Good morning. My name is Michelle, and I will be your conference call facilitator for today. At this time, I would like to welcome everyone to the Lancaster Colony Corporation Fiscal Year 2021 Second 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 session. Now I would like to begin the conference call. Here is Dale Ganobsik, Vice President of Investor Relations for Lancaster Colony Corporation. Please go ahead.

Thanks, Dale, and good morning, everyone. It's a pleasure to be here with you today as we review our second quarter results for fiscal year 2021. I'd like to begin by extending a sincere and heartfelt thank you to the entire Lancaster Colony team for all their contributions and sacrifices during the past quarter. Despite the uncertainty and obstacles that the pandemic imposed upon our business, we are very pleased to report record sales and gross profit. Throughout the pandemic, we've remained steadfast that our mission is fixed. First, to provide for the health, safety and welfare of our teammates. And second, to ensure that we continue to play our role in our country's vital food supply chain. In our fiscal second quarter, which ended December 31, consolidated net sales grew 5.6% to a second quarter record $375 million. Net sales in the retail segment grew 19.5%, while net sales in our foodservice segment declined 9.7%. Excluding omni baking sales, consolidated net sales increased 7.3% and foodservice net sales declined 6.8%. Retail net sales benefited from higher demand as the impact of the pandemic drove higher at-home food consumption. The success of our licensing program also continued to drive retail sales growth with Olive Garden dressing, Chick-fil-A sauces and Buffalo Wild Wing sauces noted contributors.

Thanks, Dave. Overall, the results for the quarter exceeded our expectations. The stronger revenue growth in the Retail segment offset the higher costs we incurred due to the impact of COVID-19, allowing the company to drive improved bottom line performance.

Thanks, Tom. As we look ahead, Lancaster Colony will continue to leverage the combined strength of our team, our operating strategy and our balance sheet in support of the three simple pillars of our growth plan: to accelerate core business growth, to simplify our supply chain to reduce our cost and grow our margins, and to identify and execute complementary M&A to grow our core. In our fiscal third quarter, we expect net sales to benefit from continued growth from our licensing program and frozen and bread products. We remain very bullish regarding the future of Chick-fil-A sauces for our business. Shipments to retailers in Texas will start next week with distribution to 10 more states from Oklahoma to the Mid-Atlantic set to begin later this month. We expect to reach national distribution of Chick-fil-A sauces by the end of the fiscal year. The impacts of COVID-19 will remain a headwind for our manufacturing cost in our fiscal third quarter while commodities and trade expenses are projected to become increasingly inflationary. We expect our ongoing cost savings program and net new price realization efforts to help offset these higher costs. Our ERP initiative, Project Ascent, is progressing as planned. Earlier this month, we successfully executed Wave Zero, a limited launch of SAP, which included one factory as well as our corporate-wide master data. Thanks to the creativity and perseverance of the Project Ascent team, we remain on track for the larger Wave 1 launch to commence early in fiscal 2022. Specific to our supply chain strategy, as Tom mentioned, we are making a significant investment in production capacity to address the increasing demand for our dressing and sauce products. Here, again, thanks to the creativity and perseverance of the supply chain team, groundbreaking for this important project took place last month with a target completion time frame in the first quarter of fiscal year 2023.

Your first question comes from Ryan Bell from Consumer Edge. Your line is open.

The robust growth that you're seeing in retail has been providing an offset to the trends they've seen in foodservice. Would you like to talk a little bit more about your assumptions for what foodservice will look like when it's returning to growth? And how do you think about the balancing act now between foodservice returning to growth and some of the wins coming out of the retail sales growth story as there's less at-home consumption?

