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Lancaster Colony Corporation (NASDAQ:LANC)

Q4 2014 Results Earnings Conference Call

August 21, 2014, 10:00 AM ET

Executives

Dale N. Ganobsik - Director of IR

John B. Gerlach, Jr. - Chairman, President and CEO

Douglas A. Fell - VP, CFO and Treasurer

Analysts

Philip Terpolilli - Longbow Research

Jason Rodgers - Great Lakes Review

Operator

Good morning. My name is Christine and I will be your conference facilitator today. At this time I would like to welcome everyone to the Lancaster Colony Corporation’s Fiscal Year 2014 Fourth Quarter Conference Call.

Conducting today’s call will be Jay Gerlach, Lancaster Colony Chairman and CEO; and Doug Fell, 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 session. (Operator Instructions).

Thank you and now to begin the conference call here is Dale Ganobsik, Director of Investor Relations for Lancaster Colony Corporation. Please go ahead.

Dale N. Ganobsik

Thank you, Christie. Good morning everyone and thank you for joining us today for Lancaster Colony’s fiscal 2014 fourth quarter conference call.

Let me begin by reminding everyone that our discussion this morning may include forward-looking statements which are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially and the company undertakes no obligation to update these statements based upon subsequent events. A detailed discussion of these risks and uncertainties is contained in the company’s filings with the SEC.

With that said I will now turn the call over to Lancaster Colony’s Chairman and CEO, Jay Gerlach. Jay?

John B. Gerlach, Jr.

Good morning and thank you for joining us today. I’m pleased to be here this morning with our new Chief Financial Officer, Doug Fell, for his first time on our earnings call. Doug’s been with us for 21 years, including three years as our corporate controller before spending 18 years in our food business, mostly in a senior financial role. He will make some comments in a few minutes as we discuss our fourth quarter and full year results. My comments will reflect our continuing operations without our Candle business that was divested in January.

Looking at our fourth quarter results we were pleased with higher sales, which were up almost 6% and all volume driven as we saw continued price deflation in our foodservice channel and higher promotional spending on retail products. Unfortunately we couldn’t bring that to the bottom line as a number of factors resulted in operating income declining 11% from last year. Earnings per share from continuing operations declined 18% to $0.76 from $0.93 last year, reflecting with a noticeably lower tax rate than the prior year quarter.

For the year sales were up about 3% and again all volume driven as we experienced higher promotional spending on retail sales and pricing decline in the foodservice channel. Operating income was flat with the prior year and earnings per share from continuing operations was $3.69 versus $3.79 with the full year tax rate somewhat lower last year than normal.

This year’s fourth quarter benefited from Easter sales that were in the third quarter the prior year and growth in our dressing and crouton product lines. Our foodservice channel sales grew modestly in the quarter and resulted in our sales mix shifting to about 51% retail versus 49% last year.

Looking to IRI data for the 12 weeks ended July 13th we saw our market leading positions grow in four of our five key categories with Marzetti refrigerated dressings losing just a fraction of a share point with continued good growth from our Simply Dressed line offset by declines in our classic dressings. Frozen dinner rolls was our only category showing negative sales comparisons. IRI data shows our sales were down slightly over 1% while the category was down over 3% reflecting the continued challenges in the overall frozen category with today's consumers.

Our operating income declined for the quarter which resulted in our segment operating income margin declining about 230 basis points to 13.5%, was impacted by higher marketing spend and greater trade promotional cost. Not only did we continue to invest in brand marketing and provide promotional support to Easter related volume we also invested to introduce several new products in the quarter. We spent about $2 million to support these new product introductions and look forward to growing distribution as we move into the fall season.

Also impacting the quarter were higher freight costs due to higher base rates and incremental internal freight cost driven by our dressing capacity constraints. The latter issue should be remediated once our expansion project is completed later this calendar year. In addition to the added freight costs we also incurred higher operating cost in our dressing plants due to higher overtime expense and other inefficiencies of running at such a high utilization rate.

While material costs were down about $4 million in the quarter, they were largely offset by lower foodservice selling prices. For the year segment operating income was basically flat and operating margin declined about 45 basis points to 15.9%. Full year sales mix was little changed from last year at approximately 51% retail.

Foodservice channel price declines totaled about $8 million with input cost savings for the year at about $14 million. Also impacting the year were higher trade and consumer marketing spend as well as higher operating and freight cost largely due to our capacity constraints in the second half. We finished the year with just under 2,500 employees down from 3,100 a year ago when we still had the candle business.

With those comments, I now look to Doug and rejoin you with some comments on fiscal ‘15 to conclude. Go ahead Doug.

Douglas A. Fell

Thank you, Jay. Relative to the balance sheet information contained within this morning's release and consistent with our third quarter presentation I believe that the most notable year-over-year fluctuations reflect the separate line items of current and non-current assets and current liabilities associated with our divested candle business. As we have reported in previous announcements and calls in January 2014 we divested our candle business, which represented our last non-food business.

