you seeing any change in the competitive climate, I mean, broadly speaking, forget about June or any particular quarter, but have you seen more aggressive competitors, how do you intend to play that?

Charles Pizzi

Well, I think you always play to your strength, right Mitch, and so we are going to be playing to our products in our core market area, and as well as new products, but I will tell you we have seen the promotional levels a lot higher, but going up and down, not a status, any kind of predictable way, but so, we’re playing to our strengths, and that is in our core market area. Paul, I don’t know if you want to comment further.

Paul Ridder

I think that Charlie is right, we have seen some increased promotional activity although we historically have seen that level of activity ebb and flow on a somewhat seasonal basis. I think as you pointed out, we had a more balanced promotion set within the numbers, yet we still outpaced the category marginally. So I think there are some benefits. To what Charlie said, we try to play to our strengths across product quality, innovation et cetera to make up whatever difference we may have in promotional spending if necessary.

Mitchell Pinheiro – Janney Montgomery Scott

Has the higher cost level due to the transition expense and other redundant expenses, did any of that play a part in your promotional strategy as far as spending, or are these two different situations or not, and your market activity has been unaffected by your bakery activity?

Paul Ridder

I think there is a couple of important pieces in there to answer Mitch, one is that we did as part of our planning process try to balance out some of our promotional schedule were possible to try to reduce the impact on the facility as were transitioning lines from the old Hunting Park bakery that did close in June.

So that impacted more from a scheduling perspective as opposed to the levels. I think one of the things that is really important for us to go through as you talked about added cost, this overall project, we expect $13 million to $15 million in net savings and that is asset and lease. So from a gross perspective it is much higher than that. I think it is important to point out that the remainder that we are talking about of cost getting out of the system in the third quarter into the fourth quarter is the optimization component.

We have previously talked about the fact that two thirds of the cost, a little more related to labor and the closure of the Hunting Park facility, both of which we were able to fully execute upon fully in June. So we are actually already starting to see some of the savings come through from the project, and we are talking about really the last third. So, I think it is important for everyone to understand, while there is more cost because of that, we’re starting to see benefits from the project.

Mitchell Pinheiro – Janney Montgomery Scott

Okay, all right. That is helpful. All right, (inaudible), I have asked a bunch of questions, I will yield the floor to see if anyone else has any.

Paul Ridder

Thanks Mitch.

Mitchell Pinheiro – Janney Montgomery Scott

Thank you.

Charles Pizzi

Thanks Mitch.

Operator

Our next question comes from Nick Kovich with Kovich Capital.

Charles Pizzi

Good morning Nick.

Nick Kovich – Kovich Capital Management

Good morning. What was employment in the total company as of August 1 or July 31, do you have that number?

Paul Ridder

We actually don’t give interim employment numbers. I think we talked about this on our last call. I know you had a question about, the numbers is disclosed in our 10-K and we do go through and given at that point in time.

Nick Kovich – Kovich Capital Management

No, I know it is in here, 870 as of March 09, 2010. And since labor is such an important component of that, I am just trying to understand…

Charles Pizzi

I think, yes, I think and so therefore we have said very directly that we have made the number that we had targeted for some three years ago of reduction in our bakery.

Nick Kovich – Kovich Capital Management

Thanks. If you look at management’s incentive bonus compensation, what was that geared to in 2009, and what are the metrics for 2010. I guess, I don’t have a proxy in front of me, but I wondered what are the drivers to determine management’s incentive bonus compensation?

Paul Ridder

Well, let me go through and answer some of those Nick, although I do want to make sure you refer back to the proxy for the details behind it to make sure, because I think obviously has the greatest level laid out possible. There were metrics in 2009 related to EBITDA as defined under the incentive compensation plan, as well as metrics related to the milestones out of this whole project, were key components of the plan and that the second part related to long-term incentive plans with stock awards, and the first part to EBITDA was a cash incentive program.

In 2010, we likewise have an annual incentive program, a cash based program related to EBITDA. We also have a long-term incentive plan, which has stock compensation and there are a number of different metrics included with that within that related to those two market share milestones under the store project, and there is a multi-year program also with embedded. So, I encourage you to actually go through the proxy in detail, because there are a number of specifics that are important to read through that we would not have enough time to cover on the call.

