The Marzetti - Earnings Call - Q3 2020

Transcript

Operator (participant)

Good morning. My name is Ursula, 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 2023 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 would 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, President of Investor Relations and Treasurer for Lancaster Colony Corporation. Please go ahead, sir.

Dale Ganobsik (President of Investor Relations and Treasurer)

Thank you, Ursula. Good morning, everyone, and thank you for joining us today for Lancaster Colony's Fiscal Year 2023 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 takes 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 a business update and 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 our fiscal fourth quarter. 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. I'll now turn the call over to Lancaster Colony's President and CEO, Dave Ciesinski. Dave?

Dave Ciesinski (CEO and President)

Thanks, Dale, and good morning, everyone. It's a pleasure to be here with you today as we review our third quarter results for fiscal year 2020. I'd like to begin by sharing some comments regarding the coronavirus pandemic and its impact on our business. Before I do, on behalf of all of us at Lancaster Colony, I'd like to thank all the healthcare workers and first responders for their tireless efforts to keep us safe. From the onset of the coronavirus pandemic, we've been steadfast that our mission is fixed. First, provide for the health, safety, and welfare of our teammates, and second, ensure that we continue to play our role in our country's vital food supply chain. Thanks to the diligence and care of our teammates, I believe we've remained true to both elements of our mission, all the while we have fortified and sustained our business.

I'd like to extend a very sincere thank you to our frontline teammates, including those that work in manufacturing, distribution, transportation, and retail merchandising for the incredible work they do every day to keep our business operating. Through it all, our business continues to source ingredients, manufacture products, and ship them to our customers. We've done this all while having implemented safety protocols as outlined by the CDC, OSHA, the FDA, and local government authorities to ensure that we continue to operate safely. I would also like to extend a special thank you to our office-based teammates for embracing this change and sustaining our business during this unprecedented time. Collectively, they've conducted countless Microsoft Teams meetings with customers, suppliers, partners, and each other. Our sales teams have conducted virtual category reviews with our customers. Our marketers have launched marketing campaigns. The procurement team has brought on board new suppliers.

Our transportation team has conducted carrier bids, and our finance team has closed the books and helped us prepare our third quarter filings. Moving on to fiscal third quarter financial results, our reported consolidated net sales grew by 1.1%, excluding all Omni Baking sales, consolidated net sales grew 1.9%. Net sales in our retail segment increased 10.7%, while net sales in our food service segment declined 7.8%. Retail net sales benefited from higher demand as the COVID-19 outbreak led to increased consumer demand that built upon solid base business performance. Third quarter sales also benefited from new product offerings, including Buffalo Wild Wings sauces in single bottles and a promising start for a regional pilot of Chick-fil-A sauces that we are supplying to grocery stores. Both Buffalo Wild Wings and Chick-fil-A sauce are sold under exclusive license agreements.

Separately, sales trends for our New York Bakery frozen garlic bread products remain favorable as the brand continued to gain share. Olive Garden dressings posted share gains for the quarter, and our Sister Schubert's brand of frozen dinner rolls achieved significant sales growth in the quarter as well. It's notable that prior to the impact of COVID-19, our quarter-to-date retail sales were up about 4% due to the contributions from our new product introductions and growth from our core retail business. In our food service segment, excluding all Omni Baking sales, net sales declined 6.6%. Food service channel demand was adversely impacted by COVID-19 beginning in mid-March as restaurant dine-in purchases were eliminated and consumer purchase options were limited to carry-out, delivery, and drive-thru. These service restrictions in the food service industry, combined with the stay-at-home orders, led to reduced consumer demand and lower sales for our food service segment.

Despite the unfavorable influences of the COVID-19 pandemic, we grew our fiscal third quarter consolidated gross profit $1.6 million, or 2.1%, as we benefited from the favorable sales mix shift to the retail channel along with our ongoing cost savings program. Gross profit was reduced by a $4.5 million inventory write-down resulting from an abrupt slowdown in food service orders in mid-March due to the COVID-19 impacts. It was further reduced when we paid out $1 million in bonuses to frontline employees in our factories and distribution network in gratitude for their work in helping meet the shifting demand within our business. I'll now turn the call over to Tom Pigott, our CFO, for his commentary on our Q3 financial results.

