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Executives

Charles Pizzi – President and CEO

Paul Ridder – SVP and CFO

Autumn Bayles – SVP, Strategic Operations

Analysts

Nelson Cruz [ph] – Keller Capital [ph]

Mitch Pinheiro – Janney Montgomery

Nick Kovich – Kovich Capital Management

Sanjay Shetty – BOE Securities

Tasty Baking Company (TSTY) Q3 2010 Earnings Call Transcript November 1, 2010 11:00 AM ET

Unidentified Company Participant

Good morning, everyone. Thank you for joining us for Tasty Baking Company’s third quarter 2010 investor conference call. If for any reason you have not received a copy of this morning’s press release, please call 215-221-8538 and it will be sent to you immediately. Today’s call is also being webcast at www.tastykake.com. Please visit the Investors section under the Webcasts and Presentations subheading for access.

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

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

This discussion also includes certain 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. And once again, thank you for joining us today. While the third quarter of 2010 presented challenges for Tasty Baking Company, the quarter ended on a much more positive note than it began. Gross sales for the third quarter of 2010 declined $5.8 million versus the same period in 2009, with the non-Route businesses accounting for $4.4 million and $1.4 million of decline respectively. The largest driver of the negative sales performance for the quarter was production limitations at the new Navy Yard bakery, which drove more than $4 million in unfulfilled demand.

Non-Route gross sales were negatively impacted by lower sales to our third-party distributors and a decline in sales with our national retail partners, driven in part by timing and frequency of promotional events. In addition, strategic realignments of our distribution in certain new geographies, including the New England markets, negatively impacted gross sales, but are expected to have a favorable impact on profitability as we move forward.

Approximately $3.4 million of total production limitations for the third quarter of 2010 impacted Route operations, which experienced a $1.4 million decline in gross sales. Absent these issues, the Route side of the business would have had favorable year-over-year growth during the third quarter of 2010.

As I mentioned, the quarter ended on a more positive note than it began. By the end of the third quarter, virtually all of the production limitations have been resolved, and as of today, there are no material impacts on the business. At this point, in the fourth quarter, Route gross sales have outpaced prior year by 5% while the total gross sales are below the same period in the prior year by approximately 1.8%.

I think that it is important to point out that sales from new products have historically been an integral part of the business and have helped fuel top-line growth. During 2010, we had to largely hold off on introductions of new products to minimize complexity and difficulties with the startup and optimization of the new bakery. While that project nearing completion, we have reenergized our new product process and expect to begin seeing a favorable benefit from new products early in 2011.

Despite the impact of production limitations that caused sales to fall below expectations for the third quarter, the Tastykake brand continued outperform the Sweet baked good category in our core Route markets. This increase in share is due to a number of important factors, including a successful promotional strategy, execution within store, and the strength of our marketing support.

While we experienced $4.4 million in transition and optimization costs in the third quarter, we did make significant advances in optimization of our Navy Yard bakery, most notably, in the latter half of the third quarter. These advances brought about through a continued focus of senior management combined with changes in plant management and personnel that increased the level of process and plant startup expertise on the bakery flour.

In addition, we continued to leverage our vendor partners and third-party experts to further enhance the optimization process. At the end of the third quarter, the only remaining material optimization costs included those related to manufacturing variances resulting from scrap rates.

For competitive reasons, I won’t provide actual costs. However, I will provide certain costs on an indexed basis to give a frame of reference for the improvements that we made over the third quarter as it relates to manufacturing variances resulting primarily from higher than normal scrap rates.

On an indexed basis, if manufacturing variances were $1.00 per case at the end of the second quarter, they were down more than 20% to $0.79 per case at the end of the third quarter. The progress didn’t stop there, but has steadily continued. And on the same indexed basis, it is now at approximately $0.62 per case or down an additional 22% since the end of September. By the end of the year, we expect those indexed variances to fall an additional $0.20 per case, at which point we will fall within the range of expected savings for the entire project.

For the last several quarters, we have said that we expect a new bakery transition and optimization to be complete and that the company would begin to achieve the full saving benefits from the investment during the fourth quarter. Despite the economic challenges of the past years, I believe by the end of the fourth quarter, Tasty Baking will achieve the annual run rate pretax cash savings from the project of approximately $13 million, which falls within the $13 million to $15 million range provided at the inception of the project in May of 2007.

Having said that, I think it is important to once again provide a frame of reference of where we were at today versus where we expect to be by the end of the year. When we began this project, we indicated that the benefits from the new bakery would mainly be derived from reductions in labor as well as lower utility, maintenance and infrastructure spending, combined with improvements in operational efficiencies in the form of lower waste.

As of today, we have achieved our target savings from labor, utility, maintenance and infrastructure spending, and we are now achieving more than $11 million of annualized pretax cash savings. By the end of the year, we expect to have reached the optimal efficiency improvements necessary to achieve the anticipated $13 million in pretax cash savings.

