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Executives

Carole Buyers - Senior Vice President, IR and Business Development

Steve Hughes - Chairman and CEO

Christine Sacco - CFO and Treasurer

Analysts

Scott Van Winkle - Canaccord

Mitch Pinheiro - Janney Capital

Andrew Wolf - BB&T Capital Markets

Jon Andersen - William Blair

Akshay Jagdale - Keybanc Capital

Smart Balance, Inc. (SMBL) Q3 2012 Results Earnings Call November 8, 2012 9:30 AM ET

Operator

Good morning. My name is Zac. I’ll be your conference operator today. It’s November 8th and I welcome you to the Smart Balance 2012 Third Quarter Conference Call and Audio Webcast.

This call is being recorded for playback purposes and will be available beginning two hours after the conclusion of today’s call. The playback will be available through November 22, 2012. The number for the replay is 1800-688-7339. You may also listen to the broadcast by logging into www.smartbalance.com and in the Investor Center clicking on the link.

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)

Some of the statements we will make on this conference call including statements about the company’s plans, strategies, beliefs and expectations are forward-looking and subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from what is expressed in those forward-looking statements for a number of reasons including those risks and uncertainties disclosed in the company’s filings with the SEC and in its earnings release.

Now, I’d like to turn the call over to Ms. Carole Buyers, Smart Balance’s Senior Vice President of Investor Relations and Business Development. Please go ahead, Carole.

Carole Buyers

Thank you, Zac, and good morning, everyone. With me today are Steve Hughes, our Chairman and CEO; Christine Sacco, our CFO and Treasurer. Earlier this morning, we issued our third quarter earnings release. If you’ve not seen the press release, it is available on the Investor Center page of our website at www.smartbalance.com.

The company uses the terms cash operating income and net income and earnings per share, excluding non-cash and certain items as a non-GAAP measure. The company believes that these measures better explain its profitability and performance consistent with the way the investor’s and security analyst evaluate our company in a competitive environment in which we operate.

Cash operating income is defined as operating income excluding stock-based compensation expense, depreciation, amortization, purchase accounting adjustments, restructuring acquisition and integration related costs and certain other items.

The company believes that the exclusion of both non-cash and certain items provide a better reflection of the operating profitability of the company and strongly complement the company’s planning and forecasting models used in providing investor and security analyst with important supplemental information regarding the company’s underlying profitability and operating performance.

However, non-GAAP financial measures should be viewed in addition to and not as an alternative for the company’s results prepared in accordance with GAAP. In addition the non-GAAP measures the company uses may differ from the non-GAAP measures used by other companies.

We have included in our press release reconciliations of cash operating income to operating income and of net income and EPS excluding non-cash and certain items to net income and EPS in each case as calculated in accordance with GAAP.

With that, I’ll turn the call over to Steve.

Steve Hughes

Thank you, Carole, and good morning, everyone. Before I start the call I want to take a moment to thank everyone in our New Jersey office for all their hard work and dedication over the past week.

In midst of Hurricane Sandy they worked very well together, kept the business running and help each other out through this difficult time. Also I want to send best wishes to those back, you’re still grappling with the aftermath of the storm.

Now let me provide the agenda for our call. This morning I will begin providing high level highlights from our third quarter results, as well as some specifics on our retail and consumer activity in the quarter.

Chris will then review the third quarter financials and provide some detail of 2012 and 2013 outlook -- financial outlook. I’ll then close the call with a review of what look for -- forward to in the last quarter of 2012 and 2013, and then take questions.

With that, on to the third quarter results. Beginning this quarter, we are reporting two business segments, Natural, which includes Udi's, Glutino and Earth Balance, and Smart Balance, which includes spreads, Spreadable Butter, grocery and milk. We publicized this change during our corporate reorganization announcement on October 2nd.

We also announced the plan to move the corporate offices to Boulder, Colorado, as well as change our name to Boulder Brands, Inc. This move is consistent with our strategic view of the company and will allow us to plan and execute more effectively. In addition, the new segment reporting is in line with how our company is now managed, the Smart Balance being led by John Becker and Natural Brands by TJ McIntyre

Overall, we are pleased with the third quarter results which are in line with our expectations and continue to reflect the impact of our key strategies and priorities. Our key strategies and priorities for the businesses are as follows. To continue with our growth plan for our Natural Brands while hold line of profits for our Smart Balance Brands.

Let me review the third quarter by highlighting some of our key accomplishments for our newly formed segments, Natural and Smart Balance.

First, our Natural segment, Udi's, Glutino and Earth Balance y had a strong quarter. Let me make a quick comment on each of these brands.

On July 2nd we closed on Udi’s and hit the ground running with this brand as we quickly integrated Udi’s into our sales and top-to-top customer presentations of the Glutino. It is clear, our customers are highly motivated, in many cases urgently so, to address the needs of the Gluten-aware in sensitive consumers. Our ability to provide a complete solution for grocery, frozen and bakery is proving to be very compelling.

Overall, we experienced strong net sales for Glutino and Udi’s combining for over 50% organic net sales growth in the quarter. Growth came from distribution wins, as well as building velocities on existing distribution.

Consumption growth was just as strong with Glutino’s consumption growth at plus 34% across all sales channels and Udi’s reporting plus 63% across all retail channels. While difficult to precisely determine, we believe approximately half of the gains are coming from increased velocity and half from distribution gains.

On Glutino, we are starting to see the benefits of all of our hard work over the past year, since the acquisition in August 2011. Our focus on innovation, renovation and top-to-top customer sales presentations are starting to payoff in a significant way.

So its embarking on our distribution driver Glutino over the past nine months, we have built a number of items at conventional retail to 9.4 from 8.4 just last quarter to 7.7 items a year ago.

Major distribution gains was shipped late in Q3 and as such we expect this trend to continue if not accelerate. In addition, we started to ship 12 new Glutino products in the third quarter. These include a range of past items, new crackers, a range of snacks, potato chips and tortilla Dippers and two new Genius bread items. Overall, Glutino was secured warehouse distribution of over 300 incremental items across all retail customers year-to-date.