Sure. Well, if I may, maybe I'd start with a little context just in terms of the trends that we're seeing in the broader category in our business for both retail and foodservice. Maybe I'll start with retail first. If you look at all edible categories for all outlets during the handful of, let's say, probably the last four months, they're averaging — this would be our business and everybody else's in the universe out there — being up about 12.3%. If you look at our business, this is Lancaster Colony, for all of our outlets, we're averaging up about 19%. So this is consumption sort of pull-through the business. What I would share with you is, in about five to six weeks, we're going to begin to lap the very first of the effects of the coronavirus from last year. Now if we pivot and we look at the Foodservice business, and in this case, instead of IRI, we look at NPD Crest data, what we're seeing is that the entire restaurant universe, where this is 71 or 72 of the largest chains, are running in transaction totals down roughly 9% for that same period of time. QSRs are down in transactions more like 7.5%, mid-scale is down probably more like 35%, and casual is down more like 30%. If you look at our business here again, as I shared in my commentary, we're outperforming the foodservice averages as well. Now your bigger question that you asked is, so how do we think about this from a forecasting perspective? And honestly, this is a pretty difficult exercise just because of the uncertainty surrounding the pandemic. What we do know is we're going to begin to lap the impacts of COVID. And we can see on the calendar when that's going to be, like I said, that's probably about six weeks out, and it's going to be most severe in those first couple of weeks where we lap the stock up that took place in categories. And maybe you'll see it begin to sort of slow back down and normalize.

That was very detailed and helpful. And when we're thinking about some of the incremental costs that you've been having to bear as a result of COVID, I think you said it was like $3 million in soft costs, $1 million in hard costs. As you're looking out to a point where a critical percentage of your employees do get vaccinated, what type of that — what percentage of that cost or what the size of that cost that ends up getting removed on a permanent basis? And we've heard some firms providing financial incentives to their employees to get vaccinated. If you guys are doing that, would you be able to touch on the magnitude of that one-off cost?

Sure. Well, why don't we — maybe there's two parts to the question. There's the what, and then the how we're going to address it. And for the what, why don't I turn it over to Tom and let Tom dimensionalize the COVID cost in the period. And then maybe I'll talk briefly about how we're thinking about it on a go-forward basis. So Tom, I'll turn it over to you.

Yes. Thanks, Dave. So the components of the quarter, we had $4 million in Hero Pay and another $1 million in shift separations and PPE. That's what we call the hard cost. And that's really — I'll let Dave talk to the outlook on that, but those are really specific COVID costs. And then we have another $3 million in what we call our soft costs. And the way to think about those costs, those are really costs we're incurring because the network wasn't necessarily set up for this mix shift. So we're having to run more — less efficient lines, more overtime to keep up with the demand shift that we had. And in there, we've got increased overtime, unfavorable plant mix, transportation to move product around the network. So that's — so the total COVID impact is $5 million hard, $3 million soft. So I'll stop there and then let Dave share about how we're thinking about the outlook.

Yes. Thanks, Tom. So you guys are probably aware of this, so bear with me. The vaccine-driven strategy really operates in two tiers: first is availability, which is a function of what's happening at the federal level. And then each unique state is responsible for putting in place their implementation plan. So as we think about our 16 factories that operate in nine states, it's likely to be somewhat different between what we see in California and what we might see in New Jersey, where we have an important co-packer, or what we might see in Ohio. What I can share with you is we had an opportunity to talk to the governor yesterday here in Ohio, Governor DeWine, and he walked us through how he's thinking through his implementation plans. And essentially, what he and his team have focused on are frontline health care workers in hospital settings, and then moving to nursing homes where we had tragically a number of deaths, given the concentration of an older population in those residences. So he's made it a priority to work through those. And now what he's starting to expand out to are our other frontline workers and teachers and then work down just straight across the range, age-related vaccines. I think the plan was he indicated to expand it to people that are 65 and above starting next week. So if you think about our employee population, given that it tends to be younger and healthier, whether it's in the state of Ohio or in other states, our view is we're probably still a ways down the line in terms of when we can expect to see it. What we have begun to do internally though, is we — early on in the pandemic, engaged a pulmonologist and critical care physician. And along with this physician, we've developed a series of educational emails that we've been sending out to our employees to educate them about what is the vaccine, what are the side effects, why should we feel that it's safe for use, et cetera. So we've begun that education process. And the second thing that we're in the process of doing is planning how we can incentivize people to get the shot. And we're leaning towards creating a financial incentive of sorts for our employees, rather than something that's punitive. We feel much better about just a positive financial incentive for their safety and well-being. And we're working through that, and we'll probably be announcing something I would guess in the next handful of months as we start to get line of sight to when we would expect to see the vaccine. So if you sort of then come back, that brings me back to where I started and maybe to the earlier comments, that we think for all intents and purposes that we're going to have to be ready to deal with some of the challenging impacts of the pandemic without the vaccine through at least the third quarter and looking into the fourth quarter.