Nick Kovich – Kovich Capital Management

Okay, so the EBITDA targets are in the proxy statement?

Paul Ridder

The discussion of the metric, the target itself is not within the proxy statement, nor have we publicly disclosed that.

Nick Kovich – Kovich Capital Management

Okay, what were the key reasons in the middle of June, why the compensation committee back settled, and decided not to pay out the $1.5 million in incentive compensation from last year?

Paul Ridder

Well, I think we take very seriously our relationship with our banks, and we wanted to make sure that we were making a statement that by returning that would send a very strong signal out that the management team has lots of passion, and frankly it is because we hit this speed bump along the way. And we think that was a responsible thing to do.

Nick Kovich – Kovich Capital Management

I guess Charlie, what is going to happen in the next 60 days that is magically going to result in a significant reduction in employment, you have now gone outside and brought in external experts to help you solve an operating problem, I’m just trying to understand why we should have confidence in the next 60 days this is going to be resolved, because you have reiterated again that you are going to hit this $13 million to $15 million annualized run rate in the fourth quarter, and to me that seems like you have hit some speed bumps that are way out of the field, and why should shareholders have confidence in 60 days that it is going to be fixed?

Charles Pizzi

Well, I can assure you Nick there is nothing magical about the fix. I can assure you that it is documented. We have hit the target on our people, and what we are looking at now is more based on machinery. I can tell you in conversations I’ve had with experts in the industry that these speed bumps happen all the time when you bring up a very complex operation. We are addressing that and have brought a sense of urgency behind it.

We have a very talented team that has met every one of our milestones since we started down this path in 2006. That is why I can assure you, and that we have the passion to make this happen.

Nick Kovich – Kovich Capital Management

Okay. So the headcount is where you want to be, it is totally an operating problem with the machinery?

Paul Ridder

Nick, it is Paul, that is correct. That is what I was trying to relay is the headcount portion of it, which as we said in the past, equates to about two thirds of the overall savings, is where we need it to be.

Nick Kovich – Kovich Capital Management

Okay. That is great to hear. What are the operating rates in the bakery in the second quarter, and where do you expect them to be in the fourth quarter to achieve this target?

Autumn Bayles

That is something for competitive reasons another reason why we don’t discuss it at that level. As Charlie and Paul and I have mentioned, we know where our targets have to be, we know where we are right now. And we are working to get them to that target level with this new team.

Nick Kovich – Kovich Capital Management

Okay. I will let some others ask questions. Thank you very much. Good luck.

Paul Ridder

Thank you Nick.

Charles Pizzi

Thank you Nick.

Operator

Our next question comes from Sanjay Shetty with BOE Securities.

Sanjay Shetty – BOE Securities

Good morning guys.

Charles Pizzi

Good morning.

Paul Ridder

Good morning Sanjay, how are you?

Sanjay Shetty – BOE Securities

Doing good. Thank you for taking my call. Most of my questions have been answered in the previous session, the question I had for the revenue side was in terms of like routes and nonroutes any transition between that like have you converted any of the non-routes to routes or from within routes from independents to owner like company owned routes.

Charles Pizzi

We have during the quarter, I think as we spoke on our last call, we have had some transition from third-party routes to our own routes. I think one of the things that we do continuously is make sure we evaluate each of the third-party markets, those new core regions, as well as our core market to make sure that we are making the right level of investments to make sure that the profitability that we expect and that we are seeing from those is where they should be. And as appropriate we made changes from a variety of forms, one of which in the past quarter was converting from a third party distributor to accompany our routes. But we will continue to look at those, particularly given the environment that we are seeing today.

Sanjay Shetty – BOE Securities

Okay, okay. And how about the new markets that launched that you did in the previous quarters like Long Island, how are they operating, or how are they performing right now?

Charles Pizzi

Well, right now for example, in Long Island we are seeing that they are – that Long Island is meeting its projection for us.

Sanjay Shetty – BOE Securities

Okay, and any challenges or issues that you are facing at that and also during your market penetration efforts?

