The Marzetti Company (MZTI) Q3 2010 Earnings Report, Transcript and Summary

Good morning. My name is Kimberley and I will be your conference operator today. At this time, I would like to welcome everyone to the Lancaster Colony Corporation's third quarter fiscal 2010 conference call. Conducting today's call will be Jay Gerlach, Lancaster Colony Chairman and CEO, and John Boylan, Vice President, Treasurer and CFO. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (Operator instructions). Thank you. And now to begin your conference, here is Earl Brown, Lancaster Colony Investor Relations.

Thank you and good morning. Let me also say thank you for joining us today for the Lancaster Colony third quarter fiscal 2010 conference call. Now please bear with me while we take care of a few details. As with other presentations of this type, today's discussion by Jay Gerlach, Chairman and CEO, and John Boylan, Vice President, Treasurer and CFO, will contain forward-looking statements of what may happen in the future, including statements relating to Lancaster Colony's sales prospects, growth rates, expected future levels of profitability, as well as the extent of share repurchases and business acquisitions to be made by the company. These forward-looking statements are based on numerous assumptions and are subject to uncertainties and risks. Accordingly, investors are cautioned not to place undue reliance on such statements. Factors that might cause Lancaster's results to differ materially from forward-looking statements include but are not limited to risks relating to the economy, competitive challenges, changes in raw materials costs, the success of new product introductions, the effect of any restructurings and other factors as are discussed from time to time in more detail in the company's filings with the SEC, including Lancaster Colony's report on Form 10-K. Please note that the cautionary statements contained in the Safe Harbor paragraph of today's news release also apply to this conference call. Now here is Jay Gerlach. Jay?

Good morning, and thank you again for joining us. We are pleased to report overall sales growth in our non-seasonal third quarter of just under 2%. While our Food segment sales were close to flat, the Glassware and Candle segment again provided all the sales growth. Profitability improved in both segments resulting in total earnings per share of $0.86 versus $0.76 last year. There were no share repurchases in the quarter. Capital expenditures reached $4.4 million in the quarter and $8.1 million for the nine months. We anticipate somewhat less than $15 million for all of fiscal 2010. Specialty food sales were close to flat, down $423,000 with retail channel sales up about 6% while food service channel sales were up just over 6%. Pricing was down about $6 million, mostly food service and largely due to lower commodity costs. While difficult to estimate, the earlier Easter this year helped retail sales by perhaps $3 million to $4 million. Year-over-year, the quarter's operating margins benefited from a higher retail sales mix as well as lower material costs estimated at over $7 million. However operating margins in the quarter of 17.9% were below the 23% second quarter margins as increased promotional spending, both to the trade and consumer higher marketing costs and product recall costs all contributed to bringing down our operating margins from their peaks. We did see a need to react to some competitive situations which drove up our trade promotion spending. At the same time, we were increasing our consumer spending to support our key brands especially during the Easter sales period. Sales mix in the quarter was 53% retail compared to roughly 50% a year ago. We saw growth in each of our key branded retail product lines, Marzetti refrigerated salad dressings and veggie dips, Texas brand croutons, and Sister Schubert brand frozen dinner rolls and New York brand Texas garlic toast. Glassware and Candle. Glassware and Candles segment sales were up 16% in the off season quarter. The growth drivers included the benefit of recently introduced products, good candle sellthrough during the holidays creating post seasons orders and continued strong sellthrough in our key mass channel customers. Higher capacity utilization, good operations and lower wax cost contributed to the earnings improvement. Now let me ask John to make a few comments.

