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Lancaster Colony Corporation (NASDAQ:LANC)

F4Q2010 Earnings Call Transcript

August 19, 2010 10:00 am ET

Executives

Earle Brown – IR

Jay Gerlach – Chairman, President and CEO

John Boylan – VP, CFO, Treasurer and Assistant Secretary

Analysts

Alex Bisson – Northcoast Research

Shaumo Sadhukhan [ph] – Meritage

Brian [ph] – Janney Montgomery Scott

Greg Halter – Great Lakes Review

A.J. Strasser – Cooper Creek Partners

Operator

Good morning. My name is Kelly and I will be your conference operator today. At this time, I would like to welcome everyone to the Lancaster Colony Corporation's fiscal year and fourth quarter 2010 earnings conference call. Conducting today's call will be Jay Gerlach, Lancaster Colony Chairman and CEO, and John Boylan, Vice President, Treasurer and CFO. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (Operator instructions) Thank you.

And now to begin your conference, here is Earle Brown, Lancaster Colony’s Investor Relations.

Earle Brown

Thank you. Good morning. Let me also say thank you for joining us today for the Lancaster Colony fiscal year and fourth quarter 2010 conference call. Now please bear with me while we take care of a few details. As with other presentations of this type, today's discussion by Jay Gerlach, Chairman and CEO, and John Boylan, Vice President, Treasurer and CFO, will contain forward-looking statements of what may happen in the future, including statements relating to Lancaster Colony's sales prospects, growth rates, expected future levels of profitability, as well as the extent of share repurchases and business acquisitions to be made by the company.

These forward-looking statements are based on numerous assumptions and are subject to uncertainties and risks. Accordingly, investors are cautioned not to place undue reliance on such statements. Factors that might cause Lancaster's results to differ materially from forward-looking statements include but are not limited to risks relating to the economy, competitive challenges, changes in raw materials costs, the success of new product introductions, the effect of any restructurings and other factors as are discussed from time to time in more detail in the company's filings with the SEC, including Lancaster Colony's report on Form 10-K.

Please note that the cautionary statements contained in the Safe Harbor paragraph of today's news release also apply to this conference call. Now here is Jay Gerlach. Jay?

Jay Gerlach

Good morning. Thank you for joining us. We are pleased to report a record year in 2010 for operating income, net income and earnings per share, yet disappointed with our fourth quarter finish. While macroeconomic conditions were certainly a factor, a number of our own issues contributed to our results in the quarter and I’ll comment further when I review our two operating segments.

Overall sales for the quarter were down 2% as off-season candle growth was more than offset by softness in our food business. Food operating margins for the quarter of almost 18% were down from last year's over 20% level but nearly the same as our third quarter margins and within our longer-term range of mid-to-upper teens. Glassware and Candles segment fourth quarter margins were close to breakeven versus a 3% loss last year. Earnings per share of $0.81 were off last year’s record $1.10.

Sales for the year were up 0.5% to $1,057 million with all the growth from increased candle sales. Food sales were down almost 2% in the year, our first food sales decline.

For the year and all in the fourth quarter, we repurchased 80,334 shares for $4.4 million and have 344,000 shares authorized to repurchase after 84,000 shares repurchased so far in the first quarter.

Capital expenditures in the quarter totaled $4.7 million and for the full year $12.8 million. With a need to expand our frozen dinner roll capacity to supply our fast growing Sister Schubert’s brand, and some dressing and sauce related projects, we estimate fiscal 2011 capital expense could reach $45 million [ph].

Turning to our segments – our glass and candle sales, as you know mostly candles, finished the year up over 15% with a similar increase in the fourth quarter. While we benefited from some new programs and new products, I think the consumer was also looking more to the mass channel for their candle needs. Good operations, capacity utilization and primarily lower wax costs were the factors improving this year's operating income to $9.4 million from last year’s $5.7 million operating loss.