On September 7, 2010, in the midst of one of the most challenging commercial real estate markets, we closed on the sale of our Hunting Park bakery and Fox Street distribution center. The net proceeds from the sale were approximately $5.6 million and were used to pay down debt, including debt associated with the investment in the new bakery. This sale marked a milestone and a significant step in the transformation of the company.

With the anticipated future redevelopment of this property, we have left the Hunting Park neighborhood where we operated for more than 88 years better than I founded in 2002. With that chapter now firmly behind us, we are focused on growing the top line and leveraging the benefit for the new bakery.

Now Paul will comment on some specifics regarding our third quarter performance.

Paul Ridder

Thank you, and good morning. As Charlie mentioned, our top-line performance for the third quarter was weaker than expected due to the impact of production limitations combined with lower sales to third-party distributors and national retail chains. Nevertheless, excluding the impact of production limitations, the Route operations had solid revenue performance versus the prior year period. Partially offsetting the decline in gross sales was improved net sales realization resulting from more efficient promotional spending and beneficial channel mix.

As compared to the third quarter of 2010, cost of sales, excluding depreciation, rose 4.2% or $1.2 million on a volume decline of 7.4%. This increase includes $3.5 million in transition and optimization related costs. Absent this, cost of sales would have declined by $2.3 million despite a $1.8 million increase in key ingredient and packaging costs and $1.5 million in rental expense associated with the Navy Yard facility, $1.4 million of which was non-cash.

During the quarter, the company was able to reap some of the benefits associated with the new bakery, including lower utility and employee related costs, which when combined with the impact of lower volumes favorably impacted cost of sales. During the third quarter, the cost of key ingredients and packaging continued to rise and represented an increase of approximately $1.8 million over the third quarter of the prior year.

Since the third quarter of 2009, the costs of most of our commodities have increased, with sugar and cocoa accounting for almost 70% of the total increase. We continue to employ a risk management program with respect to not only commodities, but also utilities and other costs where the risk of volatility exists.

The goals of this program are to manage costs, but more importantly, to ensure supply and to manage the risk associated with extreme price volatility. For example, for certain of our ingredients, we have entered into contracts that allow us to buy at prices favorable to the current market and it locked price in short supply through the end of 2011.

We have also taken similar actions with respect to some of our utility costs to lock in those prices through the end of 2011, and in certain cases where prices were favorable, through 2012 as well. While we expect the commodity costs will be a headwind in future periods, we believe that we have an appropriate strategy to help mitigate its impact. In addition, we will continue to evaluate the proper levels of pricing and promotion to help offset the impact of commodity cost increases.

For the quarter ended September 25, 2010, depreciation expense declined by more than $800,000 as compared to the third quarter of 2009 to $2.7 million, as the accelerated depreciation associated with the move from the company’s former facilities was completed. As a result, depreciation for the third quarter is reflective of the company’s current run rate with respect to depreciation expense.

For the third quarter of 2010, the company had capital expenditures of approximately $1.7 million, which included $800,000 in expenditures related to the new bakery project. As we move forward through 2011, we anticipate that capital expenditures will be less than $7 million and would primarily be used for a combination of future cost improvements and revenue enhancement projects.

For the third quarter, selling, general and administrative expense increased 5.2% versus the third quarter of 2009, driven primarily by transition-related costs. During the quarter, the company recorded $700,000 in post-employment costs related to the restructuring of the company’s Philadelphia operations and equipment workforce. This restructuring, which was completed to appropriately align our workforce with the company’s needs as we complete the new bakery and distribution center project, is expected to reduce total cost by more than $2.5 million annually, with a substantial majority of that impacting SG&A costs.

At the end of the third quarter, total debt was $103.8 million, and we were in full compliance with all covenants under our debt facilities. We have said on several occasions that we anticipate providing forward-looking guidance once we complete the optimization of the new bakery and distribution center. As a result, we currently expect to provide guidance for 2011 sometime early next year.

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

Charles Pizzi

Thanks, Paul. For over three years, the team of Tasty Baking Company has focused on moving our operations from a facility we occupied for 88 years to a new state-of-the-art green bakery. This quarter, we closed another chapter in this transformation as we sold our former Philadelphia property.

We understand the stress that the challenges and significant complexity of the new bakery project has placed on our shareholders, our company, our independent sales distributors, and our retail partners. As with most things, great rewards require sacrifice. We have made great progress since the beginning of the third quarter. But there is work to be done to fully complete the transformation.

Our fourth quarter will provide, the first time in many years, that our earnings won’t reflect accelerated depreciation from the move. Our costs won’t include maintaining a third facility. We will reap the benefits of the new bakery, and our team can be focused once again on growing the top line. We look forward to speaking with you after the fourth quarter to share our progress.

Thanks once again, and I now will ask the operator to open the call to questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question comes from Nelson Cruz [ph] from Keller Capital [ph].

Charles Pizzi

Okay. Morning, Nelson.

Autumn Bayles

Good morning, Nelson.