As evidence by strongest division gains in the warehouse, our consumers are committed to gain in front of the gluten-free trend. The challenge over the next six to 12 months will be to secure the space at retail to ensure these headquarter acceptances resolved in retail distribution gain. Most of this new distribution just began shipping in Q3 and we expect the number of average items nationally to increase approximately 10 items by the end of 2012.

Adding Udi’s to our distribution drive over the past quarter has given us tremendous credibility with our customers as the strategic leader in gluten-free. We believe this will add our -- add to our strong distribution momentum on Glutino.

We also built on 5.6 items Udi’s items have in conventional grocery channel that company had just last quarter. At the end of the quarter Udi’s was up to 6.1 items and the conventional grocery as compared to 3.7 a year ago. This quarter alone Udi’s secured a 100 incremental customer headquarter accepted items across all retail channels and we’ll begin shipping these wins in Q4.

We expect these gains to continue and potentially increase, as our integrated sales team has more time to sell the very impressive Udi’s story and the combination Udi's Glutino solution.

For an operational view, we started up our Glutino Pretzel production in the U.S. in mid-July. Recall, our Pretzel are previously been manufactured overseas. This project allowed us to significantly increase gross margin for Glutino and we should see additional benefits from this project in Q4.

Moving onto our third Natural Brand, Earth Balance. Earth Balance continues to perform well with strong consumption trends of approximately plus 26% across all channels at natural, conventional and club. While Earth Balance performed well at retail, the net sales of 11.5% were impacted by the timing of promotions.

Also in the quarter, Earth Balance introduced two new culinary spread items, which were well received by the Natural channel and voted best new items at the Natural Product Expo East in Baltimore. More importantly, Earth Balance October sales trends are now matching consumption trends in the mid-20s.

Moving to the Smart Balance business segment. Our strategy for this segment is to hold the line on profits. Despite an overall net sales increase of 9.8% for the segment in the quarter, which was primarily impacted by the winding down of the Bestlife spreads and Smart Balance Butter Blends, we’re able to achieve brand profit improvement excluding the launch of Spreadable Butter.

If we exclude the impact of the categories and products we are strategically exiting, the Smart Balance segment only declined 4%, outpacing the spreads and butter category. We view the individual categories in Smart Balance.

On Smart Balance Spreads and Spreadable Butter, in the quarter, revenue for spreads and Spreadable Butter decreased 6.1% and consumption for the 12-week period ending 9/29/12 declined only 3.6%. We continued to be encouraged by the initial success of Spreadable Butters with an estimated 85% of the volume incremental to our franchise.

It appears this initiative has the potential to source significant volume from the butter category, adding an important new dimension to our most profitable business. Initial results including trial and repeat purchased data give us confidence. We are strategically -- we can strategically hold a line in the Smart Balance segment and grow our market share in the premium butter and spreads category.

Over the past 12 weeks ending September 29th, Smart Balance Spreadable Butters gained 12 share for the overall Spreadable Butter category. In addition to building on this early success, we launched the Better Butter Stick to complement it’s -- and already have 40% headquarter acceptance from this item. In addition, we are positioning -- position for a very strong trial generating program during the peak holiday baking season.

Our focus on premium spreads and butter is coming to life. The consumption trends for our premium spreads and butter category has continued to outperform the overall category.

Although, near-term, our net sales are impacted by the exit of certain products who are not strategic to our premium strategy, as well as continued weakness in the spreads category.

Recall that over the past two quarters, we begin to provide new consumption data -- trends which reflect our premium spreads and butter strategy. In order to do so, we began a more targeted focus on the premium segment of spreads with Earth Balance and Smart Balance, and expanded our view to include premium segment trends of butter, the Smart Balance Spreadable Butter.

In this way, it will better reflect how we are performing in a competitive set and which we market, merchandize our products in the premier consumer segments in which we can compete.

Let me review the March, the Nielsen data for the 12-week period ending September 29th for this premium spreads and butter strategy. The 12-week period ending September 29th, the premium spread segment declined 7.6%, while our premier brands outperformed the segment by declining only 4.5% on a dollar basis.

Overall, our dollar share in the premium segment increased 80 basis points to 24.6. It’s important to note that we expected -- we experienced historically unique phenomena in Q3 where the price of Smart Balance Spreads is actually higher than butter. We actually -- we expect that headwind to moderate as we move through the next several quarters, as the commodity price on butter has started to firm up.

As for the grocery business, consumption decreased 1.6% in dollars during the 12-week period, driven by pricing promotion in the cooking oil category.

Finally on milk, milk rebounded somewhat in the quarter with net sales increase of 16%. In the quarter we are able to improve our efficiency and trade spends with retailer, which improved our gross margin and net sales adjustment.

As we highlighted last quarter, we are making measured moves to improve profitability in milk by scaling back less profitable customers. Importantly, in the quarter, we were able to -- significantly reduced losses in milk.

And finally in Q3, we launched Smart Balance Kids Milk in the test market. We should have initial read on trail repeat performance on our year end call.

Now, with that, let me turn the call back over to Chris. Chris?

Christine Sacco

Thanks, Steve. Good morning, everyone. Turning to our financial results. Third quarter net sales increased 41.4% to $101.3 million, compared to net sales of $71.7 million in the same period last year. A number of positive factors impacted our net sales.

Udi’s represented $22.5 million of our net sales in the quarter. In isolation when compared to the same period last year, Udi’s net sales increased 46.1% in the period, notably below 62.9% consumption trend due to promotional timing.

Glutino represented three months this quarter, compared to two months in the last year's quarter. And finally, Earth Balance and milk reported positive growth, offset by declines in Smart Balance Spreads and grocery.

Organic net sales increased 11.1% in the third quarter of 2012, which assumes the company-owned Udi’s and Glutino for the entire third quarter of 2012, compared to the third quarter of 2000, excuse me, 2011 compared to the third quarter of 2012.

Excluding the impact of the fair value adjustment to finished goods inventory for Udi’s in Q3 2012 and Glutino for Q3 2011, gross profit dollars increased to $43.3 million in the third quarter of 2012 from $31 million in last year's quarter.

This primarily reflects the inclusion of Udi’s results, as well as the net impact of higher selling prices, which more than offset the impact of higher commodity costs and lower volumes in our Smart Balance segment.