Our specialty food segment saw operating margins reach 19.7% for the year versus 16% [ph] last year and operating income increased $30.3 million despite an $8.6 million decline in year-over-year fourth quarter operating income.

The unfavorable aspects of the fourth quarter that I would highlight are continued volume and price weakness in the foodservice channel, Easter falling in the third quarter versus fourth quarter last year, perhaps about a $4 million sales impact, retail sales in the quarter were down 3%, food service sales were down 5%.

Material costs were favorably by perhaps $4 million or so, our lowest quarter this year, although offset by about $4 million of price declines. Promotional spending on frozen products was also up quarter over quarter. Operating efficiencies were not good in the quarter as we struggled with some new item startup and the relocation of dressing production from our closed New York plant.

Higher freight costs were also a low seven-figure headwind. Operating expenses rose from a variety of causes including some costs we hope not to see repeated in fiscal 2011. Overall, for the full year, our food business saw favorable material costs in excess of $40 million, unfavorable pricing of about $18 million, sales mix of 53.5% retail versus 51% last year, and increased investment in consumer brand marketing of about $6 million.

Reviewing our key category performance for the year ended July 11 – in the refrigerated dressing category, we slipped slightly to number three by 0.2-percentage point. The category for that 52-week period grew 4%, our Marzetti brand was down about 0.5%. We definitely saw more aggressive promotional spending by competition.

In the vegetable, fruit and apple dip category, we remained a strong number one, 86% share. Category performance was down 4%. Our Marzetti brand was down 1.6%. We’ll try to address needs in that category with some new product I’ll comment on shortly.

The garlic bread category – we remain number one with a 29% share. The category was down 1%. Our New York brand was up 1.7%.

In the dinner roll category, again, maintained our number one share, almost 43%. Category was down 3%. Our Sister Schubert’s brand was up just under 22%. During the year, we saw Pillsbury exit the dinner roll category and create new distribution opportunities for us as well as benefiting from some new product introduction.

And then lastly in the crouton category with our various brands we are number one with a bit over 28% share. Category was up just under 4%. Our brands collectively were up about 15%.

Let me ask John to make some comments here.

John Boylan

Thanks, Jay. I’ll briefly cover several matters this morning regarding our June 30 balance sheet and fiscal 2010 cash flows. Let’s start by taking a look at several of our major year-end balance sheet components.

Our accounts receivable at June 30 totaled over $67 million, which is an increase of over $6 million from a year ago. This growth primarily reflects a sales-driven increase in candle related receivables as well as stronger food sales in June. Our account receivable agings remain in reasonably good shape.

Turning to the largest component of our working capital, inventories – we saw our June 30 total of over $121 million that reflected a significant year-over-year increase over the prior-year total of $103 million. Most of this increase resulted from higher candle inventories, reflecting anticipated seasonal sales growth in the first half of fiscal 2011 as well as somewhat slower than expected fourth quarter sales. We also saw increased food inventories primary from a seasonal pre-build of frozen roll inventories.

Moving on, other current assets rose by roughly $7 million reflecting a relative shift in current tax balances. Our net property balance declined about $5 million of 3%. Similar to the last couple of years, this year's total capital expenditures of $12.833 million was less than our depreciation expense.

Finally, commenting on the other side of the balance sheet I'd note that we continue to have no debt and ended the year with shareholders’ equity of nearly $485 million. Considering we also have just over $100 million in cash and equivalents, we retained considerable flexibility to meet most foreseeable needs.

Turning to this year's cash flows, cash flows from operating activities totaled $107.691 million, which compares to $133.164 million for the prior year. This decline reflects cash utilized in the higher levels of inventory and receivables being partially offset by the benefit of this year’s record level of net income. And arriving at this year’s cash provided from operations, the most prominent non-cash add back remain depreciation and amortization, which totaled $20.533 million.

