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Executives

Erica Abrams – Investor Relations

John M. Foraker – Chief Executive Officer

Kelly J. Kennedy – Chief Financial Officer and Treasurer

Analysts

Jon Andersen - William Blair

Rachel Nabatian - Credit Suisse

Edward Aaron – RBC Capital Markets

Scott Van Winkle - Canaccord Genuity

Chris Growe - Stifel Nicolaus

Bill Chappell - SunTrust

Annie’s (BNNY) F2Q13 Earnings Call October 30, 2012 5:00 PM ET

Operator

Good day ladies and gentlemen and thank you for standing by. Welcome to the Annie’s, Inc. second quarter fiscal 2013 earnings conference call. [Operator instructions.] This conference is being recorded today, October 30, 2012. I would now like to turn the conference over to Erica Abrams of the Blueshirt Group. Please go ahead ma’am.

Erica Abrams

Hello, and thanks for joining us today, as we report financial results for the second quarter of fiscal 2013. Joining me on the call today are John Foraker, CEO; and Kelly Kennedy, CFO of Annie’s.

I will now present our comments on forward-looking statements. Some of the statements we make during this conference call are forward-looking, including statements concerning our positioning for future growth; investments in areas of strategic focus including continued innovation; increasing demand for natural and organic food products; and our expectations concerning market position, financial performance, and operating information.

The forward-looking statements made on this conference call are based on management’s current expectations as of today’s date only, and are subject to uncertainty and changes in circumstances and are therefore subject to significant risks. We cannot assure you that future developments affecting us will be those that we have anticipated. Actual results may differ materially from those expectations.

Our reported results should not be considered an indication of future performance. There are many potential risks and uncertainties that could cause actual results to differ from our current expectations, as well as those risks and uncertainties included in the risk factors section of our filings with the SEC, which were available on our investor relations portion of our website at Annies.com, and on the SEC website at sec.gov.

Additional information is also available in our Annual Report filed on Form 10-K for the fiscal year ended March 31, 2012. All information provided in our release and in the attachment today is as of October 30, 2012, and we undertake no duty to update this information for any reason unless required by law.

Certain financial measures that we use on this conference call such as adjusted net income are not prepared in accordance with GAAP, and have been adjusted to eliminate the impact of certain non-recurring, expired, or non-cash expenses or charges, as the case may be. Our GAAP results and reconciliation of GAAP to non-GAAP financial measures can be found in our earnings press release.

This conference call is being webcast, and an archive of the webcast will be available on the investor relations section of our website at Annies.com. It’s also available live at this time.

Now, I will turn the call over to John. Please go ahead.

John M. Foraker

Hello, and thanks to everyone for joining us today as we report our fiscal 2013 second quarter financial results. We know it may have been difficult for some of you to make this call today, so we’re really grateful for your participation. We hope that you, your families, and friends are all safe.

Our strong second quarter results were driven by robust consumer trends and execution of our proven growth strategies. We achieved 20% top line growth, or $46.7 million in net sales, and adjusted net income of $4.2 million, or $0.24 per share.

In light of our strong growth in the first half, current sales momentum, and our conference looking ahead, we are now raising our full year sales guidance from a prior range of 16% to 19% to a new range of 19% to 21%.

In the second quarter, we continued to focus on our four strategic growth drivers. First, expanding mainstream distribution. Second, improving placement locations in stores. Third, increasing Annie’s brand awareness and household penetration, and finally, continuing to deliver existing innovation that our consumers love.

We made good progress during the quarter in each of these areas. The consumer opportunity for natural and organic alternatives remains very strong. More and more consumers are seeking cleaner and simpler food options for their families.

Against this favorable consumer backdrop, we continue to experience strong consumption trends. During the quarter we saw year over year consumption growth in our key product categories, retail channels, and top customers that was in the mid to high teens. We’re very consistent with our trends over the last three quarters.

Our mainline initiative, where we are moving our best-selling items out of standalone natural sets and into mainline grocery aisles progressed nicely. During the quarter we made significant progress against this initiative, placing approximately 17,000 SKU points of distribution in grocery mainline sets. About two-thirds of these placements were moves from natural sets to mainline sets in the same store. The remaining placements were incremental points of new mainline aisle distribution.