Excluding these adjustments, gross profit as a percentage of net sales was 42.7% in the third quarter, compared to 43.2% in Q3 last year. As expected, the mix impact from lower average gross margins of Glutino and Udi’s and the introduction of Spreadable Butter mostly contributed to the 50 basis point decline in margin.

Looking at the segment results, in Q3 2012, natural gross margin increased to 40.6% from 39.7% in the third quarter last year, excluding the impact of purchase accounting. The increase in gross margin reflects supply chain improvement project for Glutino where gross margin improved 420 basis points year-over-year.

These include the Laval facility consolidation project completed in the second quarter of 2012, as well as the move of Pretzel manufacturing to the U.S. in the middle of the third quarter.

We have a wide range of margin improvement projects underway on our gluten-free portfolio and expect the gross margins on this business unit to continue to improve as we move into 2013.

Smart Balance gross margin increased to 45% from 44.4% in last year's quarter. The improvement in the quarter primarily reflects the positive impact of pricing in the spreads category, as well as the improvement in overall gross margins for milk, as the company gained efficiency on its trade spending.

Moving to brand profit by segment. Brand profit is calculated as gross profit less marketing, selling and royalty expense income. For the company’s natural segment and excluding the purchase accounting charges from the acquisitions, brand profit increased to $13.6 million in the third quarter of 2012 from $5 million in last year's quarter.

Brand profit margin excluding the purchase accounting adjustments was 26%, compared to 28.7% in last year's quarter as we invested more heavily in marketing for our gluten-free brands.

Brand profit for Smart Balance decreased moderately to $12.7 million in the third quarter of 2012 from $13.2 million in the previous year's quarter, primarily due to the investment costs related to Spreadable Butter. Excluding these costs, Smart Balance segment brand profit increased in the quarter.

Operating income increased 19.7% to $7.9 million in Q3, excluding restructuring, acquisition, and integration-related costs related to Udi’s and certain other items versus $6.6 million last year.

The charges impacting operating income in the third quarter of 2011 include costs associated with the Glutino acquisition, settlement of a class-action lawsuit and certain other items. Higher depreciation, amortization and stock-based compensation expense impacted Q3 2012 operating income by approximately $4.1 million when compared to last year's quarter.

Cash operating income increased 55.7% to $15.1 million in the third quarter, compared to $9.7 million in the prior-year’s quarter. If we assume the company-owned Udi's and Glutino for both period, organic cash operating income increased 22.5%.

Excluding the previously mentioned items, net income in Q3 was $2.1 million, or $0.03 per share, compared with net income of $3.5 million or $0.06 per share in last year's quarter. In the third quarter of 2012, net income was impacted by higher interest, depreciation, amortization and stock-based compensation expense when compared to last year by approximately $4.3 million, or $0.07 per share.

Now, let me provide some balance sheet specifics for the quarter. We entered Q3 with $243.5 million in funded bank debt. Taking cash into account, our net funded debt at the end of the quarter was $238.8 million.

Capital spending in the quarter was $2.8 million compared to $400,000 in the year-ago quarter. The increase in capital expenditures is primarily related to certain investments in machinery and equipment for our gluten-free businesses to drive further gross margin improvement.

Moving to our full-year 2012 outlook, we're reaffirming our outlook as we continue to expect net sales in the $360 million to $370 million range, gross margins in the 42% to 44% range and cash operating income in the $53 million to $55 million range.

Some other specifics as it relates to 2012, the company continues to expect interest expense to be approximately $14 million and depreciation and amortization to be approximately $14 million. However, given the increase in the company's share price and the resulting impact on performance-based awards, the company updated its estimate for stock-based compensation to be approximately $12 million.

Excluding the impact from severance-related stock-based compensation from our recently announced corporate reorganization, stock-based compensation is estimated to be approximately $10.5 million compared to our previous estimate of $9 million.

For 2013, we are reiterating our outlook initially provided on August 2nd. For 2013, we continue to expect sales to be in the range of $440 million to $450 million in cash operating income in the range of $70 million to $75 million. In addition, we are providing more specifics regarding this outlook.

Overall, we expect net sales growth in the 20% to 25% range versus 2012. We expect growth to be driven by the inclusion of Udi’s on a full-year basis and continued growth in our natural segment. We expect the natural segment to report organic sales growth of 20% to 25%.

In addition, we expect the smart balance segment to grow in the low single-digit range, driven by the benefit of Smart Balance Spreadable Butter. Gross profit margin for the year is expected to be in the 42% to 44% range as strong growth in the natural segment will have a mix impact on overall gross margin.

2013 stock-based compensation expense is expected to be approximately $7 million. Capital expenditures are estimated to be approximately $13 million primarily for margin improvement projects and capacity additions for our gluten-free business as we plan to stay ahead of the growth curve.

Depreciation and amortization is estimated to be $18 million. Interest expense is estimated to be $19 million, reflecting a full-year of increased debt and related interest rate and the amortization of deferred loan costs resulting from the Udi’s acquisition. The company tax rate is expected to be approximately 40%.

With that, I'll turn the call back over to Steve. Steve?

Steve Hughes

Thanks Chris. Let me wrap our call and say that we lookout to the remainder of 2012 and 2013 and there is much to look forward to. We'll be driving our natural growth platform with Udi’s, Glutino and Earth Balance and focus on holding the line on profit contribution for our Smart Balance segment as we benefit from the successful launch of Smart Balance Spreadable Butter.

With Udi’s and the combination of Glutino and Earth Balance, we’re now offering the offering the premier equities in two of the most powerful emerging trends in food, gluten-free and plant-based diet. So it’s a very strong hand as their net sales performance in Q3 sums it up.

Our natural brand portfolio grew at organic net sales of 42% in Q3 and consumption was even stronger at 44.5%. We expect this momentum to continue in Q4 and in 2013.

Second, the power of combining Udi’s and Glutino will create a unique competitive advantage. Let me review the product placement for profits on these products as we look at 2013. On placement, as evidenced by an additional 400 customer headquartered accepted items year-to-date on distribution of these two brands, the combined strength of Udi’s and Glutino is apparent.

This is going to be a very powerful combination. Retailers are looking for strategic partners to address the gluten-free trend and the combination of these two premier brands enable us to provide consumers with a two-tier brand solution with a comprehensive portfolio of great tasty products.