As Jay alluded to, total annual cash flow distributions to shareholders were $33.430 million for the payment of dividends and $4.398 million for share repurchases. Given what I've shared this morning and our current expectations for fiscal 2011, we believe that we continue to be financially well positioned to address our anticipated cash needs whether it be for CapEx, share repurchases, dividends or business acquisitions.

Thanks again for your participation with us this morning. I’ll now turn the call back over to Jay.

Jay Gerlach

Thanks, John. Looking to 2011, we continue to see a very challenged consumer spending environment. While our food service channel business had some new programs starting up, the sector appears likely to stay soft for the foreseeable future. We are also not seeing any real encouraging signs from the consumer at retail.

We do have some new products we are excited about including our new Marzetti Otria Greek Yogurt Veggie Dips, including Omega-3. They are getting a strong reception from the trade and just now reaching store shelves.

Our New York brand, we’ll introduce this fall, our garlic Ciabatta roll to go with our successful Ciabatta cheese roll and our growing Sister Schubert brand will add a multigrain roll in the fall with additional introductions as the year progresses. Couple of other concepts we are excited about were just a bit too early to be announced today.

We expect to continue to invest in our consumer marketing spend this year, at the same time we are likely to see our trade promotions increase to meet competitive activity. We anticipate input costs will increase this year as dairy, sugar, eggs and packaging are all up at this time. If the recent run-up in grains continues, it could impact soybean oil and wheat costs as the year progresses. We will look for pricing opportunities but that will likely to be very difficult in this environment.

Critical for us will be good sales execution with our new products and promotional programs and consistently good operating efficiencies.

Regarding candles, we are looking for somewhat better volumes from new placements but anticipate margin challenge from higher wax costs, especially in the first half of the fiscal year. We are in process of implementing price adjustments, which may serve to offset some of that impact.

We continue to hunt for the right acquisition opportunity in a market that seems to be seeing more activity, although nothing is probable at this time.

Kelly, we are ready to take questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from Alex Bisson of Northcoast Research.

Alex Bisson – Northcoast Research

Good morning, everyone.

Jay Gerlach

Good morning, Alex.

John Boylan

Good morning, Alex.

Alex Bisson – Northcoast Research

First, I missed what you said or what your guidance was for CapEx in 2011.

Jay Gerlach

We are estimating close to $45 million.

Alex Bisson – Northcoast Research

Okay. And I know you mentioned that that's going to increase capacity in some rolls and dressing. Does that go – will that increase capacity at existing plants or does that perhaps encompass a new plant as well?

Jay Gerlach

No. That's existing facilities, although a piece of it is an actual plant expansion. That being for our Sister Schubert’s brand.

Alex Bisson – Northcoast Research

All right. This is the first quarter in sometime that we've seen you repurchase stock, and I was just wondering given what you're seeing in the acquisition environment, apparently a little bit more willingness to buy back stock, could you talk a little bit about uses of cash going in to 2011?

Jay Gerlach

I think acquisitions continue to be our priority. In fact with a little more activity, we’ve seen just in the last four to six weeks as far as opportunities to take a good look at. We might be a little more encouraged that – and a little more inclined to continue to keep a strong balance sheet and focus on that particular use. However, we have bought back at a relatively modest pace starting kind of mid- or late-fourth quarter, and I would think we will continue to do that, again, at a modest pace anyhow.

Alex Bisson – Northcoast Research

Can you talk a little bit more about the promotional environment and maybe what your plans are in the aggregate to increase promotional spending going forward given your new products and what appears to be going on in the environment?

Jay Gerlach

We are largely from a promotional spend standpoint reacting to competitive activity and threats rather than leading that effort, we're concerned that in this environment added promotional spending doesn’t seem to be driving a lot of incremental volume. So we are pretty cautious on what we are doing there, but again don't want to give up position in share. We will add spend with the new products we are rolling out; obviously there will be some slotting involved and other activities around those introductions.

So with a series of those as we work through the year, that will take a piece of our increased promotional spend.