Thanks, Jay. Let’s start out by discussing several key components of our consolidated balance sheet. Accounts receivable at March 31, 2010 totaled $80,011,000. This amount represented a 31% increase over last June’s total and was 11% above the level of last March. The relative strength and timing of the quarter sales including that of March in particular led to this growth. With respect to our inventories, the consolidated total of approximately $97 million at the end of this March reflected somewhat decrease of about $5 million or 5% from the level of this past June. On a year-over-year basis, our March inventories increased about $7 million or 7% as we've begun building some candle inventories to meet anticipated increased demand. As it relates to our capitalization, we continue to have no debt and as of March 31st our shareholders equity exceeded $475 million. With cash and equivalents on hand of over $95 million, we remain well positioned to meet our foreseeable cash needs and retain flexibility to consider business acquisition opportunities. Echoing the observations of others, at least compared to a year ago we do seem to be seeing more proposed transactions coming our way which is encouraging. Except for the items I have already discussed and for a change in how the timing of our estimated federal income tax payments have affected our other current asset balances between last June and this March, I believe the other fluctuations in our balance sheet components are relatively unremarkable. Turning to cash flows, I’d like to share a few items for your consideration. Within the current fiscal year, depreciation and amortization for the first nine months totaled $15, 666, 000 and shareholder dividends were $24,959,000. Lancanster's consolidated cash flows provided by operating activities for the nine months ended March 31 2010, totaled approximately $86.9 million compared to $92.8 million a year ago. While the prior year's net income for the nine months was $31 million lower, cash flows of fiscal 2009 benefited from several comparatively favorable changes in working capital components including a period of declining inventories resulting from both the planned reduction program for candles and from generally declining material costs compared to fiscal 2008. Finally one matter some of you maybe wondering about is the impact of the recent product recall activities we conducted in the quarter. These efforts were required due to the potential for product contamination resulting from certain raw materials received from one ingredient supplier, Basic Food Flavors. Like the many other food processors affected by this issue, we diligently work with our customers in conducting a formal recall of a limited number of various finished goods, primarily certain flavors of vegetable dips. The financial pretax impacts to the quarter's results was less than $1 million. We have also recorded a somewhat greater than $1 million receivable from a recall insurance carrier from whom we expect to ultimately receive reimbursement of various incurred costs that exceed our deductible. In the end, while requiring the significant and timely involvement of a number of our employees we were pleased that the recall process itself proceeded as smoothly as it did. I appreciate your attention this morning and I will now turn the call back over to Jay for this concluding remarks.

Thanks John. We start our fourth quarter without the benefit of Easter related sales volume versus last year and knowing our food ingredient cost will likely be favorable, but much less so than the previous quarters this year. Especially food sales will hopefully see some improving trends in the food service channel while retail sales should continue to benefit from our marketing efforts. We have one new branded product introduction planned later in the quarter which won't impact immediate sales much, but could be a promise for fiscal 2011. Candle sales growth momentum should continue in the quarter, however wax costs maybe inching up some in the quarter. The acquisition environment in the food sector appears to be picking up and looks likely to continue as the year progresses. We have nothing to report as likely near term, but we remain very interested in growing by acquisition. Kimberly, we are ready to take questions.

(Operator Instructions). Your first question comes from the line of Mitchell Pinheiro from Janney Montgomery

You are moving kind of rapidly there at the beginning and you said something about in the Specialty Foods segment, retail was up 6%. But you mentioned them at $3 million to $4 million of help due to something?

Easter timing versus last year.

So, when you look at that, so as that relates to this [quarter], has it just pulled forward some of the sales that you had versus last year?

That's correct.

When I look at the March IRI data, you had very good unit growth, and I know IRI is limited, but from what I can use this for, unit growth, clearly there was some pricing as you kind of talked about some maybe aggressive competition in the salad dressing segment. How would you characterize the competition? Do you think it's giving back some of the margin expansion that you've had with the lower commodity costs or is there any other sort of strategy around the increase in promotion?

Yes, I do think we have seen some competitors probably taking advantage of a little lower cost to be a little more aggressive on the trade side trying to certainly drive sales and we have been expecting the need to react to that and we probably saw a little bit more of it in the third quarter than we have seen in the first half of the fiscal year and it did revolve around our refrigerated dressings to a degree and probably more so in the garlic bread category.

So, are these list price declines or is it just higher promotion?

It is not list price decline. So yes it is more promotional spend.

On the food service side, we're beginning to see signs of a recovery. So, it was still down for you 6%. That's not a volume number. That's more of a passthrough? Is that a function of lower (inaudible)?

Yes we are talking dollars first of all rather than unit volumes and so the price declines are certainly a piece of that. I would say we are seeing a little bit more optimism in the customer base out there and at least a few examples of some pickup with our customers. I don’t know that is wide spread enough yet that we are getting confident that's behind us and we should be on a longer term upward trend but there are signs of that potentially starting to happen.

So, of the down 6%, how would that compare to unit volumes in that? Is it flattish or are volumes still weak?

I think the volumes are a little bit weak still and that particular channel, unit volumes can be difficult to compare as products change and packaging quantities change over time.

I think the way I would look at it Mitch is more than half of that decline was pricing related, again primarily driven by lower commodity costs.

You talked about $7 million of your commodity costs helped in the quarter in Specialty Foods. What kind of impact helped on the candle side?

It was around $2 million.

Obviously I see oil, up 60% year over year. How fast those costs tend to be pulled into the candle business?

Well it doesn’t necessarily follow oil directly all the time. It seems to always follow up, never come down. But I think relatively quick, we are seeing some uptick now in paraffin wax costs?

So, how do you handle that typically? Do you try and pass that through or is it something that you absorb?