The additional items, we’ll be launching, will continue to benefit us in Q4 and early 2013. A number of customers have already are in the process of appointing us category advisor. Over the next six to 12 months, our focus will be on continuing to fill in headquarter distribution gaps and securing -- importantly securing the space of retail.

Ultimately, we expect three distinct retail placements, one is a 6 foot to 12 foot grocery shelf set -- shelf stable set, two is a half to full door in the frozen food isle and finally, placement in the frozen bakery set or shelf stable rack where velocities warrant. In all three areas, it appears that many retailers were looking to ask for guidance and recommendations for the options of shelf set and space requirement as importantly, where the space is going to come from.

On product renovation, we complete the major phase of reformulation across the entire Glutino product line in Q3, where we improved on taste and health benefits. As we said, when we acquire the business, taste delivery was an opportunity and a priority. We believe we have significantly improved taste on all of our Glutino items as well as improved the nutritional profile.

New packaging line look for the line for Glutino will begin to ship late in Q4 and early Q1. Product innovation in 2013, we have over 20 new Udi’s and Glutino items expected to launch while we will not disclose the items for some thick embedded reasons, I can say that they are complementary to our current line of business and will include the range of Udi’s grocery items. Look forward to sharing them with you as we roll them out.

And on profits, while Glutino reported 420-basis point improvement in gross profits in Q3 excluding purchase accounting, we expect continued improvement in Q4 and 2013 as we experience the full benefits of the pretzel manufacturing in the states from abroad and begin to leverage our optimally located state-of-the-art plants in Denver and Montreal.

As we begin to build volumes across all kind of Udi’s and Glutino items, a wide range of significant margin improvement projects are now evident. Chris mentioned we are building some additional CapEx into our 2013 model to capitalize. Most of these projects has very high ROIs and very best paybacks.

Third, with Earth Balance, we expect Earth Balance to continue a strong momentum in 2013 as the brand will benefit from its recent product introduction of culinary spreads and additional distribution gains in grocery and the supercenter channel. In addition, we’ll be launching several new and exciting products that are new categories in Q4 and 2013. For example, in Q4, we begin shipping four innovative plant-based snack items with broad distribution in the natural channel expected by the end of the first half in 2013.

Finally, I continue to be excited about the early success of Spreadable Butter as it will begin to help us ensure, we hold the line in our core spreads and grocery categories in Smart Balance. This new product adds strategically significant dimension to our most profitable business enabling us to source volume from butter and participate the fastest growing segment in spreads and butter, which is Spreadable Butter and increase our market share in the overall premium spreads and butter category.

Let me end the call by highlighting our corporate mission. Our mission has become leading health and wellness company, building out and acquiring natural brands that address consumer need states and focuses on supporting each of our brands with the robust pipeline and innovation, category leading brands and packaging graphics, strong customer relationship to fast track distribution build out and strong consumer support do marketing and education to drive awareness and loyalty. Our vision is to help change the way we one product, one solution at a time.

Now with that, let’s turn the call back over to conference operator for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) And we’ll go first to the site of Scott Van Winkle with Canaccord. Please go ahead.

Scott Van Winkle - Canaccord

Hi.

Steve Hughes

Hi.

Scott Van Winkle - Canaccord

Congrats on a growth. So, a few questions first the easy one. The interest expense assumption for next year seems high as the rate on that debt over 8%?

Christine Sacco

No. It’s not Scott, the rate on the debt is 7%, but we also in our interest expense line include the amortization of deferred loan cost, which is approximately $2 million a year.

Scott Van Winkle - Canaccord

Got you. Okay. And so, when we compare Udi’s to Glutino, obviously Udi’s has got a lot more to sales, consolidate on our couple of product categories versus Glutino. Yet, it looks like the same kind of same actions, they say, relatively close number of items per door. Is it ultimately going to be the Glutino has two, three x the numbers of items per door that Udi’s does?

Steve Hughes

I think Scott, that’s going. I think they might actually mirror each other as we move forward. I mean I think the current state, its tough to get the frozen space, the bakery space, narrow range of products. I think the key dimension is going to be pretty exciting to watch next year as we move Udi’s into that gross trial where we have some very exciting items. They are very complementary to Glutino and the Udi’s brand is got fabulous following.

That said, I think these two businesses have potential to be of comparable size and grow at a comparable rate. Right now, Udi is obviously copying some lower distribution numbers that has a higher rate today. But I think as you look at the absolute volumes for the last several months, the business have been shipping about the same sizes. Glutino has added some major new distribution gains.

So, I think we actually have potential here to have two brands that are going to be very complementary, but equal in scale and ultimately I think we’ll have a comparable number of items in each door. Might be Udi’s is more concentrated in frozen and bakery with a narrower range of grocery items and Glutino is primarily in the grocery set. But I think it gives us a really strong hand and it’s -- the reaction from the customers has been phenomenal.

I mean they are mostly thank you. Finally, someway they help show us the way in gluten-free. And as we go in with new products, we’re getting the great -- headquarter distribution the real hand-to-hand combats going to be carving this into 25,000 grocery stores and that’s in some accounts that’s going to have it quickly, other accounts is going to be take a little bit longer and take a little more work.

Scott Van Winkle - Canaccord

Great. And then Earth Balance, this Earth Balancing expansion into traditional supermarkets, mass channels obviously not at the rate of gluten-free stop, I understand but is that happening?

Steve Hughes

It has -- I mean this year we’ve grown distribution a bit. I think we’ve gone from like 1.0 -- the total brand 1.2 to 1.5 to 1.6 items. It’s going to be a major focus next year. We expect to make some major moves we got to focus on. I mean, the only brand growing in spreads right now is Earth Balance and we think that’s very good growing story. Well, we know about that while Earth Balance, they naturally sell at the rate of Smart Balance product.

We know that the consumer that they go to grocery store and they’ll find Smart Balance. They will go by at some place to sell us like whole food. So, we are getting that point across to our major retailers. So, I would expect Earth Balance that begin to get accelerated distribution not going to be at the scale and the speed which we are seeing on gluten-free. But I think it’s going to be a really nice growth story. And while we have a little bit of disconnect this quarter, our consumption was up 25% and shippings are running up 11%. We -- I would like to see us accelerate that 25% assumption growth rate as moving to 2013.