Alex Bisson – Northcoast Research

Great. I guess that it. Thank you very much.

Jay Gerlach

You are welcome.

Operator

Your next question comes from Shaumo Sadhukhan [ph] of Meritage.

Shaumo Sadhukhan – Meritage

I was wondering if you could talk a little bit about the sales potential from some of the new products that are in the pipeline.

Jay Gerlach

Well, always hard to predict but I think as we look at what I mentioned this morning, probably the thing that we might identify as having the biggest single potential is our Otria Greek Yogurt Veggie Dips, and we are probably looking on an annual basis there we think it maybe an upper 7, low 8 figure kind of sales opportunity on a full-year basis. But that’s, again, just getting introduced. So other than good trade acceptance, we don’t have any consumer data yet to look at to really support that yet.

Shaumo Sadhukhan – Meritage

The other question that I had is if you look at your margin, you guys peaked out at about 24%, 23%, 24% in the food segment a couple of quarters ago and now you're running mid-17s this quarter. And historically you’ve been around the 16 range, at least if I just take a long-term average.

I'm curious if you think you can hold the level kind of at this level, mid-17s, or do you think that the level going forward would be higher or lower and it seems on one hand you are talking about a promotional environment and costs being higher but on the other hand it sounds like there were some one-time costs in the quarter, this quarter, that brought the margin down. So I am thinking – the question is where do you see that settling out over the next year or so and then longer term?

Jay Gerlach

I think we would be uncomfortable to pin anything down to as close as mid 17s or something like that. I think, again, longer term kind of the mid-to-upper teens range is what we think is realistic. We do go into this year with some ingredient cost headwinds which we haven't had for the last four to five quarters.

Don’t know whether we can offset those with some modest pricing adjustments. We will certainly try to implement some things as the year progresses and the need gets clarified. We do anticipate, again, a little more promotional activity both from a competitive standpoint and to roll out these new products.

Yes, there are some one-time costs that hopefully we can get and keep behind us. So that could be an added plus. So that's I think as much as I would be comfortable commenting on this morning.

Shaumo Sadhukhan – Meritage

Okay. Thanks.

Jay Gerlach

You are welcome.

Operator

Your next question is coming from Mitchell Pinheiro of Janney Scott Montgomery.

Brian – Janney Montgomery Scott

Good morning, everyone. This is actually Brian [ph] stepping in for Mitch this morning.

Jay Gerlach

Hi, Brian.

Brian – Janney Montgomery Scott

I want to ask you guys just real quickly about the candle segment. In the past that’s a segment you talked about maybe that that's something that could be paired from the portfolio at some point and you talked a little bit about the M&A environment sort of what it looks like. I am wondering where you sort of stand on your strategy with the candle segment and if that’s something that maybe given the better M&A environment, is that something that’s still is something you consider selling at this point or – and I will step back and let you guys talk about that.

Jay Gerlach

Yes, we are continuing to evaluate all the factor relative to that and you certainly touched on one of them. Another major one is our concern about the wax costs headwinds we are looking at. But we are continuing to evaluate that but have not made any decisions as of today.

Brian – Janney Montgomery Scott

Okay. Then moving over, looking at the foodservice side, you guys talked last quarter about seeing small signs of a recovery in maybe certain pockets nothing widespread and we see volume, again, down this quarter. Is that a product still of cost pass through and if you could just talk about the attitude of your foodservice customer right now or how they are holding up, and have you seen any acceleration in negative trends, are we still holding steady to where we were last quarter or whatever color you could give there.

Jay Gerlach

I don’t know that I would say acceleration in negative trends but certainly after what seemed like a springtime expectation that maybe things were going to start getting a little bit better and an attitude that seemed to be somewhat in the industry that doesn't seem to be there anymore today. So I'd say it's just a sluggish environment, it's not terrible, it's just not showing growth in too many parts of the channel and overall just generally soft.