Our mainline wins were most heavily focused in macaroni and cheese, primarily because we’ve been making that case to retailers for a longer period of time. During the quarter Annie’s macaroni and cheese consumption grew by more than 20% in grocery and mass channels, clearly benefiting from improved placement, deeper distribution, more competitive price points, and stronger merchandising. We are gaining similar traction in our other product categories such as grahams, snack crackers, fruit snacks, and dressings, and we expect to benefit in the future as a result.

Our second quarter is a big merchandising period for Annie’s and our retailers around consumer back to school programs. We experienced very strong retailer merchandising and consumer response to these programs across all of our channels, particularly for mac and cheese. In fact, August was our single largest sales month in company history. That was followed by continued strength into September, so much so that unfortunately we experienced some shorts on our top items during the last three weeks of the quarter.

As a result, we were unable to fill customer demand, which we estimated cost us about $1 million in net sales in the quarter. This had nothing to do with either availability of ingredients, aggregate production capacity at our manufacturing facilities, or our ERP implementation. Simply put, our forecasting and production planning processes underestimated demand in the quarter and we were slow to adjust and catch up.

We’ve taken a number of corrective measures to improve the process going forward and our customers have been very supportive. Sell rates are now back to normal high levels and business as usual.

Now I’d like to provide you an update on the progress of our innovation execution. In January 2013 we will begin shipping two line extensions to our snacks business. We are presenting these items and products to retailers at this time, and the reception thus far has been very good.

The first extension is in our grahams category. We are introducing two certified organic SKUs of conventional style flat graham crackers. Flat grahams, like the ones you make s’mores with, are a more than $150 million segment of the $330 million U.S. grocery graham category. And this is a segment in which we do not presently compete.

We have a great opportunity to position a cleaner, healthier, certified organic alternative to the mainstream conventional brand. This extension will be incremental and gives us the opportunity to expand our graham share in all channels.

The second extension is in our cracker business. We are introducing a line of certified organic and made with organic cheddar squares. This familiar product form represents more than 30% of the $1.2 billion snack cracker category in U.S. grocery. Our new cheddar squares will age us up into more all family usage occasions, particularly with teens and millennial consumers. Again, we have a nice opportunity here to position a cleaner, healthier alternative to the mainstream brand leader.

Both products deliver great taste and based on our testing, Annie’s consumers are very excited by them. We expect solid and incremental sales contribution from these line extensions going forward in the coming years.

In Frannie, our frozen category initiative, we continue to make solid progress. We began shipping made with organic rising crust pizza into more than 2,500 highly targeted grocery points of distribution in the second quarter, about a quarter ahead of our expectations as we entered the year.

Our goal with the initial placement is to build a strong track record of success with each account, such that we are well-positioned to expand our distribution footprint with these retailers as we go into our fiscal 2014. In addition, we’ve begun selling these items to independent natural foods retailers with great success, and we expect to have a large distribution footprint in the natural channel by the end of our fiscal year.

Retailers in all channels are enthusiastic about these new pizza offerings, and we are pleased with the retail price points we are securing and with the strong overall retailer support we are receiving for this important growth initiative.

Because of the strong reception we’ve received to our initial launch of pizza, we remain optimistic about the potential for Annie’s in frozen. While it is only the beginning, we are seeing very encouraging initial velocity reads from early placement of the made with organic pizza items.

As a result of our success thus far, we are actively developing additional products for other frozen categories that we expect to bring to market in the 2014 and 2015 timeframes. We will keep you updated on the progress of these initiatives over coming quarters as we get closer.

We are pleased with where we are through the first half of the fiscal year and our first six months as a public company. We are making good progress in the development of our business and we are confident in our outlook and our strategic initiatives.

I’m particularly proud of our people and thank them for their continued hard work, our many accomplishments this quarter and year to date, and most importantly for the commitment to Annie’s mission and values.

Now I’ll turn the call over to Kelly Kennedy for more financial details about the quarter.

Kelly Kennedy

Thanks John, and thanks for joining us today as we report our second quarter financial results. As John highlighted, net sales for the quarter were $46.7 million, up 20.1% over the second quarter of fiscal 2012.

Similar to Q1, volume was the largest driver in our year over year growth, driving approximately 17%, with the balance coming from higher average selling prices. As a reminder, we completed a secondary offering during the second quarter, which resulted in one-time costs of approximately $700,000, or $419,000 net of tax. There were no proceeds received by the company and no change to our share count. Throughout my prepared remarks today, I’ll discuss our financial results excluding these one-time costs associated with the secondary offering.