Tom Pigott (CFO)

Thanks, Dave. Overall, we are pleased with the underlying business performance and the many actions taken by our employees to address the COVID-19 outbreak during the quarter. Consolidated net sales increased 1.1% to a third quarter record of $321.4 million. Excluding Omni Baking sales of $5.3 million in the current year quarter and $7.9 million in the prior year quarter, consolidated net sales increased by 1.9%. As you'll recall, Omni Baking sales are attributed to a temporary supply agreement. These sales will decline from the current level in coming quarters with the expectation that the supply agreement will end by December of 2020. Consolidated gross profit increased $1.6 million, or 2.1%, to $77 million, and gross margins grew by 20 basis points. The increase was driven by a favorable product mix as revenues shifted from food service to retail, our cost savings programs, lower commodity costs, and improved net price realization.

These improvements were offset by the $4.5 million inventory write-down and the $1 million spent on the frontline bonuses. These two items reduced our gross margin growth by 170 basis points. Selling, general and administrative expenses increased $8.9 million, or 24%. The largest driver of the increase was our ERP program, which accounted for $4.9 million in SG&A costs for the quarter. Other drivers of the increase included higher spending on information technology and increased consumer promotional spending, as well as a $500,000 increase in our loss-for-doubt flow of accounts related to the impact of COVID-19. Consolidated operating income declined $7.3 million, or 20%, due in part to the COVID-19 items I mentioned, which totaled $6 million, and the ERP investment of $4.9 million. These two items reduced our operating income growth by 29 percentage points.

Key drivers of the operating income growth, excluding these items, include the top-line performance, favorable mix, and cost savings programs. Our effective tax rate increased to 27% this quarter from 21% in the third quarter of fiscal 2019. This increase reflects an adjustment to our estimated foreign-derived intangible income tax credit, higher state taxes, and a lower tax benefit from stock-based compensation activity. We estimate the tax rate for the fiscal fourth quarter to be 24%. Third quarter diluted earnings per share decreased $0.30-$0.81. The decline was due to the COVID-19 items, the investment in ERP, and the higher tax rate, partially offset by the underlying business performance. With regard to capital expenditures, we project our fiscal year 2020 expenditures will be approximately $90 million.

Our year-to-date payments for property additions of $72 million include investments for the capacity expansion project at our frozen dinner roll facility in Horse Cave, Kentucky, that we recently completed, and the purchase of the Omni Baking facility that was previously leased. Separately, specific to our ERP initiative, we also capitalized $4 million in expenditures in our fiscal third quarter for application development stage activities. In addition to investing in our business, we also returned funds to shareholders. Our quarterly cash dividend paid on March 31 was $0.70 per share, an 8% increase from the prior year amount. Our long-standing streak of annual dividend increases reached 57 years this past December. Despite the higher level of investments and increased dividend payments, our financial position remains very strong as we finished the quarter debt-free with $178 million in cash on the balance sheet.

The company also replaced its revolving line of credit during the quarter, which remains at the same size at $150 million. The facility was replaced in the ordinary course of business and not prompted by the impacts of COVID-19. The term of the previous facility was set to expire in April of 2021. We have no borrowings against the facility. To wrap up my commentary, the quarter featured strong underlying performance as well as some significant impacts from COVID-19. The business continues to monitor and adjust to the COVID-19 outbreak while investing for longer-term growth. Now I'll turn it back over to Dave for his closing remarks. Thank you.

Dave Ciesinski (CEO and President)

Thanks, Tom. As we progress through our fiscal fourth quarter, we're going to continue to focus on delivering against our mission. First, provide for the health, safety, and welfare of our teammates. Second, ensure that we continue to play our role in the country's vital food supply chain. We will add one additional priority to leverage the combined strength of our team, our operating strategy, and our balance sheet to seek opportunities to better position ourselves for future growth. During the month of April, our business overall continued to be impacted by the same factors in retail and food service that shaped our fiscal third quarter results. In retail, the sub-position is supported by IRI data, and in food service, this is supported by NPD transaction data.

Looking forward to the remainder of Q4, we anticipate net sales in our retail segment will continue to benefit from increased demand due to the stay-at-home orders and other changes in consumer behavior attributed to COVID-19. We also expect our recent new product introduction and channel expansion into dollar and drug channels to remain important contributors to our retail segment sales growth. Separately, we expect the food service industry overall will continue to be negatively impacted by COVID-19. We expect the negative impact to be most pronounced on the casual dining and mid-scale segments and the impact to be more muted on the QSR segment. For reference, prior to the impact of COVID-19, our food service segment customer mix was approximately two-thirds QSR, which has and will continue to help soften the impact on our business. I'll now provide an update on a couple of notable projects for our business.