Scott Van Winkle - Canaccord

And then my last question I will get back in the queue. What percentage of the gluten-free products today are main produced at end of Q3 say are being produced in-house and how we begun to see the Udi’s and Glutino products moving from -- moving across manufacturing space, Glutino and Udi’s plan, Udi’s and Glutino plan if we see not yet?

Steve Hughes

Let me serve with the last part and I will turn to Chris, back to Chris for the first part of the question. We are beginning to look at both, Laval and the Denver facilities what they do uniquely well. So, we are going to be moving some production in the Laval and we’ll be moving some production into Udi’s to get maximum leverage on cost to goods there. But maybe Chris, you can question about the mix of internal, external.

Christine Sacco

Sure. Overall for the total company, it’s about 75%, 25% mix, 75% co-packed. On a Glutino basis, think of it as 35% to 40% of their products are co-packed, excuse me, are self manufactured and 90% to 95% of Udi’s are self manufactured.

Scott Van Winkle - Canaccord

Great. And Chris, where did that come from six months ago on Glutino?

Steve Hughes

It’s about the same, I think.

Christine Sacco

Yeah. We haven’t have big swings in Glutino. We used to talk 60:40 at the time of the acquisition. So it’s right around there.

Scott Van Winkle - Canaccord

Great. Thank you much.

Christine Sacco

Got it.

Operator

And we’ll go next to the site of Mitch Pinheiro with Janney Capital. Please go ahead.

Mitch Pinheiro - Janney Capital

Yeah. Hi, good morning.

Steve Hughes

Hey, Mitch.

Mitch Pinheiro - Janney Capital

My one, sort of big picture question is you are going to the national food show. I mean, I couldn’t tell you the number of new gluten-free products out there but Steve, let’s just say it’s got to be in the hundreds -- multiple hundreds and so you talk about the combination of Glutino and Udi’s and the strategic nature and in fact that you are being looked at as category advisor captain of this emerging category at mainstream grocery.

But to the non-celiac to be, to those unaware right now but maybe soon to be gluten-free, Gluten-aware consumers, does Glutino need anything? Does Udi’s need anything? Why do you have confidence that those brands will maintain their current market share of gluten-free and maybe even grow. And how do you think about the coming influx of gluten-free and all the noise it’s going to be around that?

How do you standout as this is going to require more marketing expense, more in-store promotion? How should we think about that and then if you could just give me an update on the average number of items? I thought you gave that. I was little confused that the average items per store and your market share among the total items of gluten-free and where you expect that to go? Thanks.

Steve Hughes

I think let me talk about the broader category. This obviously, when there is growth, there is competition. But this is really -- we really are the big fish in the smaller -- small but growing pond. All of our competitors right now are really offering one brand, one category ideas and there are small mostly, very under capitalized companies. I think the thing that’s really unique is by putting Udi’s and Glutino together. We’ve got this business that we will do $160 million this year growing at 50%.

The number two brand now is like $25 million that’s a one category, very narrow play. So, with that, there comes the infrastructure that was in place. We had built phenomenal credibility with customers with Smart Balance. Smart Balance, while hasn’t had to kind of growth in the last few years we would like to see. Over the last 15 years, it’s been the fastest growing brand that’s been in the market for last 15 years and that creates a lot of credibility with customers.

So, we not only have that, but we also have the category management sophistication, the ability to invest in shopper studies and Nielsen and all the tools that, the retailers really need to make strategic decision. So, I think we really are the big fish here and I think its being very well received. I mean, we’ve had great complements from a lot of customers.

The position of the two brands, again, we are comprehensive category solutions. We now covered 20% categories that all the time we probably see Udi’s and Glutino participate in all 20 of those categories. Glutino is a legacy brand. It’s been around for 20 years. It’s the brand that does concentrate more with the truly hardcore celiac and Gluten sensitive. Udi’s, Denise Sirovatka and the marketing team there has done a phenomenal job positioning that brand is friendly engaging partner and the journey of solving gluten-free and the friends of Udi’s engagement there is pretty extraordinary.

So, I think within the strategic context. I mean we really do have a comprehensive solution. That does have the scale which scale comes better gross margins with better gross margins does gives you the flexibility to deliver great growth in earnings while you are growing the business, but saw -- also it does allow you to increase your marketing spend affectively and efficiently.

So, I think that’s a pretty good combination. When you look at total items, we’re up to now, I think, 15.5 a year ago we were about 9.5. But a lot of new distribution went into the pipeline as you got towards the end of the third quarter. With the holiday season, some of that will not fully get the retail to the first quarter.

But I think we are going to see, every quarter I would like to see us picking up one to two items across Glutino and Udi’s. We might see a spike in that. We have some retailers that are already committed to in grocery and eight foot section, on average across their four chain of stores but that’s going to be sequel.

Wal-Mart is an example where they just moved from 1,200 stores to 1,800 stores. They are committed to move the 3,000 stores in May, not only they are keep moving that up with their first wave of products, we presented. We’ve got a second wave of new products that are taking the majority of those items. We just presented a third wave of items, but we think they are taking majority of the items.

Another one, the top retailers is basically going to make a move in April, where they are going to carve about eight foot sections and 1,200 stores. We were closely with them trying to figure out where would they find eight feet. And it’s kind of that kind of almost operational challenge.

It’s not a strategic issue with the retailers going to be in front of this trend and getting pod up. I mean there is real urgency there at the strategic level. It really comes down to the operational nuts and bolts to carving the space out.

Mitch Pinheiro - Janney Capital

Okay. And that’s extremely helpful. On the 15.5 versus the 9.5, what would be like the total average category, I think I remember is 35 items, has that grown?

Steve Hughes

Yeah. That’s it was 39, and I think it’s now up like 45. I think what you are going to find and this is our objective is we get these eight foot sections in place and eight foot section will ultimately handle about 80 items. We are targeting to have at least half of that set. So, when -- if I fast forward 12, 18 months from now then we have eight foot sections in 25,000 grocery stores.

I mean you are going to see it. The first thing you are going to see is a big block of Glutino and you are going to see a tier of Udi’s items. And I think we are going to have -- my objective is to drive this. So we get to ultimately 40 items of an 80 items set. Now, that you just say 30,000 feet. It’s going to happen in 25,000 grocery stores.