Adjusted net income for the second quarter was $4.2 million, or $0.24 per adjusted diluted share. This compares to $3.6 million, or $0.22 per adjusted diluted share, in the same period a year ago. EPS in the second quarter was based on our diluted share count of $17.7 million, as compared to an adjusted diluted share count of $16.2 million in the same period a year ago. The share count increase was primarily due to the 950,000 shares issued in the IPO in April, combined with approximately 400,000 shares from stock option exercises year to date.

In the second quarter of 2013, we accelerated the rollout of our made with organic pizza products, which increased costs by approximately $400,000 overall in the quarter. We had promotions and slotting fees that impacted gross margins, as well as other marketing expenses in SG&A. The net impact to the bottom line for the quarter was approximately $0.01 per share. This small investment will benefit us in fiscal 2014 and beyond.

Our effective tax rate in Q2 was 40.5%. We expect our full fiscal year 2013 tax rate to be 40.7%. As we discussed on our last call, this is higher than we had originally planned.

Now I’d like to share some color on our net sales results by product category for the second quarter. 47% of net sales were from meals, up from 43% in prior year second quarter, reflecting 31% year over year growth. Meals growth was predominantly driven by our mac and cheese line, but also benefited from sales of organic and made with organic pizza.

41% of sales were from snacks, up 17% over the prior year quarter. We saw a strong rebound in snack sales versus the prior quarter, which was impacted by the mix of business toward meals.

12% of sales were from dressings, condiments, and other. Over time, we expect this category to contribute less to growth as we experience more growth in meals and snacks.

As a reminder, you can find the quarterly net sales trends by product category on our website in the investor relations section.

Now moving to margins, gross margin for the second quarter was 38.3%, up 190 basis points over the prior year’s second quarter. The year over year increase was primarily related to trade efficiencies as we continue to improve the effectiveness of our promotional programs and were partially offset by the margin impact of slotting and incremental trade programs made in the quarter to support our made with pizza launch.

As a reminder, we experienced volatility from quarter to quarter in our margin based on product mix and timing of promotions. We still expect margins in the mid-39s for the fiscal year.

We are experiencing higher commodity costs in fiscal 2013, which we planned for. We implemented a pricing increase of approximately 3%, which took effect this month, and [laps] a similar size increase from October 2011.

We also expect modest increases in key commodity prices in fiscal 2014. We expect to continue to offset higher commodity costs with pricing and our Fat Rabbit projects, as we have in recent years.

Now turning to adjusted selling, general, and administrative expenses, where we have both fixed and variable components. In the second quarter, adjusted SG&A increased $2.8 million to $10.8 million. SG&A spending in fiscal 2013 reflects the planned increases and investments we are making in people, infrastructure, our brand, and innovation to drive growth and to support our public company status.

Adjusted operating income for the second quarter was $7.1 million, up 16% over the prior year. Adjusted operating margin for the second quarter was 15%, bringing us to an adjusted margin of 13% year to date.

Turning to our cash flow, we generated $9.1 million in free cash flow this quarter. As a reminder, our asset-light hybrid supply chain model is efficient and generates a strong cash return on invested capital.

We ended the quarter with $14.6 million in cash on our balance sheet. The free cash flow and our cash balance was somewhat higher than we expected, because of lower than typical inventory levels and the tax benefit from stock option exercises year to date.

We spent $274,000 in capital expenditures this quarter, primarily related to investments in our Fat Rabbit projects.

In closing, we are pleased with our solid financial performance in the second quarter. Strong consumer trends, combined with a continued focus on our strategies around distribution, placement, awareness, and innovation continue to overdrive our top line results.

As a result, we are increasing our full year net sales guidance to 19-21%, which reflects fiscal 2013 net sales in the range of $168-171 million. We expect adjusted net income in the range of $14.2 million to $14.5 million, which represents year over year growth in the range of 25-27% on an equivalent tax basis.

The new adjusted EPS range for fiscal 2013 is $0.79 to $0.82, which reflects a tax rate of 40.7% and 17.9 million diluted shares outstanding. Relative to our original guidance, the higher expected tax rate reduced EPS by $0.02 per share this year.

Over time, we are confident in our ability to deliver stronger operating margins and higher net income and EPS leverage.

Now I’d like to turn the call back over to John for closing remarks.

