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Lance, Inc. (NASDAQ:LNCE)

Q2 2008 Earnings Call

July 25, 2008 9:00 am ET

Executives

Russell Allen – Director of Planning & Investor Relations

David V. Singer – President, Chief Executive Officer & Director

Rick D. Puckett – Chief Financial Officer, Executive Vice President, Treasurer & Secretary

Analysts

Jonathan Feeney – Wachovia Capital Markets, LLC

Mitchell Pinheiro – Janney Montgomery Scott, LLC

Heather Jones – BB&T Capital Markets

Diane Geissler – Merrill Lynch

Benjamin Brownlow – Morgan, Keegan & Company, LLC

Sarah Lester – Sidoti & Company

Operator

Welcome to the Lance, Inc. conference call. (Operator Instructions) I would now like to hand the conference over to Russell Allen, Director of Planning and Investor Relations.

Russell Allen

With me today are Dave Singer, President and Chief Executive Officer and Rick Puckett, our Executive Vice President and Chief Financial Officer. In today’s call Dave and Rick will discuss our 2008 second quarter results as well as an outlook for the full year 2008. As a reminder, we are webcasting this conference call including the supporting slide presentation on our website at www.Lance.com.

Before we begin I’d like to point out that during today’s presentation, management may make forward-looking statements about our company’s performance. Actual results could differ materially from those projected in such forward-looking statements. Information concerning certain factors that could cause results to differ materially from those projected in forward-looking statements is contained in the company’s most recent Form 10K filed with the Securities & Exchange Commission.

I will now turn the call over to Rick Puckett, Executive Vice President and Chief Financial Officer to begin management’s comments.

Rick D. Puckett

Consistent with our expectations, the second quarter was again a difficult quarter relative to the balance between pricing and input costs. In addition, in the second quarter we experienced higher energy costs with the escalating crude oil that everyone is seeing and also higher inefficiencies with our Canadian facility consolidation.

Some of the highlights on page four I will take you through, solid revenue growth in core products and channels continue. We did execute a second round of price increases on our private brands products, we’ve still had continued escalation in the ingredient costs negatively impacting our margins and in addition the escalating fuel and natural gas costs negatively impacted margins. We had greater than anticipated inefficiencies from the consolidation or our Canadian sugar wafer facilities and I’ll talk about that in a little bit more. But, we did have continued improvement in supply chain and DSD operating efficiencies.

Turning to page five in our deck, some of the highlights of the financials for this quarter, we recorded $213.6 million for the quarter, an increase of 8.4%. The gross margin, 37.4% down 700 basis points from our year ago margins. Just a quick break out of that, the pricing versus the input costs made up about 300 basis points, we had a negative mix shift in the quarter versus last year of about 300 basis points, the Canadian facility consolidation contributed 80 basis points negative, and then we also had a 40 basis point impact on foreign exchange. However, the SG&A expense continues to show improvement year-over-year where we took 140 basis points out of that and essentially what drops to the bottom line is in fact the gross profit line fall short.

The tax rate was 37.5% versus 36.3% at the end of Q2 of 07. We do expect that tax rate to be in the 35% to 36% range for the year so the third and fourth quarters will have a positive impact as we go forward. Much of that will show up in the third quarter, the rest will show up in the fourth quarter.

On a diluted earnings per share basis, we are reporting $0.09 per share compared to $0.30 last year. On page six, if we look at the sales broken down between branded and non-branded, we show a 6.4% increase in branded sales. Of that 6.4%, 3% is price, 2% is volume and mix and Brent & Sam’s our recent acquisitions, contributed just less than 1% on the branded side. On the non-branded side, we’re showing a 12% increase in revenue. Of that 12%, price is 12%, volume mix is an actual -4% and Brent & Sam’s contributed around 4%. The volume mix was primarily in the contract side.

On page seven, the EBITDA was $51.3 million for the trailing four quarters compared to $75.1 in the four quarters ending in Q2. This reflects the rising input costs from the third and fourth quarter of last year through this quarter. Net debt is at $87 million, this increases from the Brent & Sam’s acquisition and the continued escalation of the input costs. However, net debt to EBITDA ratio is still at 1.7 so we’re not highly leveraged at all.

On page eight, is the key statistics for the first six months. We reported $411 million in net sales, an increase of 8.5%. The gross margin, 37.5% versus 44% and the breakout there is very similar to the breakout that I gave you on the first quarter with about 300 basis points being price versus input costs and about 300 basis points being mix and volume and then the Canadian FX was another 40 basis points. The tax rate, again 37.7% versus 36.6% and again, the full year number will be somewhere between 35% and 36%. So, we’re showing $0.11 for the first half compared to $0.49 for the first half last year.