Charles Pizzi

I think Sanjay, as I tried to say before, as you might expect there was some softness both in our category larger consumer packaged goods because of the excessive heat, we were more impacted in those areas where we had recently gone into or where we were expanding, because we don’t have a stronger presence. So those were clearly challenges in some of those newer markets up and down the New England coast and in parts of the five routes [ph] at Manhattan. That impacted us greater than it did within our core market, although as Charlie said, Long Island, which is where we talked about particularly on our last quarter that continues to meet our expectations.

Sanjay Shetty – BOE Securities

Okay. In terms of production limitation you mentioned in your prepared comments, was there any product category within that which had more impact than others?

Charles Pizzi

No, Sanjay, I am sure Autumn could go into it, really because of the consistency of the equipment, it is somewhat across-the-board and what we mean by that as we say, we had orders for approximately $1.3 million during the quarter that because of those limitations or lack of consistent production, we weren’t able to fulfill.

So we are able because of the nature of our business, because we get orders in everyday from our 450 plus independent sales distributors, we get a great deal of data that we can act upon, but unfortunately we are also able to see when we are not able to fulfill the orders.

Sanjay Shetty – BOE Securities

Okay. That is fair. In terms of raw materials, you mentioned about sugar, how about other raw material components within your input costs, what are you seeing into that, and any impacts on that, price variations over the next 6 to 12 months?

Autumn Bayles

In addition to the sugar that you mentioned, cocoa is one that we’re keeping our eye on. We have covered our supplies through the end of this year, and we have locked in our costs for the third quarter. But it is certainly one that you know, there has been a lot of discussion on in recent years.

Charles Pizzi

Yes, Sanjay, we’ve typically discussed forward-looking in terms of sugar and cocoa, although we haven’t gone into the other commodity costs, particularly so that were not disadvantaged from a negotiating perspective, but we do have a very rigorous risk management program that looks at those ingredients, both packaging and raw materials that go into the process, evaluate whether we’re able to lock those in a forward-looking basis at costs that we feel are advantageous to us, and that can take the form of advantageous in terms of either guaranteeing supply or having a price that’s advantageous, but at the same time there are certain ingredients that we’re not able to lock in the price such as eggs and certain dairy components. Nevertheless, we still watch those very closely and try and manage our exposure where possible.

Sanjay Shetty – BOE Securities

Okay, okay. Sounds fair. In terms of debt covenants, can you give us an update on where do you stand right now at the end of second quarter with the newly negotiated covenants?

Charles Pizzi

Sure. We did enter into an amendment to our credit facility, really three purposes. One was to provide additional flexibility to the operations. The other was to avoid an instance of noncompliance at the end of the second quarter, and the third was to really do a forward look at the dollar or debt covenants themselves. Many of our covenant calculations are a last 12 month calculation.

So the financial results we’ve had this quarter and the prior quarter do stay with us for a while. We made sure that we took a forward-looking approach and adjusted those covenants to provide us with as much flexibility as possible. We are in compliance at the end of the second quarter. The copy of the amendment itself was filed with our 8-K with all the details. Don’t necessarily want to take the time to go through all detail in the call, because once again that would take a great bit of time we could answer any specific questions, but I would encourage you to go through and read this specific amendment itself for any other questions that you have.

Sanjay Shetty – BOE Securities

Okay, and in terms of the new negotiated covenants is that like have a margin of safety where you can assume like you won’t be have to renegotiate in the next quarter or maybe end of the year?

Charles Pizzi

We – our approach to looking at covenants and setting covenants is to make sure that we set them at a level where the company feels comfortable at the current time that we have the ability to achieve those. We have a pretty rigorous forecasting process. We’ll go through and we’ll have more discretion on that obviously within the 10-Q as is required, but the whole process in terms of setting covenants is one where you want to make sure that you are comfortable that you can achieve those when you set them.

Sanjay Shetty – BOE Securities

Okay, okay. One final question is regarding the cost for optimization, which will be the major component from your transition in the third quarter. How should we look at that, like is it fair to assume whether it should be more of a component from the cost of goods like impacting gross margins other than SG&A?