John Foraker

Thanks Kelly. I’m happy to report that retailer and consumer interest in natural and organic has never been higher. We are in the early innings of our opportunity to build mainstream distribution on our existing items and to grow our brand footprint with exciting innovation.

Our strategies are working. As an organization, we are growing fast and we are culturally committed to continue improvement and winning for our shareholders, business partners, employees, and consumers. We’re excited about the opportunities that lie ahead, and we look forward to reporting more to you in the coming quarters.

Thanks.

Question-and-Answer Session

Operator

Thank you sir. We will now begin the question and answer session. [Operator instructions.] Our first question is from the line of Jon Andersen with William Blair. Please go ahead.

Jon Andersen - William Blair

I wanted to start out by asking you about two of the four key growth drivers. John, you talked about the focus on improving distribution in mainstream doors as well as improving the location of your products within existing doors. Could you just give us a little bit better sense of where you sit today with respect to those initiatives? Trying to understand what inning are we in, and how much opportunity is left there in the base business?

John M. Foraker

We’re in the early innings. The way to think about it is in two ways. First, in terms of depth of distribution on our existing items, our best distributed item is our purple box macaroni and cheese product, which right now is in the high 60 ACV range in U.S. grocery. The next item in that line would be in the mid-50s approximately.

There’s a significant dropoff below that, and when you look at our newer product categories over the last five to seven years, most of them are at ACV levels, on the best item, that are in the 30s. So we see significant opportunities to go deeper in mainstream grocery.

And second, and very related to that, we talked about in this quarter the impact of moving SKUs over from natural sections into mainline aisles. That’s been an initiative that we’ve been working very hard on for the last 18 months, and it’s really bearing fruit.

It’s bearing fruit not only because we’re doing a really good job communicating the retailer story and the consumer story and why the products will deliver incremental sales growth, incremental profitability, and category outperformance for the retailer, but also because we’re in the right place at the right time.

Most of the big chains in the U.S. are actively seeking opportunities to develop better and bigger business opportunities with the natural and organic inclined consumer, which as you know tends to have a higher income, they tend to be more loyal to the stores they shop, and they’ve got a really profitable basket.

So we’re seeing a lot of success in moving into the mainline aisles. And when we move into the mainline aisles, very often we’re expanding our ACV footprint opportunity with the chain because lots of times the natural sections somewhat delineate a small universe of stores you can get in within that chain. So we think we’re in the early innings of that.

The other thing, John, is that the innovation that we’ve been doing over the last few years and are continuing to do is benefitting from this same trend. So as we’re going in and resetting in the mac and cheese category, delivering strong results, it’s creating a narrative which is true that is spreading through the chains that that opportunity exists in other categories where we have our strong brand and can represent the same growth opportunity for consumers.

So we’ve had success more and more over the last couple of quarters in particular at selling that same story and growth opportunity to retailers in categories like fruit snacks, snack crackers. So we think we’ve got a long way to go, and we’re very early.

And then the other thing is we have a very deep innovation pipeline. We mentioned that we’ve talked a lot about frozen pizza, and I made it clear in my opening remarks that frozen pizza was really just part of a much broader strategy for Annie’s in frozen. And we see the same opportunity in those categories as well.

Positioning Annie’s as the natural and organic, cleaner, more premium alternative to the mainstream brand that appeals to this consumer’s need and desire for better products that they feel better about giving their family. And so I think you can view our business as a cycle of innovation, coming in, securing that position and category and building out distribution. And both those strategies work well together. So I think we’re in the early innings.

Jon Andersen - William Blair

I had one question on pizza. Can you help me understand where you are right now in terms of the distribution for pizza? Where you expect to be, I guess, by fiscal year end. And then are there any thresholds, any milestones you need to reach on pizza before you embark into other categories in frozen?

John M. Foraker

I’ll give you a little more color on where we want to be by the end of the year, and we’ll certainly talk a little bit more about this on our next conference call as we get more and more information on how the items are performing and how the distribution is rolling out.

As I mentioned last call, and as I reiterated this call, we’ve been targeting a list of about 25 top retailers across the country that we think have the right BDI, brand development index, category development index, for pizza. Stores where we can create a great footprint of initial distribution to build out a success story. So by definition we’re going to these chains, and we’re not necessarily saying we want to be in all your stores. In fact, in most cases we’re saying we want to be in this universe of your stores.