On page nine, we’ve added a 12 month rolling line here, the red line, and you can see a significant dip in the first part of that. That was the result of the SKU rationalization that happened as part of the [TOMs] integration. If you’ll recall, back in early 2006 we were in the process of eliminating a lot of unprofitable SKUs so we had gotten some revenue impact of that in the first half of 2006. So, as we’ve gone from a fully rationalized SKU mix from [TOMs] which was sort of in Q3 of 07 we’ve continued to grow sales on the top line and we show continued growth even in this quarter. Of the 8.4%, overall pricing is 6.4% and volume is up 2%. Brent & Sam’s and other increases are somewhat offset by the contract manufacturing volume decrease. Some of that contract manufacturing was in Canada and was planned as part of the consolidation plan.

On page 10 you’ll see the gross margin trend. If you look at Q2 of 2007 we were at 44.5%, we’re 37.4%, I’ve explained that in the previous slides and our trend here on a rolling four quarter basis is downward, however the outlook is going to be more positive.

On page 11, this is the SG&A percent of net sales. If you look again at Q2 of 07, we were at 36.3%, we’re at 34.9% today, an improvement of 1.4% in spite of the rising fuel cost we continue to make progress here. Dave will talk a bit about what our initiatives are going forward. On the operating profit margin trend, as we have said, we expect this to be back at the levels we were at in the first half of last year by the end of this year. We’re still guiding in that direction.

On page 13, are some selected cash flow items, we actually contributed cash flow from operations of $10.3 million. We’ve spent so far this year $22 million approximately in cap ex and you’ll see our guidance has changed a little bit on cap ex which is on the next page. So, on page 14, this is our revised estimates for the year. We’re looking at net sales of $830 million to $850 million, that had previously been $805 to $835 million. Our diluted earnings per share is at $0.62 to $0.70, that had previously been $0.70 to $0.80. And, our capital spending has been reduced to $40 to $42 million compared to $45 to $50 previously. We have not made any reductions in productivity projects so this would be other than those projects.

Some of the major items in the diluted earnings per share reduction, we are experiencing energy costs like others and they’re higher in the second half than we original anticipated. That’s about $0.10 of the difference. Some of that was experienced in the second quarter, the rest is in the second half. The price volume versus inputs is roughly a breakeven to $0.04 for the back half of the year and the Canadian consolidation is costing us $0.03. Most of that occurred in the second quarter, there might be a $0.005 or $0.01 in the third quarter.

At this point I’ll turn it over to Dave Singer for some other comments.

David V. Singer

If you look at Slide 16, I’ll start by giving you some insights in to our second quarter results. We’re very pleased with the strength in our sales performance for the quarter. As Rick mentioned our top line growth was very solid. Our branded portfolio was up 6% reflecting solid volume in our key product lines, higher prices and about one point from the Brent & Sam’s acquisition. This was offset by some declines in product lines and channels we deemphasized.

The volume growth reflects distribution gains and market share growth in our key product categories. Lance Home Packed Sandwich Crackers had solid market share performance and showed mid single digit volume growth. Cape Cod Chips also had solid market share performance and low double digit volume growth. We continued to see declines in product lines in channels we’ve deemphasized as we narrow our focus on more profitable business. Although we’re encouraged by continued volume growth despite of the price increases we’ve taken to date, it’s still too early to tell the net impact we’ll ultimately have considering the competitive environment and consumer reactions over the long term.

Sales in our non-brand portfolio which include our private brands and our contract manufacturing, were up 12% in the quarter or about 8% excluding the impact of our new Brent & Sam’s acquisition. Our non-branded pricing was up in the low double digits, our private brands volume was up about 3% and we saw some decline in volumes in a few contract customers. We also saw a modest shift in the mix of products which had the impact of offsetting some of the price increase. In general, our pricing actions in the first and second quarter have gone as planned however, our cost escalated beyond our expectations. As Rick mentioned, we’re in the process of implementing additional pricing in both our branded and private brand products geared to restore our profit margins which have been squeezed by the increase in cost of wheat and vegetable oils as well as the rising costs of fuel and natural gas.

These input costs have had a significant impact on our earnings per share over the past several quarters. As Lance entered this unprecedented run up in costs, we were not as well positioned as we will be in the future. We had profit margins that were too low, the input costs that have skyrocketed make up an inordinately high percentage of our product content. We had not yet implemented the commodity hedging program which is now in place which protects our margins by providing sufficient time to adjust pricing in a commodity spike environment. As such, the rapid and sustained growth in these costs outpaced our ability to implement sufficient pricing while maintaining our profit margins. These issues are compounded by the fact that virtually all our sales are in the United States. As such, we experience no margin improvement from the decline in value of the dollar. In fact, the products produced in our Canadian operations are sold primarily in the United States so the weakening dollar hurt our profit margins, as Rick mentioned.

