Marzetti Co Q1 FY2022 Earnings Call

Hi, good morning, and sorry for the delay. Thank you, everyone, for joining us today for Lancaster Colony's Fiscal Year 2022 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 on our company's website, lancastercolony.com, later this afternoon. For today's call, Dave Ciesinski, our President and CEO, will begin with the 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 current outlook and strategy. At the conclusion of the 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?

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 2022. I'd like to begin by expressing my sincere and heartfelt thanks to everyone here at Lancaster Colony for their tremendous efforts and ongoing commitment to servicing our customers and growing our business. In our first fiscal quarter, ended September 30, consolidated net sales grew 12.3% to a record $392 million. Net sales in our Retail segment grew 15.6%, while net sales in our Foodservice segment advanced 8.1%. As expected, we experienced significant cost inflation during the quarter that reduced our profit before our pricing initiatives took full effect. The 15.6% growth in Retail net sales compares to a strong first quarter last year, when Retail net sales grew 16.6%, as the impacts of COVID-19 drove increased at-home food consumption. Retail sales growth in this year's first fiscal quarter was driven by our licensing program, led by Chick-fil-A sauces and Buffalo Wild Wings sauces. Sales for those product lines combined account for nearly 13 percentage points of growth for the Retail segment in the quarter. IRI scanner data for the 13-week period ending September 26 showed total U.S. retail sales of Chick-fil-A sauces at $35.1 million and sales of Buffalo Wild Wings sauces at $13 million. Olive Garden dressings remain another bright spot in our licensing program as it continues to gain market share in the $2.1 billion shelf-stable dressing category. Per IRI, Olive Garden dressings grew its category share to 6.3% during the quarter. With respect to our own brands, per IRI data for the 13-week period ending September 26, highlights included a 450 basis point pickup in market share for our New York Bakery brand in the frozen garlic bread category. In our Foodservice segment, excluding Omni Baking sales attributed to a temporary supply agreement that ended October 31 last year, net sales increased 10.1%. The increase in net sales was driven by inflationary pricing and volume growth for our branded foodservice products. Excluding inflationary pricing, sales volumes to our national chain restaurant customers were similar to last year. Foodservice operators industry-wide are facing the challenges of a tight labor market, product supply issues, and rising costs. NPD CREST data for the U.S. foodservice industry shows weekly transactions for the quarter ending September 30 were pacing ahead of last year through mid-August, and then fell slightly below prior year levels for the remainder of the quarter. I'll now turn the call over to Tom Pigott, our CFO, for his commentary on our first quarter financial results. Tom?

Thanks, Dave. Overall, the results for the quarter reflected strong top-line performance, as well as significant inflationary cost impacts. First quarter consolidated net sales increased by 12.3% to $392.1 million. This growth was driven by consolidated volume growth of approximately 5%, pricing primarily in our Foodservice segment, and favorable revenue mix. Consolidated gross profit decreased by $300,000 to $92.4 million. Gross profit benefited from the volume and pricing actions. These benefits were offset by a significant amount of commodity inflation. Our raw material costs were up in the mid-teens on a percentage basis. This commodity inflation in excess of our pricing was the primary driver of the 290 basis point gross margin decline we reported in the quarter. As we have shared, our planned retail pricing will be fully reflected in the second quarter. In addition, our Foodservice pricing lagged the commodity increases during the quarter. Beyond the significant commodity inflation, we incurred higher co-manufacturing cost as we outsourced additional production to meet our growing demand, as well as higher freight and warehousing costs and labor inflation. These increases were partially offset by reduced costs related to COVID-19 and our productivity initiatives. Selling, general, and administrative expenses increased $3.7 million or 7.6%. The largest driver of the increase was Project Ascent, which was up $1.1 million. Other increases included investments in personnel and business initiatives to support growth. Consolidated operating income declined $8.4 million or 17.2% versus the prior year quarter to $40.5 million. The main driver of the reported operating income decline was the prior year's net $4.5 million benefit for the special items related to the Bantam Bagels business. These items included a $5.7 million favorable reduction in contingent consideration and a $1.2 million intangible asset impairment charge as specified on our income statement. Excluding these items, our operating income was lower due to the modest gross profit decline and the increase in SG&A expenses. Our effective tax rate was 24.4% this quarter versus a tax rate of 24.3% in the first quarter of fiscal 2021. We estimate the tax rate for fiscal 2022 to be 24%. First quarter diluted earnings per share decreased $0.24 to $1.11. The decrease was primarily driven by the prior year favorable impact of the Bantam special items I mentioned previously. These items benefited prior year EPS by $0.13 a share. In addition, costs related to Project Ascent reduced this quarter’s EPS growth by $0.03 per share; the remainder of the decline related to the underlying performance of the business. With regard to capital expenditures, first quarter payments for property additions totaled $30.2 million. For our fiscal year 2022, we are forecasting total capital expenditures between $170 million and $190 million. This forecast includes approximately $105 million for the Horse Cave expansion project that will help us meet the increasing demand for our dressings and sauce products. In addition to investing in our business, we also returned funds to shareholders. Our quarterly cash dividend of $0.75 per share paid on September 30 represented a 7% increase from the prior year amount. Our enduring streak of annual dividend increases currently stands at 58 years. Even with the investments we're making and the increased dividend payments, our financial position remains very strong as we finished the quarter debt-free with $130 million of cash on the balance sheet. To wrap up my commentary, this quarter featured strong top-line growth and significant inflationary impacts in advance of our full pricing actions. We continue to monitor and adjust for the inflationary cost increases we are forecasting this year while investing in the long-term potential of the business. I'll now turn it back over to Dave for his closing remarks. Thank you.