Brian – Janney Montgomery Scott

Okay, guys. Thanks for your time.

Jay Gerlach

You are welcome.

Operator

Your next question comes from Greg Halter of Great Lakes Review.

Greg Halter – Great Lakes Review

Yes, good morning guys.

Jay Gerlach

Hi, Greg.

John Boylan

Hi, Greg.

Greg Halter – Great Lakes Review

I know you had a recall either a quarter or so ago, wonder if there were any costs in the quarter, in the fourth quarter related to that?

John Boylan

There were no costs, Greg, in the quarter related to the recall.

Greg Halter – Great Lakes Review

And I think I noticed in your release there was a restructuring impairment charge of $179,000, very small, but what segment did that relate to?

John Boylan

That would actually be in the corporate expense category related to some closed operations.

Greg Halter – Great Lakes Review

Okay. And wax cost, Jay I think you had mentioned, do– can you elaborate on how much that was a headwind for you in the fourth quarter?

Jay Gerlach

In the quarter, I think it was right around $1 million.

Greg Halter – Great Lakes Review

Okay. And you continue to see costs go higher as we sit here in fiscal ‘11?

Jay Gerlach

Yes, they’ve uptick a little bit from what we saw in that quarter. Yes.

Greg Halter – Great Lakes Review

Okay. And relative to the soybean oil sides of things as well as wheat, it would be helpful if you could elaborate on your philosophy and current standing in terms of forward contracts.

Jay Gerlach

Well, from a flower standpoint we're 100% covered out through March. So our primary exposure to the volatility you're seeing in the market today comes late in this current fiscal year. Soybean oil is – I think you appreciate, Greg, we buy on a, kind of a laddered basis with declining amount of coverage going out as far 12 months but the heavier part of that coverage in the next six months.

So as we work through the next three to four months, we will start to see less coverage available to shield us from the uptick we've recently seen in soybean oil. So if and when those costs stay up, we will start to see some impact I think maybe noticeably even late in this first half.

Greg Halter – Great Lakes Review

Obviously it's a spike there and we don't know whether or not that will be maintained in both wheat and the soybean oil.

Jay Gerlach

That’s right.

Greg Halter – Great Lakes Review

And the other areas that you mentioned I think it was sugar and dairy, eggs and so forth, there's really not much you can do there in regard to protecting yourself in terms of hedging or forwards or anything like that?

Jay Gerlach

That’s right. We are pretty much buy all that at the market and all those are staying at higher levels than a year ago right now.

Greg Halter – Great Lakes Review

Okay. Relative to geographic expansion, I think that was a comment in the fiscal 2011 commentary, can you give some concrete examples or some examples on geographic penetration that you're currently working on or where you expect to be more involved in fiscal 2011?

Jay Gerlach

Well, we are particularly trying to move the Sister Schubert’s brand out geographically, including some into select western markets, we got started on that during fiscal ’10 and we’d anticipate continuing that in fiscal ’11. We also with the introduction of some new products I think we have some opportunity to strengthen our geographic position via Marzetti Otria Greek Yogurt Veggie Dips for example we might have an added appeal to perhaps the more health conscious consumers that you see on both coasts.

Greg Halter – Great Lakes Review

Okay. And would that – on that Sister Schubert's side, the select moves there, would that be directly translating in to the as much as $45 million figure you talked about on the capital spending side being used to serve some of that expansion?

Jay Gerlach

Well, a little bit but a lot of that is just coming from strong growth out of still the core markets for Sister Schubert's.

Greg Halter – Great Lakes Review

Okay. And I presume that's the facility down there in Kentucky?

Jay Gerlach

That’s right. Yes.

Greg Halter – Great Lakes Review

Any plans to open a facility that would serve the West Coast markets?

Jay Gerlach

No, not at this time. We’ve got a long way to go to build enough volume to warrant that for Sister Schubert's.