Although our profit margins have been squeezed over the past few quarters, this situation is temporary. We now have our commodity hedging program in place and it eliminated the vast majority of our input risk for the remainder of the year. We are confident that the pricing we are implementing now will restore our profit margins. We’re very encouraged by our sales performance and we continue to make progress on our supply chain and DSD efficiency initiatives. From a supply chain perspective, we’ve implemented a more aggressive backlog program to leverage our in house transportation fleet. In the past, much of our fleet was returning to our manufacturing facilities empty. We’re now more focused on back hauling packaging and ingredients as well as hauling other companies products on our trucks on the return trip. This is generating income for Lance and improving the return on our fleet assets.

We also continue to invest in capital projects that drive productivity improvements. Our capital spending is above historical levels again this year as we take advantage of productivity improvement projects that drive solid returns focused primarily on automation and capacity improvements. We continue to push the concepts of lean manufacturing through the organization as more and more employees get involved in our formulized process to drive creative thinking such as [Kizantines] the level of education throughout the organization increases and we begin to develop a strong foundation for our vision of a truly lean environment in our manufacturing for the future.

In the area of DSD improvements, we continue to improve the key measure of health in the DSD system, sales per route which grew by more than 10% in the quarter. During the quarter, we launched a pilot program in a few markets where we’re testing methods that are geared to significantly accelerate the gains we’ve been making in our DSD system sales per route. We’ll learn from these pilot programs, refine the approach as necessary and then begin to implement the changes in all of our markets during 2009.

In conclusion, although we’ve been working against some strong headwinds over the past several quarters, we’ve made solid progress in our business and we are confident that our third quarter pricing actions will restore our profit margins. As you will see from our revised guidance, the earnings level implied for the back half of this year is more reflective of the profit margins we were driving through the first half of 2007. As we regain this profit base, we will be positioned to continue down our path of revenue growth and margin improvement.

I’ll now turn it over to our moderator to start the Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Jonathan Feeney – Wachovia Capital Markets, LLC.

Jonathan Feeney – Wachovia Capital Markets, LLC

I guess my first question is the convenience and gas channel Pepsi Co talked about a double digit decline in foot traffic. What percent of sales would you say convenience and gas was for you? And, did you see or feel the impact on the retail side of less volume there?

David V. Singer

It’s about one eighth of our business in total and it was about flat for us in total sales.

Jonathan Feeney – Wachovia Capital Markets, LLC

Was that a disappointment versus your expectations Dave going in? Or, was that just about as you expected?

David V. Singer

We were up about – I think we were probably up 3% or 4% year-to-date so it’s softer than the first quarter but it wasn’t material to our expectations.

Jonathan Feeney – Wachovia Capital Markets, LLC

A big picture question here, you’ve done a lot of the work you said you were going to do taking out relative SG&A over the past couple of years only to sort of frustratingly give that back in gross profit. Now, I know you want to get margins back to the first half of 07 levels at the out margin lay but of course that’s still – what I’m wondering is what’s the kind of 09 and out long term gross margin level that’s right for Lance do you think?

David V. Singer

What’s going to happen because our mix of non-branded products is growing relative to the total and frankly in the environment we’re in we expect pretty solid gains over the next couple of years in private brands, the gross margin because of that mix will decline modestly. However, it has a solid operating profit margins and we anticipate our profit margins over the next several years to grow relative to where we were before this commodity spike. We’re much more focused on not so much balancing the business growing them all because they all will help support growth in our operating profit margin.

Jonathan Feeney – Wachovia Capital Markets, LLC

Can you give us a rough sense in what the difference in gross margin between those two businesses is?

David V. Singer

It’s more than two to one at the gross margin line.

Jonathan Feeney – Wachovia Capital Markets, LLC

A little algebra problem for me.

David V. Singer

We really haven’t disclosed the margins in particular.

Jonathan Feeney – Wachovia Capital Markets, LLC

Just one last question, I’m sorry if I missed this but did you disclose the financial impact on EBIT of Brent & Sam’s in the release anywhere?

Rick D. Puckett

We have not. It’s nominal to the year John, but it is positive.

Operator

Our next question comes from Mitchell Pinheiro – Janney Montgomery Scott, LLC.

Mitchell Pinheiro – Janney Montgomery Scott, LLC

A couple of things, I guess speaking to commodities, given that you feel confident that your pricing actions will offset your commodity pressure in the back half, that I assume means you are totally covered in your positions or mostly covered for 08?