Autumn Bayles

I think the best way to talk about it is in the second quarter we had $3 million in optimization transition cost, and we’re saying that during the fourth quarter, we are going to ramp this down to zero. So the best way to think about it is a ramp down between those two points.

Paul Ridder

And Sanjay, let me hit the accounting side of your question. That is we would expect the most significant piece of those costs to hit cost of sales and not SG&A.

Sanjay Shetty – BOE Securities

Okay, got it. Thank you very much.

Paul Ridder

Thank you.

Charles Pizzi

Thank you.

Operator

(Operator instructions) Our next question comes from Tom Graves with Standard & Poor’s.

Tom Graves – Standard & Poor’s

Hi, a couple of things I want to check on. One, you know, I think you mentioned that in terms of trying to you know, deal with the sale softness you’ve seen recently, there are a variety of measures including innovation and new packaging. Is this something that’s more likely to be 2011 type of response or might we see some of that in the latter part of 2010, and the second question I think you said that some of the sale softness in the second quarter came from, you know, the optimization issue and just not being able to you know, fulfill some orders. I just want to double-check on the quantification that you had estimated for how much lost sales was just because you didn’t have all those – get the lines up and running the way you’d like.

Charles Pizzi

Okay, so to your first question. We are now in market with all new packaging. We will have all new packaging completed within the next 30 to 60 days, but have already started that process earlier in July. So we are excited about the new look because essentially we wanted to let the consumer know that this product is being made in a new facility that it’s being made with the highest-quality, and I think our packaging comes across that, as well as telling our consumers that we are now in the world’s largest green bakery.

So I think our new packaging does that. I think what you also find in the balance of this calendar year is more product innovation. I mean, the whole purpose of our investment was to provide flexibility and efficiency, and we do have the programs that are in place and that we’re building on to get a fair size [ph]. I mentioned on our last call we did have and create a new position of the director of new product development. With regard to your second question, I will tell you that and Paul can tell you from a more analytical standpoint, but the cuts have had an effect on our sales numbers now. That’s one of the things we’ve been working on to get, you know, control over but they have had an effect on our bottom line.

Paul Ridder

Tom, to quantify for you, I did mention we had approximately $1.3 million of orders that we were not able to fulfill, because of the inconsistency of some of the equipment. That’s against a gross sales decline of about $4.7 million. So it was a meaningful component during the quarter of our sales performance.

Tom Graves – Standard & Poor’s

Okay, yes that helps. Yes, I thought you’ve given a number. I just wanted to double check and so thank you very much.

Charles Pizzi

Great. Welcome Tom.

Operator

Our next question comes from Nick Kovich with Kovich Capital Management.

Charles Pizzi

Hi Nick.

Nick Kovich – Kovich Capital Management

Hi, a follow-up question, I’m looking at page seven of the press release. You have depreciation and amortization for the first half at about $8.9 million. Is it reasonable to assume for the full-year 2010 that number is going to be $17.5 million or $18 million for the full-year?

Charles Pizzi

No Nick. I think that there is a couple pieces that impact that, one I believe the first question came that from Mitch Pinheiro, when we talked about, we’ve had accelerated depreciation coming through on our income statement on a quarterly basis since May of – since the second quarter of 2007, when we announced the project. With the closure of the Hunting Park facility and the full transition of the equipment, we would no longer expect to have any accelerated depreciation going forward. So that we would expect that number to be less than that, less than that in the second half of the year.

I think the other piece that impacts that which Charlie discussed is we do have a pending sale of the Hunting Park building. We had extra depreciation related to that building to go down to the expected net proceeds. We do expect that the gross sales price is $6 million. The due diligence period expired at the end of July and buyer put in an additional $500,000 deposit. We expect that to close in September. So because of all those factors the extra depreciation that was running through really ended at the end of the second quarter.

So we do expect to see a meaningful decline going forward. I think that the company didn’t, but I believe that Mitch Pinheiro said commented that this initial calculation was between $2.4 million and $2.5 million. Our comment to that was that we may still have some assets that would need to be put in servicing the third quarter that might increase that number somewhat.

Nick Kovich – Kovich Capital Management

So the $2.4 million to $2.5 million would be the run rate in the second half of the year?