But the will and wind is at the back of getting this done from a retailer standpoint. It’s just going to be each customer, each store is going to be a challenge to carve it out. But I think we are going to be clear, significant leader in this section. And we are doing it, build faster way. We are bringing the insights. We’re bringing investment and graphics and packaging brand. We’re bringing it in terms of really fabulous new products and improvement in products.

And I think lastly, this is going to be a little bit of arms raise. I mean as people get more and more scale, you are going to see products improving. We are watching all these new products we’re mentioning. We had good ideas out there that we think we can incorporate but the other element because of setting some competitive installation here is we are getting real scale now.

And I think we are going to see this in our gross margin line over the next 12 to 18 months as we are going to be able to I think generate profit -- levels of profitability on this business that are different than people that are, kind of, one brand, one category $10 million, $15 million business. But it’s going to be competitive. We’ve got to be on our toes. And I think we’ve got clear strategy that we are going to be leaning into and it looks the retailers right now are leaning back with us.

Mitch Pinheiro - Janney Capital

Great. Thank you. Very helpful color there.

Operator

And we’ll go next to the site of Andrew Wolf with BB&T Capital Markets. Please go ahead.

Andrew Wolf - BB&T Capital Markets

Hi. Good morning.

Steve Hughes

Good morning.

Andrew Wolf - BB&T Capital Markets

Just a few things to clarify, the things you’re saying. So I understand them. You said you had I think 400 new product -- incremental product placements. And then last -- I think on last call you said, just specific to Glutino 150 new.

Steve Hughes

Right.

Andrew Wolf - BB&T Capital Markets

At 20, I guess retailers, is that -- are you just talking Glutino, is that an apples-to-apples I mean have you?

Steve Hughes

Yeah. We basically in the third quarter again, little of this is we started really selling the top strategy in the first quarter. So it takes a while for the bill and get around decision making through the decision making windows. But we in the third quarter went from 150 items to 300 items on Glutino and added an incremental 100 placements on Udi’s. But we really -- we didn’t get our integrated sales force really turned lose one, Udi’s until early August. So I think this is going to continue to build.

I mean I think we are going to -- fourth quarter you will get a lot of headquarter replacements because it kind of shutdowns for the holidays but I think as we end the first quarter, I think we’ve got a lot of open opportunities. And the nice thing is I mean I’ve never seen this for my career.

I mean we picked up -- we’ll have sales cause, we pick up 20 items. We’ve had sales cause we picked up 65 items in one customers. So, it’s building and the fact in the third quarter we added about 250 points of distribution in warehouse now. Our big focus is how to convert that, the convert -- the yield of that to retail.

So, we have examples, for instance, one customer who took 27 items, Harris Teeter. Well, they’ve -- we've seen of those 25 items, 17 get the retail and Harris Teeter is up 175% of the sales.

So, we clearly have the cause and effect here that we will keep having away. We will be going back to customers who make big moves in warehouse but have -- aren't getting the right yield of those retail because they are really trying to become a destination. I mean, I think what we are really getting across to these retailers is -- this is a very valuable consumer. They spend three times the regular consumer, when they’re going to shopping trip, its been a $100, versus $32.

They will -- 61% of them will leave the store, if they can’t find their selection. And they are not interested in treasure hunts. So they wanted one devoted eight foot section. So it’s got -- and all those points resonate nicely with the customers. So its really now the logistics that we have carved into the 25,000 stores.

Andrew Wolf - BB&T Capital Markets

I can see that in different stores. Some of them are trashing conventional, some kind of get in, some are just are itself for products there?

Steve Hughes

I think right now I would say all but -- I can count on one hand the customers that are getting this at the strategic level. But each customer is got a whole different operational set of complexities. And some like Wal-Mart are moving quickly and comprehensively, I mean, I think ultimately Wal-Mart is going to have placements in grocery, in frozen and in bakery. There are others there, right now just trying to get the grocery figured out and we’ll fall later with frozen and bakery.

So it’s a -- it's pretty complex, we actually have a very divalent plan for each retailer and we know where we want each of them to get to. Some of them will get there by the end of the first half next year. Some of them won’t get there until the end of the first half in 2014.

Andrew Wolf - BB&T Capital Markets

Got you. And some of the numbers, I think, Chris gave on Udi’s, it looks like the sales absolute dollars was sequentially a little lighter as was the year-over-year growth. But it was below consumption.

Steve Hughes

Yeah.

Andrew Wolf - BB&T Capital Markets

And I think the reference was to not matching promotions. But it kind of looks like if you smooth it out the last two quarters sales growth, you get to pretty much where consumption was.

Steve Hughes

Yeah.

Andrew Wolf - BB&T Capital Markets

Just looks like the sales growth was a little lumpy. But I’m just trying to understand, it looks like it’s growing 60%, 70%, if you smooth it out…

Steve Hughes

Yeah.

Andrew Wolf - BB&T Capital Markets

… on both sides. But what did you mean by the promotions or people just pre-buying price increase or something last quarter, just little on that?

Steve Hughes

No. It’s actually really pretty simple. I mean, we had about a 20-point disconnect between shipment and consumption annuities. And again, in addition to the consumption number, we are putting in new incremental distribution as well.

So, we would have expected, if we are up 63% in consumption, I wouldn’t really count that the expected shipments be up 70% or 75% because of the new distribution we are getting.

But on Udi’s, it was -- it’s as simple as, they were a private company. They have a major fall promotion that starts October 1st. Last year, as a private company, they recognized revenue when they shifted. So they had a huge week that last week of September, going into the promotion. As a public company, we recognize revenue when we delivered.

So, we didn’t have, we really kind of cut out that first week. We had a very strong October on both Udi’s and Glutino, very pleased on both those businesses. So, again, I think that we should all ultimately all we see revenue. We had the same issue -- we had the same disconnect on our balance. We have 25% in revenue and 11% in shipments. It was kind of a promotional timing change from last year.

So, I mean, we arguably could have had $2 million, $3 million, $4 million more of revenue this quarter, if everything lined up consumption and revenue. So, ultimately that equals out and we are encouraged by what we are seeing from the start of the fourth quarter.

