The Marzetti - Earnings Call - Q1 2020

Transcript

Operator (participant)

Good morning. My name is Sharon, and I will be your conference call facilitator today. At this time, I would like to welcome everyone to the Lancaster Colony Corporation Fiscal Year 2020 First Quarter Conference Call. Conducting today's call will be Dave Ciesinski, President and CEO, and Tom Pigott, CFO. All lines have been placed on mute to prevent any background noise. After the speakers have completed their prepared remarks, there will be a question-and-answer period. If you'd like to ask a question during this time, simply press star, then the number one on your telephone keypad, and questions will be taken in the order that they are received. If you would like to withdraw your question, press the pound key. Thank you. Now, to begin the conference call, here is Dale Ganobsik, Vice President of Investor Relations and Treasurer for Lancaster Colony Corporation.

Dale Ganobsik (VP of Investor Relations and Treasurer)

Thank you, Sharon. Good morning, everyone, and thank you for joining us today for Lancaster Colony's Fiscal Year 2020 First Quarter Conference Call. Our discussion this morning may include forward-looking statements, which are subject to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially, and the company undertakes no obligation to update these statements based upon subsequent events. A detailed discussion of these risks and uncertainties is contained in the company's filings with the SEC. Also note that the audio replay of this call will be archived and available at our company's website, lancastercolony.com, later this afternoon. For today's call, Dave Ciesinski, our President and CEO, will begin with an update on our strategic initiatives and the highlights for the quarter.

Tom Pigott, our CFO, will then provide an overview of the financial results. Dave will then share some comments regarding our outlook for the remainder of our fiscal year. At the conclusion of our prepared remarks, we'll be happy to respond to any of your questions. Once again, we appreciate your participation this morning, and I'll turn the call over to Lancaster Colony's President and CEO, Dave Ciesinski. Dave?

Dave Ciesinski (President and CEO)

Thanks, Dale, and good morning, everyone. It's a pleasure to be here with you today as we review our first quarter results for fiscal year 2020. Roughly three years ago, we launched our Better Food Company Growth Plan, which consists of three simple pillars. Number one, accelerate our base business growth. Number two, simplify our supply chain to reduce our cost and grow our margins. Number three, identify and execute complementary M&A to grow our core. During the last several years, we have focused on strengthening our team, implementing our growth plan, and harvesting the results. During this past quarter, we continued to leverage our strategy and grew our base business, organic net sales, by 2.6%. Our retail segment grew organic net sales by 1.5%, while our food service segment grew organic net sales by 3.9%.

The increase in retail organic net sales was fueled by growth of our Marzetti branded produce dressings, veggie dips, and caramel dips, a return to growth for New York Bakery frozen garlic bread, and continued growth of shelf-stable dressings and sauces sold under license agreements. We were particularly pleased with the performance of our retail team in Q1, which included relevant new innovation items such as the launch of New York Bakery three cheese cheese sticks and Sister Schubert's pumpkin spice sweet treats. The team is also successfully executing brand renovation initiatives such as our Marzetti branded dips with a more simplified ingredient panel and improved taste.

Shifting our attention to our food service segment, the 3.9% increase in organic net sales was led by volume gains with key national chain restaurant account customers, higher sales of branded products sold through distributors, and increased sales for our industrial business, which is predominantly frozen pasta. It is worth noting that this is the seventh consecutive quarter of organic net sales growth for the food service segment, with an average gain of 7.7% per quarter over that period. Our supply chain team posted another quarter of strong results in reducing cost and improving productivity. These results were driven by our Lean Six Sigma program, which is now in its third year. Our new transportation management system, which started to go live last January, was a noted source of cost savings in the quarter.

Combined with the benefit from the growth in sales and some favorability in commodity cost, the supply chain team's efforts led to a 13.4% increase in gross profit and a 170 basis point increase in gross margin for our fiscal first quarter. Since we launched our strategy to simplify our supply chain to reduce our cost and grow our margins, the supply chain team has achieved gross savings in excess of $20 million per year. Updating you on our recent acquisitions, Bantam Bagels continues to perform in line with our expectations as we invested to further expand retail distribution. We are also pleased to report that, per IRI data, retail sales for Bantam Bagels nearly doubled for the 52-week period ending September 29th.