While the remaining fluctuations are relatively minor by comparison let me comment on some of the larger line items. Turning first to our accounts receivable; these remain relatively consistent in total with the year ago level and we continue to see our overall ageings remain solid.

With respect to our inventories that totaled about $75 million at June 30th we saw an increase of about 10% since last June. This growth reflected several factors including the timing of some foodservice customer programs as well as some early buildup of seasonal frozen inventories. The net balance of property, plant and equipment remained comparable to the year ago total with our fiscal ‘14 capital expenditures totaling nearly $16 million.

Our largest expenditure this year related to an ongoing expansion of our dressing and sauce capacity in Kentucky. We currently expect this project to be completed this fall. Not only will this expansion provide us some much needed capacity to support future growth it will also allow us to gain better efficiencies and reduce a variety of incremental cost that affected our results in the back half of fiscal ‘14. Although we remain in the process of evaluating several projects we expect fiscal ‘15 capital expenditures to total roughly $20 million.

With respect to our balance sheet capitalization we continue to have no debt and over $528 million in total shareholders’ equity. We also ended the fiscal year with over $211 million in cash and equivalents as we benefited from continued strong operating cash flows as well as the proceeds relating to the divestiture of our Candle business.

Given our balance sheet posture we believe we continue to possess considerable flexibility to address foreseeable cash requirements including those supportive of our future growth initiatives.

Turning to this year’s cash flows, cash flows from operating activities totaled approximately $129.1 million which was just off from the $131.7 million for the prior year. There were two notable non-cash items influencing the current year total; the non-cash loss on the sale of the Candle business that totaled approximately $44 million; and depreciation and amortization which totaled $20.4 million. Relative to fiscal ‘15 and now absent the Candle operations we expect depreciation and amortization to decline slightly to approximately $19 million.

Also of note total annual cash dividends during fiscal ‘14 totaled nearly $47 million compared to $178 million a year ago. While this decline primarily reflects the prior year special dividend distribution of $5 per share our total pay out on our regular quarterly dividend did increase 13% to $1.72 per share in fiscal ’14 compared to $1.52 in fiscal ’13.

Finally one another matter to comment on is the disparity in the comparative effective tax rates for the quarter and year. With respect to the fourth quarter the majority of the tax rate differential relates to the prior year’s recognition of a tax benefit of approximately $700,000 that resulted from a release of reserves associated with uncertain tax positions. The fiscal ’13 full year rate also benefited from the tax consequences associated with that year’s large special dividend mentioned earlier related to our company’s frozen ESOP. Looking forward we expect the fiscal ’15 effective rate to remain comparable to the fiscal ’14 rate of approximately 34%.

Thanks again for your participation with us this morning. And I will now turn the call back over to Jay for our concluding comments. Jay?

John B. Gerlach, Jr.

Thanks Doug. Looking to fiscal 2015 we are pleased to have new products getting initial distribution, including Reames Presto Pasta, New York BRAND Soft pull-apart rolls and Whole Grain Texas Toast, our expanded salad toppings line under the Marzetti Chatham Village and New York Texas Toast brands include Crispy Onions and Whole Grains already introduced with gluten free croutons coming soon as well.

We are also shortly introducing Super Grain Baked Croutons made with ancient grains under the Simply Dressed label. The completion of our dressing and sauce expansion project and several other smaller investments in equipment and facilities will contribute to an estimated $20 million of capital investment for fiscal 2015. We do see further ingredient cost savings, particularly in the first half of the year largely offset by some further foodservice channel price deflation. We expect our retail channel pricing to be relatively flat although there could be some select pricing, particularly where dairy related input costs have moved upward.

While we remain interested in growing by acquisition we are finding limited opportunities for branded businesses with values that allow a reasonable return. Product innovation will be an important growth avenue for us and we look forward to the potential growth of the new items I mentioned earlier as well as additional introductions later in the fiscal year.

We expect the introductory cost of these new products may be significant in the first half. We hope to partially offset this investment by moderating the level of promotional support on other products, particularly in the first quarter. While continuing to maintain good leadership positions in our key categories we remain concerned about overall category growth particularly in frozen. Our position in foodservice remains strong yet we are dependent on the store traffic our restaurant customers generate in this slow growth economy.

We are cautiously optimistic about the current year and look forward to improving on last year’s results.

Christie, we are ready to take questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And your first question comes from Phil Terpolilli of Longbow Research.

Philip Terpolilli - Longbow Research

Hi, good morning.

John B. Gerlach, Jr.

Good morning Phil.

Philip Terpolilli - Longbow Research

Hi, I just want to understand the cost a little bit better for, I guess first half fiscal, second half of this calendar year. So correct me if I’m wrong, capacity coming online in second half of the year, that should help a little bit, sounds like fall commodity cost, I am trying to understand you're saying they will be favorable in the first half year, is it similar to the run rate we've seen over the last two quarters? And then those incremental freight costs, you mentioned, are they going to remain elevated pretty much on an ongoing basis here, what you expect from that standpoint and any other buckets I am missing, just trying to get a sense of how all three of those things come together.