Charles Pizzi

Hello?

Operator

Nelson, your line is open.

Nelson Cruz – Keller Capital

Hello?

Charles Pizzi

Yes. Good morning, Nelson.

Operator

Our next question comes from Mitch Pinheiro from Janney Montgomery.

Charles Pizzi

Good morning, Mitch.

Operator

Mitch, can you please re-queue? (Operator instructions) And we have Mitch on the line now.

Charles Pizzi

Hi, Mitch. Sorry for the inconvenience.

Mitch Pinheiro – Janney Montgomery

Can you hear me?

Charles Pizzi

Yes.

Mitch Pinheiro – Janney Montgomery

Okay, great.

Charles Pizzi

Good morning.

Mitch Pinheiro – Janney Montgomery

It was helpful to get a sense of the sort of case variances that you are experiencing. I was curious to know relative to the same index of one or your year-end sort of target of 42 where the old Hunting Park facility was indexing?

Charles Pizzi

Nick, it’s complicated to answer that because there are also the standards of both facilities were different. So the relative – those indices and variance per case wouldn’t – it will be like comparing apples and oranges. I think the question that is probably more appropriate is, how were the relative scrap rates of both of those facilities? I don’t think we want to go into – that I couldn’t index them off of the top of my head, although I could tell you that the scrap rates of Hunting Park were higher than we’re experiencing today.

Mitch Pinheiro – Janney Montgomery

Okay. Higher than you’re experiencing today and not down – not in the end of the year?

Charles Pizzi

Hang on. What we experienced at Huntington Park is higher than we experience it today. We expect to be even at lower scrap rates at the end of the year. We’re saying that the Navy Yard facility today is operating with lower scrap rates than we had at the old facility.

Mitch Pinheiro – Janney Montgomery

Okay. It’s helpful. The cash savings, I guess, Charlie, that you referenced, the $11 million, which I guess comprises labor, the utility, maintenance and infrastructure efficiencies –

Charles Pizzi

Yes.

Mitch Pinheiro – Janney Montgomery

That’s pretax, and that’s cash savings. So, would there be any variance between cash and GAAP in this case?

Charles Pizzi

Mitch, it’s Paul. There would be some as the depreciation would be a differential in the investment. There also continued to be non-cash rental expense associated with the facility. As you know, we have to straight-line rental expense, which will be different of cash. And that’s why we’ve continued to say that pretax cash savings that people would know the cash generated from the project, because there are GAAP differentials, most notably, depreciation and the non-cash rental.

Mitch Pinheiro – Janney Montgomery

Okay. And so, that non-cash rental is – it will become cash at some point. Right?

Paul Ridder

It is. We begin paying cash for the bakery itself in the fourth quarter, however, because you straight-line at least the expense over the life of the lease for the coming period to fourth quarter of 2010 and 2011 in its entirety. The cash outlay will be less than the P&L expense.

Mitch Pinheiro – Janney Montgomery

Okay. Therefore the $11 million in cash savings is understating the savings on a GAAP basis slightly?

Paul Ridder

You have it the opposite way, Mitch. The $11 million in pretax cash savings, there would be an additional non-cash P&L expense –

Mitch Pinheiro – Janney Montgomery

In this quarter. How about ’11?

Paul Ridder

It would in ’11 as well because you are straight-lining the expense associated with the 26-year facility lease. And the cash payments are in the first periods are less than the average.

Mitch Pinheiro – Janney Montgomery

Okay. But that’s not going to be a big variance. Is that – I mean, it’s relatively minor, I would think.

Paul Ridder

We could go through and calculate the exact amount. I don’t have it with me. I don’t want say it’s immaterial though.

Mitch Pinheiro – Janney Montgomery

Okay, okay. Fair enough. And then depreciation net-net is actually – looking at the last quarter here, has come down. So, that would actually have the opposite impact. Is that correct? I mean, the fact that the depreciation – let me first ask you. Is depreciation going to remain relatively stable to where we were in this quarter?

Paul Ridder

The third quarter depreciation reflects our current run rate, and that would be absent the future investments to the extent that we make future investments in cost improvement projects and revenue enhancement projects. Those would have depreciation associated with them. And we believe that the third quarter’s rate reflects our current run rate.

Mitch Pinheiro – Janney Montgomery

Okay. So – I mean, if you just use a round number of roughly $3 million, say, depreciation in the fourth quarter a year ago was $6.6 million of depreciation. So, is that – so since you’re going to have $11 million, you’re at a run rate of $11 million pretax. You are already starting out at a minus 3.5. Is that correct? In other words, you are already being – your cash would be down from depreciation. Is that correct?

Paul Ridder

I’m not certain I follow your question. I mean, the cash savings and depreciation are independent from each other. I think you’re trying to get at – I mean, if you take the $2.7 million that we ramped in the third quarter and just annualized it, you would get a number that would be less than the prior – if you did that for the prior year. I think that’s what you’re asking. Is that correct?