During our fiscal second quarter earnings callback in February, I referenced our plans for a major capacity expansion project at one of our dressing facilities. Based on the impact of COVID-19 and related near-term uncertainties, we have decided to cancel this project. We will continue to invest in capacity as required to support the growth of our business. However, we felt it was prudent to halt this project until we had a better feel for the near and intermediate-term outlook. With respect to our ERP initiative Project Ascent, due to the current work environment, including stay-at-home orders and travel restrictions, we are delaying the implementation time frame for the project until the back half of fiscal year 2021 or early 2022. In closing, while the impacts of COVID-19 have unfavorably influenced our short-term results, we remain very confident in the future of our business.

Excluding the COVID-19 impacts, we delivered another quarter of solid financial results. We entered the COVID-19 pandemic from a position of financial and competitive strength, and we expect to emerge the same way with opportunities to grow both organically and through acquisitions. In the interim, in our food service segment, as our national chain customers face deep challenges, we are focusing our efforts to support them through this period of uncertainty and offer our assistance as they develop plans to return to full service. In the retail segment, we will continue in our pursuit of growth through new product introductions and channel expansions. This concludes our prepared remarks for today, and we'd be happy to answer any questions you may have. Ursula, over to you.

Operator (participant)

As a reminder, if you would like to ask a question, please press star then the number one on your telephone keypad. Again, that's star one to ask a question. We'll pause for a moment to compile the Q&A roster. Your first question comes from Brian Holland with D.A. Davidson.

Brian Holland (Managing Director and Senior Research Analyst)

Thanks. Good morning, gentlemen.

Tom Pigott (CFO)

Morning, Brian.

Dave Ciesinski (CEO and President)

Morning, Brian.

Brian Holland (Managing Director and Senior Research Analyst)

I guess first question on the food service side, can you give us a sense of how much of your food service business is down, say, 50% or more, due either to stay-at-home orders or maybe doors closing? I know you have high exposure to national chains, but just have you had customers go out of business? If so, can you maybe quantify any contribution from those?

Dave Ciesinski (CEO and President)

Sure. Maybe starting with the breakdown, we said during the prepared remarks, Brian, that two-thirds of our business is QSR. Among that, and that's all our food service sales, straight up two-thirds across all of our various product types is QSR. That is the segment that seems to be least impacted by this. If I had to sort of ballpark that for you, I would say they're probably down in terms of traffic 30% with some doing better than that. Notable, all of these customers are experiencing larger ring for each transaction. Chances are their sales through, let's say, April, were probably down somewhere closer to 20%, with the pizza chains actually being closer to flat and maybe up. I would then clarify, as you look at April, it looked like mid-April was the low watermark.

If March 8, let's say, was a line of demarcation where sales all of a sudden dropped off, what we found was basically the second week of April, the end of the second week of April was the low watermark. What we've seen is sequentially those trends getting better with each passing week in April into the first week here now of May. Laddering back up to your question, two-thirds of our business is QSR. I would say those businesses are probably off, let's just say, on average to date somewhere like 20%, maybe a little bit less than that. The part that's down hardest is casual dining. It's going to vary a little bit by segment. Some of those chains are probably operating closer to 50%, and there are a couple of them that are off a little bit harder than that.

I would submit the segments that are the absolute hardest hit are the non-commercial segments that are tied into schools and venues because, as you might imagine, they're just altogether shut down. Other venues that have been hit hard are mom-and-pop shops up and down the street because they don't have drive-through, and they may not have had, let's say, the balance sheet to withstand them. We have not had any big customer that's gone bankrupt on us to date. It just hasn't happened. To the best of my knowledge, there's one national chain that has announced something, but they're not one of our customers.

Brian Holland (Managing Director and Senior Research Analyst)

Okay. Got it. That's very helpful. I guess sort of spinning forward your sort of breakdown on the food service channel, I would imagine even though you're getting better or you're seeing better trends coming off of the mid-April trough, they're still probably down. Just trying to think forward here, I guess near-term first, I mean, should we expect food service sales to be materially worse in Q4 than they were in Q3, just kind of on a year-over-year basis? If not, what would you sort of be pointing to as reasons for confidence?