John B. Gerlach, Jr.

I think Phil, roughly as it relates to ingredient costs the first half of the year probably is similar to what we've seen in the last couple of quarters. Second half doesn't look so favorable, certainly subject to change as we get closer to that, but right now that looks like the case.

Freight cost, as we get into the second half of the year at least the incremental freight that we've had relative to some of these capacity constraints should be behind us, higher rates though will still be with us. And I don't know we've got a perfect estimate there but we're probably talking just in the seven figures or so per quarter on higher freight costs, absent the -- again the capacity constraint-related freight. Was there another part of that I overlooked?

Philip Terpolilli - Longbow Research

No, and then just the timing of the capacity, when that does come online, is there incremental pressure in the near term until you kind of get fully utilized or is not, that’s not the right way to think about it.

John B. Gerlach, Jr.

In this case not a lot of pressure. First it comes on fully by the end of the calendar year, we’ll actually start bringing a little bit of it on just in the next 30 days or so. But we do have, again a number of plants running at high rates of utilization, sort of let us get back to a normal operating schedule, reduce overtime and get less efficient operation which usually come from more frequent job changes. And we have outsourced some production that will likely come back in-house relatively quickly. So no, I don't think there'll be any significant impact from initial unused capacity.

Philip Terpolilli - Longbow Research

Got it. That's helpful. And then just on the product investments that you talked about, certainly it makes a lot of sense to support those new products you're coming out with. I’m trying to get a better sense of how you guys measure, are you getting the returns you're hoping for on these product investments. Whenever you think about this product portfolio that's coming out, Reames Presto Pasta et cetera, should we expect the investments to accelerate over the next two quarters versus what we've seen recently and how do we think about that side of things.

John B. Gerlach, Jr.

Yeah, I think they do accelerate over the next couple quarters, a little bit, again with continued slotting as well as both trade, other trade and consumer support around those. Presto Pasta is the most significant investment we're going to be making and probably has a little longer term timeframe before we'll see some return off of that, off of that investment. Some of the other more incremental changes the pull-apart rolls, whole grain toast, croutons et cetera we should see more quick returns from those investments.

Philip Terpolilli - Longbow Research

Okay, that's helpful. And then just one more if I could just obviously lot of cash on hand here, any update on what you are thinking about with that strategically, there’ll be a special dividend or anything on the horizon? Thanks.

John B. Gerlach, Jr.

So we continued to think about all the alternatives for that again our priority would be finding a good acquisition opportunity but regular dividends, special dividend, share repurchases all get discussed routinely.

Philip Terpolilli - Longbow Research

Okay, perfect. Thank you, Jay.

John B. Gerlach, Jr.

You're welcome.

Operator

Your next question comes from Jason Rodgers of Great Lakes Review.

Jason Rodgers - Great Lakes Review

Hi, good morning.

John B. Gerlach, Jr.

Hi, Jason.

Jason Rodgers - Great Lakes Review

You talked about accelerating new product -- spending on new product support in the first half, partially offset by lower promotional spending. I just wondered how that dynamic looks in Q1 and Q2 of the next fiscal year versus the net results in the fourth quarter?

John B. Gerlach, Jr.

We’ll probably have a little bit more spend in Q1 and Q2, although again we do expect to get same saves, particularly in Q1 on relative trade spending where we were pretty aggressive a year ago, and have dialed that back to a degree this year. As we move into the fall season it’s probably a little bit more noticeable going through that time frame.

The other thing I think you need to remember Jason is, is we were in a little bit of a gap in our introduction of new products a year ago. So we are comparing it to very little of that kind of activity last year as we do more of this year.

Jason Rodgers - Great Lakes Review

Okay, and then looking at the Presto Pasta line just wanted to gauge your initial reaction to that product and if the plan is to expand that product line like you have the others and how the profitability of that line compares to your other frozen products?

John B. Gerlach, Jr.

Yeah, actually, Jason it’s literally just getting on store shelves, in fact a number of key retailers aren’t even going to get it on till early this fall. So it’s just too early to tell about acceptance and certainly as we gauge that acceptance and if we see opportunities to expand the product line we definitely would consider doing that.

Jason Rodgers - Great Lakes Review

Then, were there any share repurchases in the quarter?

John B. Gerlach, Jr.

No, there weren’t.

Jason Rodgers - Great Lakes Review

Okay, thank you.

John B. Gerlach, Jr.

You are welcome.

Operator

(Operator Instructions). We have no further questions at this time. I will hand the call back to over Jay Gerlach for any additional or concluding remarks.

John B. Gerlach, Jr.

We do appreciate you joining us this morning. We look forward to talking to you again late October with our first quarter results. Thank you.

Operator

Thank you. This does conclude today’s conference call. You may now disconnect.

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