We began shipping into about 2,500 of those stores during the second quarter. We continue to knock down additional chains and expect to knock down more through the third quarter. The pace of store resets will slow down a little bit in the third quarter, because we’re ahead of the major category resets for frozen pizza, which will be in our Q4.

So we expect this 2,500 stores, plus the buildout in natural that I mentioned, to really take hold in Q3. We will add some incremental stores in Q3 for sure. And then that sets us up really well for Q4 to deliver strong performance at retail, a great story with the retailers, and then a big distribution expansion opportunity as those resets for their main annual reviews get done.

It’s important to note, and just remind everyone, that the distribution that we’re picking up in grocery stores for the most part on this 2,500 SKUs is coming outside of the normal category review windows. And that’s happening, as I mentioned before, because the retailers are so excited about these products they wanted to bring them into their stores earlier. That’s a very good sign.

They create some challenges for us, because as we get into the sections sometimes our placement’s not optimal, because it hasn’t been a full category reset, but rather a bit of a plug and play, where they’re pulling items that are underperforming out and putting Annie’s in. But as a general rule, we’re getting the price points we want, we’re getting a lot of really good facings. We have some work to do to improve our placement in some of the chains in terms of getting off the bottom shelf and getting off of our side of the box, but we expected that.

And so far the retailers have been very positive on how we’re doing. By the end of this fiscal year, we expect to have significantly more distribution than we have now, and we hope to see, and we expect to see, really strong retail performance through the whole rest of the year. I mentioned, and really wanted to imply that, we have seen some very strong early velocity results on the products, which we expected, frankly, because they have tested so strong and we’ve seen the certified organic items perform exceptionally well where they are.

So I’d say we’re on track, Jon. That hopefully gives you a good idea of how we see the year rolling out.

Jon Andersen - William Blair

The guidance revision on the top line was more than we saw in the bottom line. Did something change in there? Are your gross margin expectations lower because of some of the slotting and incremental investments in pizza?

Kelly J. Kennedy

We still expect our margins to be in the mid-39s. So that’s similar to what our expectations were previously. Two things I’ll point out are that we do have some headwinds with the tax rate. We went into our original guidance with an expected tax rate of 39.5%. We now have a good handle. We’ve bumped up to a higher federal rate. So our current tax rate estimate is 40.7%. So cost is about $0.02.

If you actually look at our net income we have tightened the range slightly. On an equivalent basis it’s 20. While we’ve raised the top lines at 19-21 net income growth is 24-27%. The only additional thing that I think we highlighted in our call is that we do have some incremental spend for this year to support pizza, because we are supporting it for three quarters.

However, we are dynamically managing our budget, and we have done some shifting, and we do expect to deliver for the year slightly improved, very similar to what we’ve been mentioning, SG&A leverage over fiscal ’12 on an adjusted basis as well as having slightly improved operating margin as well.

Operator

And our next question comes from the line of Rachel Nabatian with Credit Suisse. Please go ahead.

Rachel Nabatian - Credit Suisse

My question is regarding dressing and condiments. I know you guys said that it’s going to be less of a contribution as the other categories increase as a percent of your total sales. But just looking at the Nielsen data, it looks like growth for this category has been accelerating, especially in the last month. So I was kind of just wondering if there’s anything in particular that’s causing that, and what your strategy with the category is going forward.

John M. Foraker

I would caution you to really look at 12-week data. On a 4-week basis there can be volatility in our numbers up and down, just because of the timing of promotions year over year. However, your basic premise is definitely correct. We’ve seen strength in our dressing business. We’ve been focusing on building out more mainline distribution on dressing, making sure we have the right assortment and the right price points. And we’re seeing the benefit from that.

We also believe that the just generally improving consumer confidence and consumers feeling a little bit better about their pocketbook is also helping them in this category trade up. So we’re very pleased with what we’re seeing there. We’re still managing that business for modest growth and strong profitability, but we are seeing better than expected top line trends than we would have predicted earlier this year.

Kelly J. Kennedy

The total category, as we report, in terms of dressings, condiments, and other, while looking flat and/or down, we are lapping against a cereal discontinuation which happened in the fourth quarter of fiscal ‘12. If you exclude cereal, that category was up in the double digits, consistent with what we saw last quarter.

Operator

And our next question comes from the line of Ed Aaron with RBC Capital Markets. Please go ahead.

Edward Aaron – RBC Capital Markets

You mentioned in your prepared remarks having missed some sales because demand was stronger than you expected. I know you referred to it as kind of your top selling items. Could you be a little bit more specific on where you left sales on the table in the quarter?