David V. Singer

We have very little risk in the back half compared to – I mean, we’ve covered most of our commodities, yes.

Mitchell Pinheiro – Janney Montgomery Scott, LLC

How’s that look as you enter 09?

David V. Singer

We’ll, we’ve already started with our program. The way our commodity program is working and what we put in place is geared to manage margins. We have started to buy in to next year and we’re trying to have the vast majority of the next six months covered and then some beyond that and then we’ll continue to roll that forward. So, we’ve continued to start buying forward. We anticipate, unless there’s a significant drop off we would anticipate slightly higher commodities next year than this year on average but our pricing that we’ll have in place by the fourth quarter should cover us and restore the margins.

Mitchell Pinheiro – Janney Montgomery Scott, LLC

So the pricing that you anticipate being able to realize does that also anticipate Q1 or Q2 of 09 pressure so that you’re not in a position to see just your delayed implementation?

David V. Singer

What we have in place and what we’re implementing during the third quarter should position us so that unless there’s another dramatic spike, we’re covered as we work our way in to next year.

Rick D. Puckett

Mitch, the only thing I would add to that is the energy cost is something that we cannot hedge quite as far out because we do buy gasoline at retail. So, there is some exposure there potentially if crude goes to $250 a barrel as an example.

Mitchell Pinheiro – Janney Montgomery Scott, LLC

When I look at the mix shift and the impact that had, you’re talking about on the sales line, you’re just talking about the difference between branded and non-branded, is that correct? Or, is there a mix shift within the categories?

David V. Singer

The majority of the mix shift is branded to non-branded from an impacting the percentages.

Rick D. Puckett

Even Brent & Sam’s is a lower margin on a gross basis than branded so the acquisition actually contributes a little bit of that mix.

Mitchell Pinheiro – Janney Montgomery Scott, LLC

When you look at Lance Home Packed business, mid single digit type of volume growth, is that – when you look at the single serve I should say, is that having any pressure, any volume pressure there?

David V. Singer

The single serve did not have the kind of growth we had in the multipack and that’s largely because a lot of that goes through the convenience store channel which was soft. But, the key long term strategic growth component for us, is the home packed.

Mitchell Pinheiro – Janney Montgomery Scott, LLC

In terms of Cape Cod, were gains there sort of same store gains or were there distribution gains, new distribution gains?

David V. Singer

It’s both but the kettle chip business was up not quite 20% but it’s up strongly and our market share actually gained a little so more came from same store but there were some distribution gains.

Mitchell Pinheiro – Janney Montgomery Scott, LLC

Last question is on the sort of one-time costs with your Canadian rationalization. Just to be clear, is that over here now or is there anything that’s going to sort of carry over here in to the third quarter?

David V. Singer

Well, we anticipate it will carry a little in to the third quarter. The majority – more of the hit in the second quarter were some anticipated one-time items, or a lot of the hit was related to severance and consolidation costs but there were quite a bit that related to the fact that after it was up and running we were not as efficient as we anticipated so our throughput rates, our scrap rates were higher than we anticipated, actually significantly as a bunch of new people were doing things they hadn’t been use to. We’ve done a lot of training, we anticipate that to settle down during the third quarter and we should be in good shape about half way through the third quarter.

Operator

Our next question comes from Heather Jones – BB&T Capital Markets.

Heather Jones – BB&T Capital Markets

Real quick, while we’re on the subject of Canada, when you said $0.03 per year the hit to guidance, was that the cost you hadn’t anticipated?

Rick D. Puckett

That’s right Heather. A couple of pennies of that was in the second quarter and we expect maybe another penny in the third quarter.

Heather Jones – BB&T Capital Markets

Just trying to figure out, assuming this rectifies itself, what are the total cost from Canada for the year that would have presumably go away in 09?

Rick D. Puckett

Well, it will continue because we have consolidated three facilities down to two and when you think about it’s really this $0.03 that we’re talking about that will correct itself in the third quarter then the ongoing cost are included in our guidance. Year-over-year we don’t provide specific information about specific facilities but from your perspective it’s $0.03 better than it was this year.

Heather Jones – BB&T Capital Markets

Well I mean, the severance costs all the stuff that presumably you anticipated at the beginning of the year and I would assume wouldn’t repeat next year what does that total?

Rick D. Puckett

That was in our guidance.

Heather Jones – BB&T Capital Markets

Oh I know, I’m just trying to figure out what costs will go away in 09 relative to Canada?

Rick D. Puckett

It’s certainly the $0.03 we’ve talked about, it’s the fixed costs associated with the third facility which is not that significant, these are not large facilities up there so it’s not a $0.10 kind of number, it’s less than $0.05.