Dave Ciesinski (CEO and President)

Yeah. I would say there's been a lot of worse, Brian. I don't know if I would dimensionalize for him for the following reason. That if you think about it, for all intents and purposes, Q3 was really just the last couple of weeks, right? I mean, COVID-19 was on the horizon. I think we talked about it together towards the end of—was it the end of February? No, it was the very beginning of March, actually. We spoke with you during the conference, and we were talking about it coming upon the horizon and the impact of Italy. In the U.S., if you look at what happened in terms of store closings, it was really the back half of March. We are going to see more of a financial impact through the entirety of the fourth quarter this quarter.

I think what you're going to see is it's going to hit the low watermark in April. With openings in various states taking place now, you're going to just continue to see sequential improvements.

Brian Holland (Managing Director and Senior Research Analyst)

Okay. And then just operating expenses, should we—I guess for how long should we anticipate or do you anticipate those sort of maybe remaining elevated specific to COVID-19? Is that another quarter? Do you see drag on beyond Q4?

Dave Ciesinski (CEO and President)

Here's what I would do. I mean, I'll let Tom comment on the charge that we took for inventory. I view that a bit more strictly transitory, maybe an event. What we've done is we initially granted a $300 bonus for the month of April. What we've done for our frontline employees is we've actually put in place a $2 an hour increase. We've tied them to the stay-at-home orders with the idea being that once a local government authority lifts its stay-at-home orders, we intend to pull back on that $2 an hour increase. It is going to vary a little bit state by state, jurisdiction by jurisdiction. In some cases where it is counties that are making those calls, you could have the state that may be leaning one way and a county leaning another way.

That's, in essence, the agreement that we put forth with our employees that, I mean, I just can't say enough good things about the way they're operating. My guess is we probably have at least another quarter, two of the fourth quarter of that, and we'll see what it looks like into the first quarter of next fiscal year.

Brian Holland (Managing Director and Senior Research Analyst)

Okay. Just one last one from me. On the retail side, you referenced in your prepared remarks, obviously, the 4% growth prior to the COVID-19 demand surge. Obviously, you had big channel expansion plans and initiatives underway. Just curious, given the commentary that we've heard, it sounds like those flowed through, although I'm sure there's some demand surge in there as well. Any impact to the timing or your ability to get all of those sort of plans that have been set in place, I guess specifically club and dollar channels ahead of all this and whether there's any impact going forward?

Dave Ciesinski (CEO and President)

So far, no. I mean, we were fortunate that we began shipping those products in January and in some cases February. Those pipes were already starting to build. I think the more likely impact would be on future products that are in the works because, as I'm sure you're canvassing other manufacturers in your conversations, what you're hearing is retailers are really focusing pretty narrowly on execution. Within the realm of what you're talking about there, those products have been out there. I would say the same is true for things like Buffalo Wild Wings and Chick-fil-A sauce. I mean, fortunately, those products are relevant enough because customers are excited about them enough that they're saying, "Hey, just bring them," even in spite of everything that's going on.

Brian Holland (Managing Director and Senior Research Analyst)

Appreciate the color as always. I'll get back in the queue.

Dave Ciesinski (CEO and President)

Of course. Hey, Brian. One thing that I would note that was not in my prepared comments, but it may help you understand the algorithm a little bit as far as our operating cost. We have done two things. One is, obviously, we put in place bonuses and incentives for frontline workers that I have talked about. The other thing that we have done is we did enact a voluntary furlough program at select locations where we are allowing employees that may have an underlying health concern or may be of such an age that they are concerned about working. We are allowing those employees to opt out. What we are doing is we are taking the savings from that voluntary furlough program, and we are actually using that to fund the incremental $2 an hour that we are paying for those other employees.

If you're modeling this out on a labor basis, it's essentially a push. The voluntary furlough program is funding what we're doing on the incremental bonus.

Tom Pigott (CFO)

Yeah, Brian, I'll just add—this is Tom—I'll add a little more color to our margin outlook. From the way we look at it today, you have this favorable tailwind of the mix that Dave talked about. You also have a reduction in food service volume, which will impact our factory overhead absorption in that we have less volume going through the facilities and a fixed factory overhead piece to absorb. You have the frontline incremental pay that Dave mentioned, but then trying to offset that with the furlough program. There are some other items that we're doing to make sure we operate safely, the shift separations, extra sanitation, and other procedures just to manage the risk. There are a number of tailwinds as well as headwinds as we look at Q4 and going forward.