John M. Foraker

It was mainly in macaroni and cheese. There were few top snack items where we saw some shortness as well. But basically the way to think about it is we’ve looked at what happened versus what we expected. We went into this quarter with a much stronger footprint of distribution on our macaroni and cheese business, not only higher ACV levels than prior year, which we obviously knew, but a lot more mainline distribution and much greater retailer participation in the brand in giving us strong secondary merchandising opportunities.

And so when we went into July and then August, we saw extremely strong macaroni and cheese business in that August timeframe, and really early in the month of August it was very clear that we were going to shatter all records in macaroni and cheese. And unfortunately we did not respond quickly enough to ramp the production up in our manufacturing facilities to be able to catch that demand before the end of the quarter.

So we shorted a number of customers across our top SKUs in macaroni and cheese, particularly in the last three weeks of the quarter. And it’s regrettable, and we absolutely could have done better. I’ll take credit and call out when I think we’ve executed well, but I’m also going to be very honest when we don’t execute well. And this is an area where we could have done a lot better in the quarter. I guess it’s a good problem to have, to have very strong demand like that, but we should have just executed better.

So we’ve taken a number of steps to make sure that we can avoid this kind of problem in the future, and I’ll mention a couple of those right now. We’ve relooked and reworked a number of our forecasting processes internally. We also are subjecting our production planning to much more rigorous external management review.

The third thing we’ve done is that our manufacturing partner is actually adding a second, smaller macaroni and cheese facility into the same facility where we manufacture all of our macaroni and cheese products. And what that line is going to allow us to do is allow us to do much faster cutovers on smaller secondary items that we’re maybe running short on so that we don’t have to do major changeovers on our line. Our main line is a very high speed line that can crank out huge volumes, and so when we stop that line to cut over to do a flavor changeover, we’re really reducing our efficiency.

The fourth thing we’re going to do is we’re going to be much more careful, and we’re going to carry modestly higher inventory levels on these very high velocity SKUs, particularly as we go into key merchandising periods. Back to school would be an example of a key merchandising period. Going into our Q4 timeframe and into the February-March timeframe would be another one. We don’t think it will wrinkle the total inventory numbers dramatically, but another million or two most likely on those items would be a good place for us to invest in capital, so we’re going to do that.

But the net effect was, if you really step back and look at it, our growth rate for the quarter would have been between two and three points higher had we executed well. And unfortunately we didn’t.

Edward Aaron – RBC Capital Markets

And then as a follow up, I know that small dollar changes can impact your financial metrics quite a bit. But I’m just trying to better understand the drivers of the SG&A deleverage in the quarter. I know you addressed it briefly in your comments, but what were the biggest contributors of the higher costs? And then also, how should we think about your ratio of fixed versus variable SG&A components?

Kelly J. Kennedy

The deleverage was expected. We knew that the spending pattern on SG&A for this year was going to look a little different than last year, mainly because in fiscal ’12 so much of that investment was in the second half of the year. Of course as we move into the second half we’ll start lapping against those spendings a little in Q3 and particularly in Q4.

But I do want to remind people that more than a third of our SG&A is variable, and that includes our freight and warehouse, our commissions, and a portion of our marketing spend. And so I think as we move into having much stronger top line, a portion of that does roll down to our SG&A.

With that said, as we highlighted in our pizza spend, a portion of that was in marketing spend that we moved up. It was planned later in the year and we moved it up into Q2. So we did have some incremental spending that was more than we originally anticipated to support the pizza made with launch in the second quarter.

John M. Foraker

But we do expect stronger leverage in the second half and in fact that’s implied in our guidance. And we expect that in the second half of the year and into next year as well.

Kelly J. Kennedy

Total SG&A overall, our expectations are similar, that we’ll have slight leverage for the full fiscal year over fiscal year ’12.

Operator

And our next question comes from the line of Scott Van Winkle with Canaccord Genuity. Please go ahead.

Scott Van Winkle - Canaccord Genuity

I missed it if you gave it. What was the timing on grahams and cheddar squares? Was that this quarter?

John M. Foraker

We are actually actively out presenting those to retailers right now. The first shipments will be in early January. That’s our plan.

Kelly J. Kennedy

So fourth quarter.

John M. Foraker

Fourth quarter, beginning of our fourth quarter.