Andrew Wolf - BB&T Capital Markets

Okay. So that was just an accounting treatment. One last question kind of big picture. As you look at potentially doing more acquisitions, is that only going to -- in your mind is that reserved with buying another business, would that just be in what you call a natural segment or could you do one and what you call in the Smart Balance segment or as I think of it, conventional/functional foods company?

Steve Hughes

Yeah. I think our focus is going to be on the emerging natural company that’s one of the key trends. So it’s a really neat state play. Brands that we see can be category elastic that can be a multiple categories.

But we think our core competitive strength is going to be the crossover, being able to maximize businesses in the natural channel, keep them maximized and white-hot even as we get them crossover.

And but then this crossover capability and we worked closely with Acosta who has both the conventional sales team and a natural sales team. We kind of integrated those for the crossover and we are tying to really create a unique competitive skill there.

So, I would think that going forward, future acquisitions will be kind of those emerging brands that are ready to blow up in grocery, but haven’t yet because they haven’t had necessarily the investment or more importantly the skill set to do that. But that will be, probably kind of where we focus and I think one of the reasons, why we move to the Boulder Brands -- brand name is kind of make that kind of self evident.

And the nice thing is, we have a very short list of companies that would be interesting to us. We are getting -- we get a lot of interest now. So, I think when the time is right and opportunity is right, you will see us making moves, quite likely be Natural Brands that are really well-established in the Natural food channel, but probably have little or limited distribution in grocery and we think that’s when we can power up pretty significantly over the first 12 to 24 months.

Just what we have done with Glutino, I mean, the thing about Glutino, which is very impressive. We bought Glutino. The business currently had been installed. There hadn’t been a lot of investment. It was actually down and whole food is down in the Natural channel.

I mean, we are seeing Glutino now plus 25% in the Natural channel. Obviously doing -- starting to do better, done a lot better in the supercenter channel, but starting to build momentum and now we got a business growing at 35% and we are pulling all levers to see if we can accelerate that going into 2013.

Andrew Wolf - BB&T Capital Markets

Thank you.

Steve Hughes

Yeah.

Operator

And we’ll go next to the side of Jon Andersen with William Blair. Please go ahead. Your line is open. Mr. Anderson, your line is open.

Jon Andersen - William Blair

Good morning. Can you hear me?

Steve Hughes

Yeah. Hey, Jon.

Jon Andersen - William Blair

Hi, guys. Hey, just a couple of quick questions. One, Steve, you mentioned a couple times that most of your customers are getting the gluten-free story, but some may not be. What -- for those who are not or are pushing back a little bit, what are they missing? Is it a matter of priorities for them right now? Are they not seeing there is a long-term opportunity and kind of, what are your plans for breaking that down?

Steve Hughes

So good news, all the top 10 accounts get it and they are kind of in a horse race to get right with it. The accounts that right now aren’t need it and aggressively are kind of smaller accounts. They might have 1% U.S. market. They are only about three or four of them. And I think it is just a little bit, those -- a couple of -- are companies that are having pretty cyclical business issues.

So they are not really able to focus as well on this. But I don’ think, I think that all changes. I think we’ll have kind of a unanimous buy in on this within the next six months as it scales and they’ll also add some of the leading accounts, a Wal-Mart or Kroger or Safeway, as they really kind of get in the full gear with the distribution in the market -- and start merchandizing these products and promoting these products. I think you will see everything fall.

I mean the customers that the world follows, the rest of the retail world follows are very aggressive one on building out their gluten-free solution. And I -- so again, I think it really is an exception right now and the ones that are exceptions, if I read off the names you wouldn’t be surprise who they were and they tend to be not be leaders, they tend to be followers.

Jon Andersen - William Blair

Great. That’s extremely helpful. Sorry, if this has already been asked, I’ve just jumped on the call. But Wal-Mart has been -- it seems like a leader in terms of kind of approaching this opportunity at least with the mainstream food channel.

Can you just give us an update on where they are in terms of the number of doors they have the eight foot sets in and how Glutino and Udi’s fit within that? And then what you see them, how you see them expanding on -- over the next several quarters?

Steve Hughes

Yeah. I mean, it’s a moving target. They’ve started this year and started off with 1,200 stores. In October, they moved to 1,800 stores. In May, they will move to 3,100 stores in grocery.

They are very focused store and figuring out the frozen door. They will probably be doing a door in a kind of similar model. It won’t be 1,200 stores but they will take the first step on frozen we think in December. They are trying to figure out exactly how to handle this in bakery.

So they and I think in that grocery set, they’ll have -- across those 3,100 stores they’ll have some stores of 4 foot sections, some with 12. I really expect us to have about 50% of those sets, when it’s all said and done, but we’ll see. We’ve had a great relationship there. We’ve actually been -- we’ve been very close with them on trying to help them figure out the right -- in addition, not only do the right items from Glutino and Udi’s to put in but the right other items to put in the section.

So it’s been a really great relationship in that standpoint. And I think we’ve actually start doing some [downloads] with them that have been very effective. And so we really expect to kind of work hand in hand with them. We’re doing the same thing with taking -- we're really trying to partner with each customer, given where they are on the learning curve and the development curve.

But I think Wal-Mart, one of the things that Wal-Mart said to us which is pretty exciting because right now Udi’s is only in 50 or 100 stores, kind of, in different variations of test but they actually told us that Udi’s is the most requested brand they get in entire store. So the likelihood is they’re going to figure out how to get Udi’s in 3,100 stores in next 12 to 18 months.

But it’s pretty exciting, this Udi’s brand, I’m not -- I've been developing and building brands for 35 years. I have never seen anything with any brand with this kind of connection. I mean, we launched Udi’s into Canada. They launched Udi’s into Canada 12 months ago with four items, no devoted market in Canada. They went from zero to the number one brand that they agree in Canada with four items. And Laval’s just went from four to 17 items on Udi’s.

So I think we’re getting clumps of vibration. I think when Udi’s moves into these groceries categories, it’s going to have a real major impact. On Udi’s pizza, I mean, it’s another example where -- just -- it's one part of the portfolio, with Udi’s pizza right now is about 15% ACV, on a velocity per point basis, it’s out showing Amy’s 4 to 1. On a velocity per point basis it now show at Amy’s by 30% and we’re just getting it going and we haven’t changed the graphics we want to get.