That was very helpful. And I think one last one for me. As you've commented on and as we've been seeing in the regional and state IRI data, the Chick-fil-A products are doing very well in retail. Can you think about how this has helped maybe facilitate conversations with other potential foodservice partnerships to bring products to retail?

Yes. No, it's a great question, and it's true. I think not only has the Chick-fil-A proposition catalyzed incremental conversations, but I would ladder back to the fact that if you look at Olive Garden, which is a five-plus year overnight success, in the most recent period, it was up actually 61%, which is eye-popping for a very big business. But I think you put the success of an Olive Garden proposition together with Buffalo Wild Wings and Chick-fil-A, what we're seeing is that, with passing days, more and more of our foodservice partners are reaching out just to have early discussions about the suitability of a license program. And what I'm particularly proud of in these cases is that these are not a zero-sum game that when we restructure these appropriately, it's a big win for our foodservice partners in terms of building branding and awareness. It's also an important source of incremental revenue as they're seeing the traffic in their core business impacted. And obviously, it's a chance for us to grow with them. So they're just a great proposition, and we're just trying to be deliberate. As we get the calls, we sit down in good faith with the new partners and just try to decide, is it truly going to be a good long-term fit for everybody or not?

Your next question will come from Brian Holland from D.A. Davidson & Company. Your line is open.

So just curious, you provided a few metrics there on Chick-fil-A penetration and repeat. Just curious, whether you want to go that way or look at it from a velocity standpoint, can you give us any context for how Chick-fil-A is performing versus its relevant competitors in some of those markets? Where do you sort of — maybe whether it's in the top quartile or whatever versus your peers?

Sure. No, happy to, Brian. And maybe starting with our penetration and repeat rate. This is early. So the most comprehensive source of data that we have is in Florida, where we look at that data, it's performing at and ahead of our own Olive Garden business, which has been sort of a benchmark that we've been tracking all along. So that gives us comfort that it's most certainly in line with our expectations, maybe with some room beyond that as well. But given that we're so early in this, we're a little bit hesitant to get out over our skis and really to commit to more, right? Velocity is another way to look at it. The velocity of the item has been really strong. It's been up there in the top of the condiments and sauces category, the top quartile. The only reason why we're a little bit hesitant on looking at just velocity is that we want to be careful that we're not overestimating the novelty effect of this. When somebody buys it once, they love it, but they may not come back. That's why we're looking at trial, we're looking at repeat and we're looking at velocity. But we can triangulate on all three of those metrics, and it's all very favorable across the board.

That's helpful. And then if I could move to the Horse Cave facility. That sounds like — that feels like a substantial investment that's not something that's done for $25 million of revenue or something like that. I'm wondering what — I mean, can you give us any perspective as to the revenue opportunity that could come out of that facility and how you're thinking about it? I think you said it comes online in 2023 is the expectation?

Correct. Yes. So first things first. Essentially, it's going to double the number of square feet that we have at that facility. Now that's not the only testing facility we have, but it's our largest. It's our flagship. And it's essentially going to double that. What I would point to also, Brian, is that this particular build isn't just going to include bottling lines, but it's going to include kitchens and then capacity for both foodservice and retail. If you remember, about a year ago, before the onset of the pandemic, we had announced plans for an expansion at Horse Cave, a little bit smaller project just to keep up with the growth of Chick-fil-A, particularly kitchen capacity and then additional capacity. That was in flight. We backed away from that. Then we rescoped the project to include that, plus bottling capacity. So it's a substantial investment. It's our biggest in terms of dollars that we've made, but I would prefer not to necessarily try to extrapolate for you how far into the future it's going to take us. We feel like it will comfortably provide capacity based on our growth for probably the next four to five years with the co-factors that we have in place.