We would like to think we could pass it through, but frankly it is a pretty completive pricing environment. So I don’t think that is real likely near term. Over time we may find opportunity particularly as we bring our new products to try to build in higher costs, but just raising the existing product line prices across the board is pretty challenging to do.

As you look forward, and looking at the sales growth in Specialty Foods, clearly you have a little momentum, sales momentum, in the retail side. The food service seems to be improving a little bit. Are we talking like a low single-digit kind of growth in Specialty Foods or can you frame it in any way?

Well, I would like to think if we can get the food service channel back to a little more typical growth rate we had seen in the past we could see the whole segment up close to mid single digit growth area. It is obviously dependant on getting that channel growing again for one, in the fourth quarter I guess looking forward that short term, we do have this kind of hole we start in at the beginning of the quarter with that Easter business in the third quarter.

Second was related to margins. Certainly you had some fantastic margins in the first half. I don't know if you'd call them peak margins, but certainly very healthy. They came down a little bit more than I thought they would, from near 24% to about 18%. Is there anything unusual that it was down that low, I wouldn't think it would fall that hard, is I guess what I'm looking at?

Well there was probably a little more spend on both the trade and the consumer promotion side in the same quarter than we might expect to see going forward. Although again depending on the competitive nature of particular categories that could certainly fluctuate. We have a little bit of operational challenge in the quarter as we relocated production out of our Wilson, New York plant we closed at the end of the second quarter. So there were probably a couple of plants dealing with some inefficiencies that we would like to think we have put behind us now. I mean those are the things that would come to mind.

(Operator Instructions). Your next question comes from the line of Greg Halter with Great Lakes Review

Can you discuss where you stand currently on your forward buys?

I think it's generally been the case in the past, Greg with respect to soybean oil. We have some purchases as far out as the year from now, with about half our needs bought out six months forward. With respect to flour, we have coverage largely through the end of the calendar year.

Relative to the food service business, I know you mentioned the pricing side of things. What does that look like in the current quarter? Are you continuing to give back price or has that stabilized?

There will continue to be some give back of food service pricing. We will see that diminish as the calendar year progresses.

Can you comment on how your capacity is currently looking, on both the food side and the candle side?

Well Greg, generally we are in pretty good shape, but we do have a couple of areas, couple of product lines that we're running pretty hard, where we are seeing some pretty strong growth, but I think overall we are in pretty good shape to service the business looking forward. Through this year, we actually probably will be expanding some capacity as we look into fiscal 2011 particularly in the frozen bread side of the business.

Would that appreciably increase the capital spending runrate from the $15 million figure you're looking at for this year?

Yes probably would assuming we go forward with some of the initial plans we have right now we could see that uptick maybe $15 million to $20 million.

Over the $15 million?

Yes.

So as much as maybe $30 million or so?

Or a little more.

I picked up a pan of the Sister Schubert's yesterday, by the way, so.

Good, thank you.

Relative to geographic expansion, are there any new distribution points or food service opportunities that you were able to capture in the quarter or any you think you'll have in the near term here?

On the food service channel, we did land some new things that really didn’t have much sales dollar impact in the quarter but should start to generate some volume as we move into the fourth quarter. We also are picking up additional points of distribution, I don’t have a count on that for you. Not dramatically, new geographic distribution at this point although some of it gets into some of our western markets or we have a little bit less presence than we do back east, but yes some growth there on the retail side.

On the recall, I think, John, you had mentioned it had less than $1 million impact. Can you frame that a little closer? Is it closer to $200,000 or closer to $900,000?

Greg, you can think of it in the neighborhood of $0.5 million.

That's pretax.

Is that issue completed now where you won't believe to have any further costs?

We think it is completed. We still have to work our way through the insurance claim as we were fortunate in the respect that we don’t believe it's had any consequence on the sale of those products?

Relative to the promotional activity side, as you commented you had increased spending on the trade and consumer spending, and I think you had signaled that would be the case for the quarter. Is that the same case for the fourth quarter or do you see that trailing off a little bit from what you had spent?

Actually we do see it trailing off a little bit, partly because some of that spend was again around the timing of Easter that skewed that a little bit. So as we see it right now, it probably trails off a bit and although again if we were to see some particular competitive situations we had to react to on the trade promotion side that could still develop in the quarter.

At this time there are no further questions. I'd now like to turn the call back over to Mr. Gerlach for any concluding remarks.

Well, thank you all for joining us this morning. We'll look forward to talking to your in August as we will release our fourth quarter and full fiscal year 2010 results.

At this time that does concludes today's Lancaster Colony Corporation's third quarter fiscal 2010 conference call. You may now disconnect.