Those graphics could be fabulous. So I think pizza is going to be a great dimension for us. The ability about gluten-free, it really gives us an entry in any category that we compete in it and while the pizza -- while the world doesn’t really need another pizza, the world does need a gluten-free option. So I think it’s going to be really our biggest challenge as a company is going to be shop selection, which is a high-class problem to have.

I think we’re going to see some of these -- I mean, we just launched Glutino pasta. It’s already been on the shelf for one customer for four weeks. But -- last week, it outsold pretzels. So I mean, we’ve got these dimensions, they’re going to put in and as these things unfolds over the next 12 months, I think we’re going to see some very surprising segments of the business grow and maybe segments of growing business that run today becomes some of the more exciting larger pieces of the portfolio.

Jon Andersen - William Blair

Terrific. Just one quick big picture question is when we change in terms of your expectations for the respected gluten-free standards, the definition that maybe coming out from regulatory authorities and what are the implications there for you?

Steve Hughes

Yeah. I think this is a big deal. Right now, there are no guidelines and there is no required testing. I would be surprised if everything has been marketed gluten-free as gluten-free today. The celiac, the tripwire for celiac is 20 parts per million. Now, Canada has a guideline of 10 parts per million, Europe has a guideline of 10 parts per million. We want that parts per million to be as low as it possibly can be.

We test all of their products where they’ve shipped. We have untraceable levels of gluten and we think that they’re really sophisticated consumer. The really concerned consumer, the one is the celiac are highly sensitive basically has two questions. I mean, they are concerned about co-manufacturing, trying to produce a gluten-free product and gluten-filled facility.

They are so concerned that they really don’t like the idea of it being merchandised next to each other. So in the baking mix isle are having gluten-free next to gluten-filled product. They know those packages are not amicably sealed. So one of the reasons for the most motivating consumer is they wanted to devote their set is they’re concerned about the shelf contamination.

So I think this is -- again this is another bar. We’re already operating on it -- on the most restricted untraceable levels. We test rigorously. That’s the cost and we give a benefit. Right now, it’s not something that rest of the world competes with. So I think as these criteria get set, testing becomes mandatory. I think it’s going to be more challenging for the emerging companies to be able to invest that money to make sure that they are in fact delivering a gluten-free product.

Jon Andersen - William Blair

Okay. Thanks.

Operator

And we’ll go next to the site of Akshay Jagdale with Keybanc Capital. Please go ahead. Mr. Jagdale?

Akshay Jagdale - Keybanc Capital

Hi. Just wanted to ask a question on the gross margin profile for Glutino and Udi’s. Can you remind us what the trajectory is longer term and so where you are in that process? I know you had given some guidance on Glutino, but we’ll be helpful if you could just refresh us on that and also give us some color on Udi’s? Thanks.

Steve Hughes

Chris?

Christine Sacco

Sure. We talked that our Udi’s gross margins are around 40%.

Steve Hughes

Correct.

Christine Sacco

We see improvement in projects and opportunities as Steve mentioned on the opening remarks. In a lot of different areas, we see opportunities for either automation, opportunities to bring something in-house that could potentially be outsource, right, co-packed right now.

Glutino margins during the quarter, we’ve talked about the consolidation of the facilities in Laval that was completed in the second quarter, late in the second quarter. Glutino has in the third quarter 420 basis point improvement year-over-year net margins. We expect those to continue to improve.

We also mentioned on the call that we have in the middle of the quarter, we begin shipping our pretzel line out of the U.S. have previously been international -- internationally co-packed and so we saw part of that benefit in this quarter, but we’ll continue to see that in Q4.

So, we expect Glutino’s margin to continue to improve in the fourth quarter, say in 300 to 400 basis point range. What’s interesting to note about the brands with these kind of growth, we expect -- but we expect a lot of margin improvements and we definitely see that there. There will be some investments for new distribution in programs to support the growth and the new products going forward. So it’s just something to keep in mind to help you with as space in the guidance that we gave.

Steve Hughes

I think going that as well, I mean if you look at these businesses. I mean scales are powerful things. So, even though Udi’s is 40%, they are making bread at a fabulous gross margin and that still a batch -- that’s still a system where we have 53 ovens. So, there was an opportunity for us to go to continuous production and further improve those gross margins going forward.

And scale will be leveragable. I think these businesses, I wouldn’t put a timeframe on it, but as we scale that’s combined businesses and get the right products produce in the right plans and such. I think we have -- when the total Glutino, Udi’s business potentially Udi’s and do a mid-40s kind of gross margin and that will be a pretty powerful competitive point, difference of those will be in the batched model.

The other thing that we are thinking through is -- we provide a guidance and we have an internal plan and I put that in the sleep at night category for 2013. We want to be prepared, if everything breaks away to be able to handle demand. It is primarily bread that has its focus little bit. We have great upside capacity as we bought the business, but the business is growing 63%.

So, we may actually do some proactive investment in 2013 to be positioned. It may not be capacity we need till 2014, but we might need it in April in 2013. So, we are going to be out in front of this that we can support demand. I mean, we have a pretty complex line of the products, 20 categories, 150 items in the gluten-free space, we need to be in position that, as we get new distribution and the -- new distribution turns into velocity that we can handle a range of outcomes next year. And we are spending a lot of time making sure exactly how we do that and when we do that, so that we don’t get cost short.

The worst thing could happen to us is, this moves up much faster in 2013 then we are calling for in our guidance or in our internal plans. And we are out of, behind eight months or six months as we scrambling again capacity in place.

Because, I think the retailers -- the retailers are going to -- are we at end of this. The question is just, at what point in time we see it all come together with broad based retail availability against the businesses. If there, are there any questions operator?

Operator

We have no further questions. Thank you.

Steve Hughes

Great. Well, again, I appreciate everybody’s time. Again this was a bit of transition quarter. I think its, look back what has been an inflection point. I think we’ve got a lot of good things in the works and we are looking forward to seeing strong finish in 2012 and really getting into 2013, and really seeing what we have with our Natural portfolio also feel, very looking forward to seeing what happens during this major trail portion of Spreadable Butters in the fourth quarter as well. So everybody have a great day. I appreciate you taking the time.

Operator

And this thus concludes today’s teleconference. You may now disconnect. And have a wonderful day.

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