Heather Jones – BB&T Capital Markets

Now going to your outlook for the back half, soybean oil, etc. it sounds like you’ve got the vast majority of that hedged but what about natural gas?

Rick D. Puckett

Natural gas continues to be an exposure for the second half but not very much and certainly next year is still exposed.

Heather Jones – BB&T Capital Markets

So you can hedge some of your natural gas so there’s some exposure but it’s not 100% exposed.

David V. Singer

That’s right and we can hedge it, yes.

Heather Jones – BB&T Capital Markets

Now, as far as the price increases you’re taking in the back half because we’ve seen where potato acreage has gone down and potatoes prices have gone up pretty significantly. The increases you’re taking in the back half, are they simply catch up for this year or are you look at 09 and seeing where your cost may end up and trying to be ahead of the curve?

David V. Singer

We’re basically positioning ourselves so that based on our overall expectations for what costs will be from the fourth quarter onward we should be covered. But, we don’t own our potato crop for next year, we do for this year and if for some reason potatoes were to sky rocket that would have to be something we’d consider but at this point we’re not expecting problems with potatoes next year.

Heather Jones – BB&T Capital Markets

You’re not? Because, we’re seeing prices up like 80%.

David V. Singer

Well prices were up very, very high for a short period of time this year but our current expectation, I don’t believe our expectation is that big of an increase.

Heather Jones – BB&T Capital Markets

Then as far as your guidance, just to try to get a handle on how exposed you are, say if wheat went to $13 for the back half of this year but natural gas and diesel, etc. stays where it is, would you still be comfortable with your guidance.

David V. Singer

Yes.

Rick D. Puckett

Absolutely.

Heather Jones – BB&T Capital Markets

Are you taking advantage of recent weakness? How is your hedging program structured? Are you doing any market timing at all or is it very methodically like you’re layering and coverage daily and then simply, “Okay here is where our costs are going to be for the next six months,” and then putting price accordingly. Are you trying to time the market at all?

David V. Singer

We’re really not focused – I mean, our strategy doesn’t relate to market timing. It’s more like you described, we really want to make sure that we have the vast majority of our costs covered for the ensuing six months to give us time to adjust pricing if needed.

Heather Jones – BB&T Capital Markets

Then my final question, going over this mix shift and then you’re guidance. This back half guidance implies more than 100% increase on the back half of 07. So, you’re assuming EBIT margins, if I hear you correctly in the range of what you saw in the first half of 07?

Rick D. Puckett

That’s right.

David V. Singer

Fundamentally, I would say the concept would be seasonally adjusted, yes. We would expect that the pricing would put us in a position so that the margins we were generating through the first half of 2007 would be restored. We’re not being very specific with exactly what to expect because there are a lot of moving parts. We were operating with really pretty decent margins through the first half and we anticipate just regaining those and having that as a base to build from.

Heather Jones – BB&T Capital Markets

Okay because the math I’m getting to implies that the back half should be somewhere between a 6.5% and 7% EBIT margin.

David V. Singer

That’s right. But, the third quarter will be slightly depressed compared to where we would anticipate it longer term because the pricing is going in to effect during the third quarter and will continue to have a little pressure from our Canadian subsidiaries.

Rick D. Puckett

So on a run rate basis to that point going in to 2009 we would expect it to continue to climb from that level.

Heather Jones – BB&T Capital Markets

That was where I was leading so going in to 09, and I know all of this assumes that there’s not another big ramp up in cost, but let’s assume we’re in a steady state basis. 09 should see an EBIT margin somewhere between 6.5% and 7% and potentially better assuming you continue to make progress against your turnaround plan. Is that a reasonable assumption?

Rick D. Puckett

It’s a reasonable assumption and just keep in mind that we have not invested at all this year to speak of in advertising supporting our brands. So, it may not be specifically that Heather but as we manage our business and manage our portfolio products, it may fluctuate a little bit around that but generally speaking you’re right.

David V. Singer

Our strategy all along has been to drive our profit margins higher and then use some of that to reinvest to drive sales faster and we’re just going through this squeeze right now that’s gotten us off that and we’ll be back on that as we work our way through the fourth quarter.

Heather Jones – BB&T Capital Markets

I agree, I agree. Sales fortunately doesn’t seem to be your problem so I’m just trying to figure out what is a reasonable number for 09 and also with that – I mean, if you look at the SG&A total operating expense line relative to when you came in Dave there’s been some pretty significant costs taken out. I know some of that is simply mix shift from branded to private label but I believe a fair amount of that is costs so I’m trying to figure out when we’re going to see the benefit of that. When are you going to be caught up because if we look at 05 you were about 5.4% and you’ve taken out significant costs since then, something that’s on the order that should put you close to 8% EBIT. I mean, when you do anticipate fully recapturing all that commodities have taken away the last few years and getting you to level where the costs that you’ve taken out should completely show through?