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: number one, to accelerate our core business growth; number two, to simplify our supply chain to reduce our costs and grow our margins; and number three, to identify and execute complementary M&A to grow our core. In our fiscal second quarter, we expect our licensing program to remain an important source of growth in the Retail segment. Our Foodservice segment should continue to benefit from higher demand for our foodservice products and growth from select QSR and pizza chain customers. We anticipate the inflationary environment will continue as we face higher commodity costs, particularly for soybean oil, along with increased costs for packaging, freight and labor. Inflationary pricing, including retail segment pricing actions that took effect near the end of our first fiscal quarter, combined with additional pricing in the Foodservice segment will help to partially offset the input cost inflation. Our ongoing cost savings programs and other net price realization efforts will also serve to reduce the unfavorable impacts of inflation in the quarter. Note that our projected financial results and expectations remain subject to the impacts of COVID-19 including shifts in consumer demand between the retail and foodservice channels, industry-wide supply chain challenges and inefficiencies, and higher costs to produce our products and service our customers. Moving on to our supply chain strategy, our significant investment in production capacity at our dressing and sauce facility in Horse Cave, Kentucky, is progressing as planned with a target completion timeframe in the first quarter of fiscal year 2023. Given the strong growth we are experiencing across our portfolio of products, we are continuing to evaluate other alternatives to add production capacity and grow our manufacturing footprint. Finally, consistent with the update that we shared with you in our fourth quarter earnings results back in August, the implementation phase of our ERP project, Project Ascent, is scheduled to begin in the first quarter of fiscal year 2023. This concludes our prepared remarks for today, and we'd be happy to answer any questions you may have. Cheryl?

The first question is from Ryan Bell of Consumer Edge Research. Please go ahead.

Good morning, everyone.

Hi, Ryan. Good morning.

With respect to the top-line growth in the Retail business and we're continuing to see strength driven by your Chick-fil-A partnership, it appears there is room for that to continue growing throughout fiscal 2022. How are you thinking about the growth prospects of the national launch last year, and specifically the months where it had been nationally distributed already?

Yes, absolutely, Ryan. If you go back and look at the scanner data sales, Q4 of last fiscal year was about $38 million, Q1 of this quarter scanner data was about $35 million. I think what you're likely to see is sequential growth as we continue through at least the next several quarters. When we get into Q4, we're probably going to be close to a pause, because, as you're well aware, right now we're constrained on capacity. This is just on Chick-fil-A sauce that I'm talking about. We're constrained on capacity. More broadly, across the retail channel, we expect to see continued sequential growth throughout the year. As we finish this fiscal year and continue this growth, there are several things that will start to open up as we get into the next fiscal year. First, we're bringing online incremental bottling capacity that will allow us to take the product off allocation with our customers and allow them to merchandize the item in ways you would other items in a grocery store. That capacity will also allow us to bring to market new flavors and new sizes, and these are discussions that are actively underway with our partner at Chick-fil-A. We'll be excited to share more news about that with you in the forthcoming quarter. We're excited to see how this product is performing. We continue to see strong results in terms of trial and repeat, and we believe there is significant upside for this brand proposition.

Thanks, that's helpful. And then it seems largely the biggest thing holding you back is just capacity. As we're thinking about potentially other opportunities within foodservice partnerships at retail, how would you think about that playing out?

That's a great question. The way we're looking at this is almost like how you would look at inorganic growth. Our company, like others, is constantly looking at acquisition opportunities, and we think of that in terms of a pipeline. We take that same approach to licensing. We apply the same thinking: start with expanding with existing partners, then look at new partners. When we bring that capacity online, it will give us the opportunity to bring on new partners, potentially in some categories. I'm not in a position to share specifics right now, but we have a number of things underway and look forward to sharing more in due course.

Thanks. In terms of the Project Ascent costs, could you provide any details regarding the expected magnitude of those costs over the coming quarters? And a bit more detail on your decision to shift the implementation out until 2023?