Brian Holland (Managing Director and Senior Research Analyst)

Thanks, Dave and Tom. Appreciate that context.

Dave Ciesinski (CEO and President)

Of course.

Operator (participant)

Your next question comes from Ryan Bell of Consumer Edge Research.

Ryan Bell (Equity Research Analyst)

Hi everyone. Do you see your current environment helping or the current environment helping to create more opportunities to bring food service products to retail in the short-term and then maybe in the medium term?

Dave Ciesinski (CEO and President)

Certainly over the intermediate term. I think as much as I'd like to say it'll help us right now, I mean, for deals that we have negotiated license agreements, I think retailers are excited about it, and I believe our food service customers are excited about them. As it pertains to new deals, I would surmise that food service operators are really focusing on their core business. Over a longer period of time, Ryan, I think this is really going to help us because it helps to create a diversified stream of revenue and profit for the operators to help them sustain any sort of things that their business might encounter, hopefully not another COVID-19 or COVID-20, let's say, but just creates another source of revenue and just another source of strength for their business.

Ryan Bell (Equity Research Analyst)

Great. Thanks. During a recessionary environment, could you speak about your thoughts of the puts and takes between food at home and food away from home consumption, especially as you have two business units that operate in each?

Dave Ciesinski (CEO and President)

Yeah. Ordinarily, they're a natural hedge. If you go back to the Great Recession and other periods, what you would ordinarily see is in times of economic uncertainty, consumers would pull back from spending away from home. When they did spend away from home, they tended to spend on QSR. You would see QSR strengthen during that period of time. Obviously, they would spend more at home. That shift was a natural hedge for our benefit. Given the shift in mix between food service and retail, there was a bit of a tailwind for us as well. During periods of economic expansion, when people spent more away from home, you could see it flow the other way. We have looked at that just to see if past is prologue here.

What is so very unique in this set of circumstances is that it is not a slowdown, at least that we are in right now. What we are looking at is just a full-up stop in some cases. As we come out of the shelter-in-place orders and this thing starts to take on a look of maybe an ordinary recession, I would expect those sorts of rules to come back into focus again.

Ryan Bell (Equity Research Analyst)

Thanks for the clarity. Do you see any opportunities that your strong balance sheet would afford as you get out of the primary uncertainty that would be related to COVID-19?

Dave Ciesinski (CEO and President)

We are certainly monitoring that. I mentioned in the comments that we canceled a large capacity expansion project. Part of that was borne out of just the uncertainty of the near-term and intermediate-term environment. We felt like we had enough time to let this play out a little bit before we committed. There is always the scenario that an asset comes on the market that we can buy that is both faster and a cheaper way to solve our capacity issues. Yes, most certainly. I think this is why from the onset, when this broke, we went into a mode where we focused on the two elements of our mission: make sure that our people were safe, let's get a complete understanding of all the safety protocols, let's implement those, right? Then let's make sure that our factories continue to run, albeit safely, to supply food.

Now we're kind of moving the focus beyond just that. We're continuing to do that every day in our factories. Suffice it to say, that's a big challenge. We are looking at the external world now. We're looking at our balance sheet and trying to figure out if there's a way that we can really just not only come out of this, but come out of this stronger in position for faster growth in the future.

Ryan Bell (Equity Research Analyst)

Great. Thank you. That's it for me.

Dave Ciesinski (CEO and President)

Your next question comes from Todd Brooks with C.L. King & Associates.

Todd Brooks (Senior Analyst and Managing Director)

Hey, good morning, everybody. I hope you're all well.

Dave Ciesinski (CEO and President)

Morning, Todd.

Dale Ganobsik (President of Investor Relations and Treasurer)

Good morning, Todd.

Todd Brooks (Senior Analyst and Managing Director)

A few quick questions for you. One, you talked about how retail was tracking prior to kind of the onset of the COVID-19 outbreak. Do you have any data either through February or through when you think you want to call it the outbreak start date? How was food service tracking going into the COVID-19 related data?

Dave Ciesinski (CEO and President)

It was closer to flat. It was flat-ish. Yeah. And that was more or less what we had foreshadowed in our Q2 earnings.