Mitch Pinheiro – Janney Montgomery

Right. I am sort of – but I guess just want to make sure I understand – I'm trying to really drill down the $11 million of pretax cost savings and its cash. And you have a lot – you have some moving parts here. Since your depreciation expense is coming down by over $3 million Q4-over-Q4 a year ago, that cash savings –

Paul Ridder

It’s not, Mitch. The depreciation is a non-cash –

Mitch Pinheiro – Janney Montgomery

It’s non-cash, right. So that’s excluded from this. Is that right?

Paul Ridder

That’s right. That $11 million is pretax cash. It excludes those non-cash items such as depreciation changes or non-cash rentals.

Mitch Pinheiro – Janney Montgomery

Okay. All right. Then, Paul, I missed another number. You talked about something about SG&A $2.5 million. I didn’t hear what that was.

Paul Ridder

We said that during the third quarter, we had a charge of approximately $700,000 related to the realignment of – further realignment of our corporate workforce and Philadelphia operations. We recorded that to other expense. The benefit associated with that is expected to be approximately $2.5 million annually with a substantial majority of that impacting SG&A costs.

Mitch Pinheiro – Janney Montgomery

Okay. And with these costs, were those cost savings a part of your project cost savings?

Paul Ridder

Yes.

Mitch Pinheiro – Janney Montgomery

Okay. So that’s nothing new – nothing incremental in there?

Paul Ridder

That’s correct. Just a relatively final step that needed to be taken.

Mitch Pinheiro – Janney Montgomery

Okay. When you look at your input costs of – I guess, in this quarter they’re up $1.8 million. Was there any – I can’t recall, but did you take any price actions over the last 12 months?

Paul Ridder

Yes, we have. We’ve taken a couple pricing actions. We took single serve pricing action at the beginning of the year, but we have taken selective pricing action over the last 12 months.

Mitch Pinheiro – Janney Montgomery

Have your last 12-month pricing actions offset the current impact of commodity costs? Or are you actually – that minus $1.8 million, is that larger than you kind of forecasted six months ago? If you – what I'm trying to get is, are your current pricing actions able to sustain for next quarter?

Paul Ridder

I think that – the real answer is we expect the commodity costs in the near-term are going to continue to be a headwind. We’ll evaluate pricing action, promotional action that’s necessary to offset that. I think, as we’ve said in the past, you can’t immediately offset the impact of commodity cost increases. There is a lag. We will look at pricing, promotion, efficiency improvements and others to offset that. You also asked the question, are they more than we anticipated six months ago? I think we’ve seen higher volatility and larger increases than we expected, but the basis for the magnitude of the increase in particular is the fact that we do have a relatively strong risk management program. And in the prior years, we had locked in it some favorable rates that everyone – I mean, no matter how long you lock for, at some point, they roll over and we experienced the rollover in some of those contracts this years. So we’re comparing to very favorable rates in the prior year.

Mitch Pinheiro – Janney Montgomery

Okay. And then when you talk about – when you’re looking at your coverage, I sort of didn’t hear what you were saying about next year on input costs.

Paul Ridder

We talked about the fact that – I think we’ve mentioned before that we have a risk management program. We will look at managing those input costs or input ingredients, packaging, et cetera, where there is risk of supply or extreme volatility. And for several of those, we have locked the pricing and guarantee supply through 2011. Also with respect to our utilities, we’ve locked those through 2011 and in certain cases where prices were favorable even through 2012. So, our goal being to ensure supply and limit risk where possible.

Mitch Pinheiro – Janney Montgomery

Okay. Perfect. And couple other items. One, discounts and allowances, how did the – so for the quarter, it was pretty much the same level as the second quarter, and then for that matter, a year ago. Is there going to be any impact when you start to the loss of production and the $4 million of lost sales? Does that have any impact on that line that will change in the fourth quarter?

Paul Ridder

There is always the possibility that eliminating the lost sales will have some impact on it. I think there is a couple things to point out there. One is the production limitations that gave rise to that $4 million have been eliminated. And as of today, we are completely fulfilling the demand. Sometimes when you have production limitations and miss on the top-line, that can skew your promotional costs and discounts as a percentage. We don’t believe it was a dramatic impact in the third quarter, but there was some impact.

Mitch Pinheiro – Janney Montgomery

Okay. So it will remain relatively flat or very similar levels. We shouldn’t see any major spiking up or down in the promotion – in the discount promotion line?

Paul Ridder

It didn’t have a significant impact on the third quarter from the production limitations. And the production limitations are gone now. It’s the best way to look at it.

Mitch Pinheiro – Janney Montgomery

Okay. And how did you calculate, by the way, sort of the loss – the production limitation – I guess, the lost sales due to production limitations? How is that calculated?

Paul Ridder

That’s one of the nice benefits of our business. We have very strong distribution network with our sales distributor partners, almost 500 of them. They are in the stores every day. So we have orders from them almost every day. So we’re able to see what the demand is out in the field. The downside during this quarter is we weren’t able to fulfill that demand in all cases. So we are able to have a very good visibility in terms of what’s needed in the street to fulfill the demand, and we’re able to aggregate it and look at it that way.