Understood. You mentioned meal kits, Dave, briefly in your prepared remarks. For guidance, what are you doing there in that space?

It's a great question. So a number of the different meal kit companies have sauces or different protein builds. And the other thing that they're offering are salad and various sorts, and we've been working on both proprietary sauces for their protein builds, but also just proprietary or our own branded salad dressings for their meal kits.

Got it. Last one for me. So Dave, perhaps the widest divergence, I think, between the CPG industry and the investment community is the subject of pricing, right? I believe the market is often skeptical companies can sufficiently pass on higher cost when they need to pull that lever. So as we watch the commodities market today and contemplate whether food can manage an inflationary basket, I guess the backdrop really of like anything we've ever seen, would love to get your big picture perspective on how food companies like yourself are going to try to manage that and your level of confidence that you can get it through what you need?

Yes. Well, Brian, I would say for the industry, it's an executional imperative. If you look at it right now, I think we're in for a period of sustained inflation. It remains to be seen how strong that inflation is, but we're seeing it across our entire basket of commodities. We're seeing it in soybeans, we're seeing it in wheat, we're seeing it in other segments as well. We've seen inflation in the transportation space and packaging. And as you on the call can all appreciate, there's been so much money pumped into the economy that we feel like it's just inevitable that we're going to see inflation, which brings me back to the fact that for us at Lancaster Colony, and for that matter, our other peer companies, we're going to need to figure out how we can pull together the insights and just play appropriately to pass on these costs because we need to — I don't believe there's a path for us in the sector to cut cost to prosperity. Cost discipline needs to be an important part of what we do, but I think it becomes problematic if you can't at least just pass on the inflation that you see.

Your next question comes from Todd Brooks from CL King & Associates. Your line is open.

If we could maybe start on the gross margin side and the strong performance that you saw in the quarter. You've highlighted a lot of different puts and takes. So you've talked about the inflationary sides of the business. We've had a mix change in retail growth. There's obviously the undertones of continued cost saves and your net price realization gains. Can we walk through the puts and takes that drove the gross margin performance in the quarter?

Of course. Tom, why don't I turn that one over to you and let you take that.

Sure. So as I mentioned, the quarter exceeded our expectations. And I think, obviously, the key driver for us, as you compare it to Q1's performance, we had stronger growth in the retail segment, and that really enabled us to drive better gross profit performance. We also did ladder back the trade spending that we reduced in the face of higher demand. We did reduce trade spending, and that helped margins — that helped the revenue growth in the retail segment as well as the margins. Commodities and the cost savings programs weren't as big a driver this quarter. Certainly, we do expect commodity inflation to accelerate. And as we get into a post-COVID environment, you could expect to see a bigger impact of our cost savings programs. And certainly, the COVID costs I've outlined for you. So those were the key items. The things that we're keenly focused on, as Dave mentioned, we do expect going forward more commodity inflation. So we're certainly going to have to look at different ways to offset that as you get into the second half. And we've got a good effort in terms of identifying opportunities and then executing against them.

That's great. That's helpful. And then secondly, with the growth that you're seeing with existing programs, I just wanted to spend a few minutes talking strategically about how you're managing that growth. Are there opportunities that you're not necessarily delaying, but maybe not pursuing as aggressively either with additional foodservice partners or maybe with some of the newer distribution channels like Drug and Dollar, as you're managing the strong growth that you've got with the new product rollouts in retail?