Greg Halter – Great Lakes Review

Okay. One last one for you, I think last conference call, within the food service segment, you had indicated that you had gained some new customers in the last quarter, just wondering how those are doing and if there is any new gain for this quarter or this year as well?

Jay Gerlach

Greg, I am – I guess maybe we’ve picked up maybe one key customer on the food service channel in the last – this being a chain account customer, in the last couple of quarters. And they are one of the encouraging signs in our look at the food service channel for ’11. But obviously it’s because it’s new business for us and we do have a new program or two going on with existing customers but we also see some opportunities for increased volume in that channel.

Greg Halter – Great Lakes Review

Okay. Thank you.

Jay Gerlach

You are welcome.

Operator

(Operator instructions) And your next question comes from A.J. Strasser, Cooper Creek Partners.

A.J. Strasser – Cooper Creek Partners

Hi, guys, thanks for taking my call. You guys talked a lot about increasing costs and I just wanted to understand how much of that actually hit Q4? Did it happen at the beginning of the quarter, did it happen in the middle of the quarter? You guys had about a 17.6% I think operating margin in specialty foods and I'm just basing on the commentary, should we be conservative and expect that to be – the margin to be less so in the near term?

Jay Gerlach

Actually I think in the quarters in the food business in particular still saw a decline actually in input costs of about $4 million. Our increase in the quarter was actually on the wax side of things. Now some of the specifics we were touching on like dairy and eggs they were going up during the quarter but it was being offset by, particularly still soybean oil costs coming down year over year in that period of time.

So it was happening during the quarter and it’s probably, I guess, particularly on the grain side although not having as an immediate impact, it certainly had a pretty good spike here in the month of July and on into August.

A.J. Strasser – Cooper Creek Partners

Okay, so just to be clear, the full impact of the higher input costs on the food side actually hasn't hit you yet?

Jay Gerlach

Yes, that’s fair.

A.J. Strasser – Cooper Creek Partners

So is it safe to say then that 17.6% margin is still benefiting from lower costs and therefore just we should be conservative on in the near term? Thanks.

Jay Gerlach

Yes. It did benefit from lower costs, yes.

Operator

Your next question comes from Alex Bisson of North Coast Research.

Alex Bisson – North Coast Research

Yes, thanks for taking the follow up.

Jay Gerlach

Sure.

Alex Bisson – North Coast Research

You mentioned the possibility of a pricing action. I guess two questions, what would you need to see to go after higher prices? And then two, what would it take to make higher prices stick in the marketplace?

Jay Gerlach

Well, I think, I guess two things Alex. One, on the candle side of things, much smaller component of the business obviously but we’ve been out with pricing actually starting probably in late June and into July, so we’ve been working to get some pricing implemented and having some success there.

The food side of things on the retail end, we would likely anticipate doing that I think a little bit later in the fiscal year or at least little bit later in the calendar year. It will be selective where we think we have opportunity versus what’s going on in the category from a sales standpoint, from a competitive standpoint, what retail price points are, what kind of story we've got around the input costs. And I do think if these gain costs hold up, there will be a universal story for many suppliers of food products perhaps needing pricing.

So that would be the environment I think that would make it most likely for us to implement pricing that'll stick.

Alex Bisson – North Coast Research

Okay. And then secondly, you noted some operational inefficiencies between moving some dressing capacity around and starting up some new products, could you quantify that and how much of that shouldn't repeat?

Jay Gerlach

I don't know that we can give you a real good quantification there right this morning, but it's certainly into – somewhere into the lower or maybe approaching mid-7 figures.

Alex Bisson – North Coast Research

All right. Well, thank you very much.

Jay Gerlach

You are welcome.

Operator

There are no further questions at this time. I would now turn the call over to Mr. John Gerlach for any concluding remarks.

Jay Gerlach

Thank you all for joining us today and we'll look forward to reviewing our first quarter with you in early October. Thank you – or late October.

Operator

Thank you. This concludes today's conference call. You may now disconnect.

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