Mitch Pinheiro – Janney Montgomery

Okay. Last question just relates to New England. What did you do in New England as far as realigning? How did that change? And why is that a positive?

Paul Ridder

I want to be careful how much we go into for some competitive reasons, but we really looked at the way we were distributing products, who we were distributing them to, and how we were distributing them. We do know that it has had and it will probably continue to have some downward pressure on the top-line. But we really made the changes because it had some significant upside benefit on profitability. It’s relatively new. We want to be cautious about how much we disclose that so we don’t get an unfavorable competitive response.

Mitch Pinheiro – Janney Montgomery

Okay. All right. Well, thank you. I’ll get back in the queue.

Paul Ridder

Thank you.

Charles Pizzi

Thank you, Mitch.

Operator

Our next question comes from Nelson Cruz will Keller Capital.

Charles Pizzi

Good morning, Nelson.

Nelson Cruz – Keller Capital

Hi, guys. Can you hear me now?

Charles Pizzi

Yes.

Paul Ridder

Yes.

Nelson Cruz – Keller Capital

Perfect. Good job this quarter. I congratulate both of you. Couple of things. Can you provide some color today on the call as to how you are planning to sell more products online through your website or through other means, but mostly like through your website and how you are going to drive incremental e-commerce growth through 2011?

Charles Pizzi

Yes. We are now engaged and partnered with an online marketing group. And we feel as though they are going to add great energy and capacity to our online products because that’s their business, is the online selling. And so, with this new partnership, we are very happy that we are outsourcing this part of our business because actually we think we can drive considerable more volume through it.

Nelson Cruz – Keller Capital

Okay. Do you have numbers on how much in 2010 you guys sold through your website? Did you break those down? Or did you have any –?

Charles Pizzi

We do, but I do not have them with me now. But the key is the shopability. And with this online partner, I think it gives us a great ability to do that.

Nelson Cruz – Keller Capital

In the next couple of years, what would you like to see e-commerce sales? I mean, not like projections of revenues. Do you want to see them double where they currently are? Where do you see guys headed in terms of online growth?

Paul Ridder

Nelson, it’s Paul. I think that we do want to be confident. As Charlie said, we did outsource our ecommerce study. We did that recently. We have expectations for growth in that business and somewhat significant growth. I will tell you it’s not a material component of our business right now. We have not come out and said what growth rates we would expect that or want that to grow at. Typically, our ecommerce site has its largest selling season during the fourth quarter holidays. And so I think the recent outsourcing and the fact that we have not yet had a chance to go through those, it would be premature to come out with how much we believe it could grow under that program. And it’s something we would consider talking about in the future.

Nelson Cruz – Keller Capital

Okay, great. And final question. Are you guys developing any type of mobile strategy, which seems to be very popular now, developing apps for the iPhone, Android, so customers can shop via their phones, or also what you are guys doing in the social networking space as well?

Charles Pizzi

It’s just in the testing phase at this point, but we are testing the options. We do have Facebook and Twitter accounts. So we are working the social networks at this time.

Nelson Cruz – Keller Capital

You said mobile is in test mode, or is that –?

Charles Pizzi

Yes.

Nelson Cruz – Keller Capital

Okay. All right. Good job, guys. I congratulate you on your success.

Charles Pizzi

Thank you.

Nelson Cruz – Keller Capital

Thank you.

Operator

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

Nick Kovich – Kovich Capital Management

Good morning, gentlemen. Congratulations on the efficiencies you are starting to garner out of the new bakery.

Charles Pizzi

Thank you, Nick. I also want to let you know that Autumn Bayles is on the phone with us, and she deserves most of the big credit with all of our bakery folks.

Autumn Bayles

Thanks, Charlie. Good morning, Nick.

Nick Kovich – Kovich Capital Management

Good morning. One of the questions I wanted to ask pertains to packaging. I know that's a very integral part of the manufacturing process, and I sense it was most sensitive to any dis-equilibriums in the manufacturing process. My sense in conversations with you folks that you were considering additional packaging machines on the lines, particularly a couple of them, are you at a point where you have made a decision to either lease or buy a couple of new packaging machines to increase efficiency in the plant? And if so, can you talk about the costs and implications of that?

Paul Ridder

Nick, I’ll let Autumn go – it's Paul – Autumn go into some details on the plant. I think that we’re a little premature in talking about buy versus lease. We do continue, as you know, to look at a variety of options to further improve the cost beyond – the cost beyond the original phase of the project. We say we do believe there are opportunities to further improve the cost from revenue enhancement projects. But we do want to be cautious about not being too early in that assessment. Autumn, talk about where we’re at with packaging.