Tom, I'll take maybe a first shot at that. It's a good question. As we've seen the strong demand and you look at Olive Garden as a case in point — mature business, great brand, seeing 61% growth in consumption and sales in the period — what that is forcing us to do, obviously, is continue to work hard just to make sure that we have available capacity. The way that we're managing that is by pulling back on trade promotions in various categories. As Tom mentioned in his comments, we also made the choice to pull back on some of our advertising. Internally, we felt that it didn't make sense to advertise the prior promotions when we're in the middle of the sell-through. People are buying the products. We don't need to advertise them. And it's a compounding problem. The more we advertise those things, and if we don't meet service requirements for our customers, we incur penalties, right? So it's sort of a double whammy. So we have churned sales in terms of promotion activities and marketing. Obviously, we mentioned in earlier calls how we're working with co-packers. And so as we sort of round our way out of COVID and we see things start to normalize, we would expect to resume levels of marketing spend, put back in place profitable promotion strategies. But one of the other things we can start to do is get more aggressive with just expansion into other channels, which we've just tapped the brakes on a little bit as well because we just didn't want to get ourselves in a situation where because of our own actions, we're driving service issues, disappointing our customers and incurring penalties and fines for that poor service.

That's great. And then a final question, if I may. If you think about the trial that a lot of your brands in retail saw during pantry loading and then just the elevated demand that we've seen during the pandemic, you talk about, okay, we're pulling back on some trade promotions and advertising. But what does your data show as far as new-to-brand customers? How were you able to activate them? How have they been from a repeat standpoint? And as we're thinking about lapping some of the tougher compares during pantry load, how important are these new customers that you've been able to retain in being able to successfully lap that?

Yes, it's a great question. And what I will tell you is our retail team has narrowed their marketing focus on that problem specifically to take those new triers and to get them to try again and to try again. And so far, we've seen a fair amount of success doing that. So we've taken and focused a lot on the tools in retail that will allow us to do specifically that and we're optimistic that we're going to be able to hang on to some of those consumers. What we're going to see, and this is industry-wide, is sort of a regression to the mean, where people begin to go back to their normal patterns in terms of when they eat away from home and what they're eating at home. And we know inevitably, we're going to see the number of occasions in the home start to revert back to the mean. Our hope in that process is, even though the number of occasions go down, we can hold on to a disproportionate share of those new triers in those occasions.

Just to add, as Dave mentioned, as we get further into the year, we do expect to restore spending in both the trade line and the consumer line to try to continue to maintain those customers in the full.

Okay. Great. I got to have one more final one. When I look at the segment operating margins for the retail, north of 27% in the quarter — a tremendous result. Can we talk — how much is kind of mix with the licensed products working in versus this lower promotional level that we're seeing? Because like you said, they're buying products anyway?

Right. So Tom, why don't I let you take a shot at that?

Sure. So the mix was certainly the overall growth in the performance was the key driver of that margin expansion. The trade spending reduction was secondary to that. So those were your key items. And as we said before, the licensing program, which was a good part of the growth in the retail segment, those products are at or above the overall margins of the segment. So that's going to be the key driver. And as we progress into the back half, as Dave mentioned, as we expand Chick-fil-A sauce, we expect that to continue to be a tailwind for us as we start to hit the more difficult comps towards the end of Q3 and in Q4.

And that may be just a point where it's hiding again as we think about sort of our outlook across Q3 and into Q4, as we begin to lap the impacts of COVID, that's going to create a natural headwind in our retail business. But at the same time that that's happening, as you heard in my comments, we're shipping into Texas this week. And then next week, we're going to begin shipping into a handful of more states. I think it's 10 more states in the Mid-Atlantic, Oklahoma and sweeping back towards the east. We're going to stay in that posture until we build out distribution and then around the fourth quarter beginning, begin to expand through the remainder of the United States, up in the Northeast and then the Far West. It's those activities that we think, as we lap the effects of COVID in retail, that are going to allow us to continue to outperform.

I have no further questions in queue. I now turn the call over to Mr. Ciesinski for closing remarks.

All right. Michelle, thank you, and thank you, everyone, for participating this morning. We look forward to sharing our third quarter results with you in early May. Have a great rest of the day.

Thank you, everyone. This will conclude today's conference call. You may now disconnect.