Todd Brooks (Senior Analyst and Managing Director)

Okay. Great. I know you reviewed some of the new product successes at retail. Not much discussion yet about the extension of Olive Garden into the drug and discount channel. Did that happen as planned and any early reads on success of extending that brand into new channels of distribution?

Dave Ciesinski (CEO and President)

It's a great question. It has, and it is. The way I would characterize it is it's almost like you get an athlete on a team and you sort of track them on the depth chart. We watch the velocity of the new item. Obviously, when we first got out there, it was barely registering as it was building on the shelf. We can already see that it's becoming one of the fastest-growing Italian dressings in the segments. We have every confidence that it's going to continue just to grow and pass the leaders like it has in retail. Very, very excited about that. Honestly, Chick-fil-A has been a tremendous success so far at retail. The test is just going on in Florida. Consumer demand has been fantastic. We're having, honestly, a very hard time just keeping it on the shelf.

It hits the shelf and it disappears. We are excited about it. Our partners at Chick-fil-A are very excited about it. We are just going to continue to nurture that and plan and prepare for a national launch.

Todd Brooks (Senior Analyst and Managing Director)

I think there was one point where you talked about maybe sizing that opportunity as equivalent to the Olive Garden dressing opportunity. How are you thinking about, based on early results out of the pilot, the size of the Chick-fil-A opportunity?

Dave Ciesinski (CEO and President)

I would say it's larger. Just the way we backed into this was if you look at the overall salad dressing category, it's north of $2 billion. Olive Garden predominantly plays in the Italian subsegment, which is smaller, right? Ranch is the big space, which is about $700 million. I think Italian's about half of that size. If you look at something like Chick-fil-A sauce, it plays in dipping sauce occasions. I would say the opportunity for occasions there would include the same occasions that ranch might play in, that ketchup might play in, that honey mustard might play in, a whole range of dipping sauces. I think that the opportunity here, the playing field, could easily be north of a couple billion dollars. I would—and not just me. I think the team, our retail team, has done a very nice job sizing this opportunity.

Our sales team has done a great job. Our retailers believe the same thing. We all tend to believe that the addressable opportunity here is, let's just begin with, larger than Olive Garden, and we'll see how much larger.

Todd Brooks (Senior Analyst and Managing Director)

Great. My final one—and this is just some of my ignorance around manufacturing inefficiencies—can we talk about either pick an example number of food service sales being down x percent, how that kind of volume drop in the production facilities flows through to the margin standpoint, just to get some color around how we should be thinking about the margin impact of that volume drop?

Dale Ganobsik (President of Investor Relations and Treasurer)

Yep. It's a great question. Overall, food service is two-thirds of our volume. You look at our factory costs, and there's a portion that's fixed. I don't want to get into specifics on that regard. As that volume goes down, there is a negative absorption impact to our margins in that we're not able to absorb as much cost out of the factories through cost of goods sold. It's very difficult to say what that impact will be right now because it's highly dependent on food service volumes. As Dave had mentioned, we saw the beginnings of the month being down considerably and some recovery towards the end of the month. I hesitate to give you kind of any specific numbers in terms of that impact, but it's something that we're monitoring.

Some of the things we're doing to manage the incremental costs is reducing temporary labor and overtime, the voluntary furlough program, or reducing hiring. We're also implementing other austerity measures to try to offset this potential impact.

Todd Brooks (Senior Analyst and Managing Director)

Not to give out any detail, but is there any kind of rule of thumb equation you can give us that a percent drop or maybe a 5% drop in food service equates to some type of drop at the operating margin line? That way, we will not know the components, but we can start to size.

Dave Ciesinski (CEO and President)

What I would say is because the situation is so dynamic right now, and we're taking a number of actions to try to minimize that impact, I don't want to put a specific number out right now. Certainly, as we get through this quarter, we'll have much better visibility and be able to share those impacts with you.

Todd Brooks (Senior Analyst and Managing Director)

Okay. Great. Thanks for the time.

Dave Ciesinski (CEO and President)

Of course. Thanks, Todd.

Operator (participant)

If there are no further questions, we will now turn the call back to Mr. Ciesinski for his concluding remarks.

Dave Ciesinski (CEO and President)

Thank you, Ursula. Thank you, everyone, for participating this morning. We look forward to sharing our fourth quarter results with you in August. In the meantime, we wish that each of you stay safe. Thank you.

Operator (participant)

Thank you. Thank you for participating in today's conference. You may now disconnect.