Autumn Bayles

Right. I mean, Nick, as you said, the high-speed automation in the plant did require a significant amount of effort in tweaking to get it where we needed it to be. And we’re still focused on getting that final piece of optimization – you know, working that equipment and other pieces of equipment. So I think, to Paul’s point, once we’re completed with that, then we’re going to evaluate what further efficiencies could be gained by further purchase and/or lease.

Nick Kovich – Kovich Capital Management

Okay. Great. The second question relates to marketing. Of the – looking at the SG&A line, year-to-date it is $38 million. How much of that is true marketing expense?

Paul Ridder

We’ve historically spent about $4 million annually. There’s always some timing differentials depending on what programs, whether it’s a sports team or radio, television, et cetera. But $4 million annually is usually our true marketing number. I believe it was approximately $2.8 million through the third quarter. But that’s our historical run rate.

Charles Pizzi

But that’s something from prior years. We are – Nick, I would say probably three years ago, with half that amount, maybe a little bit more than half that amount. And one of the things that we lived by – as we drive efficiencies in the bakery, we want to continue to invest in the brand.

Nick Kovich – Kovich Capital Management

Okay. Where do you think you need to be in terms of a dollar level of marketing if you have gone from a little over $2 million to $4 million in the last three years to drive brand growth and the opportunities you now have in hand with the manufacturing flexibility? Where do you need to be on marketing expense, say, three or four years from now?

Charles Pizzi

I think it really depends on the markets that we enter. And there is a lot of strategy around that with regard to new markets and new products and how effective we are at spending. We always try to evaluate in an analytical way how marketing drives volumes. We have a good base in this area, but we could do more out of the markets and I think that’s what poses our opportunities. But I do believe that some of the efficiencies that we garner from the new facility we will be investing in our marketing area. But we do not have any specific numbers on our long-term at this time. I can tell you that we also invested in new packaging that came about in the third quarter that covers all of our SKUs. So we’re pretty excited about the new packaging, getting some favorable response. And we are looking at innovative ways to develop our packaging. I think that’s all part of marketing support, just the way we worked with the new pie and how we worked that, and we’ve seen good results from the improvements we made to that from that. But we do expect to spend dollars and we do expect them to go up.

Paul Ridder

Nick, if I can just say on that, Charlie hit the key point. We do try to challenge kind of the conventional. You should spend X percent of your sales. Our goal is to make sure it’s a very effective spend and get the most out of it. And we’ve done that over the last several years, and we’re going to continue to do that.

Charles Pizzi

And Nick, just one final thing. I think, after the brand, the biggest thing we have going forward is our distribution network. And we work very closely with guerilla marketing to make sure that our displays are really topnotch. And we work really hard at that. And so – I just wanted to let you know that that guerilla marketing is very important to our business since we are an impulse item. And we have expanded our teams from not only the Flyers and the Eagles and the Steelers, but this year we expanded them to the Ravens and Penn State football. So – and of course, the Phillies.

Nick Kovich – Kovich Capital Management

Right. I know Pittsburgh is a relatively new market for you. Of the $4 million you are roughly spending annually, is Pittsburgh 10% of that and you expect that because of the opportunities there to double or triple marketing expenses in Pittsburgh to drive the brand recognition there?

Charles Pizzi

Good question, and I can – without getting into specific dollars amount, I will tell you that we found great promise in the partnership with the Pittsburgh Steelers in which we cover all media, radio and TV. And then we were able to partner with our retail folks to provide prominent displays in all of the stores. So it’s really a tag team effort so that we really work with the teams that have partnership with retail stores, so then we can generate the merchandising opportunities in store with the teams.

Paul Ridder

And Nick, we’re very sensitive to talk to you about the amount of marketing spend in a particular region, given that gives your competition a real idea of what you are doing and what you are planning on doing. So we’re very sensitive to those specifics. I do think there are great opportunities in the Pittsburgh region, but we just don’t want to get into the exact spend that we have in those areas.

Nick Kovich – Kovich Capital Management

Right. Okay. Last question for you, and then I will get back in the queue, relates to the dividend and dividend policy. Back in '03, you cut the dividend because of the needs to put the money in the new plant. What is the dividend philosophy of Tasty Baking and the Board's view of this and management's recommendation? What should shareholders expect from a dividend out of Tasty?

Paul Ridder

I think, Nick – and we’ve said on last call, we’re not going to go forward or project what they should expect going forward. The dividend position of the company is obviously decided by the Board of Directors. As you correctly referenced, the dividend was reduced back in prior year. It’s something that the Board will continue to look at, particularly as we come out with the completion of the new bakery project, and we’ll make the decisions that are appropriate based on those fundamentals.

Charles Pizzi

And I think that’s something that we – we have a very strong Board, as you know, made up of three major brands in the United States. So we will do that on a continuing basis.

Nick Kovich – Kovich Capital Management

Okay. Well, thank you very much, and I look forward to the next quarterly conference call to hear about the outlook for 2011. Thank you, gentlemen and lady.

Charles Pizzi

Thank you, Nick.