Scott Van Winkle - Canaccord Genuity

And obviously you talk about slotting this quarter with pizza. When you have a fairly meaningful new product effort coming in Q1 of next year, shipping grahams and cheddar squares, should we be on the lookout for higher slotting around those launches?

John M. Foraker

We will definitely spend some slotting on those launches in Q4, but that’s baked into the guidance that we’ve just reiterated. And it won’t be a material number overall. Shouldn’t be.

Scott Van Winkle - Canaccord Genuity

And then if we look at last year, Q3 of last year was a real strong growth quarter. Can you remind us, what was the driver behind that?

John M. Foraker

Off the top of my head, it was higher levels of distribution on macaroni and cheese, some expansion in the mass channels. Basically just solid execution of the same four strategies that we’ve been talking about here for quite some time.

Scott Van Winkle - Canaccord Genuity

So you’re not cycling against some new product or something of that nature.

John M. Foraker

No, it’s core, base business growth that drove all of our growth last year really. Key items, expanding distribution, all channels, and also strong acceleration in consumer trends. We were at a good level, but we picked up to a higher level in Q3 last year. So it’s really this last four quarters we’ve seen a continuation and very consistent consumption growth.

Kelly J. Kennedy

And then promotions we run tend to be very similar year over year. There’s no major shift. There are small shifts in timing based on where holidays fall sometimes, especially when they come at the end of a quarter, but overall our general pattern this year is looking very similar to last year.

Scott Van Winkle - Canaccord Genuity

And then can you give us a little detail on the specifics behind the higher than expected tax rate? Was there something you were expecting to come through that didn’t come through? Is this a level we should think about for subsequent years?

Kelly J. Kennedy

This is definitely the level. We just ticked up to the highest federal tax rate, and we also have had, if you recall, I was talking a little bit about the shift to our customer pickups that are at our distribution center in Illinois. So we’ve had a shift over time with a little bit more concentration in Illinois, which has one of the highest state tax rates when you apportion there for net income. But this is a level where we could only, in future, if we had any tax beneficial programs, could come off this slightly. But this is a good rate to expect. And mainly, we’re just getting better. We finally have dialed in, and we feel like we have a good handle on the tax rate. And coming into the year, the federal tax rate jumped up on us.

Scott Van Winkle - Canaccord Genuity

And John, do you have any comments on next week’s vote on Proposition 37 in California? Any implications if it were passed for Annie’s?

John M. Foraker

The only comment I have is that we’ve been strongly in support of it. The fundamental proposition requires labeling of genetically modified foods, and we think that’s in the consumer’s best interest, to have the information and make their own choices. We looked at it and if it passes, I think it’s safe to say that it’s very likely to be held up in litigation for a long time. We here in California are used to initiatives passing and having them be held up in the courts for some time.

I think our assessment is that if it does pass, it will be a net positive, clearly, for natural and organic products, and GMO-free products. The issues for us to watch out for are making sure that we’re in a good position with respect to the supply chain if there’s an acceleration in demand for some of those items as bigger companies may switch over. We don’t really know the outcome right now. We’re hopeful that it will pass, but there’s an incredible amount of money being spent against it right now. So I call it probably 50-50 at this point.

Operator

And our next question comes from the line of Chris Growe with Stifel Nicolaus. Please go ahead.

Chris Growe - Stifel Nicolaus

I had a question for you, just to better understand the sales growth guidance. And I don’t know if there’s a way you can give any more color around it, but just to understand how pizza is contributing to that, for example. And also, you had talked about these new snack products, but is that something that now that they’re out there and developed, you’ve added a little bit more to your guidance for those products as well as they ship in in the fourth quarter?

John M. Foraker

We’ve been conservative in what we’ve baked into our guidance for those items, and you typically would be, especially in your first quarter of shipments. It will take retailers a while to approve those items and then get them set into category review. So we’re expecting some modest positive impact in Q4, but that really isn’t the driver.

I’d say we are definitely expecting some stronger growth from pizza year over year in the third and fourth quarter, and just progressive strength. But really the fundamental reason that we’re raising the range and feeling very confident about where we’re at is that the two biggest drivers in our business right now are expanded distribution of our best-selling items in mainstream grocery and also getting placed in better parts of the store, as we talked about earlier.