Charles Pizzi

No. I believe the comment that was made with that would be the quarterly number and our comment to that was that we may still have some additional equipment to be put in service that could increase that slightly.

Nick Kovich – Kovich Capital Management

Okay. So for 2011 a number of $10 million might seem reasonable?

Charles Pizzi

Yes, we are not at this point in time – I think you can annualize your numbers and get to that although we are not giving any guidance at 2011 at this point, but I think that that’s the – that your math and the numbers that have been put out there.

Nick Kovich – Kovich Capital Management

Okay and how about capital spending. I don’t see anything about capital spending in here for the first half of the year, and where you expect it to be for the full year?

Charles Pizzi

Our capital expenditures are broken into two categories. We have capital expenditures with respect to the new bakery project, and then we have regular capital expenditures. Let me answer the second part of your question first, which is our bank credit facilities have limitations on capital expenditures on a year-by-year basis or a fiscal year basis, and we historically have indicated to everyone that those levels that will be held to and that we will discuss, we will continue to do so, some of the levels that are in there for 2011. The maximum amount is approximately $6.75 million and 2011 is the maximum allowable regular capital expenditure on our bank credit facility. In terms of the actuals for this year, we’ve expended about a little less than $11 million through the end of the second quarter with about $3.4 million of that being regular capital and the remainder being associated with the new project.

Nick Kovich – Kovich Capital Management

Okay, great. Thank you very much. That’s helpful.

Charles Pizzi

Thank you.

Operator

Our next question comes from Mitchell Pinheiro with Janney Montgomery Scott.

Charles Pizzi

Hi Mitch.

Mitchell Pinheiro – Janney Montgomery Scott

Hello there. Commodities, Autumn you had mentioned you know, cocoa is becoming a little bit of the concern perhaps, you know, I look at butter. Butter is up, we know sugar is up. You know, on your cost, but still favorable, but perhaps by you know, early next year you know, I don’t know where sugar is going to be. Wheat has been up a lot. So my question is as you look into 2011, as far as, I mean, we’re a long way, but it looks like, you know, you might have to consider some pricing actions. I know there’s a lot that goes into that including competitive activity, but how do you intend to handle the commodity cost increases. Is that, you know, you take pricing early. You take it in the fourth quarter if you can?

Autumn Bayles

Yes, I understand Mitch what you’re asking and I think you know, we’ve discussed in the past we have a rigorous risk management program, and what we try to do is get our, you know, contracts favorable to the market and cover, you know, for a period of time just to take off the table any sort of risk that could have been depending on what’s going on with specific market. We’ve talked about we have sugar covered through mid 2011. So that one is, you know, we’ve managed that from a risk perspective and if something else would happen to change where the market goes, we might take an additional action there, but that’s sort of our strategy for all of these commodities.

Charles Pizzi

I think the second half of that Mitch is your question on pricing action. We’re very sensitive to not discussing the timing of pricing action or whether or not we are going to take price because of competitive reasons, although we’ve talked about, and I can assure you we still have the same process in place, where we evaluate the pricing of all of our products and all of our portfolios against what’s going on in the marketplace as well as our input costs, and the overall impact also on our customers and consumers to make sure we balance that.

I think in the past we’ve been able to be responsive when price increases are warranted and we’re able to put those through and obtain the benefit of them. But that’s something that we evaluate very closely, and really we’ll make that action, have that in the marketplace before we’re willing to discuss publicly when it happens that we are not disadvantaged competitively.

Mitchell Pinheiro – Janney Montgomery Scott

Okay, that’s all I needed. Thank you.

Paul Ridder

Thank you very much.

Charles Pizzi

Thank you Mitch.

Thanks a lot. We appreciate everybody’s continued interest and we look forward to talking to you in a few months. Thank you very much.

Operator

Thank you. Ladies and gentlemen thank you for your participation in today’s conference. This does conclude the conference. Just as a reminder, this conference will be available for replay after 1 PM today through August 9th. You may access the replay by dialing 1800-642-1687 and also dialing 706-645-9291. Thank you very much. You may now disconnect.

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Source: Tasty Baking Company Q2 2010 Earnings Call Transcript
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