David V. Singer

We have not put our plan together for 2009 yet. However, what we’re working on is to get to the point where that will begin to show in 2009. So, if things go as planned we should have a pretty strong 2009 for those exact reasons.

Heather Jones – BB&T Capital Markets

So am I thinking correctly going back to 05 when you came in, 5.4% EBIT, you’ve taken out – I mean the expense ratio is down over 400 bips since then so assuming some of that is mix shift but I would estimate at least three quarters is costs you’ve taken out. So at some point when you get caught up, that implies over 80% EBIT margins and I’m just trying to figure out am I faulty in my thinking?

Rick D. Puckett

Heather I think the only thing I would say is that the logic that you’re suggesting is pretty accurate. The absolute number may not be exactly there because again of the opportunities we have on the advertising and the media side. I wouldn’t want to commit to a specific number to you given the fact that we have not truly invested in our brands. We continue to want to do that. I think directly you’re correct, absolute maybe it will change a little bit but I think your logic is pretty sound.

Operator

Our next question comes from the line of Diane Geissler – Merrill Lynch.

Diane Geissler – Merrill Lynch

Just a question on your SG&A and the amount of pricing you took in the quarter which I’ve calculated out somewhere around $12 million, is that about right? $12 million in pricing in the quarter?

Rick D. Puckett

It’s not too far off.

Diane Geissler – Merrill Lynch

Because if I look at it and I look at your total SG&A expenses sort of x pricing, I actually have SG&A expenses up as a percentage of sales. Now, I don’t know if there’s any pricing action you’re taking because you have increased prices. Just if you could help me understand because what I’m trying to get at is excluding sort of the pricing gains that you’re taking what should we be thinking longer term from your actions to be more efficient etc., I the back haul and things like that?

Rick D. Puckett

I think there are a couple of pieces we have to consider. The SG&A is certainly inclusive of commissions and broker fees as well so you can’t really just take 100% of the pricing out and say that’s a good calculation. In addition, we’ve been hit with fuel costs, all the gasoline costs fall in to this category as does the diesel costs so all of those things are there. We’re pricing to cover those on the top line as well so it’s not really a straight calculation to do in simply taking all the pricing out because the pricing obviously covers some of those things. It does not suggest that our performance on these lines are diminished.

Diane Geissler – Merrill Lynch

Well you know what I struggle with every quarter is to come to a number that truly reflects the work that you’ve been doing to become a more efficient organization and understanding that impact not only in the cogs line but on the SG&A line. Is there any kind of guidance you can give us in terms of if we see a 200 basis point improvement or 50 basis point improvement, a certain percentage can be construed to be from efficiency efforts on our part versus the pricing?

Rick D. Puckett

I think we go back to what Dave mentioned a few minutes ago in terms of all the initiatives we have going on and continue to have going and we still believe there are opportunities on the supply chain side. The consolidation in Canada was one of those even though we stumbled a little bit in the quarter on that one. The DSD transformation which we expect to be pay dividends going from the rest of this year in to 2009. So, there’s still quite a bit of effort and quite a bit of opportunity on the SG&A line. We have not provided, obviously, guidance for 2009 so I can’t get as specific as you’d like for me to but just know that as we go through the rest of this year we’re going to be more clear on that and there is opportunity there that we have not yet disclosed.

Diane Geissler – Merrill Lynch

Could you comment on what your expectations are hit to SG&A from the diesel side or the fuel side, things that you’re trying to price against?

Rick D. Puckett

The last time we talked diesel was in the $3.70 range and even a little less as a quarter, that has sense gone up $0.70 and that’s kind of where we’re experiencing it today. In a similar fashion, gasoline has gone up almost $1.00 since we last talked so the two of those together on an annualized basis is about $0.08 a share. So we experienced some of that obviously in the second quarter which is again, part of our earnings guidance reflection but that’s costs going in to next year as well if it maintains at these levels so it’s pretty significant to us at $1.00 per gallon increases.

Diane Geissler – Merrill Lynch

Then I guess your comments earlier that you felt it was too early to really gage the reaction, the price elasticity to the amount of pricing that you’ve taken. When will you have a good idea about that? I mean, it sounds like the convenience channel is down weaker than expected although certainly not your main focus for your strategic plan. But, can you talk about what’s going on with grocery, what your expectations are for when you might have a better feel for what the reaction is to all these prices you’ve taken?