The third thing, which is also really positive, and we’re seeing this in our business, is our core business in the natural channel remains very strong. We’ve seen continuation of strong growth trends in the independent natural foods retailers as well as the super naturals all this year, and we feel like we’re in a good spot. We certainly took the range up. We’re going to do everything we can to continue to grow the business in a solid way. And we just think it represents confidence in the future and the fact that our strategies are working.

Chris Growe - Stifel Nicolaus

And I guess somewhat related to that, I was trying to understand, you have an expectation for more of your earnings in the second half of the year than you have historically. Is there anything to the phasing of the year? I guess part of this is just due to the lapping of some of the costs from a year ago. Is there anything between Q3 and Q4 we should be aware of, whether it be launch costs or that kind of thing, new product costs we need to be aware of?

Kelly J. Kennedy

The only thing I would point out is you’re correct, it has to do with the flow mainly of SG&A over fiscal ’12 versus ’13. And for ’12, we began to make investments. We mentioned that we’ve added people. We’ve added infrastructure. We began to incur some public company costs in the third quarter, but a little stronger in the fourth quarter.

Chris Growe - Stifel Nicolaus

You talked about some incremental marketing costs you pulled forward. Last quarter it was some incremental R&D costs. As you look at those items in particular, I don’t know to what degree you can talk about it for the year in rough terms. But sort of incremental investment you’re making this year to put behind these new products, or how much got pulled forward earlier in the year versus the second half of the year.

Kelly J. Kennedy

The spending that we did against pizza, and some of the slotting, we had actually planned for later in the year. So it was really timing to pull them up. But overall, it is a year of investment for us. We’ll be certainly making a little stronger support of pizza. However, we are going to be looking at some other programs and dynamically managing our budget just to shift some of those dollars. So overall, we’re not giving specific guidance, but we’re expecting operating leverage in the second half as well as over fiscal ’12 overall. So again, these are investments we’re making that really the strength behind them will be in ’14 and beyond as we see some of these sales really ramp up.

Operator

[Operator instructions.] Our next question comes from the line of Bill Chappell with SunTrust. Please go ahead.

Bill Chappell - SunTrust

I don’t know if you’re willing to break it out, but I’m looking at the meals growth. Was much of it driven by pizza? Or was it really just the upside from the mac and cheese?

Kelly J. Kennedy

Pizza actually drove a larger portion than it has previously with the made with and organic in the quarter. We’re not breaking out the specific. But it was material to the growth in the meal category.

John M. Foraker

The significant majority of it still is macaroni and cheese, and that business is really healthy.

Bill Chappell - SunTrust

And I don’t know the exact timing of these things, but I would think you’re finishing the bakeoffs (excuse the pun) as you look toward the new listings for the spring reset. When will you have a pretty good idea of where you’re going to be added in and how big that could be in terms of revenue?

John M. Foraker

We are doing a lot of bakeoffs. That’s a good way to put it. The way I think to characterize this is that on the last call, last quarter, we had really gotten through maybe seven or eight of the retailers on our top 25 grocery and mass lists that we were really targeting for these. We knew we had locked them down. We’ve knocked down a significant number more of those. We expect the vast majority of that list to translate over into pizza placements before the end of our fiscal year.

It’s a little bit early to call the exact numbers, because oftentimes the presentations involve two or three rounds. An initial presentation, follow ups, and discussion of stores. And we’re really working through that now. I can say that it’s going really well, and the response has been great. And we think we’re going to add a lot more stores.

And on top of that, I mentioned the strategy earlier, but we really believe that we have a great chance to perform strongly in this footprint of stores that we’re building right now. And if we do that, we think we’re going to position ourselves really well for the next set of reviews, which will be coming up. And a lot of those will be coming up in the spring, February/March/April timeframe.

Bill Chappell - SunTrust

And then just one housekeeping, Kelly. If I’m trying to get to 17.9 million shares for the full year, it looks like you have to have about 18 million for the next two quarters. Is that right, or is there something I’m missing from the 17.7 that was in this quarter?

Kelly J. Kennedy

No, I apologize. I’m rounding to 17.9. It’s 17.85, but it’s rounding up to 17.9. But you’re correct, we expect to build some additional shares over the next two quarters.

Bill Chappell - SunTrust

And that’s just from options exercising?

Kelly J. Kennedy

Yes.

Operator

And I’m showing there are no further questions. So with that, we’ll close the call. And if you’d like to listen to a replay of today’s conference, it will be available until midnight, November 10, by dialing 303-590-3030 or 1-800-406-7325, with the access code of 4570831.

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