On the food service side, Bantam achieved a sequential improvement in sales of about 15% in FY20 Q1 compared with FY20 Q4, as Bantam is gaining placement in the counter display case at Starbucks cafes nationwide. Consistent with the comments we shared during Q4 FY19 earnings call, our supply chain team remains fully focused on implementing operational improvements at our Omni Baking facility, which we acquired in November 2018. We expect most of these changes to be completed by the end of this calendar year. Overall, we were pleased with the progress made during our fiscal first quarter in growing our base business, reducing our cost through supply chain initiatives, and integrating our most recent acquisitions. I'll now turn the call over to Tom Pigott, our CFO, for his commentary on our Q1 financial results.

Tom Pigott (CFO)

Thanks, Dave. Overall, the results of the quarter exceeded our expectations. Consolidated net sales increased 6.4% to a first quarter record of $337.1 million. This growth was driven by increases in both the retail and food service segments. Excluding net sales attributed to the acquisitions of Bantam and Omni, organic net sales increased 2.6% for the quarter. Consolidated gross profit increased $10.9 million or 13.4% to $92.1 million. The increase was driven by higher net sales, cost savings from our Lean Six Sigma project, as well as favorable commodity costs. Selling general administrative expenses increased as we invested behind the strategies Dave highlighted. Reported SG&A increased $7.4 million or 23%. The largest driver of that increase was our ERP program, in which we incurred $2.7 million in costs related to the design phase of the project.

Other investments included higher consumer promotional spending in our retail segment to drive top-line growth, incremental costs from the Bantam acquisition as we begin to scale that business, and increased personnel costs. Consolidated operating income increased 5.3% to a first quarter record of $51.7 million. The increase reflects the higher gross profit, investments in SG&A, as well as a $900,000 restructuring charge related to the plant closure that we announced in Q4. It's important to note that the ERP investment, combined with the restructuring charge, reduced our operating income growth by 730 basis points for the quarter. Our effective tax rate increased this quarter to 23.3% from 22.6% in the first quarter of fiscal 2019. The increase reflected a lower tax benefit on stock compensation, as well as an increase in state taxes. Our tax rate for the remainder of fiscal year 2020 is forecasted to be 24%.

First quarter earnings per share increased 6 cents or 4.2% to $1.48. The investment in ERP reduced earnings per share by 8 cents, and the restructuring charge had a negative 2-cent impact. Together, these two items reduced our reported earnings per share growth by 10 cents or 710 basis points. With regard to capital expenditures, we continue to project our fiscal year 2020 expenditures to be in the range of $80-$100 million. Our Q1 expenditures of $43.2 million included ongoing investments for the capacity expansion at our frozen dinner roll facility in Horse Cave, Kentucky, that we expect to be complete near the end of the second quarter, and the purchase of the Omni Baking facility property that was previously leased.

To wrap up my commentary, overall, the quarter featured nice pipeline growth, pricing discipline, commodity favorability, and cost savings programs that helped fund our investments for future growth. Now I'll turn it back over to Dave for his closing remarks. Thank you.

Dave Ciesinski (President and CEO)

Thanks, Tom. Looking ahead to the remaining three quarters of our fiscal year, our expectations for consolidated top-line growth remain in the low to mid-single digits. Overall, commodity costs are projected to be generally flat in our fiscal second quarter and then turn modestly inflationary in the back half of our fiscal year. Our supply chain team's Lean Six Sigma program, including initiatives in strategic procurement combined with our net price realization programs, will help offset the impact of commodity cost increases. We also anticipate continued progress with our Bantam Bagels and Omni Baking acquisitions. Our planned investment in production automation for Bantam, which we expect to be completed near the end of our fiscal third quarter, will add capacity for continued growth and provide a notable benefit to the overall profitability of that business.