Operator

Our next question comes from Sanjay Shetty with BOE Securities.

Charles Pizzi

Hi, Sanjay.

Sanjay Shetty – BOE Securities

Hi, good morning, guys. Thank you for taking my call.

Charles Pizzi

Good morning.

Sanjay Shetty – BOE Securities

My first question is regarding the Q4 savings like – first of all, congratulations on getting close to your target of $13 million to $15 million in savings. Now you mentioned you will be reaching close to, like, $13 million in savings in cash. Now, what would mask the savings like in terms of costs? Now you mentioned that there will be some optimization costs that will be there in Q4. What other expenses that we can expect, which will mask this benefit?

Autumn Bayles

Sanjay, if I can start out – it's Autumn. As far as the optimization that you referenced, as Charlie said, we’re currently achieving a run rate of $11 million, which is about 85% of the savings that we expect. This last piece is really around the line optimization, primarily driving our scrap down to the targets we expect. As far as the offsets, I guess I’d let Paul address that.

Paul Ridder

I think there’s a couple offsets. We mentioned a few of those. I mean, obviously depreciation, which is a non-cash item, and the bakery lease components will impact that, and commodity costs. The commodity costs for us in the third quarter, we said expect those to be a headwind. They have offset some of the benefits that we received. We expect that will happen to some extent in the fourth quarter although we will look at opportunities where appropriate to price or change our promotional strategy to help offset the impact of that. But I think those are large ones when you look at commodities, getting the remaining optimization, bakery lease, and depreciation as of today. We’ll offset some of that.

Sanjay Shetty – BOE Securities

Okay. And in terms of optimization, just a follow-up, like, since you already passed the first month of the last quarter, in this case, like, where do you stand on optimization? Is it behind you? Is it in this quarter, or is it still like optimization to go all the way till the end of the quarter?

Paul Ridder

As we said, we are at a point where we are on a run rate today of about $11 million. We expect that by the end of the year, we’ll be at $13 million. And as Autumn said, that really goes to driving down the scrap rates, which reduce your materials variance per case. So there is more that have to be done. We do expect to get there within the next 60 days, but we’ve made some great progress really since the beginning and end of the third quarter.

Sanjay Shetty – BOE Securities

Okay, that helps. My second question is regarding the markets, the market share gain, you guys overall basically gain market share within [ph] that category. Now, in terms of macroeconomic conditions, what are you looking at the whole market in terms of demand for baked goods out there? And how is that helping you to make your outlook for the strategy for coming out with new products and entering new markets?

Charles Pizzi

I think that’s really a two-part question. One is about markets, one is about products. And let me start with the last one first and then move into the latter. We built this bakery for two reasons. One, to get expected efficiency savings, and two, to provide for flexibility with regard to product innovation. We, in the last six months, brought on a new – created a new position here at Tasty for Director of New Products. And so we are very cognizant that we must stick within the lifestyles of today, and we are doing that with our new product strategy. We are also looking at our market segments. For example, we told – we said the last market that we moved into was Long Island, and we are meeting or exceeding our projections for that new market, which we entered probably six months ago. Our strategy is really based on a bolt-on strategy so that we are entering markets that are adjacent to our existing areas. So we’re working on that, and we’re also working on opportunities from working with our national retailers on new products as well.

Paul Ridder

Sanjay, let me hit the macroeconomic piece as well.

Sanjay Shetty – BOE Securities

Sure.

Paul Ridder

Couple things. As you mentioned, we do evaluate – we look at the research we’ve done. We do evaluate macroeconomic factors, things such as unemployment, consumer confidence and gas prices, the macroeconomic factors that impact this category. They have a greater impact on the convenience store channel and the grocery channel, but they do impact those sides. We evaluate those to terminate. There is pent-up demand or things at risk. We also know there has been some shift to value-oriented consumers. You see some of that in private label. As a result, when we look at new areas, as Charlie said, in New England, we kind of realign how we were going to market in the way we were to try and make those areas more profitable, put some downward pressure on the top-line. But we look at all those macroeconomic factors that we believe kind of correlate the volume change when we are making decisions, not only in new markets, but in our current market as well – in our core market as well.

Sanjay Shetty – BOE Securities

Okay. Okay. And in terms of private labels like – when I go to a convenience store nowadays, you’ll see more of private labels manufactured by the store. It’s, for example, like 7-Eleven pushing their products in front of, like, branded products like Tastykake and others of your competitors. What kind of competition are you facing at that end? Is that really ramping up, or it is the same level quarter-over-quarter?

Charles Pizzi

First of all, this year, we’ve seen private label move from 28% to 35%. And that’s across the entire food category. We have the capacity to do private label, and we are looking at product introductions as well as new products to garner some of that opportunity. So we play in that arena of private label, and we really feel that there is opportunity there. But once again, we make sure analytically and from a margin standpoint, it meets certain of our criteria.