Yes. What I would tell you is next quarter is going to be approximately on par with where we were in this quarter. You can expect to see probably a very marginal uptick in Q3 and Q4 as we get ready for the final push and go-live in Q4, and then you can expect to see those costs start to wind down into fiscal year 2023. The reason they're essentially flat from this quarter into the next is that at this point we are preparing. As we cross over into the next calendar year, our Q3 and Q4 will involve very intensive training and getting employees ready to take the product live. These are expenses that flow through the P&L and cannot be capitalized. The first wave we're bringing live is the back office of the business: order to cash, procure-to-pay, and trade spending. We're also bringing online our frozen systems and a couple of factories. In subsequent waves, the scope of the implementation will start to wind down and we'll bring factories online several at a time until the project completes, which we expect to wind down through the end of 2023. As to why we deferred the project and aligned it with the fiscal year, there are a couple of reasons. We stepped back and prioritized our business: first and foremost, servicing our key strategic customers, namely our Foodservice customers, such as Darden Restaurants, Olive Garden, Chipotle, Buffalo Wild Wings, and others. In many cases, we are the sole supplier for menu items. We did not want to put them in a situation where we're not able to deliver, which could severely impact their business. Given the external complexities we observed during planning, we elected to push it out to ensure we can build up inventory and execute safely. If you look at our inventory, part of the rebound is driven by inflation, but part is driven by carrying more inventory as a buffer to ensure we can service our business now and when we go live. That decision was driven by our desire to nail the implementation for our company and our shareholders, and to ensure we can adequately support our strategic partners.

Thanks. Where in your business are you seeing the largest inflationary pressures? As we're thinking about gross margins through the balance of the year, I know you don't provide guidance, but any color on the moving pieces would be helpful. Also, with Foodservice coming back and Retail running strongly, how might those shifts impact gross margins?

Thanks, Ryan. Overall, we saw commodity inflation in the quarter in the mid-teens. The most pronounced impact for us was soybean oil, where costs are close to double. That impacts both segments. In this particular quarter, we saw more of an impact in the Foodservice P&L as our pricing lagged the commodities, and you can see that in the Foodservice results we reported. Going forward, as we shared on the retail side, we will get the full impact of the first round of retail pricing fully reflected in Q2, as well as a catch-up on Foodservice pricing, which will improve our margins versus the declines reported this quarter. Looking forward, we model PNOC and forecast commodities closely and run multiple scenarios. Over time, our goal is to offset these commodity impacts through pricing, trade reductions, and other revenue realization approaches.

Thanks. As we're looking at some of the Foodservice trends that continue to see improvement, how much hasn't really recovered due to COVID yet? You noted some NPD trends in your prepared remarks, but could you go into more detail about the industry-level trends you're seeing in Foodservice, and how you think about potential for sequential improvement continuing?

I'll take that. It's an interesting quarter. If you look at where the quarter began in July, transaction data was actually strong, running in the low-to-mid single-digit range for various outlets, principally QSR on a consolidated basis. As we got towards mid-August, transaction data started to pull back and went slightly negative, roughly down 1%, and it stayed slightly negative through the remainder of the quarter. Some segments, like midscale, continued to perform well through the whole quarter, though they were comping against a very difficult prior year. The center of gravity of Foodservice is QSR and casual dining, principally QSR. The story to watch is that we started the quarter in the mid-single-digit positive range for transactions, and then it flipped slightly negative, so on a 13-week basis transactions were basically flat. We believe operators are wrestling with labor, and as a consequence they're curtailing hours of operation and, in some cases, days of operation, which translates into fewer transactions. Sales data can mask that because operators are passing through price increases, but volumes through their systems are modestly down. Looking across the remainder of our fiscal year, we will be lapping some softer comps which helps, but performance will depend on how well operators can staff and run their operations. I wouldn't expect a material pullback in hours and operations from current levels, but operators are making triage decisions: limiting menu items to reduce complexity, limiting hours to manage complexity, and in some QSR cases closing dining rooms and focusing on drive-through or takeout. We see line of sight to continued growth given soft comps, and it's a business we believe in, but the challenges for operators are manifest and real.

Thanks. Then in terms of capital allocation priorities for fiscal 2022, any details or thoughts on M&A or additional capital expenditures to support the demand you're seeing within the Retail business?

Yes, Ryan, that's an excellent question. As we've shared this year, we'll be spending between $170 million and $190 million, with a heavy spend behind the Horse Cave expansion project. Today we are looking at a number of growth scenarios and, as it relates to capital allocation, position one is supporting that growth. We're evaluating potential greenfield and brownfield expansions, as well as potential acquisitions of existing dressings and sauce businesses to support robust growth. Beyond that, we do think about M&A, but our short-term focus is to support existing demand, continue the growth of the licensing platform with our capital allocation, implement the ERP system, and then consider other alternatives to continue to support our growth.

Thanks. That's it for me.

All right, thank you, Ryan. If there are any other questions, I want to thank each of you for joining this morning. We look forward to getting together on the call when we share our second quarter updates. In the meantime, I hope you have a happy, safe, and productive fall.

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