Our supply chain team will also continue with upgrading and automating our Omni Baking facility to reduce cost and increase productivity. Finally, I'd like to provide you with an update on our ERP initiative, Project Ascent. As you may recall, Project Ascent will enable us to replace our 20-year-old ERP system and provide us with a long-term scalable system infrastructure well into the future to facilitate organic growth and scale acquisitions while also helping us drive cost savings. We have recently completed the groundwork of building our internal team and selecting our system integrator and software vendor. We're now beginning the design phase of the project with deployment scheduled to start in the first half of fiscal 2021. We expect to have more details to share with you regarding the cost and the timeline for Project Ascent during our fiscal second quarter earnings call.

We will continue to disclose the ERP project costs separately in our quarterly earnings releases and SEC filings to provide the investment community and all of our stakeholders with a clear understanding of the associated expenditures for this important project. This concludes our prepared remarks for today, and we'd be happy to answer any questions you may have.

Operator (participant)

At this time, I would like to remind everyone in order to ask a question, please press star one on your telephone keypad. Your first question comes from Jason Rodgers with Great Lakes Review.

Jason Rodgers (Equity Analyst)

Yes. Just had a question on the gross margins. Obviously, very strong at the 27% level. Just wondering on the sustainability of that going forward, just expectations on raw material costs and everything else baked in there as far as just modeling that margin out.

Dave Ciesinski (President and CEO)

Sure. Jason, as we pointed out in the back part of my commentary, we expect in the second quarter for commodities to be essentially flat and then to turn modestly inflationary in the back half of the year. We do think we're going to be able to offset the commodity inflation through a combination of our Lean Six Sigma program and our discipline PNOC program that we have in place. I think, generally, that gives you a view for things of how we see them today. I don't know, Tom, if you'd want to add anything on.

Tom Pigott (CFO)

Overall, it was a very strong quarter. As Dave highlighted, we did benefit from some commodity favorability in it that we do expect to moderate as the year progresses.

Jason Rodgers (Equity Analyst)

Could you quantify what that benefit was as far as the lower raw material cost?

Tom Pigott (CFO)

It was approximately $2 million in commodity favorability. We also had some procurement savings that increased that number, but it was roughly around $2 million.

Jason Rodgers (Equity Analyst)

All right. Just as far as the costs that you're incurring to automate processes at Omni and Bantam and expanding distribution at Bantam, I wonder if you could kind of give us an idea of what those were in the quarter and how we should be thinking about those going forward.

Dave Ciesinski (President and CEO)

Sure. I'll describe them for you a little bit on the front end. First of all, with Bantam, essentially where we're spending, there's two areas, one of which is in slotting to help continue to expand the distribution of the product in retail. The second area in Bantam where we're investing is, in essence, we're building an end-to-end automated line for this product. Today, where it's manufactured, we literally have envisioned dozens of people or more than a dozen people that are working on a line that are manually filling the bagel balls with cream cheese or eggs or whatever the filling is. The new line will be completely automated, and it's going to take that manual labor off. It's also going to run at a considerably faster pace to allow the product to continue to scale. We've been negotiating with the equipment manufacturers.

The project has begun, and as we mentioned in my prepared comments, we expect that to be complete at the end of our third quarter. I think roughly March timing, somewhere around there. As it pertains to Bantam, what we're doing there is it was November of 2018 when we bought it. Excuse me. They were an RA; they were a co-packer for us on our New York, Texas toast business. They did about half of our volume. We bought the business, and over the course of the last year, what we've been doing is investing in upgrading ovens, freezers, and automating some of their processes as well. The nature of the costs that we're taking on there, in some cases, are CapEx, and others, it's expense. I'll give you a case in point.

When we need to replace or repair a floor, if we replace an entire floor in a building, we can capitalize that. If it's a portion of a floor, it gets expensed. The other area that we end up taking on headwind with that project in particular is whenever we do these heavy maintenance or heavy investment projects, we end up shutting the factory down for several days at a time, two, three, four, five days at a time, which results in a lot of absorption in the period. You put those together, they're both running, I would venture to guess, somewhere in the low to mid-single digits in the period. We are going to expect those to continue on and then taper as we work into the back half.

Tom Pigott (CFO)

Yeah, the impact combined of the two was a low seven-digit impact on the quarter's results.