Paul Ridder

We also do benefit with having our independent sales distributors who are in the stores in some cases seven days a week. We’ve some real benefit to our products and our branded products in particular by the service they provide and the information they are able to provide. So, as a result, we feel that, particularly in the convenience store segment, that we are competing very effectively.

Sanjay Shetty – BOE Securities

Okay. And in terms of the new initiative that you have mentioned in your call about online marketing, what are the drivers for that division to get on partnering with this online marketing company?

Paul Ridder

Let me hit that, Sanjay. As we said, it’s a relatively small component of our business. It’s our ecommerce website. We believe that we were better off to partner with someone whose core competence was online, ecommerce selling, market, et cetera. Our core competence was elsewhere, but we do believe there is some value there. So we outsource that or allow them to help us grow the business and increase the overall profit profile. We’ve always had a larger focus on the Route business, but we do believe that this change provides a better experience for our customers on the website.

Sanjay Shetty – BOE Securities

Okay, okay. And one final housekeeping question, you mentioned about the run rate for your fixed capital expenditure for the next year. Was it – I have in general like $7 million. I just want to double check that.

Paul Ridder

That’s right that we said we’ll be less than $7 million. It would primarily be focused on future cost reduction programs or revenue enhancement projects.

Sanjay Shetty – BOE Securities

Okay, okay. Thank you very much. That’s all from my end.

Paul Ridder

Thank you, Sanjay.

Autumn Bayles

Thank you.

Operator

(Operator instructions) And we have a follow-up from Nick Kovich from Kovich Capital Management.

Paul Ridder

Hi, Nick.

Nick Kovich – Kovich Capital Management

Good morning again. I guess I have a question – I don't know who it is for, Autumn or the other management team. There is a unionization effort at the plant, and I guess the employees have approved a new union. Can you walk through the process by which you negotiate with the union, and how does this impact the cost structure of the plant out over the next couple of years?

Paul Ridder

Okay, Nick. The company is engaged in negotiations with a collective bargaining unit, as we are legally required to do. But as expected, no agreement if this time has been reached. So at this point in time, we won’t have any further comment. It’s very early on in the process.

Nick Kovich – Kovich Capital Management

Okay. So it’s a couple of years away?

Charles Pizzi

I really – I have no sense of timeframe. That’s with another party and – but it’s – I believe we have the right people in place and the right parties at the table to really abide by an agreement.

Nick Kovich – Kovich Capital Management

Okay. The second question relates to – on page 34 of the Annual Report. You have $68 million of debt coming due in 2012 per the annual. There has been a bull market in bonds over the last – for quite some time, but particularly the last year the appetite for debt is greater than anybody expected in corporate borrowing rates at record low levels. How does management plan on addressing this $68 million debt due? And would you consider a debt offering next year to pre-refund any of that?

Paul Ridder

I think – Nick, it’s Paul. We look at a variety of options. All those options are available to us whether it includes debt or equity or refinancing. We are very confident of the fact that our bank facilities in total come due in September of 2012, recognizing that most companies don’t want their debt to come current. And we’re evaluating those options to ensure that we have the complete ability to repay and satisfy all our obligations as they come due. I don’t think we want to discuss particulars, but we are evaluating all of our options, including debt.

Nick Kovich – Kovich Capital Management

Okay. What’s the most restrictive covenant on maximum debt-to-EBITDA? Page 19 shows it was six times back in fiscal year 2009, and I know you have renegotiated that several times with the bank. Have you been in non-compliance? What is the maximum debt, I guess, to bank EBITDA in the fourth quarter of 2010?

Paul Ridder

The maximum allowed ratio of bank debt is debt-to-bank-EBITDA of 5.5 times.

Nick Kovich – Kovich Capital Management

5.5 times. For the fourth quarter?

Paul Ridder

That’s correct.

Nick Kovich – Kovich Capital Management

And how does that change into 2011? Is it step function decline like it was as per page 19?

Paul Ridder

There is a step function decline. That amendment has actually been filed, is out there. I don’t have it right in front of me, but it does have a step function decline quarter-by-quarter through 2011 and then – through the end of 2011 and then remains relatively constant through the term of the facility.

Nick Kovich – Kovich Capital Management

And do you recall what the lowest level is through the last four quarters into 2012? Was it 4.75, which –?

Paul Ridder

It goes down in 2011, Nick, or in 2012?

Nick Kovich – Kovich Capital Management

Into 2012.

Paul Ridder

I’ll get you the exact number, Nick. We’ve changed that and just filed that document, and I don’t want to go with 4.75 through 2011, which is over the next five quarters. Now that information is out there for 2012. It does get down beyond that.

Nick Kovich – Kovich Capital Management

Yes. Okay. That’s good. Thank you very much. Appreciate it.

Charles Pizzi

Thank you.

Paul Ridder

Thank you, Nick.

Operator

(Operator instructions) I’m showing no questions in the queue.

Charles Pizzi

Thank you very much for joining us. We look forward to talking with you real soon.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program. You may all disconnect. Everyone, have a great day.

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