David V. Singer

What’s going on right now in the economy is something that is very unprecedented. If you look at the impact of food inflation and the cost of energy for the average consumer, it is probably the single biggest increase and bit out of the wallet that we’ve seen certainly in my lifetime. So, I think what we are seeing is consumers are starting to change behavior at a rate that has not been seen before and the outcome is at this moment at little uncertain. Some things we really have going for us is that our products tend to be a pretty good value. They’re aligned with a little bit more of a wholesome snack, our Cape Cod products are kind of an affordable indulgence which I think goes well at this moment. We’ve got a large private label presence which we made a lot of improvements in our private label business and we’re seeing a shift to private label. There are a lot of things going on in the economy right now so the ability for most consumer products companies to accurately predict what’s going to happen is not like it’s been in the past. I think we’ll have a better feeling for how things are going in another six months but at this moment there’s more change going on with the consumer than we’ve seen in years and years.

Diane Geissler – Merrill Lynch

Well no, I understand that point but a shift to private label would not be – although you have certainly exposure to private label that would not be beneficial to your earnings would it? A shift from branded to private label?

David V. Singer

Well a shift from our branded sandwich crackers to our private label sandwich crackers would not be overly beneficial to our earnings. On the other hand, a lot of the private label sandwich cracker business is up. But, that’s not the biggest issue, the biggest issue we see would not be so much a shift from our product lines that are branded to a non-branded, we don’t see a tremendous risk there, our issue is that our private label business can benefit from the growing private label business.

Rick D. Puckett

Diane, keep in mind that our private label business does not directly compete with our branded business for the most part, it’s not the same product.

Operator

Our next question comes from the line of Benjamin Brownlow – Morgan, Keegan & Company, LLC.

Benjamin Brownlow – Morgan, Keegan & Company, LLC

Can you talk about kind of what you’re seeing in the acquisition environment right now and then regionally and what your plans are there?

David V. Singer

I think that we continue to see opportunities in that arena Ben and we look at those on a very consistent basis. We did make the acquisition in March with Brent & Sam’s, we still remain interested in specific acquisitions that fill voids in our strategic plan so we’re pretty selective in what we go after and what we pursue. I think the environment has not really slowed down much and there seems to be quite a few opportunities out there.

Benjamin Brownlow – Morgan, Keegan & Company, LLC

In regards to Brent & Sam’s, how’s that meeting your expectations and along that same line, what are you seeing when you see the shift over the private label and the profitability I guess as the consumer is getting squeezed and maybe going over to the mass channel. How does that compare to the other channels?

David V. Singer

Our profit margins in mass are very good. Our profit margins, once we restore them with pricing in our private branded business are solid and so those shifts are not negative for us at all. As it relates to our expectations with Brent & Sam’s, we anticipate frankly that at the rate we’re going now Brent & Sam’s will meet our expectations fully.

Benjamin Brownlow – Morgan, Keegan & Company, LLC

Are you seeing any stepped up competition on the private label side?

David V. Singer

Well, I think the private label, I imagine most private label businesses are doing well right now. I think we’re seeing growth, even with prices increases have exceeded our expectations and we are this moment are starting – that’s one of the reasons we’ve increased our revenue guidance.

Benjamin Brownlow – Morgan, Keegan & Company, LLC

So you think you’re gaining market share there?

David V. Singer

I don’t know so much that we’re getting market share as much as the entire industry is growing.

Benjamin Brownlow – Morgan, Keegan & Company, LLC

Then going back to the contract manufacturing, can you just give a little more color on the decline there?

Rick D. Puckett

Some of that was planned with the consolidation of the three facilities to two in Canada because a lot of the contract manufacturing fall short was there. But, some of it is also timing. I don’t think that there is any long term impacts that we’re concerned about.

Benjamin Brownlow – Morgan, Keegan & Company, LLC

Then one last one, on the gross margin you guys typically, if I’m not misunderstanding, you guys typically buy several months ahead so should we assume that gross margin in the second quarter was kind of factoring in at $9 or $10 wheat range?

Rick D. Puckett

I mean yes but we’re not specific at what we buy at.

Benjamin Brownlow – Morgan, Keegan & Company, LLC

So I guess my follow up wouldn’t be answered in terms of just detailing out more of those hedging positions or forward buys.

Rick D. Puckett

That’s a fair statement, yes.

Operator

Our next question comes from the line of Sarah Lester – Sidoti & Company.

Sarah Lester – Sidoti & Company

Could you break out the price versus volume overall? I think I missed that, I’m not sure if you went over that.

Rick D. Puckett

Price versus volume for the quarter?

Sarah Lester – Sidoti & Company

Total, yeah total.

Rick D. Puckett

For the half year?

Sarah Lester – Sidoti & Company

Either half year or just for the quarter.