Jason Rodgers (Equity Analyst)

Okay. That's helpful. Just finally, obviously, Bantam's doing well with the expanded distribution, Starbucks. How much of a contribution can that make to the top line in fiscal 2020?

Dave Ciesinski (President and CEO)

I think it could be material. I don't know. Have we disclosed? I'm looking around here in the room. Have we disclosed?

Tom Pigott (CFO)

Yeah. I think at this point, we're very optimistic about the growth potential of the business. Given that we're in kind of a rollout mode, we don't want to put a specific number out there for you right now. As we get better visibility as we progress, we'll certainly be happy to share that information.

Jason Rodgers (Equity Analyst)

Okay. Thank you.

Operator (participant)

Once again, if you'd like to ask a question, please press star one on your telephone keypad. We have a question from Frank Camma with Sidoti.

Frank Camma (Senior Equity Research Analyst)

Hey. Good morning, guys. How you doing?

Tom Pigott (CFO)

Good morning, Frank.

Dave Ciesinski (President and CEO)

Morning, Frank.

Frank Camma (Senior Equity Research Analyst)

Hey. I was wondering if you could talk about the benefit in the quarter. I don't know if you quantify this at all, either from margin or not just the benefit, but maybe the head, how it impacted the quarter from revenue, from eliminating some SKUs that last year wasn't very profitable. Obviously, it had a bit of a headwind to your revenue going into the quarter. You probably benefited, I guess, on the margin side if you could talk about that.

Dave Ciesinski (President and CEO)

Right. I think I would probably point to two cases in point where we have several cases in point where we focused here. One is Sister Schubert, where if you remember, we announced a restructuring project. We closed our Saraland facility. We discontinued some items there. If you're looking at the IRI data, you could see some headwind on that business. If you look at the profit, we don't disclose by segment. It was a pretty significant pickup on the bottom line. That same thing would be true on Angelic and on our flatbread wraps. It was roughly to the tune of about what we'd call it a—go ahead, Tom.

Tom Pigott (CFO)

Yeah. I would say the two together about 100 basis points of growth impact.

Frank Camma (Senior Equity Research Analyst)

Got it. That must have positively affected the growth, though, I'm assuming.

Tom Pigott (CFO)

Yes. Yep.

Frank Camma (Senior Equity Research Analyst)

Since those are lower than your—okay.

Tom Pigott (CFO)

Yeah. So.

[audio distortion]

That's what I suppose, Frank. The Angelic was lapped out in October, and the flatbread was lapped out in November.

Frank Camma (Senior Equity Research Analyst)

Oh, okay. That's helpful. My other question is just sort of on the food service side, the strength that you're seeing there, particularly you mentioned the national accounts. Can you just give us a little more color on that as far as are you seeing it from, obviously, the underlying accounts must be doing good, but is it because they're opening more doors? Is it because they're just doing well overall? Can you just talk about—or are you gaining more customers? I assume it's not the last, what I said, but if you can kind of talk about that.

Dave Ciesinski (President and CEO)

Sure. The single largest component of the growth is an increase in same-store sales growth from some of our key customers. Another contributor to that would be some store openings, but the lion's share of it has been from our biggest customers, an increase in same-store sales growth. In other cases, we are selling more to some existing customers as well. If you're trying to think your way through how to think about this, I would say half of it at least is being powered by same-store sales growth of our largest customers. The next piece would be coming from store openings of some of those customers. The last would either be new sales to existing customers or just new customers altogether. It is overall a pretty healthy mix on our national accounts.

On the branded side, we've talked about it for a while now. We're building share, and we're driving penetration.

Frank Camma (Senior Equity Research Analyst)

Got it. Thank you. That's all I had.

Tom Pigott (CFO)

Thanks, Frank.

Operator (participant)

Once again, if you'd like to ask a question, please press star one on your telephone keypad. If we do not have any telephone questions at this time, we will now turn the call back to Mr. Ciesinski.

Dave Ciesinski (President and CEO)

Thanks, everyone, for your participation this morning. We look forward to sharing our second quarter results with you in early February.

Operator (participant)

This concludes today's conference call. You may now disconnect.