Rick D. Puckett

For the quarter we added about $13 million in pricing as someone mentioned a few minutes ago and the volume was not up dramatically year-over-year. That’s a year-over-year comparison.

Sarah Lester – Sidoti & Company

Then for the price increases that you’re implementing in the third quarter, can you just talk about those? Have those already started and have they already been all passed through already?

David V. Singer

Everything has not started. Almost everything has been announced and we have dates for them to start but they’re not all in place yet. In place meaning we’re not starting to receive the higher prices on the products but we are on some and we aren’t on everything but almost everything we’ve announced we anticipate being up and running no later than the beginning of the fourth quarter.

Sarah Lester – Sidoti & Company

Then for cap ex guidance which is lower, can you talk about where you’re lowering spending?

David V. Singer

Basically some of it – Lance for a series of years had under spent in certain areas related to cafeterias and parking lot and bathrooms and plant facilities. So what we did was we put together basically a three year plan to bring all of our facilities up to a particular level. We have pushed some of those things out and stretched that and that’s a lot of the issue we are dealing with. Some are replacements there’s kind of a routine replacement on certain equipment, we stretched a little of that but nothing related to productivity.

Rick D. Puckett

It’s about 20% related to our ORACLE implementation as it will fall in to 09 instead of 08.

Operator

Our next question comes from Jonathan Feeney – Wachovia Capital Markets, LLC.

Jonathan Feeney – Wachovia Capital Markets, LLC

I wanted to talk a little bit more about the structure of this price increase, is this all via list pricing at this point or is there any plans for taking weight out of either your Cape Cod or Lance packages?

David V. Singer

We have a variety of ways to go at it. There are weight outs not so much in the branded side as the private brand side but there is some weight outs across the board but more of it is in private label.

Jonathan Feeney – Wachovia Capital Markets, LLC

Do you think that there would be a – considering some value seeking and other categories by the consumer, if let’s say the commodity costs have kind of cracked and they stay where they are now, do you worry about a more promotional environment perhaps in the second half of the year at all? Or, has historically when commodities sort of come down off highs do manufacturers sort of hang on to that pricing they’ve put in place?

David V. Singer

I think it’s a little hard to tell, as I said, because the environment that we’re going in to is different than we’ve seen historically. I think we’re structured that we would be reasonably successful in a promotional environment or not. We have high gross margins on our branded items and we also have generally pretty low household penetration so a promotional environment will tend to benefit us because we can get deeper household penetration. But, on the other hand we’re fine the other way. I’m comfortable with either at this moment.

Jonathan Feeney – Wachovia Capital Markets, LLC

I’m sorry Dave I’m not sure I understand, you’re relatively low household penetration how would that help you in a promotional environment?

David V. Singer

Well, a lot of times in a promotional environment if more things are on promotion, we end up increasing household penetration. People go buy, see a deal, buy it, somebody who would otherwise not have bought it. If you have a very high household penetration sometimes promotions just basically eat in to the future months sales expectations.

Jonathan Feeney – Wachovia Capital Markets, LLC

Have you seen some of your competitors with higher household penetration, have they become more promotional at all or has it been about the same?

David V. Singer

It’s not something that I’ve got an opinion on at the moment, I’m sorry. I just don’t have a feel for it.

Operator

Our next question is a follow up question from the line of Heather Jones – BB&T Capital Markets.

Heather Jones – BB&T Capital Markets

I was wondering, and I apologize if you already gave this, but what is about the magnitude of the price increase you’re going to take in the back half?

Rick D. Puckett

We haven’t been that specific about it Heather because other than – as we try to make all that happen still too so we want to make sure it happens but it is significant enough to offset the commodity increase and the energy cost increase that we’re experiencing in the back half of the year. On an absolute term I can’t go in to that detail but it is meant to cover those things going forward.

Heather Jones – BB&T Capital Markets

Then on C store volume, clearly a weakening in Q2, have you seen further weakening in to Q3 or is it still, I think you had characterized it as flat year-on-year.

David V. Singer

I don’t have that number in front of me as to what has happened in the last couple of weeks so I’m sorry I can’t help you.

Heather Jones – BB&T Capital Markets

Then finally, on advertising, what is the target level for you all as far as that goes?

Rick D. Puckett

A typical food service company might do somewhere between 4% and 5% of branded sales. We’re not going to do advertising of private brands obviously so it’s really only on our branded sales. We’re at less than 1% right now so it’s somewhere in between so in the near term we’re not going to get up to 4% or 5% but we’ll be somewhere in between.

David V. Singer

Thanks for attending the conference call and we’ll talk to you next quarter.

Operator

Thank you for participating in today’s conference.

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Source: Lance, Inc. Q2 2008 Earnings Call Transcript
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